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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM
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COMMISSION FILE NUMBER 0-25418
CENTRAL COAST BANCORP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
STATE OF CALIFORNIA 77-0367061
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OR ORGANIZATION)
301 MAIN STREET, SALINAS, CALIFORNIA 93901
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (408) 422-6642
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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COMMON STOCK NONE
(NO PAR VALUE)
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. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant at March 6, 1998 was $106,999,026. As of March 6, 1998, the
registrant had 4,808,945 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents are incorporated by reference into this Form 10-K:
Part III, Items 10 through 13 from registrant's definitive proxy statement for
the 1998 annual meeting of shareholders.
THE INDEX TO EXHIBITS IS LOCATED AT PAGE 57
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PART I
ITEM 1. BUSINESS
General Development of Business.
Certain matters discussed or incorporated by reference in this Annual
Report on Form 10-K including, but not limited to, matters described in Item
7 -- "Management's Discussion and Analysis of Financial Condition and Results of
Operations," are forward-looking statements that are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. Changes to such risks and uncertainties, which could impact future
financial performance, include, among others, (1) competitive pressures in the
banking industry; (2) changes in the interest rate environment; (3) general
economic conditions, nationally, regionally and in the operating market areas of
the Company and the Banks; (4) changes in the regulatory environment; (5)
changes in business conditions and inflation; and (6) changes in securities
markets. Therefore, the information set forth therein should be carefully
considered when evaluating the business prospects of the Company and the Banks.
Central Coast Bancorp (the "Company") is a California corporation organized
in 1994 to act as the bank holding company of Bank of Salinas and Cypress Bank,
state-chartered banks (the "Banks"). The Banks, headquartered in Salinas and
Seaside, respectively, serve individuals, merchants, small and medium-sized
businesses, professionals, agribusiness enterprises and wage earners located in
the Salinas Valley and the Monterey Peninsula.
On February 21, 1997, the Bank of Salinas purchased certain assets and
assumed certain liabilities of the Gonzales and Castroville branch offices of
Wells Fargo Bank. As a result of the transaction the Bank assumed deposit
liabilities, received cash, and acquired tangible assets. This transaction
resulted in intangible assets, representing the excess of the liabilities
assumed over the fair value of the tangible assets acquired.
In January 1997, Cypress Bank opened a new branch office in Monterey,
California, so that it might better serve business and individual customers on
the Monterey Peninsula.
Other than holding the shares of the subsidiary Banks, the Company conducts
no significant activities. Although, it is authorized, with the prior approval
of the Board of Governors of the Federal Reserve System (the "Board of
Governors"), the Company's principal regulator, to engage in a variety of
activities which are deemed closely related to the business of banking.
The Banks operate through their headquarters offices located in Salinas and
Seaside, California and through their branch offices located in Castroville,
Gonzales, King City, Marina and Monterey, California. The Banks offer a full
range of commercial banking services, including the acceptance of demand,
savings and time deposits, and the making of commercial, real estate (including
residential mortgage), Small Business Administration, personal, home
improvement, automobile and other installment and term loans. They also offer
travelers' checks, safe deposit boxes, notary public, customer courier and other
customary bank services. The Bank of Salinas and Cypress Bank Offices are open
from 9:00 a.m. to 5:00 p.m., Monday through Thursday, and 9:00 a.m. to 6:00 p.m.
on Friday. The Bank of Salinas also operates a limited service facility in a
retirement home located in Salinas, California. The facility is open from 10:00
a.m. to 12:00 p.m. on Wednesday of each week. The Banks have automated teller
machines (ATMs) located at the Castroville, Gonzales, King City, Marina,
Monterey and Seaside offices, the Monterey County Fairgrounds, the Soledad
Correctional Training Facility Credit Union, Salinas Valley Memorial Hospital
and Fort Hunter Liggett which is located in Jolon, California. The Banks are
insured under the Federal Deposit Insurance Act and each depositor's account is
insured up to the legal limits thereon. The Banks are chartered (licensed) by
the California Commissioner of Financial Institutions ("Commissioner") and have
chosen not to become a member of the Federal Reserve System. The Banks have no
subsidiaries.
The Banks also currently offer personal and business Visa credit cards. The
Banks have arranged with a correspondent institution to offer trust services to
the Banks' customers on request. The Banks operate an on-site computer system
which provides independent processing of the Banks' deposits, loans and
financial accounting.
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The three areas in which the Banks have directed virtually all of their
lending activities are: (i) commercial loans; (ii) consumer loans; and (iii)
real estate loans (including residential construction and mortgage loans). As of
December 31, 1997, these three categories accounted for approximately 49
percent, 4 percent and 47 percent, respectively, of the Banks' loan portfolio.
The Banks' deposits are attracted primarily from individuals, merchants,
small and medium-sized businesses, professionals and agribusiness enterprises.
The Banks' deposits are not received from a single depositor or group of
affiliated depositors the loss of any one of which would have a materially
adverse effect on the business of the Banks, nor is a material portion of the
Banks' deposits concentrated within a single industry or group of related
industries.
As of December 31, 1997, the Banks served a total of 31 municipality and
governmental agency depositors totaling $26,441,000 in deposits. In connection
with the deposits of municipalities or other governmental agencies or entities,
the Banks are generally required to pledge securities to secure such deposits,
except for the first $100,000 of such deposits which are insured by the Federal
Deposit Insurance Corporation ("FDIC").
As of December 31, 1997, the Banks had total deposits of $450,301,000. Of
this total, $126,818,000 represented noninterest-bearing demand deposits,
$89,107,000 represented interest-bearing demand deposits, and $234,376,000
represented interest-bearing savings and time deposits.
The principal sources of the Banks' revenues are: (i) interest and fees on
loans; (ii) interest on Federal Funds sold (funds loaned on a short-term basis
to other banks) ; and (iii) interest on investments (principally government
securities). For the fiscal year ended December 31, 1997 these sources comprised
73 percent, 10 percent, and 17 percent, respectively, of the Banks' total
interest income.
Supervision and Regulation
The common stock of the Company is subject to the registration requirements
of the Securities Act of 1933, as amended, and the qualification requirements of
the California Corporate Securities Law of 1968, as amended. The Banks' common
stock, however, is exempt from such requirements. The Company is also subject to
the periodic reporting requirements of Section 13 of the Securities Exchange Act
of 1934, as amended, which include, but are not limited to, annual, quarterly
and other current reports with the Securities and Exchange Commission.
The Banks are licensed by the California Commissioner of Financial
Institutions ("Commissioner"), their deposits are insured by the FDIC, and they
have chosen not to become members of the Federal Reserve System. The Banks have
no subsidiaries. Consequently, the Banks are subject to the supervision of, and
are regularly examined by, the Commissioner and the FDIC. Such supervision and
regulation include comprehensive reviews of all major aspects of the Banks'
business and condition, including their capital ratios, allowance for possible
loan losses and other factors. However, no inference should be drawn that such
authorities have approved any such factors. The Company and the Banks are
required to file reports with the Commissioner, the FDIC and the Board of
Governors and provide such additional information as the Commissioner, FDIC and
the Board of Governors may require.
The Company is a bank holding company within the meaning of the Bank
Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is
registered as such with, and subject to the supervision of, the Board of
Governors. The Company is required to obtain the approval of the Board of
Governors before it may acquire all or substantially all of the assets of any
bank, or ownership or control of the voting shares of any bank if, after giving
effect to such acquisition of shares, the Company would own or control more than
5% of the voting shares of such bank. The Bank Holding Company Act prohibits the
Company from acquiring any voting shares of, or interest in, all or
substantially all of the assets of, a bank located outside the State of
California unless such an acquisition is specifically authorized by the laws of
the state in which such bank is located. Any such interstate acquisition is also
subject to the provisions of the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 discussed below.
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The Company, and any subsidiaries which it may acquire or organize, are
deemed to be "affiliates" of the Banks within the meaning of that term as
defined in the Federal Reserve Act. This means, for example, that there are
limitations (a) on loans by the Banks to affiliates, and (b) on investments by
the Banks in affiliates' stock as collateral for loans to any borrower. The
Company and its subsidiary are also subject to certain restrictions with respect
to engaging in the underwriting, public sale and distribution of securities.
In addition, regulations of the Board of Governors promulgated under the
Federal Reserve Act require that reserves be maintained by the Banks in
conjunction with any liability of the Company under any obligation (promissory
note, acknowledgement of advance, banker's acceptance or similar obligation)
with a weighted average maturity of less than seven (7) years to the extent that
the proceeds of such obligations are used for the purpose of supplying funds to
the Banks for use in its banking business, or to maintain the availability of
such funds.
The Board of Governors and the FDIC have adopted risk-based capital
guidelines for evaluating the capital adequacy of bank holding companies and
banks. The guidelines are designed to make capital requirements sensitive to
differences in risk profiles among banking organizations, to take into account
off-balance sheet exposures and to aid in making the definition of bank capital
uniform internationally. Under the guidelines, the Company and the Banks are
required to maintain capital equal to at least 8.0% of its assets and
commitments to extend credit, weighted by risk, of which at least 4.0% must
consist primarily of common equity (including retained earnings) and the
remainder may consist of subordinated debt, cumulative preferred stock, or a
limited amount of loan loss reserves.
Assets, commitments to extend credit, and off-balance sheet items are
categorized according to risk and certain assets considered to present less risk
than others permit maintenance of capital at less than the 8% ratio. For
example, most home mortgage loans are placed in a 50% risk category and
therefore require maintenance of capital equal to 4% of such loans, while
commercial loans are placed in a 100% risk category and therefore require
maintenance of capital equal to 8% of such loans.
The guidelines establish two categories of qualifying capital: Tier 1
capital comprising core capital elements, and Tier 2 comprising supplementary
capital requirements. At least one-half of the required capital must be
maintained in the form of Tier 1 capital. Tier 1 capital includes common
shareholders' equity and qualifying perpetual preferred stock. However, no more
than 25% of the Company's total Tier 1 capital may consist of perpetual
preferred stock. The definition of Tier 1 capital for the Banks is the same,
except that perpetual preferred stock may be included only if it is
noncumulative. Tier 2 capital includes, among other items, limited life (and in
the case of banks, cumulative) preferred stock, mandatory convertible
securities, subordinated debt and a limited amount of reserve for credit losses.
The Board of Governors and the FDIC also adopted minimum leverage ratios
for banking organizations as a supplement to the risk-weighted capital
guidelines. The leverage ratio is generally calculated using Tier 1 capital (as
defined under risk-based capital guidelines) divided by quarterly average net
total assets (excluding intangible assets and certain other adjustments). The
leverage ratio establishes a limit on the ability of banking organizations,
including the Company and the Banks, to increase assets and liabilities without
increasing capital proportionately.
The Board of Governors emphasized that the leverage ratio constitutes a
minimum requirement for well-run banking organizations having diversified risk,
including no undue interest rate risk exposure, excellent asset quality, high
liquidity, good earnings and a composite rating of 1 under the regulatory rating
system for banks and 1 under the regulatory rating system for bank holding
companies. Banking organizations experiencing or anticipating significant
growth, as well as those organizations which do not exhibit the characteristics
of a strong, well-run banking organization described above, will be required to
maintain minimum capital ranging generally from 100 to 200 basis points in
excess of the leverage ratio. The FDIC adopted a substantially similar leverage
ratio for state non-member banks which established (i) a 3 percent Tier 1
minimum capital leverage ratio for highly-rated banks (those with a composite
regulatory rating of 1 and not experiencing or anticipating significant growth);
and (ii) a 4 percent Tier 1 minimum capital leverage ratio for all other banks,
as a supplement to the risk-based capital guidelines.
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At December 31, 1997, the Banks and the Company are in compliance with the
risk-based capital and leverage ratios described above. See Item 7 below for a
listing of the Company's risk-based capital ratios at December 31, 1997 and
1996.
The Company's ability to pay cash dividends is subject to restrictions set
forth in the California General Corporation Law. Funds for payment of any cash
dividends by the Company would be obtained from its investments as well as
dividends and/or management fees from the Banks. The payment of cash dividends
and/or management fees by the Banks is subject to restrictions set forth in the
California Financial Code, as well as restrictions established by the FDIC. See
Item 5 below for further information regarding the payment of cash dividends by
the Company and the Banks.
Competition
At December 31, 1997, there were 34 branches of commercial and savings
banks in the cities of Castroville, Gonzales, King City, Marina, Salinas,
Seaside and the Monterey Peninsula. Additionally, the Banks compete with savings
and loan associations and, to a lesser extent, credit unions, finance companies
and other financial service providers for deposit and loan customers.
Larger banks may have a competitive advantage because of higher lending
limits and major advertising and marketing campaigns. They also perform
services, such as trust services, international banking, discount brokerage and
insurance services which the Banks are not authorized or prepared to offer
currently. The Banks have made arrangements with their correspondent banks and
with others to provide such services for its customers. For borrowers requiring
loans in excess of the Banks' legal lending limits, the Banks have offered, and
intend to offer in the future, such loans on a participating basis with its
correspondent banks and with other independent banks, retaining the portion of
such loans which is within their lending limits. As of December 31, 1997, the
Banks' aggregate legal lending limits to a single borrower and such borrower's
related parties were $6,910,000 on an unsecured basis and $11,516,000 on a fully
secured basis based on regulatory capital of $46,064,000.
Each Bank's business is concentrated in its service area, which primarily
encompasses Monterey County, including the Salinas Valley area and to a lesser
extent, the contiguous areas of San Benito County, Southern Santa Cruz County,
and Santa Clara County. The economy of the Bank of Salinas's service area is
primarily dependent upon the agricultural industry. Consequently, Bank of
Salinas competes with other financial institutions for deposits from and loans
to individuals and companies who are also dependent upon the agricultural
industry. The economy of Cypress Bank's service area is primarily dependent on
the tourist supported small business industry. Cypress Bank competes with other
financial institutions located in their own communities and in surrounding
communities.
Based upon data as of the most recent practicable date (June 30, 1997(1)),
there were 76 operating commercial and savings bank branches in Monterey County
with total deposits of $3,470,353,000. The Banks held a total of $450,301,000 in
deposits, representing approximately 13.0% of total commercial and savings banks
deposits in Monterey County as of June 30, 1997. Of the Banks' competitors,
three are independent banks headquartered in Monterey County. The Banks also
compete with savings and loans associations in Monterey County.
In order to compete with the major financial institutions in their primary
service areas, the Banks use to the fullest extent possible the flexibility
which is accorded by their independent status. This includes an emphasis on
specialized services, local promotional activity, and personal contacts by the
Banks' officers, directors and employees. The Banks also seek to provide special
services and programs for individuals in its primary service area who are
employed in the agricultural, professional and business fields, such as loans
for equipment, furniture, tools of the trade or expansion of practices or
businesses. In the event there are customers whose loan demands exceed the
Banks' lending limits, the Banks seek to arrange for such loans on a
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1"Data Book Summary of Deposits in all FDIC Insured Commercial and Savings
Banks", June 30, 1997
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participation basis with other financial institutions. The Banks also assist
those customers requiring services not offered by the Banks to obtain such
services from correspondent banks.
Banking is a business which depends on interest rate differentials. In
general, the difference between the interest rate paid by the Banks to obtain
their deposits and other borrowings and the interest rate received by the Banks
on loans extended to customers and on securities held in the Banks' portfolio
comprise the major portion of the Banks' earnings.
Commercial banks compete with savings and loan associations, credit unions,
other financial institutions and other entities for funds. For instance, yields
on corporate and government debt securities and other commercial paper affect
the ability of commercial banks to attract and hold deposits. Commercial banks
also compete for loans with savings and loan associations, credit unions,
consumer finance companies, mortgage companies and other lending institutions.
The interest rate differentials of the Banks, and therefore their earnings,
are affected not only by general economic conditions, both domestic and foreign,
but also by the monetary and fiscal policies of the United States as set by
statutes and as implemented by federal agencies, particularly the Federal
Reserve Board. This agency can and does implement national monetary policy, such
as seeking to curb inflation and combat recession, by its open market operations
in United States government securities, adjustments in the amount of interest
free reserves that banks and other financial institutions are required to
maintain, and adjustments to the discount rates applicable to borrowing by banks
from the Federal Reserve Board. These activities influence the growth of bank
loans, investments and deposits and also affect interest rates charged on loans
and paid on deposits. The nature and timing of any future changes in monetary
policies and their impact on the Banks are not predictable.
On December 19, 1991, President Bush signed the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"). The FDICIA substantially revised
banking regulations, certain aspects of the Federal Deposit Insurance Act and
established a framework for determination of capital adequacy of financial
institutions, among other matters. Under the FDICIA, financial institutions are
placed into five capital adequacy categories as follows: (1) well capitalized,
(2) adequately capitalized, (3) undercapitalized, (4) significantly
undercapitalized, and (5) critically undercapitalized. The FDICIA authorized the
Board of Governors, the Comptroller and FDIC to establish limits below which
financial institutions will be deemed critically undercapitalized, provided that
such limits can not be less than two percent (2%) of the ratio of tangible
equity to total assets or sixty-five percent (65%) of the minimum leverage ratio
established by regulation. Financial institutions classified as undercapitalized
or below are subject to limitations including restrictions related to (i) growth
of assets, (ii) payment of interest on subordinated indebtedness, (iii) capital
distributions, and (iv) payment of management fees to a parent holding company.
The FDICIA requires the Board of Governors and FDIC to initiate corrective
action regarding financial institutions which fail to meet minimum capital
requirements. Such action may result in orders to augment capital such as
through sale of voting stock, reduction in total assets, and restrictions
related to correspondent bank deposits. Critically undercapitalized financial
institutions may also be subject to appointment of a receiver or conservator
unless the financial institution submits an adequate capitalization plan.
In 1995 the FDIC, pursuant to Congressional mandate, reduced bank deposit
insurance assessment rates to a range from $0 to $0.27 per $100 of deposits,
dependent upon a bank's risk. Based upon the above risk-based assessment rate
schedule, the Banks' current capital ratios and the Banks' current levels of
deposits, the Banks anticipate no change in the assessment rate applicable to
the Banks during 1998 from that in 1997.
The Board of Governors and FDIC adopted regulations effective December 19,
1992, implementing a system of prompt corrective action pursuant to Section 38
of the Federal Deposit Insurance Act and Section 131 of the FDICIA. The
regulations establish five capital categories with the following
characteristics: (1) "Well capitalized" -- consisting of institutions with a
total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital
ratio of 6% or greater and a leverage ratio of 5% or greater, and the
institution is not subject to an order, written agreement, capital directive or
prompt corrective action directive; (2) "Adequately capitalized" -- consisting
of institutions with a total risk-based capital ratio of 8% or greater, a Tier 1
risk-
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based capital ratio of 4% or greater and a leverage ratio of 4% or greater, and
the institution does not meet the definition of a "well capitalized'
institution; (3) "Undercapitalized" -- consisting of institutions with a total
risk-based capital ratio less than 8%, a Tier 1 risk-based capital ratio of less
than 4%, or a leverage ratio of less than 4%; (4) "Significantly
undercapitalized" -- consisting of institutions with a total risk-based capital
ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a
leverage ratio of less than 3%; (5) "Critically undercapitalized" -- consisting
of an institution with a ratio of tangible equity to total assets that is equal
to or less than 2%.
