<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarterly Period Ended June 30, 1998
Commission file number 2-76555
COMMERCE SECURITY BANCORP, INC.
-------------------------------
(Exact name of registrant as specified in its charter)
Delaware 33-0720548
-------- ----------
(State or other jurisdiction of (I.R.S. Employer or
incorporation or organization) Identification No.)
24012 Calle de la Plata,Suite 150, Laguna Hills, California 92653
----------------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(949) 699-4344
--------------
(Issuer's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $.01 par value 18,347,397 shares outstanding on August 14, 1998
<PAGE>
COMMERCE SECURITY BANCORP, INC.
U.S. SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
<S> <C>
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Condition - 3
June 30, 1998 and December 31, 1997
Condensed Consolidated Statements of Operations 5
For the three and six months ended June 30, 1998 and 1997
Condensed Consolidated Statements of Cash Flows - 6
For the six months ended June 30, 1998 and 1997
Notes to the Condensed Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis or Plan of Operation 10
Item 3. Qualitative and Quantitative Disclosure about Market Risk 20
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Condition
June 30, 1998 and December 31, 1997
<TABLE>
<CAPTION>
June 30,
1998 December 31,
(Unaudited) 1997
------------- ------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 160,245,000 $ 81,030,000
Federal funds sold - 40,000,000
--------------- -------------
Total cash and cash equivalents 160,245,000 121,030,000
Available-for-sale investment securities 61,054,000 67,295,000
Mortgage loans held for sale 187,603,000 96,230,000
Loans and leases, net of unearned income 508,694,000 519,048,000
Less allowance for loan and lease loss (7,820,000) (9,395,000)
--------------- -------------
Loans, net 688,477,000 605,883,000
Loan and servicing sale receivable 4,655,000 1,247,000
Premises and equipment, net 9,539,000 11,232,000
Real estate acquired through foreclosure, net 1,499,000 2,740,000
Intangibles arising from acquisitions, net 65,078,000 66,769,000
Accrued interest receivable and other assets 32,763,000 26,159,000
--------------- -------------
Total assets $ 1,023,310,000 $ 902,355,000
--------------- -------------
--------------- -------------
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Condition (Continued)
June 30, 1998 and December 31, 1997
<TABLE>
<CAPTION>
June 30,
1998 December 31,
(Unaudited) 1997
----------- ------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand:
Non-interest bearing $ 256,166,000 $ 289,344,000
Interest bearing 99,166,000 97,416,000
Savings:
Regular 190,350,000 98,465,000
Money market 87,898,000 98,189,000
Time:
Under $100,000 141,751,000 99,713,000
$100,000 or more 101,271,000 82,076,000
------------- -------------
Total deposits 876,602,000 765,203,000
Federal funds purchased 3,374,000 2,050,000
Due to related parties 473,000 -
Accrued expenses and other liabilities 17,510,000 12,172,000
Mandatory convertible debentures - 537,000
Subordinated debentures 27,657,000 27,657,000
--------------- -------------
Total liabilities 925,616,000 807,619,000
Shareholders' equity:
Preferred stock, $.01 par value, 1,500,000
shares authorized, 116,593 issued and
outstanding at June 30, 1998 11,659,000 11,659,000
Special common stock, $.01 par value,
9,651,600 shares authorized, 4,825,718
issued and outstanding at June 30, 1998 48,000 48,000
Common stock, $.01 par value, 50,000,000
shares authorized, 13,521,679 issued and
outstanding at a June 30, 1998 135,000 135,000
Additional paid-in capital 83,855,000 83,855,000
Retained earnings 3,314,000 524,000
Unearned compensation (1,258,000) (1,509,000)
Unrealized gain on securities available-for-sale (59,000) 24,000
--------------- -------------
Total shareholders' equity 97,694,000 94,736,000
--------------- -------------
Total liabilities and shareholders' equity $ 1,023,310,000 $ 902,355,000
--------------- -------------
--------------- -------------
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
Three months and six months ended June 30, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
3 months ended 6 months ended
June 30, June 30,
--------------------------- ---------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Interest and fee income on loans $ 16,041,000 $ 8,768,000 $ 31,253,000 $ 15,463,000
Income from lease finance receivables 1,429,000 988,000 2,582,000 2,168,000
Interest and dividend income on securities 932,000 1,099,000 1,919,000 1,693,000
Interest income on Federal funds sold 235,000 425,000 320,000 673,000
------------ ------------ ------------ ------------
Total interest and fee income 18,637,000 11,280,000 36,074,000 19,997,000
Interest on deposits 6,437,000 4,219,000 11,550,000 7,372,000
Interest on Federal funds purchased 211,000 10,000 662,000 107,000
Interest on subordinated notes 830,000 218,000 1,658,000 233,000
------------ ------------ ------------ ------------
Total interest expense 7,478,000 4,447,000 13,870,000 7,712,000
------------ ------------ ------------ ------------
Net interest income 11,159,000 6,833,000 22,204,000 12,285,000
Provision for loan and lease losses 1,000,000 308,000 1,922,000 715,000
------------ ------------ ------------ ------------
Net interest income after provision
for loan and lease losses 10,159,000 6,525,000 20,282,000 11,570,000
Service charges on deposit accounts 887,000 394,000 1,780,000 652,000
Gain on sale of mortgage loans 4,183,000 1,558,000 6,710,000 3,452,000
Other non-interest income 1,669,000 749,000 2,871,000 1,885,000
------------ ------------ ------------ ------------
Total non-interest income 6,739,000 2,701,000 11,361,000 5,989,000
Salaries and employee benefits 5,609,000 3,629,000 10,457,000 6,650,000
Expenses of premises & fixed assets 1,795,000 1,321,000 3,504,000 2,491,000
Amortization of intangibles 975,000 494,000 1,739,000 705,000
Other non-interest expense 4,818,000 3,491,000 8,777,000 6,246,000
------------ ------------ ------------ ------------
Total non-interest expense 13,197,000 8,935,000 24,477,000 16,092,000
------------ ------------ ------------ ------------
Income before taxes and other 3,701,000 291,000 7,166,000 1,467,000
Applicable income taxes 1,965,000 170,000 3,743,000 912,000
------------ ------------ ------------ ------------
Net income $ 1,736,000 $ 121,000 $ 3,423,000 $ 555,000
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Net income available to common $ 1,416,000 $ 36,000 $ 2,787,000 $ 470,000
Earnings per share (basic) $ 0.078 $ 0.003 $ 0.152 $0.040
Earnings per share (dilutive) $ 0.068 $ 0.003 $ 0.135 $0.040
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
---------------------------
1998 1997
---- ----
<S> <C> <C>
OPERATING ACTIVITIES:
Net income 3,423,000 555,000
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Provision for loan and lease losses 1,922,000 715,000
Provision for loss on real estate acquired through foreclosure - 116,000
Gain on sale of mortgage loans (6,710,000) (3,452,000)
(Gain) loss on sale of premises and equipment - 16,000
Loss on sale of real estate owned 284,000 29,000
Depreciation and amortization 1,359,000 540,000
Amortization of goodwill 1,406,000 705,000
Accretion/amortization related to securities (281,000) 2,000
Amortization of deferred compensation 252,000 -
Provision for deferred taxes 2,103,000 412,000
Mortgage loans originated for sale (754,377,000) (361,127,000)
Proceeds from sales of loans and servicing 767,791,000 363,476,000
Equity in loss of real estate joint venture - 306,000
Decrease (increase) in servicing sale receivable (3,408,000) 1,625,000
Decrease (increase) in loans held for sale (91,373,000) 993,000
Other, net (4,035,000) (1,009,000)
------------ ------------
Net used in provided by operating activities (81,644,000) 3,902,000
INVESTING ACTIVITIES:
Decrease in interest bearing deposits with other financial
institutions - 338,000
Purchase of investment securities (43,236,000) (17,016,000)
Proceeds from maturities of investment securities 6,244,000 -
Proceeds from sales of investment securities 43,434,000 15,707,000
Loans/Leases originated for portfolio net of principal repayment 139,000 (5,198,000)
Purchase of premises and equipment (546,000) (220,000)
Proceeds from sale of premises and equipment 1,211,000 9,000
Proceeds from sales of real estate acquired through foreclosure 1,591,000 2,139,000
Capital expenditures for other real estate owned - (1,405,000)
Purchase of Eldorado Bank, net of cash received - (61,299,000)
------------ ------------
Net cash (used in) provided by investing activities 8,837,000 (66,945,000)
</TABLE>
See notes to consolidated financial statements.
