FORM 10-K/A
(Amendment No. 1)
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 AND 12CFR16.3
For the fiscal year ended December 31, 1999
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
445 Pine Street, Goleta, California 93117
(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, including area code) (805) 692-1862
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered:
Common Stock, no par value National Market tier of The NASDAQ Stock Market
Securities registered under Section 12(g) of the Exchange Act:
None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act and 12CFR16.3 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[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained, and will not be contained, to the best of
the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K/A or any amendment to
this Form 10-K/A. [X]
There were 6,241,793 shares of common stock for the registrant issued and
outstanding as of March 1, 2000. The aggregate market value of the voting
stock, based on the closing price of the stock on the NASDAQ National Market
System on March 1, 2000, held by the nonaffiliates of the registrant was
approximately $24,455,000.
This Form 10-K/A contains 82 pages
<PAGE>
<TABLE>
<CAPTION>
COMMUNITY WEST BANCSHARES
FORM 10-K/A
INDEX
PART I PAGES
<S> <C>
ITEM 1. Description of Business . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 2. Description of Property . . . . . . . . . . . . . . . . . . . . . . . . . 5
ITEM 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
ITEM 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . 7
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters 7
ITEM 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . 8
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . 9
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk . . . . . . . . 50
ITEM 8. Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . 52
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure. . . . . . . . . . . . . . . . . . . . . . . . . 80
PART III
ITEM 10. Directors, Executive Officers, Promoters and Control Persons. . . . . . . 80
ITEM 11. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . . . . 80
ITEM 12. Security Ownership of Certain Beneficial Owners and Management. . . . . . 80
ITEM 13. Certain Relationships and Related Transactions. . . . . . . . . . . . . . 80
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. . . . . 81
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
</TABLE>
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
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General
- -------
Community West Bancshares was incorporated in the State of California on
November 26, 1996, for the purpose of forming a financial services holding
company. On December 31, 1997, Community West Bancshares acquired a 100%
interest in Goleta National Bank ("Goleta"). Effective that date, shareholders
of Goleta (NASDAQ:GLTB) became shareholders of the Company (NASDAQ:CWBC) in a
one-for-one exchange. Such acquisition was accounted at historical cost in a
manner similar to a pooling-of-interests. On December 14, 1998, the Company
acquired a 100% interest in Palomar Savings & Loan Association, now known, as
Palomar Community Bank ("Palomar"). As of that date, shareholders of Palomar
(OTCBB:PALO) became shareholders of the Company by receiving 2.11 shares of CWBC
for each share of PALO they held. The acquisition was accounted for under the
purchase method. Community West, Goleta and Palomar are collectively referred
to herein as the Company.
The Company offers a full range of commercial and retail financial services,
including the acceptance of demand, savings, and time deposits, and the
origination of commercial, U.S. Small Business Administration ("SBA"), accounts
receivable, real estate, construction, home improvement, and other installment
and term loans. It also offers cash management, remittance processing,
electronic banking, merchant credit card processing, online banking, and other
financial services to its customers.
The financial services industry as a whole offers a broad range of products. Few
companies today can effectively offer every product and service available.
Accordingly, the Company continually investigates products and services with
which it can attain a competitive advantage over others in the financial
services industry. In this way, management positions the Company to offer those
products and services requested by its customers.
The Company has been an approved lender/servicer of loans guaranteed by the SBA
since late 1990. The Company originates SBA loans, sells the guaranteed portion
into the secondary market, and services the loans. During 1995, the SBA
designated the Company as a Preferred Lender. As a Preferred Lender, the Company
has the ability to move loans through the approval process at the SBA much more
quickly than financial institutions that do not have such a designation. The
Company was granted SBA Preferred Lender status in the California districts of
Los Angeles, Fresno, Sacramento, San Francisco, and Santa Ana. The Company also
has Preferred Lender Status in Birmingham, Alabama, Atlanta, Georgia and Miami
and Jacksonville, Florida.
During 1994, the Company established a Mortgage Loan Processing Center. Through
the Mortgage Loan Processing Center, the Company takes applications for
residential real estate loans and processes those loans for a fee for lenders
located throughout the nation. At any point in time, the Company processes loans
for 50-70 such lenders. Because it has so many lenders for which it processes,
the Company can offer many more loan programs than normally offered by any
single institution. By virtue of the large number of loan programs being
offered, the Company has developed the ability to remain ahead of its
competition.
Also in 1994, the Company began offering home improvement loans under Title I of
FHA regulations. This is the oldest government insured loan program in
existence, having begun in 1934. From 1994 to 1998 the Company originated Title
I loans and sold them into the secondary market and retained the servicing.
During that time the Company was approved as one of a small number of financial
institutions to be able to sell Title I loans directly to the Federal National
Mortgage Association ("FNMA").
During 1996, the Company began offering second mortgage loans which allows
borrowers to borrow (when combined with the balance of the first mortgage loan)
up to 125% of their home's appraised value for debt consolidation, home
improvement, school tuition, or any worthwhile cash outlay up to a maximum loan
of $100,000. The Company relies principally on the creditworthiness of the
borrower, and to a lesser extent on the underlying collateral, for repayment of
these second mortgage loans. The loan terms under the program range from one to
25 years. In 1997 and 1998, the Company sold these loans at a premium to third
parties. In March of 1998, the Company began accumulating the majority of these
loans for the purposes of securitization. On December 22, 1998, the Company
completed the securitization of an $81 million pool of loans. On June 18, 1999
the Company completed the securitization of a $122 million pool of loans. In
the fourth quarter of 1999 the Company decided to cease securitization
activities. As of December 31, 1999, the Company had accumulated $150 million in
second mortgage loans that will be sold to third parties. On an ongoing basis,
the Company will continue to originate second mortgage loans, which are expected
to be sold to third parties for a premium shortly after origination.
<PAGE>
Because of the development costs involved, most small community banks have
difficulty providing electronic banking services to their customers. From its
inception, the Company has made significant investments in the hardware and
software necessary to offer electronic banking services. In addition to the
normal financial services, the Company offers such services as online cash
management, internet banking, automated clearinghouse origination, electronic
data interchange, remittance processing, draft preparation and processing, and
merchant credit card processing. Not only do these services generate significant
fee income, but they also attract companies with large deposit balances. These
services have helped the Company maintain a competitive advantage over most
institutions of comparable size and many which are significantly larger than the
Company.
On October 16, 1997, the Company purchased a 70% interest in Electronic
Paycheck, LLC, a California Company that is a provider of customized debit card
payment systems and electronic funds transfer services. The Company has
developed an Internet-based transaction processing system using propriety
software that provides complete front-end to back-end electronic funds transfer
processing services. The Company is focusing the marketing of its e-commerce
payment services to consumer lenders, companies with non-banked employees,
network marketing organizations and loyalty reward programs. In addition, the
Company plans to establish a card-based payment system for Internet purchases
particularly focused on teenagers, utilizing its "virtual" pinpad technology.
On November 4, 1999 Electronic Paycheck LLC merged with ePacific.com
Incorporated, a Delaware Corporation, which merger was accounted in a manner
similar to a pooling-of-interests. Subsequent to year-end, ePacific.com
redeemed 1,800,000 of the Company's 2,100,000 shares and repaid a loan from the
Company with a balance of $3,725,000 for $4.5 million in cash. The Company
continues to hold a 10% interest in ePacific.com.
In September of 1998, the Company opened its second full service Branch in
Ventura, California. The Company simultaneously consolidated into that location
its Ventura SBA and mortgage loan production office and the accounts receivable
financing department.
On December 14, 1998, the Company acquired 100% of Palomar Savings & Loan, a
state-chartered full service savings and loan association. During 1999 Palomar
Savings & Loan was converted to a state chartered commercial bank and
subsequently changed the name to Palomar Community Bank ("Palomar"). The
Federal Deposit Insurance Corporation ("FDIC") insures the deposits of Palomar
up to the applicable limits. Palomar is a member of the Federal Home Loan Bank
("FHLB") system. It's main office is located at 355 West Grand Avenue,
Escondido, California 92025. It is the Company's intent to maintain Palomar as
a separate subsidiary of the Company.
Competition and Service Area
- -------------------------------
The financial service industry in California is highly competitive with respect
to both loans and deposits; and is dominated overall by a relatively small
number of major banks with many offices operating over wide geographic areas.
Some of the major commercial banks operating in the communities nearby the
Company's service areas offer certain services such as trust and investment
services and international banking which are not offered directly by the Company
or any of its subsidiaries, and by virtue of their greater total capitalization,
such institutions have substantially higher lending limits than the Company. To
help offset the numerous branch offices of banks, thrifts, and credit unions, as
well as competition from mortgage brokers, insurance companies, credit card
companies, and brokerage houses within the Company's service areas, the Company,
through its subsidiaries, has established loan production offices in Fresno,
<PAGE>
Costa Mesa, San Rafael, Solvang, Santa Barbara, Anaheim, and West Covina in
California; Las Vegas and Reno, Nevada; Woodstock, Georgia; and Jacksonville,
Pensacola, and Panama City Beach, Florida. The Company's online capabilities
allow it to support these offices from its main computer center in Goleta,
California. Part of the Company's strategy is to establish loan production
offices in areas where there is high demand for the loan products it originates.
In order to compete for loans and deposits within its primary service area, the
Company uses, to the fullest extent possible, the flexibility its independent
status permits. This includes an emphasis on meeting the specialized banking
needs of its customers, including personal contact by the Company's directors,
officers, and employees, newspaper publications, direct mailings and other local
advertising, and by providing experienced management and trained staff to deal
with the specific banking needs of the Company's customers. Management has
established a highly personalized banking relationship with the Company's
customers and is attuned and responsive to their financial and service
requirements. In the event there are customers whose loan demands exceed the
Company's lending limits, the Company seeks to arrange for such loans on a
participation basis with other financial institutions and intermediaries. The
Company also assists those few customers requiring highly specialized services
not offered by the Company to obtain such services from correspondent
institutions.
Employees
- ---------
As of December 31, 1999, the Company employed 234 persons, including 3 principal
officers. The Company's employees are not represented by a union or covered by a
collective bargaining agreement. Management of the Company believes that, in
general, its employee relations are very positive.
ITEM 2. DESCRIPTION OF PROPERTY
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The Company owns the following property:
- ---------------------------------------------
The Goleta National Bank Main office is located at 5827 Hollister Avenue,
Goleta, California. This 4,000 square foot facility houses the bank's main
office, and a separate 400 square foot building provides additional office
space.
The Company leases the following properties:
- -------------------------------------------------
The Company leases, under three separate leases, seven suites in an office
building at 5638 Hollister Avenue, Goleta, California. The leases are for terms
expiring May 31, 2003, with a current monthly rent of $24,725 per month for all
seven suites. The leases also provide the Company with two additional
consecutive options of three years each to extend the leases. The suites consist
of approximately 17,800 square feet of office space. These suites house the
Company's Corporate Offices, Finance, Data Processing, Compliance, Human
Resources, and Electronic Business Services departments as well as the offices
of the Company's subsidiary, ePacific.com. On January 4, 2000, the Company
sublet 6,200 square feet of these suites. The sublease is for a term commencing
May 1, 2000 and expiring May 31, 2003. The sublease does not provide the
sublessor an option to extend the sublease.
On February 1, 2000, the Company leased approximately 20,684 square feet of
office space located at 445 Pine Avenue, Goleta, California. The lease is for a
term expiring March 31, 2007, with a current monthly rent of $26,889. The lease
also provides the Company with two options of five years to extend the lease.
This facility will house the Company's Corporate Offices, Finance, Data
Processing, Compliance, Human Resources, Electronic Business Services, Special
Assets and Loan Collection departments.
The Company leases approximately 1,500 square feet of office space located at
310 South Pine Avenue, Goleta, California. The lease is month to month, with a
current monthly rent of $960 per month. This facility currently houses the
Special Assets and Loan Collection departments of the Company and will be
vacated on June 1, 2000.
<PAGE>
The Company leases under two separate leases approximately 3,744 square feet of
office space located at 3891 State Street, Santa Barbara, California. The leases
are for terms expiring April 30, 2002 and March 31, 2001, with a current monthly
rent of $7,715 per month for both leases. The leases also provide the Company
with two additional consecutive options of three years each to extend the lease.
This facility houses the Retail and Wholesale Mortgage Lending departments of
the Company.
The Company leases approximately 3,431 square feet of office space located at
1463 South Victoria Avenue, Ventura, California. The lease is for a term
expiring July 20, 2002, with a current monthly rent of $5,555 per month. The
lease provides the Company with one option of three years to extend the lease.
This facility houses the Ventura Branch office, as well as the Ventura Mortgage,
SBA and Accounts Receivable Financing departments of the Company.
The Company leases approximately 6,032 square feet of space located at 4025 East
La Palma Avenue Suite 201A, 201B, and 201C Anaheim, California. The lease is for
a term expiring February 29, 2000, with a current monthly rent of $6,746 per
month. This facility houses the Anaheim Loan Production office of the Company.
The Company leases approximately 1,032 square feet of storefront space located
at 4170 South Decatur, Unit D-4, Las Vegas, Nevada, from an independent third
party. The lease is for a term expiring February 28, 2000, with a current
monthly rent of $1,909 per month. This facility houses the Las Vegas, Nevada
Loan Production office of the Company. On February 26, 2000 the Las Vegas Loan
Production office relocated to 4570 S. Eastern, Suite 26 Las Vegas, Nevada with
a monthly rent of $850 per month.
The Company leases approximately 6,380 square feet of space located at 5383
Hollister Avenue, 2nd Floor, Goleta, California, from an independent third
party. The lease is for a term expiring November 30, 2002, with a current
monthly rent of $8,718 per month. The lease also provides the Company with two
options of three years to extend the lease. This facility houses the Alternative
Mortgage lending and SBA lending departments of the Company. Subsequent to
year-end, the Company sublet the entire space. The sublease does not provide an
option for the sublessor to extend the sublease.
The Company also leases small executive suites on a month-to-month basis in
Bakersfield, Fresno, Modesto, San Rafael and Costa Mesa, California. The Company
has executive suites in Woodstock, Georgia; in Jacksonville and Pensacola,
Florida; and in Reno, Nevada. These offices allow the Company to have a local
presence for the production of loans while controlling the underwriting and
funding of the loans at the main office in Goleta. The Company also leases, on a
month-to-month basis, two storage units and portions of a parking lot which are
located in Goleta.
The Company also leases approximately 7,000 square feet of office space at 355
West Grand Avenue, Escondido, California, which houses the main branch office of
Palomar. The lease is for a term expiring November 20, 2007, with a ten-year
option to renew and a current monthly rent of $12,971.
The Company's total occupancy expense for the year ended December 31, 1999 was
$3,845,000. Management believes that its existing facilities are adequate for
its present purposes.
ITEM 3. LEGAL PROCEEDINGS
- ----------------------------
From time to time the Company is party to claims and legal proceedings arising
in the ordinary course of business. After taking into consideration information
furnished by counsel to the Company, management believes that the ultimate
aggregate liability represented thereby, if any, will not have a materially
adverse effect on the Company's financial position or results of operations.
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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An annual meeting of security holders of the Company was held May 27, 1999. The
security holders voted on and approved Board Members for 1999-2000. There was a
total of 5,016,451 or 91.5% proxies voted out of 5,482,571shares. The following
indicates how the votes were cast:
FOR AGAINST ABSTAIN NON-VOTES
Number of Votes Received 4,971,200 45,251 0.0 466,120
Percentage of Total Shares 90.7% 0.8% 0.0% 8.5%
PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
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STOCKHOLDER MATTERS
As of the close of business December 31, 1997, the common stock for
Goleta National Bank, symbol "GLTB", was converted to Community West Bancshares
common stock, symbol "CWBC". On January 5, 1998, NASDAQ National Market
("NASDAQ") listed the new common stock symbol "CWBC" for trading and the
old symbol "GLTB" was removed. On December 18, 1998, the Company acquired
Palomar (OTCBB: PALO). Both the table and the paragraph below relate to CWBC
and its predecessor GLTB.
The common stock was listed on NASDAQ on November 19, 1996, under the symbol
"GLTB ". During the secondary stock offering, which took place in the third
quarter of 1996, warrants were issued. Each warrant entitled the holder to
purchase two shares of common stock at an exercise price of $4.375 per share.
The warrants expired on June 30, 1998, and were traded over-the-counter under
the new symbol "CWBCW" until that time. The following table sets forth the high
and low sales prices on a per share basis for the common stock and a per warrant
basis for the warrants, as reported by the respective exchanges for the period
indicated:
<TABLE>
<CAPTION>
Common Stock(1) Warrants
Low High Low High
----- -------- ----- -----
<C> <S> <C> <C> <C> <C>
1998 First Quarter 9.25 13.25 9.63 16.50
Second Quarter 11.88 14.31 9.00 15.00
Third Quarter 9.25 14.00 N/A N/A
Fourth Quarter 8.13 11.00 N/A N/A
1999 First Quarter 7.75 9.25 N/A N/A
Second Quarter 7.50 10.50 N/A N/A
Third Quarter 10.00 16.88 N/A N/A
Fourth Quarter 6.75 16.75 N/A N/A
<FN>
</TABLE>
On March 1, 2000, the last reported sale price per share for the Company's stock
was $6.50.
The Company declared and issued a 10% stock dividend in 1995, and effected a
2-for-1 stock split in 1996 and again in 1998. The Company declared three
quarterly dividends of $.04 per share during 1999. Each quarterly dividend
totaled approximately $220,000.
The Company had 557 shareholders of record of its common stock as of December
31, 1999.
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
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SUMMARY OF OPERATIONS
The following Summary of Operations of the Company, as of December 31, 1999 and
1998 and for the years ended December 31, 1999, 1998, 1997, have been derived
from the consolidated financial statements included elsewhere in this document.
<TABLE>
<CAPTION>
AS OF AND FOR YEAR ENDED DECEMBER 31, (1)
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(Dollars in thousands, except per share data) 1999 1998 (3) 1997(3) 1996(3) 1995(3)
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Interest income $ 48,495 $ 15,279 $ 8,009 $ 6,812 $ 6,504
Interest expense 25,145 6,317 2,910 2,425 2,451
----------- ----------- ----------- ----------- -----------
Net interest income 23,350 8,962 5,099 4,387 4,053
Provision for loan losses 6,133 1,760 260 435 360
Net interest income
after provision for loan losses 17,217 7,202 4,839 3,952 3,693
Other operating income 11,021 11,023 9,432 6,620 4,481
Other operating expense 30,506 17,482 11,524 8,667 6,436
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes (2,268) 743 2,747 1,905 1,738
(Benefit) Provision for income taxes (622) 289 1,158 800 730
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (1,646) $ 454 $ 1,589 $ 1,105 $ 1,008
=========== =========== =========== =========== ===========
Income (loss) per common share - Basic $ (0.30) $ 0.12 $ 0.53 $ 0.47 $ 0.50
Number of shares used in income (loss)
per share calculation - Basic (2) 5,494,217 3,767,607 3,016,208 2,356,162 2,013,830
Income (loss) per common share - Diluted $ (0.30) $ 0.12 $ 0.44 $ 0.44 $ 0.47
Number of shares used in income (loss)
per share calculation - Diluted (2) 5,494,217 3,941,749 3,588,478 2,510,352 2,128,212
Net Loans $ 451,664 $ 247,411 $ 59,315 $ 54,206 $ 46,472
Total Assets 523,847 327,569 87,468 72,718 64,245
Deposits 313,131 223,853 75,962 65,032 58,256
Total Liabilities 489,915 298,448 76,623 65,169 58,610
Total Stockholders' Equity 33,932 29,121 10,845 7,549 5,635
<FN>
(1) See Notes to Consolidated Financial Statements for a summary of significant accounting policies and
other related data.
(2) Earnings per common share information is based on a weighted average number of common shares
outstanding during each period. Earnings per share amounts have been adjusted to reflect the 2-for-1 stock
splits in 1996 and 1998, and a 10% stock dividend in 1995.
(3) As restated, see Note 21 of Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
The following table sets forth selected ratios for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 1998 (1) 1997(1) 1996(1) 1995(1)
------ -------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net income (loss) average stockholder equity -6.68% 3.50% 14.64% 13.67% 17.89%
------ -------- ------- ------- -------
Net income (loss) to average total assets -0.37% 0.20% 1.82% 1.52% 1.57%
Total interest expense to total interest income 51.85% 41.34% 36.33% 35.59% 37.69%
Other operating income to other operating expense 36.13% 63.05% 81.85% 76.39% 69.63%
Dividend pay-out ratio 3.37% 0.00% 0.00% 0.00% 0.00%
Equity to assets ratio 6.51% 8.77% 12.73% 12.44% 8.72%
<FN>
(1) As restated, see Note 21 to Notes to Consolidated Financial Statements.
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
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Introduction
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This discussion is designed to provide a better understanding of significant
trends related to the Company's financial condition, results of operations,
liquidity, capital resources, and interest rate sensitivity. It should be read
in conjunction with the consolidated financial statements and notes thereto and
the other financial information appearing elsewhere in this filing.
Restatement
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Subsequent to the issuance of the Company's 1998 financial statements, the
Company's management determined that (1) the acquisition of Palomar Community
Bank in December 1998 which was previously accounted for under the
pooling-of-interests method of accounting, should have been accounted for under
the purchase method of accounting, (2) the securitization of loans completed in
December 1998, which was previously accounted for as a sale should have been
accounted for as a secured borrowing with a pledge of collateral, (3) certain
costs related to second mortgage loans which were previously capitalized, should
have been charged to expense as incurred, (4) the prepayment assumption used to
value the I/O strip retained on sales of Title I loans during 1998 was
incorrect, (5) certain loan fees which were previously recognized as income
when received, should have been deferred and amortized, and (6) the
calculation of regulatory capital amounts and ratios as of December 31,
1998 was incorrect. In addition, management also identified certain other
insignificant errors in the 1998 financial statements. As a result, the 1998
and 1997 financial statements have been restated from amounts previously
reported to properly account for these transactions. The effects of the
restatement are disclosed in Note 21 to the consolidated financial statements
and are included herein.
<PAGE>
Results of Operations
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The following table sets forth, for the period indicated, the increase or
decrease of certain items in the statements of operations of the Company as
compared to the prior periods:
<TABLE>
<CAPTION>
For the Year Ended December 31,
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1999 versus 1998 1998 versus 1997 1997 versus 1996
------------------------ ------------------------ ------------------------
Amount of Percent of Amount of Percent of Amount of Percent of
increase Increase increase increase increase Increase
(decrease) (decrease) (decrease) (decrease) (decrease) (decrease)
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<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME:
Loans, including fees . . . . . . . . . . . . . . $32,246,557 218.60% $ 7,401,202 100.70% $1,009,083 15.91%
Federal funds sold. . . . . . . . . . . . . . . . 597,248 145.49% (13,153) -3.10% 140,529 49.63%
Time deposits in other financial institutions . . (19,195) -28.94% (54,264) -45.00% 32,795 37.35%
Investment securities . . . . . . . . . . . . . . 390,840 758.81% (63,746) -55.31% 14,953 14.91%
------------ ---------- ------------ ---------- ----------- -----------
Total interest income. . . . . . . . . . . . . 33,215,450 217.39% 7,270,039 90.77% 1,197,360 17.58%
INTEREST EXPENSE:
Deposits. . . . . . . . . . . . . . . . . . . . . $ 9,357,741 163.54% $ 2,811,508 96.60% $ 485,720 20.03%
Bonds payable . . . . . . . . . . . . . . . . . . 9,470,824 1592.52% 594,707 0.00% - 0.00%
------------ ---------- ------------ ---------- ----------- -----------
Total interest expense. . . . . . . . . . . . . . 18,828,565 298.08% 3,406,215 117.03% 485,720 20.03%
NET INTEREST INCOME . . . . . . . . . . . . . . . . 14,386,885 160.52% 3,863,824 75.78% 711,640 16.22%
PROVISION FOR LOAN LOSSES . . . . . . . . . . . . . 4,373,336 248.54% 1,499,623 576.78% (175,000) -40.23%
------------ ---------- ------------ ---------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,013,549 139.02% 2,364,201 48.86% 886,640 22.43%
------------ ---------- ------------ ---------- ----------- -----------
OTHER INCOME:
Gains from loan sales . . . . . . . . . . . . . . 1,928,127 47.49% (41,406) -1.01% 1,486,862 56.87%
Loan origination fees - sold or brokered loans. . (969,273) -26.34% 718,826 24.28% 903,103 43.90%
Document processing fees. . . . . . . . . . . . . (150,590) -12.31% 403,853 49.29% 309,705 60.77%
Loan servicing fees . . . . . . . . . . . . . . . (286,007) -36.40% 154,159 24.41% (43,047) -6.38%
Service charges . . . . . . . . . . . . . . . . . (349,759) -40.46% (31,746) -3.54% 306,056 51.85%
Other income. . . . . . . . . . . . . . . . . . . (174,318) -42.52% 386,556 1651.45% (150,955) -86.58%
------------ ---------- ------------ ---------- ----------- -----------
Total other income . . . . . . . . . . . . . . (1,820) -0.02% 1,590,242 16.86% 2,811,724 42.47%
OTHER EXPENSES:
Salaries and employee benefits. . . . . . . . . . 5,428,596 50.27% 3,484,228 47.63% 1,862,466 34.16%
Occupancy expenses. . . . . . . . . . . . . . . . 1,446,658 60.33% 889,490 58.97% 322,933 27.24%
Other operating expenses. . . . . . . . . . . . . 1,785,840 88.12% 1,465,496 261.20% (109,156) -13.87%
Advertising expense . . . . . . . . . . . . . . . 357,215 44.98% 211,466 36.29% 271,449 87.23%
Professional services . . . . . . . . . . . . . . 2,058,416 395.31% 94,885 22.28% 180,062 73.27%
Postage & freight . . . . . . . . . . . . . . . . (84,920) -19.44% (385,228) -46.86% 279,272 51.44%
Data processing/ATM processing. . . . . . . . . . 262,746 105.52% 95,944 62.69% 36,211 0.00%
Amortization of Goodwill & Excess . . . . . . . . 300,008 471.99% 63,562 0.00% - N/A
LOCOM Expense . . . . . . . . . . . . . . . . . . 1,276,709 100.00% - 0.00% - N/A
Office supply expense . . . . . . . . . . . . . . 192,142 99.21% 38,384 24.72% 13,736 9.7%
------------ ---------- ------------ ---------- ----------- -----------
Total other expenses . . . . . . . . . . . . . 13,023,410 74.50% 5,958,227 51.70% 2,856,973 32.96%
INCOME (LOSS) BEFORE PROVISION (BENEFIT)
FOR INCOME TAXES . . . . . . . . . . . . . . . . . . (3,011,681) -405.06% (2,003,784) -72.94% 841,391 44.15%
PROVISION (BENEFIT) FOR INCOME TAXES. . . . . . . . (911,286) -314.84% (868,903) -75.01% 357,873 44.71%
------------ ---------- ------------ ---------- ----------- -----------
NET (LOSS) INCOME. . . . . . . . . . .. . . . . . . $(2,100,395) -462.58% $(1,134,881) -71.42% $ 483,518 43.74%
============ ========== ============ ========== =========== ===========
</TABLE>
Net Interest Income and Net Interest Margin
- -------------------------------------------------
The Company's earnings partially depend upon the difference between the interest
received from its loan portfolio and investment securities and the interest paid
on its liabilities, including interest paid on deposits. This difference is
"net interest income". The net interest income, when expressed as a percentage
of average total interest-earning assets, is referred to as the net interest
margin on interest-earning assets. The Company's net interest income is
affected by the change in the level and the mix of interest-earning assets and
interest-bearing liabilities, referred to as volume changes. The Company's net
yield on interest-earning assets is also affected by changes in the yields
earned on assets and rates paid on liabilities, referred to as rate changes.
Interest rates charged on the Company's loans are affected principally by the
demand for such loans, the supply of money available for lending purposes and
competitive factors. These factors are in turn affected by general economic
conditions and other factors beyond the Company's control, such as federal
economic policies, the general supply of money in the economy, legislative tax
policies, governmental budgetary matters and the actions of the FRB.
