SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual report pursuant to Section 13 of the
Securities Exchange Act of 1934, as amended
For the fiscal year ended December 31, 1998
Commission File No.: 0-24802
MONTEREY BAY BANCORP, INC.
(exact name of registrant as specified in its charter)
DELAWARE 77-0381362
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
567 Auto Center Drive, Watsonville, California
95076 (Address of principal executive offices)
Registrant's telephone number, including area code: (831) 768-4800
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K.
The aggregate market value of the voting stock held by non-affiliates
of the registrant, i.e., persons other than the directors and executive officers
of the registrant, was $39,557,394, based upon the last sales price as quoted on
the Nasdaq Stock Market for March 25, 1999.
The number of shares of Common Stock outstanding as of March 25, 1999:
3,528,886
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1999 Annual Meeting of Stockholders are
incorporated by reference into Part III of this Form 10-K.
Portions of the Annual Report to Stockholders for the year ended December 31,
1998 are incorporated by reference into Part II of this Form 10-K.
<PAGE>
INDEX
PAGE
PART I
Item 1. Business........................................................ 1
Item 2. Properties...................................................... 34
Item 3. Legal Proceedings............................................... 35
Item 4. Submission of Matters to a Vote of Security Holders............. 35
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters............................................. 35
Item 6. Selected Financial Data......................................... 36
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 36
Item 7a. Quantitative and Qualitative Disclosures about Market Risk...... 36
Item 8. Financial Statements and Supplementary Data..................... 36
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.......................... 36
PART III
Item 10. Directors and Executive Officers of the Registrant.............. 36
Item 11. Executive Compensation.......................................... 36
Item 12. Security Ownership of Certain Beneficial Owners
and Management.................................................. 37
Item 13. Certain Relationships and Related Transactions.................. 37
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K..................................................... 37
<PAGE>
PART I
Item 1. Business.
General
Monterey Bay Bancorp, Inc. (the "Company") is a unitary savings and
loan holding company incorporated in 1994 under the laws of the state of
Delaware. The significant operating subsidiary of the Company is Monterey Bay
Bank ("the Bank"), formerly Watsonville Federal Savings and Loan Association.
The Company was organized as the holding company for the Bank in connection with
the Bank's conversion from the mutual to stock form of ownership in 1995. The
Company's primary business is providing conveniently located deposit facilities
to attract checking, money market, savings and certificate of deposit accounts,
and investing such deposits and other available funds in mortgage loans secured
by one-to-four family residences, construction, commercial real estate, and
business loans. As part of its ongoing operating strategy, the Company has been
diversifying its loan portfolio by increasing the amount of its construction,
commercial real estate, and business lending activities. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
largest source of the Company's revenue is interest income from loans,
mortgage-backed securities, and investment securities. The Company's primary
sources of funds are customer deposits, principal and interest payments on loans
and mortgage-backed securities, advances from the Federal Home Loan Bank
("FHLB") and, to a lesser extent, proceeds from the sales of securities and
loans. Through its wholly-owned subsidiary, Portola Investment Corporation
("Portola"), the Bank engages in the sale of noninsured insurance and investment
products on an agency basis and acts as trustee on the Bank's deeds of trust.
See "Subsidiary Activities."
Market Area and Competition
The Bank is a community-oriented financial institution, which
originates one-to-four family residential mortgage loans, construction,
commercial real estate, and business loans within its market area. The Bank's
deposit gathering and lending markets are concentrated primarily in the
communities surrounding its full service offices in Santa Cruz, Monterey and
portions of Santa Clara County in Central California. The economy in the
Company's primary market area is predominantly agricultural, with some light
manufacturing and tourism industry in the coastal communities on Monterey Bay.
The Company believes that the economies in which it operates have experienced
strong growth and favorable economic activity in the past two years, as
reflected in sustained loan demand and deposit growth. The economic performance
in the Company's primary market area typically mirrors the national economy and
shows seasonal economic fluctuations.
The Company faces significant competition both in originating loans and
in attracting deposits. The Company's competitors are the financial institutions
operating in its primary market area, many of which are significantly larger and
have greater financial resources than the Company. The Company's competition for
loans comes principally from commercial banks, savings and loan associations,
mortgage banking companies, credit unions, and insurance companies. Its most
direct competition for deposits has historically come from savings and loan
associations and commercial banks. In addition, the Company faces increasing
competition for deposits from nonbank institutions such as brokerage firms and
insurance companies in such areas as short-term money market funds, corporate
and government securities funds, mutual funds, and annuities.
The Company serves its market area with a variety of mortgage loan
products and other retail financial services. Management considers the Company's
reputation for financial strength and competitive deposit and loan products as
its major competitive advantage in attracting and retaining customers within its
primary market area.
1
<PAGE>
Lending Activities
<TABLE>
General. The Company originates permanent and construction mortgage
loans collateralized by residential and commercial real estate, business loans,
and consumer loans. The following table sets forth information on the Company's
loan originations, purchases, sales and principal repayments for the periods
indicated.
<CAPTION>
For the Years Ended December 31,
----------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
(In thousands)
<S> <C> <C> <C>
Gross loans(1):
Beginning balance............................. $265,934 $234,649 $229,841
Loans originated:
One-to-four family......................... 47,440 22,423 27,768
Multi-family............................... 11,240 1,686 1,944
Commercial real estate..................... 18,024 13,177 3,363
Construction............................... 32,870 34,724 3,790
Land....................................... 6,137 2,169 -
Business................................... 6,563 1,213 -
-------- -------- --------
-
Total loans originated.................. 122,274 75,392 36,865
Loans purchased............................ 79,902 14,661 -
-------- -------- --------
-
Total gross loans....................... 468,110 324,702 266,706
Less:
Transfers to real estate owned............. 299 610 369
Principal repayments(2).................... 98,727 33,696 27,238
Sales of loans............................. 14,223 3,020 2,628
Securitized loans.......................... 48,370 - -
Loans in process........................... 2,759 21,442 1,822
-------- -------- --------
Total loans............................. 303,732 265,934 234,649
Less loans held for sale...................... 2,177 514 130
-------- -------- --------
Ending balance held for investment............ $301,555 $265,420 $234,519
======== ======== ========
<FN>
- -----------------------
(1) Gross loans includes loans receivable held for investment and loans held
for sale, net of deferred loan fees and unamortized premiums and
discounts.
(2) Principal repayments include amortization of premiums, net of discounts;
amortization of deferred loan fees; net changes in nonmortgage loans
receivable; and other adjustments.
</FN>
</TABLE>
Loans originated by the Company are subject to federal and state law
and regulations. Interest rates charged by the Company on loans are affected by
the demand for such loans and the supply of money available for lending purposes
and the rates offered by competitors. These factors are, in turn, affected by,
among other things, economic conditions, monetary policies of the federal
government, including the Federal Reserve Board, and legislative tax policies.
One-to-Four Family Mortgage Lending. The Company originates both fixed
rate and adjustable rate mortgage loans secured by one-to-four family
residential properties. Adjustable rate mortgage loans have interest rates that
adjust monthly or semiannually and are indexed to either the 11th FHLB District
Cost of Funds Index ("11th District Cost of Funds") or to current market
indices. The majority of loan originations are to existing or past customers and
members of the local communities. The Company also originates one-to-four family
residential construction loans.
2
<PAGE>
The Company had total outstanding loans including commitments of $325.7
million at December 31, 1998, of which $185.0 million, or 56.8%, were
one-to-four family residential mortgage loans. The majority of the loans were
secured by properties located within the state of California. At December 31,
1998, 9% of the Company's one-to-four family mortgage loans had fixed terms and
91% had adjustable rates indexed to the 11th FHLB District Cost of Funds or to
current market indices. The Company offers a number of adjustable rate loan
products, including an "easy qualifier" loan and a 30-year adjustable rate
one-to-four family residential loan with initial three-to seven-year fixed rate
terms. The Company began originating loans subject to negative amortization in
1996. Negative amortization involves a greater risk to the Company because
during a period of high interest rates the loan principal may increase above the
amount originally advanced. However, the Company believes that the risk of
default on these loans is mitigated by negative amortization caps, underwriting
criteria, relatively low loan to value ratios, and the stability provided by
payment schedules. At December 31, 1998, the Company's loan portfolio included
$14.5 million of mortgage loans subject to negative amortization, which
represented 4.8% of total loans outstanding.
The Company originated $47.5 million of permanent one-to-four family
mortgage loans in 1998, compared to $22.4 million and $27.8 million,
respectively, in 1997 and 1996. The increase in loan volume during 1998 was
partly due to a decline in interest rates, which resulted in an increase in
purchase and refinance activity of one-to-four family mortgage loans. From time
to time, based on its asset and liability strategy, the Company purchases
mortgage loans originated by other institutions. In 1998, the Company purchased
$79.9 million of primarily one-to-four family adjustable rate mortgage loans
secured by properties located largely within the State of California. See
"Origination, Purchase, Sale and Servicing of Loans."
The Company originates one-to-four family residential mortgage loans in
amounts up to 80% of the lower of the appraised value or the selling price of
the property securing the loan, and up to 97% of the appraised value or selling
price if private mortgage insurance is obtained. Mortgage loans originated by
the Company generally include due-on-sale clauses which provide the Company with
the contractual right to deem the loan immediately due and payable in the event
the borrower transfers ownership of the property without the Company's consent.
Due-on-sale clauses are an important means of adjusting the rates on the
Company's fixed rate mortgage loan portfolio and the Company has generally
exercised its rights under these clauses.
Multi-family Lending. The Company offers adjustable rate multi-family
residential real estate loans secured by real property in California. Permanent
loans on multi-family properties typically have maturities of 30 years and are
secured by five or more unit apartment buildings. Factors considered by the
Company in reaching a lending decision on such properties include the net
operating income of the mortgaged premises before debt service and depreciation,
the debt service ratio (the ratio of net earnings to debt service), and the
ratio of the loan amount to appraised value. Pursuant to the Company's
underwriting policies, multi-family adjustable rate mortgage loans are only
originated in amounts up to 70% of the appraised value of the underlying
properties. The Company generally requires a debt service ratio of 1.10.
Properties securing loans are appraised by an independent appraiser. Title
insurance is required on all loans. When evaluating the qualifications of the
borrower for a multi-family loan, the Company considers the financial resources
and income level of the borrower, the borrower's experience in owning or
managing similar property and the Company's lending experience with the
borrower. The Company's underwriting policies require that the borrower provide
evidence of ability to repay the mortgage on a timely basis and maintain the
property from current rental income. In evaluating the creditworthiness of the
borrower, the Company generally reviews the borrower's financial statements,
employment, and credit history, as well as other related documentation.
Loans secured by apartment buildings and other multi-family residential
properties are generally larger and involve a greater degree of risk than
one-to-four family residential mortgage loans. Because payments on loans secured
by multi-family properties are often dependent on successful operation or
management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate
3
<PAGE>
market or the economy. The Company seeks to minimize these risks through its
underwriting policies, which require such loans to be qualified at origination
on the basis of the property's income and debt coverage ratio. The Company also
attempts to limit its risk exposure by requiring operating annual statements on
the properties and by acquiring personal guarantees from the borrowers.
As part of its operating strategy, the Company intends to moderately
increase its multi-family lending within the state of California. At December
31, 1998, the Company's portfolio of multi-family loans totaled $33.3 million,
or 10.2% of the Company's total loans outstanding. Included in this total was
$3.9 million of multi-family loans purchased during 1998, consisting primarily
of newly originated loans secured by apartment buildings in the Southern
California area. These loans were underwritten to standards substantially
similar to those utilized by the Company in originating loans. See
"Originations, Purchases and Sales of Loans."
At December 31, 1998, the Company's largest multi-family loan had an
outstanding balance of $2.0 million. The loan was secured by an apartment
building located in Stockton, California.
Permanent Commercial Real Estate Lending. The Company originates both
permanent and construction commercial real estate loans, collateralized by real
property located in California. Commercial real estate loans are generally
secured by properties used for business purposes. The Company's underwriting
procedures provide that commercial real estate loans may be made in amounts up
to the lesser of 65% of the appraised value of the property or up to the
Company's current loans-to-one borrower limit. Permanent loans may be made with
terms up to 25 years and are typically adjustable to the one-year Constant
Maturity Treasury rate or the 11th District Cost of Funds. Construction loans on
commercial real estate carry adjustable rates and typically have terms of 12 to
18 months. The Company's underwriting standards and procedures on commercial
loans are similar to those applicable to its multi-family loans. The Company
considers the net operating income of the property and the borrower's expertise,
credit history and profitability, and requires that the properties securing
commercial real estate loans have debt service coverage ratios of at least 1.10.
At December 31, 1998, the Company's permanent commercial real estate
loan portfolio totaled $40.0 million, or 12.2% of total loans. The largest
permanent commercial real estate loan in the Company's portfolio at December 31,
1998 was secured by commercial real property located in San Jose, California,
with an outstanding principal balance of $4.5 million.
As part of its operating strategy, the Company has increased the level
of its commercial real estate lending in California. The majority of the
commercial loans are located in Northern and Central California. Loans secured
by commercial real estate properties, like multi-family loans, are generally
larger and involve a greater degree of risk than one-to-four family residential
mortgage loans. Because payments on loans secured by commercial real estate
properties are often dependent on successful operation or management of the
properties, repayment of such loans may be subject to a great extent to adverse
conditions in the real estate market or the economy. The Company seeks to
minimize these risks through strict underwriting standards, which require such
loans to be qualified on the basis of the property's income and debt service
ratio, by requiring annual operating statements on the properties, and by
acquiring personal guarantees from the borrowers.
Construction Lending. The Company originates construction loans for the
acquisition and development of property. Historically, the majority of the
Company's construction loans have been to finance the construction of
one-to-four family, owner-occupied residential properties. During 1998, the
Company increased the amount of its construction lending on commercial real
estate, residential land development projects and in one case a church.
4
<PAGE>
Construction financing is generally considered to involve a higher
degree of risk than long-term financing on improved, occupied real estate. The
Company's risk of loss on construction loans depends largely upon the accuracy
of the initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. If the
estimate of construction costs proves to be inaccurate, the Company may have to
advance funds beyond the amount originally committed to permit completion of the
development and to protect its security position. The Company may also be
confronted, at or prior to maturity of the loan, with a project with
insufficient value to ensure full repayment. The Company's underwriting,
monitoring, and disbursement practices with respect to construction financing
are intended to ensure that sufficient funds are available to complete
construction projects. The Company attempts to limit its risk through its
underwriting procedures, by using only approved, qualified appraisers, and by
dealing with qualified builder/borrowers.
The Company's construction loans typically have adjustable rates and
terms of 12 to 18 months. The Company originates one-to-four family and
multi-family residential construction loans in amounts up to 80% of the
appraised value of the property, subject to loans to one-borrower limitations.
Land development loans are determined on an individual basis, but in general
they do not exceed 70% of the actual cost or current appraised value of the
property, whichever is less. Loan proceeds are disbursed in increments as
construction progresses and as inspections warrant.
At December 31, 1998, the Company had gross construction and land
development loans totaling $51.6 million or 15.8% of total loans, on which there
were total undisbursed loan funds of $24.2 million. The largest construction
loan in the Company's portfolio at year-end was a $5.6 million land development
loan secured by real estate located in Castroville, California.