The regulations established procedures for classification of financial
institutions within the capital categories, filing and reviewing capital
restoration plans required under the regulations and procedures for issuance of
directives by the appropriate regulatory agency, among other matters. The
regulations impose restrictions upon all institutions to refrain from certain
actions which would cause an institution to be classified within any one of the
three "undercapitalized" categories, such as declaration of dividends or other
capital distributions or payment of management fees, if following the
distribution or payment the institution would be classified within one of the
"undercapitalized" categories. In addition, institutions which are classified in
one of the three "undercapitalized" categories are subject to certain mandatory
and discretionary supervisory actions. Mandatory supervisory actions include (1)
increased monitoring and review by the appropriate federal banking agency; (2)
implementation of a capital restoration plan; (3) total asset growth
restrictions; and (4) limitation upon acquisitions, branch expansion, and new
business activities without prior approval of the appropriate federal banking
agency. Discretionary supervisory actions may include (1) requirements to
augment capital; (2) restrictions upon affiliate transactions; (3) restrictions
upon deposit gathering activities and interest rates paid; (4) replacement of
senior executive officers and directors; (5) restrictions upon activities of the
institution and its affiliates; (6) requiring divestiture or sale of the
institution; and (7) any other supervisory action that the appropriate federal
banking agency determines is necessary to further the purposes of the
regulations. Further, the federal banking agencies may not accept a capital
restoration plan without determining, among other things, that the plan is based
on realistic assumptions and is likely to succeed in restoring the depository
institution's capital. In addition, for a capital restoration plan to be
acceptable, the depository institution's parent holding company must guarantee
that the institution will comply with such capital restoration plan. The
aggregate liability of the parent holding company under the guaranty is limited
to the lesser of (i) an amount equal to 5 percent of the depository
institution's total assets at the time it became undercapitalized, and (ii) the
amount that is necessary (or would have been necessary) to bring the institution
into compliance with all capital standards applicable with respect to such
institution as of the time it fails to comply with the plan. If a depository
institution fails to submit an acceptable plan, it is treated as if it were
"significantly undercapitalized." FDICIA also restricts the solicitation and
acceptance of and interest rates payable on brokered deposits by insured
depository institutions that are not "well capitalized." An "undercapitalized"
institution is not allowed to solicit deposits by offering rates of interest
that are significantly higher than the prevailing rates of interest on insured
deposits in the particular institution's normal market areas or in the market
areas in which such deposits would otherwise be accepted.
Any financial institution which is classified as "critically
undercapitalized" must be placed in conservatorship or receivership within 90
days of such determination unless it is also determined that some other course
of action would better serve the purposes of the regulations. Critically
undercapitalized institutions are also prohibited from making (but not accruing)
any payment of principal or interest on subordinated debt without the prior
approval of the FDIC and the FDIC must prohibit a critically undercapitalized
institution from taking certain other actions without its prior approval,
including (1) entering into any material transaction other than in the usual
course of business, including investment expansion, acquisition, sale of assets
or other similar actions; (2) extending credit for any highly leveraged
transaction; (3) amending articles or bylaws unless required to do so to comply
with any law, regulation or order; (4) making any material change in accounting
methods; (5) engaging in certain affiliate transactions; (6) paying excessive
compensation or bonuses; and (7) paying interest on new or renewed liabilities
at rates which would increase the weighted average costs of funds beyond
prevailing rates in the institution's normal market areas.
The capital ratio requirements for the "adequately capitalized" category
generally are the same as the existing minimum risk-based capital ratios
applicable to the Company and the Banks. It is not possible to
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predict what effect the prompt corrective action regulation will have upon the
Company and the Banks or the banking industry taken as a whole in the
foreseeable future.
Under the FDICIA, the federal financial institution agencies have adopted
regulations which require institutions to establish and maintain comprehensive
written real estate policies which address certain lending considerations,
including loan-to-value limits, loan administrative policies, portfolio
diversification standards, and documentation, approval and reporting
requirements. FDICIA further generally prohibits an insured state bank from
engaging as a principal in any activity that is impermissible for a national
bank, absent FDIC determination that the activity would not pose a significant
risk to the Bank Insurance Fund, and that the bank is, and will continue to be,
within applicable capital standards. Similar restrictions apply to subsidiaries
of insured state banks. The Company does not currently intend to engage in any
activities which would be restricted or prohibited under the FDICIA.
The federal banking agencies during 1996 issued a joint agency policy
statement regarding the management of interest-rate risk exposure (interest rate
risk is the risk that changes in market interest rates might adversely affect a
bank's financial condition) with the goal of ensuring that institutions with
high levels of interest-rate risk have sufficient capital to cover their
exposures. This policy statement reflected the agencies' decision at that time
not to promulgate a standardized measure and explicit capital charge for
interest rate risk, in the expectation that industry techniques for measurement
of such risk will evolve.
However, the Federal Financial Institution Examination Counsel ("FFIEC") on
December 13, 1996, approved an updated Uniform Financial Institutions Rating
System ("UFIRS"). In addition to the five components traditionally included in
the so-called "CAMEL" rating system which has been used by bank examiners for a
number of years to classify and evaluate the soundness of financial institutions
(including capital adequacy, asset quality, management, earnings and liquidity),
UFIRS includes for all bank regulatory examinations conducted on or after
January 1, 1997, a new rating for a sixth category identified as sensitivity to
market risk. Ratings in this category are intended to reflect the degree to
which changes in interest rates, foreign exchange rates, commodity prices or
equity prices may adversely affect an institution's earnings and capital. The
rating system henceforth will be identified as the "CAMELS" system.
The federal financial institution agencies have established safety and
soundness standards for insured financial institutions covering (1) internal
controls, information systems and internal audit systems; (2) loan
documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset
growth; (6) compensation, fees and benefits; and (7) excessive compensation for
executive officers, directors or principal shareholders which could lead to
material financial loss. If an agency determines that an institution fails to
meet any standard, the agency may require the financial institution to submit to
the agency an acceptable plan to achieve compliance with the standard. If the
agency requires submission of a compliance plan and the institution fails to
timely submit an acceptable plan or to implement an accepted plan, the agency
must require the institution to correct the deficiency. Under the final rule, an
institution must file a compliance plan within 30 days of a request to do so
from the institution's primary federal regulatory agency. The agencies may elect
to initiate enforcement action in certain cases rather than rely on an existing
plan particularly where failure to meet one or more of the standards could
threaten the safe and sound operation of the institution.
The Board of Governors issued final amendments to its risk-based capital
guidelines to be effective December 31, 1994, requiring that net unrealized
holding gains and losses on securities available for sale determined in
accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," are not to be included in the Tier 1 capital component
consisting of common stockholders' equity. Net unrealized losses on marketable
equity securities (equity securities with a readily determinable fair value),
however, will continue to be deducted from Tier 1 capital. This rule has the
general effect of valuing available for sale securities at amortized cost (based
on historical cost) rather than at fair value (generally at market value) for
purposes of calculating the risk-based and leverage capital ratios.
On December 13, 1994, the Board of Governors issued amendments to its
risk-based capital guidelines regarding concentration of credit risk and risks
of non-traditional activities, which were effective January 17, 1995. As
amended, the risk-based capital guidelines identify concentrations of credit
risk and evaluate an
8
9
institution's ability to manage such risks and the risk posed by non-traditional
activities as important factors in assessing an institution's overall capital
adequacy.
Since 1986, California has permitted California banks and bank holding
companies to be acquired by banking organizations based in other states on a
"reciprocal" basis (i.e., provided the other state's laws permit California
banking organizations to acquire banking organizations in that state on
substantially the same terms and conditions applicable to local banking
organizations). Some increase in merger and acquisition activity among
California and out-of-state banking organizations has occurred as a result of
this law, as well as increased competition for loans and deposits.
Since October 2, 1995, California law implementing certain provisions of
prior federal law has (1) permitted interstate merger transactions; (2)
prohibited interstate branching through the acquisition of a branch business
unit located in California without acquisition of the whole business unit of the
California bank; and (3) prohibited interstate branching through de novo
establishment of California branch offices. Initial entry into California by an
out-of-state institution must be accomplished by acquisition of or merger with
an existing whole bank which has been in existence for at least five years.
Community Reinvestment Act ("CRA") regulations effective as of July 1, 1995
evaluate banks' lending to low and moderate income individuals and businesses
across a four-point scale from "outstanding" to "substantial noncompliance," and
are a factor in regulatory review of applications to merge, establish new
branches or form bank holding companies. In addition, any bank rated in
"substantial noncompliance" with the CRA regulations may be subject to
enforcement proceedings.
The Banks have a current rating of "satisfactory" or better for CRA
compliance.
Recently, the Federal banking agencies, especially the OCC and the Board of
Governors, have taken steps to increase the types of activities in which
national banks and bank holding companies can engage, and to make it easier to
engage in such activities. On November 20, 1996, the OCC issued final
regulations permitting national banks to engage in a wider range of activities
through subsidiaries. "Eligible institutions" (those national banks that are
well capitalized, have a high overall rating and a satisfactory CRA rating, and
are not subject to an enforcement order) may engage in activities related to
banking through operating subsidiaries after going through a new expedited
application process. In addition, the new regulations include a provision
whereby a national bank may apply to the OCC to engage in an activity through a
subsidiary in which the bank itself may not engage. This OCC regulation could be
advantageous to national banks depending on the extent to which the OCC permits
national banks to engage in new lines of business.
Certain legislative and regulatory proposals that could affect the Bank and
the banking business in general are pending or may be introduced before the
United States Congress, the California State Legislature and Federal and state
government agencies. The United States Congress is considering numerous bills
that could reform banking laws substantially. For example, proposed bank
modernization legislation under consideration would, among other matters include
a repeal of the Glass-Steagall Act restrictions on banks that now prohibit the
combination of commercial and investment banks.
It is not known to what extent, if any, the legislative proposals will be
enacted and what effect such legislation would have on the structure, regulation
and competitive relationships of financial institutions. It is likely, however,
that many of these proposals would subject the Company and the Banks to
increased regulation, disclosure and reporting requirements and would increase
competition and the Banks' cost of doing business.
In additional to pending legislative changes, the various banking
regulatory agencies frequently propose rules and regulations to implement and
enforce already existing legislation. It cannot be predicted whether or in what
form any such rules or regulations will be enacted or the effect that such and
regulations may have on the Company and the Banks.
9
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ITEM 2. PROPERTIES
The headquarters office and centralized operations of the Company are
located at 301 Main Street, Salinas, California.
Bank of Salinas is headquartered at 301 Main Street, Salinas, California,
with branch offices located at 301 Main Street, Salinas, California; 10601
Merritt Street, Castroville, California; 346 Alta Street, Gonzales, California;
and 532 Broadway, King City, California.
Cypress Bank is headquartered at 1658 Fremont Boulevard in Seaside,
California, with branch offices located at 228 Reservation Road, Marina,
California and 484 Lighthouse Avenue, Monterey, California. The Marina office is
leased from a joint venture that includes affiliates of Central Coast Bancorp.
In addition to the monthly rental expense, the Bank paid to the joint venture
$18,000 for a security deposit and $12,000 for the January 1994 and last three
months rent.
In addition to the branch facilities owned by the Company in Castroville
and Gonzales, the Company operates its headquarters and other branch offices
under facilities leases which expire in November 1998 through February 2000,
with options to extend for three to fifteen years. These include facilities
leased from a shareholder and from directors at terms and conditions which
management believes are consistent with the commercial lease market. Rental
rates are adjusted annually for changes in certain economic indices. The annual
minimum lease commitments are set forth in Footnote 7 of Item 8 Financial
Statements and Supplementary Data included in this report and incorporated
herein by reference. The forgoing description of the Lease Agreements is
qualified by reference to the Lease Agreements included in Exhibits listed in
Part IV of this Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
There are no material proceedings adverse to the Company or the Banks to
which any director, officer, affiliate of the Company or 5% shareholder of the
Company or the Banks, or any associate of any such director, officer, affiliate
or 5% shareholder of the Company or Banks are a party, and none of the above
persons has a material interest adverse to the Company or the Banks.
Neither the Company nor the Banks are a party to any pending legal or
administrative proceedings (other than ordinary routine litigation incidental to
the Company's or the Banks' business) and no such proceedings are known to be
contemplated.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(A) Market Information
There is limited trading in and no established public trading market for
the Company's common stock. The Company's common stock is not listed on any
exchange. Hoefer & Arnett, Incorporated and Ryan Beck are registered as market
makers in the Company's stock. Dean Witter Reynolds, Smith Barney and Paine
Webber also facilitate trades in the Company's common stock. Based on
information provided to the Company from Dean Witter Reynolds and Smith Barney,
the range of high and low bids for the common stock for the two most recent
fiscal years, restated to reflect all stock dividends and stock splits
distributed by the Company and the 10% stock dividend declared in January 1998,
are presented below.
CALENDAR YEAR LOW HIGH
------------- ------ ------
1997
First Quarter............................................ $14.32 $22.27
Second Quarter........................................... 15.45 21.25
Third Quarter............................................ 20.23 22.73
Fourth Quarter........................................... 17.50 20.57
1996
First Quarter............................................ $ 8.95 $ 9.65
Second Quarter........................................... 9.36 10.46
Third Quarter............................................ 10.45 11.52
Fourth Quarter........................................... 11.52 13.34
The bid price for the Company's common stock was $21.00 as of January 31,
1998.
(B) Holders
As of January 31, 1998, there were approximately 1,261 holders of the
common stock of the Company. There are no other classes of common equity
outstanding.
(C) Dividends
The Company's shareholders are entitled to receive dividends when and as
declared by its Board of Directors, out of funds legally available therefor,
subject to the restrictions set forth in the California General Corporation Law
(the "Corporation Law"). The Corporation Law provides that a corporation may
make a distribution to its shareholders if the corporation's retained earnings
equal at least the amount of the proposed distribution. The Corporation Law
further provides that, in the event that sufficient retained earnings are not
available for the proposed distribution, a corporation may nevertheless make a
distribution to its shareholders if it meets two conditions, which generally
stated are as follows: (1) the corporation's assets equal at least 1 1/4 times
its liabilities; and (2) the corporation's current assets equal at least its
current liabilities or, if the average of the corporation's earnings before
taxes on income and before interest expenses for the two preceding fiscal years
was less than the average of the corporation's interest expenses for such fiscal
years, then the corporation's current assets must equal at least 1 1/4 times its
current liabilities. Funds for payment of any cash dividends by the Company
would be obtained from its investments as well as dividends and/or management
fees from the Banks.
The payment of cash dividends by the subsidiary Banks is subject to
restrictions set forth in the California Financial Code (the "Financial Code").
The Financial Code provides that a bank may not make a cash distribution to its
shareholders in excess of the lesser of (a) the bank's retained earnings; or (b)
the bank's net income for its last three fiscal years, less the amount of any
distributions made by the bank or by any majority-owned subsidiary of the bank
to the shareholders of the bank during such period. However, a bank may, with
the approval of the Commissioner, make a distribution to its shareholders in an
amount not exceeding the greater of (a) its retained earnings; (b) its net
income for its last fiscal year; or (c) its net income for its
11
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current fiscal year. In the event that the Commissioner determines that the
shareholders' equity of a bank is inadequate or that the making of a
distribution by the bank would be unsafe or unsound, the Commissioner may order
the bank to refrain from making a proposed distribution.
The FDIC may also restrict the payment of dividends if such payment would
be deemed unsafe or unsound or if after the payment of such dividends, the bank
would be included in one of the "undercapitalized" categories for capital
adequacy purposes pursuant to the Federal Deposit Insurance Corporation
Improvement Act of 1991. Additionally, while the Board of Governors has no
general restriction with respect to the payment of cash dividends by an
adequately capitalized bank to its parent holding company, the Board of
Governors might, under certain circumstances, place restrictions on the ability
of a particular bank to pay dividends based upon peer group averages and the
performance and maturity of the particular bank, or object to management fees on
the basis that such fees cannot be supported by the value of the services
rendered or are not the result of an arm's length transaction.
Under these provisions and considering minimum regulatory capital
requirements, the amount available for distribution from the Banks to the
Company was approximately $15,034,000 as of December 31, 1997.
To date, the Company has not paid a cash dividend and presently does not
intend to pay cash dividends in the foreseeable future. The Company distributed
a ten percent stock dividend in 1998, a three-for-two stock split in 1997, a ten
percent stock dividend in 1996 and a twelve percent stock dividend in 1995. The
Board of Directors will determine payment of dividends in the future after
consideration of various factors including the profitability and capital
adequacy of the Company and the Banks.
12
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ITEM 6. SELECTED FINANCIAL DATA
The following table presents certain consolidated financial information
concerning the business of the Company and its subsidiary Banks. This
information should be read in conjunction with the Consolidated Financial
Statements, the notes thereto, and Management's Discussion and Analysis included
in this report.
YEARS ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(DOLLARS AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING RESULTS
Total Interest Income............... $ 33,916 $ 29,301 $ 26,964 $ 21,646 $ 18,492
Total Interest Expense.............. 12,041 9,859 10,008 7,071 6,198
-------- -------- -------- -------- --------
Net Interest Income....... 21,875 19,442 16,956 14,575 12,294
Provision for Credit Losses......... 64 352 695 1,745 915
-------- -------- -------- -------- --------
Net Interest Income After Provision
for Credit Losses................. 21,811 19,090 16,261 12,830 11,379
Other Income........................ 1,765 1,456 1,302 1,315 1,384
Other Expenses...................... 12,573 11,115 10,263 9,170 8,546
-------- -------- -------- -------- --------
Income before Income Taxes.......... 11,003 9,431 7,300 4,975 4,217
Income Taxes........................ 4,500 3,571 2,975 2,046 1,760
-------- -------- -------- -------- --------
NET INCOME.......................... $ 6,503 $ 5,860 $ 4,325 $ 2,929 $ 2,457
======== ======== ======== ======== ========
BASIC EARNINGS PER SHARE(1)......... $ 1.36 $ 1.26 $ 0.94 $ 0.66 $ 0.56
DILUTED EARNINGS PER SHARE(1)....... 1.26 1.18 0.88 0.63 0.53
FINANCIAL CONDITION AND CAPITAL --
YEAR-END BALANCES
Net Loans........................... $251,271 $235,992 $191,000 $179,266 $181,250
Total Assets........................ 497,674 376,832 357,236 310,362 269,820
Deposits............................ 450,301 338,663 326,089 283,823 247,112
Shareholders' Equity................ 43,724 36,332 29,916 25,547 21,932
FINANCIAL CONDITION AND CAPITAL --
AVERAGE BALANCES
Net Loans........................... $238,793 $203,117 $173,065 $179,514 $169,829
Total Assets........................ 441,013 355,386 329,502 290,166 265,935
Deposits............................ 396,457 319,110 300,291 265,512 234,228
Shareholders' Equity................ 39,969 33,228 27,684 23,691 20,670
SELECTED FINANCIAL RATIOS
Rate of Return on:
Average Total Assets.............. 1.47% 1.65% 1.31% 1.01% 0.92%
Average Shareholders' Equity...... 16.27% 17.64% 15.62% 12.36% 11.89%
Rate of Average Shareholders' Equity
to Total Average Assets........... 9.06% 9.35% 8.40% 8.16% 7.77%
- ---------------
(1) Earnings per share data has been restated to reflect the adoption of
Statement of Financial Accounting Standards No. 128.
