SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual report pursuant to Section 13 of the
Securities Exchange Act of 1934, as amended
For the fiscal year ended December 31, 1997
Commission File No.: 0-24802
MONTEREY BAY BANCORP, INC.
(exact name of registrant as specified in its charter)
DELAWARE 77-0381362
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
36 Brennan Street, Watsonville, California 95076
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 722-3885
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
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 .
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, 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 the Form 10-K or any
amendment to this Form 10-K. X .
---
The aggregate market value of the voting stock held by non-affiliates
of the registrant, i.e., persons other than the directors and executive officers
of the registrant, was $66,286,770, based upon the last sales price as quoted on
the Nasdaq Stock Market for March 20, 1998.
The number of shares of Common Stock outstanding as of March 20, 1998:
3,166,214
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1998 Annual Meeting of Stockholders are
incorporated by reference into Part III of this Form 10-K.
Portions of the Annual Report to Stockholders for the year ended December 31,
1997 are incorporated by reference into Part II of this Form 10-K.
<PAGE>
INDEX
PAGE
PART I
Item 1. Business..........................................................1
Item 2. Properties.......................................................38
Item 3. Legal Proceedings................................................39
Item 4. Submission of Matters to a Vote of Security Holders..............39
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters..............................................39
Item 6. Selected Financial Data..........................................40
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..............................40
Item 7a. Quantitative and Qualitative Disclosures about Market Risk.......40
Item 8. Financial Statements and Supplementary Data......................40
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure...........................40
PART III
Item 10. Directors and Executive Officers of the Registrant...............40
Item 11. Executive Compensation...........................................40
Item 12. Security Ownership of Certain Beneficial Owners
and Management...................................................41
Item 13. Certain Relationships and Related Transactions...................41
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K......................................................41
<PAGE>
PART I
Item 1. Business.
- ------------------
General
Monterey Bay Bancorp, Inc. (the "Company"), is a unitary savings and
loan holding company incorporated in 1994 under the laws of the state of
Delaware. The significant operating subsidiary of the Company is Monterey Bay
Bank ("the Bank"), formerly Watsonville Federal Savings and Loan Association.
The Company was organized as the holding company for the Bank in connection with
the Bank's conversion from the mutual to stock form of ownership in 1995. The
Company's primary business is providing conveniently located deposit facilities
to attract checking, money market, savings and certificate of deposit accounts,
and investing such deposits and other available funds in mortgage loans secured
by one- to four-family residences and, to a lesser extent, construction,
commercial real estate, and business loans. As part of its ongoing operating
strategy, the Company has been diversifying its loan portfolio by increasing the
amount of its construction, commercial real estate, and business lending
activities. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations." The largest source of the Company's revenue is interest
income from loans, mortgage-backed securities, and investment securities. The
Company's primary sources of funds are customer deposits, principal and interest
payments on loans and mortgage-backed securities, advances from the Federal Home
Loan Bank ("FHLB") and, to a lesser extent, proceeds from the sales of
securities and loans. Through its wholly-owned subsidiary, Portola Investment
Corporation ("Portola"), the Bank engages in the sale of noninsured insurance
and investment products on an agency basis and acts as trustee on the Bank's
deeds of trust. See "Subsidiary Activities."
Market Area And Competition
The Bank is a community-oriented financial institution, which
originates one-to-four family residential mortgage loans, and, to a lesser
extent, construction, commercial real estate, and business loans within its
market area. The Bank's deposit gathering and lending markets are concentrated
primarily in the communities surrounding its full service offices in Santa Cruz,
Monterey and portions of Santa Clara counties in Central California. The economy
in the Company's primary market area is predominantly agricultural, with some
light manufacturing and tourism industry in the coastal communities on Monterey
Bay. The Company believes that the economies in which it operates have
experienced strong growth and favorable economic activity in the past two years,
as reflected in sustained loan demand and deposit growth. The economic
performance in the Company's primary market area typically mirrors the national
economy and shows seasonal economic fluctuations.
The Company faces significant competition both in originating loans and
in attracting deposits. The Company's competitors are the financial institutions
operating in its primary market area, many of which are significantly larger and
have greater financial resources than the Company. The Company's competition for
loans comes principally from commercial banks, savings and loan associations,
mortgage banking companies, credit unions and insurance companies. Its most
direct competition for deposits has historically come from savings and loan
associations and commercial banks. In addition, the Company faces increasing
competition for deposits from nonbank institutions such as brokerage firms and
insurance companies in such areas as short-term money market funds, corporate
and government securities funds, mutual funds, and annuities.
The Company serves its market area with a variety of mortgage loan
products and other retail financial services. Management considers the
Company's reputation for financial strength and competitive deposit and
loan products as its major competitive advantage in attracting and retaining
customers within its primary market area.
1
<PAGE>
Lending Activities
General. The Company originates permanent and construction mortgage
loans collateralized by residential and commercial real estate, business loans,
and consumer loans. The following table sets forth information on the Company's
loan originations, purchases, sales and principal repayments for the periods
indicated.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------
1997 1996 1995
--------------- ---------------- ----------------
(In thousands)
<S><C>
Gross loans(1):
Beginning balance............................ $234,649 $229,841 $244,313
Loans originated:
One- to four-family(2)................. 22,423 27,768 38,630
Multifamily............................ 1,686 1,944 2,515
Commercial real estate................. 13,177 3,363 349
Construction........................... 34,724 3,790 5,776
Land................................... 2,169 - -
Business............................... 1,213 - -
-------- -------- --------
Total loans originated.............. 75,392 36,865 47,270
Loans purchased........................... 14,661 - -
-------- -------- --------
Total gross loans................... 324,702 266,706 291,583
Less:
Transfers to real estate owned............ 610 369 297
Principal repayments(3)................... 33,696 27,238 26,017
Sales of loans............................ 3,020 2,628 18,541
Securitized loans(4)...................... - - 14,992
Loans in process.......................... 21,442 1,822 1,895
-------- -------- --------
Total loans................................... 265,934 234,649 229,841
Less loans held for sale(2)............... 514 130 92
-------- -------- --------
Ending balance held for investment............ $265,420 $234,519 $229,749
======== ======== ========
</TABLE>
- --------------------
(1) Gross loans includes loans receivable held for investment and loans held
for sale, net of deferred loan fees and unamortized premiums and
discounts.
(2) During 1995, the Company transferred, at market value, $7.4 million of
loans held for sale to loans held for investment, and recorded a lower
of cost or market adjustment of $35,000 through earnings.
(3) Principal repayments include amortization of premiums, net of discounts;
amortization of deferred loan fees; net changes in nonmortgage loans
receivable; and other adjustments.
(4) During 1995, the Company securitized $15.0 million of mortgage
loans and acquired mortgage-backed securities in exchange.
Loans originated by the Company are subject to federal and state law
and regulations. Interest rates charged by the Company on loans are affected by
the demand for such loans and the supply of money available for lending purposes
and the rates offered by competitors. These factors are, in turn, affected by,
among other things, economic conditions, monetary policies of the federal
government, including the Federal Reserve Board, and legislative tax policies.
ONE- TO FOUR-FAMILY MORTGAGE LENDING. The Company originates both fixed
rate and adjustable rate mortgage loans secured by one- to four-family
residential properties. Adjustable rate mortgage loans have interest rates that
adjust monthly or semiannually and are indexed to either the 11th FHLB District
Cost of Funds Index ("11th District Cost of Funds") or to current market
indices. The majority of loan originations are
2
<PAGE>
to existing or past customers and members of the local communities. The Company
also originates one- to four-family residential construction loans.
The Company had total outstanding loans of $287.6 million at December
31, 1997, of which $205.2 million, or 71.4%, were one- to four-family
residential mortgage loans. All of the loans were secured by properties located
within the state of California. At December 31, 1997, 39% of the Company's one-
to four-family mortgage loans had fixed terms and 61% had adjustable rates
indexed to the 11th FHLB District Cost of Funds or to current market indices.
The Company offers a number of adjustable rate loan products, including an "easy
qualifier" loan and a 30-year adjustable rate one- to four-family residential
loan with initial three- to seven-year fixed rate terms. The Company began
originating loans subject to negative amortization in 1996. Negative
amortization involves a greater risk to the Company because during a period of
high interest rates the loan principal may increase above the amount originally
advanced. However, the Company believes that the risk of default on these loans
is mitigated by negative amortization caps, underwriting criteria, relatively
low loan to value ratios, and the stability provided by payment schedules. At
December 31, 1997, the Company's loan portfolio included $9.3 million of
mortgage loans subject to negative amortization, which represented 3.2% of total
loans outstanding.
The Company originated $22.4 million of permanent one- to four-family
mortgage loans in 1997, compared to $27.8 million and $38.6 million,
respectively, in 1996 and 1995. The decline in loan volume during 1997 was
partly due to increased competition and partially as the result of a shift in
the Company's emphasis toward higher-yielding construction, commercial real
estate, and business loans. From time to time, based on its asset and liability
strategy, the Company purchases mortgage loans originated by other institutions.
In 1997, the Company purchased $14.7 million of one- to four-family adjustable
rate mortgage loans secured by properties located within the state of
California. See "Origination, Purchase, Sale and Servicing of Loans."
The Company originates one- to four-family residential mortgage loans
in amounts up to 80% of the lower of the appraised value or the selling price of
the property securing the loan, and up to 97% of the appraised value or selling
price if private mortgage insurance is obtained. Mortgage loans originated by
the Company generally include due-on-sale clauses which provide the Company with
the contractual right to deem the loan immediately due and payable in the event
the borrower transfers ownership of the property without the Company's consent.
Due-on-sale clauses are an important means of adjusting the rates on the
Company's fixed rate mortgage loan portfolio and the Company has generally
exercised its rights under these clauses.
Multifamily Lending. The Company offers adjustable rate multifamily
residential real estate loans secured by real property in Northern and Central
California. Permanent loans on multifamily properties typically have maturities
of 25 to 30 years and are secured by five or more unit apartment buildings.
Factors considered by the Company in reaching a lending decision on such
properties include the net operating income of the mortgaged premises before
debt service and depreciation, the debt service ratio (the ratio of net earnings
to debt service), and the ratio of the loan amount to appraised value. Pursuant
to the Company's underwriting policies, multifamily adjustable rate mortgage
loans are only originated in amounts up to 70% of the appraised value of the
underlying properties, although subsequent declines in real estate values in the
Company's primary market area have resulted in increases in loan-to-value ratios
on some of the Company's mortgage loans. The Company generally requires a debt
service ratio of 1.10x. Properties securing loans are appraised by an
independent appraiser. Title insurance is required on all loans. When evaluating
the qualifications of the borrower for a multifamily loan, the Company considers
the financial resources and income level of the borrower, the borrower's
experience in owning or managing similar property, and the Company's lending
experience with the borrower. The Company's underwriting policies require that
the borrower provide evidence of ability to repay the mortgage on a timely basis
and maintain the property from current rental income. In evaluating the
creditworthiness of the borrower, the Company generally reviews the borrower's
financial statements, employment, and credit history, as well as other related
documentation.
Loans secured by apartment buildings and other multifamily residential
properties are generally larger and involve a greater degree of risk than one-
to four-family residential mortgage loans. Because payments on
3
loans secured by multifamily properties are often dependent on successful
operation or management of the properties, repayment of such loans may be
subject to a greater extent to adverse conditions in the real estate market or
the economy. The Company seeks to minimize these risks through its underwriting
policies, which require such loans to be qualified at origination on the basis
of the property's income and debt coverage ratio. The Company also attempts to
limit its risk exposure by requiring that financial statements from borrowers be
updated at least annually, by requiring operating statements on the properties,
and by acquiring personal guarantees from the borrowers.
As part of its operating strategy, the Company intends to moderately
increase its multifamily lending within the state of California. At December 31,
1997, the Company's portfolio of multifamily loans totaled $23.4 million, or
8.1% of the Company's total loans outstanding. Included in this total was $9.1
million of multifamily loans purchased during 1993, consisting primarily of
newly originated loans secured by apartment buildings in the greater San
Francisco Bay Area. These loans were underwritten to standards substantially
similar to those utilized by the Company in originating loans. See
"Originations, Purchases and Sales of Loans."
At December 31, 1997, the Company's largest multifamily loan had an
outstanding balance of $903,000. The loan was secured by a 26-unit apartment
building located in Sacramento, California.
Commercial Real Estate Lending. The Company originates both permanent
and construction commercial real estate loans, collateralized by real property
located in Northern and Central California. Commercial real estate loans are
generally secured by properties used for business purposes. The Company's
underwriting procedures provide that commercial real estate loans may be made in
amounts up to the lesser of 65% of the appraised value of the property or up to
the Company's current loans-to-one borrower limit. Permanent loans may be made
with terms up to 25 years and are typically adjustable to the one-year Constant
Maturity Treasury rate or the 11th District Cost of Funds. Construction loans on
commercial real estate carry adjustable rates and typically have terms of 12 to
18 months. The Company's underwriting standards and procedures on commercial
loans are similar to those applicable to its multifamily loans. The Company
considers the net operating income of the property and the borrower's expertise,
credit history and profitability, and requires that the properties securing
commercial real estate loans have debt service coverage ratios of at least
1.10x.
At December 31, 1997, the Company's commercial real estate loan
portfolio totaled $20.2 million, or 7.0% of total loans. The largest commercial
real estate loan in the Company's portfolio at December 31, 1997 was secured by
commercial real property located in Carmel, California, with an outstanding
principal balance of $2.2 million.
As part of its operating strategy, the Company has increased the level
of its commercial real estate lending in Northern and Central California. Loans
secured by commercial real estate properties, like multifamily loans, are
generally larger and involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by commercial real
estate properties are often dependent on successful operation or management of
the properties, repayment of such loans may be subject to a great extent to
adverse conditions in the real estate market or the economy. The Company seeks
to minimize these risks through strict underwriting standards, which require
such loans to be qualified on the basis of the property's income and debt
service ratio; by requiring that financial statements from borrowers be updated
at least annually; by requiring operating statements on the properties; and by
acquiring personal guarantees from the borrowers.
Construction Lending. The Company originates construction loans for the
acquisition and development of property. Historically, the majority of the
Company's construction loans have been to finance the construction of one- to
four-family, owner-occupied residential properties. During 1997, the Company
4
<PAGE>
increased the amount of its construction lending on commercial real estate and
residential land development projects.
Construction financing is generally considered to involve a higher
degree of risk than long-term financing on improved, occupied real estate. The
Company's risk of loss on construction loans depends largely upon the accuracy
of the initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. If the
estimate of construction costs proves to be inaccurate, the Company may have to
advance funds beyond the amount originally committed to permit completion of the
development and to protect its security position. The Company may also be
confronted, at or prior to maturity of the loan, with a project with
insufficient value to ensure full repayment. The Company's underwriting,
monitoring, and disbursement practices with respect to construction financing
are intended to ensure that sufficient funds are available to complete
construction projects. The Company attempts to limit its risk through its
underwriting procedures, by using only approved, qualified appraisers, and by
dealing with qualified builder/borrowers.
The Company's construction loans typically have adjustable rates and
terms of 12 to 18 months. The Company originates one- to four-family and
multifamily residential construction loans in amounts up to 80% of the appraised
value of the property, subject to loans to one borrower limitations. Land
development loans are determined on an individual basis, but in general they do
not exceed 50% of the actual cost or current appraised value of the property,
whichever is less. Loan proceeds are disbursed in increments as construction
progresses and as inspections warrant.
At December 31, 1997, the Company had gross construction and land
development loans totaling $35.2 million, on which there were total undisbursed
loan funds of $21.4 million. The largest construction loan in the Company's
portfolio at year end was a $5.0 million land development loan secured by real
estate located in Roseville, California.
Loan Approval Procedures and Authority. The Board of Directors
authorizes or may limit the lending activity of the Company, establishes the
lending policies of the Company, and reviews properties offered as security. The
Board of Directors has authorized the following loan approval authorities:
mortgage loans in amounts of $214,600 and below may be approved by the Company's
staff underwriters; mortgage loans in excess of $214,600 and up to $275,000 may
be approved by the underwriting/processing manager; mortgage loans in excess of
$275,000 and up to $350,000 may be approved by the real estate loan
administrator; loans in excess of $350,000 and up to $500,000 require the
approval of the Chief Lending Officer; and loans in excess of $500,000 and up to
$750,000 require the approval of the Chief Executive Officer or the President.
Loans in excess of $750,000 and up to $2.0 million require the approval of the
Directors' Loan Committee, which is comprised of members of the Company's Board
of Directors. A resolution of the Board of Directors is required for mortgage
loans in excess of $2.0 million.
The loan origination process requires that upon receipt of a completed
loan application, a credit report is obtained and certain information is
verified by an independent credit agency. If necessary, additional financial
information is obtained from the prospective borrower. An appraisal of the
related real estate is performed by an independent appraiser. On an annual
basis, the Company's Board of Directors reviews the list of independent
appraisers used by the Company. The Company uses only those appraisers who have
been approved by the Board of Directors. The Company's policy is to obtain title
and hazard insurance on all real estate loans. If the original loan amount
exceeds 80% on a sale or refinance of a first trust deed loan or private
mortgage insurance is required, the borrower is required to make payments to a
mortgage impound account from which the Company makes disbursements for property
taxes and mortgage insurance.
Business Lending. The Company offers business loans primarily
collateralized by business assets. Such collateral is typically comprised of
accounts receivable, inventory, and equipment. Business lending is generally
considered to involve a higher degree of risk than the financing of real estate,
primarily because
5
<PAGE>
security interests in the collateral are more difficult to perfect and the
collateral may be difficult to obtain or liquidate following an uncured default.
Business banking loans typically offer relatively higher yields, short
maturities, and variable interest rates. The availability of such loans enables
potential depositors to establish a full-service banking relationship with the
Bank. The Company attempts to reduce the risk of loss associated with business
lending by closely monitoring the financial condition and performance of its
customers.
6
<PAGE>
Loan Portfolio Composition. The following table sets forth the
composition of the Company's loan portfolio in dollar amounts and as a
percentage of the portfolio at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------ ------------------ ------------------ ------------------ ------------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S><C>
Real estate:
Residential:
One- to four-family....... $205,218 71.36% $201,579 85.22% $199,917 86.29% $216,872 88.36% $166,654 85.64%
Multifamily............... 23,355 8.12% 22,455 9.49% 21,503 9.28% 22,231 9.06% 19,052 9.79%
Commercial real estate...... 20,159 7.01% 7,524 3.18% 4,191 1.81% 2,903 1.18% 2,724 1.40%
Construction................ 35,150 12.23% 4,131 1.75% 5,379 2.32% 2,848 1.16% 5,589 2.87%
Land........................ 1,869 .65% 95 .04% 97 .04% 99 .04% 112 .06%
Business loans............... 943 .33% - .00% - .00% - .00% - .00%
Business lines of credit..... 270 .09% - .00% - .00% - .00% - .00%
Other(1)..................... 598 .21% 763 .32% 605 .36% 503 .20% 475 .24%
-------- ------- -------- -------- -------- ------- -------- ------- -------- --------
Total loans.............. 287,562 100.00% 236,547 100.00% 231,692 100.00% 245,456 100.00% 194,606 100.00%
======= ======== ======= ======= ========
Plus (Less):
Undisbursed loan funds...... (21,442) (1,822) (1,895) (1,178) (3,116)
Unamortized premium, net.... 556 452 651 1,006 1,380
Deferred loan fees, net..... (742) (528) (607) (971) (905)
Allowance for loan losses... (1,669) (1,311) (1,362) (808) (387)
-------- -------- -------- -------- --------
Total loans, net......... 264,265 233,338 228,479 243,505 191,578
Less:
Loans held for sale:
One- to four-family(2)..... (514) (130) (92) (16,082) (58,875)
-------- -------- -------- -------- --------
Total loans held
for investment........ $263,751 $233,208 $228,387 $227,423 $132,703
======== ======== ======== ======== ========
</TABLE>
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(1) Includes loans secured by savings accounts and unsecured consumer loans.
(2) Loans classified as held for sale at December 31, 1993 were transferred to
loans held for investment in April 1994.
7
<PAGE>
Loan Maturity: The following table shows the contractual maturities of
the Company's gross loans at December 31, 1997. The table includes loans held
for sale of $514,000. The table does not include principal repayments. Principal
repayments on total loans totaled $37.8 million for the year ended December 31,
1997.
<TABLE>
<CAPTION>
At December 31, 1997
--------------------------------------------------------------------------------------
One-To-Four Commercial Construction Total Loans
Family Multi-Family Real Estate And Land Business Other(1) Receivable
----------- ------------ ----------- ------------ -------- -------- -----------
(In thousands)
<S><C>
Amounts due:
One year or less........................... $ 193 $ - $ 679 $ 25,058 $ 250 $ 566 $ 26,746
-------- -------- -------- -------- ------- ------ --------
After one year:
More than one year to three years........ 593 - 1,406 8,463 20 32 10,514
More than three years to five years...... 1,232 96 787 1,098 479 - 3,692
More than five years to 10 years......... 5,327 656 200 - 464 - 6,647
More than 10 years to 20 years........... 7,036 1,556 413 - - - 9,005
More than 20 years....................... 190,837 21,047 16,674 2,400 - - 230,958
-------- -------- -------- -------- ------- ------ --------
Total due after December 31, 1998..... 205,025 23,355 19,480 11,961 963 32 260,816
-------- -------- -------- -------- ------- ------ --------
Total amount due......................... 205,218 23,355 20,159 37,019 1,213 598 287,562
Less:
Undisbursed loan funds................... - - - (21,442) - - (21,442)
Unamortized (discounts)premiums.......... 590 (34) - - - - 556
Deferred loan fees, net.................. (400) (57) (98) (181) (6) - (742)
Allowance for loan losses................ (846) (278) (241) (229) (41) (34) (1,669)
-------- -------- -------- -------- ------- ------- --------
Total loans, net........................... 204,562 22,986 19,820 15,167 1,166 564 264,265
Loans held for sale....................... (514) - - - - - (514)
-------- -------- -------- -------- ------- ------ --------
Loans receivable held for investment...... $204,048 $ 22,986 $ 19,820 $ 15,167 $ 1,166 $ 564 $263,751
======== ======== ======== ======== ======= ====== ========
</TABLE>
- --------------------
(1) Includes loans secured by savings accounts and unsecured loans.
8
<PAGE>
The following table sets forth at December 31, 1997, the dollar amount
of gross loans receivable contractually due after December 31, 1998, and whether
such loans have fixed or adjustable rates.
Due After December 31, 1998
-------------------------------
Fixed Adjustable Total
------- ---------- --------
(In thousands)
Real estate loans:
One-to-four family............... $79,707 $125,318 $205,025
Multifamily...................... 545 22,810 23,355
Commercial real estate........... 833 18,647 19,480
Construction and land............ 3,547 8,414 11,961
Business loans..................... - 963 963
Other loans........................ 32 - 32
------- -------- --------
Total loans receivable
due after December 31, 1998...... $84,664 $176,152 $260,816
======= ======== ========
Originations, Purchases and Sales of Loans. The Company's mortgage
lending activities are conducted primarily through its seven branch offices and
approximately 25 wholesale loan brokers who process loan applications through
the Company. In addition, the Company has developed correspondent relationships
with a number of financial institutions to facilitate the origination of
mortgage loans on a participation basis. Loans presented to the Company for
purchase or participation are underwritten substantially in accordance with the
Company's established lending standards, which consider the financial condition
of the borrower, the location of the underlying property, and the appraised
value of the property, among other factors. The majority of the Company's
purchased loans and participations are current index, adjustable rate mortgages
secured by real estate located within the state of California. At December 31,
1997, the Company had entered into participation agreements with other financial
institutions to originate construction, commercial real estate, and land loans,
of which the Company's share was $16.2 million.
As part of its interest rate risk management strategy, during 1997 the
Company purchased $14.7 million of one- to four-family adjustable rate mortgage
loans. As of December 31, 1997, $39.2 million, or 14.8%, of the Company's net
loans receivable had been purchased from other financial institutions. Of this
amount, $30.1 million, or 76.7%, were loans secured by one- to four-family
residences and $9.1 million, or 23.3%, were multifamily mortgage loans secured
by apartment buildings located in the Greater San Francisco Bay area.
On an ongoing basis, depending on its asset and liability strategy, the
Company originates one- to four-family residential mortgage loans for sale in
the secondary market. Loan sales are dependent on the level of loan originations
and the relative customer demand for mortgage loans, which is affected by the
current and expected future level of interest rates. During the years ended
December 31, 1997 and 1996, the Company sold $3.0 million and $2.6 million,
respectively, of fixed rate mortgage loans to FHLMC. In 1995, the Company sold
$18.5 million of adjustable rate mortgage loans to another financial
institution, pursuant to an agreement which expired in 1995. The level and
timing of any future loan sales will depend upon market opportunities and
prevailing interest rates at the time such a decision is made. From time to
time, depending on its asset and liability strategy, the Company converts a
portion of its mortgages into readily-marketable FHLMC mortgage-backed
securities. In 1995, the Company converted approximately $15.0 million of fixed
rate residential loans into mortgage-backed securities. The Company did not
securitize mortgages during 1996 or 1997.
The Company recognizes gains or losses on the sale of loans at the time
of sale, based on the difference between the net sale proceeds and the carrying
value of the loans sold. When the right to service the loans is retained, an
excess servicing gain or loss is recognized based upon the net present value of
any difference between the interest rate charged to the borrower and the
interest rate paid to the purchaser after deducting a normal servicing fee. The
excess servicing gain or loss is dependent on prepayment estimates and discount
rate
9
<PAGE>
assumptions. Historically, such excess servicing gains or losses have not had a
material impact on the Company's earnings. See "- Loan Servicing."
Effective December 1995, the Company adopted Statement of Financial
Accounting Standards No. 122 ("SFAS 122"), ACCOUNTING FOR MORTGAGE SERVICING
RIGHTS. SFAS 122 makes no distinction between purchased and originated mortgage
servicing rights, and allows financial institutions that originate mortgages and
sell them into the secondary market to recognize the retained right to service
the loans. In 1997 and 1996, respectively, the Company recorded $7,000 and
$21,000 of originated mortgage servicing rights.
Loan Servicing. The Company services its own loans as well as loans
owned by others. Loan servicing includes collecting and remitting loan payments,
accounting for principal and interest, holding escrow funds for the payment of
real estate taxes and insurance premiums, contacting delinquent borrowers, and
supervising foreclosures and property dispositions in the event of unremedied
defaults. Loan servicing income is recorded on an accrual basis and includes
servicing fees from investors and certain charges collected from borrowers, such
as late payment fees. At December 31, 1997 and 1996, respectively, the Company
was servicing $52.1 million and $61.3 million of loans for others.
Classified Assets and Real Estate Owned. To measure the quality of
assets, the Company has established internal asset classification guidelines as
part of its credit monitoring system for identifying and reporting problem
assets and determining provisions for anticipated loan and real estate owned
("REO") losses. Under these guidelines, an allowance for anticipated loan and
REO losses is established when certain conditions exist. The Internal Asset
Review Committee, comprised of senior management, oversees the administration of
the internal asset classification guidelines and reports results to the Board of
Directors.
The Company classifies assets it considers of questionable quality
employing the classification categories of "substandard," "doubtful," and
"loss." An asset is considered substandard if it is inadequately protected by
the current net worth and paying capacity of the obligor or of the collateral
pledged. Substandard assets include those characterized by the distinct
possibility that the insured institution will sustain some loss if the
deficiencies are not corrected. Assets classified as doubtful have all of the
weaknesses inherent in those classified substandard, with the added
characteristic that the weaknesses make collection or liquidation in full, on
the basis of currently existing facts, conditions, and values, questionable and
there is a high probability of loss. An asset classified as loss is considered
uncollectible and of such little value that it should not be included as an
asset. Total classified assets of the Company declined to $2.5 million at
December 31, 1997 from $4.9 million at December 31, 1996. Classified assets were
0.6% of total assets at December 31, 1997, compared to 1.2% a year earlier.
At December 31, 1997, the Company had $2.5 million of assets classified
as substandard and no assets classified as doubtful or loss. Substandard assets
included $1.6 million of loans past due 90 days or more and $900,000 of loans
with identified risk characteristics such as a pattern of historical
delinquencies and/or delinquent property tax status. The largest substandard
loan at December 31, 1997 was a multifamily mortgage with an outstanding
principal balance of $817,000.
Assets which possess weaknesses but do not currently expose the Company
to sufficient risk to warrant classification as substandard, doubtful, or loss
are designated as "special mention." At December 31, 1997, the Company had $2.3
million of assets classified as special mention due to past delinquencies and
other identifiable weaknesses. The largest special mention loan was a
multifamily mortgage loan with an outstanding balance of $388,000 on December
31, 1997.
Assets classified as substandard or doubtful require the establishment
of general valuation allowances in amounts considered by management to be
adequate under generally accepted accounting principles. These amounts represent
loss allowances which have been established to recognize the inherent risk
associated with lending activities, but which, unlike specific allowances, have
not been allocated to particular problem assets.
10
<PAGE>
Judgments regarding the adequacy of general valuation allowances are based on
continual evaluation of the nature, volume and quality of the loan portfolio,
other assets, and current economic conditions that may affect the recoverability
of recorded amounts. Assets classified as a loss require either a specific
valuation allowance equal to 100% of the amount classified or a charge-off of
such amount.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
Office of Thrift Supervision ("OTS"), which can require the establishment of
additional general or specific loss allowances. The OTS, in conjunction with the
other federal banking agencies, has adopted an interagency policy statement on
allowances for loan and lease losses which provides guidance in determining the
adequacy of general valuation guidelines. The policy statement recommends that
savings institutions establish effective systems and controls to identify,
monitor and address asset quality problems, analyze significant factors that
affect the collectibility of assets, and establish prudent allowance evaluation
processes. Management believes that the Company's allowance for loan losses is
adequate given the composition and risks of the loan portfolio. However, actual
losses are dependent upon future events and, as such, further additions to the
level of specific and general loan loss allowances may become necessary. In
addition, there can be no assurance that at some time in the future the OTS
regulators, in reviewing the Company's loan portfolio, will not request the
Company to increase its allowance for loan losses, thus negatively impacting the
Company's earnings for that time period.
REO is recorded at the lower of the recorded investment in the loan or
the fair value of the related asset on the date of foreclosure, less costs to
sell. Fair value is defined as the amount in cash or cash-equivalent value of
other consideration that a real estate asset would yield in a current sale
between a willing buyer and a willing seller. Development and improvement costs
relating to the property are capitalized to the extent they are deemed to be
recovered upon disposal. The carrying value of acquired property is continuously
evaluated and, if necessary, an allowance is established to reduce the carrying
value to net realizable value (which considers, among other things, estimated
direct holding costs and selling expenses). At December 31, 1997, the Company
had REO of $321,000, representing three one- to four-family residential
properties acquired through foreclosure in 1997.
The Company obtains appraisals on all real estate acquired through
foreclosure at the time of foreclosure. Appraisals on REO are updated annually.
The Company generally conducts external inspections on foreclosed properties and
properties deemed in-substance foreclosures on a quarterly basis.
Delinquent Loan Procedures. Specific delinquency procedures vary
depending on the loan type and period of delinquency. However, the Company's
policies generally provide that loans be reviewed monthly for delinquencies, and
that if a borrower fails to make a required payment when due, the Company
institutes internal collection procedures. For mortgage loans, written late
charge notices are mailed no later than the 15th day of delinquency. At 25 days
past due, the borrower is contacted by telephone and the Company makes a verbal
request for payment. In most cases, deficiencies are cured promptly. At 30 days
past due, the Company begins tracking the loan as a delinquency, and at 45 days
past due a notice of intent to foreclose is mailed. When contact is made with
the borrower prior to foreclosure, the Company generally attempts to obtain full
payment or work out a repayment schedule with the borrower to avoid foreclosure.
It is the Company's policy to accrue interest on all loans up to 90 days past
due, unless it is determined that the collection of interest and/or principal is
not probable under the contractual terms of the agreement.
