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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1998.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OR THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from
Commission File Number 0-23299
BAY BANCSHARES, INC.
(Name of small business issuer in its charter)
TEXAS 76-0046244
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1001 HIGHWAY 146 SOUTH
LA PORTE, TEXAS 77571
(Address of principal executive offices)
(Zip Code)
(281) 471-4400
(Issuer's telephone number, including area code)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, par value $1.00 per share
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
Issuer's revenues as of December 31, 1998: $23,787,000
Aggregate market value of the voting stock held by non-affiliates computed
by reference to the price at which the stock was sold, or the average bid and
asked prices of such stock, as of a specified date within the past 60 days:
$14,482,000.
As of March 15, 1999, the number of outstanding shares of Common Stock was
1,995,603.
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III Items 9, 10, 11 and 12 will be
included in the Company's Proxy Statement for the 1999 Annual Meeting of
Shareholders to be filed pursuant to Regulation 14A of the Securities Exchange
Act of 1934, as amended, and is incorporated herein by reference.
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TABLE OF CONTENTS
Page
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PART I
ITEM 1 - Description of Business .......................................... 2
ITEM 2 - Description of Property .......................................... 12
ITEM 3 - Legal Proceedings ................................................ 13
ITEM 4 - Submission of Matters to a Vote of Security Holders .............. 13
PART II
ITEM 5 - Market for Common Equity and Related Stockholder Matters ......... 13
ITEM 6 - Management's Discussion and Analysis or Plan of Operations ....... 15
ITEM 7 - Financial Statements ............................................. 36
ITEM 8 - Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure ........................................ 36
PART III
ITEM 9 - Directors, Executive Officers, Promoters and Control Persons:
Compliance With Section 16(a) of the Exchange Act .............. 36
ITEM 10 - Executive Compensation .......................................... 36
ITEM 11 - Security Ownership of Certain Beneficial Owners and Management .. 36
ITEM 12 - Certain Relationships and Related Transactions .................. 37
ITEM 13 - Exhibits and Reports on Form 8-K ................................ 37
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PART I
ITEM 1. - DESCRIPTION OF BUSINESS
HISTORY
Bay Bancshares, Inc. (the "Company") was incorporated as a business
corporation in 1982 under the laws of the State of Texas to be a multi-bank
holding company for Bayshore National Bank (the "Bank"), which was chartered in
1965, and for Bayport National Bank, which was chartered in 1979. The two banks
merged in 1985 in conjunction with a change in Texas branching laws. In 1991,
the Company began to expand its operations, diversify its lending base and seek
additional deposits by assuming the deposits of Liberty County Federal Savings
and Loan Association and Bayshore Federal Savings and Loan, which added branch
locations in the cities of Liberty, Cleveland, and Seabrook, Texas. In 1994, the
Company established a new branch in Pasadena, Texas. In 1996, the Company
assumed the deposits of the Cleveland branch of a commercial bank and opened two
Loan Production Offices ("LPOs") in Houston. In the fourth quarter of 1997, the
Company successfully completed an initial public offering of 690,000 shares of
common stock and consummated the planned acquisitions of Texas Bank, Baytown,
Texas ("Texas Bank"), Texas National Bank of Baytown, Texas ("TNB") and First
Bank of Deer Park, Texas ("First Bank")(collectively, the "1997 Acquisitions").
The Company currently serves its communities from its headquarters in
La Porte and ten full-service banking office locations in La Porte, Liberty,
Cleveland, Seabrook, Pasadena, Baytown, Deer Park and Mont Belvieu, Texas.
Additionally, the Company operates three LPOs in Houston.
BUSINESS
The Company's commitment to being the premier provider of financial
services in the eastern portion of the greater Houston metropolitan area is
reflected in the types of products and services that it makes available to its
business and retail customers. The Company offers a wide variety of lending
products, including term loans, lines of credit and fixed asset loans to small
and medium-sized businesses, and offers consumers automobile, home improvement
and personal loans. In addition, the Company has developed expertise in the
following:
o INDIRECT LENDING - In 1988, the Company initiated a program of purchasing
indirect loans from automobile dealers. The Company purchases almost
exclusively "A"-rated loans from a select list of dealers after performing
its own analysis of the loan application. At December 31, 1998, the
Company's loan portfolio held a total of $65.1 million or 37.94% of
outstanding loans in indirect loans with an associated delinquency ratio of
0.46%. Senior management of the Company has extensive experience in
indirect automobile financing as well as consumer lending in general.
Because of increasing competition and accompanying pressure on yields
in the indirect market, management has shifted its focus to other lending
products, as described below. The Company does not intend to exit the indirect
business, but rather to grow other areas in order to further diversify its
lending risk.
o COMMERCIAL LENDING/REAL ESTATE LENDING - The Company's primary market is
located in the heart of the eastern Harris County manufacturing and
petrochemical district. While the Company has no extensions of credit to
oil production or exploration concerns and historically has not pursued
this line of business, the Company has gained an expertise in fulfilling
the banking needs of the businesses that service this industry. Maintaining
a reasonably diverse commercial customer base, the Company offers real
estate financing for owner-occupied businesses, lines of credit, working
capital, equipment and inventory financing. At December 31, 1998, the
Company's loan portfolio held a total of $76.6 million or 44.64% of
outstanding loans in commercial and real estate loans excluding factored
receivables and commercial Small Business Administration ("SBA") loans.
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o SBA LENDING - The Bank is a Preferred Lender under the federally
guaranteed SBA lending program. Under this program, the Bank originates and
funds SBA 7-A and 504 chapter loans qualifying for federal guarantees of
75% to 90% of principal and accrued interest. The guaranteed portion of
these loans is generally sold into the secondary market with servicing
retained. At December 31, 1998, the Company's loan portfolio held a total
of $7.3 million or 4.25% of outstanding loans in the retained portion of
SBA commercial and real estate loans. The Company uses its three LPOs which
are located in the City of Houston to generate SBA loans.
o MORTGAGE LENDING DIVISION - In 1997, the Company launched the Mortgage
Lending Division, which is comprised of two departments; the Construction
Department and the Retail Department. The Construction Department provides
financing to build new homes for builders and individuals in established
subdivisions. All construction loans are funded as work is completed and
have a maturity of six to 12 months. The Retail Department originates
long-term (permanent) financing for individuals and families for terms of
ten to 30 years and then immediately sells them in the secondary market,
which generates loan fee income. The financing can be for the purchase or
refinancing of a homestead or investment property. All types of plans are
available including conventional, FHA and VA loans that include fixed rate,
six month to ten year adjustable rate mortgages, LIBOR, limited
documentation, no income and no ratio loans.
The Company funds its lending activities primarily from its core
deposit base. These deposits are gathered from the local market with no material
portion dependent upon any one person, entity or industry. The Company also
pursues public deposits from entities such as schools, cities and colleges. The
Company has developed an ability to compete with regional banks for public
deposits through competitive pricing and developing continuing relationships
based on service with the individuals responsible for the administration or
selection of financial institutions to hold these funds.
The Company has enhanced its relationship banking capabilities with its
most profitable customers by marketing individually to the top 5% of its
customer base (Tier 1 accounts) and the next 10% of its customer base (Tier 2
accounts). The Tier 1 customers are provided with a pass key which enables them
to enter the Bank through a private entrance before and after normal banking
hours and are assigned a specific Bank officer to service their banking needs.
Each Tier 1 and Tier 2 customer is personally contacted a minimum of eight times
per year by an assigned officer.
The Company builds customer loyalty through exceptional service levels,
a wide variety of products and responsive local decision making. To complement
its traditional banking products, the Company endeavors to be a full financial
services organization by continuing to develop and enhance additional financial
services. The Company currently employs five full-time investment brokers
offering various alternative investments such as annuity and mutual fund
products. Additionally, the Bank established an insurance subsidiary, BayBanc
Independent Insurance Agency, Inc. ("BBIIA") which was granted a license to sell
both life insurance and property and casualty insurance by the Texas Department
of Insurance in January 1998. The Company also established a direct affiliation
with Bayshore Insurance Agency ("BIA") which became operational in June 1998
with the acquisition of a long-standing profitable insurance operation in the La
Porte, Texas community. The Bank has agreed to provide lease space, data
processing, clerical, payroll and other related fee-based services to BIA.
During 1998, the Company increased its commitment to technology by
purchasing and converting to an advanced line of core software and installing
new communication technology into its branch network and communication systems.
The Company completed conversion of the new core software in late March 1998.
The Company believes that its new technology will allow it to compete
effectively with any super-regional or national banking organization with
respect to communications and electronic convenience to the customer. Not only
does the new technology allow the Company to compete effectively but it promotes
a higher level of community banking service and added technological
efficiencies. In September 1998, the Bank's virtual banking site "Click Bank!SM"
went online, offering a convenient alternative to traditional banking. Among
other capabilities, this virtual banking site offers the retail customer 24 hour
access to account activity and the ability to view check images and to conduct
banking transactions. In November
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1998, the Bank introduced the "Navigator Series", a comprehensive Internet-based
treasury management program which offers an array of commercial banking products
and services allowing the commercial customer to manage cash, investments and
general account activity. The new communications network has enhanced the
Company's call center by enabling highly trained personnel to focus on both
inbound and outbound sales calling efforts.
COMPETITION
The banking business is highly competitive, and the profitability of
the Company depends principally upon the Company's ability to compete in the
market areas in which its banking operations are located. The Company competes
with other commercial banks, savings banks, savings and loan associations,
credit unions, finance companies, mutual funds, insurance companies, brokerage
and investment banking firms, asset-based non-bank lenders and certain other
nonfinancial institutions, including retail stores which may maintain their own
credit programs and certain governmental organizations which may offer more
favorable financing than the Company. Many of such competitors may have greater
financial and other resources than the Company. The Company has been able to
compete effectively with other financial institutions by emphasizing customer
service, technology and local office decision-making, by establishing long term
customer relationships and building customer loyalty, and by providing products
and services designed to address the specific needs of its customers. Although
the Company has been able to compete effectively in the past, no assurances may
be given that the Company will continue to be able to compete effectively in the
future. Various legislative acts in recent years have led to increased
competition among financial institutions. There can be no assurance that the
United States Congress or the Texas Legislature will not enact legislation that
may further increase competitive pressures on the Company. Competition from both
financial and nonfinancial institutions is expected to continue.
The Company's strategy is to compete effectively not just with other
commercial banks but with a variety of providers of financial services by
providing a responsive blend of relationship banking and a full line of
financial service products, including a full line of brokerage and insurance
products. The Company continually looks for additional acquisitions and
branching opportunities to enhance its retail delivery systems throughout the
greater Houston metropolitan area.
SUPERVISION AND REGULATION
The supervision and regulation of bank holding companies and their
subsidiaries is intended primarily for the protection of depositors, the deposit
insurance funds of the Federal Deposit Insurance Corporation ("FDIC") and the
banking system as a whole, and not for the protection of the bank holding
company shareholders or creditors. The banking agencies have broad enforcement
power over bank holding companies and banks including the power to impose
substantial fines and other penalties for violations of laws and regulations.
The following description summarizes some of the laws to which the
Company and the Bank are subject. References herein to applicable statutes and
regulations are brief summaries thereof, do not purport to be complete, and are
qualified in their entirety by reference to such statutes and regulations.
THE COMPANY. The Company is a bank holding company registered under the
Bank Holding Company Act of 1956, as amended ("BHCA"), and it is subject to
supervision, regulation and examination by the Board of Governors of the Federal
Reserve System ("Federal Reserve"). The BHCA and other federal laws subject bank
holding companies to particular restrictions on the types of activities in which
they may engage, and to a range of supervisory requirements and activities,
including regulatory enforcement actions for violations of laws and regulations.
REGULATORY RESTRICTIONS ON DIVIDENDS; SOURCE OF STRENGTH. It is the
policy of the Federal Reserve that bank holding companies should pay cash
dividends on common stock only out of income available over the past year and
only if prospective earnings retention is consistent with the organization's
expected future needs and financial condition. The policy provides that bank
holding companies should not maintain a level
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of cash dividends that undermines the bank holding company's ability to serve as
a source of strength to its banking subsidiaries.
Under Federal Reserve policy, a bank holding company is expected to act
as a source of financial strength to each of its banking subsidiaries and commit
resources to their support. Such support may be required at times when, absent
this Federal Reserve policy, a holding company may not be inclined to provide
it. As discussed below, a bank holding company in certain circumstances could be
required to guarantee the capital plan of an undercapitalized banking
subsidiary.
In the event of a bank holding company's bankruptcy under Chapter 11 of
the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is
required to cure immediately any deficit under any commitment by the debtor
holding company to any of the federal banking agencies to maintain the capital
of an insured depository institution, and any claim for breach of such
obligation will generally have priority over most other unsecured claims.
ACTIVITIES "CLOSELY RELATED" TO BANKING. The BHCA prohibits a bank
holding company, with certain limited exceptions, from acquiring direct or
indirect ownership or control of any voting shares of any company which is not a
bank or from engaging in any activities other than those of banking, managing or
controlling banks and certain other subsidiaries, or furnishing services to or
performing services for its subsidiaries. One principal exception to these
prohibitions allows the acquisition of interests in companies whose activities
are found by the Federal Reserve, by order or regulation, to be so closely
related to banking or managing or controlling banks, as to be a proper incident
thereto. Some of the activities that have been determined by regulation to be
closely related to banking are making or servicing loans, performing certain
data processing services, acting as an investment or financial advisor to
certain investment trusts and investment companies, and providing securities
brokerage services. Other activities approved by the Federal Reserve include
consumer financial counseling, tax planning and tax preparation, futures and
options advisory services, check guaranty services, collection agency and credit
bureau services, and personal property appraisals. In approving acquisitions by
bank holding companies of companies engaged in banking-related activities, the
Federal Reserve considers a number of factors, and weighs the expected benefits
to the public (such as greater convenience and increased competition or gains
inefficiency) against the risks of possible adverse effects (such as undue
concentration of resources, decreased or unfair competition, conflicts of
interest, or unsound banking practices). The Federal Reserve is also empowered
to differentiate between activities commenced de novo and activities commenced
through acquisition of a going concern.
SECURITIES ACTIVITIES. The Federal Reserve has approved applications by
bank holding companies to engage, through nonbank subsidiaries, in certain
securities-related activities (underwriting of municipal revenue bonds,
commercial paper, consumer receivable-related securities and one-to-four family
mortgage-backed securities), provided that the affiliates would not be
"principally engaged" in such activities for purposes of Section 20 of the
Glass-Steagall Act. In limited situations, holding companies may be able to use
such subsidiaries to underwrite and deal in corporate debt and equity
securities.
SAFE AND SOUND BANKING PRACTICES. Bank holding companies are not
permitted to engage in unsafe and unsound banking practices. The Federal
Reserve's Regulation Y, for example, generally requires a holding company to
give the Federal Reserve prior notice of any redemption or repurchase of its own
equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding year, is
equal to 10% or more of the company's consolidated net worth. The Federal
Reserve may oppose the transaction if it believes that the transaction would
constitute an unsafe or unsound practice or would violate any law or regulation.
Depending upon the circumstances, the Federal Reserve could take the position
that paying a dividend would constitute an unsafe or unsound banking practice.
The Federal Reserve has broad authority to prohibit activities of bank
holding companies and their nonbanking subsidiaries which represent unsafe and
unsound banking practices or which constitute violations of laws or regulations,
and can assess civil money penalties for certain activities conducted on a
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knowing and reckless basis, if those activities caused a substantial loss to a
depository institution. The penalties can be as high as $1 million for each day
the activity continues.
ANTI-TYING RESTRICTIONS. Bank holding companies and their affiliates
are prohibited from tying the provision of certain services, such as extensions
of credit, to other services offered by a holding company or its affiliates.
CAPITAL ADEQUACY REQUIREMENTS. The Federal Reserve has adopted a system
using risk-based capital guidelines to evaluate the capital adequacy of bank
holding companies. Under the guidelines, specific categories of assets are
assigned different risk weights, based generally on the perceived credit risk of
the asset. These risk weights are multiplied by corresponding asset balances to
determine a "risk-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2
capital. As of December 31, 1998, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 9.72% and its ratio of total capital to total
risk-weighted assets was 10.72%. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OR
PLAN OF OPERATIONS."
In addition to the risk-based capital guidelines, the Federal Reserve
uses a leverage ratio as an additional tool to evaluate the capital adequacy of
bank holding companies. The leverage ratio is a company's Tier 1 capital divided
by its average total consolidated assets. Certain highly-rated bank holding
companies may maintain a minimum leverage ratio of 3.0%, but other bank holding
companies may be required to maintain a leverage ratio of up to 200 basis points
above the regulatory minimum. As of December 31, 1998, the Company's leverage
ratio was 6.84%.
The federal banking agencies' risk-based and leverage ratios are
minimum supervisory ratios generally applicable to banking organizations that
meet certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Federal Reserve guidelines also provide that banking organizations experiencing
internal growth or making acquisitions will be expected to maintain strong
capital positions substantially above the minimum supervisory levels, without
significant reliance on intangible assets.
IMPOSITION OF LIABILITY FOR UNDERCAPITALIZED SUBSIDIARIES. Bank
regulators are required to take "prompt corrective action" to resolve problems
associated with insured depository institutions whose capital declines below
certain levels. In the event an institution becomes "undercapitalized," it must
submit a capital restoration plan. The capital restoration plan will not be
accepted by the regulators unless each company having control of the
undercapitalized institution guarantees the subsidiary's compliance with the
capital restoration plan up to a certain specified amount. Any such guarantee
from a depository institution's holding company is entitled to a priority of
payment in bankruptcy.
The aggregate liability of the holding company of an undercapitalized
bank is limited to the lesser of 5% of the institution's assets at the time it
became undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically" undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior Federal Reserve
approval of proposed dividends, or might be required to consent to a
consolidation or to divest the troubled institution or other affiliates.
ACQUISITIONS BY BANK HOLDING COMPANIES. The BHCA requires every bank
holding company to obtain the prior approval of the Federal Reserve before it
may acquire all or substantially all of the assets of any bank, or ownership or
control of any voting shares of any bank, if after such acquisition it would own
or control, directly or indirectly, more than 5% of the voting shares of such
bank. In approving bank acquisitions by bank holding companies, the Federal
Reserve is required to consider the financial and
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managerial resources and future prospects of the bank holding company and the
banks concerned, the convenience and needs of the communities to be served, and
various competitive factors.
CONTROL ACQUISITIONS. The Change in Bank Control Act prohibits a person
or group of persons from acquiring "control" of a bank holding company unless
the Federal Reserve has been notified and has not objected to the transaction.
Under a rebuttable presumption established by the Federal Reserve, the
acquisition of 10% or more of a class of voting stock of a bank holding company
with a class of securities registered under Section 12 of the Exchange Act, such
as the Company, would, under the circumstances set forth in the presumption,
constitute acquisition of control of the Company.
In addition, any company is required to obtain the approval of the
Federal Reserve under the BHCA before acquiring 25% (5% in the case of an
acquiror that is a bank holding company) or more of the outstanding Common Stock
of the Company, or otherwise obtaining control or a "controlling influence" over
the Company.
THE BANK. The Bank is a national banking association, the deposits of
which are insured by the Bank Insurance Fund ("BIF") and the Savings Association
Insurance Fund ("SAIF") of the FDIC. The Bank is subject to supervision and
regulation by the Office on the Comptroller of the Currency ("OCC"). Such
supervision and regulation subjects the Bank to special restrictions, potential
enforcement actions and period examination by the OCC. Because the Federal
Reserve regulates the bank holding company parent of the Bank, the Federal
Reserve also has supervisory authority which directly affects the Bank.