6
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Continued)
For the Six Months Ended June 30, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
1998 1997
---- ----
<S> <C> <C>
FINANCING ACTIVITIES
Net increase in deposits 111,399,000 50,309,000
Issuance of subordinated debentures - 27,657,000
Issuance of preferred stock preferred stock - 11,659,000
Issuance of common stock - 18,004,000
Issuance of special common stock - 23,212,000
Payment of dividends (636,000) (85,000)
Redemption of mandatory convertible debentures (537,000) (4,500,000)
Repayment of notes payable (68,000) -
Proceeds from issuance of notes payable to
related parties 540,000 -
Net increase in other borrowings 1,324,000 8,009,000
------------- -------------
Net cash provided by financing activities 112,022,000 134,265,000
------------- -------------
INCREASE IN CASH AND CASH EQUIVALENTS 39,215,000 71,222,000
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 121,030,000 46,222,000
------------- -------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 160,245,000 $ 117,444,000
------------- -------------
Supplemental disclosures of cash flow
information:
Cash paid for Interest on deposits $ 12,432,000 $ 7,521,000
Cash paid for Income taxes 1,640,000 500,000
Supplemental disclosures of non-cash
investing activities:
Real estate acquired through foreclosure 634,000 1,379,000
Supplemental disclosures of non-cash
financing activities
Issuance of restricted stock - 2,012,000
</TABLE>
See notes to consolidated financial statements.
7
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates. The accompanying
financial information for Commerce Security Bancorp, Inc. ("CSBI" or the
"registrant") has been prepared in accordance with the Securities and
Exchange Commission rules and regulations for quarterly reporting and
therefore does not necessarily include all information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles. The interim financial data is
unaudited; however, in the opinion of management, the interim data includes
all adjustments, consisting only of normal recurring adjustments, necessary
for a fair statement of the results for the interim periods. Certain
reclassifications have been made in the 1997 financial information to conform
to the presentation used in 1998. Results for the period ending June 30, 1998
are not necessarily indicative of results which may be expected for any other
interim period or for the year as a whole. The information contained in this
report should be read in conjunction with the Annual Report of CSBI on Form
10-K for the year ended December 31, 1997 and in particular the footnotes to
the audited financial statements included therewith.
RISKS AND UNCERTAINTIES
In the normal course of its business, the Company encounters two
significant types of risk: economic and regulatory. Economic risk is
comprised of three components - interest rate risk, credit risk and market
risk. The Company is subject to interest rate risk to the degree that its
interest-bearing liabilities mature and reprice at different speeds, or on a
different basis, than its interest-bearing assets. Credit risk is the risk
of default on the Company's loan portfolio that results from the borrower's
inability or unwillingness to make contractually required payments. Market
risk results from changes in the value of assets and liabilities which may
impact, favorably or unfavorably, the realizability of those assets and
liabilities.
The Company is subject to the regulations of various governmental
agencies. These regulations can and do change significantly from period to
period. The Company is also subject to periodic examinations by the
regulatory agencies, which may subject it to changes in asset valuations, in
amounts of required loss allowances and in operating restrictions resulting
from the regulators' judgments based on information available to them at the
time of their examination.
8
<PAGE>
EARNINGS PER COMMON SHARE
The actual number of common shares outstanding at June 30, 1998 was
18,347,397. Basic earnings per share is computed by dividing net income less
dividends paid to preferred shareholders by the weighted average number of
common shares outstanding during the period. Dilutive earnings per share is
computed by dividing net income less dividends paid to preferred shareholders
plus the income impact of dilutive securities by the common shares outstanding
plus dilutive common stock equivalents by using the treasury stock method.
At June 30, 1998, the Company had outstanding common stock purchase
warrants entitling the holders to purchase a total of 4,482,433 shares of common
stock and stock options entitling the holder to purchase a total of 988,600
shares if common stock. Lacking an active market for its shares, the Company
assumed a weighted average per share price in computing the dilutive impact of
the outstanding warrants and options of $8.00 and $4.81 for the three and six
months ended June 30, 1998 and 1997, respectively.
The weighted average number of common shares used to compute basic earnings
per share were 18,347,397 and 12,087,232 for the three months ended June 30,
1998 and 1997, respectively and 18,347,397 and 10,898,933 for the six months
ended June 30, 1998 and 1997, respectively. The fully diluted average number of
common shares used to compute dilutive earnings per share were 20,589,350 and
12,087,232 for the three months ended June 30, 1998 and 1997, respectively and
20,589,350 and 10,898,933 for the six months ended June 30, 1998 and 1997,
respectively. Net income was not adjusted in the calculation of dilutive
earnings per share.
COMPREHENSIVE INCOME
Effective January 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income". This
statement requires that all items recognized under accounting standards
as components of comprehensive income be reported in an annual financial
statement that is displayed with the same prominence as other annual
financial statements. This Statement also requires that an entity classify
items of other comprehensive income by their nature in an annual financial
statement. For example, other comprehensive income may include foreign
currency translation adjustments, minimum pension liability adjustments,
and unrealized gains and losses on marketable securities classified as
available-for-sale. Annual financial statements for prior periods will be
reclassified, as required. The Company's total comprehensive income were as
follows:
<TABLE>
<CAPTION>
Three months Six months
ended June 30, ended June 30,
-------------------------------------
1998 1997 1998 1997
---- ---- ---- ----
(In thousands)
<S> <C> <C> <C> <C>
Net income $ 1,736 $ 121 $ 3,423 $ 555
Other comprehensive income (loss) (109) 160 (83) 152
------- ----- ------- -----
Total comprehensive income $ 1,627 $ 281 $ 3,340 $ 707
------- ----- ------- -----
------- ----- ------- -----
</TABLE>
9
<PAGE>
Item 2. Management's Discussion and Analysis or Plan of Operations
This information should be read in conjunction with the consolidated
financial statements and the notes thereto of Commerce Security Bancorp, Inc.