11
<PAGE>
The following table sets forth delinquencies in the Company's loan
portfolio as of the dates indicated:
<TABLE>
<CAPTION>
At December 31, 1997 At December 31, 1996
------------------------------------------------ ----------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days Or More
--------------------- ---------------------- --------------------- ---------------------
Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans
-------- --------- -------- --------- -------- --------- -------- ---------
(Dollars in thousands)
<S><C>
One-to-four family......... 2 $ 413 5 $ 781 3 $455 11 $1,392
Multifamily................ - - 1 817 - - - -
Commercial................. - - - - - - - -
Construction and land...... - - - - - - - -
Other...................... - - - - 3 1 2 1
---- ----- ---- ------ -- ---- -- ------
Total...................... 2 $ 413 6 $1,598 6 $456 13 $1,393
==== ===== ==== ====== = ==== == ======
Delinquent loans to total
gross loans........... .09% .16% .35% .60% .14% .19% .06% .59%
</TABLE>
At December 31, 1995
------------------------------------------------
60-89 Days 90 Days or More
--------------------- ----------------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
-------- --------- -------- ---------
(Dollars in thousands)
One-to-four family......... 4 $ 297 8 $1,544
Multifamily................ 1 170 - -
Commercial................. - - - -
Construction and land...... 1 48 - -
Other...................... - - 2 1
---- ----- ---- ------
Total...................... 6 $ 515 10 $1,545
==== ===== ==== ======
Delinquent loans to total
gross loans........... .22% .22% .37% .67%
12
<PAGE>
Nonaccrual and Past Due Loans. Loans are generally placed on nonaccrual
status when the payment of interest is 90 days or more delinquent, or the
collection of interest and/or principal is not probable under the contractual
terms of the loan agreement. Loans on which the Company has ceased the accrual
of interest constitute the primary component of the portfolio of nonperforming
loans. Nonperforming loans consist of all nonaccrual loans and restructured
loans not performing in accordance with their restructured terms. Nonperforming
assets include all nonperforming loans and REO.
At December 31, 1997, loans on nonaccrual totaled $1.6 million. The
effect on interest income due to the nonaccrual status of these loans was
$62,000. The Company recognized $64,000 of interest income on these loans during
1997. For the year ended December 31, 1997, interest income which would have
been earned had these loans been performing in accordance with contractual terms
was $126,000. At December 31, 1997, the Company had $448,000 of loans that met
the definition of a troubled debt restructuring, of which $300,000 were 60-89
days delinquent and $149,000 were current and paying according to the terms of
their contractually restructured agreements. The Company had $321,000 in REO at
December 31, 1997, and no REO at year end from 1993 to 1996.
The following table sets forth information regarding nonperforming
assets. The Company does not accrue interest on loans past due 90 days or more,
and accordingly, there were no accruing loans past due 90 days or more at any of
the dates presented below.
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S><C>
Nonaccrual loans 90 days or more past due: (Dollars in thousands)
Residential real estate:
One-to-four family....................... $ 781 $ 1,393 $ 1,544 $ 711 $ -
Multifamily.............................. 817 - 830 - -
Construction and land...................... - - 825 - -
Non-mortgage............................... - - 1 - 1
------- ------- ------- ------ ------
Total loans on nonaccrual................ 1,598 1,393 3,200 711 1
Restructured loans not performing............ 300 - - - -
Real estate owned............................ 321 - - - -
------- ------- ------- ------ ------
Total nonperforming assets(1)............ $ 2,219 $ 1,393 $ 3,200 $ 711 $ 1
======= ======= ======= ====== ======
Allowance for loan losses as a percent
of gross loans receivable(2)............... .63% .56% .59% .33% .20%
Allowance for loan losses as a percent
of total nonperforming loans(1) 87.98% 94.10% 42.56% 113.64% NM(3)
Nonperforming loans as a percent
of gross loans receivable(1)(2)............ .71% .59% 1.39% .29% NM(3)
Nonperforming assets as a percent
of total assets(1)......................... .54% .33% .97% .24% NM(3)
</TABLE>
- --------------------
(1) Nonperforming assets consist of nonperforming loans (nonaccrual loans and
restructured loans not performing in accordance with their restructured
terms) and REO. REO consists of real estate acquired through foreclosure
and real estate acquired by acceptance of a deed-in-lieu of foreclosure.
(2) Gross loans receivable includes loans receivable held for investment and
loans held for sale, less undisbursed loan funds, deferred loan
origination fees, and unamortized discounts and premiums.
(3) At December 31, 1993, the Company had $1,000 of nonperforming loans.
Accordingly, ratio data presenting the allowance for loan losses as a
percentage of nonperforming loans for such periods would not be
meaningful.
13
<PAGE>
Impaired Loans. A loan is designated as impaired when the Company
determines it may be unable to collect all amounts due according to the
contractual terms of the loan agreement, whether or not the loan is 90 days past
due. Excluded from the definition of impairment are smaller balance homogenous
loans that are collectively evaluated for impairment. In addition, any loans
which meet the definition of a troubled debt restructuring, or are partially or
completely classified as Doubtful or Loss, are considered impaired.
The Company has established a monitoring system for its loans in order
to identify impaired loans and potential problem loans, and to permit periodic
evaluation of the adequacy of allowances for losses in a timely manner. In
analyzing its loans, the Company has established specific monitoring policies
and procedures suitable for the relative risk profile and other characteristics
of loans by type. The Company's smaller-balance residential one-to-four family,
multifamily and non-mortgage loans are considered to be relatively homogeneous
and no single loan is individually significant in terms of its size or potential
risk of loss. Therefore, the Company generally reviews these loans by analyzing
their performance and composition of their collateral for the portfolio as a
whole. For non-homogenous loans the Company conducts a periodic review of each
loan. The frequency and type of review is dependent upon the inherent risk
attributed to each loan and the adversity of the loan grade. The Company
evaluates the risk of loss and default for each loan subject to individual
monitoring.
Factors considered as part of the periodic loan review process to
determine whether a loan is impaired address both the amount the Company
believes is probable that it will collect and the timing of such collection. As
part of the Company's loan review process the Company considers such factors as
the ability of the borrower to continue meeting the debt service requirements,
assessments of other sources of repayment, and the fair value of any collateral.
Insignificant delays or shortfalls in payment amounts, in the absence of other
facts and circumstances, would not alone lead to the conclusion that a loan is
impaired.
When a loan is designated as impaired, the Company measures impairment
based on the fair value of the collateral of the collateral-dependent loan. The
amount by which the recorded investment of the loan exceeds the measure of the
impaired loan is recognized by recording a valuation allowance with a
corresponding charge to earnings. The Company charges off a portion of an
impaired loan against the valuation allowance when it is probable that there is
no possibility of recovering the full amount of the impaired loan.
The following table identifies the Company's total recorded investment
in impaired loans by type at December 31, 1997 and 1996 (in thousands).
December 31,
--------------------
1997 1996
Residential one-to-four family
non-homogenous loans................... $ 985 $ 354
Multifamily loans........................ 817 821
Non-mortgage loans....................... - 1
------- -------
Total impaired loans................... $ 1,802 $ 1,176
======= =======
For the year ended December 31, 1997, the Company recognized interest
on impaired loans of $49,000. $1.4 million of impaired loans were on nonaccrual
status at December 31, 1997, and $57,000 of interest was uncollected on impaired
loans. During the year ended December 31, 1997, the Company's average investment
in impaired loans was $1.3 million. Valuation allowances on impaired loans were
$237,000 at December 31, 1997.
14
<PAGE>
Allowance for Estimated Loan Losses. The allowance for loan losses is
established through a provision for loan losses based on management's
evaluation of the risks inherent in its loan portfolio and the general economy.
The allowance for loan losses is maintained at an amount management considers
adequate to cover estimated losses in loans receivable which are deemed
probable and estimable. The allowance is based upon a number of factors,
including asset classifications, economic trends, industry experience and
trends, industry and geographic concentrations, estimated collateral values,
management's assessment of the credit risk inherent in the portfolio,
historical loan loss experience, and the Company's underwriting policies. At
December 31, 1997, the Company's allowance for loan losses was .63 % of total
loans, compared to .56% at December 31, 1996. The Company will continue
to monitor and modify its allowance for loan losses as conditions dictate.
Various regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. These agencies may
require the Company to make additional provisions for loan losses, based on
their judgments of the information available at the time of the examination.
Activity in the Company's allowance for loan losses for the periods
indicated are set forth in the table below (in thousands).
At or for the Year Ended December 31,
------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
Balance at beginning of year....... $1,311 $1,362 $ 808 $ 387 $ 167
Provision for loan losses.......... 375 28 663 421 220
Charge-offs, net................... (17) (79) (109) - -
------ ------ ------ ------ ------
Balance at end of period........... $1,669 $1,311 $1,362 $ 808 $ 387
====== ====== ====== ====== ======
15
<PAGE>
The following table sets forth the Company's allowance for loan losses
as a percentage of the total allowance, and the percentage of loans to total
loans in each of the categories listed at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------------
1997 1996
------------------------------------ ------------------------------------
Percent of Percent of
Percent of Loans in Percent of Loans in
Allowance Each Allowance Each
to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
-------- --------- ----------- -------- --------- -----------
(Dollars in thousands)
<S><C>
One- to four-
family.......... $ 846 50.69% 69.80% $ 911 69.49% 85.22%
Multifamily....... 278 16.66% 7.85% 171 13.04% 9.49%
Commercial
real estate..... 241 14.44% 6.79% 174 13.27% 3.18%
Construction
and land........ 229 13.72% 13.64% 20 1.53% 1.79%
Other............. 75 4.49% 1.93% 35 2.67% .32%
------- ------- ------- ------- ------- -------
Total valuation
allowances...... $ 1,669 100.00% 100.00% $ 1,311 100.00% 100.00%
======= ======= ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------------
1995 1994
------------------------------------ ------------------------------------
Percent of Percent of
Percent of Loans in Percent of Loans in
Allowance Each Allowance Each
to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
-------- --------- ----------- -------- --------- -----------
(Dollars in thousands)
<S><C>
One- to four-
family.......... $ 1,080 79.30% 86.29% $ 676 83.66% 88.36%
Multifamily....... 143 10.50% 9.28% 91 11.26% 9.06%
Commercial
real estate..... 58 4.26% 1.81% 31 3.84% 1.18%
Construction
and land........ 77 5.65% 2.36% 7 .87% 1.20%
Other............. 4 .29% .26% 3 .37% .20%
------- ------- ------- ------ ------- -------
Total valuation
allowances...... $ 1,362 100.00% 100.00% $ 808 100.00% 100.00%
======= ======= ======= ====== ======= =======
</TABLE>
At December 31,
------------------------------------
1993
------------------------------------
Percent of
Percent of Loans in
Allowance Each
to Total Category to
Amount Allowance Total Loans
-------- --------- -----------
(Dollars in thousands)
One- to four-
family.......... $ 264 68.22% 85.64%
Multifamily....... 60 15.50% 9.79%
Commercial
real estate..... 26 6.72% 1.40%
Construction
and land........ 31 8.01% 2.93%
Other............. 6 1.55% .24%
------- ------- -------
Total valuation
allowances...... $ 387 100.00% 100.00%
====== ======= =======
16
<PAGE>
Investment Activities
Federally chartered savings institutions have the authority to invest
in various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, certificates of deposit of insured banks
and savings institutions, bankers' acceptances, repurchase agreements and
federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest their assets in commercial paper, investment-grade
corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. Additionally, the Company must maintain minimum
levels of investments that qualify as liquid assets under OTS regulations. See
"Regulation - Federal Savings Institution Regulation - Liquidity." Historically,
the Company has maintained liquid assets above the minimum OTS requirements and
at a level considered to be adequate to meet its normal daily activities.
The Company's investment activities described herein include
transactions related to short-term investments, investment securities and
mortgage-backed securities held by the Company. The investment policies of the
Company as established by the Board of Directors attempt to provide and maintain
liquidity, generate a favorable return on investments without incurring undue
interest rate and credit risk, and complement the Company's lending activities.
Specifically, the Company's policies generally limit investments to government
and federal agency-backed securities and other non-government guaranteed
securities, including corporate debt obligations, that are investment grade. The
Company's policies provide the authority to invest in marketable equity
securities meeting the Company's guidelines and in mortgage-backed securities
guaranteed by the U.S. government and agencies thereof and other financial
institutions. At December 31, 1997, the Company had federal funds sold and other
short-term investments, investment securities (including certificates of
deposit) and mortgage-backed securities with an aggregate amortized cost of
$117.3 million and a market value of $117.5 million.
At December 31, 1997, the Company had $40.5 million of investment
securities, consisting of $14.9 million invested in a short-term government
securities fund and $25.6 million invested in U.S. government and agency
obligations. The Company's mortgage-backed and mortgage-related securities
portfolio consists primarily of seasoned fixed rate and adjustable rate
mortgage-backed and mortgage-related securities. At December 31, 1997, the
Company had a total of $70.6 million of mortgage-backed securities insured or
guaranteed by the FNMA, GNMA, and FHLMC, of which $70.5 million were designated
as available for sale. Investments in mortgage-backed securities involve a risk
that actual prepayments will exceed prepayments estimated over the life of the
security, which may result in a loss of any premium paid for such instruments,
thereby reducing the net yield on the securities. If interest rates increase,
the market value of these securities may be adversely affected.
17
<PAGE>
At December 31, 1997, the Company held mortgage-backed securities and
investment securities issued by the following entities. For each issuer, the
aggregate total amortized cost of such securities exceeded 10% of the Company's
equity.
Amortized Market
Cost Value
--------- ------
(In thousands)
Issuer:
Smith Breeden Short-Term Government
Securities Mutual Fund........................ $15,000 $14,934
Federal Home Loan Mortgage Corporation.......... 34,009 34,163
Federal National Mortgage Company............... 28,537 28,605
Federal Home Loan Bank.......................... 11,998 12,029
Government National Mortgage Association........ 17,184 17,217
Federal Farm Credit Banks....................... 4,000 4,010
18
<PAGE>
The following table sets forth the composition of the Company's
mortgage-backed securities portfolio in dollar amounts and in percentages of the
respective portfolios at the dates indicated. Available for sale securities are
reflected at fair market value and held to maturity securities are reflected at
amortized cost pursuant to Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities ("SFAS No.
115").
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------
1997 1996 1995
-------------------- -------------------- --------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
-------- ---------- -------- ---------- -------- ----------
(Dollars in thousands)
<S><C>
Mortgage-backed securities:
FNMA.................................. $ 24,983 36.20% $ 45,243 39.62% $ 23,485 45.57%
FHLMC................................. 27,389 39.68% 38,206 33.46% 28,046 54.43%
GNMA.................................. 16,650 24.12% 15,158 13.27% - -
CMOs(1)............................... - - 15,590 13.65% - -
-------- ------- -------- ------- -------- -------
Total mortgage-backed securities.... 69,022 100.00% 114,197 100.00% 51,531 100.00%
======= ======= =======
Plus:
Unamortized premium, net.............. 1,585 2,586 1,091
-------- -------- --------
Total mortgage-backed
securities, net................... 70,607 116,783 52,622
Less:
Mortgage-backed securities
available for sale.................. (70,465) (116,610) (52,417)
-------- -------- --------
Total mortgage-backed securities
held to maturity.................... $ 142 $ 173 $ 205
======== ======== ========
</TABLE>
- --------------------
(1) The CMOs consisted primarily of mortgage-backed securities tied to single
current index securities.
19
<PAGE>
The following tables set forth the Company's mortgage-backed securities
activities for the periods indicated.
<TABLE>
<CAPTION>
For the Year Ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(In thousands)
<S><C>
Beginning balance ............................................... $116,783 $ 52,622 $ 13,683
Mortgage-backed securities purchased - held to maturity....... - - 69
Mortgage-backed securities purchased - available for sale..... 6,900 85,467 43,022
Mortgage-backed securities acquired in exchange for
securitized loans........................................... - - 14,992
Sales of mortgage-backed securities available for sale,
proceeds from sale.......................................... (38,613) (8,427) (13,746)
Principal repayments ......................................... (14,989) (11,776) (6,240)
Realized gain (loss) on sale of
mortgage-backed securities.................................. 213 70 (258)
Amortization of (premium)/discount............................ (401) (276) (277)
Unrealized gain (loss) on available for sale.................. 714 (897) 1,377
-------- -------- --------
Ending balance................................................... $ 70,607 $116,783 $ 52,622
======== ======== ========
</TABLE>
The following table sets forth certain information regarding the
amortized cost and market values of the Company's mortgage-backed securities at
the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------------------------
1997 1996 1995
-------------------- -------------------- ---------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- --------- --------- --------- --------- ----------
(In thousands)
<S><C>
Mortgage-backed securities:
Available for sale:
GNMA............................. $17,184 $17,217 $ 15,786 $ 15,696 $ - $ -
FHLMC............................ 27,908 28,046 39,110 38,988 27,984 28,187
FNMA............................. 25,142 25,202 46,410 46,221 24,020 24,230
CMO(1)........................... - - 15,788 15,705 - -
------- ------- -------- -------- ------- -------
Total available for sale....... 70,234 70,465 117,094 116,610 52,004 52,417
------- ------- -------- -------- ------- -------
Held to maturity:
FNMA............................. 142 138 173 169 205 199
------- ------- -------- -------- ------- -------
Total held to maturity......... 142 138 173 169 205 199
------- ------- -------- -------- ------- -------
Total mortgage-backed
securities................... $70,376 $70,603 $117,267 $116,779 $52,209 $52,616
======= ======= ======== ======== ======= =======
</TABLE>
- --------------------
(1) The CMOs consisted primarily of mortgage-backed securities tied to single
current index securities.
20
<PAGE>
The following table sets forth certain information regarding the
amortized cost and market values of the Company's federal funds sold and other
short-term investments and investment securities at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------------------------
1997 1996 1995
-------------------- -------------------- ---------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- --------- --------- --------- --------- ----------
(In thousands)
<S><C>
Federal funds sold and other
short-term investments............. $ 6,300 $ 6,300 $ 531 $ 531 $ - $ -
======= ======= ======= ======== ======= =======
Investment securities:
Certificates of deposit(1)......... $ 99 $ 99 $ 199 $ 199 $ 782 $ 782
------- ------- ------- ------- ------- -------
Held to maturity:
U.S. Treasury notes.............. - - 153 152 355 359
Tennessee Valley bond............ 145 145 144 144 145 144
FICO zero coupon bond............ - - 107 107 290 294
------- ------- ------- ------- ------- -------
Total held to maturity......... 145 145 404 403 790 797
------- ------- ------- ------- ------- -------
Available for sale:
U.S. government and federal
agency obligations............. 25,351 25,421 35,322 35,156 16,025 16,161
Short-term government
securities mutual fund......... 15,000 14,934 15,000 14,799 15,000 14,723
Common stock..................... - - - - 85 106
------- ------- ------- ------- ------- -------
Total available for sale....... 40,351 40,355 50,322 49,955 31,110 30,990
------- ------- ------- ------- ------- -------
Total investment securities........ $46,895 $46,899 $51,456 $51,088 $32,682 $32,569
======= ======= ======= ======== ======= =======
</TABLE>
- --------------------
(1) Includes certificates of deposit with original maturities of greater than
90 days.
21
<PAGE>
The table below sets forth certain information regarding the amortized
cost, weighted average yields and contractual maturities of the Company's
federal funds sold and other short-term investments, investment securities and
mortgage-backed securities as of December 31, 1997.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE
ONE YEAR OR LESS YEAR TO FIVE YEARS YEARS TO TEN YEARS
------------------------ ------------------------ --------------------------
WEIGHTED WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE
COST YIELD COST YIELD COST YIELD
------------ ----------- ------------ ----------- ------------- ------------
(DOLLARS IN THOUSANDS)
<S><C>
Investment securities:
Certificates of deposit(1)............ $ 99 6.25% $ - $ -
------- -------- ------
Held to maturity:
U.S. government and
federal agency obligations..... 145 5.28% - -
------- -------- ------
Available for sale:
U.S. government and
federal agency obligations..... - 18,998 6.59% 6,353 6.88%
-------
Short-term government securities
mutual fund.................... 15,000 5.01% - -
------- ------- ------
Total available for sale....... 15,000 5.01% 18,998 6.59% 6,353 6.88%
------- ------- ------
Total investment securities.... $15,244 5.02% $18,998 6.59% $6,353 6.88%
======= ======= ======
Mortgage-backed securities:
Held to maturity:
FNMA........................... - 142 5.04% -
------- ------- ------
Total held for investment.. $ - $ 142 5.04% $ -
------- ------- ------
Available for sale:
FHLMC.......................... $ - $ 67 7.00% $ -
GNMA........................... - - -
FNMA........................... - - 5,895 6.55%
------- -------- ------
Total available for sale... - 67 7.00% 5,895 6.55%
------- -------- ------
Total mortgage-backed
securities............... $ - $ 209 5.67% $5,895 6.55%
======= ======= ======
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
----------------------------------------------------
MORE THAN TEN YEARS TOTAL
------------------------ ---------------------------
WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE
COST YIELD COST YIELD
------------ ----------- ------------ --------------
(DOLLARS IN THOUSANDS)
<S><C>
Investment securities:
Certificates of deposit(1)............ $ - $ 99 6.25%
--------- -------
Held to maturity:
U.S. government and
federal agency obligations..... - 145 5.28%
--------- -------
Available for sale:
U.S. government and
federal agency obligations..... - 25,351 6.66%
--------- -------
Short-term government securities
mutual fund.................... - 15,000 5.01%
--------- ------
Total available for sale....... - 40,351 6.05%
--------- -------
Total investment securities.... $ - $40,595 6.05%
========= =======
Mortgage-backed securities:
Held to maturity:
FNMA........................... - 142 5.04%
--------- -------
Total held for investment.. $ - $ 142 5.04%
--------- -------
Available for sale:
FHLMC.......................... $27,841 6.85% $27,908 6.85%
GNMA........................... 17,184 7.18% 17,184 7.18%
FNMA........................... 19,247 6.55% 25,142 6.55%
------- -------
Total available for sale... 64,272 6.85% 70,234 6.82%
------- -------
Total mortgage-backed
securities............... $64,272 6.85% $70,376 6.82%
======= =======
</TABLE>
- ---------------------------------
(1) Certificates of deposit had original maturities of greater than 90 days.
22
<PAGE>
Sources of Funds
General. The Company's primary sources of funds are customer deposits,
principal and interest payments on loans and mortgage-backed securities, FHLB
advances and other borrowings and, to a lesser extent, proceeds from sales of
securities and loans. While maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions, and competition.
Deposits. The Company offers a variety of deposit accounts with a range
of interest rates and terms. The Company's deposits consist of passbook savings,
checking accounts, money market accounts and certificates of deposit. For the
year ended December 31, 1997, certificates of deposit constituted 79.3% of total
average deposits. The flow of deposits is influenced significantly by general
economic conditions, changes in money market rates, prevailing interest rates
and competition. The Company's deposits are obtained predominantly from the
areas in which its branch offices are located. The Company relies primarily on
customer service and long-standing relationships with customers to attract and
retain these deposits; however, market interest rates and rates offered by
competing financial institutions significantly affect the Company's ability to
attract and retain deposits. Certificate accounts in excess of $100,000 are not
actively solicited by the Company, nor does the Company use brokers to obtain
deposits.
In December 1996, the Company assumed $102.1 million of deposit
liabilities in exchange for cash. In 1993, the Company acquired three branch
offices and assumed related deposit liabilities of $95.3 million.
The Company offers a "multi-flex" certificate account with interest
rates which may be adjusted to prevailing market rates according to the terms of
the account. The multi-flex account is available to customers for terms of
either seven months or 17 months. The depositor may increase the interest rate
once during the term to the current quoted rate, and may also withdraw all or a
portion of the deposited funds once during the term of the account without
penalty. The seven-month multi-flex certificate account allows the depositor to
increase the deposit amount in the account. Management continually monitors the
level of certificate accounts. Based on historical experience, management
believes it will retain a large portion of such accounts upon maturity. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The following table presents the deposit activity of the Company for
the periods indicated (in thousands).
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
<S><C>
Deposits................................. $ 695,432 $ 509,649 $ 474,839
Purchased deposits....................... - 102,063 -
Withdrawals.............................. (708,545) (519,800) (484,467)
--------- --------- ---------
Net deposits (withdrawals)............... (13,113) 91,912 (9,628)
Interest credited on deposits............ 15,527 10,949 10,602
--------- --------- ---------
Total increase in deposits............... $ 2,414 $ 102,861 $ 974
========= ========= =========
</TABLE>
23
<PAGE>
At December 31, 1997, the Company had $59.0 million in certificate
accounts in amounts of $100,000 or more ("jumbo certificate accounts") maturing
as indicated in the following table. At December 31, 1996, the Company had $49.2
million of jumbo certificate accounts, with a weighted average rate of 5.51%% at
year end. The Company does not offer premium rates on jumbo certificate
accounts.
WEIGHTED
MATURITY PERIOD AMOUNT AVERAGE RATE
- ---------------------------------------------- -------------- --------------
(IN THOUSANDS)
Three months or less.......................... $ 11,732 5.45%
Over three through six months................. 7,056 5.38%
Over six through 12 months.................... 14,588 5.64%
Over 12 months................................ 25,649 5.64%
------
Total................................ $ 59,025 5.57%
========
24
<PAGE>
The following table sets forth the distribution of the Company's
average deposit accounts for the periods indicated and the weighted average
interest rates on each category of deposits presented.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------------- ------------------------------------- -------------
PERCENT PERCENT
OF TOTAL WEIGHTED OF TOTAL WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE
---------- ----------- ----------- ----------- ----------- ----------- -------------
(DOLLARS IN THOUSANDS)
<S><C>
Money market deposits............. $ 34,612 10.89% 3.88% $ 19,387 8.65% 3.58% $ 14,619
Passbook deposits................. 13,396 4.22% 1.89% 13,381 5.97% 1.90% 15,048
Checking accounts................. 17,925 5.64% .49% 13,485 6.01% .58% 15,012
-------- ------ ------- ------ --------
Total.......................... 65,933 20.75% 46,253 20.63% 44,679
-------- ------ ------- ------ --------
Certificate accounts:
Three months or less............ 53,470 16.83% 5.34% 35,720 15.93% 5.57% 29,772
Over three through six months... 48,621 15.29% 5.35% 37,366 16.67% 5.61% 42,264
Over six through 12 months...... 83,101 26.15% 5.57% 58,924 26.28% 5.61% 66,272
Over one to three years......... 64,251 20.22% 5.62% 44,584 19.88% 5.71% 32,492
Over three to five years........ 2,267 .71% 6.14% 1,166 .52% 6.65% 735
Over five to ten years.......... 145 .05% 6.98% 204 .09% 7.23% 343
-------- ------ ------- ------ --------
Total certificates............. 251,855 79.25% 5.50% 177,964 79.37% 5.58% 171.878
-------- ------ -------- ------ --------
Total average deposits......... $317,788 100.00% 4.89% $224,217 100.00% 4.88% $216,577
======== ======= ======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1995
-------------------------------
PERCENT
OF TOTAL WEIGHTED
AVERAGE AVERAGE
DEPOSITS RATE
-------------- ---------------
<S><C>
Money market deposits............. 6.75% 2.70%
Passbook deposits................. 6.95% 2.04%
Checking accounts................. 6.93% .80%
------
Total.......................... 20.63%
------
Certificate accounts:
Three months or less............ 13.75% 5.52%
Over three through six months... 19.52% 5.95%
Over six through 12 months...... 30.60% 5.31%
Over one to three years......... 15.00% 6.22%
Over three to five years........ .34% 7.29%
Over five to ten years.......... .16% 7.28%
------
Total certificates............. 79.37% 5.69%
------
Total average deposits......... 100.00% 4.99%
=======
</TABLE>
25
<PAGE>
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1997 (in
thousands).
<TABLE>
<CAPTION>
PERIOD TO MATURITY FROM DECEMBER 31, 1997
-----------------------------------------------------------------------------------
OVER ONE OVER TWO THREE
ONE YEAR TO TWO TO THREE TO FOUR FOUR TO OVER FIVE
OR LESS YEARS YEARS YEARS FIVE YEARS YEARS
------------ ------------ ----------- ----------- ------------ ------------
<S><C>
Certificate accounts:
0 to 4.00%.................. $ 3 $ 23 $ - $ - $ - $ -
4.01 to 5.00%............... 3,999 443 2 - - -
5.01 to 6.00%............... 169,142 60,439 1,579 460 698 -
6.01 to 7.00%............... 11,348 1,926 344 351 1,226 -
7.01 to 8.00%............... 635 483 159 155 - -
8.01 to 9.00%............... 44 423 18 - - -
Over 9.01%.................. 20 103 37 - 16 -
-------- ------- ------- ------ ------ ------
Total....................... $185,191 $63,840 $ 2,139 $ 966 $ 1,940 $ -
======== ======= ======= ======== ======= ======
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
<S><C>
Certificate accounts:
0 to 4.00%.................. $ 26 $ 1,431 $ 1,747
4.01 to 5.00%............... 4,444 31,457 12,129
5.01 to 6.00%............... 232,318 194,505 83,449
6.01 to 7.00%............... 15,195 21,753 72,200
7.01 to 8.00%............... 1,432 3,311 2,400
8.01 to 9.00%............... 485 511 468
Over 9.01%.................. 176 276 377
-------- -------- --------
Total....................... $254,076 $253,244 $172,770
======== ======== ========
</TABLE>
26
<PAGE>
BORROWINGS
From time to time the Company obtains borrowed funds through FHLB
advances and reverse repurchase agreements as an alternative to retail deposit
funds, and may do so in the future as part of its operating strategy. Borrowings
are also utilized to acquire certain other assets as deemed appropriate by
management for investment purposes.
FHLB advances are collateralized by the Company's mortgage loans,
mortgage-backed securities, and investment in the capital stock of the FHLB. See
"Regulation - Federal Home Loan Bank System." FHLB advances are made pursuant to
several different credit programs with varying interest rate and maturity terms.
The maximum amount that the FHLB will advance to member institutions, including
the Bank, fluctuates from time to time in accordance with the policies of the
OTS and the FHLB. At December 31, 1997, the Company had $32.3 million of
outstanding borrowings from the FHLB.
Reverse repurchase agreements are collateralized by mortgage-backed
securities. At December 31, 1997, the Company had $5.2 million of securities
sold under agreements to repurchase.
The following table sets forth information regarding the Company's
borrowed funds at or for the indicated years.
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------- ----------- ------------
(DOLLARS IN THOUSANDS)
<S><C>
FHLB ADVANCES:
Average balance outstanding..................... $40,520 $43,619 $45,744
Maximum amount outstanding at any
month end during the year................... 46,432 99,607 68,032
Balance outstanding at year end................. 32,282 46,807 46,520
Weighted average interest rate during
the year.................................... 5.92% 5.75% 6.00%
Weighted average interest rate at
year end.................................... 6.09% 5.72% 5.84%
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------- ----------- ------------
(DOLLARS IN THOUSANDS)
<S><C>
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE:
Average balance outstanding..................... $ 8,234 $14,644 $14,497
Maximum amount outstanding at any
month end during the year................... 13,000 16,648 26,124
Balance outstanding at year end................. 5,200 13,000 17,361
Weighted average interest rate during
the year.................................... 5.91% 5.98% 6.06%
Weighted average interest rate at
year end.................................... 5.95% 5.94% 5.91%
</TABLE>
27
<PAGE>
SUBSIDIARY ACTIVITIES
Portola, a California corporation, is engaged on an agency basis in the
sale of insurance and investment products to the Company's customers and members
of the local community. At December 31, 1997, Portola had $429,000 in total
assets. Portola recorded a net loss of $25,000 for the year ended December 31,
1997.
PERSONNEL
As of December 31, 1997, the Company had 96 full-time employees and
three part-time employees. The employees are not represented by a collective
bargaining unit and the Company considers its relationship with its employees to
be good.