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES AND INSIDERS. Transactions
between the Bank and its nonbanking subsidiaries, including the Company, are
subject to Section 23A of the Federal Reserve Act. In general, Section 23A
imposes limits on the amount of such transactions, and also requires certain
levels of collateral for loans to affiliated parties. It also limits the amount
of advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal
Reserve Act which generally requires that certain transactions between the Bank
and its affiliates be on terms substantially the same, or at least as favorable
to the Bank, as those prevailing at the time for comparable transactions with or
involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the FDIC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
RESTRICTIONS ON DISTRIBUTION OF SUBSIDIARY BANK DIVIDENDS AND ASSETS.
Dividends paid by the Bank have provided a substantial part of the Company's
operating funds and for the foreseeable future it is anticipated that dividends
paid by the Bank to the Company will continue to be the Company's principal
source of operating funds. Capital adequacy requirements serve to limit the
amount of dividends that may be paid by the Bank. Until a national bank's
capital surplus equals or exceeds its capital stock, the bank must transfer ten
percent of its net income to capital surplus prior to paying a dividend. Without
the prior approval of the OCC, a national bank may not pay dividends in excess
of the bank's total net profits for that year, plus its retained profits for the
preceding two years, less any required transfers to capital surplus.
Additionally, a national bank may not pay dividends in excess of total retained
profits, including current year's earnings. Under federal law, the Bank cannot
pay a dividend if, after paying the dividend, the Bank will be
"undercapitalized." The OCC may declare a dividend payment to be unsafe and
unsound even though the Bank would continue to meet its capital requirements
after the dividend.
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Because the Company is a legal entity separate and distinct from its
subsidiaries, its right to participate in the distribution of assets of any
subsidiary upon the subsidiary's liquidation or reorganization will be subject
to the prior claims of the subsidiary's creditors. In the event of a liquidation
or other resolution of an insured depository institution, the claims of
depositors and other general or subordinated creditors are entitled to a
priority of payment over the claims of holders of any obligation of the
institution to its shareholders, including any depository institution holding
company (such as the Company) or any shareholder or creditor thereof.
EXAMINATIONS. The OCC periodically examines and evaluates insured
banks. Based upon such an evaluation, the OCC may revalue the assets of the
institution and require that it establish specific reserves to compensate for
the difference between the OCC-determined value and the book value of such
assets.
AUDIT REPORTS. Insured institutions with total assets of $500 million
or more must submit annual audit reports prepared by independent auditors to
federal and state regulators. In some instances, the audit report of the
institution's holding company can be used to satisfy this requirement. Auditors
must receive examination reports, supervisory agreements and reports of
enforcement actions. In addition, financial statements prepared in accordance
with generally accepted accounting principles, management's certifications
concerning responsibility for the financial statements, internal controls and
compliance with legal requirements designated by the FDIC, and an attestation by
the auditor regarding the statements of management relating to the internal
controls must be submitted. For institutions with total assets of more than $3
billion, independent auditors may be required to review quarterly financial
statements. The Federal Deposit Insurance Corporation Improvement Act ("FDICIA")
requires that independent audit committees be formed, consisting of outside
directors only. The committees of such institutions must include members with
experience in banking or financial management, must have access to outside
counsel, and must not include representatives of large customers.
CAPITAL ADEQUACY REQUIREMENTS. The OCC has adopted regulations
establishing minimum requirements for the capital adequacy of insured
institutions. The OCC may establish higher minimum requirements if, for example,
a bank has previously received special attention or has a high susceptibility to
interest rate risk.
The OCC's risk-based capital guidelines generally require banks to have
a minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and a
ratio of total capital to total risk-weighted assets of 8.0%. The capital
categories have the same definitions for the Bank as for the Company. As of
December 31, 1998, the Bank's ratio of Tier 1 capital to total risk-weighted
assets was 9.63% and its ratio of total capital to risk-weighted assets was
10.63%. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS."
The OCC's leverage guidelines require national banks to maintain Tier 1
capital of no less than 5.0% of average total assets, except in the case of
certain highly rated banks for which the requirement is 3.0% of average total
assets. As of December 31, 1998, the Bank's ratio of Tier 1 capital to average
total assets (leverage ratio) was 6.76%. SEE "MANAGEMENT'S DISCUSSION AND
ANALYSIS OR PLAN OF OPERATIONS".
CORRECTIVE MEASURES FOR CAPITAL DEFICIENCIES. The federal banking
regulators are required to take "prompt corrective action" with respect to
capital-deficient institutions. Agency regulations define, for each capital
category, the levels at which institutions are "well capitalized," "adequately
capitalized," "under capitalized," "significantly under capitalized" and
"critically under capitalized." A "well capitalized" bank has a total risk based
capital ratio of 10.0% or higher; a Tier 1 risk based capital ratio of 6.0% or
higher; a leverage ratio of 5.0% or higher; and is not subject to any written
agreement, order or directive requiring it to maintain a specific capital level
for any capital measure. An "adequately capitalized" bank has a total risk based
capital ratio of 8.0% or higher; a Tier 1 risk based capital ratio of 4.0% or
higher; a leverage ratio of 4.0% or higher (3.0% or higher if the bank was rated
a composite 1 in its most recent examination report and is not experiencing
significant growth); and does not meet the criteria for a well capitalized bank.
A bank is "under capitalized" if it fails to meet any one of the ratios required
to be adequately capitalized.
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In addition to requiring undercapitalized institutions to submit a
capital restoration plan, agency regulations contain broad restrictions on
certain activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment, and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
As an institution's capital decreases, the OCC's enforcement powers
become more severe. A significantly undercapitalized institution is subject to
mandated capital raising activities, restrictions on interest rates paid and
transactions with affiliates, removal of management, and other restrictions. The
OCC's has only very limited discretion in dealing with a critically
undercapitalized institution and is virtually required to appoint a receiver or
conservator.
Banks with risk-based capital and leverage ratios below the required
minimums may also be subject to certain administrative actions, including the
termination of deposit insurance upon notice and hearing, or a temporary
suspension of insurance without a hearing in the event the institution has no
tangible capital.
DEPOSIT INSURANCE ASSESSMENTS. The Bank must pay assessments to the
FDIC for federal deposit insurance protection. The FDIC has adopted a risk based
assessment system as required by FDICIA. Under this system, FDIC- insured
depository institutions pay insurance premiums at rates based on their risk
classification. Institutions assigned to higher-risk classifications (that is,
institutions that pose a greater risk of loss to their respective deposit
insurance funds) pay assessments at higher rates than institutions that pose a
lower risk. An institution's risk classification is assigned based on its
capital levels and the level of supervisory concern the institution poses to the
regulators. In addition, the FDIC can impose special assessments in certain
instances. The current range of BIF and SAIF assessments is between 0% and 0.27%
of deposits.
The FDIC established a process for raising or lowering all rates for
insured institutions semi-annually if conditions warrant a change. Under this
system, the FDIC has the flexibility to adjust the assessment rate schedule
twice a year without seeking prior public comment, but only within a range of
five cents per $100 above or below the premium schedule adopted. Changes in the
rate schedule outside the five cent range above or below the current schedule
can be made by the FDIC only after a full rulemaking with opportunity for public
comment.
On September 30, 1996, President Clinton signed into law an act that
contained a comprehensive approach to recapitalize the SAIF and assure the
payment of the Financing Corporation's ("FICO") bond obligations. Under this new
act, banks insured under the BIF are required to pay a portion of the interest
due on bonds that were issued by FICO to help shore up the ailing Federal
Savings and Loan Insurance Corporation in 1987. The BIF rate must equal
one-fifth of the SAIF rate through year-end 1999, or until the insurance funds
are merged, whichever occurs first. Thereafter BIF and SAIF payers will be
assessed pro rata for the FICO bond obligations. With regard to the assessment
for the FICO obligation, the current BIF rate is 0.0126% of deposits and the
SAIF rate is 0.0630% of deposits.
ENFORCEMENT POWERS. The FDIC and the other federal banking agencies
have broad enforcement powers, including the power to terminate deposit
insurance, impose substantial fines and other civil and criminal penalties and
appoint a conservator or receiver. Failure to comply with applicable laws,
regulations and supervisory agreements could subject the Company or its banking
subsidiaries, as well as officers, directors and other institution-affiliated
parties of these organizations, to administrative sanctions and potentially
substantial civil money penalties. The appropriate federal banking agency may
appoint the FDIC as conservator or receiver for a banking institution (or the
FDIC may appoint itself, under certain circumstances) if any one or more of a
number of circumstances exist, including, without limitation, the fact that the
banking institution is undercapitalized and has no reasonable prospect of
becoming adequately capitalized; fails to become adequately capitalized when
required to do so; fails to submit a timely and acceptable capital restoration
plan; or materially fails to implement an accepted capital restoration plan.
9
<PAGE>
BROKERED DEPOSIT RESTRICTIONS. Adequately capitalized institutions
cannot accept, renew or roll over brokered deposits except with a waiver from
the OCC, and are subject to restrictions on the interest rates that can be paid
on such deposits. Undercapitalized institutions may not accept, renew or roll
over brokered deposits.
CROSS-GUARANTEE PROVISIONS. The Financial Institutions Reform, Recovery
and Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee" provision
which generally makes commonly controlled insured depository institutions liable
to the FDIC for any losses incurred in connection with the failure of a commonly
controlled depository institution.
COMMUNITY REINVESTMENT ACT. The Community Reinvestment Act of 1977
("CRA") and the regulations issued thereunder are intended to encourage banks to
help meet the credit needs of their service area, including low and moderate
income neighborhoods, consistent with the safe and sound operations of the
banks. These regulations also provide for regulatory assessment of a bank's
record in meeting the needs of its service area when considering applications to
establish branches, merger applications and applications to acquire the assets
and assume the liabilities of another bank. FIRREA requires federal banking
agencies to make public a rating of a bank's performance under the CRA. In the
case of a bank holding company, the CRA performance record of the banks involved
in the transaction are reviewed in connection with the filing of an application
to acquire ownership or control of shares or assets of a bank or to merge with
any other bank holding company. An unsatisfactory record can substantially delay
or block the transaction.
CONSUMER LAWS AND REGULATIONS. In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds
Transfer Act, the expedited Funds Availability Act, the Equal Credit Opportunity
Act, and the Fair Housing Act, among others. These laws and regulations mandate
certain disclosure requirements and regulate the manner in which financial
institutions must deal with customers when taking deposits or making loans to
such customers. The Bank must comply with the applicable provisions of these
consumer protection laws and regulations as part of their ongoing customer
relations.
INSTABILITY OF REGULATORY STRUCTURE. Various legislation, including
proposals to overhaul the bank regulatory system, expand the powers of banking
institutions and bank holding companies and limit the investments that a
depository institution may make with insured funds, is from time to time
introduced in Congress. Such legislation may change banking statutes and the
operating environment of the Company and the Bank in substantial and
unpredictable ways. The Company cannot determine the ultimate effect that
potential legislation, if enacted, or implementing regulations with respect
thereto, would have upon the financial condition or results of operations of the
Company or its subsidiaries.
EXPANDING ENFORCEMENT AUTHORITY. One of the major additional burdens
imposed on the banking industry by FDICIA is the increased ability of banking
regulators to monitor the activities of banks and their holding companies. In
addition, the Federal Reserve and FDIC are possessed of extensive authority to
police unsafe or unsound practices and violations of applicable laws and
regulations by depository institutions and their holding companies. For example,
the FDIC may terminate the deposit insurance of any institution which it
determines has engaged in an unsafe or unsound practice. The agencies can also
assess civil money penalties, issue cease and desist or removal orders, seek
injunctions, and publicly disclose such actions. FDICIA, FIRREA and other laws
have expanded the agencies' authority in recent years, and the agencies have not
yet fully tested the limits of their powers.
EFFECT ON ECONOMIC ENVIRONMENT. The policies of regulatory authorities,
including the monetary policy of the Federal Reserve, have a significant effect
on the operating results of bank holding companies and their subsidiaries. Among
the means available to the Federal Reserve to affect the money supply are open
market operations in U.S. Government securities, changes in the discount rate on
member bank borrowings, and changes in reserve requirements against member bank
deposits. These means are
10
<PAGE>
used in varying combinations to influence overall growth and distribution of
bank loans, investments and deposits, and their use may affect interest rates
charged on loans or paid for deposits.
Federal Reserve monetary policies have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect of
such policies on the business and earnings of the Company and the Bank cannot be
predicted.
EMPLOYEES
As of December 31, 1998, the Company had 154 full-time employees, 40 of
whom were officers, and 16 part-time employees. The Company provides medical and
hospitalization insurance to its full-time employees. The Company actively and
continually trains its employees in the areas of successful sales and service,
long-term customer relationships, teller excellence, business development and
consumer lending. As part of this process, virtually every employee is placed on
incentive and merit standards which award compensation based on the achievement
of sales goals and other business development-related goals. The Company is not
a party to any collective bargaining agreement. The Company considers its
relations with employees to be excellent.
11
<PAGE>
ITEM 2 - DESCRIPTION OF PROPERTY
FACILITIES
The Company conducts business at ten full-service banking office and
three LPOs. The following table sets forth specific information on each such
location. The Company's headquarters are located at 1001 Highway 146 South in La
Porte in a two story office building owned by the Bank. Unless otherwise noted,
all facilities are owned by the Company.
BANKING OFFICE LOCATION
La Porte - Main Office 1001 Highway 146 South
La Porte, Texas 77571
La Porte - Spencer Office 9841 Spencer Highway
La Porte, Texas 77571
Deer Park 1601 Center
Deer Park, Texas 77536
Pasadena 5960 Fairmont Parkway
Pasadena, Texas 77505
Seabrook 2929 Nasa Road One
Seabrook, Texas 77589
Baytown - Decker Office 1900 Decker Drive
Baytown, Texas 77520
Baytown - Garth Office 6810 Garth Road
Baytown, Texas 77521
Mont Belvieu (1) 11522 Eagle Drive
Mont Belvieu, Texas 77580
Liberty 2329 North Main
Liberty, Texas 77535
Cleveland 1408 East Houston
Cleveland, Texas 77327
Northwest LPO - Houston (2)(3) 9835 North Villa Drive
Houston, Texas 77064
Southeast LPO - Pasadena (3) 5960 Fairmont Parkway
Pasadena, Texas 77505
West LPO - Houston (3)(4) 8323 Southwest Freeway, Suite 270
Houston, Texas 77074
Bayshore Center (5)(6) 719 8th Street
La Porte, Texas 77571
- --------------------------------------------------------------------------------
(1) In February 1998, the Company consolidated the Mt. Belvieu grocery store
office into the full-service banking facility located across the street
from such office in Mt. Belvieu.
(2) This facility is provided without charge by the officer of this LPO.
(3) Indicates loan production office.
(4) This facility is leased month to month at an annual cost of $7,000.
(5) Mortgage Lending Division headquarters and lease space for BIA.
(6) This facility is leased at an annual cost of $46,000.
12
<PAGE>
ITEM 3 - LEGAL PROCEEDINGS
Neither the Company nor the Bank is currently a party to, nor is any of
their property the subject of, any material pending legal proceedings incidental
to the business of the Company or the Bank.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1998.
PART II
ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market
System ("Nasdaq NMS") under the symbol "BAYB". As of March 15, 1999, there were
1,995,603 shares of the Company's Common Stock outstanding and held of record by
approximately 700 shareholders. The table below shows the reported high and low
closing sale prices of the Common Stock for the periods indicated during the
fiscal years ended December 31, 1998 and 1997:
High Low
--------- --------
Fourth Quarter 1998 .................................... $15.25 $12.25
Third Quarter 1998 ..................................... 19.50 12.44
Second Quarter 1998 .................................... 24.00 17.00
First Quarter 1998 ..................................... 23.00 19.00
Fourth Quarter 1997 (since November 12, 1997) .......... 19.75 16.00
Holders of Common Stock are entitled to receive dividends when, as and
if declared by the Company's Board of Directors out of funds legally available
therefor. While the Company has declared dividends on its Common Stock since
December 1992 and paid quarterly dividends aggregating $0.24 per share per annum
in 1998, there is no assurance that the Company will continue to pay dividends
in the future.
For a foreseeable period of time, the principal source of cash revenues
to the Company will be dividends paid by the Bank with respect to the Bank's
capital stock. There are certain restrictions on the payment of such dividends
imposed by federal banking laws, regulations and authorities. Prior to declaring
a dividend, a national bank must transfer to surplus 10% of its net profits
earned since its last dividend unless its surplus equals or exceeds stated
capital. As of December 31, 1998, the Bank's surplus exceeded its stated
capital. Without approval of the OCC, dividends may not be paid in excess of a
bank's total net profits for that year, plus its retained profits plus its
retained profits for the preceding two years, less any required transfers to
capital surplus. See "Business-Supervision and Regulation-The Bank".
In the future, the declaration and payment of dividends on the Common
Stock will depend upon the earnings and financial condition of the Company,
liquidity and capital requirements, the general economic and regulatory climate,
the Company's ability to service any equity or debt obligations senior to the
Common Stock and other factors deemed relevant by the Company's Board of
Directors.
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<PAGE>
The cash dividends paid per share by quarter were as follows:
1998 1997
--------- --------
Fourth Quarter ............................. $0.06 $0.06
Third Quarter .............................. 0.06 0.06
Second Quarter ............................. 0.06 0.06
First Quarter .............................. 0.06 0.06
On January 6, 1999, the Company announced the completion of the June
30, 1998 Common Stock repurchase plan whereby the Company's Board of Directors
authorized the Company to spend up to $500,000 to repurchase shares of its
Common Stock. On February 2, 1999 the Company announced that its Board of
Directors authorized the Company to spend up to an additional $1.0 million to
repurchase shares of its Common Stock. Such repurchases will be made through the
open market at current market price. The Company intends to use its available
cash to fund the share repurchase.
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company Consists of (i) 10,000,000
shares of Preferred Stock, $1.00 per share value, issuable in series, none of
which are issued and outstanding and (ii) 50,000,000 shares of Common Stock,
$1.00 per share par value, of which 2,091,029 shares were issued and 2,017,603
shares were outstanding as of December 31, 1998. The terms of any new series of
preferred stock may be fixed by the Board of Directors of the Company within
certain limits set by the Company's Articles of Incorporation. As of December
31, 1998, an additional 35,800 shares of Common Stock were issuable upon
exercise of the Company's outstanding employee stock options, and 66,630 shares
of Common Stock were issuable under the Bay Bancshares, Inc. 1993 Phantom Stock
Plan.
The following discussion of the terms and provisions of the Company's
capital stock is qualified in its entirety by reference to the Company's
Articles of Incorporation and Bylaws, copies of which have been filed as
exhibits to this Annual Report on Form 10-KSB.
The holders of the Common Stock are entitled to one vote for each share
of Common Stock owned. Except as expressly provided by law and except for any
voting rights which may be conferred by the Board of Directors on any shares of
Preferred Stock issued, all voting power is in the Common Stock. Holders of
Common Stock may not cumulate their votes for the election of directors. Holders
of Common Stock do not have preemptive rights to acquire any additional,
unissued or treasury shares of the Company, or securities of the Company
convertible into or carrying a right to subscribe for or acquire shares of the
Company.