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ -----------
<S> <C> <C> <C>
Interest Income $48,494,921 $15,279,471 $8,009,432
------------ ------------ -----------
Interest Expense 25,145,230 6,316,665 2,910,450
Net Interest Income $23,349,691 $ 8,962,806 $5,098,982
Net Interest Margin 5.6% 4.1% 6.6%
============ ============ ===========
</TABLE>
<PAGE>
Total interest income increased 217% from $15,279,471 in 1998 to $48,494,921 in
1999. This increase in 1999 over 1998 was due to an increase in
interest-earnings assets. Total interest expense increased 298% from $6,316,665
in 1998 to $25,145,230 in 1999. The increase was due to an increase in
interest-bearing liabilities and an increase in rates paid on deposits. As a
result, net interest income increased 161% from $8,962,806 in 1998 to
$23,349,691 in 1999.
Total interest income increased 91% from $8,009,432 in 1997 to $15,279,471 in
1998. The increase was due to an increase in interest-earnings assets offset
with a decrease due to lower rates. Total interest expense increased 117% from
$2,910,450 in 1997 to $6,316,665 in 1998. This increase was due to an increase
in interest-bearing liabilities and an increase in rates paid on deposits. As a
result, net interest income increased 76% from $5,098,982 in 1997 to $8,962,806
in 1998.
The following table sets forth the changes in interest income and expense
attributable to changes in rates and volumes:
<TABLE>
<CAPTION>
Year Ended December 31,
Dollars in Thousands 1999 Versus 1998 1998 Versus 1997 1997 Versus 1996
--------------------------- ---------------------------- ---------------------------
Total Change Change Total Change Change Total Change Change
Change Due to Due to Change Due to Due to Change Due to Due to
Rate Volume Rate Volume Rate Volume
-------- -------- -------- -------- -------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Time deposits in other
financial institutions $ (20) 48 (68) $ (55) 5 $ (60) 33 - 33
Federal funds sold 597 16 581 (13) (15) 2 141 11 130
Investment securities 391 271 120 (63) (63) 0 15 (32) 47
Loans, net 32,247 12,949 19,298 7,402 (1,784) 9,186 1,009 (169) 1,178
-------- -------- -------- -------- -------- ------- -------- -------- --------
Total interest-earning assets 33,215 13,284 19,931 7,271 (1,857) 9,128 1,198 (190) 1,388
-------- -------- -------- -------- -------- ------- -------- -------- --------
Interest-bearing 74 (21) 95 60 (9) 69 8 (14) 22
demand
Savings 396 45 351 97 (32) 129 (23) (12) (11)
Time certificates of 8,888 1,334 7,554 2,655 (92) 2,747 501 66 435
deposit
Federal funds (41) - (41) 85 - 85 - - -
purchased
Bonds payable 9,428 - 9,428 510 - 510 - - -
Other borrowings 83 - 83 - - - - - -
-------- -------- -------- -------- -------- ------- -------- -------- --------
Total interest-bearing 18,828 1,358 17,470 3,407 (133) 3,540 486 40 446
liabilities
-------- -------- -------- -------- -------- ------- -------- -------- --------
Net interest income $14,387 $11,926 $ 2,461 $ 3,864 $(1,724) $ 5,588 $ 712 $ (230) $ 942
</TABLE>
The change in interest income or interest expense that is attributable to both
changes in rate and changes in volume has been allocated to the change due to
rate and the change due to volume in proportion to the relationship of the
absolute amounts of changes in each.
Provision for Loan Losses
- ----------------------------
The provision for loan losses corresponds directly to the level of the allowance
that management deems sufficient to provide for probable loan losses. The
balance in the allowance for loan loss reflects the amount which, in
management's judgment, is adequate to provide for these probable loan losses,
after considering the mix of the loan portfolio, current economic conditions,
past loan experience and other factors deemed relevant in estimating loan
losses.
Each month, management reviews the allowance for loan losses and records
additional provisions to the allowance, as needed. Management allocated
<PAGE>
$6,132,959 as a provision for loan losses in 1999, $1,759,623 in 1998 and
$260,000 in 1997. This increase was due to the significant growth in the loan
portfolio. Loans charged off, net of recoveries, in 1999 were $3,977,108, in
1998 were $298,685 and in 1997 were $383,469. The increased chargeoffs in 1999
were due to two commercial loans in the accounts receivable financing program,
which program has since been curtailed. The ratio of the allowance for loan
losses to total gross loans was 1.9% at December 3l, 1999, 1.8% at December 31,
1998, and 2.2% at December 31, 1997.
In management's opinion, the balance of the allowance for loan losses at
December 31, 1999 was sufficient to absorb known and inherent probable losses in
the loan portfolio at that time.
Other Income Other income increased 17% from $9,432,215 in 1997 to $11,022,457
- ------------
in 1998 and remained flat to $11,020,637 in 1999. Although the Company continues
to emphasize the generation of non-interest income, the percentage of
non-interest income to total income dropped significantly from 42% in 1998 to
19% in 1999. This was primarily a result of the decrease in fees on sold or
brokered loans, and in loan servicing fees and other service charges.
Other Expenses
- ---------------
Other expenses include salaries and employee benefits, occupancy and equipment,
and other operating expenses. As a result of continued Company growth, other
expenses rose 52% from $11,523,906 in 1997 to $17,482,133 in 1998 and 74% in
1999. Employee compensation increased from $10,799,675 in 1998 to $16,228,271
in 1999. Most of this increase in compensation can be attributed to variable
pay, since 40% of the Company personnel derive their income from loan
production. The majority of other expenses are variable expenses since employee
compensation represents 53% of other expenses in 1999. Other expenses that were
also impacted by loan production included occupancy due to the increase in
locations, advertising and marketing and general office expenditures.
Professional fees increased as a result of activity related to ePacific.com's
change in corporate status and a three-year audit of its accounting records.
There was also a $1.3 million lower of cost or market provision on loans held
for sale in 1999. This provision resulted from a change in the company's
strategy from the securitization of second mortgage loans to whole loan sales.
The following table compares the various elements of other expenses as a
percentage of average assets for the three years ended December 31 (in thousands
except percentage amounts):
<TABLE>
<CAPTION>
Salaries
and Other
Average Total Other Employee Occupancy Operating
Assets (1) Expense Benefits Expenses Expenses
---------- ----------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
December 31, 1999 $ 450,041 6.78% 3.61% 0.85% 0.85%
December 31, 1998 $ 225,258 7.76% 4.79% 1.06% 0.90%
December 31, 1997 $ 87,468 13.18% 8.36% 1.72% 0.64%
<FN>
(1) Based on the average of daily balances.
</TABLE>
Income Taxes
- -------------
Income taxes/(benefits) were $(621,838) in 1999, $289,448 in 1998, and
$1,158,351 in 1997. The effective income tax rate was (27.4)%, 38.9% and 42.2%
for 1999, 1998 and 1997, respectively.
Net (Loss) Income
- -------------------
The net (loss) income of the Company was ($1,646,336) in 1999, $454,059 in 1998,
and $1,588,940 in 1997. Loss (earnings) per share were $(0.30) basic in 1999;
$(0.12) basic in 1998; and $.53 basic and $.44 diluted in 1997 adjusted to
reflect the 2-for-1 stock split in 1998. The loss for 1999 was primarily the
result of the $2.1 million in losses of ePacific.com and the LOCOM provision.
The Company decided to cease any further securitization activities. At the
time of that decision the Company had approximately $150,000,000 in second
mortgage loans accumulated for a third securitization. Those loans were written
down in the fourth quarter of 1999 to fair market value. The adjustment was
approximately $1.3 million.
Capital Resources
- ------------------
The Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 was
signed into law on December 19, 1991. Regulations implementing the prompt
corrective action provisions of FDICIA include significant changes to the legal
and regulatory environment for insured depository institutions, including
reductions in insurance coverage for certain kinds of deposits, increased
supervision by the federal regulatory agencies, increased reporting requirements
for insured institutions, and new regulations concerning internal controls,
accounting, and operations.
The prompt corrective action regulations define specific capital categories
based on institutions' capital ratios. The capital categories, in declining
order, are "well capitalized", "adequately capitalized", "undercapitalized",
"significantly undercapitalized", and "critically undercapitalized". To be
considered "well capitalized" an institution must have a core capital ratio of
at least 5% and a total risk-based capital ratio of at least 10%. Additionally,
FDICIA imposed in 1994 a new Tier I risk-based capital ratio of at least 6% to
be considered "well capitalized". Tier I risk-based capital is, primarily,
common stock and retained earnings less goodwill and other intangible assets.
<PAGE>
As of December 31, 1999, and 1998 the most recent notification from the FDIC
categorized Goleta as "adequately capitalized" under the regulatory framework
for prompt corrective action. At December 31, 1999 and 1998, the most recent
notification from the FDIC and the OTS, respectively, categorized Palomar as
"well-capitalized" under the regulatory framework for prompt corrective action.
To be categorized as "well capitalized" Goleta and Palomar must maintain minimum
Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in
the table below. There are no conditions or events since that notification which
management believes have caused Goleta's or Palomar's category to decline.
<TABLE>
<CAPTION>
To Be Well
For Capitalized
Capital Adequacy Under Prompt
Actual Purposes Corrective Action
Provisions
------------------- ------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------ ----------- ------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999:
Total Risk-Based Capital (to Risk Weighted assets)
Consolidated. . . . . . . . . . . . . . . . . . . . $39,474,626 8.34% $37,856,951 8.00% $47,321,188 10.00%
Goleta National Bank. . . . . . . . . . . . . . . . $33,099,716 8.01% $33,046,888 8.00% $41,308,610 10.00%
Palomar Community Bank. . . . . . . . . . . . . . . $ 7,184,663 11.94% $ 4,814,290 8.00% $ 6,017,863 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated. . . . . . . . . . . . . . . . . . . . $33,945,328 7.17% $18,928,475 4.00% $28,392,713 6.00%
Goleta National Bank. . . . . . . . . . . . . . . . $28,182,418 6.82% $16,523,444 4.00% $24,785,166 6.00%
Palomar Community Bank. . . . . . . . . . . . . . . $ 6,572,663 10.92% $ 2,407,145 4.00% $ 3,610,718 6.00%
Tier I Capital (to Average Assets)
Consolidated. . . . . . . . . . . . . . . . . . . . $33,945,328 7.52% $18,060,691 4.00% $22,575,864 5.00%
Goleta National Bank. . . . . . . . . . . . . . . . $28,182,418 7.27% $15,498,960 4.00% $19,373,700 5.00%
Palomar Community Bank. . . . . . . . . . . . . . . $ 6,572,663 12.22% $ 2,151,381 4.00% $ 2,689,226 5.00%
</TABLE>
<TABLE>
<CAPTION>
To Be Well
For Capitalized Under
Capital Adequacy Prompt Corrective
Actual Purposes Action Provisions
--------------------- ------------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ------- ----------- ------ ----------- ------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total Risk-Based Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . $ 32,226,458 12.99% $19,850,676 8.00% $24,813,345 10.00%
Goleta National Bank . . . . . . . . . . . . . . . $ 15,633,452 8.18% $15,288,458 8.00% $19,110,573 10.00%
Palomar Savings and Loan . . . . . . . . . . . . . $ 6,924,424 11.57% $ 4,787,384 8.00% $ 5,984,231 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . $ 29,121,426 11.74% $ 9,925,338 4.00% $14,888,007 6.00%
Goleta National Bank . . . . . . . . . . . . . . . $ 13,240,206 6.93% $ 7,644,229 4.00% $11,466,344 6.00%
Tier I Capital (to Average Assets)
Consolidated . . . . . . . . . . . . . . . . . . . $ 29,121,426 9.12% $12,775,029 4.00% $15,968,787 5.00%
Goleta National Bank . . . . . . . . . . . . . . . $ 13,240,206 5.90% $ 8,972,680 4.00% $11,215,850 5.00%
Core Capital (to Adjusted Tangible Assets)
Palomar Savings and Loan . . . . . . . . . . . . . $ 6,297,424 10.52% $ 2,393,692 4.00% $ 2,992,115 5.00%
Tangible Capital (to Tangible Assets)
Palomar Savings and Loan . . . . . . . . . . . . . $ 6,297,424 7.61% $ 1,240,914 1.50% N/A N/A
</TABLE>
In November 1999, the OCC notified Goleta that Goleta had not properly
calculated the amount of regulatory capital required to be held in respect of
residual interests retained by Goleta in two securitizations of loans that were
<PAGE>
consummated by Goleta in the fourth quarter of 1998 and the second quarter of
1999. Accordingly the OCC informed Goleta that it was deemed adequately
capitalized at December 31, 1998 and significantly undercapitalized at March 31,
1999, June 30,1999 and September 30, 1999. On November 17, 1999, after a new
debt and equity investment in the Company of approximately $11.15 million by
certain directors of the Company, the proceeds of which were contributed to
Goleta as equity, the OCC informed Goleta that it was adequately capitalized.
The 1998 regulatory capital amounts and ratios have been restated from amounts
and ratios previously reported to properly reflect Goleta's capital position at
December 31, 1998.
Under the regulatory framework, the Goleta's capital levels do not allow it to
accept or renew brokered deposits without prior approval from the regulators.
Goleta had approximately $1,090,896 of brokered deposits at December 31, 1999.
This prohibition is not expected to materially impact Goleta.
On March 23, 2000, Goleta signed a formal written agreement with the Comptroller
of the Currency of the United States of America (the Agreement). Under the
terms of the Agreement, by September 30, 2000, and thereafter, Goleta is
required to maintain total capital at least equal to 12% of risk-weighted
assets, and Tier 1 capital at least equal to 7% of adjusted total assets.
Goleta is required to adopt and implement a written asset diversification
program that includes specific plans to reduce the concentration of second
mortgage loans (exclusive of securitized loans bought back from the
securitization) to 100% of capital by September 30, 2000. The Agreement
requires Goleta to submit within 60 days a capital plan, which is to include,
among other things, specific plans for meeting the special capital requirements,
projections for growth and a dividend policy. The Agreement places limitations
on growth and payments of dividends until Goleta is in compliance with its
approved capital plan. The Agreement also requires that Goleta adopt and
improve certain policies and procedures and develop a three-year strategic plan.
Goleta is required to submit monthly progress reports to the OCC detailing
actions taken, results of those actions and a description of actions needed to
achieve full compliance with the Agreement.
<PAGE>
Schedule of Assets, Liabilities and Stockholders' Equity
- --------------------------------------------------------------
The following schedule shows the average balances of the Company's assets,
liabilities and stockholders' equity accounts as a percentage of average total
assets for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31, 1999 1998 1997
------------------ ------------------ -----------------
Amount % Amount % Amount %
------------------ ------------------ -----------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
- ----------------------------------------------- --------- ------- --------- ------- -------- -------
Cash and due from banks $ 8,582 1.9% $ 3,771 1.7% $ 3,203 3.7%
Federal funds sold 19,287 4.3% 8,161 3.6% 8,129 9.3%
Time deposits in other financial institutions 703 0.2% 1,099 0.5% 2,092 2.4%
FRB/FHLB Stock 621 0.1% 271 0.1% 215 0.2%
Investment securities 7,538 1.7% 6,199 2.8% 3,672 4.2%
Loans:
Commercial 19,545 4.3% 13,045 5.7% 13,637 15.6%
Real estate 43,627 9.7% 19,536 8.7% 20,612 23.6%
Unguaranteed portions of loans insured by SBA 24,139 5.4% 25,455 11.3% 21,345 24.4%
Installment 7,520 1.6% 12,531 5.6% 4,239 4.8%
Loan participations purchased 8,978 2.0% (1,109) -0.5% 1,333 1.5%
Less: allowance for loan loss (2,179) -0.5% (1,433) -0.6% (1,333) -1.5%
Less: net deferred loan fees and premiums (103) 0.0% (21) 0.0% (30) 0.0%
Less: discount on loan pool purchase (970) -0.2% (703) -0.3% (488) -0.6%
--------- ------- --------- ------- -------- ------
Net loans 100,557 22.3% 67,301 29.9% 59,315 67.8%
Securitized Loans 156,900 34.9% 80,231 35.6% - 0.0%
Loans held for sale 140,910 31.3% 48,519 21.5% 5,428 6.2%
Other real estate owned 361 0.1% 181 0.1% 216 0.3%
Premises and equipment, net 4,682 1.0% 3,433 1.5% 2,547 2.9%
Servicing asset 1,813 0.4% 849 0.4% 788 0.9%
Accrued interest receivable and other assets 8,087 1.8% 5,243 2.3% 1,863 2.1%
--------- ------- --------- ------- -------- ------
TOTAL ASSETS $450,041 100.0% $225,258 100.0% $87,468 100.0%
========= ======= ========= ======= ======== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand 24,761 5.5% 20,396 9.1% 16,915 19.3%
Interest-bearing demand 17,975 4.0% 6,385 2.8% 12,936 14.8%
Savings 23,776 5.3% 22,906 10.2% 10,413 11.9%
Time certificates, $100,000 or more 93,668 20.8% 30,338 13.5% 14,533 16.6%
Other time certificates 105,062 23.3% 50,016 22.2% 21,165 24.2%
--------- ------- --------- ------- -------- ------
Total deposits 265,242 58.9% 130,041 57.8% 75,962 86.8%
Bonds Payable 144,311 32.1% 76,475 33.9% - 0.0%
Other Borrowings 1,128 0.3% - 0.0% - 0.0%
Federal funds purchased 844 0.2% 1,479 0.7% - 0.0%
Accrued interest payable and other liabilities 5,838 1.3% 4,771 2.1% 661 0.8%
--------- ------- --------- ------- -------- ------
Total liabilities 417,363 92.8% 212,766 94.5% 76,623 87.6%
Stockholders' equity
Common stock 23,941 5.3% 8,969 4.0% 8,332 9.5%
Retained earnings 9,941 2.2% 3,523 1.5% 2,513 2.9%
Unrealized Gain/(Loss) on AFS securities (42) 0.0% - 0.0% - 0.0%
Treasury stock (1,162) -0.3% - 0.0% - 0.0%
--------- ------- --------- ------- -------- ------
Total stockholders' equity 32,678 7.2% 12,492 5.5% 10,845 12.4%
--------- ------- --------- ------- -------- ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $450,041 100.0% $225,258 100.0% $87,468 100.0%
========= ======= ========= ======= ======== ======
</TABLE>
<PAGE>
Investment Portfolio
- ---------------------
The following table summarizes the year-end carrying value balances of the
Company's investment securities.
<TABLE>
<CAPTION>
December 31,
--------------------------------------
1999 1998 1997
------------- ---------- -----------
<S> <C> <C> <C>
U.S. Treasury Securities $ 497,000 $1,256,000 $ 998,000
FRB Stock 302,000 264,000 251,000
FHLB Stock 474,000 546,000 -
GNMA Securities 2,746,000 4,230,000 -
FNMA Securities 1,107,000 1,893,000 -
FHLMC Securities 1,044,000 1,420,000 -
------------- ---------- -----------
$ 6,170,000 $9,609,000 $1,249,000
============== ========= ===========
</TABLE>
The following table summarizes the amounts, terms, distributions, and yields of
the Company's investment securities as of December 31, 1999.
<TABLE>
<CAPTION>
After One Year to
One Year or Less Five Years Over Five Years Total
----------------- ----------- ------------- -----
Amount Yield Amount Yield Amount Yield Amount Yield
----------------- ----------- --------------- ----- ------ ------ ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury Securities 497 5.40% - N/A - N/A 497 5.40%
FRB Stock 302 5.63% - N/A - N/A 302 5.63%
FHLB Stock 474 5.27% - N/A - N/A 474 5.27%
GNMA Securities - N/A - N/A 2,746 6.79% 2,746 6.79%
FNMA Securities - N/A - N/A 1,107 6.72% 1,107 6.72%
FHLMC Securities - N/A - N/A 1,044 6.80% 1,044 6.80%
Total 1,273 5.43% - N/A 4,897 6.78% 6,170 6.10%
</TABLE>
The Investment Policy of the Company sets forth the types and maturities of
investments the Company and its subsidiaries may hold.
Interest Only Strips
- ----------------------
At December 31, 1999 and 1998 the Company held interest only strips in the
amount of $5,382,994 and $2,221,900, respectively. These interest-only strips
represent the present value of the right to the estimated excess net cash flows
generated by the sold loans that represent the difference between (a) interest
at the stated rate paid by borrowers and (b) the sum of (i) pass-through
interest paid to third-party investors; and (ii) stipulated servicing fees. The
Company determines the present value of this estimated cash flow at the time of
the closing of the loan sale, utilizing valuation assumptions appropriate for
each particular transaction.
The significant valuation assumptions include the estimated average lives of the
loans sold and the estimated prepayment speeds related thereto. Present value of
the cash flow is calculated using an estimated market discount rate of 11% to
the expected gross cash flows, which are calculated utilizing the weighted
average lives of the loans. The annual prepayment rate of the loans is a
function of full and partial prepayments and defaults. In the interest-only
strips' fair value estimates, the Company makes assumptions of the prepayment
rates of the underlying loans, which the Company believes are reasonable. The
interest only strips are accounted for as investments in debt securities
classified as trading securities. Accordingly, the Company marks them to fair
value with the resulting increase or decrease recorded through operations in the
<PAGE>
current period. At December 31, 1999 the Company utilized estimated annual
prepayment assumptions of 8% for SBA loans and 30% for FHA Title 1 loans to
estimate the fair value of the interest-only strips.
Loan Portfolio
- ---------------
The Company's largest lending categories are commercial loans, real estate
loans, unguaranteed portion of loans insured by the SBA, installment loans, real
estate loan participations purchased and second mortgage loans. Loans are
carried at face amount, less payments collected, the allowance for possible loan
losses, deferred loan fees and discounts on loans purchased. Interest on all
loans is accrued daily, primarily on a simple interest basis. It is generally
the Company's policy to place loans on nonaccrual status when they are 90 days
past due. Thereafter, interest income is no longer recognized. Problem loans
are maintained on accrual status only when management of the Company is
confident of full repayment within a very short period of time.
The rates of interest charged on variable rate loans are set at specified
increments in relation to the Company's published prime lending rate or other
appropriate indices and vary as those indices vary. At December 31, 1999,
approximately 60% of the Company's loan portfolio was comprised of variable
interest rate loans. At December 31, 1998, variable rate loans comprised
approximately 63% of the Company's loan portfolio. At December 31, 1997,
variable rate loans comprised approximately 72% of the Company's loan portfolio.
Distribution of Loans
- -----------------------
The distribution of the Company's total loans by type of loan as of the dates
indicated, is shown in the following table (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C> <C> <C> <C>
Commercial 12,102 2.7% 10,612 4.3% 13,195 18.1%
Real Estate 44,139 9.7% 65,348 26.2% 19,924 27.3%
Unguaranteed portion of loans insured by SBA 25,073 5.5% 26,687 10.7% 19,602 26.9%
Installment 6,348 1.4% 5,638 2.3% 3,467 4.8%
Loan participations purchased 25,395 5.6% 2,287 0.9% 2,247 3.1%
Loans held for sale,
primarily second mortgage loans 158,274 34.7% 58,687 23.5% 14,440 19.8%
Securitized Loans 184,559 40.4% 80,232 32.1% 0 0.0%
GROSS LOANS 455,890 100.0% 249,491 100.0% 72,875 100.0%
Less:
Allowance for loan losses 5,529 3,374 1,286
Deferred loan fees (costs) -3,079 -1,995 -3
Discount on loan pools purchased 1,776 701 428
451,664 247,411 71,164
</TABLE>
Commercial Loans
- -----------------
In addition to traditional commercial loans made to business customers, the
Company also extends business lines of credit. On business lines of credit, the
Company establishes a maximum amount, which it stands ready to lend to the
customer during a specified period, in return for which the customer agrees to
maintain its primary banking relationship with the Company. Prior to extending
credit to a borrower, the purpose and security are clearly established.
Normally the Company does not make loan commitments in material amounts for
periods in excess of one year.
Real estate loans are primarily made for the purpose of purchasing, improving or
constructing single family residences, and commercial and industrial properties.
The majority of the Company's real estate loans are collateralized by first and
<PAGE>
second liens on single family homes. Maturities on such loans are generally 15
to 30 years.
A large part of the Company's real estate construction loans are first and
second trust deeds on the construction of owner-occupied single family
dwellings. The Company also makes real estate construction loans on commercial
properties. These consist of first and second trust deeds collateralized by the
related real property. Construction loans are generally written with terms of
six to twelve months and usually do not exceed a loan to appraised value of 80%.
Some real estate loans are secured by nonresidential property. Office buildings
or other commercial property often secures these loans. Loan-to-value ratios
are generally restricted to 70% of appraised value of the underlying real
property.
Unguaranteed Portion of Loans Guaranteed by the SBA
- ----------------------------------------------------------
The Company is approved as a Preferred Lender by the SBA. Loans made by the
Company under programs offered by the SBA are generally made to small businesses
for the purchase of businesses, purchase or construction of facilities, purchase
of equipment or working capital. The SBA generally guarantees between 75% and
90% of the funded commitment. Borrowers are required to provide adequate
collateral for these loans, similar to other commercial loans. The SBA does
allow less-collateralized loans for its "Low Doc" program for commitments less
than $100,000. When the Company originates SBA loans, it sells the guaranteed
portion of the loans into the secondary market. The Company retains the
unguaranteed portion of the loans, as well as the servicing on the loans, for
which it is paid a fee. The loans are all variable rate based upon the Wall
Street Journal Prime Rate. The servicing spread is a minimum of 1.00% on all
loans. The gains recognized by the Company on the sales of the guaranteed
portion of these loans and the ongoing servicing income received, are
significant revenue streams for the Company.
Installment Loans
- ------------------
While not a large portion of its loan portfolio, the Company originates
installment loans, also known as consumer loans. These loans are comprised of
automobile, small equity lines of credit and general personal loans. These loans
are primarily variable rate with terms of five years or less.
Second Mortgage Loans
- -----------------------
In 1996 the Company began offering second mortgage loans which allow borrowers
to receive up to 125% of their home value for debt consolidation, home
improvement, or any other worthwhile cash outlay. During 1997 and the first
quarter of 1998 the Company sold these loans for a premium to third parties. No
servicing was retained on these loans.
In 1998 and 1999 the Company transferred $81 million and $122 million of these
loans to special purpose entities (SPE's). The SPE's, through securitizations,
then sold bonds to third party investors, which were secured by the transferred
loans. The bonds are held in a trust independent of the Company, the trustee of
which oversees the distributions to the bondholders. The mortgage loans are
serviced by a third party (the servicer), who receives a stated servicing fee.
There is an insurance policy on the bonds that unconditionally guarantees the
ultimate payment of the bonds. As part of the securitization agreement, the
Company received an option to repurchase the bonds when the aggregate principal
balance of the mortgage loans sold has declined to 10% or less of the original
balance of mortgage loans securitized. Because the Company has a repurchase
<PAGE>
option to reacquire the loans transferred and has not retained the servicing
rights, the Company has not surrendered effective control over the loans
transferred. Therefore, the securitizations are accounted for as secured
borrowings with a pledge of collateral in accordance with SFAS No. 125
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities". Accordingly, the Company is required to consolidate the SPE's,
and the financial statements of the Company include the loans transferred and
the related bonds issued. The securitized loans are classified as held for
investment.
In the fourth quarter of 1999, the Company decided to cease future
securitization activities. As of December 31, 1999, the Company had accumulated
$150 million in second mortgage loans. These loans are classified as held for
sale. It is the Company's intent to sell these loans, servicing released, to
third parties. On an ongoing basis, the Company will continue to originate
second mortgage loans, which will be sold to third parties shortly after
origination.
Maturity of Loans and Sensitivity of Loans to Changes in Interest Rates
- --------------------------------------------------------------------------------
The following table sets forth the amount of gross loans outstanding, as of
December 31, 1999, 1998, and 1997, which, based on the remaining scheduled
repayments of principal, have the ability to be repriced or are due in less than
one year, in one to five years, or in more than five years.
