UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] Quarterly Report Under Section 13 or 15 (d) of
the Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2002
[ ] Transition Report Pursuant to Section 13 or 15 (d) of
the Securities Exchange Act of 1934
For the Transition Period from _________ to _________
Commission File Number: 0-24526
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COASTAL BANCORP, INC.
---------------------
(Exact name of Registrant as specified in its charter)
Texas 76-0428727
--------------------- --------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5718 Westheimer, Suite 600
Houston, Texas 77057
------------------------
(Address of principal executive office)
(713) 435-5000
---------------
(Registrant's telephone number)
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 the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
COMMON STOCK OUTSTANDING: 5,226,502 AS OF AUGUST 9, 2002
COASTAL BANCORP, INC. AND SUBSIDIARIES
Table of Contents
PART I. FINANCIAL INFORMATION
- -------- ----------------------
Item 1 Financial Statements (unaudited)
Consolidated Statements of Financial Condition at June 30, 2002
and December 31, 2001 1
Consolidated Statements of Income for the Six-Month Periods Ended
June 30, 2002 and 2001 2
Consolidated Statements of Income for the Three-Month Periods Ended
June 30, 2002 and 2001 3
Consolidated Statements of Comprehensive Income for the Six-Month and
Three-Month Periods Ended June 30, 2002 and 2001 4
Consolidated Statements of Cash Flows for the Six-Month Periods
Ended June 30, 2002 and 2001 5
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations 19
Item 3 Quantitative and Qualitative Disclosures About Market Risk 26
PART II. OTHER INFORMATION
- --------- ------------------
Item 1 Legal Proceedings 27
Item 2 Changes in Securities and Use of Proceeds 27
Item 3 Default upon Senior Securities 27
Item 4 Submission of Matters to a Vote of Security Holders 27
Item 5 Other Information 27
Item 6 Exhibits and Reports on Form 8-K 28
SIGNATURES
ITEM 1. FINANCIAL STATEMENTS
- -------- ---------------------
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT SHARE DATA)
June 30, December 31,
ASSETS 2002 2001
- ------------------------------------------------------ ---------- ------------
(Unaudited)
Cash and cash equivalents $ 34,023 $ 41,537
Federal funds sold 3,360 16,710
Loans receivable held for sale (note 4) 3,814 --
Loans receivable (note 4) 1,918,938 1,863,601
Mortgage-backed securities available-for-sale (note 3) 427,854 514,068
Other securities available-for-sale 1,768 42,827
Accrued interest receivable 11,509 13,243
Property and equipment 27,050 27,461
Stock in the Federal Home Loan Bank of Dallas (FHLB) 40,630 40,032
Goodwill and other intangible assets (note 5) 20,730 21,811
Prepaid expenses and other assets 17,662 16,601
---------- ----------
$2,507,338 $2,597,891
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ---------------------------------------
Liabilities:
Deposits (note 6) $1,650,759 $1,660,386
Advances from the FHLB (note 7) 609,846 690,877
Company obligated mandatorily redeemable 9.0% trust preferred
securities of Coastal Capital Trust I (note 8) 50,000 --
Senior notes payable, net (note 9) -- 43,875
Advances from borrowers for taxes and insurance 7,366 4,259
Other liabilities and accrued expenses 13,767 12,310
----------- -----------
Total liabilities 2,331,738 2,411,707
----------- -----------
Minority interest - 9.0% noncumulative preferred stock of
Coastal Banc ssb (note 12) 28,750 28,750
Commitments and contingencies (notes 4 and 10)
Stockholders' equity (notes 1, 3, 11, 13 and 14):
Preferred stock, no par value; authorized shares 5,000,000;
9.12% Cumulative, Series A, 1,100,000 shares issued and
outstanding 27,500 27,500
Common stock, $.01 par value; authorized shares
30,000,000; 7,848,806 shares issued and 5,302,847 shares
outstanding at June 30, 2002; 7,835,178 shares issued
and 5,835,178 shares outstanding at December 31, 2001 78 78
Additional paid-in capital 35,448 35,366
Retained earnings 133,101 127,425
Accumulated other comprehensive loss -
unrealized loss on securities available-for-sale (1,526) (1,590)
Treasury stock at cost (2,545,959, shares in 2002 and 2,000,000
shares in 2001) (47,751) (31,345)
----------- -----------
Total stockholders' equity 146,850 157,434
----------- -----------
$2,507,338 $2,597,891
=========== ===========
See accompanying Notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Six Months Ended
June 30,
------------------
2002 2001
-------- --------
(Unaudited)
Interest income:
Loans receivable $ 60,708 $ 84,079
Mortgage-backed securities 9,026 30,987
FHLB stock, federal funds sold and other interest-earning assets 855 1,522
----------- ---------
70,589 116,588
----------- ---------
Interest expense:
Deposits 21,243 38,982
Advances from the FHLB 10,359 25,960
Other borrowed money -- 4,578
Senior notes payable 378 2,345
Company obligated mandatorily redeemable 9.0% trust preferred
securities of Coastal Capital Trust I 163 --
----------- ---------
32,143 71,865
----------- ---------
Net interest income 38,446 44,723
Provision for loan losses 1,800 2,100
----------- ---------
Net interest income after provision for loan losses 36,646 42,623
----------- ---------
Noninterest income:
Service charges on deposit accounts 4,133 3,621
Loan fees 622 600
Loss on derivative instruments (24) (443)
Gain on sale of real estate owned 240 31
Other 492 997
----------- ---------
5,463 4,806
----------- ---------
Noninterest expense:
Compensation, payroll taxes and other benefits 15,853 15,206
Office occupancy 5,221 5,517
Data processing 822 1,687
Amortization of goodwill and other intangible assets 1,081 1,397
Advertising 850 715
Postage and delivery 795 701
Other 3,994 4,032
----------- ---------
28,616 29,255
----------- ---------
Income before provision for Federal income taxes, minority
interest and cumulative effect of accounting change 13,493 18,174
Provision for Federal income taxes 3,867 5,606
----------- ---------
Income before minority interest and cumulative effect of
accounting change 9,626 12,568
Minority interest - preferred stock dividends of Coastal Banc ssb 1,294 1,294
----------- ---------
Income before cumulative effect of accounting change 8,332 11,274
Cumulative effect of change in accounting for derivative instruments, net of tax (note 10) -- (104)
----------- ---------
Net income $ 8,332 $ 11,170
=========== =========
Net income available to common stockholders $ 7,078 $ 9,916
=========== =========
Basic earnings per share before cumulative effect of accounting change $ 1.23 $ 1.75
=========== =========
Basic earnings per share (notes 5 and 11) $ 1.23 $ 1.73
=========== ==========
Diluted earnings per share before cumulative effect of accounting change $ 1.17 $ 1.66
=========== =========
Diluted earnings per share (notes 5 and 11) $ 1.17 $ 1.64
=========== =========
See accompanying Notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended
June 30,
--------------------
2002 2001
---------- -------
(Unaudited)
Interest income:
Loans receivable $ 30,741 $41,078
Mortgage-backed securities 4,062 14,729
FHLB stock, federal funds sold and other interest-earning assets 380 616
--------- --------
35,183 56,423
--------- --------
Interest expense:
Deposits 10,202 19,061
Advances from the FHLB 5,091 9,197
Other borrowed money -- 4,575
Senior notes payable -- 1,172
Company obligated mandatorily redeemable 9.0% trust preferred
securities of Coastal Capital Trust I 163 --
--------- --------
15,456 34,005
--------- --------
Net interest income 19,727 22,418
Provision for loan losses 900 1,200
--------- --------
Net interest income after provision for loan losses 18,827 21,218
--------- --------
Noninterest income:
Service charges on deposit accounts 2,138 1,860
Loan fees 315 360
Gain on derivative instruments -- 121
Gain on sale of real estate owned 218 12
Other 283 631
--------- --------
2,954 2,984
--------- --------
Noninterest expense:
Compensation, payroll taxes and other benefits 7,992 7,608
Office occupancy 2,641 2,841
Data processing 399 833
Amortization of goodwill and other intangible assets 547 695
Advertising 421 359
Postage and delivery 367 351
Other 1,999 1,886
--------- --------
14,366 14,573
--------- --------
Income before provision for Federal income taxes and
minority interest 7,415 9,629
Provision for Federal income taxes 2,169 2,992
--------- --------
Income before minority interest 5,246 6,637
Minority interest - preferred stock dividends of Coastal Banc ssb 647 647
--------- --------
Net income $ 4,599 $ 5,990
========== ========
Net income available to common stockholders $ 3,972 $ 5,363
========== ========
Basic earnings per share (notes 5 and 11) $ 0.70 $ 0.93
========== ========
Diluted earnings per share (notes 5 and 11) $ 0.66 $ 0.89
========== ========
See accompanying Notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
Six Months Ended
June 30,
----------------
2002 2001
--------- ----------
(Unaudited)
Net income $ 8,332 $11,170
Other comprehensive income, net of tax:
Unrealized holding gains on securities available-for-sale
arising during period 64 1,543
--------- ----------
Total comprehensive income $ 8,396 $12,713
========= ==========
Three Months Ended
June 30,
---------------
2002 2001
-------- ----------
(Unaudited)
Net income $ 4,599 $5,990
Other comprehensive income, net of tax:
Unrealized holding gains on securities available-for-sale
arising during period 69 936
---------- ----------
Total comprehensive income $ 4,668 $6,926
=========- ==========
See accompanying Notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Six Months Ended
