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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, 2003
[ ] 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
--------
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 by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). [ X ]
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: 5,165,162 AS OF JULY 31, 2003
COASTAL BANCORP, INC. AND SUBSIDIARIES
Form 10-Q
Table of Contents
PART I. FINANCIAL INFORMATION
- -------- ----------------------
Item 1 Financial Statements (unaudited)
Consolidated Statements of Financial Condition at June 30, 2003
and December 31, 2002 1
Consolidated Statements of Income for the Six-Month Periods Ended
June 30, 2003 and 2002 2
Consolidated Statements of Income for the Three-Month Periods Ended
June 30, 2003 and 2002 3
Consolidated Statements of Comprehensive Income for the Six-Month and
Three-Month Periods Ended June 30, 2003 and 2002 4
Consolidated Statements of Cash Flows for the Six-Month Periods
Ended June 30, 2003 and 2002 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
Item 4 Controls and Procedures 26
PART II. OTHER INFORMATION
- --------- ------------------
Item 1 Legal Proceedings 27
Item 2 Changes in Securities and Use of Proceeds 27
Item 3 Defaults upon Senior Securities 27
Item 4 Submission of Matters to a Vote of Security Holders 28
Item 5 Other Information 28
Item 6 Exhibits and Reports on Form 8-K 28
SIGNATURES
i
ITEM 1. FINANCIAL STATEMENTS
- -------- ---------------------
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT SHARE DATA)
June 30, December 31,
ASSETS 2003 2002
- --------------------------------------------------------------------- ---------- ------------
(Unaudited)
Cash and cash equivalents $ 37,996 $ 39,766
Federal funds sold 780 27,755
Loans receivable held for sale 18,517 49,886
Loans receivable, net (note 4) 1,864,703 1,812,785
Mortgage-backed securities available-for-sale, at fair value (note 3) 500,917 475,022
Other securities available-for-sale, at fair value 2,284 1,788
Accrued interest receivable 9,530 9,781
Property and equipment 29,362 27,341
Stock in the Federal Home Loan Bank of Dallas ("FHLB") 41,733 41,221
Goodwill 21,429 21,429
Prepaid expenses and other assets 16,450 19,370
---------- ----------
$2,543,701 $2,526,144
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
---------------------------------------
Liabilities:
Deposits (note 5) $1,619,581 $1,614,368
Advances from the FHLB (note 6) 688,669 696,085
Company obligated mandatorily redeemable 9.0% trust preferred
securities of Coastal Capital Trust I (note 7) 50,000 50,000
Company obligated mandatorily redeemable variable rate trust
preferred securities of Coastal Capital Trust II (note 7) 10,000 --
Advances from borrowers for taxes and insurance 6,529 2,407
Other liabilities and accrued expenses 10,637 10,399
--------- ----------
Total liabilities 2,385,416 2,373,259
--------- ----------
Commitments and contingencies (notes 4 and 9)
Stockholders' equity (notes 1, 3, 10, 12 and 13):
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; 7,905,060 shares issued and 5,157,560 shares
outstanding at June 30, 2003; 7,867,029 shares issued
and 5,141,010 shares outstanding at December 31, 2002 79 79
Additional paid-in capital 36,093 35,736
Retained earnings 146,716 141,986
Accumulated other comprehensive income -
net unrealized gain on securities available-for-sale 1,554 619
Treasury stock at cost (2,747,500 shares in 2003 and 2,726,019
shares in 2002) (53,657) (53,035)
--------- ----------
Total stockholders' equity 158,285 152,885
----------- -----------
$2,543,701 $2,526,144
----------- -----------
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,
------------------
2003 2002
---------------- --------
(Unaudited)
Interest income:
Loans receivable $ 50,831 $60,708
Mortgage-backed securities 7,152 9,026
FHLB stock, federal funds sold and other interest-earning assets 579 855
------------------ --------
58,562 70,589
------------------ --------
Interest expense:
Deposits 15,806 21,243
Advances from the FHLB 8,458 10,359
Senior Notes payable (note 8) -- 378
Company obligated mandatorily redeemable trust preferred securities 2,258 163
------------------ --------
26,522 32,143
------------------ --------
Net interest income 32,040 38,446
Provision for loan losses (note 4) 1,800 1,800
------------------ --------
Net interest income after provision for loan losses 30,240 36,646
------------------ --------
Noninterest income:
Service charges on deposit accounts 5,846 4,133
Loan fees 422 622
Gain on sale of loans receivable held for sale 792 40
Gain (loss) on derivative instruments (note 9) 13 (24)
Gain (loss) on real estate owned (96) 240
Other 522 452
------------------ --------
7,499 5,463
------------------ --------
Noninterest expense:
Compensation, payroll taxes and other benefits 15,454 15,853
Office occupancy 4,720 5,221
Data processing 894 822
Advertising 569 850
Postage and delivery 757 795
Other 4,885 3,994
------------------ --------
27,279 27,535
------------------ --------
Income before provision for Federal income taxes and
minority interest 10,460 14,574
Provision for Federal income taxes 3,237 4,244
------------------ --------
Income before minority interest 7,223 10,330
Minority interest - preferred stock dividends of Coastal Banc ssb -- 1,294
------------------ --------