("CSBI" or the "registrant") included in Item 1 of this Quarterly Report and
the audited consolidated financial statements and notes thereto and
Management Discussion and Analysis of Financial Condition and Results of
Operations for the year ended December 31, 1997 contained in the 1997 Annual
Report of CSBI on Form 10-K.
Except for the historical information contained herein, the following
discussion contains forward looking statements that involve risks and
uncertainties. CSBI's actual results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include, but are not specifically limited to, changes in regulatory climate,
shifts in interest rate environment, change in economic conditions of various
markets CSBI serves, as well as the other risks detailed in this section, and
in the sections entitled Results of Operations, Capital Resources and
Liquidity and Interest Sensitivity, and those discussed in CSBI's Form 10-K
for the year ended December 31, 1997, including without limitation those
sections entitled Supervision and Regulation, Capital Resources and Liquidity.
Contained within this document are various measures of financial
performance that have been calculated excluding the amortization of
intangibles. These measures are identified as "excluding goodwill
amortization" and have been provided to assist the reader in evaluating the
core performance of the Company. This presentation is not defined by
Generally Accepted Accounting Principles ("GAAP"), but management believes it
to be beneficial to gaining an understanding of the Company's financial
performance.
SUMMARY
The registrant owns 100% of Eldorado Bank (the "Bank") which is the
registrant's only banking subsidiary. CSBI acquired Eldorado Bancorp and
its subsidiary bank Eldorado Bank (the "Eldorado Acquisition") on June 8,
1997 and on June 30, 1997 merged its other operating banks into a single bank
(the "Bank") known as Eldorado Bank. The Eldorado Acquisition was accounted
for using the purchase method of accounting for business combinations.
Accordingly, the following discussion related to the operating results of the
registrant during the three and six months ended June 30, 1997 include the
results of only one month of operations of Eldorado Bank. In most of the
registrant's income and expense categories and net income, the increases in
the amounts reported for the three and six months ended compared to the same
periods last year resulted from the Eldorado Acquisition. Other significant
factors affecting the registrant's results of operations and financial
condition are described in the applicable sections below.
FINANCIAL CONDITION
Total assets of CSBI at June 30, 1998 were just over $1.0 billion
compared to total assets of $902.4 million at December 31, 1997. The
increase in total assets since December 31, 1997 is primarily attributable to
the increase in mortgage loans held for sale that increased $91.4 million, or
95.0%, to $187.6 million at June 30, 1998 from $96.2 million at December 31,
1997. Total earning assets of CSBI at June 30, 1998 were $761.0 million
compared to total earning assets of $725.6 million at December 31, 1997.
Earning assets increased primarily due to the increase in mortgage loans held
for sale, partially offset by a decrease in portfolio loans and investments.
LOANS AND LEASES
Total gross loans and leases of CSBI at June 30, 1998 were $700.0
million, including $187.6 million of mortgage loans held for sale, compared
to $618.3 million and $96.2 million at December 31, 1997, respectively.
Excluding those loans held for sale at June 30, 1998 the four largest lending
categories were: (i) commercial real estate loans; (ii) commercial loans;
(iii) loans to individuals and (iv) residential mortgage loans including land
and construction loans. At June 30, 1998, these categories accounted for
$221.5 million, $103.9 million, $65.5 million and $63.2 million, or
approximately 43.2%, 20.3%, 12.8% and 12.3% of total gross loans and leases,
respectively. Leases are made to finance small equipment for businesses and
accounted for $58.3 million, or approximately 11.4% of total gross loans and
leases held for investment, at June 30, 1998.
10
<PAGE>
The Bank is an active participant in the lending programs established
through the Small Business Administration ("SBA"). All SBA loans in the
Bank's loan portfolio at June 30, 1998 totaled $96.3 million compared to
$105.7 million at December 31, 1997, the substantial majority of which was
unguaranteed. The Bank's SBA loan portfolio is composed of (i) loans made by
the Bank and guaranteed by the United States Government to the extent of 75%
to 90% of the principal and interest due on such loans ("SBA 7(a)" loans) and
(ii) loans made by the Bank in which the Bank takes a first trust deed (a
senior security position) and another unrelated entity assumes a second trust
deed (a subordinated security position) that is guaranteed by the SBA (the
"SBA 504" loans). Generally, the Bank sells the government guaranteed
portion of the SBA 7(a) loans to participants in the secondary market and
retains servicing responsibilities and the unguaranteed portion of the loans.
The government guaranteed portion of the SBA 7(a) loans are sold at a
premium, a portion of which is immediately recognized as income. The
remaining premium, representing estimated normal servicing fees or a yield
adjustment on the portion of the SBA 7(a) loan retained by the Bank, is
capitalized and recognized as income over the estimated life of the loan.
The total SBA 7(a) loan portfolio serviced by the Bank at June 30, 1998 was
approximately $267.5 million and included in this amount was approximately
$74.7 million representing the primarily unguaranteed portions of the SBA
7(a) loans retained by the Bank, which compares to $286.8 million and $90.0
million at December 31, 1997, respectively. The total SBA 504 loans held by
the Bank on June 30, 1998 was $21.6 million which compares to $15.8 at
December 31, 1997.
NONPERFORMING ASSETS
The following table summarizes the loans for which the accrual of
interest has been discontinued and loans more than 90 days past due and still
accruing interest, including those loans that have been restructured:
<TABLE>
<CAPTION>
June 30, December 31,
------------------- -------------------------------
1998 1997 1997 1996 1995
---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C>
Non-accrual Loans, not restructured $ 7,712 $ 11,600 $ 10,589 $ 5,483 $ 1,492
Accruing loans past due 90 days or more 1,136 262 4,638 1,314 46
Restructured loans 4,133 6,079 2,779 2,200 82
Total nonperforming loans ("NPL"s) 12,981 17,941 18,006 8,997 1,620
-------- -------- -------- ------- -------
Other real estate owned ("OREO") 1,530 3,195 2,740 3,635 1,411
-------- -------- -------- ------- -------
Total nonperforming assets ("NPA"s) $ 13,123 $ 21,136 $ 20,746 $ 7,288 $ 3,031
-------- -------- -------- ------- -------
-------- -------- -------- ------- -------
NPLs as a percent of outstanding loans, net 1.9% 3.6% 2.9% 2.7% 4.2%
NPAs as a percent of outstanding loans, net
and OREO 2.6% 4.2% 4.0% 2.7% 7.2%
NPAs as a percent of total assets 1.3% 2.3% 2.3% 1.7% 5.4%
</TABLE>
The Company's current policy is to stop accruing interest on loans which
are past due as to principal and interest 90 days or more, except in
circumstances where the loan is well-secured and in the process of collection.
When a loan is placed on nonaccrual, previously accrued and unpaid interest is
generally reversed out of income.