<TABLE>
<CAPTION>
1999 1998 1997
----------------- ------------------ ----------------
(Dollars in thousands) Fixed Variable Fixed Variable Fixed Variable
-------- ------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Less than One Year $ 789 $87,313 $ 5,431 $105,173 $ 8,319 $43,676
-------- ------- -------- -------- ------- -------
One Year to Five Years 8,342 4,628 10,487 1,272 7,996 -
More than Five Years 354,282 536 127,128 - 12,884 -
-------- ------- -------- -------- ------- -------
Total $363,413 $92,477 $143,046 $106,445 $29,199 $43,676
</TABLE>
The following table shows the Company's loan commitments outstanding at the
dates indicated:
<TABLE>
<CAPTION>
December 31,
(Dollars in thousands) 1999 1998 1997
-------- ------- -------
<S> <C> <C> <C>
Commercial $ 6,641 $10,693 $12,298
Real estate 4,135 12,306 2,015
Loans guaranteed by the SBA 5,266 4,230 4,177
Installment loans 2,205 1,502 1,171
Standby letters of credit 713 35 30
-------- ------- -------
Total commitments $ 18,960 $28,766 $19,691
======== ======= =======
</TABLE>
Based upon prior experience and prevailing economic conditions, it is
anticipated that approximately 80% of the commitments at December 31, 1999 will
be exercised during 2000.
Summary of Loan Losses Experience
- -------------------------------------
As a natural corollary to the Company's lending activities, some loan losses are
experienced. The risk of loss varies with the type of loan being made and the
creditworthiness of the borrower over the term of the loan. The degree of
perceived risk is taken into account in establishing the structure of, and
interest rates and security for, specific loans and for various types of loans.
The Company attempts to minimize its credit risk exposure by use of thorough
loan application and approval procedures.
The Company maintains a program of systematic review of its existing loans.
Loans are graded for their overall quality. Those loans that the Company's
management determines require further monitoring and supervision are segregated
and reviewed on a periodic basis. The Company's Loan Committee reviews
significant problem loans on a monthly basis.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
<PAGE>
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record and the amount of the
shortfall in relation to the principal and interest owed. The Company uses the
fair value of collateral method to measure impairment. Impairment is measured
on a loan by loan basis for all loans in the portfolio except for the
securitized loans, which are collectively evaluated for impairment.
The recorded investment in loans that are considered to be impaired under
Statement of Financial Accounting Standards ("SFAS") No. 114 was as follows:
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1999 1998 1997
-------------- ----------- -----------
<S> <C> <C> <C>
Impaired loans without
specific valuation allowances $ 3,250,576 $4,450,345 $1,547,168
-------------- ----------- -----------
Impaired loans with
specific valuation allowances 1,402,469 813,652 1,250,964
Specific valuation allowance
allocated to impaired loans (1,038,519) (464,336) (505,994)
-------------- ----------- -----------
Impaired loans, net $ 3,614,526 $4,799,661 $2,292,138
============== =========== ===========
Average investment in impaired loans $ 5,119,852 $4,009,400 $1,901,054
============== =========== ===========
Interest income recognized on impaired loans $ 243,913 $ 288,607 $ 287,309
============== =========== ===========
</TABLE>
It is the Company's policy to place loans on nonaccrual status when they are 90
days past due. Thereafter, interest income is no longer recognized. As such,
interest income may be recognized on impaired loans to the extent they are not
past due by 90 days or more.
Upon the adoption of SFAS No. 114, the Company classified all loans on
nonaccrual status as impaired. Accordingly, the impaired loans disclosed above
include all loans that were on nonaccrual status.
Financial difficulties encountered by certain borrowers may cause the Company to
restructure the terms of their loans to facilitate loan payments. In accordance
with the provisions of SFAS No. 114, a troubled loan that is restructured
subsequent to the adoption of SFAS No. 114 would generally be considered
impaired, while a loan restructured prior to adoption would not be considered
impaired if, at the date of measurement, it was probable that the Company would
collect all amounts due under the restructured terms. Accordingly, the balance
of impaired loans disclosed above includes all troubled debt restructured loans
that, as of December 31, 1999 1998, and 1997 are considered impaired.
<PAGE>
The recorded investment in loans that are considered to be impaired is as
follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------------
(Dollars rounded to thousands) 1999 1998 1997
------------- ---------- ----------
<S> <C> <C> <C>
Nonaccrual loans $ 3,091,000 $2,971,000 $1,259,000
Troubled debt restructured loans, gross $ 656,000 $1,313,000 $2,375,000
Interest foregone on nonaccrual loans $ 1,585,000 $ 414,000 $ 190,000
and troubled debt restructuring outstanding
Loans 30 through 90 days past due with interest accruing $ 2,550,000 $ 678,000 $ 631,000
</TABLE>
The Company charges off that portion of any loan which management considers to
represent a loss. A loan is generally considered by management to represent a
loss in whole or in part when an exposure beyond any collateral value is
apparent, servicing of the unsecured portion has been discontinued or collection
is not anticipated based on the borrower's financial condition and general
economic conditions in the borrower's industry. The principal amount of any
loan, which is declared a loss, is charged against the Company's allowance for
loan losses.
The following table summarizes the Company's loan loss experience for the
periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31, 1999 1998 1997
------------- ------------- ------------
Balances:
<S> <C> <C> <C>
Average gross loans, held for investment $260,709,000 $149,690,000 $61,166,000
Gross loans at end of period, held for investment 297,616,000 190,804,000 58,435,000
Loans charged off 4,035,000 360,000 401,000
Recoveries of loans previously charged off 58,000 61,000 17,000
------------------------------------------
Net loans charged off 3,977,000 299,000 384,000
------------------------------------------
Allowance for loan losses 5,529,000 3,374,000 1,286,000
Provisions for loan losses 6,133,000 1,760,000 260,000
Ratios:
Net loan charge-offs to average loans 1.5% 0.2% 0.6%
Net loan charge-offs to loans at end of period 1.3% 0.2% 0.7%
Allowance for loan losses to average loans 2.1% 2.3% 2.1%
Allowance for loan losses to loans
held for investment at end of period 1.9% 1.8% 2.2%
Net loan charge-offs to allowance
for loan losses at end of period 71.9% 8.9% 29.9%
Net loan charge-offs to provision for loan losses 64.8% 17.0% 147.7%
</TABLE>
The Company's allowance for loan losses is designed to provide for loan losses
which are known and inherent in the portfolio. The allowance for loan losses is
established through charges to operating expenses in the form of provisions for
loan losses. Actual loan losses or recoveries are charged or credited directly
to the allowance for loan losses. Management of the Company determines the
amount of the allowance. Among the factors considered in determining the
allowance for loan losses are the current financial condition of the Company's
borrowers and the value of the security, if any, for their loans. Estimates of
future economic conditions and their impact on various industries and individual
borrowers are also taken into consideration, as are the Company's historical
loan loss experience and reports of banking regulatory authorities. Because
these estimates, factors and evaluations are primarily judgmental, no assurance
can be given as to whether or not the Company will sustain loan losses
<PAGE>
substantially different in relation to the size of the allowance for loan losses
or that subsequent evaluation of the loan portfolio may not require substantial
changes in such allowance.
At December 31, 1999, 1998, and 1997, the allowance was 1.9%, 1.8%, and 2.2% of
the gross loans held for investment then outstanding. Although the current level
of the allowance is deemed adequate by management, future provisions will be
subject to continuing reevaluation of risks in the loan portfolio.
Management of the Company reviews with the Board of Directors the adequacy of
the allowance for loan losses on a quarterly basis. The loan loss provision is
adjusted when specific items reflect a need for such an adjustment. Management
believes that there were no material loan losses during the last fiscal year
that have not been charged off. Management also believes that the Company has
adequately provided for all individual items in its portfolio, which may result
in a material loss to the Company.
Interest Rates and Differentials
- -----------------------------------
Certain information concerning interest-earning assets and interest-bearing
liabilities, and yields thereon, is set forth in the following table. Amounts
outstanding are daily average balances:
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
1999 1998 1997
---------- --------- --------
<S> <C> <C> <C>
INTEREST-EARNING ASSETS:
Time deposits in other financial institutions:
Average outstanding $ 703 $ 1,099 $ 2,092
Average yield 6.7% 6.0% 5.8%
Interest income $ 47 $ 66 $ 120
Federal funds sold:
Average outstanding $ 19,287 $ 8,161 $ 8,129
Average yield 5.2% 5.0% 5.2%
Interest income $ 1,008 $ 411 $ 424
Investment securities:
Average outstanding $ 8,159 $ 3,788 $ 3,887
Average yield 5.4% 1.4% 3.0%
Interest income $ 442 $ 52 $ 115
Loans:
Average outstanding $397,074 $203,873 $66,594
Average yield 11.8% 7.2% 11.0%
Interest income $ 46,998 $ 14,751 $ 7,350
TOTAL INTEREST-EARNING ASSETS:
Average outstanding $425,223 $216,921 $80,702
Average yield 11.4% 7.0% 9.9%
Interest income $ 48,495 $ 15,280 $ 8,009
<PAGE>
INTEREST-BEARING LIABILITIES:
Interest-bearing demand deposits:
Average outstanding $ 17,975 $ 6,385 $12,936
Average yield 3.2% 7.9% 3.4%
Interest expense $ 576 $ 502 $ 442
Savings deposits:
Average outstanding $ 23,776 $ 22,906 $10,413
Average yield 3.7% 2.1% 3.8%
Interest expense $ 884 $ 488 $ 391
Time certificates of deposit:
Average outstanding $198,730 $ 80,354 $35,698
Average yield 6.9% 5.9% 5.8%
Interest expense $ 13,620 $ 4,732 $ 2,077
Federal funds purchased:
Average outstanding $ 844 $ 1,479 $ -
Average yield 5.2% 5.7% -
Interest expense $ 44 $ 85 $ -
Bonds Payable:
Average outstanding $144,311 $ 6,372 $ -
Average yield 6.9% 8.0%
Interest expense $ 9,938 $ 510 $ -
Other borrowings:
Average outstanding $ 1,128 $ - $ -
Average yield 7.4%
Interest expense $ 83 $ - $ -
TOTAL INTEREST-BEARING LIABILITIES:
Average outstanding $386,764 $117,496 $59,047
Average yield 6.5% 5.4% 4.9%
Interest Expense $ 25,145 $ 6,317 $ 2,910
Net interest income $ 23,350 $ 8,963 $ 5,099
AVERAGE NET INTEREST MARGIN 5.5% 4.1% 6.3%
ON INTEREST-EARNING ASSETS
</TABLE>
Liquidity Management
- ---------------------
The Company has an asset and liability management program allowing the Company
to maintain its interest margins during times of both rising and falling
interest rates and to maintain sufficient liquidity. Liquidity of the Company at
December 31, 1999, was 38%, at December 31, 1998, was 36%, based on liquid
assets (consisting of cash and due from banks, deposits in other financial
institutions, available for sale investments, federal funds sold and loans held
for sale) divided by total assets. Management believes it maintains adequate
liquidity levels.
At times, when the Company has more funds than it needs for its reserve
requirements or short-term liquidity needs, the Company increases its securities
investments and sells federal funds. It is management's policy to maintain a
substantial portion of its portfolio of assets and liabilities on a short-term
or highly liquid basis in order to maintain rate flexibility and to meet loan
funding and liquidity needs.
<PAGE>
Deposits
- --------
The following table shows the Company's average deposits for each of the periods
indicated below, based upon average daily balances:
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
-----------------------
1999 1998 1997
------------------- ------------------- -------------------
Average Percent Average Percent Average Percent
Balance of Total Balance of Total Balance of Total
-------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand $ 24,761 9.3% $ 20,396 15.7% $ 16,915 22.3%
Interest-bearing demand 17,975 6.8% 6,385 4.9% 12,936 17.0%
Savings 23,776 9.0% 22,906 17.6% 10,413 13.7%
TCDs of $100,000 or more 93,668 35.3% 30,338 23.3% 14,533 19.1%
Other TCDs 105,062 39.6% 50,016 38.5% 21,165 27.9%
-------- --------- -------- --------- -------- ---------
Total Deposits $265,242 100.0% $130,041 100.0% $ 75,962 100.0%
-------- --------- -------- --------- -------- ---------
</TABLE>
The maturities of time certificates of deposit ("TCDs") were as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) December 31, 1999 December 31, 1998
------------------ ------------------
TCD's over TCDs over
$100,000 Other TCD's $100,000 Other TCDs
----------------------------------------------
<S> <C> <C> <C> <C>
Less than three months $ 60,353 $ 64,553 $ 36,080 $ 55,362
Over three months through six months 31,638 46,955 7,016 12,395
Over six months through twelve months 7,142 22,588 15,911 17,558
Over twelve months through five years 1,624 6,056 2,735 10,472
------------ ----------- -------- ---------
Total $ 100,757 $ 140,152 $ 61,742 $ 95,787
============ =========== ======== =========
</TABLE>
While the deposits of the Company may fluctuate up and down somewhat with local
and national economic conditions, management of the Company does not believe
that such deposits or the business of the Company in general are seasonal in
nature. Liquidity management is monitored by the Chief Financial Officer daily
and by the Asset/Liability Committee of the Company's Board of Directors, which
meets quarterly.
Year 2000
- ----------
The Company had in place a plan of action designed to minimize the risk of the
year 2000 event including the establishment of an oversight committee. This
plan was fully supported by management and the Board of Directors. The committee
achieved a year 2000 date conversion with no effect on customers or disruption
to business operations. No systems, hardware or software determined as critical
needed replacement.
The Company was not required to purchase any additional hardware or software to
be year 2000 compliant. However, management has incurred and may continue to
incur some administrative costs relative to the identification and testing of
the Company's electronic data processing systems. As of December 31, 1999, the
Company had incurred $465,646 in expenses becoming Year 2000 compliant and
anticipates minimal spending in 2000.
<PAGE>
SUPERVISION AND REGULATION
- ----------------------------
INTRODUCTION
Banking is a complex, highly regulated industry. The primary goals of the
regulatory scheme are to maintain a safe and sound banking system, protect
depositors and the Federal Deposit Insurance Corporation's insurance fund, and
facilitate the conduct of sound monetary policy. In furtherance of these goals,
Congress has created several largely autonomous regulatory agencies and enacted
numerous laws that govern banks, bank holding companies and the banking
industry. Consequently, the growth and earnings performance of the Company, as
well as Goleta and Palomar (collectively, the "Banking Subsidiaries") can be
affected not only by management decisions and general economic conditions, but
also by the requirements of applicable state and federal statutes, regulations
and the policies of various governmental regulatory authorities, including:
- the Board of Governors of the Federal Reserve System (the "FRB");
- the Federal Deposit Insurance Corporation (the "FDIC");
- the Office of the Comptroller of the Currency (the "OCC"); and
- the California Department of Financial Institutions (the "DFI").
The system of supervision and regulation applicable to the Company and the
Banking Subsidiaries establishes a comprehensive framework for their respective
operations. Federal and state laws and regulations generally applicable to
financial institutions, such as the Company and the Banking Subsidiaries,
regulate, among other things:
- the scope of business that they may conduct;
- investments that they can make;
- reserves that must be maintained against deposits;
- capital levels that must be maintained relative to the amount and
risks associated with assets;
- the nature and amount of collateral that may be taken to secure loans;
- the establishment of new branches;
- mergers and consolidations with other financial institutions; and
- the amount of dividends that the Company and the Banking Subsidiaries
may pay.
The following summarizes the material elements of the regulatory framework that
applies to the Company and any subsidiaries, including the Banking Subsidiaries.
It does not describe all of the statutes, regulations and regulatory policies
that are applicable. Also, it does not restate all of the requirements of the
statutes, regulations and regulatory policies that are described. Consequently,
the following summary is qualified in its entirety by reference to the
applicable statutes, regulations and regulatory policies. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on the business of the Company and the Banking Subsidiaries.
SUPERVISION AND REGULATION - THE COMPANY
GENERAL. The Company, as a bank holding company registered under the Bank
- -------
Holding Company Act of 1956 (the "BHCA"), is subject to regulation by the FRB.
<PAGE>
According to FRB policy, the Company is expected to act as a source of financial
strength for the Banking Subsidiaries and to commit resources to support them in
circumstances where the Company might not otherwise do so. Under the BHCA, the
Company and its subsidiaries are subject to periodic examination by the FRB.
The Company is also required to file periodic reports of its operations and any
additional information regarding its activities and those of its subsidiaries
with the FRB, as may be required.
The Company is also a bank holding company within the meaning of Section 3700 of
the California Financial Code. As such, the Company and its subsidiaries are
subject to examination by, and may be required to file reports with, the
Commissioner of the California Department of Financial Institutions (the
"Commissioner"). Regulations have not yet been proposed or adopted or steps
otherwise taken to implement the Commissioner's powers under this statute.
BANK HOLDING COMPANY LIQUIDITY. The Company is a legal entity, separate and
- ---------------------------------
distinct from its subsidiaries. Although there exists the ability to raise
capital on its own behalf or borrow from external sources, it may also obtain
additional funds through dividends paid by, and fees for services provided to,
its subsidiaries. However, regulatory constraints may restrict or totally
preclude the Banking Subsidiaries from paying dividends to the Company.
Regarding Goleta, the Company is entitled to receive dividends when and as
declared by the Goleta's Board of Directors, out of funds legally available
therefore, as specified and limited by the OCC's regulations. Pursuant to the
OCC's regulations, funds available for a national bank's cash dividends are
restricted to the lesser of the bank's: (i) retained earnings; or (ii) net
income for the current and past two fiscal years (less any dividends paid during
such period), unless approved by the OCC. Furthermore, if the OCC determines
that a dividend would cause a bank's capital to be impaired or that payment
would cause it to be undercapitalized; the OCC can prohibit payment of a
dividend if it is an unsafe and unsound banking practice.
Regarding Palomar, the Company is entitled to receive dividends, when and as
declared by Palomar's Board of Directors, out of funds legally available
therefor, as specified and limited by the California Financial Code. Under the
California Financial Code, funds available for cash dividend payments by a
California state-chartered bank are restricted to the lesser of: (i) a bank's
retained earnings; or (ii) a bank's net income for its last three fiscal years
(less any distributions to shareholders made during such period). With the
prior approval of the Commissioner, cash dividends may also be paid out of the
greater of: (i) a bank's retained earnings; (ii) net income for a bank's last
preceding fiscal year; or (iii) net income for a bank's current fiscal year. If
the Commissioner finds that the shareholders' equity of the bank is not adequate
or that the payment of a dividend would be unsafe or unsound for the bank, the
Commissioner may order the bank not to pay a dividend to the bank's
shareholders.
Since the Banking Subsidiaries are also FDIC insured institutions, it is
therefore possible, depending upon their financial condition and other factors,
that the FDIC could assert that the payment of dividends or other payments
might, under some circumstances, constitute an unsafe or unsound practice and
thereby prohibit such payments.
TRANSACTIONS WITH AFFILIATES. The Company and any subsidiaries it may purchase
- -----------------------------
or organize are deemed to be affiliates of the Banking Subsidiaries within the
meaning of Sections 23A and 23B of the BHCA. Pursuant thereto, loans by the
Banking Subsidiaries to affiliates, investments by the Banking Subsidiaries in
affiliates' stock, and taking affiliates' stock by the Banking Subsidiaries as
collateral for loans to any borrower will be limited to 10% of the Banking
Subsidiary's capital, in the case of any one affiliate, and will be limited to
20% of the Banking Subsidiaries' capital in the case of all affiliates. In
addition, such transactions must be on terms and conditions that are consistent
with safe and sound banking practices; in particular, a bank and its
subsidiaries generally may not purchase from an affiliate a low-quality asset,
as defined in the Federal Reserve Act. Such restrictions also prevent a bank
holding company and its other affiliates from borrowing from a banking
subsidiary of the bank holding company unless the loans are secured by
marketable collateral of designated amounts. The Company and the Banking
Subsidiaries are also subject to certain restrictions with respect to engaging
in the underwriting, public sale and distribution of securities. (See
<PAGE>
"Supervision and Regulation - The Banking Subsidiaries - Recent Legislation and
Regulatory Developments - 1. Gramm-Leach-Bliley Act - Facilitating Affiliations
and Expansion of Financial Activities" herein.)
LIMITATIONS ON BUSINESSES AND INVESTMENT ACTIVITIES. Under the BHCA, a bank
- -------------------------------------------------------
holding company must obtain the FRB's approval before:
- directly or indirectly acquiring more than 5% ownership or control of
any voting shares of another bank or bank holding company;
- acquiring all or substantially all of the assets of another bank; or
- merging or consolidating with another bank holding company.
The FRB may allow a bank holding company to acquire banks located in any state
of the United States without regard to whether the acquisition is prohibited by
the law of the state in which the target bank is located. In approving
interstate acquisitions, however, the FRB must give effect to applicable state
laws limiting the aggregate amount of deposits that may be held by the acquiring
bank holding company and its insured depository institutions in the state in
which the target bank is located, provided that those limits do not discriminate
against out-of-state depository institutions or their holding companies, and
state laws which require that the target bank have been in existence for a
minimum period of time, not to exceed five years, before being acquired by an
out-of-state bank holding company.
In addition to owning or managing banks, bank holding companies may own
subsidiaries engaged in certain businesses that the FRB has determined to be "so
closely related to banking as to be a proper incident thereto." The Company
therefore is permitted to engage in a variety of banking-related businesses.
Some of the activities that the FRB has determined, pursuant to its Regulation
Y, to be related to banking are:
- making or acquiring loans or other extensions of credit for its own
account or for the account of others;
- servicing loans and other extensions of credit;
- operating a trust company in the manner authorized by federal or state
law under certain circumstances;
- leasing personal and real property or acting as agent, broker, or
adviser in leasing such property in accordance with various
restrictions imposed by FRB regulations;
- providing financial, banking, or economic data processing and data
transmission services;
- owning, controlling, or operating a savings association under certain
circumstances;
- selling money orders, travelers' checks and U.S. Savings Bonds;
- providing securities brokerage services, related securities credit
activities pursuant to Regulation T, and other incidental activities;
and
- underwriting and dealing in obligations of the U.S., general
obligations of states and their political subdivisions, and other
obligations authorized for state member banks under federal law.
Federal law prohibits a bank holding company and any subsidiary banks from
engaging in certain tie-in arrangements in connection with the extension of
credit. Thus, for example, the Banking Subsidiaries may not extend credit,
lease or sell property, or furnish any services, or fix or vary the
consideration for any of the foregoing on the condition that:
<PAGE>
- the customer must obtain or provide some additional credit, property
or services from or to the Banking Subsidiaries other than a loan,
discount, deposit or trust service;
- the customer must obtain or provide some additional credit, property
or service from or to the Company or any of the Banking Subsidiaries;
or
- The customer may not obtain some other credit, property or services
from competitors, except reasonable requirements to assure soundness
of credit extended.
- Generally, the BHCA does not place territorial restrictions on the
domestic activities of non-bank subsidiaries of bank holding
companies.
On November 12, 1999, the President signed into law the Gramm-Leach-Bliley Act
(the "GLB Act" or the "Financial Modernization Act"). The GLB Act
significantly changed the regulatory structure and oversight of the financial
services industry. The GLB Act permits banks and bank holding companies to
engage in previously prohibited activities under certain conditions. Also,
banks and bank holding companies may affiliate with other financial service
providers such as insurance companies and securities firms under certain
conditions. Consequently, a qualifying bank holding company, called a financial
holding company ("FHC"), can engage in a full range of financial activities,
including banking, insurance, and securities activities, as well as merchant
banking and additional activities that are beyond those permitted for
traditional bank holding companies. Moreover, various non-bank financial
service providers who were previously prohibited from engaging in banking can
now acquire banks while also offering services such as securities underwriting
and underwriting and brokering insurance products. The GLB Act also expands
passive investment activities by FHCs, permitting them to indirectly invest in
any type of company, financial or nonfinancial, through merchant banking
activities and insurance company affiliations. (See "Supervision and Regulation
- - The Banking Subsidiaries - Recent Legislation and Regulatory Developments - 1.
Gramm-Leach-Bliley Act" herein.)
CAPITAL ADEQUACY. Bank holding companies must maintain minimum levels of
- -----------------
capital under the FRB's risk based capital adequacy guidelines. If capital
falls below minimum guideline levels, a bank holding company, among other
things, may be denied approval to acquire or establish additional banks or
non-bank businesses.
The FRB's risk-based capital adequacy guidelines for bank holding companies and
state member banks, discussed in more detail below (see "Supervision and
Regulation - The Banking Subsidiaries - Recent Legislation and Regulatory
Developments - Risk-Based Capital Guidelines" herein), assign various risk
percentages to different categories of assets, and capital is measured as a
percentage of risk assets. Under the terms of the guidelines, bank holding
companies are expected to meet capital adequacy guidelines based both on total
risk assets and on total assets, without regard to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will
be required if warranted by the particular circumstances or risk profiles of
individual organizations. For example, the FRB's capital guidelines contemplate
that additional capital may be required to take adequate account of, among other
things, interest rate risk, or the risks posed by concentrations of credit,
nontraditional activities or securities trading activities. Moreover, any
banking organization experiencing or anticipating significant growth or
expansion into new activities, particularly under the expanded powers under the
GLB Act, would be expected to maintain capital ratios, including tangible
capital positions, well above the minimum levels.
LIMITATIONS ON DIVIDEND PAYMENTS. California Corporations Code Section 500
- -----------------------------------
allows the Company to pay a dividend to its shareholders only to the extent that
the Company has retained earnings and, after the dividend, the Company's:
assets (exclusive of goodwill and other intangible assets) would be 1.25
times its liabilities (exclusive of deferred taxes, deferred income and other
deferred credits); and
- current assets would be at least equal to its current liabilities.
<PAGE>
Additionally, the FRB's policy regarding dividends provides that a bank holding
company should not pay cash dividends exceeding its net income or which can only
be funded in ways that weaken the bank holding company's financial health, such
as by borrowing. The FRB also possesses enforcement powers over bank holding
companies and their non-bank subsidiaries to prevent or remedy actions that
represent unsafe or unsound practices or violations of applicable statutes and
regulations.
SUPERVISION AND REGULATION - THE BANKING SUBSIDIARIES
GENERAL. Palomar, as a state-chartered bank that is not a member of the Federal
- -------
Reserve System and whose deposits are insured by the FDIC, is subject to
regulation, supervision, and regular examination by the DFI, and the FDIC.
Goleta, as a national banking association, which is also a member of the Federal
Reserve System, is subject to regulation, supervision, and regular examination
by the OCC, the FDIC and the FRB. The Banking Subsidiaries' deposits are
insured by the FDIC up to the maximum extent provided by law. The regulations
of these agencies govern most aspects of the Banking Subsidiaries' business and
establish a comprehensive framework governing their operations. California law
exempts all banks from usury limitations on interest rates.
RECENT LEGISLATION AND REGULATORY DEVELOPMENTS. From time to time legislation
- ------------------------------------------------
is proposed or enacted which has the effect of increasing the cost of doing
business and changing the competitive balance between banks and other financial
and non-financial institutions. Various federal laws enacted over the past
several years have provided, among other things, for the maintenance of
mandatory reserves with the Federal Reserve on deposits by depository
institutions (state reserve requirements have been eliminated) and the
phasing-out of the restrictions on the amount of interest which financial
institutions may pay on certain of their customers' accounts. Federal
regulators have been given increased authority and means for providing financial
assistance to insured depository institutions and for effecting interstate and
cross-industry mergers and acquisitions of failing institutions. These laws
have generally had the effect of altering competitive relationships existing
among financial institutions, reducing the historical distinctions between the
services offered by banks, savings and loan associations and other financial
service providers, and increasing the cost of funds to banks and other
depository institutions.
1. GRAMM-LEACH-BLILEY ACT
-----------------------
GENERAL. The Gramm-Leach-Bliley ("GLB") Act was signed into law on November 12,
- -------
1999. The GLB Act represents the most significant revision of the banking and
financial services industry laws since the Depression Era by revising the BHCA
and permitting full affiliations with other financial service providers. The
GLB Act permits a qualified bank holding company, called a financial holding
company, to engage in a full range of financial activities including banking,
insurance, securities activities, as well as merchant banking and other
activities that are financial in nature. The following discusses the more
significant elements of the GLB Act.
FACILITATING AFFILIATIONS AND EXPANSION OF FINANCIAL ACTIVITIES. The GLB Act:
- -----------------------------------------------------------------
- eliminates many federal and state barriers to affiliations among banks
and securities firms, insurance companies, and other financial service
providers;
- establishes a statutory framework for permitting full affiliations to
occur;
- provides financial organizations with flexibility in structuring new
financial affiliations through the FHC structure or through a bank
financial subsidiary, with certain safeguards and limitations;
- preserves the role of the FRB as the umbrella supervisory authority
for those FHCs, while incorporating a system of functional regulation
designed to utilize the strengths of various federal and state
regulatory authorities; and
- establishes a mechanism for coordination between the FRB and the
Secretary of the Treasury (the "Secretary") regarding the approval of
new financial activities for both holding companies and financial
subsidiaries of national banks.