Net income $ 7,223 $ 9,036
------------------ --------
Net income available to common stockholders $ 5,969 $ 7,782
================== ========
Basic earnings per common share (note 10) $ 1.16 $ 1.35
================== ========
Diluted earnings per common share (note 10) $ 1.11 $ 1.29
================== ========
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,
--------------------
2003 2002
-------------------- -------
(Unaudited)
Interest income:
Loans receivable $ 25,219 $30,741
Mortgage-backed securities 3,485 4,062
FHLB stock, federal funds sold and other interest-earning assets 289 380
-------------------- -------
28,993 35,183
-------------------- -------
Interest expense:
Deposits 7,758 10,202
Advances from the FHLB 4,233 5,091
Company obligated mandatorily redeemable trust preferred securities. 1,133 163
-------------------- -------
13,124 15,456
-------------------- -------
Net interest income 15,869 19,727
Provision for loan losses (note 4) 900 900
-------------------- -------
Net interest income after provision for loan losses 14,969 18,827
-------------------- -------
Noninterest income:
Service charges on deposit accounts 2,944 2,138
Loan fees 203 315
Gain on sale of loans receivable held for sale 58 40
Gain on derivative instruments (note 9) 7 --
Gain on real estate owned 34 218
Other 260 243
-------------------- -------
3,506 2,954
-------------------- -------
Noninterest expense:
Compensation, payroll taxes and other benefits 7,446 7,992
Office occupancy 2,403 2,641
Data processing 461 399
Advertising 294 421
Postage and delivery 378 367
Other 2,377 1,999
-------------------- -------
13,359 13,819
-------------------- -------
Income before provision for Federal income taxes and
minority interest 5,116 7,962
Provision for Federal income taxes 1,578 2,360
-------------------- -------
Income before minority interest 3,538 5,602
Minority interest - preferred stock dividends of Coastal Banc ssb -- 647
-------------------- -------
Net income $ 3,538 $ 4,955
-------------------- -------
Net income available to common stockholders $ 2,911 $ 4,328
==================== =======
Basic earnings per common share (note 10) $ 0.56 $ 0.76
==================== =======
Diluted earnings per common share (note 10) $ 0.54 $ 0.72
==================== =======
See accompanying Notes to Consolidated Financial Statements
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
Six Months Ended
June 30,
------------------
2003 2002
------------------ ------
(Unaudited)
Net income $ 7,223 $9,036
Other comprehensive income, net of tax:
Unrealized gains on securities available-for-sale
arising during period 935 64
------------------ ------
Total comprehensive income $ 8,158 $9,100
------------------ ------
Three Months Ended
June 30,
--------------------
2003 2002
-------------------- ------
(Unaudited)
Net income $ 3,538 $4,955
Other comprehensive income, net of tax:
Unrealized gains on securities available-for-sale
arising during period 1,120 69
-------------------- ------
Total comprehensive income $ 4,658 $5,024
------------------- ------
See accompanying Notes to Consolidated Financial Statements
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Six Months Ended
June 30,
------------------
2003 2002
------------------ ----------
(Unaudited)
Cash flows from operating activities:
Net income $ 7,223 $ 9,036
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization of property and equipment,
and prepaid expenses and other assets 4,709 4,113
Net amortization (accretion) of premiums, discounts and loan fees 4,067 2,615
Provision for loan losses 1,800 1,800
Originations and purchases of mortgage loans held for sale (127,431) (8,592)
Sales of mortgage loans held for sale 148,095 11,758
Gain on sale of mortgage loans held for sale (792) (40)
Stock dividends from the FHLB (512) (598)
(Gain) loss on derivative instruments (13) 24
Decrease (increase) in:
Accrued interest receivable 251 1,734
Other, net 3,836 3,879
------------------- ------------
Net cash provided by operating activities 41,233 25,729
------------------- ------------
Cash flows from investing activities:
Net decrease in federal funds sold 26,975 13,350
Purchase of mortgage-backed securities available-for-sale (117,766) --
Principal repayments on mortgage-backed securities
available-for-sale 91,489 84,580
Purchase of other securities available-for-sale (511) (243)
Principal repayments on other securities available-for-sale -- 41,000
Purchases of loans receivable (252,717) (218,988)
Sales of loans receivable -- 10,111
Net decrease in loans receivable 204,179 140,822
Net purchases of property and equipment (3,663) (1,594)
------------------- ------------
Net cash provided (used) by investing activities (52,014) 69,038
------------------- ------------
(Table continued on next page)
COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(IN THOUSANDS)
Six Months Ended
June 30,
------------------
2003 2002
------------------ ------------
(Unaudited)
Cash flows from financing activities:
Net increase (decrease) in deposits $ 5,213 $ (9,627)
Advances from the FHLB 8,171,847 2,893,300
Principal payments on advances from the FHLB (8,179,263) (2,974,331)
Proceeds from issuance of trust preferred securities 9,850 48,125
Net increase in advances from borrowers for taxes and insurance 4,122 3,107
Exercise of stock options for purchase of common stock, net 342 55
