[MONTEREY BAY LOGO GOES HERE]
MONTEREY BAY
BANCORP, INC.
1998 ANNUAL REPORT
<PAGE>
CONTENTS
Page
Letter to Shareholders...................................................... 1
Selected Consolidated Financial and Other Data.............................. 3
Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................... 5
Independent Auditors' Report................................................ 22
Financial Statements:
Consolidated Statements of Financial Condition........................... 23
Consolidated Statements of Operations.................................... 24
Consolidated Statements of Stockholders' Equity.......................... 25
Consolidated Statements of Cash Flows.................................... 27
Notes to Consolidated Financial Statements.................................. 29
Quarterly Financial Information............................................. 58
Board of Directors, Executive Officers and Banking Offices.................. 59
Shareholder Information..................................................... 60
i
<PAGE>
Dear Fellow Shareholders:
Monterey Bay Bancorp, Inc. (the "Company") completed another eventful
year in 1998. In the 1997 Annual Report we noted as goals, "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." The following is a summary of
significant accomplishments during 1998 toward these goals:
Deploying available capital:
o Grew assets of the Company from $408.1 million at December 31, 1997 to
$454.8 million, a $46.7 million or 11.5% increase during the year.
o Repurchased stock of $8.6 million in outstanding common stock, which in
large part contributed to stockholder equity at December 31, 1998 ending at
9.21% of total assets compared to 11.75% of total assets at December 31,
1997. Stockholder equity at December 31, 1998 was $41.9 million compared to
$47.9 million at December 31, 1997.
Pursuing growth opportunities:
o In May 1998, the Company's wholly owned subsidiary, Monterey Bay Bank,
opened its eighth full service financial services branch in Felton,
California. At December 31, 1998 the branch had $9.5 million in deposits
with an average interest cost of 3.72%.
o In April 1998, the Company completed the purchase and assumption of
approximately $30.0 million in loans and deposits, respectively from
Commercial Pacific Bank. These deposits were added to the Capitola,
California branch, which was opened January 1997, contributing to total
deposits in this branch of $40.8 million at December 31, 1998.
Increasing higher yielding loans:
o Funded the greatest amount of loans in the history of the Bank at
approximately $122.0 million with 73% of these originations being non-one
to four family mortgage loans. This contributed to loans receivable growing
13.3% from $263.8 million at December 31, 1997 to $298.8 million at
December 31, 1998.
o Increased higher yielding non-one to four family mortgage loans from $67.4
million, or 26% of total loans to $114.8 million or 38% of total loans.
o Increased the average yield on loans receivable in a declining interest
rate environment from 7.91% during 1997 to 8.05% during 1998.
Growth in transaction deposit accounts:
o Greatest single year improvement in low cost transaction accounts.
Transaction accounts grew from $66.9 million or 20.8% of total deposits at
December 31, 1997 to $114.0 million or 30.7% at December 31, 1998.
Transaction accounts at December 31, 1998 had a 2.80% weighted average
interest rate.
o Excluding the Commercial Pacific Bank deposit assumption, the largest
increase in deposits in a single year. Deposits grew $50.1 million or 15.6%
(including $30.0 million in deposits assumed from Commercial Pacific) from
$320.6 million at December 31, 1997 to $370.7 million at December 31, 1998.
<PAGE>
o Reduced the average cost of funds of the Bank from 5.02% for the year 1997
to 4.80% during 1998.
In addition, during 1998, the Company paid two semi-annual cash
dividends totaling $ 0.12 per share, which was a 33.3% increase from 1997 when
$.09 per share was paid in two semi-annual cash dividends. In July 1998 the
Company effected a 5 for 4 stock split of its common stock.
OUTLOOK
The focus of management will continue on increasing shareholder value
through improvements in return on equity. This is expected to be accomplished
through increasing revenue, predominately net interest income, at a faster pace
than growth in general and administrative expenses. Key to accomplishing these
goals, as was true for 1998, will be further deploying the Company's available
capital, reinvesting mortgage-backed securities and investment securities into
higher yielding loans, and a continued focus on attracting low cost transaction
deposit accounts, while being efficient in managing general and administrative
expense. We look forward to reporting future successes.
/s/ Eugene R. Friend /s/ Marshall G. Delk
Eugene R. Friend Marshall G. Delk
Chairman of the Board President, and Chief Operating Officer
and Chief Executive Officer
2
<PAGE>
Annual Report to Shareholders
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
<TABLE>
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).
<CAPTION>
At December 31,
------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Selected Financial Condition Data:
Total assets ....................................... $454,819 $408,096 $425,762 $329,768 $298,278
Loans receivable held for sale ..................... 2,177 514 130 92 16,082
Investment securities available
for sale ........................................ 256 40,355 49,955 30,990 19,703
Investment securities held to
maturity ........................................ -- 145 404 790 395
Corporate trust preferreds available
for sale ........................................ 19,154 -- -- -- --
Mortgage-backed securities available
for sale ........................................ 98,006 70,465 116,610 52,417 13,523
Mortgage-backed securities held to
maturity ........................................ 97 142 173 205 160
Loans receivable held for
investment, net(1) .............................. 298,775 263,751 233,208 228,387 227,423
Deposits ........................................... 370,677 320,559 318,145 215,284 214,310
FHLB advances ...................................... 35,182 32,282 46,807 46,520 59,782
Securities sold under agreements to
repurchase ...................................... 4,490 5,200 13,000 17,361 --
Stockholders' equity ............................... 41,889 47,933 45,759 47,604 23,249
Nonperforming assets ............................... 1,777 2,219 1,393 1,545 711
</TABLE>
<TABLE>
For the Year Ended December 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Selected Operating Data:
Interest income ......................................... $30,911 $29,677 $23,986 $22,544 $17,727
Interest expense ........................................ 18,588 18,413 14,333 14,227 9,841
------- ------- ------- ------- -------
Net interest income before provision
for loan losses ....................................... 12,323 11,264 9,653 8,317 7,886
Provision for loan losses ............................... 692 375 28 663 421
------- ------- ------- ------- -------
Net interest income after provision
for loan losses ...................................... 11,631 10,889 9,625 7,654 7,465
Noninterest income ...................................... 2,177 1,614 941 573 1,048
General and administrative
expenses(2) ........................................... 11,144 9,507 9,091 7,140 6,316
------- ------- ------- ------- -------
Income before income tax expense ........................ 2,664 2,996 1,475 1,087 2,197
Income tax expense ...................................... 1,228 1,230 623 414 949
------- ------- ------- ------- -------
Net income .............................................. $ 1,436 $ 1,766 $ 852 $ 673 $ 1,248
======= ======= ======= ======= =======
Basic earnings per share(3)(4) .......................... $ .40 $ .46 $ .22 $ .14 N/A
======= ======= ======= ======= =======
Diluted earnings per share(3)(4) ........................ $ .38 $ .45 $ .22 $ .13 N/A
======= ======= ======= ======= =======
Cash dividends per share (4) ............................ $ .12 $ .09 $ .04 $ .00 N/A
======= ======= ======= ======= =======
<FN>
- ---------------------------
(1) The allowance for estimated loan losses at December 31, 1998, 1997, 1996,
1995 and 1994 was $2,780,000, $1,669,000 $1,311,000, $1,362,000, and
$808,000, 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, 1998, 1997 and 1996, 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) Per share calculations are impacted by the 5 for 4 stock split that was
effective to shareholders of record July 31, 1998. Previous periods have
been adjusted to reflect shares outstanding as if the split applied to
those periods.
</FN>
</TABLE>
3
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<TABLE>
<CAPTION>
At or For the Year Ended
December 31,
--------------------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Selected Financial Ratios and Other Data(1):
Performance Ratios:
Return on average assets ................................. .33% .43% .26% .21% .45%
Return on average stockholders' equity ................... 3.23% 3.87% 1.83% 1.49% 5.45%
Average equity to average assets ......................... 10.26% 10.99% 13.98% 14.04% 8.33%
Equity to total assets at end of period .................. 9.21% 11.75% 10.75% 14.44% 7.79%
Average interest rate spread(2) .......................... 2.63% 2.45% 2.39% 1.98% 2.73%
Net interest margin(3) ................................... 2.96% 2.83% 3.00% 2.65% 2.96%
Average interest-earning assets to
average interest-bearing liabilities .................. 107.54% 108.45% 113.76% 114.94% 107.40%
General and administrative expenses to
average assets ........................................ 2.58% 2.29% 2.74% 2.22% 2.23%
Regulatory Capital Ratios:
Tangible capital ......................................... 6.69% 9.39% 8.28% 11.65% 7.74%
Core capital ............................................. 6.69% 9.40% 8.36% 11.83% 8.03%
Risk-based capital ....................................... 11.60% 17.24% 19.22% 24.42% 15.50%
Asset Quality Ratios:
Nonperforming loans as a percent of
gross loans receivable(4)(5) .......................... .49% .71% .59% 1.39% .29%
Nonperforming assets as a percent of
total assets(5) ....................................... .39% .54% .33% .97% .24%
Allowance for loan losses
as a percent of gross loans receivable(4) ............. .92% .63% .56% .59% .33%
Allowance for loan losses
as a percent of nonperforming loans(5) ................ 185.83% 87.98% 94.10% 42.56% 113.64%
Number of full-service customer
facilities ............................................... 8 7 6 6 6
<FN>
- ------------------------
(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.
</FN>
</TABLE>
4
<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, 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, Northern Monterey, and Southern
Santa Clara Counties, in California. At December 31, 1998, the Bank had eight
full service offices and one administrative 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 investment securities, 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 deposit 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. A major factor in determining the Company's results of operations
are general and administrative expenses, which 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, 1998.
A relatively low interest rate environment prevailed during 1998, with
both long-term and short-term market interest rates declining to the lowest
levels in recent years. In the first quarter, as a consequence of the declining
interest rate environment, the Company securitized approximately $48.0 million
in 30 year fixed rate loans (see "Asset and Liability Management" and "Net
Interest Income"). This action in combination with a continued change in mix of
loans and deposits resulted in a significant decline in the interest rate risk
of the Company. Throughout the year, the Company focused on changing its mix of
interest-earning assets by emphasizing construction, commercial real estate, and
business lending activities and changing its mix of interest-bearing liabilities
by emphasizing checking, money market and savings deposits.
Financial results for 1998 were impacted by the cash assumption, during
the second quarter of 1998, of $30.0 million of savings deposits and the
purchase of loans in an equal amount from Commercial Pacific Bank. Additionally,
the Company opened its eighth branch in the town of Felton. The new branch
office began operations as a full service bank branch in May 1998, resulting in
increased general and administrative expenses during 1998. The branch ended 1998
with deposits of $9.5 million.
5
<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 commercial bank. The Company may acquire (i) other financial
institutions or branches thereof, (ii) branch facilities, or (iii) 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.
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.
Quantitative and Qualitative Disclosure of Market Risk
The results of operations for financial institutions such as the
Company 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. The Company is not
significantly exposed to foreign currency exchange rate risk, commodity price
risk or other market risks other than interest rate risk.
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 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, 1998, the Company calculated
that its
6
<PAGE>
NPV was $41.3 million, compared with $47.1 million at December 31, 1997, and
that its NPV would decrease by 10% and 61%, 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, 1998, the Company calculated its
one-year cumulative gap position to be a negative 11.47% and its three-year gap
position to be a positive 2.31%. 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, 1998, management continued to pursue
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. During the year
ended December 31, 1998, NPV decreased, due primarily to a $6.0 million net
decline in consolidated equity primarily due to stock repurchases by the
Company.
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 real estate loans.
7
<PAGE>
<TABLE>
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, 1998. 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.