(A) (1) Distribution of Assets, Liabilities and Equity; Interest Rates and
Interest Differential
Table I in Management's Discussion and Analysis included in this
report sets forth the Company's average balance sheets (based on daily
averages) and an analysis of interest rates and the interest rate
differential for each of the three years in the period ended December
31, 1997 and is hereby incorporated by reference.
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(2) Volume/Rate Analysis
Information as to the impact of changes in average rates and
average balances on interest earning assets and interest bearing
liabilities is shown in the table below. The variances attributed to
simultaneous balance and rate changes have been reflected as rate
variances.
VOLUME/RATE ANALYSIS
(IN THOUSANDS) 1997 OVER 1996
Increase (decrease) due to change in:
NET
VOLUME RATE CHANGE
------ ------- ------
INTEREST-EARNING ASSETS:
Net Loans(1)(2)(3)........................................ $3,924 $(1,426) $2,498
Investment securities..................................... 1,006 (119) 887
Federal funds sold & other................................ 1,080 150 1,230
------ ------- ------
Total............................................. 6,010 (1,395) 4,615
------ ------- ------
INTEREST-BEARING LIABILITIES:
Demand deposits........................................... 393 (141) 252
Savings deposits.......................................... (296) (132) (428)
Time deposits............................................. 2,214 46 2,260
Other Borrowings.......................................... 98 -- 98
------ ------- ------
Total............................................. 2,409 (227) 2,182
------ ------- ------
Interest differential....................................... $3,601 $(1,168) $2,433
====== ======= ======
(IN THOUSANDS) 1996 OVER 1995
Increase (decrease) due to change in:
NET
VOLUME RATE CHANGE
------ ------- ------
INTEREST-EARNING ASSETS:
Net loans(1)(2)(3)........................................ $3,426 $ (809) $2,617
Investment securities..................................... 222 194 416
Federal funds sold & other................................ (474) (222) (696)
------ ------- ------
Total............................................. 3,174 (837) 2,337
------ ------- ------
INTEREST-BEARING LIABILITIES:
Demand deposits........................................... (90) (190) (280)
Savings deposits.......................................... (392) (388) (780)
Time deposits............................................. 818 93 911
------ ------- ------
Total............................................. 336 (485) (149)
------ ------- ------
Interest differential....................................... $2,838 $ (352) $2,486
====== ======= ======
- ---------------
(1) The average balance of non-accruing loans is immaterial as a percentage of
total loans and, as such, has been included in net loans.
(2) Loan fees of $1,037,000, $901,000 and $769,000 for the years ended December
31, 1997, 1996 and 1995, respectively have been included in the interest
income computation.
(3) Rate variance includes impact of interest income recognized from payments
received on nonaccrual loans of $619,000 in 1996.
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(B) Investment Portfolio
(1) The book value of investment securities at December 31, 1997, 1996
and 1995 is set forth in Table III of Management's Discussion and Analysis
included in this report and incorporated herein by reference.
(2) The book value, maturities and weighted average yields of
investment securities as of December 31, 1997 are set forth in Table III of
Management's Discussion and Analysis included in this report and
incorporated herein by reference.
(3) There were no issuers of securities for which the book value was
greater than 10% of shareholders' equity other than U.S. Government and
U.S. Government Agencies and Corporations.
(C) Loan Portfolio
(1) The composition of the loan portfolio is summarized in Table IV of
Management's Discussion and Analysis included in this report and is
incorporated herein by reference.
(2) The following table sets forth the maturity distribution of the
loan portfolio at December 31, 1997:
ONE YEAR
ONE YEAR THROUGH OVER
OR LESS FIVE YEARS FIVE YEARS TOTAL
----------- ----------- ----------- ------------
(IN THOUSANDS)
Commercial, financial and
agricultural............... $63,907,000 $45,420,000 $16,640,000 $125,967,000
Real estate --
construction............... 14,121,000 524,000 -- 14,645,000
Real estate -- other......... 15,187,000 45,523,000 46,866,000 107,576,000
Installment.................. 6,427,000 2,623,000 155,000 9,205,000
----------- ----------- ----------- ------------
Total.............. $99,642,000 $94,090,000 $63,661,000 $257,393,000
=========== =========== =========== ============
Loans shown above with maturities greater than one year include
$114,231,000 of floating interest rate loans and $43,520,000 of
fixed rate loans.
(3) Nonperforming Loans
The Company's current policy is to cease accruing interest when a loan
becomes 90 days past due as to principal or interest, when the full timely
collection of interest or principal becomes uncertain or when a portion of the
principal balance has been charged off, unless the loan is well secured and in
the process of collection. When a loan is placed on nonaccrual status, the
accrued and uncollected interest receivable is reversed and the loan is
accounted for on the cash or cost recovery method thereafter, until qualifying
for return to accrual status. Generally, a loan may be returned to accrual
status when all delinquent interest and principal become current in accordance
with the terms of the loan agreement or when the loan is both well secured and
in process of collection.
For further discussion of nonperforming loans, refer to Risk Elements
section of Management Discussion Analysis in this report.
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(D) Summary of Loan Loss Experience
(1) An analysis of the allowance for loan losses follows:
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996 1995 1994 1993
------------- ------------- ------------- ------------- -------------
(IN THOUSANDS)
Average loans
outstanding............ $243,593 $207,556 $177,476 $182,812 $172,412
-------- -------- -------- -------- --------
Allowance for possible
credit losses at
beginning of period.... $ 4,372 $ 4,446 $ 4,068 $ 2,840 $ 2,371
Loans charged off:
Real estate............ (100) (207) (52) (45) (46)
Installment............ (61) (22) (80) (125) (164)
Commercial............. (279) (391) (302) (413) (404)
-------- -------- -------- -------- --------
(440) (620) (434) (583) (614)
-------- -------- -------- -------- --------
Recoveries of loans
previously charged off:
Real estate............ 28 11 -- -- --
Installment............ 37 27 29 35 75
Commercial............. 162 156 88 31 93
-------- -------- -------- -------- --------
227 194 117 66 168
-------- -------- -------- -------- --------
Net loans charged off.... (213) (426) (317) (517) (446)
Additions to allowance
charged to operating
expenses............... 64 352 695 1,745 915
-------- -------- -------- -------- --------
Allowance for possible
loans losses at end of
period................. $ 4,223 $ 4,372 $ 4,446 $ 4,068 $ 2,840
======== ======== ======== ======== ========
Ratio of net charge-offs
to average loans
outstanding............ 0.09% 0.21% 0.18% 0.28% 0.26%
Factors used in determination of the allowance for loan losses are
discussed in greater detail in the "Risk Elements" section of Management's
Discussion and Analysis included in this report and are incorporated herein
by reference.
(2) In evaluating the adequacy of the allowance for loan losses, the
Company attempts to allocate the allowance for loan losses to specific
categories of loans. Management believes that any breakdown or allocation
of the allowance for possible loan losses into loan categories lends an
appearance of exactness which does not exist in that the allowance is
utilized as a single unallocated allowance available for all loans.
Further, management believes that the breakdown of historical losses in the
preceding table is a reasonable representation of management's expectation
of potential losses in the next full year of operation. However, the
allowance for loan losses should not be interpreted as an indication of
when charge-offs will occur or as an indication of future charge-off
trends.
(E) Deposits
(1) Table I in Management's Discussion and Analysis included in this
report sets forth the distribution of average deposits for the years ended
December 31, 1997, 1996 and 1995 and is incorporated herein by reference.
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(2) The maturities of time certificates of deposit of $100,000 or more
at December 31, 1997 are summarized as follows:
YEAR ENDED
DECEMBER 31,
1997
------------
Three months or less........................................ $25,020,000
Over three months through six months........................ 18,629,000
Over six months through twelve months....................... 24,966,000
Over twelve months.......................................... 17,829,000
-----------
Total............................................. $86,444,000
===========
3(F) Return on Equity and Assets
(1) The table at page 13 of this section sets forth the ratios of net
income to average assets and average shareholders' equity, and average
shareholders' equity to average assets. As the Company has never paid a
cash dividend, the dividend payout ratio is not indicated.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain matters discussed or incorporated by reference in this Annual
Report on Form 10-K are forward-looking statements that are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. Such risks and uncertainties include, but are not limited to, matters
described in Item 7 -- "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Therefore, the information set forth
therein should be carefully considered when evaluating the business prospects of
the Company and the Banks.
Business Organization
Central Coast Bancorp (the "Company"), a California corporation organized
in 1994, acts as the holding company for Bank of Salinas and Cypress Bank (the
"Banks"), state-chartered banks, headquartered in Salinas and Seaside,
California, respectively. As of December 31, 1997, the Banks operated seven
full-service branches and one limited-service branch in Monterey County,
California. Other than its investment in the Banks, the Company currently
conducts no other significant business activities, although it is authorized to
engage in a variety of activities which are deemed closely related to the
business of banking upon prior approval of the Board of Governors, the Company's
principal regulator.
The Banks offer a full range of commercial banking services, offering a
diverse range of traditional banking products and services to individuals,
merchants, small and medium-sized businesses, professionals and agribusiness
enterprises located in the Salinas Valley and the Monterey Peninsula.
On February 21, 1997, the Bank of Salinas purchased certain assets and
assumed certain liabilities of the Gonzales and Castroville branch offices of
Wells Fargo Bank. As a result of the transaction the Bank assumed deposit
liabilities, received cash, and acquired tangible assets. This transaction
resulted in intangible assets, representing the excess of the liabilities
assumed over the fair value of the tangible assets acquired.
In January 1997, Cypress Bank opened a new branch office in Monterey,
California, so that it might better serve business and individual customers on
the Monterey Peninsula.
The following analysis is designed to enhance the reader's understanding of
the Company's financial condition and the results of its operations as reported
in the Consolidated Financial Statements included in this Annual Report.
Reference should be made to those statements and the Selected Financial Data
presented elsewhere in this report for additional detailed information.
Overview
The Company earned net income of $6,503,000 for the year ended December 31,
1997, representing an increase of $643,000 or 11% over 1996 net income of
$5,860,000. Net income reported for 1996 represented an
17
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increase of $1,535,000 or 35% over 1995 net income of $4,325,000. Diluted
earnings per share for 1997 was $1.26 compared to $1.18 and $.88 per share for
the preceding two years. The improvement in net income in 1997 and 1996 was
primarily due to growth in net interest income and noninterest income that
outpaced increases in operating expenses. Net income in 1997 and 1996 also
benefited from lower provisions for loan losses compared with 1996 and 1995,
respectively. Each of these factors is discussed in more detail later in this
analysis.
Common shareholders' equity increased by $7,392,000 during 1997 to
$43,724,000 at December 31, 1997, primarily through the retention of earnings
and as the result of exercises of stock options and warrants and related tax
benefits. In 1996 and 1995, common shareholders' equity increased by $6,416,000
and $4,369,000 primarily through retention of earnings. It is the objective of
management to maintain adequate capital for future growth through retention of
earnings. The Company has never declared a cash dividend, however, it
distributed a three-for-two stock split in 1997, a ten percent stock dividend
during 1996 and a twelve percent stock dividend in the year ended December 31,
1995. Also, the Company declared a 10% stock dividend in January 1998 (to be
distributed on March 3, 1998, to shareholders of record as of February 17,
1998). Per share earnings have been adjusted to reflect such stock split and
stock dividends and any dilutive effect of common stock equivalents (stock
options and warrants outstanding but not exercised) calculated using the
treasury stock method as required by SFAS 128 "Earnings Per Share".
Earnings Summary
Net Interest Income -- Net interest income refers to the difference between
the interest paid on deposits and borrowings, and the interest earned on loans
and investments. It is the primary component of the net earnings of a financial
institution. The primary factors to consider in analyzing net interest income
are the composition and volume of earning assets and interest bearing
liabilities, the amount of noninterest bearing liabilities and nonaccrual loans,
and changes in market interest rates.
Net interest income for 1997 was $21,875,000, or 5.5% of average earning
assets, representing an increase of $2,433,000 or 12.5% over $19,442,000 and
6.0% of average earning assets in 1996. Net interest income reported in 1996
represented an increase of $2,486,000 or 14.7% from $16,956,000 in 1995. The
increases in the net interest income in 1997 and 1996 primarily reflect
increases in average earning assets in each of those years.
Interest income for 1997 was $33,916,000 compared to $29,301,000 and
$26,964,000 for 1996 and 1995, respectively. The increase in interest income in
1997 and 1996 is primarily due to growth in average earning assets. Average
earning assets were $398,416,000 in 1997 representing an increase of 22.5% over
$325,203,000 in 1996. Average earning assets in 1996 represented an increase of
8.6% over $299,417,000 in 1995. Loan yields averaged 10.4% in 1997 compared to
11.0% and 11.4% in 1996 and 1995, respectively. The trend in loan yields
generally corresponds to fluctuations in market interest rates during 1997 and
1996. In addition, interest income in 1996 included approximately $600,000 of
previously foregone interest collected on two loans that had been on nonaccrual
status. A majority of the Company's loan yields float with the prime rate. The
average prime rate was 8.44%, 8.27% and 8.82% in 1997, 1996 and 1995,
respectively.
Interest expense was $12,041,000 in 1997 representing an increase of
$2,182,000 or 22.1% from $9,859,000 in 1996. The increase in interest expense
was primarily due to growth in interest bearing core deposits. Average
interest-bearing liabilities of $302,166,000 in 1997 represented 75.9% of total
deposits compared to $249,233,000 or 78.1% of total deposits in 1996. Interest
expense for 1996 decreased $149,000 or 1.5% over $10,008,000 in 1995. The
decrease in interest expense in 1996 resulted from a decrease in the average
rate paid on average interest-bearing deposits which offset an increase in the
volume of such deposits.
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The following table sets forth average balance sheet information, interest
income and expense, average yields and rates, and net interest income and margin
for the years ended December 31, 1997, 1996 and 1995.
1997 1996 1995
--------------------------- --------------------------- ---------------------------
AVG AVG AVG AVG AVG AVG
BALANCE INTEREST YIELD BALANCE INTEREST YIELD BALANCE INTEREST YIELD
-------- -------- ----- -------- -------- ----- -------- -------- -----
IN THOUSANDS (EXCEPT PERCENTAGES)
ASSETS:
Earning Assets
Loans(1)(2)......................... $238,793 $24,828 10.4% $203,117 $22,330 11.0% $173,065.. $19,713 11.4%
Investment Securities............... 99,653 5,823 5.8% 82,883 4,936 6.0% 78,980 4,520 5.7%
Other............................... 59,970 3,265 5.4% 39,203 2,035 5.2% 47,372 2,731 5.8%
-------- ------- -------- ------- -------- -------
Total Earning Assets.................. 398,416 $33,916 8.5% 325,203 $29,301 9.0% 299,417 $26,964 9.0%
------- ------- -------
Cash & due from banks................. 33,144 22,867 23,198
Other assets.......................... 9,453 7,316 6,887
-------- -------- --------
$441,013 $355,386 $329,502
======== ======== ========
LIABILITIES & SHAREHOLDERS' EQUITY:
Interest bearing liabilities:
Demand deposits..................... $ 93,161 $ 1,881 2.0% $ 75,295 $ 1,629 2.2% $ 79,065 $ 1,909 2.4%
Savings............................. 95,767 3,875 4.0% 102,819 4,303 4.2% 111,351 5,083 4.6%
Time deposits....................... 111,370 6,187 5.6% 71,119 3,927 5.5% 55,966 3,016 5.4%
Other borrowings.................... 1,868 98 5.2% 0 0 n/a 0 0 n/a
-------- ------- -------- ------- -------- -------
Total interest bearing liabilities.... 302,166 12,041 4.0% 249,233 9,859 4.0% 246,382 10,008 4.1%
------- ------- -------
Demand deposits....................... 96,159 69,877 53,909
Other Liabilities..................... 2,719 3,048 1,527
-------- -------- --------
Total Liabilities..................... 401,044 322,158 301,818
Shareholders' Equity.................. 39,969 33,228 27,684
-------- -------- --------
$441,013 $355,386 $329,502
======== ======== ========
Net interest income & margin(3)....... $21,875 5.5% $19,442 6.0% $16,956 5.7%
======= ===== ======= ==== ======= ====
- ---------------
(1) Loans interest includes loan fees of $1,037,000, $901,000 and $769,000 in
1997, 1996 and 1995, and interest recognized from payments received from
payments on nonaccrual loans of $619,000 in 1996.
(2) Average balances of loans include average allowance for loan losses of
$4,229,000, $4,439,000 and $4,411,000, and average deferred loan fees of
$571,000, $613,000 and $536,000 for the years ended December 31, 1997, 1996
and 1995, respectively.
(3) Net interest margin is computed by dividing net interest income by total
average earning assets.
Other Income -- Other income growth is a key to improving overall
profitability in a deregulated competitive environment. Noninterest income
provides stability to the income stream and enhances overall profitability.
Total noninterest income was $1,765,000 for 1997, $1,456,000 for 1996 and
$1,302,000 for 1995. The Company's noninterest income is primarily derived from
fees earned by the Banks for deposit-related customer services. Income realized
from service charges on deposit accounts increased $341,000 or 46.4% to
$1,076,000 in 1997 over $735,000 in 1996. Service charge income for 1996
represented an increase of $59,000 or 8.7% over $676,000 recognized in 1995. The
increase in income from fees and service charges was largely the result of the
increase in deposit accounts as the Banks added more branches as well as growth
in the total number of interest bearing and noninterest bearing demand deposit
accounts at all branches.
The Company also earns income from the sale and servicing of SBA loans.
Income from the sale and servicing of such loans was $119,000 in 1997
representing a decrease of $42,000 or 26.1% over $161,000 recognized in 1996.
Sale and servicing income in 1996 increased $6,000 or 3.9% over $155,000 in
1995. The decreases and increases in income from the sale and servicing of SBA
loans in 1997 and 1996, respectively, were primarily due to decreases and
increases in the volume of loans sold.
Fees earned on merchant credit card transactions decreased $1,000 or 0.7%
to $150,000 in 1997 from $151,000 in 1996. In 1996, merchant card fees
represented a decrease of $30,000 or 16.6% over $181,000 in 1995. Fluctuations
in merchant card fees are primarily due to fluctuations in merchant retail sales
volumes.
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20
Mortgage origination fees increased $19,000 or 18.3% to $123,000 for 1997
from $104,000 in 1996. In 1996, mortgage origination fees increased $15,000 or
16.9% from $89,000 in 1995. The increases in 1997 and 1996 were due to increases
in the volume of mortgage applications processed as a response to lower market
interest rates.