Holders of Common Stock will be entitled to receive dividends out of
funds legally available therefor, if and when properly declared by the Board of
Directors. However, the Board of Directors may not declare or pay cash dividends
on Common Stock, and no Common Stock may be purchased by the Company, unless
full dividends on outstanding Preferred Stock are paid for the current dividend
period, and with respect to any outstanding cumulative Preferred Stock, all past
dividend periods.
On the liquidation of the Company, the holders of Common Stock are
entitled to share pro rata in any distribution of the assets of the Company,
after the holders of shares of Preferred Stock have received the liquidation
preference of their shares plus any cumulated but unpaid dividends (whether or
not earned or declared), if any, and after all other indebtedness of the Company
has been retired.
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
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<PAGE>
Certain of the matters discussed in this document and in the documents
incorporated into this document by reference, including matters discussed under
the captions "Management's Discussion and Analysis or Plan of Operation," may
constitute forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, and as such may involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Company to be materially different
from future results, performance or achievements expressed or implied by such
forward-looking statements. The words "expects," "estimates," "anticipates,"
"contemplated," "intends," "plans," "believes," "seek," "will," "would,"
"should," "projected" and similar expressions are intended to identify such
forward-looking statements.
The Company's actual results or experience may differ materially from
the results anticipated in such forward-looking statements due to a variety of
factors, including, but not limited to: (1) the effects of future acquisitions,
if any; (2) the concentration of indirect automobile dealer paper in the loan
portfolio; (3) the effects of future economic conditions on the Company and its
customers; (4) governmental monetary and fiscal policies, as well as legislative
and regulatory changes; (5) the risks of changes in interest rates on the level
and composition of deposits, loan demand and the values of loan collateral,
securities and interest rate protection agreements, as well as interest rate
risks; (6) the effects of competition from other commercial banks, thrifts,
mortgage banking firms, insurance companies, money market and other mutual fund
and other financial institutions operation in the Company's market areas and
elsewhere, including competitors offering banking products and services by mail,
telephone, computer and the Internet; (7) the failure of assumptions underlying
the establishment of reserves for credit losses and the fact that estimations of
values of collateral and various financial assets and liabilities and
technological changes, including "Year 2000" data systems compliance issues, are
more difficult or expensive than anticipated; and (8) other uncertainties set
forth in the Company's other public reports and filings and public statements.
All written or oral forward-looking statements attributable to the Company are
expressly qualified in their entirety by these cautionary statements.
ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
Management's Discussion and Analysis or Plan of Operations analyzes the
major elements of the Company's balance sheets and statements of earnings. This
section should be read in conjunction with the Company's consolidated financial
statements and accompanying notes and other detailed information appearing
elsewhere in this Annual Report on Form 10-KSB.
OVERVIEW
Net earnings available to stockholders were $2.7 million, $1.8 million
and $1.4 million for the years ended December 31, 1998, 1997 and 1996,
respectively, and earnings per share (diluted) were $1.25, $1.16 and $0.97 for
these same periods. Earnings per share (diluted) on a cash basis (excluding the
amortization of goodwill) for the years ended December 31, 1998, 1997 and 1996
were $1.43, $1.20 and $0.97 respectively. Earnings growth from 1997 to 1998
resulted primarily from a higher dollar amount of interest-earning assets
derived from the 1997 Acquisitions, a gain on the sale of SBA loans and the
income resulting from the Company's origination of third party mortgage loans.
However, 1998 earnings were impacted by the expenses related to the Company's
mainframe computer conversion. Additionally, the Company continues to enjoy
improved yields and a low cost of funds (which declined slightly from 1997 to
1998), which have resulted in an improved net interest margin. Earnings growth
from 1996 to 1997 resulted from internal loan growth, a gain on the sale of Bank
owned property, a higher net interest margin, gains on the sale of SBA loans
generated by the LPOs and the increased volume generated by the 1997
Acquisitions. The Company posted returns on average assets of 0.97%, 0.91% and
0.79% and returns on average common equity of 11.05%, 12.39% and 11.29% for the
years ended 1998, 1997 and 1996, respectively.
Total assets at December 31, 1998, 1997 and 1996 were $284.3 million,
$276.3 million and $189.0 million, respectively. Total deposits at December 31,
1998, 1997 and 1996 were $252.7 million,
15
<PAGE>
$249.0 million and $173.3 million, respectively. In 1998, the Company increased
its asset and deposit base primarily through internal loan growth and public
fund deposits. Loans, net of allowance for credit losses, were $169.6 million at
December 31, 1998, compared with $153.8 million at the end of 1997. The growth
in net loans is primarily attributable to an increase in real estate loans and
interim construction loans. These increases predominantly resulted from the
Company's sales and marketing efforts through management's strategic decision to
shift the loan portfolio from indirect consumer lending to higher yielding
commercial and real estate lending. Loans were $118.5 million at the end of
1996. Common stockholders' equity was $26.5 million, $24.5 million and $12.9
million at December 31, 1998, 1997 and 1996, respectively.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income represents the amount by which interest income on
interest-earning assets, including securities and loans, exceeds interest
expense incurred on interest-bearing liabilities, including deposits and other
borrowed funds. Net interest income is the principal source of the Company's
earnings. Interest rate fluctuations, as well as changes in the amount and type
of earning assets and liabilities, combine to affect net interest income.
1998 VERSUS 1997. Net interest income totaled $12.3 million in 1998
compared with $8.3 million in 1997, an increase of $4.0 million or $48.19%. The
increase is due to higher interest income on a higher amount of interest-earning
assets. Interest expense increased by $1.6 million due to an increase in
deposits but was offset by a $5.6 million increase in interest income. This
resulted in net interest margins of 5.03% and 4.64% and net interest spreads of
4.06% and 3.84% for 1998 and 1997, respectively.
The increase in net interest income was the result of a higher dollar
amount of interest-earning assets derived from the 1997 Acquisitions, internal
loan growth, increased fees generated from the Mortgage Lending Division, a
continued low cost funding source and a shift in the loan portfolio from lower
yielding indirect auto loans to higher yielding commercial and real estate
loans. An increase in average interest-earning assets of $65.1 million, which
combined with an increase in net interest margin of 39 basis points, resulted in
an increase in net interest income of $4.0 million. Average loans increased
$43.1 million or 35.56% in 1998 from $121.2 million in 1997. The average
securities portfolio increased $22.6 million or 48.81% in 1998 from $46.3
million in 1997 primarily as a result of the 1997 Acquisitions.
1997 VERSUS 1996. Net interest income totaled $8.3 million in 1997
compared with $7.2 million in 1996, an increase of $1.1 million or 15.28%. The
increase is primarily due to the higher interest income on loans. Interest
expense increased by $361,000 but was offset by a $1.4 million increase in
interest income. This resulted in a net interest margins of 4.64% and 4.38% and
net interest spreads of 3.84% and 3.64% for 1997 and 1996, respectively.
The increase in average loans for 1997 was primarily due to internal
loan growth and the 1997 Acquisitions. An increase in average loans of $8.2
million, which combined with an increase in net interest margin of 26 basis
points, resulted in an increase in net interest income of $1.1 million. Interest
income on loans increased to $10.6 million in 1997 from $9.6 million. The
average securities portfolio increased $3.1 million or 7.07% in 1997 from $43.2
million in 1996 as a direct result of funds acquired in the 1997 Acquisitions.
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<PAGE>
The following table presents for the periods indicated the total dollar
amount of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates. No tax equivalent adjustments were made and
all average balances are yearly average balances. Nonaccruing loans have been
included in the tables as loans carrying a zero yield.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------ -------------------------------- ------------------------------
Average Interest Average Average Interest Average Average Interest Average
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
--------- --------- ---- --------- --------- ---- --------- --------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
Interest-earning assets:
Loans ....................... $ 164,333 $ 14,948 9.10% $ 121,191 $ 10,584 8.73% $ 113,014 $ 9,594 8.49%
Securities .................. 68,866 4,114 5.97% 46,288 2,834 6.12% 43,230 2,612 6.04%
Federal funds sold and
other temporary
investments ................ 10,588 609 5.75% 11,199 669 5.97% 8,661 460 5.31%
--------- --------- ---- --------- --------- ---- --------- --------- ----
Total interest-earning
assets ..................... 243,787 19,671 8.07% 178,678 14,087 7.88% 164,905 12,666 7.68%
--------- --------- ---- --------- --------- ---- --------- --------- ----
Less allowance for credit
losses ..................... (2,009) -- -- (1,496) -- -- (1,330) -- --
--------- --------- ---------
Total interest-earning
assets, net of allowance ... 241,778 -- -- 177,182 -- -- 163,575 -- --
Nonearning assets ........... 32,093 -- -- 18,137 -- -- 13,697 -- --
--------- --------- ---------
Total assets ............ $ 273,871 -- -- $ 195,319 -- -- $ 177,272 -- --
========= ========= =========
Liabilities and stockholders'
equity Interest-bearing liabilities:
Interest-bearing demand
deposits ................... $ 29,467 $ 336 1.14% $ 20,247 $ 238 1.18% $ 17,232 $ 206 1.20%
Public fund deposits ........ 3,034 131 4.32% 5,358 106 1.98% 5,696 104 1.83%
Savings and money market
accounts ................... 56,417 1,894 3.36% 42,776 1,450 3.39% 42,289 1,388 3.28%
Certificates of deposit ..... 94,355 4,971 5.27% 74,929 3,989 5.32% 68,588 3,698 5.39%
Federal funds purchased,
FHLB line of credit and other
borrowings ..................... 1,290 73 5.66% 334 21 6.29% 889 47 5.29%
--------- --------- ---- --------- --------- ---- --------- --------- ----
Total interest-bearing
liabilities ............ 184,563 7,405 4.01% 143,644 5,804 4.04% 134,694 5,443 4.04%
--------- --------- ---- --------- --------- ---- --------- --------- ----
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits ................... 62,204 -- -- 34,325 -- -- 28,717 -- --
Other liabilities ........... 3,060 -- -- 2,870 -- -- 1,445 -- --
--------- ---------
Total liabilities ....... 249,827 -- -- 180,839 -- -- 164,856 -- --
--------- --------- ---------
Stockholders' equity ............ 24,044 -- -- 14,480 -- -- 12,416 -- --
--------- --------- ---------
Total liabilities and
stockholders' equity ... $ 273,871 -- -- $ 195,319 -- -- $ 177,272 -- --
========= ========= =========
Net interest income ......... -- $ 12,266 -- -- $ 8,283 -- -- $ 7,223 --
========= ========= =========
Net interest spread ......... -- -- 4.06% -- -- 3.84% -- -- 3.64%
==== ==== ====
Net interest margin ......... -- -- 5.03% -- -- 4.64% -- -- 4.38%
==== ==== ====
</TABLE>
The following schedule presents the dollar amount of changes in
interest income and interest expense for the major components of
interest-earning assets and interest-bearing liabilities and distinguishes
between the increase related to higher outstanding balances and the volatility
of interest rates. For purposes of this table, changes attributable to both rate
and volume which can be segregated have been allocated.
17
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
------------------------------ -----------------------------
Increase Increase
(Decrease) (Decrease)
Due to Due to
------------------ ------------------
Volume Rate Total Volume Rate Total
------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earnings assets:
Loans ............................. $ 3,768 $ 596 $ 4,364 $ 694 $ 296 $ 990
Securities ........................ 1,382 (103) 1,279 185 37 222
Fed funds sold and other temporary
investments ...................... (36) (24) (60) 135 74 209
------- ------- ------- ------- ------- -------
Total increase (decrease) in
interest income ............... 5,114 469 5,583 1,014 407 1,421
Interest-bearings liabilities:
Interest-bearing demand deposits .. 93 29 122 36 (2) 34
Savings and money market accounts . 462 (18) 444 16 46 62
Certificates of deposits .......... 1,034 (52) 982 342 (51) 291
Other borrowings .................. 60 (8) 52 (29) 3 (26)
------- ------- ------- ------- ------- -------
Total increase (decrease) in
interest expense .............. 1,649 (49) 1,600 365 (4) 361
------- ------- ------- ------- ------- -------
Increase (decrease) in net interest
income ........................... $ 3,465 $ 518 $ 3,983 $ 649 $ 411 $ 1,060
======= ======= ======= ======= ======= =======
</TABLE>
Provision for Credit Losses
Provisions for credit losses are charged to income to bring the
Company's allowance for credit losses to a level deemed appropriate by
management based on the factors discussed under "-Allowance for Credit Losses."
The 1998 provision for credit losses increased to $480,000 from
$456,000 in 1997, an increase of $24,000 or 5.26%. The provision for the year
1997 decreased by $54,000 or 10.59% from $510,000 in 1996.
Noninterest Income
Noninterest income for the year ended December 31, 1998 was $4.1
million, up from $2.7 million or 51.85% in 1997, and $2.3 million in 1996. After
excluding the gains on the sale of Bank- owned property in 1998 and 1997, as of
December 31, 1998, noninterest income increased $1.4 million. This increase was
primarily due to the increase in service charges from increased volume as a
result of the 1997 Acquisitions, an increase on the gain recognized on the sale
of SBA loans, an increase in ATM fee income and increases in other noninterest
income (which includes safe deposit fees, credit life insurance fees, stop
payment charges and other miscellaneous customer service charges). After
excluding the gain from the sale of land previously owned by the Company in 1997
and the gain from the sale of land adjacent to the Spencer Office in 1996, as of
December 31, 1997, noninterest income increased $292,000 primarily as a result
from an increase in service charges on deposit accounts due to increased volume
from the 1997 Acquisitions and an increase in the sale of alternative
investments. The following table presents for the periods indicated the major
categories of noninterest income:
Years Ended
December 31,
------------------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
Service charges on deposit accounts ........ $2,478 $1,617 $1,379
Gain on sale of SBA loans .................. 463 241 263
ATM fee income ............................. 344 204 201
Alternative investments .................... 174 216 135
Gain on sale of Bank owned property ........ 63 84 68
Other noninterest income ................... 595 293 301
------ ------ ------
Total noninterest income .............. $4,117 $2,655 $2,347
====== ====== ======
18
<PAGE>
Noninterest Expense
For the years ended 1998, 1997 and 1996, noninterest expenses totaled
$11.8 million, $7.8 million and $7.1 million, respectively. The 51.28% increase
in 1998 reflects additional expenses including increased staffing and facility
costs associated with the 1997 Acquisitions, operational expenses incurred
during the Company's conversion to a new mainframe computer system and
communications network, amortization of goodwill and startup costs associated
with the Mortgage Lending Division. The 9.86% increase in 1997 reflects
increases in staffing and operational expenses due to the 1997 Acquisitions and
the Company's commitment to developing its sales and service culture. The
following table presents for the periods indicated the major categories of
noninterest expense:
<TABLE>
<CAPTION>
Years Ended
December 31,
---------------------------
1998 1997 1996
------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Employee compensation and benefits ................. $ 6,248 $ 3,958 $ 3,377
Non-staff expense:
Net bank premises expense ..................... 861 562 526
Equipment rentals, depreciation and maintenance 929 667 605
Data processing ............................... 287 154 181
Professional fees ............................. 459 316 280
Special FDIC assessment ....................... -- -- 287
Regulatory assessments/FDIC insurance ......... 157 103 148
Ad valorem and franchise taxes ................ 238 187 192
Amortization of goodwill ...................... 392 68 3
Other ......................................... 2,271 1,803 1,468
------- ------- -------
Total non-staff expenses ................... 5,594 3,860 3,690
------- ------- -------
Total noninterest expense .................. $11,842 $ 7,818 $ 7,067
======= ======= =======
</TABLE>
Employee compensation and benefit expense for the year ended December
31, 1998 was $6.2 million, an increase of $2.2 million or 55.0% from $4.0
million in 1997. Employee compensation and benefit expense for the year ended
December 31, 1997 was $4.0 million, an increase of $600,000 or 17.65% from $3.4
million in 1996. The increase in 1998 is primarily due to the increased staffing
from the 1997 Acquisitions, additional staff hired, temporary staffing costs
associated with the mainframe computer conversion and startup staffing costs of
the Mortgage Lending Division. The increase in 1997 is due to the full operation
of the Cleveland banking office which was acquired in September 1996, staff
acquired in the 1997 Acquisitions and additional staff hired. The number of
full-time employees for year end 1998, 1997, and 1996 were 154, 149 and 101,
respectively.
Non-staff expenses were $5.6 million in 1998, an increase of $1.7
million or 43.59% from $3.9 in 1997. Non-staff expenses were $3.9 million in
1997, an increase of $200,000 or 5.41% from $3.7 million in 1996. This increase
in 1998 was due to additional expenses including the amortization of goodwill
associated with the 1997 Acquisitions, increased advertising costs related to
the Company's expansion efforts, increased legal fees as the Company continued
to pursue collection activities, start up costs associated with the Mortgage
Lending Division and expenses related to the Company's mainframe computer and
communication systems. Net bank premises expense, depreciation and maintenance
increased primarily due to the additional facility cost associated with the 1997
Acquisitions, the completion and opening of the new Seabrook banking office and
the mainframe computer conversion. The increase in 1997 was primarily due to an
increase in net bank premises expense, depreciation and maintenance and
professional fees. The increase is in net bank premises and depreciation is the
result of the full operation of the Cleveland banking office and integration of
the new facilities from the 1997 Acquisitions.
19
<PAGE>
Income Taxes
Income tax expense includes the regular federal income tax at the
statutory rate, plus the income tax component of the Texas franchise tax. The
amount of federal income tax expense is influenced by the amount of taxable
income, the amount of tax-exempt income, the amount of non-deductible interest
expense and the amount of other non-deductible expenses. Taxable income for the
income tax component of the Texas franchise tax is the federal pre-tax income,
plus certain officers salaries, less interest income from federal securities.
The income tax component of the Texas franchise tax was zero in 1998, 1997 and
1996. Income tax expense was $1.4 million in 1998, $870,000 in 1997 and $591,000
in 1996. The effective tax rates in 1998, 1997 and 1996, respectively, were
34.60%, 32.66% and 29.65%. Income taxes for financial purposes in the
consolidated statements of earnings differ from the amount computed by applying
the statutory income tax rate of 34% to earnings before income taxes. The
difference in the statutory rate in 1997 and 1996 is primarily due to tax exempt
interest, utilization of tax credits and loss carryforwards and alternative
minimum tax.
Impact of Inflation
The effects of inflation on the local economy and on the Company's
operating results have been relatively modest for the past several years. Since
substantially all of the Company's assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their values are less
sensitive to the effects of inflation than to changing interest rates, which do
not necessarily change in accordance with inflation rates. The Company tries to
control the impact of interest rate fluctuations by managing the relationship
between its interest rate sensitive assets and liabilities.
FINANCIAL CONDITION
Loan Portfolio
Total gross loans increased by $15.8 million or 10.14% to $171.5
million at December 31, 1998, from $155.8 million at December 31, 1997 primarily
due to internal loan growth. Total gross loans increased by $35.9 million or
29.94% to $155.8 million at December 31, 1997, from $119.9 million at December
31, 1996 primarily due to the 1997 Acquisitions and internal loan growth.
At December 31, 1998, total loans represented 67.87% of deposits and
60.32% of total assets. Total loans as a percentage of deposits were 62.53% at
December 31, 1997, compared to 69.20% at December 31, 1996.