The Company would have recorded additional interest income of approximately
$402,000 for the six months ended June 30, 1998 on nonperforming loans if such
loans had been current in accordance with their original terms. Interest income
recorded on nonperforming loans for the six months ended June 30, 1998 was
approximately $120,000.
Loans aggregating $11.8 million at June 30, 1998 have been designated as
impaired in accordance with SFAS 114 as amended by SFAS 118. The Company's
impaired loans are all collateral dependent, and as such the method used to
measure the impairment on these loans is to compare the loan amount to the fair
value of collateral. The total allowance for loan losses related to these loans
was $2.1 million at June 30, 1998.
As of June 30, 1998 management was not aware of any loans that had not been
placed on nonaccrual
11
<PAGE>
status as to which there were serious doubts as to the ability of the
respective borrowers to comply with present loan repayment terms.
At June 30, 1998, the Company had OREO properties with an aggregate
carrying value of $1.5 million. During the six months ended June 30, 1998,
properties with a total carrying value of $634,000 were added to OREO and
properties with a total carrying value of $1.9 million were sold and with
write-downs or losses of $284,000. All of the OREO properties are recorded
by the Company at amounts, which are equal to or less than the market value
based on current independent appraisals reduced by estimated selling cost.
ALLOWANCE FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses represents the amounts which
have been set aside for the specific purpose of absorbing losses which may
occur in the Bank's loan and lease portfolio. The provision for loan and
lease losses is an expense charged against operating income and added to the
allowance for loan and lease losses.
In determining the adequacy of the allowance for loan and lease losses,
management considers such factors as historical loan loss experience, known
problem loans, evaluations made by regulatory agencies and the Company's
outside loan reviewer, assessment of economic conditions and other
appropriate data to identify the risks in the portfolio. In determining the
amount of the allowance, a specific allowance amount is assigned to those
loans with identified special risks, and the remaining loan portfolio is
reviewed by category and assigned an allowance percentage for inherent
losses. The allocation process does not necessarily measure anticipated
future credit losses; rather, it reflects management's assessment at a
certain date of perceived credit risk exposure and the impact of current and
anticipated economic conditions, which may or may not result in future credit
losses. While management believes the allowance to be adequate, it should be
noted that it is based on estimates, and ultimate losses may vary from such
estimates if future conditions differ materially from the assumptions used in
making the evaluation.
The Federal Reserve and the DFI, as an integral part of their respective
supervisory functions, periodically review the Company's allowance for loan
and lease losses. Such regulatory agencies may require the Company to
increase its provision for loan lease losses or to recognize further loan
charge-offs, based upon judgments different from those of management.
In December 1993, the federal banking agencies issued an inter-agency
policy statement on the allowance for loan and lease losses which, among
other things, establishes certain benchmark ratios of loan loss reserves to
classified assets. The benchmark set forth by such policy statement is the
sum of (i) assets classified loss; (ii) 50% of assets classified doubtful;
(iii) 15% of assets classified substandard; and (iv) estimated credit losses
on other assets over the upcoming 12 months. At June 30, 1998, the
Company's allowance constituted over 215% of the benchmark amount suggested
by the federal banking agencies' policy statement.
The calculation of the adequacy of the allowance for loan and lease
losses requires the use of management estimates. Those estimates are
inherently uncertain and depend on the outcome of future events. Management's
estimates are based upon previous loan loss experience, current economic
conditions as well as the volume, growth and composition of the loan
portfolio, the estimated value of collateral and other relevant factors. The
Company's lending is concentrated in Southern California, which has
experienced adverse economic conditions, including declining real estate
values. Those factors have adversely affected borrowers' ability to repay
loans. Although management believes the level of the allowance as of June
30, 1998 is adequate to absorb losses inherent in the loan portfolio,
additional decline in the local economy may result in increasing losses that
cannot reasonably be predicted at this date. The possibility of increased
costs of collection, nonaccrual of interest on those which are or may be
placed on nonaccrual, and further charge-offs could have an adverse impact on
the Company's financial condition in the future.
The allowance for loan and lease losses at CSBI was approximately $7.8
million at June 30, 1998 compared to approximately $9.4 million at December
31, 1997. During the six months ended June 30, 1998, the provision for loan
and lease losses was $1.9 million, or .75% (annualized) to average portfolio
loans at June 30, 1998, loan and lease charge-offs were $4.2 million and
recoveries were $708,000 which compares to a provision for loan and lease
losses of $715,000, or .48% (annualized) to average portfolio loans at June
30, 1997, loan and lease charge-offs of $816,000 and recoveries of $111,000
during the same period in 1997. The allowance for loan
12
<PAGE>
and lease losses for CSBI represented 1.5% of net loans, excluding those
loans held for sale, at June 30, 1998 and 1.8% at December 31, 1997.
Annualized net charge-offs as a percentage of average portfolio loans were
1.36% for the six months ended June 30, 1998 compared to .48% for the same
period in 1997.
The increase in annualized net charge-offs is primarily attributable to
the charge-off during the three months ended March 31, 1998 of two loans with
an aggregate principal balance of $2.1 million. The Company acquired those
loans in the CSB acquisition, and although the loans were performing in
accordance with their terms as of June 30, 1998, the Company became aware in
early 1998 of a deterioration in the borrowers' financial condition.
Consistent with regulatory guidelines, the Company's internal credit
administration standards dictated that the loans should be charged off as a
result of the decline in the borrowers' creditworthiness.