June 30,
------------------
2002 2001
------------------ ----------
(Unaudited)
Cash flows from operating activities:
Net income $ 8,332 $ 11,170
Adjustments to reconcile net income
to net cash provided (used) by operating activities:
Depreciation and amortization of property and equipment
and prepaid expenses and other assets 4,113 4,063
Net premium amortization (discount accretion) 2,615 (1,332)
Provision for loan losses 1,800 2,100
Amortization of goodwill and other intangible assets 1,081 1,397
Originations and purchases of mortgage loans held for sale (8,592) (15,649)
Sales of mortgage loans for held for sale 11,758 15,779
Stock dividends from the FHLB (598) (1,338)
Loss on derivative instruments 24 603
Decrease (increase) in:
Accrued interest receivable 1,734 1,368
Other, net 3,462 (30,009)
----------- -----------
Net cash provided (used) by operating activities 25,729 (11,848)
----------- -----------
Cash flows from investing activities:
Net decrease (increase) in federal funds sold 13,350 (5,701)
Purchase of other securities available-for-sale (243) --
Principal repayments on mortgage-backed securities held-to-maturity -- 33,839
Principal repayments on mortgage-backed securities
available-for-sale 84,580 6,158
Proceeds from maturity of U.S. Treasury securities held-to-maturity -- 100
Proceeds from maturity of other securities available-for-sale 41,000 --
Purchases of loans receivable (218,988) (163,327)
Sales of loans receivable 10,111 --
Net decrease in loans receivable 140,822 66,218
Purchases of property and equipment, net (1,594) (1,294)
Purchases of FHLB stock -- (3,986)
Proceeds from sales of FHLB stock -- 28,431
----------- -----------
Net cash provided (used) by investing activities 69,038 (39,562)
----------- -----------
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(IN THOUSANDS)
Six Months Ended
June 30,
------------------
2002 2001
------------------ ------------
(Unaudited)
Cash flows from financing activities:
Net increase (decrease) in deposits $ (9,627) $ 16,555
Securities sold under agreements to repurchase and federal funds
purchased -- 1,465,852
Purchases of securities sold under agreements to repurchase and
federal funds purchased -- (982,672)
Advances from the FHLB 2,893,300 6,609,380
Principal payments on advances from the FHLB (2,974,331) (7,093,527)
Proceeds from issuance of trust preferred securities 48,125 --
Redemption of senior notes payable (43,875) --
Net increase in advances from borrowers for taxes and insurance 3,107 5,055
Exercise of stock options for purchase of common stock, net 55 1,040
Purchase of treasury stock (16,436) --
Issuance of treasury shares 59 --
Dividends paid (2,658) (2,518)
------------------ ------------
Net cash provided (used) by financing activities (102,281) 19,165
------------------ ------------
Net decrease in cash and cash equivalents (7,514) (32,245)
Cash and cash equivalents at beginning of period 41,537 69,730
------------------ ------------
Cash and cash equivalents at end of period $ 34,023 $ 37,485
================== ============
Supplemental schedule of cash flows-interest paid $ 33,315 $ 71,862
================== ============
Supplemental schedule of noncash investing and financing activities:
Transfer of loans to held for sale category $ 9,075 $ --
================== ============
Foreclosures of loans receivable $ 3,436 $ 1,709
================== ============
Capitalization of costs related to issuance of trust preferred securities $ 1,875 $ --
================== ============
See accompanying Notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) BASIS OF PRESENTATION
The accompanying unaudited Consolidated Financial Statements were prepared
in accordance with the instructions for Form 10-Q and, therefore, do not include
all disclosures necessary for a complete presentation of financial condition,
results of operations, and cash flows in conformity with accounting principles
generally accepted in the United States of America. All adjustments which are,
in the opinion of management, of a normal recurring nature and are necessary for
a fair presentation of the interim financial statements, have been included.
The results of operations for the period ended June 30, 2002 are not necessarily
indicative of the results that may be expected for the entire fiscal year or any
other interim period.
On August 27, 1998, December 21, 1998, February 25, 1999, April 27, 2000,
July 27, 2000 and April 25, 2002, the Board of Directors authorized six separate
repurchase plans for up to 500,000 shares each of the outstanding shares of
common stock through an open-market repurchase program and privately negotiated
repurchases, if any. During June 2002, Coastal repurchased 547,800 shares of
common stock at an average repurchase price of $30.00 per share. Of that
amount, 500,000 shares were repurchased in a privately negotiated transaction
with a director of Coastal at $30.00 per share. As of June 30, 2002, a total of
2,547,800 shares had been repurchased under the authorized repurchase plans.
As of June 30, 2002, 2,545,959 shares were held in treasury at an average
price of $18.76 per share for a total cost of $47.8 million. Book value per
common share at June 30, 2002 was $21.78.
(2) PRINCIPLES OF CONSOLIDATION
The accompanying unaudited Consolidated Financial Statements include the
accounts of Coastal Bancorp, Inc. ("Bancorp") and its wholly-owned subsidiaries,
Coastal Capital Trust I and Coastal Banc Holding Company, Inc. and Coastal Banc
Holding Company Inc.'s wholly-owned subsidiaries, Coastal Banc ssb and its
subsidiaries, CoastalBanc Financial Corp. and Coastal Banc Insurance Agency,
Inc. (collectively, the "Bank"), and Coastal Banc Capital Corp. (collectively
"Coastal"). All significant intercompany balances and transactions have been
eliminated in consolidation.
(3) MORTGAGE-BACKED SECURITIES
Mortgage-backed securities at June 30, 2002 were as follows (in thousands):
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ----------- ---------- -------
Available-for-sale:
Agency securities $ 346,512 $ 284 $(2,041) $344,755
CMOs - Non-agency 81,421 55 (675) 80,801
Non-agency securities 2,273 25 -- 2,298
---------- ------- ------- ---------
$ 430,206 $ 364 $(2,716) $427,854
========== ======= ======= ========
Mortgage-backed securities at December 31, 2001 were as follows (in
thousands):
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ----------- ---------- -------
Available-for-sale:
Agency securities $ 406,437 $ 319 $(2,455) $404,301
CMOs - Non-agency 107,488 82 (418) 107,152
Non-agency securities 2,590 34 (9) 2,615
---------- ------ -------- ---------
$ 516,515 $ 435 $(2,882) $514,068
=========== ======= ======= ========
Effective September 30, 2001, Coastal transferred all of its mortgage-backed
securities held-to-maturity to the available-for-sale category. This was due to
management's intent to restructure a portion of the asset base to be less
vulnerable to market interest rate fluctuations. In late November 2001, Coastal
entered into a transaction in which it sold $844.9 million of its
mortgage-backed securities. Also in November, Coastal used a portion of the
proceeds of that sale to purchase approximately $512.3 million of primarily pass
through mortgage-backed securities. All of the securities purchased and the
remaining securities not sold were placed in the available-for-sale category.
(4) LOANS RECEIVABLE
Loans receivable at June 30, 2002 and December 31, 2001 were as follows (in
thousands):
June 30, 2002 December 31, 2001
--------------- -----------------
Real estate mortgage loans:
First-lien mortgage, primarily residential $ 912,045 $ 880,624
Commercial 336,403 319,377
Multifamily 126,372 124,616
Residential construction 166,527 136,035
Acquisition and development 132,451 140,009
Commercial construction 259,748 222,026
Commercial loans, secured by residential mortgage
loans held for sale 1,188 11,508
Commercial, financial and industrial 126,915 116,029
Loans secured by deposits 19,486 21,238
Consumer and other loans 36,643 43,384
2,117,778 2,014,846
--------------- -----------
Loans in process (181,643) (131,064)
Allowance for loan losses (15,233) (15,385)
Unearned interest and loan fees (3,212) (2,959)
Premium (discount) on purchased loans, net 1,248 (1,837)
--------------- -----------
$ 1,918,938 $1,863,601
=============== ===========
Weighted average yield 6.37% 6.90%
=============== ===========
At June 30, 2002, Coastal had outstanding commitments to originate or
purchase $24.5 million of real estate mortgage and other loans and had
commitments under existing lines of credit to originate primarily construction
and other loans of approximately $109.1 million. In addition, at June 30, 2002,
Coastal had $14.7 million of outstanding letters of credit. Management
anticipates the funding of these commitments through normal operations.
At June 30, 2002 and December 31, 2001, the carrying value of loans that
were considered to be impaired totaled approximately $3.6 million and $3.8
million, respectively and the related allowance for loan losses on those
impaired loans totaled $441,000 and $554,000 at June 30, 2002 and December 31,
2001, respectively. Of the impaired loans outstanding, eight loans with a
balance of $832,000 at June 30, 2002 and nineteen loans with a balance of $1.3
million at December 31, 2001 did not have specific portions of the allowance for
loan losses allocated to them at each respective date. The average recorded
investment in impaired loans during the six months ended June 30, 2002 and 2001
was $3.2 million and $4.7 million, respectively.