REGULATION AND SUPERVISION
GENERAL
The Company, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the
activities of savings institutions, such as the Bank, are governed by the HOLA
and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and
supervision by the OTS, as its primary federal regulator, and the FDIC, as the
deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB")
System and its deposit accounts are insured up to applicable limits by the
Savings Company Insurance Fund ("SAIF") managed by the FDIC. The Bank must file
reports with the OTS and the FDIC concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other savings
institutions. The OTS and/or the FDIC conduct periodic examinations to test the
Bank's safety and soundness compliance with various regulatory requirements.
This regulation and supervision establishes a comprehensive framework of
activities in which an institution can engage and is intended primarily for the
protection of the insurance fund and depositors. The regulatory structure also
gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes. Any change in such
regulatory requirements and policies, whether by the OTS, the FDIC or the
Congress could have a material adverse impact on the Company, the Bank and their
operations. Certain of the regulatory requirements applicable to the Bank and to
the Company are referred to below or elsewhere herein. The description of
statutory provisions and regulations applicable to savings institutions and
their holding companies set forth in this Form 10-K does not purport to be a
complete description of such statutes and regulations and their effects on the
Bank and the Company.
HOLDING COMPANY REGULATION
The Company is a nondiversified unitary savings and loan holding
company within the meaning of the HOLA. As a unitary savings and loan holding
company, the Company generally will not be restricted under existing laws as to
the types of business activities in which it may engage, provided that the Bank
continues to be a qualified thrift lender ("QTL"). See "Federal Savings
Institution Regulation - QTL Test." Upon any non-supervisory acquisition by the
Company of another savings institution or savings bank that meets the QTL test
and is deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities
28
<PAGE>
permissible for bank holding companies under Section 4(c)(8) of the Bank Holding
Company Act ("BHC Act"), subject to the prior approval of the OTS, and
activities authorized by OTS regulation.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5% of a nonsubsidiary company engaged in activities other
than those permitted by the HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result
in a multiple savings and loan holding company controlling savings institutions
in more than one state, subject to two exceptions: (i) the approval of
interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions, as described below. The Bank must notify the OTS 30 days
before declaring any dividend to the Company. In addition, the financial impact
of a holding company on its subsidiary institution is a matter that is evaluated
by the OTS and the agency has authority to order cessation of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.
FEDERAL SAVINGS INSTITUTION REGULATION
CAPITAL REQUIREMENTS. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio.
Core capital is defined as common stockholder's equity (including retained
earnings), certain noncumulative perpetual preferred stock and related surplus,
and minority interests in equity accounts of consolidated subsidiaries, less
intangibles other than certain purchased mortgage servicing rights and credit
card relationships. The OTS regulations also require that, in meeting the
tangible, core and risk-based capital standards, institutions must generally
deduct investments in and loans to subsidiaries engaged in activities not
permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of 4% and 8%, respectively.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, as
assigned by the OTS capital regulation based on the risks OTS believes are
inherent in the type of asset. The components of core (tier 1) capital are
equivalent to those discussed above. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock and the allowance for loan and lease losses limited to a maximum
of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
Under the OTS prompt corrective action regulations, the OTS is required
to take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of undercapitalization.
Generally, a savings institution is considered "well capitalized" if its ratio
of total capital to risk-weighted assets is at least 10%, its ratio of core
(tier 1) capital to risk-weighted assets is at least 6%, its
29
<PAGE>
ratio of core capital to total assets is at least 5%, and it is not subject to
any order or directive by the OTS to meet a specific capital level. A savings
institution generally is considered "adequately capitalized" if its ratio of
total capital to risk-weighted assets is at least 8%, its ratio of core (tier 1)
capital to risk-weighted assets is at least 4%, and its ratio of core capital to
total assets is at least 4% (3% if the institution receives the highest CAMEL
rating). A savings institution that has a ratio of total capital to weighted
assets of less of than 8%, a ratio of core (tier 1) capital to risk-weighted
assets of less than 4% or a ratio of core capital to total assets of less than
4% (3% or less for institutions with the highest examination rating) is
considered to be "undercapitalized." A savings institution that has a total
risk-based capital ratio less than 6%, a tier 1 risk-based capital ratio of less
than 3% or a leverage ratio that is less than 3% is considered to be
"significantly undercapitalized" and a savings institution that has a tangible
capital to assets ratio equal to or less than 2% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the banking regulator is
required to appoint a receiver or conservator for an institution that is
"critically undercapitalized." The regulation also provides that a capital
restoration plan must be filed with the OTS within 45 days of the date a savings
institution receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by any parent holding company. In addition, numerous
mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
The following table sets forth the amounts and ratios regarding actual
and minimum tangible, core and risk-based capital requirements, together with
the amounts and ratios required in order to meet the definition of a "well
capitalized" institution.
<TABLE>
<CAPTION>
MINIMUM CAPITAL WELL CAPITALIZED
REQUIREMENTS REQUIREMENTS ACTUAL
---------------------- ----------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- --------- ---------- ---------- ---------- ----------
<S><C>
As of December 31, 1997:
Total capital
(to risk-weighted assets) $17,898 8.00% $22,372 10.00% $38,570 17.24%
Tier 1 capital
(to risk-weighted assets) N/A N/A 13,323 6.00% 36,901 16.62%
Tier 1 capital
(to adjusted assets) 11,777 3.00% 19,629 5.00% 36,901 9.40%
Tangible capital
(to tangible assets) 5,888 1.50% N/A N/A 36,859 9.39%
</TABLE>
The OTS has adopted a regulation that adds an IRR component to the
risk-based capital requirement for thrift institutions. Currently, the OTS has
waived inclusion of the IRR component in the risk-based capital calculation,
pending the issuance by the OS of guidelines regarding the appeal of such
inclusion or calculation. Under the rule, thrift institutions meeting or
exceeding a base level of interest rate exposure must take a deduction from the
total capital available to meet their risk-based capital requirement. That
deduction is equal to one-half of the difference between the institution's
actual measured exposure and the base level of exposure. The institution's
actual measured IRR is expressed as the change that occurs in its net present
value (NPV) as a result of a hypothetical 200 basis point increase or decrease
in interest rates (whichever leads to the lower NPV) divided by the estimated
economic value of its assets. The base level of IRR which would require
inclusion of a capital component is defined as a decline in NPV which exceeds
2.0% of an institution's assets expressed in terms of economic value. If the
Bank had been subject to adding an interest rate risk component to its
risk-based capital standard at December 31, 1997, the Bank's total risk-weighted
capital would have been reduced from 17.24% to 15.31%. At December 31, 1997, the
Bank met each of its capital requirements, in each case on a fully phased-in
basis.
INSURANCE OF DEPOSIT ACCOUNTS. The deposits of the Bank are presently
insured by the SAIF, except for certain acquired deposits which are insured by
the BIF. The SAIF and the BIF are administered by the FDIC.
30
<PAGE>
The FDIC uses a risk-based assessment system under which all insured depository
institutions are placed into one of nine categories and assessed insurance
premiums on a sliding scale based upon their respective levels of capital and
results of supervisory evaluations. Institutions classified as well-capitalized
(as defined by the FDIC) and not considered to otherwise be of supervisory
concern pay the lowest premium. For the year ended December 31, 1997, regular
SAIF assessments ranged from 0 to 27 basis points. The Bank's assessment rate
for the year ended December 31, 1997 was 3 basis points and the total deposit
insurance premium paid by the Bank in fiscal 1997 was $233,000.
In addition, pursuant to the Deposit Insurance Funds Act of 1996,
effective January 1, 1997, all SAIF-insured deposits and all BIF-insured
deposits are subject to special assessments to make payments on bonds issued by
the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF.
The FDIC reviews the FICO assessment rate quarterly. For fiscal 1997, the rate
was 6.3 basis points for SAIF-insured deposits and 1.26 basis points for
BIF-insured deposits. Beginning on the earlier of January 1, 2000 or the date
that the BIF and SAIF are merged, SAIF and BIF-insured deposits will share the
cost of paying interest on the FICO bonds on a pro rata basis.
Under the FDI act, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has 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
OTS. The management of the Bank does not know of any practice, condition or
violation that might lead to the termination of deposit insurance.
PENDING LEGISLATION. In March 1998, legislation was introduced in
Congress to effect broad changes in the federal regulation of financial
institutions. The new legislation would, among other things, repeal existing
restriction on banks affiliating with securities firms and insurance companies.
The new legislation was intended to be a substitute for another pending bill
which would have, among other things, required all federal savings institutions
to convert to either a national bank or some type of a state charter. Although
the new bill would retain the federal savings institution charter, it would
require that both state and federal savings associations be treated as banks for
purposes of interstate and intrastate branching requirements. However, existing
savings and loan holding companies such as the Company would be grandfathered.
In addition, the bill would make the OTS a division of the Comptroller of the
Company and would merge the SAIF and the BIF. The bill would also supplement the
QTL test by requiring savings associations to maintain at least 10 percent of
portfolio assets in residential mortgage loans or in mortgage-backed securities
backed by or representing an interest in residential mortgage loans originated
by the savings association and sold within 90 days of origination.
The Company is unable to predict whether or when the bill described
above or other similar legislation may be enacted or the impact, if any, such
legislation would have upon the Company's future operations.
LOANS TO ONE BORROWER. Under the HOLA, savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. Generally, savings institutions may not make a loan or extend credit to a
single or related group of borrowers in excess of 15% of its unimpaired capital
and surplus. An additional amount may be lent, equal to 10% of unimpaired
capital and surplus, if such loan is secured by readily-marketable collateral,
which is defined to include certain financial instruments and bullion. At
December 31, 1997, the Bank's limit on loans to one borrower was $5.8 million.
At December 31, 1997, the Bank's largest aggregate outstanding balance of loans
to one borrower totaled $5.7 million.
QTL TEST. The HOLA requires savings institutions to meet a qualified
thrift lender ("QTL") test. A savings institution is permitted to meet the QTL
test in one of two alternative ways. Under the first method, the savings
institution is required to maintain at least 65% of its "portfolio assets,"
defined as total assets less (i) specified liquid assets up to 20% of total
assets, (ii) intangibles, including goodwill and (iii) the value of property
used to conduct business, in certain "qualified thrift investments." Assets
constituting qualified thrift
31
<PAGE>
investments and includable without limit in measuring compliance with the QTL
include residential mortgage loans, certain mortgage-backed securities and
education, small business, credit card and credit card account loans.
Alternatively, savings institutions are permitted to meet the QTL test by
qualifying as a "domestic building and loan association" under the Internal
Revenue Code.
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. At
December 31, 1997, the Bank maintained 80.83% of its portfolio assets in
qualified thrift investments and, therefore, met the QTL test.
LIMITATION ON CAPITAL DISTRIBUTIONS. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in capital requirements before and after a proposed capital
distribution ("Tier 1 Company") and has not been advised by the OTS that it is
in need of more than normal supervision, could, after prior notice but without
obtaining approval of the OTS, make capital distributions during a calendar year
equal to the greater of (i) 100% of its net earnings to date during the calendar
year plus the amount that would reduce by one-half its "surplus capital ratio"
(the excess capital over its fully phased-in capital requirements) at the
beginning of the calendar year or (ii) 75% of its net income for the previous
four quarters. Any additional capital distributions would require prior
regulatory approval. In the event the Bank's capital fell below its regulatory
requirements or the OTS notified it that it was in need of more than normal
supervision, the Bank's ability to make capital distributions could be
restricted. In addition, the OTS could prohibit a proposed capital distribution
by any institution, which would otherwise be permitted by the regulation, if the
OTS determines that such distribution would constitute an unsafe or unsound
practice. In December 1994, the OTS proposed amendments to its capital
distribution regulation that would generally authorize the payment of capital
distributions without OTS approval provided the payment does not cause the
institution to be undercapitalized within the meaning of the prompt corrective
action regulation. However, institutions in a holding company structure would
still have a prior notice requirement. At December 31, 1997, the Bank was a
Tier 1 Bank.
LIQUIDITY. The Bank is required by OTS regulations to maintain an
average daily balance of liquid assets in each calendar quarter of not less than
4% of either the amount of its liquidity base at the end of the preceding
calendar quarter or the average daily balance of its liquidity base during the
preceding calendar quarter. In addition to this minimum requirement, the Bank is
required to maintain sufficient liquidity to ensure its safe and sound
operations. The minimum liquidity requirement may be changed by the OTS to any
amount within the range of 4% to 10%, depending upon economic conditions and the
savings deposit flows of savings institutions. Monetary penalties may be imposed
for failure to meet these liquidity requirements. The Bank's average liquidity
ratio for the quarter ended December 31, 1997 was 8.1%, which exceeded the
then-applicable requirements. The Bank has never been subject to monetary
penalties for failure to meet its liquidity requirements.
ASSESSMENTS. Savings institutions are required to pay assessments to
the OTS to fund the agency's operations. The general assessment, paid on a
semi-annual basis, is computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest quarterly
thrift financial report. The assessments paid by the Bank for the fiscal year
ended December 31, 1997 totaled $90,000.
BRANCHING. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
32
<PAGE>
TRANSACTIONS WITH RELATED PARTIES. The Bank's authority to engage in
transactions with related parties or "affiliates" (E.G.., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by Sections 23A and 23B
of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of
covered transactions with any individual affiliate to 10% of the capital and
surplus of the savings institution. The aggregate amount of covered transactions
with all affiliates is limited to 20% of the savings institution's capital and
surplus. Certain transactions with affiliates are required to be secured by
collateral in an amount and of a type described in Section 23A and the purchase
of low quality assets from affiliates is generally prohibited. Section 23B
generally provides that certain transactions with affiliates, including loans
and asset purchases, must be on terms and under circumstances, including credit
standards, that are substantially the same or at least as favorable to the
institution as those prevailing at the time for comparable transactions with
non-affiliated companies. In addition, savings institutions are prohibited from
lending to any affiliate that is engaged in activities that are not permissible
for bank holding companies and no savings institution may purchase the
securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors
and 10% shareholders, ("insiders"), as well as entities such persons control, is
governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. Recent legislation created an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees. Regulation O also places individual and aggregate
limits on the amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain board approval procedures to be
followed.
ENFORCEMENT. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and an
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to be taken with respect to a particular
savings institution. If action is not taken by the Director, the FDIC has
authority to take such action under certain circumstances. Federal law also
establishes criminal penalties for certain violations.
STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset growth; and compensation, fees and benefits.
If the appropriate federal banking agency determines that an institution fails
to meet any standard prescribed by the Guidelines, the agency may require the
institution to submit to the agency an acceptable plan to achieve compliance
with the standard, as required by the FDI Act. The final rule establishes
deadlines for the submission and review of such safety and soundness compliance
plans when such plans are required.
33
<PAGE>
FEDERAL RESERVE SYSTEM
Federal Reserve System ("FRB") regulations require savings institutions
to maintain non-interest-earning reserves against their transactional accounts
(primarily checking accounts). During the year ended December 31, 1997, the
regulations generally required that reserves be maintained against transaction
accounts as follows: for accounts aggregating $49.3 million or less, the
requirement is 3%; and for accounts greater than $49.3 million, the requirement
is $1.479 million plus 10% of that portion of total transaction accounts in
excess of $49.3 million. The first $4.4 million of otherwise reservable balances
are exempted from the reserve requirements. The Bank is in compliance with the
foregoing requirements. The balances maintained to meet the reserve requirements
of the FRB may be used to satisfy OTS liquidity requirements.
34
<PAGE>
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
GENERAL. The Bank and the Company report their income on a consolidated
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS during the last
five years. For its 1997 taxable year, the Bank is subject to a maximum federal
income tax rate of 35%.
BAD DEBT RESERVE. For fiscal years beginning prior to December 31,
1995, thrift institutions which qualified under certain definitional tests and
other conditions of the Internal Revenue Code of 1986 (the "Code") were
permitted to use certain favorable provisions to calculate their deductions from
taxable income for annual additions to their bad debt reserve. A reserve could
be established for bad debts on qualifying real property loans (generally
secured by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which
was enacted on August 20, 1996, requires savings institutions to recapture
(I.E., take into income) certain portions of their accumulated bad debt
reserves. The 1996 Act repeals the reserve method of accounting for bad debts
effective for tax years beginning after 1995. Thrift institutions that would be
treated as small banks are allowed to utilize the Experience Method applicable
to such institutions, while thrift institutions that are treated as large banks
(those generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of computing
reserves for bad debts will treat such change as a change in method of
accounting, initiated by the taxpayer, and having been made with the consent of
the IRS. Any Section 481 (a) adjustment required to be taken into income with
respect to such change generally will be taken into income ratably over a
six-taxable year period, beginning with the first taxable year beginning after
1995, subject to the residential loan requirement.
Under the residential loan requirement provision, the recapture
required by the 1996 Act will be suspended for each of two successive taxable
years, beginning with the Bank's current taxable year, in which the Bank
originates a minimum of certain residential loans based upon the average of the
principal amounts of such loans made by the Bank during its six taxable years
preceding its current taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank
is permitted to make additions to its tax bad debt reserves. In addition, the
Bank is required to recapture (i. E., take into income) over a six year period
the excess of the balance of its tax bad debt reserves as of December 31, 1995
over the balance of such reserves as of December 31, 1987.
DISTRIBUTIONS. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
35
<PAGE>
The amount of additional taxable income triggered by an non-dividend is
an amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Thus, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion its bad debt reserves.
SAIF RECAPITALIZATION ASSESSMENT. The Funds Act levied a 65.7-cent fee
on every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that the
amount of any special assessment paid to capitalize SAIF under this legislation
is deductible under Section 162 of the Code in the year of payment.
CORPORATE ALTERNATIVE MINIMUM TAX. The Internal Revenue Code of 1986,
as amended (the "Code") imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using
the percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current earnings
exceeds its AMTI (determined without regard to this preference and prior to
reduction for net operating losses). In addition, for taxable years beginning
after December 31, 1986 and before January 1, 1996, an environmental tax of .12%
of the excess of AMTI (with certain modifications) over $2.0 million is imposed
on corporations, including the Company, whether or not an Alternative Minimum
Tax ("AMT") is paid. The Bank does not expect to be subject to the AMT, but may
be subject to the environmental tax liability.
DIVIDENDS RECEIVED DEDUCTION AND OTHER MATTERS. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank own more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
36
<PAGE>
STATE AND LOCAL TAXATION
STATE OF CALIFORNIA. The California franchise tax rate applicable to
the Bank equals the franchise tax rate applicable to corporations generally,
plus an "in lieu" rate approximately equal to personal property taxes and
business license taxes paid by such corporations (but not generally paid by
banks or financial corporations such as the Bank); however, the total tax rate
cannot exceed 11.7%. Under California regulations, bad debt deductions are
available in computing California franchise taxes using a three or six year
weighted average loss experience method. The Bank and its California subsidiary
file California State franchise tax returns on a combined basis. The Company, as
a savings and loan holding company commercially domiciled in California, is
treated as a financial corporation and subject to the general corporate tax rate
plus the "in lieu" rate as discussed previously for the Bank.
DELAWARE TAXATION. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
ADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the
executive officers of the Company who are not also directors:
NAME AGE (1) POSITION HELD WITH COMPANY
- ------------------------------ ----------- ------------------------------
Deborah R. Chandler 43 Senior Vice President,
Chief Financial Officer
and Treasurer
Carlene F. Anderson 45 Corporate Secretary
- -----------------------------
(1) At December 31, 1997
37
<PAGE>
ITEM 2. PROPERTIES.
The Company conducts business through an administrative office located
in Watsonville and seven branch offices, one of which includes a real estate
loan center. In December 1997, the Company entered into an agreement to
purchase, for approximately $1.1 million, an office facility located at 567 Auto
Center Drive, Watsonville. The Administrative office and the real estate loan
center will be relocated to the new facility in the second quarter of 1998. As a
result of the move, the Company intends to sell its office facility located at
36 Brennan Street, Watsonville. Management believes that with the newly acquired
office building, its facilities will be adequate to meet the immediately
foreseeable needs of the Company.
<TABLE>
<CAPTION>
ORIGINAL NET BOOK VALUE
YEAR OF PROPERTY OR
LEASED LEASED DATE OF LEASEHOLD
LOCATION OR OR LEASE IMPROVEMENTS AT
OWNED ACQUIRED EXPIRATION DECEMBER 31, 1997
- -------------------------------------- ------------- ------------ ------------ --------------------
<S><C>
ADMINISTRATIVE/BRANCH OFFICE:
15 Brennan Street Owned 12-31-65 N/A $ 18,396
Watsonville, California 95076
36 Brennan Street Owned 03-02-94 N/A 386,731
Watsonville, California 95076
BRANCH OFFICES:
35 East Lake Avenue Owned 12-31-65 N/A 322,879
Watsonville, California 95076
805 First Street Owned 12-01-76 N/A 242,846
Gilroy, California 95020
1400 Munras Avenue Owned(1) 07-07-93 Monthly 934,556
Monterey, California 93940
1890 North Main Street Owned 07-07-93 N/A 1,154,000
Salinas, California 93906
(Real estate loan center)(2)
1127 South Main Street Leased 08-08-93 07-31-98(3) 37,181
Salinas, California 93901
8071 San Miguel Canyon Road Leased 12-24-93 12-24-03(4) 72,718
Prunedale, California 93907
60 Bay Avenue Owned 12-10-96 N/A 1,125,518
Capitola, California 95020
</TABLE>
- ------------------------
(1) Majority owned, portion of property leased.
(2) The Company's real estate loan center is currently located in the facilities
of the Salinas office branch.
(3) The Company has options to extend the lease term for two consecutive
five-year periods.
(4) The Company has options to extend the lease term for three consecutive
ten-year periods.
38
<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
The Company is not involved in any pending legal proceeding other than
routine legal proceedings occurring in the ordinary course of business. Such
other routine legal proceedings in the aggregate are believed by management to
be immaterial to the Company's financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Common Stock of Monterey Bay Bancorp, Inc. is traded
over-the-counter on the Nasdaq Stock Market under the symbol "MBBC." The stock
began trading on February 15, 1995. As of March 20, 1998, there were 3,166,214
shares outstanding of the Company's common stock. As of February 28, 1998, there
were 311 stockholders of record, not including persons or entities who hold
their stock in nominee or "street" name.
The following table sets forth the high and low bid prices per share
for the Company's common stock for the periods indicated.
High Bid Low Bid
-------- -------
Year ended December 31, 1997:
Fourth quarter $20 1/2 $18 1/4
Third quarter $20 3/4 $16
Second quarter $17 1/4 $15 3/8
First quarter $18 3/4 $14 9/16
Year ended December 31, 1996:
Fourth quarter $15 7/8 $13 3/8
Third quarter $13 5/8 $11 3/8
Second quarter $12 3/4 $11 3/4
First quarter $12 3/4 $11
Year ended December 31, 1995:
Fourth quarter $13 $11 1/2
Third quarter $13 1/8 $ 9 7/8
Second quarter $10 3/4 $ 9
First quarter $ 9 1/2 $ 8 3/4
The Board of Directors declared, and the Company paid, cash dividends
of $0.11 and $0.05 per share during the years ended 1997 and 1996, respectively.
39
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
Selected consolidated financial data for each of the five years in the
period ended December 31, 1997, consisting of data captioned "Selected
Consolidated Financial and Other Data" on page two of the Company's 1997 Annual
Report to Stockholders filed as an exhibit hereto, is incorporated herein by
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
"Management's Discussion and Analysis of Financial Condition and
Results Operations" on pages 4 to 19 of the Company's 1997 Annual Report to
Stockholders filed as an exhibit hereto is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
"Management's Discussion and Analysis of Financial Condition and
Results Operations" on pages 4 to 19 of the Company's 1997 Annual Report to
Stockholders filed as an exhibit hereto is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Statements of Financial Condition of Monterey Bay
Bancorp, Inc. and Subsidiary as of December 31, 1997 and 1996 and the related
Consolidated Statements of Operations, Stockholders' Equity and Cash Flows for
each of the years in the three-year period ended December 31, 1997, together
with the related notes and the report of Deloitte and Touche LLP, independent
auditors, on pages 20 to 61 of the Company's 1997 Annual Report to Stockholders
filed as an exhibit hereto, are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 21, 1998,
which will be filed no later than 120 days following the Registrant's Fiscal
Year end. Information concerning executive officers who are not directors is
contained in Part I of this report in reliance on Instruction G of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 21, 1998, excluding the
Compensation Committee Report on Executive Compensation and the Stock
Performance Graph, which will be filed no later than 120 days following the
Registrant's Fiscal Year end.
40
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 21, 1998, which will be filed
no later than 120 days following the Registrant's Fiscal Year end.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 21, 1998, which will be filed
no later than 120 days following the Registrant's Fiscal Year end.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements
The following consolidated financial statements of the registrants and
its subsidiaries are filed as a part of this document under Item 8. Financial
Statements and Supplementary Data.
Consolidated Statements of Financial Condition at December 31, 1997
and 1996.
Consolidated Statements of Operations for each of the years in the
three-year period ended December 31, 1997.
Consolidated Statements of Changes in Stockholders' Equity for each
of the years in the three-year period ended December 31, 1997.
Consolidated Statements of Cash Flows for each of the years in the
three-year period ended December 31, 1997.
Notes to Consolidated Financial Statements.
Independent Auditors' Report.
(a)(2) Financial Statement Schedules
All schedules are omitted because they are not required or are not
applicable or the required information is shown in the consolidated financial
statements or notes thereto.
(a)(3) Exhibits
(a) The following exhibits are filed as part of this report:
3.1 Certificates of Incorporation of Monterey Bay Bancorp, Inc.*
3.2 Bylaws of Monterey Bay Bancorp, Inc.*
4.0 Stock Certificate of Monterey Bay Bancorp, Inc.*
10.1 Form of Employment Agreement between Watsonville Federal Savings
and Loan Association and certain executive officers*
10.2 Form of Employment Agreement between Monterey Bay Bancorp, Inc.
and certain executive officers*
10.3 Form of Change in Control Agreement between Watsonville Federal
Savings and Loan Association and certain executive officers*
10.4 Form of Change in Control Agreement between Monterey Bay Bancorp,
Inc. and certain executive officers*
41
<PAGE>
10.5 Form of Watsonville Federal Savings and Loan Association of
Employee Severance Compensation Plan*
10.6 Watsonville Federal Savings 401(k) Plan*
10.7 Watsonville Federal Savings and Loan Association 1995 Retirement
Plan for Executive Officers and Directors*
10.8 Form of Watsonville Federal Savings and Loan Association
Performance Equity Program for Executives**
10.9 Form of Watsonville Federal Savings and Loan Association
Recognition and Retention Plan for Outside Directors**
10.10 Form of Monterey Bay Bancorp, Inc. 1995 Incentive Stock Option
Plan**
10.11 Form of Monterey Bay Bancorp, Inc. 1995 Stock Option Plan for
Outside Directors**
11 Computation of Per Share Earnings
13 Monterey Bay Bancorp, Inc. 1997 Annual Report to Shareholders
21 Subsidiary information is incorporated herein by reference to
"Part I - Subsidiaries."
23 Consent of Deloitte & Touche LLP
27 Financial Data Schedule
(b) Report on Form 8-K
The Registrant did not file any reports on Form 8-K during
the last quarter of the fiscal year ended December 31, 1997.
* Incorporated herein by reference from the Exhibits to the
Registration Statement on Form S-1, as amended, filed on September
21, 1994, Registration No. 33-84272.
** Incorporated herein by reference from the Proxy Statement for the
Annual Meeting of Stockholders' filed on July 26, 1995.
42
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MONTEREY BAY BANCORP, INC.
Date: March 30, 1998 By: /s/ Marshall G. Delk
_____________________ ______________________________
Marshall G. Delk
President, Chief Operating Officer
and Director
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities
and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S><C>
/s/ Marshall G. Delk President, Chief Operating Officer March 30, 1998
_________________________ and Director (principal executive officer) ______________
Marshall G. Delk
/s/ Deborah R. Chandler Senior Vice President, Chief March 30, 1998
_________________________ Financial Officer and Treasurer ______________
(principal accounting officer)
Deborah R. Chandler
/s/ Eugene R. Friend Chairman of the Board of Directors March 30, 1998
_________________________ and Chief Executive Officer ______________
Eugene R. Friend
/s/ P.W. Bachan Director March 30, 1998
_________________________ ______________
P. W. Bachan
/s/ Edward K. Banks Director March 30, 1998
_________________________ ______________
Edward K. Banks
/s/ Nicholas C. Biase Director March 30, 1998
_________________________ ______________
Nicholas C. Biase
/s/ Steven Franich Director March 30, 1998
_________________________ ______________
Steven Franich
/s/ Donald K. Henrichsen Director March 30, 1998
_________________________ ______________
Donald K. Henrichsen
/s/ Stephen Hoffmann Director March 30, 1998
_________________________ ______________
Stephen Hoffmann
/s/ Gary L. Manfre Director March 30, 1998
_________________________ ______________
Gary L. Manfre
/s/ McKenzie Moss Director March 30, 1998
_________________________ ______________
McKenzie Moss
/s/ Louis Resetar, Jr. Director March 30, 1998
_________________________ ______________
Louis Resetar, Jr.
</TABLE>
43
Exhibit No. 11. Statement re: Computation of Per Share Earnings for the
years ended December 31, 1997, 1996, and 1995 (dollars in thousands except
per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S><C>
Net income(1) $ 1,766 $ 852 $ 545
======= ===== =====
Weighted average shares outstanding 3,021,983 3,087,495 3,290,765
Common stock equivalents due to dilutive
effect of stock options 103,091 35,896 -
-------- ------- ------
Diluted weighted average common
shares outstanding 3,125,074 3,123,481 3,290,765
========= ========= =========
Basic earnings per share $ 0.58 $ 0.27 $ 0.17
====== ====== ======
Diluted earnings per share $ 0.56 $ 0.27 $ 0.17
====== ====== ======
</TABLE>
(1) The Company's common stock was issued February 14, 1995 in connection with
the Conversion of Monterey Bay Bank (formerly Watsonville Federal Savings
and Loan Association) from mutual to stock form. Net income and common
shares outstanding for the period from February 15, 1995, the date of the
Conversion, to December 31, 1995 were used to compute 1995 earnings per
share.
CONTENTS
PAGE
LETTER TO SHAREHOLDERS.................................................. 1
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA.......................... 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................... 4
INDEPENDENT AUDITORS' REPORT............................................ 20
FINANCIAL STATEMENTS:
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION....................... 21
CONSOLIDATED STATEMENTS OF OPERATIONS................................ 22
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY...................... 23
CONSOLIDATED STATEMENTS OF CASH FLOWS................................ 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.............................. 26
QUARTERLY FINANCIAL INFORMATION......................................... 60
BOARD OF DIRECTORS, EXECUTIVE OFFICERS AND BANKING OFFICES.............. 61
SHAREHOLDER INFORMATION................................................. 62
i
<PAGE>
Dear Fellow Shareholders:
Monterey Bay Bancorp, Inc. (the "Company") completed another eventful
year in 1997. In January, the Company's wholly owned subsidiary, Monterey Bay
Bank, opened its seventh full service financial services branch in Capitola,
California. In December, the Company announced the purchase and assumption of
approximately $29 million of loans and deposits from Commercial Pacific Bank,
FSB, which, subject to regulatory approval, should be completed during the
second quarter of 1998. In 1997, the Company paid two semi-annual cash dividends
totaling $ 0.11 per share. Toward managing a surplus capital position, the
Company announced a third 5% stock repurchase program. Most significantly, the
common stock of the Company closed at $19.50 per share on December 31, 1997
compared to $14.75 per share on December 31, 1996, resulting in a 32%
appreciation in value for the year.
Net income for 1997 increased to $1,766,000 or $0.58 per basic share,
compared to $852,000 or $0.27 per basic share in 1996. Net income for 1996 was
reduced by a $1.4 million pre-tax charge ($815,000 net of taxes) due to the
Federal Deposit Insurance Corporation special assessment to recapitalize the
Savings Association Insurance Fund. Excluding the special assessment, the
predominant cause of the improvement in earnings from 1996 to 1997 was growth in
the average balance sheet stemming from the December 1996 assumption of $102.1
million in deposits. Cash proceeds were subsequently reinvested in
mortgage-backed securities, investment securities, and loans.