[Balance of page intentionally left blank]
13
<PAGE>
The table below summarizes average portfolio loans outstanding, gross
portfolio loans, non-performing loans and changes in the allowance for
possible loan and lease losses arising from loan and lease losses and
additions to the allowance from provisions charged to operating expense at
and for the periods indicated:
<TABLE>
<CAPTION>
As of and for the As of and for the Year
Quarter Ended June 30, Ended December 31,
---------------------- ----------------------
1998 1997 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Average portfolio loans outstanding $ 514,648 $ 295,073 $ 464,788 $ 146,743 $ 42,272
Gross portfolio loans $ 508,694 $ 498,206 $ 522,054 $ 263,641 $ 39,022
Non-performing loans $ 14,430 $ 17,941 $ 18,006 $ 8,997 $ 1,620
Allowance for loan losses
Balance at beginning of period $ 9,395 $ 5,156 $5,156 $ 639 $ 821
Balance acquired - 4,076 4,076 4,382 -
Loans charged off during period
Commercial 2,816 314 467 430 258
Leases 334 292 1,092 - -
Real estate 773 164 610 144 115
Installment 282 46 334 76 329
--------- --------- --------- --------- --------
Total 4,205 816 2,503 650 702
Recoveries during period
Commercial 481 76 397 103 121
Leases 38 - 33 - -
Real estate 154 3 517 61 2
Installment 35 32 224 106 102
--------- --------- --------- --------- --------
Total 708 111 1,171 270 225
--------- --------- --------- --------- --------
Net loans charged off during period 3,497 705 1,332 380 477
Additions charged to operations 1,922 715 1,495 515 295
--------- --------- --------- --------- --------
Balance at end of period $ 7,820 $ 9,242 $ 9,395 $ 5,156 $ 639
--------- --------- --------- --------- --------
--------- --------- --------- --------- --------
Loan loss and quality ratios:
Net charge-offs to average
portfolio loans 1.36% .48% .29% 0.26% 1.13%
Provision for loan losses to average
portfolio loans .75% .48% .32% 0.35% 0.70%
Allowance at end of period to gross
portfolio loans 1.54% 1.86% 1.80% 1.96% 1.64%
Allowance as % of non-performing
loans 54.19% 51.51% 52.18% 57.31% 39.44%
</TABLE>
14
<PAGE>
The following table indicates management's allocation of the allowance for
each of the following periods indicated:
<TABLE>
<CAPTION>
June 30, December 31
--------------- -----------------------------
1998 1997 1997 1996 1995
---- ---- ---- ---- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Allocated amount:
Commercial, financial and agricultural $ 827 $ 709 $ 799 $ 980 $ 32
Real estate and construction 1,329 1,482 1,864 1,680 242
Consumer 633 421 602 461 51
Unallocated 5,030 6,630 6,130 2,035 314
------- ------- ------- ------- -----
Total $ 7,820 $ 9,242 $ 9,395 $ 5,156 $ 639
------- ------- ------- ------- -----
------- ------- ------- ------- -----
As a percent of allowance:
Commercial, financial and agricultural 10.6% 7.7% 8.5% 19.0% 5.0%
Real estate and construction 17.0 16.0 19.8 32.6 37.9
Consumer 8.1 4.6 6.4 8.9 8.0
Unallocated 64.3 71.7 65.3 39.5 49.1
------- ------- ------- ------- ------
Total 100.0% 100.0% 100.0% 100.0% 100.0%
------- ------- ------- ------- ------
------- ------- ------- ------- ------
</TABLE>
In allocating the Company's allowance for possible loan and lease losses,
management has considered the credit risk in the various loan categories in its
portfolio. As such, the allocations of the allowance for possible loan and
lease losses are based upon the average aggregate historical net loan losses
experienced in each of the subsidiary banks. While reasonable effort has been
made to allocate the allowance to specific categories of loans, management
believes that any allocation of the allowance for possible loan and lease losses
into loan categories lends an appearance of exactness which does not exist, in
that the allowance for possible loan and lease losses is utilized a single
unallocated allowance available for losses on all types of loans and leases.
INVESTMENT SECURITIES
Total investments of CSBI at June 30, 1998 were $61.1 million compared
to $107.3 million at December 31, 1997. Investments decreased largely due to
the funds required by the increased mortgage origination activity. At June
30, 1998, the investment portfolio primarily consisted of U.S. treasury and
agency securities and mortgage backed securities. Both of these categories of
investment securities are classified as available for sale and totaled $21.1
million and $40.0 million, respectively, or 32.7% and 67.3% of total
investments, respectively.
The following table presents the amortized cost of securities and their
approximate fair values at June 30, 1998:
<TABLE>
<CAPTION>
At June 30, 1998
----------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gain Loss Value
--------- ---------- ----------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Available-for-Sale:
U.S. Treasury $ 15,998 $ 7 $ - $ 16,005
U.S. Government Agencies 5,000 - (3) 4,997
Mortgage-backed securities 40,115 33 (134) 40,014
Corporate bonds and equities 38 - - 38
-------- ---- ------ --------
Total $ 61,151 $ 40 $ (137) $ 61,054
-------- ---- ------ --------
-------- ---- ------ --------
</TABLE>
DEPOSITS
Total deposits were $876.6 million at June 30, 1998 compared to $765.2
million at December 31, 1997. An increase in regular savings deposits,
certificates of deposits and interest bearing transaction accounts, partially
offset by decreases in non-interest bearing demand deposits and money market
accounts, contributed to the increase
15
<PAGE>
in total deposits. The increase in deposits reflects the Bank's attempt to
increase funding sources required to fund the increase in mortgage lending
activity. Total non-interest bearing demand deposits were $256.2 million, or
approximately 29.2% of total deposits, at June 30, 1998 compared to $289.3
million, or approximately 37.8% of total deposits, at December 31, 1997.
Interest bearing deposits were $620.4 million, or approximately 70.8% of
total deposits, at June 30, 1998 compared to $475.9 million, or approximately
62.2% of total deposits, at December 31, 1997.
A significant amount of the Company's interest-bearing deposits are
generated from title and escrow companies ("Title and Escrow Deposits") that
customarily do not deposit funds with the Bank until mortgage funding occurs,
which is typically a month-end event. For the six months ended June 30,
1998, Title and Escrow Deposits averaged $116.9 million, representing 15.0%
of the Company's average deposits for that period. For the six months ended
June 30, 1998, average Title and Escrow Deposits were 19.9% of average
noninterest demand deposits and 48.9% of average savings deposits. Actual
balances of Title and Escrow Deposits tend to vary widely during the month,
with the highest balances occurring at the end of the month when residential
real estate closings are generally scheduled to occur . One company
controlled 11.7% of the Company's average deposits for the six months ended
June 30, 1998 and 14.5% of the Company's total deposits at June 30, 1998.
The Company considers Title and Escrow Deposits to be volatile because
of the fluctuations in deposit amounts and the concentration of control over
those deposits with a limited number of customers, even though the Company
believes that its relationships with its principal Title and Escrow Deposit
customers and its specialized deposit services partially mitigate the risk
that such customers may terminate or significantly reduce their deposits with
the Company. As a consequence of that potential volatility, the Company
utilizes Title and Escrow Deposits solely to fund short-term assets,
primarily consisting of residential mortgages held for sale, which are
generally sold within 30 days after such mortgage loans are funded. If a
substantial portion of the Title and Escrow Deposits were withdrawn suddenly,
the Company believes that it has sufficient alternative sources of liquidity
to fund its mortgage pipeline during a transition period.
BORROWINGS
Borrowings of the Company increased to $31.5 million at June 30, 1998 from
$30.2 million at December 31, 1997. This increase in borrowings was primarily
due to an increase in Federal funds purchased which increased to $3.4 million at
June 30, 1998 from $2.1 million at December 31, 1997. These additional
borrowings were undertaken primarily to the meet funding requirement presented
by increased mortgage lending volume. Additionally, the Company redeemed its
mandatorily convertible debentures of $537,000 on March 27, 1998 which was
funded by the proceeds from a fully amortizing two year note for $540,000 at
10.5% with Dartmouth Capital Group, L.P.
16
<PAGE>
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 1998
The Company's results of operations depend primarily on the Bank's net
interest income, which is the difference between interest and dividend income
and interest-earning assets and interest expense on interest-bearing
liabilities. The Bank's interest-earning assets consist primarily of loans,
mortgage-backed securities and investment securities, while its
interest-bearing liabilities are deposits and borrowings. The Company's
results of operations are also affected by the Bank's provisions for loan and
lease losses, resulting from management's assessment of the adequacy of the
Bank's allowance for loan and lease losses, the level of its other income,
including fee income from the origination of mortgage loans, the level of its
other expenses, such as compensation and employee benefits, occupancy costs,
expenses associated with the administration of problem assets, and income
taxes.
For the three months ended June 30, 1998, CSBI had net income of $1.7
million compared to net income of $121,000 for the same period in 1997.