<CAPTION>
At December 31, 1998
-------------------------------------------------------------------------------------------
More than More than More than Over Non-
3 Months 3 Months 1 Year to 3 Years to Five Interest
or Less to 1 Year 3 Years 5 Years Years Bearing Total
--------- --------- --------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets (1):
Federal funds sold and other
short-term investments ........ $ 16,951 $ -- $ -- $ -- $ -- $ -- $ 16,951
Investment securities,
net(2)(3) ..................... 19,160 -- -- -- 250 -- 19,410
Loans receivable(2)(3) ........... 106,335 70,684 65,960 17,117 43,636 -- 303,732
Mortgage-backed
securities(2)(3) ............... 3,611 10,833 76,437 7,222 -- -- 98,103
FHLB stock ....................... 3,039 -- -- -- -- -- 3,039
--------- --------- --------- --------- --------- --------- ---------
Total interest-earning
assets ...................... 149,096 81,517 142,397 24,339 43,886 -- 441,235
Allowance for loan losses ........ (973) (647) (604) (157) (399) -- (2,780)
--------- --------- --------- --------- --------- --------- ---------
Net interest-earning
assets ...................... 148,123 80,870 141,793 24,182 43,487 -- 438,455
Noninterest-earning assets ....... -- -- -- -- -- 16,364 16,364
--------- --------- --------- --------- --------- --------- ---------
Total assets ............... $ 148,123 $ 80,870 $ 141,793 $ 24,182 $ 43,487 $ 16,364 $ 454,819
========= ========= ========= ========= ========= ========= =========
Interest-bearing liabilities:
Money market deposit ............. 10,592 31,777 18,158 -- -- -- 60,528
Passbook deposits ................ 973 2,918 7,781 3,890 -- -- 15,561
Checking accounts ................ 2,341 7,024 18,731 9,366 -- -- 37,462
Certificate accounts ............. 63,290 155,141 34,464 4,231 -- -- 257,126
FHLB advances .................... 1,600 1,000 -- 25,000 7,582 -- 35,182
Securities sold under
agreements to repurchase ...... 2,490 2,000 -- -- -- -- 4,490
--------- --------- --------- --------- --------- --------- ---------
Total interest-bearing
liabilities .................... 81,286 199,860 79,134 42,487 7,582 -- 410,349
Noninterest-bearing
liabilities ................... -- -- -- -- -- 2,581 2,581
Equity ........................... -- -- -- -- -- 41,889 41,889
--------- --------- --------- --------- --------- --------- ---------
Total liabilities and
equity ................... $ 81,286 $ 199,860 $ 79,134 $ 42,487 $ 7,582 $ 44,470 $ 454,819
========= ========= ========= ========= ========= ========= =========
Interest sensitivity gap(4) ......... $ 66,837 $(118,990) $ 62,659 $ (18,305) $ 35,905
========= ========= ========= ========= =========
Cumulative interest sensitivity
gap ............................... $ 66,837 $ (52,153) $ 10,506 $ (7,799) $ 28,106
========= ========= ========= ========= =========
Cumulative interest sensitivity
gap as a percent of total assets .. 14.70% (11.47%) 2.31% (1.71%) 6.18%
========= ========= ========= ========= =========
Cumulative net interest-earning
assets as a percent of cumulative
interest bearing liabilities ..... 182.22% 81.45% 102.92% 98.06% 106.85%
========= ========= ========= ========= =========
<FN>
- ------------------------
(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) Investments and mortgage-backed securities are at fair market value. Assets
are reported net of unearned (discount) premium and deferred loan fees.
(4) The interest sensitivity gap represents the difference between
interest-earning assets and interest-bearing liabilities.
</FN>
</TABLE>
8
<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, 1998, 1997, and 1996, net interest
income before the provision for loan losses was $12.3 million, $11.3 million,
and $9.7 million, respectively. The volume of average interest-earning assets
over the same years was $416.2 million, $397.5 million, and $321.4 million,
respectively. The net interest spread was 2.63 %, 2.45%, and 2.39%,
respectively, during the years ended December 31, 1998, 1997, and 1996. During
these same periods, the net interest margin was 2.96%, 2.83%, and 3.00%,
respectively.
For the year ended December 31, 1998, the $1.0 million, or 8.8%,
increase in the Company's net interest income was due primarily to the
assumption of approximately $30.0 million in deposits and the purchase of an
equal amount of loans from Commercial Pacific Bank, the opening of an eighth
branch, strong in-market growth of low cost deposits, and growth in loans
receivable. The volume-related increase in net interest income was partially
offset by the effect of prepayments of mortgage-backed securities, which caused
the average yield during 1998 to decline to 6.57% from 7.01% during the prior
year. The increase in the net interest spread and margin was primarily
attributable to a decrease in the cost of interest-bearing savings accounts,
which decline in cost from 4.89% during 1997 to 4.70% during 1998.
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 cash
assumption, during the fourth quarter of 1996, of $102.1 million of savings
deposits, 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.
9
<PAGE>
Average Balances, Average Rates, and Net Interest Margin
<TABLE>
The following table sets forth certain information relating to the
Company for the fiscal years ended December 31, 1998, 1997 and 1996. 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.
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------
1998 1997
----------------------------------- ------------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------- -------- ---- ------- -------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Federal funds sold and other
short-term investments ................... $ 10,721 $ 578 5.39% $ 4,272 $ 231 5.42%
Investment securities,
net(1)(2) ................................ 33,016 2,023 6.13% 46,248 2,899 6.27%
Corporate trust preferreds ................. 4,381 312 7.12% -- -- --
Loans receivable(3)(6)(7) .................. 259,358 20,882 8.05% 250,370 19,804 7.91%
Mortgage-backed securities,
net(1) ................................... 105,223 6,910 6.57% 92,842 6,510 7.01%
FHLB stock ................................. 3,512 206 5.85% 3,793 233 6.14%
-------- -------- -------- --------
Total interest-earning
assets ................................. 416,211 $ 30,911 7.43% 397,525 $ 29,677 7.47%
======== ========
Non interest-earning assets ................ 18,379 17,347
-------- --------
Total assets ............................. $434,590 $414,872
======== ========
Liabilities and Stockholders'
Equity:
Interest-bearing liabilities:
Money market deposits ...................... $ 42,603 $ 1,716 4.03% $ 34,612 $ 1,344 3.88%
Passbook deposits .......................... 15,204 278 1.83% 13,396 254 1.89%
Checking accounts .......................... 29,935 227 .76% 17,925 87 .49%
Certificate accounts ....................... 266,225 14,407 5.41% 251,855 13,842 5.50%
-------- -------- -------- --------
Total savings accounts ................... 353,967 16,628 4.70% 317,788 15,527 4.89%
FHLB advances .............................. 28,059 1,663 5.93% 40,520 2,400 5.92%
Securities sold under
agreements to repurchase ................. 5,007 297 5.92% 8,234 486 5.91%
-------- -------- -------- --------
Total interest-bearing
liabilities ............................ 387,033 $ 18,588 4.80% 366,542 $ 18,413 5.02%
======== ========
Noninterest-bearing liabilities .............. 2,978 2,750
-------- --------
Total liabilities ........................ 390,011 369,292
Stockholders' equity ......................... 44,579 45,580
-------- --------
Total liabilities and
stockholders' equity ..................... $434,590 $414,872
======== ========
Net interest rate spread(4) .................. 2.63% 2.45%
Net interest margin(5) ....................... 2.96% 2.83%
Ratio of interest-earning
assets to interest-bearing
liabilities ................................ 107.54% 108.45%
</TABLE>
Year Ended December 31,
1996
-------------------------------------
Average
Average Yield/
Balance Interest Cost
------- -------- ----
Assets:
Interest-earning assets:
Federal funds sold and other
short-term investments ......... $ 3,612 $ 252 6.97%
Investment securities,
net(1)(2) ...................... 37,593 2,314 6.15%
Corporate trust preferreds ....... -- -- --
Loans receivable(3)(6)(7) ........ 231,530 18,015 7.78%
Mortgage-backed securities,
net(1) ......................... 45,635 3,224 7.06%
FHLB stock ....................... 2,986 181 6.08%
-------- --------
Total interest-earning
assets ....................... 321,356 $ 23,986 7.46%
========
Non interest-earning assets ...... 10,849
--------
Total assets ................... $332,205
========
Liabilities and Stockholders'
Equity:
Interest-bearing liabilities:
Money market deposits ............ $ 19,387 $ 695 3.58%
Passbook deposits ................ 13,381 254 1.90%
Checking accounts ................ 13,485 78 0.58%
Certificate accounts ............. 177,964 9,922 5.58%
-------- --------
Total savings accounts ......... 224,217 10,949 4.88%
FHLB advances .................... 43,619 2,509 5.75%
Securities sold under
agreements to repurchase ....... 14,644 875 5.98%
-------- --------
Total interest-bearing
liabilities .................. 282,480 $ 14,333 5.07%
========
Noninterest-bearing liabilities .... 3,284
--------
Total liabilities .............. 285,764
Stockholders' equity ............... 46,441
--------
Total liabilities and
stockholders' equity ........... $332,205
========
Net interest rate spread(4) ........ 2.39%
Net interest margin(5) ............. 3.00%
Ratio of interest-earning
assets to interest-bearing
liabilities ...................... 113.76%
- -----------------
(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, 1998 1997, and 1996
were $233,000, $293,000, and $217,000, respectively.
10
<PAGE>
Rate/Volume Analysis
<TABLE>
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 to
the changes due to rate.
<CAPTION>
Year Ended December 31, 1998 Year Ended December 31, 1997
Compared to Compared to
Year Ended December 31, 1997 Year Ended December 31, 1996
--------------------------------- ---------------------------------
Increase (decrease) due to Increase (decrease) due to
Average Average
Volume Rate Net Volume Rate Net
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Federal funds sold and
other short-term investments ................... $ 350 $ (3) $ 347 $ 46 $ (67) $ (21)
Investment securities, net (1)(2) ................. (829) (47) (876) 532 53 585
Corporate trust preferreds ........................ 312 -- 312
Loans receivable, net(2) .......................... 711 367 1,078 1,466 323 1,789
Mortgage-backed securities, net(2) ................ 867 (467) 400 3,333 (47) 3,286
FHLB stock ........................................ (17) (10) (28) 49 3 52
------- ------- ------- ------- ------- -------
Total interest-earning assets ............... 1,394 (160) 1,233 5,426 265 5,691
------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Money market deposits ............................. 310 62 372 545 104 649
Passbook deposits ................................. 34 (10) 24 -- -- --
Checking accounts ................................. 59 81 140 26 (17) 9
Certificate accounts .............................. 790 (225) 565 4,123 (203) 3,920
FHLB advances ..................................... (738) 1 (737) (178) 69 (109)
Securities sold under agreements
to repurchase .................................. (190) 1 (189) (383) (6) (389)
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities .......... 265 (90) 175 4,133 (53) 4,080
------- ------- ------- ------- ------- -------
Net change in net interest income .................... $ 1,129 $ (70) $ 1,059 $ 1,293 $ 318 $ 1,611
======= ======= ======= ======= ======= =======
<FN>
- -------------------------
(1) Includes certificates of deposit with original maturities greater than 90
days.
(2) Includes assets available for sale.
</FN>
</TABLE>
11
<PAGE>
Results of Operations for the Years Ended December 31, 1998 and December 31,
1997
Overview
The Company recorded net income of $1.4 million, or $0.40 per basic
share ($0.38 per share diluted) for the year ended December 31, 1998, compared
to $1.8 million, or $0.46 per basic share ($0.45 per share diluted) for the year
ended December 31, 1997. The Company's return on average assets for 1998 was
0.33%, compared to 0.43% in 1997. The return on average equity for 1998 was
3.22%, compared with 3.87% in 1997.
Net income for the year ended December 31, 1998 reflected higher net
interest income and noninterest income compared to the year ended December 31,
1997, 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, 1998 reflect the assumption of approximately $30.0 million in
deposits and the purchase of an equal amount of loans from Commercial Pacific
Bank, the opening of an eighth branch, and strong in-market growth of low cost
deposits. Net interest income before the provision for loan losses was $12.3
million for the year ended December 31, 1998, compared to $11.3 million for the
year ended December 31, 1997. During the same periods, the average volume of
interest-earning assets was $416.2 million and $397.5 million, respectively. The
increase in net interest income reflects the growth in higher yielding loans and
mortgage-backed securities, funded primarily by growth in low cost deposits.
The Company has, for the last two years, focused its efforts on
becoming more like a community-based commercial bank by increasing its
commercial real estate, construction, multi-family and business lending
activities. Additionally, the bank focused its deposit gathering efforts on
low-cost transaction accounts, consisting of checking, statement savings, and
money market accounts, partly by pursuing small businesses in-market, which will
complement the business lending function.
Continued 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
1998. Expansion activity included the Company's opening of a branch site in
Felton, California, which began operations as a full service bank branch in May
1998 and the assumption of approximately $30.0 million in deposits and the
purchase of an approximately equal amount of loans in April 1998 from Commercial
Pacific Bank.
