SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act
of 1934 For the fiscal year ended December 31, 2002
Commission File Number: 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
Incorporation Or Organization) Identification Number)
567 Auto Center Drive, Watsonville, California 95076
(Address Of Principal Executive Offices)(Zip Code)
(831) 768 - 4800
(Registrant's Telephone Number, Including Area Code)
(831) 722 - 6794
(Registrant's Facsimile Number, Including Area Code)
WWW.MONTEREYBAYBANK.COM
(Registrant's Internet Site)
INFO@MONTEREYBAYBANK.COM
(Registrant's Electronic Mail Address)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value 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 this Form 10-K or any
amendment to this Form 10-K. [ X ]
1
Monterey Bay Bancorp, Inc.
Form 10-K
Cover Page, Continued
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
Yes No X .
---------- ---------
The aggregate market value of the Common Stock held by "non-affiliates"
of the registrant, based upon the closing price of its Common Stock on March 5,
2003 of $20.18, as quoted on the Nasdaq National Market System, was
approximately $38,779,000. The aggregate market value of the Common Stock held
by "non-affiliates" of the registrant, based upon the closing price of its
Common Stock on June 28, 2002 (the last business day of the registrant's most
recently completed second fiscal quarter) of $18.00, as quoted on the Nasdaq
National Market System, was approximately $36,915,000. Shares of common stock
held by each officer, director, and holder of 5% or more of the outstanding
Common Stock have been excluded in that such persons or entities may be deemed
to be affiliates. Such determination of affiliate status is not necessarily a
conclusive determination for other purposes.
The registrant had 3,460,974 shares of Common Stock outstanding as of
March 20, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2003 Annual Meeting
of Stockholders to be filed within 120 days of the fiscal year ended December
31, 2002 are incorporated by reference into Part III of this Form 10-K.
2
INDEX
PAGE
Introduction and Availability of Information........................................................4
PART I
Item 1. Business............................................................................................5
Item 2. Properties.........................................................................................76
Item 3. Legal Proceedings..................................................................................77
Item 4. Submission of Matters to a Vote of Security Holders................................................77
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..............................77
Item 6. Selected Financial Data............................................................................78
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..............80
Item 7a. Quantitative and Qualitative Disclosures About Market Risk........................................109
Item 8. Financial Statements and Supplementary Data.......................................................114
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..............159
PART III
Item 10. Directors and Executive Officers of the Registrant................................................159
Item 11. Executive Compensation............................................................................159
Item 12. Security Ownership of Certain Beneficial Owners and Management....................................159
Item 13. Certain Relationships and Related Transactions....................................................159
Item 14. Controls and Procedures...........................................................................159
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................160
Signature Page......................................................................................................162
Certifications Pursuant To Section 302 Of The Sarbanes-Oxley Act Of 2002............................................163
3
INTRODUCTION
Discussions of certain matters in this Annual Report on Form 10-K may
constitute forward-looking statements within the meaning of the Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities and
Exchange Act of 1934, as amended (the "Exchange Act"), and as such, may involve
risks and uncertainties. Forward-looking statements, which are based on certain
assumptions and describe future plans, strategies, and expectations, are
generally identifiable by the use of words or phrases such as "believe", "plan",
"expect", "intend", "anticipate", "estimate", "project", "forecast", "may
increase", "may fluctuate", "may improve" and similar expressions or future or
conditional verbs such as "will", "should", "would", and "could". These
forward-looking statements relate to, among other things, expectations of the
business environment in which Monterey Bay Bancorp, Inc. operates, opportunities
and expectations regarding technologies, anticipated performance or
contributions from new and existing employees, projections of future
performance, potential future credit experience, possible changes in laws and
regulations, potential risks and benefits arising from the implementation of the
Company's strategic and tactical plans, perceived opportunities in the market,
potential actions of significant stockholders and investment banking firms, the
potential impact of past and possible future terrorist or military actions upon
consumer confidence, income, and spending, and statements regarding the
Company's mission and vision. The Company's actual results, performance, and
achievements may differ materially from the results, performance, and
achievements expressed or implied in such forward-looking statements due to a
wide range of factors. For a discussion of some of the factors that might cause
such a difference, including, but not limited to, changes in interest rates,
general economic conditions, technology, legislative and regulatory changes,
monetary and fiscal policies of the US Government, US Treasury, and Federal
Reserve, real estate valuations, and competition in the financial services
industry, see "Item 1. Business - Risk Factors That May Affect Future Results."
These factors should be considered in evaluating the forward-looking statements,
and undue reliance should not be placed on such statements. The Company does not
undertake, and specifically disclaims any obligation, to update any
forward-looking statements to reflect occurrences or unanticipated events or
circumstances after the date of such statements.
AVAILABILITY OF INFORMATION
Reports filed with the Securities and Exchange Commission ("SEC")
including proxy statements and other information can be inspected and copied at
the public reference facilities of the SEC at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549 and 500 West Madison Street, Suite 1400, Chicago, IL.
60661. Copies of such materials can be obtained from the Public Reference
Section of the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. The SEC maintains an Internet site that contains reports,
proxy, and information statements and other information. The address of the site
is http://www.sec.gov.
Monterey Bay Bancorp, Inc. makes available free of charge through its
Internet site its Annual Report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports as soon as
reasonably practicable after such material is electronically filed with or
furnished to the SEC. The Internet site address for Monterey Bay Bancorp, Inc.
is http://www.montereybaybank.com.
Additional corporate information regarding Monterey Bay Bancorp, Inc.
and Monterey Bay bank is also available at the www.montereybaybank.com Internet
site. This Internet site is not a part of this Annual Report on Form 10-K.
4
PART I
Item 1. Business
General
Monterey Bay Bancorp, Inc. (referred to herein on an unconsolidated
basis as "MBBC" and on a consolidated basis as the "Company") is a unitary
savings and loan holding company incorporated in 1994 under the laws of the
state of Delaware. MBBC currently maintains a single subsidiary company,
Monterey Bay Bank (the "Bank"), formerly Watsonville Federal Savings and Loan
Association. The Bank is a federally chartered savings and loan association
organized under the laws of the United States of America. The Bank was founded
in 1925. MBBC 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 principal executive offices of the Company and the Bank are located
at 567 Auto Center Drive, Watsonville, California, 95076, telephone number (831)
768 - 4800, facsimile number (831) 722 - 6794. The Company may also be contacted
via electronic mail at: INFO@MONTEREYBAYBANK.COM.
At December 31, 2002, the Company had $609.7 million in total assets,
$523.5 million in net loans receivable, and $458.3 million in total deposits.
The Company is subject to regulation by the Office of Thrift Supervision
("OTS"), the Federal Deposit Insurance Corporation ("FDIC"), and the SEC. The
Bank is subject to certain regulations of the Board of Governors of the Federal
Reserve System ("FRB") with respect to reserves required to be maintained
against deposits and certain other matters.
The Bank is a member of the Federal Home Loan Bank ("FHLB") of San
Francisco, which is one of the twelve regional banks comprising the Federal Home
Loan Bank System. The Bank's deposits are insured by the FDIC to the maximum
extent permitted by law.
The Company conducts business from eight full-service branch offices in
its primary market area in Central California, one loan production office in Los
Angeles, 11 automated teller machines ("ATM's") including two stand-alone ATM's,
and its administrative facilities in Watsonville, California. The Company's
headquarters building in Watsonville also functions as a limited service branch
office. In addition, in March 2003, the Company was in the process of finalizing
a lease for a full service de novo branch in Pacific Grove, California, within
its primary market area. Should a final lease be executed and all regulatory and
local approvals and permits be obtained in a timely manner, the Company
anticipates opening the new full service branch in the third quarter of 2003.
The Company also supports its customers through Internet Banking for
both consumers and businesses, 24 hour bilingual (English / Spanish) telephone
banking, electronic bill payment, remote deposit capability, courier service,
bank by mail, night depository, and ATM access through an array of ATM networks
including STAR, CIRRUS, and PLUS.
5
Through its network of banking offices, the Bank emphasizes
personalized service in assisting individuals, families, professionals,
community organizations, non-profit organizations, and businesses in attaining
their financial objectives. The Bank offers a wide complement of lending
products, including:
o a broad array of residential mortgage products, both fixed and adjustable
rate
o consumer loans, including home equity lines of credit and overdraft lines
of credit
o specialized financing programs to support community development
o mortgages for multifamily real estate
o commercial and industrial real estate loans
o construction lending for single family residences, apartment buildings, and
commercial real estate
o commercial loans to businesses, including both revolving lines of credit
and term loans
The Bank also provides an extensive selection of deposit instruments. These
include:
o multiple checking products for both personal and business accounts, with
imaged statements available
o various savings accounts
o tiered money market accounts offering a variety of access methods
o tax qualified deposit accounts (e.g. IRA's)
o a broad array of certificate of deposit products
Through its wholly-owned subsidiary, Portola Investment Corporation
("Portola"), the Bank provides, on an agency basis, life insurance (term, whole
life, and universal life insurance), long term care insurance, tax qualified
plans including Section 529 plans and 401(k) plans, and a wide selection of
non-FDIC insured investment products including:
o fixed annuities
o variable annuities
o an extensive inventory of mutual funds
o individual fixed income and equity securities
Please see "Subsidiary Activities" for additional information regarding business
activities by Portola.
The Bank also supports its customers by functioning as a federal tax
depository, selling and purchasing foreign banknotes, issuing debit and ATM
cards, providing domestic and international collection services, furnishing
trade finance services, and supplying various forms of electronic funds
transfer.
The Company participates in the wholesale capital markets through the
management of its security portfolio and its use of various forms of wholesale
funding. The Company's security portfolio contains a variety of instruments,
including collateralized mortgage obligations ("CMO's"). The Company also
participates in the secondary market for loans as both a purchaser and a seller
of various types of loan products.
The Company's revenues are primarily derived from interest on its loan
and mortgage backed securities portfolios, interest and dividends on its
investment securities, and fee income associated with the provision of various
customer services. Interest paid on deposits and borrowings typically
constitutes the Company's largest type of expense. The Company's primary sources
of funds are deposits, principal and interest payments on its asset portfolios,
and various sources of wholesale borrowings including FHLB advances, federal
funds purchased, and securities sold under agreements to repurchase. The
Company's most significant operating expenditures are its staffing expenses and
the costs associated with maintaining its branch network.
Additional information concerning the Company's business is presented
under "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
6
Company Strategy
During the past several years, the Company has implemented a business
strategy of evolving away from its traditional savings and loan roots and into a
community focused commercial bank serving the financial needs of individuals,
families, professionals, organizations, and businesses. This business strategy
was selected:
o so that the Company might better and more completely address the financial
needs of the communities it serves
o because of the constrained financial returns associated with the
traditional thrift business of funding residential mortgage loans with
certificates of deposit for entities the size of the Bank
o due to the increasing commoditization of residential mortgages, spurred by
new technologies and revised business practices supported by Federal
Agencies such as the Federal National Mortgage Association ("FNMA" or
"Fannie Mae") and the Federal Home Loan Mortgage Corporation ("FHLMC" or
"Freddie Mac")
o to augment stockholder value, as the Company believes that successful
community commercial banks generally receive a more favorable valuation in
the capital markets than traditional savings and loans
o to develop more robust and recurring sources of income
The Company's community commercial banking strategy incorporates:
o a relationship based approach to customer service, marketing, product
design, and pricing
o a focus on understanding the profile and objectives of the Company's
customers as a means to provide enhanced service while also supporting
credit quality
o a high level of community involvement and visibility by the Company, its
directors, and its employees
o a balance sheet profile presenting loan and deposit portfolios diversified
among multiple products
o a ratio of net loans to total assets of between 85.0% and 90.0%
o income property, construction, and commercial business loans representing a
greater percentage of total loans than has been maintained in the past,
with a reduced concentration in residential mortgages
o a deposit mix with a greater percentage of transaction accounts than has
been maintained in the past, with a lower concentration of certificates of
deposit
o increasing fee income to a greater portion of total revenue than
historically generated
o utilizing new technologies to better meet the financial needs of
individuals, families, professionals, and businesses
The Company's business strategy incorporates consideration of a future
conversion to a commercial bank charter. Such a change in charter to either a
California State chartered commercial bank or a nationally chartered commercial
bank would be primarily driven by the Bank's changing asset mix, as the Bank
expects to eventually fall below the minimum thresholds for federally chartered
thrifts under the Qualified Thrift Lender ("QTL") test as it conducts additional
commercial real estate and commercial business lending. At December 31, 2002,
the Bank was under no immediate pressure to pursue a change in charter, as the
Bank's QTL ratio at that time was 68.4%, compared to a regulatory minimum of
65.0%. In addition, the Bank has certain elections available that would allow
continued operation as a federally chartered thrift even with a QTL ratio below
65.0%.
7
As discussed below and throughout this Annual Report, the Company has
achieved progress in regards to its strategic plan over the past several years,
including some particular accomplishments in 2002.
Key Company Accomplishments
In general, the Company's recent accomplishments can be grouped into four
categories:
1. The achievement of historically favorable financial results in 2002,
including:
A. the generation of the highest levels of net income and
earnings per share in the Company's history, with six
consecutive quarters of record quarterly earnings through the
quarter ended December 31, 2002
B. increases in return on average assets and return on average
stockholders' equity to the highest annual levels in the
Company's history
C. significant improvement in the Company's efficiency ratio,
with such ratio declining from 64.41% in 2001 to 55.78% in
2002 (53.41% during the fourth quarter of 2002)
D. a rise in the Company's stock price from $15.50 per share at
December 31, 2001 to $19.95 per share at December 31, 2002
despite a challenging capital markets environment
2. The increased visibility of the Bank, which in turn led to greater
volumes of business, as a result of:
A. a further expansion in the Company's commitment to its local
communities, as exemplified by the Bank's active support of a
wider range of community organizations and events, and by an
increased amount of time donated by the Company's directors
and employees
B. increased advertising aimed at heightening local market
awareness of the expanded range of financial services offered
by the Company
3. The continued investment in and implementation of the human resource,
product inventory, distribution channel, and technology foundations
necessary to successfully implement the Company's business strategy,
including:
A. the recruitment in early 2003 of a veteran commercial banker
with in-market experience to serve as the Bank's Director of
Retail Banking
B. the hiring of additional commercial business relationship
officers and experienced commercial bank branch managers
C. the introduction of remote deposit services, Internet banking
for businesses, letters of credit, and new deposit products
for both businesses and individuals
D. the opening of the Los Angeles loan production office during
the first quarter of 2002
E. the designation of the Bank's administrative headquarters as
an additional (limited service) branch office
F. identification of a desirable site for a de novo full service
branch in the Bank's primary market area
G. upgrades of the Company's telecommunications network, primary
data processing equipment, and disaster recovery capabilities
4. The enhancement of stockholder value, as subsequently discussed
8
Additional information regarding the Company's strategic plan and its
accomplishments in relation thereto is presented in the following paragraphs and
throughout this Annual Report.
The loan portfolio product mix of loans held for investment shifted
during 2002 in conformity with the Company's strategic plan. Residential one to
four unit loans declined from 42.2% of gross loans held for investment at
December 31, 2001 to 33.1% at December 31, 2002. In contrast, commercial and
industrial real estate loans rose from 22.7% to 24.7%, construction loans
increased from 7.9% to 12.3%, land loans increased from 2.5% to 4.4%, commercial
business loans rose from 1.8% to 3.1%, and consumer loans (primarily home equity
lines of credit) increased from 1.5% to 1.6%. This change in loan mix was
facilitated by the commercial business and real estate relationship officers the
Company hired over the past year and by the new Los Angeles loan production
office, which concentrates on income property and construction lending. This
loan production office is managed by a veteran banker with significant
experience in Southern California, long-standing relationships with area
developers and property investors, and particular expertise in marketing and
underwriting construction and income property credits. The opening of this
office advanced the geographic diversification of the Company's real estate loan
portfolio, which has been historically concentrated in the California counties
of Santa Cruz, Monterey, and Santa Clara.
At December 31, 2002, certificates of deposits constituted 53.8% of the
deposit portfolio, down from 56.4% at December 31, 2001. Certificates of deposit
would have reflected a smaller percentage of the deposit portfolio at December
31, 2002 if not for the Bank's:
o acquiring an additional net $9.0 million in certificates of deposit through
the State of California Time Deposit Program during 2002, whereby the State
of California makes deposits available to support reinvestment back into
California communities
o issuing a $20.0 million brokered CD in May 2002 to provide funding for the
Company's strong loan demand
Over the past several years, the Company has emphasized checking and
money market accounts in its marketing, new product development, and advertising
as a means of cementing its relationship with its customers, decreasing its
relative cost of funds, and bolstering non-interest income.
The Company's strategy of transitioning into a community commercial
bank also incorporates increasing the percentage of the Company's total revenues
generated from fees and service charges, as compared to net interest income. In
this regard, the Company has expanded its scope of fee based services, altered
its pricing, and enhanced the product line offered through Portola.
In implementing its business strategy, the Company intends to continue
enhancing its inventory of financial products targeted at both businesses and
individuals. In 2003, the Company plans to:
o expand its full service branch hours for Mondays through Thursdays
o offer payroll and merchant bankcard services for business through
third-party relationships
o introduce several consumer relationship products, whereby individuals
benefit from expanding their overall relationship with the Company
The Company intends to complement the new technology implemented in
2001 and 2002 during the coming year with a new item processing environment,
enhanced customer statements, and various ancillary systems such as current
generation safe deposit box management software.
9
Throughout 2002, the Company maintained its commitment to support the
quality of life in the Greater Monterey Bay Area. Employees are encouraged to be
involved with local community and service organizations. A significant
contribution was made to advance post-secondary education, and other charitable
donations of funds or services were conducted throughout the year. As just one
example, during the months of November and December 2002, the Company focused
its efforts on helping the less fortunate by providing food and donations to
local food banks through a Holiday Food Drive Campaign. Each of the Bank's eight
branches as well as the Administrative Headquarters served as public collection
sites promoting donations of non-perishable food items. Through the combined
efforts of employees, directors, customers, and the general public, the Company
collected the equivalent of over 7,000 pounds of food.
The Company employs a Director of Community Relations, whose
responsibilities include further enhancing the Company's visibility in the
Greater Monterey Bay Area, improving the effectiveness of the Company's
community relations program, and coordinating employee and director
participation in local chambers of commerce and Rotary organizations, in
addition to many special community, charity, and educational events.
The implementation of the Company's business strategy presents various
costs and risks. In general, the Company incurs operating and capital expenses
in advance of associated revenues, as the human and technology resources
necessary to implement the strategic plan must be in place before new sales can
be generated. The amount of change concomitant with this strategy, particularly
given the relatively rapid pace of implementation undertaken by the Company,
presents significant execution risks. Some of these execution risks include
exposure in the implementation of new technology, the delivery of financial
products and services with greater innate levels of operating risk, and the
greater credit risk inherent in consumer and commercial (versus mortgage)
lending. The Company has endeavored to mitigate these risks, in part, by:
o recruiting experienced commercial bankers for open positions within the
Company
o hiring certain professionals on a consulting basis to provide technical
assistance, risk assessment and testing, and asset quality review
o increasing its allowance for loan losses in both nominal and relative terms
in conformity with the change in inherent risk present in the loan
portfolio
The Company's Board of Directors has evolved over the past three years,
with new directors adding skills in corporate governance, financial expertise,
an appreciation of the importance of advancing stockholder value, and the
capacity to refer local business to the Company.
In 2003, the Company intends to continue pursuing the business strategy
outlined above. Furthermore, the Company plans to explore avenues for further
growth in product diversification and market share, including the purchase of
banking branches in the Greater Monterey Bay Area, the opening of a de novo full
service branch in Pacific Grove, and / or an alignment with new vendors that can
facilitate the more rapid implementation of the strategic plan.
10
Stockholder Value
A key aspect of the Company's business strategy is to enhance
stockholder value. The Company's efforts and achievements in this regard have
included:
o Since 1995, the Company has repurchased over 1.3 million of its common
shares, including 61,000 shares during 2002. At December 31, 2002, there
were 53,035 remaining shares authorized for repurchase under the Company's
current repurchase program.
o The Company's directors continued to receive their retainer fees in Company
common stock during 2002.
o The Company's bylaws specify a minimum stock ownership requirement for all
Directors.
o The Company's executive management volunteered to accept a portion of their
2002 cash incentive compensation in Company common stock, repeating
elections made in prior years.
o The Company's employee stock option plan provides that stock options are
issued at 110% of the fair market value of the Company's stock on the date
of grant, versus the 100% level prevalent in the financial services
industry.
o Incentive stock options have been awarded to the vast majority of managers
in the Company, thus encouraging alignment of employee interests with those
of stockholders.
o The addition of new market makers for the Company's common stock.
At its October 2002 meeting, the MBBC Board of Directors approved an
increase in the total Company stock ownership requirement for Directors, subject
to certain conditions, from 1,000 shares to 5,000 shares. All of the Company's
directors owned at least 5,000 shares of the Company's common stock at December
31, 2002, with the exception of Ms. Rita Alves, a recently appointed director.
Per the terms of the Bylaws, Ms. Alves has until September 2003 to cumulatively
purchase 1,000 shares of the Company's common stock. In addition, Ms. Alves has
until September 2005 to own at least 5,000 shares of the Company's common stock.
At December 31, 2002, Ms. Alves owned 401 shares of the Company's common stock.
Effective November 1, 2002, the Company's directors adopted a revised
director fee program. The new program provides for all director compensation of
any type, other than travel reimbursement, to be paid exclusively in Company
common stock on a quarterly basis. In addition, base retainer fees were reduced,
with new fees implemented based upon meeting attendance and the number of Board
committees served. In adopting the new director fee plan, the Board sought to
even more closely align their compensation with stockholder interests by making
director compensation more performance and activity based. Total annual costs
under the new director fee plan are projected to be close to those associated
with the prior program that was primarily focused upon flat retainer fees.
The Company's directors and officers continued to be net purchasers of
the Company's common stock during 2002, with recurring purchases by the
Company's Chief Executive Officer, Chief Financial Officer, and Chief Loan
Officer.
11
A significant number of the Bank's employees have an ownership interest
in the Company, through one or more of the following:
o direct stock purchases
o the Employee Stock Ownership Plan ("ESOP")
o incentive stock options
o stock grant awards
o stock purchased with funds contributed by employees to the Bank's 401(k)
Plan (Company common stock is one of twelve investment options)
In addition, the Company maintains a relationship with an investment
banking firm specializing in the financial services industry as a means of:
o supporting a number of initiatives aimed at increasing stockholder value
o obtaining advice regarding balance sheet, interest rate risk, and capital
management
o acquiring expanded competitive information and market intelligence
o advising the Board of Directors and Management regarding trends, risks, and
tactical and strategic opportunities within the financial services industry
In 2003, the Company intends to pursue additional equity analyst
coverage and continuing to leverage the growing capital base in order to support
further expansion in return on average stockholders' equity.
The Board of Directors and Management have targeted the transformation
strategy into a community focused commercial bank based on their belief that
this approach presents the best current opportunity to enhance long term
stockholder value.
Corporate Governance
The Company supports strong corporate governance and has adopted
policies and procedures designed to facilitate quality corporate governance. The
Company's profile in regards to corporate governance at December 31, 2002
included the following:
1. All directors other than the Chief Executive Officer are outside directors
with no executive position with the Company.
2. No outside directors are under consulting or similar contracts with the
Company.
3. During 2002, the Board Audit Committee held 12 meetings.
4. Members of the Board Audit Committee include two active chief financial
officers of private companies and one retired bank chief executive officer.
The Company added the second active chief financial officer to its Board of
Directors in the past year, with that individual also serving on the Board
Audit Committee.
12
5. All services provided by the independent auditor must be approved in
advance by the Board Audit Committee.
6. The Board Audit Committee approves the annual internal audit plan and
reviews all internal audit reports, credit review reports, and regulatory
examinations, including Management's written response thereto.
7. The Chairman of the Board Audit Committee discusses the Company's financial
results, accounting, condition, and internal controls with the independent
auditor at least quarterly.
8. The Company has in place a "whistle-blowing procedure" whereby the Chairman
of the Audit Committee may be confidentially and anonymously contacted by
any Company employee. The Company's policy provides protections to
whistle-blowing employees from retaliation and other adverse responses to
whistle-blowing.
9. The Company maintains a Code of Ethics And Standards of Personal Conduct
policy for all employees and a Code of Ethics policy for directors. These
policies:
A. emphasize the importance of complying with all laws and
regulations and conducting business for the Company in an
ethical and honest manner
B. require employees and directors to report in writing any
actual or potential conflicts of interest
C. govern the acceptance of gifts by employees
D. restrict Company political contributions and activities
E. govern lending practices
F. support the maintenance of Company and customer
confidentiality in conformity with laws and regulations
G. provide guidance for directors and employees in regards to
various business activities where ethics are exposed to
potential compromise
H. address other topics and issues which could create a conflict
of interest or present ethical issues to the Company, its
directors, and its employees
I. delineate accountability for adherence to the policies
10. The Company maintains an Insider Trading policy that requires all directors
and Section 16 SEC reporting officers to obtain approval prior to
conducting any transactions in the Company's common stock and to comply
with all applicable laws and regulations associated with insider trading.
This policy also prohibits insiders from selling the Company's common stock
"short".
11. All loans to directors and officers of the Company are in compliance with
FRB Regulation O.
13
Market Area and Competition
Market Area. The Bank is a community-oriented financial institution
that originates residential, multifamily, construction, land, commercial real
estate, consumer, and commercial business loans within its primary market area
in Central California surrounding Monterey Bay. In addition, the Bank originates
primarily income property and construction loans through its Los Angeles loan
production office, participates in construction and income property lending with
other California based community and correspondent banks, and purchases loans
secured by real estate generally located between San Francisco Bay Area and San
Diego as a means of geographically diversifying its loan portfolio and in
conjunction with its asset / liability management program. The Company conducts
only limited business north of the San Francisco Bay Area and east of the
Central Valley of California. The Company conducts only a minor volume of
business outside the State of California.
The economy in the Company's primary market areas in Santa Cruz,
Monterey, and Santa Clara Counties has historically been primarily agricultural.
However, in recent years, other economic segments have assumed a larger portion
of total business activity, caused in part by the continuing southward expansion
of the San Francisco Bay Area. These newer and in some cases relatively rapidly
expanding segments include:
o an increasing professional presence, both in commercial property and in
residential housing, as technology related companies have expanded
southward, primarily down the Highway 101 corridor
o light manufacturing, taking advantage of the availability of land and
pro-business orientation of certain cities
o post-secondary education
o tourism and marine biology, especially in the coastal communities on
Monterey Bay
o residential construction, supported by the historically low interest rate
environment of the past 18 months and by the lower cost of land versus much
of the San Francisco Bay Area
The Company's primary market areas were adversely impacted during 2002
by:
o the limited pace of national economic expansion
o an increase in local unemployment rates, particularly in Santa Clara County
o the difficulties experienced by the technology industry following the
significant reduction in the NASDAQ Index in recent years, constrained
investment by businesses, and limited availability of venture capital
financing
o weakness in the telecommunications industry
o concerns over the potential effects of a record budget deficit by the State
of California
o the potential ongoing impact of and possible resolution of issues stemming
from the 2001 California energy crisis, including what monies the State
might be able to recoup from energy suppliers and the potential emergence
from bankruptcy status by the largest energy utilities in the State
o the impacts of consumer reactions to the threats of possible future
terrorist activity and geopolitical issues, especially as reflected in
reduced travel and tourism, which has a particular negative effect upon the
hospitality industry
14
To the extent that the State of California fiscal situation continues
to affect the State's budget, spending, and potential level and manner of
taxation, the Company will continue to be impacted.
Supported by historically low interest rates, a growing population, and
limited supply in certain markets, residential real estate values in many of the
communities served by the Company were steady to slightly increasing in 2002,
with the notable exception of very high end residential properties ($1.5 million
and above). While the Company does serve the high end real estate market by
virtue of its presence in various higher cost communities along the Monterey
Bay, the Company does not target this market.
Despite a general rise in foreclosure activity in California during
2002, the Company had only one foreclosure, on a single residential property, in
2002.
Throughout 2002, many large national corporations with operations in
Northern and Central California announced significant layoffs. In addition, many
local technology companies shut down due to a combination of weak (or negative)
earnings, limited liquidity, or a lack of access to additional capital.
Unemployment in the Company's market areas increased in 2002, with a particular
concentration among technology and telecommunications industry workers in the
Silicon Valley area of the South San Francisco Bay Area.
During 2002, the local and State economy, and the State's level of
income tax receipts, did not materially benefit from a significant rise in stock
and stock option wealth among individuals. This situation contrasts
significantly to the impacts of a rising stock market in 1999 and early 2000.
Lease rates for many types of commercial real estate declined
significantly in the San Francisco Bay Area during 2001 and 2002, reversing
strong rises in 1999 and early 2000 fueled by the technology industry and
Internet boom. Vacancy rates for commercial real estate generally rose in 2002,
with particularly large rises in areas that served the technology boom of the
late 1990's. Vacancy rates for Class A commercial real estate in downtown San
Francisco were reported at nearly 20.0% at the end of 2002. While the Company
originates and purchases commercial real estate loans in the San Francisco Bay
Area, Management did not generally pursue loans based upon the high lease rates
and market values during 1998 through 2000. The Company had no classified loans
at December 31, 2002 that were secured by commercial real estate in the San
Francisco Bay Area.
Vacancy rates increased and average effective room rates declined for
California hotels and motels in 2001, with the trend worsening after the events
of September 11, 2001. During 2002, the hospitality industry in the Company's
primary market area improved somewhat from the results experienced during the
fourth quarter of 2001, but did not generally achieve the business levels
enjoyed in 1999 and 2000.
In general, the real estate markets where the Company lends in Southern
California were more favorable during 2002 than the San Francisco Bay Area, as
the Southern California markets did not have the high concentration of
technology and telecommunication firms present in the Silicon Valley and other
areas around San Francisco Bay.
The economy in some segments of the Company's primary market area
remains seasonal. These segments include tourism and agriculture, both of which
slow during the winter months.
15
Competition. The banking and financial services business in California
generally, and in the Bank's market areas specifically, is highly competitive.
The increasingly competitive environment is a result of many factors including,
but not limited to:
o the ongoing expansion of the Internet, whereby the Bank must more
frequently compete with remote entities soliciting customers in its primary
market areas via web based advertising and product delivery, especially for
certificates of deposit and residential mortgages
o the significant consolidation among financial institutions which has
occurred over the past several years, resulting in a number of
substantially larger competitors with greater resources than the Company
o the increasing integration among commercial banks, insurance companies,
securities brokers, and investment banks
o the continued growth and market share of non-bank financial services
providers that often specialize in a single product line such as credit
cards or residential mortgages
o the introduction of new technologies which may bypass the traditional
banking system for funds settlement
o the addition of financial services oriented subsidiaries by firms not
historically in the banking business, but with significant consumer reach
o the continued tax relief enjoyed by credit unions in serving the consumer
market combined with a trend toward loosening restrictions on credit union
activities and requirements for credit union membership
The Company competes for loans, deposits, fee based products, and
customers for financial services with commercial banks, savings and loans,
credit unions, thrift and loans, mortgage bankers, securities and brokerage
companies, insurance firms, finance companies, mutual funds, and other non-bank
financial services providers. Many of these competitors are much larger than the
Company in total assets, market reach, and capitalization; and enjoy greater
access to capital markets and can offer a broader array of products and services
than the Company presently markets.
Two banks, each with several billion dollars in assets and more
diversified revenue sources, present particular competition to the Company. Both
these banks follow the "super community banking" business model, whereby
multiple community banks are owned and operated under a unified umbrella
organization. Both of these firms have expanded rapidly in recent years and have
acquired community banks in the Company's primary market areas. These firms have
access to far greater amounts of capital than the Company. These firms also
benefit from greater economies of scale than the Company. Acquisitions by these
two banks have resulted in the Company's being the largest truly local financial
institution in many of its markets.
The Company also competes increasingly frequently with another
community bank, which has over the past two years opened de novo offices in some
of the same communities served by the Company. Additionally, in 2002, the
Company experienced particular competition for retail deposits from the two
largest thrifts that operate in California. These large thrifts benefited from
the declining interest rate environment, with expanding net interest margins
resulting from their net liability sensitivity. These thrifts used their
expanding margins to bid up retail deposit rates, particularly for certain
transaction accounts, in an effort to build market share.
16
In order to compete with other financial services providers, the
Company relies upon:
o local community involvement, contributions, and visibility
o personal service and the resulting personal relationships of its staff and
customers
o referrals from satisfied customers, employees, and directors
o the development and sale of specialized products and services tailored to
meet its customers' needs
o local and fast decision making
In addition, Management considers the Company's reputation for
financial strength and competitive services, as developed over 77 years of local
Company history, as a competitive advantage in attracting and retaining
customers within its primary market area.
Risk Factors That May Affect Future Results
The following discusses certain factors that may affect the Company's
financial results and operations and should be considered in evaluating the
Company. The two general categories of greatest risk faced by the Company are
credit risk and interest rate risk, both of which are inherent to community
banking.
Ability Of The Company To Execute Its Business Strategy. The financial
performance and profitability of the Company will depend, in large part, on its
ability to favorably execute its business strategy in converting from a savings
& loan into a community based financial services firm. This evolution entails
risks in, among other areas, technology implementation, market segmentation,
brand identification, banking operations, and capital and human resource
investments. Accordingly, there can be no assurance that the Company will be
successful in its business strategy.
Economic Conditions And Geographic Concentration. The Company's
operations are located in California and are concentrated in Santa Cruz,
Monterey, and Santa Clara Counties. Although Management has diversified the
Company's loan portfolio into other California counties, the majority of the
Company's credits remain concentrated in the three primary counties. As a result
of this geographic concentration, the Company's results depend largely upon
economic and real estate market conditions in these areas. Deterioration in
economic or real estate market conditions in the Company's primary market areas
could have a material adverse impact on the quality of the Company's loan
portfolio, the demand for its products and services, and its financial condition
and results of operations. In addition, because the Company does not require
earthquake insurance in conjunction with its real estate lending, an earthquake
with an epicenter in or near the Company's primary market areas could also
significantly adversely impact the Company's financial condition and results of
operations.
Interest Rates. By nature, all financial institutions are impacted by
changing interest rates, due to the impact of such upon:
o the demand for new loans
o prepayment speeds experienced on various asset classes, particularly
mortgage backed securities and residential loans
o credit profiles of existing borrowers
o rates received on loans and securities
o rates paid on deposits and borrowings
17
As presented under "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" and under "Item 7a. Quantitative
and Qualitative Disclosure of Market Risk", the Company is financially exposed
to parallel shifts in general market interest rates, changes in the relative
pricing of the term structure of general market interest rates, and relative
credit spreads. Therefore, significant fluctuations in interest rates may
present an adverse effect upon the Company's financial condition and results of
operations.
Government Regulation And Monetary Policy. The financial services
industry is subject to extensive federal and state supervision and regulation.
Significant new laws, changes in existing laws, or repeals of present laws could
cause the Company's financial results to materially differ from past results.
Further, federal monetary policy, particularly as implemented through the Board
of Governors of the Federal Reserve System, significantly affects credit
conditions for the Company, and a material change in these conditions could
present an adverse impact on the Company's financial condition and results of
operations.
Competition. The financial services business in the Company's market
areas is highly competitive, and is becoming more so due to technological
advances (particularly Internet-based financial services delivery), changes in
the regulatory environment, and the significant consolidation that has occurred
among financial services providers. Many of the Company's competitors are much
larger in total assets and market capitalization, enjoy greater liquidity in
their equity securities, have greater access to capital and funding, and offer a
broader array of financial products and services. In light of this environment,
there can be no assurance that the Company will be able to compete effectively.
The results of the Company may materially differ in future periods depending
upon the nature or level of competition.
Credit Quality. A significant source of risk arises from the
possibility that losses will be sustained because borrowers, guarantors, and
related parties may fail to perform in accordance with the terms of their loans.
The Company has adopted underwriting and credit monitoring procedures and credit
policies, including the establishment and review of the allowance for loan
losses, that Management believes are appropriate to control this risk by
assessing the likelihood of non performance, tracking loan performance, and
diversifying the credit portfolio. Such policies and procedures may not,
however, prevent unexpected losses that could have a material adverse effect on
the Company's financial condition or results of operations. Unexpected losses
may arise from a wide variety of specific or systemic factors, many of which are
beyond the Company's ability to predict, influence, and control.
State Of California Budget Crisis. The State of California is currently
facing a substantial budget deficit. A combination of reductions in State
provided services and increases in the level and nature of taxation might
result, which could present an unfavorable impact upon the Company's business,
financial condition, and results of operations. At December 31, 2002, the State
of California maintained $28.0 million in deposits with the Company. If the
State were to withdraw these deposits, replacement funding would likely be more
expensive.
Technology Industry And Technological Change. The pace of economic
activity, the demand and pay rates for labor, and real estate valuations in many
of the Company's primary market areas are impacted by the technology industry. A
prolonged slowdown in the technology business would therefore likely have an
adverse impact on the Company's financial condition and results of operations.
New products and delivery mechanisms being developed as a result of new
technologies present the potential for bypassing the historic bank payments
settlement process. As such, the Company is exposed to various associated
financial risks.
Terrorism And The War On Terrorism. Tourism constitutes a significant
component of the economy in the Company's primary market areas. In addition, the
Company maintains a concentration of loans extended to the hospitality industry.
Should new terrorist actions or the continued war on terrorism continue to or
more dramatically curtail travel and tourism, the Company's financial condition
and results of operations could be significantly impacted.
Other Risks. From time to time, the Company details other risks with
respect to its business and financial results in its filings with the Securities
and Exchange Commission.
18
Lending Activities
General. The Company originates a wide variety of loan products. Loans
originated by the Company are subject to federal and state laws 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. The Company
targets certain lending toward low to moderate income borrowers as part of its
commitment to serve its local communities.
At December 31, 2002, the Company's net loan portfolio held for
investment totaled $521.9 million. This represented the highest total in the
Company's history. The vast majority of this portfolio was associated with real
estate of various types. Lending activity in 2002 was supported by an active
mortgage refinance market, spurred by the historically low level of interest
rates following rate cuts implemented by the Federal Reserve during 2001 and
2002.
Net loans as a percentage of total assets decreased slightly from 86.8%
at December 31, 2001 to 85.9% at December 31, 2002 primarily due to the
Company's purchase of $9.0 million in bank owned life insurance during 2002.
Allocating a greater percentage of its total assets to loans is fundamental to
the Company's strategies of effectively supporting the financing needs of its
local communities, increasing its net interest margin, and effectively
leveraging the Company's capital position.
The Company accepts loan applications generated through brokers for
most of its product line. Broker referred loans are underwritten in the same
manner as direct originations. The Company encourages its employees and
directors to refer and solicit loan business as an integral part of functioning
as a community bank. Employees receive various types of awards or commissions
based upon the volume and nature of business booked.
In purchasing individual loans or pools of loans, the Company
underwrites each loan in a manner similar to its internal originations. The
Company generally purchases income property loans on a servicing released basis
in order to facilitate more effective credit management and in order to acquaint
such borrowers with the other products and services offered by the Company. The
residential mortgages purchased in 2002 were servicing retained by the seller.
The Company also pursues acquiring loan participations from and selling
loan participations to other California community banks and other financial
institutions. In acquiring participations, the Company underwrites each credit
in a manner similar to that followed for its own internal loan production. The
Company sells loan participations in order to diversify its credit risk and in
order to remain below its regulatory limitation for loans to one borrower. In
general, most of the Company's loan participations are for construction loans.
The Company requires title and hazard (fire, and, if applicable, flood)
insurance for all real estate loans. The Company does not require earthquake
insurance for real estate loans. More detailed information regarding the
Company's lending activity is included in the following paragraphs that present
activity by loan product category.
Residential One To Four Unit Mortgage Lending. The Company originates
fixed rate, adjustable rate, and hybrid (fixed for a period, and then
adjustable) mortgage loans secured by one to four family residential properties.
Adjustable rate mortgage loans have interest rates that adjust monthly,
semiannually, or annually and reprice based upon various indices, primarily the
US Treasury One Year Constant Maturities Index ("1 Year CMT") or the MTA index,
which is equivalent to the twelve month rolling average of the 1 Year CMT index.
The MTA index is utilized by a number of the Company's primary competitors and
is often preferred by consumers due to its limited volatility relative to the 1
Year CMT index. The Company ceased originating loans tied to the 11th District
Cost of Funds ("COFI") Index in 2002. COFI is now comprised of funding results
from just 41 financial institutions and is dominated by the results and actions
of a small number of very large thrifts. In 2002, the Company purchased hybrid
residential loans based upon the 1 Year LIBOR Index as a means of diversifying
the index basis of its loan portfolio and in conjunction with its balance sheet
management strategy. The Company's hybrid and adjustable rate residential
mortgages typically contain various periodic and lifetime rate caps, and also
lifetime rate floors. The Company regularly adjusts its loan products to meet
changing customer needs and to respond to the marketplace.
19
By the end of 2002, the Company was selling the majority of its
residential loan production into the secondary market on a servicing released
basis in order to retain a greater volume of higher yielding and more interest
rate sensitive loans on its balance sheet, as part of the Company's asset /
liability management strategy, and also as a means of increasing non-interest
income. The sales are generally on a servicing released basis because the
Company believes the servicing is more valuable to high volume, low marginal
cost servicers.
The majority of loan originations are to existing or past customers and
members of the Bank's local communities. The Company also originates one to four
family residential construction loans for both owner occupants and developers /
contractors ("speculative construction loans"), and residential mortgages
secured by non-owner occupied one to four family properties acquired as an
investment by the borrower. The Company provides escrow (impounds) services as
requested by its customers and generally for those loans in excess of 80.0% loan
to value.
At December 31, 2002, the Company maintained $187.5 million in
residential permanent mortgages, representing 33.1% of gross loans held for
investment. This compares to $204.8 million in permanent residential mortgages a
year earlier, which then constituted 42.2% of gross loans held for investment.
The majority of the residential loans at December 31, 2002 were secured
by properties located within the Company's primary market area in Central
California. At December 31, 2002, 6.5% of the Company's one to four family
mortgage loans held for investment had fixed terms and 93.5% had adjustable
rates, including adjustable rate loans that have a fixed rate for an initial
period. The Company offers a variety of adjustable rate residential loan
products, including an "easy qualifier" loan with more limited documentation
required than other mortgages. 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 somewhat by negative
amortization caps, underwriting criteria, relatively low loan to value ratios,
and the stability provided by payment schedules. At December 31, 2002, the
Company's residential loan portfolio included $19.9 million of loans subject to
negative amortization.
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 mortgage loan portfolio and the Company has generally exercised its
rights under these clauses.
The five largest residential loans in the Company's portfolio at
December 31, 2002 are presented in the following table. Original loan to value
ratio equals the loan's original principal balance divided by the original
appraisal amount obtained at the time of loan origination. Current loan to value
ratio equals the December 31, 2002 principal balance divided by the original
appraisal amount obtained at the time of loan origination.
(Dollars In Thousands)
Year
Principal Of Original Current
Balance Origination / Loan To Loan To
Outstanding Acquisition Property Location Value Ratio Value Ratio
----------- ----------- ----------------- ----------- -----------
$ 3,088 2000 Carmel Valley, California 50% 49% *
$ 2,500 2002 Monterey, California 71% 71%
$ 2,493 2002 Pleasanton, California 61% 61%
$ 2,006 2000 Pebble Beach, California 70% 72% *
$ 1,785 2002 Rancho Santa Fe, California 39% 38%
----------------------
* Loan product permitting negative amortization
20
Multifamily Lending. The Company offers hybrid and adjustable rate
permanent multifamily (five or more units) real estate loans secured by real
property in California. The Company also periodically extends construction
financing to builders of multifamily housing. From time to time, the Company
extends loans secured by mixed use property in more urban areas, which typically
present commercial (generally retail) space in one part of the building (often
street level) and residential units in other parts of the building.
Multifamily property valuations have generally increased in California
during the past several years, as supply has not expanded with the same speed as
population growth, with property values further enhanced by low financing rates
and reduced competition from other forms of investment. Apartment market rents
and vacancies during 2002 varied by local market conditions, with the strongest
performance in various Southern California communities and the softest market
conditions in the greater San Jose area. Apartment rent levels in the Central
Coast area during 2002 were generally stable to rising, supported by limited new
supply. Multifamily property valuations are impacted by local rent control
ordinances, which are administered in a number of California communities.
Permanent loans on multifamily properties typically present maturities
of up to 30 years. 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), the ratio of the loan amount to appraised
value, and the financial profile of any guarantors. Pursuant to the Company's
underwriting policies, multifamily hybrid and adjustable rate mortgage loans are
generally originated in amounts up to 75% of the appraised value of the
underlying properties. The Company generally requires a debt service ratio of at
least 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 multifamily
loan, the Company considers the financial resources and income level of the
borrower, the borrower's experience in owning or managing similar property, and
the Company's lending experience with the borrower. The Company's underwriting
policies require that the borrower provide evidence of ability to repay the
mortgage on a timely basis and maintain the property from current rental income.
In evaluating the creditworthiness of the borrower, the Company generally
reviews the borrower's financial statements, employment, tax returns, and credit
history, as well as other related documentation.
Loans secured by apartment buildings and other multifamily residential
properties are generally larger and involve a greater degree of risk than one to
four family residential loans. Because payments on loans secured by multifamily
properties are often dependent on successful operation or management of the
properties, repayment of such loans may be subject to a greater extent to
adverse conditions in the real estate market or the economy. The Company seeks
to mitigate 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 annual operating statements on the properties and by acquiring
personal guarantees from the borrowers when available.
There is a limited volume of multifamily properties in the Company's
primary market area due to the more rural aspects of many local communities.
Therefore, in conjunction with its business strategy, the Company in 2003
intends to continue increasing its multifamily real estate lending within the
State of California. At December 31, 2002, the Company's portfolio of
multifamily loans totaled $118.0 million, or 20.8% of gross loans receivable
held for investment. This compares to $103.9 million, or 21.4% of gross loans
receivable held for investment, at December 31, 2001. The Company acquired
multifamily loans from direct originations, broker referrals, and individual
loan purchases during 2002. It is expected that all of these sources will be
utilized in 2003.