Other Expense -- Noninterest expense reflects the costs of products and
services, systems, facilities and personnel for the Company. The major
components of other expense stated as a percentage of average earning assets are
as follows:
TABLE II OTHER OPERATING EXPENSE TO AVERAGE EARNING ASSETS
1997 1996 1995
---- ---- ----
Salaries and benefits.................................. 1.90% 1.98% 1.81%
Occupancy.............................................. 0.22% 0.22% 0.25%
Furniture and equipment................................ 0.20% 0.26% 0.22%
Stationary and supplies................................ 0.12% 0.10% 0.08%
Professional fees...................................... 0.09% 0.14% 0.22%
Customer expenses...................................... 0.09% 0.12% 0.07%
Data processing........................................ 0.08% 0.10% 0.09%
Marketing.............................................. 0.08% 0.11% 0.09%
Shareholder and director............................... 0.06% 0.09% 0.06%
Amortization of intangibles............................ 0.05% 0.00% 0.00%
Insurance.............................................. 0.05% 0.05% 0.07%
Dues and assessments................................... 0.03% 0.02% 0.16%
Net cost of other real estate owned.................... 0.00% 0.00% 0.07%
Other.................................................. 0.19% 0.23% 0.24%
---- ---- ----
Total........................................ 3.16% 3.42% 3.43%
==== ==== ====
Noninterest expense increased to $12,573,000 in the year ended December 31,
1997 over $11,115,000 and $10,263,000 for the same periods in 1996 and 1995. As
a percentage of average earning assets, noninterest expense decreased to 3.16%
in 1997 compared to 3.42% in 1996. Noninterest expense as a percentage of
average earning assets for 1996 represented a decrease from 3.43% in 1995.
Salaries and employee benefits expense for 1997 was $7,586,000, an increase
of 17.9% over $6,437,000 in 1996, and represented approximately 1.90% of average
earning assets. The increase in 1997 primarily reflects the impact of increased
headcount to accommodate growth in the Banks. Salaries and employee benefits
expense for 1996 represented an increase of $1,018,000 or 18.8% over $5,419,000
in 1995. Salaries and employee benefits in 1996 included approximately $175,000
of nonrecurring charges for restructuring related to the acquisition of Cypress
Bank and $250,000 for a salary continuation plan. The remaining increase was due
to increased headcount to accommodate growth and higher contributions to the
Company's profit sharing and employee retirement plans. As a percentage of
average earning assets, salaries and employee benefits expense was 1.98% in 1996
representing an increase from 1.81% in 1995.
Occupancy expense increased $161,000 or 22.1% to $889,000 in 1997 from
$728,000 in 1996 and compares to a decrease of $18,000 or 2.4% over $746,000 in
1995. As a percentage of average earning assets, occupancy expense was .22%
representing no change from .22% in 1996 and a decrease from .25% in 1995.
Furniture and equipment expenses of $800,000 in 1997 represented a decrease
of $37,000 or 4.4% over $837,000 in 1996. The decrease in 1997 was primarily due
to lower maintenance costs on equipment. Expense for 1996 represented an
increase of $165,000 or 24.6% from $672,000 in 1995. The increase in 1996 was
primarily due to a one-time charge of approximately $192,000 from restructuring
of operations in connection with the acquisition of Cypress Bank. Furniture and
equipment expenses represented .20%, .26% and .22% of average earning assets in
1997, 1996 and 1995, respectively.
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21
Other noninterest expenses were $3,298,000 in 1997 representing an increase
of $185,000 or 5.9% from 1996 expenses of $3,113,000. The increase in 1997 was
primarily related to increased supplies expenses and amortization of intangibles
related to the purchase of two branches in that year. Other noninterest expenses
for 1996 decreased $313,000 or 9.1% from $3,426,000 in 1995. The decrease in
1996 is primarily due to decreases in professional fees, deposit insurance
premiums and write-downs of other real estate owned.
The Company's effective income tax rate was 40.9% for 1997 compared to
37.9% for 1996 and 40.8% for 1995. The primary factor reducing the effective tax
rate of the Company in 1996 was a change in the valuation allowance for the
deferred tax assets of Cypress Bank.
Balance Sheet Analysis
Total assets of Central Coast Bancorp at December 31, 1997 were
$497,674,000 compared to $376,832,000 in 1996 and $357,236,000 in 1995,
representing increases of 32.1% and 5.5%, respectively. Based on average
balances, total assets of $441,013,000 in 1997 represent an increase of
$85,627,000 or 24.1% over $355,386,000 in 1996. Average total assets in 1996
represent an increase of $25,884,000 or 7.9% over 1995.
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22
Earning Assets
Investment Portfolio -- The scheduled maturities and weighted average
yields of the Company's investment securities portfolio as of December 31, 1997
and 1996 are as follows:
TABLE III MATURITY AND YIELDS OF INVESTMENT SECURITIES
WEIGHTED
AMORTIZED UNREALIZED UNREALIZED MARKET AVERAGE
COST GAIN LOSSES VALUE YIELD
--------- ---------- ---------- -------- --------
IN THOUSANDS (EXCEPT PERCENTAGES)
DECEMBER 31, 1997
AVAILABLE FOR SALE SECURITIES:
U.S. Treasury and agency securities
Maturing within 1 year..................... $ 32,861 $ -- $ 5 $ 32,856 5.68%
Maturing after 1 year but within 5 years... 48,410 184 7 48,587 6.16%
Bankers' Acceptances
Maturing within 1 year..................... 10,034 -- -- 10,034 5.05%
Other........................................ 4 -- -- 4 --
-------- ---- ---- -------- ----
Total available for sale........... $ 91,309 $184 $ 12 $ 91,481 5.87%
-------- ---- ---- -------- ----
HELD TO MATURITY SECURITIES:
U.S. Treasury and agency securities
Maturing within 1 year..................... $ 27,484 $ 7 $ 11 $ 27,480 5.60%
Maturing after 1 year but within 5 years... 8,495 66 2 8,559 6.34%
Maturing after 5 years but within 10
years................................... 20 -- -- 20 9.05%
Maturing after 10 years.................... 857 6 9 854 7.00%
State & Political Subdivision
Maturing after 5 Years but within 10
years................................... 2,192 -- -- 2,192 5.60%
-------- ---- ---- -------- ----
Total held to maturity............. $ 39,048 $ 79 $ 22 $ 39,105 5.79%
-------- ---- ---- -------- ----
Total investment securities.................. $130,357 $263 $ 34 $130,586 5.85%
======== ==== ==== ======== ====
DECEMBER 31, 1996
HELD TO MATURITY SECURITIES:
U.S. Treasury and agency securities
Maturing within 1 year..................... $ 29,358 $ 46 $ 9 $ 29,395 5.72%
Maturing after 1 year but within 5 years... 37,460 71 96 37,435 5.80%
Maturing after 10 years.................... 1,027 1 44 984 6.06%
Corporate Debt Securities
Maturing within 1 year..................... 3,028 -- 11 3,017 5.28%
Other........................................ 4 -- -- 4 --
-------- ---- ---- -------- ----
Total investment securities.................. $ 70,877 $118 $160 $ 70,835 5.75%
======== ==== ==== ======== ====
The Company designated securities with an estimated market value of
$91,481,000 as available-for-sale at December 31, 1997. The amortized cost on
that date of securities designated as available-for-sale was $91,309,000
reflecting a net available-for-sale adjustment of $172,000 or 0.2% of amortized
cost. No securities were designated as available-for-sale at December 31, 1996
and 1995. During the year ended December 31, 1997, the Company made purchases of
securities designated as available-for-sale of $154,353,000 to replace
$63,750,000 of maturities and to more fully employ excess liquidity.
Investment securities designated as held-to-maturity at December 31, 1997
were carried at an amortized cost of $39,048,000. The estimated market value of
the held-to-maturity portfolio on that date was $39,105,000 reflecting a net
unrealized gain of $57,000 or 0.1% of amortized cost. The book value of held-to-
maturity investment securities at the end of 1997 compared to $70,877,000 and
$79,643,000 at December 31,
22
23
1996 and 1995, respectively. During the year ended December 31, 1997, the
Company made purchases of securities designated as held-to-maturity of
$10,181,000 to replace $41,882,000 of maturities and to more fully employ excess
liquidity.
Fluctuations in the investment portfolio reflect funding needs for
anticipated and actual levels of loan demand. In 1997, investment balances
increased as growth in deposits outpaced growth in the loan portfolio.
Conversely, in 1996, the Company experienced growth in loan balances that
outpaced growth in deposits resulting in generally higher loan to deposit ratios
and lower liquidity as compared to 1997. It is the Banks' policy to invest
primarily in U.S. Treasury and U.S. Government Agency securities. Further, it is
management's intent to reduce the market valuation risk of the investment
portfolio by generally limiting the average life of portfolio maturities to 3
years or less.
There were no sales of investment securities in 1997, 1996 or 1995.
Loan Portfolio -- The following table summarizes the composition of the
loan portfolio for the past five years as of December 31:
TABLE IV ANALYSIS OF LOANS OUTSTANDING BY TYPE
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
IN THOUSANDS
Commercial.......................... $124,714 $111,545 $ 85,823 $ 78,627 $ 73,083
Installment......................... 9,349 8,230 5,677 6,445 7,384
Real Estate:
Construction...................... 14,645 27,997 24,852 24,076 30,159
Other............................. 107,354 93,241 79,644 74,769 74,075
-------- -------- -------- -------- --------
Total Loans............... 256,062 241,013 195,996 183,917 184,701
Allowance for
Credit Losses..................... (4,223) (4,372) (4,446) (4,068) (2,840)
Deferred Loans Fees............... (568) (649) (550) (583) (611)
-------- -------- -------- -------- --------
Total..................... $251,271 $235,992 $191,000 $179,266 $181,250
======== ======== ======== ======== ========
Average net loans in 1997 were $238,793,000 representing an increase of
$35,676,000 or 17.6% over 1996. Average net loans of $203,117,000 in 1996
represented an increase of $30,052,000 or 17.4% from $173,065,000 in 1995.
Average net loans comprised 59.9% of average earning assets in 1997 compared to
62.5% and 57.8% in 1996 and 1995, respectively.
Net loans outstanding at December 31, 1997 were $251,271,000, which
represented an increase of $15,279,000 or 6.5% over $235,992,000 on the same
date one year earlier. The overall composition of loan balances at December 31,
1997 compared to 1996 reflected strong growth in commercial and other real
estate loans, offsetting a slight decrease in construction loans. At December
31, 1996 net loans outstanding represented an increase of $44,992,000 or 23.6%
over $191,000,000 at December 31, 1995.
Commercial loans consist of credit lines for operating needs, loans for
equipment purchases and working capital, and various other business loan
products. At December 31, 1997, the Company had $124,714,000 in commercial loans
outstanding representing 48.7% of total gross loans compared to $111,545,000 and
46.3% and $85,823,000 and 43.8% at December 31, 1996 and 1995, respectively.
Fluctuations in commercial loan balances in 1997 and 1996 primarily reflect
cyclical changes in customer borrowing needs related to changes in the
agri-business sector of the local economy.
Installment loans include a range of traditional consumer loan products
offered by the Company such as personal lines of credit and loans to finance
purchases of autos, boats, recreational vehicles, mobile homes and various other
consumer items. At December 31, 1997, installment loans outstanding were
$9,349,000 representing 3.7% of total loans. This compares to installment loans
of $8,230,000 and $5,677,000 representing 3.4% and 2.9% at December 31, 1996 and
1995, respectively.
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24
The Company's construction loan portfolio decreased $13,352,000 or 47.7% to
$14,645,000 at December 31, 1997 from $27,997,000 at December 31, 1996 due to
fluctuations in the market and increased competition from traditional and
non-traditional sources. This compares to an increase of $3,145,000 or 12.7% in
1996 from $24,852,000 at December 31, 1995. Construction loans expressed as a
percentage of total loans were 5.7%, 11.6% and 12.7% at December 31, 1997, 1996
and 1995, respectively. The construction loans outstanding at December 31, 1997
are generally composed of commitments to customers within the Company's service
area for construction of custom and semi-custom single family residences.
Other real estate loans consist primarily of loans to the Banks' depositors
secured by first trust deeds on commercial and residential properties typically
with short-term maturities and original loan to value ratios not exceeding 75%.
Other real estate loans increased $14,113,000 or 15.1% to $107,354,000 at
December 31, 1997 compared to $93,241,000 and $79,644,000 on December 31, 1996
and 1995, respectively. In general, except in the case of loans with SBA
guarantees, the Company does not make long-term mortgage loans; however, the
Company has informal arrangements in place with mortgage lenders to assist
customers in securing single-family mortgage financing.
Risk Elements -- The Company assesses and manages credit risk on an ongoing
basis through stringent credit review and approval policies, extensive internal
monitoring and established formal lending policies. Additionally, the Company
contracts with an outside loan review consultant to periodically grade new loans
and to review the existing loan portfolio. Management believes its ability to
identify and assess risk and return characteristics of the Company's loan
portfolio is critical for profitability and growth. Management strives to
continue the historically low level of credit losses by continuing its emphasis
on credit quality in the loan approval process, active credit administration and
regular monitoring. With this in mind, management has designed and implemented a
comprehensive loan review and grading system that functions to continually
assess the credit risk inherent in the loan portfolio.
Ultimately, credit quality may be influenced by underlying trends in the
economic and business cycles. The Company's business is concentrated in Monterey
County, California whose economy is highly dependent on the agricultural
industry. As a result, the Company lends money to individuals and companies
dependent upon the agricultural industry. In addition, the Company has
significant extensions of credit and commitments to extend credit which are
secured by real estate, totalling approximately $146.5 million at December 31,
1997. The ultimate recovery of these loans is generally dependent on the
successful operation, sale or refinancing of the real estate. The Company
monitors the effects of current and expected market conditions and other factors
on the collectibility of real estate loans. When, in management's judgement,
these loans are impaired, an appropriate provision for losses is recorded. The
more significant assumptions management considers involve estimates of the
following: lease, absorption and sale rates; real estate values and rates of
return; operating expenses; inflation; and sufficiency of collateral independent
of the real estate including, in limited instances, personal guarantees.
In extending credit and commitments to borrowers, the Company generally
requires collateral and/or guarantees as security. The repayment of such loans
is expected to come from cash flow or from proceeds from the sale of selected
assets of the borrowers. The Company's requirement for collateral and/or
guarantees is determined on a case-by-case basis in connection with management's
evaluation of the credit-worthiness of the borrower. Collateral held varies but
may include accounts receivable, inventory, property, plant and equipment,
income-producing properties, residences and other real property. The Company
secures its collateral by perfecting its interest in business assets, obtaining
deeds of trust, or outright possession among other means. Credit losses from
lending transactions related to real estate and agriculture compare favorably
with the Company's credit losses on its loan portfolio as a whole.
In the period spanning the second half of 1993 and continuing through 1995,
California's economy began a gradual recovery from the recession that persisted
early in the decade. During 1993, real estate values firmed up slightly as
housing became more affordable due to the low levels of interest rates, however,
economic conditions in California continued to lag behind the national trend
toward recovery. During 1994 and 1995, economic conditions in California
continued to improve, however, the level of activity remained less vigorous than
the national trend. In the year ended 1996, California's economic recovery
gained momentum, growing at
24
25
a rate that exceeded the national average. Economic activity and job growth has
been particularly strong in the northern portion of the state. As a result, real
estate values have firmed and construction activity has increased and in 1997,
California is said to have recovered from one of the deepest recessions since
the 1930's. At December 31, 1997, construction loans and other real estate
secured loans comprised 6% and 42%, respectively, of total loans outstanding.
Management believes that its lending policies and underwriting standards
will tend to minimize losses in an economic downturn, however, there is no
assurance that losses will not occur under such circumstances. The Banks' loan
policies and underwriting standards include, but are not limited to, the
following: 1) maintaining a thorough understanding of the Banks' service area
and limiting investments outside of this area, 2) maintaining a thorough
understanding of borrowers' knowledge and capacity in their field of expertise,
3) basing real estate construction loan approval not only on salability of the
project, but also on the borrowers' capacity to support the project financially
in the event it does not sell within the original projected time period, and 4)
maintaining conforming and prudent loan to value and loan to cost ratios based
on independent outside appraisals and ongoing inspection and analysis by the
Banks' construction lending officers. In addition, the Banks strive to diversify
the risk inherent in the construction portfolio by avoiding concentrations to
individual borrowers and on any one project.
Nonaccrual Loans, Loans Past Due 90 Days and OREO -- Management generally
places loans on nonaccrual status when they become 90 days past due, unless the
loan is well secured and in the process of collection. Loans are charged off
when, in the opinion of management, collection appears unlikely. The following
Table sets forth nonaccrual loans and loans past due 90 days or more for
December 31:
TABLE V NON-PERFORMING LOANS
1997 1996 1995 1994 1993
---- ---- ---- ------ ------
IN THOUSANDS
Past due 90 days or more and still accruing
Real estate...................................... $ 6 $ 59 $ 71 $ -- $ 42
Commercial....................................... 73 60 35 -- --
Installment and other............................ -- 90 -- 6 --
---- ---- ---- ------ ------
79 209 106 6 42
---- ---- ---- ------ ------
Nonaccrual:
Real estate...................................... 628 419 633 2,697 2,462
Commercial....................................... 188 184 194 99 454
Installment and other............................ -- 1 24 33 43
---- ---- ---- ------ ------
816 604 851 2,829 2,959
---- ---- ---- ------ ------
Total nonperforming loans................ $895 $813 $957 $2,835 $3,001
==== ==== ==== ====== ======
Interest due but excluded from interest income on nonaccrual loans was
approximately $7,000 in 1997, $50,000 in 1996 and $166,000 in 1995. In 1997 and
1996, interest income recognized from payments received on nonaccrual loans was
$7,000 and $619,000, respectively. In 1995, no payments received on nonaccrual
loans were included in interest income.
At December 31, 1997, the recorded investment in loans that are considered
impaired was $996,000 of which $816,000 are included as nonaccrual loans above.
Such impaired loans had a valuation allowance of $200,000. The average recorded
investment in impaired loans during 1997 was $829,000. The Company recognized
interest income on impaired loans of $33,000.
There were no troubled debt restructurings or loan concentrations in excess
of 10% of total loans not otherwise disclosed as a category of loans as of
December 31, 1997. Management is not aware of any potential problem loans, which
were accruing and current at December 31, 1997, where serious doubt exists as to
the ability of the borrower to comply with the present repayment terms.
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26
Other real estate owned was $105,000, $348,000 and $506,000 at December 31,
1997, 1996 and 1995, respectively.
Provision and Allowance for Possible Credit Losses -- The provision for
credit losses is based upon management's evaluation of the adequacy of the
existing allowance for loans outstanding. This allowance is increased by
provisions charged to expense and reduced by loan charge-offs net of recoveries.