While total assets at year end declined by $17.6 million from the
previous year period, average interest-earning assets increased by $76.2 million
and interest-bearing liabilities increased by $84.1 million. At the same, time,
the net interest rate spread increased to 2.45% for the year ended December 31,
1997, from 2.39% a year earlier. The Bank was successful in reducing the cost of
deposits from 24 basis points over the 11th district cost of funds at December
31, 1996 to 2 basis point above at December 31, 1997. This came about as a
result of a continued increase in low cost checking accounts and an aggressive
pricing approach to maturing time deposits. The average yield on loans
receivable increased to 7.91% in 1997, from 7.78% a year earlier, primarily due
to the origination of higher yield construction, commercial real estate, and
multi-family loans during 1997. The weighted average yield on loans originated
in 1997 was 8.75%. The combination of these factors resulted in a $1,611,000
increase in net interest income, before provision for loan losses, during 1997.
Continued emphasis will be placed on both expanding the balance sheet of the
Company, and increasing the net interest spread.
OUTLOOK
The focus of management will be on further deploying the Company's
available capital and, in so doing, increasing the return on equity. Management
will strive to accomplish this goal by a combination of pursuing growth
opportunities, further reinvesting of mortgage-backed securities and investment
securities into higher yielding loans, and a continued focus on attracting low
cost transaction deposit accounts. We look forward to reporting future
successes.
EUGENE R. FRIEND MARSHALL G. DELK
CHAIRMAN OF THE BOARD PRESIDENT, AND CHIEF OPERATING OFFICER
AND CHIEF EXECUTIVE OFFICER
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data set forth below is derived in
part from, and should be read in conjunction with, the Consolidated Financial
Statements and Related Notes of the Company (dollars in thousands).
<TABLE>
<CAPTION>
AT DECEMBER 31,
-----------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------- ------------ ------------ ------------
<S><C>
SELECTED FINANCIAL CONDITION DATA:
Total assets......................... $408,096 $425,762 $329,768 $298,278 $252,389
Loans receivable held for sale....... 514 130 92 16,082 58,875
Investment securities available
for sale......................... 40,355 49,955 30,990 19,703 8,235
Investment securities held to
maturity......................... 145 404 790 395 -
Mortgage-backed securities available
for sale......................... 70,465 116,610 52,417 13,523 32,218
Mortgage-backed securities held to
maturity......................... 142 173 205 160 177
Loans receivable held for
investment, net(1)............... 263,751 233,208 228,387 227,423 132,703
Deposits............................. 320,559 318,145 215,284 214,310 218,342
FHLB advances........................ 32,282 46,807 46,520 59,782 10,000
Securities sold under agreements to
repurchase....................... 5,200 13,000 17,361 - -
Stockholders' equity................. 47,933 45,759 47,604 23,249 23,073
Nonperforming assets................. 2,219 1,393 1,545 711 1
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
<S><C>
SELECTED OPERATING DATA:
Interest income.......................... $29,677 $23,986 $22,544 $17,727 $16,048
Interest expense......................... 18,413 14,333 14,227 9,841 8,253
------- ------- ------- ------- -------
Net interest income before provision for
loan losses.......................... 11,264 9,653 8,317 7,886 7,795
Provision for loan losses................ 375 28 663 421 220
------- ------- ------- ------- -------
Net interest income after provision
for loan losses...................... 10,889 9,625 7,654 7,465 7,575
Noninterest income....................... 1,614 941 573 1,048 1,961
General and administrative expenses(2)... 9,507 9,091 7,140 6,316 5,235
------- ------- ------- ------- -------
Income before income tax expense......... 2,996 1,475 1,087 2,197 4,301
Income tax expense....................... 1,230 623 414 949 1,786
------- ------- ------- ------- -------
Net income............................... $ 1,766 $ 852 $ 673 $1,248 $2,515
======= ======= ======= ====== ======
Basic earnings per share(3) (4).......... $ .58 $ .27 $ .17 N/A N/A
======= ======= ======= ====== ======
Diluted earnings per share(3) (4) ....... $ .56 $ .27 $ .17 N/A N/A
======= ======= ======= ====== ======
</TABLE>
(1) The allowance for estimated loan losses at December 31, 1997, 1996,
1995, 1994 and 1993 was $1,669,000, $1,311,000 $1,362,000, $808,000,
and $387,000, respectively.
(2) General and administrative expenses for 1996 include a non-recurring
special insurance premium assessment of $1.4 million.
(3) Net income per share is meaningful only for the twelve months ended
December 31, 1997, 1996 and 1995, since the Company's common stock was
issued February 14, 1995 in connection with the Conversion of Monterey
Bay Bank (formerly Watsonville Federal Savings and Loan Association) from
mutual to stock form. Net income and common shares outstanding for the
period from February 15, 1995 to December 31, 1995 were used to compute
net income per share for the year ended December 31, 1995.
(4) In December 1997, the Company adopted SFAS No. 128, "Measurement of
Earnings Per Share," which replaces "primary" and "fully diluted"
earnings per share with "basic" and "diluted" earnings per share. Prior
periods have been restated to reflect this change.
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED
DECEMBER 31,
--------------------------------------------------------------------
1997 1996 1995 1994 1993
------------- ------------- ------------- ------------- ------------
<S><C>
SELECTED FINANCIAL RATIOS AND OTHER DATA(1):
PERFORMANCE RATIOS:
Return on average assets...................... .43% .26% .21% .45% 1.03%
Return on average stockholders' equity........ 3.87% 1.83% 1.49% 5.45% 11.47%
Average equity to average assets.............. 10.99% 13.98% 14.04% 8.33% 8.96%
Equity to total assets at end of period....... 11.75% 10.75% 14.44% 7.79% 9.14%
Average interest rate spread(2)............... 2.45% 2.39% 1.98% 2.73% 2.98%
Net interest margin(3)........................ 2.83% 3.00% 2.65% 2.96% 3.27%
Average interest-earning assets to
average interest-bearing liabilities....... 108.45% 113.76% 114.94% 107.40% 108.49%
General and administrative expenses to
average assets............................. 2.29% 2.74% 2.22% 2.23% 2.14%
REGULATORY CAPITAL RATIOS:
Tangible capital.............................. 9.39% 8.28% 11.65% 7.74% 8.69%
Core capital.................................. 9.40% 8.36% 11.83% 8.03% 9.14%
Risk-based capital............................ 17.24% 19.22% 24.42% 15.50% 18.70%
ASSET QUALITY RATIOS:
Nonperforming loans as a percent of
gross loans receivable(4)(5)............... .71% .59% 1.39% .29% NM(6)
Nonperforming assets as a percent of
total assets(5)............................ .54% .33% .97% .24% NM(6)
Allowance for loan losses
as a percent of gross loans receivable(4) .63% .56% .59% .33% .20%
Allowance for loan losses
as a percent of nonperforming loans(5)... 87.98% 94.10% 42.56% 113.64% NM(6)
NUMBER OF FULL-SERVICE CUSTOMER
FACILITIES.................................... 7 6 6 6 6
</TABLE>
- ------------------------
(1) Regulatory Capital Ratios and Asset Quality Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based
on average daily balances during the indicated periods and are annualized
where appropriate.
(2) The average interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted
average cost of interest-bearing liabilities.
(3) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(4) Gross loans receivable includes loans receivable held for investment and
loans held for sale, less undisbursed loan funds, deferred loan fees and
unamortized discounts/premiums.
(5) Nonperforming assets consist of nonperforming loans (nonaccrual loans and
restructured loans not performing in accordance with their restructured
terms) and REO. REO consists of real estate acquired through foreclosure
and real estate acquired by acceptance of a deed-in-lieu of foreclosure.
(6) At December 31, 1993, the Company had $1,000 of nonperforming loans and
no other nonperforming assets. Accordingly, referenced ratio data would
not be meaningful.
2
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Monterey Bay Bancorp, Inc. (the "Company") is a savings and loan
holding company incorporated in 1994 under the laws of the State of Delaware.
The Company was organized as the holding company for Monterey Bay Bank ("the
Bank") in connection with the Bank's conversion from the mutual to stock form of
ownership. On February 14, 1995, the Company issued and sold 3,593,750 shares of
its common stock at an issuance price of $8.00 per share to complete the
conversion. Net proceeds to the Company, including shares purchased by the
employee stock ownership plan, were $27.1 million, after deduction of conversion
expenses and underwriting fees of $1.6 million. The Company used $13.5 million
of the net proceeds to acquire all of the stock of the Bank. The Bank owns a
subsidiary, Portola Investment Corporation ("Portola"), which sells insurance
and brokerage services.
The Company's primary business is providing conveniently located
deposit facilities to attract checking, money market, savings and certificate of
deposit accounts, and investing such deposits and other available funds in
mortgage loans secured by one- to four-family residences and, to a lesser
extent, construction, commercial real estate, and business loans. The Bank's
deposit gathering and lending markets are primarily concentrated in the
communities surrounding its full service offices located in Santa Cruz,
Monterey, and Santa Clara counties, in California. At December 31, 1997, the
Bank had seven full service offices and one real estate loan office.
The most significant component of the Company's revenue is net
interest income. Net interest income is the difference between interest income,
primarily from loans, mortgage-backed securities, and the investment portfolio,
and interest expense, primarily on deposits and borrowings. The Company's net
interest income and net interest margin, which is defined as net interest income
divided by average interest-earning assets, are affected by its asset growth and
quality, its asset and liability composition, and the general interest rate
environment.
The Company's service charges, mortgage loan servicing fees, and
commissions from the sale of insurance products and investments through its
wholly owned subsidiary also have significant effects on the Company's results
of operations. General and administrative expenses consist primarily of employee
compensation, occupancy expenses, federal deposit insurance premiums, data
processing fees and other operating expenses. The Company's results of
operations are also significantly affected by general economic and competitive
conditions, particularly changes in market interest rates, government policies,
and actions of regulatory agencies. The Company exceeded all of its regulatory
capital requirements at December 31, 1997.
A relatively stable interest rate environment prevailed during the
first nine months of 1997, followed by a fourth quarter during which long-term
market interest rates declined to the lowest level in recent years. In the
fourth quarter, as a consequence of the declining interest rate environment, the
market value of the Company's longer-term assets significantly increased (see
"Asset and Liability Management" and "Net Interest Income"). Throughout the
year, the Company focused its efforts on changing its mix of interest-earning
assets by emphasizing construction, commercial real estate, and business lending
activities, which resulted in increased loan yields.
Financial results for 1997 were impacted by the cash assumption, during
the fourth quarter of 1996, of $102.1 million of savings deposits (the "Deposit
Assumption"). Cash proceeds from the Deposit Assumption were subsequently
reinvested in mortgage-backed securities, other investments, and loans,
resulting in higher net interest income for 1997 compared to 1996.
Also impacting 1997 financial results was the Company's purchase of a
branch site in Capitola, California. The new branch office began operations as a
full service bank branch in January 1997, resulting in increased general and
administrative expenses during 1997. As expected, the planned long-term benefits
of this expansion activity, increased net interest margin and fee income, have
lagged behind the increase in expenditures.
3
<PAGE>
The Company intends to pursue a growth strategy by focusing on internal
growth, as well as acquisition opportunities. As part of this strategy, the
Company is changing the mix of its assets and liabilities to become more like a
community-based retail bank. The Company may acquire (i) other financial
institutions or branches thereof, (ii) branch facilities, (iii) mortgage loan
servicing portfolios or mortgage banking operations, or (iv) other substantial
assets or deposits liabilities, all of which would be subject to prior
regulatory approval. Also, as part of the growth strategy, the Company engages
from time to time in discussions concerning possible acquisitions. However,
there can be no assurance that the Company will be successful in identifying,
acquiring or assimilating appropriate acquisition candidates, in implementing
its internal growth strategy, or that these activities will result in improved
financial performance.
On December 22, 1997, as part of its growth strategy, the Company
entered into an agreement with Commercial Pacific Bank ("CPB") to assume
approximately $29.0 million in deposits and to acquire certain related assets.
The agreement also calls for the Company to make a $5.0 million loan to the
parent holding company of CPB. Consummation of this transaction, which is
subject to customary conditions, is expected to occur during the second quarter
of fiscal 1998.
SAFE HARBOR STATEMENT FOR FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements, which are based on certain assumptions and describe future plans,
strategies, and expectations of the Company, are generally identifiable by use
of the words "believe," "expect," "intend," "anticipate," "estimate," "project"
or similar expressions. The Company's ability to predict results or the actual
effect of future plans or strategies is inherently uncertain. Factors which
could have a material adverse affect on the operations and future prospects of
the Company include, but are not limited to, changes in: interest rates, general
economic conditions, legislative/regulatory changes, monetary and fiscal
policies of the U.S. Government, including policies of the U.S. Treasury and the
Board of Governors of the Federal Reserve System, the quality or composition of
the loan or investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in the Company's market area and
accounting principles, policies and guidelines. These risks and uncertainties
should be considered in evaluating forward-looking statements and undue reliance
should not be placed on such statements. Further information concerning the
Company and its business, including additional factors that could materially
affect the Company's financial results, is included in the Company's filings
with the Securities and Exchange Commission.
ASSET AND LIABILITY MANAGEMENT
The results of operations for savings institutions may be materially
and adversely affected by changes in prevailing economic conditions, including
rapid changes in interest rates, declines in real estate market values, and the
monetary and fiscal policies of the federal government. Like all financial
institutions, the Company's net interest income and its NPV (net present value
of assets, liabilities and off-balance sheet contracts) are subject to
fluctuations in interest rates. Currently, the Company's interest-bearing
liabilities, consisting primarily of savings deposits, FHLB advances, and other
borrowings, mature or reprice more rapidly, and on different terms, than do its
interest-earning assets. The fact that liabilities mature or reprice more
frequently on average than assets may be beneficial in times of declining
interest rates; however, such an asset/liability structure may result in
declining net interest income during periods of rising interest rates.
Additionally, the extent to which borrowers prepay loans is affected by
prevailing interest rates.
When interest rates increase, borrowers are less likely to prepay
loans; whereas when interest rates decrease, borrowers are more likely to prepay
loans. Prepayments may affect the levels of loans retained in an institution's
portfolio, as well as its net interest income. The Company maintains an asset
and liability management program intended to manage net interest income through
interest rate cycles and to protect its NPV by controlling its exposure to
changing interest rates.
The Company uses a simulation model designed to measure the sensitivity
of net interest income and NPV to changes in interest rates. This simulation
model is designed to enable the Company to generate a
4
<PAGE>
forecast of net interest income and NPV given various interest rate forecasts
and alternative strategies. The model is also designed to measure the
anticipated impact that prepayment risk, basis risk, customer maturity
preferences, volumes of new business and changes in the relationship between
long- and short-term interest rates have on the performance of the Company. At
December 31, 1997, the Company calculated that its NPV was $47.1 million,
compared with $39.6 million at December 31, 1996, and that its NPV would
decrease by 24% and 51%, respectively, if interest rate levels generally were to
increase by 2% and 4%. These calculations, which are highly subjective and
technical, may differ materially from regulatory calculations. See "Notes to
Consolidated Financial Statements - Regulatory Capital Requirements and Other
Regulatory Matters."
The Company also uses gap analysis, a traditional analytical tool
designated to measure the difference between the amount of interest-earning
assets and the amount of interest-bearing liabilities expected to mature or
reprice in a given period. At December 31, 1997, the Company calculated its
one-year cumulative gap position to be a negative 7.4% and its three-year gap
position to be a negative 14.6%. Management is evaluating strategies to reduce
its cumulative gap positions in future periods. There can be no assurance that
the Company will be successful in either decreasing its liability costs or
reducing its gap positions and that its net interest income incline will not
decline.
During the year ended December 31, 1997, management pursued strategies
to increase its NPV and to reduce the impact of changes in interest rates on the
NPV. These strategies included extending maturities of deposits and borrowings,
originating and retaining variable-rate mortgages and mortgage loans with
frequent repricing features, and selling fixed-rate mortgage-backed securities
currently held in the available-for-sale portfolio. They also resulted in
realized losses on certain mortgage-backed securities sales and lower net
interest income. During the year ended December 31, 1997, NPV increased, due
primarily to an increase in the value of long-term assets and a change in the
loan mix.
The Company is continuing to pursue strategies to reduce the level of
interest rate risk while also endeavoring to increase its net interest income
through the origination and retention of variable-rate consumer, business,
construction and commercial real estate loans which generally have higher yields
than residential permanent loans.
5
<PAGE>
The following table sets forth the estimated maturity/repricing and the
resulting gap between the Company's interest-earning assets and interest-bearing
liabilities at December 31, 1997. The estimated maturity/repricing amounts
reflect contractual maturities and amortization, assumed loan prepayments based
upon the Company's historical experience, estimates from secondary market
sources, and estimated passbook deposit decay rates.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
-------------------------------------------------------------------------------------
MORE THAN 3 MORE THAN 1 MORE THAN 3 OVER NON-
3 MONTHS MONTHS TO YEAR TO YEARS TO FIVE INTEREST
OR LESS 1 YEAR 3 YEARS 5 YEARS YEARS BEARING TOTAL
-------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S><C>
INTEREST-EARNING ASSETS (1):
Federal funds sold and other
short-term investments............. $ 13,514 $ - $ - $ - $ - $ - $ 13,514
Investment securities, net(2)(3)(5)... 15,179 - - 19,035 6,385 - 40,599
Loans receivable(2)(4)(5)............. 92,121 67,930 27,655 31,369 45,261 - 264,336
Mortgage-backed securities(2)(5)...... 5,043 15,129 40,348 10,087 - - 70,607
FHLB stock............................ 3,383 - - - - - 3,383
-------- -------- -------- -------- -------- ------- --------
Total interest-earning assets...... 129,240 83,059 68,003 60,491 51,646 - 392,439
Allowance for loan losses............. (581) (429) (175) (198) (286) - (1,669)
-------- -------- -------- -------- -------- ------- --------
Net interest-earning assets........ 128,659 82,630 67,828 60,293 51,360 - 390,770
Noninterest-earning assets............ - - - - - 17,326 17,326
-------- -------- -------- -------- -------- ------- --------
Total assets................... $128,659 $ 82,630 $ 67,828 $ 60,293 $ 51,360 $17,326 $408,096
======== ======== ======== ======== ======== ======= ========
INTEREST-BEARING LIABILITIES:
Money market deposit.................. 5,531 16,593 9,481 - - - 31,605
Passbook deposits..................... 847 2,541 6,777 3,388 - - 13,553
Checking accounts..................... 1,333 3,998 10,663 5,331 - - 21,325
Certificate accounts.................. 56,833 128,471 65,866 2,906 - - 254,076
FHLB advances......................... 10,000 12,100 2,600 - 7,582 - 32,282
Securities sold under agreements
to repurchase...................... 3,200 - 2,000 - - - 5,200
-------- -------- -------- -------- -------- ------- --------
Total interest-bearing liabilities.... 77,744 163,703 97,387 11,625 7,582 - 358,041
Noninterest-bearing liabilities....... - - - - - 2,122 2,122
Equity................................ - - - - - 47,933 47,933
-------- -------- -------- -------- -------- ------- --------
Total liabilities and equity....... $ 77,744 $163,703 $ 97,387 $ 11,625 $ 7,582 $50,055 $408,096
======== ======== ======== ======== ======== ======= ========
Interest sensitivity gap(6).............. $ 50,915 $(81,073) $(29,559) $ 48,668 $ 43,778
======== ========= ======== ========== ========
Cumulative interest sensitivity gap...... $ 50,915 $(30,158) (59,717) $ (11,049) $ 32,729
======== ========= ======== ========== ========
Cumulative interest sensitivity gap as
a percent of total assets............. 12.48% (7.39%) (14.63%) (2.71%) 8.02%
====== ======= ======== ======= =====
Cumulative net interest-earning assets
as a percent of cumulative interest
bearing liabilities................... 165.49% 87.51% 82.38% 96.85% 109.14%
======= ====== ====== ====== =======
</TABLE>
- ------------------------
(1) Interest-earning assets are included in the period in which the balances
are expected to be redeployed and/or repriced as a result of anticipated
early payoffs, scheduled rate adjustments, and contractual maturities.
(2) Includes assets available for sale.
(3) Includes a $99,000 certificate of deposit with an original maturity of
greater than 90 days.
(4) For purposes of the gap analysis, mortgage and other loans are reduced for
loans greater than 90 days past due ($1,598,000 at December 31, 1997) but
are not reduced for the allowance for loan losses.
(5) Investments and mortgage-backed securities are at fair market value.
Assets are reported net of unearned (discount) premium and deferred loan
fees.
(6) The interest sensitivity gap represents the difference between
interest-earning assets and interest-bearing liabilities.
6
<PAGE>
NET INTEREST INCOME
The largest source of the Company's revenue is net interest income. Net
interest income is interest earned on loans and investments less interest
expense on deposit accounts and borrowings. Changes in net interest income
result from changes in volume, net interest spread, and net interest margin.
Volume refers to the dollar level of interest-earnings assets and
interest-bearing liabilities. Net interest spread refers to the difference
between the yield on interest-earning assets and the rate paid on
interest-bearing liabilities. Net interest margin refers to net interest income
divided by total interest-earning assets and is influenced by the level and
relative mix of interest-earning assets and interest-bearing liabilities.
During the years ended December 31, 1997, 1996, and 1995, net interest
income before the provision for loan losses was $11.3 million, $9.7 million, and
$8.3 million, respectively. The volume of average interest-earning assets over
the same years was $397.5 million, $321.4 million, and $313.3 million,
respectively. The net interest spread was 2.45%, 2.39%, and 1.98%, respectively,
during the years ended December 31, 1997, 1996, and 1995. During these same
periods, the net interest margin was 2.83%, 3.00%, and 2.65%, respectively.
For the year ended December 31, 1997, the $1.6 million, or 16.5%,
increase in the Company's net interest income was due primarily to the Deposit
Assumption, which resulted in an increase in the average outstanding balance of
mortgage-backed securities and loans, partly offset by an increase in average
savings deposits. The volume-related increase in net interest income was
partially offset by the effect of a decrease in the net interest margin from
3.00% in 1996 to 2.83% in 1997. The decrease in the net interest margin was
primarily attributable to a decrease in the proportion of funding provided by
noninterest-bearing sources of funds, from 15% in 1996 to 12% in 1997.
For the year ended December 31, 1996, the increase in net interest
income, compared to 1995, was primarily due to an increase in the yield on
interest-earning assets coupled with a decrease in the cost of deposits and
borrowings.
7
<PAGE>
AVERAGE BALANCES, AVERAGE RATES, AND NET INTEREST MARGIN
The following table sets forth certain information relating to the
Company for the fiscal years ended December 31, 1997, 1996 and 1995. The yields
and costs are derived by dividing income or expense by the average balance of
assets or liabilities, respectively, for the periods shown. Average balances are
derived from average daily balances. The yields and costs include fees which are
considered adjustments to yields.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------------- -------------------------------- --------------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
----------- -------- -------- ----------- -------- --------- ----------- -------- ---------
(DOLLARS IN THOUSANDS)
<S><C>
ASSETS:
Interest-earning assets:
Federal funds sold
and other short-term
investments............... $ 4,272 $ 231 5.42% $ 3,612 $ 252 6.97% $ 4,299 $ 276 6.43%
Investment securities,
net(1)(2)................. 46,248 2,899 6.27% 37,593 2,314 6.15% 33,309 2,228 6.69%
Loans receivable(3)(6)(7) 250,370 19,804 7.91% 231,530 18,015 7.78% 241,744 17,826 7.37%
Mortgage-backed securities,
net(1).................... 92,842 6,510 7.01% 45,635 3,224 7.06% 31,291 2,080 6.65%
FHLB stock................. 3,793 233 6.14% 2,986 181 6.08% 2,657 134 5.06%
-------- ------- -------- ------- -------- -------
Total interest-earning
assets.................. 397,525 $29,677 7.47% 321,356 $23,986 7.46% 313,300 $22,544 7.20%
======= ======= =======
Non interest-earning assets 17,347 10,849 8,666
-------- -------- --------
Total assets............. $414,872 $332,205 $321,966
======== ======== ========
LIABILITIES AND
STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Money market deposits.... $ 34,612 $ 1,344 3.88% $ 19,387 $ 695 3.58% $ 14,619 $ 395 2.70%
Passbook deposits........ 13,396 254 1.89% 13,381 254 1.90% 15,048 308 2.04%
Checking accounts........ 17,925 87 .49% 13,485 78 0.58% 10,781 120 .80%
Certificate accounts..... 251,855 13,842 5.50% 177,964 9,922 5.58% 171,878 9,779 5.69%
-------- ------- -------- ------- -------- -------
Total savings accounts... 317,788 15,527 4.89% 224,217 10,949 4.88% 212,326 10,602 4.99%
FHLB advances............ 40,520 2,400 5.92% 43,619 2,509 5.75% 45,744 2,746 6.00%
Securities sold under
agreements to repurchase 8,234 486 5.91% 14,644 875 5.98% 14,497 879 6.06%
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities........... 366,542 $18,413 5.02% 282,480 $14,333 5.07% 272,567 $14,227 5.22%
======= ======= =======
Noninterest-bearing
liabilities................ 2,750 3,284 4,231
-------- -------- --------
Total liabilities...... 369,292 285,764 276,798
Stockholders' equity........ 45,580 46,441 45,168
-------- -------- --------
Total liabilities and
stockholders' equity.... $414,872 $332,205 $321,966
======== ======== ========
Net interest rate spread(4) 2.45% 2.39% 1.98%
spread(4)............
Net interest margin(5)...... 2.83% 3.00% 2.65%
Ratio of interest-earning
assets to interest-bearing
liabilities................ 108.45% 113.76% 114.94%
</TABLE>
- ------------------------
(1) Includes related assets available for sale and unamortized discounts and
premiums.
(2) Amount includes certificate of deposit with an original maturity of greater
than 90 days.
(3) Amount is net of deferred loan fees, loan discounts and premiums, loans in
process, and loan loss allowances, and includes loans held for sale.
(4) Net interest rate spread represents the difference between the yield on
average interest-earning assets and the cost of average interest-bearing
liabilities.
(5) Net interest margin represents net interest income divided by average
interest-earning assets.
(6) For purposes of these calculations, the nonaccruing loans receivable have
been included in the average balances.
(7) Loan fees recognized for the years ended December 31, 1997, 1996, and 1995
were $293,000, $217,000, and $580,000, respectively.
8
<PAGE>
RATE/VOLUME ANALYSIS
The following table presents the extent to which changes in interest
rates and changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by prior rate); (ii) changes attributable to changes in rate (changes
in rate multiplied by prior volume); and (iii) the net change. The changes
attributable to the combined impact of volume and rate have been allocated
proportionately to the changes due to volume and the changes due to rate.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
COMPARED TO
YEAR ENDED DECEMBER 31, 1996
----------------------------------------------
INCREASE (DECREASE) DUE TO
AVERAGE
VOLUME RATE NET
-------------- -------------- --------------
<S><C>
INTEREST-EARNING ASSETS:
Federal funds sold and
other short-term investments.................. $ 46 $ (67) $ (21)
Investment securities, net (1)(2)................ 532 53 585
Loans receivable, net(2) ........................ 1,466 323 1,789
Mortgage-backed securities, net(2) .............. 3,333 (47) 3,286
FHLB stock....................................... 49 3 52
------ ------ ------
Total interest-earning assets................ 5,426 265 5,691
------ ------ ------
INTEREST-BEARING LIABILITIES:
Money market deposits............................ 545 104 649
Passbook deposits................................ - - -
Checking accounts................................ 26 (17) 9
Certificate accounts............................. 4,123 (203) 3,920
FHLB advances.................................... (178) 69 (109)
Securities sold under agreements to repurchase... (383) (6) (389)
------ ------ ------
Total interest-bearing liabilities........... 4,133 (53) 4,080
------ ------ ------
Net change in net interest income................... $1,293 $ 318 $1,611
====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
COMPARED TO
YEAR ENDED DECEMBER 31, 1995
---------------------------------------------
INCREASE (DECREASE) DUE TO
AVERAGE
VOLUME RATE NET
------------- ------------- --------------
<S><C>
INTEREST-EARNING ASSETS:
Federal funds sold and
other short-term investments.................. $ (41) $ 17 $ (24)
Investment securities, net (1)(2)................ 358 (272) 86
Loans receivable, net(2) ........................ (1,019) 1,208 189
Mortgage-backed securities, net(2) .............. 963 181 1,144
FHLB stock....................................... 19 28 47
------- ------ -------
Total interest-earning assets................ 280 1,162 1,442
------- ------ -------
INTEREST-BEARING LIABILITIES:
Money market deposits............................ 150 150 300
Passbook deposits................................ (33) (21) (54)
Checking accounts................................ 12 (54) (42)
Certificate accounts............................. 356 (213) 143
FHLB advances.................................... (125) (112) (237)
Securities sold under agreements to repurchase... 8 (12) (4)
------- ------ -------
Total interest-bearing liabilities........... 368 (262) 106
------- ------ -------
Net change in net interest income................... $ (88) $1,424 $1,336
======== ====== ======
</TABLE>
- ------------------------
(1) Includes certificates of deposit with original maturities greater than 90
days.
(2) Includes assets available for sale.
9
<PAGE>
17
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997 AND
DECEMBER 31, 1996
OVERVIEW
The Company recorded net income of $1.8 million, or $0.58 per basic
share ($0.56 per share diluted) for the year ended December 31, 1997, compared
to $852,000, or $0.27 per basic share ($0.27 per share diluted) for the year
ended December 31, 1996. Net income for the year ended December 31, 1996 was
reduced by a $1.4 million pre-tax charge ($815,000 net of taxes) for the amount
of the Federal Deposit Insurance Corporation ("FDIC") special assessment to
recapitalize the Savings Association Insurance fund ("SAIF"). Excluding the SAIF
charge, net income would have been $1.7 million, or $0.53 per basic and diluted
share for the year ended December 31, 1996.
Net income for the year ended December 31, 1997 reflected higher net
interest income and noninterest income compared to the year ended December 31,
1996, offset by a higher provision for loan losses and increases in general and
administrative expenses. The operating results of the Company for the year ended
December 31, 1997 were influenced by the December 1996 assumption of $102.1
million of savings deposits. Cash proceeds from the Deposit Assumption were
subsequently reinvested in mortgage-backed securities, other investment
securities, and loans receivable, resulting in higher net interest income for
the year ended December 31, 1997, compared to 1996. Net interest income before
the provision for loan losses was $11.3 million for the year ended December 31,
1997, compared to $9.7 million for the year ended December 31, 1996. During the
same periods, the average volume of interest-earning assets was $397.5 million
and $321.4 million, respectively. The increase in net interest income reflects
the increase in average interest-earning assets during 1997, partly offset by a
higher average balance of interest-bearing savings deposits, due to the Deposit
Assumption. See "Net Interest Income."
Implementation of the Company's strategic decision to transition from a
traditional savings institution to a community banking orientation, and the
expansion of the Company's branch locations and product lines, resulted in an
increase in general and administrative expenses during 1997. Expansion activity
included the Company's purchase of a branch site in Capitola, California, which
began operations as a full service bank branch in January 1997.
The Company's return on average assets for 1997 was 0.43%, compared to
0.26% in 1996. Excluding the SAIF charge, the return on average assets for 1996
would have been .50%. The return on average equity for 1997 was 3.87%, compared
with 1.83% in 1996 (3.56% excluding the SAIF charge).
INTEREST INCOME
For the year ended December 31, 1997, interest income was $29.7
million, an increase of $5.7 million, or 23.4%, over the amount recorded for the
year ended December 31, 1996. The primary reason for the significant increase in
interest income during 1997 was growth in average outstanding balances of
mortgage-backed securities, loans receivable, and investment securities due to
the investment of cash proceeds from the Deposit Assumption in December 1996.
Interest income on mortgage-backed securities was $6.5 million for the year
ended December 31, 1997, approximately double the amount recorded a year
earlier, due to a higher average outstanding balance of mortgage-backed
securities in 1997. Interest income from loans, which accounted for 67% of total
interest income for the year ended December 31, 1997, increased by $1.8 million,
or 10.0%, to $19.8 million in 1997, due to a higher average balance of
outstanding loans receivable and an increase in the average yield earned on
loans receivable. Interest income from other investment securities, federal
funds sold, and FHLB stock increased by $616,000, or 22.2%, for the year ended
December 31, 1997, due to higher average volumes of these assets in 1997
compared to 1996.