Interest Income
For the year ended December 31, 1998, interest income was $30.9
million, an increase of $1.2 million, or 4.0%, over the amount recorded for the
year ended December 31, 1997. The primary reason for the increase in interest
income during 1998 was growth in average outstanding balances of mortgage-backed
securities and loans receivable due to the purchase of approximately $30.0
million in loans from Commercial Pacific Bank as well as in-market growth of
loans receivable. Interest income on loans receivable, which accounted for 68%
of total interest income for the year ended December 31, 1998, grew by $1.1
million in 1998 compared to 1997. The growth in interest income on loans
receivable during 1998 was due to a higher average balance of outstanding loans
receivable and an increase in the average yield earned. Interest income on
mortgage-backed securities grew by $0.4 million, for the year ended December 31,
1998. Interest income from other investment securities declined by $0.2 million,
for the year ended December 31, 1998, due to lower average volumes and rates on
investment securities in 1998 compared to 1997.
The weighted average yield on interest-earning assets was 7.43% for the
year ended December 31, 1998, compared to 7.47% for the year ended December 31,
1997. Despite a declining interest rate environment, the average yield on
interest-earning assets declined only 4 basis points in 1998 compared to 1997.
The magnitude of the decline in the yield on interest-earning assets was limited
due to a 14% increase in the average balance of the highest interest-earning
category loans receivable. The average yield on loans receivable increased 14
basis points, primarily due to the fact that 73% of the loans originated for the
portfolio during 1998 were higher yielding construction, commercial real estate,
multi-family and
12
<PAGE>
business loans. Yields on mortgage-backed securities declined slightly during
1998 due to higher prepayments and a corresponding increase in premium
amortization.
Interest Expense
Interest expense for the year ended December 31, 1998 was $18.6
million, compared to $18.4 million for the year ended December 31, 1997, an
increase of $0.2 million. The increase in interest expense was primarily
attributable to a higher average balance of savings deposits resulting from the
assumption of approximately $29 million in deposits from Commercial Pacific Bank
and the opening of the Felton branch office. The Company's average cost of
interest-bearing liabilities declined to 4.80% in 1998, from 5.02% in 1997,
primarily due to the effects of a more favorable mix of savings deposits and a
lower interest rate environment. This reduction was primarily due to a 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
$0.9 million due to a lower average outstanding balance of borrowings in 1998.
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, 1998 the provision for loan losses was
$692,000, compared to $375,000 for the year ended December 31, 1997. During
1998, the Company increased its provision for loan losses in connection with
implementing its strategy to increase the amount of construction, commercial
real estate, multifamily, and business lending. These types of loans generally
involve a greater risk of loss than do one-to-four family residential mortgage
loans. The provision as well as the $416,000 of allowance for loan losses
provided on loans acquired from Commercial Pacific Bank, resulted in a total
allowance for loan losses of $2,780,000, or .93% of loans receivable, at
December 31, 1998, compared to an allowance for loan losses of $1,669,000, or
.63% of loans receivable, at December 31, 1997. Nonperforming loans were $1.5
million, or .49% of gross loans receivable, at December 31, 1998, compared to
$1.9 million, or .71% of gross loans receivable, a year earlier.
Noninterest Income
Noninterest income increased by 34.9% to $2.2 million for the year
ended December 31, 1998, compared to $1.6 million for the year ended December
31, 1997, primarily due to increases in customer service charges and commissions
from sales of noninsured products during 1998. 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
1998 was primarily due to a larger customer base, a higher number of
transaction-related customer deposit accounts, and a full year of surcharging
foreign ATM card holders. The increase in commission income from sales of
noninsured products reflects a more effective job of cross-selling these
products to the Company's customer base.
During the years ended December 31, 1998 and 1997, the Company sold
$96.0 million and $38.6 million, respectively, of securities held for sale
including mortgage-backed securities and investment securities and recorded net
gains of $283,000 and $213,000, respectively, on the sales.
13
<PAGE>
General and Administrative Expense
General and administrative expense was $11.1 million and $9.5 million,
respectively, for the years ended December 31, 1998 and 1997. The increases in
1998 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 1998 included higher data
processing costs, increased professional fees and advertising expenses, higher
stationery, telephone, and office expenses.
The increases in certain categories of general and administrative
expenses for the year ended December 31,1998 were partially offset by lower
amortization of core deposit premium and reduced deposit insurance premiums
compared to 1997. Amortization of core deposit premium was $144,000 lower in
1998 and deposit insurance premiums were $94,000 lower, compared to 1997.
Income Tax Expense
The Company recorded income tax expense of $1.2 million for both the
years ended December 31, 1998 and 1997. Income tax expense remained the same in
1998 compared to 1997 despite a decline in 1998 income before income tax due to
an increase in the effective tax rate in 1998 compared to the previous year. The
effective tax rate for the year ended December 31, 1998 was 46.1%, compared to
41.1% for the year ended December 31, 1997.
Comparison of Financial Condition at December 31, 1998 and December 31, 1997
Total assets of the Company were $454.8 million at December 31, 1998,
compared to $408.1 million at December 31, 1997, an increase of $46.7 million,
or 11.4%.
Mortgage-backed securities and investment securities increased by $6.4
million, or 5.8%, during 1998. These increases were due in part to the decision
to securitize approximately $48.0 million in 30 year fixed rate portfolio loans.
This was partially offset by principal paydowns of $27.9 million on
mortgage-backed securities and $26.2 million in maturities during the year ended
December 31, 1998.
Loans receivable held for investment were $298.8 million at December
31, 1998, compared to $263.8 million at December 31, 1997. Residential real
estate loans represent the largest category in the loan portfolio. At December
31, 1998, total one-to-four family and multifamily residential real estate loans
were $218.3 million, or 67% 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, 1998, the Company's commercial real estate loan portfolio was $40.0
million, or 12.3% of the loan portfolio. Gross construction loans at December
31, 1998 totaled $51.6 million or 15.8% of the loan portfolio. Net construction
loans totaled $27.4 million at December 31, 1998.
During the year ended December 31, 1998, the Company's liabilities
increased by $52.7 million to $412.9 million, from $360.2 million at December
31, 1997. The increase in liabilities was attributable to a increase of $50.1
million, or 15.6 %, in savings deposits. The increase in savings deposits in
1998 was due to the assumption of approximately $29 million in deposits from
Commercial Pacific Bank, the opening of the Felton branch office and in-market
growth of existing branches. Borrowings from the Federal Home Loan Bank and
through repurchase agreements increased from $37.5 million at December 31, 1997
to $39.7 million at December 31, 1998.
At December 31, 1998, shareholders' equity was $41.9 million, compared
to $47.9 million at December 31, 1997 or a $6.0 million decline. The decrease in
equity during 1998 was primarily due to the Company's repurchase of 567,094 of
its outstanding treasury shares, which decreased equity by $8.2 million. This
decline was partially offset by net income of $1.4 million, a $0.2 million
increase in earned ESOP shares, and a net increase of $0.7 million in unrealized
gains on securities available for sale. Equity was further reduced during 1998
by the payment of cash dividends totaling $463,000, or $.13 per share, on the
Company's outstanding common stock.
14
<PAGE>
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 $0.46 per basic
share ($0.45 per share diluted) for the year ended December 31, 1997, compared
to $852,000, or $0.22 per basic share ($0.22 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 $0.42 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 (the "Deposit Assumption"). 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.
15
<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.
16
<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.
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 8.95%, 8.1%, and
7.7% for the years ended December 31, 1998, 1997 and 1996, respectively. The
higher levels of liquidity in 1998 and 1997, compared to 1996, 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
$4.4 million, $2.1 million, and $24,000, respectively, for the years ended
December 31, 1998, 1997 and 1996. 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 "Quantitative and Qualitative Disclosure of
Market Risk"). 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, 1998, 1997, and 1996, the Company sold loans
totaling $15.9 million, $3.4 million, and $2.7 million, respectively. 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.
17
<PAGE>
Cash provided or used by investing activities consists primarily of
loan originations for the portfolio, 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 $183.6 million, $69.1 million, and
$36.1 million, respectively, in 1998, 1997 and 1996. Disbursements to purchase
mortgage-backed securities and investment securities totaled $119.0 million,
$28.1 million, and $122.3 million during the same periods. Cash principal
payments received on loans and mortgage-backed securities were $127.2 million,
$52.8 million, and $42.9 million, respectively, during 1998, 1997, and 1996. The
increase in principal payments during 1998 was due to a heavy refinance market
driven by historically low interest rates. The Company received proceeds of
$48.0 million, $38.6 million, and $8.4 million, respectively, from sales of
mortgage-backed securities during 1998, 1997, and 1996, and received proceeds of
$8.2 million, $31.5 million, and $14.9 million, respectively, for proceeds from
maturities of investment securities during the same periods. The Company also
securitized $48.4 million in primarily 30 year fixed rate residential portfolio
loans during 1998.
The Company received net cash of $42.5 million from financing
activities in 1998. Of this increase, deposits increased by $50.1 million to
$370.7 million at December 31, 1998, from $320.6 million a year earlier. The
increase in deposits was primarily due to the assumption of approximately $29
million in deposits from Commercial Pacific Bank, the opening of the Felton
branch office and in-market growth of existing branches. The net increase in
deposits was partially offset by a $8.2 million net repurchase of outstanding
stock. Repurchase of outstanding stock was undertaken in 1998 in order to more
effectively utilize the equity position of the Company.
The Company received net cash of $92.8 million in 1996 from financing
activities. 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 core deposit premium. In 1997, cash used by financing
activities totaled $20.6 million consisting primarily of repayments of Federal
Home Loan Bank advances and reverse repurchase agreements of $22.3 million.
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, 1998,
cash and short-term investments totaled $17.0 million.
At December 31, 1998, the Company had outstanding commitments to
originate $26.6 million of real estate loans, include $2.6 million for fixed
rate loans and $24 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 commitments being exercised; therefore, total
commitments outstanding do not necessarily represent future cash requirements.
At December 31, 1998, the Company had made available various secured
and unsecured business, personal, and residential lines of credit totaling
approximately $9.3 million, of which the undisbursed portion was approximately
$5.3 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, 1998, the Company had issued letters of credit totaling $4.1 million
compared to $8.3 million at December 31, 1997. 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 1998, the Company converted approximately $48.4 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.
18
<PAGE>
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, 1998,
this credit line represented a total borrowing capacity of approximately $177.2
million, of which $35.2 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, 1998,
totaled $217.3 million.
At December 31, 1998, the Bank exceeded all of its regulatory capital
requirements with a tangible capital level of $29.3 million, or 6.69% of total
adjusted assets, which was above the required level of $6.6 million or 1.5%;
core capital of $29.3 million, or 6.69% of total adjusted assets, which was
above the required level of $17.5 million or 4.00%, and risk-based capital of
$31.9 million, or 11.60% of risk-weighted assets, which was above the required
level of $22.0 million or 8.00%.
During 1998, the Company acquired 566,991 shares of common stock
previously approved for repurchase by the Board of Directors. Also during 1998,
35,349 stock options were exercised using treasury shares (see "Notes to
Consolidated Financial Statements - Stock Benefit Plans"). As a result, the
Company held 986,731 shares of treasury stock, or 22.0% of the Company's issued
shares, at December 31, 1998, compared to 455,089 treasury shares held by the
Company at December 31, 1997.
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
The "Year 2000 issue" relates to the fact that many computer programs
use only two digits to represent a year, such as "98" to represent "1998," which
means that in the Year 2000 such programs could incorrectly treat the Year 2000
as the year 1900. This issue has grown in importance as the use of computers and
microchips has become more pervasive throughout the economy, and
interdependencies between systems have multiplied. The issue must be recognized
as a business problem, rather than simply a computer problem, because of the way
its effects could ripple through the economy. The Company could be materially
and adversely affected either directly or indirectly by the Year 2000 issue.
This could happen if any of its critical computer systems or equipment
containing embedded logic fail, if the local infrastructure (electric power,
phone system, or water system) fails, if its significant vendors are adversely
impacted, or if its borrowers or depositors are adversely impacted by their
internal systems or those of their customers or suppliers. Failure of the
Company to complete testing and renovation of its critical systems on a timely
basis, could have a material adverse effect on the Company's financial condition
and results of operations, as could Year 2000 problems faced by others with whom
the Company does business.