21
The five largest multifamily real estate loans in the Company's
portfolio at December 31, 2002 are presented in the following table:
(Dollars In Thousands)
Year
Principal Of Original Current
Balance Origination / Loan To Loan To
Outstanding Acquisition Property Location Value Ratio Value Ratio
----------- ----------- ----------------- ----------- -----------
$ 3,822 2001 Van Nuys, California 64% 62%
$ 2,561 2002 Westminster, California 75% 74%
$ 2,472 2002 San Francisco, California 66% 65%
$ 2,470 2001 West Hollywood, California 74% 73%
$ 2,271 2001 Oakland, California 74% 73%
Because the primary marketplace the Company serves has a limited volume
of multifamily properties, the Company intends to continue pursuing multifamily
real estate loans secured by properties located throughout California. The
Company's strategy in this regard includes purchasing participations in
multifamily loans originated by experienced, local lenders with a favorable
record of quality loan origination. The acquisition and origination of
multifamily loans throughout California presents the Company with geographic
diversification, but also introduces credit exposure due to the greater demands
of monitoring the demand for and value of multifamily real estate in a greater
number of market areas.
Commercial & Industrial Real Estate Lending. The Company originates
both permanent and construction loans secured by commercial & industrial real
estate located in California. The Company's underwriting procedures provide that
commercial & industrial real estate loans may generally be made in amounts up to
the lesser of 65% of the appraised value of the property or up to a debt service
coverage ratio of 1.20. The Company occasionally extends commercial & industrial
real estate loans with an initial loan to value ratio in excess of 65.0% based
upon the nature of the property and the financial strength of the borrowers and
guarantors. Permanent loans may be made with terms up to 25 years and are
typically hybrid (fixed for three to five years, then adjustable) or adjustable
based upon the 1 Year CMT Index. The Company's underwriting standards and credit
review procedures on commercial & industrial real estate loans are similar to
those applicable to multifamily loans. The Company considers the property's net
operating income, the loan to value ratio, the presence of guarantees, and the
borrower's expertise, credit history, and financial status.
The Company's commercial & industrial real estate loans are typically
secured by properties such as retail stores, retail strip centers, office
buildings, and light manufacturing facilities. The Company typically does not
extend loans for the acquisition or refinance of major manufacturing facilities,
as that type of real estate generally encompasses larger loans than the Company
makes. The Company generally avoids originating or purchasing commercial &
industrial real estate loans secured by unique or single use buildings, such as
theatres or bowling alleys. The Company also takes various steps to attempt to
avoid extending loans secured by commercial & industrial real estate that
presents significant environmental issues, such as groundwater contamination or
the presence of toxic chemicals. However, despite these steps, including
environmental reviews, there can be no assurance that the Company can avoid
financial exposure resulting from environmental issues associated with loan
collateral.
The majority of the commercial & industrial real estate loans are
secured by property located in Northern and Central California. However, the
Company has in the past several years pursued participations on and purchases of
commercial & industrial real estate loans with experienced, local lenders in the
greater San Diego and Los Angeles markets as a means of increasing loans
outstanding and geographically diversifying the Company's loan portfolio.
22
At December 31, 2002, the Company's permanent commercial & industrial
real estate loan portfolio totaled $140.0 million, or 24.7% of gross loans held
for investment. This compares to $110.0 million, or 22.7% of gross loans held
for investment, at December 31, 2001. This nominal expansion is consistent with
the Company's business strategies of:
o increasing the percentage of its balance sheet represented by income
property loans
o meeting the real estate and business financing needs of businesses and
individuals whose business is domiciled in real estate owned by the
borrower
o seeking comprehensive relationships with businesses in the Company's
primary market areas, including the placement of deposits with the Company
and the Company's provision of funds transfer services
The five largest commercial & industrial real estate loans in the
Company's portfolio at December 31, 2002 are presented in the following table:
(Dollars In Thousands)
Year Original Current
Principal Of Type Loan To Loan To
Balance Origination / Of Value Value
Outstanding Acquisition Property Property Location Ratio Ratio
----------- ----------- -------- ----------------- ----- -----
$ 4,905 2002 Retail Los Angeles, California 53% 52%
$ 3,794 2002 Retail Long Beach, California 71% 71%
$ 3,745 2002 General Office Santa Monica, California 61% 61%
$ 3,321 2001 Mini-Storage Facility San Jose, California 65% 63%
$ 2,992 2002 Motel Monterey, California 49% 49%
At December 31, 2002, the Company had $29.0 million in outstanding
loans secured by hotel / motel properties. None of these loans were construction
loans. The Company continues to actively monitor these loans, as the hospitality
industry has been particularly impacted by the weak pace of national economic
growth, reduced business travel, and a general slowdown in tourism and
recreational travel versus the levels experienced in 1999 and 2000.
Loans secured by commercial & industrial real estate properties, like
multifamily loans, are generally larger and involve a greater degree of risk
than one to four family residential mortgage loans. Because payments on loans
secured by commercial real estate properties are often dependent on successful
operation or management of the properties, repayment of such loans may be
significantly subject to adverse conditions in the properties' management or
real estate markets in general or particular to a subject property. The Company
seeks to mitigate these risks through its underwriting standards and credit
review policy, which requires annual operating statements for each collateral
property. The Company also participates larger commercial & industrial real
estate loans with other financial institutions as a means of diversifying its
credit risk and remaining below the Bank's regulatory limit on loans to one
borrower.
Commercial & industrial real estate loans can present various
environmental risks, as such properties are sometimes located on sites or in
areas where various types of pollution may have historically occurred. The
Company takes various steps to attempt to avoid extending loans secured by
commercial & industrial real estate that presents significant environmental
issues, such as groundwater contamination or the presence of toxic chemicals.
However, despite these steps, there can be no assurance that the Company can
avoid financial exposure resulting from environmental issues associated with
loan collateral. The Company attempts to mitigate environmental risk via
surveys, reports, and, in some cases, testing; in addition to using a limited
list of pre-approved appraisers. In addition, Company lending staff directly
inspect most commercial & industrial real estate properties on which the Company
lends.
Commercial & industrial real estate can also be impacted by changing
government regulation, with a potential associated impact on the market value of
the collateral securing the Company's loans.
23
Construction Lending. The Company originates construction loans for the
acquisition and development of property. Collateral has been historically
concentrated in residential properties, both owner occupied and speculative
(i.e. not being built by an owner occupant, but perhaps pre-sold to third
parties). In addition, the Company makes construction loans for the development
and rehabilitation of apartments and commercial buildings.
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:
o the accuracy of the initial estimate of the property's value at completion
of construction or development
o the accuracy of the estimated cost of construction
o the borrower's ability to complete the construction project within
estimated timeframes
o the market demand for the subject property at the completion of
construction
o the ability of tenants, if any, to honor lease obligations for the subject
property
o the availability of permanent financing for the subject property at the
conclusion of the construction period
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 project 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 appraisers, and
by dealing with qualified builders / borrowers. The Company also participates
larger construction loans with other financial institutions as a means of
diversifying its credit risk and remaining below the Bank's regulatory limit on
loans to one borrower.
The Company's construction loans typically have adjustable rates and
terms of 12 to 18 months. The Company originates one to four family and
multifamily residential construction loans in amounts up to 80% of the appraised
value of the property. 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 construction site inspections
warrant.
At December 31, 2002, the Company had gross construction and land
development loans totaling $69.5 million, on which there were undisbursed loan
funds of $36.7 million. At December 31, 2001, the Company had gross construction
and land development loans totaling $38.5 million, on which there were
undisbursed loan funds of $12.6 million. The gross balance of construction loans
as a percentage of gross loans held for investment thus increased from 7.9% at
December 31, 2001 to 12.3% at December 31, 2002.
The increase in construction loans during 2002 was in conformity with
the strategic business plan and was fostered by borrower relationships serviced
through the Los Angeles loan production office. The Company has strategically
targeted increased construction lending because of the interest rate sensitivity
of the loans, the Company's experience in this type of lending, the yields
available from this type of lending, and, in the case of owner residential
construction loans, the strong customer bond developed in financing the building
of someone's home.
24
The five largest construction loans in the Company's portfolio at
December 31, 2002 are presented in the following table:
(Dollars In Thousands)
Year
Construction Of Type
Commitment Origination / Of Disbursed
Amount Acquisition Construction Property Location Balance
------ ----------- ------------ ----------------- -------
$ 7,500 2002 Apartment Building Los Angeles, California $ 2,692
$ 6,950 2002 Residential Development Soledad, California $ 1,482
$ 6,100 2002 Light Industrial Watsonville, California $ --
$ 3,708 2000 Light Industrial Fremont, California $ 3,398
$ 3,605 2002 Retail Riverside, California $ 929
The light industrial construction project located in Fremont presented
in the above table was in the process of being subdivided from one large real
estate project into individual buildings and parcels at December 31, 2002. This
change, in addition to soft market conditions, contributed to the delay in
finalizing the construction project. The borrowers present significant financial
resources and the loan was current in its payments at December 31, 2002.
Because construction loans are generally larger and more complex than
typical residential mortgages, they present a greater degree of credit risk. The
Company attempts to control this credit risk through its underwriting and funds
disbursement processes. In addition, it is the Company's strategy to, over time,
build a series of strong relationships with local developers / builders /
contractors with whom the Company has detailed financial knowledge and receives
a steady stream of repeat business.
Land Lending. The Company offers loans secured by land, generally
located in its immediate marketplace. The types of land generally considered by
the Company are suitable for residential development or are demarcated
residential lots. The Company does not extend loans on agricultural land where
repayment of the loan is dependent upon crop sales.
At December 31, 2002, land loans totaled $24.8 million, or 4.4% of
gross loans held for investment. This compares to land loans totaling $11.9
million, or 2.5% of gross loans held for investment, at December 31, 2001.
The five largest land loans in the Company's portfolio at December 31,
2002 are presented in the following table. These five loans constituted almost
34.0% of the Company's total portfolio of land loans, as measured by principal
balance, at December 31, 2002.
(Dollars In Thousands)
Year Original Current
Principal Of Type Loan To Loan To
Balance Origination / Of Value Value
Outstanding Acquisition Land Property Location Ratio Ratio
----------- ----------- ---- ----------------- ----- -----
$ 2,275 2002 Residential Lots Santa Monica, California 65% 65%
$ 2,080 2002 Commercial Burbank, California 75% 75%
$ 1,500 2001 Residential Lots Monterey, California 50% 50%
$ 1,319 2001 Residential Lots Los Gatos, California 60% 60%
$ 1,268 2002 Residential Lots West Hollywood, California 65% 65%
The land loan in the above table secured by the West Hollywood lots was
paid off in full in early 2003.
25
Because land and lots are generally less readily marketable than
residential real estate, lending on land presents additional risks not present
in residential mortgages. The market value of land and lots can be more
susceptible to changes in interest rates, economic conditions, or local real
estate markets than the market value for homes. Zoning changes by various
government authorities may also impact the value and marketability of certain
types of land. To mitigate these risks, the Company generally requires lower
loan to value ratios and shorter contractual terms for land and lot loans. The
$2.1 million loan secured by commercial land presented in the above table was
originated with a 75.0% loan to value ratio because the borrower is a real
estate professional well known to the Company. This borrower has substantial
financial resources and personally guaranteed the loan. The loan is planned to
be repaid in 2003 through a construction loan to build an office building that
has been pre-leased.
Commercial Business Lending. The Company offers a wide variety of
commercial business loans, both in the form of lines of credit and amortizing
term loans. Commercial business loans are extended for accounts receivable
financing, inventory acquisition, equipment purchase, and business expansion,
among other purposes.
The majority of the Company's business loans are collateralized by
business assets. Such collateral is typically comprised of accounts receivable,
inventory, and / or equipment. In addition, the Company frequently obtains a
deed of trust on real estate as additional collateral for certain business loans
and generally pursues personal guarantees from principals of closely held
businesses. Commercial 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 at desirable values following an uncured
default. Commercial business loans typically offer relatively higher yields,
short maturities, and variable interest rates. The availability of such loans
enables existing and potential business depositors to establish a more complete
financial relationship with the Company.
For closely held businesses, the Company pursues a marketing objective
of obtaining both the personal and commercial banking business from the
principals. The Company believes that multiple benefits arise from establishing
strong relationships with and thoroughly understanding customers. These benefits
include the ability to offer more proactive and effective financial solutions
and the opportunity to mitigate credit losses through the timely receipt of key
information.
The Company attempts to reduce the risk of loss associated with
business lending by closely monitoring the financial condition and performance
of its customers. Each business loan customer is assigned to a commercial
banking relationship officer. The relationship officer is responsible for
monitoring the financial condition of the borrower, developing solutions to the
financial needs of the customer, facilitating the growth of the customer's
business, and expanding the customer's overall business relationship with the
Company. The Company's business strategy envisions commercial business loans
representing a greater percentage of total assets in the future.
The Company also attempts to mitigate the risk inherent in commercial
business lending by having third parties review the credits on a periodic basis
and by engaging specialists to audit the collateral, including accounts
receivable, of the business. In 2003, the Company plans to participate larger
commercial business loans with other community banks as a means of diversifying
credit risk and remaining below the Bank's regulatory limit on loans to one
borrower. The Company also intends to seek similar participations from other
California community banks.
At December 31, 2002, the Company had commercial business term loans
totaling $5.2 million and drawn balances against commercial lines of credit
totaling $12.8 million. In the aggregate, commercial business loans comprised
3.2% of gross loans held for investment at December 31, 2002. In comparison, the
Company had a total of $8.8 million in commercial business loans outstanding at
December 31, 2001, representing 1.8% of gross loans held for investment.
26
The five largest commercial business loans in the Company's portfolio
at December 31, 2002 are presented in the following table:
(Dollars In Thousands)
Line Of Year
Credit Of Type
Commitment Origination / Of Outstanding
Amount Acquisition Business Business Location Balance
------ ----------- -------- ----------------- -------
$ 2,000 2001 Semiconductor Equipment Scotts Valley, California $ 1,263
$ 2,000 2002 Photographic Equipment Watsonville, California $ 813
$ 1,600 2002 Wholesale Produce Distribution Watsonville, California $ 1,036
$ 1,000 2002 Retail Monterey, California $ 1,000
$ 1,000 2001 Industrial Gases Watsonville, California $ 616
All of the above commercial business loans are associated with firms in
the Company's primary market area.
Loan Approval Procedures And Authority. The Board of Directors has
ultimate responsibility for the lending activity of the Company and establishes
the lending policies of the Company, including the appraisal policy and credit
approval authorities. The Board of Directors also approves all appraisers used
by the Company. As of December 31, 2002, the Board of Directors has authorized
the following loan approval authorities:
Real Estate Loans
(1) Residential mortgage loans in amounts up to the federal agency (e.g.
Federal National Mortgage Association or "FNMA") conforming limit may be
approved by the Company's staff underwriters.
(2) Loans in excess of the agency conforming limits and up to $500,000 may be
approved by the underwriting / processing manager.
(3) Loans in excess of $500,000 and up to $1,000,000 require the approval of
the Chief Executive Officer / President, Chief Loan Officer, or the
Director of Commercial Banking.
(4) Loans in excess of $1,000,000 and up to $2,000,000 require the approval of
two of the Chief Executive Officer / President, Chief Loan Officer, or
Director of Commercial Banking.
(5) Loans in excess of $2,000,000 require the approval of the Board of
Directors Loan Committee.
Non-Real Estate Loans
(1) Overdraft lines of credit of up to $1,500 require the approval of the
underwriting / processing manager or the Chief Loan Officer.
(2) Loans up to $500,000 require the approval of the Chief Executive Officer /
President, Chief Loan Officer, or Director of Commercial Banking.
(3) Loans in excess of $500,000 require the approval of the Board of Directors
Loan Committee.
The loan origination process requires that upon receipt of a completed
loan application, a credit report is obtained and certain information is
verified. If necessary, additional financial information is obtained from the
prospective borrower. An appraisal of the related real estate is performed by an
independent, licensed appraiser. If the original loan exceeds 80% loan to value
on a first trust deed loan or private mortgage insurance is required, the
borrower is required to make payments to a loan impound account from which the
Company makes disbursements for property taxes and insurance.
27
Loan Portfolio Composition. The following table presents the
composition of the Company's net loans receivable held for investment at the
dates indicated.
At December 31,
----------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------------- ------------------ ------------------ ----------------- ------------------
Amount % Amount % Amount % Amount % Amount %
--------- ----- ------- ------ ------- ------ ------- ----- ------- ------
(Dollars In Thousands)
Real estate loans
Residential one to four unit $187,471 33.1% $204,829 42.2% $160,155 37.8% $168,465 43.4% $181,771 55.8%
Multifamily five or more units 118,004 20.8% 103,854 21.4% 76,727 18.1% 42,173 10.9% 33,340 10.2%
Commercial and industrial 140,027 24.7% 109,988 22.7% 102,322 24.1% 72,344 18.6% 39,997 12.3%
Construction 69,526 12.3% 38,522 7.9% 59,052 13.9% 79,034 20.3% 51,624 15.9%
Land 24,801 4.4% 11,924 2.5% 16,310 3.9% 13,930 3.6% 7,774 2.4%
--------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Sub-total real estate loans 539,829 95.3% 469,117 96.7% 414,566 97.8% 375,946 96.8% 314,506 96.6%
--------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Other loans
Home equity lines of credit 8,779 1.5% 6,608 1.4% 5,631 1.3% 3,968 1.0% 3,262 1.0%
Other consumer loans 437 0.1% 372 0.1% 669 0.2% 587 0.2% 658 0.2%
Commercial term loans 5,231 0.9% 3,163 0.6% 1,641 0.4% 6,670 1.7% 6,679 2.0%
Commercial lines of credit 12,777 2.2% 5,680 1.2% 1,438 0.3% 1,027 0.3% 595 0.2%
--------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Sub-total other loans 27,224 4.7% 15,823 3.3% 9,379 2.2% 12,252 3.2% 11,193 3.4%
--------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total gross loans held for
investment 567,053 100.0% 484,940 100.0% 423,945 100.0% 388,198 100.0% 325,699 100.0%
--------- ------ ------- ------ ------- ------ ------- ------ ------- ------
(Less) / Plus
Undisbursed loan funds (36,683) (12,621) (26,580) (23,863) (24,201)
Unamortized premiums &
discounts 848 435 21 134 491
Deferred loan fees, net (1,127) (202) (202) (281) (434)
Allowance for loan losses (8,162) (6,665) (5,364) (3,502) (2,780)
--------- ------- ------- ------- -------
Total loans held for
investment, net $521,929 $465,887 $391,820 $ 60,686 $298,775
========= ======== ======== ======== ========
Loan Maturity Profile. The following table shows the contractual
maturities of the Company's gross loans held for investment at December 31,
2002.
At December 31, 2002
-------------------------------------
2004 2008 Total
Through And Gross
2003 2007 Thereafter Loans
------- ------- --------- --------
(Dollars In Thousands)
Residential one to four unit $ 598 $ 2,675 $184,198 $187,471
Multifamily five or more units 4 4,646 113,354 118,004
Commercial and industrial real estate -- 16,620 123,407 140,027
Construction 34,069 35,457 -- 69,526
Land 16,821 7,980 -- 24,801
Home equity lines of credit -- 47 8,732 8,779
Other consumer loans 265 -- 172 437
Commercial term loans 25 4,046 1,160 5,231
Commercial lines of credit 9,371 3,406 -- 12,777
------ ------- ------- --------
Total $61,153 $74,877 $431,023 $567,053
======= ======= ======== ========
28
The following table presents the Company's gross loans held for
investment at December 31, 2002, segregating those with fixed versus adjustable
interest rates and also isolating those loans with contractual maturities less
than or equal to and greater than one year.
Matures In 2003 Matures After 2003 Total Gross Loans
-------------------- --------------------- ---------------------------------
Fixed Adjustable Fixed Adjustable Fixed Adjustable Total
------- --------- ----- ---------- ----- ---------- ------
(Dollars In Thousands)
Residential one to four unit $ -- $ 598 $12,219 $174,654 $12,219 $175,252 $187,471
Multifamily five or more units 4 -- 840 117,160 844 117,160 118,004
Commercial and industrial real estate -- -- 8,662 131,365 8,662 131,365 140,027
Construction 3,112 30,957 -- 35,457 3,112 66,414 69,526
Land -- 16,821 -- 7,980 -- 24,801 24,801
Home equity lines of credit -- -- -- 8,779 -- 8,779 8,779
Other consumer loans 265 -- 172 -- 437 -- 437
Commercial term loans -- 25 481 4,725 481 4,750 5,231
Commercial lines of credit -- 9,371 -- 3,406 -- 12,777 12,777
------ ------- ------- -------- ------- -------- --------
Total $3,381 $57,772 $22,374 $483,526 $25,755 $541,298 $567,053
====== ======= ======= ======== ======= ======== ========
Percent of gross loans outstanding
held for investment 0.6% 10.2% 3.9% 85.3% 4.5% 95.5% 100.0%
Loan Commitments. At December 31, 2002, the Company had $39.4 million
in outstanding commitments to originate loans and lines of credit, not all of
which were rate locked at that time. These commitments had expiration dates or
other termination clauses. Because customers do not always accept loan
commitments (e.g. perhaps as a result of applying to more than one lender), the
Company anticipates future cash requirements associated with these commitments
to be less than the $39.4 million total.
At December 31, 2002, the Company had made available various
commercial, personal, and residential lines of credit totaling $37.2 million, of
which the undisbursed portion was $15.6 million. Of this $15.6 million, $9.4
million was associated with commercial business lines of credit, $5.8 million
was associated with home equity lines of credit, and $0.4 million was associated
with consumer overdraft lines of credit. The Company's commercial lines of
credit are generally extended for terms of one year, although the Company does
provide two to three year line of credit facilities in certain cases based upon
the customer's business need and available collateral. The Company's home equity
lines of credit generally revolve for ten years, and then amortize over the
following fifteen years. For additional information regarding the Company's loan
commitments, please refer to Note 15 to the Consolidated Financial Statements.
Originations, Purchases, And Sales Of Loans. The Company's mortgage
lending activities are conducted primarily through Bank employees in its eight
full service branch offices, construction and commercial real estate
relationship officers domiciled in its Watsonville headquarters building and its
Los Angeles loan production office, and approximately 60 wholesale loan brokers
who deliver completed loan applications to the Company. In addition, the Company
has developed correspondent relationships with a number of financial
institutions to facilitate the origination and sale of real estate and
commercial business 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.
The Company plans to continue actively purchasing individual loans,
loan pools, and loan participations in 2003 as a means of utilizing the Bank's
strong regulatory capital position and supporting the more rapid transformation
of the Company's balance sheet into that more consistent with a community
commercial bank. The Company anticipates that a majority of loan purchases and
loan participations in 2003 will be associated with loans collateralized by
income property.
29
Depending on its asset / liability strategy, the Company originates one
to four family residential 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, 2002 and 2001, the
Company sold $18.5 million and $11.5 million, respectively, of longer term,
fixed rate residential loans. The Company generally sells its fixed rate
residential loans on a servicing released basis in order to take advantage of
comparatively attractive servicing premiums being offered in the secondary
market. While the level and timing of any future loan sales will depend upon
market opportunities and prevailing interest rates, the Company anticipates
selling the vast majority of its long term, fixed rate residential loan
production and residential hybrid loan originations in 2003 on a servicing
released basis into the secondary market in conjunction with its asset /
liability management program and in order to continue shifting its loan mix away
from the historical concentration in residential mortgages.
From time to time, depending on its asset / liability and capital
management strategies, the Company considers converting a portion of its
mortgages into readily marketable mortgage backed securities, which can also be
utilized in collateralized borrowings such as securities sold under agreements
to repurchase. The Company's last such securitization occurred in 1998.
Securitization is undertaken primarily to provide greater liquidity for the
assets and thereby augment the Company's ability to manage its interest rate
risk profile and cash flows. The Company may conduct future securitizations
depending upon its asset / liability, liquidity, and capital management
strategies.
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 includes servicing fees from investors and
certain charges collected from borrowers, such as late payment fees. At December
31, 2002, the Company was servicing $35.3 million in various types of loans for
others.
The Company's strategic plan does not contain a significant expansion
in its loan servicing for others, as Management believes large volume
residential loan servicers enjoy economies of scale and efficiencies in this
business that render it difficult for the Company to compete and generate a
desirable rate of return. The significant consolidation in the residential loan
servicing industry that has occurred over the past several years, in the opinion
of Management, supports this position.
Credit Quality
General. Although Management believes that non-performing loans are
generally well secured and / or reserved, real estate acquired through
foreclosure is properly valued, and inherent losses are provided for in the
allowance for loan losses, there can be no assurance that future deterioration
in local or national economic conditions, collateral values, borrowers'
financial status, or other factors will not result in future credit losses and
associated charges against operations. In regards to real estate acquired via
foreclosure, although all such properties are actively marketed by the Company,
no assurance can be provided regarding when these properties will be sold or
what the terms of sale will be when they are sold. It is the Company's general
policy to obtain appraisals at the time of foreclosure and to periodically
obtain updated appraisals for foreclosed properties that remain unsold.
Non-accrual, Delinquent, And Restructured Loans. Management generally
places loans on non-accrual status when they become 90 days past due, unless
they are well secured and in the process of collection. Management also places
loans on non-accrual status when they are less than 90 days delinquent when
there is concern about the collection of the debt in accordance with the terms
of the loan agreement. When a loan is placed on non-accrual status, any interest
previously accrued but not collected is reversed from income. Loans are charged
off when management determines that collection has become unlikely. Restructured
loans are those where the Company has granted a concession on the interest paid,
principal owed, or the original repayment terms due to financial difficulties of
the borrower or because of issues with the collateral securing the loan.
30
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 at least 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. 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 develop a
repayment schedule with the borrower to avoid foreclosure.
For commercial business loans, the account relationship officer
generally contacts the borrower within ten days of a delinquency. If the
borrower is unable or unwilling to make contracted payments, the Company
initiates collection efforts that vary by the type of commercial business loan
and the nature of the collateral. If the commercial business loan is real estate
secured, the Company follows collection procedures similar to those described
above for mortgage loans. If the business loan is secured by inventory,
equipment, or other non-real estate collateral, the Company pursues acquisition
and liquidation of the pledged collateral. If the commercial business loan has a
personal guarantee, the Company will contact the guarantor to honor the
guarantee and make the contractual loan payments. The Company may also proceed
with various forms of legal action to enforce collection of delinquent
commercial business loans.
Non-performing Assets. Non-performing loans include non-accrual loans,
loans 90 or more days past due and still accruing interest, and restructured
loans. Non-performing assets include all non-performing loans, real estate
acquired via foreclosure, and repossessed consumer assets.
Real estate acquired via foreclosure 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 estimated costs to sell. Fair value is defined as the
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 recoverable
upon disposal. The carrying value of acquired property is regularly evaluated
and, if appropriate, an allowance is established to reduce the carrying value to
fair value less estimated costs to sell. The Company typically obtains
appraisals on real estate acquired through foreclosure at the time of
foreclosure, and generally conducts inspections on foreclosed properties on a
quarterly basis.
The following table presents information regarding non-performing
assets at the dates indicated.
At December 31,
-----------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
(Dollars In Thousands)
Outstanding Balances Before Valuation Reserves
Non-accrual loans $2,643 $2,252 $4,666 $6,888 $1,478
Loans 90 or more days delinquent and accruing interest -- -- -- -- --
Restructured loans in compliance with modified terms -- -- 75 1,294 1,437
------ ------ ------ ------ ------
Total gross non-performing loans 2,643 2,252 4,741 8,182 2,915
Investment in foreclosed real estate before valuation 846 -- -- 96 322
reserves
Repossessed consumer assets -- -- -- -- --
------ ------ ------ ------ ------
Total gross non-performing assets $3,489 $2,252 $4,741 $8,278 $3,237
====== ====== ====== ====== ======
Gross non-performing loans to total loans 0.50% 0.48% 1.19% 2.25% 0.96%
Gross non-performing assets to total assets 0.57% 0.42% 0.98% 1.79% 0.71%
Allowance for loan losses $8,162 $6,665 $5,364 $3,502 $2,780
Allowance for loan losses / non-performing loans 308.82% 295.96% 113.14% 42.80% 95.37%
Valuation allowances for foreclosed real estate $ -- $ -- $ -- $ -- $ 41
31
Non-accrual loans increased from $2.3 million at December 31, 2001 to
$2.6 million at December 31, 2002 primarily due to the placement of a $2.3
million commercial real estate mortgage on non-accrual status during the first
quarter of 2002; only partially offset by payoffs and reinstatements. This $2.3
million credit is a participation loan where the Bank is not the lead financial
institution. The loan is secured by a first deed of trust on a hotel / resort
located within the Company's primary market area and by a first deed of trust on
a residential lot located in California. The borrowers are directly personally
indebted. The hotel / resort is a relatively new development that has
experienced limited cash flow. The hotel / resort was also adversely impacted by
the decline in tourism and travel during late 2001 and all of 2002.
At December 31, 2002, the Company maintained a $462 thousand specific
reserve for this hotel / resort loan, based upon estimated net proceeds
following foreclosure and sale. Although the loan was current in its payments at
December 31, 2002, the Company maintained the loan on non-accrual status at
December 31, 2002 due to concern about the future net cash flow of the hotel /
resort during the seasonally slow winter months, particularly in light of the
status of the economy, the tourism industry, and the outlook for business travel
activity. These factors also create particular volatility in the market value of
the hotel / resort.
Non-accrual loans at December 31, 2002 also included:
o a residential mortgage with a principal balance of $201 thousand
o a $129 thousand loan secured by a first deed of trust on residential land
o a $49 thousand home equity line of credit
All of the Company's non-accrual loans at December 31, 2002 were graded
substandard (see Criticized And Classified Assets, below). The residential
mortgage with a principal balance of $201 thousand fully reinstated late in the
first quarter of 2003. The Company anticipates foreclosing on the above $129
thousand non-accrual loan near the end of the first quarter of 2003. However,
because of the low loan to value ratio, the Company may be paid off in full at
the foreclosure sale; a likelihood reinforced by the volume of inquiries
received by the Company during the first quarter of 2003.
At December 31, 2002, the Company had one foreclosed property with a
book value of $846 thousand. This property is a custom single family home
located in an upscale neighborhood in the East Bay of the Greater San Francisco
Bay Area. The property is currently under contract for sale to close prior to
the end of the first quarter of 2003 at a price that would generate a gain on
sale for the Company. In addition, the Company during the first quarter of 2003
accepted a "backup" offer on the property that would generate approximately the
same net proceeds.
The following table presents information concerning loans 60 to 89 days
delinquent at the dates indicated.
Loans On Accrual Status And Delinquent 60 - 89 Days At December 31,
--------------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------ ------------------------
Number Number Number
(Dollars In Thousands) Of Principal Of Principal Of Principal
Loans Balance Loans Balance Loans Balance
----- ------- ----- ------- ----- -------
Residential one to four unit 2 $ 396 1 $ 154 4 $ 857
Other consumer loans -- -- 2 2 --
----- ------- ----- ------- ----- --------
Total 2 $ 396 3 $ 156 4 $ 857
===== ======= ===== ======= ===== ========
60 - 89 day delinquent loans to gross
loans net of undisbursed loan funds
and unamortized yield adjustments 0.07% 0.03% 0.22%
32
The following table presents information regarding non-accrual loans at
the dates indicated.
Loans On Non-accrual Status At December 31,
--------------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------ ------------------------
(Dollars In Thousands) Number Number Number
Of Principal Of Principal Of Principal
Loans Balance Loans Balance Loans Balance
----- ------- ----- ------- ----- -------
Residential one to four unit 1 $ 201 3 $ 1,372 2 $ 603
Commercial and industrial real estate 1 2,264 1 851 2 1,133
Commercial construction -- -- -- -- 1 2,852
Land 1 129 -- -- -- --
Home equity lines of credit 1 49 -- -- -- --
Consumer lines of credit -- -- 1 1 -- --
Commercial term loans -- -- 2 28 3 78
---- ---------- ----- ------- ----- -------
Total 4 $ 2,643 7 $ 2,252 8 $ 4,666
==== ========== ===== ======= ===== =======
Non-accrual loans to gross loans
net of undisbursed loan funds
and unamortized yield adjustments 0.50% 0.48% 1.17%
Interest income foregone on non-accrual loans outstanding at year-end
totaled $18 thousand, $46 thousand, and $110 thousand at December 31, 2002,
2001, and 2000, respectively. At December 31, 2002, the Company had no
commitments to extend additional funds to loans on non-accrual status.
Criticized And Classified Assets. 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 current and potential
problem assets. Under these guidelines, both asset specific and general
portfolio valuation allowances are established.
The Company currently classifies problem and potential problem assets
into one of four categories, presented below in order of increasing severity.
Category Definition
---------------------------- ------------------------------------------
Criticized Assets
Special Mention Special Mention loans (sometimes referred
to as "watch list" loans) possess
weaknesses, but do not currently expose
the Company to sufficient risk to warrant
categorization as a classified asset or
assignment of a specific valuation
allowance. Weaknesses that might
categorize a loan as Special Mention
include, but are not limited to, past
delinquencies or a general decline in
business, real estate, or economic
conditions applicable to the loan.
Classified Assets
Substandard Substandard loans have one or more defined
weakness and are characterized by the
distinct possibility that the Company will
sustain some loss if the deficiencies are
not corrected.
Doubtful Doubtful loans have the weaknesses of
substandard loans, with the additional
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 possibility of loss of
some portion of the principal balance.
Loss Loss loans are considered uncollectible
and their continuance as an asset is not
warranted.
33
The Company's methodology for calculating the allowance for loan losses
includes higher formula allowance factors for criticized and classified loans
than for loans not adversely graded ("Pass loans"). The formula allowance factor
for a given type of loan (e.g. commercial & industrial real estate loans) is
progressively higher for loans graded Special Mention, Substandard, and
Doubtful. These amounts represent loss allowances which have been established to
recognize the inherent risk associated with these lending activities, but which,
unlike specific allowances, have not been allocated to particular problem
assets. Judgments regarding the adequacy of valuation allowances are based on
continual evaluation of the nature, volume and quality of the loan portfolio,
collateral assets, borrower financial status, 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.
The following table presents the Company's criticized and classified
assets at the dates indicated:
At December 31,
------------------------------------
Outstanding Balances Before Specific Valuation Allowances 2002 2001 2000
--------- --------- ---------
(Dollars In Thousands)
Criticized Assets
Special mention $ 4,899 $ 6,207 $ 2,283
========= ========= =========
Classified Assets
Substandard loans $ 3,387 $ 5,098 $ 6,923
Real estate acquired via foreclosure 846 -- --
--------- --------- ---------
Total classified assets $ 4,233 $ 5,098 $ 6,923
========= ========= =========
Classified assets to total loans plus other real estate owned (1) 0.79% 1.08% 1.74%
Classified assets to total assets 0.69% 0.95% 1.42%
Classified assets to stockholders' equity 7.55% 10.16% 15.79%
Allowance for loan losses to total classified assets 192.82% 130.74% 77.48%
--------------------------------------------------------------------------------
(1) Total loans equals total gross loans less undisbursed loan funds and (less)
or plus unamortized yield adjustments. Other real estate owned is included
on a gross basis before any valuation allowances.
Substandard loans at December 31, 2002 included:
o $414 thousand in commercial loans to a business located in the Company's
primary market area. These loans were paid off in full during the first
quarter of 2003 in conjunction with the sale of the business.
o $326 thousand in commercial loans to a business where the sole stockholder
and guarantor declared Chapter 11 bankruptcy in 2002. These loans have
exhibited recurring payment delinquencies. The Company is currently working
with the principal to fully reinstate the loans and obtain additional real
estate collateral.
Special Mention loans at December 31, 2002 included:
o A $1.7 million residential first mortgage on a home located in Pebble
Beach, California. The borrowers have exhibited chronic delinquency over
the past several years, but have consistently reinstated the loan to avoid
foreclosure. The home was appraised for $2.65 million in the fourth quarter
of 2000.
o A $1.3 million commercial real estate loan secured by a motel in Palo Alto,
California. The combination of the weak economic environment, the
difficulties being experienced by the technology industry, and the general
softness in business travel have all unfavorably impacted the operating
results of the motel. The borrowers have, however, never been delinquent.
The hotel was appraised for $1.96 million in mid-1999. Real estate
valuations in the hospitality industry have been volatile, and generally
declining, during the past two years due to factors such as consumer
reaction to the events of September 11, 2001, reduced business travel,
constrained recreational travel (including from overseas tourists) in
response to international events, and the general weakness in the U.S. and
California economies.
34
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
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
that 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 results of operations for that
time period.
Impaired Loans. The Company defines a loan as impaired when it meets
one or more of the following criteria:
o It is probable that the Company will be unable to collect all contractual
principal and interest in accordance with the original terms of the loan
agreement.
o The loan is ninety or more days past due.
o The loan is placed on non-accrual status although less than ninety days
past due.
o A specific valuation reserve has been allocated against the loan.
o The loan meets the criteria for a troubled debt restructuring.
The policy of the Company is to review each loan in the portfolio to
identify problem credits. The nature of this review varies by the type of loan
and its underlying collateral. For example, most residential mortgages are
evaluated for impairment following a delinquency, while the Company conducts
credit analysis on each income property loan exceeding certain thresholds at
least annually regardless of payment performance. In reviewing each loan, the
Company evaluates both the amount the Company believes is probable that it will
collect and the timing of such collection. As part of the 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.
Each loan identified as impaired is evaluated for the need for a
specific loss reserve. The adequacy of these specific loss reserves is reviewed
regularly, and no less frequently than quarterly. A loan's specific loss reserve
is calculated by comparing the Company's net investment in the loan to one or
more of the following, as applicable to the nature of the loan:
o the present value of the loan's expected future cash flows discounted at
the loan's effective interest rate at the date of initial impairment
o the loan's observable market price
o the fair value of the collateral securing the loan
The Company charges off a portion of an impaired loan against the specific
valuation allowance when it is probable that a part of the loan will not be
recoverable.
35
At December 31, 2002, the Company had impaired loans totaling $2.6
million, with a $462 thousand specific reserve for the loan secured in part by a
hotel in the Company's primary market area, as discussed above in conjunction
with non-accrual loans. At December 31, 2001, the Company had impaired loans of
$2.3 million, which had no related specific reserves. Additional information
concerning impaired loans is presented below and in Note 5 to the Consolidated
Financial Statements.
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Average investment in impaired loans for the year $3,860 $2,304 $7,790
Interest recognized on impaired loans at December 31 $ 159 $ 146 $ 461
Interest not recognized on impaired loans at December 31 $ 18 $ 46 $ 110
The increase in the average investment in impaired loans in 2002 versus
2001 was primarily caused by the $2.3 million commercial real estate loan placed
on non-accrual status in 2002, as discussed above, secured in part by a hotel in
the Company's market area.
Other than those loans already categorized as non-performing or
classified at December 31, 2002, the Company has not identified any other
potential problem loans which would result in those loans being included as
non-performing or classified loans at a future date.
The Company had no loans outstanding to foreign entities at December
31, 2002.
Allowance For 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 the Company's loan portfolio, including unused commitments to
provide financing. The allowance for loan losses is increased by provisions
charged against earnings and reduced by net loan charge-offs. Loans are
charged-off when they are deemed to be uncollectible; recoveries are generally
recorded only when cash payments are received.
The allowance for loan losses is maintained at an amount management
considers adequate to cover losses in loans receivable that are deemed probable
and estimable. The allowance is based upon a number of factors, including, but
not limited to, asset classifications, the size and mix of the loan portfolio,
economic trends and conditions, 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,
changes in non-performing and past due loans, and the Company's underwriting
policies. While Management uses the best information available to make these
estimates, future adjustments to allowances may be necessary due to economic,
operating, regulatory, and other conditions that may be beyond the Company's
control or ability to foresee.
36
The allowance for loan losses is comprised of three primary types of
allowances:
1. Formula Allowance
Formula allowances are based upon loan loss factors that reflect
Management's estimate of the inherent loss in various segments of
or pools within the loan portfolio. The loss factor is multiplied
by the portfolio segment (e.g. multifamily permanent mortgages)
balance (or credit commitment, as applicable) to derive the
formula allowance amount. The loss factors are updated
periodically by the Company to reflect current information that
has an effect on the amount of loss inherent in each segment. The
formula allowance at December 31, 2002 was $7.0 million, compared
to $6.0 million at December 31, 2001.
2. Specific Allowance
Specific allowances are established in cases where management has
identified significant conditions or circumstances related to an
individually impaired credit. In other words, these allowances are
specific to the loss inherent in a particular loan. The amount for
a specific allowance is calculated in accordance with SFAS No.
114, "Accounting By Creditors For Impairment Of A Loan". The
Company had $462 thousand in specific allowance at December 31,
2002 and no specific allowance at December 31, 2001.
3. Unallocated Allowance
The Company maintains an unallocated loan loss allowance that is
based upon Management's evaluation of conditions that are not
directly measured in the determination of the formula and specific
allowances. The evaluation of inherent loss with respect to these
conditions is subject to a higher degree of uncertainty because
they are not identified with specific problem credits or
historical performance of loan portfolio segments. At December 31,
2002, the Company had $661 thousand in unallocated allowance,
compared to $668 thousand at December 31, 2001. The conditions
evaluated in connection with the unallocated allowance at December
31, 2002 included the following, which existed at the balance
sheet date:
o General business and economic conditions affecting the
Company's key lending areas
o Real estate values in California
o Loan volumes and concentrations
o Seasoning of the loan portfolio
o Status of the current business cycle
o Specific industry or market conditions within portfolio
segments
In addition to the requirements of Accounting Principles Generally
Accepted in the United States of America, or "GAAP", related to loss
contingencies, a federally chartered savings association's determination as to
the classification of its assets and the amount of its valuation allowances is
subject to review by the OTS. The OTS, in conjunction with other federal banking
agencies, provides guidance for financial institutions on both the
responsibilities of management for the assessment and establishment of adequate
allowances and guidance for banking agency examiners to use in determining the
adequacy of general valuation allowances. It is required that all institutions:
o have effective systems and controls to identify, monitor, and address asset
quality problems
o analyze all significant factors that affect the collectibility of the loan
portfolio in a reasonable manner
o establish acceptable allowance evaluation processes that meet the
objectives of the federal regulatory agencies
37
Various regulatory agencies, in particular the OTS, 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. Although Management believes that the
allowance for loan losses is adequate to provide for estimated inherent losses
in the loan portfolio, future provisions charged against operations will be
subject to continuing evaluations of the inherent risk in the loan portfolio. In
addition, if the national or local economy declines or asset quality
deteriorates, additional provisions could be required. Such additional
provisions could negatively and materially impact the Company's financial
condition and results of operations.
The following table presents information concerning the Company's
allowance for loan losses at the dates and for the years indicated.
(Dollars In Thousands) 2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
Period end loans outstanding (1) $ 531,636 $ 473,265 $ 397,184 $ 364,188 $ 303,732
Average loans outstanding (2) 483,429 432,020 379,823 339,036 259,358
Period end non-performing loans outstanding 2,643 2,252 4,741 8,182 2,915
Allowance for loan losses
Balance, at beginning of year $ 6,665 $ 5,364 $ 3,502 $ 2,780 $ 1,669
Charge-offs:
Residential one to four unit real estate loans -- -- (371) (113) --
Other consumer loans (11) (4) -- -- --
Commercial term loans (11) -- -- -- --
Commercial lines of credit (19) (95) -- -- --
--------- --------- --------- --------- ---------
Total charge-offs (41) (99) (371) (113) --
--------- --------- --------- --------- ---------
Recoveries:
Residential one to four unit real estate loans -- -- 58 -- 3
Other consumer loans 5 -- -- -- --
Commercial lines of credit 23 -- -- -- --
--------- --------- --------- --------- ---------
Total recoveries 28 -- 58 -- 3
--------- --------- --------- --------- ---------
Net (charge-offs) recoveries (13) (99) (313) (113) 3
--------- --------- --------- --------- ---------
Provision charged to operations 1,510 1,400 2,175 835 692
Allowance acquired in conjunction with loan purchase -- -- -- -- 416
--------- --------- --------- --------- ---------
Balance, at end of year $ 8,162 $ 6,665 $ 5,364 $ 3,502 $ 2,780
========= ========= ========= ========= =========
Net charge-offs (recoveries) to average loans outstanding (2) 0.00% 0.02% 0.08% 0.03% 0.00%
Allowance as a percent of year end loans outstanding (1) 1.54% 1.41% 1.35% 0.96% 0.92%
Allowance as a percent of non-performing loans 308.82% 295.96% 113.14% 42.80% 95.37%
-----------------------------------------------------------
(1) net of undisbursed loan funds, unamortized purchase premiums net of
unamortized purchase discounts, and deferred loan fees and costs, net
(2) net of undisbursed loan funds, unamortized purchase premiums net of
unamortized purchase discounts, deferred loan fees and costs, net, and
allowances for loan losses
38
The following table provides a summary of the allocation of the
allowance for loan losses for specific loan categories at the dates indicated.
The allocation presented should not be interpreted as an indication that charges
to the allowance for loan losses will be incurred in these amounts or
proportions, or that the portion of the allowance allocated to each loan
category represents the total amounts available for future losses that may occur
within these categories. The unallocated portion of the allowance and the total
allowance is applicable to the entire loan portfolio.
At December 31,
------------------------------------------------------------------
2002 2001 2000
--------------------- ------------------ -------------------
% Of % Of % Of
Loans In Loans In Loans In
Category Category Category
To Gross To Gross To Gross
(Dollars In Thousands) Amount Loans(1) Amount Loans(1) Amount Loans(1)
------ -------- ------ -------- ------ --------
Residential $ 840 33.1% $ 1,710 42.2% $ 1,143 37.8%
Multifamily 956 20.8% 713 21.4% 470 18.1%
Commercial real estate 3,145 24.7% 2,374 22.7% 1,232 24.1%
Construction 1,209 12.3% 525 7.9% 1,164 13.9%
Land 776 4.4% 336 2.5% 400 3.9%
Home equity lines of credit 55 1.5% 30 1.4% 32 1.3%
Other consumer loans 10 0.1% 11 0.1% 11 0.2%
Commercial term loans 158 0.9% 111 0.6% 148 0.4%
Commercial lines of credit 352 2.2% 187 1.2% 25 0.3%
-------- ------ -------- ----- ----- ------
Total allocated 7,501 100.0% 5,997 100.0% 4,625 100.0%
====== ===== ======
Unallocated 661 668 739
-------- -------- -----
Total $ 8,162 $ 6,665 $ 5,364
======== ======== ========
Other information
Gross loans outstanding
held for investment $567,053 $484,940 $423,945
At December 31,
-------------------------------------------
1999 1998
-------------------- -------------------
% Of % Of
Loans In Loans In
Category Category
To Gross To Gross
(Dollars In Thousands) Amount Loans(1) Amount Loans(1)
------ -------- ------ --------
Residential $ 663 43.4% $ 925 56.1%
Multifamily 185 10.9% 277 10.2%
Commercial real estate 918 18.6% 514 12.2%
Construction 960 20.3% 533 15.7%
Land 137 3.6% 101 2.4%
Home equity lines of credit 32 1.0% 34 1.0%
Other consumer loans 15 0.2% 11 0.2%
Commercial term loans 243 1.7% 190 2.0%
Commercial lines of credit 83 0.3% 26 0.2%
----- ----- ----- -----
Total allocated 3,236 100.0% 2,611 100.0%
===== =====
Unallocated 266 169
-------- --------
Total $ 3,502 $ 2,780
======== ========
Other information
Gross loans outstanding
held for investment $388,198 $327,876
------------------------------------------
(1) Gross loans held for investment
Over the past several years, the Company has increased its allowance
for loan losses in conjunction with three key trends within the loan portfolio:
o The growth in the nominal size of the loan portfolio has led Management to
increase the amount of the allowance.
o The greater diversification in the mix of the loan portfolio away from
residential one to four unit permanent mortgages toward other types of
lending, particularly income property loans, has led to higher nominal and
relative allowance levels, as these types of lending typically present more
risk than residential mortgages. This increased risk stems both from the
nature of the lending and the greater individual credit amounts associated
with income property loans.
o The increasing concentration of the portfolio in relatively less seasoned
credits, because of the Company's growth rate in recent years, has also led
Management to increase the level of the allowance, as less seasoned loans
typically present greater risk than loans which have been performing for
many years and which have amortized balances.