An analysis of activity in the allowance for loan losses for the six months
ended June 30, 2002 and 2001 is as follows (in thousands):
Six Months Ended June 30,
-------------------------
2002 2001
-------- --------
Balance, beginning of period $15,385 $14,507
Provision for loan losses 1,800 2,100
Charge-offs (2,274) (2,215)
Recoveries 322 159
------- --------
Balance, end of period $15,233 $14,551
======== ========
During the first quarter of 2002, management made the decision to liquidate
a portion of its under-performing single-family mortgage loans. On March 22,
2002, Coastal sold $10.8 million of these under-performing loans to a third
party investor. Prior to the sale, Coastal wrote these loans down to fair value
and recorded a charge-off to the allowance for loan losses of $761,000. In
addition, as of March 31, 2002, Coastal wrote down to fair value and
reclassified $9.1 million of other under-performing single-family mortgage loans
to the held for sale category. The loans that were reclassified to the held for
sale category were written down to fair value as of March 31, 2002 through a
charge-off to the allowance for loan losses of $691,000. During the second
quarter of 2002, a total of $3.1 million of these under-performing loans held
for sale were sold to the same third party investor. As of June 30, 2002,
Coastal had a total of $3.8 million loans held for sale remaining (net of second
quarter activity including sales, payoffs, foreclosures and monthly principal
payments received).
(5) GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, Coastal adopted Statement of Financial Accounting
Standards No. 141, "Business Combinations" ("Statement 141") and Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("Statement 142"). Statement 141 eliminates the pooling of interests method of
accounting for business combinations and requires that the purchase method of
accounting be used for all business combinations. Statement 141 also requires,
upon adoption of Statement 142, that Coastal evaluate its existing intangible
assets and goodwill that were acquired in prior purchase business combinations,
and make any necessary reclassifications in order to conform with the new
criteria in Statement 141 for recognition apart from goodwill. Statement 142
changes the accounting for goodwill from an amortization method to an
impairment-only approach.
At January 1, 2002, Coastal had unamortized goodwill that was subject to
the transition provisions of Statements 141 and 142 in the amount of $5.5
million. Amortization expense related to this goodwill was $154,000 for the
quarter ended June 30, 2001, $306,000 for the six months ended June 30, 2001 and
$618,000 for the year ended December 31, 2001. The remaining $16.3 million of
goodwill at January 1, 2002 was reclassified to other intangible assets, as
those amounts were originally recorded as goodwill pursuant to Statement of
Financial Accounting Standards No. 72, "Accounting for Certain Acquisitions of
Banking or Thrift Institutions" ("Statement 72") and are not subject to the
non-amortization provisions of Statement 142.
At June 30, 2002 and December 31, 2001, other intangible assets amounted to
$15.3 million and $16.3 million net of accumulated amortization of $12.8 million
and $11.7 million, respectively. The estimated aggregate amortization expense
on these other intangible assets for each of the five succeeding fiscal years is
as follows (dollars in thousands):
Year ending December 31,
- ------------------------
2002 $2,291
2003 1,790
2004 1,431
2005 1,270
2006 1,270
In connection with the adoption of these statements, Coastal tested for
impairment in accordance with the provisions of Statement 142 during the first
quarter of 2002 and did not recognize any transitional impairment losses as the
cumulative effect of a change in accounting principle. Pursuant to the
transition provisions of Statement 142, presented below are as adjusted net
income and earnings per share amounts to exclude the amortization expense (net
of any tax effect) recognized in the period prior to the implementation related
to the goodwill that is no longer being amortized (in thousands, except per
share data).
Six Months Ended
June 30,
2002 2001
------ -------
Net income:
As reported $8,332 $11,170
Add back: goodwill amortization -- 306
------ -------
As adjusted $8,332 $11,476
====== =======
Basic earnings per share:
As reported $ 1.23 $ 1.73
Add back: goodwill amortization -- 0.05
------ -------
As adjusted $ 1.23 $ 1.78
====== =======
Diluted earnings per share:
As reported $ 1.17 $ 1.64
Add back: goodwill amortization -- 0.05
------ -------
As adjusted $ 1.17 $ 1.69
====== =======
Three Months Ended
June 30,
2002 2001
------ ------
Net income:
As reported $4,599 $5,990
Add back: goodwill amortization -- 154
-------- --------
As adjusted $4,599 $6,144
======== ========
Basic earnings per share:
As reported $ 0.70 $ 0.93
Add back: goodwill amortization -- 0.03
-------- --------
As adjusted $ 0.70 $ 0.96
======== ========
Diluted earnings per share:
As reported $ 0.66 $ 0.89
Add back: goodwill amortization -- 0.03
-------- --------
As adjusted $ 0.66 $ 0.92
======== ========
(6) DEPOSITS
Deposits, their stated rates and the related weighted average interest
rates, at June 30, 2002 and December 31, 2001, are summarized below (dollars in
thousands). Effective January 1, 1998, Coastal implemented a program whereby a
portion of the balances in noninterest-bearing and interest-bearing checking
accounts is reclassified to money market demand accounts under Federal Reserve
Regulation D. The amount of such reclassification, reflected in the following
table, was approximately $249.1 million ($129.3 million from noninterest-bearing
and $119.8 million from interest-bearing) at June 30, 2002 and $243.3 million
($113.0 million from noninterest-bearing and $130.3 million from
interest-bearing) at December 31, 2001.
Stated Rate June 30, 2002 December 31, 2001
--------------- --------------- -----------------
Noninterest-bearing checking 0.00% $ 42,550 $ 47,712
Interest-bearing checking 0.50 - 1.00 11,963 15,894
Savings accounts 0.50 - 1.24 47,518 45,234
Money market demand accounts 0.00 - 2.23 529,434 505,789
------------------- -----------
631,465 614,629
------------------- -----------
Certificate accounts Less than 2.00 53,021 29,707
2.00 - 2.99 437,939 171,523
3.00 - 3.99 266,270 263,006
4.00 - 4.99 198,545 356,314
5.00 - 5.99 50,391 155,949
6.00 - 6.99 12,944 68,979
7.00 - 7.99 112 209
8.00 - 8.99 72 70
------------------- -----------
1,019,294 1,045,757
------------------- -----------
$ 1,650,759 $1,660,386
=================== ===========
Weighted average interest rate 2.44% 3.02%
=================== ===========
Prior to the reclassification as discussed above, noninterest-bearing
checking accounts, interest-bearing checking accounts and money market demand
accounts were as follows at June 30, 2002 and December 31, 2001:
June 30, 2002 December 31, 2001
-------------- -----------------
Noninterest-bearing checking $ 171,865 $160,738
Interest-bearing checking 131,797 146,144
Money market demand accounts 280,285 262,513
The scheduled maturities of certificate accounts outstanding at June 30,
2002 were as follows (dollars in thousands):
June 30, 2002
--------------
0 through 12 months $ 908,597
13 through 24 months 47,450
25 through 36 months 38,101
37 through 48 months 4,562
49 through 60 months 20,537
Over 60 months 47
--------------
$ 1,019,294
==============
(7) ADVANCES FROM THE FHLB
The weighted average interest rates on advances from the FHLB at June 30,
2002 and December 31, 2001 were 3.18% and 3.46%, respectively. The scheduled
maturities and related weighted average interest rates on advances from the FHLB
at June 30, 2002 are summarized as follows (dollars in thousands):
Weighted Average
Due during the year ending December 31, Interest Rate Amount
- --------------------------------------- ----------------- --------
2002 2.68% $195,717
2003 3.62 133,644
2004 2.57 139,741
2005 3.48 109,558
2006 5.65 7,808
2007 6.66 1,191
2008 5.52 2,256
2009 8.02 3,665
2010 6.73 987
2011 6.55 1,287
2012 5.76 292
2013 5.75 7,612
2014 5.45 2,931
2015 6.67 1,677
2018 5.05 1,480
--------
3.18% $609,846
========
Advances from the FHLB are secured by certain first-lien mortgage and
multifamily loans and mortgage-backed securities owned by Coastal.
(8) COMPANY OBLIGATED MANDATORILY REDEEMABLE 9.0% TRUST PREFERRED SECURITIES
On June 18, 2002, Coastal, through Coastal Capital Trust I (a consolidated
trust subsidiary) (the "Trust"), issued 2,000,000 in trust preferred securities
("Trust Preferred Securities") with a liquidation preference of $25 per
security. The Trust Preferred Securities represent an interest in Bancorp's
junior subordinated debentures, which were purchased by the Trust. The
debentures have the same payment terms as the Trust Preferred Securities.
Distributions on the securities are payable quarterly at the annual rate of 9.0%
and are included in interest expense in the consolidated statements of income.
The Trust Preferred Securities are subject to mandatory redemption at the
liquidation preference, in whole or in part, upon repayment of the junior
subordinated debentures at maturity or their earlier redemption. The junior
subordinated debentures are redeemable prior to the maturity date of June 30,
2032, at the option of Bancorp on or after June 30, 2007, in whole at any time
or in part from time to time. The junior subordinated debentures are also
redeemable at any time, in whole, but not in part, upon the occurrence of
specific events defined within the trust indenture. Bancorp has the option to
defer distributions on the junior subordinated debentures from time to time for
a period not to exceed 20 consecutive quarters.
A portion of the proceeds from the issuance of the Trust Preferred
Securities were used to repurchase 500,000 shares of common stock for $15.0
million from a director in June 2002. In addition, the proceeds were used on
July 15, 2002, to redeem the Bank's 9.0% Series A Noncumulative Preferred Stock
(Nasdaq:CBSAO) for $28.8 million. The remainder of the proceeds were used to
contribute additional capital to the Bank.
(9) SENIOR NOTES PAYABLE
On June 30, 1995, Coastal issued $50.0 million of 10.0% Senior Notes due
June 30, 2002. The Senior Notes became redeemable at Coastal's option, in whole
or in part, on June 30, 2000, at par, plus accrued interest to the redemption
date. Interest on the Senior Notes was payable quarterly. During 2001 and
1999, Coastal repurchased in the open market $3.0 and $3.1 million,
respectively, of the Senior Notes outstanding at par. On February 1, 2002,
Coastal redeemed all of the remaining Senior Notes outstanding ($43.9 million)
at par plus accrued interest to the redemption date.