Land Lending. The Company offers loans secured against land in its
immediate marketplace.
At December 31, 1998, the Company had land loans totaling $7.8 million
or 2.4% of total loans. The largest land loan in the Company's portfolio at
year-end was a $1.1 million loan secured by land located in Soledad, California.
Business Lending. The Company offers business loans primarily
collateralized by business assets. Such collateral is typically comprised of
accounts receivable, inventory, and equipment. Business lending is generally
considered to involve a higher degree of risk than the financing of real estate,
primarily because security interests in the collateral are more difficult to
perfect and the collateral may be difficult to obtain or liquidate following an
uncured default. Business banking loans typically offer relatively higher
yields, short maturities, and variable interest rates. The availability of such
loans enables potential depositors to establish a full-service banking
relationship with the Bank. The Company attempts to reduce the risk of loss
associated with business lending by closely monitoring the financial condition
and performance of its customers.
At December 31, 1998, the Company had business loans totaling $7.3
million or 2.2% of total loans. The largest business loan in the Company's
portfolio at year end was a $5.0 million loan to American Home Loan Corp.
(AHLC), which operates primarily as the holding company for Bank USA, a Federal
Savings Bank. Both AHLC. and Bank USA conduct operations in the Phoenix, Arizona
market. The loan is primarily secured by the 97% ownership interest that AHLC
has in Bank USA.
Loan Approval Procedures and Authority. The Board of Directors has
ultimate responsibility for the lending activity of the Company, establishes the
lending policies of the Company, and reviews properties offered as security. The
Board of Directors has authorized the following loan approval authorities:
mortgage loans in amounts of $240,000 and below may be approved by the Company's
staff underwriters; mortgage loans in excess of $240,000 and up to $350,000 may
be approved by the underwriting/processing manager;
5
<PAGE>
mortgage loans in excess of $350,000 and up to $400,000 may be approved by the
real estate loan administrator; loans in excess of $400,000 and up to $500,000
require the approval of the Chief Lending Officer; and loans in excess of
$500,000 and up to $750,000 require the approval of the Chief Executive Officer
or the President. Loans in excess of $750,000 and up to $2.0 million require the
approval of the Directors' Loan Committee, which is comprised of members of the
Company's Board of Directors. A resolution of the Board of Directors is required
for mortgage loans in excess of $2.0 million. The President or Chief Loan
Officer may approve non-real estate loans up to $75,000. The Director's Loan
Committee can approve such loans up to $2.0 million. Any loans greater than $2.0
million must be approved by the full Board of Directors.
The loan origination process requires that upon receipt of a completed
loan application, a credit report is obtained and certain information is
verified by an independent credit agency. If necessary, additional financial
information is obtained from the prospective borrower. An appraisal of the
related real estate is performed by an independent appraiser. On an annual
basis, the Company's Board of Directors reviews the list of independent
appraisers used by the Company. The Company uses only those appraisers who have
been approved by the Board of Directors. The Company's policy is to obtain title
and hazard insurance on all real estate loans. If the original loan amount
exceeds 80% on a sale or refinance of a first trust deed loan or private
mortgage insurance is required, the borrower is required to make payments to a
mortgage impound account from which the Company makes disbursements for property
taxes and mortgage insurance.
6
<PAGE>
<TABLE>
Loan Portfolio Composition. The following table sets forth the
composition of the Company's loan portfolio in dollar amounts and as a
percentage of the portfolio at the dates indicated.
<CAPTION>
At December 31,
-----------------------------------------------------------------------------------
1998 1997 1996
------------------------- ------------------------- -------------------------
Percent Percent Percent
Amount of total Amount of total Amount of total
----------- ----------- ----------- ----------- ----------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate:
Residential:
One-to-four family............. $187,208 57.10% $205,218 71.36% $201,579 85.22%
Multi-family................... 33,110 10.10% 23,355 8.12% 22,455 9.49%
Commercial real estate............... 40,227 12.27% 20,159 7.01% 7,524 3.18%
Construction......................... 51,624 15.75% 35,150 12.23% 4,131 1.75%
Land................................. 7,774 2.37% 1,869 .65% 95 .04%
Business loans....................... 6,679 2.04% 943 .33% .00%
-
Business lines of credit............. 595 .18% 270 .09% .00%
-
Other(1).......................... 658 .20% 598 .21% 763 .32%
--------- --------- --------- --------- --------- ---------
Total loans................. 327,875 100.00% 287,562 100.00% 236,547 100.00%
========= ========= =========
Plus (Less):
Undisbursed loan funds............ (24,201) (21,442) (1,822)
Unamortized premium, net.......... 492 556 452
Deferred loan fees, net........... (434) (742) (528)
Allowance for loan losses......... (2,780) (1,669) (1,311)
--------- --------- ---------
Total loans, net............... 300,952 264,265 233,338
Less:
Loans held for sale:
One-to-four family............. (2,177) (514) (130)
--------- --------- ---------
Total loans held for
investment............... $298,775 $263,751 $233,208
========= ========= =========
------------------------------------------------------
1995 1994
------------------------- -------------------------
Percent Percent
Amount of total Amount of total
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Real estate:
Residential:
One-to-four family............. $199,917 86.29% $216,872 88.36%
Multi-family................... 21,503 9.28% 22,231 9.06%
Commercial real estate............... 4,191 1.81% 2,903 1.18%
Construction......................... 5,379 2.32% 2,848 1.16%
Land................................. 97 .04% 99 .04%
Business loans....................... .00% .00%
- -
Business lines of credit............. .00% .00%
- -
Other(1).......................... 605 .36% 503 .20%
---------- ---------- ---------- ----------
Total loans................. 231,692 100.00% 245,456 100.00%
========== ==========
Plus (Less):
Undisbursed loan funds............ (1,895) (1,178)
Unamortized premium, net.......... 651 1,006
Deferred loan fees, net........... (607) (971)
Allowance for loan losses......... (1,362) (808)
---------- ----------
Total loans, net............... 228,479 243,505
Less:
Loans held for sale:
One-to-four family............. (92) (16,082)
---------- ----------
Total loans held for
investment............... $228,387 $227,423
========== ==========
<FN>
- --------------------------------------
(1) Includes loans secured by savings accounts and unsecured consumer loans.
</FN>
</TABLE>
7
<PAGE>
<TABLE>
Loan Maturity: The following table shows the contractual maturities of the
Company's gross loans at December 31, 1998. The table includes loans held for
sale of $2,177,000. The table does not include principal repayments. Principal
repayments on total loans totaled $99.3 million for the year ended December 31,
1998.
<CAPTION>
At December 31, 1998
---------------------------------------------------------------------------------
One-to-Four Commercial Construction
Family Multi-Family Real Estate and Land Business
-------------- -------------- --------------- --------------- ---------------
(In thousands)
<S> <C> <C> <C> <C> <C>
Amounts due:
One year or less............................ $ 345 $ - $ - $ 40,628 $ 990
-------- -------- -------- -------- -------
After one year:
More than one year to three years........ 270 74 2,097 17,043 5,035
More than three years to five years...... 878 127 7,010 1,429 705
More than five years to 10 years......... 2,546 1,268 380 28 544
More than 10 years to 20
years 6,011 1,581 1,615 271 -
More than 20 years....................... 177,159 30,289 28,895 - -
-------- -------- -------- -------- -------
Total due after December 31, 1999..... 186,864 33,339 39,997 18,771 6,284
-------- -------- -------- -------- -------
Total amount due............................ 187,209 33,339 39,997 59,399 7,274
Less:
Undisbursed loan funds...................... - - - (24,201) -
Unamortized (discounts) premiums............ 519 (28) - - -
Deferred loan fees, net..................... (248) (44) (53) (79) (10)
Allowance for loan losses................... (1,161) (317) (564) (677) (47)
-------- -------- -------- -------- -------
Total loans, net......................... 186,319 32,950 39,380 34,442 7,217
Loans held for sale............................ (2,177) - - - -
-------- -------- -------- -------- -------
Loans receivable held for investment........... $184,142 $ 32,950 $ 39,380 $ 34,442 $ 7,217
======== ======== ======== ======== =======
------------------------------------
Total Loans
Other(1) Receivable
--------------- -----------------
<S> <C> <C>
Amounts due:
One year or less............................ $ 658 $ 42,621
----- --------
After one year:
More than one year to three years........ - 24,519
More than three years to five years...... - 10,149
More than five years to 10 years......... - 4,766
More than 10 years to 20
years - 9,478
More than 20 years....................... - 236,343
----- --------
Total due after December 31, 1999..... - 285,255
----- --------
Total amount due............................ 658 327,876
Less:
Undisbursed loan funds...................... - (24,201)
Unamortized (discounts) premiums............ - 491
Deferred loan fees, net..................... (1) (434)
Allowance for loan losses................... (14) (2,780)
----- --------
Total loans, net......................... 644 300,952
Loans held for sale............................ - (2,177)
----- --------
Loans receivable held for investment........... $ 644 $298,775
===== ========
<FN>
- --------------------------
(1) Includes loans secured by savings accounts and unsecured loans.
</FN>
</TABLE>
8
<PAGE>
<TABLE>
The following table sets forth at December 31, 1998, the dollar amount
of gross loans receivable contractually due after December 31, 1999, and whether
such loans have fixed or adjustable rates.
<CAPTION>
Due After December 31, 1999
-------------------------------------------------
Fixed Adjustable Total
-------------- --------------- ---------------
(In thousands)
<S> <C> <C> <C>
Real estate loans:
One-to-four family.................... $25,439 $ 165,701 $ 191,141
Multi-family.......................... 806 29,735 30,541
Commercial real estate................ 6,239 39,702 45,940
Construction and land................. 2,457 18,189 20,645
Business loans........................ - 1,803 1,804
------- --------- ---------
Total loans receivable due
after December 31, 1999......... $34,941 $ 255,130 $ 290,071
======= ========= =========
</TABLE>
Originations, Purchases and Sales of Loans. The Company's mortgage
lending activities are conducted primarily through its eight branch offices and
approximately 60 wholesale loan brokers who deliver loan applications to the
Company. In addition, the Company has developed correspondent relationships with
a number of financial institutions to facilitate the origination of mortgage
loans on a participation basis. Loans presented to the Company for purchase or
participation are underwritten substantially in accordance with the Company's
established lending standards, which consider the financial condition of the
borrower, the location of the underlying property, and the appraised value of
the property, among other factors. The majority of the Company's purchased loans
and participations are current index, adjustable rate mortgages secured by real
estate located within the state of California. At December 31, 1998, the Company
had entered into participation agreements with other financial institutions to
originate construction, commercial real estate, and land loans, of which the
Company's share was $19.9 million.
As part of its interest rate risk management and investment strategy,
during 1998 the Company purchased $78.8 million of one-to-four family adjustable
rate mortgage loans. As of December 31, 1998, $52.8 million, or 17.7%, of the
Company's net loans receivable had been purchased from other financial
institutions. Of this amount, $45.0 million, or 85.2%, were loans secured by
one-to-four family residences located throughout the United States and $7.8
million, or 14.8%, were multi-family mortgage loans secured by apartment
buildings located in the Greater San Francisco Bay area.
On an ongoing basis, depending on its asset and liability strategy, the
Company originates one-to-four family residential mortgage loans for sale in the
secondary market. Loan sales are dependent on the level of loan originations and
the relative customer demand for mortgage loans, which is affected by the
current and expected future level of interest rates. During the years ended
December 31, 1998 and 1997, the Company sold $15.9 million and $3.4 million,
respectively, of fixed rate mortgage loans. The level and timing of any future
loan sales will depend upon market opportunities and prevailing interest rates
at the time such a decision is made. From time to time, depending on its asset
and liability strategy, the Company converts a portion of its mortgages into
readily marketable FHLMC or FNMA mortgage-backed securities. In 1998, the
Company converted approximately $48.4 million of fixed rate residential loans
into mortgage-backed securities. The securitization was undertaken primarily to
provide greater marketability of the loans and therefore, allow easier sale of
the loans in order to reduce interest rate risk.
The Company recognizes gains or losses on the sale of loans at the time
of sale, based on the difference between the net sale proceeds and the carrying
value of the loans sold. When the right to service the loans is retained, an
excess servicing gain or loss is recognized based upon the net present value of
any difference between the interest rate charged to the borrower and the
interest rate paid to the purchaser after deducting a normal servicing fee. The
excess servicing gain or loss is dependent on prepayment estimates and discount
rate assumptions. Historically, such excess servicing gains or losses have not
had a material impact on the Company's earnings. See "- Loan Servicing."
9
<PAGE>
Loan Servicing. The Company services its own loans as well as loans
owned by others. Loan servicing includes collecting and remitting loan payments,
accounting for principal and interest, holding escrow funds for the payment of
real estate taxes and insurance premiums, contacting delinquent borrowers, and
supervising foreclosures and property dispositions in the event of unremedied
defaults. Loan servicing income is recorded on an accrual basis and includes
servicing fees from investors and certain charges collected from borrowers, such
as late payment fees. At December 31, 1998 and 1997, respectively, the Company
was servicing $75.4 million and $52.1 million of loans for others.
Classified Assets and Real Estate Owned. To measure the quality of
assets, the Company has established internal asset classification guidelines as
part of its credit monitoring system for identifying and reporting problem
assets and determining provisions for anticipated loan and real estate owned
("REO") losses. Under these guidelines, an allowance for anticipated loan and
REO losses is established when certain conditions exist. The Internal Asset
Review Committee, comprised primarily of senior managers and Board members,
oversees the administration of the internal asset classification guidelines and
reports results to the Board of Directors.
The Company classifies assets it considers of questionable quality
employing the classification categories of "substandard," "doubtful," and
"loss." An asset is considered substandard if it is inadequately protected by
the current net worth and paying capacity of the obligor or of the collateral
pledged. Substandard assets include those characterized by the distinct
possibility that the insured institution will sustain some loss if the
deficiencies are not corrected. Assets classified as doubtful have all of the
weaknesses inherent in those classified substandard, with the added
characteristic that the weaknesses make collection or liquidation in full, on
the basis of currently existing facts, conditions, and values, questionable and
there is a high probability of loss. An asset classified as loss is considered
uncollectible and of such little value that it should not be included as an
asset. Total classified assets of the Company increased to $5.1 million at
December 31, 1998 from $2.5 million at December 31, 1997. Classified assets were
1.13% of total assets at December 31, 1998, compared to 0.63% a year earlier.
At December 31, 1998, the Company had $6.4 million of assets classified
as substandard and no assets classified as doubtful or loss. Substandard assets
included $1.5 million of loans past due 90 days or more, $3.6 million of loans
with identified risk characteristics such as a pattern of historical
delinquencies and/or delinquent property tax status and $0.3 million of real
estate owned. The largest substandard loan at December 31, 1998 was a
single-family mortgage with an outstanding principal balance of $311,000.
Assets, which possess weaknesses but do not currently expose the
Company to sufficient risk to warrant classification as substandard, doubtful or
loss are designated as "special mention." At December 31, 1998, the Company had
$6.4 million of assets classified as special mention due to past delinquencies
and other identifiable weaknesses. The largest special mention loan was a
commercial mortgage loan with an outstanding balance of $1.7 million on December
31, 1998.