The weighted average yield on interest-earning assets was 7.47% for the
year ended December 31, 1997, compared to 7.46% for the year ended December 31,
1996. The average yield earned on loans receivable increased to 7.91% in 1997,
from 7.78% a year earlier, primarily due to the origination of higher yielding
construction, commercial real estate, and one- to four-family loans during 1997.
Yields on mortgage-backed securities declined slightly during 1997 due to higher
prepayments and a corresponding increase in premium amortization.
10
<PAGE>
INTEREST EXPENSE
Interest expense for the year ended December 31, 1997 was $18.4
million, compared to $14.3 million for the year ended December 31, 1996, an
increase of $4.1 million or 28.7%. The increase in interest expense was
primarily attributable to a higher average balance of savings deposits resulting
from the Deposit Assumption and the opening of the Capitola branch office. The
Company's average cost of interest-bearing liabilities declined to 5.02% in
1997, from 5.07% in 1996, primarily due to the effects of a more favorable mix
of savings deposits. During 1997, the average cost of certificate of deposit
accounts declined by .08% to 5.50%. This reduction was primarily due to a stable
to declining interest rate environment which allowed management to lower, on
average, interest rates paid to its customers on maturing and renewing term
deposit accounts. Interest expense on FHLB advances and other borrowings
declined by $498,000, or 14.7%, due to a lower average outstanding balance of
borrowings in 1997.
PROVISION FOR LOAN LOSSES
The allowance for loan losses is maintained at a level considered
appropriate by management and is based on an ongoing assessment of the risks
inherent in the loan portfolio, including commitments to provide financing. The
allowance is increased by the provision for estimated loan losses, which is
charged against current period operating results, and is decreased by the amount
of net loans charged off during the period. In evaluating the adequacy of the
allowance for loan losses, management incorporates such factors as collateral
value, portfolio composition and concentration, and trends in local and national
economic conditions and the related impact on the financial strength of the
Company's borrowers. While the allowance is segmented by broad portfolio
categories to analyze its adequacy, the allowance is general in nature and is
available for the loan portfolio in its entirety. Although management believes
that the allowance for loan losses is adequate, future provisions will be
subject to continuing evaluation of inherent risk in the loan portfolio.
For the year ended December 31, 1997, the provision for loan losses
was $375,000, compared to $28,000 for the year ended December 31, 1996. During
1997, the Company increased its provision for loan losses in connection with
implementing its strategy to moderately increase the amount of construction,
commercial real estate, multifamily, and business lending in Northern
California. These types of loans generally involve a greater risk of loss than
do one- to four-family residential mortgage loans. The provision resulted in a
total allowance for loan losses of $1,669,000, or .63% of loans receivable, at
December 31, 1997, compared to an allowance for loan losses of $1,311,000, or
.56% of loans receivable, at December 31, 1996. Nonperforming loans were $1.9
million, or .71% of loans receivable, at December 31, 1997, compared to $1.4
million, or .59% of loans receivable, a year earlier.
NONINTEREST INCOME
Noninterest income increased by 71.5% to $1.6 million for the year
ended December 31, 1997, compared to $941,000 for the year ended December 31,
1996, primarily due to increases in customer service charges and commissions
from sales of noninsured products during 1997. Customer service charges consist
primarily of service charges on deposit accounts, fees for certain customer
services, and loan-related fees. The increase in customer service charges in
1997 was primarily due to a larger customer base and a higher number of
transaction-related customer deposit accounts. The increase in commission income
from sales of noninsured products reflects the implementation by management of a
strategic business plan to increase sales of these products, which included the
purchase of the assets of an investment firm in 1997.
Loan servicing income was $229,000 and $153,000, respectively, for the
years ended December 31, 1997 and 1996. The outstanding principal balance of
mortgage loans serviced for others was $52.1 million and $61.3 million,
respectively, on December 31, 1997 and 1996. Loan servicing income increased in
1997 due to the expiration, during 1995, of a guaranteed yield maintenance
agreement on loans serviced for another financial institution. During the years
ended December 31, 1997 and 1996, respectively, the Company sold $3.0 million
and $2.6 million of individual conforming loans to FHLMC. Gains on these sales
are included in loan servicing income.
11
<PAGE>
During the years ended December 31, 1997 and 1996, the Company sold
$38.6 million and $8.4 million, respectively, of mortgage-backed securities and
investment securities and recorded net gains of $213,000 and $168,000,
respectively, on the sales.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense was $9.5 million and $9.1 million,
respectively, for the years ended December 31, 1997 and 1996. Included in
general and administrative expense for 1996 was a non-recurring SAIF insurance
premium assessment of $1.4 million. Excluding the SAIF assessment, general and
administrative expense would have been $7.7 million for the year ended December
31, 1996. The increases in 1997 were partially attributable to higher
compensation and employee benefits, as new employees were hired to support the
Company's deposit growth and the expansion of its branch locations and new
product lines and services. In addition, general and administrative expenses for
1997 included higher data processing costs, increased professional fees and
advertising expenses, higher stationery, telephone, and office expenses, and
increased core deposit intangible amortization.
The increases in certain categories of general and administrative
expenses for the year ended December 31,1997 were partially offset by reduced
deposit insurance premiums compared to 1996. Excluding the non-recurring SAIF
assessment, deposit insurance premiums were $233,000 for the year ended December
31, 1997, compared to $532,000 a year earlier.
INCOME TAX EXPENSE
The Company recorded income tax expense of $1.2 million and $623,000,
respectively, for the years ended December 31, 1997 and 1996. Income tax expense
increased in 1997 due to an increase in taxable income compared to the previous
year. The effective tax rate for the year ended December 31, 1997 was 41.1%,
compared to 42.3% for the year ended December 31, 1996.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1997 AND DECEMBER 31, 1996
Total assets of the Company were $408.1 million at December 31, 1997,
compared to $425.8 million at December 31, 1996, a decline of $17.7 million,
or 4.2%.
Cash and overnight deposits increased to $13.5 million at December 31,
1997, from $5.0 million at December 31, 1996. The increase in cash was due to
higher-than-expected prepayments of callable agency securities in the fourth
quarter of 1997, in response to significant declines in market interest rates
(see "General"). The Company expects to reinvest the cash proceeds in investment
securities during the first quarter of 1998.
Mortgage-backed securities and investment securities decreased by $56.0
million, or 33.5%, during 1997. These decreases were partially offset by an
increase of $30.9 million, or 13.3%, in loans receivable during the same period.
During 1997, the Company sold $38.6 million of mortgage-backed securities and
utilized the proceeds, along with principal payments received on mortgage-backed
securities and loans receivable, to fund the growth of the Company's mortgage
loan portfolio and to pay down short term FHLB advances.
Loans receivable held for investment were $263.8 million at December
31, 1997, compared to $233.2 million at December 31, 1996. Residential real
estate loans represent the largest category in the loan portfolio. At December
31, 1997, total one- to four-family and multifamily residential real estate
loans were $228.0 million, or 79% of the loan portfolio. The Company also
engages in nonresidential real estate lending which includes commercial mortgage
loans and construction loans secured by deeds of trust. Construction loans are
made primarily to residential builders and to commercial property developers. At
December 31, 1997, the Company's commercial real estate loan portfolio was $20.2
million, or 7.0% of the loan portfolio. Net construction loans totaled $13.7
million at December 31, 1997.
12
<PAGE>
During the year ended December 31, 1997, the Company's liabilities
decreased by $19.8 million to $360.2 million, from $380.0 million at December
31, 1996. The decrease in liabilities was attributable to a decrease of $22.3
million, or 37.3 %, in total borrowings. Savings deposits increased to $320.6
million at December 31, 1997, compared to $318.1 million at December 31, 1996.
At December 31, 1997, shareholders' equity was $47.9 million, compared
to $45.8 million at December 31, 1996. The increase in equity during 1997 was
primarily due to net income of $1.8 million, an increase in earned ESOP shares,
and a net increase in unrealized gains on securities available for sale. Equity
was reduced during 1997 by the payment of cash dividends totaling $357,000, or
$.11 per share, on the Company's outstanding common stock.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996 AND
DECEMBER 31, 1995
OVERVIEW
The Company recorded net income of $852,000 for the year ended December
31, 1996, compared to $673,000 for the year ended December 31, 1995. Both basic
and diluted earnings per share were $0.27 for the year ended December 31, 1996,
compared to $0.17 per share for the year ended December 31, 1995. Included in
net income for the year ended December 31, 1996 was a non-recurring expense of
$1,387,000 ($815,000 net of taxes) resulting from the federally mandated
recapitalization of the Savings Association Insurance Fund (SAIF) on September
30, 1996. Excluding the non-recurring special insurance premium assessment, net
income would have been $1.7 million, or $.53 per share for the year ended
December 31, 1996. The improvement in earnings in 1996, exclusive of the special
SAIF insurance assessment, was due to higher net interest income, a reduction in
the provision for loan losses, and increased revenue from customer service
charges and mortgage loan servicing income, partially offset by higher
noninterest expenses. Increases in average yields earned on earning assets, in
addition to a decline in the Company's cost of deposits, increased the Company's
net interest margin to 3.00% for the year ended December 31, 1996, from 2.65%
for the year ended December 31, 1995.
The operating results of the Company for the year ended December 31,
1996 were influenced by the December 1996 Deposit Assumption of $102.1 million
of savings deposits for an approximately equivalent amount of cash. The cash was
reinvested in various mortgage-backed securities and other investments. Also
during the fourth quarter of 1996, the Company purchased a former First
Interstate Bank branch in Capitola, California, which began operations as a full
service bank branch on January 6, 1997. The expansion activity resulted in an
increase in general and administrative expenses for the year ended December 31,
1996.
INTEREST INCOME
Interest income for the year ended December 31, 1996 increased by $1.4
million, or 6.4%, to $24.0 million compared to $22.5 million for the year ended
December 31, 1995. Interest income from loans, which accounted for 75.1% of
total interest income for the year ended December 31, 1996, increased by $.2
million, or 1.1%, due to an increase in the Company's weighted average yield on
loans receivable to 7.78% for the year ended December 31, 1996, compared to
7.37% for the previous year, partially offset by a reduction in average
outstanding loan balances during the same period. Interest income on
mortgage-backed securities totaled $3.2 million for the year ended December 31,
1996, an increase of $1.1 million, or 55.0%. This increase was primarily
attributable to a higher average outstanding balance in 1996 and higher
effective yields on mortgage-backed securities resulting from
lower-than-projected prepayment speeds on the underlying mortgages during 1996.
Interest income from other investment securities, federal funds sold, and FHLB
stock increased nominally for the year ended December 31, 1996, due to a higher
average volume in 1996 as compared to 1995. Interest income on mortgage-backed
securities and investment securities for the year ended December 31, 1996 were
favorably impacted by the fourth quarter, 1996 purchase of securities with cash
proceeds from the Deposit Assumption.
13
<PAGE>
INTEREST EXPENSE
Interest expense for the year ended December 31, 1996 was $14.3
million, compared to $14.2 million for the year ended December 31, 1995, a $.1
million or 0.8% increase. This increase was due to a higher average balance of
savings deposits in 1996, partially offset by lower rates paid on deposit
accounts and borrowings. As compared to 1995, interest expense on deposits in
1996 increased $.5 million due to higher average outstanding balances and
declined $.1 million due to lower rates paid on deposit accounts. The Company's
average cost of deposits declined to 4.88% in 1996, from 4.99% in 1995. The
Company's cost of certificate of deposit accounts declined by 0.11% to a
weighted average rate of 5.58% in 1996, from 5.69% in 1995, due to the maturity
and renewal, at generally lower market rates, of a large portion of the
Company's certificate of deposit accounts outstanding at December 31, 1995.
Interest expense on FHLB advances and other borrowings declined $.2 million, or
6.7%, due to lower outstanding balances and reduced borrowing rates in 1996.
PROVISION FOR LOAN LOSSES
For the year ended December 31, 1996, the provision for loan losses
amounted to $28,000, a decrease of $635,000 compared to 1995. The decline in the
provision in 1996 was due to improved credit quality as reflected in lower
levels of nonperforming and classified assets. Nonperforming assets declined to
.59% of gross loans receivable at December 31, 1996, compared to 1.39% at
December 31, 1995.
NONINTEREST INCOME
Total noninterest income increased by $368,000, or 64.2%, to $941,000
for the year ended December 31, 1996 compared to 1995. This increase was
primarily attributable to increased mortgage servicing income, higher service
charge income due to a larger customer base and increased number of deposit
accounts, and a net gain on sales of investment securities. These increases were
partially offset by a decline in commission income from annuity sales, from
$464,000 in 1995 to $138,000 in 1996.
GENERAL AND ADMINISTRATIVE EXPENSE
Total general and administrative expenses were $9.1 million for the
year ended December 31, 1996, an increase of approximately $2.0 million, or
27.3%, over the $7.1 million recorded for the year ended December 31, 1995.
Included in general and administrative expense for 1996 was a non-recurring SAIF
special insurance premium assessment of $1.4 million. Excluding the special
assessment, general and administrative expense would have been $7.7 million for
the year ended December 31, 1996. The increases in 1996 were primarily
attributable to higher compensation and employee benefits, data processing
costs, legal and professional fees, and costs associated with the Company's
expansion of its branch locations and product lines.
INCOME TAX EXPENSE
Total income tax expense was $623,000 for the year ended December 31,
1996, compared to $414,000 for the comparable period in 1995. This represents an
increase of $209,000 or 50.5%. The increase was due to the increase in taxable
income in 1996 as compared to 1995. The effective tax rate for the year ended
December 31, 1996 was 42.3%, compared to 38.1% for the year ended December 31,
1995.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1996 AND DECEMBER 31, 1995
Total assets at December 31, 1996 were $425.8 million, compared to
$329.8 million at December 31, 1995, a $96.0 million or 29.1% increase. Asset
growth reflected the Company's assumption of $102.0 million of deposit
liabilities from Fremont Investment and Loan on December 6, 1996, and the
subsequent reinvestment of the related cash proceeds into the Company's
available for sale securities portfolio. Securities available for sale increased
by $83.2 million to $166.6 million at December 31, 1996, due to the investment
of the cash proceeds from the Fremont transaction, partially offset by the sale,
during 1996, of $8.5 million of mortgage-backed securities. Total loans
receivable held for investment were $233.2 million at December 31, 1996,
compared to $228.4 million at December 31, 1995, reflecting increases in
14
<PAGE>
outstanding balances of one-to four-family loans and multi-family, commercial
real estate, and land and improvement loans.
Total liabilities at December 31, 1996 were $380.0 million, compared to
$282.2 million at December 31, 1995, a $97.8 million, or 34.7% increase. The
Company's deposits totaled $318.1 million at December 31, 1996, compared to
$215.3 million at December 31, 1995, an increase of $102.9 million due to the
Deposit Assumption in December 1996. Borrowings declined to $59.8 million at
December 31, 1996, from $63.9 million at December 31, 1995.
At December 31, 1996, stockholders' equity was $45.8 million, compared
to $47.6 million at December 31, 1995. Equity was reduced by $1.8 million during
1996, primarily due to repurchases of the Company's outstanding common stock.
During the third quarter of 1996, the Company paid a cash dividend of $.05 per
share on its outstanding common stock, reducing stockholders' equity by
$165,000. Unrealized losses on securities available for sale at December 31,
1996, compared to unrealized gains at December 31, 1995, resulted in a decrease
of $0.6 million in equity.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are customer deposits, principal
and interest payments on loans and mortgage-backed securities, FHLB advances and
other borrowings and, to a lesser extent, proceeds from sales of securities and
loans. While maturities and scheduled amortization of loans are predictable
sources of funds, deposit flows and mortgage prepayments are greatly influenced
by general interest rates, economic conditions, and competition.
The Company maintains the required minimum levels of liquid assets as
defined by OTS regulations. This requirement, which may be varied at the
direction of the OTS depending upon economic conditions and deposit flows, is
based upon a percentage of deposits and short-term borrowings. The required
ratio is currently 4%. The Bank's average liquidity ratios were 8.1%, 7.7%, and
6.1% for the years ended December 31, 1997, 1996 and 1995, respectively. The
higher levels of liquidity in 1997 and 1996, compared to 1995, were primarily
due to the retention of qualifying securities. The Company's strategy generally
is to maintain its liquidity ratio at or near the required minimum in order to
maximize its yield on alternative investments.
The Company's cash flows are comprised of three primary
classifications: cash flows from operating activities, investing activities, and
financing activities. Cash flows provided by operating activities amounted to
$2.1 million, $24,000, and $12.0 million, respectively, for the years ended
December 31, 1997, 1996 and 1995. Cash provided or used by operating activities
is determined largely by changes in the level of loan sales. Loan sales are
dependent on the level of loan originations and the relative customer demand for
mortgage loans, which is affected by the current and expected future level of
interest rates (see "General" and "Asset and Liability Management"). The level
of loans held for sale also depends on the time within which investors fund the
purchase of loans from the Company. A majority of the Company's loans originated
for sale are sold within 30 days of closing. During the years ended December 31,
1997, 1996, and 1995, the Company sold loans totaling $3.0 million, $2.6
million, and $18.5 million, respectively. For the years ended December 31, 1997
and 1996, the Company was engaged only in individual sales of fixed rate loans
to FHLMC. The Company may elect to sell fixed or adjustable rate loans in the
future, depending upon market opportunities and prevailing interest rates at the
time such a decision is made.
Cash provided or used by investing activities consists primarily of
loan originations, purchases of loans receivable, purchases of mortgage-backed
securities and investment securities, principal collections on loans and
mortgage-backed securities, and proceeds from sales and maturities of
mortgage-backed securities and investment securities. Cash disbursements to
originate and purchase loans receivable were $69.1 million, $36.1 million and
$36.0 million, respectively, in 1997, 1996 and 1995. Disbursements to purchase
mortgage-backed securities and investment securities totaled $28.1 million,
$122.3 million, and $82.6 million during the same periods. The increase in 1996
was related to investment purchases made in conjunction with the Deposit
Assumption in December 1996. Cash principal payments received on loans and
mortgage-backed securities were $52.8 million, $42.9 million,
15
<PAGE>
and $32.8 million, respectively, during 1997, 1996, and 1995. The Company
received proceeds of $38.6 million, $8.4 million, and $13.7 million,
respectively, from sales of mortgage-backed securities during 1997, 1996, and
1995, and received proceeds of $31.5 million, $14.9 million, and $11.9 million,
respectively, for proceeds from maturities of investment securities during the
same periods.
The Company used $20.6 million of net cash in financing activities in
1997. During 1997, the Company utilized $22.3 million of cash to pay down FHLB
advances and other borrowings. Deposits increased by $2.4 million to $320.6
million at December 31, 1997, from $318.1 million a year earlier. Retail
deposits, which exclude deposits over $100,000, decreased by $7.4 million, or
2.8%, primarily due to outflows from customer money market accounts and an
increased level of jumbo term accounts at December 31, 1997.
The Company received net cash of $92.8 million and $27.6 million,
respectively, from financing activities in 1996 and 1995. In 1996, cash provided
by financing activities consisted primarily of cash proceeds of $98.4 million
received in connection with the Deposit Assumption, net of a core deposit
premium. The Company utilized $4.1 million of cash during 1996 to pay down
borrowings. During 1995, increases in borrowings provided cash of $4.1 million.
Also during 1995, the Company received cash proceeds of $24.7 million from the
sale of common stock. Purchases of treasury stock totaled $256,000, $2.2
million, and $2.2 million, respectively, in 1997, 1996, and 1995.
The Company's most liquid assets are cash and short-term investments.
The levels of these assets are dependent on the Company's operating, financing,
lending and investing activities during any given period. At December 31, 1997,
cash and short-term investments totaled $13.5 million.
At December 31, 1997, the Company had outstanding loan commitments of
$12.1 million. The Company anticipates that it will have sufficient funds
available to meet its current loan origination commitments.
From time to time, depending upon its asset and liability strategy, the
Company converts a portion of its mortgages into FHLMC mortgage-backed
securities. These conversions provide increased liquidity because the
mortgage-backed securities are typically more readily marketable than the
underlying loans and because they can be used as collateral for borrowings.
During 1995, the Company converted approximately $15.0 million of its fixed rate
residential loans into mortgage-backed securities and utilized the securities as
collateral for borrowings. The Company did not securitize any portion of its
mortgages during 1996 or 1997.
The Company has other sources of liquidity if a need for additional
funds arises, including FHLB advances through its subsidiary, the Bank. The
Bank's credit line with the FHLB is 40% of total assets. At December 31, 1997,
this credit line represented a total borrowing capacity of approximately $158.4
million, of which $32.3 million was outstanding. Other sources of liquidity
include investment securities maturing within one year. Certificates of deposit
which were scheduled to mature in one year or less from December 31, 1997
totaled $185.2 million.
At December 31, 1997, the Bank exceeded all of its regulatory capital
requirements with a tangible capital level of $36.9 million, or 9.39% of total
adjusted assets, which was above the required level of $5.9 million or 1.5%;
core capital of $36.9 million, or 9.40% of total adjusted assets, which was
above the required level of $11.8 million or 3.00%, and risk-based capital of
$38.6 million, or 17.24% of risk-weighted assets, which was above the required
level of $17.9 million or 8.00%.
During 1997, the Company acquired 22,500 shares of common stock
previously approved for repurchase by the Board of Directors. Also during 1997,
8,816 stock options were exercised using treasury shares (see "Notes to
Consolidated Financial Statements - Stock Benefit Plans"). As a result, the
Company held 364,071 shares of treasury stock, or 10.1% of the Company's issued
shares, at December 31, 1997, compared to 350,387 treasury shares held by the
Company at December 31, 1996.
16
<PAGE>
IMPACT OF INFLATION
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with GAAP, which require the measurement
of financial position and operating results in terms of historical dollar
amounts without considering the changes in the relative purchasing power of
money over time due to inflation. The impact of inflation is reflected in the
increased cost of the Company's operations. Unlike industrial companies, nearly
all of the assets and liabilities of the Company are monetary in nature. As a
result, interest rates have a greater impact on the Company's performance than
do the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the price of goods and
services.
YEAR 2000
In 1997, the Company initiated a program to ensure its computer systems
and applications are compliant for the year 2000. Many existing computer
programs and application software products in the marketplace were originally
designed to recognize calendar years by their last two digits. As a result, the
year 1999 (i.e. `99') may be the maximum date value these systems will be able
to process accurately. Computer programs that can only distinguish the final two
digits of the year entered are expected to read entries for the year 2000 as the
year 1900 and compute payment, interest, or delinquency based on the wrong date
or are expected to be unable to compute payment, interest, or delinquency.
The Company has conducted a review and evaluation of its computer
systems to identify systems and applications which could be adversely impacted
by year 2000 issues, and is working with providers and software vendors to
evaluate and manage the risks and costs associated with this problem. The
majority of the material data processing of the Bank is provided by a third
party service bureau. The service bureau has advised the Company that it expects
to resolve potential problems before the year 2000. However, if the service
bureau is unable to resolve these problems in a timely manner, the Company could
experience significant data processing delays, mistakes, or failures.
The Company has established a target date of December 31, 1998 to complete all
identification, evaluation, and testing of system changes to achieve year 2000
compliance. Testing and conversion of existing and replacement system
applications are expected to cost less than $25,000 over the next two years. The
Company presently believes that with the planned modifications to existing
systems and conversion to new systems, the year 2000 compliance issue will be
resolved on a timely basis and will not pose significant operational problems
for the Company.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1996, Statement of Financial Accounting Standards No. 125
("SFAS No. 125"), ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES, was issued. This statement established standards
for when transfers of financial assets, including those with continuing
involvement by the transferor, should be considered a sale. SFAS No. 125 also
established standards for when a liability should be considered extinguished. In
December 1996, the Financial Accounting Standards Board ("FASB") issued SFAS No.
127, DEFERRAL OF THE EFFECTIVE DATE OF CERTAIN PROVISIONS OF FASB STATEMENT NO.
125. SFAS No. 127 reconsiders certain provisions of SFAS 125 and defers for one
year the effective date of implementation for transactions related to repurchase
agreements, dollar-roll repurchase agreements, securities lending, and similar
transactions. This statement is effective for transfers of assets and
extinguishments of liabilities occurring after December 31, 1996, applied
prospectively. Earlier adoption or retroactive application of these statements
is not permitted. SFAS Nos. 125 and 127 have not had a material effect on the
Company's financial statements.
Effective December 1997, the Company adopted SFAS No. 128, EARNINGS PER
SHARE, which superseded APB No. 15, "EARNINGS PER SHARE." SFAS 128 establishes
standards for computing and presenting earnings per share and applies to
entities with publicly held common stock or potential common stock (i.e.
securities such as options, warrants, convertible securities, or contingent
stock agreements). The statement replaces the presentation of primary earnings
per share with a presentation of basic earnings per share and requires dual
presentation of basic and diluted earnings per share on the face of the income
17
<PAGE>
statement. SFAS 128 is effective for financial statements issued for periods
ending after December 15, 1997 and requires restatement of all presented
prior-period earnings per share data.
In February 1997, the FASB issued SFAS 129, DISCLOSURE OF INFORMATION
ABOUT CAPITAL STRUCTURE. This statement establishes standards for disclosing
information about an entity's capital structure. It supersedes specific
disclosure requirements of APB SFAS No. 47, "DISCLOSURE OF LONG-TERM
OBLIGATIONS," and consolidates them in this statement for ease of retrieval and
for greater visibility to nonpublic entities. SFAS 129 is effective for
financial statements issued for periods ending after December 15, 1997. It
contains no changes in disclosure requirements for entities that were previously
subject to the requirements of Opinions No. 10 and No. 15 and SFAS No. 47, and
therefore is not expected to have a significant impact on the consolidated
financial condition or results of operations of the Company.
In June 1997, the FASB issued SFAS No. 130, REPORTING COMPREHENSIVE
INCOME, which requires that an enterprise report, by major components and as a
single total, the change in its net assets during the period from nonowner
sources; and SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND
RELATED INFORMATION, which establishes annual and interim reporting standards
for an enterprise's operating segments and related disclosures about its
products, services, geographic areas, and major customers. Adoption of these
statements does not impact the Company's consolidated financial position,
results of operations or cash flows, and any effect is limited to the form and
content of its disclosures. Both statements are effective for fiscal years
beginning after December 15, 1997.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the dates of the balance sheets and revenues and
expenses for the periods covered. Actual results could differ significantly from
those estimates and assumptions.
18
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Monterey Bay Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition
of Monterey Bay Bancorp, Inc. and subsidiary ( the "Company") as of December 31,
1997 and 1996, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of Monterey Bay Bancorp,
Inc. and subsidiary at December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
_________________________
San Francisco, California
February 13, 1998
19
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1997 AND 1996 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
DECEMBER 31,
----------------------------
1997 1996
------------- -------------
<S><C>
ASSETS
Cash and due from depository institutions $ 7,214 $ 4,447
Overnight deposits 6,300 531
--------- ---------
Total cash and cash equivalents 13,514 4,978
Certificates of deposit 99 199
Loans held for sale, at market (Note 4) 514 130
Securities available for sale:
Mortgage-backed securities (amortized cost, 1997, $70,234; 1996, $117,094) (Note 2) 70,465 116,610
Investment securities (amortized cost, 1997, $40,351; 1996, $50,322) (Note 3) 40,355 49,955
Securities held to maturity:
Mortgage-backed securities (market value, 1997, $138; 1996, $169) (Note 2) 142 173
Investment securities (market value, 1997, $145; 1996, $403) (Note 3) 145 404
Loans receivable held for investment (net of allowance for loan losses, 1997, $1,669;
1996, $1,311) (Note 4) 263,751 233,208
Federal Home Loan Bank stock, at cost (Note 6) 3,383 5,040
Premises and equipment, net (Note 7) 4,817 4,887
Accrued interest receivable (Note 5) 2,339 2,556
Core deposit premiums and other intangibles, net 3,229 3,979
Real estate owned 321 -
Other assets 5,022 3,643
--------- ---------
TOTAL ASSETS $ 408,096 $ 425,762
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Savings deposits (Note 8) $ 320,559 $ 318,145
Federal Home Loan Bank advances (Note 9) 32,282 46,807
Securities sold under agreements to repurchase (Note 10) 5,200 13,000
Accounts payable and other liabilities 2,122 2,051
--------- ---------
Total liabilities 360,163 380,003
--------- ---------
COMMITMENTS AND CONTINGENCIES (Note 15): - -
STOCKHOLDERS' EQUITY (Note 12):
Preferred stock, $.01 par value, 2,000,000 shares authorized and unissued - -
Common stock, $.01 par value, 9,000,000 shares authorized and 3,593,750
shares issued (3,229,679 shares outstanding at December 31, 1997;
and 3,243,363 shares outstanding at December 31, 1996) 36 36
Additional paid-in capital 27,270 27,114
Unearned shares held by employee stock ownership plan (201,250 at
December 31, 1997; and 230,000 at December 31, 1996) (1,610) (1,840)
Treasury stock, at cost (364,071 shares at December 31, 1997; and 350,387
shares at December 31, 1996) (4,642) (4,374)
Retained earnings, substantially restricted 26,741 25,320
Unrealized gain (loss) on securities available for sale, net of taxes 138 (497)
--------- ---------
Total stockholders' equity 47,933 45,759
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 408,096 $ 425,762
========= =========
</TABLE>
See notes to consolidated financial statements.
20
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
---------------------------------------------
1997 1996 1995
------------- ------------ ------------
<S><C>
INTEREST INCOME:
Loans receivable $ 19,804 $ 18,015 $ 17,826
Mortgage-backed securities 6,510 3,224 2,080
Other investment securities 3,363 2,747 2,638
--------- --------- ---------
Total interest income 29,677 23,986 22,544
--------- --------- ---------
INTEREST EXPENSE:
Savings deposits 15,527 10,949 10,602
FHLB advances and other borrowings 2,886 3,384 3,625
--------- --------- ---------
Total interest expense 18,413 14,333 14,227
--------- --------- ---------
NET INTEREST INCOME BEFORE PROVISION
FOR LOAN LOSSES 11,264 9,653 8,317
PROVISION FOR LOAN LOSSES 375 28 663
--------- --------- ---------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 10,889 9,625 7,654
--------- --------- ---------
NONINTEREST INCOME:
Gains (losses) on sale of mortgage-backed securities
and investment securities, net 213 168 (250)
Commissions from sales of noninsured products 355 138 464
Customer service charges 642 403 315
Income from loan servicing 229 153 (16)
Other income 175 79 60
--------- --------- ---------
Total 1,614 941 573
--------- --------- ---------
GENERAL AND ADMINISTRATIVE EXPENSE:
Compensation and employee benefits 4,358 3,372 3,280
Occupancy and equipment 1,070 914 920
Deposit insurance premiums 233 532 516
SAIF recapitalization assessment - 1,387 -
Data processing fees 685 495 428
Legal and accounting expenses 421 360 322
Stationery, telephone and office expenses 490 353 333
Advertising and promotion 257 194 181
Amortization of core deposit premiums 839 340 304
Other expenses 1,154 1,144 856
--------- --------- ---------
Total 9,507 9,091 7,140
--------- --------- ---------
INCOME BEFORE INCOME TAX EXPENSE 2,996 1,475 1,087
INCOME TAX EXPENSE (Note 11) 1,230 623 414
--------- --------- ---------
NET INCOME $ 1,766 $ 852 $ 673
======== ========= =========
BASIC EARNINGS PER SHARE(1) (Note 17) $ 0.58 $ 0.27 $ 0.17
========== ========= =========
DILUTED EARNINGS PER SHARE(1) (Note 17) $ 0.56 $ 0.27 $ 0.17
========== ========= =========
CASH DIVIDENDS PER SHARE $ 0.11 $ 0.05 $ -
========== ========= =========
</TABLE>
(1) The 1995 earnings per share computation is based on net income from
February 14, 1995, the date Monterey Bay Bank (formerly Watsonville Federal
Savings and Loan Association) converted to a federally chartered stock
association and Monterey Bay Bancorp, Inc. became the holding company for
the Bank.