(10) DERIVATIVE INSTRUMENTS
Coastal is a party to derivative instruments in the normal course of
business to reduce its exposure to fluctuations in interest rates. These
derivative instruments have included interest rate swap agreements where Coastal
makes fixed interest payments and receives payments based on a floating index,
as well as interest rate cap agreements, as described below. Effective January
1, 2001, Coastal adopted Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and for Hedging Activities" ("Statement
133.") Statement 133 requires companies to recognize all derivatives as either
assets or liabilities in the statement of financial condition and measure all
derivatives at fair value. The interest rate swap and cap agreements held by
Coastal on December 31, 2000 did not qualify for hedge accounting, therefore on
implementation of Statement 133, Coastal recorded a transition adjustment to
record these derivative instruments at fair value. On January 1, 2001, Coastal
recorded a transition adjustment loss of $160,000, or $104,000 net of the tax
effect, as the cumulative effect of the change in accounting for derivative
instruments to record the fair value of Coastal's derivative instruments in the
consolidated statements of income. For the six months ended June 30, 2002 and
2001, Coastal recorded an additional fair value loss on these derivative
instruments of $24,000 and $443,000, respectively. The decrease in the fair
value of derivatives during 2001 was primarily due to interest rate swap
agreements, which were liquidated in June 2001. As of June 30, 2002 and
December 31, 2001, interest rate cap agreements were Coastal's only derivative
instruments and were recorded at fair value pursuant to Statement 133.
The interest rate cap agreements provide for applicable third parties to
make payments to Coastal whenever a defined floating rate exceeds rates ranging
from 8.0% to 9.0%, depending on the agreement. Payments on the interest rate
cap agreements are based on the notional principal amount of the agreements; no
funds were actually borrowed or are to be repaid. The fair value of the
interest rate cap agreements was $1,000 at June 30, 2002, which is the recorded
book value of such agreements due to the implementation of Statement 133. The
interest rate cap agreements are used to alter the interest rate sensitivity of
a portion of Coastal's mortgage-backed securities and loans receivable. As
such, the amortization of any purchase price and interest income from the
interest rate cap agreements is recorded in interest income in the accompanying
consolidated statements of income, as applicable. The net decrease in interest
income related to the interest rate cap agreements was approximately $13,000 for
the six months ended June 30, 2002 and 2001, respectively. No payments were
made to Coastal under the interest rate cap agreements during the three months
ended June 30, 2002 or 2001.
Interest rate cap agreements outstanding at June 30, 2002 expire as follows
(dollars in thousands):
Year of Strike Rate Notional
Expiration Range Amount
- ---------- -------------- ---------
2002 8.75 - 9.00% $ 16,600
2003 8.00 - 9.00 107,627
---------
$ 124,227
=========
Market risk, or the risk of loss due to movement in market prices or rates,
is quantified by Coastal through a risk monitoring process of marking to market
its assets and liabilities to expected market level changes in an instantaneous
shock of plus and minus 200 basis points on a quarterly basis. This process
discloses the effects on market values of the assets and liabilities, unrealized
gains and losses, as well as potential changes in net interest income.
Coastal is exposed to credit loss in the event of nonperformance by the
counterparty to the cap agreements and attempts to control this risk through
credit monitoring procedures. The notional principal amount does not represent
Coastal's exposure to credit loss.
(11) EARNINGS PER SHARE
The following summarizes information related to the computation of basic
and diluted earnings per common share ("EPS") for the six-and three-month
periods ended June 30, 2002 and 2001 (dollars in thousands, except per share
data):
Six Months Ended
June 30,
2002 2001
----------- -----------
Net income $ 8,332 $ 11,170
Preferred stock dividends (1,254) (1,254)
----------- -----------
Net income available to common stockholders $ 7,078 $ 9,916
=========== ===========
Weighted average number of common shares
outstanding used in basic EPS calculation 5,768,001 5,732,270
Add assumed exercise of outstanding stock
options as adjusted for dilutive securities 269,078 299,472
----------- -----------
Weighted average number of common shares
outstanding used in diluted EPS calculation 6,037,079 6,031,742
=========== ===========
Basic EPS $ 1.23 $ 1.73
=========== ===========
Diluted EPS $ 1.17 $ 1.64
=========== ===========
Three Months Ended
June 30,
2002 2001
----------- -----------
Net income $ 4,599 $ 5,990
Preferred stock dividends (627) (627)
----------- -----------
Net income available to common stockholders $ 3,972 $ 5,363
=========== ===========
Weighted average number of common shares
outstanding used in basic EPS calculation 5,715,222 5,748,708
Add assumed exercise of outstanding stock
options as adjusted for dilutive securities 269,214 310,298
----------- -----------
Weighted average number of common shares
outstanding used in diluted EPS calculation 5,984,436 6,059,006
=========== ===========
Basic EPS $ 0.70 $ 0.93
=========== ===========
Diluted EPS $ 0.66 $ 0.89
=========== ===========
The weighted average number of common shares outstanding has been reduced
by the treasury stock held by Coastal. As of June 30, 2002 and 2001, Coastal
had 2,545,959 and 2,000,000 common shares in treasury, respectively.
(12) COASTAL BANC SSB PREFERRED STOCK
On October 21, 1993, the Bank issued 1,150,000 shares of 9.0% Noncumulative
Preferred Stock, no par value, Series A, at a price of $25 per share to the
public ("Preferred Stock"). Dividends on the Preferred Stock were payable
quarterly at the annual rate of $2.25 per share, when, as and if declared by the
Board of Directors of the Bank. At any time on or after December 15, 1998, the
Preferred Stock could be redeemed in whole or in part only at the Bank's option
at $25 per share plus unpaid dividends (whether or not earned or declared) for
the then current dividend period to (but not including) the date fixed for
redemption.
With a portion of the proceeds from the issuance of the Trust Preferred
Securities, the Bank redeemed from the stockholders of record all of the 9.0%
Series A Noncumulative Preferred Stock on July 15, 2002 (see note 8). The
redemption price was $25.185 per share, which represented the stated value of
the Preferred Stock, plus accrued and unpaid dividends.
(13) STATUTORY CAPITAL REQUIREMENTS
The applicable regulations require federally insured institutions, which
are not the highest rated, to have a minimum regulatory tier 1 (core) capital to
total assets ratio equal to a minimum of 4.0%, a tier 1 risk-based capital to
risk-weighted assets ratio of 4.0% and total risk-based capital to risk-weighted
assets ratio of 8.0%.
At June 30, 2002, the Bank's regulatory capital in relation to its existing
regulatory capital requirements for capital adequacy purposes was as follows
(dollars in thousands):
Minimum For Capital Well Capitalized
Actual Adequacy Purposes Requirements
--------------------- --------------------- --------------------
Capital Requirement Amount Ratio Amount Ratio Amount Ratio
- -------------------- ------ ------- --------- -------- -------- -------
Tier 1 (core) 168,078 6.69% $100,513 4.00% $125,641 5.00%
Tier 1 risk-based 168,078 9.66 69,616 4.00 104,424 6.00
Total risk-based 183,311 10.53 139,232 8.00 174,040 10.00
As of June 30, 2002, the most recent notification from the Federal Deposit
Insurance Corporation ("FDIC") categorized the Bank as "well capitalized" under
the regulatory framework for prompt corrective action. To be categorized as
well capitalized, the Bank must maintain minimum Tier 1 (core), Tier 1
risk-based and total risk-based ratios as set forth in the table above. There
are no conditions or events since that notification that management believes
have changed the institution's category.
(14) COASTAL BANCORP, INC. PREFERRED STOCK
On May 11, 1999, Bancorp issued 1,100,000 shares of 9.12% Series A
Cumulative Preferred Stock, no par value, at a price of $25 per share to the
public ("Bancorp Preferred Stock"). Dividends on the Bancorp Preferred Stock
are payable quarterly at the annual rate of $2.28 per share. The Bancorp
Preferred Stock is callable on May 15, 2003 at Bancorp's option. The $26.0
million net proceeds was used for repurchases in the open market of Bancorp's
outstanding common stock and of Bancorp's outstanding 10% Senior Notes.
Pursuant to Coastal's tax benefit agreement with the FDIC, Coastal receives a
tax benefit for dividends paid on the Bancorp Preferred Stock.
(15) RECENT ACCOUNTING STANDARDS
In August 2001, Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("Statement
144") was issued. Statement 144 addresses financial accounting and reporting
for the impairment or disposal of long-lived assets. Statement 144 requires
that long-lived assets be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If the carrying amount of an asset exceeds its
estimated future cash flows, an impairment charge is recognized by the amount by
which the carrying amount of the asset exceeds the fair value of the asset.