39
The Company's loan portfolio at December 31, 2002 presented significant
geographic concentration, consistent with the Company's focus of serving local
individuals and businesses as a community commercial bank. The majority of the
Company's loans outstanding at December 31, 2002 were secured by real estate or
associated with businesses located in the three counties that constitute the
Company's primary market area:
o Santa Cruz County
o Monterey County
o Santa Clara County
However, with the opening of the Los Angeles loan production office in 2002 and
the Company's acquiring loan participations and purchasing loans secured by real
estate located in a greater number of California communities, the Company is
gradually reducing its geographic lending concentration.
The Company's geographic lending concentration provides certain
benefits. For example, the Company becomes well known in its local area and
therefore attracts more business. In addition, Management develops a more
comprehensive knowledge of real estate values and business trends in markets
where lending is regularly conducted. However, this concentration also presents
certain risks. A natural disaster such as an earthquake centered in the Greater
Monterey Bay Area would impact the Company more significantly than firms with
loans geographically dispersed over a wider area. Another concentration risk is
that a downturn in the economy or real estate values in the Greater Monterey Bay
Area would disproportionately unfavorably impact the Company versus a
multi-state or national lender. The geographic concentration of the Company's
loans and the Company's almost complete focus on doing business in California is
an important factor that Management considers in determining appropriate levels
of loan loss reserves.
At December 31, 2002, the Company had outstanding less than $4.0
million in loans outside the State of California. The Company's strategic plan
does not include substantial lending in 2003 outside the State of California.
During 2002, among the changes implemented to the Company's loan loss
reserve methodology were revisions in the formula allowances for the following
types of loans::
Increases In Formula Allowances Decreases In Formula Allowances
------------------------------- -------------------------------
1. Commercial real estate loans 1. Residential one to four unit mortgages
2. Income property construction loans
3. Commercial business lines of credit
Formula allowances were increased for commercial real estate loans and
income property construction loans due to:
o less favorable operating results for various types of commercial real
estate, particularly properties associated with the hospitality industry,
highlighted as the Company received financial statements during 2002 for
2001 full year and 2002 partial year performance
o the concentration of credit risk stemming from larger average loan sizes
o the portfolio's relative lack of seasoning
o unfavorable market trends in rents for many types of income property
40
Formula allowances were increased for commercial business lines of
credit due to:
o the weak state of the economy, which impacted revenues received by a number
of the Company's business clients
o increased, although generally cured, delinquencies, as certain businesses
experienced delayed collections of accounts receivable and / or a rise in
uncollectible receivables
o the portfolio's relative lack of seasoning
Formula allowances were decreased for residential mortgages due to:
o the increasing seasoning of that portfolio, as a significant portion of the
new production in 2002 was sold servicing released into the secondary
market
o the strength of residential real estate valuations in many of the Company's
markets, with the exception of high end properties
o the Company's favorable delinquency and credit loss experience on this
portfolio in recent periods
The $661 thousand in unallocated allowance at December 31, 2002 reflected
the Company's consideration of the following factors, as well as more general
factors including the condition of the State and national economies, increased
layoffs and unemployment, the high level of continuing jobless claims, the weak
equity markets, and a significant California State budget deficit:
o The adverse effects of a decline in tourism impacting the local economies
in Santa Cruz and Monterey counties, with a concomitant impact upon net
cash flows for local commercial enterprises, commercial real estate
properties, and owner / operators of small businesses, which could be in
the range of $100 thousand to $300 thousand.
o The adverse impacts of the weak technology and telecommunications
industries upon commercial real estate values. The Company's primary
lending area is near the Silicon Valley area of the San Francisco Bay Area,
which has been impacted by the slump in various technology and technology
related businesses. This impact could be in the range of $100 thousand to
$1.0 million.
Management anticipates that should the Company accomplish its strategic
plan and be successful in:
o generating further growth in loans receivable held for investment,
o emphasizing the origination and purchase of income property real estate
loans,
o continuing expansion of commercial business lending, and
o reducing the portfolio concentration in relatively lower risk residential
mortgages,
future provisions will result and the ratio of the allowance for loan losses to
loans outstanding will increase in a manner consistent with the Company's loan
loss allowance methodology. Experience across the financial services industry
indicates that commercial business and income property loans present greater
risks than residential real estate loans, and therefore should be accompanied by
suitably higher levels of reserves.
41
Investment Activities
Cash Equivalents. The Company does not include certain short term, highly
liquid investments as investment securities, instead classifying these as cash
equivalents. These include:
o federal funds sold
o securities purchased under agreements to resell
o commercial paper
o money market mutual fund investments
o banker's acceptances
o certificates of deposit in federally insured financial institutions
Liquidity Maintenance. Federally chartered savings institutions have
the authority to invest in various types of liquid assets, as defined in
applicable regulations, including United States Treasury obligations, securities
of or guaranteed by various federal agencies, certificates of deposit of insured
banks and savings institutions, bankers' acceptances, repurchase agreements, and
federal funds. Additionally, under OTS regulations, the Bank must maintain a
safe and sound level of liquidity at all times. Management agrees that
maintaining an adequate level of liquidity at all times is fundamental to
effective guidance of a financial institution. Management believes that the Bank
at all times in 2002 maintained a level of available liquidity considered to be
adequate to meet foreseeable operational needs.
Investment Policies. In addition to the above liquid assets, subject to
various restrictions, federally chartered savings institutions may also invest
in various other types of securities, including investment-grade corporate debt
securities, asset-backed securities, collateralized mortgage obligations not
guaranteed by a federal agency, and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. The Company maintains separate internal investment
policies for the Bank and MBBC. These policies are established by the Board of
Directors with the key objectives of:
o providing and maintaining liquidity
o generating a favorable total return on a risk-adjusted basis
o managing the overall interest rate risk profile of the entities
o maintaining compliance with various associated regulations
o controlling credit risk exposure
Specifically, the Company's policies generally limit investments to publicly
traded securities that are investment grade. These policies prohibit the
Company's maintenance of a trading portfolio as defined under SFAS No. 115.
Accounting And Reporting. Investment securities classified as available
for sale are recorded at fair value, while investment securities classified as
held to maturity are recorded at cost. Unrealized gains or losses on available
for sale securities, net of the deferred tax effect, are reported as a component
of other comprehensive income and are included in stockholders' equity. At
December 31, 2002, 2001, and 2000, all of the Company's investments were
classified as available for sale.
42
The amortized cost and estimated fair value of securities are presented
in the following tables. "PT" represents "pass-through" and "CMO" represents
"collateralized mortgage obligation".
December 31, 2002
---------------------------------------------------------------------
(Dollars In Thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Available for sale Cost Gains Losses Value
------------------ ---- ----- ------ -----
Variable rate corporate trust
preferred securities $ 7,719 $ -- $ (689) $ 7,030
Fixed rate FHLMC PT's 957 49 -- 1,006
Fixed rate FNMA PT's 452 35 -- 487
Fixed rate GNMA PT's 497 34 -- 531
Variable rate FNMA PT's 3,101 50 -- 3,151
Fixed rate FHLMC balloons 8,679 48 -- 8,727
Fixed rate CMO's:
Agency issuance 23,512 74 (22) 23,564
------- ----- -------- -------
Total $44,917 $ 290 $ (711) $44,496
======= ===== ======== =======
December 31, 2001
---------------------------------------------------------------------
(Dollars In Thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Available for sale Cost Gains Losses Value
------------------ ---- ----- ------ -----
Variable rate corporate trust
preferred securities $ 7,707 $ -- $ (407) $ 7,300
Fixed rate FHLMC PT's 1,551 34 -- 1,585
Fixed rate FNMA PT's 585 38 -- 623
Fixed rate GNMA PT's 744 31 -- 775
Variable rate FNMA PT's 4,629 62 -- 4,691
Fixed rate FHLMC balloons 1,956 -- -- 1,956
Fixed rate CMO's:
Agency issuance 17,062 86 -- 17,148
Non Agency issuance 3,831 35 -- 3,866
------- ----- -------- -------
Total $38,065 $ 286 $ (407) $37,944
======= ===== ======== =======
December 31, 2000
---------------------------------------------------------------------
(Dollars In Thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Available for sale Cost Gains Losses Value
------------------ ---- ----- ------ -----
Variable rate corporate trust
preferred securities $ 7,696 $ -- $ (336) $ 7,360
Fixed rate FHLMC PT's 1,090 13 -- 1,103
Fixed rate FNMA PT's 3,649 25 (2) 3,672
Fixed rate GNMA PT's 1,060 -- (11) 1,049
Variable rate FNMA PT's 571 5 -- 576
Fixed rate CMOs:
Agency issuance 19,095 5 (266) 18,834
Non Agency issuance 18,210 4 (498) 17,716
------- ----- -------- -------
$51,371 $ 52 $(1,113) $50,310
======= ===== ======== =======
43
At December 31, 2002, the Company's investment in corporate trust
preferred securities was entirely composed of variable rate securities which
reprice every three months based upon a margin over the three month LIBOR rate.
These corporate trust preferred securities were all rated "A-" or better by
Standard & Poors ratings agency at December 31, 2002.
All of the Company's mortgage backed securities at December 31, 2002
were rated AAA by at least one nationally recognized rating agency.
Over the past several years, the Company has restructured its security
portfolio in pursuing the following objectives:
o generating a steady stream of cash flows to provide liquidity in support of
the expanding loan portfolio
o increasing the interest rate sensitivity of the portfolio in conjunction
with the Company's asset / liability management program
o maintaining sufficient US Agency PT's and CMO's to provide collateral for
various types of secured deposits, primarily funds placed with the Bank by
the State of California under its time deposit program
o increasing the investment in CMO's and balloon mortgage backed securities
versus PT's in order to better tailor the portfolio's cash flows to the
projected liquidity needs of the Company
o classifying all securities as available for sale in order to provide
additional flexibility in balance sheet management
The following table presents certain information regarding the
amortized cost, estimated fair value, weighted average yields, and contractual
maturities of the Company's securities as of December 31, 2002. Actual
maturities may differ from contractual maturities due to principal prepayments,
priority of principal allocation within collateralized mortgage obligations, or
rights of issuers to call obligations prior to maturity.
At December 31, 2002
--------------------------------------------------------------------------
(Dollars In Thousands) 2004 2008 2013
Through Through And
Available for sale securities 2003 2007 2012 Thereafter Total
----------------------------- ---- ---- ---- ---------- -----
Variable rate corporate trust
preferred securities $ -- $ -- $ -- $ 7,719 $ 7,719
Fixed rate FHLMC PT's -- -- -- 957 957
Fixed rate FNMA PT's -- -- -- 452 452
Fixed rate GNMA PT's -- -- 409 88 497
Variable rate FNMA PT's -- -- -- 3,101 3,101
Fixed rate FHLMC balloons -- -- 8,679 -- 8,679
Agency fixed rate CMO's -- -- -- 23,512 23,512
----- ------ ------- -------- -------
Total amortized cost $ -- $ -- $ 9,088 $ 35,829 $44,917
===== ====== ======= ======== =======
Estimated fair value $ -- $ -- $ 9,164 $35,332 $44,496
===== ====== ======= ======= =======
Weighted average yield (1) -- -- 3.28% 1.50% 1.94%
-------------------------------------------------------------------------
(1) Weighted average yield is calculated based upon estimated fair value.
44
The weighted average yield for securities with stated maturities in
2013 and thereafter at December 31, 2002 was limited by:
o the fact that many of the CMO's were short term in nature, despite a longer
stated maturity date, and thus provided yields closer to the target federal
funds rate of 1.25%
o high prepayment speeds in December 2002 for mortgage related securities
decreased the effective yield for those securities owned at a premium to
par value
In the third and fourth quarters of 2002, the Company reduced the target
duration of its security portfolio in conjunction with its asset / liability
management program.
The Company maintained no tax-preferenced securities at December 31,
2002. At December 31, 2002, the Company did not own debt securities issued by
any one issuer other than US Agencies that exceeded ten percent of stockholders'
equity. For additional information regarding the Company's securities, please
refer to Notes 3 and 4 to the Consolidated Financial Statements.
Sources Of Funds
General. The Company's primary sources of funds are customer deposits,
principal, interest, and dividend payments on loans and securities, FHLB
advances and other borrowings, and, to a lesser extent, brokered deposits and
proceeds from sales of securities and loans. While maturities and scheduled
amortization of loans and securities are predictable sources of funds, deposit
flows and loan and security 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, features, and terms. The Company's deposits consist of demand
deposit and NOW checking accounts, savings accounts, money market accounts, and
certificates of deposit. The flow of deposits is influenced significantly by
general economic conditions, events in the capital markets, money supply,
prevailing interest rates, and competition. The Company's deposits are obtained
predominantly from the areas in which its full service 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 and
mutual funds significantly affect the Company's ability to attract and retain
deposits. At December 31, 2002, the Bank had $20.0 million in brokered
certificates of deposit. The Bank participates in the State of California Time
Deposit Program, whereby the State places certificates of deposit with banks as
a means of encouraging lending back into California's communities. Management
regularly monitors the Company's certificate accounts and historically the
Company has retained a large portion of such accounts upon maturity.
The Company's strategic plan incorporates increasing the percentage of
deposits represented by transaction accounts. Management believes that
transaction accounts present the opportunity to strengthen customer
relationships, build franchise value, generate fee income, and lower the
Company's relative cost of funds. In addition, an expansion in transaction
accounts supports the Company's asset / liability management program, as
transaction accounts are generally less interest rate sensitive than most
alternative sources of funding.
45
In recent years, the Company has offered a series of money market
deposit accounts specifically designed for certain target markets. Customers
wishing to avoid account maintenance fees and maintain low minimum balances are
marketed the Company's Easy Access money market account. Customers planning to
maintain particularly high average balances are marketed the Company's highly
tiered and more aggressively priced Investors Money Market account. Customers in
between these two profiles are marketed the competitively priced Lighthouse and
Money Market Plus money market accounts. In addition, the Company introduced its
Business Money Market account product at the beginning of 2003. This product is
tiered and priced to be an attractive alternative for excess liquid funds
maintained by the Company's commercial customers. All five of these money market
products offer check writing, 24 hour bilingual telephone banking, Internet
banking, ATM access, bank by mail, and in-branch service. As a result of this
target marketing, money market deposit balances have increased in recent years,
from $87.7 million at December 31, 2000 to $105.8 million at December 31, 2001
to $126.1 million at December 31, 2002. Expansion in money market balances
during 2001 and 2002 benefited from the interest rate environment, as certain
customers were less interested in committing to term certificates of deposit
with interest rates at historically low levels.
The Company's other area of focus in deposit acquisition in recent
years has been checking accounts, coincident with the Company's business
strategy of becoming more of a community based financial services organization,
meeting the primary financial needs of both consumers and small businesses.
Total checking balances expanded from $63.6 million at December 31, 2001 to
$67.2 million at December 31, 2002.
The rise in checking account balances during 2002 was supported by
increased checking account balances maintained by local businesses with which
the Company established comprehensive relationships in 2002 and 2001, including
such services as lines of credit, courier service, real estate financing,
letters of credit, and dedicated account relationship officers. The Company
further augmented its business checking product line in 2002 with the
introduction of Internet banking for businesses and remote deposit service. Via
the Company's remote deposit service, business and high balance individual
customers can make deposits to their Monterey Bay Bank checking accounts at any
of approximately 4,900 branches of a correspondent bank located in 23 states.
The Company also plans to augment its line of consumer checking
products in 2003, with improved customer statements and continued marketing of
Internet banking for consumers, including electronic bill payment.
At December 31, 2002, all of the Company's deposit products were
statement based (i.e. no passbooks). Management believes that statement based
products integrate more effectively with the increasingly numerous and varied
means of customer electronic access to their funds; e.g. Internet banking,
electronic bill payment, debit card / point of sale, ATM networks, and telephone
banking.
During 2002, the Company's certificate of deposit portfolio increased
by $2.9 million, as the issuance of a $20.0 million brokered certificate of
deposit and a $9.0 million increase in funds from the State of California Time
Deposit Program more than offset customer transfers of funds from certificates
of deposit into money market accounts due to the historically low interest rate
environment. During the past several years, the Company has focused its deposit
related sales efforts on transaction accounts as a means of increasing net
interest margins, bolstering fee income, and building more comprehensive
customer relationships.
The Company's weighted average cost of deposits at December 31, 2002
was 1.94%, equal to 44 basis points below the 11th District Cost Of Funds Index
("COFI") for December 2002 of 2.38%. While COFI contains funding components
other than deposits, the Company uses a comparison to COFI as a benchmark of its
success in managing its cost of deposits. The Company seeks to manage its cost
of deposits both via pricing for individual products and through the deposit
portfolio product mix.
The Company maintained no deposits in foreign banking offices at
December 31, 2002 or December 31, 2001.
46
The Company's weighted average cost of deposits decreased significantly
in 2002 primarily due to:
o the shift in product mix towards transaction accounts and away from
relatively higher costing certificates of deposit
o the general decrease in interest rate levels, assisted by the Federal
Reserve's cutting its target federal funds rate by 50 basis points in
November 2002
o certificates of deposit repricing downward upon maturity and rollover,
often significantly, in response to the decrease in interest rates during
2002 and 2001
The following table summarizes the Company's deposits at the dates
indicated.
December 31, 2002 December 31, 2001
------------------------------- -------------------------------
Weighted Weighted
(Dollars In Thousands) Average Average
Balance Rate Balance Rate
------- ---- ------- ----
Demand deposit accounts $ 23,549 -- $ 21,062 --
NOW accounts 43,629 0.16% 42,557 0.41%
Savings accounts 18,474 0.33% 19,127 0.57%
Money market accounts 126,061 1.79% 105,828 2.31%
Certificates of deposit < $100,000 133,795 2.66% 156,351 4.02%
Certificates of deposit $100,000 or more 112,826 2.59% 87,414 3.86%
-------- --------
$458,334 $432,339
======== ========
Weighted average nominal interest rate 1.94% 2.87%
The weighted average interest rates are at the end of the period and are based
upon stated interest rates without giving consideration to daily compounding of
interest or forfeiture of interest because of premature withdrawal.
The following table presents the amount and weighted average rate of
time deposits equal to or greater than $100,000 at December 31, 2002. The amount
maturing in three months or less includes $22.1 million associated with the
State of California Time Deposit Program. At December 31, 2002, under the State
of California Time Deposit Program, certificate of deposit maturities were
limited to terms of six months or less.
At December 31, 2002
----------------------------------
(Dollars In Thousands) Weighted
Average
Maturity Period Amount Rate
------ ----
Three months or less $ 41,277 2.32%
Over 3 through 6 months 33,834 2.40%
Over 6 through 12 months 15,632 2.61%
Over 12 months through 2 years 13,831 2.81%
Over 2 through 3 years 3,389 3.78%
Over 3 years 4,863 4.70%
--------- -----
Total $ 112,826 2.59%
=========
47
The following table presents the amount and weighted average rate of
time deposits less than $100,000 at December 31, 2002.
At December 31, 2002
----------------------------------
(Dollars In Thousands) Weighted
Average
Maturity Period Amount Rate
--------------- ------ ----
Three months or less $ 32,421 2.66%
Over 3 through 6 months 28,370 2.17%
Over 6 through 12 months 30,790 2.28%
Over 12 months through 2 years 27,761 2.68%
Over 2 through 3 years 7,533 4.13%
Over 3 years 6,920 4.68%
--------- -----
Total $ 133,795 2.66%
=========
The following table presents the distribution of the Company's average
balances of deposit accounts for the periods indicated and the weighted average
interest rates on each category of deposits presented.
For The Year Ended December 31,
-------------------------------------------------------------------------------------------
2002 2001 2000
----------------------------- ----------------------------- -----------------------------
% Of % Of % Of
Average Weighted Average Weighted Average Weighted
Average Total Average Average Total Average Average Total Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars In Thousands)
Demand deposits $ 22,856 5.1% -- $ 19,104 4.6% -- $ 16,720 4.3% --
NOW accounts 43,607 9.7% 0.34% 40,944 9.8% 0.89% 36,317 9.4% 1.51%
Savings accounts 18,732 4.2% 0.52% 19,370 4.6% 1.12% 15,803 4.1% 1.78%
Money market accounts 114,629 25.5% 2.11% 92,237 22.1% 3.74% 87,733 22.7% 4.60%
Certificates of deposit 249,088 55.5% 3.13% 246,315 58.9% 5.04% 230,099 59.5% 5.37%
-------- ------ ----- ------- ----- ----- ------- ----- -----
Total $448,912 100.0% 2.33% $417,970 100.0% 3.93% $386,672 100.0% 4.45%
======== ====== ======== ====== ======== ======
Please refer to Note 10 to the Consolidated Financial Statements for
additional information concerning deposits.
Borrowings
From time to time, the Company obtains borrowed funds through FHLB
advances, federal funds purchased, MBBC's line of credit, and securities sold
under agreements to repurchase. Borrowings are used to supplement deposits as a
source of funding. Borrowings are also used as a tool in the Company interest
rate risk management process.
FHLB advances are collateralized by the Bank's pledged mortgage loans,
pledged mortgage backed securities, and investment in the capital stock of the
FHLB. See "Regulation And Supervision - Federal Home Loan Bank System." FHLB
advances are made pursuant to several different credit programs with varying
interest rate, embedded option (callable / putable), amortization, and maturity
terms. All of the Bank's FHLB advances outstanding at December 31, 2002 were
either overnight borrowings or fixed rate, non-amortizing advances with single
individual maturity dates ("bullet advances"). 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 FHLB. During 2002, the Bank
periodically used FHLB advances to provide needed liquidity and to manage the
term structure and maturities of its liabilities.
48
From time to time, the Company enters into reverse repurchase
agreements (securities sold under agreements to repurchase) with approved
security dealers.
The Bank maintains federal funds lines of credit with five
correspondent banks. These lines are not committed lines, but rather function on
a funds availability basis. From time to time, the Bank borrows federal funds
from its correspondent banks as a source of short term liquidity.
MBBC maintains a committed $3.0 million revolving line of credit with
one of the Bank's correspondent banks. This line of credit expires in March
2003, and is collateralized by 800,000 shares of the Company's treasury stock.
Funds drawn on the line are priced based upon either the London Inter-Bank Offer
Rate curve ("LIBOR") or the correspondent bank's reference rate. This line of
credit contains various financial performance covenants on the part of the
Company. The line of credit agreement does not restrict the Company's ability to
declare and pay cash or stock dividends. The line of credit agreement also
contains no restrictions on the use of funds to repurchase Company common stock.
The following table sets forth information regarding the Company's FHLB
advances at or for the indicated years.
(Dollars In Thousands) At Or For The Year Ended December 31,
--------------------------------------------
2002 2001 2000
---- ---- ----
FHLB Advances
Average balance outstanding $ 57,355 $ 47,526 $ 43,946
Weighted average rate on average balance outstanding 4.25% 5.30% 5.72%
Year end balance outstanding $ 93,582 $ 53,582 $ 32,582
Weighted average rate on year end balance outstanding 3.02% 4.46% 5.48%
Maximum amount outstanding at any month end during the year $ 93,582 $ 65,582 $ 50,582
Please refer to Notes 11 and 12 to the Consolidated Financial
Statements for additional information regarding borrowings and lines of credit.
Subsidiary Activities
Portola, a California corporation wholly owned by the Bank, is engaged,
on an agency basis, in the sale of insurance, mutual funds, individual
securities, and annuity products, primarily to the Bank's customers and members
of the local communities which the Bank serves. During 2002, gross commission
income generated through Portola included $39 thousand for mutual fund sales,
$21 thousand from sales of individual securities, $15 thousand for variable
annuity sales, $10 thousand for life insurance sales, and $8 thousand for fixed
annuity sales. Portola also functions as trustee for the Bank's deeds of trust.
At December 31, 2002, Portola had $37 thousand in total assets. Portola's
revenues in 2002 were constrained by the capital markets environment and by
vacancies in investment sales representative positions.
Personnel
As of December 31, 2002, the Company had 112 full-time employees and 14
part-time employees. The employees are not represented by a collective
bargaining unit. The Company considers its relationship with its employees to be
good.
49
REGULATION AND SUPERVISION
General
Savings and loan holding companies and savings associations are
extensively regulated under both federal and state law. This regulation is
intended primarily for the protection of depositors and the FDIC Insurance Funds
and not for the benefit of stockholders of the Company. The following
information describes certain aspects of that regulation applicable to the
Company and the Bank, and does not purport to be complete. The following
discussion is qualified in its entirety by reference to all particular statutory
or regulatory provisions.
Regulation of the Company
General. MBBC is a unitary savings and loan holding company subject to
regulatory oversight by the OTS. As such, MBBC is required to register and file
reports with the OTS and is subject to regulation and examination by the OTS. In
addition, the OTS has enforcement authority over MBBC and its subsidiaries,
which also permits the OTS to restrict or prohibit activities that are
determined to be a serious risk to the subsidiary savings association. MBBC is
also governed by federal regulations that restrict transactions between the Bank
and MBBC.
Although savings and loan holding companies are not, at December 31,
2002, subject to specific capital requirements or specific restrictions on the
payment of dividends or other capital distributions, the Home Owners Loan Act
("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 MBBC.
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 non-subsidiary 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 deposit insurance funds, the convenience and needs of the community, and
competitive factors.
Activities Restriction Test. As a unitary savings and loan holding
company, MBBC is generally not subject to activity restrictions, provided the
Bank satisfies the Qualified Thrift Lender ("QTL") test or meets the definition
of domestic building and loan association pursuant to the Internal Revenue Code
of 1986, as amended (the "Code"). MBBC presently intends to continue to operate
as a unitary savings and loan holding company. Federal legislation terminated
the "unitary thrift holding company exemption" for all companies that apply to
acquire savings associations after May 4, 1999. Since the Company is
grandfathered, its unitary holding company powers and authorities were not
affected. See "Financial Services Modernization Legislation." However, if MBBC
acquires control of another savings association as a separate subsidiary, it
would become a multiple savings and loan holding company, and the activities of
MBBC and any of its subsidiaries (other than the Bank or any other SAIF-insured
savings association) would become subject to restrictions applicable to bank
holding companies unless such other associations each also qualify as a QTL or
domestic building and loan association and were acquired in a supervisory
acquisition. Furthermore, if MBBC were in the future to sell control of the Bank
to any other company, such company would not succeed to MBBC's grandfathered
status under and would be subject to the same business activity restrictions.
See "Regulation of the Bank - Qualified Thrift Lender Test."
50
Restrictions on Acquisitions. MBBC must obtain approval from the OTS
before acquiring control of any other SAIF-insured association. Such
acquisitions are generally prohibited if they result in a multiple savings and
loan holding company controlling savings institutions in more than one state.
However, such interstate acquisitions are permitted based on specific state
authorization or in a supervisory acquisition of a failing savings association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may acquire
"control," as that term is defined in OTS regulations, of a federally insured
savings association without giving at least 60 days written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition. In
addition, no company may acquire control of such an institution without prior
OTS approval. These provisions also prohibit, among other things, any director
or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of a savings and loan holding
company, from acquiring control of any savings association not a subsidiary of
the savings and loan holding company, unless the acquisition is approved by the
OTS. For additional restrictions on the acquisition of a unitary thrift holding
company, see "- Financial Services Modernization Legislation."
The Sarbanes-Oxley Act of 2002
On July 30, 2002, President Bush signed into law The Sarbanes-Oxley Act
of 2002. This new legislation addresses accounting oversight and corporate
governance matters, including:
o the creation of a five-member oversight board appointed by the SEC that
will set standards for accountants and have investigative and disciplinary
powers
o the prohibition of accounting firms furnishing audit services from
providing various types of consulting and non-audit services to public
clients
o requiring accounting firms to rotate partners among public client
assignments every five years
o enhanced independence of board audit committees
o the prohibition of most personal loans to directors and executive officers
(loans by the Bank in accordance with Regulation O are exempt)
o protection of whistle-blowers
o increased civil and criminal penalties for financial crimes
o expanded disclosure of corporate operations and internal controls and
required certification of SEC filings containing financial information
o enhanced controls on, and reporting of, insider trading
o statutory separations between investment bankers and analysts
51
Following the passage of the Sarbanes-Oxley Act of 2002, the SEC
undertook a number of initiatives to implement and help ensure compliance with
the Act. New SEC rules adopted as a result of the Sarbanes-Oxley Act of 2002
have addressed:
o conditions for the disclosure of non-GAAP financial information
o current report requirements on Form 8-K were expanded to require public
companies to include earnings releases or similar announcements in a Form
8-K filing with the SEC
o public companies must disclose whether any members of their audit committee
are considered to be audit committee financial experts, and, if not, why
not
o public companies must disclose certain information about codes of conduct
o trading restrictions for company insiders in conjunction with pension fund
blackout periods
o an expansion in the scope of the retention of records relevant to audits
and reviews
o increased disclosure requirements for off-balance sheet transactions and
arrangements and contractual obligations
o strengthened rules for auditor independence
o expanded communications between the independent auditor and the Board Audit
Committee
The primary impacts upon the Company from the Sarbanes-Oxley Act of
2002 will be increased reporting requirements and higher professional fees for
legal and accounting services. As a highly regulated savings and loan holding
company and financial institution, MBBC and the Bank were already subject to
many of the types of operating restrictions and financial control requirements
implemented following the passage of the Sarbanes-Oxley Act of 2002.
California Corporate Disclosure Act
On September 18, 2002, the Governor of California signed the California
Corporate Disclosure Act ("Disclosure Act"). The Disclosure Act is effective
January 1, 2003 and changes the current biennial filings of corporations doing
business in the State to an annual filing and, more importantly, (a) requires
significant additional information that publicly traded California domestic and
foreign corporations qualified in California must include in the Statement and
(b) requires that each filing corporation certify that the information in the
Statement is true and correct.
52
In addition to the information required of all corporations, every
publicly traded company subject to the act (such as the Company) must also
include the following information in the Statement:
o two years of information on the corporation's independent auditor and the
services provided by such auditor
o the date of the last audit report prepared by the independent auditor and a
copy of such report
o information on annual compensation of the board and the executive officers
o two years of information on director loans
o information about any bankruptcy filings by the corporation, its executive
officers or directors in the last 10 years
o information about any fraud convictions by the executive officers or board
members in the last ten years
o information about corporate violations of any federal security laws or any
banking or security provision of California law in the last 10 years for
which the corporation was found liable in an action before a federal or
state court or regulatory agency or a self-regulatory organization with
judgments over $10 thousand
The Company does not expect the added disclosure associated with the Disclosure
Act to have a material adverse effect on its operations or financial condition.
USA Patriot Act of 2001
On October 26, 2001, President Bush signed the USA Patriot Act of 2001.
The Patriot Act is intended is to strengthen U.S law enforcement's and the
intelligence communities' abilities to work cohesively to combat terrorism on a
variety of fronts. The potential impact of the Act on financial institutions of
all kinds is significant and wide ranging. The Act contains sweeping anti-money
laundering and financial transparency laws in addition to previous requirements,
and requires various regulations, including:
o due diligence requirements for financial institutions that administer,
maintain, or manage private banks accounts or correspondent accounts for
non-US persons
o standards for verifying customer identification at account opening
o rules to promote cooperation among financial institutions, regulators, and
law enforcement entities in identifying parties that may be involved in
terrorism or money laundering
o reports by non-financial businesses filed with the Treasury Department's
Financial Crimes Enforcement Network for transactions exceeding $10,000,
and
o filing of suspicious activities reports securities by brokers and dealers
if they believe a customer may be violating U.S. laws and regulations.
53
On July 23, 2002, the U.S. Treasury proposed regulations requiring
institutions to incorporate into their written money laundering plans, a board
approved customer identification program implementing reasonable procedures for:
o verifying the identity of any person seeking to open an account, to the
extent reasonable and practicable
o maintaining records of the information used to verify the person's identity
o determining whether the person appears on any list of known or suspected
terrorists or terrorist organizations
Account is defined as a formal banking or business relationship established to
provide ongoing services, dealings, or other financial transactions.
Financial Services Modernization Legislation
General. On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act of 1999 (the "GLB"). The general effect of the law is to
establish a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms, and other financial service
providers by revising and expanding the Bank Holding Company Act framework to
permit a holding company system to engage in a full range of financial
activities through a new entity known as a "financial holding company."
"Financial activities" is broadly defined to include not only banking,
insurance, and securities activities, but also merchant banking and additional
activities that the Federal Reserve Board, in consultation with the Secretary of
the Treasury, determines to be financial in nature, incidental to such financial
activities, or complementary activities that do not pose a substantial risk to
the safety and soundness of depository institutions or the financial system
generally.
The GLB provides that no company may acquire control of an insured
savings association unless that company engages, and continues to engage, only
in the financial activities permissible for a financial holding company, unless
grandfathered as a unitary savings and loan holding company. The GLB
grandfathers any company that was a unitary savings and loan holding company on
May 4, 1999 or became a unitary savings and loan holding company pursuant to an
application pending on that date. Such a company may continue to operate under
present law as long as the company continues to meet the two tests: it can
control only one savings institution, excluding supervisory acquisitions, and
each such institution must meet the QTL test. Such a grandfathered unitary
savings and loan holding company also must continue to control at least one
savings association, or a successor institution, that it controlled on May 4,
1999.
The GLB also permits national banks to engage in expanded activities
through the formation of financial subsidiaries. A national bank may have a
subsidiary engaged in any activity authorized for national banks directly or any
financial activity, except for insurance underwriting, insurance investments,
real estate investment or development, or merchant banking, which may only be
conducted through a subsidiary of a financial holding company. Financial
activities include all activities permitted under new sections of the Bank
Holding Company Act or permitted by regulation.
The Company and the Bank do not believe that the GLB has had or will
have a material adverse effect on their operations in the near-term. However, to
the extent that the act permits banks, securities firms, and insurance companies
to affiliate, the financial services industry may experience further
consolidation. The GLB is intended to grant to community banks certain powers as
a matter of right that larger institutions have accumulated on an ad hoc basis
and which unitary savings and loan holding companies already possess.
Nevertheless, this Act may have the result of increasing the amount of
competition that the Company and the Bank face from larger institutions and
other types of companies offering financial products, many of which may have
substantially more financial resources than the Company and the Bank.
54
Privacy. Under the GLB, federal banking regulators adopted rules that
limit the ability of banks and other financial institutions to disclose
non-public information about consumers to nonaffiliated third parties. Pursuant
to these rules, effective July 1, 2001, financial institutions must provide:
o initial notices to customers about their privacy policies, describing the
conditions under which they may disclose nonpublic personal information to
nonaffiliated third parties and affiliates;
o annual notices of their privacy policies to current customers; and
o a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
These privacy provisions affect how consumer information is transmitted through
diversified financial companies and conveyed to outside vendors.
Consumer Protection Rules - Sale of Insurance Products. In December
2000, pursuant to the requirements of the GLB, the federal bank and thrift
regulatory agencies adopted consumer protection rules for the sale of insurance
products by depository institutions. The rules were effective on April 1, 2001.
The final rule applies to any depository institution or any person selling,
soliciting, advertising, or offering insurance products or annuities to a
consumer at an office of the institution or on behalf of the institution. Before
an institution can complete the sale of an insurance product or annuity, the
regulation requires oral and written disclosure that such product:
o is not a deposit or other obligation of, or guaranteed by, the depository
institution or its affiliate;
o is not insured by the FDIC or any other agency of the United States, the
depository institution or its affiliate; and
o has certain risks in investment, including the possible loss of value.
Finally, the depository institution may not condition an extension of credit:
o on the consumer's purchase of an insurance product or annuity from the
depository institution or from any of its affiliates, or
o on the consumer's agreement not to obtain, or a prohibition on the consumer
from obtaining, an insurance product or annuity from an unaffiliated
entity.
The rule also requires formal acknowledgement from the consumer that disclosures
were received.
In addition, to the extent practicable, a depository institution must
keep insurance and annuity sales activities physically segregated from the areas
where retail deposits are routinely accepted from the general public.
55
Regulation of the Bank
General. As a federally chartered, FDIC insured savings association,
the Bank is subject to extensive regulation, examination, and supervision by the
OTS, as its primary federal regulator, and the FDIC, as the insurer of customer
deposits. Lending activities and other investments of the Bank must comply with
various statutory and regulatory requirements. The Bank is also subject to
certain reserve requirements promulgated by the Board of Governors of the
Federal Reserve System ("FRB").
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the consideration of the Bank's Board of Directors on any
deficiencies found in the operations of the Bank. The relationship between the
Bank and depositors and borrowers is also regulated by federal and state laws,
especially in such matters as the ownership of deposit accounts and the form and
content of mortgage documents utilized by the Bank.
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 financial institutions. 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 FDIC insurance funds
and depositors.
The OTS and / or the FDIC conduct periodic examinations to test the
Bank's safety and soundness, its operations (including technology utilization),
and its compliance with applicable laws and regulations, including, but not
limited to:
o the Community Reinvestment Act ("CRA")
o the Real Estate Settlement Procedures Act ("RESPA")
o the Bank Secrecy Act ("BSA")
o the Fair Credit Reporting Act ("FCRA")
o the Home Mortgage Disclosure Act ("HMDA")
The regulatory structure provides the regulatory authorities extensive
discretion, in connection with their supervisory and enforcement activities and
examination policies, across a wide range of the Bank's operations, including,
but not limited to:
o loss reserve adequacy
o capital requirements
o credit classification
o limitation or prohibition on dividends
o assessment levels for deposit insurance and examination costs
o permissible branching
Any change in regulatory requirements and policies, whether by the OTS,
the FDIC, the Federal Reserve Board, or Congress, could have a material adverse
impact on the Company.
56
Regulatory Capital Requirements And Capital Categories
The following discussion regarding regulatory capital requirements is
applicable to the Bank.
Regulatory Capital Requirements. OTS capital regulations require
savings institutions to meet three minimum capital standards (as defined by
applicable regulations):
o tangible capital equal to 1.5% of adjusted total assets
o leverage capital (core capital) equal to 3.0% of adjusted total assets
o risk-based capital equal to 8.0% of total risk-based assets
The Bank must meet each of these three standards in order to be deemed in
compliance with OTS capital requirements. The capital standard applicable to
savings institutions must be no less stringent than those for national banks. In
addition, the prompt corrective action ("PCA") standards discussed below also
establish, in effect, the following minimum standards:
o a 2.0% tangible capital ratio
o a 4.0% leverage (core) capital ratio (3.0% for institutions receiving the
highest regulatory rating under the CAMELS rating system)
o a 4.0% Tier One risk based capital ratio
Tangible capital is composed of:
o common stockholders' equity (including retained earnings)
o certain noncumulative perpetual preferred stock and related earnings
o minority interests in equity accounts of consolidated subsidiaries
less:
o intangible assets other than certain asset servicing rights and certain
nonsecurity financial instruments
o investments in and loans or advances to subsidiaries engaged in activities
as principal, not permissible for a national bank, with certain limited
exceptions
o servicing assets in excess of certain thresholds
o deferred tax assets in excess of certain thresholds
o accumulated unrealized gains on certain available for sale securities
o accumulated gains related to qualifying cash flow hedges
plus:
o accumulated unrealized losses on certain available for sale securities
o accumulated losses related to qualifying cash flow hedges
57
Core capital consists of tangible capital plus various adjustments for
certain intangible assets. At December 31, 2002, the Bank's tangible capital was
equivalent to its core capital, as the Bank did not maintain any qualifying
adjustments. In general, total assets calculated for regulatory capital purposes
exclude those assets deducted from capital in determining the applicable capital
ratio.
The risk based capital standard for savings institutions requires the
maintenance of Tier One capital (core capital) and total capital (defined as
core capital plus supplementary capital) to risk weighted assets of 4.0% and
8.0%, respectively. In determining the amount of an institution's risk weighted
assets, all assets, including certain off balance sheet positions, are
multiplied by a risk weight of 0.0% to 100.0%, as assigned by OTS regulations
based upon the amount of risk perceived as inherent in each type of asset. The
components of supplementary capital include:
o cumulative preferred stock
o long term perpetual preferred stock
o mandatory convertible securities
o certain subordinated debt
o intermediate preferred stock
o the general allowance for loan and lease losses, subject to a limit of
1.25% of risk weighted assets
Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100.0% of core capital.
These regulatory capital requirements are viewed as minimum standards
by the OTS, and most institutions are expected to maintain capital levels well
above the minimum. In addition, the OTS regulations provide that minimum capital
levels higher than those provided in the regulations may be established by the
OTS for individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others:
o a savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks or a high
proportion of off-balance sheet risk;
o a savings association is growing, either internally or through
acquisitions, at such a rate that supervisory problems are presented that
are not dealt with adequately by OTS regulations; or
o a savings association may be adversely affected by activities or condition
of its holding company, affiliates, subsidiaries, or other persons, or
savings associations with which it has significant business relationships.
The Home Owners' Loan Act ("HOLA") permits savings associations not in
compliance with the OTS capital standards to seek an exemption from certain
penalties or sanctions for noncompliance. Such an exemption will be granted only
if certain strict requirements are met, and must be denied under certain
circumstances. If an exemption is granted by the OTS, the savings association
still may be subject to enforcement actions for other violations of law or
unsafe or unsound practices or conditions.
As disclosed in Note 14 to the Consolidated Financial Statements, at
December 31, 2002, the Bank exceeded all minimum and institution specific
regulatory capital requirements.
58
Prompt Corrective Action Regulations. The OTS can levy sanctions
against institutions that are not adequately capitalized, with the severity of
the sanctions increasing as the institution's capital declines. The OTS has
established specific capital ratios under the Prompt Corrective Action ("PCA")
Regulations for five separate capital categories:
1. Well Capitalized 3. Under Capitalized
-------------------- ---------------------
Total risk based capital ratio of at least 10.0% Total risk based capital ratio of less than 8.0%
Tier One risk based capital ratio of at least 6.0% Tier One risk based capital ratio of less than 4.0%
Leverage ratio of at least 5.0% Leverage ratio of less than 4.0%
2. Adequately Capitalized 4. Significantly Under Capitalized
-------------------------- -----------------------------------
Total risk based capital ratio of at least 8.0% Total risk based capital ratio of less than 6.0%
Tier One risk based capital ratio of at least 4.0% Tier One risk based capital ratio of less than 3.0%
Leverage ratio of at least 4.0% Leverage ratio of less than 3.0%
5. Critically Under Capitalized
--------------------------------
Tangible capital of less than 2.0%
In general, the prompt corrective action regulation prohibits an
insured depository institution from declaring any dividends, making any other
capital distribution, or paying a management fee to a controlling person if,
following the distribution or payment, the institution would be within any of
the three undercapitalized categories. In addition, adequately capitalized
institutions may accept brokered deposits only with a waiver from the FDIC and
are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew, or roll-over
brokered deposits.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions. Finally, pursuant to an interagency
agreement, the FDIC can examine any institution that has a substandard
regulatory examination score or is considered undercapitalized - without the
express permission of the institution's primary regulator.
As disclosed in Note 14 to the Consolidated Financial Statements, at
December 31, 2002, the Bank met the requirements to be classified as a "well
capitalized" institution under Prompt Corrective Action regulations. At December
31, 2002, the Bank was eligible to acquire brokered deposits.
Regulatory Capital Requirements Associated With Subprime Lending. As a
result of a number of federally insured financial institutions extending their
risk selection standards to attract lower credit quality accounts due to such
credits having higher interest rates and fees, the federal banking regulatory
agencies jointly issued Interagency Guidelines on Subprime Lending. Subprime
lending involves extending credit to individuals with less than perfect credit
histories.
The agencies' guidelines provide that if the risks associated with
subprime lending are not properly controlled, the agencies consider subprime
lending a high-risk activity that is unsafe and unsound. Specifically, the
guidelines direct examiners to expect regulatory capital to be one and one-half
to three times higher than that typically set aside for prime assets for
institutions that:
o have subprime assets equal to 25% or higher of Tier 1 capital; or
o have subprime portfolios experiencing rapid growth or adverse performance
trends, administered by inexperienced management, or having inadequate or
weak controls.
The Bank does not normally engage in subprime lending.
59
Predatory Lending. The term "predatory lending", much like the terms
"safety and soundness" and "unfair and deceptive practices," is far-reaching and
covers a potentially broad range of behavior. As such, it does not lend itself
to a concise or a comprehensive definition. But typically predatory lending
involves at least one, and perhaps all three, of the following elements:
o making unaffordable loans based on the assets of the borrower rather than
on the borrower's ability to repay an obligation ("asset-based lending")
o inducing a borrower to refinance a loan repeatedly in order to charge high
points and fees each time the loan is refinanced ("loan flipping")
o engaging in fraud or deception to conceal the true nature of the loan
obligation from an unsuspecting or unsophisticated borrower.
On October 1, 2002, Federal Reserve Board regulations aimed at curbing
predatory lending became effective. The rule significantly widens the pool of
high-cost home-secured loans covered by the Home Ownership and Equity Protection
Act of 1994 ("HOPEA"), a federal law that requires extra disclosures and
consumer protections to borrowers. The following triggers coverage under HOPEA:
o interest rates for first lien mortgage loans in excess of 8 percentage
points above comparable term Treasury securities;
o subordinate-lien loans of 10 percentage points above comparable term
Treasury securities; or
o fees such as optional insurance and similar debt protection costs paid in
connection with the credit transaction, when combined with points and fees
if deemed excessive.