Management determines an appropriate provision based upon the interaction of
three primary factors: (1) the loan portfolio growth in the period, (2) a
comprehensive grading and review formula for total loans outstanding, and (3)
actual previous charge-offs.
The allowance for credit losses totaled $4,223,000 or 1.65% of total loans
at December 31, 1997 compared to $4,372,000 or 1.81% at December 31, 1996 and
$4,446,000 or 2.27% at December 31, 1995. The decrease in the allowance as a
percentage of total loans is primarily due to the increase in loan balances in a
generally strong economic environment. It is the policy of management to
maintain the allowance for credit losses at a level adequate for known and
future risks inherent in the loan portfolio. Based on information currently
available to analyze credit loss potential, including economic factors, overall
credit quality, historical delinquency and a history of actual charge-offs,
management believes that the credit loss provision and allowance is prudent and
adequate. However, no prediction of the ultimate level of loans charged off in
future years can be made with any certainty.
Funding Sources -- Deposits accepted by its subsidiary banks represent the
Company's principal source of funds for investment. Deposits are primarily core
deposits in that they are demand, savings and time deposits under $100,000
generated from local businesses and individuals. These sources are considered to
be relatively more stable, long-term deposit relationships thereby enhancing
steady growth of the deposit base without major fluctuations in overall deposit
balances. At December 31, 1997, such accounts comprise 80.1% of all deposit
balances compared to 87.0% and 91.4% at December 31, 1996 and 1995. Table VI
presents the composition of the deposit mix at December 31:
TABLE VI COMPOSITION OF DEPOSITS
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
IN THOUSANDS
Demand, non-interest bearing........ $126,818 $ 90,149 $ 68,541 $ 60,407 $ 47,822
Demand, interest bearing............ 89,107 76,392 74,079 70,911 87,588
Savings............................. 99,748 89,650 121,050 100,484 62,188
Time................................ 134,628 82,472 62,419 52,021 49,514
-------- -------- -------- -------- --------
Total..................... $450,301 $338,663 $326,089 $283,823 $247,112
-------- -------- -------- -------- --------
The increase in year-end total deposits is attributable to increases in
time deposits, noninterest-bearing demand and interest-bearing demand categories
resulting from the consistent growth of the Banks combined with the purchase of
two branches in February 1997. Average total deposits in 1997 of $396,457,000
represented an increase of $77,347,000 or 24.2% over 1996 totals of
$319,110,000. Average total deposits in 1996 represented an increase of
$18,819,000 or 6.3% over 1995 totals of $300,291,000. This reflects growth in
noninterest-bearing demand and time deposits which were partially offset by
decreases in the savings category. Average noninterest bearing demand deposits
increased in 1997 to $96,159,000 from $69,877,000 in 1996 and $53,909,000 in
1995 representing an increase of $26,282,000 and $15,968,000 or 37.6% and 29.6%,
respectively, between those years as a result of the Company's business
development effort which focuses on serving small and medium-size businesses.
Average time deposits were $111,370,000 in 1997 compared to $71,119,000 in 1996
and $55,966,000 in 1995 representing an increase of $40,251,000 and $15,153,000
or 56.6% and 27.1% in 1996 and 1995, respectively. Growth in time deposits was
primarily due to migration of balances from savings accounts.
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Liquidity and Interest Rate Sensitivity
Liquidity -- Liquidity management refers to the Company's ability to
provide funds on an ongoing basis to meet fluctuations in deposit levels as well
as the credit needs and requirements of its clients. Both assets and liabilities
contribute to the Company's liquidity position. Federal funds lines, short-term
investments and securities, and loan repayments contribute to liquidity, along
with deposit increases, while loan funding and deposit withdrawals decrease
liquidity. The Banks assess the likelihood of projected funding requirements by
reviewing historical funding patterns, current and forecasted economic
conditions and individual client funding needs. Commitments to fund loans and
outstanding standby letters of credit at December 31, 1997, were approximately
$90,649,000 and $5,272,000, respectively. Such loans relate primarily to
revolving lines of credit and other commercial loans, and to real estate
construction loans.
The Company's sources of liquidity consist of overnight funds sold to
correspondent banks, unpledged marketable investments and loans held for sale.
On December 31, 1997, consolidated liquid assets totaled $164.2 million or 33.0%
of total assets as compared to $85.1 million or 22.6% of total consolidated
assets on December 31, 1996. In addition to liquid assets, the subsidiary Banks
maintain lines of credit with correspondent banks for up to $25,000,000
available on a short-term basis. Informal agreements are also in place with
various other banks to purchase participations in loans, if necessary. The
Company serves primarily a business and professional customer base and, as such,
its deposit base is susceptible to economic fluctuations. Accordingly,
management strives to maintain a balanced position of liquid assets to volatile
and cyclical deposits.
Liquidity is also affected by portfolio maturities and the effect of
interest rate fluctuations on the marketability of both assets and liabilities.
In addition, it has been the Banks' policy to restrict maturities in the
investment portfolio to not more than three years. The short-term nature of the
loan and investment portfolios, and loan agreements which generally require
monthly interest payments, provide the Banks with additional secondary sources
of liquidity. Another key liquidity ratio is the ratio of gross loans to total
deposits, which was 56.9% at December 31, 1997 and 71.2% at December 31, 1996.
Interest Rate Sensitivity -- Interest rate sensitivity is a measure of the
exposure to fluctuations in the Banks' future earnings caused by fluctuations in
interest rates. Such fluctuations result from the mismatch in repricing
characteristics of assets and liabilities at a specific point in time. This
mismatch, or interest rate sensitivity gap, represents the potential mismatch in
the change in the rate of accrual of interest revenue and interest expense from
a change in market interest rates. Mismatches in interest rate repricing among
assets and liabilities arise primarily from the interaction of various customer
businesses (i.e., types of loans versus the types of deposits maintained) and
from management's discretionary investment and funds gathering activities. The
Company attempts to manage its exposure to interest rate sensitivity, but due to
its size and direct competition from the major banks, it must offer products
which are competitive in the market place, even if less than optimum with
respect to its interest rate exposure.
The Company's natural position is asset-sensitive (based upon the
significant amount of variable rate loans and the repricing characteristics of
its deposit accounts). This natural position provides a hedge against rising
interest rates, but has a detrimental effect during times of interest rate
decreases.
27
28
The following table quantifies the Company's interest rate exposure at
December 31, 1997 based upon the known repricing dates of certain assets and
liabilities and the assumed repricing dates of others. This table displays a
static view of the Company's interest rate sensitivity position and does not
consider the dynamics of the balance sheet and interest rate movements.
TABLE VII INTEREST RATE SENSITIVITY
OVER THREE
NEXT DAY MONTHS AND OVER ONE
ASSETS AND LIABILITIES AND WITHIN WITHIN AND WITHIN OVER
WHICH MATURE OR REPRICE IMMEDIATELY THREE MONTHS ONE YEAR FIVE YEARS FIVE YEARS TOTAL
----------------------- ----------- ------------ ------------ ----------- ----------- ---------
IN THOUSANDS
Interest earning assets:
Federal funds sold........... $ 64,706 $ -- $ -- $ -- $ -- $ 64,706
Investment securities........ 4 50,386 19,986 57,084 3,069 130,529
Loans, excluding Nonaccrual
loans and overdrafts....... 4,384 188,422 8,816 42,802 10,261 254,685
--------- -------- -------- -------- -------- ---------
Total.............. $ 69,094 $238,808 $ 28,802 $ 99,886 $ 13,330 $ 449,920
========= ======== ======== ======== ======== =========
Interest bearing Liabilities:
Interest bearing demand...... $ 89,107 $ -- $ -- $ -- $ -- $ 89,107
Savings...................... 99,748 -- -- -- -- 99,748
Time certificates............ 11 39,120 70,928 24,509 60 134,628
Other Borrowings............. -- 289 -- -- -- 289
--------- -------- -------- -------- -------- ---------
Total.............. $ 188,866 $ 39,409 $ 70,928 $ 24,509 $ 60 $ 323,772
========= ======== ======== ======== ======== =========
Interest rate sensitivity
gap........................ $(119,772) $199,399 $(42,126) $ 75,377 $ 13,270
Cumulative interest rate
sensitivity gap............ $(119,772) $ 79,627 $ 37,501 $112,878 $126,148
Ratios:
Interest rate sensitivity
gap........................ 0.37 6.06 0.41 4.08 222.17
Cumulative interest rate
sensitivity gap............ 0.37 1.35 1.13 1.35 1.39
It is management's objective to maintain stability in the net interest
margin in times of fluctuating interest rates by maintaining an appropriate mix
of interest sensitive assets and liabilities. The Banks strive to achieve this
goal through the composition and maturities of the investment portfolio and by
adjusting pricing of its interest bearing liabilities, however, as noted above,
the ability to manage its interest rate exposure may be constrained by
competitive pressures.
Quantitative and Qualitative Disclosures About Market Risk
Derivative financial instruments include futures, forwards, interest rate
swaps, option contracts, and other financial instruments with similar
characteristics. The Company currently does not enter into futures, forwards,
swaps or options. However, the Company is 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 commitments to
extend credit and standby letters of credit. These instruments involve to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the consolidated balance sheets. Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of
any condition established in the contract. Commitments generally have fixed
expiration dates and may require collateral from the borrower if deemed
necessary by the Company. Standby letters of credit are conditional commitments
issued by the Company to guarantee the performance of a customer to a third
party up to a stipulated amount and with specified terms and conditions.
Commitments to extend credit and standby letters of credit are not recorded
as an asset or liability by the Company until the instrument is exercised.
28
29
The Company's exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee. Interest rate risk is the potential of economic
losses due to future interest rate changes. These economic losses can be
reflected as a loss of future net interest income and/or a loss of current fair
market values. The objective is to measure the effect on net interest income and
to adjust the balance sheet to minimize the inherent risk while at the same time
maximize income. Management realizes certain risks are inherent and that the
goal is to identify and minimize the risks. Tools used by management include the
standard GAP report and the quarterly interest rate shock simulation report. The
Company has no market risk sensitive instruments held for trading purposes.
The following table presents the scheduled repricing of market risk
sensitive instruments at December 31, 1997:
OVER
ONE YEAR TWO YEARS THREE YEARS FOUR YEARS FIVE YEARS FIVE YEARS TOTAL
-------- --------- ----------- ---------- ---------- ---------- --------
IN THOUSANDS (EXCEPT PERCENTAGES)
Interest earning assets:
Federal funds sold....... $ 64,706 $ -- $ -- $ -- $ -- $ -- $ 64,706
5.4% 5.4%
Investment securities.... 70,376 30,059 20,550 4,474 2,000 3,070 130,529
5.6% 6.2% 6.1% 6.2% 6.4% 6.3% 5.8%
Loans.................... 204,330 4,255 12,836 7,892 17,819 10,261 257,393
9.9% 9.6% 9.2% 9.2% 9.0% 9.2% 9.8%
-------- ------- ------- ------- ------- ------- --------
Total.......... $339,412.. $34,314 $33,386 $12,366 $19,819 $13,331 $452,628
======== ======= ======= ======= ======= ======= ========
Interest bearing
liabilities:
Interest bearing
demand................. $ 89,107 $ -- $ -- $ -- $ -- $ -- $ 89,107
2.0% 2.0%
Savings.................. 99,748 -- -- -- -- -- 99,748
3.9% 3.9%
Time certificates........ 110,059 17,819 6,232 272 186 60 134,628
5.5% 5.9% 6.3% 6.0% 6.1% 5.5% 5.6%
Other Borrowings......... 289 -- -- -- -- -- 289
5.3% 5.3%
-------- ------- ------- ------- ------- ------- --------
Total.......... $299,203 $17,819 $ 6,232 $ 272 $ 186 $ 60 $323,772
======== ======= ======= ======= ======= ======= ========
Balance sheet carrying amounts and estimated fair values of financial
instruments at December 31, 1997 were as follows:
ESTIMATED FAIR
TOTAL VALUE
-------- --------------
ASSETS
Federal funds sold.......................... $ 64,706 $ 64,706
Securities.................................. 130,529 130,586
Loans held for sale......................... 1,331 1,453
Loans, net.................................. 251,271 256,361
LIABILITIES
Demand deposits............................. 215,925 215,925
Savings..................................... 99,748 99,748
Time certificates........................... 134,628 135,542
Other Borrowings............................ 289 289
29
30
Capital Resources
The Company's total shareholders' equity was $43,724,000 at December 31,
1997 compared to $36,332,000 as of December 31, 1996 and $29,916,000 as of
December 31, 1995.
The Company and the Banks are subject to regulations issued by the Board of
Governors and the FDIC which require maintenance of a certain level of capital.
These regulations impose two capital standards: a risk-based capital standard
and a leverage capital standard.
Under the Board of Governor's risk-based capital guidelines, assets
reported on an institution's balance sheet and certain off-balance sheet items
are assigned to risk categories, each of which has an assigned risk weight.
Capital ratios are calculated by dividing the institution's qualifying capital
by its period-end risk-weighted assets. The guidelines establish two categories
of qualifying capital: Tier 1 Capital (defined to include common shareholders'
equity and noncumulative perpetual preferred stock) and Tier 2 capital defined
to include limited life (and in the case of banks, cumulative) preferred stock,
mandatory convertible securities, subordinated debt and a limited amount of
reserves for loan and lease losses. Each institution is required to maintain a
risk-based capital ratio (including Tier 1 and Tier 2 capital) of 8%, of which
at least half must be Tier 1 capital.
Under the Board of Governors' leverage capital standard an institution is
required to maintain a minimum ratio of Tier 1 capital to the sum of its
quarterly average total assets and quarterly average reserve for loan losses,
less intangibles not included in Tier 1 capital. Period-end assets may be used
in place of quarterly average total assets on a case-by-case basis. A minimum
leverage ratio of 3% is required for institutions which have been determined to
be in the highest of five categories used by regulators to rate financial
institutions and which are not experiencing or anticipating significant growth.
All other organizations are required to maintain leverage ratios of at least 100
to 200 basis points above the 3% minimum.
The table below presents the capital and leverage ratios of the Company as
of:
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------
AMOUNT RATIO AMOUNT RATIO
-------- ----- -------- -----
(DOLLARS IN THOUSANDS)
RISK-BASED CAPITAL RATIOS
Tier 1 Capital................................. $ 41,968 14.0% $ 36,332 14.1%
-------- --------
Total Capital.................................. $ 45,782 15.2% $ 39,562 15.4%
-------- --------
Total risk-adjusted assets..................... $300,576 $257,305
-------- --------
LEVERAGE RATIO
Tier 1 Capital to average total assets......... $ 41,968 9.6% $ 36,332 10.1%
-------- --------
Quarterly average total assets................. $439,257 $358,027
-------- --------
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") substantially revised banking regulations and established a framework
for determination of capital adequacy of financial institutions. Under the
FDICIA, financial institutions are placed into one of five capital adequacy
categories as follows: (1) "well capitalized" consisting of institutions with a
total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital
ratio of 6% or greater and a leverage ratio of 5% or greater, and the
institution is not subject to an order, written agreement, capital directive or
prompt corrective action directive; (2) "adequately capitalized" consisting of
institutions with a total risk-based capital ratio of 8% or greater, a Tier 1
risk-based capital ratio of 4% or greater and a leverage ratio of 4% or greater,
and the institution does not meet the definition of a "well capitalized"
institution; (3) "undercapitalized" consisting of institutions with a total
risk-based capital ratio less than 8%, a Tier 1 risk-based capital ratio of less
than 4%, or a leverage ratio of less than 4%; (4) "significantly
undercapitalized' consisting of institutions with a total risk-based capital
ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a
leverage ratio of less than 3%; and, (5) "critically undercapitalized"
consisting of an institution with a ratio of tangible equity to total assets
that is equal to or less than 2%.
30
31
Financial institutions classified as undercapitalized or below are subject
to various limitations including, among other matters, certain supervisory
actions by bank regulatory authorities and restrictions related to (i) growth of
assets, (ii) payment of interest on subordinated indebtedness, (iii) payment of
dividends or other capital distributions, and (iv) payment of management fees to
a parent holding company. The FDICIA requires the bank regulatory authorities to
initiate corrective action regarding financial institutions which fail to meet
minimum capital requirements. Such action may, among other matters, require that
the financial institution augment capital and reduce total assets. Critically
undercapitalized financial institutions may also be subject to appointment of a
receiver or conservator unless the financial institution submits an adequate
capitalization plan.
Inflation
The impact of inflation on a financial institution differs significantly
from that exerted on manufacturing, or other commercial concerns, primarily
because its assets and liabilities are largely monetary. In general, inflation
primarily affects the Company indirectly through its effect on market rates of
interest, and thus the ability of the Banks to attract loan customers. Inflation
affects the growth of total assets by increasing the level of loan demand, and
potentially adversely affects the Company's capital adequacy because loan growth
in inflationary periods can increase at rates higher than the rate that capital
grows through retention of earnings which the Company may generate in the
future. In addition to its effects on interest rates, inflation directly affects
the Company by increasing the Company's operating expenses. Inflation has not
materially affected the results of operations during the three year period ended
December 31, 1997.
Accounting Pronouncements
In June 1996, SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" was issued. The Statement
establishes standards for when transfers of financial assets, including those
with continuing involvement by the transferor, should be considered a sale. SFAS
No. 125 also establishes standards for when a liability should be considered
extinguished. This statement is effective for transfers of assets and
extinguishments of liabilities after January 1, 1997. In December 1996, the
Financial Accounting Standards Board ("FASB") reconsidered certain provisions of
SFAS No. 125 and issued SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125" to defer for one year the effective date
of implementation for transactions related to repurchase agreements, dollar-roll
repurchase agreements, securities lending and similar transactions. Earlier
adoption or retroactive application of this statement with respect to any of its
provisions is not permitted. Management believes that the effect of adoption on
the Company's financial statements will not be material.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). The
Company adopted SFAS 128 in the fourth quarter of 1997 and restated earnings per
share (EPS) data for prior periods to conform with SFAS 128. SFAS 128 replaces
current EPS reporting requirements and requires a dual presentation of basic and
diluted EPS. Basic EPS excludes dilution and is computed by dividing net income
by the weighted average of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
In June 1997, the Financial Accounting Standards Board adopted Statements
of Financial Accounting Standards No. 130 "Reporting Comprehensive Income",
which requires that an enterprise report, by major components and as a single
total, the change in its net assets during the period from nonowner sources; and
No. 131 "Disclosures about Segments of an Enterprise and Related Information",
which establishes annual and interim reporting standards for an enterprise's
business segments and related disclosures about its products, services,
geographic areas, and major customers. Adoption of these statements will not
impact the Company's consolidated financial position, results of operations or
cash flows. Both statements are effective for fiscal years beginning after
December 15, 1997, with earlier application permitted.