Federal banking regulators have responsibility for supervision and
examination of banks to determine whether each institution has an effective plan
for identifying, renovating, testing and implementing solutions for Year 2000
processing and coordinating Year 2000 processing capabilities with its
customers, vendors and payment system partners. Bank examiners are also required
to assess the soundness of a bank's internal controls and to identify whether
further corrective action may be necessary to assure an appropriate level of
attention to Year 2000 processing capabilities.
The Company has a written plan to mitigate the risks associated with
the impact of the Year 2000. The plan directs the Company's Year 2000 activities
under the framework of the Federal Financial Institutions Examination Council
(FFIEC) five-step program. The FFIEC's five-step program includes
19
<PAGE>
the following phases: awareness, assessment, renovation, validation and
implementation. The awareness phase, which the Company has completed, discusses
the Year 2000 problem and gains executive level support for the necessary
resources to prepare the Company for Year 2000 compliance. The assessment phase,
which the Company has also completed, assesses the size and complexity of the
problem and details the magnitude of the effort necessary to address the Year
2000 issues. Although the awareness and assessment phases are completed, the
Company will continue to evaluate any new issues as they arise. In the
renovation phase, which the Company has substantially completed, the required
incremental changes to hardware and software components are tested. In the
validation stage, which the Company has also substantially completed, the
hardware and software components are tested.
The Company is utilizing both internal and external sources to
identify, correct or reprogram, and test its systems for Year 2000 compliance.
The Company has identified fourteen vendors and fifty-eight software
applications which management believes are material to the Company's operations.
Based on information received from its vendors and testing results, the Company
believes approximately 79% of such vendors are Year 2000 compliant as of
December 31, 1998. The testing of the critical system applications for core
banking product provided by the Company's primary vendor was completed and
results verified during November and December 1998.
The core banking product includes software solutions for checking,
savings, time certificates of deposit, general ledger, accounts payable,
automated clearing house, individual retirement accounts, commercial, mortgage
and installment loans, proof of deposit and ancillary supporting products.
The Company has identified three vendors that the Company does not
believe are fully Year 2000 compliant as of December 31, 1998. Each of those
vendors have advised the Company that it has completed the evaluation and
renovation stages of Year 2000 compliance and is scheduled to begin
implementation and validation beginning in January 1999 and all are scheduled to
complete final validation by June 30, 1999.
The Company is also making efforts to ensure that its customers,
particularly its significant customers, are aware of the Year 2000 problem. The
Company has sent Year 2000 correspondence to the Bank's significant deposit and
loan customers. A customer of the bank is deemed significant if the customer
possesses any of the following characteristics:
o Total indebtedness to the bank of $750,000 or more.
o Credit risk rating of five (substandard) or higher.
o The customers business is dependent on the use of high technology
and/or the electronic exchange of information.
o The customer's business is dependent on third party providers of
data processing services or products.
o An average ledger deposit balance greater than $50,000 and more than
12 transactions during the month.
The Company has amended its credit authorization documentation to
include consideration regarding the Year 2000 problem. The Company assesses its
significant customer's Year 2000 readiness and assigns an assessment of "low",
"medium" or "high" risks. Risk evaluation of the Bank's significant customers
was substantially completed by December 31, 1998. Any depositor determined to
have a high risk is scheduled for an evaluation by the Bank every 90 days until
the customer can be assigned a low risk assessment. Any depositor determined to
have medium risk is scheduled for a follow-up evaluation by March 31, 1999.
Because of the range of possible issues and large number of variables
involved, it is impossible to quantify the total potential cost of the Year 2000
problems or to determine the Company's worst-case scenario in the event the
Company's Year 2000 remediation efforts or the efforts of those with whom it
does business are not successful. In order to deal with the uncertainty
associated with the Year 2000 problem, the Company has developed a contingency
plan to address the possibility that efforts to mitigate the Year 2000 risk are
not successful either in whole or part. These plans include manual
20
<PAGE>
processing of information for critical information technology systems and
increased cash on hand. The contingency plans are expected to be completed by
March 31, 1999, after which the appropriate implementation training is scheduled
to take place.
As of December 31, 1998, the Company had incurred approximately
$200,000 in Year 2000 costs, which have been expensed as incurred. Year
2000-related costs have been funded from the continuing operations of the
Company and, as of December 31, 1998, have constituted approximately 22% of the
Company's information systems budget for 1998. The Company estimates that
additional costs to complete Year 2000 compliance will be approximately
$100,000. This estimate includes the cost of purchasing hardware and licenses
for software programming tools, the cost of the time of internal staff and the
cost of consultants. The estimate does not include the time that internal staff
is devoting to testing programming changes. Testing is not expected to add
significant incremental costs. Certain information system projects at the
Company have been deferred as a result of the Company's Year 2000 compliance
efforts. However, these deferrals are not expected to have a material effect on
the Company's business.
Impact of New Accounting Standards
On January 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income. This statement requires that all items recognized under
accounting standards as components of comprehensive income be reported in an
annual financial statement that is displayed with the same prominence as other
annual financial statements. This statement also requires that an entity
classify items of other comprehensive income by their nature in an annual
financial statement. Comprehensive income includes net income and other
comprehensive income. The Company's only source of other comprehensive income is
derived from unrealized gains and losses on investment securities held-for-sale.
Reclassification adjustments result from gains or losses on investment
securities that were realized and included in net income of the current period
that also had been included in other comprehensive income as unrealized holding
gains or losses in the period in which they arose. They are excluded from
comprehensive income of the current period to avoid double counting. Annual
financial statements for all prior periods have been restated.
On January 1, 1998, the Company adopted SFAS No. 131, Disclosures about
Segments of an Enterprise And Related Information, which establishes annual and
interim reporting standards for an enterprise's business segments and related
disclosures about its products, services, geographic areas, and major customers.
This statement will not impact the Company's consolidated financial position,
results of operations or cash flows. The Company operates as a single operating
segment and management evaluates the Company's performance as a whole and does
not allocate resources based on the performance of different lending or
transaction activities. Therefore, the financial disclosures of this standard
related to operating performance of reportable segments do not apply.
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments, and Hedging Activities. The
statement establishes accounting and reporting standards for derivative
instruments and hedging activities. The statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. The Company is in the
process of determining the impact of SFAS No. 133 on the Company's financial
statements, which is not expected to be material.
In October 1998, SFAS No. 134, Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise was issued. SFAS No. 134 is effective for the
first fiscal quarter beginning after December 15, 1998. It will allow companies
that hold mortgage loans for sale to classify mortgage-backed securities
retained in a securitization of such loans as either held-to-maturity, available
for sale, or trading based on management's ability and intent. This guidance is
consistent with the treatment established for investments covered by SFAS 115,
Accounting for Certain Investments in Debt and Equity Securities. Management
does not believe that SFAS No. 134 will have a material impact on its financial
position, results of operations or cash flows.
21
<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,
1998 and 1997, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1998. 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, 1998 and 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
San Francisco, California
February 6, 1999
22
<PAGE>
<TABLE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997 (Dollars in thousands, except per share amounts)
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
December 31,
----------------------------
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
Cash and due from depository institutions $ 11,626 $ 7,214
Overnight deposits 5,325 6,300
--------- ---------
Total cash and cash equivalents 16,951 13,514
Certificates of deposit -- 99
Loans held for sale (Note 6) 2,177 514
Securities available for sale:
Mortgage-backed securities (amortized cost, 1998, $97,158; 1997, $70,234)
(Note 3) 98,006 70,465
Corporate trust preferreds (amortized cost, 1998, $18,658) (Note 4) 19,154 --
Investment securities (amortized cost, 1998, $252; 1997, $40,351) (Note 5) 256 40,355
Securities held to maturity:
Mortgage-backed securities (market value, 1998, $96; 1997, $138) (Note 3) 97 142
Investment securities (market value, 1997, $145) (Note 5) -- 145
Loans receivable held for investment (net of allowance for loan losses, 1998,
$2,780; 1997, $1,669) (Note 6) 298,775 263,751
Federal Home Loan Bank stock, at cost (Note 8) 3,039 3,383
Premises and equipment, net (Note 9) 6,316 4,817
Accrued interest receivable (Note 7) 2,537 2,339
Core deposit premiums and other intangibles, net 3,630 3,229
Other assets 3,881 5,343
--------- ---------
TOTAL ASSETS $ 454,819 $ 408,096
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Savings deposits (Note 10) $ 370,677 $ 320,559
Federal Home Loan Bank advances (Note 11) 35,182 32,282
Securities sold under agreements to repurchase (Note 12) 4,490 5,200
Accounts payable and other liabilities 2,581 2,122
--------- ---------
Total liabilities 412,930 360,163
--------- ---------
COMMITMENTS AND CONTINGENCIES (Note 15): -- --
STOCKHOLDERS' EQUITY (Note 14):
Preferred stock, $.01 par value, 2,000,000 shares authorized and unissued -- --
Common stock, $.01 par value, 9,000,000 shares authorized and 4,492,086
shares issued (3,505,355 shares outstanding at December 31,
1998; and 4,036,997 shares outstanding at December 31, 1997) 45 45
Additional paid-in capital 27,586 27,261
Unearned shares held by employee stock ownership plan (215,623 at
December 31, 1998; and 251,561 at December 31, 1997) (1,380) (1,610)
Treasury stock, at cost (986,731 shares at December 31, 1998; and 455,089
shares at December 31, 1997) (12,920) (4,642)
Retained earnings, substantially restricted 27,764 26,741
Accumulated other comprehensive income, net of taxes 794 138
--------- ---------
Total stockholders' equity 41,889 47,933
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 454,819 $ 408,096
========= =========
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
23
<PAGE>
<TABLE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Year Ended December 31,
---------------------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
INTEREST INCOME:
Loans receivable $20,882 $19,804 $18,015
Mortgage-backed securities 6,911 6,510 3,224
Other investment securities 3,118 3,363 2,747
------- ------- -------
Total interest income 30,911 29,677 23,986
------- ------- -------
INTEREST EXPENSE:
Savings deposits 16,628 15,527 10,949
FHLB advances and other borrowings 1,960 2,886 3,384
------- ------- -------
Total interest expense 18,588 18,413 14,333
------- ------- -------
NET INTEREST INCOME BEFORE PROVISION
FOR LOAN LOSSES 12,323 11,264 9,653
PROVISION FOR LOAN LOSSES 692 375 28
------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 11,631 10,889 9,625
------- ------- -------
NONINTEREST INCOME:
Gains on sale of mortgage-backed securities
and investment securities, net 283 213 168
Commissions from sales of noninsured products 537 355 138
Customer service charges 824 642 403
Income from loan servicing 227 229 153
Other income 306 175 79
------- ------- -------
Total 2,177 1,614 941
------- ------- -------
GENERAL AND ADMINISTRATIVE EXPENSE:
Compensation and employee benefits 5,310 4,358 3,372
Occupancy and equipment 1,112 1,070 914
Deposit insurance premiums 139 233 532
SAIF recapitalization assessment -- -- 1,387
Data processing fees 833 685 495
Legal and accounting expenses 523 421 360
Stationery, telephone and office expenses 561 490 353
Advertising and promotion 359 257 194
Amortization of core deposit premiums 695 839 340
Other expenses 1,612 1,154 1,144
------- ------- -------
Total 11,144 9,507 9,091
------- ------- -------
INCOME BEFORE INCOME TAX EXPENSE 2,664 2,996 1,475
INCOME TAX EXPENSE (Note 12) 1,228 1,230 623
------- ------- -------
NET INCOME $ 1,436 $ 1,766 $ 852
======= ======= =======
BASIC EARNINGS PER SHARE (Note 17) $ 0.40 $ 0.46 $ 0.22
======= ======= =======
DILUTED EARNINGS PER SHARE (Note 17) $ 0.38 $ 0.45 $ 0.22
======= ======= =======
CASH DIVIDENDS PER SHARE $ 0.12 $ 0.09 $ 0.04
======= ======= =======
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
24
<PAGE>
<TABLE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (Dollar amounts in thousands)
- -----------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Accumulated
Other
Comprehensive
Common Stock Additional Income,
Comprehensive --------------------- Paid-In Acquired Treasury Retained net
Income Shares(1) Amount Capital by ESOP Stock(2) Earnings of tax Total
------ --------- ------ ------- ------- -------- -------- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31, 1995 4,267,477 $ 45 $ 27,028 $ (2,070) $ (2,201) $ 24,633 $ 169 $ 47,604
Purchase of
treasury stock (213,375) (2,173) (2,173)
Dividends paid (165) (165)
Earned ESOP shares 77 230 307
Comprehensive income:
Net income $ 852 852 852
Other Comprehensive
income:
Change in unrealized
loss on
securities
available for
sale, net
of taxes of
$ (403) (568)
Reclassification
adjustment for
gains on
securities
available
for sale
included in
income, net of
taxes of $69 (98)
Other comprehensive
income, net (666) (666) (666)
------
Total comprehensive
income $ 186
======
--------- ---- -------- -------- -------- -------- ----- --------
Balance at
December 31, 1996 4,054,102 45 27,105 (1,840) (4,374) 25,320 (497) 45,759
--------- ---- -------- -------- -------- -------- ----- --------
Purchase of
treasury stock (28,125) (376) (376)
Options exercised
using treasury stock 11,020 108 12 120
Dividends paid (357) (357)
Earned ESOP shares 156 230 386
Comprehensive income:
Net income $1,766 1,766 1,766
Other Comprehensive
income:
Change in unrealized
gain on
securities
available for
sale,
net of taxes of
$ 539 760
Reclassification
adjustment for
gains
on securities
available
for sale included
in income, net
of taxes
of $(89) (125)
Other comprehensive
income, net 635 635 635
------
Total comprehensive
income $2,401
======
--------- ---- -------- -------- -------- -------- ----- --------
Balance at
December 31, 1997 4,036,997 $ 45 $ 27,261 $ (1,610) $ (4,642) $ 26,741 $ 138 $ 47,933
--------- ---- -------- -------- -------- -------- ----- --------
-continued-
25
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (Dollar amounts in thousands)
- -------------------------------------------------------------------------------------------------------------------
Accumulated
Other
Comprehensive
Common Stock Additional Income,
Comprehensive --------------------- Paid-In Acquired Treasury Retained net
Income Shares(1) Amount Capital by ESOP Stock(2) Earnings of tax Total
------ --------- ------ ------- ------- -------- -------- ------ -----
Balance at
December 31, 1997 4,036,997 $ 45 $ 27,261 $ (1,610) $ (4,642) $ 26,741 $ 138 $ 47,933
Purchase of
treasury stock (566,991) (8,624) (8,624)
Options exercised
using treasury stock 35,349 346 50 396
Dividends paid (463) (463)
Earned ESOP shares 325 230 555
Comprehensive income:
Net income $1,436 1,436 1,436
Other comprehensive
income:
Change in unrealized
gain on
securities
available for
sale, net
of taxes of $583 822
Reclassification
adjustment for
gains
on securities
available
for sale
included in
income, net of
taxes
of $(118) (166)
Other comprehensive
income, net 656 656
656
------
Total comprehensive
income: $2,092
======
--------- ---- -------- -------- -------- -------- ----- --------
Balance at
December 31, 1998 3,505,355 $ 45 $ 27,586 $ (1,380) $(12,920) $ 27,764 $ 794 $ 41,889
========= ==== ======== ======== ======== ======== ===== ========
<FN>
- --------------------------
(1) Number of shares of common stock includes 359,375 shares which are pledged
as security for a loan to the Bank's ESOP. Shares earned at December 31,
1998, 1997 and 1996 were 143,750, 107,813 and 71,875, respectively.