Safety and soundness is also emphasized by requiring that banks and holding
companies be "well capitalized" and "well managed" in order to engage in the new
activities and affiliations contemplated by the GLB Act, with the appropriate
regulators given authority to address any failure to maintain safety and
soundness standards in a prompt manner.
Financial Affiliations and Activities. The GLB Act repeals previous statutory
- ---------------------------------------
prohibitions by permitting bank holding companies and FRB member banks to engage
in previously prohibited activities and affiliations. Specifically, the GLB Act
adds Section 6 to the BHCA, designating qualifying bank holding companies
engaging in the new, permissible financial activities and affiliations as FHCs.
In order for a bank holding company to qualify as an FHC, its subsidiary
depository institutions must be:
<PAGE>
- "well managed";
- "well capitalized"; and
- have at least a "satisfactory" Community Reinvestment Act ("CRA")
rating as of their last examination.
On January 19, 2000, the FRB adopted interim regulations under Subpart I of
Regulation Y implementing the FHC provisions of the GLB Act. The interim
regulations, subject to revision, became effective March 11, 2000. Under the
interim regulations, a bank holding company must submit a declaration to the FRB
stating that the company elects to become an FHC and a certification that all
depository institutions controlled by the company are "well capitalized" and
"well managed." Providing that those requirements are met and that the
depository institutions have at least a "satisfactory" CRA rating, the election
to become an FHC is effective on the 31st day after the FRB receives the
election.
If any of an FHC's subsidiary depository institutions fails to retain a "well
managed" or "well capitalized" status, the FHC must execute an agreement with
the FRB within 45 days after notice of the deficiency, agreeing to implement
specific corrective measures to return the FHC to compliance. After the
agreement is executed, the FHC will have 180 days to correct any management or
capital deficiencies. Until the FRB has determined that the deficiencies have
been corrected, the FRB may impose any conditions or limitations on the conduct
or activities of an FHC or on any of its affiliates that the FRB deems
appropriate and consistent with the BHCA and the FHC and its affiliates may not
engage in any additional activities permitted by the GLB Act without the FRB's
prior approval.
If the FHC fails to correct the capital and management deficiencies within 180
days, the FRB may require the FHC to divest itself of any insured depository
institutions or the FRB may require the FHC to cease engaging (both directly and
through any subsidiary that is not a depository institution or a subsidiary of a
depository institution) in all activities that are not otherwise permissible for
a traditional bank holding company pursuant to the FRB's Regulation Y.
If any one of an FHC's depository institutions falls out of compliance with the
"satisfactory" CRA rating requirement, the FHC may continue existing activities
permitted by the GLB Act. However, the FHC may not commence any additional GLB
Act activities, or acquire direct or indirect control of any entity engaged in
such activities.
The GLB Act permits FHCs to engage in non-banking activities beyond those
permitted for traditional bank holding companies. Rather than requiring that
the non-banking activities be "closely related to banking," FHCs may engage in
those that the FRB determines to be:
- financial in nature;
- incidental to activities that are financial in nature; or
- complimentary to financial activities.
The GLB Act enumerates certain permissible activities that the FRB considers
financial in nature. FHCs, however, may only engage in complimentary financial
activities if the FRB determines that the complimentary activities do not pose a
substantial risk to the safety and soundness of the FHC's depository
institutions or the financial system in general.
For those expanded financial activities that are not specifically enumerated in
the GLB Act, the FRB has the primary authority to determine which activities are
financial in nature, incidental or complimentary, and may act by regulation or
order. However, the FRB may not act unilaterally. Pursuant to the GLB Act, a
consultative process between the FRB and the Secretary is required. The
Secretary may also make similar proposals to the FRB with respect to determining
whether proposed activities are financial in nature or incidental to financial
activities regarding financial subsidiaries of national banks. Such a process
is intended to bring a balance to the determinations regarding the type of
activities that are financial and limit so-called "regulatory shopping" by
financial service providers.
A qualifying FHC may engage in any new activity enumerated in the GLB Act
without receiving prior approval from the FRB. Rather, the FHC is only required
to file a notice with the FRB within 30 days after the activity is commenced or
a company is acquired. The new activities enumerated in the GLB Act which are
specifically considered financial in nature include:
- underwriting insurance or annuities, or acting as an insurance or
annuity principal, agent or broker;
- providing financial or investment advice;
- issuing or selling interests in pools of assets that a bank could
hold;
- all underwriting, dealing in or making markets in securities without
any revenue limitation; - engaging within the United States in any
activity that a bank holding company could engage in outside of the
country, if the FRB determined, before the GLB Act, that the activity
was usual in connection with banking or other financial operations
internationally;
- sponsoring and distributing all types of mutual funds;
- investment company activities;
- merchant banking equity investment activities;
- insurance company equity investments; and
- engaging in any activity that the FRB determined before the GLB Act to
be permitted for a bank holding Company.
The most significant of the new activities authorized by the GLB Act are
merchant banking and insurance company portfolio investment powers. Before
enactment of the GLB Act, bank holding companies were limited in their ability
to make equity investments, including controlling equity investments, to
entities that were engaged in activities that were closely related to the
business of banking. At the same time securities and insurance companies were
free to make merchant banking and insurance company portfolio investments in
virtually any kind of financial or non-financial company. Recognizing that such
investments are financial in nature, the GLB Act substantially expands the
authority of an FHC to make controlling equity investments in any kind of
entity, including those engaged in non-financial activities.
<PAGE>
Merchant Banking. The GLB Act permits FHC's to make controlling equity
- -----------------
investments in virtually any business entity (including those that engage in
non-financial activities) by permitting the FHC to engage in merchant banking
activities. In order to engage in merchant banking activities:
- the investment must not be made by a depository institution subsidiary
of the FHC, or by a subsidiary of a depository institution;
- the FHC must own a securities affiliate;
- the investment must be made as part of a bona fide underwriting or
merchant or investment banking activity, including investment
activities engaged in for the purpose of appreciation and ultimate
resale or disposition of the investment;
- the investment must be held for a period of time to enable the sale or
disposition thereof on a reasonable basis consistent with the
financial viability of the bona fide underwriting or merchant or
investment banking activity; and
- the FHC must not routinely manage or operate the entity, in which the
investment is made, except as may be required to obtain a reasonable
return on investment upon sale or disposition.
Insurance Company Portfolio Investments. The GLB Act permits FHCs to affiliate
- ----------------------------------------
with insurance companies. The GLB Act recognizes that, as part of their
ordinary business, insurance companies frequently invest funds received from
policyholders in most or all of the shares of stock of a company that may not be
engaged in a financial activity. New Section 4(k)(4)(I) of the BHCA permits an
insurance company that is affiliated with a depository institution to continue
insurance company portfolio investment activities, provided that certain
requirements are met. Specifically, the investments held by an insurance
company affiliate of a depository institution must:
- be acquired and held by an insurance company that is predominantly
engaged in underwriting life, accident and health, or property and
casualty insurance, or in providing and issuing annuities;
- represent investments made in the ordinary course of the insurance
company's business, according to relevant state insurance laws
governing such investments; and
- not be routinely managed or operated by the FHC, except as may be
necessary or required to obtain a reasonable return.
To the extent that an FHC does participate in management of the portfolio,
participation would be limited to safeguarding the investments under the
applicable requirements of state insurance laws.
The GLB Act imposes other restrictions on equity investment activities of FHCs.
First, a depository institution controlled by an FHC may not cross market the
products or services of a company in which the FHC has made a merchant banking
or insurance company portfolio investment (a "portfolio company"), and vice
versa. However, the GLB Act does not prevent a nonbank affiliate of an FHC and
a portfolio company from cross marketing each other's products.
Second, a controlling investment made pursuant to the GLB Act's merchant banking
or insurance company portfolio investment authority would make the portfolio
company an "affiliate" of the FHC's depository institution for purposes of
Sections 23A and 23B of the Federal Reserve Act. Moreover, the GLB Act
establishes a presumption that an investment of 15% or more in the equity of a
portfolio company will make the portfolio company an affiliate. Thus, an
affiliated depository institution's credit and asset purchase transactions will
be subject to the "covered transaction" restrictions of Sections 23A and 23B of
the Federal Reserve Act, including quantitative limits, collateral requirements,
and the "arms length" transaction standard.
<PAGE>
The Riegle-Neal Act was amended to apply its prohibitions against establishment
of deposit production offices to interstate branches acquired or established
under the GLB Act, including all branches of a bank owned by an out-of-state
bank holding company.
Preemption of State Law. The GLB Act affirms that the states are the primary
- --------------------------
legal authority to regulate the insurance business and related activities.
However, in their regulation of insurance activities, state laws are pre-empted
to the extent that they prohibit the affiliations permitted under the GLB Act.
States may not prevent or restrict depository institutions or their affiliates
from engaging in any activity permitted under the GLB Act, such as insurance
sales, solicitations and cross-marketing. States, however are allowed to
continue regulating other insurance activities such as licensing and requiring
that insurance companies maintain certain levels of capital.
Additionally, state regulation of other activities is not pre-empted, even if
they do prevent or restrict an activity permitted under the GLB Act, so long as
they do not discriminate. Consequently, state securities regulations are not
pre-empted with respect to a state's ability to investigate and enforce certain
unlawful transactions or require licensing. Similarly, state corporation and
antitrust laws are not pre-empted so long as such laws are consistent with the
intent of the Financial Modernization Act permitting affiliations.
Streamlining Supervision of Bank Holding Companies. The GLB Act authorizes the
- ---------------------------------------------------
FRB to examine each holding company and its subsidiaries. The legislation
provides that the FRB may require a bank holding company or any subsidiary to
submit reports regarding: (i) financial condition; (ii) monitoring of financial
and operating risks; (iii) transactions with depository institutions; and (iv)
compliance with the BHCA and other laws that the FRB has jurisdiction to
enforce. The FRB, however, is directed to use existing examination reports
prepared by functional regulators of the particular activity, publicly reported
information and reports filed with other agencies to the fullest extent
possible.
The FRB may only directly examine subsidiaries that are functionally regulated
by other federal or state agencies if it:
- has a reasonable basis to believe that the subsidiary is engaged in
activities that pose a material risk to an affiliated depository
institution;
- reasonably believes, after reviewing the relevant reports, that
examining the subsidiary is necessary to adequately provide
information regarding its risk monitoring systems; or
- has a reasonable basis to believe that the subsidiary is not in
compliance with the BHCA or other federal law that the FRB has
specific authority to enforce, and cannot make the determination
through an examination of an affiliated depository institution or the
holding company.
The FRB is not authorized to mandate capital requirements for any subsidiary
that is functionally regulated by another agency and which is in compliance with
the capital requirements prescribed by another federal or state regulatory
authority. Insurance and securities activities conducted in regulated entities
are subject to functional regulation by relevant state insurance authorities and
the Securities and Exchange Commission (the "SEC"), respectively.
Also, the FRB cannot force a broker-dealer or insurance company that is a bank
holding company to contribute additional capital to a depository institution, if
the company's functional regulator determines, in writing, that the contribution
would have a material adverse effect on the broker-dealer or insurance holding
company. If a functional regulator, however, makes such a determination, the
FRB has authority to require the bank holding company to divest its interests in
the depository institution. The limitations on the FRB also apply to all
federal banking agencies. Thus, the OCC, the Office of Thrift Supervision (the
"OTS") which regulates savings banks, and the FDIC will not be able to assume
and duplicate the function of being the general supervisory authority over
functionally regulated subsidiaries of banks. However, the GLB Act specifically
preserves the FDIC's authority to examine a functionally regulated affiliate of
an insured depository institution, if it is necessary to protect the deposit
insurance fund.
<PAGE>
The GLB Act also specifically limits the FRB's ability to take indirect action
against functionally regulated affiliates. Consequently, the FRB may not
promulgate rules, adopt restrictions, safeguards or any other requirement
affecting a functionally regulated affiliate unless:
- the action is necessary to address a "material risk" to the safety and
soundness of a depository institution affiliate or to the domestic or
international payments system; and
- it is not possible to guard against that material risk through
requirements imposed upon the depository institution directly.
Subsidiaries of National Banks. In addition to the permissible statutory
- ---------------------------------
subsidiaries (agricultural credit corporations, bank service companies and
community development corporations, etc.) and operating subsidiaries
(subsidiaries engaged in activities that a national bank itself can perform),
the GLB Act permits national banks to establish and operate a third class of
subsidiary known as a financial subsidiary. A financial subsidiary is a
subsidiary that performs financial activities that a national bank either cannot
otherwise perform itself, or that a national bank cannot otherwise own if not
for the enabling provisions of GLB Act.
Financial activities for national banks are essentially the same as those for
FHCs. Thus, national banks, through financial subsidiaries, are permitted to
engage in the enumerated financial activities authorized by the GLB Act.
However, the following activities, although permissible for FHCs, are prohibited
for financial subsidiaries of national banks and must be performed in
subsidiaries and nonbank affiliates of an FHC. These prohibited activities are:
- insurance or annuity underwriting, except that underwriting title
insurance is permitted for national banks in those states where
state-chartered banks may do so;
- insurance company portfolio investments;
- merchant banking; and
- real estate investment and development activities beyond those
directly authorized by law. The Secretary, in concert with the FRB
may, however jointly adopt rules lifting the merchant banking,
insurance company portfolio investment and insurance underwriting
prohibitions beginning November 12, 2004. Additionally, the Secretary,
in conjunction with the FRB, has the authority to determine whether
additional activities are financial in nature and must follow the same
evaluation criteria that the FRB uses in determining additional
financial activities for FHC purposes.
On January 19, 2000, the OCC issued a proposal to amend Part 5 of its
regulations to provide that a national bank may establish a financial subsidiary
if:
- the national bank and its depository institution affiliates meet the
same "well capitalized," "well managed" and "satisfactory" CRA rating
standards for banking subsidiaries of FHCs;
- the aggregate consolidated financial assets of all of the national
bank's financial subsidiaries does not exceed the lesser of 45% of the
consolidated net assets of the parent bank or $50 billion; and
- a national bank that is one of the nation's 100 largest insured banks,
determined on the basis of consolidated total assets, has at least one
issue of outstanding eligible debt that is rated in one of the three
highest investment grade categories.
The proposed regulations provide for a filing and notification process. Once
expanded activities have commenced in a financial subsidiary, the proposed
regulations require a national bank to comply with certain conditions in order
to ensure that proper safeguards are implemented. These conditions include, but
are not limited to:
<PAGE>
- requiring the national bank to deduct the total amount of its
investment in the financial subsidiary from its assets and equity for
purposes of determining regulatory capital, and presenting the
information separately in any published financial statements for the
bank;
- prohibiting the consolidation of the financial subsidiary's assets and
liabilities with those of the bank;
- requiring the national bank to establish adequate policies and
procedures to maintain the separate corporate identities of the bank
and its financial subsidiaries; and
- requiring adoption and implementation of policies and procedures to
identify and manage financial and operational risks associated with
the financial subsidiary.
Subsidiaries of State-Chartered Nonmember Banks. The GLB Act added Section 46
- -------------------------------------------------
to the Federal Deposit Insurance Act (the "FDI Act") which permits state
nonmember banks to hold interests in a subsidiary that are essentially
equivalent to a national bank's financial subsidiary. Additionally, the state
nonmember bank must comply with substantially all of the requirements and
conditions imposed on national banks in order to qualify and maintain their
investments in financial subsidiaries established under the GLB Act, except that
there is no requirement that the state nonmember bank be "well managed."
However, the FDI Act requires the FDIC's consent to an investment in any
financial subsidiary of a state-chartered institution. (See - 5. Expanded
Enforcement Powers - Activities of State Banks herein.)
BROKER-DEALER ACTIVITIES. The GLB Act provides for the functional regulation of
- ------------------------
bank securities activities by the SEC. The GLB Act replaces the broad bank
exemption from broker-dealer regulation under the Securities Exchange Act of
1934 (the "'34 Act"). The amendments include certain previously excluded
activities within the definition of "broker" and "dealer," thereby subjecting
those activities to the registration requirements and regulation of the '34 Act,
with an exception for certain activities in which banks have traditionally
engaged. These exemptions relate to:
- third-party networking arrangements;
- trustee and fiduciary activities if the bank: (i) is chiefly
compensated by means of administration and certain other fees; and
(ii) does not publicly solicit brokerage deposits; and
- identified banking products such as commercial paper, bankers'
acceptances, employee and shareholder benefit plans, sweep accounts,
affiliate transactions, private placements, safekeeping and custody
services, asset-backed securities, derivatives and other identified
banking products.
The GLB Act also amends the Investment Company Act and the Investment Advisers
Act, subjecting banks that advise mutual funds to the same regulatory scheme as
other advisers to mutual funds. It also requires banks to make additional
disclosures when a fund is sold or advised by a bank.
INSURANCE ACTIVITIES. In addition to affirming that states are the functional
- ---------------------
regulators of insurance activities, the GLB Act prohibits federally chartered
banks from engaging in any activity involving the underwriting and sale of title
insurance. National banks may, however, sell title insurance products in any
state in which state-chartered banks are permitted to do so, so long as those
activities are undertaken: (i) in the same manner; (ii) to the same extent; and
(iii) under the same restrictions that apply to state-chartered banks.
The GLB Act requires the federal bank regulatory agencies and state insurance
regulators to coordinate efforts to supervise companies that control both
depository institutions and entities engaged in the insurance business, and to
share supervisory information including financial condition and affiliate
transactions on a confidential basis. Federal agencies are further directed to
provide notice to and consult with state regulators before taking actions which
affect any affiliates engaging in insurance activities.
<PAGE>
UNITARY SAVINGS AND LOAN HOLDING COMPANY PROVISIONS. The GLB Act amends the
- -------------------------------------------------------
Home Owners' Loan Act (the "HOLA") to prohibit unitary savings and loan holding
companies from engaging in non-financial activities or affiliations with
non-financial organizations. The prohibition applies to applications to form
unitary savings and loan holding companies filed with the OTS after May 4, 1999.
Unitary savings and loan holding companies existing or whose applications were
pending on or before May 4, 1999 retain their authority to engage in
nonfinancial activities and affiliations.
The prohibition on non-financial affiliations, however, does not prevent
transactions that involve corporate reorganizations. Specifically, it does not
prohibit transactions that solely involve an acquisition, merger, consolidation
or other type of business combination of a savings and loan holding company (or
any savings association subsidiary) with another company, where both are under
common control.
CONSUMER PRIVACY PROTECTION. The GLB Act enhances financial privacy laws by
- -----------------------------
imposing an affirmative and continuing obligation to respect the privacy and
protect the confidentiality of nonpublic personal customer information provided
by a consumer to a financial institution, or otherwise obtained by the financial
institution. For purposes of the privacy provisions of the GLB Act, a financial
institution means any entity engaging in the financial activities that are
listed in the new Section 4(k) of the of the BHCA. Thus, the privacy
protections extend to all entities engaged in financial activities defined in
the GLB Act, whether or not they are affiliated with banks or bank holding
companies, FHCs or banks.
The GLB Act also makes it a federal crime to obtain, attempt to obtain,
disclose, cause to be disclosed or attempt to cause to be disclosed customer
information of a financial institution through fraudulent or deceptive means.
These include misrepresenting the identity of the person requesting the
information and misleading an institution or customer into making unwitting
disclosures of confidential information. In addition to criminal sanctions, the
legislation provides for a private right of action and enforcement by state
attorneys general.
FEDERAL HOME LOAN BANK SYSTEM MODERNIZATION. The Federal Home Loan Bank System
- --------------------------------------------
Modernization Act of 1999 (the "FHLBSMA") was enacted as part of the GLB Act.
The FHLBSMA reforms the Federal Home Loan Bank System (the "FHLBS") in several
ways. The more significant changes include:
- voluntary rather than mandatory membership of federal savings
associations in the FHLBS;
- permitting all community financial institutions (i.e. institutions
whose deposits are insured by the FDIC and have less than $500 million
in average total assets) to obtain advances from Federal Home Loan
Banks; and
- permitting any community financial institution greater access to FHLBS
credit facilities by expanding the types of assets that may be pledged
as collateral, including small business, agricultural, rural
development, or low-income community development loans.
COMMUNITY REINVESTMENT ACT PROVISIONS. In addition to the maintenance of at
- ----------------------------------------
least a "satisfactory" CRA rating in order to qualify for expanded activities,
the GLB Act amends the FDIA to require full disclosure of agreements entered
into between an insured depository institution or its affiliates and
non-governmental entities or persons made under or in connection with
fulfillment of the CRA. These agreements are to be made available to the public
and federal regulatory agencies. Annually, the parties to each CRA agreement
are required to report the use of resources provided to the participating bank's
primary federal regulator.
Other provisions affecting the CRA include:
- reducing the frequency of CRA examinations for banks with less than
$250 million in assets to once every five years if they have
"outstanding" CRA ratings, and once every four years if they have
"satisfactory" ratings;
<PAGE>
- requiring an FRB study of the default rates, delinquency rates and
profitability of CRA loans; and
- requiring a Treasury study of whether adequate services are being
provided under the CRA.
OTHER PROVISIONS. Other provisions of the GLB Act include, but are not limited
- -----------------
to:
- requiring ATM operators who impose a fee for use of an ATM by a
non-customer to post notice on the ATM and on the screen that a fee
will be charged, the amount of the fee and that no fee will be imposed
unless such notices are made and the customer elects to proceed with
the transaction;
- requiring a General Accounting Office study of possible revisions to
the Code's Subchapter S corporation rules to permit greater access by
community banks to Subchapter S tax treatment; and
- requiring a General Accounting Office study analyzing the conflict of
interest faced by the FRB between its role as a primary regulator of
the banking industry and its role as a vendor of services to the
banking and financial services industry.
CONCLUSION. The provisions of the GLB Act are numerous and become effective at
- ----------
various times between the date of enactment and the middle of 2001 and beyond.
Additionally, various federal regulatory authorities including the FRB, OCC,
FDIC, OTS and SEC have only started to promulgate the regulations and
interpretations required by the GLB Act. Furthermore, procedures for the
coordination of information among regulators, both state and federal, have yet
to be formulated. Management of the Company and the Banking Subsidiaries,
therefore, cannot estimate with any degree of certainty the effect that the GLB
Act, future regulations and future regulatory information sharing will have on
the financial condition, results of operations or future prospects of the
Company or the Banking Subsidiaries.
Finally, the provisions of the GLB Act, particularly those permitting
affiliations and expansion of activities, may prompt mergers, joint ventures,
partnerships and other affiliations among providers of banking, insurance and
securities services, both domestically and internationally. The extent and
magnitude of these affiliations and their impact on the Company, the Banking
Subsidiaries or on the banking industry in general cannot be predicted.
2. INTERSTATE BANKING
-------------------
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Riegle-Neal Act"), allows banks to open branches across state lines and also
amended the BHCA to make it possible for bank holding companies to buy
out-of-state banks in any state and convert them into interstate branches.
The amendment to the BHCA permits bank holding companies to acquire banks in
other states provided that the acquisition does not result in the bank holding
company controlling more than 10 percent of the deposits in the United States,
or 30 percent of the deposits in the state in which the bank to be acquired is
located. However, the Riegle-Neal Act also provides that states have the
authority to waive the state concentration limit. Individual states may also
require that the bank being acquired be in existence for up to five years before
an out-of-state bank or bank holding company may acquire it.
The Riegle-Neal Act permitted interstate branching and merging of existing
banks, provided that the banks are at least adequately capitalized and
demonstrate good management. The states were also authorized to enact laws to
permit interstate banks to branch de novo. All banks, however, are prohibited
from using the interstate branching authority of the Riegle-Neal Act for the
primary purpose of deposit production or the establishment of deposit production
offices. (See "- 1. Gramm-Leach-Bliley Act - Facilitating Affiliations and
Expansion of Financial Activities" herein.)
The California Interstate Banking and Branching Act of 1995 ("CIBBA") authorized
out-of-state banks to enter California by the acquisition of or merger with a
California bank that has been in existence for at least five years, unless the
California bank is in danger of failing or in certain other emergency
situations, but limits interstate branching into California to branching by
acquisition of an existing bank. CIBBA allows a California state bank to have
<PAGE>
agency relationships with affiliated and unaffiliated insured depository
institutions and allows a bank subsidiary of a bank holding company to act as an
agent to receive deposits, renew time deposits, service loans and receive
payments for a depository institution affiliate.
3. FEDERAL DEPOSIT INSURANCE
---------------------------
GENERAL. The Financial Institutions Reform, Recovery, and Enforcement Act of
- -------
1989 ("FIRREA") has resulted in major changes in the regulation of insured
financial institutions, including significant changes in the authority of
government agencies to regulate insured financial institutions.
Under FIRREA, virtually all federal deposit insurance activities were
consolidated under the FDIC, including insuring deposits of federal savings
associations, state chartered savings and loans and other depository
institutions determined to be operated in substantially the same manner as a
savings association. FIRREA established two deposit insurance funds to be
administered by the FDIC. The money in these two funds is separately maintained
and not commingled. The Bank Insurance Fund (the "BIF") insures deposits of
commercial banking institutions and the Savings Association Insurance Fund (the
"SAIF") replaced the Federal Savings and Loan Insurance Corporation ("FSLIC").
Insurance of deposits may be terminated by the FDIC upon a finding that the
institutions have engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the institution's
primary regulator.
DEPOSIT INSURANCE ASSESSMENTS. Under FIRREA, the premium assessments made on
- -------------------------------
banks and savings associations for deposit insurance were initially increased,
with rates set separately for banks and savings associations, subject to
statutory restrictions.
Since 1994, the FDIC has assessed deposit insurance premiums pursuant to a
risk-based assessment system, under which an institution's premium assessment is
based on the probability that the deposit insurance fund will incur a loss with
respect to the institution, the likely amount of such loss, and the revenue
needs of the deposit insurance fund. Under the risk-based assessment system,
BIF member institutions such as Goleta and Palomar are categorized into one of
three capital categories (well capitalized, adequately capitalized, and
undercapitalized) and one of three categories based on supervisory evaluations
by its primary federal regulator (in Goleta's case, the OCC and in Palomar's
case, the FDIC). The three supervisory categories are: financially sound with
only a few minor weaknesses (Group A), demonstrate weaknesses that could result
in significant deterioration (Group B), and poses a substantial probability of
loss (Group C). The capital and supervisory group ratings for SAIF institutions
are the same as for BIF institutions. The capital ratios used by the OCC and
the FDIC, to define well-capitalized, adequately capitalized and
undercapitalized are the same as in the prompt corrective action regulations
(discussed below). The BIF and SAIF assessment rates since January 1, 1997 are
summarized below; assessment figures are expressed in terms of cents per $100 in
insured deposits.
<TABLE>
<CAPTION>
ASSESSMENT RATES EFFECTIVE JANUARY 1, 1997
-----------------------------------------------
SUPERVISORY GROUP
-----------------
CAPITAL GROUP GROUP A GROUP B GROUP C
- ---------------------- ----------------- ------- -------
<S> <C> <C> <C>
Well Capitalized . . . 0 3 17
Adequately Capitalized 3 10 24
Undercapitalized . . . 10 24 27
</TABLE>
Commencing the first quarter of 1997, banks were required to share in the
payment of interest on the Financing Corporation Bonds ("FICO Bonds") issued in
the 1980s to assist in the recovery of the savings and loan industry.
Previously, the FICO debt was paid solely out of the SAIF assessment base.
Prior to January 1, 2000, the FICO assessments imposed on BIF insured
institutions were assessed at a rate equal to 1/5 of the rate of the assessments
imposed on SAIF insured depository institutions. Between the first quarter of
1997 and the fourth quarter of 1999, the quarterly FICO assessment rates for
SAIF insured institutions ranged from a high of $.0650 to a low of $.0582 per
$100 in insured deposits. The BIF assessment rate for the same period ranged
from a high of $.0130 to a low of $.01164 per $100 in insured deposits. The
rates equalized effective January 1, 2000 at $.0212 per $100 in insured
deposits. Although the FICO assessment rates are annual rates, they are subject
to change quarterly. Since the FICO bonds do not mature until the year 2019, it
is conceivable that banks and savings associations will continue to share in the
payment of the interest on the bonds until then.