See notes to consolidated financial statements.
21
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
Common Stock Additional
------------ Paid-In Acquired Treasury Retained Unrealized
Shares Amount Capital by ESOP Stock Earnings Gain (Loss) Total
------ ------ ---------- -------- -------- -------- ----------- -----
<S><C>
Balance at
January 1, 1995 $ 23,960 $ (711) $ 23,249
Issuance of
common stock 3,593,750 $ 36 $ 26,990 $ (2,300) $ - 24,726
Purchase of
treasury stock (179,687) (2,201) (2,201)
Earned ESOP shares 47 230 277
Change in unrealized
gain (loss) on
securities available
for sale, net of taxes 880 880
Net income 673 673
--------- ---- --------- -------- -------- -------- ------ ---------
Balance at
December 31, 1995 3,414,063 36 27,037 (2,070) (2,201) 24,633 169 47,604
Purchase of
treasury stock (170,700) (2,173) (2,173)
Dividends paid (165) (165)
Earned ESOP shares 77 230 307
Change in unrealized
gain (loss) on
securities available
for sale, net of taxes (666) (666)
Net income 852 852
--------- ---- --------- -------- -------- -------- ------ ---------
Balance at
December 31, 1996 3,243,363 36 27,114 (1,840) (4,374) 25,320 (497) 45,759
Purchase of
treasury stock (22,500) (376) (376)
Options exercised
using treasury stock 8,816 108 12 120
Dividends paid (357) (357)
Earned ESOP shares 156 230 386
Change in unrealized
gain (loss) on
securities available
for sale, net of taxes 635 635
Net income 1,766 1,766
--------- ---- --------- -------- -------- -------- ------ ---------
Balance at
December 31, 1997 3,229,679 $ 36 $ 27,270 $ (1,610) $ (4,642) $ 26,741 $ 138 $ 47,933
========= ==== ========= ======== ======== ======== ====== =========
</TABLE>
(1) Number of shares of common stock includes 287,500 shares which are pledged
as security for a loan to the Bank's ESOP. Shares earned at December 31,
1997, 1996 and 1995 were 86,250, 57,500 and 28,750, respectively.
(2) The Company held 364,071, 350,387, and 179,687 shares of repurchased
Company common stock at December 31, 1997, 1996, and 1995, respectively.
See notes to consolidated financial statements.
22
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
<S><C>
OPERATING ACTIVITIES:
Net income $1,766 $ 852 $ 673
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of premises and equipment 440 372 362
Amortization of core deposit premiums 839 340 304
Amortization of purchase premiums, net of discounts 573 487 649
Loan origination fees deferred, net 457 138 216
Amortization of deferred loan fees (243) (217) (580)
Provision for loan losses 375 28 663
Compensation expense related to ESOP shares released 386 307 277
(Gain) loss on sale of mortgage-backed securities and
investment securities (213) (168) 250
Charge-offs on loans receivable, net of recoveries (17) (78) -
Losses on sale of fixed assets 4 5 -
Originations of loans held for sale (3,405) (2,666) (9,597)
Proceeds from sales of loans originated for sale 3,020 2,628 18,541
Change in income taxes payable and deferred income taxes (384) (234) (309)
Change in other assets (1,667) (376) (911)
Change in interest receivable 217 (447) (568)
Change in accounts payable and other liabilities (26) (947) 2,062
------- -------- --------
Net cash provided by operating activities 2,122 24 12,032
------- -------- --------
INVESTING ACTIVITIES:
Loans originated for the portfolio, net (54,389) (36,061) (35,994)
Purchases of loans receivable (14,661) - -
Principal payments on loans receivable 37,782 31,171 26,535
Purchases of mortgage-backed securities available for sale (6,900) (85,467) (43,022)
Purchases of mortgage-backed securities held to maturity - - (69)
Principal paydowns on mortgage-backed securities 14,989 11,776 6,240
Proceeds from sales of mortgage-backed securities available for sale 38,613 8,427 13,746
Purchases of investment securities available for sale (21,249) (36,833) (38,714)
Purchases of investment securities held to maturity - - (766)
Proceeds from sales of investment securities available for sale - 3,194 16,071
Proceeds from maturities of investment securities 31,459 14,900 11,900
Decreases in certificates of deposit 100 581 687
Redemptions (purchases) of FHLB stock 1,657 (2,498) 572
Purchases of premises and equipment, net (374) (1,235) (129)
Other
- - 78
------- -------- --------
Net cash provided by (used in) investing activities 27,027 (92,045) (42,865)
------- -------- --------
</TABLE>
-continued-
23
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
<S><C>
FINANCING ACTIVITIES:
Net increase in savings deposits $ 2,414 $ 798 $ 974
Assumption of savings deposits, net of core deposit premiums (Note 8) - 98,395 -
Purchase premium paid for investment company assets (89) - -
Proceeds (repayments) on Federal Home Loan Bank advances, net (14,525) 287 (13,262)
Proceeds (repayments) of reverse repurchase agreements, net (7,800) (4,360) 17,361
Proceeds from the sale of common stock - - 24,726
Cash dividends paid to stockholders (357) (165) -
Purchases of treasury stock, net (256) (2,173) (2,201)
------- -------- --------
Net cash provided by (used in) financing activities (20,613) 92,782 27,598
------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 8,536 761 (3,235)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,978 4,217 7,452
------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $13,514 $ 4,978 $ 4,217
======= ======== ========
CASH PAID DURING THE PERIOD FOR:
Interest on savings deposits and advances $18,601 $14,425 $13,654
Income taxes 1,740 954 752
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING:
Loans transferred to held for investment, at market value 69 - 7,385
Mortgage-backed securities acquired in exchange for securitized
loans, net of deferred fees - - 15,044
Mortgage-backed securities transferred from held to maturity to
available for sale, net - - 15,025
Real estate acquired in settlement of loans 610 369 297
Loans to facilitate the sale of real estate owned - - 181
</TABLE>
See notes to consolidated financial statements.
24
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies of Monterey Bay Bancorp, Inc. (the
"Company") are as follows:
BASIS OF CONSOLIDATION - The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiary, Monterey
Bay Bank (the "Bank," formerly Watsonville Federal Savings and Loan
Association), and the Bank's wholly owned subsidiary, Portola
Investment Corporation ("Portola"). All significant intercompany
transactions and balances have been eliminated in consolidation. The
Company is a Delaware corporation, organized by the Bank for the
purpose of acquiring all of the capital stock of the Bank issued upon
the 1995 conversion of the Bank from a federally chartered mutual
savings and loan association to a federally chartered stock savings and
loan association (the "Conversion"). On February 14, 1995, the Company
completed its initial public offering in connection with the Conversion
and began trading on the Nasdaq National Market under the symbol "MBBC"
on February 15, 1995. All amounts prior to the completion of the
Conversion relate to the Bank. The Company, the holding company of the
Bank, engages only in limited business operations primarily involving
investments in mortgage-backed securities and other investment
securities.
CASH EQUIVALENTS - The Company considers all highly liquid investments
with an initial maturity of three months or less to be cash
equivalents. A percentage of the Company's transaction account
liabilities are subject to Federal Reserve requirements. The Company's
Federal Reserve requirement was $378,000 and $193,000, respectively, at
December 31, 1997 and 1996.
CERTIFICATES OF DEPOSIT are interest-bearing deposits in federally
insured financial institutions with original maturities of more than
three months.
SECURITIES AVAILABLE FOR SALE are carried at fair value. Statement of
Financial Accounting Standards No. 115 ("SFAS 115"), ACCOUNTING FOR
CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES, establishes
classification of investments into three categories: held to maturity,
trading, and available for sale. The Company identifies securities as
either held to maturity or available for sale. The Company has no
trading securities. Securities available for sale increase the
Company's portfolio management flexibility for investments and are
reported at fair value. Net unrealized gains and losses are excluded
from earnings and reported net of applicable income taxes as a separate
component of stockholders' equity until realized. Gains or losses on
sales of securities are recorded in earnings at the time of sale and
are determined by the difference between the net sales proceeds and the
cost of the security, using the specific identification method,
adjusted for any unamortized premium or discount.
Any permanent decline in the fair value of individual securities held
to maturity and securities available for sale below their cost would be
recognized through a write down of the investment securities to their
fair value by a charge to earnings as a realized loss.
SECURITIES HELD TO MATURITY, consisting of mortgage-backed securities
and investment securities held for long-term investment, are carried at
amortized cost as the Company has the ability to hold these securities
to maturity and because it is management's intention to hold these
securities to maturity. Premiums and discounts on mortgage-backed
securities are amortized using the interest method over the remaining
period to contractual maturity, adjusted for actual and estimated
prepayments. Premiums and discounts on investment securities are
amortized and accreted into interest income on the interest method over
the period to maturity. Gains and losses on the sale of
25
<PAGE>
mortgage-backed securities and investment securities are determined
using the specific identification method. In limited circumstances, as
specified in the provisions of SFAS 115, the Company may transfer or
sell securities from the held to maturity portfolio.
In December 1995, the Company transferred $15.0 million of
held-to-maturity securities to the available-for-sale portfolio in
accordance with guidance from the Financial Accounting Standards Board
("FASB") on SFAS 115. The FASB allowed the reclassification of
investments in debt securities to available for sale from held to
maturity during the period November 15, 1995 through December 31, 1995
without tainting the classification of the remaining held-to-maturity
portfolio. The Securities and Exchange Commission and the banking
regulatory agencies concurred with the FASB on this issue.
Transfers of securities available for sale to securities held to
maturity portfolio are recorded at fair value. The related net
unrealized holding gains or losses, net of applicable income taxes, at
the date of transfer are reported as a separate component of
stockholders' equity and amortized over the remaining contractual life
of these securities using the interest method.
LOANS HELD FOR SALE - During the period of origination, real estate
loans are designated as either held for sale or held for investment.
Loans held for sale are carried at the lower of cost or estimated
market value, determined on an aggregate basis, and include loan
origination costs and related fees. Transfers of loans held for sale to
the held for investment portfolio are recorded at the lower of cost or
market value on the transfer date. Net unrealized losses are recognized
through an adjustment of the loan carrying values by charges to
earnings.
LOANS RECEIVABLE HELD FOR INVESTMENT are carried at cost adjusted for
unamortized premiums and discounts and net of deferred loan origination
fees and allowance for loan losses. These loans are not adjusted to the
lower of cost or market because it is management's intention, and the
Company has the ability, to hold these loans to maturity.
LOAN ORIGINATION FEES - The Company charges fees for originating loans.
These fees, net of certain related direct loan origination costs, are
deferred. The net deferred fees for loans held as investments are
recognized as an adjustment of the loan's yield over the expected life
of the loan using the interest method, which results in a constant rate
of return. When a loan is paid off or sold, the unamortized balance of
any related fees and costs is recognized as income. Other loan fees and
charges representing service costs are reported in income when
collected or earned.
ORIGINATED MORTGAGE SERVING RIGHTS - Effective December 1995, the
Company adopted Statement of Financial Accounting Standards No. 122
("SFAS 122"), ACCOUNTING FOR MORTGAGE SERVICING RIGHTS. SFAS 122 allows
financial institutions that originate mortgages and sell them into the
secondary market to recognize the retained right to service the loans.
This rule amends SFAS 65, which permitted only purchased mortgage
servicing rights to be recognized as an asset. SFAS 122 makes no
distinction between purchased and originated mortgage servicing rights.
During 1997 and 1996, the Company sold $3.0 million and $2.6 million,
respectively, of loans in the secondary market and recorded $7,000 and
$21,000, respectively, of originated mortgage servicing rights on those
loans.
SALES OF LOANS - Gains or losses resulting from sales of loans are
recorded at the time of sale and are determined by the difference
between the net sales proceeds and the carrying value of the assets
sold. When the right to service the loans is retained, a gain or loss
is recognized based upon the net present value of expected amounts to
be received resulting from the difference between the contractual
interest rates received from the borrowers and the rate paid to the
buyer, taking into account estimated prepayments and a normal servicing
fee on such loans. The net assets resulting from the present value
computation, representing deferred expense, are amortized to operations
26
<PAGE>
over the estimated remaining life of the loan using a method that
approximates the interest method. The balance of deferred premium and
expense and the amortization thereon are periodically evaluated in
relation to estimated future net servicing revenues, taking into
consideration changes in interest rates, current prepayment rates, and
expected future cash flows. The Company evaluates the carrying value of
the servicing portfolio by estimating the future net servicing income
of the portfolio based on management's best estimate of remaining loan
lives.
INTEREST ON LOANS is credited to income when earned. Interest is not
recognized on loans that are considered to be uncollectible. Loans are
placed on a nonaccrual status when they become 90 days delinquent and
an allowance is established for previously accrued but uncollected
interest on such loans. Subsequent collections of delinquent interest
are recognized as interest income when received.
IMPAIRED AND NONPERFORMING LOANS - Statement of Financial Accounting
Standards No. 114 ("SFAS 114"), ACCOUNTING BY CREDITORS FOR IMPAIRMENT
OF A LOAN, as amended by Statement of Financial Accounting Standards
No. 118 ("SFAS 118"), ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN
- INCOME RECOGNITION AND DISCLOSURES, was effective January 1, 1995.
Under SFAS 114, a loan is impaired when it is probable that a creditor
will be unable to collect all amounts due (i.e., both principal and
interest) according to the contractual terms of the loan agreement.
SFAS 114 excludes, among other items, large groups of smaller balance
homogenous loans that are collectively evaluated for impairment. SFAS
118 eliminates the income recognition provisions included in SFAS 114,
thereby permitting the use of existing methods for recognizing interest
income on impaired loans.
The Company adopted the provisions of SFAS 114 and SFAS 118 effective
January 1, 1995. The adoption of SFAS 114 and SFAS 118 has not had a
significant impact on the financial position or the earnings of the
Company.
The Company has established a monitoring system for its loans in order
to identify impaired loans, potential problem loans, and to permit
periodic evaluation of the adequacy of allowances for losses in a
timely manner. Total loans include the following portfolios: (i)
residential one- to four-family loans, (ii) multi-family loans, (iii)
commercial real estate loans, (iv) construction and land loans, and (v)
non-mortgage loans. In analyzing these loans, the Company has
established specific monitoring policies and procedures suitable for
the relative risk profile and other characteristics of the loans within
the various portfolios. The Company's residential one-to four-family,
multifamily and non-mortgage loans, where the outstanding balance is
less than $500,000, are considered to be relatively homogeneous and no
single loan is individually significant in terms of its size or
potential risk of loss. Therefore, the Company generally reviews these
loans by analyzing their performance and composition of their
collateral for the portfolio as a whole. For non-homogenous loans the
Company conducts a periodic review of each loan. The frequency and type
of review is dependent upon the inherent risk attributed to each loan,
and is directly proportionate to the adversity of the loan grade. The
Company evaluates the risk of loss and default for each loan subject to
individual monitoring.
Factors considered as part of the periodic loan review process to
determine whether a loan is impaired, as defined under SFAS 114,
address both the amount the Company believes is probable that it will
collect and the timing of such collection. As part of the Company's
loan review process the Company considers such factors as the ability
of the borrower to continue meeting the debt service requirements,
assessments of other sources of repayment, the fair value of any
collateral and the creditor's prior history in dealing with these types
of credits. In evaluating whether a loan is considered impaired,
insignificant delays (less than six months) or shortfalls (less than 5%
of the payment amount) in payment amounts, in the absence of other
facts and circumstances, would not alone lead to the conclusion that a
loan is impaired.
27
<PAGE>
Any loans which meet the definition of a troubled debt restructuring,
or are partially or completely classified as Doubtful or Loss, are
considered impaired. As of December 31, 1997 and 1996, the Company had
$448,000 and $354,000, respectively, of restructured loans. As of
December 31, 1997, the Company had no loans classified as Doubtful or
Loss, compared to $1,000 of such loans on December 31, 1996.
Loans on which the Company has ceased the accrual of interest
("nonaccrual loans") constitute the primary component of the portfolio
of nonperforming loans. Loans are generally placed on nonaccrual status
when the payment of interest is 90 days or more delinquent, or if the
loan is in the process of foreclosure.
When a loan is designated as impaired, the Company measures impairment
based on the fair value of the collateral of the collateral-dependent
loan. The amount by which the recorded investment in the loan exceeds
the measure of the impaired loan is recognized by recording a valuation
allowance with a corresponding charge to earnings. The Company charges
off a portion of an impaired loan against the valuation allowance when
it is probable that there is no possibility of recovering the full
amount of the impaired loan.
Payments received on impaired loans are recorded as a reduction of
principal or as interest income depending on management's assessment of
the ultimate collectibility of the loan principal. The amount of
interest income recognized is limited to the amount of interest that
would have accrued at the loans' contractual rate applied to the
recorded loan balance. Any difference is recorded as a loan loss
recovery.
ALLOWANCES FOR LOAN LOSSES are maintained at levels that management
deems adequate to cover estimated losses and are continually reviewed
and adjusted. The Company adheres to an internal asset review system
and an established loan loss reserve methodology. Management evaluates
factors such as the prevailing and anticipated economic conditions,
historic loss experiences, composition of the loan portfolio by
property type, levels, and trends of classified loans, and loan
delinquencies in assessing overall valuation allowance levels to be
maintained. While management uses currently available information to
provide for losses on loans, additions to the allowance may be
necessary based on new information and/or future economic conditions.
When the property collateralizing a delinquent mortgage loan is
foreclosed on by the Company and transferred to real estate owned, the
difference between the loan balance and the fair value of the property
less estimated selling costs is charged off against the allowance for
loan losses.
PREMISES AND EQUIPMENT are stated at cost, less accumulated
depreciation and amortization. The Company's policy is to depreciate
furniture and equipment on a straight-line basis over the estimated
useful lives of the various assets and to amortize leasehold
improvements over the shorter of the asset life or lease term as
follows:
<TABLE>
<CAPTION>
<S><C>
Buildings 40 to 50 years
Leasehold improvements Lesser of term of lease or life of improvement
Furniture and equipment 3 to 10 years
</TABLE>
The cost of repairs and maintenance is charged to operations as
incurred, whereas expenditures that improve or extend the service lives
of assets are capitalized.
CORE DEPOSIT INTANGIBLES arise from the acquisition of deposits and are
amortized on a straight-line basis over the estimated life of the
deposit base acquired, generally seven years. The Company continually
evaluates the periods of amortization to determine whether later events
and
28
<PAGE>
circumstances warrant revised estimates. The carrying values of
unamortized core deposit intangibles at December 31, 1997 and 1996 were
$3.2 million and $4.0 million, respectively. Accumulated amortization
of core deposit intangibles at December 31, 1997 and 1996 were $2.0
million and $1.2 million, respectively.
IMPAIRMENT OF LONG-LIVED ASSETS - Long-lived assets and certain
identifiable intangibles to be held and used are reviewed for
impairment whenever events or changes in circumstances indicate that
the carrying amount of assets may not be recoverable. Determination of
recoverability is based on an estimate of undiscounted future cash
flows resulting from the use of the asset and its eventual disposition.
Measurement of an impairment loss for long-lived assets and
identifiable intangibles that management expects to hold and use are
based on the fair value of the asset. Long-lived assets and certain
identifiable intangibles to be disposed of are reported at the lower of
carrying amount or fair value less cost to sell.
STOCK BASED COMPENSATION - The Company accounts for stock based awards
to employees using the intrinsic value method in accordance with
Accounting Principles Board Opinion (APB) No. 25, ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES.
EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP") - The Company accounts for
shares acquired by its ESOP in accordance with the guidelines
established by the American Institute of Certified Public Accountants
Statement of Position 93-6, EMPLOYERS' ACCOUNTING FOR EMPLOYEE STOCK
OWNERSHIP PLANS ("SOP 93-6"). Among other things, SOP 93-6 changed the
measure of compensation expense recorded by employers for leveraged
ESOPs from the cost of ESOP shares to the fair value of ESOP shares.
Under SOP 93-6, the Company recognizes compensation cost equal to the
fair value of the ESOP shares during the periods in which they become
committed to be released. To the extent that the fair value of the
Company's ESOP shares differ from the cost of such shares, the
differential is charged or credited to equity. Employers with
internally leveraged ESOPs such as the Company do not report the loan
receivable from the ESOP as an asset and do not report the ESOP debt
from the employer as a liability.
INCOME TAXES - The Company accounts for income taxes in accordance with
the provisions of Statement of Financial Accounting Standards No. 109
("SFAS 109"), ACCOUNTING FOR INCOME TAXES. Under the asset and
liability method prescribed by SFAS 109, deferred tax assets and
liabilities are recognized using currently applicable tax rates for the
future tax consequences of differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax bases. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in the period that includes the
enactment date. Future tax benefits attributable to temporary
differences are recognized to the extent the realization of such
benefits is more likely than not.
COMMISSIONS FROM ANNUITY SALES arise from Portola's sale of tax
deferred annuities, mutual funds, and other investment products not
insured by the FDIC. Income is based on a percentage of sales which
varies based on the investment product sold and is recognized as income
upon receipt.
EARNINGS PER SHARE - In March 1997, the FASB issued Statement of
Financial Accounting Standards No. 128, MEASUREMENT OF EARNINGS PER
SHARE (SFAS 128). SFAS 128 replaces "Primary" and "Fully Diluted"
Earnings Per Share with "Basic" and "Diluted" Earnings Per Share for
fiscal years ending after December 15, 1997. The Company has adopted
SFAS 128 as of December 31, 1997 and has calculated Basic and Diluted
Earnings Per Share in accordance with the guidelines established in
SFAS 128. Prior period amounts have been restated to reflect this
change.
29
<PAGE>
Earnings per share is based on the weighted average number of shares
outstanding adjusted for the unearned shares of the employee stock
ownership plan. On February 14, 1995, the Company issued 3,593,750
shares in connection with the formation of a holding company and the
Bank's Conversion. Common shares outstanding included 287,500 shares
purchased by the Bank's ESOP. Shares earned by the ESOP at December 31,
1997, 1996, and 1995 were 86,250, 57,500, and 28,750, respectively.
Net income and common shares outstanding for the period from February
15, 1995, the date of the Conversion, to December 31, 1995 were used to
compute earnings per share for the year ended December 31, 1995.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - In June 1996, SFAS No. 125,
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES, was issued. This statement established
standards for when transfers of financial assets, including those with
continuing involvement by the transferor, should be considered a sale.
SFAS No. 125 also established standards for when a liability should be
considered extinguished. In December 1996, the Financial Accounting
Standards Board issued SFAS No. 127, DEFERRAL OF THE EFFECTIVE DATE OF
CERTAIN PROVISIONS OF FASB STATEMENT NO. 125. SFAS No. 127 reconsidered
certain provisions of SFAS 125 and deferred for one year the effective
date of implementation for transactions related to repurchase
agreements, dollar-roll repurchase agreements, securities lending, and
similar transactions. This statement was effective for transfers of
assets and extinguishments of liabilities occurring after December 31,
1996, applied prospectively. SFAS No. 125 has not had a material effect
on the Company's financial statements, and SFAS No. 127 is not expected
to have a material effect on the Company's financial statements.
In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 129 ("SFAS 129"), "DISCLOSURE OF INFORMATION ABOUT
CAPITAL STRUCTURE." This statement established standards for disclosing
information about an entity's capital structure. It supersedes specific
disclosure requirements of APB SFAS No. 47, "DISCLOSURE OF LONG-TERM
OBLIGATIONS," and consolidates them in this statement for ease of
retrieval and for greater visibility to nonpublic entities. This
statement is effective for financial statements for periods ending
after December 15, 1997. It contains no changes in disclosure
requirements for entities that were previously subject to the
requirements of Opinions No. 10 and No. 15 and SFAS No. 47, and
therefore, it is not expected to have a significant impact on the
consolidated financial condition or results of operations of the
Company.
In June 1997, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 130, "REPORTING
COMPREHENSIVE INCOME," which requires that an enterprise report, by
major components and as a single total, the change in its net assets
during the period from nonowner sources; and No. 131, "DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION," which
establishes annual and interim reporting standards for an enterprise's
operating segments and related disclosures about its products,
services, geographic areas, and major customers. Adoption of these
statements will not impact the Company's consolidated financial
position, results of operations or cash flows, and any effect will be
limited to the form and content of its disclosures. Both statements are
effective for fiscal years beginning after December 15, 1997, with
earlier application permitted.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS - The
preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
30
<PAGE>
RECLASSIFICATIONS - Certain amounts in the 1995 and 1996 consolidated
financial statements have been reclassified to conform with the 1997
presentation.
2. MORTGAGE-BACKED SECURITIES
Mortgage-backed securities available for sale and held to maturity as
of December 31, 1997 and 1996 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------------------------------------------------------
GROSS GROSS WEIGHTED
AMORTIZED UNREALIZED UNREALIZED FAIR AVERAGE
COST GAINS LOSSES VALUE YIELD
<S><C>
Available for sale:
FHLMC certificates $ 27,908 $ 154 $ (16) $ 28,046 6.85%
FNMA certificates 25,142 113 (53) 25,202 6.55%
GNMA certificates 17,184 46 (13) 17,217 7.18%
-------- -------- -------- --------
Total $ 70,234 $ 313 $ (82) $ 70,465 6.82%
======== ======== ======== ========
Held to maturity:
FNMA certificates $ 142 $ - $ (4) $ 138 5.04%
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------------------------------------------------------------
GROSS GROSS WEIGHTED
AMORTIZED UNREALIZED UNREALIZED FAIR AVERAGE
COST GAINS LOSSES VALUE YIELD
<S><C>
Available for sale:
FHLMC certificates $ 39,110 $ 87 $ (209) $ 38,988 7.41%
FNMA certificates 46,410 206 (395) 46,221 7.68%
GNMA certificates 15,786 - (90) 15,696 7.62%
CMO/REMIC tranches 15,788 - (83) 15,705 6.74%
--------- -------- -------- ---------
Total $ 117,094 $ 293 $ (777) $ 116,610 7.46%
========= ======== ======== =========
Held to maturity:
FNMA certificates $ 173 $ - $ (4) $ 169 5.12%
========= ======== ======== =========
</TABLE>
31
<PAGE>
The amortized cost and fair value of mortgage-backed securities by
contractual maturity are shown below (dollars in thousands). Actual
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations.
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
---------------------------------- -----------------------------------
WEIGHTED WEIGHTED
AMORTIZED FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE YIELD COST VALUE YIELD
<S><C>
Mortgage-backed securities
available for sale - due
in 5 years or less $ 67 $ 67 7.00% $ 1,909 $ 1,908 7.34%
Mortgage-backed securities
available for sale - due
after 5 years through 10 years 5,895 5,874 6.55% - - -
Mortgage-backed securities
securities available
for sale - due after 10 years 64,272 64,524 6.85% 115,185 114,702 7.46%
-------- -------- --------- ---------
Total mortgage-backed
securities available for sale $ 70,234 $ 70,465 6.82% $ 117,094 $ 116,610 7.46%
======== ======== ========= =========
Mortgage-backed securities
held to maturity - due
in 5 years or less $ 142 $ 138 5.04% $ 173 $ 169 5.12%
======== ======== ========= =========
</TABLE>
Sales of mortgage-backed securities available for sale are summarized
as follows (dollars in thousands):
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
Proceeds from sales $ 38,613 $ 8,427 $ 13,746
Gross realized gains on sales 236 87 -
Gross realized losses on sales 23 17 258
32
<PAGE>
3. INVESTMENT SECURITIES
Investment securities available for sale and held to maturity at
December 31, 1997 and 1996 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,1997
---------------------------------------------------------------
GROSS GROSS WEIGHTED
AMORTIZED UNREALIZED UNREALIZED FAIR AVERAGE
COST GAINS LOSSES VALUE YIELD
<S><C>
Available for sale:
U.S. government securities:
FFCB Bond $ 4,000 $ 10 $ - $ 4,010 6.40%
FHLB Debentures 11,998 35 (4) 12,029 6.78%
FHLMC Debentures 6,101 16 - 6,117 6.70%
FNMA bond 3,252 13 - 3,265 6.47%
Other securities:
Smith Breeden short-term
government securities fund 15,000 - (66) 14,934 5.01%
-------- -------- ------- --------
Total $ 40,351 $ 74 $ (70) $ 40,355 6.05%
======== ======== ======= ========
Held to maturity:
Tennessee Valley bond $ 145 $ - $ - $ 145 5.28%
======== ======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------------------------
GROSS GROSS WEIGHTED
AMORTIZED UNREALIZED UNREALIZED FAIR AVERAGE
COST GAINS LOSSES VALUE YIELD
<S><C>
Available for sale:
U.S. government securities:
U.S. Treasury notes: $ 2,003 $ - $ (7) $ 1,996 5.28%
FHLB Debentures 22,000 3 (97) 21,906 6.99%
FHLB Debentures 8,307 10 (61) 8,256 6.86%
FNMA bond 1,001 3 - 1,004 6.57%
SLMA bond 2,011 - (17) 1,994 5.60%
Other securities:
Smith Breeden short-term
government securities fund 15,000 - (201) 14,799 5.19%
-------- -------- ------- --------
Total $ 50,322 $ 16 $ (383) $ 49,955 6.30%
======== ======== ======= ========
Held to maturity:
U. S. Government securities:
U. S. Treasury notes $ 153 $ - $ (1) $ 152 5.18%
Other securities:
Tennessee Valley bond 144 - - 144 5.29%
FICO zero coupon bond 107 - 107 5.00%
-------- -------- ------- --------
-
Total $ 404 $ - $ (1) $ 403 5.17%
======== ======== ======= ========
</TABLE>
33
<PAGE>
The amortized cost and approximate market value of investment
securities by contractual maturity are shown below (dollars in
thousands). Actual maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with
or without call premiums.
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------------------- -------------------------------------
AMORTIZED FAIR WEIGHTED AMORTIZED FAIR WEIGHTED
COST VALUE AVERAGE COST VALUE AVERAGE
<S><C>
Investment securities
available for sale:
Due within 1 year $ 15,000 $ 14,934 5.01% $ 18,004 $ 17,798 5.28%
Due after 1 year
through 5 years 18,998 19,037 6.59% 20,208 20,086 6.72%
Due after 5 years
through 10 years 6,353 6,384 6.88% 12,110 12,071 7.12%
-------- -------- --------- --------
Total $ 40,351 $ 40,355 6.05% $ 50,322 $ 49,955 6.30%
======== ======== ========= ========
Investment securities
held to maturity:
Due within 1 year $ 145 $ 145 5.28% $ 260 $ 259 5.11%
Due after 1 year
through 5 years - - 144 144 5.29%
-------- -------- --------- --------
Total $ 145 $ 145 5.28% $ 404 $ 403 5.17%
======== ======== ========= ========
Sales of investment securities available for sale are summarized as
follows:
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
Proceeds from sales $ - $ 3,194 $16,071
Gross realized gains on sales - 98 102
Gross realized losses on sales - - 94
34
<PAGE>
4. LOANS RECEIVABLE
Loans receivable at December 31, 1997 and 1996 are summarized as
follows (dollars in thousands):
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1997 1996
<S><C>
Held for investment:
Loans secured by real estate:
Residential:
One-to-four units $ 204,704 $ 201,449
Five or more units 23,355 22,455
Commercial real estate 20,159 7,524
Construction 35,150 4,131
Land 1,869 95
Other loans:
Business loans 943 -
Business lines of credit 270 -
Loans secured by deposits 505 670
Consumer lines of credit, unsecured 93 93
-- --
Total 287,048 236,417
(Less) add:
Loans in process (undisbursed loan funds) (21,442) (1,822)
Unamortized premiums, net of discounts 556 452
Deferred loan fees, net (742) (528)
Allowance for loan losses (1,669) (1,311)
--------- ---------
Loans receivable held for investment $ 263,751 $ 233,208
========= =========
Held for sale:
Loans secured by residential one-to-four units $ 514 $ 130
========= =========
Weighted average interest rate at end of period 7.96% 7.80%
</TABLE>
At December 31, 1997 and 1996, the Company was servicing loans for
others with a total unpaid principal balance of $52,141,000 and
$61,303,000, respectively. Servicing loans for others generally
consists of collecting mortgage payments, maintaining escrow accounts,
disbursing payments to investors, and conducting foreclosure
proceedings. Loan servicing income is recorded on an accrual basis and
includes servicing fees from investors and certain charges collected
from borrowers, such as late payment fees. Income from loan servicing
amounted to $229,000 and $153,000 for the years ended December 31, 1997
and 1996, respectively. At December 31, 1997, the Company held $191,000
in escrow accounts for taxes and insurance.