Assets classified as substandard or doubtful require the establishment
of general valuation allowances in amounts considered by management to be
adequate under generally accepted accounting principles. These amounts represent
loss allowances which have been established to recognize the inherent risk
associated with lending activities, but which, unlike specific allowances, have
not been allocated to particular problem assets. Judgments regarding the
adequacy of general valuation allowances are based on continual evaluation of
the nature, volume and quality of the loan portfolio, other assets, and current
economic conditions that may affect the recoverability of recorded amounts.
Assets classified as a loss require either a specific valuation allowance equal
to 100% of the amount classified or a charge-off of such amount.
10
<PAGE>
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
Office of Thrift Supervision ("OTS"), which can require the establishment of
additional general or specific loss allowances. The OTS, in conjunction with the
other federal banking agencies, has adopted an interagency policy statement on
allowances for loan and lease losses which provides guidance in determining the
adequacy of general valuation guidelines. The policy statement recommends that
savings institutions establish effective systems and controls to identify,
monitor and address asset quality problems, analyze significant factors that
affect the collectibility of assets, and establish prudent allowance evaluation
processes. Management believes that the Company's allowance for loan losses is
adequate given the composition and risks of the loan portfolio. However, actual
losses are dependent upon future events and, as such, further additions to the
level of specific and general loan loss allowances may become necessary. In
addition, there can be no assurance that at some time in the future the OTS, in
reviewing the Company's loan portfolio, will not request the Company to increase
its allowance for loan losses, thus negatively impacting the Company's earnings
for that time period.
REO is recorded at the lower of the recorded investment in the loan or
the fair value of the related asset on the date of foreclosure, less costs to
sell. Fair value is defined as the amount in cash or cash-equivalent value of
other consideration that a real estate asset would yield in a current sale
between a willing buyer and a willing seller. Development and improvement costs
relating to the property are capitalized to the extent they are deemed to be
recovered upon disposal. The carrying value of acquired property is continuously
evaluated and, if necessary, an allowance is established to reduce the carrying
value to net realizable value (which considers, among other things, estimated
direct holding costs and selling expenses). At December 31, 1998, the Company
had REO of $281,000, representing three one-to-four family residential
properties acquired through foreclosure in 1998.
The Company obtains appraisals on all real estate acquired through
foreclosure at the time of foreclosure. Appraisals on REO are updated annually.
The Company generally conducts external inspections on foreclosed properties and
properties deemed in-substance foreclosures on a quarterly basis.
Delinquent Loan Procedures. Specific delinquency procedures vary
depending on the loan type and period of delinquency. However, the Company's
policies generally provide that loans be reviewed monthly for delinquencies, and
that if a borrower fails to make a required payment when due, the Company
institutes internal collection procedures. For mortgage loans, written late
charge notices are mailed no later than the 15th day of delinquency. At 25 days
past due, the borrower is contacted by telephone and the Company makes a verbal
request for payment. In most cases, deficiencies are cured promptly. At 30 days
past due, the Company begins tracking the loan as a delinquency, and at 45 days
past due a notice of intent to foreclose is mailed. When contact is made with
the borrower prior to foreclosure, the Company generally attempts to obtain full
payment or work out a repayment schedule with the borrower to avoid foreclosure.
It is the Company's policy to accrue interest on all loans up to 90 days past
due, unless it is determined that the collection of interest and/or principal is
not probable under the contractual terms of the agreement.
11
<PAGE>
<TABLE>
The following table sets forth delinquencies in the Company's loan
portfolio as of the dates indicated:
<CAPTION>
At December 31, 1998
-----------------------------------------------------------
60-89 Days 90 Days or More
---------------------------- ---------------------------
Principal Principal
Number balance Number balance
of loans of loans of loans of loans
------------ ------------ ----------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
One-to-four family........... $ - 9 $ 1.479
Multi-family................. - - - -
Commercial................... - - - -
Construction and land........ 1 145 - -
Other........................ 1 3 - -
--------- --------- -------- --------
Total..................... 2 $148 $ 1,479
========= ========= ======== ========
Delinquent loans to total
gross loans............... .10% .05% .43% .45%
At December 31, 1997
-----------------------------------------------------------
60-89 Days 90 Days or More
--------------------------- ---------------------------
Principal Principal
Number balance Number balance
of loans of loans of loans of loans
----------- ----------- ----------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
One-to-four family........... 2 $413 5 $781
Multi-family................. - - 1 817
Commercial................... - - - -
Construction and land........ - - - -
Other........................ - - - -
-------- -------- -------- ---------
Total..................... 2 $413 6 $1,598
======== ======== ======== =========
Delinquent loans to total
gross loans............... .09% .16% .35% .60%
At December 31, 1996
-----------------------------------------------------------
60-89 Days 90 Days or More
---------------------------- ---------------------------
Principal Principal
Number balance Number balance
of loans of loans of loans of loans
------------ ------------ ----------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
One-to-four family........... 3 $455 11 $ 1,392
Multi-family................. - - - -
Commercial................... - - - -
Construction and land........ - - - -
Other........................ 3 1 2 1
--------- --------- -------- -------
- - - -
Total..................... 6 $456 13 $ 1,393
========= ========= ======== =======
Delinquent loans to total
gross loans............... .14% .19% .06% .59%
</TABLE>
12
<PAGE>
Non-accrual and Past Due Loans. Loans are generally placed on
nonaccrual status when the payment of interest is 90 days or more delinquent, or
the collection of interest and/or principal is not probable under the
contractual terms of the loan agreement. Loans on which the Company has ceased
the accrual of interest constitute the primary component of the portfolio of
nonperforming loans. Nonperforming loans consist of all nonaccrual loans and
restructured loans not performing in accordance with their restructured terms.
Nonperforming assets include all nonperforming loans and REO.
At December 31, 1998, loans on nonaccrual totaled $1.5 million. For the
year ended December 31, 1998, interest income which would have been earned had
loans on non-accrual been performing in accordance with contractual terms was
$126,000. At December 31, 1998, the Company had $1,437,000 of loans that met the
definition of a troubled debt restructuring, of which $17,000 were 0-30 days
delinquent and $1,420,000 were current and paying according to the terms of
their contractually restructured agreements. The Company had $281,000 in REO at
December 31, 1998, $321,000 at year-end 1997, and no REO at year-end 1996, 1995,
and 1994.
<TABLE>
The following table sets forth information regarding nonperforming
assets. The Company does not accrue interest on loans past due 90 days or more,
and accordingly, there were no accruing loans past due 90 days or more at any of
the dates presented below.
<CAPTION>
At December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
Nonaccrual loans 90 days or more past due: (Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Residential real estate:
One-to-four family........................ $ 1,479 $781 $ 1,393 $ 1,544 $711
Multi-family.............................. - 817 - 830 -
Construction and land........................ - - - 825 -
Non-mortgage.................................
------- ------- ------- ------- ----
- - - 1 -
- - - - -
Total loans on nonaccrual.............. 1,479 1,598 1,393 3,200 711
Restructured loans not performing............ 17 300
- - -
Real estate owned............................ 281 321
------- ------- ------- ------- ----
- - -
Total nonperforming assets(1).......... $ 1,777 $ 2,219 $ 1,393 $ 3,200 $711
======= ======= ======= ======= ====
Allowance for loan losses as a percent
of gross loans receivable(2).............. .87% .63% .56% .59% .33%
Allowance for loan losses as a percent
of total nonperforming loans(1) 175.85% 87.98% 94.10% 42.56% 113.64%
Nonperforming loans as a percent
of gross loans receivable(1)(2)........... .49% .71% .59% 1.39% .29%
Nonperforming assets as a percent
of total assets(1)........................ .39% .54% .33% .97% .24%
<FN>
- --------------------
(1) Nonperforming assets consist of nonperforming loans (nonaccrual loans and
restructured loans not performing in accordance with their restructured
terms) and REO. REO consists of real estate acquired through foreclosure
and real estate acquired by acceptance of a deed-in-lieu of foreclosure.
(2) Gross loans receivable includes loans receivable held for investment and
loans held for sale, and unamortized discounts and premiums.
</FN>
</TABLE>
13
<PAGE>
Impaired Loans. A loan is designated as impaired when the Company
determines it may be unable to collect all amounts due according to the
contractual terms of the loan agreement, whether or not the loan is 90 days past
due. Excluded from the definition of impairment are smaller balance homogenous
loans that are collectively evaluated for impairment. In addition, any loans
which meet the definition of a troubled debt restructuring, or are partially or
completely classified as Doubtful or Loss, are considered impaired.
The Company has established a monitoring system for its loans in order
to identify impaired loans and potential problem loans, and to permit periodic
evaluation of the adequacy of allowances for losses in a timely manner. In
analyzing its loans, the Company has established specific monitoring policies
and procedures suitable for the relative risk profile and other characteristics
of loans by type. The Company's smaller-balance residential one-to-four family,
multi-family and non-mortgage loans are considered to be relatively homogeneous
and no single loan is individually significant in terms of its size or potential
risk of loss. Therefore, the Company generally reviews these loans by analyzing
their performance and composition of their collateral for the portfolio as a
whole. For non-homogenous loans the Company conducts a periodic review of each
loan. The frequency and type of review is dependent upon the inherent risk
attributed to each loan and the adversity of the loan grade. The Company
evaluates the risk of loss and default for each loan subject to individual
monitoring.
Factors considered as part of the periodic loan review process to
determine whether a loan is impaired address both the amount the Company
believes is probable that it will collect and the timing of such collection. As
part of the Company's loan review process the Company considers such factors as
the ability of the borrower to continue meeting the debt service requirements,
assessments of other sources of repayment, and the fair value of any collateral.
Insignificant delays or shortfalls in payment amounts, in the absence of other
facts and circumstances, would not alone lead to the conclusion that a loan is
impaired.
When a loan is designated as impaired, the Company measures impairment
based on the fair value of the collateral of the collateral-dependent loan. The
amount by which the recorded investment of the loan exceeds the measure of the
impaired loan is recognized by recording a valuation allowance with a
corresponding charge to earnings. The Company charges off a portion of an
impaired loan against the valuation allowance when it is probable that there is
no possibility of recovering the full amount of the impaired loan.
The following table identifies the Company's total recorded investment
in impaired loans by type at December 31, 1998 and 1997 (in thousands).
December 31,
---------------------
1998 1997
------ ------
Residential one-to-four family
non-homogenous loans .......................... $2,961 $ 985
Multi-family loans ............................... 648 817
Land ............................................. 145 -
------ ------
Total impaired loans ....................... $3,754 $1,802
====== ======
For the years ended December 31, 1998 and 1997, the Company recognized
interest on impaired loans of $166,000 and $49,000, respectively. $1.5 million
of impaired loans were on nonaccrual status at December 31, 1998, and $76,000 of
interest was uncollected on impaired loans. During the years ended December 31,
1998 and 1997, the Company's average investment in impaired loans was $3.1
million and $1.3 million, respectively. Valuation allowances on impaired loans
were $409,000 at December 31, 1998.
14
<PAGE>
Allowance for Estimated Loan Losses. The allowance for loan losses is
established through a provision for loan losses based on management's evaluation
of the risks inherent in its loan portfolio and the general economy. The
allowance for loan losses is maintained at an amount management considers
adequate to cover estimated losses in loans receivable which are deemed probable
and estimable. The allowance is based upon a number of factors, including asset
classifications, economic trends, industry experience and trends, industry and
geographic concentrations, estimated collateral values, management's assessment
of the credit risk inherent in the portfolio, historical loan loss experience,
and the Company's underwriting policies. At December 31, 1998, the Company's
allowance for loan losses was .92% of total loans, compared to .63% at December
31, 1997. The Company will continue to monitor and modify its allowance for loan
losses as conditions dictate. Various regulatory agencies, as an integral part
of their examination process, periodically review the Company's allowance for
loan losses. These agencies may require the Company to make additional
provisions for loan losses, based on their judgments of the information
available at the time of the examination.
<TABLE>
Activity in the Company's allowance for loan losses for the periods
indicated are set forth in the table below (in thousands).
<CAPTION>
At or for the Year Ended December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ---------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year.............. $1,669 $1,311 $1,362 $808 $387
Provision for loan losses................. 692 375 28 663 421
Allowance related to acquired loans 416 - - - -
Charge-offs, net.......................... 3 (17) (79) (109) -
------ ------ ------ ------ ----
Balance at end of period.................. $2,780 $1,669 $1,311 $1,362 $808
====== ====== ====== ====== ====
</TABLE>
15
<PAGE>
<TABLE>
The following table sets forth the Company's allowance for loan losses
as a percentage of the total allowance, and the percentage of loans to total
loans in each of the categories listed at the dates indicated.
<CAPTION>
At December 31,
-------------------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------------------------------------------- ----------------------------------------
Percent Percent Percent
of of of
loans in loans in loans in
Percent each Percent each Percent each
of category of category of category
allowance to allowance to allowance to
to total total to total total to total total
Amount allowance loans Amount allowance loans Amount allowance loans Amount
-------- ---------- -------- --------- --------- -------- ------- ----------- ------ ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One-to-four
family..... $ 966 36.72% 57.32% $ 846 50.69% 69.79% $ 911 69.49% 85.22% $ 1,080
Multi-family.. 280 10.64% 9.82% 278 16.66% 7.85% 171 13.04% 9.49% 143
Commercial
real estate 517 19.66% 12.49% 241 14.44% 6.79% 174 13.27% 3.18% 58
Construction
and land.. 605 23.02% 17.21% 229 13.72% 13.64% 20 1.53% 1.79% 77
Other........ 262 9.96% 3.15% 75 4.49% 1.93% 35 2.67% .32% 4
------- ------ ------- ------- ------ ------- ------- ------ ------- -------
Total
valuation
allowances... $ 2,630 100.00% $ 1,669 100.00% $ 1,311 100.00% $ 1,362
======= ======= ======= ======= ======= ======= =======
------------------------------------------------------
1995 1994
------------------------------------------------------
Percent Percent
of of
loans in loans in
Percent each Percent each
of category of category
allowance to allowance to
to total total to total total
allowance loans Amount allowance loans
---------- --------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
One-to-four
family..... 79.30% 86.29% $ 676 83.66% 88.36%
Multi-family.. 10.50% 9.28% 91 11.26% 9.06%
Commercial
real estate 4.26% 1.81% 31 3.84% 1.18%
Construction
and land.. 5.65% 2.36% 7 .87% 1.20%
Other........ .29% .26% 3 .37% .20%
----- ------- ----- ----- -------
Total
valuation
allowances... 100.00% $ 808 100.00%
======= ===== =======
</TABLE>
16
<PAGE>
Investment Activities
Federally chartered savings institutions have the authority to invest
in various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, certificates of deposit of insured banks
and savings institutions, bankers' acceptances, repurchase agreements and
federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest their assets in commercial paper, investment-grade
corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. Additionally, the Company must maintain minimum
levels of investments that qualify as liquid assets under OTS regulations. See
"Regulation - Federal Savings Institution Regulation - Liquidity." Historically,
the Company has maintained liquid assets above the minimum OTS requirements and
at a level considered to be adequate to meet its normal daily activities.