31
32
Other Matters
As the year 2000 approaches, a critical issue has emerged regarding how
existing application software programs and operating systems can accommodate
this date value. In brief, many existing application software products in the
marketplace were designed to only accommodate a two digit date position which
represents the year (e.g., "95" is stored on the system and represents the year
1995). As a result, the year 1999 (i.e., "99") could be the maximum date value
these systems will be able to accurately process. This is not just a banking
problem, as corporations around the world and in all industries are similarly
impacted. Management is in the process of working with its software vendors to
assure that the Company is prepared for the year 2000. Also, the Company has put
procedures in place to inquire whether the systems of key borrowers are year
2000 compliant. At present, the Company does not have an estimate of the total
cost of evaluating and fixing any potential year 2000 problems.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by Item 7A of Form 10-K is contained in Item
7 -- "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report................................ 33
Consolidated Balance Sheets, December 31, 1997 and 1996..... 34
Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995.......................... 35
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995.......................... 36
Consolidated Statements of Shareholders' Equity for the
years ended
December 31, 1997, 1996 and 1995.......................... 37
Notes to Consolidated Financial Statements.................. 38
All schedules have been omitted since the required information is not
present in amounts sufficient to require submission of the schedule or because
the information required is included in the Consolidated Financial Statements or
notes thereto.
32
33
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of Central Coast Bancorp:
We have audited the accompanying consolidated balance sheets of Central
Coast Bancorp and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1997. 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. The consolidated financial statements give retroactive effect to the
merger of Central Coast Bancorp and Cypress Coast Bank, which has been accounted
for as a pooling of interests as described in Note 2 to the consolidated
financial statements. We did not audit the statements of income, shareholders'
equity and cash flows of Cypress Coast Bank for the year ended December 31,
1995, which statements reflect net interest income of $1,999,000 and net income
of $437,000. Those statements were audited by other auditors whose report has
been furnished to us, and our opinion, insofar as it relates to the amounts
included for Cypress Coast Bank for 1995, is based solely on the report of such
other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Central Coast Bancorp and
subsidiaries at December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Salinas, California
January 30, 1998
33
34
CONSOLIDATED BALANCE SHEETS
CENTRAL COAST BANCORP AND SUBSIDIARIES
DECEMBER 31,
----------------------------
1997 1996
------------ ------------
ASSETS
Cash and due from banks..................................... $ 39,891,000 $ 37,522,000
Federal funds sold.......................................... 64,706,000 23,135,000
------------ ------------
Total cash and equivalents........................ 104,597,000 60,657,000
Interest-bearing deposits in other financial institutions... -- 999,000
Securities:
Available-for-sale........................................ 91,481,000 --
Held-to-maturity.......................................... 39,048,000 70,877,000
(Market value: 1997, $39,105,000; 1996, $70,835,000)
Loans held for sale......................................... 1,331,000 447,000
Loans:
Commercial................................................ 124,714,000 111,545,000
Real estate-construction.................................. 14,645,000 27,997,000
Real estate-other......................................... 107,354,000 93,241,000
Installment............................................... 9,349,000 8,230,000
------------ ------------
Total loans....................................... 256,062,000 241,013,000
Allowance for credit losses................................. (4,223,000) (4,372,000)
Deferred loan fees, net..................................... (568,000) (649,000)
------------ ------------
Net Loans......................................... 251,271,000 235,992,000
------------ ------------
Premises and equipment, net................................. 2,001,000 1,140,000
Accrued interest receivable and other assets................ 7,945,000 6,720,000
------------ ------------
Total assets................................................ $497,674,000 $376,832,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand, noninterest bearing............................... $126,818,000 $ 90,149,000
Demand, interest bearing.................................. 89,107,000 76,392,000
Savings................................................... 99,748,000 89,650,000
Time...................................................... 134,628,000 82,472,000
------------ ------------
Total Deposits.................................... 450,301,000 338,663,000
Accrued interest payable and other liabilities.............. 3,649,000 1,837,000
------------ ------------
Total liabilities........................................... 453,950,000 340,500,000
------------ ------------
Commitments and contingencies (Notes 7 and 13)
Shareholders' Equity:
Preferred stock -
no par value; authorized 1,000,000 shares; no shares
issued
Common stock - no par value; authorized 30,000,000
shares; Issued and outstanding: 4,368,469 shares in
1997 and 4,273,227 shares in 1996...................... 31,644,000 30,856,000
Retained earnings......................................... 11,979,000 5,476,000
Net unrealized gains on available-for-sale securities, net
of tax................................................. 101,000 --
------------ ------------
Shareholders' equity........................................ 43,724,000 36,332,000
------------ ------------
Total liabilities and shareholders' equity.................. $497,674,000 $376,832,000
============ ============
See notes to Consolidated Financial Statements
34
35
CONSOLIDATED STATEMENTS OF INCOME
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
INTEREST INCOME
Loans (including fees)............................ $24,828,000 $22,330,000 $19,713,000
Investment securities............................. 5,823,000 4,936,000 4,520,000
Other............................................. 3,265,000 2,035,000 2,731,000
----------- ----------- -----------
Total interest income..................... 33,916,000 29,301,000 26,964,000
----------- ----------- -----------
INTEREST EXPENSE
Interest on deposits.............................. 11,943,000 9,859,000 9,998,000
Other............................................. 98,000 -- 10,000
----------- ----------- -----------
Total interest expense.................... 12,041,000 9,859,000 10,008,000
----------- ----------- -----------
Net Interest Income................................. 21,875,000 19,442,000 16,956,000
Provision for Credit Losses......................... (64,000) (352,000) (695,000)
----------- ----------- -----------
Net Interest Income after Provision for Credit
Losses............................................ 21,811,000 19,090,000 16,261,000
----------- ----------- -----------
OTHER INCOME
Service charges on deposits....................... 1,076,000 735,000 676,000
Other income...................................... 689,000 721,000 626,000
----------- ----------- -----------
Total other income........................ 1,765,000 1,456,000 1,302,000
----------- ----------- -----------
OTHER EXPENSES
Salaries and benefits............................. 7,586,000 6,437,000 5,419,000
Occupancy......................................... 889,000 728,000 746,000
Furniture and equipment........................... 800,000 837,000 672,000
Other............................................. 3,298,000 3,113,000 3,426,000
----------- ----------- -----------
Total other expenses...................... 12,573,000 11,115,000 10,263,000
----------- ----------- -----------
Income Before Income Taxes.......................... 11,003,000 9,431,000 7,300,000
Provision for Income Taxes.......................... 4,500,000 3,571,000 2,975,000
----------- ----------- -----------
Net Income................................ $ 6,503,000 $ 5,860,000 $ 4,325,000
=========== =========== ===========
Basic Earnings per Share............................ $ 1.36 $ 1.26 $ 0.94
Diluted Earnings per Share.......................... $ 1.26 $ 1.18 $ 0.88
=========== =========== ===========
See Notes to Consolidated Financial Statements
35
36
CONSOLIDATED STATEMENTS OF CASH FLOWS
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31,
-------------------------------------------
1997 1996 1995
------------- ------------ ------------
CASH FLOWS FROM OPERATIONS:
Net income........................................ $ 6,503,000 $ 5,860,000 $ 4,325,000
Reconciliation of net income to net cash provided
by operating activities:
Provision for credit losses.................... 64,000 352,000 695,000
Depreciation................................... 513,000 557,000 469,000
Amortization and accretion..................... (369,000) (42,000) (292,000)
Deferred income taxes.......................... 31,000 (300,000) (168,000)
Net (gain) loss on sale of equipment........... (19,000) 52,000 --
Write-down (gain on sale) of other real estate
owned........................................ (21,000) (87,000) 215,000
Increase in accrued interest receivable
And other assets............................... (1,779,000) (787,000) (184,000)
Increase in accrued interest payable
And other liabilities.......................... 1,939,000 606,000 251,000
Increase (decrease) in deferred loan fees......... (81,000) 99,000 (32,000)
------------- ------------ ------------
Net cash provided by operations........... 6,781,000 6,310,000 5,279,000
------------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in interest-bearing
Deposits in financial institutions............. 999,000 3,493,000 (1,693,000)
Proceeds from maturities of investment securities
Available-for-sale............................. 63,750,000 -- --
Held-to-Maturity............................... 41,882,000 56,969,000 63,117,000
Purchase of investment securities
Available-for-sale............................. (154,353,000) -- --
Held-to-Maturity............................... (10,181,000) (48,161,000) (72,972,000)
Net change in loans held for sale................. (884,000) 93,000 195,000
Net increase in loans............................. (15,723,000) (45,485,000) (12,962,000)
Proceeds from sale of other real estate owned..... 725,000 287,000 163,000
Proceeds from sale of equipment................... 31,000 1,000 --
Capital expenditures.............................. (1,386,000) (417,000) (317,000)
------------- ------------ ------------
Net cash used by investing activities..... (75,140,000) (33,220,000) (24,469,000)
------------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposit accounts.................. 111,638,000 12,574,000 42,265,000
Net increase in short-term borrowings............. 289,000 -- --
Proceeds from sale of stock....................... 380,000 319,000 32,000
Fractional shares repurchased..................... (8,000) (5,000) --
------------- ------------ ------------
Net cash provided by financing
activities.............................. 112,299,000 12,888,000 42,297,000
------------- ------------ ------------
Net increase (decrease) in cash and equivalents... 43,940,000 (14,022,000) 23,107,000
Cash and equivalents, beginning of year........... 60,657,000 74,679,000 51,572,000
------------- ------------ ------------
Cash and equivalents, end of year................. $ 104,597,000 $ 60,657,000 $ 74,679,000
============= ============ ============
NONCASH INVESTING AND FINANCING ACTIVITIES:
In 1997, 1996 and 1995 the Company obtained $461,000, $42,000 and $566,000, respectively of
real estate (OREO) in connection with foreclosures of delinquent loans.
OTHER CASH FLOW INFORMATION:
Interest paid..................................... $ 11,367,000 $ 9,852,000 $ 9,853,000
Income taxes paid................................. 3,497,000 4,063,000 3,219,000
See Notes to Consolidated Financial Statements
36
37
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
------------------------------------------------------------------------
NET UNREALIZED
COMMON STOCK GAIN ON AVAILABLE-
----------------------- RETAINED FOR-SALE
SHARES AMOUNT EARNINGS SECURITIES TOTAL
--------- ----------- ----------- ------------------ -----------
Balances, January 1, 1995..... 3,444,846 $22,440,000 $ 3,107,000 $ -- $25,547,000
12% stock dividend
(including fractional
shares).................. 355,326 3,376,000 (3,376,000) -- --
Sale of stock............... 1,944 10,000 -- -- 10,000
Stock options exercised..... 5,565 22,000 -- -- 22,000
Tax benefit of stock options
exercised................ -- 12,000 -- -- 12,000
Net Income.................. -- -- 4,325,000 -- 4,325,000
--------- ----------- ----------- -------- -----------
Balances, December 31, 1995... 3,807,681 25,860,000 4,056,000 -- 29,916,000
10% stock dividend.......... 380,768 4,440,000 (4,440,000) -- --
Fractional shares
repurchased.............. (653) (5,000) -- -- (5,000)
Stock options and warrants
exercised................ 85,431 319,000 -- -- 319,000
Tax benefit of stock options
exercised................ -- 242,000 -- -- 242,000
Net Income.................. -- -- 5,860,000 -- 5,860,000
--------- ----------- ----------- -------- -----------
Balances, December 31, 1996... 4,273,227 30,856,000 5,476,000 -- 36,332,000
Fractional shares
repurchased.............. (347) (8,000) -- (8,000)
Stock options and warrants
exercised................ 95,589 380,000 -- -- 380,000
Net change in unrealized
gain on
available-for-sale
securities (net of taxes
of $71,000).............. -- -- -- 101,000 101,000
Tax benefit of stock options
exercised................ -- 416,000 -- -- 416,000
Net income.................. -- -- 6,503,000 -- 6,503,000
--------- ----------- ----------- -------- -----------
Balances, December 31, 1997... 4,368,469 $31,644,000 $11,979,000 $101,000 $43,724,000
========= =========== =========== ======== ===========
See Notes to Consolidated Financial Statements
37
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES AND OPERATIONS.
The consolidated financial statements include Central Coast Bancorp (the
"Company") and its wholly-owned subsidiaries, Bank of Salinas and Cypress Bank
(the "Banks"). All material intercompany accounts and transactions are
eliminated in consolidation. The accounting and reporting policies of the
Company and the Banks conform to generally accepted accounting principles and
prevailing practices within the banking industry. In preparing such financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of the date of the balance
sheet and revenues and expenses for the period. Actual results could differ
significantly from those estimates. Material estimates that are particularly
susceptible to significant changes in the near term relate to the determination
of the allowance for credit losses and the carrying value of other real estate
owned. Management uses information provided by an independent loan review
service in connection with the determination of the allowance for loan losses.
Bank of Salinas operates four branches in the Salinas Valley and Cypress
Bank operates three branches on the Monterey Peninsula, serving small and medium
sized business customers, as well as individuals. The Banks focus on business
loans and deposit services to customers throughout Monterey and San Benito
counties.
Investment Securities are classified at the time of purchase into one of
three categories: held-to-maturity, trading or available-for-sale. Investment
securities classified as held-to-maturity are measured at amortized cost based
on the Company's positive intent and ability to hold such securities to
maturity. Trading securities are bought and held principally for the purpose of
selling them in the near term and are carried at market value with a
corresponding recognition of unrecognized holding gain or loss in the results of
operations. The remaining investment securities are classified as
available-for-sale and are measured at market value with a corresponding
recognition of the unrealized holding gain or loss (net of tax effect) as a
separate component of shareholders' equity until realized. Accretion of
discounts and amortization of premiums arising at acquisition are included in
income using methods approximating the effective interest method. Gains and
losses on sales of investments, if any, are determined on a specific
identification basis.
Loans are stated at the principal amount outstanding, reduced by any
charge-offs or specific valuation allowance. Loan origination fees and certain
direct loan origination costs are deferred and the net amount is recognized
using the effective yield method, generally over the contractual life of the
loan.
Interest income is accrued as earned. The accrual of interest on loans is
discontinued and any accrued and unpaid interest is reversed when principal or
interest is ninety days past due, when payment in full of principal or interest
is not expected or when a portion of the principal balance has been charged off.
Income on such loans is then recognized only to the extent that cash is received
and where the future collection of principal is probable. Senior management may
grant a waiver from nonaccrual status if a loan is well secured and in the
process of collection. When a loan is placed on nonaccrual status, the accrued
and unpaid interest receivable is reversed and the loan is accounted for on the
cash or cost recovery method thereafter, until qualifying for return to accrual
status. Generally, a loan may be returned to accrual status when all delinquent
interest and principal become current in accordance with the original terms of
the loan agreement or when the loan is both well secured and in process of
collection.
Loans held for sale are stated at the lower of cost or aggregate market
value.
The allowance for credit losses is an amount that management believes will
be adequate to absorb losses inherent in existing loans and commitments to
extend credit, based on evaluations of collectibility and prior loss experience.
The allowance is established through a provision charged to expense. Loans are
charged against the allowance when management believes that the collectibility
of the principal is unlikely. In evaluating the adequacy of the reserve,
management considers numerous factors such as changes in the
38
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
composition of the portfolio, overall portfolio quality, loan concentrations,
specific problem loans, and current and anticipated local economic conditions
that may affect the borrowers' ability to pay.
A loan is impaired when, based on current information and events, it is
probable that the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement. Impaired loans are measured based
on the present value of expected future cash flows discounted at the loan's
effective interest rate or, as a practical expedient, at the loan's observable
market price or the fair value of the collateral if the loan is
collateral-dependent.
Real estate and other assets acquired in satisfaction of indebtedness are
recorded at the lower of estimated fair market value net of anticipated selling
costs or the recorded loan amount, and any difference between this and the loan
amount is treated as a loan loss. Costs of maintaining other real estate owned,
subsequent write downs and gains or losses on the subsequent sale are reflected
in current earnings.
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed on a straight-line
basis over the lesser of the lease terms or estimated useful lives of the
assets, which are generally 3 to 30 years.
Intangible assets representing the excess of the purchase price over the
fair value of tangible net assets acquired, are being amortized on a
straight-line basis over seven years and are included in other assets.
Stock Compensation. The Company accounts for its stock-based awards using
the intrinsic value method in accordance with Accounting Principles Board No.
25, Accounting for Stock Issued to Employees and its related interpretations. No
compensation expense has been recognized in the financial statements for
employee stock arrangements. Note 11 to the Consolidated Financial Statements
contains a summary of the pro forma effects to reported net income and earnings
per share as if the Company had elected to recognize compensation cost based on
the fair value of the options granted at grant date as prescribed by Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation.
Income taxes are provided using the asset and liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences of differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities arise principally from differences in reporting
provisions for credit losses, net operating loss carryforwards, interest on
nonaccrual loans, depreciation, state franchise taxes and accruals related to
the salary continuation plan. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Earnings per share. In February 1997, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 128, "Earnings per
Share" (SFAS 128), which is effective in 1997. The Company has restated earnings
per share data for prior periods to conform with SFAS 128. SFAS 128 replaces
previous earnings per share reporting requirements and requires a dual
presentation of basic and diluted earnings per share. Basic earnings per share
is computed by dividing net income by the weighted average of common shares
outstanding for the period (4,773,000, 4,651,000 and 4,606,000 in 1997, 1996 and
1995, respectively). Diluted earnings per share reflects the potential dilution
that could occur if outstanding stock options and stock purchase warrants were
exercised. Diluted earnings per share is computed by dividing net income by the
weighted average common shares outstanding for the period plus the dilutive
effect of options and warrants (388,000, 321,000 and 282,000 in 1997, 1996 and
1995, respectively). All earnings per share information has been adjusted
retroactively for stock dividends of 12% in January 1995, 10% in July 1996 and
January 1998, and a 3-for-2 stock split in March 1997.
39
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Stock dividend. On January 20, 1998 the Board of Directors declared a 10%
stock dividend, to be distributed on March 3, 1998, to shareholders of record as
of February 17, 1998. All share and per share data including stock option and
warrant information have been retroactively adjusted to reflect the stock
dividend.
New Accounting Pronouncements. In June 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive Income, which requires that an enterprise report, by
major components and as a single total, the change in its net assets during the
period from nonowner sources, and No. 131, Disclosures about Segments of an
Enterprise and Related Information, which establishes annual and interim
reporting standards or an enterprise's business segments and related disclosures
about its products, services, geographic areas and major customers. Both
statements will become effective in 1998. Adoption of these statements will not
impact the Company's consolidated financial position, results of operations or
cash flows.
NOTE 2. ACQUISITION OF CYPRESS COAST BANK
On May 31, 1996, the Company completed its acquisition of Cypress Coast
Bank ("Cypress") whereby Cypress became a subsidiary of the Company and
continues to operate from its offices in Seaside and Marina. Cypress
shareholders received 587,741 shares of common stock of the Company in a
tax-free exchange. At May 31, 1996, Cypress had unaudited total assets of $46.9
million, including $29.8 million in net loans and total unaudited liabilities of
$42.7 million, including $42.5 million in deposits. The transaction has been
accounted for as a pooling-of-interests.