Statement 144 requires companies to separately report discontinued operations
and extends that reporting to a component of an entity that either has been
disposed of (by sale, abandonment, or in a distribution to owners) or is
classified as held for sale. Assets to be disposed of are reported at the lower
of the carrying amount or fair value less costs to sell. Statement 144 was
adopted by Coastal on January 1, 2002, and did not have a material effect on
Coastal's Consolidated Financial Statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
-------------------------------------------------------------------
RESULTS OF OPERATIONS
-----------------------
Financial Condition
- --------------------
Total assets decreased 3.5% or $90.6 million from December 31, 2001 to June
30, 2002. The net decrease resulted primarily from decreases of $86.2 million,
$41.1 million, $13.4 million and $7.5 million in mortgage-backed securities
available-for-sale, other investment securities available-for-sale, federal
funds sold and cash and cash equivalents, respectively. These decreases were
somewhat offset by an increase of $55.3 million in loans receivable. There were
also smaller changes in other asset categories. The decrease in mortgage-backed
securities available-for-sale was due to significant prepayments received (35%
on an annualized basis) resulting from a continuing low interest rate
environment, which is encouraging refinancings of mortgage loans. The decrease
in other investment securities available-for-sale was due to the maturity of one
security during the period. The increase in loans receivable was due to loan
purchases of $219.7 million, somewhat reduced by significant prepayments
received on the single-family mortgage loan portfolio, the sale of $10.8 million
of under-performing mortgage loans, the reclassification of $9.1 million of
other under-performing loans to the held for sale category and decreases in
other loan categories.
Deposits decreased $9.6 million or 0.6% from December 31, 2001 to June 30,
2002 and advances from the FHLB decreased 11.7% or $81.0 million. In addition,
during the six months ended June 30, 2002, Coastal redeemed the remaining Senior
Notes payable outstanding of $43.9 million at par plus accrued interest and
issued $50.0 million in Trust Preferred Securities through a consolidated trust
subsidiary (see note 8 to the Consolidated Financial Statements). Coastal used
part of the proceeds from the issuance of the Trust Preferred Securities to
repurchase treasury stock. Stockholders' equity decreased 6.7% or $10.6
million from December 31, 2001 to June 30, 2002 primarily as a result of the
repurchase of 547,800 shares of common stock at an average repurchase price of
$30.00 per share. This decrease was only partially offset by the net increase
in stockholders' equity due to net income, a $64,000 decrease in accumulated
other comprehensive loss and dividends declared.
Results of Operations for the Six Months Ended June 30, 2002 and 2001
- --------------------------------------------------------------------------------
General
- -------
For the six months ended June 30, 2002, net income was $8.3 million
compared to $11.2 million for the six months ended June 30, 2001. The decrease
was primarily due to a $6.3 million decrease in net interest income as a result
of Coastal's overall smaller asset size, overall lower interest rates and higher
than expected prepayments on Coastal's mortgage-backed securities
available-for-sale and loans receivable (35% on an annualized basis for
mortgage-backed securities and 40% for single-family mortgage loans). This
decrease was somewhat offset by a $300,000 decrease in the provision for loan
losses, a $657,000 increase in noninterest income (primarily due to the $443,000
fair value loss on derivative instruments recorded in 2001, compared to a
$24,000 loss recorded during the first six months of 2002), a $639,000 decrease
in noninterest expense, a $1.7 million decrease in the provision for Federal
income taxes, and the $104,000 (net of tax) cumulative transition adjustment
loss due to the change in accounting for derivative instruments recorded in
2001.
Interest Income
- ----------------
Due to Coastal's overall smaller asset size, the overall lower interest
rate environment and higher than expected prepayments, interest income for the
six months ended June 30, 2002 decreased $46.0 million or 39.5% from the six
months ended June 30, 2001. The decrease was comprised of a $23.4 million
decrease in interest income on loans receivable, a $22.0 million decrease in
interest income on mortgage-backed securities and a $667,000 decrease in
interest income on FHLB stock, federal funds sold and other interest-earning
assets.
When comparing the two periods, average interest-earning assets decreased
$568.5 million and the average yield decreased 1.95% from 7.78% in 2001 to 5.83%
in 2002. The $568.5 million decrease in average interest-earning assets
consisted primarily of a $494.0 million decrease in the average balance of
mortgage-backed securities and a $82.2 million decrease in the average balances
of loans receivable. The decrease in average mortgage-backed securities was
largely due to the sale of those securities in late November 2001. To
strategically restructure a portion of its asset base to make it less vulnerable
to market interest rate and price fluctuations, Coastal sold $844.9 million of
mortgage-backed securities and purchased $512.3 million of primarily pass
through securities at a premium. This transaction had the effect of shortening
the duration of the mortgage-backed securities portfolio, thereby lessening the
extension risk to Coastal.
In addition to the reduction in Coastal's asset size due to the
restructuring, during the first six months of 2002, due to the continuing low
interest rate environment, Coastal experienced higher than expected principal
repayments of $84.6 million (or 35% on an annualized basis) on its
mortgage-backed securities portfolio and $154.5 million (or 40% on an annualized
basis) on its single-family mortgage loan portfolio, which resulted in greater
premium amortization on those assets that were purchased at a premium.
Interest Expense
- -----------------
Interest expense on interest-bearing liabilities was $32.1 million for the
six months ended June 30, 2002, as compared to $71.9 million for the same period
in 2001. The decrease in interest expense was again due to Coastal's overall
smaller asset size and the lower overall interest rate environment. When
comparing the two periods, the average rate paid on interest-bearing liabilities
decreased to 3.01% for 2002 from 5.23% for 2001 and average interest-bearing
liabilities decreased $600.6 million. The 2.22% decrease in the average rate
paid on interest-bearing liabilities was due to the 2.17% decrease in the rate
paid on interest-bearing deposits, a 2.28% decrease in the rates paid on
advances from the FHLB and 4.40% decrease in the rates paid on other borrowings.
The decrease in average interest-bearing liabilities consisted primarily of a
$57.6 million decrease in average interest-bearing deposits, a $299.2 million
decrease in average advances from the FHLB and a $208.0 million decrease in the
average balance of other borrowings. The large decrease in the average balances
in FHLB advances and other borrowings was due primarily to Coastal's smaller
asset size because of the restructuring mentioned previously, which permitted
Coastal to reduce these borrowings. In addition, during the six months ended
June 30, 2002, Coastal redeemed the remaining Senior Notes payable outstanding
of $43.9 million at par plus accrued interest and issued $50.0 million in Trust
Preferred Securities, through a consolidated trust subsidiary (see note 8 to the
Consolidated Financial Statements).
Net Interest Income
- ---------------------
Net interest income was $38.4 million for the six months ended June 30,
2002 and $44.7 million for the same period in 2001. As discussed above, the
decrease was due to Coastal's overall smaller asset size and the overall lower
interest rate environment. When comparing the two periods, average
interest-earning assets decreased $568.5 million and average interest-bearing
liabilities decreased $600.6 million due to the restructuring and the principal
repayments discussed above. Net interest margin ("Margin") was 3.17% for the
six months ended June 30, 2002 compared to 2.99% for the six months ended June
30, 2001. Margin represents net interest income as a percentage of average
interest-earning assets. Net interest spread ("Spread"), defined to exclude
noninterest-bearing deposits, increased to 2.82% for the six months ended June
30, 2002 from 2.55% for the six months ended June 30, 2001. Management also
calculates an alternative Spread which includes noninterest-bearing deposits.
Under this calculation, the alternative Spreads for the six months ended June
30, 2002 and 2001 were 3.04% and 2.82%, respectively. Margin and Spread are
affected by the changes in the amount and composition of interest-earning assets
and interest-bearing liabilities.
Management's overall goal is to continue to improve the asset/liability
composition to be less vulnerable to market interest rate fluctuations,
primarily through the addition of loans tied to variable rates such as LIBOR and
local and regional prime rates and through the efforts to replace LIBOR based
borrowings with lower cost retail deposits.
Provision for Loan Losses and the Allowance for Loan Losses - Critical
- ---------------------------------------------------------------------------
Accounting Policy
--- --------------
The provision for loan losses was $1.8 million for the six months ended
June 30, 2002 and $2.1 million for the six months ended June 30, 2001. At June
30, 2002, Coastal had nonperforming loans totaling $13.8 million, which is a
decrease of $10.9 million, or 44%, when compared to December 31, 2001.
Nonperforming loans are those loans on nonaccrual status as well as those loans
greater than ninety days delinquent and still accruing interest. The decrease
in nonperforming loans is mainly due to Coastal's decision to liquidate a
portion of its under-performing single-family mortgage loans during the first
quarter of 2002. On March 22, 2002, Coastal sold $10.8 million of these
under-performing loans to a third party investor. Prior to the sale, Coastal
wrote these loans to fair value and recorded a charge-off to the allowance for
loan losses of $761,000.
In addition, as of March 31, 2002, Coastal also wrote down to fair value
and reclassified $9.1 million of other under-performing single-family mortgage
loans to the held for sale category. The loans that were reclassified to the
held for sale category were written down to fair value through a charge-off to
the allowance for loan losses of $691,000. During the second quarter of 2002, a
total of $3.1 million of these loans held for sale were sold. As of June 30,
2002, Coastal had $3.8 million loans held for sale remaining (net of second
quarter activity including, sales, payoffs, foreclosures and monthly principal
payments received).
The ratio of nonperforming assets to total assets was 0.73% at June 30,
2002, compared to 1.13% as of December 31, 2001. At June 30, 2002, the
allowance for loan losses as a percentage of nonperforming loans (excluding
nonperforming loans held for sale which are recorded at the lower of cost or
fair value) was 128.3% compared to 62.3% at December 31, 2001.
Although no assurance can be given, management believes that the allowance
for loan losses at June 30, 2002 is adequate considering the size and the
changing composition of the loans receivable portfolio, historical and peer
group loss experience, delinquency trends and current economic conditions.