20
<PAGE>
The following table summarizes the loan portfolio of the Company by
type of loan as of the dates indicated:
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------ ------------------ ------------------ ------------------ ------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial and
industrial ........... $ 26,109 15.22% $ 24,176 15.52% $ 17,407 14.52% $ 11,378 10.76% $ 10,477 9.81%
Real estate:
Construction and land
development ......... 15,248 8.89% 4,941 3.17% 3,306 2.76% 3,390 3.20% 2,114 1.98%
1-4 family residential .... 12,105 7.06% 7,513 4.82% 3,115 2.60% 2,879 2.72% 2,470 2.31%
Multi-family residential .. 1,149 0.67% 1,270 0.82% 625 0.52% 62 0.06% 933 0.87%
Non-farm/non residential .. 31,943 18.62% 31,594 20.28% 11,834 9.87% 11,388 10.76% 8,513 7.97%
Consumer:
Indirect ............. 65,080 37.94% 71,333 45.80% 74,657 62.28% 69,087 65.30% 75,069 70.27%
Direct ............... 19,898 11.60% 14,938 9.59% 8,936 7.45% 7,612 7.20% 7,254 6.79%
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans .......... $171,532 100.00% $155,765 100.00% $119,880 100.00% $105,796 100.00% $106,830 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
</TABLE>
The contractual maturity ranges of the commercial and industrial and
real estate loan portfolio and the amount of such loans with fixed interest
rates and floating rates in each maturity range as of December 31, 1998 are
summarized in the following table:
<TABLE>
<CAPTION>
December 31, 1998
----------------------------------------------
After One
One Year Through After Five
or Less Five Years Years Total
------- ---------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Commercial and industrial .............. $ 8,026 $11,271 $ 6,812 $26,109
Real estate ............................ 12,085 15,587 32,773 60,445
------- ------- ------- -------
Total ............................. $20,111 $26,858 $39,585 $86,554
======= ======= ======= =======
Loans with a predetermined interest rate $ 4,363 $17,899 $17,892 $40,154
Loans with a floating interest rate .... 15,748 8,959 21,693 46,400
------- ------- ------- -------
Total ............................. $20,111 $26,858 $39,585 $86,554
======= ======= ======= =======
</TABLE>
The lending focus of the Company is on small and medium-sized business
loans on both a direct and SBA supported basis and on consumer direct and
indirect loans throughout the Company's market areas. The Company offers a
variety of commercial lending products including term loans, lines of credit and
equipment financing. A broad range of short to medium-term commercial loans,
primarily collateralized, are made available to businesses for working capital
(including inventory and receivables), business expansion (including
acquisitions of real estate and improvements) and the purchase of equipment and
machinery. The purpose of a particular loan generally determines its structure.
Loans up to $300,000 are evaluated and acted upon by an Officers' Loan
Committee, which meets weekly. Loans above that amount must be approved by the
Directors' Loan Committee, which meets bi-monthly.
21
<PAGE>
Generally, the Company's commercial loans are underwritten in the
Company's market area on the basis of the borrower's ability to service such
debt from identified cash flow. As a general practice, the Company takes as
collateral a lien on any available real estate, equipment or other assets and
obtains a personal guaranty of the business principals. Working capital loans
are primarily collateralized by short-term assets whereas term loans are
primarily collateralized by long-term assets.
In addition to commercial loans secured by real estate, the Company
makes commercial mortgage loans to finance the purchase of real property which
generally consists of real estate on which structures have already been
completed or will be completed and occupied by the borrower. The Company offers
a variety of mortgage loan products which generally are amortized over five to
20 years.
Direct consumer loans collateralized by single-family residential real
estate generally have been made in amounts of no more than 80% of appraised
value. The Company requires mortgage title insurance, hazard insurance and flood
insurance when applicable, in the amount of the loan. Customers requiring fixed
rate full term loans are accommodated via an automated interactive application
process direct from the Bank's premises to the acquiring mortgage company. As a
result, the Company is able to meet all of the mortgage needs of its present and
potential customer base.
The Company's commercial mortgage loans are secured by first liens on
real estate, typically have both fixed and variable interest rates and amortize
over a 10 to 20 year period with balloon payments due at the end of three to
five years. As a Preferred SBA Lender (discussed below), the Company also issues
full term variable rate real estate loan commitments when the facility is
enhanced by the underlying SBA guaranty. In underwriting commercial mortgage
loans, consideration is given to the property's operating history, future
operating projections, current and projected occupancy, location and physical
condition. The underwriting analysis also includes credit checks, appraisals,
environmental assessments and a review of the financial condition of the
borrower.
The Company makes loans to finance the construction of residential and
nonresidential properties. Construction loans generally are secured by first
liens on real estate and have floating rates. The Company conducts periodic
inspections, either directly or through an agent, prior to approval of periodic
draws on these loans. Underwriting guidelines similar to those described above
are also used in the Company's construction lending activities. In keeping with
the community-oriented nature of its customer base, the Company provides
construction and permanent financing for churches located within its market
area.
The Company is an active SBA lender having achieved the "Preferred
Lender" status, the highest status awarded to a lender by the SBA. The Company
uses a system of satellite LPOs staffed by SBA loan specialists and located in
the Houston market. The LPO lenders generate the potential customer prospects
and produce the SBA loan package using packaging software loaded on notebook
computers. Following loan committee approval, the LPO lender passes the
customers to closing and servicing specialists located in the main banking
office.
The Company provides a factoring product known as "Cash Flow Manager"
to address the working capital needs of businesses which do not meet the loan
guidelines of the Company for commercial lines of credit but are deemed
creditworthy.
Consumer loans made by the Company include automobile loans,
recreational vehicle loans, boat loans, home improvement loans, personal loans
(collateralized and uncollateralized) and deposit account collateralized loans.
The terms of these loans typically range from 12 to 84 months and vary based
upon the nature of collateral and size of loan.
Approximately 76.58% of the Company's consumer loan portfolio as of
December 31, 1998, was comprised of "indirect loans" (representing 37.94 % of
the Company's total loan portfolio) compared with 82.69% as of December 31, 1997
(representing 45.80% of the Company's total loan portfolio). Indirect loans are
installment loans, with typical maturities of three to five years, which are
originated by automobile dealers for the purpose of financing consumer
automobile purchases and sold by automobile dealers to commercial banks and
other sources of financing. As evident in the reduction in the percentage of
indirect loans to the total loan portfolio, the Company continues to shift its
focus from indirect loans to higher yielding commercial and real estate loans.
The Company initiated an indirect auto paper lending program in 1988. Marketing
is directed to new car dealers with a specialty in class "A" credit quality
loans. The program, which forms 49.54% of outstanding loan balances at the
Company, provides for a predictable source of cash flow, liquidity and revenue
stream which has been beneficial to the Company since its inception.
<PAGE>
The Company's indirect loan programs are administered by an experienced
staff specially trained in evaluating and servicing this particular type of
loan. The Company uses three loan buyers with indirect loan experience ranging
from ten to 27 years. Mr. Wright, the Chief Executive Officer of the Company,
has managed an indirect product line in banks for over 31 years and holds
substantial expertise in the area, having lectured on indirect lending at the
American Bankers Association National Consumer Lending Schools. In the past, the
Company's indirect lending staff was requested by the OCC to conduct a seminar
for its Houston area examiners on the "how to and risks of" indirect lending.
The Company competes for indirect loans with a number of other
financial and non-financial institutions, including the captive financial
services subsidiaries of automobile manufacturers, on the basis of interest rate
and quality of service. The Company purchases primarily "A"-rated credit quality
loans from new car dealers. To obtain dealer response in this area, the Company
must timely provide superior service while purchasing contracts on a consistent
basis. Additionally, the market requires that the Company price products below
the buy rates of the captive finance companies.
The Company generally receives credit applications on a daily basis
from one or more of the 20 automobile dealerships from which it actively
purchases indirect auto loans. Upon receipt of a credit application, the Company
undertakes a credit analysis of the prospective purchaser, ordering credit
reports on the borrower which are analyzed by one of the officers specializing
in buying indirect loans. In making credit decisions, such officers evaluate,
among other things, the general credit quality of the applicant, the proposed
income to debt ratio, and residential and employment stability.
The collection of overdue indirect loans is administered by a staff
specially trained for such purpose. Holders of loans that are ten days past due
generally receive written notice of such delinquency. When any loan becomes 15
days past due, the collectors establish telephone contact with the borrower and
obtain payment promises. If the loan remains past due for 30 days, the Company
generally sends a demand letter requiring payment within ten days before
asserting its legal rights. The Company's collection staff makes all reasonable
efforts to work out credit problems before the accounts are turned over to
independent repossession agents. Repossessed automobiles are sold as soon as
possible through a number of means in order to minimize any potential losses.
In addition to the underwriting of the individual loan contracts, the
Company requires the automobile dealerships to provide annual financial
information to the Company for financial analysis and review. The Company
believes that it represents a higher risk to do business with dealerships which
have demonstrated financial weakness and which would possibly be unable to
facilitate the return of any rebates due to the Company on payoffs and
repossessions.
A loan is considered impaired based on current information and events,
if it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. The measurement of impaired loans is based on the present
value of expected future cash flows discounted at the loan's effective interest
rate or the loan's observable market price or based on the fair value of the
collateral if the loan is collateral-dependent.
Nonperforming Assets
The Company has several procedures in place to assist it in
maintaining the overall quality of its loan portfolio. The Company has
established underwriting guidelines to be followed by its officers and also
monitors its delinquency levels for any negative or adverse trends. There can be
no assurance, however, that the Company's loan portfolio will not become subject
to increasing pressures from deteriorating borrower credit due to general
economic conditions.
<PAGE>
The Company's conservative lending approach, diversification,
as well as a healthy local economy, has resulted in strong asset quality.
Nonperforming assets at December 31, 1998 were $705,000, compared with $777,000
at December 31, 1997 and $567,000 at December 31, 1996. This resulted in a ratio
of nonperforming assets to total loans plus other real estate of 0.41%, 0.49%
and 0.47% for the years ended 1998, 1997 and 1996, respectively.
The following table presents information regarding nonperforming assets
at the dates indicated:
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Repossessions ............................... $ 84 $136 $143 $136 $ 66
Nonaccrual loans ............................ 13 -- -- -- --
Restructured loans .......................... 186 203 216 228 241
Other real estate ........................... 422 438 208 234 413
---- ---- ---- ---- ----
Total nonperforming assets ............. $705 $777 $567 $598 $720
==== ==== ==== ==== ====
Nonperforming assets to total loans and other
real estate ............................ 0.41% 0.49% 0.47% 0.56% 0.67%
</TABLE>
The Company generally places a loan on nonaccrual status and ceases
accruing interest when loan payments performance is deemed unsatisfactory. All
loans past due 90 days, however, are placed on nonaccrual status, unless the
loan is both well-secured and in the process of collection. Cash payments
received while a loan is classified as nonaccrual are recorded as a deduction of
principal as long as doubt exists as to collection. The Company is sometimes
required to revise a loan's interest rate or repayments terms in a troubled debt
restructuring. The Company had performing restructured loans of $186,000,
$203,000 and $216,000 at December 31, 1998, 1997 and 1996, respectively. The
Company's internal loan review department evaluates additional loans which are
potential problem loans as to risk exposure in determining the adequacy of the
allowance for credit losses.
The Company reviews collateral value on loans secured by real estate
during the internal loan review process. New appraisals are acquired when loans
are categorized as nonperforming loans or potential problem loans. In instances
where updated appraisals reflect reduced collateral values, an evaluation of the
borrower's overall financial condition is made to determine the need, if any,
for possible write downs or appropriate additions to the allowance for credit
losses.
Allowance for Credit Losses
The allowance for credit losses is a reserve established through
charges to earnings in the form of a provision for credit losses. Management has
established an allowance for credit losses which it believes is adequate for
estimated losses in the Company's loan portfolio. Based on an evaluation of the
loan portfolio, management presents a quarterly review of the allowance for
credit losses to the Bank's Board of Directors, indicating any change in the
allowance since the last review and any recommendations as to adjustments in the
allowance. In making its evaluation, management considers the diversification by
industry of the Company's commercial loan portfolio, the effect of changes in
the local real estate market on collateral values, the results of recent
regulatory examinations, the effects on the loan portfolio of current economic
indicators and their probable impact on borrowers, the amount of charge-offs for
the period, the amount of nonperforming loans and related collateral security,
the evaluation of its loan portfolio by the loan review function and the annual
examination of the Company's financial statements by its independent auditors.
Charge-offs occur when loans are deemed to be uncollectible.
24
<PAGE>
The Company follows a loan review program to evaluate the credit risk
in the loan portfolio. Through the loan review process, the Company maintains an
internally classified loan watch list which, along with the delinquency list of
loans, helps management assess the overall quality of the loan portfolio and the
adequacy of the allowance for credit losses. Loans classified as "substandard"
are those loans with clear and defined weaknesses such as a highly-leveraged
position, unfavorable financial ratios, uncertain repayment sources or poor
financial condition, which may jeopardize recoverability of the debt.
Loans classified as "doubtful/potential loss" are those loans which
have characteristics similar to substandard accounts but with an increased risk
that a loss may occur, or at least a portion of the loan may require a
charge-off if liquidated at present. Although loans classified as substandard do
not duplicate loans classified as doubtful, both substandard and doubtful loans
include some loans that are delinquent at least 30 days or on nonaccrual status.
Loans classified as "potential loss" are those loans which are identified as
having a high probability of being liquidated with loss within the next 12
months.
In addition to the loans on the internal watch list classified as
substandard, doubtful/potential loss, the Company maintains additional
classifications on a separate watch list which further aid the Company in
monitoring loan portfolios. These additional loan classifications reflect
warning elements where the present status portrays one or more deficiencies that
require attention in the short-term or where pertinent ratios of the loan
account have weakened to a point where more frequent monitoring is warranted.
These loans do not have all of the characteristics of a classified loan
(substandard, doubtful/potential loss) but do show weakened elements as compared
with those of a satisfactory credit. The Company reviews these loans to assist
in assessing the adequacy of the allowance for credit losses.
In order to determine the adequacy of the allowance for credit losses,
management considers the risk classification or delinquency status of loans and
other factors, such as collateral value, portfolio composition, trends in
economic conditions, including those discussed below, and the financial strength
of borrowers. Management establishes specific allowances for loans which
management believes require reserves greater than those allocated according to
their classification or delinquent status. Additionally, the Company uses three
approaches for the analysis of the performing portfolio: migration, historical
and examiner rule of thumb. These methods are further broken down to identified
loan pools within the Company's portfolio. Using these methodologies, the
Company allocates reserves to each identified loan classification and to
performing loan pools. All methods are evaluated by loan pools, however, in the
migration method, commercial industrial and real estate loans are evaluated on
an individual bases. The Company then charges to operations a provision for
credit losses to maintain the allowance for credit losses at an adequate level
determined by the foregoing methodology.
As an energy center, the Houston economy has historically been affected
by the price of oil and gas. The economic downturn in the energy industry in the
mid 1980's resulted in diversification and a broader economic base in the
Houston area. Consequently, economic reliance on energy has been lessened
through these diversification efforts. Although the Company has no extensions of
credit to production or exploration companies and has not historically pursued
this line of business, it provides financing and other banking services to
companies that service the petrochemical industry. Even given the industry
diversification in Houston, management believes the economy in the Company's
market areas remains somewhat dependent on the petrochemical industry. While the
Company maintains a reasonably diverse commercial and consumer loan portfolio,
any major downturn in the energy industry could have an adverse affect on
borrowers' ability to repay loans and, therefore, could potentially affect the
results of operations and the financial condition of the Company.
25
<PAGE>
Consequently, in making its evaluation of the adequacy of the allowance
for credit losses, management incorporates among many other factors, the effects
on borrowers of an economic downturn in the energy industry, the diversification
of the loan portfolio and economic indicators and conditions. Additionally, the
Company has several procedures in place to assist it in minimizing credit risk
and maintaining the overall quality of its loan portfolio. The Company has
established, and frequently reviews, underwriting guidelines and monitors its
delinquency levels for any negative or adverse trends. To date, given the
diversification of the Company's loan portfolio along with current economic
indicators, management has not deemed it necessary to increase the allowance for
credit losses or to alter current credit underwriting standards. However, no
assurances can be given that an increase in the allowance or alteration of
underwriting standards will not be necessary in the future.
For the year ended 1998, net charge-offs totaled $535,000 or 0.33% of
average loans outstanding for the period, compared with $449,000 or 0.37% in net
charge-offs during 1997. During 1998, the Company recorded a provision for
credit losses of $480,000 compared with $456,000 for 1997. At December 31, 1998,
the allowance totaled $1.9 million or 1.13% of total loans. For the year ended
1997, net charge-offs totaled $449,000 or 0.37% of average loans outstanding for
the period, compared to $265,000 or 0.23% in net charge-offs during 1996. During
1997, the Company recorded a provision for credit losses of $456,000 compared
with $510,000 for 1996. At December 31, 1997, the allowance totaled $2.0 million
or 1.28% of total loans.
The following table presents, for the periods indicated, an analysis of
the allowance for credit losses and other data:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Average loans outstanding .................. $ 164,333 $ 121,191 $ 113,014 $ 107,286 $ 101,975
--------- --------- --------- --------- ---------
Gross loans outstanding at end of period ... $ 171,532 $ 155,765 $ 119,880 $ 105,796 $ 106,830
--------- --------- --------- --------- ---------
Allowance for credit losses at beginning of
period ................................ $ 1,999 $ 1,430 $ 1,185 $ 1,230 $ 1,344
Increase resulting from acquisitions ....... -- 562 -- -- --
Provision for credit losses ................ 480 456 510 150 75
Charge-offs:
Commercial and industrial ............. (277) (104) -- (2) (50)
Real estate ........................... (30) -- -- (29) --
Consumer .............................. (388) (448) (483) (349) (328)
Recoveries:
Commercial and industrial ............. 34 28 29 14 19
Real estate ........................... 1 3 103 82 93
Consumer .............................. 125 72 86 89 77
--------- --------- --------- --------- ---------
Net (charge-offs) recoveries ............... (535) (449) (265) (195) (189)
--------- --------- --------- --------- ---------
Allowance for credit losses at end of period $ 1,944 $ 1,999 $ 1,430 $ 1,185 $ 1,230
========= ========= ========= ========= =========
Ratio of allowance to end of period loans .. 1.13% 1.28% 1.19% 1.12% 1.15%
Ratio of net charge-offs to average loans .. 0.33% 0.37% 0.23% 0.18% 0.19%
Ratio of allowance to end of period
nonperforming loans ................... 976.88 984.72 662.04 519.74 510.37
</TABLE>
26
<PAGE>
The following tables describe the allocation of the allowance for
credit losses among various categories of loans and certain other information
for the dates indicated. The allocation is made for analytical purposes and is
not necessarily indicative of the categories in which future losses may occur.
The total allowance is available to absorb losses from any segment of loans.