Basic net income per share for the three months ended June 30, 1998 was
$0.077 per share compared to $0.003 for the three months ended June 30, 1997,
while diluted net income per share for the three months ended June 30, 1998
was $0.069 compared to $0.003 for the three months ended June 30, 1997.
Excluding the amortization of goodwill and other intangibles, basic and
diluted earnings per share for the three months ended June 30, 1998 were
$0.130 and $0.116, respectively, compared to $0.049 and $0.049 for the same
period in 1997. The Company's return on average assets was .71% and its
return on average common equity was 6.74% for the three months ended June 30,
1998 as compared to .08% and .27%, respectively, for the three months ended
June 30, 1997. Return on average assets excluding goodwill amortization was
1.11% and return on average common equity excluding goodwill amortization was
11.38% for the three months ended June 30, 1998, as compared to .43% and
4.04%, respectively, for the three months ended June 30, 1997.
Compared to the prior year results, the improvements stem from a
combination of increased net interest income of approximately $4.3 million
and non-interest income of approximately $4.0 million, partially offset by
increased loan loss provision of $692,000, non-interest expense of
approximately $4.3 million and provision for taxes of $1.8 million. The
improvement in 1998 earnings is primarily attributable to the earnings of
Eldorado in 1998 that were not included in earnings for 1997 and partly
attributable to an improvement in earnings related to the Bank's mortgage
banking operations.
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income was approximately $11.1 million for the three months
ended June 30, 1998, an increase of $4.3 million over the $6.8 million for
the same period in 1997. An increase in interest income to $18.6 million for
the three months ended June 30, 1998 from $11.3 million for the same period
in 1997, partially offset by increased interest expense of $7.5 million for
the three months ended June 30, 1998 from $4.4 million for the same period in
1997 contributed to this earnings improvement.
Loans and leases, the largest component of earning assets, increased to
an average balance of $719.1 million for the three months ended June 30, 1998
from $382.2 million for the three months ended June 30, 1997, with an
average yield of 9.7% and 10.2%, respectively. Investments in securities and
Federal funds sold declined to an average of $72.6 million for the three
months ended June 30, 1998 from an average of $103.8 million for the three
months ended June 30, 1997, with an average yield of 6.4% and 5.9%,
respectively. The yield on earning assets was 9.4% and 9.3% for the three
month periods ended June 30, 1998 and 1997.
Interest-bearing liabilities increased to an average of $630.1 million
for the three months ended June 30, 1998 from $373.1 million for the same
period in 1997. The cost of these funds was 4.8% for the three months ended
June 30, 1998 and 1997 with a decrease in the cost of deposits and borrowings
being offset by a shift in the mix of funding liabilities. The increase in
average balances is primarily attributable to an increase in deposits with
borrowings also contributing to the increase. Average interest-bearing
deposits increased to $590.5 million for the three months ended June 30, 1998
from $364.5 million for the same period in 1997. The average rate paid on
these deposits decreased to 4.4% during the three months ended June 30, 1998
compared to 4.6% during the same period in 1997. The decrease in the cost
of deposits is attributable to a decrease in rates paid on certificates of
deposit that decreased to 5.1% for the three months ended June 30, 1998
compared to 5.5% for the same period in 1997, and a decrease in rates paid on
interest bearing transaction accounts and savings accounts that in the
aggregate was 3.9% for the three months ended June 30, 1998 compared to 4.0%
for the same period in 1997.
17
<PAGE>
The average balance for all borrowings increased to $39.6 million for
the three months ended June 30, 1998 from $8.5 million for the same period in
1997. The average cost of these borrowings was 10.6% for the three months
ended June 30, 1998 compared to 10.8% for the same period in 1997. The
increase in the average balance and cost of borrowings is attributable to
Federal funds purchased and the subordinated debentures issued to fund the
Eldorado Acquisition. Federal funds purchased averaged $11.4 million with an
average rate of 6.9% for the three months ended June 30, 1998 compared to
$674,000 with an average rate of 6.0% for the same period in 1997. Other
debt, including the subordinated debentures, averaged $28.2 million at an
average rate of 12.0% for the three months ended June 30, 1998 compared to
$7.8 million at 11.2% for the same period in 1997.
As a result of the foregoing factors, the average net yield on earning
assets increased to 5.7% for the three months ended June 30, 1998 compared to
5.6% for the same period in 1997.
PROVISION FOR LOAN AND LEASE LOSSES
The provision for loan and lease losses is an expense charged against
operating income and added to the allowance for loan and lease losses.
Management of the Bank continues to carefully monitor the allowance for loan
and lease losses in relation to the size of the Bank's loan and lease
portfolio and known risks or problem loans and leases. During the three
months ended June 30, 1998, a total of $1.0 million was charged against
operations and added to the allowance for loan and lease losses which
compares to $308,000 for the same period in 1997. The increased provision is
primarily attributable to the increase in the loan portfolio due to the
Eldorado Acquisition and to increase the allowance due to the loans charged
off against the allowance discussed above.
NON-INTEREST INCOME
Non-interest income for the three months ended June 30, 1998 was $6.7
million compared to $2.7 million for the same period in 1997. Non-interest
income related to operations acquired in the Eldorado Acquisition that was
not included in income for the same period in 1997 and increased earnings
from the Bank's mortgage operations are primarily responsible for this
improvement in non-interest income. Income from service charges on deposit
accounts increased to $887,000 for the three months ended June 30, 1998
compared to $394,000 for the same period in 1997 and other non-interest
income increased to $1.7 million for the three months ended June 30, 1998
compared to $749,000 for the same period in 1997 both of which are primarily
attributable to the Eldorado Acquisition. Gains on the sale of mortgage
loans increased to $4.2 million for the six months ended June 30, 1998
compared to $1.6 million for the same period in 1997.
NON-INTEREST EXPENSES
Non-interest expense for the three months ended June 30, 1998 was
approximately $13.2 million, an increase of $4.3 million from $8.9 million
for the same period in 1997. Salaries and employee benefits increased to
$5.6 million for the three months ended June 30, 1998 from $3.6 million for
the same period in 1997, which increase is attributable to the added
personnel from the Eldorado Acquisition and an increase in mortgage related
commissions. Occupancy and equipment expense increased to $1.8 million for
the three months ended June 30, 1998 from $1.3 million for the three months
ended June 30, 1997 and represents the additional cost for facilities and
equipment for branches and related operations attributable to the Eldorado
Acquisition. Other non-interest expenses increased to $4.8 million for the
three months ended June 30, 1998 from $3.5 million for three months ended
June 30, 1997 which is primarily attributable to the Eldorado Acquisition.
Also included in non-interest expense for the three months ended June 30,
1998 is amortization of goodwill and other intangibles of $975,000 compared
to $494,000 for the same period last year which is primarily attributable to
the Eldorado Acquisition.
PROVISION FOR INCOME TAXES
As a result of the earnings for the three months ended June 30, 1998, a
provision for income taxes of $2.0 million was made compared to a $170,000
provision made for the same period in 1997. The effective tax rate was 53.1%
and 58.4% for the three months ended June 30, 1998 and 1997, respectively. The
effective tax rate was higher than the statutory rate of 42.0% primarily because
the goodwill amortization is a charge to earnings for financial statement
purposes and is not deductible for federal income tax purposes.