35
<PAGE>
The activity in the allowance for loan losses is as follows (dollars in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
<S><C>
Balance, beginning of year $ 1,311 $ 1,362 $ 808
Provision for loan losses 375 28 663
Charge-offs on mortgage loans (17) (79) (109)
------- ------- -------
Balance, end of year $ 1,669 $ 1,311 $ 1,362
======= ======= =======
</TABLE>
A loan is designated "impaired" when the Company determines it may be
unable to collect all amounts due according to the contractual terms of
the loan agreement, whether or not the loan is 90 days past due (see
Note 1). In addition, all loans designated as partially or completely
classified as Doubtful or Loss, and loans which meet the definition of
a troubled debt restructuring, are considered impaired.
The following table identifies the Company's total recorded investment
in impaired loans by type at December 31, 1997 and 1996 (dollars in
thousands).
DECEMBER 31,
----------------------
1997 1996
Loans secured by real estate:
Residential:
One-to-four units $ 985 $ 354
Five or more units 817 821
Consumer lines of credit, unsecured - 1
------- -------
Total impaired loans $1,802 $ 1,176
====== =======
The related valuation allowances on impaired loans at December 31, 1997
and 1996 were $236,000 and $83,000, respectively, which were included
as part of the allowance for loan losses in the Consolidated Statements
of Financial Condition. The provision for losses and any related
recoveries are recorded as part of the provision for estimated losses
on loans in the Consolidated Statements of Operations. For the years
ended December 31, 1997 and 1996, the Company recognized interest on
impaired loans of $49,000 and $145,000, respectively. Interest not
recognized on impaired loans at December 31, 1997 amounted to $57,000.
No impaired loans were on nonaccrual status at December 31, 1996, and
therefore no interest was uncollected on impaired loans. During the
year ended December 31, 1997, the Company's average investment in
impaired loans was $1.3 million, compared to $862,000 in 1996.
36
<PAGE>
Nonperforming loans consist of restructured loans not performing in
accordance with their restructured terms, and all nonaccrual loans.
Nonaccrual loans are loans on which the Company has ceased the accrual
of interest for any one of the following reasons: (a) the payment of
interest is 90 days or more delinquent, (b) the loan is in the process
of foreclosure, or (c) the collection of interest and/or principal is
not probable under the contractual terms of the loan agreement.
Nonperforming assets include all nonperforming loans and REO.
Nonperforming assets as of December 31, 1997 and 1996 were as follows
(dollars in thousands).
DECEMBER 31,
-----------------------
1997 1996
Residential loans secured by real estate:
One-to-four units - in foreclosure $ 124 $ 916
One-to-four units - not in foreclosure 957 477
Five or more units 817 -
Real estate owned 321 -
------- -------
Total nonperforming assets $ 2,219 $ 1,393
======= =======
At December 31, 1997 and 1996, the Company had $1.6 million and $1.4
million, respectively, of nonaccrual loans past due 90 days or more. In
addition, at December 31, 1997 and 1996, the Company had $907,000 and
$2.9 million, respectively, of loans which were less than 90 days
delinquent but were identified as having risk characteristics which
indicated that collection of principal and interest were not certain.
For the years ended 1997 and 1996, the effect on interest income had
nonaccrual and other adversely classified and impaired loans been
performing in accordance with contractual terms was approximately
$62,000 and $89,000, respectively.
Loans that have had a modification of terms are individually reviewed
to determine if they meet the definition of a troubled debt
restructuring. At December 31, 1997 and 1996, the Company had four
loans totaling $448,000 and three loans totaling $354,000,
respectively, which met the definition of a troubled debt
restructuring, of which $300,000 and $354,000, respectively, were
current and paying according to the terms of their contractually
restructured agreements on December 31, 1997 and 1996.
At December 31, 1997 and 1996, all nonperforming loans were secured by
properties located within the state of California.
37
<PAGE>
The following table presents an analysis of general and specific
allowances at the dates presented (dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------------------ --------------------------------------
SPECIFIC GENERAL SPECIFIC GENERAL
ALLOWANCE ALLOWANCE TOTAL ALLOWANCE ALLOWANCE TOTAL
<S><C>
Residential real estate:
One-to-four units $ - $ 846 $ 846 $ - $ 911 $ 911
Five or more units - 278 278 - 171 171
Commercial real estate - 241 241 - 174 174
Construction - 209 209 - 19 19
Land - 20 20 - 1 1
Off-balance sheet
letters of credit - 14 14 - - -
Business - 41 41 - - -
Consumer - 20 20 1 34 35
----- ------- ------- ------ -------- --------
Total valuation
allowances $ - $ 1,669 $ 1,669 $ 1 $ 1,310 $ 1,311
===== ======= ======= ====== ======== =======
</TABLE>
The Company made conforming loans to executive officers, directors,
subsidiary, and their affiliates in the ordinary course of business.
Activity for the year ended December 31, 1997 reflects the removal of
one loan with an outstanding balance of $110,000 due to the retirement
of a director of the Company. An analysis of the activity of these
loans is as follows (dollars in thousands):
YEAR ENDED
DECEMBER 31,
--------------------
1997 1996
Balance, beginning of period $ 811 $ 822
New loans and line of credit advances 75 -
Repayments (13) (11)
Other (110) -
------ ------
Balance, end of period $ 763 $ 811
====== ======
Under Office of Thrift Supervision ("OTS") regulations, the Company may
not make real estate loans to one borrower in an amount exceeding 15%
of the Bank's unimpaired capital and surplus, plus an additional 10%
for loans secured by readily marketable collateral. At December 31,
1997 and 1996, such limitation would have been approximately $5,786,000
and $5,415,000, respectively. There were no loans outstanding in excess
of this limitation. In calculating total loans outstanding to any one
borrower, the Bank includes loans in process (undisbursed loan funds)
but does not also include that portion of off-balance sheet performance
letters of credit which represent the undisbursed portion of gross
construction loans.
The majority of the Company's loans are secured by real estate
primarily located in Santa Cruz, Monterey, Santa Clara, and San Benito
counties. The Company's credit risk is therefore primarily related to
the economic conditions of this region. Loans are generally made on the
basis of a secure repayment source which is based on a detailed cash
flow analysis; however, collateral is generally a secondary source for
loan qualification. It is the Company's policy to originate loans with
a loan to value ratio on secured loans greater than 80% with private
mortgage insurance. Management believes this practice mitigates the
Company's risk of loss.
38
<PAGE>
5. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable as of December 31, 1997 and 1996 was as
follows (dollars in thousands):
DECEMBER 31,
-----------------
1997 1996
Interest receivable on loans $ 1,521 $ 1,341
Interest receivable on mortgage-backed securities 465 792
Interest receivable on other investments 353 423
------- -------
Total $ 2,339 $ 2,556
======= =======
6. INVESTMENT IN FHLB STOCK
As a member of the Federal Home Loan Bank of San Francisco ("FHLB"),
the Bank is required to own capital stock in an amount specified by
regulation. As of December 31, 1997 and 1996, the Bank owned 33,825 and
50,404 shares, respectively, of $100 par value FHLB stock. The amount
of stock owned meets the last annual regulatory determination. Each
Federal Home Loan Bank is authorized to make advances to its members,
subject to such regulation and limitations as the OTS may prescribe
(see Note 9).
7. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31, 1997
and 1996 (dollars in thousands):
DECEMBER 31,
-------------------------
1997 1996
Land $ 2,106 $ 2,104
Buildings and improvements 2,904 2,847
Equipment 1,800 1,569
------- -------
Total, at cost 6,810 6,520
Less accumulated depreciation (1,993) (1,633)
------- -------
Total $ 4,817 $ 4,887
======= =======
Depreciation expense was $440,000, $372,000, and $362,000 for the years
ended December 31, 1997, 1996, and 1995, respectively.
39
<PAGE>
8. SAVINGS DEPOSITS
A summary of savings deposits and related weighted average interest
rates for the years ended December 31, 1997 and 1996 follows (dollars
in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
---------------------------------- ----------------------------------
WEIGHTED WEIGHTED
AVERAGE % OF AVERAGE % OF
AMOUNT RATE TOTAL AMOUNT RATE TOTAL
------ -------- ----- ------ -------- -----
<S><C>
Consumer accounts:
Passbook accounts $ 13,533 1.89% 4.23% $ 13,423 1.90% 4.22%
Checking accounts 21,325 .49% 6.65% 13,944 .58% 4.38%
Money market accounts 31,605 3.88% 9.86% 37,534 3.58% 11.80%
Certificate accounts:
Jumbo accounts 59,025 5.57% 18.41% 49,217 5.51% 15.47%
Other term accounts 195,051 5.48% 60.85% 204,027 5.60% 64.13%
-------- ------- -------- -------
Total $320,559 100.00% $318,145 100.00%
======== ======= ======== =======
Weighted average 4.89% 4.88%
interest rate
</TABLE>
A summary of certificate accounts by maturity as of December 31, 1997
and 1996 follows (dollars in thousands):
DECEMBER 31,
----------------------
1997 1996
Within six months $101,645 $104,001
Six months to one year 83,546 83,849
One to two years 63,840 56,885
Two to three years 2,139 6,559
Over three years 2,906 1,950
-------- --------
Total $254,076 $253,244
======== ========
Savings deposits included $69,246,000 and $57,676,000 of jumbo accounts
($100,000 or greater) at December 31, 1997 and 1996, respectively. At
December 31, 1997 and 1996, total jumbo accounts included $10,221,000
and $8,459,000, respectively, of noncertificate accounts, such as
passbook, checking and money market accounts. The Company does not
offer premium rates on jumbo certificate accounts. The Savings
Association Insurance Fund only insures account balances up to
$100,000.
The interest expense on savings deposits is summarized as follows
(dollars in thousands):
YEAR ENDED DECEMBER 31,
------------------------------
1997 1996 1995
Passbook savings $ 254 $ 254 $ 308
Checking accounts 87 78 120
Money market accounts 1,344 695 395
Certificates of deposit 13,842 9,922 9,779
------- ------- -------
Total $15,527 $10,949 $10,602
======= ======= =======
At December 31, 1997 and 1996, accrued interest payable on savings
deposits, included in other liabilities, was $3,500 and $3,000,
respectively.
40
<PAGE>
In December 1996, the Company assumed $102.1 million of deposits from
Fremont Investment and Loan in exchange for cash and certain other
assets. A core deposit intangible asset of approximately $3.7 million
was recorded on the date of assumption. The Company acquired no
premises or equipment in the transaction.
9. FHLB ADVANCES
A summary of Federal Home Loan Bank advances and related maturities at
December 31, 1997 and 1996 follows (dollars in thousands):
DECEMBER 31,
------------------------
MATURITY 1997 1996
1997 $ - $ 38,225
1998 22,100 1,000
1999 2,600 -
2004 282 282
2005 1,500 1,500
2006 4,800 4,800
2010 1,000 1,000
-------- --------
Total $ 32,282 $ 46,807
======== ========
Weighted average rate during the year 5.92% 5.75%
Weighted average rate at year 6.09% 5.72%
At December 31, 1997 and 1996, advances were secured by
pledged investment securities and mortgage-backed securities with an
aggregate amortized cost of $72.5 million and $77.6 million,
respectively, and the Bank's investment in FHLB stock (see Note 6). At
December 31, 1997 and 1996, FHLB advances were also secured by mortgage
loans with carrying values of $202.9 million and $178.4 million,
respectively.
During the years ended December 31, 1997 and 1996, the
maximum amount of FHLB advances outstanding was $46.4 million and $99.6
million, respectively. The average amount of FHLB advances outstanding
during the same periods was $40.5 million and $43.6 million,
respectively.
41
<PAGE>
10. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
At December 31, 1997 and 1996, the Company held agreements to
repurchase securities resulting in net borrowings of $5.2 million and
$13.0 million, respectively. The agreements were collateralized by
Government National Mortgage Association bonds, United States Treasury
bonds, Federal Home Loan Bank bonds, and Federal National Mortgage
Association bonds which were controlled by the Company. Reverse
repurchase agreements outstanding at or during the years ended December
31, 1997 and 1996 are summarized below (dollars in thousands):
DECEMBER 31,
-----------------------
MATURITY 1997 1996
1997 $ - $13,000
1998 3,200 -
1999 2,000 -
-------- -------
Outstanding balance at year end $ 5,200 $13,000
======== =======
Weighted average rate during the year 5.91% 5.98%
Weighted average rate at the end of the year 5.95% 5.94%
Value of securities held as collateral for
reverse repurchase agreements, at year end:
Par value $ 6,162 $14,402
Amortized cost 6,357 14,784
Market value 6,364 14,910
During the years ended December 31, 1997 and 1996, the
maximum amount of reverse repurchase agreements outstanding was $13.0
million and $16.6 million, respectively. The average amount of reverse
repurchase agreements outstanding during the same periods was $8.2
million and $14.6 million, respectively.
11. INCOME TAXES
The components of the provision for income taxes for the years ended
December 31, 1997, 1996 and 1995 are as follows (dollars in thousands):
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
Current:
Federal $ 1,473 $ 626 $ 343
State 449 163 127
------- ------- -------
Total current 1,922 789 470
------- ------- -------
Deferred:
Federal (566) (173) (44)
State (126) 7 (12)
------- ------- -------
Total deferred (692) (166) (56)
------- ------- -------
Total current and deferred $ 1,230 $ 623 $ 414
======= ======= =======
42
<PAGE>
The differences between the statutory federal income tax rate and the
Company's effective tax rate, expressed as a percentage of income
before income taxes, are as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
Statutory federal tax rate 34.0% 34.0% 34.0%
California franchise tax, net of
federal income tax benefit 7.1% 7.6% 7.0%
Other (0.1%) 0.7% (2.9%)
----- ----- -----
Total 41.0% 42.3% 38.1%
===== ===== =====
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities as of December 31,
1997 and 1996 are presented below (dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
<S><C>
1997 1996
Deferred tax assets:
Deferred loan fees $ 204 $ 89
Compensation deferred for tax purposes 538 383
Allowance for loan losses 383 210
State income taxes 29 (32)
Core deposits 574 362
Unrealized loss on securities available for sale - 354
Other 32 41
------- --------
Total gross deferred tax assets 1,760 1,407
Deferred tax liabilities:
Tax over book depreciation (61) (123)
FHLB stock dividends (545) (445)
Unrealized gain on securities available for sale (96) -
Other (27) (50)
------- --------
Total gross deferred tax liabilities (729) (618)
------- --------
Net deferred tax asset $ 1,031 $ 789
======= ========
</TABLE>
Legislation regarding bad debt recapture was signed into law by the
President during the third quarter of 1996. The new law requires
recapture of reserves accumulated after 1987, and required that the
recapture tax on post-1987 reserves be paid over a six year period
starting in 1996. The payment of the tax could be deferred in each of
1996 and 1997 if an institution originates at least the same average
annual principal amount of mortgage loans that it originated in the six
years prior to 1996. Management believes that the newly enacted bad
debt recapture legislation will not have a material impact on the
operations of the Company.
In accordance with SFAS 109, a deferred tax liability has not been
recognized for the tax bad debt reserves of the Company that arose in
tax years that began prior to December 31, 1987. At December 31, 1997,
the portion of the tax bad debt reserves attributable to pre-1988 tax
years was approximately $5,700,000. The amount of unrecognized deferred
tax liability could be recognized if, in the future, there is a change
in federal tax law, the savings institution fails to meet the
definition of a "qualified savings institution," or the bad debt
reserve is used for any purpose other than absorbing bad debt losses.
43
<PAGE>
12. REGULATORY CAPITAL REQUIREMENTS AND OTHER REGULATORY
MATTERS
In connection with the insurance of its deposits by the Federal Deposit
Insurance Corporation ("FDIC") and general regulatory oversight by the
Office of Thrift Supervision ("OTS"), the Bank is required to maintain
minimum levels of regulatory capital, including tangible, core and
risk-based capital. At December 31, 1997 and 1996, the Bank was in
compliance with all regulatory capital requirements. In addition, the
OTS is empowered to take "prompt, corrective action" to resolve
problems of insured depository institutions. The extent of these powers
depends on whether an institution is classified as "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly under
capitalized," or "critically undercapitalized." At December 31, 1997
and 1996, the Bank was considered "well capitalized."
The following table sets forth the amounts and ratios regarding actual
and minimum tangible, core and risk-based capital requirements,
together with the amounts and ratios required in order to meet the
definition of a "well capitalized" institution.
<TABLE>
<CAPTION>
MINIMUM CAPITAL WELL CAPITALIZED
REQUIREMENTS REQUIREMENTS ACTUAL
---------------------- ----------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- ---------- ---------- ---------- --------- ----------
<S><C>
As of December 31, 1997:
Total capital
(to risk-weighted $17,898 8.00% $22,372 10.00% $38,570 17.24%
assets)
Tier 1 capital
(to risk-weighted N/A N/A 13,323 6.00% 36,901 16.62%
assets)
Core (tier 1) capital
(to adjusted assets) 11,777 3.00% 19,629 5.00% 36,901 9.40%
Tangible capital
(to tangible assets) 5,888 1.50% N/A N/A 36,859 9.39%
</TABLE>
<TABLE>
<CAPTION>
MINIMUM CAPITAL WELL CAPITALIZED
REQUIREMENT REQUIREMENTS ACTUAL
---------------------- ----------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- ---------- ---------- ---------- --------- ----------
<S><C>
As of December 31, 1996:
Total capital
(to risk-weighted assets) $15,026 8.00% $18,783 10.00% $36,097 19.22%
Tier 1 capital
(to risk-weighted assets) N/A N/A 11,270 6.00% 34,787 18.52%
Core (tier 1) capital
(to adjusted assets) 12,488 3.00% 20,814 5.00% 34,787 8.36%
Tangible capital
(to tangible assets) 6,239 1.50% N/A N/A 34,440 8.28%
</TABLE>
At periodic intervals, both the OTS and the FDIC routinely examine the
Company's financial statements as part of their legally prescribed
oversight of the savings and loan industry. Based on these
examinations, the regulators can direct that a savings and loan
association's financial statements be adjusted in accordance with their
findings.
The OTS has adopted a regulation that adds an IRR component to the
risk-based capital requirement for thrift institutions. Currently, the
OTS has waived inclusion of the IRR component in the risk-based capital
calculation, pending the issuance by the OS of guidelines regarding the
appeal of such inclusion or calculation. Under the rule, thrift
institutions meeting or exceeding a base level of interest rate
exposure must take a deduction from the total capital available to meet
their risk-based
44
<PAGE>
capital requirement. That deduction is equal to one-half of the
difference between the institution's actual measured exposure and the
base level of exposure. The institution's actual measured IRR is
expressed as the change that occurs in its net present value (NPV) as a
result of a hypothetical 200 basis point increase or decrease in
interest rates (whichever leads to the lower NPV) divided by the
estimated economic value of its assets. The base level of IRR which
would require inclusion of a capital component is defined as a decline
in NPV which exceeds 2.0% of an institution's assets expressed in terms
of economic value. If the Bank had been subject to adding an interest
rate risk component to its risk-based capital standard at December 31,
1997, the Bank's total risk-weighted capital would have been reduced
from 17.24% to 15.31%. At December 31, 1997, the Bank met each of its
capital requirements, in each case on a fully phased-in basis.
The OTS rules impose certain limitations regarding stock repurchases
and redemptions, cash-out mergers, and any other distributions charged
against an institution's capital accounts. The payment of dividends by
the Bank to the Parent Company is subject to OTS regulations.
"Safe-harbor" amounts of capital distributions can be made after
providing notice to the OTS, but without needing prior approval. For
Tier 1 institutions such as the Bank, the safe harbor amount is the
greater of (1) net income earned during the year or (2) the sum of net
income earned during the year plus one-half of the institution's
capital in excess of the OTS capital requirement as of the end of the
prior year. Distributions beyond these amounts are allowed only with
the specific, prior approval of the OTS. As of December 31, 1997, the
Bank had the capacity to declare dividends totaling approximately $10.3
million under the "safe harbor" limitations.
On September 30, 1996, Congress passed and the President signed
legislation to recapitalize the Savings Association Insurance Fund
("SAIF") in order to bring it into parity with the FDIC's other
insurance fund, the Bank Insurance Fund ("BIF"). The new banking law
required members to pay a one-time special assessment of $0.657 for
every $100 of deposits as of March 31, 1995. The special assessment was
designed to capitalize the SAIF up to the required reserve level of
1.25% of deposits, but lowered savings and loan deposit insurance
premiums starting in 1997. As a result of this legislation, the
Company's subsidiary, Monterey Bay Bank, incurred a one-time pre-tax
charge of $1.4 million during 1996. The SAIF assessment rate may
increase or decrease as is necessary to maintain the designated SAIF
reserve ratio of 1.25% of insured deposits.
Effective January 1, 1997, all FDIC-insured depository institutions
began paying an annual assessment to provide funds for the payment of
interest on bonds issued by the Financing Corporation ("FICO"), a
federal corporation chartered under the authority of the Federal
Housing Finance Board. The FICO Bonds were issued to capitalize the
Federal Savings and Loan Insurance Corporation. Until December 31,
1999 or when the last savings and loan association ceases to exist,
whichever occurs first, depository institutions will pay approximately
$.064 per $100 of SAIF-assessable deposits and approximately $.013 per
$100 of BIF-assessable deposits.
Management cannot predict the future level of FDIC insurance
assessments, whether the savings charter will be eliminated, or
whether the BIF and SAIF will eventually be merged.
Following the December 1996 assumption of $102.1 million of BIF
insured deposits from Fremont Investment and Loan, Monterey Bay Bank
became an "Oakar" institution and began paying insurance premiums to
the BIF as well as the SAIF. The Company paid FDIC deposit insurance
premiums of $233,000 in 1997, of which $201,000 was paid to the SAIF
and $32,000 was paid to the BIF. Excluding the special premium
assessment, the Company paid deposit insurance premiums of $532,000 in
1996.
As a result of certain legislation currently pending before the U.S.
Congress, Monterey Bay Bank may be required to convert its charter to
either a national bank charter, a state depository institution
charter, or a newly designed charter. The Company may also become
regulated at the
45
<PAGE>
holding company level by the Federal Reserve rather than by the OTS.
Regulation by the Federal Reserve could subject the Company to capital
requirements that are not currently applicable to the Company as a
thrift holding company under OTS regulation and may result in
statutory limitations on the type of business activities in which the
Company may engage at the holding company level, which business
activities currently are not restricted. At this time, the Company is
unable to predict whether a charter change will be required and, if it
is, whether the charter change will significantly impact the Company's
operations.
13. INTEREST RATE RISK
The Company is engaged principally in providing first mortgage,
commercial real estate, land, and construction loans to individuals. At
December 31, 1997 and 1996, respectively, approximately $262.5 million
and $232.1 million of the Company's assets were comprised of loans
secured by real estate.
The Company originates both fixed and adjustable rate loans. At
December 31, 1997, the loan portfolio consisted of 68% adjustable rate
and 32% fixed rate loans, compared to 63% adjustable rate and 37% fixed
rate loans at December 31, 1996. The composition of the loan portfolio
was as follows (dollars in thousands):
DECEMBER 31,
-----------------------
1997 1996
Adjustable rate:
Term to adjustment:
1 month to 1 year $ 152,713 $ 128,510
1 year to 5 years 28,243 19,754
--------- ---------
Total adjustable rate $ 180,956 $ 148,264
========= =========
Fixed rate:
Term to maturity:
1 month to 3 years $ 4,746 $ 1,730
3 years to 5 years 1,423 543
5 years to 10 years 5,301 3,302
10 years to 20 years 5,742 7,154
Over 20 years 67,766 73,656
--------- ---------
Total fixed rate $ 84,978 $ 86,385
========= =========
The adjustable rate loans have interest rate adjustment limitations and
are indexed to the Federal Home Loan Bank Eleventh District cost of
funds, the six-month London Interbank Offered Rate, prime rate, and the
one-year Constant Maturity Treasury rate. Future market factors may
affect the correlation of the interest rate adjustment with the rates
the Company pays on the short-term deposits that have been primarily
utilized to fund these loans.
At December 31, 1997, the Company had interest-earning assets of $387.0
million, having a weighted average effective yield of 7.48% (the total
of weighted average maturities for fixed rate assets and weighted
average period to adjustments for adjustable rate assets); and
interest-bearing liabilities of $358.0 million, having a weighted
average effective interest rate of 4.99%.
At December 31, 1996, the Company had interest-earning assets of $407.8
million, having a weighted average effective yield of 7.54%; and
interest-bearing liabilities of $378.0 million with a weighted average
effective interest rate of 5.10%.
46
<PAGE>
14. WHOLLY OWNED SUBSIDIARY
Monterey Bay Bank's wholly owned subsidiary, Portola, is engaged on an
agency basis in the sale of insurance and investment products to the
Company's customers and members of the local community, and acts as
trustee on the Company's deeds of trust.
Condensed statements of financial condition of Portola as of December
31, 1997 and 1996, and condensed statements of operations for the years
ended December 31, 1997, 1996 and 1995 are as follows (dollars in
thousands):
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31,
---------------------
1997 1996
<S><C>
ASSETS:
Cash and due from depository institutions $ 30 $ 77
Commissions receivable 26 -
Investment securities available for sale 252 199
Investment securities held to maturity - 153
Premises and equipment, net 11 6
Unamortized purchase premium 76 -
Accrued interest receivable and other assets 34 6
------- -------
TOTAL $ 429 $ 441
======= =======
LIABILITIES AND STOCKHOLDER'S EQUITY:
Total liabilities $ 15 $ 2
------- -------
Stockholder's equity:
Retained earnings 409 434
Capital stock 5 5
------- -------
Total stockholder's equity 414 439
------- -------
TOTAL $ 429 $ 441
======= =======
</TABLE>
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
<S><C>
INCOME:
Interest income on investments $ 20 $ 24 $ 17
Commissions and fee income 355 138 464
------- ------- -------
Total 375 162 481
------- ------- -------
EXPENSES:
Compensation and employee benefits 304 187 273
Occupancy and equipment 15 7 7
Amortization of purchase premiums 10 - -
Other 88 74 64
------- ------- -------
Total 417 268 344
------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES (42) (106) 137
INCOME TAX EXPENSE (BENEFIT) (17) (44) 56
------- ------- -------
NET INCOME (LOSS) $ (25) $ (62) $ 81
======= ======= =======
</TABLE>
47
<PAGE>
Condensed statements of cash flows of Portola as of December 31, 1997,
1996, and 1995 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF CASH FLOWS TATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
<S><C>
OPERATING ACTIVITIES:
Net income (loss) $ (25) $ (62) $ 81
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization of premises
and equipment 3 2 2
Amortization of purchase premiums,
net of discounts 12 4 (7)
Change in:
Commissions receivable (26) 148 (44)
Other assets (28) (20) 27
Other liabilities 13 (72) (195)
------ ------ ------
Net cash used in operating activities (51) - (136)
------ ------ ------
INVESTING ACTIVITIES:
Purchases of premises and equipment (8) (4) (2)
Purchases of investment securities (252) (200) (254)
Proceeds from maturities of investment securities 350 200 460
------ ------ ------
Net cash provided by (used in) investing activities 90 (4) 204
------ ------ ------
FINANCING ACTIVITIES:
Purchase premium paid for investment company assets (86) - -
------ ------ ------
Net cash used in financing activities (86) - -
------ ------ ------
NET INCREASE (DECREASE) IN CASH (47) (4) 68
CASH AT BEGINNING OF YEAR 77 81 13
------ ------ ------
CASH AT END OF YEAR $ 30 $ 77 $ 81
====== ====== ======
</TABLE>
15. COMMITMENTS AND CONTINGENCIES
The Company is involved in legal proceedings arising in the normal
course of business. In the opinion of management, the outcomes of such
proceedings should not have a material adverse effect on the
accompanying consolidated financial statements.
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 represent commitments to
originate fixed and variable rate loans, letters of credit, lines of
credit, and loans in process and involve, to varying degrees, elements
of interest rate risk and credit risk in excess of the amount
recognized in the Consolidated Statements of Financial Condition. The
Company uses the same credit policies in making commitments to
originate loans, lines of credit, and letters of credit as it does for
on-balance sheet instruments.
At December 31, 1997, the Company had outstanding commitments to
originate $7.1 million of real estate loans, include $963,000 for fixed
rate loans and $6.2 million for adjustable rate loans. Commitments to
fund loans are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments
generally have expiration dates or other termination clauses. In
addition, external market forces may impact the probability of
48
<PAGE>
commitments being exercised; therefore, total commitments outstanding
do not necessarily represent future cash requirements.
At December 31, 1997, the Company had made available various secured
and unsecured business, personal, and residential lines of credit
totaling approximately $7.5 million, of which the undisbursed portion
was approximately $4.1 million.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. At
December 31, 1997, the Company had issued letters of credit totaling
$8.3 million. The Company had issued no letters of credit at December
31, 1996.
The Company receives collateral, primarily real estate, to support
commitments for which collateral is deemed necessary. Other categories
of collateral include liens on personal property and cash on deposit
with the Bank. At December 31, 1997, the extent of collateral
supporting mortgage and other loans varied from 0% to 100% of the
maximum credit exposure.
In December 1997, the Company entered into a definitive agreement to
assume approximately $29 million of deposit liabilities from Commercial
Pacific Bank ("CPB"), a Santa Cruz based federal savings bank, in
exchange for an approximately equal amount of loan assets. The
agreement also calls for the Company to make a $5 million loan to the
parent holding company of CPB. No premises or equipment will be
acquired in the transaction. Consummation of the transaction, which is
subject to customary conditions, is expected to occur during the second
quarter of fiscal 1998.
In December 1997, the Company entered into an agreement to purchase an
administrative office facility in Watsonville, California for
approximately $1.1 million. Relocation to the new facility is expected
to occur in the second quarter of 1998.
At December 31, 1997, 1996, and 1995, the Company was obligated under
non-cancelable operating leases for office space. Certain leases
contain escalation clauses providing for increased rentals based
primarily on increases in real estate taxes or on the average consumer
price index. Rent expense under operating leases, included in occupancy
and equipment expense, was approximately $147,000, $158,000 and
$154,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.
Certain branch offices are leased by the Company under the terms of
operating leases expiring at various dates through the year 2003. At
December 31, 1997, future minimum rental commitments, including renewal
options, under non-cancelable operating leases with initial or
remaining terms of more than one year were as follows (dollars in
thousands):
1998 $ 75
1999 33
2000 35
Thereafter 112
-------
Total $ 255
=======
16. STOCK BENEFIT PLANS
On August 24, 1995, the stockholders of the Company approved the 1995
Incentive Stock Option Plan (the "Stock Option Plan"). Under the Stock
Option Plan, the Company may grant to executive officers and officers
of the Company and its affiliate, the Bank, options to purchase an
aggregate of 281,407 shares of the Company's common stock. Each option
entitles the holder to
49
<PAGE>
purchase one share of the common stock at the fair market value of the
common stock on the date of grant. The Stock Option Plan provides that
options granted thereunder begin to vest one year after the date of
grant ratably over five years and expire no later than ten years after
the date of grant. However, all options become 100% exercisable in the
event that the employee terminates his employment due to death,
disability, or, to the extent not prohibited by the OTS, in the event
of a change in control of the Company or the Bank. At December 31,
1997, unexercised options were granted and outstanding for an aggregate
of 232,590 shares. An additional 40,001 options had been reserved for
future grant. At December 31, 1997, 89,992 of the options granted were
outstanding and exercisable and 8,816 had been exercised.