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1998 1997
------------------- -------------------
Percent of Percent of
Loans to Loans to
Amount Total Loans Amount Total Loans
------ --------- ------ ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance of allowance for credit losses applicable to:
Commercial and industrial ........... $ 198 15.22% $ 26 15.52%
Real estate:
Construction and land development ... 1 8.89% -- 3.17%
1-4 family residential .............. 64 7.06% 16 4.82%
Commercial mortgage ................. 233 18.62% 51 20.28%
Multi-family ........................ -- 0.67% -- 0.82%
Consumer ................................. 49 49.54% 95 55.39%
Unallocated .............................. 1,399 -- 1,811 --
------ --------- ------ ---------
Total allowance for credit losses ........ $1,944 100.00% $1,999 100.00%
====== ========= ====== =========
<CAPTION>
December 31,
--------------------------------------------------------------
1996 1995 1994
-------------------- ------------------- -------------------
Percent of Percent of Percent of
Loans to Loans to Loans to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ -----------
Balance of allowance for credit losses applicable to:
Commercial and industrial ....... $ 105 14.52% $ 8 10.76% $ 11 9.81%
Real estate:
Construction and land development 7 2.76% -- 3.20% -- 1.98%
1-4 family residential .......... 19 2.60% 1 2.72% -- 2.31%
Commercial mortgage ............. 11 9.87% 61 10.76% 47 7.97%
Multi-family .................... -- 0.52% -- 0.06% -- 0.87%
Consumer ............................. 89 69.73% 53 72.50% 57 77.06%
Unallocated .......................... 1,199 -- 1,062 -- 1,115 --
------ ----------- ----- ----------- ----- ----------
Total allowance for credit losses .... $1,430 100.00% $1,185 100.00% $1,230 100.00%
====== =========== ====== =========== ====== ==========
</TABLE>
The Company believes that the allowance for credit losses at December
31, 1998 is adequate to cover losses inherent in the portfolio as of such date.
There can be no assurance, however, that the Company will not sustain losses in
future periods, which could be substantial in relation to the size of the
allowance at December 31, 1998.
27
<PAGE>
Securities Portfolio
The Company uses its securities portfolio to ensure liquidity for cash
flow requirements, to manage interest rate risk, to provide a source of income,
to ensure collateral is available for municipal pledging requirements and to
manage asset quality diversification. Mortgage-backed securities are securities
which have been developed by pooling a number of real estate mortgages and are
principally issued by federal agencies such as the Federal National Mortgage
Association and the Federal Home Loan Mortgage Corporation. These securities are
deemed to have high credit ratings, and minimum regular monthly cash flows of
principal and interest are guaranteed by the issuing agencies.
At December 31, 1998, 19.6% of the mortgage-backed securities held by
the Company had final maturities of more than ten years. However, unlike U.S.
Treasury and U.S. Government agency securities, which have a lump sum payment at
maturity, mortgage-backed securities provide cash flows from regular principal
and interest payments and principal prepayments throughout the lives of the
securities. Therefore, the average life, or the average amount of time until the
Company receives the total amount invested, of the mortgage-backed security will
be shorter than the contractual maturity. The Company estimates the remaining
average life of the fixed-rate mortgage backed security portfolio to be less
than six years. Mortgage-backed securities which are purchased at a premium will
generally suffer decreasing net yields as interest rates drop because home
owners tend to refinance their mortgages. Thus, the premium paid must be
amortized over a shorter period. Therefore, securities purchased at a discount
will obtain higher net yields in a decreasing interest rate environment. As
interest rates rise, the opposite will generally be true. During a period of
increasing interest rates, fixed-rate mortgage-backed securities do not tend to
experience heavy prepayments of principal and consequently, the average life of
this security will not be unduly shortened. If interest rates begin to fall,
prepayments will increase. Approximately $5.7 million of the Company's
mortgage-backed securities earn interest at floating rates and reprice within
one year, and accordingly are less susceptible to declines in value should
interest rates increase.
At the date of purchase, the Company is required to classify debt and
equity securities into one of three categories: held-to-maturity, trading or
available-for-sale. At each reporting date, the appropriateness of the
classification is reassessed. Investments in debt securities are classified as
held-to-maturity and measured at amortized cost in the financial statements only
if management has the positive intent and ability to hold those securities to
maturity. Securities that are bought and held principally for the purpose of
selling them in the near term are classified as trading and measured at fair
value in the financial statements with unrealized gains and losses included in
earnings. Investments not classified as either held-to-maturity or trading are
classified as available-for-sale and measured at fair value in the financial
statements with unrealized gains and losses reported, net of tax, in a separate
component of stockholders' equity until realized. In order to pro-actively
manage the investment portfolio and asset/liability position and to respond to
changes in the fixed income market, the Company maintains 100% of securities
owned as available-for-sale.
28
<PAGE>
The following table presents the amount of securities classified as
available-for-sale and their approximate values at December 31, 1998, December
31, 1997 and December 31, 1996:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------------------------------- -----------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Cost Gain Loss Value Cost Gain Loss Value
--------- ---------- ---------- ------- --------- ---------- ---------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities ......... $ 5,736 $ 129 $ -- $ 5,865 $14,249 $ 60 $ (21) $14,288
U.S. Government agency
securities .................. 9,516 40 (15) 9,541 20,589 31 -- 20,620
Mortgage-backed securities ....... 42,097 220 (34) 42,283 22,260 85 (92) 22,253
Other securities ................. 11,311 251 (16) 11,546 5,707 95 -- 5,802
------- ------- ------- ------- ------- ------- ------- -------
Total ....................... $68,660 $ 640 $ (65) $69,235 $62,805 $ 271 $ (113) $62,963
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
December 31, 1996
------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
--------- ---------- ---------- -------
(Dollars in thousands)
U.S. Treasury securities .......... $ 6,024 $ -- $ (47) $ 5,977
U.S. Government agency
securities ................... 9,557 30 (62) 9,525
Mortgage-backed securities ........ 25,844 61 (321) 25,584
Other securities .................. 2,606 56 (3) 2,659
------- ------- ------- -------
Total ........................ $44,031 $ 147 $ (433) $43,745
======= ======= ======= =======
The following table summarizes the contractual maturity of investment
securities and their weighted average yields:
<TABLE>
<CAPTION>
December 31, 1998
----------------------------------------------------------------------------------------
After One After Five
Within Year but Within Years but Within
One Year Five Years Ten Years After Ten Years
---------------- ---------------- ---------------- ----------------
Amount Yield Amount Yield Amount Yield Amount Yield Total Yield
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities ..... $ 2,716 5.89% $ 3,020 6.21% $ -- 0.00% $ -- -- $ 5,736 6.06%
U.S. Government agency
securities .............. 1,018 5.87% 4,503 6.10% 3,995 6.10% -- -- 9,516 6.08%
Mortgage-backed
securities ................... 7,129 5.62% 11,106 6.10% 15,619 6.56% 8,243 6.29% 42,097 6.23%
Other securities ............. 2,169 5.78% 859 6.59% 2,531 6.80% 5,752 7.21% 11,311 6.80%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total ................... $13,032 5.72% $19,488 6.14% $22,145 6.50% $13,995 6.67% $68,660 6.28%
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
</TABLE>
At December 31, 1998, securities totaled $69.2 million, an increase of
$6.2 million from $63.0 million at December 31, 1997. During 1997, securities
increased $19.0 million from $44.0 million at December 31, 1996. Increases in
the portfolio are a result of securities acquired in the 1997 Acquisitions and
investment of excess liquidity.
29
<PAGE>
Deposits
The Company offers a variety of deposit accounts having a wide range of
interest rates and terms. The Company's deposits consist of demand, savings,
money market and time accounts. The Company relies primarily on competitive
pricing policies, customer service, and employee goals and referrals to attract
and retain these deposits. The Company does not have or accept any brokered
deposits.
Total deposits at December 31, 1998 increased to $252.7 million from
$249.1 million at December 31, 1997, an increase of $3.6 million or 14.45%. The
increase was primarily due to internal growth and public fund deposit
fluctuations. Deposits in 1997 rose to $249.1 million from $173.3 million in
1996, an increase of $75.8 million or 43.74%. The increase resulted primarily
from the 1997 Acquisitions. The Company's ratio of average noninterest-bearing
demand deposits to average total deposits for years ended December 31, 1998,
1997 and 1996 were 25.34%, 19.32% and 17.67%, respectively.
The daily average balances and weighted average rates paid on interest
bearing deposits for each of the years ended December 31, 1997, 1996 and 1995
are presented below:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------------------------------------
1998 1997 1996
------------------------ ------------------------ ------------------------
Amount Rate Amount Rate Amount Rate
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
NOW .................................... $ 29,467 1.14% $ 20,186 1.20% $ 17,232 1.20%
Public Funds ........................... 3,034 4.32% 5,358 1.98% 5,696 1.83%
Regular savings ........................ 15,393 2.17% 9,597 2.30% 8,414 2.17%
Money market ........................... 12,634 2.74% 13,279 2.58% 10,735 2.34%
Investor's savings & Liquidity
Plus ................................... 28,390 4.28% 20,185 4.32% 23,140 4.12%
Time deposits less than $100,000 ....... 77,932 5.15% 67,248 5.34% 60,897 5.37%
Time deposits $100,000 and over ........ 16,423 5.84% 7,457 5.48% 7,691 5.57%
-------- -------- -------- -------- -------- --------
Total interest-bearing
deposits ......................... 183,273 4.00% 143,310 4.04% 133,805 4.03%
Noninterest-bearing deposits ........... 62,204 -- 34,325 -- 28,717 --
-------- -------- -------- -------- -------- --------
Total deposits .................... $245,477 2.99% $177,635 3.26% $162,522 3.32%
======== ======== ======== ======== ======== ========
</TABLE>
The following table sets forth the amount of the Company's certificates
of deposit that are $100,000 or greater by time remaining until maturity:
December 31, 1998
-----------------------
(Dollars in thousands)
Three months or less .................................... $ 3,377
Over three months through 12 months ..................... 4,479
Over one year through three years ....................... 7,632
Over three years ........................................ 900
-------
Total .............................................. $16,388
=======
30
<PAGE>
Interest Rate Sensitivity and Liquidity
The Company's Asset/Liability Management and Interest Rate Risk Policy,
along with the Company's Investment Policy, provides management with the
necessary guidelines for effective funds management. The Company has established
a measurement system for monitoring its net interest rate sensitivity position.
The Company manages its sensitivity position within established guidelines.
An interest rate sensitive asset or liability is one that, within a
defined time period, either matures or experiences an interest rate change in
line with general market interest rates. The management of interest rate risk is
performed by analyzing the maturity and repricing relationships between
interest-earnings assets and interest-bearing liabilities at specific points in
time ("GAP") and by analyzing the effects of interest rate changes on net
interest income over specific periods of time by projecting the performance of
the mix of assets and liabilities in varied interest rate environments. Interest
rate sensitivity reflects the potential effect on net interest income of a
movement in interest rates. A company is considered to be asset sensitive, or
having a positive GAP, when the amount of its interest-earning assets maturing
or repricing within a given period exceeds the amount of its interest-bearing
liabilities also maturing or repricing within that time period. Conversely, a
company is considered to be liability sensitive, or having a negative GAP, when
the amount of its interest-bearing liabilities maturing or repricing within a
given period exceeds the amount of its interest-earning assets also maturing or
repricing within that time period. During a period of rising interest rates, a
negative GAP would tend to affect net interest income adversely, while a
positive GAP would tend to result in an increase in net interest income. During
a period of falling interest rates, a negative GAP would tend to result in an
increase in net interest income, while a positive GAP would tend to affect net
interest income adversely. However, it is management's intent to achieve a
proper balance so that incorrect rate forecasts should not have a significant
impact on earnings.
Shortcomings are inherent in GAP analysis since certain assets and
liabilities may not move proportionally as interest rates change. Consequently,
in addition to GAP analysis the Company uses a simulation model and shock
analysis to test the interest rate sensitivity of net interest income and the
balance sheet, respectively. Contractual maturities and repricing opportunities
of loans are incorporated in the model as are prepayment assumptions, maturity
data and call options within the investment portfolio. Assumptions based on past
experience are incorporated into the model for non-maturity deposit accounts.
The Company has found that historically, interest rates on these deposits change
more slowly in a rising rate environment than in a declining rate environment.
31
<PAGE>
The following table sets forth an interest rate sensitivity analysis
for the Company at December 31, 1998:
<TABLE>
<CAPTION>
Volumes Subject to Repricing Within
-------------------------------------------------------------
0-90 91-180 181-365 After
days days days one year Total
--------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Securities ................... $ 1,386 $ 1,241 $ 8,647 $ 57,961 $ 69,235
Loans ........................ 8,844 6,274 8,844 147,570 171,532
Federal sold and other
temporary investments ..... 9,990 -- -- -- 9,990
--------- --------- --------- --------- ---------
Total interest-earning
assets ............................ 20,220 7,515 17,491 205,531 250,757
--------- --------- --------- --------- ---------
Interest-bearing liabilities:
Demand, money market and
savings deposits ....... 97,164 -- -- -- 97,164
Certificates of deposit and
other time deposits .... 12,545 12,487 24,177 45,569 94,778
Federal Home Loan Bank advance -- -- 3,000 -- 3,000
--------- --------- --------- --------- ---------
Total interest-bearing
liabilities ....................... 109,709 12,487 27,177 45,569 194,942
--------- --------- --------- --------- ---------
Period GAP ........................ $ (89,489) $ (4,972) $ (9,686) $ 159,962 $ 55,815
Cumulative GAP .................... $ (89,489) $ (94,461) $(104,147) $ 55,815 --
Period GAP to total assets ........ (32.39%) (1.80%) (3.51%) 57.90% --
Cumulative GAP to total assets .... (32.39%) (34.19%) (37.69%) 20.20% --
</TABLE>
Liquidity involves the Company's ability to raise funds to support
asset growth or reduce assets to meet deposit withdrawals and other payment
obligations, to maintain reserve requirements and otherwise to operate the
Company on an ongoing basis. The Company's liquidity needs are primarily met by
growth in core deposits. Although access to purchased funds from correspondent
banks is available and has been utilized on occasion to take advantage of
investment opportunities, the Company does not rely on these external funding
sources. The cash and federal funds sold position, supplemented by amortizing
investments along with payments and maturities within the loan portfolio, have
historically created an adequate liquidity position.
Federal Home Loan Bank ("FHLB") advances may be utilized from time to
time as either a short- term funding source or a longer-term funding source.
FHLB advances can be particularly attractive to balance interest rate
sensitivity and reduce interest rate risk. The Company is eligible for two
borrowing programs through the FHLB. The first, called "Short Term Fixed,"
requires delivery of eligible securities for collateral. Maturities under this
program range from 1-35 days. The Company does not currently have any borrowings
under this program. The second borrowing program, the "Blanket Borrowing
Program," is under a borrowing agreement which does not require the delivery of
specific collateral but is limited to 65% of the Company's 1-4 family
residential mortgage loans. As of December 31, 1998, the Company had borrowings
of $3.0 million under this program for a one year term.
32
<PAGE>
Capital Resources
Capital management consists of providing equity to support both current
and future operations. The Company is subject to capital adequacy requirements
imposed by the Federal Reserve and the Bank is subject to capital adequacy
requirements imposed by the OCC. Both the Federal Reserve and the OCC have
adopted risk-based capital requirements for assessing bank holding company and
bank capital adequacy. These standards define capital and establish minimum
capital requirements in relation to assets and off-balance sheet exposure,
adjusted for credit risk. The risk-based capital standards currently in effect
are designed to make regulatory capital requirements more sensitive to
differences in risk profiles among bank holding companies and banks, to account
for off-balance sheet exposure and to minimize disincentives for holding liquid
assets. Assets and off-balance sheet items are assigned to broad risk
categories, each with appropriate relative risk weights. The resulting capital
ratios represent capital as a percentage of total risk-weighted assets and
off-balance sheet items.
The risk-based capital standards issued by the Federal Reserve require
all financial bank holding companies to have "Tier 1 capital" of at least 4.0%
and "total risk-based" capital (Tier 1 and Tier 2) of at least 8.0% of total
risk-adjusted assets. "Tier 1 capital" generally includes common stockholders'
equity and qualifying perpetual preferred stock together with related surpluses
and retained earnings, less deductions for goodwill and various other
intangibles. "Tier 2 capital" may consist of a limited amount of
intermediate-term preferred stock, a limited amount of term subordinated debt,
certain hybrid capital instruments and other debt securities, perpetual
preferred stock not qualifying as Tier 1 capital, and a limited amount of the
general valuation allowance for credit losses. The sum of Tier 1 capital and
Tier 2 capital is "total risk-based capital."
The Federal Reserve has also adopted guidelines which supplement the
risk-based capital guidelines with a minimum ratio of Tier 1 capital to average
total consolidated assets ("leverage ratio") of 3.0% for institutions with well
diversified risk, including no undue interest rate exposure; excellent asset
quality; high liquidity; good earnings; and that are generally considered to be
strong banking organizations, rated composite 1 under applicable federal
guidelines, and that are not experiencing or anticipating significant growth.
Other banking organizations are required to maintain a leverage ratio of at
least 4.0% to 5.0%. These rules further provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
capital positions substantially above the minimum supervisory levels and
comparable to peer group averages, without significant reliance on intangible
assets.
Pursuant to FDICIA, each federal banking agency revised its risk-based
capital standards to ensure that those standards take adequate account of
interest rate risk, concentration of credit risk and the risks of nontraditional
activities, as well as reflect the actual performance and expected risk of loss
on multifamily mortgages. The Bank is subject to capital adequacy guidelines of
the OCC that are substantially similar to the Federal Reserve's guidelines. Also
pursuant to FDICIA, the OCC has promulgated regulations setting the levels at
which an insured institution such as the Bank would be considered "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under the OCC's
regulations, the Bank is classified "well capitalized" for purposes of prompt
corrective action. See "Business-Supervision and Regulation-The Company" and
"The Bank."
Stockholder's equity increased to $26.5 million at December 31, 1998
from $24.6 million at December 31, 1997, an increase of $1.9 million or 7.72%.
This increase was primarily the result of $2.7 million in net income offset by
dividends of $491,000, treasury stock purchases of $448,000 and an increase in
accumulated other comprehensive income of $275,000. During 1997, stockholders'
equity increased to $24.6 million from $12.9 million at December 31, 1996, an
increase of $11.7 million or 90.70%. This increase was primarily the result of
the Company's initial public offering of 690,000 shares in the fourth quarter of
1997, net income of $1.8 million offset by cash dividends of $367,000 and
accumulated other comprehensive income, net of tax, of $293,000.
The following table provides a comparison of the Company's and the
Bank's leverage and risk weighted capital ratios as of December 31, 1998 and the
regulatory standards:
33
<PAGE>
Minimum Actual Ratio
Required Well-Capitalized December 31, 1998
----------- ---------------- ----------------
The Company
Leverage ratio ............. 3.00%(1) N/A 6.84%
Tier 1 risk-based capital .. 4.00% N/A 9.72%
Risk-based capital ratio ... 8.00% N/A 10.72%
The Bank
Leverage ratio ............. 3.00%(2) 5.00% 6.76%
Tier 1 risk-based capital .. 4.00% 6.00% 9.63%
Risk-based capital ratio ... 8.00% 10.00% 10.63%
- ----------------------------------
(1) The Federal Reserve may require the Company to maintain a leverage ratio
of up to 200 basis points above the required minimum.
(2) The OCC may require the Bank to maintain a leverage ratio of up to 200
basis points above the required minimum.
YEAR 2000
GENERAL. The Year 2000 problem affects computers, computer software,
and other devices which contain an embedded computer chip that are not able to
perform without interruption into the Year 2000. If computer systems do not
correctly recognize the date change from December 31, 1999 to January 1, 2000,
computer applications that rely on the date field could fail or create erroneous
results. Such erroneous results could affect interest calculations, payments or
due dates or cause the temporary inability to process transactions, send
invoices or engage in similar normal business activities. If these issues are
not addressed by the Company, its correspondent institutions, its suppliers, and
its significant depository and/or borrowing customers, there could be a material
adverse impact on the Company's financial condition or results of operations.