Purchase of treasury stock (652) (16,436)
Issuance of treasury stock 45 59
Redemption of Senior Notes payable -- (43,875)
Dividends paid (2,493) (2,658)
------------------ ------------
Net cash provided (used) by financing activities 9,011 (102,281)
------------------ ------------
Net decrease in cash and cash equivalents (1,770) (7,514)
Cash and cash equivalents at beginning of period 39,766 41,537
------------------ ------------
Cash and cash equivalents at end of period $ 37,996 $ 34,023
------------------ ------------
Supplemental schedule of cash flows-interest paid $ 27,081 $ 33,315
------------------ ------------
Supplemental schedule of noncash investing and financing
activities:
Transfer of loans to the held for sale category $ -- $ 9,075
Transfer of loans from held for sale to loans receivable 9,391 --
Foreclosures of loans receivable 1,978 3,436
------------------ ------------
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, comprehensive income 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, 2003 are not necessarily indicative of the results that may be expected
for the entire fiscal year or any other interim period.
Recent Accounting Pronouncements
----------------------------------
In November 2002, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 45 "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness to Others, an
interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB
Interpretation No. 34" ("FIN 45"). This Interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002 and did not
have a material effect on Coastal's consolidated financial statements for
the six months ended June 30, 2003.
On January 17, 2003, the FASB issued FASB Interpretation No. 46
"Consolidation of Variable Interest Entities", which addresses consolidation by
business enterprises of variable interest entities. FIN 46 clarifies the
application of Accounting Research Bulletin No. 51 "Consolidated Financial
Statements", to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 applies immediately
to variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date.
It applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. Coastal does not expect the
requirements of FIN 46 to have a material impact on its financial condition or
results or operations.
In April 2003, the FASB issued Statement No. 149 ("Statement 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities".
Statement 149 amends FASB Statement No. 133 ("Statement 133"), "Accounting for
Derivative Instruments and Hedging Activities" and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities.
Statement 149 improves financial reporting by requiring that contracts with
comparable characteristics be accounted for similarly. In particular, Statement
149 clarifies under what circumstances a contract with an initial net investment
meets the characteristic of a derivative, clarifies when a derivative contains a
financing component, amends the definition of underlying to conform to the
language in FIN 45, and amends certain other existing pronouncements. Statement
149 is effective for contracts entered into or modified after June 30, 2003 and
for hedging relationships designated after June 30, 2003. However, the
provisions of Statement 149 that related to Statement 133 implementation issues
that have been effective for fiscal quarters that began prior to June 15, 2003,
should continue to be applied in accordance with their respective effective
dates. The adoption of Statement 149 is not expected to have a material impact
on Coastal's consolidated financial statements.
In May 2003, the FASB issued Statement No. 150 ("Statement 150"),
"Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity". Statement 150 requires certain financial instruments
that have characteristics of both liabilities and equity to be classified as a
liability on the consolidated statements of financial condition. Prior to the
issuance of Statement 150, Coastal classified trust preferred securities as
liabilities on the consolidated statements of financial condition and the
related interest cost as interest expense on the consolidated statements of
income, which is consistent with the requirements of Statement 150. Statement
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. Statement 150 will be effected by
reporting the cumulative effect of a change in accounting principle for
contracts created before the issuance date and still existing at the beginning
of that interim period. The adoption of Statement 150 did not have an impact on
Coastal's consolidated financial statements.
Treasury Stock
---------------
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. As of June 30, 2003, a total of 2,752,575 shares had been
repurchased under all of the authorized repurchase plans.
As of June 30, 2003, 2,747,500 shares of common stock were held in treasury
at an average price of $19.53 per share for a total cost of $53.7 million. Book
value per common share at June 30, 2003 was $24.46.
Common Stock Dividends
------------------------
On July 31, 2003, Coastal announced an increase in its quarterly common
stock dividend from $0.12 to $0.15 per common share. Future dividend increases
will be determined by the Board of Directors based upon Coastal's results of
operations and financial condition, in addition to general economic and other
factors.