In addition, the regulation bars loan flipping by the same lender or loan
servicer within a year. Lenders also will be presumed to have violated the law
-- which says loans shouldn't be made to people unable to repay them -- unless
they document that the borrower has the ability to repay. Lenders that violate
the rules face cancellation of loans and penalties equal to the finance charges
paid.
Because the Bank does not engage in the various practices generally
referenced as "predatory lending", Management does not anticipate any material
impact from these rule changes and potential state action in this area on its
financial condition or results of operation.
Safety and Soundness Standards
The OTS has established minimum standards to promote early
identification of management problems at depository institutions and to ensure
that regulators intervene promptly to require corrective action by institutions
with inadequate operational and managerial controls related to:
o internal controls, information systems, and internal audit systems
o loan documentation
o credit underwriting
o asset growth
o earnings
o interest rate risk exposure
o compensation, fees, and benefits
60
If the OTS determines that an institution fails to meet any of these
minimum standards, the agency may require the institution to submit to the
agency an acceptable plan to achieve compliance with the standard. In the event
the institution fails to submit an acceptable plan within the time allowed by
the agency or fails in any material respect to implement an accepted plan; the
agency must, by order, require the institution to correct the deficiency and may
implement a series of supervisory sanctions.
The federal banking agencies (including the OTS) have promulgated
safety and soundness regulations and accompanying interagency compliance
guidelines on asset quality and earnings standards. These guidelines provide six
standards for establishing and maintaining a system to identify problem assets
and prevent those assets from deteriorating. The institution should:
1. conduct periodic asset quality reviews to identify problem assets
2. estimate the inherent losses in those assets and establish reserves that
are sufficient to absorb estimated losses
3. compare problem asset totals to capital
4. take appropriate corrective action to resolve problem assets
5. consider the size and potential risks of material asset concentrations
6. provide periodic asset reports with adequate information for management and
the board of directors to assess the level of asset risk
These guidelines also set forth standards for evaluating and monitoring
earnings and for ensuring that earnings are sufficient for the maintenance of
adequate capital and reserves. If the institution fails to comply with a safety
and soundness standard, the appropriate federal banking agency may require the
institution to submit a compliance plan. Failure to submit a compliance plan or
to implement an accepted plan may result in enforcement action.
Potential Enforcement Actions
The OTS has primary enforcement responsibility over savings
institutions and maintains the authority to bring actions against the
institution and all institution affiliated parties, as defined under the
applicable regulations, for unsafe or unsound practices in conducting their
businesses or for violations of any law, rule, regulation, condition imposed in
writing by the agency, or any written agreement with the agency. Enforcement
actions may include the imposition of a conservator or receiver, the issuance of
a cease and desist order that can be judicially enforced, the termination of
insurance of deposits (in the case of the Bank), the imposition of civil money
penalties, the issuance of directives to increase capital, the issuance of
formal and informal agreements, the issuance of removal or prohibition orders
against institution affiliated parties, and the imposition of restrictions under
the PCA provisions of FDICIA. Federal law also establishes criminal penalties
for certain violations.
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 of the OTS, the FDIC
has authority to take such action under certain circumstances.
Additionally, a holding company's inability to serve as a source of
strength to its subsidiary financial institutions could serve as an ancillary
basis for regulatory action against the holding company. Neither MBBC, the Bank,
or any subsidiary thereof are currently subject to any enforcement actions
61
Insurance of Deposit Accounts
The Bank's deposit accounts are presently insured by the SAIF, except
for certain acquired deposits that are insured by the BIF, up to the maximum
permitted by law. The SAIF and the BIF are administered by the FDIC. Insurance
of deposits may be terminated by the FDIC upon a finding that the institution:
o has engaged in unsafe or unsound practices;
o is in an unsafe or unsound condition to continue operations; or
o has violated any applicable law, regulation, rule, order, or condition
imposed by the FDIC or the institution's primary regulator.
The management of the Bank does not know of any practice, condition, or
violation that might lead to the termination of deposit insurance.
The FDIC currently assesses its premiums based upon the insured institution's
position on two factors:
1. the institution's capital category under PCA regulations
2. the institution's supervisory category as determined by the FDIC based upon
supervisory information provided by the institution's primary federal
regulator and other information deemed pertinent by the FDIC
The supervisory categories are:
o Group A: financially sound with only a few minor weaknesses
o Group B: demonstrates weaknesses that could result in significant
deterioration
o Group C: poses a substantial probability of loss
Annual FDIC deposit insurance assessment rates as of January 1, 2003 were as
follows:
FDIC Deposit Insurance Rates Expressed In Terms
As Of January 1, 2003 Of Annual Cents Per $100 of Assessed Deposits
----------------------------------------------------
Group A Group B Group C
------- ------- -------
PCA Capital Category
--------------------
Well capitalized 0 3 17
Adequately capitalized 3 10 24
Under capitalized 10 24 27
As of January 1, 2003, the Bank had been notified by the FDIC that its
deposit insurance assessment rate during the first half of calendar 2002 would
be 0 basis points.
In addition to the deposit insurance premiums presented in the above
table, both BIF and SAIF insured institutions must also pay FDIC premiums
related to the servicing of Financing Corporation ("FICO") bonds. FICO is an
agency of the federal government that was established to recapitalize the
predecessor to the SAIF. These assessments will continue until the FICO bonds
mature in 2017. The current annual assessment rate for the FICO bonds is
approximately 2 basis points per annum on insured deposits.
In early 2003, Congress was considering various new laws applicable to
FDIC insurance premiums and insurance coverage. See "Potential Federal
Legislation and Regulation".
62
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. At this time, the Company's management has no plans to
establish physical branches outside of California, although the Bank does serve
customers domiciled outside of California via alternative delivery channels such
as telephone, mail, the Internet, and ATM networks.
Transactions With Related Parties
Transactions between a savings association and its "affiliates" are
quantitatively and qualitatively restricted under the Federal Reserve Act and by
FRB Regulation W. Affiliates of a savings association include, among other
entities, the savings association's holding company and companies that are under
common control with the savings association. In general, a savings association
or its subsidiaries are limited in their ability to engage in "covered
transactions" with affiliates:
o to an amount equal to 10% of the association's capital and surplus, in the
case of covered transactions with any one affiliate; and
o to an amount equal to 20% of the association's capital and surplus, in the
case of covered transactions with all affiliates.
In addition, a savings association and its subsidiaries may engage in
covered transactions and other specified transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction"
includes:
o a loan or extension of credit to an affiliate
o a purchase of investment securities issued by an affiliate
o a purchase of assets from an affiliate, with some exceptions
o the acceptance of securities issued by an affiliate as collateral for a
loan or extension of credit to any party
o the issuance of a guarantee, acceptance, or letter of credit on behalf of
an affiliate
In addition, under the OTS regulations:
o a savings association may not make a loan or extension of credit to an
affiliate unless the affiliate is engaged only in activities permissible
for bank holding companies;
o a savings association may not purchase or invest in securities of an
affiliate other than shares of a subsidiary;
o a savings association and its subsidiaries may not purchase a low-quality
asset from an affiliate;
o covered transactions and other specified transactions between a savings
association or its subsidiaries and an affiliate must be on terms and
conditions that are consistent with safe and sound banking practices; and
o with some exceptions, each loan or extension of credit by a savings
association to an affiliate must be secured by collateral with a market
value ranging from 100% to 130%, depending on the type of collateral, of
the amount of the loan or extension of credit.
63
OTS regulations generally exclude all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except for:
o a financial subsidiary
o a subsidiary controlled by one or more affiliates
o an ESOP
o a subsidiary determined by the OTS or the Federal Reserve to be an
affiliate
The regulations also require savings associations to make and retain
records that reflect affiliate transactions in reasonable detail and provides
that specified classes of savings associations may be required to give the OTS
prior notice of affiliate transactions.
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 the Federal Reserve Act 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. Specific 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.
For information concerning loans to executive officers and directors of the
Company, please refer to Note 5 to the Consolidated Financial Statements.
Community Reinvestment Act and Fair Lending Laws
Savings associations have a responsibility under the Community
Reinvestment Act ("CRA") and related regulations of the OTS to help meet the
credit needs of their communities. The CRA generally requires most insured
depository institutions to:
o identify and delineate the communities served through and by the
institution's offices
o affirmatively meet the credit needs of their delineated communities,
including low and moderate income neighborhoods
o market the types of credit the institution is prepared to extend within
such communities
The CRA requires the OTS to assess the performance of the institution
in meeting the credit needs of its communities and to take such assessment into
consideration in reviewing applications for mergers, acquisitions, and other
transactions. An unsatisfactory CRA rating may be the basis for denying such an
application. In addition, federal banking agencies may take compliance with CRA
into account when regulating and supervising other activities.
The Equal Credit Opportunity Act and the Fair Housing Act prohibit
lenders from discriminating in their lending practices on the basis of
characteristics specified in those statutes. In addition, an institution's
failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act
could result in the OTS, other federal regulatory agencies, or the Department of
Justice taking enforcement actions.
64
An institution's CRA performance is assessed on the basis of the
institution's actual lending, service, and investment performance. In connection
with its assessment of the Bank's CRA performance, the OTS assigns one of the
following ratings:
o outstanding
o satisfactory
o needs improvement
o substantial noncompliance
Based upon its most recent CRA examination, the Bank received a "satisfactory"
CRA rating.
Effective January 1, 2002, the OTS raised the dollar amount limit in
the definition of small business loans from $500,000 to $2.0 million, if used
for commercial, corporate, business, or agricultural purposes. Furthermore, the
rule raises the aggregate level that a thrift can invest directly in community
development funds, community centers, and economic development initiatives in
its communities from the greater of a quarter of one percent of total capital or
$100,000 to one percent of total capital or $250,000.
Qualified Thrift Lender Test
The HOLA requires savings associations to meet a qualified thrift
lender ("QTL") test. A savings association is permitted to meet the QTL test in
one of two alternative ways. Under the first method, in at least nine out of
every twelve months, the thrift 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) intangible assets, including goodwill and
(iii) the value of property used to conduct business, in certain "qualified
thrift investments." Assets constituting qualified thrift investments include
residential mortgages, qualifying mortgage backed securities, educational loans,
small business loans, and credit card loans. Certain other types of assets also
qualify as "qualified thrift investments" up to certain limitations. These
limited other types of assets include home equity lines of credit and consumer
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 by meeting the Code's 60% of assets test in nine out of every
twelve months.
Savings associations that fail to meet the QTL test will generally be
prohibited from engaging in any activity not permitted for both a national bank
and a savings association. A savings association that fails the QTL test may be
required to convert to a commercial bank charter. At December 31, 2002, the Bank
maintained 68.4% of its portfolio assets in qualified thrift investments and,
therefore, met the QTL test.
65
Loans To One Borrower Limitations
Savings associations generally are subject to the lending limits
applicable to national banks. With certain limited exceptions, the maximum
amount that a savings association or a national bank may lend to any borrower
(including certain related entities of the borrower) at one time may not exceed
15% of the unimpaired capital and surplus of the institution, plus an additional
10% of unimpaired capital and surplus for loans fully secured by readily
marketable collateral. The term "unimpaired capital and surplus" is defined as
an institution's regulatory capital, plus that portion of an institution's
general valuation allowances that is not includable in the institution's
regulatory capital. "Readily marketable collateral" is defined to include
certain financial instruments and specifically excludes real estate.
Savings associations are additionally authorized to make loans to one
borrower, for any purpose, in an amount not to exceed $500,000 or, by order of
the Director of OTS, in an amount not to exceed the lesser of $30,000,000 or 30%
of unimpaired capital and surplus to develop residential housing, provided:
o the purchase price of each single-family dwelling in the development does
not exceed $500,000;
o the savings association is in compliance with its regulatory capital
requirements;
o the loans comply with applicable loan-to-value requirements; and
o the aggregate amount of loans made under this authority does not exceed
150% of unimpaired capital and surplus.
At December 31, 2002, the Bank's limit on loans to one borrower was
$9.0 million. At December 31, 2002, the Bank's largest aggregate outstanding
balances of loans to one borrower were:
o a $7.5 million construction loan for the development of an apartment
building in Los Angeles, California
o a $7.0 million construction loan for a residential development in Soledad,
California
o a total of $6.9 million in aggregate loans associated with an upscale
residential development in Monterey, California
At December 31, 2002, all of the above loans were performing in
accordance with their terms. The Bank has conducted lending in the Monterey
residential development for the past several years.
Limitations On Capital Distributions
OTS regulations impose limitations upon all capital distributions by
savings institutions, such as cash dividends, payments to repurchase or
otherwise acquire its shares, payments to shareholders of another institution in
a cash-out merger, and other distributions charged against capital. Under
current regulations, a savings association in some circumstances may:
o be required to file an application and await approval from the OTS before
it makes a capital distribution
o be required to file a notice 30 days before the capital distribution
o be permitted to make the capital distribution without notice or application
to the OTS
66
The OTS regulations require a savings association to file an application
if:
o it is not eligible for expedited treatment of its other applications under
OTS regulations
o the total amount of all of capital distributions, including the proposed
capital distribution, for the applicable calendar year exceeds its net
income for that year to date plus retained net income for the preceding two
years
o it would not be at least adequately capitalized, under the prompt
corrective action regulations of the OTS, following the distribution
o the association's proposed capital distribution would violate a prohibition
contained in any applicable statute, regulation, or agreement between the
savings association and the OTS, or the FDIC, or violate a condition
imposed on the savings association in an OTS-approved application or notice
In addition, a savings association must give the OTS notice of a
capital distribution if the savings association is not required to file an
application, but:
o would not be well capitalized under the prompt corrective action
regulations of the OTS following the distribution
o the proposed capital distribution would reduce the amount of or retire any
part of the savings association's common or preferred stock or retire any
part of debt instruments like notes or debentures included in capital,
other than regular payments required under a debt instrument approved by
the OTS
o the savings association is a subsidiary of a savings and loan holding
company (applicable to the Bank)
The OTS may prohibit a proposed capital distribution that would
otherwise be permitted if the OTS determines that the distribution would
constitute an unsafe or unsound practice. Further, a federal savings
association, like the Bank, cannot distribute regulatory capital that is needed
for its liquidation account.
The Bank did not declare or pay any dividends to MBBC in 2001 or 2002.
Activities of Subsidiaries
A savings association seeking to establish a new subsidiary, acquire
control of an existing company or conduct a new activity through a subsidiary
must provide 30 days prior notice to the FDIC and the OTS and conduct any
activities of the subsidiary in compliance with regulations and orders of the
OTS. The OTS has the power to require a savings association to divest any
subsidiary or terminate any activity conducted by a subsidiary that the OTS
determines to pose a serious threat to the financial safety, soundness, or
stability of the savings association or to be otherwise inconsistent with sound
banking practices.
Restrictions On Investments And Loans
OTS regulations do not permit the Bank to invest directly in equity
securities (with certain very limited exceptions), non investment grade debt
securities, or real estate, other than real estate used for the institution's
offices and facilities. Indirect equity investment in real estate through a
subsidiary, such as Portola, is permissible, but is subject to certain
limitations and deductions from regulatory capital. Management has no plans to
pursue real estate development or real estate investment activity through
Portola.
67
The OTS and other federal banking agencies have jointly adopted uniform
rules on real estate lending and related Interagency Guidelines for Real Estate
Lending Policies (the "Guidelines"). The uniform rules require that institutions
adopt and maintain comprehensive written policies for real estate lending. The
policies must reflect consideration of the Guidelines and must address relevant
lending procedures, such as loan to value limitations, loan administration
procedures, portfolio diversification standards and documentation, and approval
and reporting requirements. Although the uniform rules do not impose specific
maximum loan to value ratios, the related Guidelines state that such ratio
limits established by an individual institution's board of directors generally
should not exceed levels set forth in the Guidelines, which range from a maximum
of 65% for loans secured by unimproved land to 85% for improved property. No
limit is set for single family residential mortgages, but the Guidelines state
that such loans equal to or exceeding a 90.0% loan to value ratio should have
private mortgage insurance or some other form of credit enhancement. The
Guidelines further permit a limited amount of loans that do not conform to these
criteria. In addition, aggregate loans secured by non-residential real property
are generally limited to 400% of a thrift institution's total capital, as
defined.
Classification Of Assets
Thrift institutions are required to classify their assets on a regular
basis, to establish appropriate allowances for losses, and to report the results
of such classifications quarterly to the OTS. A thrift institution is also
required to set aside adequate valuation allowances, and to establish
liabilities for off balance sheet items, such as letters of credit, when loss
becomes probable and estimable. The OTS has the authority to review the
institution's classification of its assets and to determine whether and to what
extent (i) additional assets must be classified, and (ii) whether the
institution's allowances must be increased. Such instruction by the OTS to
increase valuation allowances could have a material impact upon both the
Company's reported earnings and its financial condition.
The OTS and the other federal banking regulatory agencies have adopted
an interagency policy statement regarding the appropriate levels of valuation
allowances for loan and lease losses that insured depository institutions should
maintain. Under this policy statement, examiners will generally accept
management's evaluation of the adequacy of valuation allowances if the
institution has:
o maintained effective systems and controls for identifying and addressing
asset quality problems
o analyzed in a reasonable manner all significant factors that affect the
collectibility of the portfolio
o established an acceptable process for evaluating the adequacy of valuation
allowances
However, the policy statement also provides that OTS examiners will review
management's analysis more closely if valuation allowances do not at least equal
the following benchmarks:
o 15% of assets classified as substandard
o 50% of assets classified as doubtful
o for the portfolio of unclassified loans and leases, an estimate of credit
losses over the upcoming twelve months based upon the institution's recent
average rate of net charge-offs on similar loans, adjusted for current
trends and conditions
The Company's internal credit policy is to comply with the interagency
policy statement and to maintain adequate reserves for estimable losses.
However, the determination of estimable losses is by nature an uncertain
practice, and hence no assurance can be given that the Company's loss allowances
will prove adequate to cover future losses.
68
Assessments
Thrift 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 based upon a three component equation. The components are total assets,
regulatory rating, and amount and nature of off balance sheet activities. The
Bank's general assessment for the six month period commencing January 2003 was
$61 thousand. The general assessments paid by the Bank for the fiscal year ended
December 31, 2002 totaled $114 thousand.
Federal Home Loan Bank ("FHLB") System
The Bank is a member of the Federal Home Loan Bank of San Francisco
("FHLB-SF"). Each Federal Home Loan Bank serves as a reserve or central bank for
its members within its assigned geographic region. Each Federal Home Loan Bank
is financed primarily from the sale of consolidated obligations of the FHLB
system. The FHLB-SF provides a comprehensive credit facility and various
correspondent services to member institutions. Each FHLB makes available loans
or advances to its members in compliance with the policies and procedures
established by the Board of Directors of the individual FHLB. As a member of the
FHLB-SF, the Bank is required to own capital stock in an amount at least equal
to the greater of:
o 1.0% of the aggregate principal amount of outstanding residential loans and
mortgage backed securities, as defined, at the beginning of each calendar
year
o 5.0% of its advances from the FHLB
At its most recent evaluation, the Bank was in compliance with this
requirement. FHLB advances must be secured by specific types of collateral,
including various types of mortgage loans and securities, and the Bank's
investment in the capital stock of the FHLB. It is the policy of the Bank to
maintain an excess of pledged collateral with the FHLB-SF at all times to serve
as a ready source of additional liquidity.
The FHLB's are required to provide funds to contribute toward the
payment of certain bonds issued in the past to fund the resolution of insolvent
thrifts. In addition, FHLB's are required by statute to contribute funds toward
affordable housing programs. These requirements could reduce the amount of
dividends the FHLB's pay on their capital stock and could also negatively impact
the pricing offered for on and off balance sheet credit products - events that
could unfavorably impact the profitability of the Company.
The Gramm-Leach-Bliley Act made significant reforms to the FHLB system,
including:
o Expanded Membership - (i) expands the uses for, and types of, collateral
for advances; (ii) eliminates bias toward QTL lenders; and (iii) removes
capital limits on advances using real estate related collateral (e.g.,
commercial real estate and home equity loans)
o New Capital Structure - each FHLB is allowed to establish two classes of
stock: Class A is redeemable within six months of notice; and Class B is
redeemable within five years notice. Class B is valued at 1.5 times the
value of Class A stock. Each FHLB will be required to maintain minimum
capital equal to 5% of equity.
o Voluntary Membership - federally chartered savings associations, such as
the Bank, are no longer required to be members of the system.
o REFCorp Payments - changes the amount paid by the system on debt incurred
in connection with the thrift crisis in the late 1980s from a fixed amount
to 20% of net earnings after deducting certain expenses.
69
The new capital plan of the FHLB-SF was approved by the Federal Housing
Finance Board on June 12, 2002. The FHLB-SF has not yet established an
implementation date for the new capital plan, with such implementation required
by June 2005. The Bank will receive at least 240 days' written notice of the
implementation date. The new capital plan incorporates a single class of stock
and requires each member to own stock in amount equal to the greater of:
o a membership stock requirement, or
o an activity based stock requirement
The new capital stock is redeemable on five years' written notice, subject to
certain conditions.
The Company does not believe that the initial implementation of the
FHLB-SF new capital plan as approved will have a material impact upon our
financial condition, cash flows, or results of operations. However, the Bank
could be required to purchase as much as 50% additional capital stock or sell as
much as 50% of its proposed capital stock requirement at the discretion of the
FHLB-SF.
Federal Reserve System
The FRB requires insured depository institutions to maintain
non-interest-earning ("sterile") reserves against certain of their transactional
accounts (primarily deposit accounts that may be accessed by writing unlimited
checks). At December 31, 2002, the regulations generally required that reserves
be maintained against qualified net transaction accounts as follows:
First $6.0 million Exempt
Next $36.1 million 3.0%
Amount above $42.1 million 10.0%
The reserve requirement may be met by certain qualified cash balances.
For the calculation period including December 31, 2002, the Bank was in
compliance with its FRB reserve requirements. As a creditor and an insured
depository institution, the Bank is subject to certain regulations promulgated
by the FRB, including, but not limited to:
Regulation B Equal Credit Opportunity Act Regulation P Privacy Of Consumer Financial Information
Regulation C Home Mortgage Disclosure Act Regulation X Real Estate Settlement Procedures Act
Regulation D Reserve Requirements Regulation W Transactions With Affiliates
Regulation E Electronic Funds Transfers Act Regulation Z Truth In Lending Act
Regulation F Limits On Interbank Liabilities Regulation CC Expedited Funds Availability Act
Regulation O Extensions Of Credit To Insiders Regulation DD Truth In Savings Act
On January 9, 2003, the FRB modified its discount window programs to
encourage borrowings from financial institutions and for financial institutions
to more readily utilize the discount window programs as an additional source of
liquidity.
70
Potential Federal Legislation and Regulation
The US Congress continues to consider a broad range of legislative
initiatives that might impact the financial services industry. Among these
initiatives are:
o the potential merger of the BIF and SAIF insurance funds of the FDIC
o the elimination of fixed minimum reserve ratios for the FDIC insurance
funds in favor an expanded range
o potential FDIC deposit insurance reforms, including an increase in the
amount of coverage, indexing of coverage limits for inflation, changes in
coverage for certain deposits, and modifications in the assessment formula
for FDIC insurance, perhaps to include granting the FDIC greater latitude
in setting deposit insurance premium rates including a greater
consideration of risk-based premiums
o the potential for insured depository institutions to pay interest on
business checking deposits, perhaps in conjunction with authorization for
the Federal Reserve to pay interest on sterile reserves
o the potential relaxation of transaction count restrictions on money market
demand deposits, thereby facilitating internal fund "sweeps" (of particular
benefit to smaller financial institutions such as the Bank)
o possible modifications in federal bankruptcy laws, including potential
revisions that would encourage Chapter 13 filings (with payment
requirements) versus Chapter 7 filings (debt forgiveness)
US financial institution regulatory agencies were considering at
December 31, 2002 a series of potential regulatory changes or additions,
including:
o increased information reporting requirements under Regulation C
o enhanced enforcement procedures associated with Regulation X
o expanded investment powers for federally chartered credit unions
o revisions to bank regulatory capital requirements
o modifications to CRA compliance rules
o revisions in required financial reporting, including a proposal by the OTS
to accelerate filing deadlines for regulatory reports
The Company cannot predict what legislation and regulation, if any,
might emerge from Congress and the various federal regulatory agencies, and the
potential impact of such legislation and regulation upon the Company.
71
Environmental Regulation
The Company's business and properties are subject to federal and state
laws and regulations governing environmental matters, including the regulation
of hazardous substances and wastes. For example, under the federal Comprehensive
Environmental Response, Compensation, and Liability Act ("CERCLA") and similar
state laws, owners and operators of contaminated properties may be liable for
the costs of cleaning up hazardous substances without regard to whether such
persons actually caused the contamination. Such laws may affect the Company as
an owner or operator of properties used in its business, and through the Bank,
as a secured lender of property that is found to contain hazardous substances or
wastes.
Although CERCLA and similar state laws generally exempt holders of
security interests, the exemption may not be available if a secured party
engages in the management of its borrower or the securing property in a manner
deemed beyond the protection of the secured party's interest. Recent federal and
state legislation, as well as guidance issued by the United State Environmental
Protection Agency and a number of court decisions, have provided assurance to
lenders regarding the activities they may undertake and remain within CERCLA's
secured party exemption. However, these assurances are not absolute and
generally will not protect a lender or fiduciary that participates or otherwise
involves itself in the management of its borrower, particularly in foreclosure
proceedings. As a result, CERCLA and similar state statutes may influence the
Bank's decision whether to foreclose on property that may be or is found to be
contaminated. The Bank has adopted environmental underwriting requirements for
commercial and industrial real estate loans. The Bank's general policy is to
obtain an environmental assessment prior to foreclosure on commercial and
industrial real estate. See "Business - General" and "Lending Activities - Loan
Portfolio Composition" regarding the recent expansion in the Bank's commercial
and industrial real estate loan portfolio. The existence of hazardous substances
or wastes on commercial and industrial real estate properties could cause the
Bank to elect not to foreclose on the property, thereby limiting, and in some
cases precluding, the Bank from realizing on the related loan. Should the Bank
foreclose on property containing hazardous substances or wastes, the Bank could
become subject to other environmental statutes, regulations, and common law
relating to matters such as, but not limited to, asbestos abatement, lead-based
paint abatement, hazardous substance investigation and remediation, air
emissions, wastewater discharges, hazardous waste management, and third party
claims for personal injury and property damage.
Federal Securities Laws
The Company's common stock is registered with the SEC under Section
12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
The Company is subject to periodic reporting requirements, proxy solicitation
rules, insider trading restrictions, tender offer rules, and corporate
governance and other requirements under the Exchange Act. In addition, certain
activities of the Company, its executive officers, and directors are covered
under the Securities Act of 1933, as amended (the "Securities Act").
Non-Banking Regulation
The Company is impacted by many other laws and regulations, not
necessarily unique to insured depository institutions. Among these other laws
and regulations are federal bankruptcy laws and requirements of the Nasdaq
National Market System.
72
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 2002 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. The Bank completed
this recapture in 2001.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
73
The amount of additional taxable income triggered by a 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
0.12% 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.
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 10.84%.
In 2002, California adopted conformity with many federal tax
regulations, including in regards to bad debt deductions. MBBC, the Bank, and
Portola file California State franchise tax returns on a consolidated basis.
MBBC, 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.
The Company is headquartered in a State of California Enterprise Zone.
In addition, the Bank's Watsonville branch is also located in an Enterprise Zone
and the Bank extends credit to businesses located in a number of Enterprise
Zones located throughout California. These attributes make the Bank eligible for
certain additional State tax credits and deductions.
Please refer to Note 13 to the Consolidated Financial Statements for
additional information regarding income taxes.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, MBBC 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. Franchise tax expense for the State of Delaware totaled $55 thousand
in 2002.
74
Additional Item. Executive Officers of the Registrant
The following table sets forth certain information with respect to each
executive officer of the Company or Bank who is not also a director of the
Company. The Board of Directors appoints or reaffirms the appointment of all of
the Company's executive officers each year. Each executive officer serves until
the following year or until a respective successor is appointed.
Date
Age At Position(s) With Company Started In Previous Experience If Less
Name 12/31/02 And / Or Bank Position Than Five Years In Current Position
---- -------- ------------- -------- -----------------------------------
Carlene F. Anderson 50 Assistant Corporate Secretary 6/11/1999 Corporate Secretary
Monterey Bay Bancorp, Inc. Monterey Bay Bancorp, Inc.
1994 - 1999
Assistant Corporate Secretary 6/11/1999 Corporate Secretary
Vice President, Compliance 8/15/1998 Monterey Bay Bank
Monterey Bay Bank. 1994 - 1999
Mark R. Andino 43 Chief Financial Officer 1/26/2000 Treasurer
Treasurer Chela Financial
Monterey Bay Bancorp, Inc. 1999
Senior Vice President 1/26/2000 Senior Vice President
Chief Financial Officer Chief Financial Officer
Treasurer HF Bancorp, Inc.
Monterey Bay Bank Hemet Federal
1996 - 1999
Susan M. Carlson 50 Senior Vice President 6/28/2001 Principal
Chief Administrative Officer C&S Carlson Enterprises, Inc.
Monterey Bay Bank Financial Institution Consulting
1996 - 2001
Vice President
Director of Marketing
American Bank, NA
1981 - 1996
Mary Anne Carson 35 Corporate Secretary 5/9/2001 Vice President
Monterey Bay Bancorp, Inc. Assistant To The President
Coast Commercial Bank
Corporate Secretary 5/9/2001 1996 - 2001
Vice President
Director Of Community Relations
Monterey Bay Bank
Elaine Genevro 51 Senior Vice President 2/3/2003 Senior Vice President
Director Of Retail Banking Regional Manager
Monterey Bay Bank Bay View Bank
President 1997 - 2002
Portola Investment Corporation
Joni James 47 Senior Vice President 9/10/2001 Information Technology Manager
Director Of Information BYL Group
Technology 1999 - 2001
David E. Porter 53 Senior Vice President 10/30/2000 Executive Vice President
Director of Commercial Banking Chief Credit Officer
Monterey Bay Bank Southern Pacific Bank
1996 - 2000
Ben A. Tinkey 50 Senior Vice President 9/20/1994
Chief Loan Officer
Director of Real Estate Lending
Monterey Bay Bank
75
Item 2. Properties.
The following table sets forth information relating to each of the
Company's offices and stand alone ATM locations as of December 31, 2002:
Lease Original Date Date of
Or Leased or Lease
Location Owned Acquired Expiration
----------------------------------- ------- -------------- ----------
Administrative Offices:
15 Brennan Street
Watsonville, California 95076 Owned 12-31-65 N/A
567 Auto Center Drive
Watsonville, California 95076
(Headquarters And Limited
Service Branch Facility) Owned 03-23-98 N/A
Full Service Branch Offices:
35 East Lake Avenue
Watsonville, California 95076 Owned 12-31-65 N/A
805 First Street
Gilroy, California 95020 Owned 12-01-76 N/A
1400 Munras Avenue
Monterey, California 93940 Owned 07-07-93 N/A
1890 North Main Street
Salinas, California 93906 Owned 07-07-93 N/A
1127 South Main Street
Salinas, California 93901 Leased 08-08-93 06-30-05
8071 San Miguel Canyon Road
Prunedale, California 93907 Leased 12-24-93 12-31-03
601 Bay Avenue
Capitola, California 95020 Owned 12-10-96 N/A
6265 Highway 9
Felton, California 95018 Leased 05-01-98 04-30-03
Loan Production Office:
6080 Center Drive Month
6th Floor To
Los Angeles, CA. 90045 Leased 02-01-02 Month
Agreement Agreement
Stand Alone ATM's: Commencement Expiration
------------ ----------
601 Wave Street
Monterey, California 93940 4/11/00 4/10/03
104 Stockton Street
Capitola, California 95010 9/1/97 3/31/04
76
Item 3. Legal Proceedings.
From time to time, the Company is party to claims and legal proceedings
in the ordinary course of business. Management believes that the ultimate
aggregate liability represented thereby, if any, will not have a material
adverse effect on the Company's consolidated financial position or results of
operations.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted during the quarter ended December 31, 2002 to a
vote of Monterey Bay Bancorp, Inc.'s security holders through the solicitation
of proxies or otherwise.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Common Stock of Monterey Bay Bancorp, Inc. is traded on the NASDAQ
National Market under the symbol "MBBC." The stock commenced trading on February
15, 1995, when the Company went public and sold 4,492,085 shares at a price of
$6.40 per share (adjusted for a 5:4 stock split on July 31, 1998).
As of March 20, 2003, there were 3,460,974 shares of the Company's
common stock outstanding. As of February 28, 2003, there were 263 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 the low daily closing
prices of the Company's common stock for each of the following calendar
quarters.
High Low
---- ---
Year Ended December 31, 2002:
Fourth quarter $ 20.000 $ 17.250
Third quarter $ 18.470 $ 16.600
Second quarter $ 19.450 $ 16.730
First quarter $ 17.000 $ 15.300
Year Ended December 31, 2001:
Fourth quarter $ 15.500 $ 12.750
Third quarter $ 16.500 $ 11.400
Second quarter $ 11.970 $ 9.750
First quarter $ 11.875 $ 10.000
The Company did not pay any cash dividends in 2002 or 2001. The Board
of Directors has indefinitely suspended the declaration and payment of cash
dividends in favor of alternative uses for the Company's capital and liquidity.
The Company is subject to certain restrictions and limitations on the
payment of dividends pursuant to existing and applicable laws and regulations
(see "Item 1. Business - Regulation And Supervision - Limitation On Capital
Distributions" and Note 14 to the Consolidated Financial Statements).
77
Item 6. Selected Financial Data.
Set forth below are selected consolidated financial and other data of
the Company for the periods and the dates indicated. This financial data is
derived in part from, and should be read in conjunction with, the Consolidated
Financial Statements and related Notes of the Company presented elsewhere
herein. All per share information has been adjusted to reflect a five for four
stock split distributed to stockholders of record in July 1998.
At December 31,
-----------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Dollars In Thousands)
Selected Financial Condition Data:
Total assets $ 609,696 $ 537,391 $ 486,190 $ 462,827 $ 454,046
Investment securities available for sale 7,030 7,300 7,360 11,463 19,410
Mortgage backed securities available for sale 37,466 30,644 42,950 57,716 98,006
Mortgage backed securities held to maturity -- -- -- 60 97
Loans receivable held for investment, net 521,929 465,887 391,820 360,686 298,775
Loans held for sale 1,545 713 -- -- 2,177
Allowance for loan losses 8,162 6,665 5,364 3,502 2,780
Bank owned life insurance 9,036 -- -- -- --
Deposits 458,334 432,339 407,788 367,402 370,677
FHLB advances 93,582 53,582 32,582 49,582 35,182
Securities sold under agreements to repurchase -- -- -- 2,410 4,490
Stockholders' equity 56,103 50,162 43,837 40,803 41,116
Non-performing loans 2,643 2,252 4,741 8,182 2,915
Real estate acquired by foreclosure, net 846 -- -- 96 281
For The Year Ended December 31,
-----------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Dollars In Thousands, Except Share Data)
Selected Operating Data:
Interest and dividend income $ 35,486 $ 38,731 $ 37,757 $ 33,417 $ 30,911
Interest expense 12,907 18,990 19,777 17,388 18,588
-------- -------- -------- -------- --------
Net interest income before provision for
loan losses 22,579 19,741 17,980 16,029 12,323
Provision for loan losses 1,510 1,400 2,175 835 692
-------- -------- -------- -------- --------
Net interest income after provision for loan
losses 21,069 18,341 15,805 15,194 11,631
Non-interest income 2,127 2,566 2,340 2,505 2,177
Non-interest expense 13,780 14,369 13,676 11,887 11,144
-------- -------- -------- -------- --------
Income before provision for income taxes 9,416 6,538 4,469 5,812 2,664
Provision for income taxes 3,778 2,787 1,946 2,511 1,228
-------- -------- -------- -------- --------
Net income $ 5,638 $ 3,751 $ 2,523 $ 3,301 $ 1,436
======== ======== ======== ======== ========
Shares applicable to basic earnings per share 3,369,600 3,275,303 3,110,910 3,231,162 3,501,738
Basic earnings per share $ 1.67 $ 1.15 $ 0.81 $ 1.02 $ 0.41
======== ======== ======== ======== ========
Shares applicable to diluted earnings per share 3,497,150 3,343,233 3,123,552 3,320,178 3,638,693
Diluted earnings per share $ 1.61 $ 1.12 $ 0.81 $ 0.99 $ 0.39
======== ======== ======== ======== ========
Cash dividends per share $ -- $ -- $ 0.08 $ 0.15 $ 0.12
======== ======== ======== ======== ========
78
At Or For The Year Ended December 31,
-----------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Selected Financial Ratios and Other Data (1):
Performance Ratios
Return on average assets (2) 1.00% 0.73% 0.53% 0.73% 0.33%
Return on average stockholders' equity (3) 10.50% 7.94% 6.24% 8.05% 3.29%
Average stockholders' equity to average assets 9.55% 9.16% 8.52% 9.04% 10.06%
Stockholders' equity to total assets at
end of period 9.20% 9.33% 9.02% 8.82% 9.06%
Interest rate spread during the period (4) 3.96% 3.67% 3.54% 3.27% 2.43%
Net interest margin (5) 4.22% 4.04% 3.96% 3.69% 2.96%
Interest rate margin on average total assets (6) 4.01% 3.83% 3.79% 3.53% 2.84%
Average interest-earning assets /
average interest-bearing liabilities 110.51% 109.44% 109.62% 110.61% 112.00%
Non-interest expense / average total assets 2.45% 2.79% 2.88% 2.62% 2.57%
Efficiency ratio (7) 55.78% 64.41% 67.30% 64.14% 76.86%
Regulatory Capital Ratios (8)
Tangible capital 8.57% 8.24% 8.03% 7.11% 6.53%
Core capital 8.57% 8.24% 8.03% 7.11% 6.53%
Tier one risk based capital 11.63% 11.38% 11.03% 9.58% 10.42%
Total risk based capital 12.88% 12.64% 12.28% 10.56% 11.35%
Asset Quality Ratios
Non-performing loans / gross loans
receivable (9) 0.50% 0.48% 1.19% 2.25% 0.96%
Non-performing assets / total assets (10) 0.57% 0.42% 0.98% 1.79% 0.71%
Net charge-offs / average gross loans receivable 0.00% 0.02% 0.08% 0.03% 0.00%
Allowance for loan losses / gross
loans receivable (9) 1.54% 1.41% 1.35% 0.96% 0.92%
Allowance for loan losses / non-performing loans 308.82% 295.96% 113.14% 42.80% 95.37%
Allowance for total estimated losses /
non-performing assets 233.94% 295.96% 113.14% 42.30% 87.15%
Other Data
Number of full-service customer facilities 8 8 8 8 8
Number of limited service customer facilities 1 -- -- -- --
Number of stand alone loan production offices 1 -- -- -- --
Number of ATM's 11 11 11 10 10
------------------------------------------------------
(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.
(2) Return on average assets is net income divided by average total assets.
(3) Return on average stockholders' equity is net income divided by average
stockholders' equity.
(4) Interest rate spread during the period represents the difference between
the weighted average yield on interest-earning assets and the weighted
average cost of interest-bearing liabilities.
(5) Net interest margin equals net interest income as a percent of average
interest-earning assets.
(6) Interest rate margin on average total assets equals net interest income as
a percent of average total assets.
(7) The efficiency ratio is calculated by dividing non-interest expense by the
sum of net interest income and non-interest income. The efficiency ratio
measures how much in expense the Company invests in order to generate each
dollar of net revenue.
(8) Regulatory capital ratios are defined in Item 1. - "Business - Supervision
And Regulation - Regulatory Capital Requirements And Capital Categories."
(9) Gross loans receivable includes loans held for investment and loans held
for sale, less undisbursed loan funds and unamortized yield adjustments.
(10) Non-performing assets includes all nonperforming loans (nonaccrual loans
and restructured loans) and real estate acquired via foreclosure or by
acceptance of a deed in lieu of foreclosure.
79
Item 7. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations.
The following discussion and analysis should be read in conjunction
with the Company's Consolidated Financial Statements and Notes to the
Consolidated Financial Statements presented elsewhere in this Annual Report.
Certain matters discussed or incorporated by reference in this Annual Report
including, but not limited to, matters described in this Item 7., are forward
looking statements that are subject to risks and uncertainties that could cause
actual results to differ materially from those projected or implied in such
statements.
General
The Company's primary business is providing financial services to
individuals, families, community organizations, non-profit organizations, and
businesses. The Company is headquartered in Watsonville, California, along the
Central Coast. The Bank's history dates to 1925.
The Company pursues its business through conveniently located branch
offices, where it attracts checking, money market, savings, and certificate of
deposit accounts. These deposits, and other available funds, are invested in a
variety of loans and securities. The vast majority of the Company's loans at
December 31, 2002 were secured by various types of real estate. The Bank's
deposit gathering and lending markets are concentrated in the communities
surrounding its eight full service branch offices located in Santa Cruz,
northern Monterey, and southern Santa Clara Counties, in California. However,
during 2002, the Company took a number of steps to geographically diversify its
lending throughout more of the State of California. The Company also conducts
its business by a variety of electronic means, including Internet banking,
telephone banking, and ATM networks.
The most significant component of the Company's revenue is net interest
income. Net interest income is the difference between interest and dividend
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 as a percent of average interest-earning assets, are affected by
its asset growth and quality, its asset and liability composition, and the
general interest rate environment.
The Company's service charges on deposits, mortgage loan servicing
fees, mortgage banking income, and commissions from the sale of non-FDIC insured
insurance products and investments through Portola also have significant effects
on the Company's results of operations. An additional major factor in
determining the Company's results of operations are non-interest expenses, which
consist primarily of employee compensation, occupancy and equipment expenses,
data and item processing fees, and other operating expenses. The Company's
results of operations are also significantly affected by the level of provisions
for loan losses and general economic and competitive conditions, particularly
absolute and relative levels and changes in market interest rates, government
policies, and actions of regulatory agencies.
As discussed under "Item 1. Business - Company Strategy", the Company
is in the process of transforming itself from a savings and loan association
that was historically focused upon funding residential mortgage loans with
certificates of deposit into a community based commercial bank offering a far
wider scope of financial services to individuals, families, professionals,
organizations, and businesses. This transformation is being undertaken to
enhance stockholder value while at the same time better meeting the financial
needs of current and prospective customers. This transformation presents
significant execution risk, as the strategic profile being pursued by the
Company requires much greater human and technological resources to accomplish
than the Company's historical operations. In addition, community commercial
banking is by nature a higher risk activity than traditional savings & loan
business, with increased credit and operational risks, among other risk factors.
80
Critical Accounting Policies And Significant Estimates
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). The Notes to the Consolidated Financial Statements contain a summary
of the Company's significant accounting policies, including a presentation of
recently issued accounting pronouncements. The Company follows accounting
policies typical to the community commercial banking industry and in compliance
with various regulations and guidelines as established by the Financial
Accounting Standards Board ("FASB") and the Company's primary federal regulator,
the OTS.
Certain of the accounting policies as well as estimates made by
Management are considered to be important to the portrayal of the Company's
financial condition, since they require Management to make difficult, complex,
or subjective judgments and estimates, some of which may relate to matters that
are inherently uncertain. Management has discussed each of these significant
accounting policies and the related estimates with the Audit Committee of the
Board of Directors.
The Company's most significant management accounting estimate is the
appropriate level for the allowance for loan losses. The Company follows a
methodology for calculating the appropriate level for the allowance for loan
losses. However, various factors, many of which are beyond the control of the
Company, could lead to significant revisions in the amount of allowance for loan
losses in future periods, with a corresponding impact upon the results of
operations. In addition, the calculation of the allowance for loan losses is by
nature inexact, as the allowance represents Management's best estimate of the
loan losses inherent in the Company's credit portfolios at the reporting date.
These loan losses will occur in the future, and as such cannot be determined
with absolute certainty at the reporting date. See also "Asset Quality / Credit
Profile - Allowance For Loan Losses".
Other estimates that the Company utilizes in its accounting include the
valuation of financial instruments and the expected useful lives of depreciable
assets, such as buildings, building improvements, equipment, and furniture. The
useful lives of various technology related hardware and software can be subject
to change due to advances in technology and the general adoption of new
standards for technology or interfaces among computer or telecommunication
systems.
The Company applies Accounting Principles Board ("APB") Opinion No. 25
and related interpretations in accounting for stock options. Under APB No. 25,
compensation cost for stock options is measured as the excess, if any, of the
fair market value of the Company's stock at the date of grant over the amount
the employee or director must pay to acquire the stock. Because the Company's
stock option Plans provide for the issuance of options at a price of no less
than the fair market value at the date of grant, no compensation cost is
required to be recognized for the Plans.
Had compensation costs for the stock option Plans been determined based
upon the fair value at the date of grant consistent with SFAS No. 123,
"Accounting For Stock Based Compensation", the Company's net income and earnings
per share would have been reduced. The amount of the reduction for the fiscal
years 2000 through 2002 is disclosed in Note 1 to the Consolidated Financial
Statements, based upon the assumptions listed therein.
GAAP itself may change over time, impacting the reporting of the
Company's financial activity. Although the economic substance of the Company's
transactions would not change, alterations in GAAP could affect the timing or
manner of accounting or reporting.
81
Certain Activities Not Conducted By The Company
At December 31, 2002, the Company did not have:
o foreign currency risk, as all of the Company's operations are conducted in
US dollars
o interest rate swap, cap, floor, or collar agreements; or other freestanding
or embedded derivatives
o off balance sheet activity other than normal commitments to fund loans and
lines of credit and honor commercial letters of credit
o special purpose entities
o debt securities convertible into equity
In conjunction with its interest rate risk management program, the Company may,
however, in the future enter into interest rate swap, cap, floor, collar, or
similar arrangements. In addition, the Company may pursue different types and
sources of capital in the future to support its growth, including trust
preferred securities or convertible securities.
Primary Risks Experienced By The Company
The greatest single source of risk to the Company is credit risk.