(2) The Company held 986,731, 455,089, and 437,984 shares of repurchased
Company common stock at December 31, 1998, 1997, and 1996, respectively.
26
<PAGE>
See notes to consolidated financial statements.
</FN>
</TABLE>
27
<PAGE>
<TABLE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (Dollars in thousands)
- -----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Year Ended December 31,
-----------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 1,436 $ 1,766 $ 852
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of premises and equipment 456 440 372
Amortization of core deposit premiums 695 839 340
Amortization of purchase premiums, net of discounts 953 573 487
Loan origination fees deferred, net 591 457 138
Amortization of deferred loan fees (233) (243) (217)
Provision for loan losses 692 375 28
Compensation expense related to ESOP shares released 555 386 307
Gain on sale of mortgage-backed securities and
investment securities (283) (213) (168)
Gain on sale of real estate owned (12) -- --
Recoveries (Charge-offs) on loans receivable, net of recoveries 3 (17) (79)
Losses (gains) on sale of fixed assets (23) 4 5
Originations of loans held for sale (15,886) (3,405) (2,666)
Proceeds from sales of loans originated for sale 14,223 3,020 2,628
Change in income taxes payable and deferred income taxes 116 66 (234)
Change in other assets 1,360 (1,667) (376)
Change in interest receivable (197) 217 (447)
Change in accounts payable and other liabilities 1 (26) (947)
--------- --------- ---------
Net cash provided by operating activities 4,447 2,122 24
--------- --------- ---------
INVESTING ACTIVITIES:
Loans originated for the portfolio, net (104,742) (54,389) (36,061)
Purchases of loans receivable (48,012) (14,661) --
Principal payments on loans receivable 99,287 37,782 31,171
Purchases of corporate securities available for sale (18,645) -- --
Purchases of mortgage-backed securities available for sale (55,278) (6,900) (85,467)
Principal paydowns on mortgage-backed securities 27,913 14,989 11,776
Proceeds from sales of mortgage-backed securities available for sale 48,036 38,613 8,427
Purchases of investment securities available for sale (15,998) (21,249) (36,833)
Proceeds from sales of investment securities available for sale 29,976 -- 3,194
Proceeds from maturities of investment securities 26,245 31,459 14,900
Decreases in certificates of deposit 99 100 581
Redemptions (purchases) of FHLB stock 343 1,657 (2,498)
Purchases of premises and equipment, net (2,352) (374) (1,235)
Purchase of savings deposits and loans, net of core deposit premiums (2,267) -- --
Proceeds from sale of fixed assets 419 -- --
--------- --------- ---------
Net cash (used in) provided by investing activities (14,976) 27,027 (92,045)
--------- --------- ---------
</TABLE>
-continued-
28
<PAGE>
<TABLE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (Dollars in thousands)
- -----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Year Ended December 31,
------------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
FINANCING ACTIVITIES:
Net increase in savings deposits $ 20,467 $ 2,414 $ 798
Assumption of savings deposits, net of core deposit
premiums (Note 10) -- -- 98,395
Purchase premium paid for investment company assets -- (89) --
Proceeds (repayments) on Federal Home Loan Bank
advances, net 2,900 (14,525) 287
Repayments of reverse repurchase agreements, net (710) (7,800) (4,360)
Cash dividends paid to stockholders (463) (357) (165)
Purchases of treasury stock, net (8,228) (256) (2,173)
-------- -------- --------
Net cash provided by (used in) financing activities 13,966 (20,613) 92,782
-------- -------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 3,437 8,536 761
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 13,514 4,978 4,217
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 16,951 $ 13,514 $ 4,978
======== ======== ========
CASH PAID DURING THE PERIOD FOR:
Interest on savings deposits and advances $ 18,957 $ 18,601 $ 14,425
Income taxes 1,037 1,740 954
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING:
Loans transferred to held for investment, at market value -- 69 --
Mortgage-backed securities acquired in exchange for securitized
loans, net of deferred fees 47,703 -- --
Real estate acquired in settlement of loans 299 610 369
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
29
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
1. DESCRIPTION OF THE BUSINESS
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 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, 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, Northern
Monterey, and Southern Santa Clara Counties, in California. At December 31,
1998, the Bank had eight full service offices.
In December, 1996, the Company assumed $102.1 million of savings deposits
from Fremont Investment and Loan in exchange for cash and certain assets.
On December 22, 1997, as part of its growth strategy, the Bank 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 these transactions was
completed April, 1998.
2. 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
(formerly Watsonville Federal Savings and Loan Association), and the Bank's
wholly-owned subsidiary, Portola Investment Corporation. All significant
inter-company transactions and balances have been eliminated in
consolidation.
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
$764,000 and $378,000, respectively, at December 31, 1998 and 1997.
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
30
<PAGE>
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 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.
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.
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 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
31
<PAGE>
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
interest previously accrued is charged off. Subsequent collections of
delinquent interest are recognized as interest income when received.
Impaired and Nonperforming Loans - 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.
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 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.
Any loans, which meet the definition of a troubled debt restructuring, or
are partially or completely classified as Doubtful or Loss, are considered
impaired. Loans are classified doubtful or loss when the likelihood of a
loss on the asset is high. As of December 31, 1998 and 1997, the Company
had $1,437,000 and $448,000, respectively, of restructured loans. The
Company had no loans classified as doubtful or loss at December 31, 1998
and 1997.
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
32
<PAGE>
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 inherent losses in the loan portfolio 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:
Buildings 40 to 50 years
Leasehold improvements lesser of term of lease or life
of improvement
Furniture and equipment 3 to 10 years
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 circumstances
warrant revised estimates. The carrying values of unamortized core deposit
intangibles at December 31, 1998 and 1997 were $3.6 million and $3.2
million, respectively. Accumulated amortization of core deposit intangibles
at December 31, 1998 and 1997 were $1.3 million and $2.0 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.
33
<PAGE>
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 under the asset and
liability method whereby, 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.
Stock Split - In July, 1998, the Board of Directors of the Company
authorized a five for four stock split thereby increasing the number of
issued and outstanding shares. All references in the accompanying financial
statements to the number of common shares and per share amounts as of and
for the years ended December 31, 1997 and 1996 have been restated to
reflect the stock split.
Earnings per share - The Company accounts for earnings per share under the
standards of SFAS No. 128, Measurement of Earnings per Share. Basic
earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding during the period, net
of unreleased ESOP shares. Diluted earnings per share reflects the
potential dilution that could occur if the Company's stock options were
exercised or converted into common stock, net of shares that could be
repurchased from proceeds received from the exercise of stock options.
Common shares outstanding included 359,375 shares purchased by the Bank's
ESOP. Shares earned by the ESOP at December 31, 1998, 1997, and 1996 were
115,000, 86,250, and 57,500, respectively, adjusted for the 5 for 4 split.
Comprehensive Income - On January 1, 1998, the Company adopted SFAS No.
130, Reporting Comprehensive Income. This statement requires that all items
recognized under accounting standards as components of comprehensive income
be reported in an annual financial statement that is displayed with the
same prominence as other annual financial statements. This statement also
requires that an entity classify items of other comprehensive income by
their nature in an annual financial statement. Comprehensive income
includes net income and other comprehensive income. The Company's only
source of other comprehensive income is derived from unrealized gains and
losses on investment securities held-for-sale. Reclassification adjustments
result from gains or losses on investment securities that were realized and
included in net income of the current period that also had been
34
<PAGE>
included in other comprehensive income as unrealized holding gains or
losses in the period in which they arose. Such adjustments are excluded
from current period comprehensive income to avoid double counting. Annual
financial statements for all prior periods have been restated.
Segment Reporting - On January 1, 1998, the Company adopted SFAS No. 131,
Disclosures About Segments Of An Enterprise And Related Information, which
establishes annual and interim reporting standards for an enterprise's
business segments and related disclosures about its products, services,
geographic areas, and major customers. This statement will not impact the
Company's consolidated financial position, results of operations or cash
flows. The Company operates as a single operating segment and management
evaluates the Company's performance as a whole and does not allocate
resources based on the performance of different lending or transaction
activities. Therefore, the financial disclosures of this standard related
to operating performance of reportable segments do not apply.
Recently issued Accounting Pronouncements - In June 1998, the Financial
Accounting Standards Board issued SFAS No. 133, Accounting for Derivative
Instruments, and Hedging Activities. The statement establishes accounting
and reporting standards for derivative instruments and hedging activities.
The statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company is in the process of determining
the impact of SFAS No. 133 on the Company's financial statements, which is
not expected to be material.
In October 1998, SFAS No. 134, Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a
Mortgage Banking Enterprise was issued. SFAS No. 134 is effective for the
first fiscal quarter beginning after December 15, 1998. It will allow
companies that hold mortgage loans for sale to classify mortgage-backed
securities retained in a securitization of such loans as either
held-to-maturity, available for sale, or trading based on management's
ability and intent. This guidance is consistent with the treatment
established for investments covered by SFAS 115, Accounting for Certain
Investments in Debt and Equity Securities. Management does not believe that
SFAS No. 134 will have a material impact on its financial position, results
of operations or cash flows.
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.
Reclassifications - Certain amounts in the 1996 and 1997 consolidated
financial statements have been reclassified to conform with the 1998
presentation.