<PAGE>
With certain limited exceptions, FIRREA prohibits a bank from changing its
status as an insured depository institution with the BIF to the SAIF and
prohibits a savings association from changing its status as an insured
depository institution with the SAIF to the BIF, without the prior approval of
the FDIC.
FDIC RECEIVERSHIPS. Pursuant to FIRREA, the FDIC may be appointed conservator
- -------------------
or receiver of any insured bank or savings association. In addition, FIRREA
authorized the FDIC to appoint itself as sole conservator or receiver of any
insured state bank or savings association for any, among others, of the
following reasons:
- insolvency of such institution;
- substantial dissipation of assets or earnings due to any violation of
law or regulation or any unsafe or unsound practice;
- an unsafe or unsound condition to transact business, including
substantially insufficient capital or otherwise;
- any willful violation of a cease and desist order which has become
final;
- any concealment of books, papers, records or assets of the
institution;
- the likelihood that the institution will not be able to meet the
demands of its depositors or pay its obligations in the normal course
of business;
- the incurrence or likely incurrence of losses by the institution that
will deplete all or substantially all of its capital with no
reasonable prospect for the replenishment of the capital without
federal assistance; or
- any violation of any law or regulation, or an unsafe or unsound
practice or condition which is likely to cause insolvency or
substantial dissipation of assets or earnings, or is likely to weaken
the condition of the institution or otherwise seriously prejudice the
interest of its depositors.
As a receiver of any insured depository institution, the FDIC may liquidate such
institution. The liquidation must be done in an orderly manner. The FDIC may
also dispose of any matter concerning the institution that the FDIC determines
to be in the institution's, its depositors' and the FDIC's best interests.
Additionally, the FDIC, as the conservator or receiver, succeeds to all rights,
titles, powers and privileges of the insured institution. Consequently, the
FDIC may take over the assets of and operate an institution with all the powers
of its members, shareholders, directors or officers, and conduct all business of
the institution, collect all obligations and money due to the institution, and
preserve and conserve the assets and property of the institution.
ENFORCEMENT POWERS. Some of the most significant provisions of FIRREA were the
- -------------------
expansion of regulatory enforcement powers. FIRREA has given the federal
regulatory agencies broader and stronger enforcement authorities reaching a
wider range of persons and entities. Some of those provisions included those
which:
- expanded the category of persons subject to enforcement under the
Federal Deposit Insurance Act;
- expanded the scope of cease and desist orders and provided for the
issuance of temporary cease and desist orders;
<PAGE>
- provided for the suspension and removal of wrongdoers on an expanded
basis and on an industry-wide basis;
- prohibited the participation of persons suspended or removed or
convicted of a crime involving dishonesty or breach of trust from
serving in another insured institution;
- required the regulators to publicize all final enforcement orders; and
- provided for extensive increases in the amounts and circumstances for
assessment of civil money penalties, civil and criminal forfeiture and
other civil and criminal fines and penalties.
CRIME CONTROL ACT OF 1990. The Crime Control Act of 1990 further strengthened
- ---------------------------
the authority of federal regulators to enforce capital requirements, increased
civil and criminal penalties for financial fraud, and enacted provisions
allowing the FDIC to regulate or prohibit certain forms of golden parachute
benefits and indemnification payments to officers and directors of financial
institutions.
4. RISK-BASED CAPITAL GUIDELINES
-------------------------------
GENERAL. The federal banking agencies have established minimum capital
- -------
standards known as risk-based capital guidelines. The risk-based capital
guidelines include both a new definition of capital and a framework for
calculating the amount of capital that must be maintained against a bank's
assets and off balance sheet items. The amount of capital required to be
maintained is based upon the credit risks associated with a bank's types of
assets and off-balance sheet items. A bank's assets and off balance sheet items
are classified under several risk categories, with each category assigned a
particular risk weighting from 0% to 100%. A bank's risk-based capital ratio is
calculated by dividing its qualifying capital which is the numerator of the
ratio, by the combined risk weights of its assets and off balance sheet items
which is the denominator of the ratio.
QUALIFYING CAPITAL. A bank's qualifying total capital consists of two types of
- -------------------
capital components: "core capital elements," known as Tier 1 capital and
"supplementary capital elements," known as Tier 2 capital. The Tier 1 component
of a bank's qualifying capital must represent at least 50% of qualifying total
capital and may consist of the following items that are defined as core capital
elements:
- common stockholders' equity;
- qualifying noncumulative perpetual preferred stock (including related
surplus); and
- minority interests in the equity accounts of consolidated
subsidiaries.
The Tier 2 component of a bank's qualifying total capital may consist of the
following items:
- a portion of allowance for loan and lease losses;
- certain types of perpetual preferred stock and related surplus;
- certain types of hybrid capital instruments and mandatory convertible
debt securities; and
- a portion of term subordinated debt and intermediate-term preferred
stock, including related surplus.
RISK WEIGHTED ASSETS AND OFF BALANCE SHEET ITEMS. Assets and credit equivalent
- -------------------------------------------------
amounts of off-balance sheet items are assigned to one of several broad risk
classifications, according to the obligor or, if relevant, the guarantor or the
nature of collateral. The aggregate dollar value of the amount in each risk
classification is then multiplied by the risk weight associated with that
classification. The resulting weighted values from each of the risk
classification are added together. This total is the bank's total risk weighted
assets comprising the denominator of the risk-based capital ratio.
<PAGE>
Risk weights for off-balance sheet items, such as unfunded loan commitments,
letters of credit and recourse arrangements, are determined by a two-step
process. First, the "credit equivalent amount" of the off-balance sheet items
is determined, in most cases by multiplying the off-balance sheet item by a
credit conversion factor. Second, the credit equivalent amount is treated like
any balance sheet asset and is assigned to the appropriate risk category
according to the obligor or, if relevant, the guarantor or the nature of the
collateral.
MINIMUM CAPITAL STANDARDS. The supervisory standards set forth below specify
- ---------------------------
minimum capital ratios based primarily on broad risk considerations. The
risk-based ratios do not take explicit account of the quality of individual
asset portfolios or the range of other types of risks to which banks may be
exposed, such as interest rate, liquidity, market or operational risks. For
this reason, banks are generally expected to operate with capital positions
above the minimum ratios.
All banks are required to meet a minimum ratio of qualifying total capital to
risk weighted assets of 8%. At least 4% must be in the form of Tier 1 capital,
net of goodwill, and a minimum ratio of Tier 1 capital to risk weighted assets
of 4%. The maximum amount of supplementary capital elements that qualifies as
Tier 2 capital is limited to 100% of Tier 1 capital net of goodwill. In
addition, the combined maximum amount of subordinated debt and intermediate-term
preferred stock that qualifies as Tier 2 capital is limited to 50% of Tier 1
capital. The maximum amount of the allowance for loan and lease losses that
qualifies as Tier 2 capital is limited to 1.25% of gross risk weighted assets.
The allowance for loan and lease losses in excess of this limit may, of course,
be maintained, but would not be included in a bank's risk-based capital
calculation.
Federal banking agencies also require all banks to maintain a minimum amount of
Tier 1 capital to total assets, referred to as the leverage ratio. For a bank
rated in the highest of the five categories used by regulators to rate banks,
the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all
banks not rated in the highest category, the minimum leverage ratio must be at
least 4% to 5%. These uniform risk-based capital guidelines and leverage ratios
apply across the industry. Regulators, however, have the discretion to set
minimum capital requirements for individual institutions, which may be
significantly above the minimum guidelines and ratios.
OTHER FACTORS AFFECTING MINIMUM CAPITAL STANDARDS. The federal banking agencies
- -------------------------------------------------
have established certain benchmark ratios of loan loss reserves to be held
against classified assets. The benchmark set forth by the policy statement is
the sum of:
- 100% of assets classified loss;
- 50% of assets classified doubtful;
- 15% of assets classified substandard; and
- estimated credit losses on other assets over the upcoming twelve
months.
The federal banking agencies have recently revised their risk-based capital
rules to take account of concentrations of credit and the risks of
non-traditional activities. Concentrations of credit refers to situations where
a lender has a relatively large proportion of loans involving a single borrower,
industry, geographic location, collateral or loan type. Non-traditional
activities are considered those that have not customarily been part of the
banking business, but are conducted by a bank as a result of developments in,
for example, technology, financial markets or other additional activities
permitted by law or regulation. The regulations require institutions with high
or inordinate levels of risk to operate with higher minimum capital standards.
The federal banking agencies also are authorized to review an institution's
management of concentrations of credit risk for adequacy and consistency with
<PAGE>
safety and soundness standards regarding internal controls, credit underwriting
or other operational and managerial areas.
Further, the banking agencies recently have adopted modifications to the
risk-based capital rules to include standards for interest rate risk exposure.
Interest rate risk is the exposure of a bank's current and future earnings and
equity capital to adverse movements in interest rates. While interest rate risk
is inherent in a bank's role as financial intermediary, it introduces volatility
to bank earnings and to the economic value of the bank. The banking agencies
have addressed this problem by implementing changes to the capital standards to
include a bank's exposure to declines in the economic value of its capital due
to changes in interest rates as a factor that they will consider in evaluating
an institution's capital adequacy. A bank's interest rate risk exposure is
assessed by its primary federal regulator on an individualized basis, and it may
be required by the regulator to hold additional capital if it has a significant
exposure to interest rate risk or a weak interest rate risk management process.
The federal banking agencies also limit the amount of deferred tax assets that
are allowable in computing a bank's regulatory capital. Deferred tax assets
that can be realized for taxes paid in prior carryback years and from future
reversals of existing taxable temporary differences are generally not limited.
However, deferred tax assets that can only be realized through future taxable
earnings are limited for regulatory capital purposes to the lesser of:
- the amount that can be realized within one year of the quarter-end
report date; or
- 10% of Tier 1 capital.
The amount of any deferred tax in excess of this limit would be excluded from
Tier 1 capital, total assets and regulatory capital calculations.
5. EXPANDED ENFORCEMENT POWERS
-----------------------------
GENERAL. The Federal Deposit Insurance Corporation Improvement Act of 1991
- -------
("FDICIA") recapitalized the FDIC's Bank Insurance Fund, granted broad
authorization to the FDIC to increase deposit insurance premium assessments and
to borrow from other sources, and continued the expansion of regulatory
enforcement powers, along with many other significant changes.
PROMPT CORRECTIVE ACTION. FDICIA established five categories of bank
- --------------------------
capitalization: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized" and mandated the establishment of a system of "prompt
corrective action" for institutions falling into the lower capital categories.
Under the regulations, a bank shall be deemed to be:
- "well capitalized" if it has a total risk-based capital ratio of 10.0%
or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a
leverage capital ratio of 5.0% or more and is not subject to specified
requirements to meet and maintain a specific capital level for any
capital measure;
- "adequately capitalized" if it has a total risk-based capital ratio of
8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a
leverage capital ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized";
- "undercapitalized" if it has a total risk-based capital ratio that is
less than 8.0%, a Tier 1 risk-based capital ratio that is less than
4.0%, or a leverage capital ratio that is less than 4.0% (3.0% under
certain circumstances);
- "significantly undercapitalized" if it has a total risk-based capital
ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that
is less than 3.0% or a leverage capital ratio that is less than 3.0%;
and
<PAGE>
- "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2.0%.
Banks are prohibited from paying dividends or management fees to controlling
persons or entities if, after making the payment the bank would be
undercapitalized, that is, the bank fails to meet the required minimum level for
any relevant capital measure. Asset growth and branching restrictions apply to
undercapitalized banks, which are required to submit acceptable capital plans
guaranteed by its holding company, if any. Broad regulatory authority was
granted with respect to significantly undercapitalized banks, including forced
mergers, growth restrictions, ordering new elections for directors, forcing
divestiture by its holding company, if any, requiring management changes, and
prohibiting the payment of bonuses to senior management. Even more severe
restrictions are applicable to critically undercapitalized banks, those with
capital at or less than 2%, including the appointment of a receiver or
conservator after 90 days, even if the bank is still solvent. All of the
federal banking agencies have promulgated substantially similar regulations to
implement this system of prompt corrective action.
FDICIA and the implementing regulations also provide that a federal banking
agency may, after notice and an opportunity for a hearing, reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category if the institution
is in an unsafe or unsound condition or engaging in an unsafe or unsound
practice. The FDIC may not, however, reclassify a significantly
undercapitalized institution as critically undercapitalized.
OPERATIONAL STANDARDS. FDICIA also granted the regulatory agencies authority to
- ---------------------
prescribe standards relating to internal controls, credit underwriting, asset
growth and compensation, among others, and required the regulatory agencies to
promulgate regulations prohibiting excessive compensation or fees. Many
regulations have been adopted by the regulatory agencies to implement these
provisions and subsequent legislation (see -6 Riegle Community Development and
Regulatory Improvement Act of 1994 herein) gave the regulatory agencies the
option of prescribing the safety and soundness standards as guidelines rather
than regulations.
BROKERED DEPOSITS. Effective June 16, 1992, FDICIA placed restrictions on the
- ------------------
ability of banks to obtain brokered deposits or to solicit and pay interest
rates on deposits that are significantly higher than prevailing rates. FDICIA
provides that a bank may not accept, renew or roll over brokered deposits
unless: (i) it is "well capitalized"; or (ii) it is adequately capitalized and
receives a waiver from the FDIC permitting it to accept brokered deposits paying
an interest rate not in excess of 75 basis points over certain prevailing market
rates. FDIC regulations define brokered deposits to include any deposit
obtained, directly or indirectly, from any person engaged in the business of
placing deposits with, or selling interests in deposits of, an insured
depository institution, as well as any deposit obtained by a depository
institution that is not "well capitalized" for regulatory purposes by offering
rates significantly higher (generally more than 75 basis points) than the
prevailing interest rates offered by depository institutions in such
institution's normal market area. In addition to these restrictions on
acceptance of brokered deposits, FDICIA provides that no pass-through deposit
insurance will be provided to employee benefit plan deposits accepted by an
institution, which is ineligible to accept brokered deposits under applicable
law and regulations.
LENDING. New regulations have been issued in the area of real estate lending,
- -------
prescribing standards for extensions of credit that are secured by real property
or made for the purpose of the construction of a building or other improvement
to real estate. In addition, the aggregate of all loans to executive officers,
directors and principal shareholders and related interests may now not exceed
100% (200% in some circumstances) of the depository institution's capital.
ACTIVITIES OF STATE BANKS. FDICIA imposed restrictions on the activities of
- ----------------------------
state-chartered banks, which are otherwise authorized under state law.
Generally, FDICIA restricts investments and activities of state banks, either
directly or through subsidiaries, to those permissible for national banks,
unless the FDIC has determined that such activities would not pose a risk to the
insurance fund of which the bank is a member and the bank is also in compliance
<PAGE>
with applicable capital requirements. This restriction effectively eliminates
real estate investments authorized under California law.
6. RIEGLE COMMUNITY DEVELOPMENT AND REGULATORY IMPROVEMENT ACT OF 1994
---------------------------------------------------------------------------
The Riegle Community Development and Regulatory Improvement Act of 1994 (the
"1994 Act") provides for funding for the establishment of a Community
Development Financial Institutions Fund (the "Fund"), which provides assistance
to new and existing community development lenders to help to meet the needs of
low- and moderate-income communities and groups. The 1994 Act also mandated
changes to a wide range of banking regulations. These changes included:
- less frequent regulatory examination schedules for small institutions;
- amendments to the money laundering and currency transaction reporting
requirements of the Bank Secrecy Act; and
- amendments to the Truth in Lending Act to provide greater protection
for consumers by reducing discrimination against the disadvantaged.
The "Paperwork Reduction and Regulatory Improvement Act," Title III of the 1994
Act, required the federal banking agencies to consider the administrative
burdens that new regulations will impose before their adoption and required a
transition period in order to provide adequate time for compliance. This Act
also required the federal banking agencies to work together to establish uniform
regulations and guidelines as well as to work together to eliminate duplicative
or unnecessary requests for information in connection with applications or
notices. The Paperwork Reduction and Regulatory Improvement Act also amended
the BHCA and Securities Act of 1933 to simplify the formation of bank holding
companies.
7. SAFETY AND SOUNDNESS STANDARDS
---------------------------------
The federal banking agencies adopted uniform guidelines establishing standards
for safety and soundness. The guidelines set forth operational and managerial
standards relating to internal controls, information systems and internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth and compensation, fees and benefits and asset quality and earnings. The
guidelines establish the safety and soundness standards that the agencies will
use to identify and address problems at insured depository institutions before
capital becomes impaired. If an institution fails to comply with a safety and
soundness standard, the appropriate federal banking agency may require the
institution to submit a compliance plan. Failure to submit a compliance plan or
to implement an accepted plan may result in enforcement action.
The federal banking agencies issued regulations prescribing uniform guidelines
for real estate lending. The regulations require insured depository
institutions to adopt written policies establishing standards, consistent with
such guidelines, for extensions of credit secured by real estate. The policies
must address loan portfolio management, underwriting standards and loan to value
limits that do not exceed the supervisory limits prescribed by the regulations.
Appraisals for "real estate related financial transactions" must be conducted by
either state certified or state licensed appraisers for transactions in excess
of certain amounts. State certified appraisers are required for all
transactions with a transaction value of $1,000,000 or more; for all
nonresidential transactions valued at $250,000 or more; and for "complex" 1-4
family residential properties of $250,000 or more. A state-licensed appraiser
is required for all other appraisals. However, appraisals performed in
connection with "federally related transactions" must now comply with the
agencies' appraisal standards. Federally related transactions include the sale,
lease, purchase, investment in, or exchange of, real property or interests in
real property, the financing or refinancing of real property, and the use of
real property or interests in real property as security for a loan or
investment, including mortgage-backed securities.
<PAGE>
8. CONSUMER PROTECTION LAWS AND REGULATIONS
--------------------------------------------
The bank regulatory agencies are focusing greater attention on compliance with
consumer protection laws and their implementing regulations. Examination and
enforcement have become more intense in nature, and insured institutions have
been advised to monitor carefully compliance with various consumer protection
laws and their implementing regulations. In addition to the consumer privacy
protections enacted pursuant to the GLB Act, banks are subject to many other
federal consumer protection laws and their regulations including, but not
limited to, the Community Reinvestment Act, the Truth in Lending Act (the
"TILA"), the Fair Housing Act (the "FH Act"), the Equal Credit Opportunity Act
(the "ECOA"), the Home Mortgage Disclosure Act ("HMDA"), and the Real Estate
Settlement Procedures Act ("RESPA").
The CRA is intended to encourage insured depository institutions, while
operating safely and soundly, to help meet the credit needs of their
communities. The CRA specifically directs the federal bank regulatory agencies,
in examining insured depository institutions, to assess their record of helping
to meet the credit needs of their entire community, including low- and
moderate-income neighborhoods, consistent with safe and sound banking practices.
The CRA further requires the agencies to take a financial institution's record
of meeting its community credit needs into account when evaluating applications
for, among other things, domestic branches, consummating mergers or
acquisitions, or holding company formations.
The federal banking agencies have adopted regulations, which measure a bank's
compliance with its CRA obligations on a performance-based evaluation system.
This system bases CRA ratings on an institution's actual lending service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements. The ratings range from a high of "outstanding" to a
low of "substantial noncompliance."
The ECOA prohibits discrimination in any credit transaction, whether for
consumer or business purposes, on the basis of race, color, religion, national
origin, sex, marital status, age (except in limited circumstances), receipt of
income from public assistance programs, or good faith exercise of any rights
under the Consumer Credit Protection Act. In March 1994, the Federal
Interagency Task Force on Fair Lending issued a policy statement on
discrimination in lending. The policy statement describes the three methods
that federal agencies will use to prove discrimination: overt evidence of
discrimination, evidence of disparate treatment and evidence of disparate
impact. This means that if a creditor's actions have had the effect of
discriminating, the creditor may be held liable even when there is no intent to
discriminate.
The FH Act regulates may practices, including making it unlawful for any lender
to discriminate in its housing-related lending activities against any person
because of race, color, religion, national origin, sex, handicap, or familial
status. The FH Act is broadly written and has been broadly interpreted by the
courts. A number of lending practices have been found to be, or may be
considered illegal under the FH Act, including some that are not specifically
mentioned in the FH Act itself. Among those practices that have been found to
be, or may be considered illegal under the FH Act are: declining a loan for the
purposes of racial discrimination; making excessively low appraisals of property
based on racial considerations; pressuring, discouraging, or denying
applications for credit on a prohibited basis; using excessively burdensome
qualifications standards for the purpose or with the effect of denying housing
to minority applicants; imposing on minority loan applicants more onerous
interest rates or other terms, conditions or requirements; and; racial steering,
or deliberately guiding potential purchasers to or away from certain areas
because of race.
The TILA is designed to ensure that credit terms are disclosed in a meaningful
way so that consumers may compare credit terms more readily and knowledgeably.
As a result of the TILA, all creditors must use the same credit terminology and
expressions of rates, the annual percentage rate, the finance charge, the amount
financed, the total payments and the payment schedule.
HMDA grew out of public concern over credit shortages in certain urban
neighborhoods. One purpose of HMDA is to provide public information that will
help show whether financial institutions are serving the housing credit needs of
the neighborhoods and communities in which they are located. HMDA also includes
a "fair lending" aspect that requires the collection and disclosure of data
about applicant and borrower characteristics as a way of identifying possible
<PAGE>
discriminatory lending patterns and enforcing anti-discrimination statutes.
HMDA requires institutions to report data regarding applications for one-to-four
family loans, home improvement loans, and multifamily loans, as well as
information concerning originations and purchases of such types of loans.
Federal bank regulators rely, in part, upon data provided under HMDA to
determine whether depository institutions engage in discriminatory lending
practices.
RESPA requires lenders to provide borrowers with disclosures regarding the
nature and costs of real estate settlements. Also, RESPA prohibits certain
abusive practices, such as kickbacks, and places limitations on the amount of
escrow accounts.
Violations of these various consumer protection laws and regulations can result
in civil liability to the aggrieved party, regulatory enforcement including
civil money penalties, and even punitive damages.
9. RECENT CALIFORNIA DEVELOPMENTS
--------------------------------
Assembly Bill 1432 ("AB1432") became effective January 1, 1998. AB1432
eliminated the provisions regarding impairment of contributed capital and the
assessment of shares when there is an impairment in capital. AB1432 added as
additional grounds to close a bank, if the Commissioner finds that the bank's
tangible shareholders' equity is less than the greater of 3% of the bank's total
assets or $1 million.
In addition, California law provides the Commissioner with certain additional
enforcement powers. For example, if it appears to the Commissioner that a bank
is violating its articles of incorporation or state law, or is engaging in
unsafe or unsound business practices, the Commissioner can order the bank to
comply with the law or to cease the unsafe or injurious practices or the
Commissioner can close the bank. The Commissioner also has the power to suspend
or remove the bank's officers, directors and employees who: (i) violate any law,
regulation or fiduciary duty to the bank; (ii) engage in any unsafe or unsound
practices related to the business of the bank; or (iii) are charged with or
convicted of a crime involving dishonesty or breach of trust.
10. CONCLUSION
----------
As a result of the recent federal and California legislation, including the GLB
Act, there has been a competitive impact on commercial banking in general and
the business of the Company and the Banking Subsidiaries in particular. There
has been a lessening of the historical distinction between the services offered
by banks, savings and loan associations, credit unions, securities dealers,
insurance companies, and other financial institutions. Banks have also
experienced increased competition for deposits and loans, which may result in
increases in their cost of funds, and banks have experienced increased overall
costs. Further, the federal banking agencies have increased enforcement
authority over banks and their directors and officers.
Future legislation is also likely to impact the Company's business. Consumer
legislation has been proposed in Congress, which may require banks to offer
basic, low-cost, financial services to meet minimum consumer needs. Further,
the regulatory agencies have proposed and may propose a wide range of regulatory
changes, including the calculation of capital adequacy and limiting business
dealings with affiliates. These and other legislative and regulatory changes
may have the impact of increasing the cost of business or otherwise impacting
the earnings of financial institutions. However, the degree, timing and full
extent of the impact of these proposals cannot be predicted. Management of the
Company and the Banking Subsidiaries cannot predict what other legislation might
be enacted or what other regulations might be adopted or the effects thereof.
The foregoing summary of the relevant laws, rules and regulations governing
banks and bank holding companies do not purport to be a complete summary of all
applicable laws, rules and regulations governing banks and bank holding
companies.
<PAGE>
IMPACT OF MONETARY POLICIES
- ------------------------------
Banking is a business which depends on rate differentials. In general, the
difference between the interest rate paid by the Banking Subsidiaries on their
deposits and their other borrowings and the interest rate earned by the Banking
Subsidiaries on loans, securities and other interest-earning assets will
comprise the major source of the Company's earnings. These rates are highly
sensitive to many factors which are beyond the Company's and the Banking
Subsidiaries' control and, accordingly, the earnings and growth of the Banking
Subsidiaries are subject to the influence of economic conditions generally, both
domestic and foreign, including inflation, recession, and unemployment; and also
to the influence of monetary and fiscal policies of the United States and its
agencies, particularly the FRB. The FRB implements national monetary policy,
such as seeking to curb inflation and combat recession, by its open-market
dealings in United States government securities, by adjusting the required level
of reserves for financial institutions subject to reserve requirements, by
placing limitations upon savings and time deposit interest rates, and through
adjustments to the discount rate applicable to borrowings by banks which are
members of the Federal Reserve System. The actions of the FRB in these areas
influence the growth of bank loans, investments, and deposits and also affect
interest rates. The nature and timing of any future changes in such policies
and their impact on the Company or the Banking Subsidiaries cannot be predicted;
however, depending on the degree to which the Banking Subsidiaries'
interest-earning assets and interest-bearing liabilities are rate sensitive,
increases in rates would have the temporary effect of increasing their net
interest margin, while decreases in interest rates would have the opposite
effect.
In addition, adverse economic conditions could make a higher provision for loan
losses more prudent and could cause higher loan charge-offs, thus adversely
affecting the Company's net income.
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- --------------------------------------------------------------------------
The Company's primary market risk is interest rate risk. Interest rate risk is
the potential of economic losses caused by future interest rate change. These
economic losses can be reflected as a loss of future net interest income and/or
a loss of current fair market values. The objective is to measure the effect on
net interest income and to adjust the balance sheet to minimize the risks.
Community West Bancshares' exposure to market risk is reviewed on a regular
basis by the Asset/Liability committee. Tools used by management include the
standard GAP report. The Company has no market risk instruments held for trading
purposes except for its interest only strip. Management believes the Company's
market risk is reasonable at this time. The Company currently does not enter
into derivative financial instruments.
See "Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations - Asset and Liability Management".