Credit risk is the financial exposure to borrowers' not repaying the loans
extended by the Company. Other significant risks experienced by the Company are
interest rate risk and operational risk. Interest rate risk is the financial
exposure resulting from changes in nominal and relative interest rates, as more
fully discussed under "Item 7a. Quantitative and Qualitative Disclosure of
Market Risk". Operational risk results from the Company's funds transfer and
related activities, whereby the Company could experience loss if funds were
inappropriately transferred and not recovered. The Company maintains extensive
policies and procedures and certain insurance policies designed to mitigate
these primary risks. However, no set of practices can eliminate every potential
current and future source of these risks. In addition, the Company creates
economic value and earns income in part through the effective management, but
not elimination, of these primary risks.
Interest Rate Environment
In January 2001, the Federal Reserve commenced what would become a
historically large and rapid decrease in interest rates, as the economy slowed
and eventually fell into recession. During 2001, the Federal Reserve cut
interest rates a total of 11 times for an aggregate decrease of 475 basis
points.
Most interest rate indices rose during the first quarter of 2002, as
the capital markets were optimistic about a relatively rapid and strong rebound
in US economic activity, fueled in part by the accommodative monetary policy
implemented by the Federal Reserve in 2001. For example, during 2001, homeowners
refinanced a significant volume of residential mortgages, lowering their monthly
payments and / or obtaining "cash out" amounts. This supported consumer
discretionary spending.
82
However, by the second quarter of 2002, it became evident that the pace
of US economic growth would be restrained by multiple factors including:
o weak business spending and capital investment
o waves of layoffs by major corporations, which in turn contributed to
relatively high levels of continued unemployment in 2002
o limited stimulus from the weak economies of major trading partners,
particularly Japan and Germany
As a result, most interest rates decreased during the second quarter of
2002. Declining equity markets in the third quarter of 2002 encouraged a flow of
funds into the fixed income markets, which in turn contributed to a further
reduction in most interest rates between June and September 2002. At its
November 2002 meeting, the Federal Open Market Committee of the Federal Reserve
voted to cut its target federal funds rate by a generally unexpectedly large 50
basis points to 1.25%. Interest rates at the end of 2002 were thus the lowest in
decades.
Two other factors significantly influenced the capital markets, and
hence the level of interest rates, in 2002:
1. The crisis in corporate confidence arising from the Enron, WorldCom, and
similar corporate scandals contributed uncertainty to the equity markets in
2002, making it more challenging for the stock market to mount a sustained
recovery that might contribute to rising interest rates.
2. Geopolitical concerns contributed to a flight of capital to quality and
liquidity, which in turn led to lower rates for Treasury securities and a
buildup of balances in relatively safe and liquid investments such as money
market mutual funds and federally insured bank deposits.
The Treasury yield curve was inverted at the beginning of 2001.
Inverted yield curves often present challenges to financial institutions, as
short term funding rates can be higher than longer term investment rates. By mid
2001, the Treasury yield curve had returned to its more traditional positive
slope. By the end of 2001, the Treasury yield was the steepest in the past two
years, with a 333 basis point differential between the three month and ten year
Treasury instruments. Steep, positively sloped yield curves are generally
favorable for financial institutions, including the Company, as near term cash
flows from intermediate to longer term higher yielding assets can be funded at
comparatively low interest rates.
The Treasury yield curve flattened in 2002, as longer term interest
rates declined more rapidly than short term interest rates. At the end of 2002,
the differential between the three month Treasury bill and the 10 year Treasury
note had declined to 262 basis points. This yield curve flattening contributed
to a mortgage refinance boom of historic proportions in 2002, as borrowers
sought to lock in the lowest long term, fixed interest rates in decades. The
Mortgage Banker's Association Refinance Index rose from just over 1,000 at the
end of the first quarter of 2002 to over 6,000 during the fourth quarter of
2002. A value of 1,000 for this Index is generally considered an active
refinance market. The refinance boom led to a surge in prepayment speeds on
mortgage loans and mortgage related securities during the fourth quarter of
2002.
83
The past two years thus represented a period of substantial interest
rate volatility, with significant changes in the nominal and relative levels of
interest rates. This magnitude of interest rate volatility presents additional
challenges to financial institutions, including the Company, in managing cash
flows and interest rate risk exposure.
The table below presents an overview of the interest rate environment
during the two years ended December 31, 2002. The 11th District Cost Of Funds
Index ("COFI") and the 12 MTA Index ("12 MTA" - the 12 month cumulative average
of the 1 year Treasury Constant Maturities Index or "1 Year CMT") are by nature
lagging indices that trail changes in more responsive interest rate indices such
as those associated with the spot Treasury or LIBOR markets.
Index/ Rate (1) 12/31/00 3/31/01 6/30/01 9/30/01 12/31/01 3/31/02 6/30/02 9/30/02 12/31/02
--------------- -------- ------- ------- ------- -------- ------- ------- ------- --------
3 month Treasury bill 5.89% 4.28% 3.65% 2.37% 1.72% 1.78% 1.68% 1.55% 1.19%
6 month Treasury bill 5.70% 4.13% 3.64% 2.35% 1.79% 2.10% 1.74% 1.50% 1.20%
2 year Treasury note 5.09% 4.18% 4.24% 2.85% 3.02% 3.72% 2.81% 1.68% 1.60%
5 year Treasury note 4.97% 4.56% 4.95% 3.80% 4.30% 4.84% 4.03% 2.56% 2.73%
10 year Treasury note 5.11% 4.92% 5.41% 4.59% 5.05% 5.40% 4.80% 3.59% 3.81%
Target federal funds 6.50% 5.00% 3.75% 3.00% 1.75% 1.75% 1.75% 1.75% 1.25%
Prime rate 9.50% 8.00% 6.75% 6.00% 4.75% 4.75% 4.75% 4.75% 4.25%
3 month LIBOR 6.40% 4.88% 3.84% 2.59% 1.88% 2.03% 1.86% 1.79% 1.38%
12 month LIBOR 6.00% 4.67% 4.18% 2.64% 2.44% 3.00% 2.29% 1.73% 1.45%
1 Year CMT (2) 5.60% 4.30% 3.58% 2.82% 2.22% 2.57% 2.20% 1.72% 1.45%
12 MTA (2) 6.11% 5.71% 5.10% 4.40% 3.48% 2.91% 2.55% 2.18% 2.00%
COFI (2) 5.62% 5.20% 4.50% 3.97% 3.07% 2.65% 2.85% 2.76% 2.38%
------------------------------------------------------
(1) Indices / rates are spot values unless otherwise noted.
(2) These indices / rates are monthly averages.
Business Strategy
The Company's overall business objective is to maximize stockholder
value. The Company's directors and Management believe that the best approach to
achieving that key objective is to continue the Company's strategic
transformation from a traditional savings & loan into a community commercial
bank offering a broader range of financial services, products, and solutions to
individuals, families, professionals, organizations, and businesses in
California. The Company's directors and Management also believe that following a
relationship focused approach to helping customers attain their financial goals
progresses the Company toward its key strategic objective while also improving
the quality of life in the communities served by the Company and making the
Company a desirable employer. The Company's business strategy thus integrates
advancing the interests of its three key constituencies: stockholders, local
communities, and employees.
84
Specific elements of the Company's business strategy include:
o Increasing the ratio of loans to assets as a means of enhancing net
interest income, serving more customers, moderating exposure to changes in
interest rates, and better utilizing the Company's capital resources.
o Diversifying the product mix within the loan portfolio to reduce the
concentration in residential mortgages while also meeting the financing
needs of consumers and businesses within the Company's market areas.
o Enhancing the delivery of relationship banking, where the Company's
employees invest time and resources in thoroughly understanding their
customers and thereby provide a comprehensive financial services solution.
o Expanding services for businesses, including improved deposit courier
service and cash management products.
o Acquiring customers disaffected by the acquisition of their financial
services provider or branch office.
o Capitalizing on the Company's position as one of the largest independent
financial institutions in the Greater Monterey Bay Area and on the Bank's
77 year history.
o Bolstering non-interest income as a percent of total revenues, with such
non-interest income sourced from an expanding list of fee based products
and services, including ATM surcharges, deposit account and branch service
charges, and sales of non-FDIC insured investment products including mutual
funds and annuities.
o Changing the Company's deposit mix to emphasize transaction accounts as a
means of cementing customer relationships, lowering the Company's relative
cost of funds, generating fee income, and increasing the duration of the
Company's funding.
o Capitalizing on business opportunities unique to the Company's primary
service areas; for example, installing remote ATM's at highly trafficked
tourist attractions.
o Pursuing alternative forms of delivery and new technologies for financial
products and services as a means of attracting a greater volume of business
while also improving the Company's efficiency ratio.
o Adding additional branch or loan production office facilities to better and
more completely serve the Company's key market areas.
o Increasing the Company's visibility in and contributions to its local
communities through the donation of equipment, funds, and employee time to
a wide range of organizations committed to improving the quality of life in
the Greater Monterey Bay Area.
The Company intends to continue pursuing this business strategy in
2003, with specific goals of adding a de novo full service branch in its primary
market area, pursuing opportunities for the acquisition of existing bank
branches, expanding the Commercial Banking group, increasing customer use of
Internet banking and electronic bill payment, recruiting additional experienced
commercial bankers, pursuing additional remote ATM sites, implementing new
technologies complementary to the core data processing system installed in 2001,
and effectively managing the Company's strong capital position. However, there
can be no assurance that any such steps will be implemented, or if implemented,
whether such steps will improve the Company's financial performance.
85
Analysis Of Results Of Operations For The Years Ended December 31, 2002 And
December 31, 2001
Overview
For the year ended December 31, 2002, net income was a record $5.64
million, equivalent to $1.67 basic earnings per share and $1.61 diluted earnings
per share. This compares to net income of $3.75 million, or $1.15 basic earnings
per share and $1.12 diluted earnings per share, for the year 2001. The $1.89
million (50.3%) increase in net income for the year 2002 compared to 2001
primarily resulted from two key factors:
o the continued implementation of the Company's strategic plan to transform
the Bank into a community commercial bank with a focus on relationship
banking and strong commitment to community involvement
o during the year 2001, the Company incurred pre-tax operating costs of $447
thousand for the conversion of the core data processing system and $284
thousand for legal and other expenses associated with the arbitration of
claims by a former executive
Return on average stockholders' equity improved from 7.94% in 2001 to
10.50% in 2002, and was 11.64% for the fourth quarter of 2002. Return on average
assets rose from 0.73% in 2001 to 1.00% in 2002. At December 31, 2002, the
Company had record levels of loans, assets, and stockholders' equity. Tangible
book value per share increased from $14.08 at December 31, 2001 to $16.00 at
December 31, 2002. The closing price of the Company's common stock increased
from $15.50 per share on December 31, 2001 to $19.95 per share on December 31,
2002.
The Company's financial performance increased sequentially from the
first quarter of 2002 through to the fourth quarter, which represented the
highest quarterly earnings in the Company's history. The fourth quarter of 2002
financial results generated the seventh consecutive quarter of increased diluted
earnings per share.
Net Interest Income
Net interest income increased from $19.7 million in 2001 to $22.6
million in 2002 due to both expanded spreads and growth in the average balances
of interest earning assets and liabilities. The Company's ratio of net interest
income to average total assets increased from 3.83% in 2001 to 4.01% in 2002
despite the Company's difficulty in decreasing NOW and Savings deposit rates at
the same pace as the declines in indices used for adjustable rate loans. The
Company's NOW and Savings deposit rates were already at low nominal levels
before the significant interest rate cuts (totaling 525 basis points)
implemented by the Federal Reserve in 2001 and 2002. The Company moderated the
impact of these factors in 2002 through its proactive asset / liability
management program and a shift in balance sheet composition.
The expansion in the Company's net interest margin on average interest
earning assets has constituted a key component in the Company's improved
financial performance over the past several years. The trend for this ratio has
been:
Net
Interest
Year Margin
---------- -----------
1999 3.69%
2000 3.96%
2001 4.04%
2002 4.22%
The above trend has resulted from the actions taken by the Company coincident
with its strategic business plan.
86
The $2.8 million, or 14.4%, increase in net interest income generated
in 2002 versus 2001 primarily resulted from five factors:
1. Change In Asset Mix
Average net loans receivable increased from 83.8% of average total assets in
2001 to 85.9% of average total assets in 2002. Lower yielding cash equivalents,
investment securities, and mortgage backed securities all declined as a
percentage of average total assets in 2002 versus 2001. The benefits from this
shift in asset mix were significant, as the average rate earned on net loans
receivable in 2002 was 7.01%, substantially above the 1.72% earned on cash
equivalents, 2.87% earned on investment securities, and 3.01% earned on mortgage
backed securities.
2. Change In Loan Mix
Residential loans decreased from 42.2% of gross loans held for investment at
December 31, 2001 to 33.1% at December 31, 2002. This reduced concentration was
offset by nominal and relative increases in comparatively higher yielding
commercial real estate, construction, land, and commercial business loans.
3. Change in Liability Mix
Average transaction deposit accounts (DDA, NOW, Savings, and Money Market
combined) as a percentage of average total deposits rose from 41.1% in 2001 to
44.5% in 2002. Transaction deposit accounts present a lower cost of funding than
most alternative sources. Non-interest bearing demand deposit accounts ("DDA")
rose from 4.6% of average total deposits in 2001 to 5.1% in 2002. The Company
has targeted increased DDA balances, particularly from business customers, as an
important component of its business strategy.
4. Increased Average Balance Sheet
Average total assets increased by 9.1% from 2001 to 2002. The larger average
balances of interest earning assets and interest bearing liabilities, combined
with expanding spreads, contributed toward greater nominal net interest income.
5. Increased Capital Generation
The increasing profitability of the Company in 2002 combined with capital
management activities, including the use of stock based compensation in lieu of
certain cash compensation, to increase the ratio of average stockholders' equity
to average total assets from 9.16% in 2001 to 9.55% in 2002. The greater
relative level of interest free funding associated with the Company's capital
position contributed to the expansion in the ratio of net interest income to
average total assets and the growth in net interest income.
Net interest income was also benefited in 2002 versus 2001 by a rise in
the ratio of average interest earning assets to average interest bearing
liabilities from 109.44% to 110.51%, which occurred despite:
1. the Company's purchase of $9.0 million in Bank owned life insurance in
December 2002 (a non-interest earning asset)
2. a continued rise in net deferred tax assets during 2002 arising primarily
from:
A. the Company's increase in its allowance for loan losses
B. the differential between book and tax amortization periods for core
deposit intangibles
The Company plans to expand net interest income in future periods
through the further implementation of its business strategy, increasing the
volume of interest earning assets and more effectively leveraging the Company's
capital position, and continuing to proactively manage the Company's exposure to
changes in the nominal and relative levels of general market interest rates.
However, no assurance can be provided that the Company will be successful in
this regard, particularly if further interest rate cuts are implemented by the
Federal Reserve. Such additional interest rate cuts, depending upon market
conditions, could cause margin compression for the Company, as there is little
opportunity for the Company to further reduce its NOW and Savings deposit
account rates, which averaged 0.34% and 0.52%, respectively, in 2002. In
addition, the economic value of the Company's demand deposit balances could
further erode in a declining interest rate environment, as those interest free
funds would perhaps be invested at lower yields.
87
Average Balances, Average Rates, And Net Interest Margin
The following table presents the average amounts outstanding for the
major categories of the Company's assets and liabilities, the average rate
earned upon each major category of interest earning assets, the average rate
paid for each major category of interest bearing liabilities, and the resulting
net interest spread, net interest margin, and average interest margin on total
assets for the years indicated.
Year Ended December 31, 2002 Year Ended December 31, 2001 Year Ended December 31, 2000
----------------------------- ------------------------------ -----------------------------
Average Avg. Average Avg. Average Avg.
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
Assets (Dollars In Thousands)
------
Interest earning assets:
Cash equivalents (1) $ 3,257 $ 56 1.72% $ 7,598 $ 314 4.13% $ 8,533 $ 540 6.33%
Investment securities 7,347 211 2.87% 7,318 406 5.55% 8,915 689 7.73%
Mortgage backed securities (2) 37,676 1,133 3.01% 38,795 2,360 6.08% 53,822 3,755 6.98%
Loans receivable, net (3) 483,429 33,890 7.01% 432,020 35,485 8.21% 379,823 32,556 8.57%
FHLB stock 3,277 196 5.98% 3,065 166 5.42% 3,003 217 7.23%
-------- ------ -------- ------ -------- ------
Total interest earning assets 534,986 35,486 6.63% 488,796 38,731 7.92% 454,096 37,757 8.31%
------ ------ ------
Non-interest earnings assets 27,514 26,555 20,391
-------- -------- --------
Total assets $562,500 $515,351 $474,487
======== ======== ========
Liabilities & Equity
--------------------
Interest bearing liabilities:
NOW accounts $ 43,607 149 0.34% $ 40,944 366 0.89% $ 36,317 550 1.51%
Savings accounts 18,732 98 0.52% 19,370 216 1.12% 15,803 281 1.78%
Money market accounts 114,629 2,419 2.11% 92,237 3,452 3.74% 87,733 4,040 4.60%
Certificates of deposit 249,088 7,787 3.13% 246,315 12,415 5.04% 230,099 12,360 5.37%
------- ------ -------- ------ -------- ------
Total interest-bearing
deposits 426,056 10,453 2.45% 398,866 16,449 4.12% 369,952 17,231 4.66%
FHLB advances 57,355 2,436 4.25% 47,526 2,518 5.30% 43,946 2,514 5.72%
Other borrowings (4) 705 18 2.55% 244 23 9.43% 359 32 8.91%
------- ------ -------- ------ -------- ------
Total interest-bearing
liabilities 484,116 12,907 2.67% 446,636 18,990 4.25% 414,257 19,777 4.77%
------ ------ ------
Demand deposit accounts 22,856 19,104 16,720
Other non-interest bearing
liabilities 1,835 2,396 3,104
------- -------- --------
Total liabilities 508,807 468,136 434,081
Stockholders' equity 53,693 47,215 40,406
-------- -------- --------
Total liabilities & equity $562,500 $515,351 $474,487
======== ======== ========
Net interest income $22,579 $19,741 $17,980
======= ======= =======
Interest rate spread (5) 3.96% 3.67% 3.54%
Net interest earning assets 50,870 42,160 39,839
Net interest margin (6) 4.22% 4.04% 3.96%
Net interest income /
average total assets 4.01% 3.83% 3.79%
Interest earnings assets /
interest bearing
liabilities 1.11 1.09 1.10
Average balances in the above table were calculated using average daily figures.
Interest income is reflected on an actual basis, as the Company maintained no
tax preferenced securities during the periods reported.
-----------------------------------------
(1) Includes federal funds sold, money market fund investments, banker's
acceptances, commercial paper, interest earning deposit accounts, and
securities purchased under agreements to resell.
(2) Includes mortgage backed pass-through securities and CMOs.
(3) In computing the average balance of loans receivable, non-accrual loans and
loans held for sale have been included. Amount is net of deferred loan
fees, premiums and discounts, undisbursed loan funds, and allowances for
loan losses. Interest income on loans includes amortized loan fees and
costs, net, of $353,000, $223,000, and $250,000 in 2002, 2001, and 2000,
respectively.
(4) Includes federal funds purchased, securities sold under agreements to
repurchase, and borrowings under MBBC's line of credit.
(5) Interest rate spread represents the difference between the average rate on
interest earning assets and the average rate on interest bearing
liabilities.
(6) Net interest margin equals net interest income before provision for loan
losses divided by average interest earning assets.
88
Rate / Volume Analysis
The most significant impact on the Company's net interest income
between periods is derived from the interaction of changes in the volumes of and
rates earned or paid on interest-earning assets and interest-bearing
liabilities. The following table utilizes the figures from the preceding table
to present a comparison of interest income and interest expense resulting from
changes in the volumes and the rates on average interest earning assets and
average interest bearing liabilities for the years indicated. Changes in
interest income or interest expense attributable to volume changes are
calculated by multiplying the change in volume by the prior year average
interest rate. The changes in interest income or interest expense attributable
to interest rate changes are calculated by multiplying the change in interest
rate by the prior year average volume. The changes in interest income or
interest expense attributable to the combined impact of changes in volume and
changes in interest rate are calculated by multiplying the change in rate by the
change in volume.
Year Ended December 31, 2002 Year Ended December 31, 2001
Compared To Compared To
Year Ended December 31, 2001 Year Ended December 31, 2000
----------------------------------------- -----------------------------------------
Increase (Decrease) Due To Increase (Decrease) Due To
----------------------------------------- -----------------------------------------
Volume Volume
Volume Rate / Rate Net Volume Rate / Rate Net
------ ---- ------ --- ------ ---- ------ ---
(Dollars In Thousands)
Interest-earning assets
Cash equivalents $ (179) $ (183) $ 104 $ (258) $ (59) $ (187) $ 20 $ (226)
Investment securities 2 (196) (1) (195) (123) (194) 34 (283)
Mortgage backed securities (68) (1,193) 34 (1,227) (1,048) (481) 134 (1,395)
Loans receivable, net 4,223 (5,199) (619) (1,595) 4,474 (1,358) (187) 2,929
FHLB Stock 11 17 2 30 4 (54) (1) (51)
------- ------- ------- ------- ------- ------- ------ -------
Total interest-earning
assets 3,989 (6,754) (480) (3,245) 3,248 (2,274) 0 974
------- ------- ------- ------- ------- ------- ------ -------
Interest-bearing liabilities
NOW Accounts 24 (226) (15) $ (217) 70 (225) (29) $ (184)
Savings accounts (7) (115) 4 (118) 63 (105) (23) (65)
Money market accounts 838 (1,506) (365) (1,033) 207 (757) (38) (588)
Certificates of deposit 140 (4,715) (53) (4,628) 871 (762) (54) 55
------- ------- ------- ------- ------- ------- ------ -------
Total interest-bearing
deposits 995 (6,562) (429) (5,996) 1,211 (1,849) (144) (782)
FHLB advances 521 (499) (104) (82) 205 (186) (15) 4
Other borrowings 43 (17) (31) (5) (10) 2 (1) (9)
------- ------- ------- ------- ------- ------- ------ -------
Total interest-bearing
liabilities 1,559 (7,078) (564) (6,083) 1,406 (2,033) (160) (787)
------- ------- ------- ------- ------- ------- ------ -------
Increase (decrease) in net
interest income $ 2,430 $ 324 $ 84 $ 2,838 $ 1,842 $ (241) $ 160 $ 1,761
======= ======= ======= ======= ======= ======= ====== =======
Interest Income
Interest income for the year ended December 31, 2002 totaled $35.5
million, a decrease of $3.2 million from $38.7 million in the prior year. This
8.4% decrease was caused by the impacts of the lower interest rate environment
more than offsetting the effects of greater average balances of interest earning
assets and a shift in the earning asset mix.
Interest income on loans decreased 4.5% from $35.5 million in 2001 to
$33.9 million in 2002, as the effect of a decline in average rate from 8.21% in
2001 to 7.01% in 2002 more than offset the impact of greater average balances.
Because the vast majority of the Company's loans are either adjustable rate or
fixed rate for a limited period of time and then adjustable rate, the declining
interest rate environment prevalent throughout 2001 and 2002 reduced the
Company's yield on its loan portfolio. Historically high prepayments also
contributed toward lower loan yields in 2002, as higher yielding loans paid off
and were replaced with relatively lower yielding new originations. The drop in
loan yield during 2002 was, however, moderated by periodic caps and lifetime
floors on certain loan products.
89
Interest income on mortgage backed securities declined from $2.4
million in 2001 to $1.1 million in 2002 due to both lower average balances and
significantly reduced average rates. The reduction in average balances was
intentional, as the Company used scheduled principal payments, principal
prepayments, and sales of mortgage backed securities to support the expansion in
the loan portfolio and achieve the targeted shift in asset mix. The decline in
average rates was caused by:
o the general decline in interest rates, as adjustable rate mortgage backed
securities repriced downwards and as new security purchases during 2002
generally had lower effective rates than the securities in the portfolio at
the end of 2001
o a shift in the mix of mortgage backed securities away from long term, fixed
rate pass=though certificates and moderate duration CMO's to low duration
CMO's and seasoned balloon mortgage backed securities in conjunction with
the Company's asset / liability management program
o accelerated purchase premium amortization for mortgage backed securities,
particularly CMO's acquired in mid 2002 that then prepaid at historically
high speeds during the third and fourth quarters of 2002
o a shift in the mix of collateralized mortgage obligations away from
comparatively higher yielding Non Agency issued securities toward Agency
issued securities in order to obtain greater liquidity and to increase the
amount of securities eligible for use as collateral for various types of
deposits
Please refer to Note 4 to the Consolidated Financial Statements for additional
information regarding mortgage backed securities.
Interest income on investment securities decreased from $406 thousand
in 2001 to $211 thousand in 2002 due to a decline in average yield from 5.55% to
2.87%. The Company owned the same two investment securities during 2001 and
2002. These bonds are variable rate corporate trust preferred securities that
adjust quarterly based upon the 3 Month LIBOR Index. The yield on these
securities paralleled the decline in the three month LIBOR Index during 2001 and
2002, as presented in a previous table. Please refer to Note 3 to the
Consolidated Financial Statements for additional information regarding
investment securities.
Interest income on cash equivalents declined from $314 thousand in 2001
to $56 thousand in 2002 due to both lower average balances and lower average
rates. An objective of the Company is to minimize its cash & cash equivalent
position, subject to ensuring the maintenance of sufficient liquidity, in order
to allocate investable funds toward higher yielding types of assets. Because
cash equivalents are of limited term, they repriced downward quickly in 2001 and
2002.
Dividend income on FHLB stock increased from $166 thousand in 2001 to
$196 thousand in 2002 due to a larger average balance and higher yields. The
Company purchased additional shares of FHLB stock in 2002 in conjunction with an
expansion in its use of FHLB advances. The FHLB=SF paid a relatively high
dividend rate in 2002 when compared to most capital market benchmarks. The
Company's yield on FHLB stock during 2002 was also bolstered by the declaration
of a particularly high dividend rate for the fourth quarter of 2001, which was
paid in the first quarter of 2002 and exceeded the Company's estimated accrual
rate.
Interest Expense
Interest expense for the year ended December 31, 2002 totaled $12.9
million, representing a decrease of $6.1 million, or 32.0%, from $19.0 million
in the prior year. This decrease resulted from the change in the mix of interest
bearing liabilities and the effect of lower average rates more than offsetting
the impact of greater average balances of interest bearing liabilities.
90
Interest expense on interest bearing deposits decreased from $16.4
million in 2001 to $10.5 million in 2002, as the change in composition and the
effect of lower effective rates more than offset the impact of greater average
balances. The increased average balances were in conformity with the Company's
strategic plan of increasing market share in its local communities and better
meeting the savings, funds management, and investment needs of individuals and
businesses in the Greater Monterey Bay Area. The lower average rates in 2002
versus 2001 resulted from the lower interest rate environment and a shift in
deposit mix away from relatively higher cost certificates of deposit toward
relatively lower cost transaction accounts. Certificates of deposit constituted
55.5% of average total deposits in 2002, compared to 58.9% the prior year. The
weighted average cost of interest bearing deposits declined from 4.12% in 2001
to 2.45% in 2002. An increase in attractively priced deposits in conjunction
with the State of California Time Deposit program also contributed to the
decrease in average deposit costs in 2002.
Interest expense on FHLB advances and other borrowings decreased by $87
thousand from 2001 to 2002, as the impact of an increase in average balances was
more than offset by the effect of a reduction in average rate. While the Company
has access to various types of borrowings, most borrowings in 2002 were
concentrated in FHLB advances. The various credit programs from the FHLB=SF
provide the Company with the opportunity to undertake specific borrowings
designed to meet current and projected funding needs while also facilitating the
asset / liability management program. The average effective rate on borrowings
other than FHLB advances was inflated in 2002 and 2001 by the amortization of
the commitment fee associated with MBBC's line of credit from a correspondent
bank, combined with a lack of outstanding balances on the line.
Provision For Loan Losses
Implicit in lending activities is the risk that losses will occur and
that the amount of such losses will vary over time. Consequently, the Company
maintains an allowance for loan losses by charging a provision to operations.
Loans determined to be losses are charged against the allowance for loan losses.
The allowance for loan losses is maintained at a level considered by Management,
at a point in time and with then available information, to be adequate to
provide for estimable and probable losses inherent in the existing portfolio.
In evaluating the adequacy of the allowance for loan losses, Management
estimates the amount of probable loss for each individual loan that has been
identified as having greater than standard credit risk, including loans
identified as criticized ("Special Mention"), classified ("Substandard" or lower
graded), impaired, troubled debt restructured, and non=performing. In
determining specific and formula loss estimates, Management incorporates such
factors as collateral value, portfolio composition and concentration, trends in
local and national economic and real estate conditions, the duration of the
current business cycle, seasoning of the loan portfolio, historical credit
experience, and the financial status of borrowers. While the overall 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 is adequate, future
provisions are subject to continuing evaluation of inherent risk in the loan
portfolio, as conducted by both Management and the Bank's regulators.
Provisions for loan losses increased from $1.4 million in 2001 to $1.5
million in 2002. The amount of provision expense in 2002 resulted from the
Company's determination of its level of allowance for loan losses. Factors that
contributed to the Company's increasing its allowance for loan losses in 2002
included:
o the growth in the loan portfolio
o the change in loan portfolio mix toward credit categories that the Company
believes present higher inherent risks, and therefore should be accompanied
by suitably higher reserve levels
o the establishment of a $462 thousand specific reserve for a commercial real
estate loan
91
Factors that moderated the required level of allowance for loan losses
and hence provision levels for 2002 included:
o the Company's favorable credit experience in 2002, with net charge=offs of
just $13 thousand
o reductions in balances of criticized and classified loans
For additional information regarding the allowance for loan losses,
provision expense, and the Company's credit profile and experience, please see
"Item 1. Business = Credit Quality".
To the extent that the Company is successful in its business strategy
and thereby continues building the size of its loan portfolio while also
extending increased volumes of construction, income property, and commercial
business lending, Management anticipates that additional provisions will be
required and charged against operations in 2003, with the ratio of allowance for
loan losses to loans receivable increasing to reflect the greater credit
exposure inherent in the loan mix.
Non-Interest Income
Non-interest income decreased from $2.6 million in 2001 to $2.1 million
in 2002. This decline resulted from lower levels of non=interest income from all
of the Company's primary sources of non=interest income with the exception of
gain on the sale of loans, which benefited from the increase in residential
mortgage refinancing that occurred in 2002. Reversing this decline in
non=interest income and building a recurring and expanded stream of fee=based
revenues are key business objectives for the Company in 2003.
Customer service charge income decreased from $1.7 million in 2001 to
$1.5 million in 2002. In conjunction with the conversion to the new core data
processing system in March 2001, the Company implemented a restructured consumer
checking product line and an associated revised fee and service charge schedule.
These changes contributed to the closing of certain lower balance, recurring
overdraft, and / or higher transaction volume consumer checking accounts
beginning in the second quarter of 2001, as such accounts began incurring
increased service charges. The closure of these accounts contributed to the
reduced levels of customer service charge income for the full year, but also
decreased certain operating costs for the Company.
Gains on the sale of loans totaled $170 thousand during 2002, a 93.2%
increase from the $88 thousand recorded during 2001. Mortgage banking income
during 2002 benefited from the historically low interest rate environment and
record national refinance volume. At the beginning of 2003, the Company
commenced offering a greater variety of residential mortgages under an expanded
relationship with a secondary market conduit. This expansion was pursued in
light of the Company's desire to continue reducing the percentage of total loans
held for investment comprised of residential mortgages while at the same time
continuing to meet the home financing needs of its local communities.
Commissions from the sale of non=FDIC insured investment products were
$125 thousand during 2002, compared to $244 thousand during 2001. This decrease
was primarily due to vacancies in positions for licensed investment sales
representatives and the general state of the capital markets during 2002.
Loan servicing income totaled $63 thousand during 2002, down from $101
thousand during 2001. The Company continues to sell the vast majority of its
long term, fixed rate residential loan production into the secondary market on a
servicing released basis, and purchases more interest rate sensitive loans as
part of its interest rate risk management program. Additions to loans serviced
for others during 2002 were thus limited to loan participations sold to
correspondent banks. As a result, the portfolio of loans serviced for others
continues to decline as loans pay off. At December 31, 2002, the Company
serviced $35.3 million in various types of loans for other investors, compared
to $42.6 million at December 31, 2001. The Company maintained loan servicing
assets of $35 thousand at December 31, 2002, and is thus limited in its exposure
of loan servicing income to the accelerated loan prepayment speeds now occurring
as a result of the low interest rate environment and high volume of residential
mortgage refinance activity.
92
Gains on sale of mortgage backed securities during 2002 totaled $35
thousand, down from $190 thousand during 2001. The Company's security sales
during 2002 were limited to the sale of two collateralized mortgage obligations.
These securities were sold in conjunction with the Company's interest rate risk
management program. Although the market value of many of the Company's mortgage
backed securities exceeded historic carrying cost during 2002 due to the decline
in most capital markets interest rates, the Company retained the securities as a
means of generating net interest income.
Further augmenting non=interest income, both nominally and a percentage
of total revenue, constitutes a primary component of the Company's business
strategy. In 2003, the Company plans to enhance its fee income by continuing to
market electronic bill payment and debit card services, increasing the number of
transaction deposit accounts, conducting more trade finance business, and
selling depository and cash management services to business customers who would
be charged via account analysis.
Non-Interest Expense
Non-interest expense decreased from $14.4 million in 2001 to $13.8
million in 2002. Factors contributing to lower expenses in 2002 included the
2001 nonrecurring expenses associated with its data processing conversion ($447
thousand) and the arbitration of claims by a former executive ($284 thousand).
Costs for the 2001 data processing conversion included de-conversion fees,
printing and postage costs for additional customer communications, employee
training and travel costs, and consulting fees for technology professionals.
Compensation and employee benefits costs increased from $6.9 million in
2001 to $7.6 million in 2002 due
to:
o compensation costs associated with the Los Angeles loan production office
which opened during the first quarter of 2002
o other staff additions and changes in support of the Company's strategic
plan, particularly in the Company's commercial banking, income property
lending, and information technology functions
o higher costs for the Bank's Employee Stock Ownership Plan due to the
greater average market price of the Company's common stock
o higher costs for payroll taxes on a greater compensation base
o increased expenses for worker's compensation insurance, which is a general
problem faced by businesses in the State of California
In 2003, the Company plans to further modify its various performance
based incentive plans to better integrate employee compensation with measurement
criteria directly related to financial contribution, economic value created,
customer retention, and new customer development. Management believes that
closely linking employee compensation with performance and contributions in
support of the strategic plan is a key component of successfully and timely
achieving the objectives of the strategic business plan.
Data and item processing costs decreased from $876 thousand in 2001 to
$567 thousand in 2002 due to:
o the Company's operating on its new in-house core processing platform for
all of 2002, versus only about 9 months in 2001
o the Company's multiple steps to improve the efficiency by which it
operates, such as conducting expanded marketing of combined statements
(multiple accounts on one statement) and imaged checking statements (check
images returned instead of the physical checks) in 2002
93
Legal and accounting expenses decreased from $863 thousand in 2001 to
$442 thousand in 2002. This reduction was primarily due to the aforementioned
arbitration in 2001, and due to the Company's utilizing more cost effective
providers for certain professional services in 2002. In addition, the Company
during 2002 commenced performing certain regulatory filing functions internally
at lower cost.
Advertising and promotion costs totaled $300 thousand during 2002, up
from $251 thousand during 2001. These costs were unusually low in the first half
of 2001, as the Company postponed certain advertising and promotional activities
due to the implementation of the new computer systems environment. Advertising
expenses during 2002 were concentrated in print advertising for consumer
deposits and radio advertising targeted at local businesses.
Deposit insurance premiums decreased from $198 thousand for 2001 to
$140 thousand for 2002, despite the expansion in the Company's deposit
portfolio. The decline resulted from an adjustment in the Company's insurance
premium rate effective July 1, 2002. The lower insurance premium rate will also
favorably impact deposit insurance expenses during the first half of 2003.
Consulting expenses declined from $333 thousand in 2001 to $97 thousand
in 2002. The Company incurred significant professional costs during 2001 in
support of a data processing systems conversion to an in-house, client / server,
relational database environment from a prior service bureau system.
Other non-interest expense decreased from $2.0 million in 2001 to $1.5
million in 2002. The Company implemented a number of expense control and
efficiency initiatives over the past year that moderated various operating
costs. These initiatives included more cost effective check printing, supplies
ordering, cellular telecommunications, and processing of certain electronic
funds transfers. In addition, the Company incurred lower expenses related to the
Board of Directors in 2002 versus 2001.
The Company's efficiency ratio improved from 64.41% during 2001 to
55.78% during 2002, with the ratio for the fourth quarter of 2002 favorably
falling to 53.41%. While the Company continues to pursue a range of alternatives
to improve its efficiency and augment revenue, further progress in this ratio
will likely be tempered in coming quarters by the need to invest in support of
the continued implementation of the strategic plan. These investments are
projected to include product development, new branch sites, additional
relationship officers, and enhanced technology-facilitated services.
Stock Based Compensation
In 2002 and 2001, the Company extensively utilized stock based
compensation for directors, officers, and certain non-officer employees. The
Company believes that the use of stock based compensation aligns director,
officer, and employee interests with those of stockholders. The Company's stock
based compensation programs are discussed in Note 18 to the Consolidated
Financial Statements. Several of the Company's stock based compensation programs
provide for vesting periods of up to five years, thereby also encouraging
Management and employees to work in the best long term interests of the Company
and its stockholders. Director retainer fees during 2001 and 2002 were paid in
Company common stock. In addition, a number of the Bank's officers voluntarily
accepted Company common stock in lieu of certain cash compensation during 2001
and 2002. These decisions included the election by the Chief Executive Officer
and Chief Financial Officer to each receive a significant component of his 2002
incentive compensation in Company common stock.
The Company intends to continue extensively utilizing stock based
compensation and incentives in 2002, including the issuance of additional stock
options, as approved by stockholders, at 110% of the fair market value of the
stock on the date of grant. This compares to the 100% ratio generally prevalent
among similar financial institution holding companies.
94
Provision For Income Taxes
The provision for income taxes increased from $2.8 million in 2001 to
$3.8 million in 2002 due to a rise in pre-tax income. The Company's effective
book tax rate decreased from 42.6% in 2001 to 40.1% in 2002 due to:
o the Company's increased utilization of tax benefits under the State of
California Enterprise Zone Program
o the purchase of Bank owned life insurance during the fourth quarter of 2002
o certain non-deductible expenses and other adjustments to taxable income
representing a smaller percentage of the increased amount of book pre-tax
income
o a non-recurring reduction in the Company's provision for income taxes
during the third quarter of 2002 resulting from a change in California tax
law
The Company's Administrative Headquarters building and Watsonville branch are
located within a State of California Enterprise Zone, and the Bank has increased
its lending to local businesses also domiciled within Enterprise Zones
throughout California. The dividends the Company earns on the Bank owned life
insurance are not subject to regular Federal and State income tax.
Comparison Of Financial Condition At December 31, 2002 And December 31, 2001
Total assets increased from $537.4 million at December 31, 2001 to a
record $609.7 million at December 31, 2002.
Cash and cash equivalents decreased from $13.1 million at December 31,
2001 to $11.4 million at December 31, 2002 due to the use of cash equivalents to
fund expansions in the security and loan portfolios, and to purchase Bank owned
(universal) life insurance.
Investment securities at December 31, 2001 and 2002 were composed of
the same two variable rate corporate trust preferred securities issued by major
US banks that reprice quarterly based upon a margin over the 3 month LIBOR rate.
These two securities were rated "A" and "A-" by Standard & Poors rating agency
at December 31, 2002. Management may consider selling these two securities in
2003 to bolster the Bank's QTL ratio, shift funds into assets that function as
more effective collateral under secured borrowing arrangements, and provide
funds for further expansion in loans receivable. Increasing the QTL ratio would
provide additional time before the Bank would be forced by regulation to
allocate the management time and incur the operating expense associated with a
change in charter from a federal thrift to either a California State or national
commercial bank. Throughout 2002, the Company did not own any corporate bonds
issued by companies primarily in the telecommunications, technology, or energy
industries. For additional information regarding investment securities, please
refer to Note 3 to the Consolidated Financial Statements.
Mortgage backed securities increased from $30.6 million at December 31,
2001 to $37.5 million at December 31, 2002. Increased collateral requirements
for certain deposits contributed to the increase. All of the Company's mortgage
backed securities at December 31, 2002 were rated "AAA" by at least one
nationally recognized ratings agency.
During 2002, the Company continued altering the mix of its mortgage
backed securities in conjunction with its asset / liability and liquidity
management programs. Long term, fixed rate pass-through securities were
decreased, while balloon mortgage backed securities were increased. CMO's were
shifted to higher cash flow, shorter term securities with less extension risk.
These instruments provide more periodic funds that can be used to support
further expansion in net loans receivable. In 2001 and 2002, Management
reallocated some of the Company's capacity for longer term, fixed rate assets
from the security portfolio to the loan portfolio, where better yields were
available for comparable levels of interest rate risk.
95
The Company also shifted the mix in CMO issuers in 2002 toward Agency
issuance and away from private label, "AAA" rated securities. This alteration in
mix was conducted to provide additional eligible collateral for various types of
deposits, including time deposits placed by the State of California.
In 2003, the Company plans to continue emphasizing the use of balloon
mortgage back securities and CMO's in its security portfolio, as the Company can
use certain CMO's (e.g. Planned Amortization Classes, or "PAC's") to target
future cash flows in conjunction with its asset / liability, liquidity, and
balance sheet management programs.
Loans held for sale, carried at the lower of cost or market, totaled
$1.5 million at December 31, 2002, compared to $713 thousand at December 31,
2001. The Company sells most of its long term, fixed rate residential mortgage
production into the secondary market on a servicing released basis, and
purchases more interest rate sensitive loans as part of its interest rate risk
management program.
Loans held for investment, net, increased from $465.9 million at
December 31, 2001 to a record $521.9 million at December 31, 2002. The increase
resulted from a combination of strong internal loan originations, including
activity from the Los Angeles loan production office, and from purchases of, or
participations in, individual income property and construction loans from
correspondent banks. In addition, during the fourth quarter of 2002, the Company
purchased a $16.9 million pool of high credit quality, seasoned hybrid
residential mortgages secured by first deeds of trust on California homes in
order to better utilize the Company's capital, support the Bank's Qualified
Thrift Lender ("QTL") ratio, and offset historically high loan payoff volumes
stemming from the low interest rate environment.
Total net loans as a percentage of total assets were 85.9% at December
31, 2002, down slightly from 86.8% at December 31, 2001. The Company has
targeted increasing this ratio to 90.0% as part of its strategy of supporting
its interest margin, fostering economic activity in its local communities, and
effectively utilizing the Bank's capital. The decline in this ratio during the
fourth quarter of 2002 primarily resulted from the Company's acquisition of $9.0
million in Bank owned life insurance, as subsequently discussed. The Company
plans to continue expanding its portfolio of loans held for investment in 2003,
with a continuing reduction in the percentage of the portfolio comprised of
residential mortgages in favor of other generally higher yielding and more
interest rate sensitive types of loans.
The Company's investment in the capital stock of the Federal Home Loan
Bank ("FHLB") increased from $3.0 million at December 31, 2001 to $4.7 million
at December 31, 2002. This increase was due to a combination of required stock
purchases stemming from the Bank's increased utilization of FHLB advances and
the receipt of FHLB stock dividends.
The Company's balance of premises and equipment, net, decreased by $457
thousand in 2002, as equipment purchases were limited during 2002 following a
major investment in technology during 2001 in conjunction with the core systems
conversion. Premises and equipment balances may increase more substantially in
2003 if the Company is successful in acquiring or opening de novo one or more
new branch locations. For additional information regarding premises and
equipment, please refer to Note 8 to the Consolidated Financial Statements.
The Company continued to amortize its core deposit intangibles during
2002, reducing their balance from $1.5 million at December 31, 2001 to $833
thousand at December 31, 2002. This amortization, which is a non-cash charge to
operations, bolsters the Bank's regulatory capital ratios (all else held
constant), as intangible assets are deducted from GAAP capital in determining
regulatory capital. This amortization also increases the Company's tangible book
value per share. For additional information regarding core deposit intangibles,
please refer to Note 9 to the Consolidated Financial Statements.
At December 31, 2002, the Company maintained $35 thousand in originated
mortgage servicing rights, down from $75 thousand a year earlier. Because the
Company has adopted a program of generally selling its loans on a servicing
released basis, Management anticipates that the balance of originated mortgage
servicing rights will continue to decline as the existing portfolio of loans
serviced for others pays off.
96
The Bank purchased $9.0 million in Bank owned life insurance during the
fourth quarter of 2002. The associated policies are single premium, universal
life, modified endowment contracts spread among five insurance companies with
favorable credit profiles and histories of competitive policy dividend yields.
The insurance was purchased to fund:
o non-qualified supplemental executive retirement benefits for the Chief
Executive Officer and Chief Financial Officer that were implemented by the
Company in early 2003
o the increasing expense of the tax qualified Employee Stock Ownership Plan,
with associated costs rising due to the higher market price of the
Company's common stock
In addition, the Bank owned life insurance policies provide significant key man
insurance to the Company.
Deposits increased from $432.3 million at December 31, 2001 to $458.3
million at December 31, 2002. This increase was primarily due to:
o The Bank's issuance of its first brokered certificate of deposit ("CD"),
for $20.0 million, during the second quarter of 2002. The brokered CD was
issued in order to provide funding for loan production in 2002.
o A $9.0 million increase in deposits from the State of California time
deposit program during 2002. The State places funds with California banks
as a vehicle for encouraging employment and economic growth.
Deposit growth during 2002 was constrained by the Company's declining
to match significantly above market rates offered on selected transaction
accounts by two large thrifts. The Company was, however, successful in
increasing the number of deposit accounts maintained by customers with
commercial banking and real estate lending relationships during 2002.
The Company continues to pursue increases in transaction account
balances as a fundamental component of its strategic plan. Excluding the impact
of the aggregate $29.0 million increase in brokered and State certificates of
deposit during 2002, transaction accounts increased from 43.6% of total deposits
at December 31, 2001 to 49.3% of total deposits at December 31, 2002. This shift
in mix contributed to the Company's reducing its weighted average cost of
deposits from 2.87% at December 31, 2001 to 1.94% at December 31, 2002. This 93
basis point reduction in deposit cost was attained despite the historically low
level of interest rates and therefore the Company's limited ability to decrease
interest rates on many deposit products that were priced between zero and one
percent at December 31, 2001.