STATE OF READINESS. The Company established a Year 2000 Action
Committee in 1997 to insure there will be no material adverse effects on
customers or disruption of business operations as a result of a failure of the
Company or its third parties to properly process any data on or after January 1,
2000. This committee is comprised of senior management of the Company, as well
as the manager of each department of the Bank. The Board of Directors and senior
management of the Company fully support the Year 2000 initiative and have
allocated sufficient resources to ensure the timely completion of this project.
The committee established a Year 2000 plan, approved by the Board of Directors
of the Company, which is comprised of five phases: Awareness, Assessment,
Renovation, Validation and Implementation. This plan, as well as the Company's
compliance with the Year 2000 initiative, was reviewed by the OCC in 1998.
The Company completed both the Awareness and Assessment phases in the
third quarter of 1997. An inventory of all systems and products (including both
information technology ("IT") and non-information technology ("non-IT") systems)
was performed, and a risk assessment and prioritization of those systems
completed. The Company performs all of its processing in-house, although it does
not utilize any internally developed programming. The computer hardware and
operating system utilized for processing are IBM products which have been
certified as Year 2000 compliant by IBM. The mainframe computer application is
also certified as Year 2000 compliant by its developer, Jack Henry & Associates.
All other hardware and software utilized is provided by established companies
who retain the responsibility for Year 2000 compliance of their product. All
respective vendors of such companies (for both IT and non-IT applications) were
contacted to determine the Year 2000 status of their systems. Their responses
are being actively monitored and testing strategies and schedules have been
developed based on such responses.
34
<PAGE>
The Company is completing the Renovation and Validation phases of its
Year 2000 plan. The Renovation phase includes hardware and software upgrades,
system replacements, vendor certifications and other associated changes. The
Validation phase includes testing upgraded components, verifying connections
with other systems and acceptance of changes by internal and external customers.
The Company completed testing of the Bank's mainframe system and associated
software in January 1999 and all other mission critical systems have been
tested. Validation of the testing results is in progress and should be completed
by the end of the first quarter of 1999. The Company anticipates that the
Implementation phase will be completed by the end of the second quarter of 1999.
In this phase, systems are certified as Year 2000 compliant and accepted by
users. For any systems which fail certification, the Company's contingency plan
will be implemented for that particular application.
COSTS OF COMPLIANCE. Management does not expect that the costs for
bringing affected hardware and software applications into Year 2000 compliance
will have a material adverse effect on the Company's financial condition,
results of operations or liquidity. However, management's ability to predict the
cost associated with Year 2000 compliance is subject to some uncertainties.
While the Company has made efforts to obtain appropriate representations and
assurances from third party vendors and other organizations that such entities
will be able to meet all of their obligations to the Company without disruption
as a result of the Year 2000 issue, there can be no assurance that the Company
will not be adversely impacted by the failure of such third-party entities to
achieve Year 2000 compliance.
RISKS RELATED TO THIRD PARTIES. During the second quarter of 1998, the
Company performed a risk assessment of the potential impact of third parties'
failure to adequately address the Year 2000 problem. The Company identified its
largest dollar deposit relationships (aggregate deposits over $500,000) and loan
customers (loan relationships of $200,000 or more), yielding 260 customers were
sent a Year 2000 questionnaire. The Company received 184 responses (71%) from
the survey. An assessment of risk was made regarding non-responding customers
based upon the servicing officer's knowledge of the customer. The survey results
reflect that the majority of the Company's customers are aware of the Year 2000
issue and those which are dependent upon software and/or hardware which may
affect their business operation have acquired compliant software, or are
beginning to start a process to assure compliance by the Year 2000. Out of those
surveyed, only a few customers were deemed to have a moderate risk profile. The
Company intends to monitor such customer's progress in resolving any Year 2000
problems to determine whether any further action should be undertaken by the
Company to limit its exposure from that customer. In the event that Year 2000
noncompliance adversely affects borrowers, the Company may be required to
charge-off the loan to such borrowers. For a discussion of possible effects of
such charge-offs, see "Contingency Plans" below.
The Company relies upon the Federal Reserve Bank for electronic fund
transfers and check clearing, and understands that the Federal Reserve expected
its systems would be Year 2000 compliant by the end of 1998. With respect to its
borrowers, the Company includes in its loan documents a Year 2000 disclosure
form and an addendum to the loan agreement in which the borrower represents and
warrants its Year 2000 compliance to the Company. In addition, the Company
continues to be proactive in providing information about the Year 2000 problem
to its customer base, as well as to the communities it serves.
CONTINGENCY PLANS. The Company's Year 2000 preliminary contingency plan
was approved by the Board of Directors in November 1998. The Company is in the
process of finalizing its contingency planning with respect to the Year 2000
date change and believes that if its own systems should fail, the Company could
convert to a manual entry system for a period of up to three months without
significant losses. The Company believes that any mission critical systems could
be recovered and operating within three to five days. In the event that the
Federal Reserve is unable to handle electronic funds transfers and check
clearing, the Company does not expect the impact to be material to its financial
condition or results of operations as long as the Company is able to utilize an
alternative funds transfer and clearing source. As part of its contingency
planning, the Company has reviewed its loan customer base and the potential
impact on capital of Year 2000 noncompliance. Based upon such review, using what
it considers to be a reasonable worst case scenario, the Company has assumed
that certain of its commercial borrowers whose businesses are most likely to be
affected by Year 2000 noncompliance would be unable to repay their loans,
resulting in charge-offs of loan amounts in excess of collateral values. If such
were the case, the Company believes that it is unlikely that its exposure would
exceed $100,000, although there are no assurances that this amount will not be
substantially higher. Management does not believe that this amount is material
enough for the Company to adjust its current methodology for making provisions
to the allowance for credit losses. In addition, the Company plans to maintain
additional cash on hand to meet any unusual deposit withdrawal activity.
35
<PAGE>
ITEM 7 - FINANCIAL STATEMENTS
The financial statements, the reports thereon, the notes thereto and
supplementary data commence at page F-1 of this Annual Report on Form 10-KSB.
ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants or any
matter of accounting principles or practices, financial statement disclosure or
auditing scope or procedure during the two year period ended December 31, 1998.
PART III
ITEM 9 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information under the captions "Election of Directors," "Continuing
Directors and Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's Proxy Statement for the 1999 Annual
Meeting of Shareholders (the "1999 Proxy Statement") is incorporated herein by
reference in response to this item.
ITEM 10 - EXECUTIVE COMPENSATION
The information under the caption "Executive Compensation and Other
Matters" in the 1999 Proxy Statement is incorporated herein by reference in
response to this item.
ITEM 11- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Beneficial Ownership of Common Stock
by Management of the Company and Principal Shareholders" in the 1999 Proxy
Statement is incorporated herein by reference in response to this item.
ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Interests of Management and Others
in Certain Transactions" in the 1999 Proxy Statement is incorporated herein by
reference in response to this item.
ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K
36
<PAGE>
Exhibits
EXHIBIT
NUMBER DESCRIPTION
2.1 Agreement and Plan of Consolidation by and between Bay
Bancshares, Inc., Bayshore National Bank and Texas Bank and
certain shareholders of Texas Bank dated June 24, 1997,
together with the exhibits thereto (incorporated herein by
reference to Exhibit 10.3 to the Company's Registration
Statement on Form S-1 (Registration No. 333-36185) (the
"Registration Statement")).
2.2 Agreement and Plan of Consolidation by and between Bay
Bancshares, Inc., Bayshore National Bank and Texas National
Bank of Baytown dated August 7, 1997, together with the
exhibits thereto (incorporated herein by reference to Exhibit
10.4 to the Registration Statement).
2.3 Agreement and Plan of Consolidation by and between Bay
Bancshares, Inc., Bayshore National Bank and First Bank of
Deer Park dated August 7, 1997, together with the exhibits
thereto (incorporated herein by reference to Exhibit 10.5 to
the Registration Statement).
3.1 Amended and Restated Articles of Incorporation of the Company
(incorporated herein by reference to Exhibit 3.1 to the
Registration Statement).
3.2 Amended and Restated Bylaws of the Company (incorporated
herein by reference to Exhibit 3.2 to the Registration
Statement).
4 Specimen form of certificate evidencing the Common Stock
(incorporated herein by reference to Exhibit 4 to the
Registration Statement).
10.1 Bay Bancshares, Inc. 1997 Stock Incentive Plan (incorporated
herein by reference to Exhibit 10.1 to the Registration
Statement).
10.2 Amended and Restated Bay Bancshares, Inc. 1997 Stock Option
Plan (incorporated herein by reference to Exhibit 10.2 to the
Registration Statement).
10.3 Bay Bancshares, Inc. 1993 Phantom Stock Plan (incorporated
herein by reference to Exhibit to the Registration Statement).
21 Subsidiaries of the Company.
*23 Consent of Grant Thornton LLP
*27 Financial Data Schedule
* Filed herewith.
Reports on Form 8-K
The Company did not file any reports on Form 8-K during the fourth
quarter of 1998.
37
<PAGE>
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, Bay Bancshares, Inc., has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of La Porte and State of Texas on March 30, 1999.
BAY BANCSHARES, INC.
By: /s/ L.D. WRIGHT
-------------------------------------
L.D. Wright
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed by the following persons on behalf of the
registrant and in the indicated capacities on March 30, 1999.
SIGNATURE POSITION
--------- --------
/s/ L.D. WRIGHT Chief Executive Officer and Director
L.D. Wright (principal executive officer)
/s/ KIM E. LOVE Controller and Director
Kim E. Love (principal financial officer and
principal accounting officer)
/s/ DOUG LATIMER Chairman of the Board
Doug Latimer
/s/ LINDSAY R. PFEIFFER Vice Chairman of the Board
Lindsay R. Pfeiffer
/s/ ALBERT D. FIELDS Director
Albert D. Fields
/s/ KNOX W. ASKINS Director
Knox W. Askins
/s/ EDDIE V. GRAY Director
Eddie V. Gray
/s/ KEN STRUM Director
Ken Strum
/s/ JAMES N. WALLACE Director
James N. Wallace
/s/ RUEDE M. WHEELER, D.D.S. Director
Ruede M. Wheeler, D.D.S.
38
<PAGE>
FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS
BAY BANCSHARES, INC. AND SUBSIDIARIES
DECEMBER 31, 1998 AND 1997
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Bay Bancshares, Inc.
We have audited the accompanying consolidated balance sheets of Bay
Bancshares, Inc. and Subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of earnings, comprehensive income, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Bay Bancshares, Inc. and
Subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
/S/GRANT THORNTON LLP
Houston, Texas
January 22, 1999
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
(Dollars in thousands, except share amounts)
ASSETS 1998 1997
-------- --------
Cash and cash equivalents
Cash and due from banks ........................... $ 15,466 $ 18,165
Federal funds sold ................................ 9,990 21,900
-------- --------
Total cash and cash equivalents ............... 25,456 40,065
Interest-bearing deposits with banks ................. -- 492
Securities available-for-sale ........................ 69,235 62,963
Loans, net of allowance for credit losses of
$1,944 and $1,999 .................................... 169,588 153,766
Bank premises and equipment, net ..................... 8,588 7,241
Other real estate .................................... 422 438
Accrued interest receivable .......................... 1,480 1,809
Other assets ......................................... 9,513 9,520
-------- --------
$284,282 $276,294
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing ............................. $ 60,776 $ 66,397
Interest-bearing deposits ....................... 191,942 182,690
-------- --------
Total deposits ................................ 252,718 249,087
Accrued interest payable .......................... 576 691
Borrowings ........................................ 3,000 --
Other liabilities ................................. 1,446 1,967
-------- --------
Total liabilities ............................. 257,740 251,745
Commitments and contingencies ........................ -- --
Stockholders' equity
Common stock, $1 par value, 50,000,000
shares authorized; 2,091,029 shares issued;
2,017,603 shares outstanding in 1998 and
2,049,103 shares outstanding in 1997 ............ 2,091 2,091
Additional paid-in capital ........................ 17,542 17,541
Retained earnings ................................. 7,252 5,087
Accumulated other comprehensive income ............ 379 104
-------- --------
27,264 24,823
Less 73,426 and 41,926 shares of common
stock in treasury - at cost ..................... 722 274
-------- --------
Total stockholders' equity .................... 26,542 24,549
-------- --------
$284,282 $276,294
======== ========
The accompanying notes are an integral part of these statements.
F-2
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Year ended December 31,
(Dollars in thousands, except per share amounts)
1998 1997 1996
-------- -------- --------
Interest income
Loans, including fees .............. $ 14,948 $ 10,584 $ 9,594
Securities ......................... 4,114 2,834 2,612
Federal funds sold ................. 609 669 460
-------- -------- --------
Total interest income .......... 19,671 14,087 12,666
Interest expense
Deposits ........................... 7,332 5,783 5,396
Other .............................. 73 21 47
-------- -------- --------
Total interest expense ......... 7,405 5,804 5,443
-------- -------- --------
Net interest income ............ 12,266 8,283 7,223
Provision for credit losses ........... 480 456 510
-------- -------- --------
Net interest income
after provision for
credit losses ............... 11,786 7,827 6,713
Noninterest income
Service charges .................... 2,478 1,617 1,379
Other .............................. 1,639 1,038 968
-------- -------- --------
Total noninterest income ....... 4,117 2,655 2,347
Noninterest expense
Salaries and employee benefits ..... 6,248 3,958 3,377
Occupancy expenses, net ............ 1,790 1,229 1,131
Other operating expenses ........... 3,804 2,631 2,559
-------- -------- --------
Total noninterest expenses ..... 11,842 7,818 7,067
-------- -------- --------
Earnings before income
taxes ........................ 4,061 2,664 1,993
Provision for income taxes
Current ............................ 1,341 952 766
Deferred expense (benefit) ......... 64 (82) (175)
-------- -------- --------
1,405 870 591
-------- -------- --------
NET EARNINGS ................... $ 2,656 $ 1,794 $ 1,402
======== ======== ========
Earnings per share (basic) ............ $ 1.30 $ 1.22 $ 1.04
======== ======== ========
Earnings per share (diluted) .......... $ 1.25 $ 1.16 $ .97
======== ======== ========
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year ended December 31,
(Dollars in thousands, except per share amounts)
1998 1997 1996
------- ------- -------
Net earnings .................................. $ 2,656 $ 1,794 $ 1,402
Other comprehensive income, net of tax
Unrealized gains (losses) on securities
Unrealized holding gains (losses) arising
during period .............................. 308 301 (47)
Less: reclassification adjustment for
(gains) losses included in net earnings (33) (8) 13
------- ------- -------
275 293 (34)
------- ------- -------
Comprehensive income ................... $ 2,931 $ 2,087 $ 1,368
======= ======= =======
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Years ended December 31, 1996, 1997 and 1998
(In thousands)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER COMMON TOTAL
ADDITIONAL RETAINED COMPREHENSIVE STOCK IN STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS INCOME TREASURY EQUITY
-------- -------- -------- -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996 ........ 1,385 $ 1,385 $ 8,320 $ 2,582 $ (155) $ (229) $ 11,903
Net earnings ...................... -- -- -- 1,402 -- -- 1,402
Issuance of stock ................. 6 6 24 -- -- -- 30
Treasury stock purchased .......... -- -- -- -- -- (48) (48)
Dividends ......................... -- -- -- (324) -- -- (324)
Other comprehensive income, net ... -- -- -- -- (34) -- (34)
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1996 ...... 1,391 1,391 8,344 3,660 (189) (277) 12,929
Net earnings ...................... -- -- -- 1,794 -- -- 1,794
Net proceeds from issuance of stock 700 700 9,197 -- -- -- 9,897
Treasury stock sold ............... -- -- -- -- -- 3 3
Dividends ......................... -- -- -- (367) -- -- (367)
Other comprehensive income, net ... -- -- -- -- 293 -- 293
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1997 ...... 2,091 2,091 17,541 5,087 104 (274) 24,549
Net earnings ...................... -- -- -- 2,656 -- -- 2,656
Net proceeds from issuance of stock -- -- 1 -- -- -- 1
Treasury stock purchased .......... -- -- -- -- -- (448) (448)
Dividends ......................... -- -- -- (491) -- -- (491)
Other comprehensive income, net ... -- -- -- -- 275 -- 275
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1998 ...... 2,091 $ 2,091 $ 17,542 $ 7,252 $ 379 $ (722) $ 26,542
======== ======== ======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of this statement.
F-5
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
---------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities
Net earnings ...................................... $ 2,656 $ 1,794 $ 1,402
Adjustments to reconcile net earnings to net cash
provided (used) by operating activities
Provision for credit losses ..................... 480 456 510
Depreciation and amortization ................... 878 624 619
Amortization of premiums, net of accretion of
discounts on securities ....................... 194 74 51
Gain on sale of bank premises and equipment ..... (66) (89) (69)
(Gain) loss on sale of available-for-sale
securities .................................... (50) (12) 19
Gain on sale of other real estate ............... (31) -- --
Write-(up) write-down of other real estate ...... (10) 9 5
Compensation expense related to phantom stock
plan .......................................... 64 94 114
Change in assets and liabilities, net of effects
resulting from acquisitions
Decrease (increase) in accrued interest
receivable and other assets ................. 570 (8,399) (227)
(Decrease) increase in accrued interest payable (115) 224 15
(Decrease) increase in other liabilities ...... (958) 460 (108)
-------- -------- --------
Net cash provided (used) by operating
activities ................................ 3,612 (4,765) 2,331
Cash flows from investing activities
Maturities of interest-bearing deposits with banks 492 -- 98
Proceeds from maturities, calls, and principal
repayments of available-for-sale securities ..... 27,670 8,146 4,238
Proceeds from sale of available-for-sale securities 9,602 1,012 3,954
Purchase of available-for-sale securities ......... (43,272) (4,805) (13,468)
(Increase) decrease in loans, net of the effects
resulting from acquisitions ..................... (16,404) 51 (13,544)
Proceeds from sale of other assets ................ 159 -- 21
Purchases of bank premises and equipment .......... (2,572) (1,211) (606)
Proceeds from sale of bank premises and equipment . 413 493 198
Net increase in cash resulting from acquisitions .. -- 15,715 10,354
-------- -------- --------
Net cash (used) provided by investing
activities ................................ (23,912) 19,401 (8,755)
Cash flows from financing activities
Net (decrease) increase in securities under
agreements to repurchase ........................ -- (1,000) 1,000
Change in deposits, net of the effects resulting
from acquisitions ............................... 3,631 (1,457) 8,136
Proceeds from borrowings .......................... 3,000 -- --
Repayment of borrowings ........................... -- (162) (167)
Net proceeds from issuance of stock ............... 1 9,897 30
Purchase of treasury stock ........................ (448) -- (48)
Sale of treasury stock ............................ -- 3 --
Dividends paid .................................... (493) (324) (311)
-------- -------- --------
Net cash provided by financing activities ... 5,691 6,957 8,640
-------- -------- --------
Net (decrease) increase in cash and cash
equivalents ............................... (14,609) 21,593 2,216
Cash and cash equivalents at beginning of period ..... 40,065 18,472 16,256
-------- -------- --------
Cash and cash equivalents at end of period ........... $ 25,456 $ 40,065 $ 18,472
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting policies followed in
the preparation of the consolidated financial statements. The policies
conform to generally accepted accounting principles and to general practices
within the banking industry.