The Company's investment activities described herein include
transactions related to short-term investments, investment securities and
mortgage-backed securities held by the Company. The investment policies of the
Company as established by the Board of Directors attempt to provide and maintain
liquidity, generate a favorable return on investments without incurring undue
interest rate and credit risk, and complement the Company's lending activities.
Specifically, the Company's policies generally limit investments to government
and federal agency-backed securities and other non-government guaranteed
securities, including corporate debt obligations, that are investment grade. The
Company's policies provide the authority to invest in marketable equity
securities meeting the Company's guidelines and in mortgage-backed securities
guaranteed by the U.S. government and agencies thereof and other financial
institutions. At December 31, 1998, the Company had federal funds sold and other
short-term investments, investment securities (including certificates of
deposit) and mortgage-backed securities with an aggregate amortized cost of
$120.8 million and a market value of $122.1 million.
At December 31, 1998, the Company had a total of $98.1 million of
mortgage-backed securities of which $98.0 million were designated as available
for sale, $64.3 million of the mortgage-backed securities were insured or
guaranteed by the FNMA GNMA, and FHLMC and $47.6 million of the securities held
were collateralized mortgage obligations, CMOs are multi-class mortgage-backed
securities. A pool of mortgages is used to pay interest and principal on several
classes at obligations, which can be fixed, or adjusting, and can have different
lengths of maturity. The Company's mortgage-backed and mortgage-related
securities portfolio consists primarily of seasoned fixed rate and adjustable
rate mortgage-backed and mortgage-related securities. Investments in
mortgage-backed securities involve a risk that actual prepayments will exceed
prepayments estimated over the life of the security, which may result in a loss
of any premium paid for such instruments, thereby reducing the net yield on the
securities. At December 31, 1998, the Company had $19.2 million in corporate
trust preferred securities. Corporate trust preferred securities are corporate
debt issued by financial institutions for the purpose of augmenting capital. The
corporate trust preferred securities held by the Company have been most recently
rated not less than BBB by Standard & Poor. At December 31, 1998, the Company
had a $256,000 investment in a FNMA note. If interest rates increase, the market
value of these securities may be adversely affected.
17
<PAGE>
<TABLE>
At December 31, 1998, the Company held mortgage-backed securities, and
investment securities, including corporate trust preferred securities, issued by
the following entities as to which, the aggregate total amortized cost of such
securities exceeded 10% of the Company's equity.
<CAPTION>
Amortized Market
Cost Value
-------- -------
(In thousands)
<S> <C> <C>
Issuer:
Chase Mortgage Finance Corporation ................................. $ 9,376 $ 9,383
Federal Home Loan Mortgage Corporation ............................. 9,067 9,002
Federal National Mortgage Company .................................. 42,832 43,701
Countywide Home Loans .............................................. 4,306 4,273
Government National Mortgage Association ........................... 11,927 11,946
Residential Asset Securitization Trust ............................. 13,494 13,564
Residential Funding Mortgage Series I .............................. 6,504 6,491
BankAmerica Capital ................................................ 3,812 3,825
Chase Capital ...................................................... 3,763 3,827
Bankers Trust Capital .............................................. 3,634 3,800
State Street Capital Trust ......................................... 3,861 3,872
Bank Boston Capital Trust .......................................... 3,588 3,830
</TABLE>
18
<PAGE>
<TABLE>
The following table sets forth the composition of the Company's
mortgage-backed securities portfolio in dollar amounts and in percentages of the
total portfolio at the dates indicated. Available for sale securities are
reflected at fair market value and held to maturity securities are reflected at
amortized cost pursuant to Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities ("SFAS No.
115").
<CAPTION>
At December 31,
-----------------------------------------------------------------------------
1998 1997 1996
------------------------ ------------------------ -------------------------
Percent Percent Percent
Amount of total Amount of total Amount of total
------------ ----------- ------------ ----------- ------------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities:
FNMA.................................. $ 33,880 34.73% $ 24,983 36.20% $ 45,243 39.62%
FHLMC................................. 4,658 4.78% 27,389 39.68% 38,206 33.46%
GNMA.................................. 11,549 11.84% 16,650 24.12% 15,158 13.27%
CMO Floaters(1)....................... - - - - 15,590 13.65%
CMOs(2)............................... 47,462 48.65% - - - -
-------- -------- -------- ------- ------- -------
Total mortgage-backed securities......... 97,549 100.00% 69,022 100.00% 114,197 100.00%
======== ======= =======
Plus:
Unamortized premium, net.............. 554 1,585 2,586
------- ------- --------
Total mortgage-backed
securities, net....................... 98,103 70,607 116,783
Less:
Mortgage-backed securities
available for sale................. (98,006) (70,465) (116,610)
------- ------- --------
Total mortgage-backed securities
held to maturity...................... $ 97 $ 142 $ 173
======= ======= ========
<FN>
- -------------------------------------------------
(1) The CMOs consisted primarily of mortgage-backed securities tied to single
current index securities.
(2) Includes CMO's issued by FNMA and FHLMC.
</FN>
</TABLE>
<TABLE>
The following table sets forth, certain information regarding the
amortized cost and market values of the Company's mortgage-backed securities at
the dates indicated.
<CAPTION>
At December 31,
--------------------------------------------------------------------------------
1998 1997 1996
-------------------------- -------------------------- -------------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
------------- ------------ ------------ ------------- ------------ -----------
Mortgage-backed securities: (In thousands)
<S> <C> <C> <C> <C> <C> <C>
Available for sale:
GNMA........................ $ 11,927 $ 11,946 $ 17,184 $ 17,217 $ 15,786 $ 15,696
FHLMC....................... 4,735 4,763 27,908 28,046 39,110 38,988
FNMA........................ 32,870 33,751 25,142 25,202 46,410 46,221
CMO Floaters(1) - - - - 15,788 15,705
CMOs(2)..................... 47,626 47,546 - - - -
-------- -------- -------- -------- -------- --------
Total available for sale. 97,158 98,006 70,234 70,465 117,094 116,610
-------- -------- -------- -------- -------- --------
Held to maturity:
FNMA........................... 97 96 142 138 173 169
-------- -------- -------- -------- -------- --------
Total held to maturity...... 97 96 142 138 173 169
-------- -------- -------- -------- -------- --------
Total mortgage-backed
securities............... $ 97,255 $ 98,102 $ 70,376 $ 70,603 $117,267 $116,779
======== ======== ======== ======== ======== ========
<FN>
- ------------------------------------
(1) The CMOs consisted primarily of mortgage-backed securities tied to single
current index securities.
(2) Includes CMOs issued by FNMA and FHLMC.
</FN>
</TABLE>
19
<PAGE>
<TABLE>
The table below sets forth certain information regarding the amortized
cost, weighted average yields and contractual maturities of the Company's,
investment securities, corporate trust preferred's and mortgage-backed
securities as of December 31, 1998.
<CAPTION>
At December 31, 1998
-----------------------------------------------------------------------------
More than one year More than five years
One year or less to five years to ten years
----------------------- ----------------------- ------------------------
Weighted Weighted Weighted
Amortized average Amortized average Amortized average
cost yield cost yield cost yield
----------- ---------- ----------- --------- ----------- -----------
(Dollars in thousands)
Investment securities:
<S> <C> <C> <C> <C>
Available for sale:
U.S. government and
federal agency obligations...... $ - $ - $ 252 6.68%
----- ----- ------
Total available for sale..... - - 252 6.68%
----- ----- ------ -
Total investment securities.. $ - $ - $ 252 6.68%
----- ----- ------
Corporate trust preferreds:
Available for sale:
Corporate trust preferreds......... $ - $ - $ -
---- ----- -----
Total available for sale..... - - -
----- ----- ------
Total investment securities.. $ - $ - $ -
==== ===== =====
Mortgage-backed securities:
Held to maturity:
FNMA............................... - 97 4.67% -
----- ----- ------
Total held for investment....... $ - $ 97 4.67% $ -
----- ----- ------
Available for sale:
FHLMC.............................. $ 72 7.00% $ - $ -
GNMA............................... - - -
FNMA............................... - - 4,837 6.00%
CMOs............................... - - -
----- ----- ------
Total available for sale........ 72 7.00% - 4,837 6.00%
----- ----- ------
Total mortgage-backed
securities $ 72 7.00% $ 97 4.67% $4,837 6.00%
===== ===== ======
x ----------------------------------------------------
More than ten years Total
------------------------ --------------------------
Weighted Weighted
Amortized average Amortized average
cost yield cost yield
----------- ----------- ------------ -------------
Investment securities:
<S> <C> <C> <C>
Available for sale:
U.S. government and
federal agency obligations...... $ - $ 252 6.68%
-------- --------
Total available for sale..... - 6.68%
-------- --------
Total investment securities.. $ - $ 252 6.68%
-------- --------
Corporate trust preferreds:
Available for sale:
Corporate trust preferreds......... $ 18,658 6.71% $ 18,658 6.71%
-------- --------
Total available for sale..... 18,658 6.71% 18,658 6.71%
-------- --------
Total investment securities.. $ 18,658 6.71% $ 18,658 6.71%
======== ========
Mortgage-backed securities:
Held to maturity:
FNMA............................... - 97 4.67%
-------- --------
Total held for investment....... $ - $ 97 4.67%
-------- --------
Available for sale:
FHLMC.............................. $4,663 6.10% $4,735 6.11%
GNMA............................... 11,927 6.25% 11,927 6.25%
FNMA............................... 28,033 7.38% 32,870 7.17%
CMOs............................... 47,626 6.31% 47,626 6.31%
-------- --------
Total available for sale........ 92,249 6.62% 97,158 6.59%
-------- --------
Total mortgage-backed
securities $ 92,249 6.62% $ 97,255 6.59%
======== ========
</TABLE>
20
<PAGE>
Sources of Funds
General. The Company's primary sources of funds are customer deposits,
principal, and interest payments on loans and mortgage-backed securities, FHLB
advances and other borrowings and, to a lesser extent, proceeds from sales of
securities and loans. While maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions, and competition.
Deposits. The Company offers a variety of deposit accounts with a range
of interest rates and terms. The Company's deposits consist of passbook savings,
checking accounts, money market accounts and certificates of deposit. For the
year ended December 31, 1998, certificates of deposit constituted 69.3% of total
average deposits. The flow of deposits is influenced significantly by general
economic conditions, changes in money market rates, prevailing interest rates
and competition. The Company's deposits are obtained predominantly from the
areas in which its branch offices are located. The Company relies primarily on
customer service and long standing relationships with customers to attract and
retain these deposits; however, market interest rates and rates offered by
competing financial institutions significantly affect the Company's ability to
attract and retain deposits. Certificate accounts in excess of $100,000 are not
actively solicited by the Company, nor does the Company use brokers to obtain
deposits.
In April 1998, the Company assumed $29.7 million of deposit liabilities
in exchange for an almost equal amount of loans.
The Company offers a "multi-flex" certificate account with interest
rates which, may be adjusted to prevailing market rates according to the terms
of the account. The multi-flex account is available to customers for terms of
either seven months or 17 months. The depositor may increase the interest rate
once during the term to the current quoted rate, and may also withdraw all or a
portion of the deposited funds once during the term of the account without
penalty. The seven-month multi-flex certificate account allows the depositor to
increase the deposit amount in the account. Management continually monitors the
level of certificate accounts. Based on historical experience, management
believes it will retain a large portion of such accounts upon maturity. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
The following table presents the deposit activity of the Company for
the periods indicated).
<CAPTION>
For the Year Ended December 31,
----------------------------------------------
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Deposits.................................. $ 988,794 $ 695,432 $ 509,649
Purchased deposits........................ 29,651 - 102,063
Withdrawals............................... (984,895) (708,545) (519,800)
--------- --------- ---------
Net deposits (withdrawals)................ 33,550 (13,113) 91,912
Interest credited on deposits............. 16,568 15,527 10,949
--------- --------- ---------
Total increase in deposits................ $50,118 $ 2,414 $ 102,861
========= ========= =========
</TABLE>
<TABLE>
At December 31, 1998, the Company had $62.5 million in certificate
accounts in amounts of $100,000 or more ("jumbo certificate accounts") maturing
as indicated in the following table. At December 31, 1997, the Company had $59.0
million of jumbo certificate accounts, with a weighted average rate of 5.41% at
year-end. The Company does not offer premium rates on jumbo certificate
accounts.
<CAPTION>
Weighted
Maturity Period Amount Average Rate
---------------------------------------------------- ---------------- --------------
(In thousands)
<S> <C> <C>
Three months or less............................... $ 14,003 5.36%
Over three through six months...................... 20,226 5.24%
Over six through 12 months......................... 19,484 5.24%
Over 12 months..................................... 8,744 4.98%
--------
Total.............................. $ 62,457 5.23%
========
</TABLE>
21
<PAGE>
<TABLE>
The following table sets forth the distribution of the Company's
average deposit accounts for the periods indicated and the weighted average
interest rates on each category of deposits presented.
<CAPTION>
For the Year Ended December 31,
--------------------------------------------------------------------------------
1998 1997
------------------------------------- --------------------------------------
Percent Percent
of total Weighted of total Weighted
Average average average Average average average
balance deposits rate balance deposits rate
---------- ----------- ---------- ----------- ---------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Money market deposits............. $42,603 12.04% 4.03% $34,612 10.89% 3.88%
Passbook deposits................. 15,204 4.30% 1.83% 13,396 4.22% 1.89%
Checking accounts................. 29,935 8.46% .76% 17,925 5.64% .49%
-------- ------- -------- -------
Total....................... 87,742 24.80% 65,933 20.75%
-------- ------- -------- -------
Certificate accounts:
Three months or less........... 59,307 16.76% 5.40% 53,470 16.83% 5.34%
Over three through six months.. 54,655 15.44% 5.34% 48,621 15.29% 5.35%
Over six through 12 months..... 93,413 26.39% 5.43% 83,101 26.15% 5.57%
Over one to three years........ 54,481 15.38% 5.42% 64,251 20.22% 5.62%
Over three to five years....... 4,369 1.23% 5.98% 2,267 .71% 6.14%
Over five to ten years......... - - 145 .05% 6.98%
-------- ------- -------- -------
Total certificates.......... 266,225 75.20 5.41% 251,855 79.25% 5.50%
-------- ------- -------- -------
Total average deposits...... $353,967 100.00% 4.80% $317,788 100.00% 4.89%
======== ======= ======== =======
--------------------------------------
1996
-------------------------------------
Percent
of total Weighted
Average average average
balance deposits rate
---------- ----------- -----------
<S> <C> <C> <C>
Money market deposits............. $ 19,387 8.65% 3.58%
Passbook deposits................. 13,381 5.97% 1.90%
Checking accounts................. 13,485 6.01% .58%
-------- -------
Total....................... 46,253 20.63%
-------- -------
Certificate accounts:
Three months or less........... 35,720 15.93% 5.57%
Over three through six months.. 37,366 16.67% 5.61%
Over six through 12 months..... 58,924 26.28% 5.61%
Over one to three years........ 44,584 19.88% 5.71%
Over three to five years....... 1,166 .52% 6.65%
Over five to ten years......... 204 .09% 7.23%
-------- -------
Total certificates.......... 177,964 79.37% 5.58%
-------- -------
Total average deposits...... $224,217 100.00% 4.88%
======== =======
</TABLE>
22
<PAGE>
<TABLE>
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1998 (in
thousands).