Management is, however, not satisfied with the volume of deposit
acquisition achieved by its eight full service retail branches in 2002,
particularly in light of general deposit inflows into the banking system from
investors leaving the equity markets. Management responded to this performance
by introducing new money market products, altering branch staff compensation,
and hiring a new Director of Retail Banking effective in February 2003. The new
Director of Retail Banking has extensive local financial industry experience and
a successful track record of attracting high caliber commercial bankers and
building quality customer relationships.
The prior Director of Retail Banking will continue to assist the
Company in its implementation of the strategic plan by serving as Chief
Administrative Officer.
Checking account balances increased from $63.6 million at December 31,
2001 to $67.2 million at December 31, 2002. The Company plans to introduce
several new consumer checking products during 2003, with a particular focus on
relationship pricing and providing increased choice and options to customers. In
addition, the Company's commercial lending officers have increasing business
demand deposit balances as a key component of their sales objectives.
97
During the latter part of 2002, the Company introduced "remote deposit"
services to its business and high net worth individual accounts. Via this new
service, the Bank's customers can make deposits to their Monterey Bay Bank
checking account at any branch of a correspondent bank with over 4,900 banking
locations in 23 states. Remote deposit services were implemented to offer
improved convenience and assist the Bank in competing with larger financial
institutions with more extensive branch networks.
Money market deposits increased from $105.8 million at December 31,
2001 to $126.1 million at December 31, 2002. Factors supporting the rise in
money market balances in 2002 included the Company's active cross-selling of
this product in its branches and the desire by certain customers to avoid
committing funds to term certificates of deposit in the current historically low
interest rate environment. The Company introduced two new money market accounts
at the beginning of 2003: Investors Money Market and Business Money Market.
Investors Money Market is a highly tiered product targeted to attract funds from
money market mutual funds and brokerage firms. Business Money Market is a
product designed specifically for the Bank's local commercial customers seeking
an attractive return on liquid funds while also enjoying the many attractive
attributes provided by the Bank, including Internet banking, global ATM access,
24 hour bilingual telephone banking, and superior customer service provided by
local bankers familiar with their business. For additional information regarding
deposits, please refer to Note 10 to the Consolidated Financial Statements.
In early 2003, the Bank was actively negotiating for the lease of a
3,000 square foot building to serve as a de novo branch in its primary market
area. In addition, effective in January 2003, the Bank received approval from
the Office of Thrift Supervision to operate a branch at the Company's existing
Administrative Headquarters building in Watsonville. This branch will primarily
serve the Bank's growing base of commercial business, construction, and income
property real estate customers who are served by relationship officers operating
from the Headquarters building.
Borrowings increased from $53.8 million at December 31, 2001 to $93.8
million at December 31, 2002. The increase was associated with funding the rise
in the loan and security portfolios. All of the Company's FHLB advances at
December 31, 2002 were fixed rate, fixed term or overnight borrowings without
call or put option features.
Consolidated stockholders' equity increased from $50.2 million at
December 31, 2001 to a record $56.1 million at December 31, 2002 due to a
combination of:
o net income
o continued amortization of deferred stock compensation
o additional paid-in capital generated from the Employee Stock Ownership Plan
and the Performance Equity Plan
o Directors continuing to receive their retainer fees in Company common stock
o the exercise of 48,463 vested stock options
98
The above factors more than offset the impact of the depreciation in
the aggregate fair value of securities classified as available for sale and
acquisitions of common stock under the Company's repurchase program. The
depreciation in the portfolio of securities classified as available for sale was
concentrated in reduced market prices for the Company's two corporate trust
preferred securities. The Company's stock repurchases during 2002 were comprised
of the following:
Number Of Price
2002 Shares Of Shares
Quarter Repurchased Repurchased
----------------------- -------------------- --------------------
First 5,000 $16.25
Second None --
Third 5,000 $17.10
5,000 $17.20
5,000 $17.24
5,000 $17.25
5,000 $17.36
Fourth 31,000 $18.15
Full Year 2002 61,000 $17.62 average
At December 31, 2002, there were 53,035 remaining shares authorized for
repurchase under the Company's current repurchase program.
The Company did not declare or pay any cash dividends in 2002. In 2000,
the Company announced the indefinite suspension of the declaration and payment
of cash dividends. The Board of Directors continues to believe that, at this
time, the Company's capital is better utilized in growing the balance sheet,
expanding the Bank's franchise value, and repurchasing shares versus paying a
cash dividend. In addition, paying a nominal cash dividend would cause the
Company to incur additional operating costs for processing, mailing, and tax
information reporting.
While the Company has no current plans to commence paying cash
dividends in 2003, the Company would reconsider this position should a
significant revision to the Internal Revenue Code occur in regards to the tax
treatment of dividends, as has recently been proposed by the Administration in
Washington. However, no assurance can be provided regarding future changes to
the Internal Revenue Code, if any, and what the Company's response to such
changes might be, if any.
The Company's tangible book value per share increased from $14.08 at
December 31, 2001 to $16.00 at December 31, 2002. The Company's tangible book
value per share benefits from the amortization of deferred stock compensation
and core deposit intangibles, in addition to periodic earnings and other factors
that add to stockholders' equity without increasing the number of shares
outstanding.
99
Analysis Of Results Of Operations For The Years Ended December 31, 2001 And
December 31, 2000
Overview
For the year ended December 31, 2001, net income was $3.75 million,
equivalent to $1.15 basic earnings per share and $1.12 diluted earnings per
share. This compares to net income of $2.52 million, or $0.81 basic and diluted
earnings per share, for the year 2000. Return on average stockholders' equity
increased from 6.24% in 2000 to 7.94% in 2001. Return on average assets
increased from 0.53% in 2000 to 0.73% in 2001.
The continued implementation of the Company's strategic plan was a
primary factor in the Company's improved financial performance in 2001 versus
2000. Other factors included a more favorable credit experience in 2001 versus
2000, and better results on the sale of securities.
Net Interest Income
Net interest income increased from $18.0 million in 2000 to $19.7
million in 2001 due to both expanded spreads and greater average balances of
interest earnings assets. The Company's ratio of net interest income to average
total assets increased from 3.79% in 2000 to 3.83% in 2001 despite the Company's
difficulty in decreasing NOW and Savings deposit rates at the same pace as the
declines in indices used for adjustable rate loans. The Company's NOW and
Savings deposit rates were already at low nominal levels before the significant
interest rate cuts (totaling 475 basis points) implemented by the Federal
Reserve throughout 2001. The Company moderated the impact of these factors in
2001 through its proactive asset / liability management program and a shift in
balance sheet composition.
The $1.7 million, or 9.8%, increase in net interest income generated in
2001 versus 2000 primarily resulted from four factors:
1. Change In Asset Mix
Average net loans receivable increased from 80.0% of average total assets in
2000 to 83.8% of average total assets in 2001. Lower yielding cash equivalents,
investment securities, and mortgage backed securities all declined as a
percentage of average total assets in 2001 versus 2000. The benefits from this
shift in asset mix were significant, as the average rate earned on net loans
receivable in 2001 was 8.21%, substantially above the 4.13% earned on cash
equivalents, 5.55% earned on investment securities, and 6.08% earned on mortgage
backed securities.
2. Change in Liability Mix
Average transaction deposit accounts (DDA, NOW, Savings, and Money Market
combined) as a percentage of average total deposits rose from 40.5% in 2000 to
41.1% in 2001. Transaction deposit accounts present a lower cost of funding than
most alternative sources. Non-interest bearing demand deposit accounts ("DDA")
rose from 4.3% of average total deposits in 2000 to 4.6% in 2001.
3. Increased Average Balance Sheet
Average total assets increased by 8.6% from 2000 to 2001. The larger average
balances of interest earning assets and interest bearing liabilities, combined
with expanding spreads, contributed toward greater nominal net interest income.
4. Asset / Liability Management
Net interest income in 2001 benefited from positions taken by the Company as a
result of its asset / liability management program. Early in 2001, the Company
moderately increased the net liability sensitivity of the balance sheet in order
to benefit from the rapid and significant interest rate cuts being implemented
by the Federal Reserve. This was accomplished, in part, by adding intermediate
term, fixed rate assets during the first half of the year, primarily in the form
of residential hybrid mortgages.
Net interest income was also benefited in 2001 versus 2000 by an
increase in average stockholders' equity, which was substantially offset by an
increase in average non-interest earning assets, primarily deferred tax assets.
100
Interest Income
Interest income for the year ended December 31, 2001 totaled $38.7
million, an increase of $0.9 million from $37.8 million in the prior year. This
2.6% increase resulted from the effects of greater average balances of interest
earning assets and a shift in the earning asset mix more than offsetting the
impact of a lower interest rate environment in 2001 versus 2000.
Interest income on loans increased 9.0% from $32.6 million in 2000 to
$35.5 million in 2001, as the effect of greater average balances more than
offset a decline in average rate from 8.57% in 2000 to 8.21% in 2001. Because
the vast majority of the Company's loans are either adjustable rate or fixed
rate for a limited period of time and then adjustable rate, the declining
interest rate environment prevalent throughout 2001 reduced the Company's yield
on its loan portfolio. The drop in this yield was, however, moderated by
periodic caps and lifetime floors on certain loan products.
Interest income on mortgage backed securities declined from $3.8
million in 2000 to $2.4 million in 2001 due to both lower average balances and
reduced average rates. The reduction in average balances was intentional, as the
Company used scheduled principal payments, principal prepayments, and sales of
mortgage backed securities to support the expansion in the loan portfolio and
achieve the targeted shift in asset mix. The decline in average rates was caused
by:
o a shift in the mix of mortgage backed securities away from long term, fixed
rate pass-though certificates to lower duration collateralized mortgage
obligations and adjustable rate pass through certificates in conjunction
with the Company's asset / liability management program
o a shift in the mix of collateralized mortgage obligations away from Non
Agency issued securities toward Agency issued securities in order to obtain
greater liquidity and to increase the amount of securities eligible for use
a collateral for various types of deposits
o the general decline in interest rates, as adjustable rate mortgage backed
securities repriced downwards and as new security purchases during 2001
generally had lower effective rates than the securities in the portfolio at
the end of 2000
Interest income on investment securities decreased from $689 thousand
in 2000 to $406 thousand in 2001. This decline was due to lower average balances
and lower average rates. Because all of the Company's investment securities in
2000 and 2001 were variable rate corporate trust preferred securities that
adjust quarterly based upon the 3 Month LIBOR Index, these securities repriced
downwards rapidly in 2001 in conjunction with the interest rate cuts implemented
by the Federal Reserve.
Interest income on cash equivalents declined from $540 thousand in 2000
to $314 thousand in 2001 due to both lower average balances and lower average
rates. Because cash equivalents are of limited term, they repriced downward
quickly in 2001 in conjunction with the interest rate cuts implemented by the
Federal Reserve..
Dividend income on FHLB stock decreased from $217 thousand in 2000 to
$166 thousand in 2001 due to lower effective rates. The lower effective rates
were due to the lower interest rate environment in 2001 versus 2000 and due to
the FHLB-SF's decision to pay particularly high dividend rates during the first
half of 2000 in conjunction with its capital management program.
Interest Expense
Interest expense for the year ended December 31, 2001 totaled $19.0
million, representing a decrease of $0.8 million, or 4.0%, from $19.8 million in
the prior year. This decrease resulted from the change in the mix of interest
bearing liabilities and the effect of lower average rates more than offsetting
the impact of greater average balances of interest bearing liabilities.
101
Interest expense on interest bearing deposits decreased from $17.2
million in 2000 to $16.4 million in 2001, as the change in composition and the
effect of lower effective rates more than offset the impact of greater average
balances. The lower average rates in 2001 versus 2000 resulted from the lower
interest rate environment and a shift in deposit mix away from relatively higher
cost certificates of deposit toward relatively lower cost transaction accounts.
Certificates of deposit constituted 58.9% of average total deposits in 2001,
compared to 59.5% the prior year. The weighted average cost of interest bearing
deposits declined from 4.66% in 2000 to 4.12% in 2001. A rise in attractively
priced funds in conjunction with the State of California Time Deposit program
also contributed to the decrease in average deposit costs in 2001.
Interest expense on borrowings was nearly constant in 2000 and 2001, as
the effect of an increase in average balances was offset by the impact of lower
average rates. While the Company has access to various types of borrowings, most
borrowings in 2001 were concentrated in FHLB advances. The average effective
rate on borrowings other than FHLB advances was inflated in 2000 and 2001 by the
amortization of the commitment fee associated with MBBC's line of credit from a
correspondent bank.
Provision For Loan Losses
Provisions for loan losses declined from $2.2 million in 2000 to $1.4
million in 2001. The change in provisions was due to the result of the Company's
methodology for calculating the level of allowance for loan losses. Factors that
contributed to the reduction in provisions in 2001 versus the prior year
included:
o a lower level of net charge-offs in 2001 versus 2000
o a decrease in the amount of classified loans at December 31, 2001 versus
the prior year end
o a reduced concentration of relatively higher risk construction and land
loans in 2001 versus 2000
o the reduction in specific reserves of $600 thousand associated with a
commercial real estate construction loan that was collected in full during
the second quarter of 2001
o an increased concentration of relatively lower risk residential and
multifamily mortgages in 2001 versus 2000
The above factors more than offset the impact of a larger loan
portfolio, including growth in commercial business loans outstanding. The above
factors also more than offset higher reserve factors for the Company's
portfolios of hotel / motel real estate loans and Business Express loans.
Non-Interest Income
Non-interest income totaled $2.6 million in 2001, comparing favorably
to $2.3 million in 2000. The Company recorded $190 thousand in pre-tax gains on
security sales in 2001, versus a pre-tax loss of $55 thousand during 2000. As
discussed below, customer service charges and mortgage banking income also
increased in 2001 versus the prior year, offset by reduced loan servicing income
and decreased commissions from sales of non-FDIC insured investments.
Service charge income rose from $1.3 million during 2000 to $1.7
million during 2001. This increase primarily resulted from the revised fee and
service charge schedule implemented with the new core processing system in 2001.
102
Loan servicing income totaled $101 thousand during 2001, compared to
$118 thousand during 2000. The Company continues to sell the vast majority of
its long term, fixed rate residential loan production into the secondary market
on a servicing released basis. As a result, the portfolio of loans serviced for
others is declining as loans pay off. At December 31, 2001, the Company serviced
$42.6 million in various types of loans for other investors, compared to $62.0
million at December 31, 2000.
Commissions from sale of non-FDIC insured investments totaled $244
thousand during 2001, compared to $676 thousand during 2000. Less favorable
general capital market conditions, the events of September 11, 2001, and
investment staff turnover and vacancies contributed to the lower revenues in
2001 versus 2000.
Gains on the sale of loans increased from $23 thousand during 2000 to
$88 thousand during 2001. The lower general interest rate environment in 2001
led to a strong residential loan refinance market, which in turn bolstered the
Company's mortgage banking activity.
Non-Interest Expense
Non-interest expense rose $0.7 million, or 5.1%, from $13.7 million in
2000 to $14.4 million in 2001. Total non-interest expense in 2001 was increased
by costs for the March 2001 data processing conversion ($447 thousand) and legal
and other expenses associated with the arbitration of claims by a former
executive ($284 thousand). Total non-interest expenses in 2000 included $108
thousand in costs for the data processing conversion and $250 thousand accrued
for settlement of the claims by the former executive. Costs for the data
processing conversion included de-conversion fees to the prior service bureau,
printing and postage costs for additional customer communications, employee
training and travel costs, and consulting fees for technology professionals
retained to assist with and speed the implementation of the new system.
Throughout 2001, the Company adjusted its staffing to advance the
strategic plan, primarily through the hiring of commercial loan officers and
professional bankers. Staffing was also increased in the data processing
function, coincident with the Company's shifting from an external service bureau
to in-house data processing. The change in the Company's systems environment
also impacted various other operating expenses. Data processing fees were much
lower in 2001 versus 2000, while equipment expense was higher due to the added
depreciation from the new hardware and software installed in 2001.
Compensation and employee benefit costs also increased in 2001 versus
2000 for payments under certain incentive compensation plans. These expenses
rose in 2001 in conjunction with the Company's improved financial performance.
Costs for the Bank's employee stock ownership plan ("ESOP") increased in 2001
versus 2000 because of the higher average price of Monterey Bay Bancorp, Inc.
common stock.
Advertising and promotion costs during 2001 were $249 thousand, down
from $361 thousand in 2000 primarily due to the Company's reducing certain
marketing efforts early in 2001 while the core processing conversion was being
completed.
The Company's efficiency ratio improved from 67.30% in 2000 to 64.41%
in 2001. This ratio has been unfavorably impacted during the past two years by
the up front operating costs and other expenses that the Company has incurred in
advance of associated revenues as the Company has implemented its strategic
plan. The Company has made investments in new staff and new systems that are
necessary to successfully market a broader range of financial products to a
greater segment of individuals and businesses in its primary market areas. These
investments by nature had to precede the associated revenues.
Provision For Income Taxes
The provision for income taxes increased from $1.9 million in 2000 to
$2.8 million in 2001 due to a rise in pre-tax income. The Company's effective
book tax rate decreased slightly in 2001 versus the prior year.
103
Comparison Of Financial Condition At December 31, 2001 And December 31, 2000
Total assets of the Company were $537.4 million at December 31, 2001,
compared to $486.2 million at December 31, 2000, an increase of $51.2 million,
or 10.5%.
Cash & cash equivalents decreased from $25.2 million at December 31,
2000 to $13.1 million at December 31, 2001 due to the Company's using cash
equivalents to fund an expansion in the loan portfolio.
Investment securities at December 31, 2000 and 2001 were composed of
the same two variable rate corporate trust preferred securities issued by major
US banks that reprice quarterly based upon a margin over the 3 month LIBOR rate.
Mortgage backed securities decreased from $43.0 million at December 31,
2000 to $30.6 million at December 31, 2001. During 2001, the Company utilized
cash flows from sales and principal payments on mortgage related securities to
fund an increase in the loan portfolio.
Loans held for sale, carried at the lower of cost or market, totaled
$713 thousand at December 31, 2001. The Company sells most of its long term,
fixed rate residential mortgage production into the secondary market on a
servicing released basis, and purchases more interest rate sensitive loans as
part of its interest rate risk management program.
Loans held for investment, net, increased from $391.8 million at
December 31, 2000 to a record $465.9 million at December 31, 2001. The increase
resulted from a combination of strong internal loan originations and from pool
purchases of various types of California real estate loans. Net loans as a
percentage of total assets increased from 80.6% at December 31, 2000 to 86.8% at
December 31, 2001, in conjunction with the Company's strategy of supporting its
interest margin, fostering economic activity in its local communities, and
effectively utilizing the Bank's capital.
The Company's investment in the capital stock of the FHLB increased
from $2.9 million at December 31, 2000 to $3.0 million at December 31, 2001.
Stock dividends and capital stock purchases during 2001 were partially offset by
a mandatory capital stock redemption.
The Company's balance of premises and equipment, net, increased by $243
thousand in 2001 primarily due to hardware and software purchased in support of
the new core processing system.
The Company continued to amortize its core deposit intangibles during
2001, reducing their balance from $2.2 million at December 31, 2000 to $1.5
million at December 31, 2001.
Total liabilities rose 10.1% from $442.4 million at December 31, 2000
to $487.2 million at December 31, 2001. This $44.8 million increase was
approximately split between an increase in deposits and an increase in
borrowings. Accounts payable and other liabilities decreased by $0.9 million
during 2001 primarily due to the timing of interest payments on borrowings, a
reduction in accrued liabilities for deferred compensation and non-qualified
retirement plans, and the 2001 settlement of claims by a former executive which
had been accrued at December 31, 2000.
104
Deposits increased from $407.8 million at December 31, 2000 to a record
$432.3 million at December 31, 2001. The Company experienced strong growth in
money market deposits during 2001 due to a combination of sales and marketing
focus and the historically low interest rate environment's leading certain
customers to delay committing funds to term certificates of deposit. Deposit
growth during 2001 was, however, restrained by a small number of very large
competitors that conducted aggressive promotional campaigns based on paying
interest rates significantly above levels offered by most money center,
regional, and California community banks. Deposit growth during 2001 was also
restrained by customer response to the new systems environment, as the Company
eliminated passbooks in favor of statement accounts and as certain deposit
products were repriced upwards to reflect competitive market conditions or the
Company's costs of providing the accounts. Certificates of deposit declined from
60.0% of total deposits at December 31, 2000 to 56.4% of total deposits at
December 31, 2001, despite a $5.0 million increase in funds from the State of
California Time Deposit Program.
FHLB advances increased from $32.6 million at December 31, 2000 to
$53.6 million at December 31, 2001. During 2001, the Company utilized FHLB
advances to fund some of the expansion in the loan portfolio. During the fourth
quarter of 2001, the Company prepaid $10.0 million in FHLB advances due in the
first quarter of 2002 in order to extend the term structure of that debt in
conjunction with the Company's asset / liability management program. Despite the
Company's strong capital position in 2001, Management did not pursue extensive
leveraging via wholesale assets and liabilities, such as FHLB advances.
Management believes the Company's capital is better deployed in meeting the
financial needs of individuals, families, and businesses, and that much lesser
economic value is created by engaging in wholesale leveraging strategies.
Consolidated stockholders' equity increased from $43.8 million at
December 31, 2000 to $50.2 million at December 31, 2001 due to a combination of:
o net income
o continued amortization of deferred stock compensation
o Directors receiving their fees in Company stock
o appreciation in the portfolio of securities classified as available for
sale, recorded in other comprehensive income
o the exercise of vested stock options
The Company did not declare or pay any cash dividends in 2001. The
Company did not conduct any share repurchases during 2001. The Company's
tangible book value per share increased from $12.54 at December 31, 2000 to
$14.08 at December 31, 2001.
Off-Balance Sheet Transactions, Arrangements, And Obligations
At December 31, 2002, the Company did not have any free-standing
derivatives, loans sold with recourse, retained or contingent interests in
assets transferred to an unconsolidated entity, special purpose entities, or
material variable interests in unconsolidated entities. None of the Company's
leases contain requirements that the Company's payment obligation change based
on a multiplier or similar abstract basis.
At December 31, 2002, the Company maintained various commitments to
fund loans and to make funds available under lines of credit. Please refer to
"Item 1. Business - Loan Commitments" and Note 15 to the Consolidated Financial
Statements for additional information in this regard.
The Company had outstanding commercial letters of credit of $401
thousand at December 31, 2002.
105
Liquidity
Liquidity is actively managed to ensure sufficient funds are available
to meet the ongoing needs of both MBBC and the Bank. Liquidity management
includes projections of future sources and uses of funds to ensure the
availability of sufficient liquid reserves to provide for unanticipated
circumstances. The Bank's primary sources of liquidity are deposits, principal
and interest payments (including prepayments) on its asset portfolios, retained
earnings, FHLB advances, other borrowings, and, to a lesser extent, sales of
loans originated for sale and securities classified as available for sale. The
Bank's primary uses of funds include loan originations, customer drawdowns on
lines of credit and undisbursed construction loan commitments, loan purchases,
customer withdrawals of deposits, interest paid on liabilities, and operating
expenses.
Specific steps the Bank has taken to maintain strong liquidity include:
o arranging five federal funds lines of credit with correspondent banks in an
aggregate amount of $39.5 million (funds under these lines are provided on
an available, as opposed to on a committed, basis)
o completing agreements to be able to issue "DTC" or publicly traded
certificates of deposit through 5 investment banks
o signing PSA agreements with four counterparties to facilitate the sale of
securities under agreements to repurchase
o enrolling in the specific loan pledging program with the FHLB-SF and
pledging multifamily and commercial real estate loans in addition to
residential mortgages to the FHLB-SF to increase the Bank's borrowing
capacity
o participating in the State of California Time Deposit Program
o reducing the duration of its security portfolio during 2002 to provide
greater monthly cash flows
The Bank pledges excess collateral to the FHLB in order to have ready
access to additional liquidity. At December 31, 2002, the Bank maintained
available borrowing capacity in excess of $137 million at the FHLB.
From time to time, depending upon its asset and liability strategy, the
Bank considers converting a portion of its residential whole loans into 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 more effectively be used as collateral for
borrowings. The Bank did not securitize any portion of its residential mortgages
during the years 2000 - 2002.
The Company's ratio of net loans to deposits was 114.21% at December
31, 2002. In addition to the planned deposit related actions described above,
the Company intends to actively manage this ratio by:
o seeking additional branch locations, either de novo or through acquisition
of existing branches from other banks
o directing a higher percentage of the advertising and promotion budget to
deposit generation
o pursuing opportunities to cost effectively issue a limited volume of
brokered certificates of deposit during 2003
o selling a greater percentage of total residential loan production into the
secondary market
106
At December 31, 2002, the Bank maintained $39.4 million in commitments
to originate loans and lines of credit. Management anticipates that the Bank
will have sufficient funds available to meet these commitments, not all of which
will necessarily be drawn upon. For additional information regarding commitments
and contingencies, including available customer balances under committed lines
of credit, please refer to Note 15 to the Consolidated Financial Statements.
MBBC, as a company separate from the Bank, must provide for its own
liquidity. Substantially all of MBBC's cash inflows are obtained from interest
on its security and cash equivalent positions, repayment of the funds advanced
for the ESOP, exercise of vested stock options, sales of treasury shares to the
Bank for subsequent payment as director fees, and dividends declared and paid by
the Bank. There are statutory and regulatory provisions that limit the ability
of the Bank to pay dividends to MBBC. As of December 31, 2002, MBBC did not have
any commitments for capital expenditures or to fund loans.
At December 31, 2002, MBBC maintained a revolving $3.0 million line of
credit from a correspondent bank of the Bank. This line of credit is secured by
800,000 shares of MBBC's treasury stock. There were no outstanding balances on
this line of credit at December 31, 2002. The line of credit agreement contains
various financial performance and reporting covenants. The terms of the line of
credit do not impact or restrict MBBC's ability to pay cash dividends. The line
of credit expires in March 2003. Management obtained this line of credit as a
source of additional liquidity for MBBC, and, through MBBC, for the Bank. The
Company expects to renew this line of credit or establish a similar line of
credit with another bank upon maturity.
At December 31, 2002, MBBC had cash and cash equivalents of $3.3
million. Management knows of no factors that would restrict or eliminate the
normally recurring cash inflows obtained by MBBC.
Capital Resources
The Bank's position as a "well capitalized" financial institution under
the PCA regulatory framework is further enhanced by the financial resources
present at the holding company. At December 31, 2002, the consolidated GAAP
capital position of the Bank was $52.8 million, while the consolidated GAAP
capital position of the Company was $56.1 million. Note 14 to the Consolidated
Financial Statements provides additional information concerning the Bank's
regulatory capital position, including amounts by which the Bank exceeds minimum
and "well capitalized" thresholds for regulatory capital.
Management believes the Bank's regulatory capital position in 2003 will
benefit from the earnings for the year, plus the ongoing amortization of
intangible assets and deferred stock compensation.
The potential continued increase in the size of the loan portfolio,
combined with the ongoing planned shift in mix toward construction, income
property, and business lending, may result in the Bank's having higher levels of
nominal and risk weighted assets during 2003, thereby possibly offsetting the
effect of the above factors upon regulatory capital ratios.
The Company has conducted share repurchases since 1995. Through
December 31, 2002, the Company had repurchased 1,330,600 shares of its common
stock, including 61,000 shares in 2002. At December 31, 2002, there were
3,454,315 shares outstanding. The Company had 53,035 shares remaining for
repurchase at December 31, 2002 under its current repurchase program.
107
Transactions With Related And Certain Other Parties
The Company's conduct of business with directors, officers, significant
stockholders, and other related parties (collectively, "Related Parties") is
restricted and governed by various laws and regulations, including Regulation O
as promulgated and enforced by the Federal Reserve. Furthermore, it is the
Company's policy to conduct business with Related Parties only on an arms-length
basis at current market prices with terms and conditions no more favorable than
the Company provides in its normal course of business.
The Bank extends loans to its directors and their related interests
only after approval of a majority of disinterested Directors and with the
associated director abstaining from voting. The Bank also extends loans,
primarily residential mortgages and home equity lines of credit, to its
employees under its employee loan program. The Bank's officers are eligible to
participate in the employee loan program. Note 5 to the Consolidated Financial
Statements presents the Company's credit commitments to directors and executive
officers.
The Company periodically utilizes the professional services of a
marketing and advertising corporation with which one executive officer is
affiliated. All business orders and all invoices associated with this
corporation are approved by disinterested executive officers. Total payments to
this marketing and advertising corporation in 2002 were $190 thousand, which
included certain pass-through payments for media advertising.
The Company employs various individuals that are related to other
employees, such as spouses, siblings, children, and other relatives. It is
Company policy to disallow related employees to have a direct reporting or
supervisory relationship. At December 31, 2002, the spouses of two senior
officers and the cousin of one senior officer were also employees of the
Company.
The Company believes that the above transactions with related parties
were conducted on an arms-length basis with normal terms and conditions. The
Company also believes that the above transactions with related parties did not
impair stockholder value or present any actual or potential conflicts of
interest that were not appropriately addressed by disinterested parties.
Impact Of Inflation And Changing Prices
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP"), which requires the
measurement of most financial positions 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. Unlike industrial
companies, the Company's assets and liabilities are nearly all monetary in
nature. Consequently, relative and absolute levels of interest rates present a
greater impact on the Company's performance and condition 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 prices of goods and services. The
Company's operating costs, however, are subject to the impact of inflation,
particularly in the case of salaries and benefits costs, which typically
constitute about one-half of the Company's total non-interest expense.
108
Item 7a. 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. Interest rate risk ("IRR") and credit risk typically constitute the
two greatest sources of financial exposure for banks and thrifts. For a
discussion of the Company's credit risk, please see "Item 7. Management's
Discussion And Analysis Of Financial Condition And Results Of Operations -
Provision For Loan Losses". The Company utilizes no derivatives to mitigate
either its credit risk or its IRR, instead relying on loan review and adequate
loan loss reserves in the case of credit risk and portfolio management
techniques in the case of IRR. The Company is not significantly exposed to
foreign currency exchange rate risk, commodity price risk, or other market risks
other than interest rate risk.
IRR represents the impact that changes in absolute and relative levels
of general market interest rates might have upon the Company's net interest
income, results of operations, and theoretical liquidation value, also called
net portfolio value ("NPV"). Interest rate changes impact earnings and NPV in
many ways, including effects upon the yields generated by variable rate assets,
the cost of deposits and other sources of funds, the exercise of options
embedded in various financial instruments (especially residential mortgages),
and customer demand for and market supply of different financial assets,
liabilities, and positions.
In order to manage IRR, the Company has established an Asset /
Liability Management Committee ("ALCO"), which includes representatives from
senior management and the Board of Directors. ALCO is responsible for managing
the Company's financial assets and liabilities in a manner that balances
profitability, IRR, and various other risks (e.g. liquidity). ALCO operates
under policies and within risk limits prescribed by and periodically reviewed
and approved by the Board of Directors.
The primary objective of the Company's IRR management program is to
maximize net interest income while controlling IRR exposure to within prudent
levels. Financial institutions are subject to IRR whenever assets and
liabilities mature or reprice at different times (repricing, or gap, risk),
based upon different capital markets indices (basis risk), for different terms
(yield curve risk), or are subject to various embedded options, such as the
right of mortgage borrowers to refinance their loans when general market
interest rates decline. Companies with high concentrations of real estate
lending, such as the Company, are significantly impacted by prepayment rates on
loans, as such prepayments generally return investable funds to the Company at a
time of relatively lower prevailing general market interest rates.
Decisions to control or accept IRR are analyzed with consideration of
the probable occurrence of future interest rate changes. Stated another way, IRR
management encompasses the evaluation of the likely additional return associated
with an incremental change in the IRR profile of the Company. For example,
having liabilities that mature or reprice faster than assets can be beneficial
when interest rates decline, but may be detrimental when interest rates rise.
Assessment of potential changes in market interest rates and the relative
financial impact to earnings and NPV is used by the Company to help quantify and
manage IRR. As with credit risk, the complete elimination of IRR would curtail
the Company's profitability, as the Company generates a return, in part, through
effective risk management.
The Company monitors its interest rate risk using various analytical
methods that include participation in the OTS net portfolio value interest rate
risk modeling. The Company's exposure to IRR as of December 31, 2002 was within
the limits established by the Board of Directors.
A common, if analytically limited, measure of financial institution IRR
is the institution's "static gap". Static gap is the difference between the
amount of assets and liabilities (adjusted by off balance sheet positions, if
any) that are expected to mature or reprice within a specified period. A static
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities in a given time period
or cumulatively through that time period. The converse is true for a negative
static gap.
109
The following table presents the maturity and rate sensitivity of
interest-earning assets and interest-bearing liabilities as of December 31,
2002. The "repricing gap" figures in the table reflect the estimated difference
between the amount of interest-earning assets and interest-bearing liabilities
that are contractually scheduled to mature or reprice (whichever occurs first)
during future periods.
At December 31, 2002
-------------------------------------------------------------------------------------
More Than More Than More Than Non-
3 Months 3 Months 1 Year 3 Years Over Interest
Or Less To 1 Year To 3 Years To 5 Years 5 Years Bearing Total
------- --------- ---------- ---------- ------- ------- -----
(Dollars In Thousands)
Assets
------
Interest-earning cash equivalents $ 49 $ -- $ -- $ -- $ -- $ -- $ 49
Investment securities 7,030 -- -- -- -- -- 7,030
Mortgage backed securities 3,151 -- -- -- 34,315 -- 37,466
Loans held for sale -- -- -- -- 1,545 -- 1,545
Loans receivable, net of LIP 180,349 96,749 124,856 113,008 15,408 -- 530,370
FHLB stock 4,679 -- -- -- -- -- 4,679
--------- --------- --------- --------- -------- -------- ---------
Gross interest-earning assets 195,258 96,749 124,856 113,008 51,268 -- 581,139
Plus / (Less):
Unamortized yield adjustments -- -- -- -- -- (278) (278)
Allowance for loan losses -- -- -- -- -- (8,162) (8,162)
--------- --------- --------- --------- -------- -------- ---------
Interest-earning assets 195,258 96,749 124,856 113,008 51,268 (8,440) 572,699
Non-interest-earning assets -- -- -- -- -- 36,997 36,997
--------- --------- --------- --------- -------- -------- ---------
Total assets $ 195,258 $ 96,749 $ 124,856 $ 113,008 $ 51,268 $ 28,557 $ 609,696
========= ========= ========= ========= ======== ======== =========
Liabilities and Equity
----------------------
NOW accounts $ 43,629 $ -- $ -- $ -- $ -- $ -- $ 43,629
Savings accounts 18,474 -- -- -- -- -- 18,474
Money market accounts 126,061 -- -- -- -- -- 126,061
Certificates of deposit 73,698 108,626 52,514 11,783 -- -- 246,621
--------- --------- --------- --------- -------- -------- ---------
Total interest-bearing deposits 261,862 108,626 52,514 11,783 -- -- 434,785
Borrowings 34,223 40,000 13,782 4,800 1,000 -- 93,805
--------- --------- --------- --------- -------- -------- ---------
Total interest bearing liabilities 296,085 148,626 66,296 16,583 1,000 -- 528,590
Non-interest bearing liabilities -- -- -- -- -- 25,003 25,003
Stockholders' equity -- -- -- -- -- 56,103 56,103
--------- --------- --------- --------- -------- -------- ---------
Total liabilities and equity $ 296,085 $ 148,626 $ 66,296 $ 16,583 $ 1,000 $ 81,106 $ 609,696
========= ========= ========= ========= ======== ======== =========
Periodic repricing gap (100,827) (51,877) 58,560 96,425 50,268
Cumulative repricing gap (100,827) (152,704) (94,144) 2,281 52,549
Periodic repricing gap as a
% of interest earning assets (17.6%) (9.1%) 10.2% 16.9% 8.8%
Cumulative repricing gap as a
% of interest earning assets (17.6%) (26.7%) (16.5%) 0.4% 9.2%
Cumulative net interest-earning
assets as a % of cumulative
interest-bearing liabilities 65.9% 65.7% 81.6% 100.4% 109.9%
110
As presented in the prior table, at December 31, 2002, the Company's
cumulative one year and three year static gaps, based upon contractual repricing
and maturities (i.e. ignoring prepayments and other non-contractual factors)
were (17.6%) and (16.5%), respectively, of total interest earning assets. These
figures suggest that net interest income would increase if general market
interest rates were to decline (and vice-versa), reflecting a "net liability
sensitive" position.
However, static gap analysis such as that presented above fails to
capture material components of IRR, and therefore provides only a limited, point
in time view of the Company's IRR exposure. The assumptions and factors that are
by definition excluded from static gap analysis prepared on a contractual basis
encompass:
o prepayments on assets
o how rate movements and the shape of the Treasury curve, or the LIBOR swap
curve, affect borrower behavior
o that all loans and deposits repricing at a given time will not adjust to
the same degree or by the same magnitude
o that the nature of rate changes for assets and liabilities in the over
one-year category have a greater long term economic impact than those for
shorter term assets and liabilities
o transaction deposit accounts (significant to the Company) do not have
scheduled repricing dates or contractual maturities, and therefore may
respond to interest rate changes differently than other financial
instruments
o potential Company strategic and operating responses to changes in absolute
and relative interest rate levels
o the financial impact of options embedded in various financial instruments
Another measure of IRR, required to be performed by insured depository
institutions regulated by the OTS, is a procedure specified by Thrift Bulletin
13a, "Interest Rate Risk Management". This test measures the impact upon NPV of
an immediate and sustained change in interest rates in 100 basis point
increments. The following table presents the estimated impacts of such changes
in interest rates upon the Company as of December 31, 2002, calculated in
compliance with Thrift Bulletin 13a. However, the results from any cash flow
simulation model are dependent upon a lengthy series of assumptions about
current and future economic, behavioral, and financial conditions, including
many factors over which the Company has no control. These assumptions include,
but are not limited to, prepayment rates on various asset portfolios and decay
rates on core deposits, including savings, checking, and money market accounts.
Because of the uncertainty regarding the accuracy of assumptions utilized and
because such an analytical technique does not contemplate any actions the
Company might undertake in response to changes in interest rates, no assurance
can be provided that the valuations presented in the following table are
representative of what might actually be obtainable. In addition, the following
figures are by definition not indicative of the Company's economic value as a
going concern or of the Company's market value.
Projected Change From Base Scenario In
----------------------------------------------
(Dollars In Thousands) NPV Dollars Percent
--- ------- -------
Change In Interest Rates (In Basis Points)
+300 $ 72,763 $ (3,051) (4.0%)
+200 $ 74,765 $ (1,049) (1.4%)
+100 $ 75,932 $ 118 0.2%
Base Scenario $ 75,814 $ -- --
-100 $ 75,755 $ (59) (0.1%)
--------------------------------------------------------------------------------
Note:NPV results for downward rate changes of more than 100 basis points were
not calculated at 12/31/02 due to the low level of interest rates.
The level of interest rate risk exposure presented in the above table
is generally considered "low" in the financial services industry.
111
The prior table results show that the Company's theoretical liquidation
value at December 31, 2002 is not significantly impacted by immediate and
sustained parallel interest rate shocks in either direction. This result differs
from that suggested by the static gap analysis presented above, which indicates
that the Company would benefit from a declining interest rate environment, and
vice-versa. This divergence is due to the inherent limitations in the static gap
approach; in particular the omission of asset prepayments and the incomplete
consideration of the financial dynamics of transaction account deposits. As just
one example, the Company's CMO's are presented as having a maturity of greater
than five years in the static gap table, which is correct based upon their legal
maturity dates. However, the actual duration (weighted average life of the
associated discounted cash flows) of the Company's CMO portfolio at December 31,
2002 was estimated to be less than one year based upon current prepayment speeds
and the priority of principal allocation within the tranches of the CMO's.
The reduction in net portfolio value in the plus 200 and plus 300 basis
point rate shock scenarios presented in the prior table in part results from the
embedded options, held by borrowers, within most mortgage related products, as
described in the following paragraph.
Under rising interest rates, many of the Company's mortgage related
assets experience a lengthening of duration and slower repricing, resulting in a
reduction in market value. This occurs due to slower prepayment behavior by
borrowers, and in conjunction with embedded options such as periodic and
lifetime rate adjustment caps on adjustable rate loans. This prepayment behavior
is a result of borrowers behaving in their economic self interests by more
slowly (or not at all) curtailing or prepaying loans with interest rates at or
below current market rates.
On the other hand, under falling interest rates, the increase in the
Company's net portfolio value is constrained by a shortening of asset duration.
This occurs due to the faster prepayment behavior on mortgage related assets, as
borrowers take advantage of a lower interest rate environment to refinance their
loans. This refinancing provides cash flow into the Company at a time when
reinvestment alternatives present lower rates than the assets being paid off.
One technique the Company uses to moderate this impact is to originate certain
types of loans with prepayment penalties.
The Company further moderated its interest rate risk exposure during
2002, shifting from slightly net liability sensitive at December 31, 2001 to
approximately interest rate neutral at December 31, 2002. This moderation
resulted from many factors, including:
o a general decrease in asset duration in conjunction with the historically
low interest rate environment and the mortgage refinance boom, which in
turn led to historically high prepayment speeds
o the shift in loan mix toward relatively more interest rate sensitive
construction, income property, and commercial business loans and away from
residential mortgages
o pricing loan products and introducing new loan products to more strongly
encourage customer selection of more interest rate sensitive loans
o an increase in the Company's transaction account base and the shift in
deposit mix toward transaction accounts
o the restructuring of the Company's security portfolio
o the continued sale of the vast majority of the Company's current production
of long term, fixed rate residential mortgages into the secondary market
o an increase in the weighted average maturity of the Company's certificate
of deposit portfolio, resulting from the Company's actively marketing
intermediate to longer term certificates of deposit and from customer
demand for longer term certificates of deposit in a declining interest rate
environment in order to maintain a given level of monthly interest income
112
The continued implementation of the strategic plan also contributed to
the reduction in net liability sensitivity during 2002 through the expansion of
commercial banking and relationship banking for real estate professionals.
Commercial banking is by nature an asset sensitive business, as loans are
generally variable rate, frequently based upon the Prime Rate, while deposits
often include a significant non-interest bearing demand deposit component. The
Company's construction and income property relationship officers provide custom
designed, but generally interest rate sensitive, loans to real estate
professionals, who are then encouraged to maintain transaction accounts,
including income property operating (checking) accounts, with the Company.
Despite the Company's IRR management program and the initiatives
detailed above, due to the multiple factors which influence the Company's
exposure to IRR, many of which are beyond the control of the Company, there can
be no assurance that the Company's earnings or economic value will be maintained
in future periods, nor that the Company will be successful in continuing to
maintain a relatively low level of IRR exposure. These risks and exposures are
particularly uncertain should the Federal Reserve again decrease its benchmark
interest rates in 2003, with interest rates then possibly falling to record low
levels. Behaviors by borrowers, depositors, and the capital markets in extremely
low interest rate environments have not been tested in a modern economy with
great ease of funds mobility and unparalleled information availability through
the Internet and other technological means.
113
Item 8. Financial Statements And Supplementary Data.
Index To Consolidated Financial Statements
Page(s)
-------
Independent Auditors' Report 115
Consolidated Statements Of Financial Condition As Of December 31, 2002 and 2001 116
Consolidated Statements Of Income For The Years Ended
December 31, 2002, 2001, and 2000 117
Consolidated Statements Of Changes In Stockholders' Equity For The Years Ended
December 31, 2002, 2001, and 2000 118 - 120
Consolidated Statements Of Cash Flows For The Years Ended
December 31, 2002, 2001, and 2000 121 - 122
Notes To Consolidated Financial Statements 123 - 158
114
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Monterey Bay Bancorp, Inc.
Watsonville, California
We have audited the accompanying consolidated statements of financial condition
of Monterey Bay Bancorp, Inc. and subsidiary as of December 31, 2002 and 2001,
and the related consolidated statements of income, changes in stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Monterey Bay Bancorp, Inc. and
subsidiary as of December 31, 2002 and 2001, and the results of their operations
and their cash flows, for each of the three years in the period ended December
31, 2002 in conformity with accounting principles generally accepted in the
United States of America.