35
<PAGE>
3. MORTGAGE-BACKED SECURITIES
Mortgage-backed securities available for sale and held to maturity as of
December 31, 1998 and 1997 are as follows (dollars in thousands):
December 31, 1998
----------------------------------------------
Gross Gross Weighted
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yield
Available for sale:
FHLMC certificates $ 4,735 $ 28 $ -- $ 4,763 6.11%
FNMA certificates 32,870 891 (10) 33,751 7.18%
GNMA certificates 11,927 39 (20) 11,946 6.25%
CMO/REMIC tranches 47,626 103 (183) 47,546 6.32%
------- ------- -------- ------
Total $97,158 $ 1,061 $ (213) $98,006 6.60%
======= ======= ======== ======
Held to maturity:
FNMA certificates $ 97 $ -- $ (1) $ 96 4.67%
======= ======= ======== ======
December 31, 1997
----------------------------------------------
Gross Gross Weighted
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yield
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) $ 38 5.04%
======= ======= ======== =======
36
<PAGE>
<TABLE>
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.
<CAPTION>
December 31, 1998 December 31, 1997
------------------------------------ ------------------------------------
Weighted Weighted
Amortized Fair Average Amortized Fair Average
Cost Value Yield Cost Value Yield
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities
available for sale - due
in 5 years or less $ 72 $ 71 7.00% $ 67 $ 67 7.00%
Mortgage-backed securities
available for sale - due
after 5 years through 10 years 4,837 4,838 6.00% 5,895 5,874 6.55%
Mortgage-backed securities
securities available for
sale - due after 10 years 92,249 93,097 6.63% 64,272 64,524 6.85%
------- ------- ------- -------
Total mortgage-backed
securities available
for sale $97,158 $98,006 6.60% $70,234 $70,465 6.82%
======= ======= ======= =======
Mortgage-backed securities
held to maturity - due
in 5 years or less $ 97 $ 96 4.47% $ 142 $ 138 5.04%
======= ======= ======= =======
</TABLE>
Sales of mortgage-backed securities available for sale are summarized as
follows (dollars in thousands):
Year Ended December 31,
-----------------------------
1998 1997 1996
Proceeds from sales $48,036 $38,613 $ 8,427
Gross realized gains on sales 373 236 87
Gross realized losses on sales 68 23 17
37
<PAGE>
4. CORPORATE TRUST PREFERREDS
<TABLE>
Corporate trust preferreds available for sale and held to maturity as of
December 31, 1998 are as follows (dollars in thousands):
<CAPTION>
December 31, 1998
----------------------------------------------------------------------
Gross Gross Weighted
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yield
<S> <C> <C> <C> <C> <C>
Available for sale:
Bank of America Capital $ 3,812 $ 13 $-- $ 3,825 6.57%
Chase Manhattan Bank 3,763 64 -- 3,827 6.65%
Bankers Trust Capital 3,634 166 -- 3,800 6.94%
State Street Capital Trust 3,861 11 -- 3,872 6.48%
Bank of Boston Capital 3,588 242 -- 3,830 6.95%
------- ------- ---- -------
Total $18,658 $ 496 $-- $19,154 6.72%
======= ======= ==== =======
</TABLE>
The amortized cost and fair value of corporate trust preferreds by
contractual maturity are shown below (dollars in thousands).
December 31, 1998
--------------------------------
Weighted
Amortized Fair Average
Cost Value Yield
Corporate trust preferreds
available for sale - due
after 10 years 18,658 19,154 6.72%
------- -------
Total corporate trust preferreds
available for sale $18,658 $19,154 6.72%
======= =======
38
<PAGE>
5. INVESTMENT SECURITIES
<TABLE>
Investment securities available for sale and held to maturity at December
31, 1998 and 1997 are as follows (dollars in thousands):
<CAPTION>
December 31,1998
----------------------------------------------------------------
Gross Gross Weighted
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yield
<S> <C> <C> <C> <C> <C>
Available for sale:
U. S. government securities:
FNMA bond $252 $ 4 $ - $256 6.68%
---- ---- ---- ----
Total $252 $ 4 $ - $256 6.68%
==== ==== ==== ====
</TABLE>
<TABLE>
<CAPTION>
December 31,1997
-----------------------------------------------------------------------
Gross Gross Weighted
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yield
<S> <C> <C> <C> <C> <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>
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.
<CAPTION>
December 31, 1998 December 31, 1997
----------------------------------------- ----------------------------------------
Amortized Fair Weighted Amortized Fair Weighted
Cost Value Average Cost Value Average
<S> <C> <C> <C> <C> <C> <C>
Investment securities
available for sale:
Due within 1
year $ -- $ -- 0.00% $15,000 $14,934 5.01%
Due after 1 year
through 5
years -- -- 0.00% 18,998 19,037 6.59%
Due after 5
years
through 10
years $ 252 $ 256 6.68% 6,353 6,384 6.88%
------- ------- ------- -------
Total $ 252 $ 256 6.68% $40,351 $40,355 6.05%
======= ======= ======= =======
</TABLE>
Sales of investment securities available for sale are summarized as
follows:
Year Ended December 31,
---------------------------------
1998 1997 1996
Proceeds from sales $29,976 $ -- $ 3,194
Gross realized gains on sales 48 -- 98
Gross realized losses on sales 70 -- --
39
<PAGE>
6. LOANS RECEIVABLE
Loans receivable at December 31, 1998 and 1997 are summarized as follows
(dollars in thousands):
December 31,
-----------------------
1998 1997
Held for investment:
Loans secured by real estate:
Residential:
One-to-four units $ 185,033 $ 204,704
Five or more units 33,340 23,355
Commercial real estate 39,997 20,159
Construction 51,624 35,150
Land 7,774 1,869
Other loans:
Business loans 6,679 943
Business lines of credit 595 270
Loans secured by deposits 519 505
Consumer lines of credit, unsecured 138 93
--------- ---------
Total 325,699 287,048
(Less) add:
Loans in process (undisbursed loan funds) (24,201) (21,442)
Unamortized premiums, net of discounts 491 556
Deferred loan fees, net (434) (742)
Allowance for loan losses (2,780) (1,669)
--------- ---------
Loans receivable held for investment $ 298,775 $ 263,751
========= =========
Held for sale:
Loans secured by residential one-to-four units $ 2,177 $ 514
========= =========
Weighted average interest rate at end of period 7.92% 7.96%
At December 31, 1998 and 1997, the Company was servicing loans for others
with a total unpaid principal balance of $75,407,000 and $52,141,000,
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 $227,000 and $229,000 for the years ended
December 31, 1998 and 1997, respectively. At December 31, 1998, the Company
held $208,000 in escrow accounts for taxes and insurance.
The activity in the allowance for loan losses is as follows (dollars in
thousands):
Year Ended December 31,
-----------------------------
1998 1997 1996
Balance, beginning of year $ 1,669 $ 1,311 $ 1,362
Provision for loan losses 692 375 28
Acquired allowance associated with
Commercial Pacific Bank loans 416 -- --
Net (charge-offs) recoveries 3 (17) (79)
------- ------- -------
Balance, end of year $ 2,780 $ 1,669 $ 1,311
======= ======= =======
40
<PAGE>
The following table identifies the Company's total recorded investment in
impaired loans by type at December 31, 1998 and 1997 (dollars in
thousands).
December 31,
---------------------
Loans secured by real estate: 1998 1997
Residential:
One-to-four units $2,961 $ 985
Five or more units 648 817
Land 145 --
------ ------
Total impaired loans $3,754 $1,802
====== ======
The principal balances of impaired loans on which valuation allowances were
recorded were, $3.8 million and $1.8 million in 1998 and 1997 respectively.
The related valuation allowances on impaired loans at December 31, 1998 and
1997 were $409,000 and $236,000, 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,
1998 and 1997, the Company recognized interest on impaired loans of
$166,000 and $49,000, respectively. Interest not recognized on impaired
loans at December 31, 1998 amounted to $76,000. During the year ended
December 31, 1998, the Company's average investment in impaired loans was
$3.1 million, compared to $1.3 million in 1997.
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, 1998 and 1997 were as follows (dollars in thousands).
December 31,
-----------------
1998 1997
Residential loans secured by real estate:
One-to-four units - in foreclosure $1,248 $ 124
One-to-four units - not in foreclosure 248 957
Five or more units -- 817
Real estate owned 281 321
------ ------
Total nonperforming assets $1,777 $2,219
====== ======
At December 31, 1998 and 1997, the Company had $1.5 million and $1.6
million, respectively, of nonaccrual loans. For the years ended 1998 and
1997, the effect on interest income had nonaccrual and other adversely
classified and impaired loans been performing in accordance with
contractual terms was approximately $76,000 and $62,000, 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, 1998 and 1997, the Company had eight loans totaling $1,437,000
and four loans totaling $448,000, respectively, which met the definition of
a troubled debt restructuring, of which $1,420,000 and $300,000,
respectively, were current and paying according to the terms of their
contractually restructured agreements on December 31, 1998 and 1997.
41
<PAGE>
At December 31, 1998 and 1997, all nonperforming loans were secured by
properties located within the State of California.
The Company made conforming loans to executive officers, directors, and
their affiliates in the ordinary course of business. Activity for the year
ended December 31, 1998 reflects the removal of one loan with an
outstanding balance of $186,000 due to the retirement of an officer of the
Company. An analysis of the activity of these loans is as follows (dollars
in thousands):
Year Ended
December 31,
--------------------
1998 1997
Balance, beginning of period $ 780 $ 811
New loans and line of credit advances 1,104 92
Repayments (530) (13)
Other (710) (110)
------- -------
Balance, end of period $ 644 $ 780
======= =======
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, 1998 and 1997,
such limitation would have been approximately $4,783,000 and $5,786,000,
respectively. There were no loans originated in violation 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.
7. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable as of December 31, 1998 and 1997 was as follows
(dollars in thousands):
December 31,
----------------
1998 1997
Interest receivable on loans $1,777 $1,521
Interest receivable on mortgage-backed securities 583 465
Interest receivable on other investments 177 353
------ ------
Total $2,537 $2,339
====== ======
42
<PAGE>
8. 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, 1998 and 1997, the Bank owned 30,393 and 33,825 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 11).
9. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31, 1998 and
1997 (dollars in thousands):
December 31,
----------------------
1998 1997
Land $ 2,312 $ 2,106
Buildings and improvements 3,953 2,904
Equipment 2,284 1,800
------- -------
Total, at cost 8,549 6,810
Less accumulated depreciation (2,233) (1,993)
------- -------
Total $ 6,316 $ 4,817
======= =======
Depreciation expense was $456,000, $440,000, and $372,000 for the years
ended December 31, 1998, 1997, and 1996, respectively.
10. SAVINGS DEPOSITS
<TABLE>
A summary of savings deposits and related weighted average interest rates
for the years ended December 31, 1998 and 1997 follows (dollars in
thousands):
<CAPTION>
December 31, 1998 December 31, 1997
----------------------------- ----------------------------
Weighted Weighted
Average % of Average % of
Amount Rate Total Amount Rate Total
<S> <C> <C> <C> <C> <C> <C>
Consumer accounts:
Passbook accounts $15,561 1.83% 4.20% $ 13,553 1.89% 4.23%
Checking accounts 37,462 .76% 10.11% 21,325 .49% 6.65%
Money market accounts 60,528 4.03% 16.33% 31,605 3.88% 9.86%
Certificate accounts:
Jumbo accounts 62,457 5.23% 16.85% 59,025 5.57% 18.41%
Other term accounts 194,669 5.47% 52.51% 195,051 5.48% 60.85%
------- ------ -------- ------
Total $370,677 100.00% $320,559 100.00%
======= ====== ======= ======
Weighted average interest
rate 4.70% 4.89%
</TABLE>
43
<PAGE>
A summary of certificate accounts by maturity as of December 31, 1998 and
1997 follows (dollars in thousands):
December 31,
------------------------
1998 1997
Within six months $141,937 $101,645
Six months to one year 75,391 83,546
One to two years 33,581 63,840
Two to three years 1,960 2,139
Over three years 4,257 2,906
-------- --------
Total $257,126 $254,076
======== ========
Savings deposits included $91,582,000 and $69,246,000 of jumbo accounts
($100,000 or greater) at December 31, 1998 and 1997, respectively. At
December 31, 1998 and 1997, total jumbo accounts included $29,125,000 and
$10,221,000, 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,
---------------------------------
1998 1997 1996
Passbook savings $ 278 $ 254 $ 254
Checking accounts 227 87 78
Money market accounts 1,716 1,344 695
Certificates of deposit 14,407 13,842 9,922
------- ------- -------
Total $16,628 $15,527 $10,949
======= ======= =======
11. FHLB ADVANCES
A summary of Federal Home Loan Bank advances and related maturities at
December 31, 1998 and 1997 follows (dollars in thousands):
December 31,
------------------------
Maturity 1998 1997
1998 $ -- $22,100
1999 2,600 2,600
2003 25,000 --
2004 282 282
2005 1,500 1,500
2006 4,800 4,800
2010 1,000 1,000
------- -------
Total $35,182 $32,282
======= =======
Weighted average rate during the year 5.93% 5.92%
Weighted average rate at year end 5.54% 6.09%
At December 31, 1998 and 1997, advances were secured by pledged investment
securities and mortgage-backed securities with an aggregate amortized cost
of $86.9 million and $72.5 million, respectively, and the Bank's investment
in FHLB stock (see Note 8). At December 31, 1998 and 1997, FHLB advances
were also secured by mortgage loans with carrying values of $134.0 million
and $202.9 million, respectively.