1. PRINCIPLES OF CONSOLIDATION AND INVESTMENT IN SUBSIDIARIES
The consolidated financial statements include the accounts of Bay Bancshares,
Inc. (BBI) and its wholly-owned subsidiaries, Bayshore National Bank of La
Porte (BNB), Bay Bancshares of Delaware, Inc. (BBDI) and BayBanc Independent
Insurance Agency, Inc. (BBIIA), collectively referred to as the Company. All
significant intercompany accounts and transactions have been eliminated in
the consolidated financial statements of the Company.
2. CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash
on hand, amounts due from banks with a maturity at date of purchase of three
months or less, and federal funds sold.
3. SECURITIES
At the date of purchase, the Company classifies debt and equity securities
into one of three categories: held-to-maturity, trading, or
available-for-sale. At each reporting date, the appropriateness of the
classification is reassessed. Investments in debt securities are classified
as held-to-maturity and measured at amortized cost in the financial
statements only if management has the positive intent and ability to hold
those securities to maturity. Securities that are bought and held principally
for the purpose of selling them in the near term are classified as trading
and are measured at fair value in the financial statements with unrealized
gains and losses included in earnings. Investments not classified as
held-to-maturity or trading are classified as available-for-sale and are
measured at fair value in the financial statements with unrealized gains and
losses reported, net of tax, in a separate component of stockholders' equity
until realized. The Company has classified all investment securities as
available-for-sale.
Gains or losses on disposition are recorded in other income on the trade
date, based on the net proceeds and the adjusted carrying amount of the
securities sold using the specific identification method.
Declines in the fair values of individual held-to-maturity and
available-for-sale securities below their carrying value that are other than
temporary result in write-downs of the individual securities to their fair
value. The related write-downs are included in earnings as realized losses.
F-7
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
4. LOANS
The Company grants loans to customers primarily in Harris County, Texas and
surrounding counties. Although the Company has a diversified loan portfolio,
a substantial portion of its debtors' ability to honor their contracts is
dependent upon the economy in this area.
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at their
outstanding principal, adjusted for unearned discounts, any chargeoffs and
the allowance for credit losses. Accretion of unearned discount on certain
installment loans is recognized principally using the sum-of-the-periodic
balance method which approximates the level yield method. For other loans,
interest income is recognized using the simple interest method.
The Company applies SFAS No. 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A
LOAN and SFAS No. 118, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A
LOAN-INCOME RECOGNITION AND DISCLOSURES. A loan is identified as impaired
when it is probable that interest and principal will not be collected
according to the contractual terms of the loan agreement.
The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they
become due. All loans past due 90 days are placed on nonaccrual status unless
the loan is both well-secured and in the process of collection. When interest
accrual is discontinued, all unpaid accrued interest is reversed. Interest
income is subsequently recognized only to the extent cash payments are
received. Loans are returned to accrual status when payments are brought
current and, in management's judgment, the loan will continue to pay as
agreed.
5. ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is considered adequate to provide for credit
losses based on past loan loss experience and management's evaluation of the
loan portfolio under current economic conditions. While management uses
available information to recognize losses on loans, future additions to the
allowance may be necessary based on changes in economic conditions.
Recognized losses, net of recoveries, are charged to the allowance for credit
losses. Additions to the allowance are included in the consolidated
statements of earnings as provision for credit losses.
F-8
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
6. BANK PREMISES AND EQUIPMENT
Bank premises and equipment are stated at cost, less accumulated
depreciation. Depreciation is computed on the straight-line method over the
estimated useful lives of the related assets. Maintenance, repairs and minor
improvements are charged to noninterest expense as incurred.
7. OTHER REAL ESTATE AND REPOSSESSED ASSETS
Real estate properties acquired by foreclosure and repossessed assets are
recorded at fair value at the date of foreclosure, establishing a new cost
basis. After foreclosure, valuations are periodically performed by management
and the real estate is carried at the lower of carrying amount or fair value
less cost to sell. Revenue and expenses from operations and changes in the
valuation allowance are included in other non-interest expenses. Repossessed
assets consist of primarily automobiles and trucks and are presented on the
Balance Sheet as a component of other assets.
8. INCOME TAXES
The Company files a consolidated federal income tax return. By agreement with
BBI, BBDI and BBIIA, BNB records a provision or benefit for federal income
taxes on the same basis as if it filed a separate federal income tax return.
Deferred income tax assets and liabilities are reported for temporary
differences between items of income or expense reported in the financial
statements and those reported for income tax purposes. For income tax
purposes, BNB deducts the statutory provision for possible loan losses and
depreciates bank premises and equipment using accelerated methods. As changes
in tax laws or rates are enacted, deferred tax assets and liabilities are
adjusted through the provision for income taxes.
9. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
In the ordinary course of business the Company enters into off-balance sheet
financial instruments consisting of commitments to extend credit, commercial
letters of credit and standby letters of credit. Such financial instruments
are recorded in the financial statements when they are funded. Related fees
are recognized when they are incurred or received.
F-9
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
10. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
11. EARNINGS PER SHARE
Basic earnings per share is calculated by dividing net income available to
common stockholders by the weighted average number of common shares
outstanding. Dilutive earnings per share is calculated by dividing net income
available for common stockholders by the weighted average number of common
shares and dilutive potential common shares outstanding. Stock options may be
dilutive potential common shares and are therefore considered in the earnings
per share calculations, if dilutive. The number of dilutive potential common
shares is determined using the treasury stock method.
12. RECLASSIFICATIONS
Certain amounts in prior financial statements have been reclassified to
conform to the 1998 financial statement presentation.
F-10
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE B - SECURITIES
The Company has classified all securities as available-for-sale, which are
carried at fair value. The carrying amounts of securities and their
approximate fair value are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
AVAILABLE-FOR-SALE SECURITIES:
December 31, 1998:
U. S. Treasury securities .... $ 5,736 $ 129 $ -- $ 5,865
Obligations of U.S. government
agencies ................... 9,516 40 (15) 9,541
Mortgage-backed securities ... 42,097 220 (34) 42,283
Other ........................ 11,311 251 (16) 11,546
-------- -------- -------- --------
$ 68,660 $ 640 $ (65) $ 69,235
======== ======== ======== ========
December 31, 1997:
U. S. Treasury securities .... $ 14,249 $ 60 $ (21) $ 14,288
Obligations of U.S. government
agencies ................... 20,589 31 -- 20,620
Mortgage-backed securities ... 22,260 85 (92) 22,253
Other ........................ 5,707 95 -- 5,802
-------- -------- -------- --------
$ 62,805 $ 271 $ (113) $ 62,963
======== ======== ======== ========
</TABLE>
F-11
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE B - SECURITIES - CONTINUED
Gross realized gains and gross realized losses on sales of available-for-sale
securities for the periods ended are as follows as of December 31:
1998 1997 1996
----- ------ ------
Gross realized gains
U.S. Treasury securities .............. $23 $-- $20
U.S. Government Agency ................ 28 -- --
Mortgage-backed securities ............ 2 12 --
--- --- ---
$53 $12 $20
=== === ===
Gross realized losses
U.S. Government Agency ................ $ 3 $-- $--
U.S. Treasury securities .............. -- -- 39
--- --- ---
$ 3 $-- $39
=== === ===
The scheduled maturities of available-for-sale securities at December 31,
1998 are as follows.
ESTIMATED
AMORTIZED MARKET
COST VALUE
--------- ----------
Due in one year or less ...................... $ 3,734 $ 3,760
Due after one through five years ............. 7,523 7,645
Due after five through ten years ............. 3,995 4,001
Mortgage-backed securities and other ......... 53,408 53,829
------- -------
$68,660 $69,235
======= =======
Contractual maturities will differ from expected maturities because borrowers
may call or prepay obligations with or without call or prepayment penalties.
The carrying value of securities pledged to secure public deposits, as
required or permitted by law, is approximately $49,300 and $36,600 at
December 31, 1998 and 1997.
F-12
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE C - LOANS AND ALLOWANCE FOR CREDIT LOSSES
Major classifications of loans are as follows at December 31,:
1998 1997
--------- ---------
Commercial ............................... $ 26,109 $ 24,176
Real estate
Construction and land development ...... 15,248 4,941
1-4 family residential ................. 12,105 7,513
Multi-family residential ............... 1,149 1,270
Non-farm/non-residential ............... 31,943 31,594
Consumer ................................. 85,063 86,453
--------- ---------
171,617 155,947
Less unearned interest ................... (85) (182)
Allowance for credit losses .............. (1,944) (1,999)
--------- ---------
$ 169,588 $ 153,766
========= =========
As of December 31, 1998 and 1997, the Company has no significant loans which
meet the impairment definition; therefore, no valuation for credit losses
related to impaired loans has been established.
The Company has loans, deposits and other transactions with its principal
stockholders, officers, directors and organizations with which such persons
are associated. The aggregate amount of loans outstanding to these related
parties at December 31, 1998 and 1997 is approximately $2,649 and $3,415. In
addition, the Company makes consumer loans through several automobile
dealerships, two of which are controlled by two members of the board of
directors. Loans obtained through these dealerships totaled approximately
$13,810 and $12,825 at December 31, 1998 and 1997.
F-13
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE C - LOANS AND ALLOWANCE FOR CREDIT LOSSES - CONTINUED
Changes in the allowance for credit losses were as follows at December 31:
1998 1997 1996
------- ------- -------
Balance at January 1 .................. $ 1,999 $ 1,430 $ 1,185
Increase resulting from acquisitions .. -- 562 --
Provision ............................. 480 456 510
Charge-offs ........................... (695) (552) (483)
Recoveries ............................ 160 103 218
------- ------- -------
Balance at end of period .............. $ 1,944 $ 1,999 $ 1,430
======= ======= =======
NOTE D - BANK PREMISES AND EQUIPMENT
Bank premises and equipment are summarized as follows at December 31:
ESTIMATED
USEFUL LIVES 1998 1997
-------------- -------- ---------
Land - $ 2,052 $ 2,106
Building and improvements 15-30 years 6,314 5,621
Furniture and fixtures 5-10 years 5,373 4,079
Automobiles 3 years 135 62
-------- --------
13,874 11,868
Less accumulated depreciation 5,286 4,627
------- --------
$ 8,588 $ 7,241
======= ========
F-14
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE E - INTEREST BEARING DEPOSITS
The types of accounts and their respective balances included in
interest-bearing deposits are as follows at December 31:
1998 1997
-------- --------
NOW accounts ......................... $ 37,638 $ 30,630
Money market accounts ................ 26,841 17,418
Savings accounts ..................... 32,684 36,277
Other time deposits .................. 94,779 98,365
-------- --------
$191,942 $182,690
======== ========
Included in other time deposits at December 31, 1998 and 1997 are
approximately $16,400 and $15,000, in certificates of deposit in
denominations of $100,000 or more.
As of December 31, 1998, the scheduled maturities of other time deposits are
as follows:
YEAR ENDED
DECEMBER 31, AMOUNT
------------- ---------
1999....................... $49,363
2000....................... 24,960
2001....................... 11,709
2002....................... 6,273
2003 and Thereafter........ 2,474
-------
$94,779
=======
F-15
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE F - BORROWINGS
Borrowings at December 31, are as follows:
1998 1997
------- ------
Advance payable to the Federal Home Loan Bank;
principal due July 1999; interest due monthly at
5.613%............................................... $3,000 $--
====== ===
NOTE G - INCOME TAXES
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December
31 are presented below:
1998 1997
------- -------
Deferred tax assets:
Allowance for credit losses .................... $ 403 $ 374
Stock grant expense ............................ 152 150
Difference in basis of other real estate ....... 125 151
Other .......................................... 15 8
Valuation allowance ............................ (45) (123)
----- -----
$ 650 $ 560
===== =====
Deferred tax liabilities:
Depreciation and amortization differences ...... $(545) $(438)
Unrealized gain on available-
for-sale securities .......................... (197) (54)
Other .......................................... (74) (27)
----- -----
$(816) $(519)
===== =====
F-16
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE G - INCOME TAXES - CONTINUED
The reconciliation between the Company's effective income tax rate and the
statutory federal income tax rate is as follows at December 31:
1998 1997 1996
------- -------- -------
Statutory federal income tax rate ..... 34.00% 34.00% 34.00%
Decrease in valuation allowance ....... (1.92) (.11) (5.07)
Tax exempt income ..................... (2.56) (1.88) (0.95)
Other ................................. 2.08 .65 1.67
Goodwill amortization ................. 3.00 -- --
----- ----- -----
Effective income tax rate ............. 34.60% 32.66% 29.65%
===== ===== =====
The valuation allowance on the deferred tax asset was decreased by
approximately $78, $3 and $102 during 1998, 1997 and 1996 based on
management's reevaluation of the likelihood of realization.
NOTE H - COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company enters into various
transactions which, in accordance with generally accepted accounting
principles, are not included in the consolidated balance sheets. These
transactions are referred to as "off-balance sheet commitments". The Company
enters into these transactions to meet the financing needs of its customers.
These transactions include commitments to extend credit and letters of credit
which involve elements of credit risk in excess of the amounts recognized in
the consolidated balance sheets. The Company minimizes its exposure to loss
under these commitments by subjecting them to credit approval and monitoring
procedures.
The Company enters into contractual commitments to extend credit, normally
with fixed expiration dates or termination clauses, at specified rates and
for specific purposes. Customers use credit commitments to ensure that funds
will be available for working capital purposes, for capital expenditures and
to ensure access to funds at specified terms and conditions. Substantially
all of the Company's commitments to extend credit are contingent upon
customers maintaining specific credit standards at the time of loan funding.
Management assesses the credit risk associated with certain commitments to
extend credit in determining the level of the allowance for credit losses.
F-17
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE H - COMMITMENTS AND CONTINGENCIES - CONTINUED
Letters of credit are written conditional commitments issued by the Company
to guarantee the performance of a customer to a third party. The Company's
policies generally require that letters of credit arrangements contain
security and debt covenants similar to those contained in loan agreements.
Outstanding commitments and letters of credit are approximately as follows at
December 31:
1998 1997
------- -------
Commitments to extend credit ............. $22,090 $14,268
======= =======
Letters of credit ........................ $ 274 $ 277
======= =======
The Company is involved in certain claims and lawsuits occurring in the
normal course of business. Management, after consultation with outside legal
counsel, does not believe that the outcome of these actions would have a
material impact on the financial statements of the Company.
BNB has a 401(k) plan which covers substantially all employees. BNB matches
50% of each employee's contribution up to 6% of annual salary. Total
contributions accrued or paid for the period ended December 31, 1998, 1997
and 1996 are approximately $79, $58 and $27.
During 1997, the Company created the 1997 Stock Plan (the "1997 Stock Plan").
This plan authorizes the issuance of up to 150,000 shares of common stock
under both "nonqualified" and "incentive stock" options to employees and
"nonqualified" options to directors who are not employees. Under the 1997
Stock Plan, the vesting of options is governed by individual option
agreements. The option agreements provide that 20% of the options granted
vest one year from the date of grant and an additional 20% each year
thereafter. Options granted under the 1997 Stock Plan generally must be
exercised within 10 years following the date of grant.
The Company's Board of Directors and shareholders approved a new stock option
plan in 1997 (the "1997 Incentive Plan") which authorizes the issuance of up
to 1,000,000 shares of common stock under both "non-qualified" and "incentive
stock" options to employees and "non-qualified" options to directors who are
not employees. Generally, the options vest 60% at the end of the third year
following the date of grant and an additional 20% at the end of the next two
years; however, an individual option may vest as much as 20% a year during
the first two years following the date of the grant if necessary to maximize
the "incentive" tax treatment to the optionee for the particular option being
granted. Options under the 1997 Incentive Plan must be exercised within 10
years following the date of grant. No options have been granted under the
1997 Incentive Plan.
F-18
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE H - COMMITMENTS AND CONTINGENCIES - CONTINUED
Following is a summary of the status of the stock option plans:
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
---------- ----------
Options outstanding at January 1, 1997 ......... -- $ --
Options granted ($7.05-$18.50 a share) ......... 34,300 7.38
Options exercised ($7.05 a share) .............. (200) 7.05
------- ------
Options outstanding at December 31, 1997
($7.05-$18.50 a share) ....................... 34,100 7.39
Options granted ($17.00-$21.78 a share) ........ 2,500 19.87
Options exercised ($7.05 a share) .............. (300) 7.05
Options terminated ($21.78 a share) ............ (500) 21.78
------- ------
Options outstanding at December 31, 1998 ....... 35,800 $ 8.05
======= ======
Options exercisable at December 31, 1998 ....... 13,220 7.73
Options exercisable at December 31, 1997 ....... 6,660 7.39
Following is a summary of the options outstanding at December 31, 1998:
OUTSTANDING
-------------------------
WEIGHTED
AVERAGE
REMAINING
EXERCISE CONTRACTUAL EXCERCISABLE
PRICE NUMBER LIFE NUMBER
----------- -------- ------------- --------------
$ 7.05 32,800 8.48 years 12,820
$17.00 1,000 8.92 years -
$18.50 1,000 9.64 years 400
$21.78 1,000 9.15 years -
------- -------
35,800 13,220
======= =======
F-19
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE H - COMMITMENTS AND CONTINGENCIES - CONTINUED
The Company applies APB 25 and related Interpretations in accounting for
stock-based compensation. Had compensation costs been determined based on the
fair value at the grant dates for awards consistent with the method of FASB
Statement 123, the Company's net earnings and earnings per share would have
been as follows at December 31:
1998 1997
------ ------
Net earnings As reported $2,656 $1,794
Pro forma $2,633 $1,755
Basic earnings per share As reported $ 1.30 $ 1.22
Pro forma $ 1.29 $ 1.19
Diluted earnings per share As reported $ 1.25 $ 1.16
Pro forma $ 1.23 $ 1.13
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for the grants issued for December 31 were:
1998 1997
---------- ---------
Weighted average fair value $11.57 $2.78
Expected volatility 79% 29%
Risk free rate 5.5% 6.1%
Expected life of options 5 years 5 years
Expected dividend yield 1.9% 1.3%
NOTE I - ACQUISITIONS
On November 12, 1997, the Company purchased all of the assets and liabilities
of Texas Bank. The acquisition has been accounted for as a purchase and
resulted in the Company acquiring $18,595 in loans, $5,224 in investments,
and $35,532 in deposits. The purchase price was allocated based on the fair
value of the assets acquired and liabilities assumed, and the excess of the
cost over the fair value of the net assets acquired of $2,024 is being
amortized over twenty years using the straight-line method.
On November 21, 1997, the Company purchased all of the assets and liabilities
of Texas National Bank of Baytown. The acquisition has been accounted for as
a purchase and resulted in the Company acquiring $3,740 in loans, $4,066 in
investments and $11,885 in deposits. The purchase price was allocated based
on the fair value of the assets acquired and liabilities assumed, and the
excess of the cost over the fair value of the net assets acquired in the
amount of $840 is being amortized over twenty years using the straight-line
method.
F-20
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE I - ACQUISITIONS - CONTINUED
On November 21, 1997, the Company purchased all of the assets and liabilities
of First Bank of Deer Park. The acquisition has been accounted for as a
purchase and resulted in the Company acquiring $13,488 in loans, $13,998 in
investments and $29,766 in deposits. The purchase price was allocated based
on the fair value of the assets acquired and liabilities assumed, and the
excess of the cost over the fair value of the net assets acquired in the
amount of $4,117 is being amortized over twenty years using the straight-line
method.