The table below provides information about the Company's financial instruments
that are sensitive to changes in interest rates. For all outstanding financial
instruments, the tables present the outstanding principal balance at December
31, 1999 and 1998, and the weighted average interest yield/rate of the
instruments by either the date the instrument can be repriced for variable rate
financial instruments or the expected maturity date for fixed rate financial
instruments,
<TABLE>
<CAPTION>
At December 31, 1999
Expected maturity dates or repricing dates by year
--------------------------------------------------
2004 and Fair Value
(Dollars in thousands) 2000 2001 2002 2003 beyond Total at 12/31/99
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Time deposits in other
financial institutions:
Average Yield
Federal Funds Sold: 8,707 8,707 8,707
Average Yield 5.2%
Investment securities, held to maturity: 497 497 494
Average Yield 5.3%
Investment securities, available-for-sale: 4,896 4,896 4,897
Average Yield 7.7%
Federal Reserve Bank/Federal Home
Loan Bank stock: 776 776 776
Average Yield 5.6%
Interest only strip: 5,383 5,383 5,383
Average Yield 11.0%
Servicing asset: 1,956 1,956
Average Yield 11.0%
Securitized Loans: 184,268 184,268 184,821
Average Yield 13.2%
LIABILITIES:
Non-interest bearing demand: 19,391 19,391 19,391
Average Yield 0.0%
Interest- bearing demand: 24,887 24,887 24,887
Average Yield 3.2%
Savings: 27,944 27,944 27,944
Average Yield 3.7%
Time certificates of deposit: 240,909 240,909 243,095
Average Yield 6.9%
Bonds Payable: 167,332 167,332 172,686
Average Yield 8.0%
(continued on next page)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
At December 31, 1998
Expected maturity dates or repricing dates by year
--------------------------------------------------
2003 and Fair Value
(Dollars in thousands) 1999 2000 2001 2002 beyond Total at 12/31/98
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Time deposits in other
financial institutions: $ 1,500 $ 1,500 $ 1,500
Average Yield 6.0% - - - -
Federal Funds Sold: $ 43,355 $ 43,355 $ 43,355
Average Yield 5.0% - - - -
Investment securities,
Held to maturity: $ 501 $ 501 $ 503
Average Yield 6.8% - - - -
Investment securities,
Available-for-sale: $ 757 $ 7,541 $ 8,298 $ 8,298
Average Yield 6.0% - - - 6.7%
Federal Reserve Bank/
Federal Home Loan Bank stock: - $ 810 $ 810 $ 810
Average Yield - - - 6.1%
Interest only strip: $ 2,222 $ 2,222 $ 2,222
Average Yield 11.0% - - - - - -
Servicing asset: $ 1,372 $ 1,372 $ 1,372
Average Yield 11.0% - - - - - -
Securitized Loans: $ 81,119 $ 81,119 $ 81,119
Average Yield - - - 13.2%
LIABILITIES:
Non-interest bearing demand: $ 19,487 $ 19,487 $ 19,487
Average Yield 0.0% - - - - - -
Interest- bearing demand: $ 19,976 $ 19,976 $ 19,976
Average Yield 3.3% - - - - - -
Savings: $ 26,860 $ 26,860 $ 26,860
Average Yield 3.4% - - - - - -
Time certificates of deposit: $155,905 $1,624 $157,529 $ 162,260
Average Yield 5.5% 5.5 - - - -
Bonds Payable: $ 72,051 $ 72,051 $ 74,357
Average Yield - - - 8.0%
ASSETS:
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Community West Bancshares
We have audited the consolidated balance sheets of Community West Bancshares and
subsidiaries (the "Company") as of December 31, 1999 and 1998, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1999. 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 auditing standards generally accepted
in the United States of America. 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.
As discussed in Note 14 to the consolidated financial statements, the Company's
wholly-owned subsidiary, Goleta National Bank, has entered into a formal written
agreement with the Comptroller of the Currency of the United States of America
that requires, among other things, the achievement of higher prescribed capital
requirements by no later than September 30, 2000.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Community West Bancshares and
subsidiaries at December 31, 1999 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1999 in conformity with accounting principles generally accepted in the
United States of America.
As discussed in Note 1, the Company adopted Statement of Position 98-1
"Accounting for Costs of Software Developed and Obtained for Internal Use",
effective January 1, 1998.
As discussed in Note 21, the accompanying 1998 and 1997 financial statements
have been restated.
/s/ Deloitte & Touche LLP
Los Angeles, California
April 14, 2000
<PAGE>
<TABLE>
<CAPTION>
COMMUNITY WEST BANCSHARES 1999 1998
CONSOLIDATED BALANCE SHEETS DECEMBER 31, AS RESTATED, SEE NOTE 21
------------- --------------------------
<S> <C> <C>
ASSETS
Cash and due from banks. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 27,396,464 $ 6,124,128
Federal funds sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,706,798 43,355,000
------------- --------------------------
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . 36,103,262 49,479,128
Time deposits in other financial institutions. . . . . . . . . . . . . . . . - 1,500,000
Federal Reserve Bank and Federal Home Loan Bank stock, at cost . . . . . . . 775,650 810,350
Investment securities held to maturity, at amortized cost;
fair value of $494,375 in 1999 and $502,656 in 1998 . . . . . . . . . . . 496,647 501,094
Investment securities available for sale, at fair value; amortized cost
of $4,985,539 in 1999 and $8,297,546 in 1998 . . . . . . . . . . . . . . . 4,897,242 8,297,546
Interest only strips, at fair value. . . . . . . . . . . . . . . . . . . . . 5,382,994 2,221,900
Servicing assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,956,266 1,372,453
Loans
Held for investment, net of allowance for loan losses
of $2,013,298 in 1999 and $2,154,167 in 1998. . . . . . . . . . . . . . 109,121,814 107,605,184
Held for sale, at lower of cost or fair value . . . . . . . . . . . . . . 158,273,597 58,686,767
Securitized loans, net of allowance for loan losses
of $3,516,000 in 1999 and $1,220,000 in 1998. . . . . . . . . . . . . . . 184,268,425 81,118,909
Other real estate owned, net . . . . . . . . . . . . . . . . . . . . . . . . 346,483 192,434
Premises and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . 4,466,454 4,413,119
Intangible assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,249,955 6,609,654
Accrued interest receivable and other assets . . . . . . . . . . . . . . . . 11,507,978 4,760,748
------------- --------------------------
TOTAL. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $523,846,767 $ 327,569,286
============= ==========================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand. . . . . . . . . . . . . . . . . . . . . . . . $ 19,390,661 $ 19,487,328
Interest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . 24,886,947 19,976,138
Savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,943,582 26,860,381
Time certificates of $100,000 or more . . . . . . . . . . . . . . . . . . 100,757,394 61,742,177
Other time certificates . . . . . . . . . . . . . . . . . . . . . . . . . 140,152,131 95,786,775
------------- --------------------------
Total deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313,130,715 223,852,799
Bonds payable in connection with securitized loans . . . . . . . . . . . . . 167,331,665 72,051,498
Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,307,303
Accrued interest payable and other liabilities . . . . . . . . . . . . . . . 2,144,942 2,543,564
------------- --------------------------
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 489,914,625 298,447,861
------------- --------------------------
COMMITMENTS AND CONTINGENCIES (Notes 12 and 14)
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized; 6,241,793
and 5,479,710 shares issued and outstanding at December 31, 1999 and 1998. 33,727,959 25,249,551
Retained earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,495,272 4,012,613
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . (55,333) -
Less: Treasury stock, at cost; 137,437 and 14,807 shares
at December 31, 1999 and 1998. . . . . . . . . . . . . . . . . . . . . . . . (1,235,756) (140,739)
------------- --------------------------
Total stockholders' equity. . . . . . . . . . . . . . . . . . . . . . . . 33,932,142 29,121,425
------------- --------------------------
TOTAL. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $523,846,767 $ 327,569,286
============= ==========================
</TABLE>
See notes to consolidated financial statements.
F-1
<PAGE>
<TABLE>
<CAPTION>
COMMUNITY WEST BANCSHARES 1999 1998 1997
CONSOLIDATED STATEMENTS OF OPERATIONS AS RESTATED, AS RESTATED,
THREE YEARS ENDED DECEMBER 31, SEE NOTE 21 SEE NOTE 21
-------------- ------------- -----------
<S> <C> <C> <C>
INTEREST INCOME:
Loans, including fees. . . . . . . . . . . . . $ 46,997,684 $ 14,751,127 $ 7,349,925
Federal funds sold . . . . . . . . . . . . . . 1,007,761 410,513 423,666
Time deposits in other financial institutions. 47,129 66,324 120,588
Investment securities. . . . . . . . . . . . . 442,347 51,507 115,253
-------------- ------------- -----------
Total interest income . . . . . . . . . . . 48,494,921 15,279,471 8,009,432
INTEREST EXPENSE:
Deposits . . . . . . . . . . . . . . . . . . . 15,079,699 5,721,958 2,910,450
Bonds payable and other borrowings . . . . . . 10,065,531 594,707
-------------- ------------- -----------
Total interest expense . . . . . . . . . . . 25,145,230 6,316,665 2,910,450
NET INTEREST INCOME. . . . . . . . . . . . . . . 23,349,691 8,962,806 5,098,982
PROVISION FOR LOAN LOSSES. . . . . . . . . . . . 6,132,959 1,759,623 260,000
-------------- ------------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES. . . . . . . . . . . 17,216,732 7,203,183 4,838,982
OTHER INCOME:
Gains from loan sales, net . . . . . . . . . . 5,987,943 4,059,816 4,101,222
Other loan fees - sold or brokered loans . . . 2,709,938 3,679,211 2,960,385
Document processing fees . . . . . . . . . . . 1,072,618 1,223,208 819,355
Loan servicing fees. . . . . . . . . . . . . . 499,703 785,710 631,551
Service charges. . . . . . . . . . . . . . . . 514,790 864,549 896,295
Other income . . . . . . . . . . . . . . . . . 235,645 409,963 23,407
-------------- ------------- -----------
Total other income. . . . . . . . . . . . . 11,020,637 11,022,457 9,432,215
OTHER EXPENSES:
Salaries and employee benefits . . . . . . . . 16,228,271 10,799,675 7,315,447
Other operating expenses . . . . . . . . . . . 3,812,402 2,026,562 561,066
Occupancy expenses . . . . . . . . . . . . . . 3,844,583 2,397,925 1,508,435
Professional services. . . . . . . . . . . . . 2,579,129 520,713 425,828
Advertising expense. . . . . . . . . . . . . . 1,151,317 794,102 582,636
Data processing/ATM processing . . . . . . . . 511,743 248,997 153,053
Amortization of intangible assets. . . . . . . 363,570 63,562 -
Office supply expense. . . . . . . . . . . . . 385,805 193,663 155,279
Lower of cost or market provision. . . . . . . 1,276,709 - -
Postage & freight. . . . . . . . . . . . . . . 352,014 436,934 822,162
-------------- ------------- -----------
Total other expenses. . . . . . . . . . . . 30,505,543 17,482,133 11,523,906
-------------- ------------- -----------
(LOSS) INCOME BEFORE (BENEFIT)
PROVISION FOR INCOME TAXES . . . . . . . . . . (2,268,174) 743,507 2,747,291
(BENEFIT) PROVISION FOR INCOME TAXES . . . . . . (621,838) 289,448 1,158,351
-------------- ------------- -----------
NET (LOSS) INCOME. . . . . . . . . . . . . . . . $ (1,646,336) $ 454,059 $ 1,588,940
============== ============= ===========
NET (LOSS) INCOME PER SHARE - BASIC. . . . . . . $ (0.30) $ 0.12 $ 0.53
============== ============= ===========
NET (LOSS) INCOME PER SHARE - DILUTED. . . . . . $ (0.30) $ 0.12 $ 0.44
============== ============= ===========
</TABLE>
See notes to consolidated financial statements.
F-2
<PAGE>
<TABLE>
<CAPTION>
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (As restated, See Note 21)
THREE YEARS ENDED DECEMBER 31
Accum Other Total
Common Stock Treasury Stock Retained Comprehensive Stockholders' Comprehensive
Shares Amount Shares Amount Earnings Income (loss) Equity Income (loss)
--------- ------------ ------- ------------ ------------ -------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE
JANUARY 1,
1997 . . . . . . . 2,946,984 $ 8,089,527 - $ - $ 1,969,614 $ - $10,059,141
Issuance of
founders stock . - 10,000 - - - - 10,000
Exercise of
warrants . . . . 63,692 278,653 - - - - 278,653
Exercise of
stock options. . 70,640 192,130 - - - - 192,130
Net income . . . . - - - - 1,588,940 - 1,588,940 $ 1,588,940
--------- ------------ ------- ------------ ------------ -------------- ------------ --------------
BALANCE
DECEMBER 31,
1997 . . . . . . . 3,081,316 8,570,310 - - 3,558,554 - 12,128,864
Retirement of
Founders
stock. . . . . . - (10,000) - - - - (10,000)
Exercise of
warrants . . . . 875,140 3,828,738 - - - - 3,828,738
Exercise of
stock options. . 155,712 375,156 - - - - 375,156
Treasury stock
purchase . . . . - - 14,807 (140,739) - - (140,739) -
Purchase of
Palomar
Community
Bank . . . . . . 1,367,542 12,485,347 - - - 12,485,347 -
Net income . . . . - - - - 454,059 - 454,059 $ 454,059
--------- ------------ ------- ------------ ------------ -------------- ------------ --------------
BALANCE
DECEMBER 31,
1998 . . . . . . . 5,479,710 25,249,551 14,807 (140,739) 4,012,613 - 29,121,425
Issuance of stock
to directors . . 582,924 7,522,698 - - - - 7,522,698
Exercise of
stock options. . 179,159 955,710 - - - - 955,710
Cash dividends
paid ($0.16
per share) . . . - - - (871,005) - (871,005) -
Treasury stock
purchase . . . . - 122,630 (1,095,017) - - (1,095,017) -
Comprehensive
loss:. . . . . .
Net loss . . . . - - (1,646,336) - (1,646,336) (1,646,336)
Other
comprehensive
loss . . . . . . - - - (55,333) (55,333) (55,333)
--------- ------------ ------- ------------ ------------ -------------- ------------ --------------
BALANCE
DECEMBER 31,
1999 . . . . . . . 6,241,793 $33,727,959 137,437 $(1,235,756) $ 1,495,272 $ (55,333) $33,932,142 $ (1,701,669)
========= ============ ======= ============ ============ ============== ============ ==============
Disclosure of reclassification amount for December 31: 1999
-----------
Unrealized holding gains (losses) arising during the period, net of tax benefit of $32,964 in 1999 $ (55,333)
===========
</TABLE>
See Notes to Consolidated Financial Statements
F-3
<PAGE>
<TABLE>
<CAPTION>
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------------------------------------
1998 1997
As restated, see As restated, see
1999 Note 21 Note 21
-------------- ---------------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income ($1,646,336) $ 454,059 $ 1,588,940
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Provision for loan losses 6,132,959 1,759,622 260,000
Writedown of real estate owned 130,643 48,929 -
Losses on sale of premises and equipment - 12,979 -
Deferred income taxes (benefit) provision (3,745,819) 845,197 77,892
Depreciation and amortization 1,568,060 976,845 593,433
Amortization of intangibles 363,570
Gain on sale of other real estate owned - (42,092) (38,707)
Amortization of discount of available for sale securities 42,109 - -
Gain on sale of loans held for sale (5,987,943) (4,059,816) (4,101,222)
Lower of cost or market provision 1,276,709 - -
Change in market valuation of interest only strips (187,000) 543,000 -
Purchase/origination of loans held for sale (303,039,882) (161,250,438)
Proceeds from sales of loans 83,793,790 38,226,533
Additions to interest only strip assets, net of amortization (2,974,094) (236,313) (294,947)
Additions to servicing assets, net of amortization (583,813) (451,662) -
Changes in operating assets and liabilities:
Accrued interest receivable and other assets (3,001,411) (1,447,228) (1,603,550)
Accrued interest payable and other liabilities 6,928,458 (2,360,222) 2,634,443
-------------- -------------- -------------
Net cash used in operating activities (220,930,000) (126,980,607) (883,718)
-------------- -------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities (495,553) - (1,096,395)
Purchase of Federal reserve stock (37,500) (12,750) -
Redemption of FHLB stock 72,200 - -
Maturities of held-to-maturity securities 500,000 497,357 2,000,000
Maturities of available-for-sale securities 750,000 - -
Proceeds from payments and maturities of available for sales securities 2,529,214 - -
Net change in loans and loans held for investment 13,286,699 11,306,964 (10,196,186)
Proceeds from sale of other real estate owned - 171,666 370,600
Net cash acquired from acquisition of Palomar Community Bank - 8,747,755 -
Net decrease (increase) in time deposits in other financial institutions 1,500,000 2,477,000 (99,000)
Purchase of premises and equipment (1,621,395) (2,434,286) (912,061)
-------------- -------------- -------------
Net cash provided by (used in) investing activities 16,483,665 20,753,706 (9,933,042)
-------------- -------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, and savings accounts 5,897,343 7,516,709 4,547,703
Net increase in time certificates of deposit 83,380,573 59,982,154 5,099,138
Net increase in bonds payable 95,280,167 72,051,498 -
Purchase of treasury stock (1,095,017) (140,739) -
(Retirement) issuance of founder's stock - (10,000) 10,000
Exercise of stock options and warrants 955,710 4,203,894 470,783
Issuance of common stock 7,522,698 - -
Cash dividend paid (871,005) - -
-------------- -------------- -------------
Net cash provided by financing activities 191,070,469 143,603,516 10,127,624
-------------- -------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (13,375,866) 37,376,615 (689,136)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 49,479,128 12,102,513 12,791,649
-------------- -------------- -------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 36,103,262 $ 49,479,128 $ 12,102,513
============== ============== =============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 24,401,341 $ 6,021,378 $ 2,869,088
Cash paid for income taxes 4,061,182 2,301,261 789,956
-------------- -------------- -------------
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real-estate owned $ 284,692 $ 370,937 $ 272,369
Transfers from loans held for sale to securitized loans 123,328,043 82,463,072 -
Transfers from loans held for sale to loans held for investment 1,042,453 374,237 -
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
COMMUNITY WEST BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Community West Bancshares and its
wholly-owned subsidiaries, Goleta National Bank ("Goleta") and Palomar Community
Bank ("Palomar"), and its majority owned subsidiary ePacific.com (collectively,
the "Company"), are in accordance with accounting principles generally accepted
in the United States of America and general practices within the financial
services industry. All material intercompany transactions and accounts have
been eliminated. The following are descriptions of the more significant of
those policies.
Nature of Operations - The Company's primary operations are related to
traditional financial services, including the acceptance of deposits and the
lending and investing of money. In addition, the Company also engages in
electronic services. The Company's customers consist of small to mid-sized
businesses, as well as individuals. The Company also originates and sells U. S.
Small Business Administration ("SBA") and first and second mortgage loans
through its normal operations and fifteen loan production offices.
Business Combination - On December 14, 1998, the Company acquired Palomar (then
known as Palomar Savings and Loan). As of that date, shareholders of Palomar
became shareholders of the Company by receiving 2.11 shares of Community West
Bancshares for each share of Palomar stock they held. This acquisition was
accounted for under the purchase method of accounting. Palomar was chartered as
a state-chartered full service savings and loan association. On November 4,
1999, Palomar changed both its charter and name. The charter was changed from
that of a state-chartered savings and loan to a state-chartered community bank,
and the name was changed to Palomar Community Bank. It is the Company's intent
to maintain Palomar as a separate subsidiary of the Company.
Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks and federal funds sold.
Generally, federal funds are sold for one-day periods.
Loans - Generally, loans are stated at amounts advanced less payments collected.
Interest on loans is accrued daily on a simple-interest basis, except where
doubt exists as to collectibility of the loan, in which case the accrual of
interest income is discontinued.
Loan Fees and Costs - Loan origination fees and certain direct origination
costs, as well as purchase premiums and discounts, are deferred and recognized
as an adjustment to the loan yield over the life of the loan using the level
yield method.
Securitized Loans and Bonds Payable - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
entities ("SPE"s). The transfers have been accounted for as secured borrowings
with a pledge of collateral, and accordingly the mortgage loans and related
bonds issued are included in the Company's balance sheet. The transferred loans
are recorded on the balance sheet as securitized loans and the bonds issued are
recorded as bonds payable. Deferred debt issuance costs related to the bonds
are amortized on a level yield basis over the estimated life of the bonds.
Loans Held for Sale - Loans which are originated and intended for sale in the
secondary market are carried at the lower of cost or estimated fair value
determined on an aggregate basis. Net unrealized losses, if any, are recognized
through a valuation allowance by charges to income. Loans held for sale are
primarily comprised of SBA loans, second mortgage loans, and residential
mortgage loans. Funding for SBA programs depends on annual appropriations by
the U.S. Congress, and accordingly, the continued sale of loans under these
programs is dependent on the continuation of such programs. At December 31,
1999, loans held for sale are net of a market valuation allowance of $1,276,709.
There was no market valuation allowance at December 31, 1998.
F-5
<PAGE>
Investment Securities - The Company classifies as held to maturity those debt
securities it has the positive intent and ability to hold to maturity.
Securities held to maturity are accounted for at amortized cost. Debt
securities to be held for indefinite periods of time, but not necessarily to be
held-to-maturity or on a long term basis, and equity securities are classified
as available-for-sale and carried at fair value with unrealized gains or losses
reported as a separate component of accumulated other comprehensive income, net
of any applicable income taxes. Realized gains or losses on the sale of
securities available-for-sale, if any, are determined on a specific
identification basis. Purchase premiums and discounts are recognized in
interest income using the interest method over the terms of the securities.
Declines in the fair value of held-to-maturity and available-for-sale securities
below their cost that are deemed to be other than temporary, if any, are
reflected in income as realized losses.
Loan Sales and Servicing - The Company originates certain loans for the purpose
of selling either a portion of or the entire loan into the secondary market.
FHA Title 1 loans and the guaranteed portion of SBA loans are sold into the
secondary market, servicing retained. Servicing assets are recognized when
loans are sold with servicing retained. Servicing assets are amortized in
proportion to and over the period of estimated future net servicing income. The
fair value of servicing assets is estimated by discounting the future cash flows
at estimated future current market rates for the expected life of the loans.
The Company uses industry prepayment statistics and its own prepayment
experience in estimating the expected life of the loans. Management
periodically evaluates servicing assets for impairment. Servicing assets are
evaluated for impairment based upon the fair value of the rights as compared to
amortized cost and are generally stratified on a loan by loan basis. Fair value
is determined using prices for similar assets with similar characteristics, when
available, or based upon discounted cash flows using market-based assumptions.
Impairment is recognized through a valuation allowance for an individual
stratum, to the extent that fair value is less than the capitalized amount for
the stratum.
On loan sales, the Company also retains interest only ("I/O") strips, which
represent the present value of the right to the estimated excess net cash flows
generated by the serviced loans which represents the difference between (a)
interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors, and (ii) contractual
servicing fees. The Company determines the present value of this estimated cash
flow at the time each loan sale transaction closes, utilizing valuation
assumptions as to discount rate and prepayment rate appropriate for each
particular transaction.
The I/O strips are accounted for like investments in debt securities classified
as trading securities under Statement of Financial Accounting Standards ("SFAS")
No. 115, "Accounting for Certain Investments in Debt and Equity Securities".
Accordingly, the Company marks the I/O's to fair value with the resulting
increase or decrease in fair value being recorded through operations in the
current period. For the years ended December 31, 1999 and 1998 respectively,
net unrealized gains (losses) of $187,000 and $(543,000) are included in results
of operations. There was no net unrealized gain (loss) in 1997.
Provision and Allowance for Loan Losses - The allowance for loan losses is
maintained at a level believed adequate by management to absorb known and
inherent probable losses on existing loans through a provision for loan losses
charged to expense. The allowance is charged for losses when management believes
that full recovery on loans is unlikely. Management's determination of the
adequacy of the allowance is based on periodic evaluations of the loan
portfolio, which take into consideration such factors as changes in the growth,
size and composition of the loan portfolio, overall portfolio quality, review of
specific problem loans, collateral, guarantees and economic conditions that may
affect the borrowers' ability to pay and/or the value of the underlying
collateral. These estimates depend on the outcome of future events and,
therefore, contain inherent uncertainties.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses. Such agencies may require the Company to recognize additions to the
allowance based on judgments different from those of management.
Management believes the level of the allowance for loan losses as of December
31, 1999, is adequate to absorb future losses; however, changes in the local
economy, the ability of borrowers to repay amounts borrowed and other factors
may result in the need to increase the allowance through charges to earnings.
F-6
<PAGE>
Other Real Estate Owned - Real estate acquired by foreclosure is recorded at
fair value at the time of foreclosure, less estimated selling costs. Any
subsequent operating expenses or income, reduction in estimated values, and
gains or losses on disposition of such properties are charged to current
operations.
Premises and Equipment - Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, which range
from 2 to 31.5 years. Leasehold improvements are amortized over the term of the
lease or the estimated useful lives, whichever is shorter.
Intangible Assets - Intangible assets include goodwill, which is the excess of
the purchase price over the fair value of net assets acquired, and core deposit
intangible, which is the long-term deposit relationships resulting from deposit
liabilities assumed in an acquisition. Goodwill is amortized using the
straight-line method over the estimated useful life, not to exceed 20 years.
Core deposit intangible is amortized using a method that approximates the
expected run-off of the deposit base, which averages 7 years. The Company
periodically evaluates whether events and circumstances have occurred that may
affect the estimated useful lives or the recoverability of the remaining balance
of the intangible assets. An asset is deemed impaired if the sum of the
expected future cash flows is less than the carrying amount of the asset and any
excess of the carrying value over fair value will be written off through a
charge to current operations. Management does not believe the value of the core
deposit intangible or goodwill has been impaired. Accumulated amortization of
intangible assets is $427,132 and $63,562 as of December 31, 1999 and 1988,
respectively.
Income Taxes - Deferred income taxes are recognized for the tax consequences in
future years of differences between the tax basis of assets and liabilities and
their financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income.
Net Income (Loss) per Share - Net income (loss) per share - Basic has been
computed based on the weighted average number of shares outstanding during each
year. Net income (loss) per share - Diluted has been computed based on the
weighted average number of shares outstanding during each year plus the dilutive
effect of outstanding warrants and options. Net income (loss) per share amounts
have been retroactively restated to reflect the two-for-one stock split in 1998.
Net income (loss) per share was computed as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ---------- ----------
<S> <C> <C> <C>
Basic weighted average shares outstanding . 5,494,217 3,767,607 3,016,208
Dilutive effect of options. . . . . . . . . - 174,142 209,970
Dilutive effect of warrants . . . . . . . . - - 362,300
------------ ---------- ----------
Diluted weighted average shares outstanding 5,494,217 3,941,749 3,588,478
============ ========== ==========
Net (loss) income . . . . . . . . . . . . . $(1,646,336) $ 454,059 $1,588,940
Net (loss) income per share - Basic . . . . $ (0.30) $ 0.12 $ 0.53
Net (loss) income per share - Diluted . . . $ (0.30) $ 0.12 $ 0.44
</TABLE>
Options for 78,161 shares were excluded from the 1999 computation due to the
antidilutive effect.
Reserve Requirements - All depository institutions are required by law to
maintain reserves on transaction accounts and nonpersonal time deposits in the
form of cash balances at the Federal Reserve Bank. These reserve requirements
can be offset by cash balances held at the Company. At December 31, 1999 and
1998, the Company's cash balance was sufficient to offset the Federal Reserve
requirement.
Use of Estimates in the Preparation of Financial Statements - The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosures 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.
F-7
<PAGE>
Recent Accounting Pronouncements - SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", was issued in June 1998 and establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133 was effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. In July 1999,
SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133" was issued, which
delays the effective date of SFAS No. 133 to fiscal years beginning after June
15, 2000. Earlier application is encouraged, but it is permitted only as of the
beginning of any fiscal quarter that begins after June 1998. The Company early
adopted SFAS No. 133 on October 1, 1998. There was no impact on the Company's
financial position and results of operations upon adoption of SFAS No. 133.
Statement of Position ("SOP") 98-1 "Accounting for the Costs of Computer
Software Developed and Obtained for Internal Use", issued in March 1998 requires
capitalization of certain costs of computer software developed or obtained for
internal use. The SOP describes three stages of software development projects:
the preliminary project stage where all costs are expensed, the application
development stage where some costs are capitalized, while others are expensed,
and the post-implementation/operation stage where all costs are expensed. Other
costs associated with the development and implementation of internal-use
software systems projects are expensed as incurred. The SOP does not change the
requirement that the external and internal costs associated with modifying
internal use software currently in use for the year 2000 should be charged to
expense as incurred. The SOP is effective for financial statements for fiscal
years beginning after December 15, 1998 with earlier application encouraged.
The Company early adopted SOP 98-1, effective January 1, 1998 and capitalized
certain costs, amounting to $470,566 in 1998, (classified in premises and
equipment) related to the development of internal use software as required by
the SOP.
Reclassifications - Certain amounts in the accompanying financial statements for
1998 and 1997 have been reclassified to conform to the 1999 presentation.
2. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities at December
31, were as follows:
<TABLE>
<CAPTION>
1999 Gross Gross
Amortized Unrealized Unrealized Fair
Available-for-Sale Securities Cost Gain Loss Value
- ----------------------------------------- ---------- ----------- ------------ ----------
<S> <C> <C> <C> <C>
Government National Mortgage Association
Participation certificates. . . . . . . . $2,781,163 $ 9,317 $ (44,174) $2,746,306
Federal National Mortgage Association . . 1,113,977 317 (7,557) 1,106,737
Federal Home Loan Mortgage Corporation
Bond and participation certificates . . . 1,090,399 - (46,200) 1,044,199
---------- ----------- ------------ ----------
$4,985,539 $ 9,634 $ (97,931) $4,897,242
========== =========== ============ ==========
Held to Maturity Securities
- -----------------------------------------
Due in less than one year:
U.S. Treasury note, par value $500,000,
4.5% due 9/30/00. . . . . . . . . . . . $ 496,647 $ - $ (2,272) $ 494,375
========== =========== ============ ==========
</TABLE>
F-8
<PAGE>
<TABLE>
<CAPTION>
1998 Gross Gross
Amortized Unrealized Unrealized Fair
Available-for-Sale Securities Cost Gain Loss Value
- ------------------------------------------- ---------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Government National Mortgage Association
Participation certificates. . . . . . . . . $4,230,350 $ - $ - $4,230,350
Federal National Mortgage Association
And Federal Home Loan Mortgage Corporation
Participation certificates. . . . . . . . . 2,815,303 - - 2,815,303
Federal Home Loan Mortgage Corporation Bond 497,830 - - 497,830
U.S. Treasury Securities. . . . . . . . . . 754,063 - - 754,063
---------- ----------- ----------- ----------
$8,297,546 $ - $ - $8,297,546
========== =========== =========== ==========
Held to Maturity Securities
- -------------------------------------------
Due in less than one year:
U.S. Treasury note, par value $500,000,
5.875% due 7/31/99. . . . . . . . . . . . $ 501,094 $ 1,562 $ - $ 502,656
========== =========== =========== ==========
</TABLE>
At December 31, 1999, the U.S. Treasury Note, with a face value of $500,000, was
pledged as collateral to the U.S. Treasury for its Treasury, Tax and Loan
account with the Company.
3. LOAN SALES AND TRANSFERS
SBA Loan Sales
- ----------------
The Company sells the guaranteed portion of SBA loans into the secondary market,
on a servicing retained basis, in exchange for cash, retained servicing assets
and I/O strips. At December 31, 1999 and 1998, the fair value of the I/O strips
and servicing assets was estimated using an 11% discount rate and an 8%
prepayment rate. As of December 31, 1999, the Company had $7 million in SBA
loans held for sale.
FHA Title 1 Loan Sales
- --------------------------
From 1995 to 1997, the Company sold FHA Title 1 loans in the secondary market,
on a servicing retained basis, in exchange for cash, retained servicing assets
and I/O strips. At December 31, 1999 and 1998, the fair value of the I/O strips
was estimated using an 11% discount rate and a weighted average prepayment rate
of 30% and 25%, respectively. As of December 31, 1999, the Company had less than
$1 million in FHA Title 1 loans held for sale. During 1999, the related
servicing asset was fully amortized.
Traditional Mortgages
- ----------------------
Amount represents servicing asset purchased.
The balances of these assets are as follows:
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
---------------------------- ----------------------------
Servicing Asset I/O Strip Servicing Asset I/O Strip
---------------- ---------- ---------------- ----------
<S> <C> <C> <C> <C>
SBA . . . . . . . . . . . $ 1,771,000 $4,836,000 $ 1,094,000 $1,150,000
FHA Title 1 . . . . . . . - 547,000 22,000 1,072,000
Traditional Mortgages . . 185,000 - 256,000 -
---------------- ---------- ---------------- ----------
Total . . . . . . . . . . $ 1,956,000 $5,383,000 $ 1,372,000 $2,222,000
================ ========== ================ ==========
</TABLE>
F-9
<PAGE>
The following is a summary of activity in servicing assets for the years ended
December 31:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Balance, beginning of year . . $1,372,000 $ 664,000 $ 26,000
Additions through loan sales . 1,136,000 942,000 787,000
Amortization . . . . . . . . . (496,000) (134,000) (149,000)
Valuation adjustment . . . . . (56,000) (100,000)
----------- ----------- ----------
Balance, end of year . . . . . $1,956,000 $1,372,000 $ 664,000
=========== =========== ==========
</TABLE>
The principal balance of loans serviced for others at December 31, 1999, 1998
and 1997 totaled $121,935,031, $86,601,390 and $78,016,040 respectively.
Second Mortgage Loan Sales and Transfers
- ---------------------------------------------
In 1996 the Company began offering second mortgage loans which allow borrowers
to borrow (when combined with the balance of the first mortgage loan) up to 125%
of their home's appraised value for debt consolidation, home improvement or any
other worthwhile cash outlay up to a maximum loan of $100,000. During 1997 and
the first quarter of 1998, the Company sold these loans for cash to third
parties. No servicing was retained on these loans.
In 1998 and 1999, the Company transferred $81 million and $122 million,
respectively, of these loans to SPE's. These loans were both originated and
purchased by the Company. The SPE's, through securitizations, then sold bonds
to third party investors which were secured by the transferred loans. The bonds
are held in a trust independent of the Company, the trustee of which oversees
the distributions to the bondholders. The mortgage loans are serviced by a
third party (the "servicer"), who receives a stated servicing fee. There is an
insurance policy on the bonds that unconditionally guarantees the ultimate
payment of the bonds.
As part of the securitization agreements, the Company received an option to
repurchase the bonds when the aggregate principal balance of the mortgage loans
sold declined to 10% or less of the original balance of mortgage loans
securitized. Because the Company has a call option to reacquire the loans
transferred and did not retain the servicing rights, the Company has not
surrendered effective control over the loans transferred. Therefore, the
securitizations are accounted for as secured borrowings with a pledge of
collateral in accordance with SFAS No. 125 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities". Accordingly,
the Company is required to consolidate the SPE's, and the financial statements
of the Company include the loans transferred and the related bonds issued.
The securitized loans are classified as held for investment. At December 31,
1999 and 1998, respectively, securitized loans are net of an allowance for loan
losses as set forth below, and include purchase premiums (net of deferred
fees/costs) of $3,225,443 and $2,107,132.
Transactions in the allowance for loan losses for securitized loans for the
years ended December 31 are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ----------
<S> <C> <C>
Balance, beginning of year. . . . . . . . . $ 1,220,000 $ -
Provisions for loan losses. . . . . . . . . 3,547,000 1,220,000
Loans charged off . . . . . . . . . . . . . (1,942,000) -
Recoveries on loans previously charged off. 26,000 -
Transfers from loans held for investment. . 665,000 -
------------ ----------
Balance, end of year. . . . . . . . . . . . $ 3,516,000 $1,220,000
============ ==========
</TABLE>
In the fourth quarter of 1999, the Company decided to cease future
securitization activities. As of December 31, 1999, the Company had accumulated
over $150 million in second mortgage loans. These loans are classified as held
for sale. It is the Company's intent to sell these loans, servicing released,
to third parties. On an ongoing basis, the Company will continue to originate
second mortgage loans, which are expected to be sold to third parties shortly
after origination.
F-10
<PAGE>
4. LOANS HELD FOR INVESTMENT
The composition of the Company's loans held for investment portfolio at December
31 was as follows:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Installment . . . . . . . . . . . . . . . $ 6,347,963 $ 5,637,827
Commercial. . . . . . . . . . . . . . . . 12,102,289 10,612,861
Real estate . . . . . . . . . . . . . . . 44,138,958 65,347,561
Loan participations purchased real estate 25,395,322 2,287,036
Unguaranteed portion of SBA loans . . . . 25,073,030 26,686,850
------------- -------------
113,057,562 110,572,135
Less:
Allowance for loan losses . . . . . . . 2,013,298 2,154,167
Net deferred loan fees (costs) . . . . 145,758 112,199
Other discount on SBA loans . . . . . . 1,776,692 700,585
------------- -------------
Loans held for investment, net. . . . . . $109,121,814 $107,605,184
============= =============
</TABLE>
Transactions in the allowance for loan losses for loans held for investment for
the years ended December 31 are summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ----------- -----------
<S> <C> <C> <C>
Balance, beginning of year . . . . . . . . $ 2,154,167 $1,285,852 $1,409,321
Provision for loan losses. . . . . . . . . 2,585,239 540,000 260,000
Loans charged off. . . . . . . . . . . . . (2,093,159) (359,500) (400,745)
Recoveries on loans previously charged off 32,051 60,815 17,276
Transfers to securitized loans . . . . . . (665,000) - -
Increase in allowance from acquisition . . - 627,000 -
------------ ----------- -----------
Balance, end of year . . . . . . . . . . . $ 2,013,298 $2,154,167 $1,285,852
============ =========== ===========
</TABLE>
A loan is considered impaired when, based on current information and events, 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. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record and the amount of the
shortfall in relation to the principal and interest owed. The Company uses
either the present value of expected cash flows discounted at the loan's
effective rate or the fair value of collateral method to measure impairment.
Impairment is measured on a loan by loan basis for all loans in the portfolio
except for the securitized loans, which are collectively evaluated for
impairment.
F-11
<PAGE>
The recorded investment in loans that are considered to be impaired is as
follows:
<TABLE>
<CAPTION>
December 31,
--------------------------------------
1999 1998 1997
------------ ----------- -----------
<S> <C> <C> <C>
Impaired loans without specific valuation allowances. . . $ 3,250,576 $4,450,345 $1,547,168
Impaired loans with specific valuation allowances . . . . 1,402,469 813,652 1,250,964
Specific valuation allowance related to impaired loans. . (1,038,519) (464,336) (505,994)
------------ ----------- -----------
Impaired loans, net . . . . . . . . . . . . . . . . . . . $ 3,614,526 $4,799,661 $2,292,138
============ =========== ===========
Average investment in impaired loans. . . . . . . . . . . $ 5,119,852 $4,009,400 $1,901,054
============ =========== ===========
Interest income recognized on impaired loans. . . . . . . $ 243,913 $ 288,607 $ 287,309
============ =========== ===========
Nonaccrual loans (included in impaired loans) . . . . . . $ 3,090,684 $2,971,000 $1,259,000
============ =========== ===========
Troubled debt restructured loans, gross . . . . . . . . . $ 655,597 $1,313,000 $2,375,000
============ =========== ===========
Interest forgone on nonaccrual loans and
Troubled debt restructured loans outstanding. . . . . . . $ 1,584,546 $ 414,000 $ 190,000
============ =========== ===========
Loans 30 through 90 days past due with interest accruing. $ 2,549,632 $ 678,000 $ 631,000
============ =========== ===========
</TABLE>
It is generally the Company's policy to place loans on nonaccrual status when
they are 90 days past due, and any unpaid but accrued interest is reversed at
that time. Thereafter, interest income is no longer recognized. As such,
interest income may be recognized on impaired loans to the extent they are not
past due by 90 days or more.
The Company makes loans to borrowers in a number of different industries. No
single industry comprises 10% or more of the Company's loan portfolio. At
December 31, 1999, approximately 73% of the Company's loans are high loan to
value second mortgages. Although the Company has a diversified loan portfolio,
the ability of the Company's customers to honor their loan agreements is
dependent upon, among other things, the general economy of the Company's market
area.
5. TRANSACTIONS INVOLVING RELATED PARTIES
In the ordinary course of business, the Company has extended credit to directors
and employees of the Company. Such loans are subject to approval by the Loan
Committee and ratification by the Board of Directors, exclusive of the borrowing
director. The following is an analysis of the activity of all such loans:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ------------ -----------
<S> <C> <C> <C>
Balance, beginning of year . . . . $2,756,069 $ 2,554,699 $2,253,822
Credit granted, including renewals 2,649,419 1,454,000 751,534
Repayments . . . . . . . . . . . . (284,903) (1,252,630) (450,657)
----------- ------------ -----------
Balance, end of year . . . . . . . $5,120,585 $ 2,756,069 $2,554,699
=========== ============ ===========
</TABLE>
In November 1999, the Company obtained a $3.6 million loan from a shareholder,
who is also a director, the proceeds of which were contributed to Goleta
National Bank as capital. Under the terms and conditions of the loan, the
Company must pay interest each month at a fixed rate of 8.25%. The loan matures
on May 16, 2001. At December 31, 1999, the outstanding borrowing was $3.3
million.
F-12
<PAGE>
6. PREMISES AND EQUIPMENT
Premises and equipment as of December 31 was as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Furniture, fixtures and equipment
(including capitalized software). . . . . . . $ 6,606,235 $ 5,053,803
Building and land . . . . . . . . . . . . . . . 782,423 782,423
Leasehold improvements. . . . . . . . . . . . . 1,595,854 1,389,749
Construction in progress. . . . . . . . . . . . 133,653 640,116
------------ ------------
9,118,165 7,866,091
Less accumulated depreciation and amortization. (4,651,711) (3,452,972)
------------ ------------
Premises and equipment, net . . . . . . . . . . $ 4,466,454 $ 4,413,119
============ ============
</TABLE>
7. DEPOSITS
At December 31, 1999, the scheduled maturities of time certificates of deposits
are as follows:
<TABLE>
<CAPTION>
<S> <C>
2000. . . . . . . . $233,471,215
2001. . . . . . . . 6,577,935
2002. . . . . . . . 733,188
2003. . . . . . . . 84,000
2004 and thereafter 43,187
------------
$240,909,525
============
</TABLE>
8. BONDS PAYABLE
The following is a summary of the outstanding bonds payable, by class, as of
December 31:
<TABLE>
<CAPTION>
Fixed Stated
1999 1998 interest rate Maturity date
------------ ----------- -------------- -----------------
<S> <C> <C> <C> <C>
Series 1998-1:
Class A. . . . $ 42,654,078 $56,480,685 7.057% November 25, 2024
Class B. . . . 19,994,000 19,994,000 7.950% November 25, 2024
------------ -----------
62,648,078 76,474,685
------------ -----------
Series 1999-1:
Class A1 . . . 10,010,263 - 6.455% May 25, 2025
Class A2 . . . 66,681,000 - 7.050% May 25, 2025
Class M1 . . . 14,335,000 - 7.850% May 25, 2025
Class M2 . . . 15,860,000 - 8.750% May 25, 2025
------------ -----------
106,886,263 -
------------ -----------
$169,534,341 $76,474,685
============ ===========
</TABLE>
The bonds are collateralized by securitized loans with an aggregate outstanding
principal balance of $68,845,438 and $115,713,544 as of December 31, 1999 for
Series 1998-1 and Series 1999-1, respectively. There is no cross
collateralization between the bond issues. Unamortized debt issuance costs are
approximately $2,203,000 and $4,423,000 at December 31, 1999 and 1998,
respectively.
F-13
<PAGE>
Amounts collected by the servicer of the mortgage loans are distributed by the
trustee each month to the bondholders, together with other amounts received with
respect to the mortgage loans, net of fees payable to the servicer, trustee and
insurer of the bonds. Interest collected each month on the mortgage loans will
generally exceed the amount of interest accrued on the bonds. A portion of such
excess interest will initially be distributed as principal to the bonds. As a
result of such principal distributions, the excess of the unpaid principal
balance of the loans over the unpaid principal balance of the bonds
("overcollateralization") will increase. The securitization agreements require
that a certain level of overcollateralization be maintained. Once a required
level has been reached, excess interest will no longer be used to accelerate the
amortization of the bonds. Whenever the level of overcollateralization falls
below the required level, excess interest will again be paid as principal to the
bonds until the required level has been reached. Excess interest that is not
paid to the bonds in order to create or maintain the required
overcollateralization level, or used to make certain other payments, will be
passed through to the Company. Therefore, the bonds are not necessarily expected
to be outstanding through the stated maturity date set forth above.
While all the bondholders receive interest payments each month, the various
classes of bonds have different priorities for the timing of receipt of
principal repayments. The classes of bonds presented in the table are shown in
order of such priority.
9. OTHER BORROWINGS
From time to time, the Company will utilize a federal funds facility
("facility") on an overnight basis to manage its liquidity or reserve needs.
The facilities have a total availability of $8,500,000, which is available on a
discretionary basis. The facilities are renewed annually with various maturity
dates and borrowing rates. Under the agreements, the Company must maintain
certain conditions in order for the facilities to be available. At December 31,
1999 and 1998, there were no outstanding borrowings under these facilities. In
addition the Company, through Palomar, obtained a line of credit during 1999
with the Federal Home Loan Bank for up to 25% Palomar's total assets. At
December 31, 1999, there were no outstanding borrowings under this facility.
The following summarizes activities in the line of credit for the year ended
December 31, 1999:
<TABLE>
<CAPTION>
1999
-----------
<S> <C>
Average balance outstanding:. . . . . . . . . . . . . . $ 119,863
Maximum amount outstanding at any month-end during year $1,750,000
Weighted average interest rate during the year. . . . . 5.489%
</TABLE>
In November 1999, the Company obtained a $3.6 million loan from a shareholder,
who is also a director, the proceeds of which were contributed to Goleta
National Bank as capital. Under the terms and conditions of the loan, the
Company must pay interest each month at a fixed rate of 8.25%. The loan matures
on May 16, 2001. At December 31, 1999, the outstanding borrowing was $3.3
million.
In December 1999, Zions First National Bank renewed the Company's $4 million
loan collateralized by stock of the subsidiaries. This loan is due and payable
on June 3, 2000, with a principal reduction of $2.0 million due on April 1,
2000. Interest payments are due on a monthly basis and are calculated at Zion's
prime rate for the period January 1,2000 to April 1, 2000; thereafter the rate
is increased by .5%. The loan's interest rate was 8.5% at December 31, 1999.
10. BUSINESS COMBINATION
On December 14, 1998, the Company issued 1,367,542 common shares with a value of
approximately $12.5 million to consummate a merger with Palomar. The Company
exchanged 2.11 shares of its common stock for each share of Palomar common
stock. The transaction constituted a tax-free reorganization and has been
accounted for using the purchase method of accounting. The Company's total cost
for the acquisition was approximately $12.5 million which was allocated to the
fair value of the assets acquired and liabilities assumed. The amount paid in
excess of the fair value of the net tangible and intangible assets acquired,
approximately $6.2 million, was recorded as goodwill and is being amortized on a
straight-line basis over 20 years. Approximately $571,000 of the purchase price
was allocated to core deposit intangible and is being amortized on a level yield
basis over seven years. Results of operations of Palomar are included in the
Company's consolidated results of operations from January 1, 1999. Palomar's
results of operations were not significant for the period from December 14, 1998
through December 31, 1998.
F-14
<PAGE>
There were no transactions between the Company and Palomar prior to the business
combination other than loan participations. These participations were transacted
in the normal course of business. Immaterial adjustments and reclassifications
were recorded to conform Palomar's accounting policies to those of the Company.
On a proforma basis, the results of operations for the years ended December 31 ,
1998 and 1997 are presented below as if the companies had been combined as of
the beginning of the respective year:
<TABLE>
<CAPTION>
UNAUDITED
PRO FORMA INFORMATION
(In thousands) 1998 1997
------- ------
<S> <C> <C>
Net interest income $11,202 $7,192
Net income $ 507 $1,806
Net income per share - basic. $ 0.10 $ 0.41
</TABLE>
11. STOCKHOLDERS' EQUITY
Common Stock
- -------------
On January 22, 1998, the Company declared a two-for-one stock split for
shareholders of record on February 3, 1998, which was issued on February 27,
1998. All share and per share amounts included in the accompanying financial
statements and related notes have been retroactively restated for the effect of
this split.
On December 28, 1998, the Board of Directors of the Company authorized a stock
buy-back plan. Under this plan, management is authorized to repurchase up to
$2,000,000 worth of the outstanding shares of the Company's common stock. As of
December 31, 1999, management had repurchased 137,437 shares of common stock at
a cost of $1,235,756.
Stock Options
- --------------
Under the terms of the Company's stock option plan, full-time salaried employees
may be granted nonqualified stock options or incentive stock options and
directors may be granted nonqualified stock options. Options may be granted at a
price not less than 100% of the fair market value of the stock on the date of
grant. Options are generally exercisable in cumulative 20% installments. All
options expire no later than ten years from the date of grant. As of December
31, 1999, all options are outstanding at prices of $6.00 to $16.875 per share
with 139,456 options exercisable and 216,140 options available for future grant.
As of December 31, 1999, the average life of the outstanding options was
approximately 6 years. Stock option activity is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
--------------------- --------------------- --------------------
Shares Price (1) Shares Price (1) Shares Price (1)
--------- ---------- --------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding, January 1, . 415,366 $ 6.95 359,652 $ 3.10 427,812 $ 2.78
Granted . . . . . . . . . . . . . 85,000 10.51 218,986 10.11 20,000 8.30
Canceled. . . . . . . . . . . . . (52,180) 10.39 (7,560) 3.21 (17,520) 2.67
Exercised . . . . . . . . . . . . (179,159) 5.33 (155,712) 2.90 (70,640) 2.72
--------- ---------- --------- ---------- -------- ----------
Options outstanding, December 31, 269,027 $ 8.48 415,366 $ 6.95 359,652 $ 3.10
========= ========== ========= ========== ======== ==========
Options exercisable, December 31, 139,456 $ 6.90 287,766 $ 4.11 280,132 $ 2.73
========= ========== ========= ========== ======== ==========
(1) Weighted Average
</TABLE>
F-15
<PAGE>
The weighted average grant date estimated fair value of options was $5.11 per
share in 1999, $3.94 per share in 1998, and $4.50 per share in 1997. The
Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option plan. Accordingly, no
compensation cost has been recognized for its stock option plan. Had
compensation cost for the Company's stock option plan been determined based on
the fair value at the grant dates for awards under the plan consistent with the
method prescribed by SFAS No. 123 "Accounting for Stock Compensation", the
Company's net income (loss) and income (loss) per share for the years ended
December 31, 1999, 1998, and 1997 would have been adjusted to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
Net income (loss): 1999 1998 1997
------------ --------- ----------
<S> <C> <C> <C>
As reported. . . . . . . . . . . . . . . . . . . . . . $(1,646,336) $454,059 $1,588,940
Pro forma. . . . . . . . . . . . . . . . . . . . . . . (1,812,788) $(52,126) $1,553,592
Net income (loss) per common share - Basic
As reported. . . . . . . . . . . . . . . . . . . . . . $ (0.30) $ 0.12 $ 0.53
Pro forma. . . . . . . . . . . . . . . . . . . . . . . $ (0.33) $ (0.01) $ 0.52
Net income (loss) per common share - assuming dilution
As reported. . . . . . . . . . . . . . . . . . . . . . $ (0.30) $ 0.12 $ 0.44
Pro forma. . . . . . . . . . . . . . . . . . . . . . . $ (0.33) $ (0.01) $ 0.43
</TABLE>
The fair value of options granted under the Company's fixed stock option plan
during 1999, 1998 and 1997 was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Annual dividend yield. . 2.0% 5.0% 8.5%
Expected volatility. . . 54.0% 47.0% 53.0%
Risk free interest rate. 6.5% 6.0% 6.5%
Expected life (in years) 6 6 6
</TABLE>
12. COMMITMENTS AND CONTINGENCIES
The Company leases twenty office facilities under various operating lease
agreements with terms that expire at various dates between February 2000 and
March 2007, plus options to extend the lease terms for periods of up to ten
years. The minimum lease commitments as of December 31, 1999, under all
operating lease agreements are as follows:
<TABLE>
<CAPTION>
For the Year Ending December 31,
<S> <C>
2000 . . . . . . . . . . . . . . $1,115,021
2001 . . . . . . . . . . . . . . 1,031,633
2002 . . . . . . . . . . . . . . 933,178
2003 . . . . . . . . . . . . . . 601,945
2004 . . . . . . . . . . . . . . 478,320
Thereafter . . . . . . . . . . . 1,434,960
----------
Total. . . . . . . . . . . . . . $5,595,057
==========
</TABLE>
Rent expense for the years ended December 31, 1999, 1998, and 1997 was $953,022,
$504,985 and $294,230, respectively.
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet. The Company's exposure to credit loss in the event of nonperformance by
the other party to commitments to extend credit and standby letters of credit is
represented by the contractual notional amount of those instruments. At December
31, 1999, the Company had commitments to extend credit of $18,960,000 including
obligations to extend standby letters of credit of $713,000.
F-16
<PAGE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support private borrowing arrangements. All guarantees are
short term and expire within one year.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for extending loan facilities to customers. The Company
evaluates each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company upon extension of
credit, is based on management's credit evaluation of the counterparty.
Collateral held varies but may include accounts receivable, inventory, property,
plant and equipment and income-producing commercial properties.
The Company has sold loans that are guaranteed or insured by government agencies
for which the Company retains all servicing rights and responsibilities. The
Company is required to perform certain monitoring functions in connection with
these loans to preserve the guarantee by the government agency and prevent loss
to the Company in the event of nonperformance by the borrower. Management
believes that the Company is in compliance with these requirements. The
outstanding balance of the sold portion of such loans was approximately
$121,935,000 at December 31, 1999.
Although the Company sells without recourse substantially all of the mortgage
loans it originates or purchases, the Company retains some degree of risk on
substantially all of the loans it sells. In addition, during the period of time
that the loans are held for sale, the Company is subject to various business
risks associated with the lending business, including borrower default,
foreclosure, and the risk that a rapid increase in interest rates would result
in a decline of the value of loans held for sale to potential purchasers. In
connection with its loan sales, the Company enters agreements which generally
require the Company to repurchase or substitute loans in the event of a breach
of a representation or warranty made by the Company to the loan purchaser, any
misrepresentation during the mortgage loan origination process or, in some
cases, upon any fraud or early default on such mortgage loans.
The Company's ability to originate, purchase and sell loans is also
significantly impacted by changes in interest rates. Increases in interest
rates may also reduce the amount of loan and commitment fees received by the
Company. A significant decline in interest rates could also decrease the size
of the Company's servicing portfolio and the related servicing income by
increasing the level of prepayments. The Company does not currently utilize any
specific hedging instruments to minimize exposure to fluctuations in the market
price of loans and interest rates with regard to loans held for sale in the
secondary mortgage market. Therefore, between the time the Company originates
and sells the loans, the Company is exposed to downward movements in the market
price of such loans due to upward movements in interest rates.
The Company entered into a salary continuation agreement with an Officer
(Officer) of the Company who is currently on the Board of Directors. The
agreement provides monthly cash payments to the Officer or beneficiaries in the
event of death or disability, beginning in the month after retirement date or
death and extending for a period of fifteen years. The commitment is funded by
a life insurance policy owned by the Company, and the present value of the
Company's liability under the agreement is included in accrued interest payable
and other liabilities in the accompanying consolidated balance sheets.
The Company is involved in various litigation matters through the normal course
of business. In the opinion of management, after taking into consideration
information provided by counsel, the disposition of all pending litigation
should not have a material effect on the Company's financial position or results
of operations.
F-17
<PAGE>
13. INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31
consists of the following:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ---------- ----------
<S> <C> <C> <C>
Current:
Federal . . . . . . . . $ 2,456,745 $(460,457) $ 828,398
State . . . . . . . . . 667,236 (95,292) 252,061
------------ ---------- ----------
3,123,981 (555,749) 1,080,459
Deferred:
Federal . . . . . . . . (2,889,569) 671,611 54,155
State . . . . . . . . . (856,250) 173,586 23,737
------------ ---------- ----------
(3,745,819) 845,197 77,892
------------ ---------- ----------
Total provision (benefit) $ (621,838) $ 289,448 $1,158,351
============ ========== ==========
</TABLE>
Significant components of the Company's net deferred tax account at December 31
are as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Deferred tax assets:
Allowance for loan loss . . . . . . . . . $ 3,471,456 $ 1,711,220
Depreciation. . . . . . . . . . . . . . . 130,482 52,323
State taxes . . . . . . . . . . . . . . . 9,497 30,832
Unrealized loss on investment securities. 37,100 1,750
State NOL . . . . . . . . . . . . . . . . 32,049 69,523
Investment in ePacific.com . . . . . . . . 655,601 -
Other . . . . . . . . . . . . . . . . . . 330,791 360,556
------------ ------------
4,666,976 2,226,204
------------ ------------
Deferred tax liabilities:
Deferred loan fees. . . . . . . . . . . . (417,096) (1,007,694)
Purchase accounting . . . . . . . . . . . (327,928) (323,000)
FHLB stock dividends. . . . . . . . . . . (76,423) (89,111)
Deferred loan costs . . . . . . . . . . . (796,416) (1,445,317)
Other . . . . . . . . . . . . . . . . . . (142,666) (235,804)
------------ ------------
(1,760,529) (3,100,926)
------------ ------------
Valuation allowance. . . . . . . . . . . . . - -
------------ ------------
Net deferred tax asset (liability) . . . . . $ 2,906,447 $ (874,722)
============ ============
</TABLE>
At December 31, 1999 and 1998, respectively, the deferred tax asset is included
in other assets and the deferred tax liability is included in other liabilities
in the accompanying consolidated balance sheets.