18
<PAGE>
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 1998
The Company's results of operations depend primarily on the Bank's net
interest income, which is the difference between interest and dividend income
and interest-earning assets and interest expense on interest-bearing
liabilities. The Bank's interest-earning assets consist primarily of loans,
mortgage-backed securities and investment securities, while its
interest-bearing liabilities are deposits and borrowings. The Company's
results of operations are also affected by the Bank's provisions for loan and
lease losses, resulting from management's assessment of the adequacy of the
Bank's allowance for loan and lease losses, the level of its other income,
including fee income from the origination of mortgage loans, the level of its
other expenses, such as compensation and employee benefits, occupancy costs,
expenses associated with the administration of problem assets, and income
taxes.
For the six months ended June 30, 1998, CSBI had net income of $3.4
million compared to net income of $555,000 for the same period in 1997.
Basic net income per share for the six months ended June 30, 1998 was $.15
per share compared to $.04 for the six months ended June 30, 1997, while
diluted net income per share for the six months ended June 30, 1998 was $.14
compared to $.04 for the six months ended June 30, 1997. Excluding the
amortization of goodwill and other intangibles, basic and diluted earnings
per share for the six months ended June 30, 1998 were $.25 and $.22,
respectively, compared to $.11 and $.11 for the same period in 1997. The
Company's return on average assets was .73% and its return on average common
equity was 6.69% for the six months ended June 30, 1998 as compared to .22%
and 2.02%, respectively, for the six months ended June 30, 1997. Return on
average assets excluding goodwill amortization was 1.10% and return on
average common equity excluding goodwill amortization was 10.86% for the six
months ended June 30, 1998, as compared to .51% and 5.06%, respectively, for
the six months ended June 30, 1997.
Compared to the prior year results, the improvement in the Company's net
income for the six months ended June 30, 1998 stems primarily from a
combination of increased net interest income of approximately $9.9 million
and non-interest income of approximately $5.4 million, partially offset by
increased loan loss provision of $1.2 million, non-interest expense of
approximately $8.4 million and provision for taxes of $2.8 million. The
improvement in 1998 earnings is primarily attributable to the earnings of
Eldorado in 1998 that were not included in earnings for 1997 and partly
attributable to an improvement in earnings related to the Bank's mortgage
banking operations.
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income was approximately $22.2 million for the six months
ended June 30, 1998, an increase of $9.9 million over the $12.3 million for
the same period in 1997. An increase in interest income to $36.1 million for
the six months ended June 30, 1998 from $20.0 million for the same period in
1997, partially offset by increased interest expense of $13.9 million for the
six months ended June 30, 1998 from $7.7 million for the same period in 1997
contributed to this earnings improvement.
Loans and leases, the largest component of earning assets, increased to
an average balance of $688.9 million for the six months ended June 30, 1998
from $349.9 million for the six months ended June 30, 1997, with an average
yield of 9.9% and 10.2%, respectively. Investments in securities and Federal
funds sold declined to an average of $72.2 million for the six months ended
June 30, 1998 from an average of $80.5 million for the six months ended June
30, 1997, with an average yield of 6.3% and 5.9%, respectively. The yield
on earning assets was 9.6% for the six months ended June 30, 1998 compared to
9.4% for the same period in 1997.
Interest-bearing liabilities increased to an average of $594.5 million
for the six months ended June 30, 1998 from $323.7 million for the same
period in 1997. The cost of these funds decreased to 4.7% for the six months
ended June 30, 1998 compared to 4.8% for the same period in 1997. The
increase in average balances and the decrease in cost is primarily
attributable to an increase in deposits and decrease in rates paid with
borrowings also contributing to the increase in average balances but
partially offsetting the decrease in rates paid. Average interest-bearing
deposits increased to $544.0 million for the six months ended June 30, 1998
from $315.8 million for the same period in 1997. The average rate paid on
these deposits decreased to 4.3% during the six months ended June 30, 1998
compared to 4.7% during the same period in 1997. The decrease in the cost
of deposits is attributable to a decrease in rates paid on certificates of
deposit that decreased to 5.1% for the six months ended June 30, 1998
compared to 5.7% for the same period in 1997, and a decrease in rates paid on
interest bearing transaction accounts and savings accounts that in the
aggregate was 3.8% for the six months ended June 30, 1998
19
<PAGE>
compared to 3.9% for the same period in 1997.
The average balance for all borrowings increased to $50.4 million for
the six months ended June 30, 1998 from $7.9 million for the same period in
1997. The average cost of these borrowings was 9.3% for the six months ended
June 30, 1998 compared to 8.7% for the same period in 1997. The increase in
the average balance and cost of borrowings is attributable to Federal funds
purchased and the subordinated debentures issued to fund the Eldorado
Acquisition. Federal funds purchased averaged $22.2 million with an average
rate of 5.9% for the six months ended June 30, 1998 compared to $3.7 million
with an average rate of 5.9% for the same period in 1997. Other debt,
including the subordinated debentures, averaged $28.2 million at an average
rate of 12.0% for six months ended June 30, 1998 compared to $4.2 million at
11.2% for the same period in 1997.
As a result of the foregoing factors, the average net yield on earning
assets increased to 5.9% for the six months ended June 30, 1998 compared to
5.8% for the same period in 1997.
PROVISION FOR LOAN AND LEASE LOSSES
The provision for loan and lease losses is an expense charged against
operating income and added to the allowance for loan and lease losses.
Management of the Bank continues to carefully monitor the allowance for loan
and lease losses in relation to the size of the Bank's loan and lease
portfolio and known risks or problem loans and leases. During the six months
ended June 30, 1998, a total of $1.9 million was charged against operations
and added to the allowance for loan and lease losses which compares to
$715,000 for the same period in 1997. The increased provision is primarily
attributable to the increase in the loan portfolio due to the Eldorado
Acquisition and to increase the allowance due to the loans charged off
against the allowance discussed above.
NON-INTEREST INCOME
Non-interest income for the six months ended June 30, 1998 was $11.4
million compared to $6.0 million for the same period in 1997. Non-interest
income related to operations acquired in the Eldorado Acquisition that was
not included in income for the same period in 1997 and increased earnings
from the Bank's mortgage operations are primarily responsible for this
improvement in non-interest income. Income from service charges on deposit
accounts increased to $1.8 million for the six months ended June 30, 1998
compared to $652,000 for the same period in 1997 and other non-interest
income increased to $2.9 million for the six months ended June 30, 1998
compared to $1.9 million for the same period in 1997 both of which are
primarily attributable to the Eldorado Acquisition. Gains on the sale of
mortgage loans increased to $6.7 million for the six months ended June 30,
1998 compared to $3.5 million for the same period in 1997.
NON-INTEREST EXPENSES
Non-interest expense for the six months ended June 30, 1998 was
approximately $24.5 million, an increase of $8.4 million from for the same
period in 1997. Salaries and employee benefits increased to $10.5 million
for the six months ended June 30, 1998 from $6.7 million for the same period
in 1997, which increase is attributable to the added personnel from the
Eldorado Acquisition and an increase in mortgage related commissions.