<CAPTION>
Period to Maturity from December 31, 1998
----------------------------------------------------------------------------------
Over Two
One Over One to Three Four Over
Year or to Two Three to Four to Five Five
Less Years Years Years Years Years
----------- ----------- ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Certificate accounts:
0 to 4.00%................$ 981 $ 3 $ - $ - $ - $ -
4.01 to 5.00%............. 69,037 19,032 163 - 143 -
5.01 to 6.00%............. 143,851 13,948 1,158 773 1,976 -
6.01 to 7.00%............. 2,439 449 484 1,257 90 -
7.01 to 8.00%............. 500 128 155 - - -
8.01 to 9.00%............. 415 19 - - - -
Over 9.01%................ 105 2 - - - -
-------- ------- ------- ------ ------- -----
Total.................. $217,328 $33,581 $ 1,960 $2,048 $ 2,209 $ -
======== ======= ======= ====== ======= =====
At December 31,
----------------------------------------
1998 1997 1996
------------ ----------- -----------
<S> <C> <C> <C>
Certificate accounts:
0 to 4.00%................ $ 984 $ 26 $ 1,431
4.01 to 5.00%............. 88,375 4,444 31,457
5.01 to 6.00%............. 161,706 232,318 194,505
6.01 to 7.00%............. 4,719 15,195 21,753
7.01 to 8.00%............. 783 1,432 3,311
8.01 to 9.00%............. 434 485 511
Over 9.01%................ 125 176
-------- -------- --------
Total.................. $257,126 $254,076 $253,244
======== ======== ========
</TABLE>
23
<PAGE>
Borrowings
From time to time the Company obtains borrowed funds through FHLB
advances and reverse repurchase agreements as an alternative to retail deposit
funds, and may do so in the future as part of its operating strategy. Borrowings
are also utilized to acquire certain other assets as deemed appropriate by
management for investment purposes.
FHLB advances are collateralized by the Company's mortgage loans,
mortgage-backed securities, and investment in the capital stock of the FHLB. See
"Regulation - Federal Home Loan Bank System." FHLB advances are made pursuant to
several different credit programs with varying interest rate and maturity terms.
The maximum amount that the FHLB will advance to member institutions, including
the Bank, fluctuates from time to time in accordance with the policies of the
OTS and the FHLB. At December 31, 1998, the Company had $35.2 million of
outstanding borrowings from the FHLB.
Reverse repurchase agreements are collateralized by mortgage-backed
securities. At December 31, 1998 the Company had $4.5 million of securities sold
under agreements to repurchase.
<TABLE>
The following table sets forth information regarding the Company's
borrowed funds at or for the indicated years.
<CAPTION>
At or For the Years Ended December 31,
---------------------------------------------
1998 1997 1996
(Dollars in thousands)
<S> <C> <C> <C>
FHLB advances:
Average balance outstanding..................... $28,059 $40,520 $43,619
Maximum amount outstanding at any
month end during the year.................... 73,787 46,432 99,607
Balance outstanding at year end................. 35,182 32,282 46,807
Weighted average interest rate during
the year..................................... 5.93% 5.92% 5.75%
Weighted average interest rate at
year end..................................... 5.54% 6.09% 5.72%
At or For the Years Ended December 31,
---------------------------------------------
1998 1997 1996
(Dollars in thousands)
Securities sold under agreements to repurchase:
Average balance outstanding..................... $ 5,007 $ 8,234 $14,644
Maximum amount outstanding at any
month end during the year.................... 5,200 13,000 16,648
Balance outstanding at year end................. 4,490 5,200 13,000
Weighted average interest rate during
the year..................................... 5.92% 5.91% 5.98%
Weighted average interest rate at
Year-end..................................... 5.69% 5.95% 5.94%
</TABLE>
24
<PAGE>
Subsidiary Activities
Portola, a California corporation, is engaged on an agency basis in the
sale of insurance and investment products to the Company's customers and members
of the local community. At December 31, 1998, Portola had $458,500 in total
assets. Portola recorded a net loss of $3,677 for the year ended December 31,
1998.
Personnel
As of December 31, 1998, the Company had 110 full-time employees and 5
part-time employees. The employees are not represented by a collective
bargaining unit and the Company considers its relationship with its employees to
be good.
REGULATION AND SUPERVISION
General
The Company, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the
activities of savings institutions, such as the Bank, are governed by the HOLA
and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and
supervision by the OTS, as its primary federal regulator, and the FDIC, as the
deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB")
System and its deposit accounts are insured up to applicable limits by the
Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Bank must
file reports with the OTS and the FDIC concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other savings
institutions. The OTS and/or the FDIC conduct periodic examinations to test the
Bank's safety and soundness compliance with various regulatory requirements.
This regulation and supervision establishes a comprehensive framework of
activities in which an institution can engage and is intended primarily for the
protection of the insurance fund and depositors. The regulatory structure also
gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes. Any change in such
regulatory requirements and policies, whether by the OTS, the FDIC or the
Congress could have a material adverse impact on the Company, the Bank and their
operations. Certain of the regulatory requirements applicable to the Bank and to
the Company are referred to below or elsewhere herein. The description of
statutory provisions and regulations applicable to savings institutions and
their holding companies set forth in this Form 10-K does not purport to be a
complete description of such statutes and regulations and their effects on the
Bank and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding
company within the meaning of the HOLA. As a unitary savings and loan holding
company, the Company generally will not be restricted under existing laws as to
the types of business activities in which it may engage, provided that the Bank
continues to be a qualified thrift lender ("QTL"). See "Federal Savings
Institution Regulation - QTL Test." Upon any non-supervisory acquisition by the
Company of another savings institution or savings bank that meets the QTL test
and is deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a
25
<PAGE>
multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities permissible for bank holding companies
under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"), subject to
the prior approval of the OTS, and activities authorized by OTS regulation.
The HOLA prohibits a savings and loan holding company directly, or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5% of a nonsubsidiary company engaged in activities other
than those permitted by the HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result
in a multiple savings and loan holding company controlling savings institutions
in more than one state, subject to two exceptions: (i) the approval of
interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions, as described below. The Bank must notify the OTS 30 days
before declaring any dividend to the Company. In addition, the financial impact
of a holding company on its subsidiary institution is a matter that is evaluated
by the OTS and the agency has authority to order cessation of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3.0% leverage (core) capital ratio, and an 8.0% risk-based capital
ratio. Core capital is defined as common stockholder's equity (including
retained earnings), certain noncumulative perpetual preferred stock and related
surplus, and minority interests in equity accounts of consolidated subsidiaries,
less intangibles other than certain purchased mortgage servicing rights and
credit card relationships. The OTS regulations also require that, in meeting the
tangible, core and risk-based capital standards, institutions must generally
deduct investments in and loans to subsidiaries engaged in activities not
permissible for a national bank. The holding company is not subject to the
minimum capital requirements that the Bank is subject to.
The risk-based capital standard for savings institutions requires the
maintenance of tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of 4% and 8%, respectively.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, as
assigned by the OTS capital regulation based on the risks OTS believes are
inherent in the type of asset. The components of core (tier 1) capital are
equivalent to those discussed above. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock and the allowance for loan and lease losses limited to a maximum
of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
26
<PAGE>
Under the OTS prompt corrective action regulations, the OTS is required
to take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of undercapitalization.
Generally, a savings institution is considered "well capitalized" if its ratio
of total capital to risk-weighted assets is at least 10%, its ratio of core
(tier 1) capital to risk-weighted assets is at least 6%, its ratio of core
capital to total assets is at least 5%, and it is not subject to any order or
directive by the OTS to meet a specific capital level. A savings institution
generally is considered "adequately capitalized" if its ratio of total capital
to risk-weighted assets is at least 8%, its ratio of core (tier 1) capital to
risk-weighted assets is at least 4%, and its ratio of core capital to total
assets is at least 4% (3% if the institution receives the highest CAMEL rating).
A savings institution that has a ratio of total capital to weighted assets of
less of than 8%, a ratio of core (tier 1) capital to risk-weighted assets of
less than 4% or a ratio of core capital to total assets of less than 4% (3% or
less for institutions with the highest examination rating) is considered to be
"undercapitalized." A savings institution that has a total risk-based capital
ratio less than 6%, a tier 1 risk-based capital ratio of less than 3% or a
leverage ratio that is less than 3% is considered to be "significantly
undercapitalized" and a savings institution that has a tangible capital to
assets ratio equal to or less than 2% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the banking regulator is
required to appoint a receiver or conservator for an institution that is
"critically undercapitalized." The regulation also provides that a capital
restoration plan must be filed with the OTS within 45 days of the date a savings
institution receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by any parent holding company. In addition, numerous
mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
<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%
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%
</TABLE>
Insurance of Deposit Accounts. The deposits of the Bank are presently
insured by the SAIF, except for certain acquired deposits which are insured by
the BIF. The SAIF and the BIF are administered by the FDIC. The FDIC uses a
risk-based assessment system under which all insured depository institutions are
placed into one of nine categories and assessed insurance premiums on a sliding
scale based upon their respective levels of capital and results of supervisory
evaluations. Institutions classified as well-capitalized (as defined by the
FDIC) and not considered to otherwise be of supervisory concern pay the lowest
premium. For the year ended December 31, 1998, regular SAIF assessments ranged
from 0 to 27 basis points. The Bank's assessment rate for the year ended
December 31, 1998 was 0 basis points and the total deposit insurance premium
paid by the Bank in fiscal 1998 was $139,000.
27
<PAGE>
In addition, pursuant to the Deposit Insurance Funds Act of 1996,
effective January 1, 1997, all SAIF-insured deposits and all BIF-insured
deposits are subject to special assessments to make payments on bonds issued by
the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF.
The FDIC reviews the FICO assessment rate quarterly. For fiscal 1998, the rate
was 6.1 basis points for SAIF-insured deposits and 1.22 basis points for
BIF-insured deposits. Beginning on the earlier of January 1, 2000 or the date
that the BIF and SAIF are merged, SAIF and BIF-insured deposits will share the
cost of paying interest on the FICO bonds on a pro rata basis.
Under the FDI act, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has engaged in unsafe or unsound practices,
is in an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
OTS. The management of the Bank does not know of any practice, condition or
violation that might lead to the termination of deposit insurance.
SAIF Recapitalization Assessment. The Funds Act levied a 65.7-cent fee
on every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision, which states that the
amount of any special assessment paid to capitalize SAIF under this legislation
is deductible under Section 162 of the Code in the year of payment.
Pending Legislation. Various proposals to eliminate the federal savings
association charter, create a uniform financial institutions charter, and
abolish the OTS to restrict savings and loan holding company activities have
been introduced in Congress. The Company is unable to predict whether any of
this legislation will be enacted or the extent to which laws enacted may
restrict or otherwise adversely affect its operations.
Loans to One Borrower. Under the HOLA, savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. Generally, savings institutions may not make a loan or extend credit to a
single or related group of borrowers in excess of 15% of its unimpaired capital
and surplus. An additional amount may be lent, equal to 10% of unimpaired
capital and surplus, if such loan is secured by readily marketable collateral,
which is defined to include certain financial instruments and bullion. At
December 31, 1998, the Bank's limit on loans to one borrower was $4.8 million.
At December 31, 1998, the Bank's largest aggregate outstanding balance of loans
to one borrower totaled $5.0 million. This loan complied with the Bank's loans
to one borrower limit at the time the loan was made.
QTL Test. The HOLA requires savings institutions to meet a qualified
thrift lender ("QTL") test. A savings institution is permitted to meet the QTL
test in one of two alternative ways. Under the first method, the savings
institution is required to maintain at least 65% of its "portfolio assets,"
defined as total assets less (i) specified liquid assets up to 20% of total
assets, (ii) intangibles, including goodwill and (iii) the value of property
used to conduct business, in certain "qualified thrift investments." Assets
constituting qualified thrift investments and includable without limit in
measuring compliance with the QTL include residential mortgage loans, certain
mortgage-backed securities and education, small business, credit card and credit
card account loans. Alternatively, savings institutions are permitted to meet
the QTL test by qualifying as a "domestic building and loan association" under
the Internal Revenue Code.
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. At
December 31, 1998, the Bank maintained 82.24% of its portfolio assets in
qualified thrift investments and, therefore, met the QTL test.
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against
28
<PAGE>
capital. The rule establishes three tiers of institutions, which are based
primarily on an institution's capital level. An institution that exceeds all
fully phased-in capital requirements before and after a proposed capital
distribution ("Tier 1 Institution") and has not been advised by the OTS that it
is in need of more than normal supervision, could, after prior notice but
without obtaining approval of the OTS, make capital distributions during a
calendar year equal to the greater of (i) 100% of its net earnings to date
during the calendar year plus the amount that would reduce by one-half its
"surplus capital ratio" (the excess capital over its fully phased-in capital
requirements) at the beginning of the calendar year or (ii) 75% of its net
income for the previous four quarters. Any additional capital distributions
would require prior regulatory approval. In the event the Bank's capital fell
below its regulatory requirements or the OTS notified it that it was in need of
more than normal supervision, the Bank's ability to make capital distributions
could be restricted. In addition, the OTS could prohibit a proposed capital
distribution by any institution, which would otherwise be permitted by the
regulation, if the OTS determines that such distribution would constitute an
unsafe or unsound practice. In January 1999, the OTS adopted amendments to its
capital distribution regulation, effective April 1999, that would generally
authorize the payment of capital distributions without OTS approval if the
institution met the requirement of the OTS for expedited treatment of
applications, and the total capital distributions for calendar year did not
require certain limits. However, institutions in a holding company structure
would still have a prior notice requirement. At December 31, 1998, the Bank was
a Tier 1 Bank.
Liquidity. The Bank is required by OTS regulations to maintain an
average daily balance of liquid assets in each calendar quarter of not less than
4% of either the amount of its liquidity base at the end of the preceding
calendar quarter or the average daily balance of its liquidity base during the
preceding calendar quarter. In addition to this minimum requirement, the Bank is
required to maintain sufficient liquidity to ensure its safe and sound
operations. The minimum liquidity requirement may be changed by the OTS to any
amount within the range of 4% to 10%, depending upon economic conditions and the
savings deposit flows of savings institutions. Monetary penalties may be imposed
for failure to meet these liquidity requirements. The Bank's average liquidity
ratio for the quarter ended December 31, 1998 was 5.2%. The Bank has never been
subject to monetary penalties for failure to meet its liquidity requirements.
Assessments. Savings institutions are required to pay assessments to
the OTS to fund the agency's operations. The general assessment, paid on a
semi-annual basis, is computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest quarterly
thrift financial report. The assessments paid by the Bank for the fiscal year
ended December 31, 1998 totaled $112,000.