The federal income tax provision (benefit) for the years ended December 31
differs from the applicable statutory rate as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------- ------ -----
<S> <C> <C> <C>
Federal income tax at statutory rate (35.0)% 35.0% 35.0%
State franchise tax, net of federal. (5.5)% 7.0% 6.8%
Amortization of goodwill . . . . . . 5.6% 0.7% -
Disallowed losses on ePacific.com . . 3.9% - -
Other. . . . . . . . . . . . . . . . 3.6% (3.8)% 0.4%
------- ------ -----
(27.4)% 38.9% 42.2%
======= ====== =====
</TABLE>
F-18
<PAGE>
14. REGULATORY MATTERS
The Company (on a consolidated basis), Goleta and Palomar 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 the Company's, Goleta's and
Palomar's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company, Goleta and
Palomar must meet specific capital guidelines that involve quantitative measures
of the Company's, Goleta's and Palomar's, assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
The Company's, Goleta's and Palomar's capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings and other factors. Prompt corrective action provisions are not
applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Company, Goleta and Palomar, to maintain minimum amounts and ratios
(set forth in the following table) of Total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I capital to
average assets (as defined). Management believes, as of December 31, 1999 and
1998, that the Company, Goleta and Palomar meet all capital adequacy
requirements to which they are subject.
As of December 31, 1999 and 1998, the most recent notification from the Federal
Deposit Insurance Corporation ("FDIC") categorized Goleta as "adequately
capitalized" under the regulatory framework for prompt corrective action. At
December 31, 1999 and 1998, the most recent notification from the FDIC and the
Office of Thrift Supervision, respectively, categorized Palomar as
"well capitalized" under the regulatory framework for prompt corrective action.
To be categorized as "adequately capitalized" or "well capitalized", Goleta and
Palomar must maintain minimum Total risk-based, Tier I risk-based, and Tier I
leverage ratios as set forth in the table below. There are no conditions or
events since that notification which management believes have caused Goleta's or
Palomar's category to decline.
The Company's, Goleta's and Palomar's actual capital amounts and ratios at
December 31 are as follows:
<TABLE>
<CAPTION>
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
------------------- ------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------ ----------- ------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999:
Total Risk-Based Capital (to Risk Weighted assets)
Consolidated. . . . . . . . . . . . . . . . . . . . $39,474,626 8.34% $37,856,951 8.00% $47,321,188 10.00%
Goleta National Bank. . . . . . . . . . . . . . . . $33,099,716 8.01% $33,046,888 8.00% $41,308,610 10.00%
Palomar Community Bank. . . . . . . . . . . . . . . $ 7,184,663 11.94% $ 4,814,290 8.00% $ 6,017,863 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated. . . . . . . . . . . . . . . . . . . . $33,945,328 7.17% $18,928,475 4.00% $28,392,713 6.00%
Goleta National Bank. . . . . . . . . . . . . . . . $28,182,418 6.82% $16,523,444 4.00% $24,785,166 6.00%
Palomar Community Bank. . . . . . . . . . . . . . . $ 6,572,663 10.92% $ 2,407,145 4.00% $ 3,610,718 6.00%
Tier I Capital (to Average Assets)
Consolidated. . . . . . . . . . . . . . . . . . . . $33,945,328 7.52% $18,060,691 4.00% $22,575,864 5.00%
Goleta National Bank. . . . . . . . . . . . . . . . $28,182,418 7.27% $15,498,960 4.00% $19,373,700 5.00%
Palomar Community Bank. . . . . . . . . . . . . . . $ 6,572,663 12.22% $ 2,151,381 4.00% $ 2,689,226 5.00%
</TABLE>
F-19
<PAGE>
<TABLE>
<CAPTION>
To Be Well Capitalized
For Capital Under Prompt
Adequacy Corrective Action
Actual Purposes Provisions
------------------- ------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------ ----------- ------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total Risk-Based Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . $32,226,458 12.99% $19,850,676 8.00% $24,813,345 10.00%
Goleta National Bank . . . . . . . . . . . . . . . $15,633,452 8.18% $15,288,458 8.00% $19,110,573 10.00%
Palomar Savings and Loan . . . . . . . . . . . . . $ 6,924,424 11.57% $ 4,787,384 8.00% $ 5,984,231 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . $29,121,426 11.74% $ 9,925,338 4.00% $14,888,007 6.00%
Goleta National Bank . . . . . . . . . . . . . . . $13,240,206 6.93% $ 7,644,229 4.00% $11,466,344 6.00%
Tier I Capital (to Average Assets)
Consolidated . . . . . . . . . . . . . . . . . . . $29,121,426 9.12% $12,775,029 4.00% $15,968,787 5.00%
Goleta National Bank . . . . . . . . . . . . . . . $13,240,206 5.90% $ 8,972,680 4.00% $11,215,850 5.00%
Core Capital (to Adjusted Tangible Assets)
Palomar Savings and Loan . . . . . . . . . . . . . $ 6,297,424 10.52% $ 2,393,692 4.00% $ 2,992,115 5.00%
Tangible Capital (to Tangible Assets)
Palomar Savings and Loan . . . . . . . . . . . . . $ 6,297,424 7.61% $ 1,240,914 1.50% N/A N/A
</TABLE>
Under the regulatory framework, Goleta's capital levels do not allow it to
accept or renew brokered deposits without prior approval from the regulators.
Goleta had approximately $1,090,896 of brokered deposits at December 31, 1999.
In the opinion of management, this prohibition is not expected to materially
impact Goleta.
In November 1999, the OCC notified Goleta that Goleta had not properly
calculated the amount of regulatory capital required to be held with respect to
retained interests by Goleta in two securitizations of loans that were
consummated by Goleta in the fourth quarter of 1998 and the second quarter of
1999. Accordingly, the OCC informed Goleta that it was deemed adequately
capitalized at December 31, 1998 and significantly undercapitalized at March 31,
1999, June 30, 1999 and September 30, 1999. On November 17, 1999, after a new
debt and equity investment in the Company of approximately $11.15 million by
certain directors of the Company, the proceeds of which were contributed to
Goleta as equity, the OCC informed Goleta that it was adequately capitalized. As
a result, the 1998 regulatory capital amounts and ratios have been restated from
amounts and ratios previously reported to properly reflect Goleta's regulatory
capital position at December 31, 1998.
On March 23, 2000, Goleta signed a formal written agreement with Comptroller of
the Currency of the United States of America (the Agreement). Under the
terms of the Agreement, by September 30, 2000, and thereafter, Goleta is
required to maintain total capital at least equal to 12% of risk-weighted
assets, and Tier 1 capital at least equal to 7% of adjusted total assets. Goleta
is required to adopt and implement a written asset diversification program that
includes specific plans to reduce the concentration of second mortgage loans
(exclusive of securitized loans brought back from the securitization) to 100% of
capital by September 30, 2000. The Agreement requires Goleta to submit, within
60 days, a capital plan, which is to include, among other things, specific plans
for meeting the special capital requirements, projections for growth and a
dividend policy. The Agreement places limitations on growth and payments of
dividends until Goleta is in compliance with its approved capital plan. The
Agreement also requires that Goleta adopt and improve certain policies and
procedures and develop a three-year strategic plan. Goleta is required to submit
monthly progress reports to the regulators detailing actions taken, results of
those actions and a description of actions needed to achieve full compliance
with the Agreement.
15. EMPLOYEE BENEFIT PLAN
On September 1, 1995, the Company established a 401(k) plan for the benefit of
its employees. Employees are eligible to participate in the plan if the Company
employed them on September 1, 1995, or after 3 months of consecutive service.
Employees may make contributions to the plan under the plan's 401(k) component,
and the Company may make contributions under the plan's profit sharing
component, subject to certain limitations. The Company's contributions were
determined by the Board of Directors and amounted to $149,037, $122,767, and
$112,592 in 1999, 1998, and 1997, respectively.
F-20
<PAGE>
16. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
that the Company disclose estimated fair values for its financial instruments.
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop estimates
of fair value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
---------------------------------------------
Carrying Estimated Carrying Estimated
(in thousands) Amount Fair Value Amount Fair Value
---------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents . . . . . . . $ 36,103 $ 36,103 $ 49,479 $ 49,479
Investment Securities. . . . . . . . . 6,170 6,167 9,609 9,611
Interest-only Strips . . . . . . . . . 5,383 5,383 2,222 2,222
Net Loans . . . . . . . . . . . . . . . . 451,664 453,019 247,411 248,153
Liabilities:
Deposits (other than TDs). . . . . . . 72,221 72,221 66,324 66,324
Time deposits. . . . . . . . . . . . . 240,910 243,095 157,529 162,260
Bonds Payable. . . . . . . . . . . . . 167,332 172,686 72,051 74,357
Other borrowings . . . . . . . . . . . 7,307 7,307 - -
</TABLE>
The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below:
Cash and cash equivalents - The carrying amounts approximate fair values because
of the short-term nature of these investments.
Investment securities - The fair value is based on quoted market prices from
security brokers or dealers if available. If a quoted market price is not
available, fair value is estimated using the quoted market price for similar
securities.
Federal Reserve and Federal Home Loan Bank stock carrying value approximates the
fair value because the stock can be sold back to the Federal Reserve and Federal
Home Loan Bank at anytime.
Loans - Fair values of loans are estimated for portfolios of loans with similar
financial characteristics, primarily fixed and adjustable rate interest terms.
The fair values of fixed rate mortgage loans are based upon discounted cash
flows utilizing the rate that the Company currently offers as well as
anticipated prepayment schedules. The fair values of adjustable rate loans are
also based upon discounted cash flows utilizing discount rates that the Company
currently offers, as well as anticipated prepayment schedules. No adjustments
have been made for changes in credit within the loan portfolio. It is
management's opinion that the allowance for estimated loan losses pertaining to
performing and non-performing loans results in a fair valuation of such loans.
The fair value of loans held for sale is determined based on quoted market
prices or dealer quotes.
F-21
<PAGE>
Interest Only Strip - The fair value of the interest-only strip has been
determined by discounted cash flow methods, using market discount and prepayment
rates.
Deposits - The fair values of deposits are estimated based upon the type of
deposit products. Demand accounts, which include savings and transaction
accounts, are presumed to have equal book and fair values, since the interest
rates paid on these accounts are based on prevailing market rates. The estimated
fair values of time deposits are determined by discounting the cash flows of
segments of deposits that have similar maturities and rates, utilizing a yield
curve that approximates the prevailing rates offered to depositors as of the
measurement date.
Bonds Payable - The fair value is estimated using discounted cash flow analysis
based on rates for similar types of borrowing arrangements.
Other Borrowings - The carrying amount is assumed to be the fair value because
the interest rate is the same as rates currently offered for borrowings with
similar remaining maturities and characteristics.
Commitments to Extend Credit, Commercial and Standby Letters of Credit - Fair
values of commitments are immaterial to the financial statements.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 1999 and 1998. Although management is
not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since those dates, and therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
17. SEGMENT PROFIT (LOSS)
The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information" in 1998. SFAS No. 131 established standards for
reporting information about operating segments. The 1999 and 1998 information is
presented below. The 1997 information is not presented because the data is not
available and would be impracticable to develop.
The Company's management, while managing the overall company, reviews individual
areas considered "significant" to revenue and net income. These significant
areas, or segments, are: SBA Lending, Alternative Lending, the Mortgage
Division, Goleta National Bank Branch Operations, and Palomar Community Bank.
For this discussion, the remaining divisions, including ePacific.com, are
considered immaterial and are consolidated into "Other". The Other segment
includes the administration areas, human resources and tech support, along with
others. The accounting policies of the individual segments are the same as
those described in the summary of significant accounting policies.
The SBA Lending, Alternative Lending and Mortgage Divisions from Goleta National
Bank are considered individual segments because of the different loan products
involved and the significance of the associated revenue. Goleta National Bank
Branch Operations, includes the deposits and commercial lending. Management
analyzes Palomar separately from Goleta National Bank, as they are two different
subsidiaries under Community West Bancshares.
All of the Company's assets and operations are located within the United States.
The assets shown below for each segment, other than Palomar, are estimates.
F-22
<PAGE>
The following tables sets forth various revenue and expense items that
management relies on in decision making.
<TABLE>
<CAPTION>
As of and for
The year ended
December 31, 1999
SBA Alternative Mortgage GNB Branch Consolidated
Lending Lending Division Operations Palomar Other Total
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest Income. . . . $ 3,046,000 $ 35,735,000 $ 569,000 $ 2,816,000 $ 5,889,000 440,000 $ 48,495,000
Interest Expense . . . 1,578,000 18,517,000 295,000 1,459,000 2,884,000 412,000 25,145,000
----------- ------------ ---------- ------------ ----------- ------------- --------------
Net Interest Income. . 1,468,000 17,218,000 274,000 1,357,000 3,005,000 28,000 23,350,000
----------- ------------ ---------- ------------ ----------- ------------- --------------
Provision
For Loan Losses. . . . 434,000 5,093,000 81,000 401,000 115,000 9,000 6,133,000
Non-interest Income. . 5,369,000 412,000 4,266,000 241,000 733,000 11,021,000
Non-interest Expense. 3,307,000 9,158,000 4,061,000 2,057,000 3,466,000 8,457,000 30,506,000
----------- ------------ ---------- ------------ ----------- ------------- --------------
Segment Profit (Loss). $ 3,096,000 $ 3,379,000 $ 398,000 $ (860,000) $ 157,000 $ (8,438,000) $ (2,268,000)
=========== ============ ========== ============ =========== ============= ==============
Segment Assets . . . . $30,114,000 $349,221,000 $5,339,000 $62,507,000 $76,076,000 $ 590,000 $ 523,847,000
</TABLE>
<TABLE>
<CAPTION>
As of and for
the year ended SBA Alternative Mortgage GNB Branch Consolidated
December 31, 1998(1) Lending Lending Division Operations Other Total
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest Income . . . $ 3,046,000 $ 5,726,000 $ 569,000 $ 5,938,000 $ - $ 15,279,000
Interest Expense. . . 1,259,000 2,367,000 235,000 2,455,000 - 6,316,000
----------- ------------ ----------- ---------------- ------------ -------------
Net Interest Income . 1,787,000 3,359,000 334,000 3,483,000 - 8,963,000
Provision
For Loan Losses . . 354,000 665,000 66,000 674,000 - 1,759,000
Noninterest Income . 4,171,000 1,318,000 5,201,000 385,000 (53,000) 11,022,000
Non-interest Expense. 2,048,000 7,568,000 4,333,000 2,106,000 1,427,000 17,482,000
----------- ------------ ----------- ---------------- ------------ -------------
Segment Profit (loss) $ 3,556,000 $(3,556,000) $ 1,136,000 $ 1,088,000 $(1,480,000) $ 744,000
=========== ============ =========== ================ ============ =============
Segment Assets. . . . $32,142,000 $97,987,000 $22,099,000 $ 60,902,000 $25,775,000 $ 327,569,000
=========== ============ =========== ================ ============ =============
<FN>
(1) Palomar Community Bank was acquired on December 14, 1998. Accordingly, its results of operation are
excluded prior to that time. Palomar's total assets as of December 31, 1998 were approximately $88.7 million.
</TABLE>
F-23
<PAGE>
18. COMMUNITY WEST BANCSHARES (PARENT COMPANY ONLY)
<TABLE>
<CAPTION>
(Dollars in thousands) DECEMBER 31, DECEMBER 31,
BALANCE SHEETS 1999 1998
-------------- --------------
<S> <C> <C>
ASSETS
Cash and equivalents. . . . . . . . . . . $ - $ 3,171
Investment in subsidiaries. . . . . . . . 41,009 25,713
Other assets. . . . . . . . . . . . . . . 231 379
-------------- --------------
Total Assets. . . . . . . . . . . . . . . . $ 41,240 $ 29,263
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Other Liabilities . . . . . . . . . . . . $ 7,308 $ 141
Common stock. . . . . . . . . . . . . . . 33,728 25,250
Retained earnings . . . . . . . . . . . . 1,495 4,013
Treasury stock. . . . . . . . . . . . . . (1,236) (141)
Accumulated other comprehensive loss. . . (55) -
-------------- --------------
Total Liabilities and Shareholders' Equity. $ 41,240 $ 29,263
============== ==============
FOR THE YEAR ENDED DECEMBER 31, . . . . . . 1999 1998 1997
-------------- -------------- -------
STATEMENTS OF OPERATIONS
Total Income. . . . . . . . . . . . . . . . $ - $ 60 $ -
Total Expense . . . . . . . . . . . . . . . (1,167) (195)
Equity in undistributed
net income(loss) from Subsidiaries
subsidiaries. . . . . . . . . . . . . . . (969) 531 1,589
-------------- -------------- -------
Income(loss) before
Income tax provision(benefit) . . . . . . . (2,136) 396 1,589
Income tax provision (benefit). . . . . . (490) (58) -
-------------- -------------- -------
Net income(loss). . . . . . . . . . . . . . $ (1,646) $ 454 $1,589
============== ============== =======
</TABLE>
F-24
<PAGE>
<TABLE>
<CAPTION>
STATEMENTS OF CASHFLOWS 1999 1998 1997
--------- -------- --------
<S> <C> <C> <C>
Cash Flows from operating activities:
Net Income(loss) . . . . . . . . . . . . . . . . . . $ (1,646) $ 454 $ 1,589
Adjustments to reconcile net (income) loss to
cash provided by/(used in) operating activities:
Equity in undistributed
(income) loss from subsidiaries. . . . . . . . . . . 969 (531) (1,589)
Net change in other liabilities. . . . . . . . . . . 7,167 (125) -
Net change in other assets . . . . . . . . . . . . . (148) (358) -
--------- -------- --------
Total adjustments. . . . . . . . . . . . . . . . . . 7,988 (1,014) (1,589)
--------- -------- --------
Net cash provided by/(used in) operating activities. 6,342 (560) -
Cash flows from investing activities:
Payments for investments in
And advances to subsidiaries (16,025) (576)
--------- -------- --------
Net cash used in investing activities. . . . . . . . (16,025) (576) -
Cash flows from financing activities:
Proceeds from issuance of common stock . . . . . . 8,478 4,193 10
Dividends from nonbank subsidiaries 245
Dividends. . . . . . . . . . . . . . . . . . . . . (871)
Payments to repurchase common stock. . . . . . . . (1,095) (141)
--------- -------- --------
Net cash provided by financing activities . . . . . 6,512 4,052 255
Cash and cash equivalents:
Net(decrease) increase in cash and
cash equivalents . . . . . . . . . . . . . . . . . (3,171) 2,916 255
Cash and cash equivalents at beginning of year . . 3,171 255 -
--------- -------- --------
Cash and cash equivalents, at end of year. . . . . $ - $ 3,171 $ 255
========= ======== ========
</TABLE>
Community West Bancshares was incorporated for the purpose of being a financial
services holding company. Prior to the acquisition of Goleta, which became
effective on December 31, 1997, the Company had minimal activity.
F-25
<PAGE>
19. QUARTERLY FINANCIAL DATA (unaudited)
Summarized quarterly financial data follows:
<TABLE>
<CAPTION>
(All amounts in thousands except per share data)
Quarter Ended
Mar 31, 1999 (1) Jun 30, 1999 (1) Sep 30, 1999 (1) Dec 31, 1999(1)
-------------------------------------------------------------------------------------------
As As As As
previously As previously As previously As previously As
reported restated reported restated reported restated reported restated
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1999
Net interest income. . . . . . . . . . $ 4,184 $ 3,735 $ 6,689 $ 4,750 $ 6,969 $ 5,891 $ 5,508 $ 8,974
Provision for loan losses. . . . . . . 541 271 3,701 2,677 1,783 1,509 108 1,676
Net income(loss) . . . . . . . . . . . 398 454 (2,149) 220 430 (131) (325) (2,189)
Net income(loss) per share - basic. . $ 0.12 $ 0.08 $ (0.62) $ 0.04 $ 0.11 $ (0.02) $(0.06) $ (0.38)
- diluted. $ 0.10 $ 0.08 $ (0.62) $ 0.04 $ 0.11 $ (0.02) $(0.06) $ (0.38)
</TABLE>
<TABLE>
<CAPTION>
Quarter Ended
Mar 31, 1998 (2) Jun 30, 1998 (2) Sep 30, 1998 (2) Dec 31, 1998 (2)
-----------------------------------------------------------------------------------------------
As As As As
previously As previously As previously As previously As
reported restated reported restated reported restated reported restated
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998
Net interest income . . . . $ 1,326 $ 1,326 $ 2,421 $ 2,421 $ 2,594 $ 2,594 $ 2,622 $ 2,622
Provision for loan losses . 60 60 220 220 120 120 1,360 1,360
Net income(loss). . . . . . 204 324 (653) 642 (241) (127) 1,144 (385)
Net income(loss) per share
- basic . . . . . . . . . $ 0.04 $ .10 $ 0.12 $ 0.19 $ (0.04) $ (0.03) $ (0.23) $ (0.09)
- diluted . . . . . . . . $ 0.04 $ .08 $ 0.12 $ 0.17 $ (0.04) $ (0.03) $ (0.22) $ (0.09)
<FN>
(1) The interim financial statements for the quarterly periods ended March 31, 1999, June 30, 1999, September 30, 1999
and December 31, 1999 have been restated from amounts previously reported in the Company's Annual Report on Form 10-K for
the year ended December 31, 1999 to correct for certain errors made in the allocations among such quarterly periods relating
to matters described in items (1) through (5) of Note 21, the June 1999 securitization previously accounted for as a sale
that should have been accounted for as a secured borrowing, losses at ePacific.com, errors in the calculation of weighted
average shares outstanding, and certain other insignificant items.
(2) The interim financial statements for the quarterly periods ended March 31, 1998, June 30, 1998, September 30, 1998
and December 31, 1998 have been restated from amounts previously reported in the Company's Annual Report on Form 10-K for
the year ended December 31, 1999 to correct for certain errors made in the allocations among such quarterly periods relating
to matters described in items (1) through (5) of Note 21, errors in the calculation of weighted average shares outstanding,
and certain other insignificant items.
</TABLE>
20. SUBSEQUENT EVENT
On March 29, 2000, the Company received approximately $4.5 million in proceeds
related to the repayment of amounts due from ePacific.com of approximately
$3.7 million and the sale of a portion of the Company's 70% ownership interest
in ePacific.com. The Company retained a 10% ownership interest in ePacific.com.
The Company's investment in ePacific.com was previously accounted for under the
consolidation method of accounting.
21. RESTATEMENT OF FINANCIAL STATEMENTS
Subsequent to the issuance of the Company's 1998 financial statements, the
Company's management determined that (1) the acquisition of Palomar Community
Bank in December 1998 which was previously accounted for under the
pooling-of-interests method of accounting, should have been accounted for under
the purchase method of accounting, (2) the securitization of loans completed in
December 1998, which was previously accounted for as a sale should have been
accounted for as a secured borrowing with a pledge of collateral, (3) certain
costs related to second mortgage loans which were previously capitalized, should
have been charged to expense as incurred, (4) the prepayment assumption used to
value the I/O strip retained on sales of Title I loans during 1998 was
incorrect, (5) certain loan fees which were previously recognized as income when
received, should have been deferred and amortized, and (6) the calculation of
regulatory capital amounts and ratios as of December 31, 1998 was incorrect. In
addition, management also identified certain other insignificant errors in the
1998 financial statements. As a result, the 1998 and 1997 financial statements
have been restated from amounts previously reported to properly account for
these transactions.
F-26
<PAGE>
A summary of the significant effects of the restatement is as follows (amounts
are in thousands):
<TABLE>
<CAPTION>
1998 1997
AS PREVIOUSLY AS AS PREVIOUSLY AS
AT DECEMBER 31, REPORTED RESTATED REPORTED RESTATED
----------------------------------------------------
<S> <C> <C> <C> <C>
Interest - only strips . . . . . . . . $ 10,915 $ 2,222 $ 2,528 $ 2,528
Servicing assets . . . . . . . . . . . 1,472 1,372 664 664
Securitized loans. . . . . . . . . . . - 81,119 - -
Loans held for investment. . . . . . . 107,099 107,605 112,645 56,724
Intangible assets. . . . . . . . . . . 435 6,610 485 485
Total assets . . . . . . . . . . . . . 252,034 327,569 173,920 95,312
Deposits . . . . . . . . . . . . . . . 223,545 223,853 152,691 80,252
Accrued interest payable
and other liabilities. . . . . . . . . 3,936 2,544 3,574 2,931
Bonds payable. . . . . . . . . . . . . - 72,051 - -
Total liabilities. . . . . . . . . . . 227,481 298,448 156,265 83,184
Common stock . . . . . . . . . . . . . 17,304 25,250 12,833 8,570
Retained earnings. . . . . . . . . . . 7,393 4,013 4,790 3,559
Total stockholders' equity . . . . . . 24,553 29,121 17,655 12,129
FOR THE YEAR ENDED DECEMBER 31,
Interest income on loans . . . . . . . $ 18,879 $ 14,751 11,762 7,350
Total interest income. . . . . . . . . 20,547 15,279 13,553 8,009
Interest expense . . . . . . . . . . . 9,257 6,317 6,361 2,910
Gains from loan sales. . . . . . . . . 6,394 4,060 4,390 4,101
Total other income . . . . . . . . . . 14,036 11,022 9,911 9,432
Total other expenses . . . . . . . . . 20,075 17,482 13,446 11,524
Income (loss) before
provision (benefit) for income taxes . 4,822 744 3,466 2,747
Provision (benefit) for income taxes . 1,941 290 1,316 1,158
Net income (loss). . . . . . . . . . . $ 2,881 $ 454 $ 2,150 $ 1,589
Net income (loss) per share - basic. . $ 0.57 $ .12 $ 0.49 $ 0.53
Net income (loss) per share - diluted. $ 0.55 $ .12 $ 0.43 $ 0.44
</TABLE>
F-27
<PAGE>
82
rev9 04/14/00
3:22 PM
SIGNATURES
----------
Pursuant to the requirements of Section 13 of 15(d) of the Securities and
Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, on the 11th day of
May, 2000.
COMMUNITY WEST BANCSHARES
(Registrant)
By /s/ Llewellyn W. Stone
---------------------------------
Llewellyn W. Stone
President and
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ Michael A. Alexander
- -------------------------- Director May 11, 2000
Michael A. Alexander
/s/ Mounir R. Ashamalla
- -------------------------- Director May 11, 2000
Mounir R. Ashamalla
/s/ Robert H. Bartlein
- -------------------------- Director and Vice Chairman of the Board May 11, 2000
Robert H. Bartlein
/s/ Jean W. Blois
- -------------------------- Director May 11, 2000
Jean W. Blois
/s/ John D. Illgen
- -------------------------- Director May 11, 2000
John D. Illgen
/s/ John D. Markel
- -------------------------- Chairman of the Board May 11, 2000
John D. Markel
/s/ Michel Nellis
- -------------------------- Director and Secretary May 11, 2000
Michel Nellis
/s/ William R. Peeples
- -------------------------- Director May 11, 2000
William R. Peeples
/s/ James Rady
- -------------------------- Director May 11, 2000
James Rady
/s/ Lynda Pullon Radke
- -------------------------- Senior Vice President and Chief May 11, 2000
Lynda Pullon Radke Financial Officer (Principal
Financial and Accounting Officer)
/s/ James R. Sims Jr.
- -------------------------- Director May 11, 2000
James R. Sims Jr.
/s/ Llewellyn W. Stone
- -------------------------- Director, President and Chief Executive Officer May 11, 2000
Llewellyn W. Stone
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-43531 of Community West Bancshares on Form S-8 of our report dated April
14, 2000 (which expresses an unqualified opinion and includes explanatory
paragraphs relating to an agreement with the regulators described in Note 14,
the adoption of Statement of Position 98-1, "Accounting for Costs of Software
Developed and Obtained for Internal Use", described in Note 1 and the
restatement described in Note 21), appearing in the Annual Report on Form
10-K/A (Amendment No. 1) of Community West Bancshares for the year ended
December 31, 1999.
/s/ Deloitte & Touche LLP
May 11, 2000
Los Angeles, California
<PAGE>
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