Management will continue to review its loan loss allowance policy as Coastal's
loan portfolio diversifies to determine if changes to the policy and the
resulting allowance for loan losses are necessary.
Noninterest Income
- -------------------
For the six months ended June 30, 2002, noninterest income increased
$657,000 to $5.5 million, compared to $4.8 million for the six months ended June
30, 2001. The increase in noninterest income was primarily due to the $512,000
increase in service charges on deposits accounts, the effect of the fair value
loss on derivative instruments of $443,000 recorded during the six months ended
June 30, 2001 pursuant to Statement 133 (compared to a $24,000 loss in 2002), in
addition to a $209,000 increase in the gain on the sale of real estate when
comparing the two periods. These increases were somewhat offset by a $505,000
decrease in other noninterest income, due primarily to $300,000 in insurance
proceeds received in 2001 for the reimbursement of certain deposit losses
incurred in prior years and a $90,000 decrease in the gain on the sale of loans
held for sale. The increase in service charges on deposit accounts was due to
Coastal's continuing focus on increasing transaction type accounts and the
related fee income. The fair value loss recorded during the six months ended
June 30, 2001 was primarily attributable to Coastal's interest rate swap
positions, which were liquidated in June 2001. As of June 30, 2002, interest
rate cap agreements were Coastal's only derivative instruments and were recorded
at fair value on Coastal's consolidated statement of financial condition.
Noninterest Expense
- --------------------
For the six months ended June 30, 2002, noninterest expense decreased
$639,000 from the six months ended June 30, 2001. The $639,000 decrease in
noninterest expense was primarily due to decreases of $865,000, $316,00,
$296,000 and $38,000 in data processing, the amortization of goodwill and other
intangible assets, office occupancy and other noninterest income, respectively,
partially offset by a $647,000 increase in compensation, payroll taxes and other
benefit, a $135,000 increase in advertising and a $94,000 increase in postage
and delivery expenses. The decrease in data processing expense was due to the
conversion to a new mortgage loan data processing system in the second quarter
of 2001, the conversion of the Valley Region branches to Coastal's primary
deposit and loan data processing system during the third quarter of 2001 and the
item processing functions brought in-house during the third quarter of 2001.
The decrease in the amortization of goodwill and other intangible assets was due
to the implementation of FASB Statements 141 and 142 on January 1, 2002 (see
note 5 to the Consolidated Financial Statements). The decrease in office
occupancy was primarily due to certain assets becoming fully depreciated during
2001. The increase in compensation, payroll taxes and other benefits was due to
normal merit increases for existing staff, in addition to the staff increases
for the item processing functions brought in-house during the third quarter of
2001 and additional personnel needed to continue Coastal's focus on commercial
banking products and lending, including Coastal Banc Capital Corp. staff. The
increase in advertising and postage and delivery expenses were primarily due to
Coastal's continued focus on commercial banking products and lending.
Provision for Federal Income Taxes
- --------------------------------------
The provision for Federal income taxes for the six months ended June 30,
2002 was $3.9 million compared to $5.6 million for the six months ended June 30,
2001. The decrease was due to the decreased income before provision for federal
income taxes, minority interest and cumulative effect of accounting change in
2001, with the effective tax rate for the periods being approximately 29% for
six months ended June 30, 2002 and 31% for the same period in 2001. The
decrease in the effective tax rate when comparing the two periods is due to the
elimination of the goodwill amortization.
Results of Operations for the Three Months Ended June 30, 2002 and 2001
- --------------------------------------------------------------------------------
General
- -------
For the three months ended June 30, 2002, net income was $4.6 million
compared to $6.0 million for the three months ended June 30, 2001. The decrease
was primarily due to a $2.7 million decrease in net interest income, as a result
of Coastal's overall smaller asset size, overall lower interest rates and higher
than expected principal repayments on Coastal's mortgage-backed securities
available-for-sale and loans receivable (35% on an annualized basis for
mortgage-backed securities and 40% for single-family mortgage loans). This
decrease was somewhat offset by a $300,000 decrease in the provision for loan
losses, a $207,000 decrease in noninterest expense and a $823,000 decrease in
the provision for Federal income taxes. In addition, noninterest income
decreased slightly by $30,000.
Interest Income
- ----------------
As noted previously, due to Coastal's overall smaller asset size, the
overall lower interest rate environment and higher than expected principal
repayments, interest income for the three months ended June 30, 2002 decreased
$21.2 million or 37.6% from the three months ended June 30, 2001. The decrease
was comprised of a $10.3 million decrease in interest income on loans
receivable, a $10.7 million decrease in interest income on mortgage-backed
securities and a $236,000 decrease in interest income on FHLB stock, federal
funds sold and other interest-earning assets.
When comparing the two periods, average interest-earning assets decreased
$557.3 million and the average yield decreased 1.76% from 7.52% in 2001 to 5.76%
in 2002. The $557.3 million decrease in average interest-earning assets
consisted primarily of a $507.2 million decrease in the average balance of
mortgage-backed securities and a $51.8 million decrease in the average balances
of loans receivable. The decrease in average mortgage-backed securities was
largely due to the restructuring discussed previously.
In addition to the reduction in Coastal's asset size due to the
restructuring, during the three months ended June 30, 2002, due to the
continuing low interest rate environment, Coastal experienced higher than
expected principal repayments of $39.9 million (or 35% on an annualized basis)
on its mortgage-backed securities portfolio and $75.8 million (or 40% on an
annualized basis) on its single-family mortgage loan portfolio, which resulted
in greater premium amortization on those assets that were purchased at a
premium.
Interest Expense
- -----------------
Interest expense on interest-bearing liabilities was $15.5 million for the
three months ended June 30, 2002, as compared to $34.0 million for the same
period in 2001. As discussed previously, the decrease in interest expense was
due to Coastal's overall smaller asset size and the lower overall interest rate
environment. When comparing the two periods, the average rate paid on
interest-bearing liabilities decreased to 2.87% for 2002 from 4.94% for 2001 and
average interest-bearing liabilities decreased $587.6 million. The 2.07%
decrease in the average rate paid on interest-bearing liabilities was due to the
2.19% decrease in the rate paid on interest-bearing deposits, a 1.88% decrease
in the rates paid on advances from the FHLB and a 4.38% decrease in the rates
paid on other borrowings. The decrease in average interest-bearing liabilities
consisted primarily of a $63.7 million decrease in average interest-bearing
deposits, a $70.5 million decrease in average advances from the FHLB, a $413.7
million decrease in the average balance of other borrowings and a $46.9 million
decrease in the average balance of Senior Notes payable. The large decrease in
the average balances in FHLB advances and other borrowings was due primarily to
Coastal's repayment of such borrowings as a part of the restructuring done in
late 2001. The decrease in the balance of the Senior Notes payable was due to
their redemption during the first quarter of 2002. During the second quarter of
2002, Coastal issued $50.0 million in Trust Preferred Securities through a
consolidated trust subsidiary (see note 8 to the Consolidated Financial
Statements).
Net Interest Income
- ---------------------
Net interest income was $19.7 million for the three months ended June 30,
2002 and $22.4 million for the same period in 2001. As discussed above, the
decrease was due to Coastal's overall smaller asset size and the overall lower
interest rate environment. When comparing the two periods, average
interest-earning assets decreased $557.3 million and average interest-bearing
liabilities decreased $587.6 million due to the restructuring and the
prepayments discussed above. Net interest margin ("Margin") was 3.23% for the
three months ended June 30, 2002 compared to 2.99% for the three months ended
June 30, 2001. Margin represents net interest income as a percentage of average
interest-earning assets. Net interest spread ("Spread"), defined to exclude
noninterest-bearing deposits, increased to 2.89% for the three months ended June
30, 2002 from 2.58% for the three months ended June 30, 2001. Management also
calculates an alternative Spread which includes noninterest-bearing deposits.
Under this calculation, the alternative Spreads for the three months ended June
30, 2002 and 2001 were 3.10% and 2.84%, respectively. Margin and Spread are
affected by the changes in the amount and composition of interest-earning assets
and interest-bearing liabilities.
Management's overall goal is to continue to improve the asset/liability
composition to be less vulnerable to market interest rate fluctuations,
primarily through the addition of loans tied to variable rates such as LIBOR and
local and regional prime rates and through the efforts to replace LIBOR based
borrowings with lower cost retail deposits.
Provision for Loan Losses and the Allowance for Loan Losses - Critical
- ---------------------------------------------------------------------------
Accounting Policy
------------------
The provision for loan losses was $900,000 for the three months ended June
30, 2002 compared to $1.2 million for the three months ended June 30, 2001. At
June 30, 2002, Coastal had nonperforming loans totaling $13.8 million, which is
a decrease of $10.9 million, or 44%, when compared to December 31, 2001. See
previous discussion under "Results of Operations for the Six Months Ended June
30, 2002 and 2001 - Provision for Loan Losses and the Allowance for Loan
Losses."
Although no assurance can be given, management believes that the allowance
for loan losses at June 30, 2002 is adequate considering the size and the
changing composition of the loans receivable portfolio, historical and peer
group loss experience, delinquency trends and current economic conditions.
Management will continue to review its loan loss allowance policy as Coastal's
loan portfolio diversifies to determine if changes to the policy and the
resulting allowance for loan losses are necessary.