Branching. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (e.g.., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by Sections 23A and 23B
of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of
covered transactions with any individual affiliate to 10% of the capital and
surplus of the savings institution. The aggregate amount of covered transactions
with all affiliates is limited to 20% of the savings institution's capital and
surplus. Certain transactions with affiliates are required to be secured by
collateral in an amount and of a type described in Section 23A and the purchase
of low quality assets from affiliates is generally prohibited. Section 23B
generally provides that certain transactions with affiliates, including loans
and asset purchases, must be on terms and under circumstances, including credit
standards, that are substantially the same or at least as favorable to the
institution as those prevailing at the time for comparable transactions with
non-affiliated companies. In addition, savings institutions are prohibited from
lending to any affiliate that is engaged in
29
<PAGE>
activities that are not permissible for bank holding companies and no savings
institution may purchase the securities of any affiliate other than a
subsidiary.
The Bank's authority to extend credit to executive officers, directors
and 10% shareholders, ("insiders"), as well as entities such persons control, is
governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. Recent legislation created an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees. Regulation O also places individual and aggregate
limits on the amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain board approval procedures to be
followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and an
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to be taken with respect to a particular
savings institution. If action is not taken by the Director, the FDIC has
authority to take such action under certain circumstances. Federal law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset growth; and compensation, fees and benefits.
If the appropriate federal banking agency determines that an institution fails
to meet any standard prescribed by the Guidelines, the agency may require the
institution to submit to the agency an acceptable plan to achieve compliance
with the standard, as required by the FDI Act. The final rule establishes
deadlines for the submission and review of such safety and soundness compliance
plans when such plans are required.
Federal Reserve System
Federal Reserve System ("FRB") regulations require savings institutions
to maintain non-interest-earning reserves against their transactional accounts
(primarily checking accounts). During the year ended December 31, 1998, the
regulations generally required that reserves be maintained against transaction
accounts as follows: for accounts aggregating $47.8 million or less, the
requirement is 3%; and for accounts greater than $47.8 million, the requirement
is $1.293 million plus 10% of that portion of total transaction accounts in
excess of $47.8 million. The first $4.7 million of otherwise reservable balances
are exempted from the reserve requirements. The Bank is in compliance with the
foregoing requirements. The balances maintained to meet the reserve requirements
of the FRB may be used to satisfy OTS liquidity requirements.
30
<PAGE>
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Bank and the Company report their income on a consolidated
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS during the last
five years. For its 1998 taxable year, the Bank is subject to a maximum federal
income tax rate of 35%.
Bad Debt Reserve. For fiscal years beginning prior to December 31,
1995, thrift institutions which qualified under certain definitional tests and
other conditions of the Internal Revenue Code of 1986 (the "Code") were
permitted to use certain favorable provisions to calculate their deductions from
taxable income for annual additions to their bad debt reserve. A reserve could
be established for bad debts on qualifying real property loans (generally
secured by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which
was enacted on August 20, 1996, requires savings institutions to recapture
(i.e., take into income) certain portions of their accumulated bad debt
reserves. The 1996 Act repeals the reserve method of accounting for bad debts
effective for tax years beginning after 1995. Thrift institutions that would be
treated as small banks are allowed to utilize the Experience Method applicable
to such institutions, while thrift institutions that are treated as large banks
(those generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of computing
reserves for bad debts will treat such change as a change in method of
accounting, initiated by the taxpayer, and having been made with the consent of
the IRS. Any Section 481 (a) adjustment required to be taken into income with
respect to such change generally will be taken into income ratably over a
six-taxable year period, beginning with the first taxable year beginning after
1995, subject to the residential loan requirement.
Under the residential loan requirement provision, the recapture
required by the 1996 Act will be suspended for each of two successive taxable
years, beginning with the Bank's current taxable year, in which the Bank
originates a minimum of certain residential loans based upon the average of the
principal amounts of such loans made by the Bank during its six taxable years
preceding its current taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank
is permitted to make additions to its tax bad debt reserves. In addition, the
Bank is required to recapture (i. e., take into income) over a six year period
the excess of the balance of its tax bad debt reserves as of December 31, 1995
over the balance of such reserves as of December 31, 1987.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or
31
<PAGE>
complete liquidation. Dividends paid out of the Bank's current or accumulated
earnings and profits will not be so included in the Bank's income.
The amount of additional taxable income triggered by an non-dividend is
an amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Thus, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion its bad debt reserves.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986,
as amended (the "Code") imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using
the percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current earnings
exceeds its AMTI (determined without regard to this preference and prior to
reduction for net operating losses). In addition, for taxable years beginning
after December 31, 1986 and before January 1, 1996, an environmental tax of .12%
of the excess of AMTI (with certain modifications) over $2.0 million is imposed
on corporations, including the Company, whether or not an Alternative Minimum
Tax ("AMT") is paid. The Bank does not expect to be subject to the AMT, but may
be subject to the environmental tax liability.
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank own more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
32
<PAGE>
State and Local Taxation
State of California. The California franchise tax rate applicable to
the Bank equals the franchise tax rate applicable to corporations generally,
plus an "in lieu" rate approximately equal to personal property taxes and
business license taxes paid by such corporations (but not generally paid by
banks or financial corporations such as the Bank); however, the total tax rate
cannot exceed 11.7%. Under California regulations, bad debt deductions are
available in computing California franchise taxes using a three or six year
weighted average loss experience method. The Bank and its California subsidiary
file California State franchise tax returns on a combined basis. The Company, as
a savings and loan holding company commercially domiciled in California, is
treated as a financial corporation and subject to the general corporate tax rate
plus the "in lieu" rate as discussed previously for the Bank.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
Additional Item. Executive Officers of the Registrant
The following table sets forth certain information regarding the
executive officers of the Company who are not also directors.
Name Age(1) Position Held With Company
- ------------------------------- ----------- --------------------------
Carlene F. Anderson 46 Corporate Secretary
- ---------------------------------------
(1) At December 31, 1998
33
<PAGE>
Item 2. Properties.
The Company conducts business through an administrative office located
in Watsonville and eight branch offices. During 1998 the Company purchased and
remodeled an existing office building located at 567 Auto Center Drive,
Watsonville, California to serve as its centralized administrative building.
Personnel of the Bank moved into the building in September 1998. As a result of
the move, the Company sold its previous office facility located at 36 Brennan
Street, Watsonville, California in September 1998. Management believes that with
the newly acquired office building, its facilities will be adequate to meet the
needs of the Company in the foreseeable future.
<TABLE>
<CAPTION>
Net Book Value
of Property or
Original Leasehold
Lease Year Date of Improvements at
or Leased or Lease December 31,
Location Owned Acquired Expiration 1998
----------------------------------- ------------- -------------- ---------- ---------------
<S> <C> <C> <C> <C>
Administrative Offices:
15 Brennan Street
Watsonville, California 95076 Owned 12-31-65 N/A $ 18,396
567 Auto Center Drive
Watsonville, California 95076 Owned 03-23-98 N/A 1,612,408
Branch Offices:
35 East Lake Avenue
Watsonville, California 95076 Owned 12-31-65 N/A 322,879
805 First Street
Gilroy, California 95020 Owned 12-01-76 N/A 242,846
1400 Munras Avenue
Monterey, California 93940 Owned(1) 07-07-93 Monthly 934,556
1890 North Main Street
Salinas, California 93906 Owned 07-07-93 N/A 1,154,000
1127 South Main Street
Salinas, California 93901 Leased 08-08-93 07-31-98(2) 37,181
8071 San Miguel Canyon Road
Prunedale, California 93907 Leased 12-24-93 12-24-03(3) 72,718
60 Bay Avenue
Capitola, California 95020 Owned 12-10-96 N/A 1,125,518
6265 Highway 9
Felton, California 95018 Leased 04-07-98 04-07-03(2) 13,241
<FN>
- --------------------------------------------
(1) Majority owned, portion of property leased.
(2) The Company has options to extend the lease term for two consecutive five-year periods.
(3) The Company has options to extend the lease term for three consecutive ten-year periods.
</FN>
</TABLE>
34
<PAGE>
Item 3. Legal Proceedings.
The Company is not involved in any pending legal proceeding other than
routine legal proceedings occurring in the ordinary course of business. Such
other routine legal proceedings in the aggregate are believed by management to
be immaterial to the Company's financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Common Stock of Monterey Bay Bancorp, Inc. is traded
over-the-counter on the Nasdaq Stock Market under the symbol "MBBC." The stock
began trading on February 15, 1995. As of March 24, 1999, there were 3,525,280
shares outstanding of the Company's common stock. As of February 26, 1999, there
were 292 stockholders of record, not including persons or entities who hold
their stock in nominee or "street" name.
The following table sets forth the high and low bid prices per share
for the Company's common stock for the periods indicated.
High Bid(1) Low Bid(1)
----------- ----------
Year ended December 31, 1998:
Fourth quarter $14.875 $10.750
Third quarter $17.000 $13.200
Second quarter $21.100 $14.800
First quarter $21.600 $14.800
Year ended December 31, 1997:
Fourth quarter $16.400 $14.600
Third quarter $16.600 $12.800
Second quarter $13.800 $12.300
First quarter $15.000 $11.650
Year ended December 31, 1996:
Fourth quarter $12.700 $10.700
Third quarter $10.900 $ 9.100
Second quarter $10.200 $ 9.400
First quarter $10.200 $ 8.800
- ------------------------------------------
(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.
The Board of Directors declared, and the Company paid, cash dividends
of $0.12 and $0.09 per share during the years ended 1998 and 1997, respectively.
35
<PAGE>
Item 6. Selected Financial Data.
Selected consolidated financial data for each of the five years in the
period ended December 31, 1998, consisting of data captioned "Selected
Consolidated Financial and Other Data" appears on page three of the Company's
1998 Annual Report to Stockholders and is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" appears on pages 5 to 21 of the Company's 1998 Annual
Report to Stockholders and is incorporated herein by reference.
Item 7a. Quantitative and Qualitative Disclosure of Market Risk.
"Quantitative and Qualitative Disclosure of Market Risk" appears on
pages 6 to 8 of the Company's 1998 Annual Report to Stockholders and is
incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data.
The Consolidated Statements of Financial Condition of Monterey Bay
Bancorp, Inc. and Subsidiary as of December 31, 1998 and 1997 and the related
Consolidated Statements of Operations, Stockholders' Equity and Cash Flows for
each of the years in the three-year period ended December 31, 1998, together
with the related notes and the report of Deloitte and Touche LLP, independent
auditors, appears on pages 22 to 58 of the Company's 1998 Annual Report to
Stockholders and are incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on June 11, 1999,
which will be filed no later than 120 days following the Registrant's Fiscal
Year end. Information concerning executive officers who are not directors is
contained in Part I of this report in reliance on Instruction G of Form 10-K.
Item 11. Executive Compensation.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on June 11, 1999, excluding the
Compensation Committee Report on Executive Compensation and the Stock
Performance Graph, which will be filed no later than 120 days following the
Registrant's Fiscal Year end.
36
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on June 11, 1999, which will be filed
no later than 120 days following the Registrant's Fiscal Year end.
Item 13. Certain Relationships and Related Transactions.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on June 11, 1999, which will be filed
no later than 120 days following the Registrant's Fiscal Year end.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a)(1) Financial Statements
The following consolidated financial statements of the registrants and
its subsidiaries are filed as a part of this document under Item 8. Financial
Statements and Supplementary Data.
Consolidated Statements of Financial Condition at December 31, 1998
and 1997.
Consolidated Statements of Operations for each of the years in the
three-year period ended December 31, 1998.
Consolidated Statements of Changes in Stockholders' Equity for each of
the years in the three-year period ended December 31, 1998.
Consolidated Statements of Cash Flows for each of the years in the
three-year period ended December 31, 1998.
Notes to Consolidated Financial Statements.
Independent Auditors' Report.
(a)(2) Financial Statement Schedules
All schedules are omitted because they are not required or are not
applicable or the required information is shown in the consolidated financial
statements or notes thereto.
(a)(3) Exhibits
(a) The following exhibits are filed as part of this report:
3.1 Certificates of Incorporation of Monterey Bay Bancorp, Inc.*
3.2 Bylaws of Monterey Bay Bancorp, Inc.
4.0 Stock Certificate of Monterey Bay Bancorp, Inc.*
10.1 Form of Employment Agreement between Monterey Bay Bank
and certain executive officers.*
37
<PAGE>
10.2 Form of Employment Agreement between Monterey Bay Bancorp, Inc.
and certain executive officers.*
10.3 Form of Change in Control Agreement between Monterey Bay Bank
and certain executive officers.*
10.4 Form of Change in Control Agreement between Monterey Bay Bancorp, Inc.
and certain executive officers.*
10.5 Form of Monterey Bay Bank of Employee Severance Compensation Plan.*
10.6 Monterey Bay Bank 401(k) Plan.*
10.7 Monterey Bay Bank 1995 Retirement Plan for Executive Officers and
Directors.*
10.8 Form of Monterey Bay Bank Performance Equity Program for Executives.**
10.9 Form of Monterey Bay Bank Recognition and Retention Plan for Outside
Directors.**
10.10 Form of Monterey Bay Bancorp, Inc. 1995 Incentive Stock Option Plan.**
10.11 Form of Monterey Bay Bancorp, Inc. 1995 Stock Option Plan for Outside
Directors.**
11 Computation of Per Share Earnings.
13 Portions of the Monterey Bay Bancorp, Inc. 1998 Annual Report to
Shareholders.
21 Subsidiary information is incorporated herein by reference to "Part I
- Subsidiaries."
23 Consent of Deloitte & Touche LLP.
27 Financial Data Schedule.
(b) Report on Form 8-K
The Registrant did not file any reports on Form 8-K during the last
quarter of the fiscal year ended December 31, 1998.
* Incorporated herein by reference from the Exhibits to the Registration
Statement on Form S-1, as amended, filed on September 21, 1994,
Registration No. 33-84272.
** Incorporated herein by reference from the Proxy Statement for the
Annual Meeting of Stockholders' filed on July 26, 1995.
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
MONTEREY BAY BANCORP, INC.
Date: March 30, 1999 By: /s/ Marshall G. Delk
- --------------------- --------------------
Marshall G. Delk
President, Chief Operating Officer,
Director and Chief Financial Officer
<TABLE>
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities and
on the dates indicated.
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ Gene R. Friend Chairman of the Board of Directors March 30, 1999
- ----------------------------------- and Chief Executive Officer --------------
Gene R. Friend
/s/ Marshall G. Delk President, Chief Operating Officer, Director March 30, 1999
- ----------------------------------- and Chief Financial Officer --------------
Marshall G. Delk
/s/ P. W. Bachan Director March 30, 1999
- ----------------------------------- --------------
P. W. Bachan
/s/ Edward K. Banks Director March 30, 1999
- ----------------------------------- --------------
Edward K. Banks
/s/ Nicholas C. Biase Director March 30, 1999
- ----------------------------------- --------------
Nicholas C. Biase
/s/ Diane S. Bordoni Director March 30, 1999
- ----------------------------------- --------------
Diane S. Bordoni
/s/ Steven Franich Director March 30, 1999
- ----------------------------------- --------------
Steven Franich
/s/ Donald K. Henrichsen Director March 30, 1999
- ----------------------------------- --------------
Donald K. Henrichsen
/s/ Stephen G. Hoffmann Director March 30, 1999
- ----------------------------------- --------------
Stephen G. Hoffmann
/s/ Gary L. Manfre Director March 30, 1999
- ----------------------------------- --------------
Gary L. Manfre
/s/ McKenzie Moss Director March 30, 1999
- ----------------------------------- --------------
McKenzie Moss
/s/ Louis Resetar, Jr. Director March 30, 1999
- ----------------------------------- --------------
Louis Resetar, Jr.