NOTE 3. BRANCH ACQUISITION
On February 21, 1997, the Bank of Salinas purchased certain assets and
assumed certain liabilities of the Gonzales and Castroville branch offices of
Wells Fargo Bank. As a result of the transaction the Bank assumed deposit
liabilities ($34 million), received cash ($31 million), and acquired tangible
assets ($1 million). This transaction resulted in intangible assets,
representing the excess of the liabilities assumed over the fair value of the
tangible assets acquired.
NOTE 4. CASH AND DUE FROM BANKS
The Company, through its bank subsidiaries, is required to maintain
reserves with the Federal Reserve Bank. Reserve requirements are based on a
percentage of deposits. At December 31, 1997 the Company maintained reserves of
approximately $9,331,000 in the form of vault cash and balances at the Federal
Reserve to satisfy regulatory requirements.
40
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
NOTE 5. SECURITIES
The scheduled maturities and weighted average yields of the Company's
investment securities portfolio as of December 31, 1997 and 1996 are as follows:
WEIGHTED
AMORTIZED UNREALIZED UNREALIZED MARKET AVERAGE
COST GAIN LOSSES VALUE YIELD
--------- ---------- ---------- -------- --------
(IN THOUSANDS)
DECEMBER 31, 1997
Available for sale securities:
U.S. Treasury and agency securities
Maturing within 1 year.................. $ 32,861 $ -- $ 5 $ 32,856 5.68%
Maturing after 1 year but within 5
years................................. 48,410 184 7 48,587 6.16%
Bankers' Acceptances
Maturing within 1 year.................. 10,034 -- -- 10,034 5.05%
Other........................................ 4 -- -- 4 --
-------- ---- ---- -------- -----
Total available for sale........... $ 91,309 $184 $ 12 91,481 5.87%
-------- ---- ---- -------- -----
Held to maturity securities:
U.S. Treasury and agency securities
Maturing within 1 year.................. $ 27,484 $ 7 $ 11 $ 27,480 5.60%
Maturing after 1 year but within 5
years................................. 8,495 66 2 8,559 6.34%
Maturing after 5 years but within 10
years................................. 20 -- -- 20 9.05%
Maturing after 10 years................. 857 6 9 854 7.00%
State and Political Subdivision
Maturing after 5 years but within 10
years................................. 2,192 -- -- 2,192 5.60%
-------- ---- ---- -------- -----
Total held to maturity............. $ 39,048 $ 79 $ 22 $ 39,105 5.79%
-------- ---- ---- -------- -----
Total investment securities........ $130,357 $263 $ 34 $130,586 5.85%
======== ==== ==== ======== =====
DECEMBER 31, 1996
Held to maturity securities:
U.S. Treasury and agency securities
Maturing within 1 year.................. $ 29,358 $ 46 $ 9 $ 29,395 5.72%
Maturing after 1 year but within 5
years................................. 37,460 71 96 37,437 5.80%
Maturing after 10 years................. 1,027 1 44 984 6.06%
Corporate Debt Securities
Maturing within 1 year.................. 3,028 -- 11 3,017 5.28%
Other........................................ 4 -- -- 4 --
-------- ---- ---- -------- -----
Total investment securities........ $ 70,877 $118 $160 $ 70,835 5.75%
======== ==== ==== ======== =====
At December 31, 1997 and 1996, securities with a book value of $57,289,000
and $45,834,000 were pledged as collateral for deposits of public funds and
other purposes as required by law or contract.
There were no sales of securities in 1997, 1996 or 1995.
NOTE 6. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The Company's business is concentrated in Monterey County, California whose
economy is highly dependent on the agricultural industry. As a result, the
Company lends money to individuals and companies
41
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
dependent upon the agricultural industry. In addition, the Company has
significant extensions of credit and commitments to extend credit which are
secured by real estate, the ultimate recovery of which is generally dependent on
the successful operation, sale or refinancing of real estate, totaling
approximately $146.5 million. The Company monitors the effects of current and
expected market conditions and other factors on the collectibility of real
estate loans. When, in management's judgment, these loans are impaired,
appropriate provision for losses are recorded. The more significant assumptions
management considers involve estimates of the following: lease, absorption and
sale rates; real estate values and rates of return; operating expenses;
inflation; and sufficiency of collateral independent of the real estate
including, in limited instances, personal guarantees.
In extending credit and commitments to borrowers, the Company generally
requires collateral and/or guarantees as security. The repayment of such loans
is expected to come from cash flow or from proceeds from the sale of selected
assets of the borrowers. The Company's requirement for collateral and/or
guarantees is determined on a case-by-case basis in connection with management's
evaluation of the credit worthiness of the borrower. Collateral held varies but
may include accounts receivable, inventory, property, plant and equipment,
income-producing properties, residences and other real property. The Company
secures its collateral by perfecting its interest in business assets, obtaining
deeds of trust, or outright possession among other means. Credit losses from
lending transactions related to real estate and agriculture compare favorably
with the Company's credit losses on its loan portfolio as a whole.
The activity in the allowance for credit losses is summarized as follows:
1997 1996 1995
------ ------ ------
(IN THOUSANDS)
Balances, beginning of year...................... $4,372 $4,446 $4,068
Provision charged to expense..................... 64 352 695
Loans charged off................................ (440) (620) (434)
Recoveries....................................... 227 194 117
------ ------ ------
Balance, end of year............................. $4,223 $4,372 $4,446
====== ====== ======
In determining the provision for estimated losses related to specific major
loans, management evaluates its allowance on an individual loan basis, including
an analysis of the credit worthiness, cash flows and financial status of the
borrower, and the condition and the estimated value of the collateral. Specific
valuation allowances for secured loans are determined by the excess of recorded
investment in the loan over the fair market value or net realizable value where
appropriate, of the collateral. In determining overall general valuation
allowances to be maintained and the loan loss allowance ratio, management
evaluates many factors including prevailing and forecasted economic conditions,
regular reviews of the quality of loans, industry experience, historical loss
experience, composition and geographic concentrations of the loan portfolio, the
borrowers' ability to repay and repayment performance and estimated collateral
values.
Management believes that the allowance for credit losses at December 31,
1997 is prudent and warranted, based on information currently available.
However, no prediction of the ultimate level of loans charged off in future
years can be made with any certainty.
42
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Nonperforming loans at December 31 are summarized below:
1997 1996
----- -----
(IN THOUSANDS)
Past due 90 days or more and still accruing
Real estate............................................... $ 6 $ 59
Commercial................................................ 73 60
Installment and other..................................... -- 90
---- ----
79 209
---- ----
Nonaccrual:
Real estate............................................... 628 419
Commercial................................................ 188 184
Installment and other..................................... -- 1
---- ----
816 604
---- ----
Total nonperforming loans......................... $895 $813
==== ====
Interest due but excluded from interest income on nonaccrual loans was
approximately $7,000 in 1997, $50,000 in 1996 and $166,000 in 1995. In 1997 and
1996, interest income recognized from payments received on nonaccrual loans was
$7,000 and $619,000, respectively. In 1995, no payments received on nonaccrual
loans were included in interest income.
At December 31, 1997 and 1996, the recorded investment in loans that are
considered impaired under SFAS No. 114 was $995,000 and $965,000 of which
$816,000 and $541,000 are included as nonaccrual loans above. Such impaired
loans had valuation allowances totalling $200,000 and $446,000 based on the
estimated fair values of the collateral. The average recorded investment in
impaired loans during 1997 and 1996 was $829,000 and $1,376,000. The Company
recognized interest income on impaired loans of $33,000 and $13,000 in 1997 and
1996, respectively.
Other real estate owned included in other assets was $105,000 and $348,000
(net of a $185,000 valuation allowance in 1996) at December 31, 1997 and 1996,
respectively.
NOTE 7. PREMISES AND EQUIPMENT
Premises and equipment at December 31 are summarized as follows:
1997 1996
------ ------
(IN THOUSANDS)
Land....................................................... $ 145 $ --
Building................................................... 478 --
Furniture and equipment.................................... 4,073 3,450
Leasehold improvement...................................... 1,161 1,079
------ ------
5,857 4,529
Accumulated depreciation and amortization.................. (3,856) (3,389)
------ ------
Premises and equipment, net................................ $2,001 $1,140
====== ======
The Company's facilities leases expire in November 1998 through February
2000 with options to extend for three to fifteen years. These include four
facilities leased from shareholders at terms and conditions which management
believes are consistent with the market. Rental rates are adjusted annually for
changes in certain economic indices. Rental expense was approximately $422,000,
$406,000 and $397,000, including lease expense to shareholders of $152,000,
$174,000 and $170,000 in 1997, 1996 and 1995, respectively. The
43
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
minimum annual rental commitments under these leases, including the remaining
rental commitment under the leases to shareholders, are as follows:
OPERATING LEASES
----------------
(IN THOUSANDS)
1998.......................................... $419
1999.......................................... 327
2000.......................................... 4
----
Total............................... $750
====
NOTE 8. INCOME TAXES
The provision for income taxes is as follows:
1997 1996 1995
------ ------ ------
(IN THOUSANDS)
Current:
Federal........................................ $3,255 $2,830 $2,287
State.......................................... 1,214 1,041 856
------ ------ ------
Total.................................. 4,469 3,871 3,143
------ ------ ------
Deferred:
Federal........................................ 32 (289) (125)
State.......................................... (1) (11) (43)
------ ------ ------
Total.................................. 31 (300) (168)
------ ------ ------
Total.................................. $4,500 $3,571 $2,975
====== ====== ======
A reconciliation of the Federal income tax rate to the effective tax rate
is as follows:
1997 1996 1995
---- ---- ----
Statutory Federal income tax rate.................. 35.0% 35.0% 35.0%
State income taxes (net of Federal income tax
benefit)......................................... 7.2% 7.6% 7.8%
Change in the valuation allowance for deferred
taxes............................................ -- (4.0)% (2.5)%
Tax exempt interest income......................... (0.8)% -- --
Other.............................................. (0.5)% (0.7)% 0.5%
---- ---- ----
Effective tax rate................................. 40.9% 37.9% 40.8%
==== ==== ====
44
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1997 and 1996, respectively, are presented below:
1997 1996
------ ------
(IN THOUSANDS)
Deferred tax assets (liabilities):
Provision for credit losses.............................. $1,609 $1,699
State income taxes....................................... 185 152
Salary continuation plan................................. 165 113
Depreciation and amortization............................ 161 16
Excess serving rights.................................... 110 97
Unrealized gain on available-for-sale investment
securities............................................ (71) --
Accrual to cash adjustments.............................. 45 (51)
Interest on nonaccrual loans............................. 22 25
Net operating loss....................................... -- 187
OREO valuation reserve................................... -- 97
Other.................................................... 3 33
------ ------
Net deferred tax asset..................................... $2,229 $2,368
====== ======
NOTE 9. DETAIL OF OTHER EXPENSE
Other expense for the years ended December 31, 1997, 1996 and 1995 consists
of the following:
1997 1996 1995
------ ------ ------
(IN THOUSANDS)
Professional fees................................ $ 358 $ 454 $ 644
Customer expenses................................ 340 379 213
Marketing........................................ 302 345 253
Data processing.................................. 334 330 261
Stationary and supplies.......................... 466 319 247
Shareholder and director......................... 249 284 187
Amortization of intangibles...................... 209 -- --
Insurance........................................ 180 176 215
Dues and assessments............................. 123 65 487
Write down of other real estate owned............ -- -- 215
Other............................................ 737 761 704
------ ------ ------
Total.................................. $3,298 $3,113 $3,426
====== ====== ======
NOTE 10. STOCK PURCHASE WARRANTS
During 1995 and 1994, warrants were issued in connection with the sale of
the Company's common stock at a rate of one warrant for every share of stock
purchased. The warrants are exercisable at $5.23 and expire on June 30, 1999.
During 1997 and 1996, respectively 4,700 and 24,125 warrants were exercised
(none in 1995) and at December 31, 1997, 123,090 warrants were outstanding.
45
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
NOTE 11. EMPLOYEE BENEFIT PLANS
The Company has two stock option plans under which incentive stock options
or nonqualified stock options may be granted to certain key employees or
directors to purchase authorized, but unissued, common stock. Shares may be
purchased at a price not less than the fair market value of such stock on the
date of grant. Options vest over various periods not in excess of ten years from
date of grant and expire not more than ten years from date of grant.
Activity under the stock option plans adjusted for stock dividends and the
stock split is as follows:
WEIGHTED
AVERAGE
SHARES PRICE PER SHARE PRICE
-------- --------------- --------
Balances, January 1, 1995.................. 556,520 $ 1.77 - 5.90 $ 2.98
Granted (wt. avg. fair value $2.42 per
share)................................ 207,743 4.35 - 8.82 7.38
Canceled................................. (37,870) 3.21 - 7.72 5.38
Exercised................................ (6,734) 1.77 - 5.90 3.27
-------- -------------- ------
Balances, December 31, 1995................ 719,659 1.77 - 8.82 4.13
Granted (wt. avg. fair value $3.64 per
share)................................ 353,100 10.05 - 13.03 12.91
Expired.................................. (19,883) 1.77 - 7.72 4.15
Exercised................................ (69,849) 1.77 - 5.90 2.79
-------- -------------- ------
Balances, December 31, 1996................ 983,027 1.77 - 13.03 7.07
Granted (wt. avg. fair value $4.33 per
share)................................ 30,250 12.43 - 20.63 13.92
Expired.................................. (76,591) 2.90 - 12.27 10.46
Exercised................................ (100,447) 1.77 - 7.72 3.56
-------- -------------- ------
Balances, December 31, 1997................ 836,239 $ 1.77 - 20.63 $ 7.43
======== ============== ======
Additional information regarding options outstanding as of December 31,
1997 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------ ----------------------------
WEIGHTED AVERAGE
REMAINING WEIGHTED WEIGHTED
RANGE OF NUMBER CONTRACTUAL AVERAGE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING LIFE (YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- --------------- ----------- ---------------- -------------- ----------- --------------
$ 2.90 343,728 2.1 $ 2.90 274,982 $ 2.90
5.90 - 7.71 160,806 7.6 7.35 95,831 7.41
8.81 - 12.43 326,205 9.9 12.01 119,284 11.97
20.63 5,500 11.0 20.63 -- --
------------- ------- ---- ------ ------- ------
$2.90 - 20.63 836,239 6.3 $ 7.43 490,097 $ 5.99
============= ======= ==== ====== ======= ======
At December 31, 1997, 565,066 shares were available for additional grants.
401(K) SAVINGS PLAN
The Company has a 401(k) Savings Plan under which eligible employees may
elect to make tax deferred contributions from their annual salary, to a maximum
established annually by the IRS. The Company matches 20% of the employees'
contributions. The Company may make additional contributions to the plan at the
discretion of the Board of Directors. All employees meeting age and service
requirements are eligible to participate in the Plan. Company contributions vest
after 3 years of service. Company contributions during 1997, 1996 and 1995 which
are funded currently, totaled $56,000, $46,000 and $43,000, respectively.
46
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
SALARY CONTINUATION PLAN
In 1996 the Company established a salary continuation plan for five
officers which provides for retirement benefits upon reaching age 63. During
1997 two of such officers terminated their employment with the Company without
vesting in the plan. The Company accrues such post-retirement benefits over the
vesting periods (of five or ten years). In the event of a change in control of
the Company, the officers' benefits will fully vest. The Company accrued
compensation expense of $117,000 and $250,000 in 1997 and 1996, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN
Effective January 1, 1996, the Company established an employee stock
ownership plan. Under this plan, the Company intends to make contributions which
will be invested primarily in Company stock. All full time employees meeting the
age and service requirements are eligible to participate and will receive a
share of each company contribution either in proportion to their annual
compensation expense or in an equal amount for each eligible employee at the
discretion of the Company. Contributions vest to each employee based on their
years of service (three to seven years). Upon retirement, employees will receive
the value of the amounts which have been accumulated in their accounts in the
form of Company stock. Contributions to the plan are at the discretion of the
Company. Company contributions during 1996 totaled $50,000. No contributions
were made in 1997.
ADDITIONAL STOCK PLAN INFORMATION
As discussed in Note 1, the Company continues to account for its
stock-based awards using the intrinsic value method in accordance with
Accounting Principles Board No. 25, Accounting for Stock Issued to Employees and
its related interpretations. No compensation expense has been recognized in the
financial statements for employee stock arrangements.
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, (SFAS 123) requires the disclosure of pro forma net
income and earnings per share had the Company adopted the fair value method as
of the beginning of fiscal 1995. Under SFAS 123, the fair value of stock-based
awards to employees is calculated through the use of option pricing models, even
though such models were developed to estimate the fair value of freely tradable,
fully transferable options without vesting restrictions, which significantly
differ from the Company's stock option awards. These models also require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect the calculated values. The Company's
calculations were made using the Black-Scholes option pricing model with the
following weighted average assumptions: expected life, four years following
vesting; average stock volatility of 13%; risk free interest rates ranging from
5.47% to 6.18%; and no dividends during the expected term. The Company's
calculations are based on a multiple option valuation approach and forfeitures
are recognized as they occur. If the computed fair values of the 1997, 1996 and
1995 awards had been amortized to expense over the vesting period of the awards,
pro forma net income would have been $6,345,000 ($1.33 basic and $1.23 diluted
earnings per share), $5,348,000 ($1.15 basic and $1.08 diluted per share) and
$4,203,000 ($0.91 basic and $0.86 diluted earnings per share) in 1997, 1996 and
1995, respectively. However, the impact of outstanding non-vested stock options
granted prior to 1995 has been excluded from the pro forma calculation;
accordingly, the 1997, 1996 and 1995 pro forma adjustments are not indicative of
future period pro forma adjustments, when the calculation will apply to all
applicable stock options.
NOTE 12. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments". The estimated
47
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
fair value amounts have been determined by using available market information
and appropriate valuation methodologies. However, considerable judgment is
required to interpret market data to develop the estimates of fair value.
Accordingly, the estimates presented are not necessarily indicative of the
amounts that could be realized in a current market exchange. The use of
different market assumptions and/or estimation techniques may have a material
effect on the estimated fair value amounts.
DECEMBER 31, 1997 DECEMBER 31, 1996
---------------------- ---------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ----------- -------- ----------
IN THOUSANDS
FINANCIAL ASSETS
Cash and cash equivalents............................ $104,597 $104,597 $ 60,657 $ 60,657
Interest-bearing deposits in other financial
institutions....................................... -- -- 999 999
Securities........................................... 130,529 130,586 70,877 70,835
Loans held for sale.................................. 1,331 1,453 447 483
Loans, net........................................... 251,271 256,361 235,992 236,060
FINANCIAL LIABILITIES
Demand deposits...................................... 215,925 215,925 166,541 166,541
Time deposits........................................ 134,628 135,542 82,472 82,863
Savings deposits..................................... 99,748 99,748 89,650 89,650
Other borrowings..................................... 289 289 -- --
The following estimates and assumptions were used to estimate the fair
value of the financial instruments.
Cash and cash equivalents -- The carrying amount is a reasonable estimate
of fair value.
Interest-bearing deposits in other financial institutions and
securities -- Fair values of interest-bearing deposits in other financial
institutions and securities are based on quoted market prices or dealer quotes.