Noninterest Income
- -------------------
Noninterest income decreased slightly by $30,000 for the quarter ended June
30, 2002 compared to the quarter ended June 30, 2001. This decrease was
comprised of a $348,000 decrease in other noninterest income, a $121,000
decrease in the fair value gain on derivative instruments (interest rate swap
and cap agreements) and a $45,000 decrease in loan fees. These decreases were
substantially offset by the $278,000 increase in service charges on deposit
accounts and a $206,000 increase in the gain on sale of real estate owned. The
decrease in other noninterest income was primarily due to $300,000 in insurance
proceeds received in 2001 for reimbursement of certain deposit account losses
incurred in prior years. The fair value gain recorded during the quarter ended
June 30, 2001 was primarily attributable to Coastal's interest rate swap
positions, which were liquidated in June 2001. As of June 30, 2002, interest
rate cap agreements were Coastal's only derivative instruments and were recorded
at fair value on Coastal's consolidated statement of financial condition. The
increase in service charges on deposit accounts was due to Coastal's continuing
focus on increasing transaction type accounts and the related fee income.
Noninterest Expense
- --------------------
For the three months ended June 30, 2002, noninterest expense decreased
$207,000 from the three months ended June 30, 2001. The $207,000 decrease in
noninterest expense was primarily due to decreases of $434,000, $148,000 and
$200,000 in data processing, the amortization of goodwill and other intangible
assets and office occupancy, respectively, partially offset by a $384,000
increase in compensation, payroll taxes and other benefits, a $62,000 increase
in advertising, a $16,000 increase in postage and delivery expenses, in addition
to a $113,000 increase in other noninterest expense. The decrease in data
processing expense was due to the conversion to a new mortgage loan data
processing system in the second quarter of 2001, the conversion of the Valley
Region branches to Coastal's primary deposit and loan data processing system
during the third quarter of 2001 and the item processing functions brought
in-house during the third quarter of 2001. The decrease in the amortization of
goodwill and other intangible assets was due to the implementation of FASB
Statements 141 and 142 on January 1, 2002 (see note 5 to the Consolidated
Financial Statements). The decrease in office occupancy was primarily due to
certain assets becoming fully depreciated during 2001. The increase in
compensation, payroll taxes and other benefits was due to normal merit increases
for existing staff, in addition to the staff increases for the item processing
functions brought in-house during the third quarter of 2001 and additional
personnel needed to continue Coastal's focus on commercial banking products and
lending, including Coastal Banc Capital Corp. staff. The increase in
advertising and postage and delivery expenses were primarily due to Coastal's
continued focus on commercial banking products and lending. The increase in
other noninterest expense was due to smaller changes in various categories of
expenses.
Provision for Federal Income Taxes
- --------------------------------------
The provision for Federal income taxes for the three months ended June 30,
2002 was $2.2 million compared to $3.0 million for the three months ended June
30, 2001. The decrease was due to the decreased income before provision for
Federal income taxes and minority interest in 2001, with the effective tax rate
for the periods being approximately 29% for three months ended June 30, 2002 and
31% for the same period in 2001. The decrease in the effective tax rate when
comparing the two periods is due to the elimination of the goodwill
amortization.
Liquidity and Capital Resources
- ----------------------------------
Coastal's primary sources of funds consist of deposits bearing market rates of
interest, advances from the FHLB, securities sold under agreements to
repurchase, federal funds purchased and principal payments on loans receivable
and mortgage-backed securities. Coastal uses its funding resources principally
to meet its ongoing commitments to fund maturing deposits and deposit
withdrawals, repay borrowings, purchase loans receivable and mortgage-backed
securities, fund existing and continuing loan commitments, maintain its
liquidity, meet operating expenses and fund acquisitions of other banks and
thrifts, either on a branch office or whole bank acquisition basis, in addition
to purchasing treasury stock. At June 30, 2002, Coastal had binding commitments
to originate or purchase loans totaling approximately $24.5 million and had
$181.6 million of undisbursed loans in process. Scheduled maturities of
certificates of deposit during the 12 months following June 30, 2002 totaled
$908.6 million at June 30, 2002. Management believes that Coastal has adequate
resources to fund all of its commitments.
As of June 30, 2002, Coastal operated 49 retail banking offices in Texas
cities, including Houston, Austin, Corpus Christi, the Rio Grande Valley and
small cities in the southeast quadrant of Texas. Management's overall goal is
to continue to improve the asset/liability composition of Coastal's balance
sheet to be less vulnerable to market interest rate fluctuations.
Forward-Looking Information
- ----------------------------
The Management's Discussion and Analysis of Financial Condition and Results
of Operations set forth in the Form 10-Q should be read in conjunction with the
information contained in the Consolidated Financial Statements and the Notes
thereto.
The statements contained in this Quarterly Report on Form 10-Q which are not
historical facts contain forward looking information with respect to plans,
projections or future performance of Coastal, the occurrence of which involve
certain risks and uncertainties detailed in Coastal's filings with the
Securities and Exchange Commission ("SEC"). Such discussion contains
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act"), and is subject to the safe
harbor created by that Reform Act. The words "estimate," "project,"
"anticipate," "expect," "intend," "believe," "plans," and similar expressions
are intended to identify forward-looking statements. Because such
forward-looking statements involve risks and uncertainties, there are important
factors that could cause actual results to differ materially from those
expressed or implied by such forward-looking statements. Factors, all of which
are difficult to predict and many of which are beyond the control of Coastal,
that could cause actual results to differ materially include, but are not
limited to: risks related to changes in market rates of interest, changes in
our loan portfolio, including the risks associated with our non-traditional
lending (loans other than single-family residential mortgage loans such as
multifamily, real estate acquisition and development, commercial real estate,
commercial business, commercial construction and warehouse loans), the
possibility that Coastal's allowance for loan losses proves to be inadequate,
Coastal's ability to attract core deposits, the concentration of Coastal's loan
portfolio in Texas and California to the extent that the economies of those
states experience problems, Coastal's acquisition strategy, including risks of
adversely changing results of operations and factors affecting Coastal's ability
to consummate further acquisitions; risks involved in Coastal's ability to
quickly and efficiently integrate the operations of acquired entities with those
of Coastal; changes in business strategies, changes in general economic and
business conditions and changes in the laws and regulations applicable to
Coastal; and other factors as discussed in Coastal's Annual Report on Form 10-K
for the year ended December 31, 2001, as filed with the SEC on March 26, 2002,
and a filed in Exhibit 99.3, attached hereto.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------------
There have been no material changes in Coastal's interest rate risk
position since December 31, 2001. Coastal's principal market risk exposure is to
interest rates. See note 10 of the Notes to Consolidated Financial Statements.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
------------------
We are, and have been involved, from time to time, in various claims,
complaints, proceedings and litigation relating to activities arising from the
normal course of our operations. Based on the facts currently available to us,
we believe that the matters pending at June 30, 2002 are without merit, or will
be covered by insurance, any other matters are of such amounts, which upon
resolution, are not likely to have a material adverse effect on our consolidated
financial condition, results of operations or cash flows.
Item 2. Changes in Securities and Use of Proceeds
-----------------------------------------------
Not applicable.
Item 3. Default Upon Senior Securities
---------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
-----------------------------------------------------------
On April 25, 2002, at the Annual Meeting of Stockholders of Coastal Bancorp,
Inc. (the "Company"), the stockholders voted upon and approved the election of
one director and the ratification of the appointment of KPMG LLP as the
Company's independent public accountants for the fiscal year ending December 31,
2002.
With respect to such matters, the results of the votes were as follows:
1) Election of director:
Number of Votes
-----------------
In favor Withheld
--------- --------
Robert E. Johnson, Jr. 5,189,151 78,405
2) Ratification of KPMG LLP as the Company's independent public accountants
for the fiscal year ending December 31, 2002:
Number of votes in favor: 5,212,756
Number of votes against: 52,050
Number of votes abstaining 2,750
Item 5. Other Information
------------------
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
-------------------------------------
Reports on Form 8-K.
1) Form 8-K filed with the SEC on April 26, 2002 concerning the announcement
that the Company. had entered into a transaction that would complete its
previously authorized stock repurchase plan, by repurchasing 500,000 shares from
a director for $30.00 per share.
2) Form 8-K filed with the SEC on June 6, 2002 concerning the announcement
that the Board of Directors of Coastal Banc ssb (the "Bank") had voted to redeem
all of the issued and outstanding shares of the Bank's 9.0% Noncumulative
Preferred Stock, Series A (Nasdaq:CBSAP), subject to certain regulatory
approvals.
Exhibits.
99.1 Certification of the Chairman of the Board and Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.1 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.3 Statement of Factors Under Private Securities Litigation Reform Act of
1995.
SIGNATURES
Pursuant to the requirement 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.