</TABLE>
39
MONTEREY BAY BANCORP, INC.
BYLAWS
ARTICLE I - STOCKHOLDERS
Section 1. Annual Meeting.
An annual meeting of the stockholders, for the election of Directors to
succeed those whose terms expire and for the transaction of such other business
as may properly come before the meeting, shall be held at such place, on such
date, and at such time as the Board of Directors shall each year fix, which date
shall be within thirteen (13) months subsequent to the later of the date of
incorporation or the last annual meeting of stockholders.
Section 2. Special Meetings.
Subject to the rights of the holders of any class or series of
preferred stock of the Corporation, special meetings of stockholders of the
Corporation may be called only by the Board of Directors pursuant to a
resolution adopted by a majority of the total number of Directors which the
Corporation would have if there were no vacancies on the Board of Directors
(hereinafter the "Whole Board").
Section 3. Notice of Meetings.
Written notice of the place, date, and time of all meetings of the
stockholders shall be given, not less than ten (10) nor more than sixty (60)
days before the date on which the meeting is to be held, to each stockholder
entitled to vote at such meeting, except as otherwise provided herein or
required by law (meaning, here and hereinafter, as required from time to time by
the Delaware General Corporation Law or the Certificate of Incorporation of the
Corporation).
When a meeting is adjourned to another place, date or time, written
notice need not be given of the adjourned meeting if the place, date and time
thereof are announced at the meeting at which the adjournment is taken;
provided, however, that if the date of any adjourned meeting is more than thirty
(30) days after the date for which the meeting was originally noticed, or if a
new record date is fixed for the adjourned meeting, written notice of the place,
date, and time of the adjourned meeting shall be given in conformity herewith.
At any adjourned meeting, any business may be transacted which might have been
transacted at the original meeting.
Section 4. Quorum.
At any meeting of the stockholders, the holders of a majority of all of
the shares of the stock entitled to vote at the meeting, present in person or by
proxy (after giving effect to the provisions of Article FOURTH of the
Corporation's Certificate of Incorporation), shall constitute a quorum for all
purposes, unless or except to the extent that the presence of a larger number
may be required by law. Where a separate vote by a class or classes is required,
a majority of the
<PAGE>
shares of such class or classes present in person or represented by proxy (after
giving effect to the provisions of Article FOURTH of the Corporation's
Certificate of Incorporation) shall constitute a quorum entitled to take action
with respect to that vote on that matter.
If a quorum shall fail to attend any meeting, the chairman of the
meeting or the holders of a majority of the shares of stock entitled to vote who
are present, in person or by proxy, may adjourn the meeting to another place,
date, or time.
If a notice of any adjourned special meeting of stockholders is sent to
all stockholders entitled to vote thereat, stating that it will be held with
those present in person or by proxy constituting a quorum, then except as
otherwise required by law, those present in person or by proxy at such adjourned
meeting shall constitute a quorum, and all matters shall be determined by a
majority of the votes cast at such meeting.
Section 5. Organization.
Such person as the Board of Directors may have designated or, in the
absence of such a person, the Chairman of the Board of the Corporation or, in
his or her absence, such person as may be chosen by the holders of a majority of
the shares entitled to vote who are present, in person or by proxy, shall call
to order any meeting of the stockholders and act as chairman of the meeting. In
the absence of the Secretary of the Corporation, the secretary of the meeting
shall be such person as the chairman appoints.
Section 6. Conduct of Business.
(a) The chairman of any meeting of stockholders shall determine the
order of business and the procedures at the meeting, including such regulation
of the manner of voting and the conduct of discussion as seem to him or her in
order. The date and time of the opening and closing of the polls for each matter
upon which the stockholders will vote at the meeting shall be announced at the
meeting.
(b) At any annual meeting of the stockholders, only such business shall
be conducted as shall have been brought before the meeting (i) by or at the
direction of the Board of Directors or (ii) by any stockholder of the
Corporation who is entitled to vote with respect thereto and who complies with
the notice procedures set forth in this Section 6(b). For business to be
properly brought before an annual meeting by a stockholder, the business must
relate to a proper subject matter for stockholder action and the stockholder
must have given timely notice thereof in writing to the Secretary of the
Corporation. To be timely, a stockholder's notice must be delivered or mailed to
and received at the principal executive offices of the Corporation not less than
ninety (90) days prior to the date of the annual meeting; provided, however,
that in the event that less than one hundred (100) days' notice or prior public
disclosure of the date of the meeting is given or made to stockholders, notice
by the stockholder to be timely must be received not later than the close of
business on the 10th day following the day on which such notice of the date of
the annual meeting was mailed or such public disclosure was made. A
stockholder's notice to the Secretary shall set forth as to each matter such
stockholder proposes to bring before the annual meeting (i) a brief description
of the business desired to be brought before the annual
2
<PAGE>
meeting and the reasons for conducting such business at the annual meeting, (ii)
the name and address, as they appear on the Corporation's books, of the
stockholder proposing such business, (iii) the class and number of shares of the
Corporation's capital stock that are beneficially owned by such stockholder and
(iv) any material interest of such stockholder in such business. Notwithstanding
anything in these Bylaws to the contrary, no business shall be brought before or
conducted at an annual meeting except in accordance with the provisions of this
Section 6(b). The Officer of the Corporation or other person presiding over the
annual meeting shall, if the facts so warrant, determine and declare to the
meeting that business was not properly brought before the meeting in accordance
with the provisions of this Section 6(b) and, if he should so determine, he
shall so declare to the meeting and any such business so determined to be not
properly brought before the meeting shall not be transacted.
At any special meeting of the stockholders, only such business shall be
conducted as shall have been brought before the meeting by or at the direction
of the Board of Directors.
(c) Only persons who are nominated in accordance with the procedures
set forth in these Bylaws shall be eligible for election as Directors.
Nominations of persons for election to the Board of Directors of the Corporation
may be made at a meeting of stockholders at which directors are to be elected
only (i) by or at the direction of the Board of Directors or (ii) by any
stockholder of the Corporation entitled to vote for the election of Directors at
the meeting who complies with the notice procedures set forth in this Section
6(c). Such nominations, other than those made by or at the direction of the
Board of Directors, shall be made by timely notice in writing to the Secretary
of the Corporation. To be timely, a stockholder's notice shall be delivered or
mailed to and received at the principal executive offices of the Corporation not
less than ninety (90) days prior to the date of the meeting; provided, however,
that in the event that less than one hundred (100) days' notice or prior
disclosure of the date of the meeting is given or made to stockholders, notice
by the stockholder to be timely must be so received not later than the close of
business on the 10th day following the day on which such notice of the date of
the meeting was mailed or such public disclosure was made. Such stockholder's
notice shall set forth (i) as to each person whom such stockholder proposes to
nominate for election or re-election as a Director, all information relating to
such person that is required to be disclosed in solicitations of proxies for
election of directors, or is otherwise required, in each case pursuant to
Regulation 14A under the Securities Exchange Act of 1934, as amended (including
such person's written consent to being named in the proxy statement as a nominee
and to serving as a director if elected); and (ii) as to the stockholder giving
the notice (x) the name and address, as they appear on the Corporation's books,
of such stockholder and (y) the class and number of shares of the Corporation's
capital stock that are beneficially owned by such stockholder. At the request of
the Board of Directors any person nominated by the Board of Directors for
election as a Director shall furnish to the Secretary of the Corporation that
information required to be set forth in a stockholder's notice of nomination
which pertains to the nominee. No person shall be eligible for election as a
Director of the Corporation unless nominated in accordance with the provisions
of this Section 6(c). The Officer of the Corporation or other person presiding
at the meeting shall, if the facts so warrant, determine that a nomination was
not made in accordance with such provisions and, if he or she shall so
determine, he or she shall so declare to the meeting and the defective
nomination shall be disregarded.
3
<PAGE>
Section 7. Proxies and Voting.
At any meeting of the stockholders, every stockholder entitled to vote
may vote in person or by proxy authorized by an instrument in writing filed in
accordance with the procedure established for the meeting. Any facsimile
telecommunication or other reliable reproduction of the writing or transmission
created pursuant to this paragraph may be substituted or used in lieu of the
original writing or transmission for any and all purposes for which the original
writing or transmission could be used, provided that such copy, facsimile
telecommunication or other reproduction shall be a complete reproduction of the
entire original writing or transmission.
All voting, including on the election of Directors but excepting where
otherwise required by law or by the governing documents of the Corporation, may
be made by a voice vote; provided, however, that upon demand therefor by a
stockholder entitled to vote or his or her proxy, a stock vote shall be taken.
Every stock vote shall be taken by ballot, each of which shall state the name of
the stockholder or proxy voting and such other information as may be required
under the procedures established for the meeting. The Corporation shall, in
advance of any meeting of stockholders, appoint one or more inspectors to act at
the meeting and make a written report thereof. The Corporation may designate one
or more persons as alternate inspectors to replace any inspector who fails to
act. If no inspector or alternate is able to act at a meeting of stockholders,
the person presiding at the meeting shall appoint one or more inspectors to act
at the meeting. Each inspector, before entering upon the discharge of his
duties, shall take and sign an oath faithfully to execute the duties of
inspector with strict impartiality and according to the best of his ability.
All elections shall be determined by a plurality of the votes cast, and
except as otherwise required by law or the Certificate of Incorporation, all
other matters shall be determined by a majority of the votes cast.
Section 8. Stock List.
A complete list of stockholders entitled to vote at any meeting of
stockholders, arranged in alphabetical order for each class of stock and showing
the address of each such stockholder and the number of shares registered in his
or her name, shall be open to the examination of any such stockholder, for any
purpose germane to the meeting, during ordinary business hours for a period of
at least ten (10) days prior to the meeting, either at a place within the city
where the meeting is to be held, which place shall be specified in the notice of
the meeting, or if not so specified, at the place where the meeting is to be
held.
The stock list shall also be kept at the place of the meeting during
the whole time thereof and shall be open to the examination of any such
stockholder who is present. This list shall presumptively determine the identity
of the stockholders entitled to vote at the meeting and the number of shares
held by each of them.
4
<PAGE>
Section 9. Consent of Stockholders in Lieu of Meeting.
Subject to the rights of the holders of any class or series of
preferred stock of the Corporation, any action required or permitted to be taken
by the stockholders of the Corporation must be effected at an annual or special
meeting of stockholders of the Corporation and may not be effected by any
consent in writing by such stockholders.
ARTICLE II - BOARD OF DIRECTORS
Section 1. General Powers, Number and Term of Office.
The business and affairs of the Corporation shall be under the
direction of its Board of Directors. The number of Directors who shall
constitute the Whole Board shall be such number as the Board of Directors shall
from time to time have designated, except that in the absence of such
designation shall be twelve (12). The Board of Directors shall annually elect a
Chairman of the Board from among its members who shall, when present, preside at
its meetings.
The Directors, other than those who may be elected by the holders of
any class or series of Preferred Stock, shall be divided, with respect to the
time for which they severally hold office, into three classes, with the term of
office of the first class to expire at the first annual meeting of stockholders,
the term of office of the second class to expire at the annual meeting of
stockholders one year thereafter and the term of office of the third class to
expire at the annual meeting of stockholders two years thereafter, with each
Director to hold office until his or her successor shall have been duly elected
and qualified. At each annual meeting of stockholders, Directors elected to
succeed those Directors whose terms then expire shall be elected for a term of
office to expire at the third succeeding annual meeting of stockholders after
their election, with each Director to hold office until his or her successor
shall have been duly elected and qualified.
Section 2. Vacancies and Newly Created Directorships.
Subject to the rights of the holders of any class or series of
Preferred Stock, and unless the Board of Directors otherwise determines, newly
created directorships resulting from any increase in the authorized number of
directors or any vacancies in the Board of Directors resulting from death,
resignation, retirement, disqualification, removal from office or other cause
may be filled only by a majority vote of the Directors then in office, though
less than a quorum, and Directors so chosen shall hold office for a term
expiring at the annual meeting of stockholders at which the term of office of
the class to which they have been elected expires and until such Director's
successor shall have been duly elected and qualified. No decrease in the number
of authorized directors constituting the Board shall shorten the term of any
incumbent Director.
5
<PAGE>
Section 3. Regular Meetings.
Regular meetings of the Board of Directors shall be held at such place
or places, on such date or dates, and at such time or times as shall have been
established by the Board of Directors and publicized among all Directors. A
notice of each regular meeting shall not be required.
Section 4. Special Meetings.
Special meetings of the Board of Directors may be called by one-third
(1/3) of the Directors then in office (rounded up to the nearest whole number),
by the Chairman of the Board or the President and shall be held at such place,
on such date, and at such time as they, or he or she, shall fix. Notice of the
place, date, and time of each such special meeting shall be given each Director
by whom it is not waived by mailing written notice not less than five (5) days
before the meeting or by telegraphing or telexing or by facsimile transmission
of the same not less than twenty-four (24) hours before the meeting. Unless
otherwise indicated in the notice thereof, any and all business may be
transacted at a special meeting.
Section 5. Quorum.
At any meeting of the Board of Directors, a majority of the Whole Board
shall constitute a quorum for all purposes. If a quorum shall fail to attend any
meeting, a majority of those present may adjourn the meeting to another place,
date, or time, without further notice or waiver thereof.
Section 6. Participation in Meetings By Conference Telephone.
Members of the Board of Directors are required to participate in
regular meetings (as defined in Article II, Section 3, of the Company's bylaws)
of such Board by being physically present in person at a minimum of
three-fourths of the Company" regular meetings scheduled within a calendar year.
Physical attendance in person for at least three-fourths of the Board's regular
meetings within a calendar year shall be a requirement for a director to be
qualified to serve as a director and the failure of a director to remain so
qualified shall result in the automatic termination of such director.
Members of the Board of Directors may participate in special meetings
(as defined in Article II, Section 4 of the Company's bylaws), or any committee
thereof, by means of confernce telephone, or similar communications equipment,
through which all persons participating in the meeting can hear each other. Such
participation shall constitute presence in person at such meeting.
Section 7. Conduct of Business.
At any meeting of the Board of Directors, business shall be transacted
in such order and manner as the Board may from time to time determine, and all
matters shall be determined by the vote of a majority of the Directors present,
except as otherwise provided herein or required by law. Action may be taken by
the Board of Directors without a meeting if all members thereof
6
<PAGE>
consent thereto in writing, and the writing or writings are filed with the
minutes of proceedings of the Board of Directors.
Section 8. Powers.