If a quoted market price was not available, fair value was estimated using
quoted market prices for similar securities.
Loans, net -- Fair values for certain commercial, construction, revolving
customer credit and other loans were estimated by discounting the future cash
flows using current rates at which similar loans would be made to borrowers with
similar credit ratings and similar maturities, adjusted for the allowance for
credit losses.
Certain adjustable rate loans have been valued at their carrying values, if
no significant changes in credit standing have occurred since origination and
the interest rate adjustment characteristics of the loan effectively adjust the
interest rate to maintain a market rate of return. For adjustable rate loans
which have had changes in credit quality, appropriate adjustments to the fair
value of the loans are made.
Demand, time and savings deposits -- The fair value of noninterest-bearing
and adjustable rate deposits and savings is the amount payable upon demand at
the reporting date. The fair value of fixed-rate interest-bearing deposits with
fixed maturity dates was estimated by discounting the cash flows using rates
currently offered for deposits of similar remaining maturities.
Off-balance sheet instruments -- The fair value of commitments to extend
credit is estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present credit-worthiness of the counterparties. The fair values of standby and
commercial letters of credit are based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparties. The fair values of such off-balance sheet
instruments were not significant at December 31, 1997 and 1996 and, therefore,
have not been included in the table above.
48
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
NOTE 13. COMMITMENTS AND CONTINGENCIES
In the normal course of business there are various commitments outstanding
to extend credit which are not reflected in the financial statements, including
loan commitments of approximately $90,649,000 and standby letters of credit and
financial guarantees of $5,272,000 at December 31, 1997. The Bank does not
anticipate any losses as a result of these transactions.
Approximately $15,871,000 of loan commitments outstanding at December 31,
1997 relate to construction loans and are expected to fund within the next
twelve months. The remainder relate primarily to revolving lines of credit or
other commercial loans. Many of these loan commitments are expected to expire
without being drawn upon. Therefore the total commitments do not necessarily
represent future cash requirements.
Stand-by letters of credit are commitments written by the Bank to guarantee
the performance of a customer to a third party. These guarantees are issued
primarily relating to purchases of inventory by the Banks' commercial customers,
are typically short-term in nature and virtually all such commitments are
collateralized.
Most of the outstanding commitments to extend credit are at variable rates
tied to the Banks' reference rate of interest. The Company's exposure to credit
loss in the event of nonperformance by the other party to the financial
instrument for commitments to extend credit and standby letters of credit issued
is the contractual amount of those instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments. The Company controls the credit risk of the
off-balance sheet financial instruments through the normal credit approval and
monitoring process.
NOTE 14. RELATED PARTY LOANS
The Company makes loans to officers and directors and their associates
subject to loan committee approval and ratification by the Board of Directors.
These transactions are on substantially the same terms as those prevailing at
the time for comparable transactions with unaffiliated parties and do not
involve more than normal risk of collectibility. An analysis of changes in
related party loans for the year ended December 31, 1997 is as follows:
BEGINNING BALANCE ADDITIONS REPAYMENTS ENDING BALANCE
- ----------------- ---------- ---------- --------------
$9,746,000 $6,726,000 $7,353,000 $9,119,000
Committed lines of credit, undisbursed loans and standby letters of credit
to directors and officers at December 31, 1997 were approximately $7,299,000.
NOTE 15. REGULATORY MATTERS
The Company is subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly, additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Capital adequacy
guidelines and the regulatory framework for prompt corrective action require
that the Company meet specific capital adequacy guidelines that involve
quantitative measures of the Company's assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting practices. The
Company's capital amounts and classifications are also subject to qualitative
judgments by the regulators about components, risk weighting and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum ratios of total and Tier 1 capital (as
defined in the regulations) to risk-weighted assets (as
49
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
defined) and a minimum leverage ratio of Tier 1 capital to average assets (as
defined). Management believes, as of December 31, 1997 that the Company meets
all capital adequacy requirements to which it is subject.
As of December 31, 1997 and 1996, the most recent notifications from the
Federal Deposit Insurance Corporation categorized the Banks as well capitalized
under the regulatory framework for prompt corrective action. To be categorized
as well capitalized the Banks must maintain minimum total risk-based, Tier 1
risk-based and Tier 1 leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
The following table shows the Company's and the Banks' actual capital
amounts and ratios at December 31, as well as the minimum capital ratios to be
categorized as "well capitalized" under the regulatory framework:
TO BE CATEGORIZED
WELL CAPITALIZED
UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS:
------------------- ------------------ ------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ----- ---------- ----- ---------- -----
As of December 31, 1997:
Total Capital (to Risk Weighted
Assets):
COMPANY............................ 45,782,000 15.2% 24,046,000 8.0% N/A
Bank of Salinas.................... 38,877,000 14.5% 21,514,000 8.0% 26,892,000 10.0%
Cypress Bank....................... 5,012,000 14.6% 2,739,000 8.0% 3,423,000 10.0%
Tier 1 Capital (to Risk Weighted
Assets):
COMPANY............................ 41,968,000 14.0% 12,023,000 4.0% N/A
Bank of Salinas.................... 35,501,000 13.2% 10,757,000 4.0% 16,135,000 6.0%
Cypress Bank....................... 4,584,000 13.4% 1,369,000 4.0% 2,054,000 6.0%
Tier 1 Capital (to Average Assets):
COMPANY............................ 41,968,000 9.6% 17,570,000 4.0% N/A
Bank of Salinas.................... 35,501,000 8.9% 15,869,000 4.0% 19,837,000 5.0%
Cypress Bank....................... 4,584,000 8.8% 2,084,000 4.0% 2,605,000 5.0%
As of December 31, 1996:
Total Capital (to Risk Weighted
Assets):
COMPANY............................ 39,562,000 15.4% 20,584,000 8.0% N/A
Bank of Salinas.................... 34,134,000 15.1% 18,043,000 8.0% 22,554,000 10.0%
Cypress Bank....................... 4,700,000 15.1% 2,493,000 8.0% 3,117,000 10.0%
Tier 1 Capital (to Risk Weighted
Assets):
COMPANY............................ 36,332,000 14.1% 10,292,000 4.0% N/A
Bank of Salinas.................... 31,302,000 13.9% 9,021,000 4.0% 13,532,000 6.0%
Cypress Bank....................... 4,309,000 13.8% 1,247,000 4.0% 1,870,000 6.0%
Tier 1 Capital (to Average Assets):
COMPANY............................ 36,332,000 10.1% 14,321,000 4.0% N/A
Bank of Salinas.................... 31,302,000 10.1% 9,326,000 3.0% 15,543,000 5.0%
Cypress Bank....................... 4,309,000 9.1% 1,887,000 4.0% 2,358,000 5.0%
The ability of the Company to pay cash dividends in the future will largely
depend upon the cash dividends paid to it by its subsidiary Banks. Under State
and Federal law regulating banks, cash dividends declared by a Bank in any
calendar year generally may not exceed its net income for the preceding three
fiscal
50
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
years, less distributions to the Company, or its retained earnings. Under these
provisions, and considering minimum regulatory capital requirements, the amount
available for distribution from the Banks to the Company was approximately
$15,034,000 as of December 31, 1997.
The Banks are subject to certain restrictions under the Federal Reserve
Act, including restrictions on the extension of credit to affiliates. In
particular, the Banks are prohibited from lending to the Company unless the
loans are secured by specified types of collateral. Such secured loans and other
advances from the Banks are limited to 10% of Bank shareholders' equity, or a
combined maximum of $4,174,000 at December 31, 1997. No such advances were made
during 1997 or 1996.
NOTE 16. CENTRAL COAST BANCORP (PARENT COMPANY ONLY)
The condensed financial statements of Central Coast Bancorp follow (in
thousands):
CONDENSED BALANCE SHEETS
DECEMBER 31,
------------------
1997 1996
------- -------
Assets:
Cash -- interest bearing account with Bank................ $ 191 $ 74
Investment in Banks....................................... 41,841 35,611
Premises and equipment, net............................... 491 68
Other Assets.............................................. 1,916 844
------- -------
Total assets...................................... $44,439 $36,597
======= =======
Liabilities and Shareholders' Equity
Liabilities............................................... $ 715 $ 265
Shareholders' Equity...................................... 43,724 36,332
------- -------
Total liabilities and shareholders' equity........ $44,439 $36,597
======= =======
CONDENSED INCOME STATEMENTS
YEARS ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------ ------
Management fees............................................. $ 3,624 $ 840
Other income................................................ 11 --
Cash dividends received from Banks.......................... 2,000 500 $ 600
------- ------ ------
Total income...................................... 5,635 1,340 600
Operating expenses.......................................... 6,386 1,737 437
------- ------ ------
Income (loss) before income taxes and equity in
undistributed net income of Banks......................... (751) (397) 163
Provision (credit) for income taxes......................... (1,125) (352) (66)
Equity in undistributed net income of Banks................. 6,129 5,905 4,096
------- ------ ------
Net income........................................ $ 6,503 $5,860 $4,325
======= ====== ======
51
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
Increase (decrease) in cash:
Operations:
Net income................................................ $ 6,503 $ 5,860 $ 4,325
Adjustments to reconcile net income to net cash provided
(used) by operations:
Equity in undistributed net income of Banks............ (6,129) (5,905) (4,096)
Depreciation........................................... 71 1 --
(Increase) decrease in other assets.................... (656) (522) (34)
Increase (decrease) in liabilities..................... 450 80 194
------- ------- -------
Net cash provided (used) by operations................. 239 (486) 389
------- ------- -------
Investing Activities --
Capital expenditures...................................... (494) (69) --
------- ------- -------
Financing Activities:
Short-term borrowings..................................... -- -- (125)
Fractional shares repurchased............................. (8) (5) --
Stock options exercised................................... 380 319 22
------- ------- -------
Net cash provided (used) by financing activities....... 372 314 (103)
------- ------- -------
Net increase (decrease) in cash........................ 117 (241) 286
Cash balance, beginning of year........................... 74 315 29
------- ------- -------
Cash balance, end of year................................. $ 191 $ 74 $ 315
======= ======= =======
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by Item 10 of Form 10-K is incorporated by
reference to the information contained in the Company's Proxy Statement for the
1998 Annual Meeting of Shareholders which will be filed pursuant to Regulation
14A.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors, executive officers and ten percent or more shareholders of the
Company's equity securities, to file with the Securities and Exchange Commission
initial reports of ownership and reports of changes of ownership of the
Company's equity securities. Officers, directors and ten percent or more
shareholders are required by SEC regulation to furnish the Company with copies
of all Section 16(a) forms they file. To the Company's knowledge, based solely
on review of the copies of such reports furnished to the Company and written
representations that no other reports were required, during the fiscal year
ended December 31, 1997, except for Director Boutonnet who failed to timely file
one report on Form 3, all Section 16(a) filing requirements applicable to its
executive
52
53
officers, directors and beneficial owners of ten percent or more of the
Company's equity securities appear to have been met.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by
reference to the information contained in the Company's Proxy Statement for the
1998 Annual Meeting of Shareholders which will be filed pursuant to Regulation
14A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 of Form 10-K is incorporated by
reference to the information contained in the Company's Proxy Statement for the
1998 Annual Meeting of Shareholders which will be filed pursuant to Regulation
14A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 of Form 10-K is incorporated by
reference to the information contained in the Company's Proxy Statement for the
1998 Annual Meeting of Shareholders which will be filed pursuant to Regulation
14A.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS.
Listed and included in Part II, Item 8.
(2) FINANCIAL STATEMENT SCHEDULES.
Not applicable.
(3) EXHIBITS.
(2.1) Agreement and Plan of Reorganization and Merger by and
between Central Coast Bancorp, CCB Merger Company and
Cypress Coast Bank dated as of December 5, 1995,
incorporated by reference from Exhibit 99.1 to Form 8-K
filed with the Commission on December 7, 1995.
(3.1) Articles of Incorporation, incorporated by reference from
Exhibit 4.8 to Registration Statement on Form S-8 No.
33-89948, filed with the Commission on March 3, 1995.
(3.2) Bylaws, incorporated by reference from Exhibit 4.9 to
Registration Statement on Form S-8 No. 33-89948, filed with
the Commission on March 3, 1995.
(4.1) Specimen form of Central Coast Bancorp stock certificate
incorporated by reference from the Company's 1994 Annual
Report on Form 10K filed with the Commission on March 31,
1995.
(10.1) Lease agreement dated December 12, 1994, related to 301 Main
Street, Salinas, California incorporated by reference from
the Company's 1994 Annual Report on Form 10K filed with the
Commission on March 31, 1995.
(10.2) King City Branch Lease incorporated by reference from
Exhibit 10.3 to Registration Statement on Form S-4 No.
33-76972, filed with the Commission on March 28, 1994.
(10.3) Amendment to King City Branch Lease incorporated by
reference from Exhibit 10.4 to Registration Statement on
Form S-4 No. 33-76972, filed with the Commission on March
28, 1994.
53
54
*(10.4) 1982 Stock Option Plan, as amended, incorporated by
reference from Exhibit 4.2 to Registration Statement on Form
S-8 No. 33-89948, filed with the Commission on March 3,
1995.
*(10.5) Form of Nonstatutory Stock Option Agreement under the 1982
Stock Option Plan incorporated by reference from Exhibit 4.6
to Registration Statement on Form S-8 No. 33-89948, filed
with the Commission on March 3, 1995.
*(10.6) Form of Incentive Stock Option Agreement under the 1982
Stock Option Plan incorporated by reference from Exhibit 4.7
to Registration Statement on Form S-8 No. 33-89948, filed
with the Commission on March 3, 1995.
*(10.7) 1994 Stock Option Plan incorporated by reference from
Exhibit 4.1 to Registration Statement on Form S-8 No.
33-89948, filed with the Commission on March 3, 1995.
*(10.8) Form of Nonstatutory Stock Option Agreement under the 1994
Stock Option Plan incorporated by reference from Exhibit 4.3
to Registration Statement on Form S-8 No. 33-89948, filed
with Commission on March 3, 1995.
*(10.9) Form of Incentive Stock Option Agreement under the 1994
Stock Option Plan incorporated by reference from Exhibit 4.4
to Registration Statement on Form S-8 No. 33-89948, filed
with the commission on March 3, 1995.
*(10.10) Form of Director Nonstatutory Stock Option Agreement under
the 1994 Stock Option Plan incorporated by reference from
Exhibit 4.5 to Registration Statement on Form S-8 No. 33-
89948, filed with the commission on March 3, 1995.
*(10.11) Form of Bank of Salinas Indemnification Agreement for
directors and executive officers incorporated by reference
from Exhibit 10.9 to Amendment No. 1 to Registration
Statement on Form S-4 No. 33-76972, filed with the
Commission on April 15, 1994.
*(10.12) 401(k) Pension and Profit Sharing Plan Summary Plan
Description incorporated by reference from Exhibit 10.8 to
Registration Statement on Form S-4 No. 33-76972, filed with
the Commission on March 28, 1994.
*(10.13) Specimen form of Employment Agreement incorporated by
reference from Exhibit 10.13 to the Company's 1996 Annual
Report on Form 10K filed with the Commission on March 31,
1997.
*(10.14) Specimen form of Executive Salary Continuation Agreement
incorporated by reference from Exhibit 10.14 to the
Company's 1996 Annual Report on Form 10K filed with the
Commission on March 31, 1997.
*(10.15) 1994 Stock Option Plan, as amended, incorporated by
reference from Exhibit A to the Proxy Statement filed with
the Commission on September 3, 1996 in connection with
Central Coast Bancorp's 1996 Annual Shareholders' Meeting
held on September 23, 1996.
(10.16) Specimen of Indemnification Agreement, incorporated by
reference from Exhibit D to the Proxy Statement filed with
the Commission on September 3, 1996 in connection with
Central Coast Bancorp's 1996 Annual Shareholders' Meeting
held on September 23, 1996.
(10.17) Purchase and Assumption Agreement for the Acquisition of
Wells Fargo Bank Branches incorporated by reference from
Exhibit 10.17 to the Company's 1996 Annual Report on Form
10K filed with the Commission on March 31, 1997.
*(10.18) Employee Stock Ownership Plan and Trust Agreement
incorporated by reference from Exhibit 10.18 to the
Company's 1996 Annual Report on Form 10K filed with the
Commission on March 31, 1997.
(10.19) Lease agreement dated March 7, 1997, related to 484
Lighthouse Avenue, Monterey, California
(21.1) The Registrant's only subsidiaries are its wholly-owned
subsidiaries, Bank of Salinas and Cypress Bank
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(23.1) Independent auditors' consent
(27.1) Financial Data Schedule
- ---------------
* Denotes management contracts, compensatory plans or arrangements.
(B) REPORTS ON FORM 8-K.
Filed with the Commission on December 8, 1997
An Annual Report for the fiscal year ended December 31, 1997, and Notice of
Annual Meeting and Proxy Statement for the Company's 1998 Annual Meeting will be
mailed to security holders subsequent to the date of filing this Report. Copies
of said materials will be furnished to the Commission in accordance with the
Commission's Rules and Regulations.
55
56
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.
CENTRAL COAST BANCORP
Date: March 19, 1998 By: /s/ NICK VENTIMIGLIA
------------------------------------
Nick Ventimiglia,
President and Chief Executive
Officer
(Principal Executive Officer)
Date: March 19, 1998 By: /s/ JAYME C. FIELDS
------------------------------------
Jayme C. Fields, Controller
(Principle Accounting and Finance
Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934 this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ANDREW E. AUSONIO Director March 19, 1998
- --------------------------------------------------------
Andrew E. Ausonio
/s/ C. EDWARD BOUTONNET Director March 19, 1998
- --------------------------------------------------------
C. Edward Boutonnet
/s/ BRADFORD G. CRANDALL Director March 19, 1998
- --------------------------------------------------------
Bradford G. Crandall
/s/ ALFRED P. GLOVER Director March 19, 1998
- --------------------------------------------------------
Alfred P. Glover
/s/ RICHARD C. GREEN Director March 19, 1998
- --------------------------------------------------------
Richard C. Green
/s/ MICHAEL T. LAPSYS Director March 19, 1998
- --------------------------------------------------------
Michael T. Lapsys
/s/ ROBERT M. MRAULE Director March 19, 1998
- --------------------------------------------------------
Robert M. Mraule
/s/ DUNCAN L. MCCARTER Director March 19, 1998
- --------------------------------------------------------
Duncan L. McCarter
/s/ LOUIS A. SOUZA Director March 19, 1998
- --------------------------------------------------------
Louis A. Souza
/s/ MOSE E. THOMAS Director March 19, 1998
- --------------------------------------------------------
Mose E. Thomas
/s/ NICK VENTIMIGLIA Chairman, President and CEO March 19, 1998
- --------------------------------------------------------
Nick Ventimiglia
56
57
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.19 Lease agreement dated March 7, 1997, related to 484
Lighthouse Avenue, Monterey, California
23.1 Independent auditors' consent
27.1 Financial Data Schedule
57