/s/ Deloitte & Touche LLP
-------------------------
Deloitte & Touche LLP
San Francisco, California
January 28, 2003
115
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2002 AND 2001
(Dollars In Thousands, Except Per Share Amounts)
--------------------------------------------------------------------------------
December 31,
-------------------------------
2002 2001
---- ----
ASSETS
Cash and cash equivalents $ 11,447 $ 13,079
Securities available for sale, at estimated fair value:
Investment securities 7,030 7,300
Mortgage backed securities 37,466 30,644
Loans held for sale, at lower of cost or market 1,545 713
Loans receivable held for investment (net of allowances for loan losses of
$8,162 at December 31, 2002 and $6,665 at December 31, 2001) 521,929 465,887
Investment in capital stock of the Federal Home Loan Bank, at cost 4,679 2,998
Accrued interest receivable 2,867 2,915
Premises and equipment, net 7,161 7,618
Core deposit intangibles, net 833 1,514
Bank owned life insurance 9,036 --
Real estate acquired via foreclosure, net 846 --
Other assets 4,857 4,723
-------- --------
TOTAL ASSETS $609,696 $537,391
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits $458,334 $432,339
Advances from the Federal Home Loan Bank and other borrowings 93,805 53,800
Accounts payable and other liabilities 1,454 1,090
-------- --------
Total liabilities 553,593 487,229
-------- --------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value, 2,000,000 authorized; none issued Common
stock, $0.01 par value, 9,000,000 shares authorized;
4,492,085 issued at December 31, 2002 and December 31, 2001; 3,454,315
outstanding at December 31, 2002 and
3,456,097 outstanding at December 31, 2001 45 45
Additional paid-in capital 29,281 28,584
Retained earnings, substantially restricted 42,111 36,473
Unallocated ESOP shares (460) (690)
Treasury shares designated for compensation plans, at cost (11,769 shares
at December 31, 2002 and 17,969 shares at December 31, 2001) (113) (173)
Treasury stock, at cost (1,037,770 shares at December 31, 2002 and
1,035,988 shares at December 31, 2001) (14,513) (14,006)
Accumulated other comprehensive loss, net of taxes (248) (71)
-------- --------
Total stockholders' equity 56,103 50,162
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $609,696 $537,391
======== ========
See Notes to Consolidated Financial Statements
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Dollars In Thousands, Except Per Share Amounts)
--------------------------------------------------------------------------------
Year Ended December 31,
-----------------------------------------------
INTEREST AND DIVIDEND INCOME: 2002 2001 2000
---- ---- ----
Loans receivable $ 33,890 $ 35,485 $ 32,556
Mortgage backed securities 1,133 2,360 3,755
Investment securities and cash equivalents 463 886 1,446
-------- -------- --------
Total interest and dividend income 35,486 38,731 37,757
-------- -------- --------
INTEREST EXPENSE:
Deposit accounts 10,453 16,449 17,231
Advances from the Federal Home Loan Bank and other borrowings 2,454 2,541 2,546
-------- -------- --------
Total interest expense 12,907 18,990 19,777
-------- -------- --------
NET INTEREST INCOME BEFORE PROVISION
FOR LOAN LOSSES 22,579 19,741 17,980
PROVISION FOR LOAN LOSSES 1,510 1,400 2,175
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 21,069 18,341 15,805
-------- -------- --------
NON-INTEREST INCOME:
Customer service charges 1,541 1,688 1,306
Gain on sale of loans 170 88 23
Commissions from sales of noninsured products 125 244 676
Income from loan servicing 63 101 118
Gains (losses) on sale of mortgage backed securities
and investment securities, net 35 190 (55)
Other income 193 255 272
-------- -------- --------
Total 2,127 2,566 2,340
-------- -------- --------
NON-INTEREST EXPENSE:
Compensation and employee benefits 7,626 6,857 6,569
Occupancy and equipment 1,705 1,652 1,278
Amortization of intangible assets 681 681 723
Supplies, postage, telephone, and office expenses 675 663 679
Data and item processing 567 876 1,142
Legal and accounting 442 863 661
Advertising and promotion 300 251 361
Deposit insurance premiums 140 198 188
Consulting 97 333 212
Other expenses 1,547 1,995 1,863
-------- -------- --------
Total 13,780 14,369 13,676
-------- -------- --------
INCOME BEFORE PROVISION FOR INCOME TAXES 9,416 6,538 4,469
PROVISION FOR INCOME TAXES 3,778 2,787 1,946
-------- -------- --------
NET INCOME $ 5,638 $ 3,751 $ 2,523
======== ======== ========
EARNINGS PER SHARE:
BASIC EARNINGS PER SHARE $ 1.67 $ 1.15 $ 0.81
======== ======== ========
DILUTED EARNINGS PER SHARE $ 1.61 $ 1.12 $ 0.81
======== ======== ========
See Notes to Consolidated Financial Statements
117
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Dollars And Shares In Thousands)
--------------------------------------------------------------------------------
Treasury
Shares
Desig-
nated Accum-
For ulated
Addi- Unal- Com- Other
Common Stock tional located pen- Compre-
------------ Paid-In Retained ESOP sation Treasury hensive
Shares Amount Capital Earnings Shares Plans Stock Loss Total
------ ------ ------- -------- ------ ----- ----- ---- -----
Balance At January 1, 2000 3,423 $45 $ 28,237 $ 30,473 $(1,150) $(1,376) $(14,257) $(1,169) $ 40,803
Purchase of treasury stock (120) (1,251) (1,251)
Cash dividends paid ($0.08 per
share) (274) (274)
Director fees paid using treasury
stock 18 9 182 191
Amortization of stock compensation 32 230 822 1,084
Sale of stock for stock
compensation plans 216 216
Comprehensive income:
Net income 2,523 2,523
Other comprehensive income:
Change in net
unrealized loss
on securities
available for
sale, net of taxes
of $359 513 513
Reclassification
adjustment for
losses on
securities available
for sale included
in income,
net of taxes of $23 32 32
-----
Other comprehensive income,
net 545
-----
Total comprehensive income 3,068
-----
------ ------ -------- -------- -------- -------- --------- -------- ---------
Balance at December 31, 2000 3,321 $45 $ 28,278 $ 32,722 $ (920) $ (338) $(15,326) $(624) $ 43,837
====== ====== ======== ======== ======== ======== ========= ======== =========
See Notes to Consolidated Financial Statements
118
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Continued)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Dollars And Shares In Thousands)
--------------------------------------------------------------------------------
Treasury
Shares
Desig-
nated Accum-
For ulated
Addi- Unal- Com- Other
Common Stock tional located pen- Compre-
------------ Paid-In Retained ESOP sation Treasury hensive
Shares Amount Capital Earnings Shares Plans Stock Loss Total
------ ------ ------- -------- ------ ----- ----- ---- -----
Balance At December 31, 2000 3,321 $45 $ 28,278 $ 32,722 $ (920) $ (338) $(15,326) $(624) $ 43,837
Options exercised using treasury
stock 116 (5) 1,132 1,127
Director fees paid using treasury
stock 19 47 188 235
Amortization of stock compensation 264 230 165 659
Comprehensive income:
Net income 3,751 3,751
Other comprehensive income:
Change in net
unrealized loss
on securities
available for
sale, net of taxes
of $465 665 665
Reclassification
adjustment for
gains on
securities available
for sale included
in income,
net of taxes of $(78) (112) (112)
-----
Other comprehensive income, net 553
-----
Total comprehensive income 4,304
-----
------ ------ -------- -------- -------- -------- --------- -------- ---------
Balance at December 31, 2001 3,456 $45 $ 28,584 $ 36,473 $ (690) $ (173) $(14,006) $ (71) $ 50,162
====== ====== ======== ======== ======== ======== ========= ======== =========
See Notes to Consolidated Financial Statements
119
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Continued)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Dollars And Shares In Thousands)
--------------------------------------------------------------------------------
Treasury
Shares
Desig-
nated Accum-
For ulated
Addi- Unal- Com- Other
Common Stock tional located pen- Compre-
------------ Paid-In Retained ESOP sation Treasury hensive
Shares Amount Capital Earnings Shares Plans Stock Loss Total
------ ------ ------- -------- ------ ----- ----- ---- -----
Balance At December 31, 2001 3,456 $45 $ 28,584 $ 36,473 $ (690) $ (173) $(14,006) $(71) $ 50,162
Purchase of treasury stock (61) (1,075) (1,075)
Options exercised using treasury
stock 48 159 465 624
Director fees paid using treasury
stock 11 88 103 191
Amortization of stock compensation 450 230 60 740
Comprehensive income:
Net income 5,638 5,638
Other comprehensive income:
Change in net
unrealized loss
on securities
available for
sale, net of taxes
of $(109) (157) (157)
Reclassification
adjustment for
gains on
securities available
for sale included
in income,
net of taxes of $(15) (20) (20)
-----
Other comprehensive income, net (177)
-----
Total comprehensive income 5,461
-----
------ ------ -------- -------- -------- -------- --------- -------- ---------
Balance at December 31, 2002 3,454 $45 $ 29,281 $ 42,111 $ (460) $ (113) $(14,513) $ (248) $ 56,103
====== ====== ======== ======== ======== ======== ========= ======== =========
See Notes to Consolidated Financial Statements
120
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Dollars In Thousands)
--------------------------------------------------------------------------------
Year Ended December 31,
---------------------------------------
2002 2001 2000
---- ---- ----
OPERATING ACTIVITIES:
Net income $ 5,638 $ 3,751 $ 2,523
Adjustments to reconcile net income to net cash provided by
Operating activities:
Depreciation and amortization of premises and equipment 727 663 441
Amortization of intangible assets 681 681 723
Amortization of purchase premiums, net of accretion of discounts 1,217 241 104
Amortization of deferred loans fees and costs, net (353) (223) (250)
Provision for loan losses 1,510 1,400 2,175
Federal Home Loan Bank stock dividends (177) (184) (214)
Gross ESOP expense before dividends received on unallocated shares 638 437 334
Compensation expense related to stock compensation plans 100 200 296
Director retainer fees paid in stock 191 219 112
(Gain) loss on sale of investment and mortgage-backed securities (35) (190) 55
Gain on the sale of loans held for sale (170) (88) (23)
Loss on sale of real estate acquired via foreclosure -- -- 5
Loss (gain) on sale of fixed assets 15 (8) --
Origination of loans held for sale (19,206) (12,112) (2,652)
Proceeds from sales of loans held for sale 18,544 11,487 2,674
Deferred income taxes (613) (521) (595)
Decrease (increase) in accrued interest receivable 48 (14) (213)
Appreciation on bank owned life insurance (36) -- --
(Increase) decrease in other assets (134) (1,177) 566
Increase (decrease) in accounts payable and other liabilities 364 (893) (647)
Other, net (1,414) (830) (1,209)
------- ------- -------
Net cash provided by operating activities 7,535 2,839 4,205
------- ------- -------
INVESTING ACTIVITIES:
Net increase in loans held for investment (56,042) (74,067) (31,134)
Purchases of investment securities available for sale (4,854) -- --
Proceeds from sales of investment securities available for sale -- -- 3,730
Proceeds from maturities of investment securities available for sale 4,850 -- --
Purchases of mortgage backed securities available for sale (66,878) (29,250) (26,818)
Principal repayments on mortgage backed securities available for sale 54,627 30,337 18,422
Proceeds from maturities of mortgage backed securities held to maturity -- -- 60
Proceeds from sales of mortgage backed securities available for sale 4,500 12,287 24,425
(Purchases) redemptions of FHLB stock, net (1,504) 70 543
Purchases of Bank owned life insurance (9,000) -- --
Purchases of premises and equipment (285) (1,129) (774)
Proceeds from the sale of premises and equipment -- 11 --
------- ------- -------
Net cash used in investing activities (74,586) (61,741) (11,546)
------- ------- --------
See Notes to Consolidated Financial Statements
121
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Dollars In Thousands)
--------------------------------------------------------------------------------
Year Ended December 31,
---------------------------------------
2002 2001 2000
---- ---- ----
FINANCING ACTIVITIES:
Net increase in deposits 25,995 24,551 40,386
Proceeds (repayments) of FHLB advances, net 40,000 21,000 (17,000)
Proceeds (repayments) of other borrowings, net 5 218 (2,410)
Cash dividends paid to stockholders -- -- (274)
Purchases of treasury stock (1,075) -- (1,251)
Sales of treasury stock for exercise of stock options 494 1,053 ---
Sales of stock for stock compensation plans -- -- 216
-------- -------- --------
Net cash provided by financing activities 65,419 46,822 19,667
-------- -------- --------
NET (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS (1,632) (12,080) 12,326
CASH & CASH EQUIVALENTS AT BEGINNING OF YEAR 13,079 25,159 12,833
-------- -------- --------
CASH & CASH EQUIVALENTS AT END OF YEAR $ 11,447 $ 13,079 $ 25,159
======== ======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid during the period for:
Interest on deposits and borrowings $ 12,620 $ 19,147 $ 19,655
Income taxes $ 3,600 $ 4,150 $ 3,060
SUPPLEMENTAL DISCLOSURES OF NON CASH
INVESTING AND FINANCING ACTIVITIES:
Loans transferred to held for investment, at market value $ -- $ 85 $ 385
Real estate acquired in settlement of loans $ 846 $ -- $ --
See Notes to Consolidated Financial Statements
122
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
--------------------------------------------------------------------------------
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization And Nature Of Operations
Monterey Bay Bancorp, Inc. ("MBBC") is a unitary savings and loan holding
company incorporated in 1994 under the laws of the state of Delaware. MBBC
operates as the holding company for its wholly owned subsidiary Monterey Bay
Bank (the "Bank"), a federally chartered savings and loan association. The Bank
has one wholly owned subsidiary, Portola Investment Corporation ("Portola"),
which sells various non-FDIC insured investment products and provides trustee
services to the Bank. Portola operates within the Bank's facilities in
segregated areas. MBBC, the Bank, and Portola are hereinafter collectively
referred to as the "Company".
The Company's primary business is attracting checking, money market, savings,
and certificate of deposit accounts through its branch facilities and various
electronic means, and investing such deposits and other available funds in
various types of loans, including real estate mortgages, business loans,
construction loans, and consumer loans. The Company also provides a range of fee
based services. The Bank's deposit gathering 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. The Bank
extends loans throughout a majority of California, with a concentration in the
three counties surrounding its full service branch officers. At December 31,
2002, the Bank maintained eight full service branch offices, two administrative
buildings, one stand-alone loan production office, and eleven ATM's, two of
which were stand-alone.
Summary Of Significant Accounting Policies
Basis Of Consolidation - The consolidated financial statements include the
accounts of Monterey Bay Bancorp, Inc. and its wholly-owned subsidiary, Monterey
Bay Bank, and the Bank's wholly-owned subsidiary, Portola Investment
Corporation. All significant inter-company transactions and balances are
eliminated in consolidation.
Financial Statement Presentation And Use Of Estimates - The financial statements
have been prepared and presented in accordance with accounting principles
generally accepted in the United States of America, or "GAAP" and general
practices within the banking and savings and loan industry. The preparation of
the financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, and contingent assets and liabilities, and disclosure of contingent
assets and liabilities, as of the balance sheet dates and revenues and expenses
for the reporting periods. Actual results could differ from those estimates.
Cash And Cash Equivalents - Cash and cash equivalents include cash on hand,
amounts due from banks, federal funds sold, investments in money market mutual
funds, securities purchased under agreements to resell with original maturities
of three months of less, certificates of deposit with original maturities of
three months or less, and highly liquid debt instruments purchased with
remaining terms to maturity of three months or less from the date of
acquisition.
Securities Available For Sale - Securities to be held for indefinite periods of
time, including securities that management intends to use as part of its asset /
liability management strategy that may be sold in response to changes in
interest rates, loan prepayments, or other factors, are classified as available
for sale. Securities available for sale are carried at estimated fair value.
Gains or losses on the sale of securities are determined using the specific
identification method. Premiums and discounts are recognized in interest income
using the interest method over the period to contractual maturity. Unrealized
holding gains or losses, net of tax, for securities available for sale are
reported within accumulated other comprehensive income, which is a separate
component of stockholders' equity, until realized.
A decline in the fair value of individual securities available for sale below
their cost that is deemed other than temporary would be recognized through a
write down of the investment securities to their fair value by a charge to
earnings as a realized loss.
All of the Company's securities were classified as available for sale at
December 31, 2002 and 2001.
123
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Mortgage Backed Securities - The Company's mortgage backed securities include
collateralized mortgage obligations ("CMO's") issued by both Federal Agencies
and private entities ("private label CMO's"). Private label CMO's expose the
Company to credit and liquidity risks not typically present in Federal Agency
issued securities.
Loans Held For Sale - Loans held for sale are carried at the lower of aggregate
cost, including qualified loan origination costs and related fees, or estimated
market value, grouped by category. Unrealized losses by category are recognized
via a charge against operations. Realized gains and losses on loans held for
sale are accounted for under the specific identification method. Qualified loan
origination fees and costs are retained and not amortized during the period the
loans are held for sale. Transfers of loans held for sale to the held for
investment portfolio are recorded at the lower of cost or estimated market value
on the transfer date.
Loans Receivable Held For Investment - Loans receivable held for investment are
stated at unpaid principal balances less undisbursed loan funds for
constructions loans, unearned discounts, deferred loan origination fees, and
allowances for estimated loan losses, plus unamortized premiums (including
purchase premiums) and qualified deferred loan origination costs. 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.
Interest Income On Loans - Interest income on loans is accrued and credited to
income as it is earned. However, interest is generally not accrued on loans over
90 days contractually delinquent. In addition, interest is not accrued on loans
that are less than 90 days contractually delinquent, but where management has
identified concern over future collection. Accrued interest income is reversed
when a loan is placed on non-accrual status. Discounts, premiums, and net
deferred loan origination fees and costs are amortized into interest income over
the contractual lives of the related loans using a procedure approximating the
interest method, except when a loan is in non-accrual status. When a loan pays
off or is sold, any unamortized balance of any related premiums, discounts, and
qualified net deferred loan origination fees and costs is recognized in income.
Payments received on non-accrual loans are allocated between principal and
interest based upon the terms of the underlying note.
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 (i) the net sales
proceeds plus the estimated fair value of any interests retained in the loans,
such as loan servicing rights, and (ii) the carrying value of the assets sold.
The difference between the adjusted carrying value of the interests retained and
the face amount of the interests retained is amortized to operations over the
estimated remaining life of the associated loans using a method that
approximates the interest method. The fair value of any interests retained is
periodically evaluated, with any shortfall in estimated fair value versus
carrying amount being charged against operations.
Troubled Debt Restructured - A loan is considered "troubled debt restructured"
when the Company provides the borrower certain concessions that it would not
normally consider. The concessions are provided with the objective of maximizing
the recovery of the Company's investment. Troubled debt restructured includes
situations in which the Company accepts a note (secured or unsecured) from a
third party in payment of its receivable from the borrower, other assets in
payment of the loan, an equity interest in the borrower or its assets in lieu of
the Company's receivable, or a modification of the terms of the debt including,
but not limited to, (i) a reduction in the stated interest rate to below market
rates, (ii) an extension of maturity at an interest rate or other terms below
market, (iii) a reduction in the face amount of the debt, and / or (iv) a
reduction in the accrued interest receivable. The Company did not have any loans
considered to be troubled debt restructurings at December 31, 2002 or December
31, 2001.
124
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Impaired Loans - The Company considers a loan to be impaired when it is deemed
probable by management that the Company will be unable to collect all
contractual interest and contractual principal payments in accordance with the
terms of the original loan agreement. However, when determining whether a loan
is impaired, management also considers the current ratio of the loan's balance
to collateral value, other sources of repayment, and the borrower's present
financial position. In evaluating whether a loan is considered impaired,
insignificant delays or shortfalls in payments, in the absence of other facts
and circumstances, would not alone lead to the conclusion that a loan is
impaired. The Company includes among impaired loans all loans that (i) are
contractually delinquent 90 days or more, (ii) meet the definition of a troubled
debt restructuring, (iii) are classified in part or in whole as either doubtful
or loss, (iv) the Company has suspended accrual of interest, and (v) have a
specific loss allowance applied to adjust the loan to fair value. The Company
may also classify other loans as impaired based upon their specific
circumstances.
The Company accounts for impaired loans, except those loans that are accounted
for at market value or at the lower of cost or market value, at the present
value of the expected future cash flows discounted at the loan's effective
interest rate at the date of initial impairment, or, as a practical expedient,
at the loan's observable market price or fair value of the collateral if the
loan is collateral dependent. The Company evaluates the collectibility of both
contractual interest and contractual principal when assessing the need for a
loss accrual for impaired loans. Interest income received on impaired
non-accrual loans is recognized on a cash basis. Interest income on other
impaired loans is recognized on an accrual basis. The Company uses the cash
basis method of accounting for payments received on impaired loans.
Real Estate Acquired Via Foreclosure - Real estate acquired via foreclosure is
initially recorded at the lower of the recorded investment in the property or
fair value less estimated costs to sell. If the fair value less estimated costs
to sell is less than amortized cost, a charge against the allowance for loan
losses is recorded at property acquisition. Following foreclosure, valuations
are periodically performed, with any subsequent write-downs recorded as a
valuation allowance and charged to operations. Operating expenses, net of
related income, incurred in conjunction with the maintenance of real estate
acquired via foreclosure are charged to operations.
Recognition of gains on the sale of real estate is dependent upon the
transaction meeting certain criteria relating to the nature of the property and
the terms of the sale and potential financing. These gains are included in
non-interest income. Losses on disposition of real estate, including expenses
incurred in connection with the disposition, are charged to operations.
Allowances For Loan Losses - The Company maintains an allowance for loan losses
to absorb probable losses inherent in the loan portfolio. The allowance is based
on ongoing assessments of the probable estimated inherent losses. Loans are
charged against the allowance when management believes the principal to not be
recoverable. The allowance is increased by the provision for loan losses. The
provision for loan losses is charged against current period operating results.
The allowance is decreased by the amount of charge-offs, net of recoveries. The
Company's methodology for assessing the appropriateness of the allowance
consists of several key elements, which include the formula allowance, specific
allowances, and the unallocated allowance.
The formula allowance is calculated by applying loss factors to outstanding
loans and certain unused commitments. Loss factors reflect management's estimate
of the inherent loss in various segments of the loan portfolio. Loss factors are
determined based upon various information, including the Company's historical
loss experience. Loss factors may be adjusted for factors that, in management's
judgment, affect the collectibility of the portfolio as of the evaluation date.
Specific allowances are established for loans that are deemed impaired if the
fair value of the loan or the collateral or the present value of expected future
cash flows is estimated to be less than the Company's investment in the loan. In
developing specific valuation allowances, the Company considers (i) the
estimated cash payments expected to be received by the Company, (ii) the
estimated net sales proceeds from the loan or its collateral, (iii) cost of
refurbishment, (iv) certain operating income and expenses, and (v) the costs of
acquiring and holding the collateral. The Company charges off a portion of an
impaired loan against the specific allowance when that portion is deemed
probable to not be recoverable.
125
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
The unallocated allowance is based upon management's evaluation of various
conditions that are not directly measured in the determination of the formula
and specific allowances. The evaluation of the inherent loss with respect to
these conditions is subject to a higher degree of uncertainty because they are
not identified with specific problem credits or portfolio segments. The
conditions evaluated in connection with the unallocated allowance may include
existing general economic and business conditions affecting key lending areas of
the Company, the status of the real estate market in California, credit quality
trends, delinquencies, collateral values, loan volumes, concentrations, and
seasoning, specific industry conditions, recent loss experience, and the
duration of the business cycle.
While management uses currently available information to determine the allowance
for loan losses, additions to or recoveries from the allowance may be necessary
based upon a number of factors including, but not limited to, changes in
economic conditions and credit quality trends, particularly in the real estate
market, borrower financial status, the regulatory environment, real estate
values, and loan portfolio size and composition. Many of these factors are
beyond the Company's control and, accordingly, periodic provisions for loan
losses may vary from time to time. In addition, various regulatory agencies, as
an integral part of the examination process, periodically review the Bank's
allowance for loan losses. Such regulatory agencies may develop judgements
different from those of management and may require the Bank to recognize
additional provisions against operations.
Premises And Equipment - Land is carried at cost. Other premises and equipment
are stated at cost, less accumulated depreciation and amortization. The Company
depreciates or amortizes premises and equipment on a straight-line basis over
the estimated useful lives of the various assets, and amortizes leasehold
improvements over the shorter of the asset's useful life or the remaining term
of the lease. The useful lives for the principal classes of assets are:
Asset Useful Life
Buildings 30 to 40 years
Leasehold improvements Shorter of remaining 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.
Impairment Of Long-Lived Assets Other Than Core Deposit Intangibles - Effective
January 1, 2002, the Company adopted SFAS No. 144, "Accounting For The
Impairment Or Disposal Of Long-Lived Assets". SFAS No. 144 supersedes SFAS No.
121, "Accounting For The Impairment Of Long-Lived Assets And For Long-Lived
Assets To Be Disposed Of" and the accounting and reporting provisions of
Accounting Principles Board ("APB") No 30, "Reporting The Results Of Operations
- Reporting The Effects Of Disposal Of A Segment Of A Business, And
Extraordinary, Unusual, And Infrequently Occurring Events And Transactions".
SFAS No. 144 unified the accounting treatment for various types of long-lived
assets to be disposed of, and resolves implementation issues related to SFAS No.
121. The adoption of SFAS No. 144 did not have a material effect on the
Company's financial position, results of operations, or cash flows.
The Company's primary long-lived assets other than core deposit intangibles are
its branches and administrative buildings. The Company periodically evaluates
the recoverability of these long-lived assets. Long-lived assets 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 that management expects
to hold and use are based on the fair value of the asset. Long-lived assets to
be disposed of are reported at the lower of carrying amount or fair value less
estimated cost to sell.
126
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Goodwill And Other Intangible Assets - Effective January 1, 2002, the Company
adopted SFAS No. 142, "Goodwill And Other Intangible Assets" which addresses
financial accounting and reporting for acquired goodwill and other intangible
assets at acquisition in transactions other than business combinations covered
by SFAS No.141, and the accounting treatment of goodwill and other intangible
assets after acquisition and initial recognition in the financial statements.
The adoption of this statement did not have a material effect on the Company's
consolidated financial position, results of operations, or cash flows.
The Company's core deposit intangibles represent assets 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 periodically
evaluates the periods of amortization to determine whether later events and
circumstances warrant revised estimates.
Stock Based Compensation - The Company accounts for its stock option and stock
award plans under Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting For Stock-Based Compensation". This Statement establishes financial
accounting and reporting standards for stock-based compensation plans. These
standards include the recognition of compensation expense over the vesting
period of the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No 123 also permits entities to continue to apply the
provisions of APB No. 25, Accounting For Stock Issued To Employees, and provide
pro forma net earnings (loss) and pro forma net earnings (loss) per share
disclosures as if the fair value based method defined in SFAS No. 123 had been
applied.
The Company has elected to continue to apply the provisions of APB No. 25 and
related interpretations in accounting for stock options and to continue to
provide the pro forma disclosure requirements of SFAS No. 123, as amended by
SFAS No. 148, in the table below. Under APB No. 25, compensation cost for stock
options is measured as the excess, if any, of the fair market value of the
Company's common stock at the date of grant over the amount the employee or
director must pay to acquire the stock. Because the Company's stock option Plans
provide for the issuance of stock options at a price of no less than the fair
market value at the date of grant, no compensation cost is required to be
recognized for the Company's stock option Plans.
Had compensation costs for the stock options Plans been determined based upon
the fair value at the date of grant consistent with SFAS No. 123, net income and
earnings per share would have been reduced to the pro forma amounts indicated
below. The pro forma amounts presented below were calculated utilizing the
Black-Scholes option pricing model, with forfeitures recognized as they occur,
incorporating the assumptions detailed on the following page.
(Dollars In Thousands, Except Share Data) Year Ended December 31,
-----------------------------------------
2002 2001 2000
---- ---- ----
Net income:
Before recognized stock compensation expense, net of taxes $ 5,698 $ 3,866 $ 2,690
Deduct recognized stock compensation expense, net of taxes ($60) ($115) ($167)
------- ------- -------
As reported $ 5,638 $ 3,751 $ 2,523
Deduct compensation expense from amortization of fair value of
all stock options, net of taxes of $87, $160, and $210,
in 2002, 2001, and 2000 ($124) ($229) ($300)
------- ------- -------
Pro forma $ 5,514 $ 3,522 $ 2,223
======= ======= =======
Basic earnings per share:
As reported $ 1.67 $ 1.15 $ 0.81
====== ====== ======
Pro forma $ 1.64 $ 1.08 $ 0.71
====== ====== ======
Diluted earnings per share:
As reported $ 1.61 $ 1.12 $ 0.81
====== ====== ======
Pro forma $ 1.58 $ 1.05 $ 0.71
====== ====== ======
Shares utilized in Basic EPS calculations 3,369,600 3,275,303 3,110,910
Shares utilized in Diluted EPS calculations 3,497,150 3,343,233 3,123,552
127
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Weighted average assumptions utilized in the Black-Scholes option pricing model
for all options granted each year:
2002 2001 2000
---- ---- ----
Dividend Yield 0.00% 0.00% 0.00%
Expected stock price volatility 25.00% 35.00% 35.00%
Average risk-free interest rate 3.94% 4.44% 6.11%
Expected option lives 8 years 6 years 8 years
Employee Stock Ownership Plan ("ESOP") - To account for the shares acquired by
the Bank's ESOP, 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
committed to be released 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. The Company's ESOP
is a tax-qualified plan. Non-vested shares owned by the ESOP are accounted for
via a contra-equity account based upon historic cost. ESOP shares that have not
been committed to be released (uncommitted shares) are excluded from outstanding
shares on a weighted average basis for earnings per share calculations.
Income Taxes - The Company accounts for income taxes under the liability method.
Under this method, deferred tax assets and deferred tax liabilities are
recognized for future tax consequences attributable to temporary differences
between the financial statement carrying amounts of certain existing assets and
liabilities, and their respective bases for Federal income and California
franchise taxes. Deferred tax assets and liabilities are calculated by applying
current effective tax rates against future deductible or taxable amounts. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in operations 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 Sales Of Non-FDIC Insured Products - The Company realizes
commissions from the sales of various non-FDIC insured products, including
mutual funds, annuities, and specific securities, as a result of business
conducted through Portola. Commission income is typically based upon a
percentage of sales. Periodic commission income varies based on the volume and
mix of investment products sold, and is recognized on a cash basis.
Earnings Per Share - Basic earnings per share excludes dilution and is computed
by dividing net income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted earnings per
share reflects the potential dilution that could occur if contracts to issue
common stock or securities convertible into common stock were exercised or
converted. Dilution resulting from the Company's stock option and stock award
plans is calculated using the treasury stock method.
Comprehensive Income - Comprehensive income includes (i) net income and (ii)
other comprehensive income. The Company's only source of other comprehensive
income is derived from unrealized gains and losses on securities available for
sale. The Company displays comprehensive income within the Consolidated
Statements of Changes in Stockholders' Equity. Reclassification adjustments
result from gains or losses on 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.
Such adjustments are excluded from current period comprehensive income in order
to avoid double counting.
Derivative Instruments And Hedging Activities - The Company did not enter into
any freestanding derivative contracts, did not conduct any hedging activities,
and did not identify any embedded derivatives requiring bifurcation and separate
valuation during 2002 or 2001.
128
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Segment Disclosure - The Company operates a single line of business (financial
services) with no customer accounting for more than 10% of its revenue and
manages its operation under a unified management and reporting structure.
Therefore, no additional segment disclosures are provided.
Reclassifications - Certain reclassifications have been made to prior period
financial statements to conform them to the current year presentation.
Recent Accounting Developments
Effective April 1, 2002, the Company adopted SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". SFAS No. 145 rescinds and amends these statements to eliminate any
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. SFAS No. 145 also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions including clarification that gains or losses from normal
extinguishments of debt need not be classified as extraordinary items. The
adoption of SFAS No. 145 did not have a material effect on the Company's
financial position, results of operations, or cash flows.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which addresses accounting for restructuring
and similar costs. SFAS No. 146 supersedes previous accounting guidance,
principally Emerging Issues Task Force Issue No. 94-3. The Company will adopt
the provisions of SFAS No. 146 for restructuring activities initiated after
December 31, 2002. SFAS No. 146 requires that the liability for costs associated
with an exit or disposal activity be recognized when the liability is incurred.
Under Issue No. 94-3, a liability for an exit cost was recognized at the date of
the Company's commitment to an exit plan. SFAS No. 146 also establishes that the
liability should initially be measured and recorded at fair value. Accordingly,
SFAS No. 146 may affect the timing of recognizing future restructuring costs as
well as the amounts recognized.
Effective October 1, 2002, the Company adopted SFAS No. 147, "Acquisitions of
Certain Financial Institutions - an Amendment of FASB Statements No. 72 and 144
and FASB Interpretation No.9", which removes acquisitions of financial
institutions from the scope of both Statement 72 and Interpretation 9 and
requires those transactions be accounted for in accordance with FASB Statements
No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets". This Statement is effective for acquisitions on or after
October 1, 2002 with earlier application permitted for the transition provisions
for previously recorded unidentifiable intangible assets. The adoption of SFAS
No. 147 did not have a material effect on the Company's financial position,
results of operations, or cash flows.
Effective December 31, 2002 the Company adopted SFAS No. 148, "Accounting for
Stock Based Compensation - Transition and Disclosure - an Amendment of FASB
Statement No, 123", which provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation and amends the disclosure requirements of No. 123 to
require prominent disclosures in both annual and interim financial statements
within the Significant Accounting Policies footnote about the method of
accounting for stock-based employee compensation and the effect of the method
used (intrinsic value or fair value) on reported results. The Company continues
to account for stock-based compensation using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", and presents the required disclosures in accordance
with SFAS No. 123 as amended by SFAS No. 148. The adoption of SFAS No. 148 did
not have a material effect on the Company's financial position, results of
operations, or cash flows.
129
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
2. CASH AND CASH EQUIVALENTS
Cash and cash equivalents are summarized as follows:
December 31,
----------------------------------------
2002 2001
---- ----
(Dollars In Thousands)
Cash on hand $ 1,436 $ 1,444
Due from banks 10,011 10,891
Certificates of deposit -- 194
Federal funds sold -- 550
-------- --------
$ 11,447 $ 13,079
======== ========
3. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are
presented below. All securities held are publicly traded.
December 31, 2002
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars In Thousands)
Available for sale
------------------
Variable rate corporate trust
preferred securities $ 7,719 $ -- $ (689) $ 7,030
======= ==== ======= =======
December 31, 2001
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars In Thousands)
Available for sale
------------------
Variable rate corporate trust
preferred securities $ 7,707 $ -- $ (407) $ 7,300
======= ==== ======= =======
The following table shows the amortized cost, estimated fair value, and weighted
average yield of the Company's investment securities by year of contractual
maturity. Actual maturities may differ from contractual maturities due to rights
of issuers to call obligations.
December 31, 2002
-----------------------------------------------------------------
Estimated Weighted
Amortized Fair Average
Cost Value Yield
---- ----- -----
Available for sale (Dollars In Thousands)
------------------
Variable rate corporate trust
preferred securities
Due in 2013 and thereafter $ 7,719 $ 7,030 2.31%
======= ======= =====
130
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Proceeds from and realized gains and losses on sales of investment securities
available for sale are summarized as follows:
Year Ended December 31,
------------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Proceeds from sales $ -- $ -- $ 3,730
Gross realized gains on sales -- -- --
Gross realized losses on sales -- -- 44
4. MORTGAGE BACKED SECURITIES
The amortized cost and estimated fair value of mortgage backed securities
("MBS") are presented below. Types of mortgage backed securities include pass
through certificates ("PT's"), balloon MBS ("Balloon's"), and collateralized
mortgage obligations ("CMO's"). All securities held are publicly traded.
December 31, 2002
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars In Thousands)
Available for sale
Fixed rate FHLMC PT's $ 957 $ 49 $ -- $ 1,006
Fixed rate FNMA PT's 452 35 -- 487
Fixed rate GNMA PT's 497 34 -- 531
Variable rate FNMA PT's 3,101 50 -- 3,151
Fixed rate FHLMC balloons 8,679 48 -- 8,727
Fixed rate CMO's:
Agency issuance 23,512 74 (22) 23,564
------- ------ ------- -------
$37,198 $ 290 $ (22) $37,466
------- ------ ------- -------
December 31, 2001
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars In Thousands)
Available for sale
Fixed rate FHLMC PT's $ 1,551 $ 34 $ -- $ 1,585
Fixed rate FNMA PT's 585 38 -- 623
Fixed rate GNMA PT's 744 31 -- 775
Variable rate FNMA PT's 4,629 62 -- 4,691
Fixed rate FHLMC balloons 1,956 -- -- 1,956
Fixed rate CMO's:
Agency issuance 17,062 86 -- 17,148
Non Agency issuance 3,831 35 -- 3,866
------- ----- ------ -------
$30,358 $ 286 $ -- $30,644
------- ----- ------ -------
131
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
The following table shows the amortized cost, estimated fair value, and weighted
average yield of the Company's mortgage backed securities by year of contractual
maturity. Actual maturities may differ from contractual maturities due to
principal prepayments, priority of principal allocation within collateralized
mortgage obligations, or rights of issuers to call obligations prior to
maturity.
December 31, 2002
-----------------------------------------------------------------
Estimated Weighted
Amortized Fair Average
Cost Value Yield
---- ----- -----
(Dollars In Thousands)
Available for sale
------------------
Due in 2008 through 2012 $ 9,088 $ 9,164 3.28%
Due in 2013 and thereafter 28,110 28,302 1.50%
------- ------- -----
$37,198 $37,466 1.94%
======= ======= =====
Proceeds from and realized gains and losses on sales of mortgage backed
securities available for sale are summarized as follows:
Year Ended December 31,
-----------------------------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Proceeds from sales $ 4,500 $ 12,287 $ 24,425
Gross realized gains on sales $ 43 $ 190 $ 72
Gross realized losses on sales $ 8 $ -- $ 83
The Company from time to time pledges mortgage backed securities to the Federal
Home Loan Bank as collateral for advances, to the State of California as
collateral for certain deposits, to public entities as collateral for certain
deposits, and to the Federal Reserve as collateral for certain customer
payments. The following table details the amortized cost of mortgage backed
securities pledged for various purposes:
December 31,
----------------------------------
2002 2001
---- ----
(Dollars In Thousands)
Pledged to the Federal Home Loan Bank $ -- $ 3,831
Pledged to the State of California 36,119 24,962
Pledged to public funds 376 470
Pledged to the Federal Reserve 703 1,095
-------- --------
$ 37,198 $ 30,358
======== ========
132
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
5. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans receivable held for investment, net are summarized as follows:
December 31,
----------------------------------
2002 2001
---- ----
(Dollars In Thousands)
Loans held for investment:
Real estate loans:
Residential one to four unit $187,471 $204,829
Multifamily five or more units 118,004 103,854
Commercial and industrial 140,027 109,988
Construction 69,526 38,522
Land 24,801 11,924
-------- --------
Sub-total real estate loans 539,829 469,117
Other loans:
Home equity lines of credit 8,779 6,608
Loans secured by deposits 265 202
Consumer lines of credit, unsecured 172 170
Commercial term loans 5,231 3,163
Commercial lines of credit 12,777 5,680
-------- --------
Sub-total other loans 27,224 15,823
Sub-total gross loans held for investment 567,053 484,940
(Less) / Plus:
Undisbursed construction loan funds (36,683) (12,621)
Unamortized purchase premiums, net of purchase discounts 848 435
Deferred loan fees and costs, net (1,127) (202)
Allowance for loan losses (8,162) (6,665)
-------- --------
Loans receivable held for investment, net $521,929 $465,887
======== ========
The Company serviced various types of loans for others, with the principal
balance amounts summarized below:
December 31,
------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Loans serviced for others $ 35,328 $ 42,637 $ 62,031
133
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Activity in the allowance for loan losses is summarized as follows:
Year Ended December 31,
------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Balance, beginning of year $ 6,665 $ 5,364 $ 3,502
Provision for loan losses 1,510 1,400 2,175
Charge-offs:
Residential one to four unit real estate loans -- -- (371)
Consumer lines of credit, unsecured (11) (4) --
Commercial term loans (11) -- --
Commercial lines of credit (19) (95) --
------- ------- -------
Total charge-offs (41) (99) (371)
Recoveries:
Residential one to four unit real estate loans -- -- 58
Consumer lines of credit, unsecured 5 -- --
Commercial lines of credit 23 -- --
------- ------- -------
Total recoveries 28 -- 58
Balance, end of year $ 8,162 $ 6,665 $ 5,364
======= ======= =======
The following tables summarizes the Company's recorded investment in impaired
loans by type:
Accrual Status Non-Accrual Status Total Impaired Loans
----------------------- ----------------------- -----------------------
Specific Specific Specific
Principal Allowances Principal Allowances Principal Allowances
--------- ---------- --------- ---------- --------- ----------
(Dollars In Thousands)
December 31, 2002
Residential one to four unit $ -- $ -- $ 201 $ -- $ 201 $ --
Commercial real estate -- -- 2,264 462 2,264 462
Land loans -- -- 129 -- 129 --
Home equity lines of credit -- -- 49 -- 49 --
------ ------ ------- ------ ------- ------
Total $ -- $ -- $ 2,643 $ 462 $ 2,643 $ 462
====== ====== ======= ===== ======= ======
December 31, 2001
Residential one to four unit $ -- $ -- $ 1,372 $ -- $ 1,372 $ --
Commercial real estate -- -- 851 -- 851 --
Consumer lines of credit -- -- 1 -- 1 --
Business term loans -- -- 28 -- 28 --
------ ------ ------- ------ ------- ------
Total $ -- $ -- $ 2,252 $ -- $ 2,252 $ --
====== ====== ======= ====== ======= ======
134
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Additional information concerning impaired loans is as follows:
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Average investment in impaired loans for the year $ 3,860 $ 2,304 $ 7,790
======= ======= =======
Interest recognized on impaired loans at December 31 $ 159 $ 146 $ 461
======= ======= =======
Interest not recognized on impaired loans at December 31 $ 18 $ 46 $ 110
======= ======= =======
Additional information concerning non-accrual loans is as follows:
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Interest recognized on non-accrual loans at December 31 $ 159 $ 146 $ 400
===== ===== =====
Interest not recognized on non-accrual loans at December 31 $ 18 $ 46 $ 110
===== ===== =====
The Company extends loans to executive officers and directors in the ordinary
course of business. These transactions were on substantially the same terms as
those prevailing at the time for comparable transactions with unrelated parties
and do not involve more than normal risk or unfavorable terms for the Company.
An analysis of the activity of these loans is as follows:
Year Ended December 31,
------------------------------
2002 2001
---- ----
(Dollars In Thousands)
Credit commitments, beginning of year $1,960 $1,724
New term loans and lines of credit 2,498 1,781
Repayments (400) (1,195)
Other (450) (350)
------ ------
Credit commitments, end of year $3,608 $1,960
====== ======
Under OTS regulations, the Bank may not extend loans to one borrower ("LTOB
Limit") 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, 2002 and 2001, the Bank's LTOB Limit was approximately $8,991,000
and $7,623,000, respectively.
The vast majority of the Company's loans are secured by real estate located in
California. The Company's credit risk is therefore primarily related to the
economic conditions and real estate valuations of this state. 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. Under the Company's policy, private mortgage insurance
is required for all residential real estate loans with an initial loan to value
ratio greater than 80%.
135
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
6. INVESTMENT IN CAPITAL STOCK OF THE FEDERAL HOME LOAN BANK
As a member of the Federal Home Loan Bank of San Francisco, the Bank is required
to own capital stock in an amount specified by regulation. As of December 31,
2002 and 2001, the Bank owned 46,792 and 29,977 shares, respectively, of $100
par value FHLB stock. The amount of stock owned at December 31, 2002 meets the
most recent regulatory determination.
7. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows:
December 31,
----------------------------------
2002 2001
---- ----
(Dollars In Thousands)
Interest receivable on investment securities $ 31 $ 39
Interest receivable on mortgage backed securities 168 161
Interest receivable on capital stock of the Federal Home Loan Bank 47 29
Interest receivable on loans 2,621 2,686
------- -------
$ 2,867 $ 2,915
======= =======
8. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
December 31,
-------------------------------
2002 2001
---- ----
(Dollars In Thousands)
Land $ 3,213 $ 3,213
Buildings and improvements 4,278 4,257
Equipment 2,993 3,733
------- -------
Total, at cost 10,484 11,203
Less accumulated depreciation (3,323) (3,585)
------- -------
Premises and equipment, net $ 7,161 $ 7,618
======= =======
Depreciation expense was $727 thousand, $663 thousand, and $441 thousand for the
years ended December 31, 2002, 2001, and 2000, respectively.
136
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
9. CORE DEPOSIT INTANGIBLES
Core deposit intangibles, net, totaled approximately $0.8 million at December
31, 2002. This balance was comprised of two assets that were generated as a
result of the purchase of deposit accounts by the Bank from other financial
institutions in December 1996 and April 1998. Each of these assets is being
amortized on a straight-line basis over seven years. At December 31, 2002, the
Company had no other intangible assets or goodwill.
Additional information regarding the Company's core deposit intangibles is as
follows:
Original Current
Carrying Accumulated Carrying
Amount Amortization Amount
------ ------------ ------
(Dollars In Thousands)
1996 Core Deposit Intangible
-------------------------------------
Balance at December 31, 2001 $ 3,670 $ 2,665 $ 1,005
2002 amortization expense 524
-------
Balance at December 31, 2002 $ 3,670 $ 3,189 $ 481
1998 Core Deposit Intangible
-------------------------------------
Balance at December 31, 2001 $ 1,096 $ 587 $ 509
2002 amortization expense 157
-------
Balance at December 31, 2002 $ 1,096 $ 744 $ 352
Total Core Deposit Intangibles
-------------------------------------
Balance at December 31, 2001 $ 4,766 $ 3,252 $ 1,514
2002 amortization expense 681
-------
Balance at December 31, 2002 $ 4,766 $ 3,933 $ 833
Estimated future amortization expense for the Company's core deposit intangibles
as of December 31, 2002 is as follows:
1996 1998
Deposit Deposit
Acquisition Acquisition Total
----------- ----------- -----
(Dollars In Thousands)
2003 $ 481 $ 157 $ 638
2004 -- 157 157
2005 -- 38 38
Thereafter -- -- --
----- ----- -----
Total $ 481 $ 352 $ 833
===== ===== =====
137
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
10. DEPOSITS
Deposits are summarized as follows:
December 31,
----------------------------------
(Dollars In Thousands) 2002 2001
---- ----
Demand deposit accounts $ 23,549 $ 21,062
NOW accounts 43,629 42,557
Savings accounts 18,474 19,127
Money market accounts 126,061 105,828
Certificates of deposit < $100,000 133,795 156,351
Certificates of deposit $100,000 or more 112,826 87,414
-------- --------
$458,334 $432,339
======== ========
The following table sets forth the maturity distribution of certificates of
deposit:
December 31, 2002
-----------------------------------------------------------------
Balance Balance
Less Than $100,000
$100,000 And Over Total
-------- -------- -----
(Dollars In Thousands)
Three months or less $ 32,421 $ 41,277 $ 73,698
Over three through six months 28,370 33,834 62,204
Over six through twelve months 30,790 15,632 46,422
Over twelve months through two years 27,761 13,831 41,592
Over two years through three years 7,533 3,389 10,922
Over three years 6,920 4,863 11,783
--------- --------- ---------
$ 133,795 $ 112,826 $ 246,621
========= ========= =========
At December 31, 2002 and 2001, respectively, total accounts with balances of
$100,000 or greater in deposit products other than certificates of deposit
amounted to $84,261,000 and $72,814,000.
Interest expense on deposits is summarized as follows:
Year Ended December 31,
----------------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
NOW accounts $ 149 $ 366 $ 550
Savings accounts 98 216 281
Money market accounts 2,419 3,452 4,040
Certificates of deposit 7,787 12,415 12,360
------- ------- -------
$10,453 $16,449 $17,231
======= ======= =======
138
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
11. ADVANCES FROM THE FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
The Bank is a member of the Federal Home Loan Bank ("FHLB") of San Francisco and
borrows from the FHLB through various types of collateralized advances. Assets
pledged to the FHLB to collateralize advances include the Bank's ownership
interest in the capital stock of the FHLB, mortgage backed securities, and
various types of qualifying whole loans.
A summary of advances from the FHLB and related maturities follows. All FHLB
advances outstanding at December 31, 2002 and December 31, 2001 were overnight
or term, bullet maturity, and non-structured advances.