44
<PAGE>
During the years ended December 31, 1998 and 1997, the maximum amount of
FHLB advances outstanding was $73.8 million and $46.4 million,
respectively. The average amount of FHLB advances outstanding during the
same periods was $28.1 million and $40.5 million, respectively.
12. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
At December 31, 1998 and 1997, the Company held agreements to repurchase
securities resulting in net borrowings of $4.5 million and $5.2 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, 1998 and 1997 are summarized below
(dollars in thousands):
December 31,
--------------------------
1998 1997
1998 $ -- $ 3,200
1999 4,490 2,000
------- -------
Outstanding balance at year end $ 4,490 $ 5,200
======= =======
Weighted average rate during the year 5.92% 5.91%
Weighted average rate at the end of the year 5.69% 5.95%
Value of securities held as collateral for
reverse repurchase agreements, at
year end:
Par value $ 4,494 $ 6,162
Amortized cost 4,633 6,357
Market value 4,643 6,364
During the years ended December 31, 1998 and 1997, the maximum amount of
reverse repurchase agreements outstanding was $5.2 million and $13.0
million, respectively. The average amount of reverse repurchase agreements
outstanding during the same periods was $5.0 million and $8.2 million,
respectively.
13. INCOME TAXES
The components of the provision for income taxes for the years ended
December 31, 1998, 1997 and 1996 are as follows (dollars in thousands):
Year Ended December 31,
-------------------------------
1998 1997 1996
Current:
Federal $ 1,150 $ 1,473 $ 626
State 357 449 163
------- ------- -------
Total current 1,507 1,922 789
------- ------- -------
Deferred:
Federal (244) (566) (173)
State (35) (126) 7
------- ------- -------
Total deferred (279) (692) (166)
------- ------- -------
Total current and deferred $ 1,228 $ 1,230 $ 623
======= ======= =======
45
<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,
-------------------------------------
1998 1997 1996
Statutory federal tax rate 34.0% 34.0% 34.0%
California franchise tax, net of
Federal income tax benefit 8.0% 7.1% 7.6%
Other 4.1% (0.1%) 0.7%
---- ---- ----
Total 46.1% 41.0% 42.3%
==== ==== ====
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities as of December 31, 1998
and 1997 are presented below (dollars in thousands):
December 31,
------------------
1998 1997
Deferred tax assets:
Deferred loan fees $ (59) $ 204
Compensation deferred for tax purposes 575 538
Allowance for loan losses 797 383
State income taxes (10) 29
Core deposits 716 574
Other 58 32
------- -------
Total gross deferred tax assets 2,077 1,760
Deferred tax liabilities:
Tax over book depreciation (35) (61)
FHLB stock dividends (545) (545)
Unrealized gain on securities available for sale (554) (96)
Other (92 (27)
------- -------
Total gross deferred tax liabilities (1,226) (729)
------- -------
Net deferred tax asset $ 851 $ 1,031
======= =======
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.
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, 1998, 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.
46
<PAGE>
14. 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, 1998 and 1997, 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, 1998 and 1997, the Bank was
considered "well capitalized."
<TABLE>
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.
<CAPTION>
Minimum Capital Well Capitalized
Requirements Requirements Actual
---------------------- ---------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
---------- --------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total capital
(to risk-weighted
assets) $21,980 8.00% $27,475 10.00% $31,882 11.60%
Tier 1 capital
(to risk-weighted
assets) N/A N/A 16,334 6.00% 29,319 10.77%
Core (tier 1) capital
(to adjusted assets) 17,522 4.00% 21,902 5.00% 29,319 6.69%
Tangible capital
(to tangible assets) 6,571 1.50% N/A N/A 29,319 6.69%
Minimum Capital Well Capitalized
Requirements Requirements Actual
---------------------- ---------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
---------- --------- ---------- ---------- ---------- ----------
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%
Core (tier 1) capital
(to adjusted assets) 15,703 4.00% 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>
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 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
47
<PAGE>
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, 1998, the
Bank had the capacity to declare dividends totaling approximately $2.2
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 insurance premiums of $139,000 in 1998
of which $127,000 were SAIF premiums and $12,000 were BIF premiums. In 1997
the Company paid $233,000 of FDIC insurance premiums of which $201,000 were
SAIF premiums and $32,000 were BIF premiums. The FDIC bases its insurance
premiums on the perceived risk of the savings institution. During 1998 the
Company paid lower premiums as the perceived risk level of the Bank was
judged by the FDIC to be lower than in prior years as a result of
regulatory examinations and reports. In 1996 the Company paid $532,000 of
FDIC insurance premiums excluding the one-time SAIF assessment.
48
<PAGE>
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, 1998, the Company had outstanding commitments to originate
$26.6 million of real estate loans, include $2.6 million for fixed rate
loans and $24 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 commitments being exercised;
therefore, total commitments outstanding do not necessarily represent
future cash requirements.
At December 31, 1998, the Company had made available various secured and
unsecured business, personal, and residential lines of credit totaling
approximately $9.3 million, of which the undisbursed portion was
approximately $5.3 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, 1998, the Company had issued letters of credit totaling $4.1 million
compared to $8.3 million at December 31, 1997.
At December 31, 1998, 1997, and 1996, 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 $170,000, $147,000 and $158,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
Certain branch offices are leased by the Company under the terms of
operating leases expiring at various dates through the year 2005. At
December 31, 1998, 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):
1999 $ 128
2000 131
2001 135
Thereafter 354
-----
Total $ 748
=====
49
<PAGE>
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 351,758 shares of the Company's common stock. Each option entitles the
holder to 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, 1998, unexercised
options were granted and outstanding for an aggregate of 338,869 shares. At
December 31, 1998, 153,764 of the options granted were outstanding and
exercisable and 27,888 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 97,925 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, 1998, for an aggregate of 79,440 shares with
an exercise price equal to the fair market value of the Company's common
stock at the date of grant. At December 31, 1998, 37,816 of the options
granted were outstanding and exercisable. Through December 31, 1998, 18,481
options had been exercised under the Directors' Option Plan.
<TABLE>
A summary of stock option transactions under the plans for the years
December 31, 1998, 1997, and 1996 follows:
<CAPTION>
Weighted
Number Average Exercise
Of Exercise Price Expiration
Shares Price Per Share Date
------ ----- --------- ----
<S> <C> <C> <C> <C>
Balance, December 31, 1995 446,957 $ 9.100 $ 9.100 2005
Options granted 19,033 $ 11.242 $ 10.700-11.800 2005
Options cancelled/expired (22,233) $ 9.100 $ 9.100 2005
-------
Balance, December 31, 1996 443,757 $ 9.192 $ 9.100-11.800 2005-2006
Options exercised (11,019) $ 9.100 $ 9.100 2005
Options cancelled/expired (44,084) $ 9.100 $ 9.100 2005
-------
Balance, December 31, 1997 388,654 $ 9.205 $11.375-14.750 2005-2006
Options granted 85,496 $ 14.902 $14.312-16.600 2008
Options cancelled/expired (55,841) $ 9.100 $ 9.100 2005
-------
Balance at December 31, 1998 418,309 $ 10.383 2005-2008
=======
Exercisable, December 31, 1998 191,580 $ 9.185
=======
</TABLE>
50
<PAGE>
The following table summarizes stock option information at year-end 1998:
Exercise Number of Remaining Exercisable
Price Options Life Options
----- ------- ---- -------
$ 9.100 313,780 6.7 years 183,967
10.700 9,658 7.5 years 3,863
11.800 9,375 8.0 years 3,750
14.800 68,750 9.5 years --
16.600 7,371 9.7 years --
14.312 9,375 10 years --
$ 9.10 - 16.600 418,309 7.3 years 191,580
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 359,375 split adjusted
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, 1998, the loan had an outstanding balance of
$1,380,000 and carried an interest rate of 8.00%. Interest expense for the
obligation was $128,000 and $147,000, respectively, for the years ended
December 31, 1998 and 1997. 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, 1998, 143,750 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, 1998, the fair market value of the 215,625 unearned shares was
$3,056,133.
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
1998, and 1996, the Company granted 18,145 and 7,246 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, 1998, 72,913 shares were the subject of
outstanding grant awards to officers and directors and 28,402 remained
reserved for future awards.
51
<PAGE>
The following is a summary of transactions under the PEP and RRP:
Number of Grant Weighted Average
Shares Awarded Fair Value
and Outstanding on Grant Date
--------------- -------------
Balance, December 31, 1995 165,088 $ 9.100
Grant shares awarded 7,246 11.459
Grant shares vested and issued (24,975) 9.100
Grant shares forfeited (14,338) 9.100
-------
Balance, December 31, 1996 133,021 9.229
Grant shares vested and issued (28,069) 9.100
Grant shares forfeited (13,813) 9.100
-------
Balance, December 31, 1997 91,140 9.288
Grant shares awarded 18,145 15.257
Grant shares vested and issued (27,058) 9.195
Grant shares forfeited (7,887) 9.140
-------
Balance, December 31, 1998 74,340 $ 10.794
=======
The Company recorded compensation expense for the ESOP, PEP, and RRP of
$817,000, $751,000, and $599,000, respectively, for the years ended
December 31, 1998, 1997, and 1996.
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,
---------------------------------
1998 1997 1996
Net income:
As reported $ 1,436 $ 1,766 $ 852
Pro forma 1,256 1,622 708
Basic earnings per share:
As reported $ .41 $ .47 $ .22
Pro forma .36 .44 .19
Diluted earnings per share:
As reported $ .38 $ .45 $ .22
Pro forma .33 .42 .19
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 1998,
1997 and 1996, respectively: dividend yield of .87% for 1998 and .72% for
1996, expected volatility of 12% for 1998 and 9% for 1996; expected lives
of 7 years for both years; and risk-free interest rates of 5.00% for 1998
6.2% for 1996. 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 1998 and 1996 were
$3.82 and $4.08, respectively.
52
<PAGE>
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 income
for the period by the weighted average common shares outstanding for that
period. Weighted average shares includes ESOP shares earned. 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.
Following is a summary of the calculation of basic and diluted EPS (dollars
are in thousands except per share amounts).
Year Ended December 31,
------------------------------------
1998 1997 1996
Net income $ 1,436 $ 1,766 $ 852
========== ========== ==========
Weighted average shares-basic 3,621,258 3,777,479 3,859,369
Dilutive effect of option shares 127,211 128,864 44,982
---------- ---------- ----------
Weighted average shares
outstanding-diluted 3,748,469 3,906,343 3,904,351
========== ========== ==========
Basic earnings per share $ 0.40 $ 0.46 $ 0.22
========== ========== ==========
Diluted earnings per share $ 0.38 $ 0.45 $ 0.22
========== ========== ==========
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 $1,623,000 and
$1,532,000 at other financial institutions as of December 31, 1998 and
1997, 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, 1998 and 1997, 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 7.0%, was $911,000 at December 31,
1998, and using a discount rate of 7.5%, was $909,000 at December 31, 1997.
Plan assets are not segregated for purposes of paying benefits under the
Salary Continuation and Retirement Plans. The Company accrued pension
liability expenses of $52,000, $36,000 and $35,000 under the Plans for the
years ended December 31, 1998, 1997 and 1996, respectively. Such expense
amounts approximated the computed actuarial net periodic plan costs for
each period.