On August 22, 1996, the Company acquired in a purchase and assumption
transaction, certain assets and liabilities of First Bank of Texas. The
acquisition has been accounted for as a purchase and resulted in the Company
acquiring approximately $800 in loans, $200 in fixed assets and $12,000 in
deposits. The excess of the cost over the fair value of the net assets
acquired in the amount of $533 is being amortized over fifteen years.
The following summarized proforma information assumes the Texas Bank, Texas
National Bank of Baytown, and First Bank of Deer Park acquisitions had
occurred on January 1, 1996:
YEAR ENDED DECEMBER 31,
1997 1996
---------- ----------
Interest income ...................... $ 19,547 $ 18,547
Net earnings ......................... $ 2,283 $ 2,400
Earnings per share (basic) ........... $ 1.55 $ 1.78
Earnings per share (diluted) ......... $ 1.47 $ 1.67
NOTE J - EXECUTIVE COMPENSATION
The Company has a phantom stock grant plan whereby the Company may issue
shares of phantom stock to certain officers and key employees. The aggregate
number of shares that may be issued under the Plan is limited to 135,000. The
number of shares issued is determined based on a financial performance test
for BNB. The phantom stock is nonvoting, accrues dividends declared on the
Company's common stock, and is granted subject to a vesting schedule.
The shares of phantom stock may be redeemed, as vested, at a maximum rate of
6,000 shares per year. Such redemption is payable, at the Company's
discretion, in shares of the Company's common stock or cash at the then fair
market value of the Company's common stock. In 1997 and 1996, 35,411 and
18,478 shares of phantom stock were granted and 6,000 shares of phantom stock
were redeemed for 6,000 shares of the Company's common stock each year.
Effective June 24, 1997, the plan was amended and no more shares will be
granted under this plan. Total compensation expense charged to the Company's
operations for the years ended December 31, 1998, 1997 and 1996 was $64, $94
and $114, respectively.
F-21
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE J - EXECUTIVE COMPENSATION - CONTINUED
The Bank has a cash incentive plan which provides guidelines whereby key
executive employees can earn bonus compensation based on the profitability of
BNB. The bonus amounts are determined based on achievement by BNB of certain
percentages of return on equity targets. Total expense under this plan for
the years ended December 31, 1998, 1997 and 1996 was $88, $117 and $78,
respectively.
NOTE K - FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, DISCLOSURE ABOUT FAIR
VALUE OF FINANCIAL INSTRUMENTS (Statement 107) and Statement of Financial
Accounting Standards No. 119, DISCLOSURES ABOUT DERIVATIVE FINANCIAL
INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS (Statement 119) requires
that the Company disclose estimated fair values for its financial
instruments. Such information, which pertains to financial instrument assets
and liabilities, is based on the requirements in Statements 107 and 119 and
does not purport to represent the aggregate net fair value of the Company.
Further, the fair value estimates are based on various assumptions,
methodologies and subjective considerations, which vary widely among
different financial institutions and which are subject to change.
The following methods and assumptions were used by the Company in estimating
financial instrument fair values:
CASH AND CASH EQUIVALENTS, FEDERAL FUNDS PURCHASED AND REPURCHASE
AGREEMENTS
The balance sheet carrying amount approximates fair value.
SECURITIES TO BE HELD-TO-MATURITY, AND SECURITIES AVAILABLE-FOR-SALE
Fair values for investment securities are based on quoted market prices or
quotations received from securities dealers. If quoted market prices are not
available, fair value estimates may be based on quoted market prices of
similar instruments, adjusted for differences between the quoted instruments
and the instruments being valued.
LOANS
Fair values of loans are estimated for segregated groupings of loans with
similar financial characteristics. Loans are segregated by type such as
commercial, commercial real estate, residential mortgage and consumer loans.
Each of these categories is further subdivided into fixed and adjustable rate
loans and performing and nonperforming loans. The fair value of performing
loans is calculated by discounting scheduled cash flows through the estimated
maturity using estimated market discount rates that reflect the credit and
interest rate risk inherent in the various types of loans.
F-22
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE K - FAIR VALUES OF FINANCIAL STATEMENTS - CONTINUED
DEPOSITS
Under Statement 107, the fair value of demand deposits, such as non-interest
bearing demand deposits and interest-bearing transaction accounts such as
savings, NOW and money market accounts are equal to the amount payable on
demand as of December 31, 1998 (i.e., their carrying amounts).
Statement 107 defines the fair value of demand deposits as the amount
payable, and prohibits adjustment for any value derived from the expected
retention of such deposits for a period of time. That value, commonly
referred to as the core deposit base intangible, is neither included in the
above fair value amounts nor recorded as an intangible asset in the balance
sheet.
The fair value of certificates of deposit is based on the discounted value of
contractual cash flows. The discount rate used represents rates currently
offered for deposits of similar remaining maturities. The carrying amount of
accrued interest payable approximates its fair value.
OFF-BALANCE SHEET INSTRUMENTS
Estimated fair values for the Company's off-balance sheet instruments are
based on fees, net of related expenses, currently charged to enter into
similar agreements, considering the remaining terms of the agreements and the
counterparties' credit standing.
BORROWINGS
The fair value of borrowings is estimated based on quoted market prices for
similar agreements or current rates offered for borrowings with similar
remaining maturities.
The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at December 31.
1998 1997
------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
Financial assets:
Cash and cash equivalents $ 25,456 $ 25,456 $ 40,065 $ 40,065
Securities .............. 69,235 69,235 62,963 62,963
Loans, net .............. 169,588 171,000 153,766 154,000
Financial liabilities:
Deposits
Noninterest-bearing 60,776 60,776 66,397 66,397
Interest-bearing
transaction
accounts ......... 97,163 97,163 84,325 84,325
Certificates of
deposits ......... 94,779 96,000 98,365 99,000
Borrowings .............. 3,000 3,000 -- --
F-23
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE L - REGULATORY MATTERS
BBI and BNB are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on their financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, BBI and
BNB must meet specific capital guidelines that involve quantitative measures
of the assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The capital amounts and
classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require minimum amounts and ratios(set forth in the table below) of total and
Tier I capital (as defined in the regulations) to risk-weighted assets(as
defined), and of Tier I capital (as defined) to average assets (as defined)
be maintained. Management believes, as of December 31, 1998, that BBI and BNB
meet all capital adequacy requirements to which they are subject.
The most recent notification the Office of the Comptroller of the Currency
categorized BNB as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Bank must
maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table.
BBI and BNB's actual capital amounts and ratios are also presented in the
table.
<TABLE>
<CAPTION>
FOR CAPITAL
ACTUAL: ADEQUACY PURPOSES:
------------------ -----------------------------------------------------
AMOUNT RATIO AMOUNT RATIO
------ ------- ---------- -------
<S> <C> <C> <C> <C>
As of December 31, 1998
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
Bay Bancshares, Inc.................... $20,896 10.72% (less than or = to)$15,595 (less than or = to)8.0%
Bayshore National Bank................. $20,649 10.63% (less than or = to)$15,540 (less than or = to)8.0%
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
Bay Bancshares, Inc.................... $18,952 9.72% (less than or = to)$ 7,797 (less than or = to)4.0%
Bayshore National Bank................. $18,705 9.63% (less than or = to)$ 7,769 (less than or = to)4.0%
TIER 1 CAPITAL (TO AVERAGE ASSETS)
Bay Bancshares, Inc.................... $18,952 6.84% (less than or = to)$ 8,312 (less than or = to)3.0%
Bayshore National Bank................ $18,705 6.76% (less than or = to)$ 8,301 (less than or = to)3.0%
</TABLE>
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
PROMPT CORRECTIVE
ACTION PROVISIONS:
----------------------------------------------------
AMOUNT RATIO
-------- -------
<S> <C> <C>
As of December 31, 1998
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
Bay Bancshares, Inc.................... N/A
Bayshore National Bank................. (less than or = to)$19,425 (less than or = to)10.0%
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
Bay Bancshares, Inc.................... N/A
Bayshore National Bank................. (less than or = to)$11,654 (less than or = to)6.0%
TIER 1 CAPITAL (TO AVERAGE ASSETS)
Bay Bancshares, Inc.................... N/A
Bayshore National Bank................ (less than or = to)$13,835 (less than or = to)5.0%
</TABLE>
F-24
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE L - REGULATORY MATTERS - CONTINUED
<TABLE>
<CAPTION>
FOR CAPITAL
ACTUAL: ADEQUACY PURPOSES:
------------------ -----------------------------------------------------
AMOUNT RATIO AMOUNT RATIO
------ ------- ---------- -------
<S> <C> <C> <C> <C>
As of December 31, 1997
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
Bay Bancshares, Inc................... $19,018 10.59% (less than or = to)$14,367 (less than or = to)8.0%
Bayshore National Bank................ $17,330 9.66% (less than or = to)$14,352 (less than or = to)8.0%
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
Bay Bancshares, Inc................... $17,019 9.48% (less than or = to)$ 7,181 (less than or = to)4.0%
Bayshore National Bank................ $15,331 8.54% (less than or = to)$ 7,181 (less than or = to)4.0%
TIER 1 CAPITAL (TO AVERAGE ASSETS)
Bay Bancshares, Inc................... $17,019 6.33% (less than or = to)$ 8,066 (less than or = to)3.0%
Bayshore National Bank................ $15,331 5.70% (less than or = to)$ 8,069 (less than or = to)3.0%
</TABLE>
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
PROMPT CORRECTIVE
ACTION PROVISIONS:
----------------------------------------------------
AMOUNT RATIO
-------- -------
<S> <C> <C>
As of December 31, 1997
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
Bay Bancshares, Inc................... N/A
Bayshore National Bank................ (less than or = to)$17,940 (less than or = to)10.0%
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
Bay Bancshares, Inc................... N/A
Bayshore National Bank................ (less than or = to)$10,771 (less than or = to)6.0%
TIER 1 CAPITAL (TO AVERAGE ASSETS)
Bay Bancshares, Inc................... N/A
Bayshore National Bank................ (less than or = to)$13,448 (less than or = to)5.0%
</TABLE>
NOTE M - SUPPLEMENTAL STATEMENT OF CASH FLOW INFORMATION
Cash paid during the period for:
1998 1997 1996
------ ------ ------
Interest ............................... $7,520 $5,580 $5,392
Income taxes ........................... $1,435 $ 768 $ 811
Noncash transactions during the period:
Dividends payable .................... $ 122 $ 124 $ 81
F-25
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE N - EARNINGS PER SHARE
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net earnings ..................................... $ 2,656 $ 1,794 $ 1,402
Divided by weighted average common shares ........ 2,045,453 1,472,408 1,351,872
---------- ---------- ----------
Earnings per share (basic) ....................... $ 1.30 $ 1.22 $ 1.04
========== ========== ==========
Net earnings ..................................... $ 2,656 $ 1,794 $ 1,402
Divided by adjusted weighted average common shares
Weighted average common shares ................. 2,045,453 1,472,408 1,351,872
Weighted average dilutive potential common
shares ....................................... 87,069 77,396 89,012
---------- ---------- ----------
Adjusted weighted average common shares .......... 2,132,522 1,549,804 1,440,884
---------- ---------- ----------
Earnings per share (diluted) ..................... $ 1.25 $ 1.16 $ .97
========== ========== ==========
</TABLE>
NOTE O - COMPREHENSIVE INCOME
Effective January 1, 1998, the Company has adopted Financial Accounting
Standards No. 130, REPORTING COMPREHENSIVE INCOME, which requires an entity
to report and display comprehensive income and its components. Comprehensive
income includes net earnings plus other comprehensive income. The Company's
other comrehensive income consists of unrealized gains or losses on
securities.
Other comprehensive income and its tax effects are as follows:
<TABLE>
<CAPTION>
BEFORE TAX TAX (EXPENSE) NET OF TAX
AMOUNT BENEFIT AMOUNT
---------- ------------- -----------
1998
<S> <C> <C> <C>
Unrealized gains on securities:
Unrealized holding gains arising
during period ........................... $ 466 $(158) $ 308
Less: reclassification adjustment
for gains included in net earnings ...... (50) 17 (33)
----- ----- -----
Other comprehensive income .................. $ 416 $(141) $ 275
===== ===== =====
</TABLE>
F-26
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE O - COMPREHENSIVE INCOME - CONTINUED
<TABLE>
<CAPTION>
BEFORE TAX TAX (EXPENSE) NET OF TAX
AMOUNT BENEFIT AMOUNT
---------- ------------- ----------
1997
<S> <C> <C> <C>
Unrealized gains on securities:
Unrealized holding gains arising
during period ........................... $ 470 $(169) $ 301
Less: reclassification adjustment
for gains included in net earnings ...... (12) 4 (8)
----- ----- -----
Other comprehensive income .................. $ 458 $(165) $ 293
===== ===== =====
1996
Unrealized losses on securities:
Unrealized holding losses arising
during period ........................... $ (71) $ 24 $ (47)
Less: reclassification adjustment
for losses included in net earnings ..... 19 (6) 13
----- ----- -----
Other comprehensive income .................. $ (52) $ 18 $ (34)
===== ===== =====
</TABLE>
NOTE P - NEW PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES ("SFAS No. 133"), which is effective for financial
statements issued for periods beginning after June 15, 1999. SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
for hedging activities. It requires that an entity recognize all derivatives
as either assets or liabilities in the statement of financial position and
measure those instruments at fair value. The Company does not expect the
effect of SFAS No. 133 to be material to the financial statements taken as a
whole.
F-27
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE Q - PARENT-ONLY FINANCIAL STATEMENTS
BAY BANCSHARES, INC.
(Parent Only)
BALANCE SHEETS
DECEMBER 31,
ASSETS 1998 1997
-------- --------
Cash and cash equivalents .................... $ 627 $ 2,085
Investment security .......................... 250 --
Investment in subsidiary ..................... 26,291 22,862
Other assets ................................. 95 331
-------- --------
$ 27,263 $ 25,278
======== ========
LIABILITIES
Other liabilities ............................ $ 721 $ 729
-------- --------
Total liabilities .......................... 721 729
Commitments and contingencies ................ -- --
Stockholders' equity
Common stock ............................... 2,091 2,091
Additional paid-in capital ................. 17,542 17,541
Retained earnings .......................... 7,252 5,087
Accumulated other comprehensive income ..... 379 104
-------- --------
27,264 24,823
Less common stock in treasury - at cost .... (722) (274)
-------- --------
26,542 24,549
-------- --------
$ 27,263 $ 25,278
======== ========
F-28
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE Q - PARENT-ONLY FINANCIAL STATEMENTS - CONTINUED
BAY BANCSHARES, INC.
(Parent Only)
STATEMENTS OF EARNINGS
YEAR ENDED DECEMBER 31,
1998 1997 1996
------- ------- -------
Interest income
Securities .......................... $ 13 $ -- $ 4
------- ------- -------
13 -- 4
Costs and expenses
General and administrative .......... 80 112 152
------- ------- -------
Loss before income taxes and equity
in net earnings of subsidiary .... (67) (112) (148)
Income taxes (benefit)
Current ............................. -- (21) 52
Deferred ............................ (18) (11) (92)
------- ------- -------
(18) (32) (40)
------- ------- -------
Loss before equity in net earnings
of subsidiary ................... (49) (80) (108)
Equity in net earnings of subsidiary .. 2,705 1,874 1,510
------- ------- -------
NET EARNINGS .................... $ 2,656 $ 1,794 $ 1,402
======= ======= =======
F-29
<PAGE>
BAY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
December 31, 1998, 1997 and 1996
(DOLLARS IN THOUSANDS)
NOTE Q - PARENT-ONLY FINANCIAL STATEMENTS - CONTINUED
BAY BANCSHARES, INC.
(Parent Only)
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings ............................................. $ 2,656 $ 1,794 $ 1,402
Adjustments to reconcile net
earnings to net cash provided
(used) in operating activities:
Earnings of subsidiaries ............................... (2,705) (1,874) (1,510)
Compensation expenses related
Phantom stock plan .................................. 64 94 114
Change in assets and liabilities
(Increase) decrease in other assets ................. 238 (143) (75)
Increase (decrease) in other liabilities ............ (73) 395 (9)
-------- -------- --------
Net cash provided (used) in operating activities .. 180 266 (78)
Cash flows from investing activities:
Maturities of interest-bearing deposits with banks .... -- -- 98
Purchases of securities ............................... (250) --
Dividends from subsidiary ............................. 300 7,900 --
Capital contribution to subsidiary .................... (750) -- --
Capital contribution of banks acquired ................ -- (15,715) --
-------- -------- --------
Net cash (used) provided by investing activities . (700) (7,815) 98
Cash flows from financing activities:
Proceeds from issuance of stock ....................... 1 9,897 30
Purchase of treasury stock ............................ (448) -- (48)
Sale of treasury stock ................................ -- 3 --
Dividends paid ........................................ (491) (324) (311)
-------- -------- --------
Net cash (used) provided by financing activities (938) 9,576 (329)
-------- -------- --------
Net (decrease) increase in cash and cash equivalents ....... (1,458) 2,027 (309)
Cash and cash equivalents at beginning of year ............. 2,085 58 367
-------- -------- --------
Cash and cash equivalents at end of year ................... $ 627 $ 2,085 $ 58
======== ======== ========
</TABLE>
F-30
EXHIBIT 21
LIST OF SUBSIDIARIES FOR
BAY BANCSHARES, INC.
NAME JURISDICTION OF INCORPORATION
---- -----------------------------
Bayshore National Bank United States
BayBanc Independent Insurance Agency, Inc. Texas
Bay Bancshares of Delaware, Inc. Delaware
EXHIBIT 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated January 22, 1999, accompanying the
consolidated financial statements included in the Annual Report of Bay
Bancshares, Inc. and Subsidiaries on Form 10-KSB for the year ended December 31,
1998. We hereby consent to the incorporation by reference of said report in the
Registration Statement of Bay Bancshares, Inc. and Subsidiaries on Form S-8
(File No. 333-45583, effective February 4, 1998).
/S/GRANT THORNTON LLP
Houston, Texas
March 30, 1999
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 15,466
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 9,990
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 69,235
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 171,532
<ALLOWANCE> 1,944
<TOTAL-ASSETS> 284,282
<DEPOSITS> 252,718
<SHORT-TERM> 3,000
<LIABILITIES-OTHER> 1,446
<LONG-TERM> 0
0
0
<COMMON> 2,091
<OTHER-SE> 24,451
<TOTAL-LIABILITIES-AND-EQUITY> 284,282
<INTEREST-LOAN> 14,948
<INTEREST-INVEST> 4,114
<INTEREST-OTHER> 609
<INTEREST-TOTAL> 19,671
<INTEREST-DEPOSIT> 7,332
<INTEREST-EXPENSE> 7,405
<INTEREST-INCOME-NET> 12,266
<LOAN-LOSSES> 480
<SECURITIES-GAINS> 50
<EXPENSE-OTHER> 11,842
<INCOME-PRETAX> 4,061
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,656
<EPS-PRIMARY> 1.30
<EPS-DILUTED> 1.25
<YIELD-ACTUAL> 8.07
<LOANS-NON> 13
<LOANS-PAST> 0
<LOANS-TROUBLED> 186
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,999
<CHARGE-OFFS> 695
<RECOVERIES> 160
<ALLOWANCE-CLOSE> 1,944
<ALLOWANCE-DOMESTIC> 1,944
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,399
</TABLE>