December 31,
----------------------------------
Year Of Maturity 2002 2001
---------------- ---- ----
(Dollars In Thousands)
2002 $ -- $13,000
2003 74,000 33,000
2004 12,282 282
2005 1,500 1,500
2006 4,800 4,800
2010 1,000 1,000
------- -------
$93,582 $53,582
======= =======
Weighted average nominal rate 3.02% 4.46%
Additional information concerning advances from the FHLB includes:
2002 2001
---- ----
(Dollars In Thousands)
Average amount outstanding during the year $ 57,355 $ 47,526
Maximum amount outstanding at any month-end during the year $ 93,582 $ 65,582
Weighted average interest rate during the year 4.25% 5.30%
Collateral pledged to secured advances from the FHLB is comprised of the
following (amortized cost):
December 31,
------------------------------
2002 2001
---- ----
(Dollars In Thousands)
Mortgage backed securities $ -- $ 3,831
Capital stock in the Federal Home Loan Bank 4,679 2,998
Mortgage loans 346,150 279,539
Other borrowings at December 31, 2002 and 2001 included certain impound accounts
totaling $225 thousand and $218 thousand that bear interest at a rate of 2.00%.
These accounts are used to pay various costs associated with real property,
including property taxes and insurance.
139
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
12. LINES OF CREDIT
At December 31, 2002, Monterey Bay Bancorp, Inc. had a revolving line of credit
from a correspondent bank of Monterey Bay Bank. The line of credit is for $3.0
million and expires on March 31, 2003. There was no balance outstanding on the
line of credit at December 31, 2002. The line of credit is collateralized by
eight hundred thousand shares of Monterey Bay Bancorp, Inc.'s treasury stock,
which is in the custody of the correspondent bank. The line of credit contains
various covenants regarding the maintenance of certain financial conditions and
the provision of financial and operating information. This line of credit
provides an additional source of liquidity to the Monterey Bay Bancorp, Inc.
holding company.
13. INCOME TAXES
The components of the provision for income taxes are summarized as follows:
Year Ended December 31,
----------------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Current:
Federal $ 3,447 $ 2,544 $ 1,889
State 944 764 652
------- ------- -------
Total current 4,391 3,308 2,541
------- ------- -------
Deferred:
Federal (392) (495) (457)
State (221) (26) (138)
------- ------- -------
Total deferred (613) (521) (595)
------- ------- -------
Provision for income taxes $ 3,778 $ 2,787 $ 1,946
======= ======= =======
A reconciliation from the statutory federal income and state franchise tax rates
to the consolidated effective tax rates, expressed as a percentage of income
before income taxes, follows:
Year Ended December 31,
----------------------------------------------------
2002 2001 2000
---- ---- ----
Statutory federal income tax rate 35.0% 35.0% 35.0%
California franchise tax, net of federal income tax benefit 5.0% 7.4% 7.6%
Other 0.1% 0.2% 0.9%
----- ----- -----
Effective income tax rate 40.1% 42.6% 43.5%
===== ===== =====
140
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Deferred income taxes reflect the net tax effects of temporary differences,
between the carrying amount of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. Net deferred tax assets
are included within other assets on the Consolidated Statements of Financial
Condition. The tax effects of temporary differences that gave rise to
significant portions of the deferred tax assets and liabilities are as follows:
December 31,
----------------------------------
2002 2001
---- ----
(Dollars In Thousands)
Deferred tax assets:
Allowance for loan losses $ 3,266 $ 2,706
Intangible assets 1,174 1,057
Unrealized loss on securities available for sale 173 50
Depreciation 113 93
Deferred compensation 40 46
Other 46 48
------- -------
Total gross deferred tax assets 4,812 4,000
------- -------
Deferred tax liabilities:
FHLB stock dividends (529) (441)
Deferred loan fees and costs (220) (217)
Other (14) (28)
------- -------
Total gross deferred tax liabilities (763) (686)
------- -------
Net deferred tax asset $ 4,049 $ 3,314
======= =======
The Company believes that it is more likely than not that it will realize the
above deferred tax assets in future periods; therefore, no valuation allowance
has been provided against its deferred tax assets.
Legislation regarding bad debt recapture became law in 1996. The 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
Company completed this recapture in 2001.
The Bank maintains a tax bad debt reserve of approximately $5.0 million that
arose in tax years that began prior to December 31, 1987. This tax bad debt
reserve will, in future years, be subject to recapture in whole or in part upon
the occurrence of certain events, including, but not limited to:
o a distribution to stockholders in excess of the Bank's current and
accumulated post-1951 earnings and profits
o distributions to shareholders in a partial or complete redemption or
liquidation of the Bank
o the Bank ceases to be a "bank" or "thrift" as defined under the Internal
Revenue Code
The Bank does not intend to make distributions to stockholders that would result
in recapture of any portion of its tax bad debt reserve if such recapture would
create an additional tax liability. As a result, an associated deferred tax
liability has not been recorded for the $5.0 million pre-1988 tax bad debt
reserve.
141
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
14. REGULATORY CAPITAL REQUIREMENTS AND OTHER REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
result in certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could present a direct material effect upon the
Bank's and the Company's financial statements.
The OTS maintains regulations that require the Bank to maintain a minimum
regulatory tangible capital ratio (as defined) of 1.50%, a minimum regulatory
core capital ratio (as defined) of 4.00% (unless the Bank has been assigned the
highest composite rating under the Uniform Financial Institutions Rating System,
in which case 3.00%), and a regulatory risk based capital ratio (as defined) of
8.00%. The following table presents a reconciliation as of December 31, 2002 and
2001, between the Bank's capital under accounting principles generally accepted
in the United States of America ("GAAP") and regulatory capital as presently
defined under OTS regulations, in addition to a review of the Bank's compliance
with OTS capital requirements:
(Dollars In Thousands)
Tangible Capital Core (Tier One) Capital Risk Based Capital
------------------------ ------------------------ ------------------------
As Of December 31, 2002 Amount Percent Amount Percent Amount Percent
----------------------- ------ ------- ------ ------- ------ -------
Capital of the Bank presented on a
GAAP basis $ 52,825 $ 52,825 $ 52,825
Adjustments to GAAP capital to derive
regulatory capital:
Net unrealized loss on debt
securities classified as
available for sale 248 248 248
Non-qualifying intangible assets (833) (833) (833)
Qualifying general allowance for
loan Losses -- -- 5,640
-------- -------- --------
Bank regulatory capital 52,240 8.57% 52,240 8.57% 57,880 12.88%
Less minimum capital requirement 9,139 1.50% 24,371 4.00% 35,940 8.00%
-------- ----- -------- ----- -------- -----
Regulatory capital in excess of minimums $ 43,101 7.07% $ 27,869 4.57% $ 21,940 4.88%
======== ===== ======== ===== ======== =====
Additional information:
Bank regulatory total assets $ 609,279
Bank regulatory risk based assets $ 449,248
(Dollars In Thousands)
Tangible Capital Core (Tier One) Capital Risk Based Capital
------------------------ ------------------------ ------------------------
As Of December 31, 2001 Amount Percent Amount Percent Amount Percent
----------------------- ------ ------- ------ ------- ------ -------
Capital of the Bank presented on a
GAAP basis $ 45,597 $ 45,597 $ 45,597
Adjustments to GAAP capital to derive
regulatory capital:
Net unrealized loss on debt
securities classified as
available for sale 71 71 71
Non-qualifying intangible assets (1,514) (1,514) (1,514)
Qualifying general allowance for
loan Losses -- -- 4,871
-------- -------- --------
Bank regulatory capital 44,154 8.24% 44,154 8.24% 49,025 12.64%
Less minimum capital requirement 8,040 1.50% 21,440 4.00% 31,031 8.00%
-------- ----- -------- ----- -------- -----
Regulatory capital in excess of minimums $ 36,114 6.74% $ 22,714 4.24% $ 17,994 4.64%
======== ===== ======== ===== ======== =====
Additional information:
Bank regulatory total assets $ 535,998
Bank regulatory risk based assets $ 387,892
142
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
The OTS can take prompt corrective action against thrift institutions such as
the Bank in the event the institution fails to meet certain regulatory capital
thresholds. The prompt corrective action regulations define five specific
capital categories based upon an institution's regulatory capital ratios. These
five capital categories, in declining order, are "well capitalized", "adequately
capitalized", "undercapitalized", "significantly undercapitalized", and
"critically undercapitalized". Institutions categorized as "undercapitalized" or
worse are subject to certain restrictions, including the requirement to file a
capital plan with the OTS, prohibitions on the payment of dividends and
management fees, restrictions on executive compensation, and increased
supervisory monitoring, among other things. Other restrictions may be imposed on
the institution either by the OTS or by the FDIC, including requirements to
raise additional capital, sell assets, or sell the entire institution.
As of December 31, 2002 and 2001, the most recent notification from the OTS
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. To be categorized as "well capitalized", the Bank must
maintain minimum core capital, tier one risk based, and total risk based capital
ratios as presented in the following table. There are no conditions or events
since that notification that management believes have changed the Bank's
category.
To Be Well
Capitalized
Under Prompt
For Capital Adequacy Corrective
Actual Purposes Action Provisions
--------------------- ---------------------- ----------------------
As Of December 31, 2002 Amount Ratio Amount Ratio Amount Ratio
----------------------- ------ ----- ------ ----- ------ -----
Total Capital (to risk weighted assets) $ 57,880 12.88% $ 35,940 8.00% $ 44,925 10.00%
Tier One Capital (to risk weighted assets) 52,240 11.63% N/A N/A 26,955 6.00%
Core Capital (to adjusted tangible assets) 52,240 8.57% 24,371 4.00% 30,464 5.00%
Tangible Capital (to tangible assets) 52,240 8.57% 9,139 1.50% N/A N/A
As Of December 31, 2001 Amount Ratio Amount Ratio Amount Ratio
----------------------- ------ ----- ------ ----- ------ -----
Total Capital (to risk weighted assets) $ 49,025 12.64% $ 31,031 8.00% $ 38,789 10.00%
Tier One Capital (to risk weighted assets) 44,154 11.38% N/A N/A 23,274 6.00%
Core Capital (to adjusted tangible assets) 44,154 8.24% 21,440 4.00% 26,800 5.00%
Tangible Capital (to tangible assets) 44,154 8.24% 8,040 1.50% N/A N/A
Management believes that, under current regulations, the Bank will continue to
meet its minimum capital requirements in the coming year. However, events beyond
the control of the Bank, such as changing interest rates or a downturn in the
economy and / or real estate markets where the Bank maintains most of its loans,
could adversely affect future earnings and, consequently, the ability of the
Bank to meet its future minimum regulatory capital requirements.
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 Monterey Bay Bank to
Monterey Bay Bancorp, Inc. is subject to OTS regulations. "Safe-harbor" amounts
of capital distributions can be made after providing notice to the OTS, but
without needing prior approval. For Tier 1 institutions such as the Bank, an
application is not required if the total amount of all capital distributions
(including any proposed distribution) for any particular calendar year does not
exceed net income for the year to date plus the institution's retained net
income for the preceding two years, subject to the Bank's remaining classified
as at least "adequately capitalized" following the proposed distribution.
Distributions beyond this amount are allowed only with the prior approval of the
OTS.
143
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES
The Company is involved in certain 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 Company's financial
position or results of operations.
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include letters of credit, commitments to originate
fixed and variable rate loans, 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 and lines of credit as it does for on-balance sheet instruments.
At December 31, 2002, the Company had outstanding the following commitments to
originate loans and lines of credit:
(Dollars In Thousands) December 31, 2002
Outstanding
Loan Category Commitments
------------------------------------------------------ -----------
Residential fixed rate mortgages $ 1,529
Residential variable rate mortgages 4,049
Multifamily five or more units 2,254
Commercial and industrial real estate 2,390
Construction 22,081
Land 102
Home equity lines of credit 42
Commercial term loans 3,845
Commercial lines of credit 3,150
--------
Total $ 39,442
========
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, 2002, the Company had optional commitments totaling $4.9 million
to sell fixed rate residential mortgages to various secondary market purchasers
on a servicing released basis. These optional commitments do not expose the
Company to financial loss in the event of non-delivery.
At December 31, 2002, the Company had made available various business, personal,
and residential lines of credit totaling $37.2 million, of which the undisbursed
portion was $15.6 million.
Commercial letters of credit are commitments issued by the Company to guarantee
payment by one of the Company's customers, typically for the import of goods. At
December 31, 2002, the Company maintained $401 thousand in outstanding
commercial letters of credit. No commercial letters of credit were outstanding
at December 31, 2001.
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, 2002
and 2001, the Company maintained no outstanding standby letters of credit.
144
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
At December 31, 2002, the Company maintained no recourse liability for loans
previously sold and did not have any losses from any recourse liabilities during
2002 or 2001.
The Company is 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 $177 thousand, $136 thousand, and $133 thousand for the years ended
December 31, 2002, 2001, and 2000, respectively. The increase in rent expense in
2002 was due to the opening of the Los Angeles loan production office.
Certain facilities are leased under the terms of operating leases expiring at
various dates through the year 2005. At December 31, 2002, future minimum rental
commitments under non-cancelable operating leases were as follows:
(Dollars In Thousands)
2003 119
2004 66
2005 33
Thereafter --
-----
Total $ 218
=====
At December 31, 2002, the Company sub-leased space within its facilities to a
total of three parties. The following table presents the minimum scheduled rent
obligations by the three parties under non-cancelable operating leases:
(Dollars In Thousands)
2003 91
2004 89
2005 68
Thereafter --
-----
Total $ 248
=====
In the normal course of business, the Company and Bank have negotiated
employment agreements with the Chief Executive Officer / President and the Chief
Financial Officer / Treasurer. In addition, at December 31, 2002, the Company
and Bank also maintained change in control agreements with four officers. These
agreements result in severance payments following certain events associated with
a change in control of the Company or the Bank.
At December 31, 2002, the Company had indemnification agreements outstanding
with each of the Company's Directors, the Chief Executive Officer, and the Chief
Financial Officer. These agreements provide indemnification by the Company for
certain claims against the Directors and Executive Officers resulting from their
service to the Company.
145
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
16. EARNINGS PER SHARE
Basic Earnings Per Share ("EPS") are computed by dividing net income available
to common stockholders by the weighted average number of common shares
outstanding during each period. During the years 2000 through 2002, all of the
Company's net income was available to common stockholders. The weighted average
number of common shares outstanding for the Company is decreased in each
reporting period by:
o shares associated with the Company's ESOP which have not been committed to
be released
o shares associated with the Company's stock grant programs which are not yet
vested to Plan participants
o the weighted average number of Treasury shares maintained by the Company
during each period
The computation of Diluted EPS also considers, via the treasury stock method of
calculation, the impact of shares issuable upon the assumed exercise of
outstanding stock options (both incentive stock options and non-statutory stock
options) and stemming from the grant of time-based stock awards under the
Company's associated Plans for officers and directors. In calculating diluted
earnings per share, no anti-dilutive calculations are permitted and diluted
share counts are applicable only in the event of positive earnings. For the
years 2000 through 2002, there was no difference in the Company's income used in
calculating basic and diluted earnings per share.
The following table reconciles the calculation of the Company's Basic and
Diluted EPS for the periods indicated.
For The Year Ended December 31,
----------------------------------------------------
(In Whole Dollars And Whole Shares) 2002 2001 2000
---- ---- ----
Net income $5,638,000 $ 3,751,000 $ 2,523,000
========== =========== ===========
Average shares issued 4,492,085 4,492,085 4,492,085
Less weighted average:
Uncommitted ESOP shares (89,844) (125,781) (161,719)
Non-vested stock award shares (15,772) (28,413) (60,612)
Treasury shares (1,016,869) (1,062,588) (1,158,844)
----------- ----------- -----------
Sub-total (1,122,485) (1,216,782) (1,381,175)
----------- ----------- -----------
Weighted average BASIC shares outstanding 3,369,600 3,275,303 3,110,910
Add dilutive effect of:
Stock options 126,127 67,121 12,483
Stock awards 1,423 809 159
----------- ----------- -----------
Sub-total 127,550 67,930 12,642
----------- ----------- -----------
Weighted average DILUTED shares outstanding 3,497,150 3,343,233 3,123,552
=========== =========== ===========
Earnings per share:
BASIC $ 1.67 $ 1.15 $ 0.81
======= ======= =======
DILUTED $ 1.61 $ 1.12 $ 0.81
======= ======= =======
146
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
17. OTHER COMPREHENSIVE INCOME
The Company's only source of other comprehensive income has been derived from
unrealized gains and losses on the portfolios of investment and mortgage backed
securities classified as available for sale.
Reclassification adjustments for the change in net gains (losses) included in
other comprehensive income from investment and mortgage backed securities
classified as available for sale during the past three years are summarized as
follows:
Year Ended December 31,
----------------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Gross reclassification adjustment $ 35 $ 190 $ (55)
Tax (expense) benefit (15) (78) 23
----- ------ -------
Reclassification adjustment, net of tax $ 20 $ 112 $ (32)
===== ====== =======
A reconciliation of the net unrealized gain or loss on available for sale
securities recognized in other comprehensive income is as follows:
Year Ended December 31,
--------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Holding (loss) gain arising during the year, net of tax $ (157) $ 665 $ 513
Reclassification adjustment, net of tax (20) (112) 32
------- ------ ------
Net unrealized (loss) gain recognized in other comprehensive income $ (177) $ 553 $ 545
======= ====== ======
147
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
18. STOCK BENEFIT PLANS
Stock Option Programs - The Company's stock option programs have all been
approved by the Company's stockholders and provide for the issuance of options
to directors and employees only, and not to any unaffiliated individuals or
entities.
In 1995, the 1995 Incentive Stock Option Plan ("Stock Option Plan") was
approved. Under the Stock Option Plan, the Company may grant to officers and
employees of the Company and its subsidiary, the Bank, both non-statutory and
incentive stock options, as defined under the Internal Revenue Code, to purchase
shares of the Company's common stock.
In 1995, the 1995 Stock Option Plan For Outside Directors (the "Directors Option
Plan") was also approved. Under the Directors' Option Plan, directors who are
not officers or employees of the Company or Bank may be granted non-statutory
stock options to purchase up to 97,929 shares of the Company's common stock.
On May 25, 2000, the stockholders of the Company approved amendments to the
Stock Option Plan. These amendments included:
o an increase in the number of shares reserved for issuance under the Stock
Option Plan to 660,000 shares
o an increase in the strike price of options granted under the Stock Option
Plan from not less than 100% of the fair market value of the common stock
on the date of grant (except that the exercise price for beneficial owners
of more than 10.0% of the outstanding voting stock of the Company must be
equal to 110% of the fair market value of the common stock on the date of
grant) to at least 110% of the fair market value of the common stock on the
date of grant for all grants occurring on or after May 25, 2000
o providing additional flexibility in the vesting schedule for both incentive
and non-statutory stock options
o allowing non-employee directors to be eligible for the grant of
non-statutory stock options under the Stock Option Plan
Options granted under the Stock Option Plan prior to May 25, 2000 entitle the
holder to purchase one share of the common stock at the fair market value of the
common stock on the date of grant. Options granted under the Stock Option Plan
prior to May 25, 2000 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.
Options granted under the Stock Option Plan after May 24, 2000 entitle the
holder to purchase one share of the common stock at 110% of the fair market
value of the common stock on the date of grant. Options granted under the Stock
Option Plan after May 24, 2000 vest at various times as specified under each
individual option agreement and expire no later than ten years after the date of
grant.
Options granted under the Directors Option Plan entitle the holder to purchase
one share of the common stock at the fair market value of the common stock on
the date of grant. 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.
As of December 31, 2002, there were 1,500 non-statutory stock options issued
under the Stock Option Plan granted to an individual owning more than 10.0% of
the Company's common shares then outstanding. However, restrictions contained in
the Company's Articles Of Incorporation limit the combined voting power of the
Company common stock owned by this individual, who was a Director of the Company
at December 31, 2002, to no more than 10.0% of the total combined voting power
of the Company's common stock.
148
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
During the years ended December 31, 2002, 2001, and 2000, the Company did not
amend the terms or conditions of any existing stock option grant. The Company
has never repriced a stock option following its issuance.
All options under the Stock Option Plan 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.
All options under the Directors Option Plan 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.
The status of the aggregate stock options under the two Plans as of December 31,
2002, 2001, and 2000, and changes during the years then ended, are presented
below. The abbreviation "FMV" represents "fair market value" and the
abbreviation "N/A" represents "not applicable".
December 31,
--------------------------------------------------------------------------------------
2002 2001 2000
------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Options outstanding at the
beginning of the year 425,104 $11.02 550,236 $10.19 362,597 $10.30
Granted 18,500 $19.19 82,750 $15.19 197,865 $10.00
Forfeited 25,249 $14.43 92,271 $12.03 10,226 $10.49
Exercised 48,463 $10.20 115,611 $ 9.11 -- $ --
------ ------- -------
Options outstanding at year end 369,892 $11.31 425,104 $11.02 550,236 $10.19
======= ======= =======
Options outstanding at year end:
Granted at 100% FMV 222,242 $ 9.55 270,354 $ 9.71 464,236 $10.04
Granted at 110% FMV 147,650 $13.95 154,750 $13.32 86,000 $10.98
------- ------- -------
Total 369,892 $11.31 425,104 $11.02 550,236 $10.19
======= ======= =======
Options exercisable at year end:
Granted at 100% FMV 162,416 $ 9.58 184,932 $ 9.65 308,262 $ 9.65
Granted at 110% FMV 84,194 $13.84 70,292 $14.10 17,240 $11.76
------- ------- -------
Total 246,610 $11.04 255,224 $10.88 325,502 $ 9.76
======= ======= =======
Options available for future grants 143,813 137,064 127,543
Weighted average remaining
contractual life of options
outstanding at year end 5.5 years 6.2 years 6.6 years
Weighted average fair value for
options granted during the year
at 100% of FMV: N/A N/A $4.68
Weighted average fair value for
options granted during the year
at 110% of FMV: $6.00 $5.08 $4.41
149
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
The following table summarizes information about the stock options outstanding
at December 31, 2002:
Options Granted At 100% Of Fair Market Value:
Weighted
Average
Remaining
Exercise Number Contractual Life Number
Price Outstanding In Years Exercisable
----- ----------- -------- -----------
$ 8.19 45,000 7.3 18,000
$ 9.10 103,353 2.6 103,353
$ 9.50 9,658 3.5 9,658
$ 9.69 9,941 7.2 3,974
$10.13 40,000 7.1 16,000
$14.80 9,375 5.5 7,500
$16.60 4,915 5.2 3,931
------- -------
$8.19 - $16.60 222,242 4.8 162,416
======= =======
Options Granted At 110% Of Fair Market Value:
Weighted
Average
Remaining
Exercise Number Contractual Life Number
Price Outstanding In Years Exercisable
----- ----------- -------- -----------
$ 9.90 10,000 7.4 4,000
$11.21 37,400 7.9 14,600
$11.76 20,000 3.7 18,344
$12.62 8,000 8.5 1,600
$15.88 50,250 4.7 43,650
$16.26 3,000 8.7 600
$16.64 1,000 9.0 1,000
$16.82 2,000 9.0 400
$17.09 500 9.1 --
$17.73 2,000 9.2 --
$17.81 3,000 9.2 --
$19.26 1,000 9.4 --
$20.13 8,000 10.0 --
$20.19 1,000 9.7 --
$21.89 500 9.9 --
------- -------
$9.90 - $21.89 147,650 6.5 84,194
======= =======
TOTAL 369,892 5.5 246,610
======= =======
Stock Award Programs - The Company maintains a Performance Equity Program
("PEP") for officers and employees. The Company also maintained a Recognition
and Retention Plan for Outside Directors ("RRP") that was terminated during
2000. These stock award Plans were designed to provide directors, officers, and
employees with a proprietary interest in the Company in a manner designed to
encourage such persons to remain with the Company and to improve the financial
performance of the Company. These stock award plans were approved by the
Company's stockholders.
150
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
The Bank contributed $1.7 million during the fourth quarter of 1995 and the
first quarter of 1996 to purchase 179,687 shares of Company common stock in the
open market at a weighted average cost of $9.62 per share. This contribution was
initially recorded as a reduction in stockholders' equity and then is ratably
charged to compensation expense over the vesting period of the actual stock
awards. Of the 179,687 shares acquired, 38,010 were allocated to the RRP, with
the remaining 141,677 allocated to the PEP.
The PEP provides for two types of stock awards: time-based grants and
performance-based grants. Time-based grants vest pro-rata on each anniversary of
the grant date and become fully vested over the applicable time period as
determined by the board of directors, typically five years. Vesting of
performance-based grants is dependent upon achievement of criteria established
by the board of directors for each stock award.
All stock awards granted will be immediately vested in the event the recipient
terminates his employment (or in the case of a director, his service, including
service as a Director Emeritus) due to death, disability, or a change in control
of Monterey Bay Bank or Monterey Bay Bancorp, Inc. In the event the award
recipient terminates his employment or service due to any reason other than
death, disability, or a change in control, all unvested stock awards become null
and void. In addition, to the extent that criteria for performance-based stock
awards are not achieved, associated awards are forfeited and become available
for re-issuance.
Periodic operating expense for time-based stock awards is recognized based upon
fair market value at date of grant. Periodic operating expense for
performance-based stock awards is recognized based upon fair market value at the
earlier of the reporting date or the performance measurement date.
During 2002, 2001, and 2000, the Company utilized previously unallocated shares
under the PEP to compensate certain employees for their favorable performance.
These shares were granted in lieu of cash incentive compensation and vested
immediately. During the years ended December 31, 2002, 2001, and 2000, the
Company made no changes to the terms or conditions of existing stock award
grants.
A summary of the PEP as of December 31, 2002, 2001, and 2000, and changes and
related expense during the years ended on those dates, is presented below:
2002 2001 2000
---- ---- ----
Stock awards outstanding at the beginning of the year 17,969 35,079 30,864
Stock award activity during the year:
Time based shares granted -- -- 11,576
Performance based shares granted -- -- 18,168
Performance based shares granted in lieu of cash compensation 1,483 9,438 3,160
Performance based shares immediately vested upon grant (1,483) (9,438) (3,160)
Time based shares forfeited (634) (6,329) --
Performance based shares forfeited (849) (3,109) (1,129)
Time based shares vested (2,717) (4,298) (11,860)
Performance based shares vested (2,000) (3,374) (12,540)
----- ----- ------
Stock awards outstanding at the end of the year 11,769 17,969 35,079
====== ====== ======
Available for future awards at the end of the year -- -- --
===== ===== ======
PEP compensation expense (Dollars In Thousands) $ 100 $ 200 $ 230
===== ===== ======
In 2000, the remaining 9,541 shares in the RRP were vested and the Company
recognized $66 thousand in related compensation expenses.
151
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Employee Stock Ownership Plan and Trust - The Company established for eligible
employees an Employee Stock Ownership Plan and Trust ("ESOP"), which became
effective upon the conversion of the Bank from a mutual to a stock association.
Employees who have been credited with at least 1,000 hours of service during a
twelve month period, have attained age twenty-one, and were employed on the last
business day of the calendar year are eligible to participate.
The ESOP subscribed for 8.0% (or 359,375) of the shares of Company common stock
issued in the Conversion at an adjusted price of $6.40 per share. During 1995,
the ESOP borrowed $2.3 million from Monterey Bay Bancorp, Inc. in order to fund
the purchase of the common stock. This loan is being repaid pro-rata over an
approximately ten year period concluding on December 31, 2004, with the funds
for repayment primarily coming from the Bank's contributions to the ESOP over a
similar time period. The loan is collateralized by the shares of common stock
held by the ESOP.
As an internally leveraged ESOP, no interest income or interest expense is
recognized on the loan in the consolidated financial statements of the Company.
Annual principal payments of $230,000 are scheduled for the conclusion of each
calendar year in conjunction with a release of shares for allocation to
individual employee accounts. Shares are allocated on the basis of eligible
compensation, as defined in the ESOP plan document, in the year of allocation.
Benefits generally become 100% vested after three years of credited service.
Employees with at least one, but fewer than three, years of credited service
receive a partial vesting according to a sliding schedule. However, in the event
of retirement, disability, or death, any unvested portion of benefits shall vest
immediately. Any share forfeitures are allocated among participating employees
in the same proportion as annual share allocations. Benefits are payable upon
separation from service based on vesting status and share allocations made.
As of December 31, 2002, 287,500 shares had been cumulatively allocated to
participants and committed to be released. As of December 31, 2002, the fair
market value of the 71,875 unearned shares was $1.4 million based upon a closing
market price per share of $19.95. The outstanding ESOP loan balance, which is
not a component of the Company's consolidated financial statements, was $460
thousand at December 31, 2002.
Periodic operating expense associated with the ESOP is recognized based upon:
o the number of Company common shares pro-rata allocated
o the fair market value of the Company's common stock at the dates shares are
committed to be released
o any dividends received on unallocated shares as a reduction to periodic
operating expense
The benefits expenses, not including administrative costs, related to the ESOP
for the years ended December 31, 2002, 2001, and 2000 were $638 thousand, $437
thousand, and $317 thousand, respectively. At December 31, 2002 and 2001, the
unearned compensation related to the ESOP was $460 thousand and $690 thousand,
respectively. These amounts are shown as a reduction of stockholders' equity in
the Consolidated Statements Of Financial Condition.
19. 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 at least 30 days, and are
scheduled to complete 1,000 hours of service or more per calendar year. While
the 401(k) Plan allows the Company to provide periodic or matching contributions
to employee accounts within the 401(k) Plan, no such contributions were made in
the years 2000 through 2002.
The trust that administers the 401(k) Plan had assets of approximately $1.7
million and $1.7 million as of December 31, 2002 and 2001, respectively. None of
these assets have been maintained at the Company or its subsidiary. At December
31, 2002, 401(k) Plan participants were able to invest in one or more of a total
of twelve different investment alternatives at their discretion. One of the
investment alternatives is the Company's common stock. The 401(k) Plan also
allows participants to borrow funds, subject to certain limitations.
152
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
20. RETIREMENT PLAN
In January 2003, following Board of Director approval, the Company established a
supplemental retirement plan ("Plan") covering two key executives. The Plan is a
non-qualified defined benefit plan and is unfunded. The Plan has no assets, and
the benefits payable under the Plan are not secured. The Plan participants are
general creditors of the Company in regards to their vested Plan benefits. The
Plan provides for retirement benefits upon reaching age 65, and the two
participants are fully vested at the inception of the Plan.
During December 2002, the Company purchased Bank owned life insurance on the
lives of the two participants. The cash surrender value of the ten life
insurance policies purchased aggregated $9,036,000 at December 31, 2002. The
Company intends to utilize the increase in cash surrender value of these
insurance policies to fund the retirement benefit obligations. There is no
accrued pension obligation included in the accompanying financial statements at
December 31, 2002, as the Plan was not established until January 2003.
21. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
The Parent Company (Monterey Bay Bancorp, Inc.) and its subsidiary, the Bank,
file consolidated federal income tax returns in which the taxable income or loss
of the Parent 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 stand alone financial
statement purposes.
The condensed financial statements of Monterey Bay Bancorp, Inc. (parent company
only) are summarized as follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
December 31,
------------------------
2002 2001
---- ----
(Dollars In Thousands)
ASSETS:
Cash and due from depository institutions $ 3,314 $ 4,619
Other assets 6 1
Investment in subsidiary 52,825 45,597
------- -------
TOTAL ASSETS $56,145 $50,217
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities $ 42 $ 55
Stockholders' equity 56,103 50,162
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $56,145 $50,217
======= =======
153
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
CONDENSED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME
Year Ended December 31,
---------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
Interest income:
Interest on mortgage backed securities and investment securities $ -- $ -- $ 19
Interest on loan receivable -- -- 560
Other interest income 15 130 46
------ ------ ------
Total interest income 15 130 625
Interest expense - borrowings 10 9 31
------ ------ ------
Net interest income before benefit for loan losses 5 121 594
Benefit for loan losses -- -- (200)
------ ------ ------
Net interest income after benefit for loan losses 5 121 794
Loss on sale of mortgage backed securities available for sale -- -- 79
Non-interest expense 442 612 817
------ ------ ------
Loss before benefit for income taxes (437) (491) (102)
Benefit for income taxes (180) (202) (42)
------ ------ ------
Loss before undistributed net income of subsidiary (257) (289) (60)
Undistributed net income of subsidiary 5,895 4,040 2,583
------ ------ ------
Net income $5,638 $3,751 $2,523
====== ====== ======
Other comprehensive (loss) income (177) 553 545
------ ------ ------
Total comprehensive income $5,461 $4,304 $3,068
====== ====== ======
154
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31,
---------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands)
OPERATING ACTIVITIES:
Net income $ 5,638 $ 3,751 $ 2,523
Adjustments to reconcile net income to net cash
provided by operatingactivities:
Undistributed net income of subsidiary (5,895) (4,040) (2,583)
Benefit for loan losses -- -- (200)
Loss on sale of securities -- -- 79
Cash receipts associated with ESOP 230 230 460
(Increase) decrease in other assets (5) 50 473
Tax benefit arising from stock option exercises 130 74 --
Other, net 178 33 138
------- ------- -------
Net cash provided by operating activities 276 98 890
------- ------- -------
INVESTING ACTIVITIES:
Proceeds from repayments of loans -- -- 5,000
Investment in subsidiary (1,000) (300) (2,100)
Principal repayments on mortgage backed securities available for sale -- -- 49
Proceeds from sales of mortgage backed securities available for sale -- -- 3,702
------- ------- -------
Net cash (used in) provided by investing activities (1,000) (300) 6,651
------- ------- -------
FINANCING ACTIVITIES:
(Repayments) proceeds of borrowings, net -- -- (2,410)
Cash dividends paid to stockholders -- -- (274)
Sales of treasury stock for exercise of stock options 494 1,053 --
Purchases of treasury stock (1,075) -- (1,251)
------- ------- -------
Net cash (used in) provided by financing activities (581) 1,053 (3,935)
------- ------- -------
NET (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS (1,305) 851 3,606
CASH & CASH EQUIVALENTS AT BEGINNING OF YEAR 4,619 3,768 162
------- ------- -------
CASH & CASH EQUIVALENTS AT END OF YEAR $ 3,314 $ 4,619 $ 3,768
======= ======= =======
155
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
22. ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company, using
available market information and appropriate valuation methodologies. However,
considerable judgement is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different assumptions and / or estimation
methodologies may have a material effect on the estimated fair value amounts.
The following methods and assumptions were used by the Company in computing the
estimated fair values:
Cash And Cash Equivalents - Current carrying amounts approximate estimated fair
value.
Investment Securities and Mortgage Backed Securities - Fair values of these
securities are based on year-end market prices or dealer quotes. If quoted
market prices are not available, estimated fair values were based upon quoted
market prices of comparable instruments.
Loans Held For Sale - Fair values of these loans are based on prices in the
secondary market for similar residential mortgages.
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 remaining terms to borrowers
of similar credit quality. Prepayment estimates were based on historical
experience and published data for similar loans.
Capital Stock Of The Federal Home Loan Bank - Fair value is based upon its
redemption value, which equates to current carrying amounts.
Transaction Deposit Accounts - The estimated fair value of checking, savings,
and money market deposit accounts is the amount payable on demand at the
reporting dates.
Certificates Of Deposit - Fair value has been estimated by discounting the
contractual cash flows using current market rates for similar time deposits with
comparable remaining terms.
FHLB Advances - Fair value was estimated by discounting the contractual cash
flows using current market rates offered for advances with comparable conditions
and remaining terms.
Other Borrowings - Current carrying amounts approximate estimated fair value.
Off-Balance Sheet Instruments - The estimated fair values of commitments to fund
loans and commercial letters of credit are estimated using the fees currently
charged to enter into similar agreements, considering the remaining terms of the
agreements and the present creditworthiness of the counterparties. For fixed
rate loan commitments, the estimated fair values also incorporate the difference
between current levels of interest rates for similar commitments and the
committed rates. The fair value of such off-balance sheet instruments were not
significant as December 31, 2002 and 2001 and therefore have not been included
in the following table.
156
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
The carrying amounts and estimated fair values of the Company's financial
instruments are as follows:
December 31, 2002 December 31, 2001
--------------------------- ---------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
(Dollars In Thousands)
ASSETS:
Cash and cash equivalents $ 11,447 $ 11,447 $ 13,079 $ 13,079
Investment securities available for sale 7,030 7,030 7,300 7,300
Mortgage backed securities available for sale 37,466 37,466 30,644 30,644
Loans held for sale 1,545 1,571 713 717
Loans receivable held for investment, net 521,929 535,024 465,887 477,117
FHLB stock 4,679 4,679 2,998 2,998
LIABILITIES:
Transaction deposit accounts 211,713 211,713 188,574 188,574
Certificates of deposit 246,621 248,794 243,765 245,574
Advances from the Federal Home Loan Bank 93,582 95,628 53,582 55,165
Other borrowings 223 223 218 218
The fair value estimates presented herein are based upon pertinent information
available to management as of December 31, 2002 and 2001. The fair value amounts
have not been comprehensively reevaluated since the reporting date. Therefore,
current estimates of fair value and the amounts realizable in current secondary
market transactions may differ significantly from the amounts presented herein.
157
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
23. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of quarterly results:
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars In Thousands, Except Share Data)
Year Ended December 31, 2002:
Interest and dividend income $ 8,755 $ 8,891 $ 8,979 $ 8,861
Interest expense 3,405 3,328 3,184 2,990
Provision for loan losses 325 385 400 400
Non-interest income 512 503 490 622
Non-interest expense 3,466 3,404 3,442 3,468
Provision for income taxes 866 930 977 1,005
Net income 1,205 1,347 1,466 1,620
Shares applicable to Basic earnings per share 3,348,387 3,375,688 3,384,522 3,369,803
Basic earnings per share $ 0.36 $ 0.40 $ 0.43 $ 0.48
Shares applicable to Diluted earnings per share 3,465,286 3,509,181 3,509,118 3,505,016
Diluted earnings per share $ 0.35 $ 0.38 $ 0.42 $ 0.46
Cash dividends paid per share $ -- $ -- $ -- $ --
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars In Thousands, Except Share Data)
Year Ended December 31, 2001:
Interest and dividend income $ 9,996 $ 9,710 $ 9,758 $ 9,267
Interest expense 5,244 4,937 4,743 4,066
Provision for loan losses 500 300 275 325
Non-interest income 643 695 690 538
Non-interest expense 3,843 3,520 3,586 3,420
Provision for income taxes 450 699 787 851
Net income 602 949 1,057 1,143
Shares applicable to Basic earnings per share 3,227,241 3,262,003 3,293,853 3,318,113
Basic earnings per share $ 0.19 $ 0.29 $ 0.32 $ 0.34
Shares applicable to Diluted earnings per share 3,274,559 3,300,595 3,385,556 3,412,222
Diluted earnings per share $ 0.18 $ 0.29 $ 0.31 $ 0.33
Cash dividends paid per share $ -- $ -- $ -- $ --
158
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
Item 9. Changes In And Disagreements With Accountants On Accounting And
Financial Disclosure.
None.
PART III
Item 10. Directors And Executive Officers Of The Registrant.
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 22, 2003,
which will be filed no later than 120 days following Registrant's fiscal year
end. Information concerning Executive Officers who are not Directors is also
contained in Part I of this report pursuant to paragraph (b) of Item 401 of
Regulation S-K in reliance on Instruction G.
Item 11. Executive Compensation.
The information relating to Director and Executive Officer compensation
is incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 22, 2003, 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.
Item 12. Security Ownership Of Certain Beneficial Owners And Management.
The information relating to security ownership of certain beneficial
owners and management is incorporated herein by reference to the Registrant's
Proxy Statement for the Annual Meeting of Stockholders to be held on May 22,
2003, 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 certain relationships and related
transactions is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 22, 2003,
which will be filed no later than 120 days following the Registrant's fiscal
year end.
Item 14. Controls And Procedures.
(a) The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Company's
reports in compliance with the Securities Exchange Act of 1934, as amended
("Exchange Act"), is recorded, processed, summarized, and reported within
the time periods specified in the Securities and Exchange Commission's
("SEC") rules and forms, and that such information is accumulated and
communicated to the Company's Management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure based closely on the definition of
"disclosure controls and procedures" in Rule 13a-14(c) promulgated under
the Exchange Act. Within 90 days prior to the date of this report, the
Company carried out an evaluation, under the supervision and with the
participation of the Company's Management, including the Company's Chief
Executive Officer and the Company's Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure
controls and procedures. Based on the foregoing, the Company's Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective.
(b) There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect the internal controls
subsequent to the date of the evaluation referenced in paragraph (a) above.
159
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
PART IV
Item 15. Exhibits, Financial Statement Schedules, And Reports On Form 8-K.
(a)(1) Financial Statements
The following consolidated financial statements of the Registrant are
filed as a part of this document under Item 8, "Financial Statements and
Supplementary Data."
Independent Auditors' Report
Consolidated Statements Of Financial Condition At December 31, 2002
And 2001.
Consolidated Statements of Income For Each Of The Years In The Three
Year Period Ended December 31, 2002.
Consolidated Statements Of Changes In Stockholders' Equity For Each Of
The Years In The Three Year Period Ended December 31, 2002.
Consolidated Statements Of Cash Flows For Each Of The Years In The
Three Year Period Ended December 31, 2002.
Notes To Consolidated Financial Statements.
(a)(2) Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated Financial
Statements or Notes thereto under Item 8, "Financial Statements and
Supplementary Data."
(a)(3) Management Contracts (see Item 15 (c), below)
(b) Reports On Form 8-K Filed During The Last Quarter Of The
Registrant's Fiscal Year Ended December 31, 2002
(1) Form 8-K dated October 21, 2002. This Current Report
reported the Company's financial and operating results for
the three month and nine month periods ending September 30,
2002.
160
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (Continued)
--------------------------------------------------------------------------------
(c) Exhibits Required by Securities and Exchange Commission
Regulation S-K
Exhibit
Number Description
3.1 Certificate Of Incorporation Of Monterey Bay Bancorp, Inc. (1)
3.4 Amended And Restated Bylaws Of Monterey Bay Bancorp, Inc.
Effective October 24, 2002 (2)
4.0 Stock Certificate Of Monterey Bay Bancorp, Inc. (1)
10.9 Monterey Bay Bank 401(k) Plan (1)
10.11 Monterey Bay Bank Performance Equity Program (3)
10.13 Monterey Bay Bancorp, Inc. 1995 Incentive Stock Option Plan As
Amended And Restated Effective May 25, 2000 (4)
10.14 Monterey Bay Bancorp, Inc. 1995 Stock Option Plan For Outside
Directors (3)
10.21 Employment Agreement With C. Edward Holden (5)
10.22 Employment Agreement With Mark R. Andino (5)
10.23 Monterey Bay Bancorp, Inc. Form Of Indemnification Agreement
Between The Company And All Directors Plus The Chief Financial
Officer (2)
10.24 Monterey Bay Bank Form Of Indemnification Agreement Between The
Bank And All Directors Plus The Chief Financial Officer (2)
10.26 Form Of Salary Continuation, Split Dollar, And Executive Bonus
Agreement Between Monterey Bay Bancorp, Inc., Monterey Bay Bank,
And Two Executive Officers Dated January 1, 2003
10.27 Form Of Change In Control Agreement Between Monterey Bay Bancorp,
Inc., Monterey Bay Bank, And Five Officers Effective March 22,
2003
21 Subsidiary information is incorporated herein by reference to
"Part I - Subsidiaries"
23 Consent Of Deloitte & Touche LLP, Independent Auditors
99.1 Certification Of Chief Executive Officer Pursuant To 18 U.S.C.
Section 1350, As Adopted Pursuant To Section 906 Of The
Sarbanes-Oxley Act Of 2002
99.2 Certification Of Chief Financial Officer Pursuant To 18 U.S.C.
Section 1350, As Adopted Pursuant To Section 906 Of The
Sarbanes-Oxley Act Of 2002
--------------------------------------------------------------------------------
(1) 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.
(2) Incorporated herein by reference from the Exhibits to the
Quarterly Report on Form 10-Q for September 30, 2002 filed on
November 12, 2002.
(3) Incorporated herein by reference from the Proxy Statement for
the Annual Meeting of Stockholders' filed on July 26, 1995.
(4) Incorporated herein by reference from the Proxy Statement for
the Annual Meeting of Stockholders' filed on April 14, 2000.
(5) Incorporated herein by reference from the Exhibits to the
Quarterly Report on Form 10-Q for March 31, 2002 filed on May
13, 2002
161
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 27, 2003 By: /s/ C. Edward Holden
--------------------- --------------------
C. Edward Holden
Vice Chairman, Director, Chief Executive
Officer, President
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ McKenzie Moss Chairman of the Board of Directors March 27, 2003
----------------------------------- --------------
McKenzie Moss
/s/ C. Edward Holden Vice Chairman, Director, Chief Executive Officer, March 27, 2003
----------------------------------- --------------
C. Edward Holden President
/s/ Mark R. Andino Chief Financial Officer, Treasurer March 27, 2003
----------------------------------- (Principal Financial and Accounting Officer) --------------
Mark R. Andino
/s/ Rita Alves Director March 27, 2003
----------------------------------- --------------
Rita Alves
/s/ Josiah T. Austin Director March 27, 2003
----------------------------------- --------------
Josiah T. Austin
/s/ Edward K. Banks Director March 27, 2003
----------------------------------- --------------
Edward K. Banks
/s/ Diane S. Bordoni Director March 27, 2003
----------------------------------- --------------
Diane S. Bordoni
/s/ Larry A. Daniels Director March 27, 2003
----------------------------------- --------------
Larry A. Daniels
/s/ Steven Franich Director March 27, 2003
----------------------------------- --------------
Steven Franich
/s/ Stephen G. Hoffmann Director March 27, 2003
----------------------------------- --------------
Stephen G. Hoffmann
/s/ Gary L. Manfre Director March 27, 2003
----------------------------------- --------------
Gary L. Manfre
162
CERTIFICATIONS
Certification of the Principal Executive Officer
(Section 302 of the Sarbanes-Oxley Act of 2002)
I, C. Edward Holden, Chief Executive Officer and President, certify that:
1. I have reviewed this annual report on Form 10-K of Monterey Bay Bancorp,
Inc.;
2. Based on my knowledge, this annual report does not contain and untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors and any material weakness in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 27, 2003
By: /s/ C. Edward Holden
-----------------------
C. Edward Holden
Chief Executive Officer
President
Vice Chairman
163
Certification of the Principal Financial Officer
(Section 302 of the Sarbanes-Oxley Act of 2002)
I, Mark R. Andino, Chief Financial Officer and Treasurer, certify that:
1. I have reviewed this annual report on Form 10-K of Monterey Bay Bancorp,
Inc.;
2. Based on my knowledge, this annual report does not contain and untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors and any material weakness in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 27, 2003
By: /s/ Mark R. Andino
------------------
Mark R. Andino
Chief Financial Officer
Treasurer
164