The Board of Directors may, except as otherwise required by law,
exercise all such powers and do all such acts and things as may be exercised or
done by the Corporation, including, without limiting the generality of the
foregoing, the unqualified power:
(1) To declare dividends from time to time in accordance with
law;
(2) To purchase or otherwise acquire any property, rights or
privileges on such terms as it shall determine;
(3) To authorize the creation, making and issuance, in such
form as it may determine, of written obligations of every kind,
negotiable or non-negotiable, secured or unsecured, and to do all
things necessary in connection therewith;
(4) To remove any Officer of the Corporation with or without
cause, and from time to time to devolve the powers and duties of any
Officer upon any other person for the time being;
(5) To confer upon any Officer of the Corporation the power to
appoint, remove and suspend subordinate Officers, employees and agents;
(6) To adopt from time to time such stock, option, stock
purchase, bonus or other compensation plans for Directors, Officers,
employees and agents of the Corporation and its subsidiaries as it may
determine;
(7) To adopt from time to time such insurance, retirement, and
other benefit plans for Directors, Officers, employees and agents of
the Corporation and its subsidiaries as it may determine; and
(8) To adopt from time to time regulations, not inconsistent
with these Bylaws, for the management of the Corporation's business and
affairs.
Section 9. Compensation of Directors.
Directors, as such, may receive, pursuant to resolution of the Board of
Directors, fixed fees and other compensation for their services as Directors,
including, without limitation, their services as members of committees of the
Board of Directors.
7
<PAGE>
ARTICLE III - COMMITTEES
Section 1. Committees of the Board of Directors.
The Board of Directors, by a vote of a majority of the Board of
Directors, may from time to time designate committees of the Board, with such
lawfully delegable powers and duties as it thereby confers, to serve at the
pleasure of the Board and shall, for these committees and any others provided
for herein, elect a Director or Directors to serve as the member or members,
designating, if it desires, other Directors as alternate members who may replace
any absent or disqualified member at any meeting of the committee. Any committee
so designated may exercise the power and authority of the Board of Directors to
declare a dividend, to authorize the issuance of stock or to adopt a certificate
of ownership and merger pursuant to Section 253 of the Delaware General
Corporation Law if the resolution which designates the committee or a
supplemental resolution of the Board of Directors shall so provide. In the
absence or disqualification of any member of any committee and any alternate
member in his or her place, the member or members of the committee present at
the meeting and not disqualified form voting, whether or not he or she or they
constitute a quorum, may by unanimous vote appoint another member of the Board
of Directors to act at the meeting in the place of the absent or disqualified
member.
Section 2. Conduct of Business.
Each committee may determine the procedural rules for meeting and
conducting its business and shall act in accordance therewith, except as
otherwise provided herein or required by law. Adequate provision shall be made
for notice to members of all meetings; one-third (1/3) of the members shall
constitute a quorum unless the committee shall consist of one (1) or two (2)
members, in which event one (1) member shall constitute a quorum; and all
matters shall be determined by a majority vote of the members present. Action
may be taken by any committee without a meeting if all members thereof consent
thereto in writing, and the writing or writings are filed with the minutes of
the proceedings of such committee.
Section 3. Nominating Committee.
The Board of Directors shall appoint a Nominating Committee of the
Board, consisting of not less than three (3) members. The Nominating Committee
shall have authority (a) to review any nominations for election to the Board of
Directors made by a stockholder of the Corporation pursuant to Section 6(c)(ii)
of Article I of these Bylaws in order to determine compliance with such Bylaw
and (b) to recommend to the Whole Board nominees for election to the Board of
Directors to replace those Directors whose terms expire at the annual meeting of
stockholders next ensuing.
8
<PAGE>
ARTICLE IV - OFFICERS
Section 1. Generally.
(a) The Board of Directors as soon as may be practicable after the
annual meeting of stockholders shall choose a Chairman of the Board and Chief
Executive Officer, a President, one or more Vice Presidents, a Secretary and a
Treasurer and from time to time may choose such other officers as it may deem
proper. The Chairman of the Board shall be chosen from among the Directors. Any
number of offices may be held by the same person.
(b) The term of office of all Officers shall be until the next annual
election of Officers and until their respective successors are chosen buy any
Officer may be removed from office at any time by the affirmative vote of a
majority of the authorized number of Directors then constituting the Board of
Directors.
(c) All Officers chosen by the Board of Directors shall have such
powers and duties as generally pertain to their respective Offices, subject to
the specific provisions of this ARTICLE IV. Such officers shall also have such
powers and duties as from time to time may be conferred by the Board of
Directors or by any committee thereof.
Section 2. Chairman of the Board of Directors and Chief Executive
Officer.
The Chairman of the Board and Chief Executive Officer shall, subject to
the provisions of these Bylaws and to the direction of the Board of Directors,
serve in general executive capacity and unless the Board has designated another
person, when present, shall preside at all meetings of the stockholders of the
Corporation. The Chairman of the Board and Chief Executive Officer shall perform
all duties and have all powers which are commonly incident to the office of
Chairman of the Board and Chief Executive Officer or which are delegated to him
or her by the Board of Directors. He or she shall have power to sign all stock
certificates, contracts and other instruments of the Corporation which are
authorized.
Section 3. President and Chief Operating Officer.
The President and Chief Operating Officer (the "President") shall have
responsibility for the management and control of the business and affairs of the
Corporation and shall perform all duties and have all powers which are commonly
incident to the offices of President and Chief Operating Officer or which are
delegated to him or her by the Board of Directors. Subject to the direction of
the Board of Directors, the President shall have power to sign all stock
certificates, contracts and other instruments of the Corporation which are
authorized and shall have general supervision of all of the other Officers
(other than the Chairman of the Board and Chief Executive Officer), employees
and agents of the Corporation.
Section 4. Vice President.
The Vice President or Vice Presidents shall perform the duties of the
President in his absence or during his inability to act. In addition, the Vice
Presidents shall perform the duties
9
<PAGE>
and exercise the powers usually incident to their respective offices and/or such
other duties and powers as may be properly assigned to them by the Board of
Directors, the Chairman of the Board or the President. A Vice President or Vice
Presidents may be designated as Executive Vice President or Senior Vice
President.
Section 5. Secretary.
The Secretary or Assistant Secretary shall issue notices of meetings,
shall keep their minutes, shall have charge of the seal and the corporate books,
shall perform such other duties and exercise such other powers as are usually
incident to such office and/or such other duties and powers as are properly
assigned thereto by the Board of Directors, the Chairman of the Board or the
President. Subject to the direction of the Board of Directors, the Secretary
shall have the power to sign all stock certificates.
Section 6. Treasurer.
The Treasurer shall be the Comptroller of the Corporation and shall
have the responsibility for maintaining the financial records of the
Corporation. He or she shall make such disbursements of the funds of the
Corporation as are authorized and shall render from time to time an account of
all such transactions and of the financial condition of the Corporation. The
Treasurer shall also perform such other duties as the Board of Directors may
from time to time prescribe. Subject to the direction of the Board of Directors,
the Treasurer shall have the power to sign all stock certificates.
Section 7. Assistant Secretaries and Other Officers.
The Board of Directors may appoint one or more Assistant Secretaries
and such other Officers who shall have such powers and shall perform such duties
as are provided in these Bylaws or as may be assigned to them by the Board of
Directors, the Chairman of the Board or the President.
Section 8. Action with Respect to Securities of Other Corporations.
Unless otherwise directed by the Board of Directors, the President or
any Officer of the Corporation authorized by the President shall have power to
vote and otherwise act on behalf of the Corporation, in person or by proxy, at
any meeting of stockholders of or with respect to any action of stockholders of
any other corporation in which this Corporation may hold securities and
otherwise to exercise any and all rights and powers which this Corporation may
possess by reason of its ownership of securities in such other corporation.
10
<PAGE>
ARTICLE V - STOCK
Section 1. Certificates of Stock.
Each stockholder shall be entitled to a certificate signed by, or in
the name of the Corporation by, the Chairman of the Board or the President, and
by the Secretary or an Assistant Secretary, or any Treasurer or Assistant
Treasurer, certifying the number of shares owned by him or her. Any or all of
the signatures on the certificate may be by facsimile.
Section 2. Transfers of Stock.
Transfers of stock shall be made only upon the transfer books of the
Corporation kept at an office of the Corporation or by transfer agents
designated to transfer shares of the stock of the Corporation. Except where a
certificate is issued in accordance with Section 4 of Article V of these Bylaws,
an outstanding certificate for the number of shares involved shall be
surrendered for cancellation before a new certificate is issued therefor.
Section 3. Record Date.
In order that the Corporation may determine the stockholders entitled
to notice of or to vote at any meeting of stockholders, or to receive payment of
any dividend or other distribution or allotment of any rights or to exercise any
rights in respect of any change, conversion or exchange of stock or for the
purpose of any other lawful action, the Board of Directors may fix a record
date, which record date shall not precede the date on which the resolution
fixing the record date is adopted and which record date shall not be more than
sixty (60) nor less than ten (10) days before the date of any meeting of
stockholders, nor more than sixty (60) days prior to the time for such other
action as hereinbefore described; provided, however, that if no record date is
fixed by the Board of Directors, the record date for determining stockholders
entitled to notice of or to vote at a meeting of stockholders shall be at the
close of business on the day next preceding the day on which notice is given or,
if notice is waived, at the close of business on the next day preceding the day
on which the meeting is held, and, for determining stockholders entitled to
receive payment of any dividend or other distribution or allotment or rights or
to exercise any rights of change, conversion or exchange of stock or for any
other purpose, the record date shall be at the close of business on the day on
which the Board of Directors adopts a resolution relating thereto.
A determination of stockholders of record entitled to notice of or to
vote at a meeting of stockholders shall apply to any adjournment of the meeting;
provided, however, that the Board of Directors may fix a new record date for the
adjourned meeting.
Section 4. Lost, Stolen or Destroyed Certificates.
In the event of the loss, theft or destruction of any certificate of
stock, another may be issued in its place pursuant to such regulations as the
Board of Directors may establish concerning proof of such loss, theft or
destruction and concerning the giving of a satisfactory bond or bonds of
indemnity.
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Section 5. Regulations.
The issue, transfer, conversion and registration of certificates of
stock shall be governed by such other regulations as the Board of Directors may
establish.
ARTICLE VI - NOTICES
Section 1. Notices.
Except as otherwise specifically provided herein or required by law,
all notices required to be given to any stockholder, Director, Officer, employee
or agent shall be in writing and may in every instance be effectively given by
hand delivery to the recipient thereof, by depositing such notice in the mails,
postage paid, or by sending such notice by prepaid telegram or mailgram or other
courier. Any such notice shall be addressed to such stockholder, Director,
Officer, employee or agent at his or her last known address as the same appears
on the books of the Corporation. The time when such notice is received, if hand
delivered, or dispatched, if delivered through the mails or by telegram or
mailgram or other courier, shall be the time of the giving of the notice.
Section 2. Waivers.
A written waiver of any notice, signed by a stockholder, Director,
Officer, employee or agent, whether before or after the time of the event for
which notice is to be given, shall be deemed equivalent to the notice required
to be given to such stockholder, Director, Officer, employee or agent. Neither
the business nor the purpose of any meeting need be specified in such a waiver.
ARTICLE VII - MISCELLANEOUS
Section 1. Facsimile Signatures.
In addition to the provisions for use of facsimile signatures elsewhere
specifically authorized in these Bylaws, facsimile signatures of any officer or
officers of the Corporation may be used whenever and as authorized by the Board
of Directors or a committee thereof:
Section 2. Corporate Seal.
The Board of Directors may provide a suitable seal, containing the name
of the Corporation, which seal shall be in the charge of the Secretary. If and
when so directed by the Board of Directors or a committee thereof, duplicates of
the seal may be kept and used by the Treasurer or by an Assistant Secretary or
an assistant to the Treasurer.
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Section 3. Reliance Upon Books, Reports and Records.
Each Director, each member of any committee designated by the Board of
Directors, and each Officer of the Corporation shall, in the performance of his
or her duties, be fully protected in relying in good faith upon the books of
account or other records of the Corporation and upon such information, opinions,
reports or statements presented to the Corporation by any of its Officers or
employees, or committees of the Board of Directors so designated, or by any
other person as to matters which such Director or committee member reasonably
believes are within such other person's professional or expert competence and
who has been selected with reasonable care by or on behalf of the Corporation.
Section 4. Fiscal Year.
The fiscal year of the Corporation shall be as fixed by the Board of
Directors.
Section 5. Time Periods.
In applying any provision of these Bylaws which requires that an act be
done or not be done a specified number of days prior to an event or that an act
be done during a period of a specified number of days prior to an event,
calendar days shall be used, the day of the doing of the act shall be excluded,
and the day of the event shall be included.
ARTICLE VIII - AMENDMENTS
The Board of Directors may amend, alter or repeal these Bylaws at any
meeting of the Board, provided notice of the proposed change was given not less
than two days prior to the meeting. The stockholders shall also have power to
amend, alter or repeal these Bylaws at any meeting of stockholders provided
notice of the proposed change was given in the notice of the meeting; provided,
however, that, notwithstanding any other provisions of the Bylaws or any
provision of law which might otherwise permit a lesser vote or no vote, but in
addition to any affirmative vote of the holders of any particular class or
series of the voting stock required by law, the Certificate of Incorporation,
any Preferred Stock Designation or these Bylaws, the affirmative votes of the
holders of at least 80% of the voting power of all the then-outstanding shares
of the Voting Stock, voting together as a single class, shall be required to
alter, amend or repeal any provisions of these Bylaws.
The above Bylaws were adopted as of July 28th, 1994, the date of incorporation
of Monterey Bay Bancorp, Inc. and were amended and restated as of January 28,
1999.
13
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
<PAGE>
<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
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No's.
33-99112 and 333-6859 on Form S-8 of Monterey Bay Bancorp, Inc. of our report
dated February 6, 1999, appearing in this Annual Report on Form 10-K of Monterey
Bay Bancorp, Inc. for the year ended December 31, 1998.
/s/ Deloitte & Touche LLP
San Francisco, California
March 30, 1999
40
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 9,459
<INT-BEARING-DEPOSITS> 7,492
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 117,416
<INVESTMENTS-CARRYING> 97
<INVESTMENTS-MARKET> 96
<LOANS> 301,555
<ALLOWANCE> (2,780)
<TOTAL-ASSETS> 454,819
<DEPOSITS> 370,677
<SHORT-TERM> 7,090
<LIABILITIES-OTHER> 2,581
<LONG-TERM> 32,582
0
0
<COMMON> 45
<OTHER-SE> 41,844
<TOTAL-LIABILITIES-AND-EQUITY> 454,819
<INTEREST-LOAN> 20,882
<INTEREST-INVEST> 10,029
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 30,911
<INTEREST-DEPOSIT> 16,628
<INTEREST-EXPENSE> 18,588
<INTEREST-INCOME-NET> 12,323
<LOAN-LOSSES> 692
<SECURITIES-GAINS> 283
<EXPENSE-OTHER> 11,144
<INCOME-PRETAX> 2,664
<INCOME-PRE-EXTRAORDINARY> 2,664
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,436
<EPS-PRIMARY> .40
<EPS-DILUTED> .38
<YIELD-ACTUAL> 7.43
<LOANS-NON> 1,496
<LOANS-PAST> 0
<LOANS-TROUBLED> 1,437
<LOANS-PROBLEM> 839
<ALLOWANCE-OPEN> 1,669
<CHARGE-OFFS> 0
<RECOVERIES> 2
<ALLOWANCE-CLOSE> 2,780
<ALLOWANCE-DOMESTIC> 2,780
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