Occupancy and equipment expense increased to $3.5 million for the six months
ended June 30, 1998 from $2.5 million for the six months ended June 30, 1997
and represents the additional cost for facilities and equipment for branches
and related operations attributable to the Eldorado Acquisition. Other
non-interest expenses increased to $8.8 million for the six months ended June
30, 1998 from $6.2 million for six months ended June 30, 1997 which is
primarily attributable to the Eldorado Acquisition. Also included in
non-interest expense for the six months ended June 30, 1998 is amortization
of goodwill and other intangibles of $1.7 million compared to $705,000 for
the same period last year which is primarily attributable to the Eldorado
Acquisition.
PROVISION FOR INCOME TAXES
As a result of the earnings for the six months ended June 30, 1998, a
provision for income taxes of $3.7 million was made compared to a $912,000
provision made for the same period in 1997. The effective tax rate was 52.2%
and 62.2% for the six months ended June 30, 1998 and 1997, respectively. The
effective tax rate was higher than the statutory rate of 42.0% primarily
because the goodwill amortization is a charge to earnings for financial
statement purposes and is not deductible for federal income tax purposes.
20
<PAGE>
CAPITAL RESOURCES
Current risk-based regulatory capital standards generally require banks
and holding companies to maintain a ratio of "core" or "Tier 1" capital
(consisting principally of common equity) to risk-weighted assets of at least
4%, a ratio of Tier 1 capital to adjusted total assets (leverage ratio) of at
least 3% and a ratio of total capital (which includes Tier 1 capital plus
certain forms of subordinated debt, a portion of the allowance for loan
losses and preferred stock) to risk-weighted assets of at least 8%.
Risk-weighted assets are calculated by multiplying the balance in each
category of assets according to a risk factor which ranges from zero for cash
assets and certain government obligations to 100% for some types of loans and
adding the products together.
CSBI and the Bank were well capitalized June 30, 1998 for federal
regulatory purposes. As of June 30, 1998, both the Bank and CSBI had
leverage ratios of 6.6%, Tier 1 risk-weighted capital ratios of 8.9% and
total risk-weighted capital ratios of 10.0%. For further discussion
regarding capital requirements for the registrant and its operating bank
subsidiary, refer to sections in CSBI's Form 10-K for the year ended December
31, 1997 entitled Regulation and Supervision, Capital Resources and the
footnotes to the audited financial statements contained therein.
LIQUIDITY
The Company relies on deposits as its principal source of funds and,
therefore, must be in a position to service depositors' needs as they arise.
Management attempts to maintain a loan-to-deposit ratio of not greater than
80% and a liquidity ratio (liquid assets, including cash and due from banks,
Federal funds sold and investment securities to deposits) of approximately
20%. The average loan-to-deposit ratio was 88% for the six months ended June
30, 1998, 78% in 1997, 68% in 1996 and 78% in 1995. The average liquidity
ratio was 19% for the six months ended June 30, 1998, 29% in 1997, 30% in
1996 and 22% in 1995. At June 30, 1998, the Company's loan-to-deposit ratio
was 69% and the liquidity ratio was 20.8%. While fluctuations in the
balances of a few large depositors cause temporary increases and decreases in
liquidity from time to time, the Company has not experienced difficulty in
dealing with such fluctuations from existing liquidity sources.
Should the level of liquid assets (primary liquidity) not meet the
liquidity needs of the Company, other available sources of liquid assets
(secondary liquidity), including the purchase of Federal funds, sale of
securities under agreements to repurchase, sale of loans, window borrowing
from the Federal Reserve Bank and, to a lesser extent, borrowings from the
FHLB. could be employed. The Company has relied primarily upon the purchase
of Federal funds and the sale of securities under agreements to repurchase
for its secondary source of liquidity.
INFLATION
The majority of the Company's assets and liabilities are monetary items
held by the Banks, and only a small portion of total assets is in premises
and equipment. The lower inflation rate of recent years did not have the
positive impact on the Bank that was felt in many other industries. The
small fixed asset investment of the Company minimizes any material
misstatement of asset values and depreciation expenses which may result from
fluctuating market values due to inflation. A higher inflation rate,
however, may increase operating expenses or have other adverse effects on
borrowers of the Bank, making collection more difficult for the Bank. Rates
of interest paid or charged generally rise if the marketplace believes
inflation rates will increase.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
In Management's opinion there has not been a material change in the
Company's market risk profile during the three months ended June 30, 1998.
At June 30, 1998 the Company had net repriceable liabilities (a "negative
gap") as measured at one year of approximately $51.5 million or 5.0% of total
assets that compared to $63.9 million or 7.1% of total assets at December 31,
1997. The Company had a positive gap as measured at a 90-day time horizon of
approximately $42.0 million, or 4.1% of total assets that compared to $104.2
million, or 11.6% of total assets at December 31, 1997. The ratio of
interest earning assets to interest bearing liabilities maturing or repricing
within one year at June 30, 1998 was .92 which compares to 1.14 at December
31, 1997 and management tries to maintain this ratio as close to zero as
possible while remaining in a
21
<PAGE>
range between .80 and 1.20. Interest income is likely to be affected to a
greater extent than interest expense for any changes in interest rates
within one year from June 30, 1998. With a positive gap, a bank would
anticipate higher net yields over the near term in a rising rate environment
and lower net yields in a declining rate environment. Conversely, with a
negative gap, a bank would anticipate lower net yields over the near term in
a rising rate environment and higher net yields in a declining rate
environment.
Since interest rate changes do not affect all categories of assets and
liabilities equally or simultaneously, a cumulative gap analysis alone cannot
be used to evaluate the Company's interest rate sensitivity position. To
supplement traditional gap analysis, the Company performs simulation modeling
to estimate the potential effects of changing interest rates. The process
allows the Company to explore the complex relationships within the gap over
time and various interest rate environments. In performing this type of
analysis, certain assumptions are made which include the nature and timing of
interest rate levels including yield curve shape, prepayments on loans and
securities, changes in deposit levels, pricing decisions on loans and
deposits, reinvestment/replacement of asset and liability cashflows, and
others. While assumptions are developed based upon current economic and
local market conditions, the Bank cannot make any assurances as to the
predictive nature of these assumptions including how customer preferences or
competitor influences might change. Furthermore, the sensitivity analysis
does not reflect actions that the Bank might take in responding to or
anticipating changes in interest rates.
22
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
U.S. SECURITIES AND EXCHANGE COMMISSION FORM 10-Q
SIGNATURES
Pursuant to the requirements of the U.S. Securities Exchange Act of 1934, CSBI
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
COMMERCE SECURITY BANCORP, INC.
DATE: August 14, 1998 /s/ Robert P. Keller
------------------------------------------
Robert P. Keller
President and Chief Executive Officer
DATE: August 14, 1998 /s/ John L. Gordon
-----------------------------------------
John L. Gordon
Senior Vice President and Chief Financial Officer
23
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<PERIOD-START> JAN-01-1998
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