Dated: 8/13/02 By /s/ Manuel J. Mehos
------- --------------------
Manuel J. Mehos
Chief Executive Officer
Dated: 8/13/02 By /s/ Catherine N. Wylie
------- ------------------------
Catherine N. Wylie
Chief Financial Officer
EXHIBIT 99.1
CERTIFICATION PURSUANT TO
18 U.S.C SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Coastal Bancorp, Inc. (the
"Company") on Form 10-Q for the period ended June 30, 2002 as filed with the
Securities and Exchange Commission on August 13, 2002 (the "Report"), I Manuel
J. Mehos, Chairman of the Board and Chief Executive Officer of the Company,
certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: 8/13/02 By /s/ Manuel J. Mehos
------- --------------------
Manuel J. Mehos
Chairman of the Board and Chief
Executive Officer
EXHIBIT 99.2
CERTIFICATION PURSUANT TO
18 U.S.C SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Coastal Bancorp, Inc. (the
"Company") on Form 10-Q for the period ended June 30, 2002 as filed with the
Securities and Exchange Commission on August 13, 2002 (the "Report"), I
Catherine N. Wylie, Chief Financial Officer of the Company, certify, pursuant to
18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of section 13(a)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: 8/13/02 By /s/ Catherine N. Wylie
------- ------------------------
Catherine N. Wylie
Chief Financial Officer
EXHIBIT 99.3
STATEMENT OF FACTORS UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
From time to time, Coastal Bancorp, Inc. ("Coastal" or "we," "us," "our"
and other terms referring to Coastal Bancorp, Inc. and Coastal Banc ssb) has
made and will make forward-looking statements. These statements can be
identified by the fact that they do not relate strictly to historical or current
facts. Forward-looking statements often use words such as "anticipate,"
"target," "expect," "estimate," "intend," "plan," "goal," "believe" or other
words of similar meaning. Forward-looking statements give Coastal's current
expectations or forecasts of future events, circumstances or results. Our
disclosure in this report, including in the Section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
("MD&A"), contains forward-looking statements. We also may make forward-looking
statements in its other documents filed with the Securities and Exchange
Commission (the "SEC") and in other written materials. In addition, Coastal's
senior management may make forward-looking statements orally to analysts,
investors, representatives of the media and others. Any forward-looking
statements made by or on behalf of Coastal speak only as of the date they are
made. We do not undertake to update forward-looking statements to reflect the
impact of circumstances or events that arise after the date the forward-looking
statement was made. The reader should, however, consult any further disclosures
of a forward-looking nature we may make in our Annual Reports on Form 10-K, its
Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. All
forward-looking statements, by their nature, are subject to risks and
uncertainties. Coastal's actual future results may differ materially from those
set forth in our forward-looking statements. Factors that might cause our future
financial performance to vary from that described in our forward-looking
statements include the credit, market, operational, liquidity, interest rate and
other risks discussed in the MD&A section of this report and in other periodic
reports filed with the SEC. In addition, the following discussion sets forth
certain risks and uncertainties that we believe could cause our actual future
results to differ materially from expected results. However, other factors
besides those listed below or discussed in Coastal's reports to the SEC also
could adversely affect our results, and the reader should not consider any such
list of factors to be a complete set of all potential risks or uncertainties.
This discussion is provided as permitted by the Private Securities Litigation
Reform Act of 1995.
WE ARE VULNERABLE TO CHANGES IN INTEREST RATES.
Our ability to make a profit, like that of most financial institutions,
substantially depends upon our net interest income, which is the difference
between the interest income we earn on our interest-earning assets, such as
loans and investment securities, and the interest expense we pay on our
interest-bearing liabilities, such as deposits and borrowings. Certain assets
and liabilities, however, may react in different degrees to changes in market
interest rates. Further, interest rates on some types of assets and liabilities
may fluctuate prior to changes in broader market interest rates, while rates on
other types may lag behind. Additionally, some of our assets, such as
adjustable rate mortgages, have features, including payment and rate caps, which
restrict changes in their interest rates.
Factors such as inflation, recession, unemployment, money supply, acts of
terrorism, international disorders, instability in domestic and foreign
financial markets, and other factors beyond our control may affect interest
rates. Changes in market interest rates will also affect the level of voluntary
prepayments on our loans and the receipt of payments on our mortgage-backed
securities resulting in the receipt of proceeds that may be reinvested at a
lower rate than the loan or mortgage-backed security being prepaid. Although we
pursue an asset-liability management strategy designed to manage our risk
resulting from changes in market interest rates, changes in interest rates can
still have a material adverse effect on our profitability.
OUR EXPOSURE TO CREDIT RISK WILL INCREASE AS WE INCREASE OUR COMMERCIAL BANKING
ACTIVITIES.
As we increase our focus on commercial business banking and attempt to
increase our net interest margin, a gradual increase in our consolidated credit
risk is likely to occur. One of our main strategies is to replace
lower-yielding first lien single-family residential mortgage loans and
mortgage-backed securities with commercial and consumer loans. Generally,
commercial loans (including commercial and multi-family real estate loans) are
considered to be riskier than first lien, single-family residential loans
because they have larger balances to a single borrower or group of related
borrowers and because their repayment generally relies on the success of the
borrowing enterprise. In addition, consumer loans are usually secured by
depreciating assets (such as cars and boats) and collections are dependent on
the borrower's continuing financial stability, which is more likely to be
adversely affected by job loss, divorce, illness and personal bankruptcy.
Accordingly, we expect higher loan losses on this type of lending. If we have
to provide for loan losses that are higher than our historical experience, our
results of operations and financial condition could be adversely affected.
OUR ALLOWANCE FOR LOAN LOSSES MAY BE INADEQUATE TO COVER LOSSES ACTUALLY
INCURRED, WHICH COULD AFFECT OUR ABILITY TO MAKE PAYMENTS ON THE DEBENTURES.
We maintain an allowance for loan losses in an amount management believe is
sufficient to provide for known and inherent risks in our loan portfolio. If we
incur actual losses on our loans in excess of our allowance for loan losses, our
profitability may be adversely affected and we may be unable to make payments on
the debentures.
THE CONCENTRATION OF OUR LOAN PORTFOLIO IN TEXAS AND CALIFORNIA SUBJECTS US TO
RISK TO THE EXTENT THE CALIFORNIA AND TEXAS ECONOMIES EXPERIENCE PROBLEMS.
A substantial portion of the loans we originate and purchase are secured by
properties located in Texas and California or are made to businesses which
operate in those states. As a result, the number of borrowers unable to repay
their loans may be affected by changes in those economic conditions.
The Texas economy has been historically sensitive to business cycles,
particularly those in the oil and gas industry. Unfavorable economic conditions
in Texas could significantly increase the number of borrowers which are unable
to pay their loans on a timely basis and cause a decline in the value of the
properties securing our loans which could have an adverse effect on our results
of operations and financial condition.
The California economy had a slowdown in 2001 due to its current energy crisis.
The expected hike in energy rates could impede growth by reducing business
investment and consumer spending within the state. Economic conditions in
California are subject to various uncertainties at this time, including the
long-term impact of the energy crisis and the decline in the technology sector.
If economic conditions in California continue to decline, we expect that our
level of problem assets could increase accordingly.
WE MAY FAIL TO IDENTIFY OR CONSUMMATE ADDITIONAL ACQUISITIONS.
Our business strategy has historically relied, in part, upon our ability to
obtain low cost deposits, expand into new markets and enhance our presence in
existing markets by identifying and acquiring branches of other financial
institutions or whole banks that meet our acquisition criteria. In pursuing
these opportunities, we compete with other financial institutions with similar
acquisition strategies, many of which are larger than we are and have greater
financial and other resources than we have. We will compete for potential
acquisitions based on a number of factors, including price, terms and
conditions, size, access to capital and our ability to offer cash, stock or
other forms of consideration. We cannot assure investors that we will be able to
identify suitable acquisition candidates or, once a suitable acquisition
candidate is identified, that we will be able to consummate the acquisition on
terms and conditions acceptable to us.
WE MAY FAIL TO INTEGRATE OUR ACQUISITIONS SUCCESSFULLY.
We have grown through the acquisition of branches of other financial
institutions or of whole banks. To a certain extent, our success is tied to our
ability to integrate the operations, management, products and services of the
entities we acquire. After each acquisition, we must expend substantial
managerial, operating, financial and other resources to integrate these
entities. In particular, we must install and standardize adequate operational
and control systems, deploy or modify certain equipment, implement marketing
efforts in new as well as existing locations and employ and maintain qualified
personnel. Our operating results may be adversely affected if we fail to
properly integrate companies we acquire.
COMPETITION WITH OTHER FINANCIAL INSTITUTIONS COULD ADVERSELY AFFECT OUR
PROFITABILITY.
We face substantial competition in purchasing and originating loans and in
attracting deposits. This competition in purchasing and originating loans comes
principally from banks, other savings institutions, mortgage banking companies
and other lenders and purchasers of loans. Many of our competitors enjoy
competitive advantages including greater financial resources, a wider geographic
presence or more accessible branch office locations, the ability to offer
additional services or more favorable pricing alternatives and lower origination
and operating costs. This competition could result in a decrease in loans
originated or purchased by us that could adversely affect our results of
operations, and financial condition.
In attracting deposits, we compete with insured depository institutions
such as savings institutions, credit unions and banks, as well as institutions
offering uninsured investment alternatives including money market funds. These
competitors may offer higher interest rates than we do, which could result in
either our attracting fewer deposits or in our being required to increase our
rates in order to attract deposits. Increased deposit competition could increase
our cost of funds and adversely affect our ability to generate the funds
necessary for our lending operations, thereby adversely affecting our results of
operations and financial condition.
CHANGES IN STATUTES AND REGULATIONS COULD ADVERSELY AFFECT US.
We are subject to extensive regulation and supervision by federal and state
authorities. Such supervision and regulation establish a comprehensive
framework of activities in which an institution may engage, and are intended
primarily for the protection of the federal deposit insurance fund and our
depositors. This regulatory structure also provides our regulators with
significant discretion in the performance of their supervisory and enforcement
duties. Any change in such regulation, whether by our regulators or as a result
of legislation subsequently enacted by the Congress of the United States or the
Texas legislature, could have a substantial impact on our operations and us.
Additional legislation and regulations may be enacted or adopted in the future
that could significantly affect our powers, authority and operations, which
could have a material adverse effect on our operations.