The Company also maintains the 1995 Stock Option Plan for Outside
Directors (the "Directors' Option Plan"), approved by the stockholders
of the Company on August 24, 1995. Under the Directors' Option Plan,
members of the Board of Directors who are not officers or employees of
the Company or Bank may be granted an aggregate of 78,343 shares of the
Company's common stock. Options begin to vest one year after the date
of grant ratably over five years and expire no later than ten years
after the date of grant. However, all options become 100% exercisable
in the event that the Director terminates membership on the Board of
Directors due to death, disability, or, to the extent not prohibited by
the OTS, in the event of a change in control of the Company or the
Bank. Unexercised options were granted and outstanding as of December
31, 1997, for an aggregate of 72,443 shares with an exercise price
equal to the fair market value of the Company's common stock at the
date of grant. An additional 5,900 options had been reserved for future
grant. At December 31, 1997, 31,340 of the options granted were
outstanding and exercisable. Through December 31, 1997, no options had
been exercised under the Directors' Option Plan.
A summary of stock option transactions under the plans for the years
December 31, 1997, 1996, and 1995 follows:
<TABLE>
<CAPTION>
NUMBER WEIGHTED EXERCISE
OF AVERAGE PRICE EXPIRATION
SHARES EXERCISE PRICE PER SHARE DATE
------ -------------- --------- ----------
<S><C>
Balance, December 31, 1994 0 N/A N/A N/A
Options granted 357,577 $11.375 $11.375 2005
-------
Balance, December 31, 1995 357,577 $11.375 $11.375 2005
Options granted 15,227 $14.052 $13.375 - 14.75 2005
Options cancelled/expired (17,787) $11.375 $11.375 2005
-------
Balance, December 31, 1996 355,017 $11.490 $11.375 - 14.75 2005-2006
Options exercised (8,816) $11.375 $11.375 2005
Options cancelled/expired (41,168) $11.375 $11.375 2005
-------
Balance, December 31, 1997 305,033 $11.509 $11.375 - 14.75 2005-2006
=======
Exercisable, December 31, 1997 121,332 $11.442
=======
</TABLE>
The following table summarizes stock option information at year-end
1997:
EXERCISE NUMBER OF REMAINING EXERCISABLE
PRICE OPTIONS LIFE OPTIONS
--------------- ------------ ----------- -----------
$ 11.375 289,806 7.7 years 106,105
13.375 7,727 8.5 years 7,727
14.750 7,500 9.0 years 7,500
$ 11.375-14.75 305,033 7.8 years 121,332
50
<PAGE>
The Bank has established an Employee Stock Owner Plan and Trust
("ESOP") for eligible employees. Full-time employees employed with the
Company or Bank as of January 1, 1995, and full-time employees of the
Company or the Bank employed after such date who have been credited
with at least 1,000 hours during a twelve-month period, have attained
age 21, and were employed on the last business day of the year are
eligible to participate.
On February 14, 1995, the Conversion date, the ESOP borrowed $2,300,000
from the Company and used the funds to purchase 287,500 shares of
common stock issued in the Conversion. The loan is being repaid
principally by contributions by the Bank to the ESOP, but may be paid
from the Company's discretionary contributions to the ESOP, over a ten
year period. At December 31, 1997, the loan had an outstanding balance
of $1,610,000 and carried an interest rate of 8.00%. Interest expense
for the obligation was $147,000 and $166,000, respectively, for the
years ended December 31, 1997 and 1996. Shares purchased with the loan
proceeds are held in trust for allocation among participants as the
loan is paid. Contributions to the ESOP and shares released from the
loan collateral in an amount proportional to the repayment of the ESOP
loan is allocated among participants on the basis of compensation, as
described in the plan, in the year of allocation. Benefits generally
become 100% vested after seven years of credited service. However, in
the event of retirement, disability or death, as defined in the plan,
any unvested portion of benefits shall vest immediately. Forfeitures
will be reallocated among participating employees, in the same
proportion as contributions. Benefits are payable upon separation from
service based on vesting status and share allocations made. As of
December 31, 1997, 86,250 shares were allocated to participants and
committed to be released. As shares are released from collateral, the
shares become outstanding for earnings per share computations. As of
December 31, 1997, the fair market value of the 201,250 unearned shares
was $3,924,375.
The Company maintains a Performance Equity Program for Officers (the
"PEP") and a Recognition and Retention Plan for Outside Directors (the
"RRP"). The purpose of the PEP and RRP is to provide executive
officers, officers, and directors of the Company with a proprietary
interest in the Company in a manner designed to encourage such persons
to remain with the Company. In 1996 and 1995, the Company granted 5,797
shares and 132,071 shares, respectively, of Company common stock under
the PEP and RRP. No grant shares were awarded in 1997. Awards vest pro
rata on each anniversary of the grant date and become fully vested five
years from the grant date, provided that the employee has completed the
specified continuous service requirement. Awards become 100% vested
upon termination of employment due to death, disability, or following a
change in control of the Company. Some awards are based on the
attainment of certain performance goals and are forfeited if such goals
are not met. At December 31, 1997, 72,913 shares were the subject of
outstanding grant awards to officers and directors and 28,402 remained
reserved for future awards. The following is a summary of transactions
under the PEP and RRP:
<TABLE>
<CAPTION>
NUMBER OF GRANT WEIGHTED AVERAGE
SHARES AWARDED FAIR VALUE
AND OUTSTANDING ON GRANT DATE
--------------- ----------------
<S><C>
Balance, January 1, 1995 - N/A
Grant shares awarded 132,071 $11.375
-------
Balance, December 31, 1995 132,071 11.375
Grant shares awarded 5,797 14.324
Grant shares vested and issued (19,980) 11.375
Grant shares forfeited (11,470) 11.375
-------
Balance, December 31, 1996 106,418 11.536
Grant shares vested and issued (22,455) 11.375
Grant shares forfeited (11,050) 11.375
-------
Balance, December 31, 1997 72,913 $11.609
=======
</TABLE>
51
<PAGE>
The Company recorded compensation expense for the ESOP, PEP, and RRP of
$751,000 and $599,000, and $326,000, respectively, for the years ended
December 31, 1997, 1996, and 1995.
In October 1995, the FASB issued Statement of Financial Standards No.
123 ("SFAS 123"), ACCOUNTING FOR STOCK BASED COMPENSATION, which
established accounting and disclosure requirements using a fair value
based method of accounting for stock based employee compensation plans.
Under SFAS 123, beginning in 1996 the Company had the option to either
adopt the new fair value based accounting method or continue the
intrinsic value based method and provide pro forma net income and
earnings per share as if the accounting provisions of SFAS 123 had been
adopted. The Company has adopted only the disclosure requirements of
SFAS 123, and applies Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock issued to Employees," in accounting for its stock
options.
Had compensation cost been determined in accordance with SFAS No. 123,
the Company's net income and earnings per share would have been changed
to the pro forma amounts indicated below (dollars in thousands).
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
Net income:
As reported $1,766 $ 852 $ 673
Pro forma 1,622 708 535
Basic earnings per share:
As reported $ .58 $ .27 $ .17
Pro forma .54 .23 .16
Diluted earnings per share:
As reported $ .56 $ .27 $ .17
Pro forma .52 .23 .16
For these disclosure purposes, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions used for grants
in 1996 and 1995, respectively: dividend yield of .72% for both years;
expected volatility of 9% for both years; expected lives of 7 years for
both years; and risk-free interest rates of 6.20% (1996) and 6.41%
(1995). No options were awarded in 1997. During the initial phase-in
period, the effects of applying SFAS 123 may not be representative of
the effects on reported net income for future years because options
vest over several years and additional awards can be made each year.
The weighted average fair value per share of options granted during
1996 and 1995 were $4.08 and $4.42, respectively.
17. EARNINGS PER SHARE
The Company calculates Basic Earnings per Share ("EPS") and
Diluted EPS in accordance with SFAS 128. Basic EPS is calculated by
dividing net earnings for the period by the weighted average common
shares outstanding for that period. Diluted EPS takes into account the
effect of dilutive instruments, such as stock options, but uses the
average share price for the period in determining the number of
incremental shares that are to be added to the weighted average number
of shares outstanding.
52
<PAGE>
Following is a summary of the calculation of basic and
diluted EPS (dollars are in thousands except per share amounts). Net
income and common shares outstanding for the period from February 15,
1995, the date of the mutual to stock conversion, to December 31, 1995
were used to compute earnings per share for the year ended December 31,
1995.
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
Net income $ 1,766 $ 852 $ 545
======= ===== =====
Weighted average shares 3,021,983 3,087,495 3,290,765
Dilutive effect of option shares 103,091 35,986 -
------- ------ -----
Diluted average shares outstanding 3,125,074 3,123,481 3,290,765
========= ========= =========
Basic earnings per share $ 0.58 $ 0.27 $ 0.17
====== ====== ======
Diluted earnings per share $ 0.56 $ 0.27 $ 0.17
====== ====== ======
18. 401(K) PLAN
The Company maintains a tax deferred employee savings plan under
Section 401(k) of the Internal Revenue Code. All employees are eligible
to participate who are 21 years of age, have been employed by the
Company for 90 days, and have completed 1,000 hours of service. The
Company does not provide contributions to the 401(k) plan.
The trust that administers the 401(k) plan had assets of $1,532,000 and
$1,288,000 at other financial institutions as of December 31, 1997 and
1996, respectively.
19. SALARY CONTINUATION AND RETIREMENT PLAN
The Company maintains a Salary Continuation Plan for the benefit of
certain officers and a Retirement Plan for members of the Board of
Directors of the Company. Officers participating in the Salary
Continuation Plan are entitled to receive a monthly payment for a
period of 10 years upon retirement. Directors of the Company who have
served on the Board of Directors for a minimum of nine years are
entitled under the Retirement Plan to receive a quarterly payment equal
to the amount of their quarterly retainer fee in effect at the date of
retirement for a period of ten years. The Salary Continuation Plan and
the Retirement Plan provide that payments will be accelerated upon the
death of a Participant or in the event of a change in control of the
Company. As of December 31, 1997 and 1996, there were eight officers
and Directors participating in the Plan.
The actuarial present value of the accumulated plan benefit obligation,
calculated using a discount rate of 7.5%, was $909,000 at December 31,
1997 and $914,000 at December 31, 1996. Plan assets are not segregated
for purposes of paying benefits under the Salary Continuation and
Retirement Plans. The Company accrued pension liability expenses of
$36,000 and $35,000 under the Plans for the years ended December 31,
1997 and 1996, respectively. The Company did not accrue pension
expenses during 1995. Such expense amounts approximated the computed
actuarial net periodic plan costs for each period.
20. PARENT COMPANY FINANCIAL INFORMATION
The Parent Company and its subsidiary, the Bank, file consolidated
federal income tax returns in which the taxable income or loss of the
Company is combined with that of the Bank. The Parent Company's share
of income tax expense is based on the amount which would be payable if
separate returns were filed. Accordingly, the Parent Company's equity
in the net income of its
53
<PAGE>
subsidiaries (distributed and undistributed) is excluded from the
computation of the provision for income taxes for financial statement
purposes.
Following are the Parent Company's summary statements of financial
condition for the years ended December 31, 1997 and 1996, and condensed
statements of operations and cash flows for the years ended December
31, 1997, 1996, and 1995 (dollars in thousands):
<TABLE>
<CAPTION>
SUMMARY STATEMENTS OF FINANCIAL CONDITION YEAR ENDED DECEMBER 31,
----------------------------
1997 1996
<S><C>
ASSETS
Cash and due from depository institutions $ 442 $ 588
Overnight deposits 1,400 -
-------- --------
Total cash and cash equivalents 1,842 588
Mortgage-backed securities available for sale 10,939 7,144
Investment securities available for sale 101 102
Other assets 109 55
Investment in subsidiary 40,212 37,939
-------- --------
TOTAL $ 53,203 $ 45,828
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Securities sold under agreements to repurchase $ 5,200 $ -
Other liabilities 70 69
-------- --------
Total liabilities 5,270 69
Stockholders' equity (see Consolidated Statements
of Financial Condition) 47,933 45,759
-------- --------
TOTAL $ 53,203 $ 45,828
======== ========
</TABLE>
<TABLE>
<CAPTION>
SUMMARY STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
<S><C>
Interest income:
Interest on mortgage-backed securities and investment securities $ 569 $ 582 $ 690
Interest on ESOP 147 166 184
------ ------- -------
Total interest income 716 748 874
------ ------- -------
Interest expense:
Interest on reverse repurchase agreements 61 7 42
------ ------- -------
Total interest expense 61 7 42
------ ------- -------
Noninterest revenue - 47 -
General and administrative expense 476 397 271
------ ------- -------
Income before income tax expense 179 391 561
Income tax expense 74 162 219
------ ------- -------
Income before undistributed net income of the Bank 105 229 342
Undistributed net income of the Bank 1,661 623 331
------ ------- -------
Net income $1,766 $ 852 $ 673
====== ======= =======
</TABLE>
54
<PAGE>
Following are the Parent Company's condensed statements of cash flows
for the years ended December 31, 1997, 1996, and 1995 (dollars in thousands):
<TABLE>
<CAPTION>
SUMMARY STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
<S><C>
OPERATING ACTIVITIES:
Net income $ 1,766 $ 852 $ 673
Adjustments to reconcile net income to net cash provided by
operating activities:
Undisbursed net income of subsidiary (1,661) (623) (331)
Amortization of premiums 50 8 41
Compensation expense related to ESOP shares released 386 307 277
Change in interest receivable (32) 86 (134)
Change in other assets (4) 53 (35)
Change in income taxes payable and deferred income taxes (24) (150) 149
Change in other liabilities (9) (49) 99
------- -------- --------
Net cash provided by operating activities 472 484 739
------- -------- --------
INVESTING ACTIVITIES:
Investment in subsidiary - - (13,513)
Purchases of mortgage-backed securities available for sale (6,899) (5,284) (5,891)
Paydowns on mortgage-backed securities 3,094 3,010 998
Purchases of investment securities available for sale - (3,593) (6,634)
Proceeds from maturities of investment securities - 8,500 1,500
Proceeds from sales of investment securities - 85 -
------- -------- --------
Net cash (used in) provided by investing activities (3,805) 2,718 (23,540)
------- -------- --------
FINANCING ACTIVITIES:
Proceeds from the sale of common stock - - 24,726
Proceeds (repayments) of reverse repurchase agreements, net 5,200 (713) 713
Cash dividends paid to stockholders (357) (165) -
Purchases of treasury stock, net (256) (2,173) (2,201)
------- -------- --------
Net cash provided by (used in) financing activities 4,587 (3,051) 23,238
------- -------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,254 151 437
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 588 437 -
------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,842 $ 588 $ 437
======= ======== ========
</TABLE>
21. ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of the Company's
financial instruments is in accordance with the provisions of Statement
of Financial Accounting Standards No. 107, DISCLOSURES ABOUT FAIR VALUE
OF FINANCIAL INSTRUMENTS ("SFAS 107"). The estimated fair value amounts
have been computed by the Company using quoted market prices where
available or other appropriate valuation methodologies as discussed
below.
The following factors should be considered in assessing the accuracy
and usefulness of the estimated fair value data discussed below:
o Because no market exists for a significant portion of the
Company's financial instruments, fair value estimates are based on
judgments regarding future expected loss experience, current
economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant
55
<PAGE>
judgment and therefore cannot be determined with precision. Changes
in these assumptions could significantly affect the estimates.
o These estimates do not reflect any premium or discount that could
result from offering for sale at one time the Company's entire
holding of a particular financial asset.
o SFAS 107 excludes from its disclosure requirements certain
financial instruments and various significant assets and
liabilities that are not considered to be financial instruments.
Because of these limitations, the aggregate fair value amounts
presented in the following tables do not represent the underlying value
of the Company at December 31, 1997 and 1996.
The following methods and assumptions were used by the Company in
computing the estimated fair values:
a. CASH AND CASH EQUIVALENTS, CERTIFICATES OF DEPOSIT AND FEDERAL HOME
LOAN BANK STOCK - Current carrying amounts approximate their
estimated fair value.
b. MORTGAGE-BACKED SECURITIES AND INVESTMENT SECURITIES - Fair value of
these securities are based on year-end quoted market prices.
c. LOANS HELD FOR SALE - The fair value of these loans has been based
on market prices of similar loans traded in the secondary market.
d. LOANS RECEIVABLE HELD FOR INVESTMENT - For fair value estimation
purposes, these loans have been categorized by type of loan (e.g.,
one- to four-unit residential) and then further segmented between
adjustable or fixed rates. Where possible, the fair value of these
groups of loans has been based on secondary market prices for loans
with similar characteristics. The fair value of the remaining loans
has been estimated by discounting the future cash flows using
current interest rates being offered for loans with similar terms to
borrowers of similar credit quality. Prepayment estimates were based
on historical experience and published data for similar loans.
e. DEMAND DEPOSITS - Current carrying amounts approximate estimated
fair value.
f. CERTIFICATE ACCOUNTS - Fair value has been estimated by discounting
the contractual cash flows using current market rates offered in the
Company's market area for deposits with comparable terms and
maturities.
g. FHLB ADVANCES - Fair value was estimated by discounting the
contractual cash flows using current market rates offered for
advances with comparable terms and maturities.
h. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - Fair value was
estimated by discounting the contractual cash flows using current
market rates offered for borrowings with comparable terms and
maturities.
i. COMMITMENTS TO EXTEND CREDIT - The majority of the Company's
commitments to extend credit carry current market interest rates if
converted to loans. Because commitments to extend credit are
generally unassignable by either the Company or the borrower, they
only have value to the Company and the borrower. The Company does
not have deferred commitment fees on loans prior to origination.
56
<PAGE>
The carrying amounts and estimated fair values of the Company's
financial instruments as of December 31, 1997 and 1996 were as follows
(dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------
CARRYING FAIR
AMOUNT VALUE
<S><C>
Assets:
Cash and cash equivalents $ 13,514 $ 13,514
Certificates of deposit 99 99
Investment securities available for sale 40,355 40,355
Investment securities held to maturity 145 145
Mortgage-backed securities available for sale 70,465 70,465
Mortgage-backed securities held to maturity 142 138
Loans receivable held for investment 263,751 268,274
Loans held for sale 514 514
Federal Home Loan Bank stock 3,383 3,383
Liabilities:
Consumer accounts 66,483 66,483
Certificate accounts 254,076 254,381
FHLB advances 32,282 32,259
Securities sold under agreements to repurchase 5,200 5,196
Commitments to extend credit - -
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------------
CARRYING FAIR
AMOUNT VALUE
<S><C>
Assets:
Cash and cash equivalents $ 4,978 $ 4,978
Certificates of deposit 199 199
Investment securities available for sale 49,955 49,955
Investment securities held to maturity 404 403
Mortgage-backed securities available for sale 116,610 116,610
Mortgage-backed securities held to maturity 173 169
Loans receivable held to maturity 233,208 233,788
Loans held for sale 130 130
Federal Home Loan Bank stock 5,040 5,040
Liabilities
Consumer accounts 64,901 64,901
Certificate accounts 253,244 254,508
FHLB advances 46,807 47,423
Securities sold under agreements to repurchase 13,000 13,024
Commitments to extend credit - -
</TABLE>
57
<PAGE>
22. LIQUIDATION ACCOUNT
At the time of the Conversion, the Bank established a liquidation
account in an amount equal to its equity as of September 30, 1994. The
liquidation account is maintained by the Bank for the benefit of
depositors as of the eligibility record date who continue to maintain
their accounts at the Bank after the conversion. The liquidation
account is reduced annually to the extent that eligible account holders
have reduced their qualifying deposits as of each anniversary date.
Subsequent increases do not restore an eligible account holder's
interest in the liquidation account. In the event of a complete
liquidation of the Bank (and only in such an event), each eligible
account holder will be entitled to receive a distribution from the
liquidation account in an amount proportionate to the current adjusted
qualifying balances for accounts then held, before any liquidation
distribution may be made with respect to the stockholders. Except for
the repurchase of stock and payment of dividends by the Company, the
existence of the liquidation account will not restrict the use or
application of such net worth. At December 31, 1997, the amount of the
remaining balance in this liquidation account was approximately $3.4
million.
58
<PAGE>
Quarterly Results of Operations (Unaudited)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------------ ------------ ------------ -------------
<S><C>
Interest income............................... $ 7,636 $ 7,425 $ 7,286 $ 7,330
Interest expense.............................. 4,692 4,624 4,559 4,538
--------- --------- --------- ---------
Net interest income before
provision for loan losses............... 2,944 2,801 2,727 2,792
Provision for loan losses..................... 123 102 90 60
--------- --------- --------- ---------
Net interest income after
provision for loan losses............... 2,821 2,699 2,637 2,732
Noninterest income............................ 311 333 506 464
General and administrative expense............ 2,337 2,401 2,276 2,493
--------- --------- --------- ---------
Income before income tax expense.............. 795 631 867 703
Income tax expense............................ 324 256 356 294
--------- --------- --------- ---------
Net income.................................... $ 471 $ 375 $ 511 $ 409
========= ========= ========= =========
Basic earnings per share...................... $ .15 $ .12 $ .17 $ .14
========= ========= ========= =========
Diluted earnings per share.................... $ .15 $ .12 $ .16 $ .13
========= ========= ========= =========
Cash dividends per share...................... $ .05 $ .00 $ .06 $ .00
========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1996
------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------------ ------------ ------------ -------------
<S><C>
Interest income............................. $ 5,793 $ 5,681 $ 5,823 $ 6,689
Interest expense............................ 3,577 3,375 3,376 4,005
--------- --------- --------- ---------
Net interest income before
provision for loan losses............. 2,216 2,306 2,447 2,684
Provision for loan losses................... 22 0 0 6
--------- --------- --------- ---------
Net interest income after
provision for loan losses............. 2,194 2,306 2,447 2,678
Noninterest income.......................... 160 234 241 306
General and administrative expense(1)....... 1,829 1,759 3,386 2,117
--------- --------- --------- ---------
Income (loss) before income tax expense..... 525 781 (698) 867
Income tax expense (benefit)................ 206 332 (278) 363
--------- --------- --------- ---------
Net income (loss)........................... $ 319 $ 449 $ (420) $ 504
========= ======== ========= ========
Basic earnings (loss) per share............. $ .10 $ .14 $ (.14) $ .17
========= ======== ========= ========
Diluted earnings (loss) per share........... $ .10 $ .14 $ (.13) $ .16
========= ======== ========= ========
Cash dividend per share..................... $ .00 $ .00 $ .05 $ .00
========= ======== ========= ========
</TABLE>
(1) General and administrative expenses for the third quarter of 1996
included a non-recurring special insurance premium assessment of
$1.4 million.
59
<PAGE>
EXECUTIVE OFFICERS
<TABLE>
<S><C>
- ----------------------------------------------------------------------------------------------------------------
MARSHALL G. DELK DEBORAH R. CHANDLER CARLENE F. ANDERSON
PRESIDENT, CHIEF OPERATING SENIOR VICE PRESIDENT, VICE PRESIDENT AND
OFFICER AND DIRECTOR CHIEF FINANCIAL OFFICER CORPORATE SECRETARY
MONTEREY BAY BANCORP, INC. AND TREASURER MONTEREY BAY BANCORP, INC.
AND MONTEREY BAY BANK MONTEREY BAY BANCORP, INC. AND MONTEREY BAY BANK
AND MONTEREY BAY BANK
BEN A. TINKEY GARY C. TYACK PHILIP E. SAFRAN
SENIOR VICE PRESIDENT AND SENIOR VICE PRESIDENT, VICE PRESIDENT AND CONTROLLER
CHIEF LOAN OFFICER RETAIL BANKING MONTEREY BAY BANK
MONTEREY BAY BANK MONTEREY BAY BANK
BOARD OF DIRECTORS
- ----------------------------------------------------------------------------------------------------------------
EUGENE R. FRIEND STEVEN FRANICH GARY L. MANFRE
CHAIRMAN OF THE BOARD PRESIDENT, MARTY FRANICH PRESIDENT
AND CHIEF EXECUTIVE OFFICER FORD LINCOLN MERCURY WATSONVILLE COAST PRODUCE, INC.
MONTEREY BAY BANCORP, INC.
AND MONTEREY BAY BANK
P. W. BACHAN DONALD K. HENRICHSEN MCKENZIE MOSS
PARTNER, BACHAN, SKILLICORN, PRESIDENT FINANCIAL AND STRATEGIC
MARINOVICH, BALIAN, AND JOHN'S SHOE STORE, INC. PLANNING CONSULTANT, LECTURER,
BARSI AND WRITER
EDWARD K. BANKS STEPHEN G. HOFFMANN LOUIS RESETAR, JR.
CHIEF EXECUTIVE OFFICER PAST PRESIDENT AND RETIRED, AGRIBUSINESS,
PAJARO VALLEY AGENCIES, INC. CHIEF EXECUTIVE OFFICER RESETAR FARMS
PALM SPRINGS SAVINGS BANK
NICHOLAS C. BIASE
REPRESENTATIVE OF FINDIM
INVESTMENTS, S.A.
BANKING OFFICES
- ----------------------------------------------------------------------------------------------------------------
WATSONVILLE GILROY MONTEREY
35 EAST LAKE AVENUE 805 FIRST STREET 1400 MUNRAS AVENUE
WATSONVILLE, CALIFORNIA 95076 GILROY, CALIFORNIA 95020 MONTEREY, CALIFORNIA 93940
PRUNEDALE SOUTH SALINAS NORTH SALINAS
8071 SAN MIGUEL CANYON ROAD 1127 SOUTH MAIN STREET 1890 NORTH MAIN STREET
PRUNEDALE, CALIFORNIA 93907 SALINAS, CALIFORNIA 93901 SALINAS, CALIFORNIA 93906
CAPITOLA
601 BAY AVENUE
CAPITOLA, CALIFORNIA 95010
</TABLE>
60
<PAGE>
MONTEREY BAY BANCORP, INC. CORPORATE INFORMATION
STOCK PRICE INFORMATION
MONTEREY BAY BANCORP, INC.'S COMMON STOCK IS TRADED ON THE NASDAQ STOCK
MARKET UNDER THE SYMBOL "MBBC." THE COMPANY DECLARED ITS FIRST CASH DIVIDEND OF
$0.05 PER SHARE DURING THE THIRD QUARTER OF 1996 AND PAID TOTAL CASH DIVIDENDS
OF $0.11 PER SHARE IN 1997. IN FEBRUARY 1998, THE COMPANY PAID A SEMIANNUAL CASH
DIVIDEND OF $0.07 PER SHARE. AT DECEMBER 31, 1997, THE COMPANY HAD
APPROXIMATELY 311 STOCKHOLDERS OF RECORD (NOT INCLUDING THE NUMBER OF PERSONS OR
ENTITIES HOLDING STOCK IN NOMINEE OR STREET NAME THROUGH VARIOUS BROKERAGE
FIRMS) AND 3,229,679 OUTSTANDING SHARES OF COMMON STOCK. THE TABLE BELOW SHOWS
THE REPORTED HIGH AND LOW SALE PRICES OF THE COMMON STOCK SINCE IT WAS FIRST
LISTED ON FEBRUARY 15, 1995.
1997 HIGH LOW
- --------------------------------------------------
FIRST QUARTER 18 3/4 14 9/16
SECOND QUARTER 17 1/4 15 3/8
THIRD QUARTER 20 3/4 16
FOURTH QUARTER 20 1/2 18 1/4
1996 HIGH LOW
- --------------------------------------------------
FIRST QUARTER 12 3/4 11
SECOND QUARTER 12 3/4 11 3/4
THIRD QUARTER 13 5/8 11 3/8
FOURTH QUARTER 15 7/8 13 3/8
1995 HIGH LOW
- --------------------------------------------------
FIRST QUARTER 9 1/2 8 3/4
SECOND QUARTER 10 3/4 9
THIRD QUARTER 13 1/8 9 7/8
FOURTH QUARTER 13 11 1/2
ANNUAL REPORT ON FORM 10-K
COPIES OF MONTEREY BAY BANCORP, INC.'S ANNUAL REPORT ON FORM 10-K FOR THE
YEAR ENDED DECEMBER 31, 1997, AS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION, ARE AVAILABLE WITHOUT CHARGE TO STOCKHOLDERS UPON WRITTEN REQUEST
TO:
DEBORAH CHANDLER
SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER
AND TREASURER
MONTEREY BAY BANCORP, INC.
36 BRENNAN STREET
WATSONVILLE, CA 95076
ANNUAL MEETING OF STOCKHOLDERS
THE ANNUAL MEETING OF STOCKHOLDERS OF MONTEREY BAY BANCORP, INC. WILL BE
HELD ON THURSDAY, MAY 21, 1998, AT 11:00 A.M. AT THE WATSONVILLE WOMEN'S CLUB,
LOCATED AT 12 BRENNAN STREET, WATSONVILLE, CALIFORNIA 95076. ALL STOCKHOLDERS
ARE CORDIALLY INVITED.
STOCK TRANSFER AGENT AND REGISTRAR
MONTEREY BAY BANCORP, INC.'S TRANSFER AGENT, CHASEMELLON SHAREHOLDER
SERVICES LLC, MAINTAINS ALL STOCKHOLDER RECORDS AND CAN ASSIST WITH STOCK
TRANSFER AND REGISTRATION, ADDRESS CHANGE, AND CHANGES OR CORRECTIONS IN SOCIAL
SECURITY OR TAX IDENTIFICATION NUMBERS. IF YOU HAVE ANY QUESTIONS, PLEASE
CONTACT THE STOCK TRANSFER AGENT AT THE ADDRESS BELOW:
CHASEMELLON SHAREHOLDER SERVICES LLC
235 MONTGOMERY STREET, 23RD FLOOR
SAN FRANCISCO, CA 94104
(800) 356-2017
INDEPENDENT AUDITORS
DELOITTE & TOUCHE LLP
50 FREMONT STREET
SAN FRANCISCO, CA 94105
LEGAL COUNSEL
MCGUIRE WOODS BATTLE & BOOTHE LLP
1627 EYE STREET, N.W.
WASHINGTON, DC 20006-4007
CORPORATE OFFICES
MONTEREY BAY BANCORP, INC.
36 BRENNAN STREET
WATSONVILLE, CA 95076
61
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-99112 on Form S-8 and Registration Statement No. 33-6859 on Form S-8 of
Monterey Bay Bancorp, Inc. of our report dated February 13, 1998, appearing in
this Annual Report on Form 10-K of Monterey Bay Bancorp, Inc. for the year ended
December 31, 1997.
Deloitte & Touche LLP
San Francisco, California
March 30, 1998
62
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<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 7,081
<INT-BEARING-DEPOSITS> 6,532
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 110,820
<INVESTMENTS-CARRYING> 287
<INVESTMENTS-MARKET> 283
<LOANS> 265,420
<ALLOWANCE> (1,669)
<TOTAL-ASSETS> 408,096
<DEPOSITS> 320,559
<SHORT-TERM> 22,100
<LIABILITIES-OTHER> 2,122
<LONG-TERM> 10,182
0
0
<COMMON> 36
<OTHER-SE> 47,897
<TOTAL-LIABILITIES-AND-EQUITY> 408,096
<INTEREST-LOAN> 19,804
<INTEREST-INVEST> 9,873
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 29,677
<INTEREST-DEPOSIT> 15,527
<INTEREST-EXPENSE> 18,413
<INTEREST-INCOME-NET> 11,264
<LOAN-LOSSES> 375
<SECURITIES-GAINS> 213
<EXPENSE-OTHER> 9,507
<INCOME-PRETAX> 2,996
<INCOME-PRE-EXTRAORDINARY> 2,996
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,766
<EPS-PRIMARY> .56
<EPS-DILUTED> .56
<YIELD-ACTUAL> 7.47
<LOANS-NON> 1,897
<LOANS-PAST> 0
<LOANS-TROUBLED> 448
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,311
<CHARGE-OFFS> (21)
<RECOVERIES> 4
<ALLOWANCE-CLOSE> 1,669
<ALLOWANCE-DOMESTIC> 1,669
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