53
<PAGE>
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 subsidiaries (distributed and undistributed) is excluded from the
computation of the provision for income taxes for financial statement
purposes.
<TABLE>
Following are the Parent Company's summary statements of financial
condition for the years ended December 31, 1998 and 1997, and condensed
statements of operations and cash flows for the years ended December 31,
1998, 1997, and 1996 (dollars in thousands):
<CAPTION>
SUMMARY STATEMENTS OF FINANCIAL CONDITION Year Ended December 31,
---------------------------
1998 1997
<S> <C> <C>
ASSETS
Cash and due from depository institutions $ 428 $ 442
Overnight deposits 725 1,400
------- -------
Total cash and cash equivalents 1,153 1,842
Mortgage-backed securities available for sale 6,664 10,939
Investment securities available for sale -- 101
Loan receivable 4,850 --
Other assets 58 109
Investment in subsidiary 33,732 40,212
------- -------
TOTAL $46,457 $53,203
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Securities sold under agreements to repurchase $ 4,490 $ 5,200
Other liabilities 78 70
------- -------
Total liabilities 4,568 5,270
Stockholders' equity (see Consolidated Statements
Of Financial Condition) 41,889 47,933
TOTAL $46,457 $53,203
======= =======
</TABLE>
<TABLE>
SUMMARY STATEMENTS OF OPERATIONS Year Ended December 31,
------------------------------------------
1998 1997 1996
<S> <C> <C> <C>
Interest income:
Interest on mortgage-backed securities
and investment securities $ 641 $ 569 $ 582
Interest on ESOP loan 129 147 166
Interest on loan receivable 306 -- --
------- ------- -------
Total interest income 1,076 716 748
------- ------- -------
Interest expense:
Interest on reverse repurchase agreements 297 61 7
------- ------- -------
Total interest expense 297 61 7
------- ------- -------
Provision for loan losses 150 -- --
Noninterest revenue (1) -- 47
General and administrative expense 503 476 397
------- ------- -------
Income before income tax expense 125 179 391
Income tax expense 50 74 162
------- ------- -------
Income before undistributed net income of the Bank 75 105 229
Undistributed net income of the Bank 1,361 1,661 623
------- ------- -------
Net income $ 1,436 $ 1,766 $ 852
======= ======= =======
</TABLE>
54
<PAGE>
<TABLE>
Following are the Parent Company's condensed statements of cash flows for
the years ended December 31, 1998, 1997, and 1996 (dollars in thousands):
<CAPTION>
SUMMARY STATEMENTS OF CASH FLOWS Year Ended December 31,
-------------------------------------
1998 1997 1996
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 1,436 $ 1,766 $ 852
Adjustments to reconcile net income to net cash provided by
operating activities:
Undisbursed net income of subsidiary (1,361) (1,661) (623)
Amortization of premiums 102 50 8
Provision for loan losses 150 -- --
Compensation expense related to ESOP shares released 555 386 307
Unrealized (gain) loss on securities, net of taxes (3) -- --
Change in interest receivable (4) (32) 86
Change in other assets 3 (4) 53
Change in income taxes payable and deferred income taxes 50 (24) (150)
Change in other liabilities 10 (9) (49)
------- ------- -------
Net cash provided by operating activities 938 472 484
------- ------- -------
INVESTING ACTIVITIES:
Loans originated (5,000) -- --
Dividend from subsidiary 8,500 -- --
Purchases of mortgage-backed securities available for sale -- (6,899) (5,284)
Paydowns on mortgage-backed securities 3,199 3,094 3,010
Proceeds from sales of mortgage-backed securities 975
Purchases of investment securities available for sale -- -- (3,593)
Proceeds from maturities of investment securities 100 -- 8,500
Proceeds from sales of investment securities -- -- 85
------- ------- -------
Net cash (used in) provided by investing activities 7,774 (3,805) 2,718
------- ------- -------
FINANCING ACTIVITIES:
Proceeds (repayments) of reverse repurchase agreements, net (710) 5,200 (713)
Cash dividends paid to stockholders (463) (357) (165)
Purchases of treasury stock, net (8,228) (256) (2,173)
------- ------- -------
Net cash (used in) provided by financing activities (9,401) 4,587 (3,051)
------- ------- -------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (689) 1,254 151
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD 1,842 588 437
------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,153 $ 1,842 $ 588
======= ======= =======
</TABLE>
55
<PAGE>
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 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, 1998 and 1997.
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.
56
<PAGE>
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.
The carrying amounts and estimated fair values of the Company's financial
instruments as of December 31, 1998 and 1997 were as follows (dollars in
thousands):
December 31, 1998
-------------------
Carrying Fair
Amount Value
Assets:
Cash and cash equivalents $ 16,951 $ 16,951
Investment securities available for sale 256 256
Corporate securities available for sale 19,154 19,154
Mortgage-backed securities available for sale 98,006 98,006
Mortgage-backed securities held to maturity 97 96
Loans receivable held for investment 298,775 306,215
Loans held for sale 2,177 2,177
Federal Home Loan Bank stock 3,039 3,039
Liabilities:
Consumer accounts 113,551 113,551
Certificate accounts 257,126 257,975
FHLB advances 35,182 35,780
Securities sold under agreements to repurchase 4,990 4,990
Commitments to extend credit -- --
December 31, 1997
-------------------
Carrying Fair
Amount Value
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 -- --
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, 1998, the amount of the remaining balance in
this liquidation account was approximately $3.4 million.
58
<PAGE>
<TABLE>
QUARTERLY RESULTS OF OPERATIONS (Unaudited)
- --------------------------------------------------------------------------------
<CAPTION>
For the Year Ended December 31, 1998
-------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C>
Interest income ....................... $ 7,325 $ 7,547 $ 7,749 $ 8,290
Interest Expense ...................... 4,377 4,591 4,621 4,999
------- ------- ------- -------
Net interest income before
provision for loan losaes ...... 2,948 2,956 3,128 3,291
Provision for loan losses ............. 109 496 77 10
------- ------- ------- -------
Net interest income after
provision for loan losses ...... 2,839 2,460 3,051 3,281
Noninterest income .................... 400 492 498 787
General and administrative expense .... 2,440 2,986 2,718 3,000
------- ------- ------- -------
Income (loss) before income tax expense 799 (34) 831 1,068
Income tax expense .................... 360 31 371 466
------- ------- ------- -------
Net income (loss) .............. $ 439 $ (65)(1) $ 460 $ 602
======= ======= ======= =======
Basic earnings (loss) per share ....... $ .11 $ (.02) $ .13 $ .18
======= ======= ======= =======
Diluted earnings (loss) per share ..... $ .11 $ (.02) $ .12 $ .17
======= ======= ======= =======
Cash dividends per share .............. $ .06 $ .00 $ .06 $ .00
======= ======= ======= =======
For the Year Ended December 31, 1997
-------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
Interest income ....................... $ 7,636 $ 7,425 $ 7,286 $ 7,330
Interest expense ...................... 4,624 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 .............. $ .12 $ .10 $ .13 $ .11
======= ======= ======= =======
Diluted earnings per share ............ $ .12 $ .10 $ .13 $ .10
======= ======= ======= =======
Cash dividends per share .............. $ .04 $ .00 $ .05 $ .00
======= ======= ======= =======
- -------------------------------------------------
<FN>
(1) The net loss of $65,000 was primarily due to a substantial increase in the
provision for loan losses and to lesser extent the settlement by the Bank
of two outstanding legal matters. The Bank increased the loan loss
provision to address potential losses on loans secured by properties
damaged by unusually severe Winter weather conditions in its market area.
</FN>
</TABLE>
59
<PAGE>
<TABLE>
<CAPTION>
EXECUTIVE OFFICERS/INSIDE DIRECTORS
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Eugene R. Friend Marshall G. Delk Carlene F. Anderson
Chairman of the Board and President, Chief Operating Corporate Secretary
Chief Executive Officer Officer, Director , Monterey Bay Bancorp, Inc., and
Monterey Bay Bancorp, Inc. and Chief Financial Officer Vice President, Compliance
and Monterey Bay Bank Monterey Bay Bancorp, Inc. Officer, and Secretary
and Monterey Bay Bank Monterey Bay Bank
Ben A. Tinkey Gary C. Tyack Philip E. Safran
Senior Vice President Senior Vice President, Vice President and Controller
and Chief Loan Officer Retail Banking Monterey Bay Bank
Monterey Bay Bank Monterey Bay Bank
OUTSIDE DIRECTORS
- ---------------------------------------------------------------------------------------------------------------------
P. W. Bachan Steven Franich McKenzie Moss
Partner, in the law firm of President, Marty Franich Financial and Strategic
Bachan, Skillicorn, Auto Dealerships, Planning Consultant; University
Marinovich, and Balian Watsonville, CA Instructor, and Lecturer; Writer;
Watsonville, CA Retired Bank Executive
Edward K. Banks Donald K. Henrichsen Louis Resetar, Jr.
Chief Executive Officer President Retired, AgriBusiness,
Pajaro Valley Agencies, Inc. John's Shoe Store, Inc. Resetar Farms
Watsonville, CA Watsonville, CA
Nicholas C. Biase Stephen G. Hoffmann
Representative of Findim President,
Investments, S.A. Chief Executive Officer
President Omabuild, Inc. Canyon National Bank
New York, NY Palm Springs, CA
Diane S. Bordoni Gary L. Manfre
Chief Financial Officer President
System Studies, Inc. Watsonville Coast Produce, Inc.
Santa Cruz, CA Watsonville, CA
BANKING OFFICES
- ---------------------------------------------------------------------------------------------------------------------
Capitola Monterey South Salinas
601 Bay Avenue 1400 Munras Avenue 1127 South Main Street
Capitola, California 95010 Monterey, California 93940 Salinas, California 93901
Felton North Salinas Watsonville
6265 Highway 9 1890 North Main Street 35 East Lake Avenue
Felton, CA 95018 Salinas, California 93906 Watsonville, California 95076
Gilroy Prunedale
805 First Street 8071 San Miguel Canyon Road
Gilroy, California 95020 Prunedale, California 93907
</TABLE>
59
<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 $0.12 and $0.09 per share in 1998 and 1997 respectively. In February 1999,
the Company paid a semiannual cash dividend of $0.07 per share. At December 31,
1998, the Company had approximately 297 stockholders of record (not including
the number of persons or entities holding stock in nominee or street name
through various brokerage firms) and 3,505,355 outstanding shares of common
stock. The table below shows the reported high, and low sale prices of the
common stock for 1996, 1997,and 1998.
1998 High(1) Low(1)
- ----------------------------------------------------------
First Quarter 21.600 14.800
Second Quarter 21.100 14.800
Third Quarter 17.000 13.200
Fourth Quarter 14.875 10.750
1997 High(1) Low(1)
- ----------------------------------------------------------
First Quarter 15.000 11.650
Second Quarter 13.800 12.300
Third Quarter 16.600 12.800
Fourth Quarter 16.400 14.600
1996 High(1) Low(1)
- ----------------------------------------------------------
First Quarter 10.200 8.800
Second Quarter 10.200 9.400
Third Quarter 10.900 9.100
Fourth Quarter 12.700 10.700
- ----------------------------------------------------------
(1) Per share prices for periods ended prior to July 31, 1998, have been
adjusted to reflect the 5 for 4 stock split effected on that date.
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, 1998, as filed with the Securities and Exchange
Commission, are available without charge to stockholders upon written request
to:
Marshall G. Delk
President, Chief Operating Officer; Director,
and Chief Financial Officer
Monterey Bay Bancorp, Inc.
567 Auto Center Drive, Watsonville, CA 95076
Annual Meeting of Stockholders
The annual meeting of stockholders of Monterey Bay Bancorp, Inc. will be
held on Friday, June 11, 1999, at 9:00 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
Tel. (800) 356-2017
Web site: www.chasemellon.com.
Independent Auditors
Deloitte & Touche LLP
50 Fremont Street
San Francisco, CA 94105
Legal Counsel
McGuire Woods Battle & Boothe LLP
Washington Square, Suite 1200
1050 Connecticut Avenue, N.W.
Washington, DC 20006-4007
Corporate Offices
Monterey Bay Bancorp, Inc
567 Auto Center Drive
Watsonville, CA 95076.