Stock Options
--------------
Statement of Financial Accounting Standards No. 148 ("Statement 148")
"Accounting for Stock-Based Compensation - Transition and Disclosure" was issued
in December 2002. Statement 148 amends FASB Statement No. 123 "Accounting for
Stock-Based Compensation" ("Statement 123") to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, Statement 148 amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. Coastal has adopted the disclosure provisions included in Statement 148
in the notes to the consolidated financial statements for the three months and
six months ended June 30, 2003 and 2002 contained herein.
As provided by Statement 123, Coastal accounts for its stock compensation
programs in accordance with the provisions of Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. Under this method, no stock-based compensation expense is
reflected in net income, as all options granted had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following tables illustrate the effects on net income and earnings per share as
if Coastal had applied the fair value recognition provisions of Statement 123 as
amended by Statement 148.
Six Months Ended June 30,
2003 2002
------------------------------------
(In thousands, except per share data)
Net income available to common stockholders, as reported $5,969 $7,782
Deduct: Total stock-based compensation expense determined
under the fair value based method for all awards, net of
related tax effects (123) (213)
-------- --------
Proforma net income available to common stockholders $5,846 $7,569
-------- --------
Earnings per common share:
Basic - as reported $ 1.16 $ 1.35
-------- --------
Basic - proforma $ 1.13 $ 1.31
-------- --------
Diluted - as reported $ 1.11 $ 1.29
-------- --------
Diluted - proforma $ 1.08 $ 1.25
-------- --------
Three Months Ended June 30,
2003 2002
----------------------------
(In thousands, except per share data)
Net income available to common stockholders, as reported $2,911 $4,328
Deduct: Total stock-based compensation expense determined
under the fair value based method for all awards, net of
related tax effects (61) (106)
------- -------
Proforma net income available to common stockholders $2,850 $4,222
------- -------
Earnings per common share:
Basic - as reported $ 0.56 $ 0.76
------- -------
Basic - proforma $ 0.55 $ 0.74
------- -------
Diluted - as reported $ 0.54 $ 0.72
------- -------
Diluted - proforma $ 0.53 $ 0.71
------- -------
(2) PRINCIPLES OF CONSOLIDATION
The accompanying unaudited Consolidated Financial Statements include the
accounts of Coastal Bancorp, Inc. ("Bancorp") and its wholly-owned subsidiaries,
Coastal Banc Holding Company, Inc., Coastal Capital Trust I and Coastal Capital
Trust II (collectively "Coastal"). Coastal Banc Holding Company Inc.'s
wholly-owned subsidiaries are Coastal Banc ssb, Coastal Banc Capital Corp. and
Coastal Banc Mortgage Corp. Coastal Banc ssb's wholly-owned subsidiaries are
CoastalBanc Financial Corp. and Coastal Banc Insurance Agency, Inc.
(collectively, the "Bank"). All significant intercompany balances and
transactions have been eliminated in consolidation.
(3) MORTGAGE-BACKED SECURITIES
Mortgage-backed securities at June 30, 2003 were as follows (in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- --------- ----------
Available-for-sale:
Agency securities $ 437,368 $2,841 $(100) $440,109
CMOs - Non-agency 59,312 -- (357) 58,955
Non-agency securities 1,852 6 (5) 1,853
---------- ---------- --------- ----------
$ 498,532 $2,847 $(462) $500,917
---------- ---------- --------- ----------
As overall interest rates increase, the fair value of Coastal's
mortgage-backed securities could be negatively effected by decreasing the
unrealized gains and possibly resulting in net unrealized losses in future
periods.
Mortgage-backed securities at December 31, 2002 were as follows (in
thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- --------- -------- ----------
Available-for-sale:
Agency securities $ 387,636 $1,983 $ (470) $389,149
CMOs - Non-agency 84,376 67 (644) 83,799
Non-agency securities 2,060 14 -- 2,074
---------- --------- -------- ----------
$ 474,072 $2,064 $(1,114) $475,022
---------- --------- -------- ----------
(4) LOANS RECEIVABLE
Loans receivable at June 30, 2003 and December 31, 2002 were as follows
(dollars in thousands):
June 30, 2003 December 31, 2002
--------------- -----------------
Real estate mortgage loans:
First-lien mortgage, primarily residential $ 899,418 $ 855,633
Commercial 359,565 317,692
Multifamily 106,605 116,020
Residential construction 119,269 123,085
Acquisition and development 133,937 143,463
Commercial construction 184,943 241,128
Commercial, financial and industrial 149,788 135,209
Loans secured by deposits 13,662 14,465
Consumer and other loans 31,767 33,430
--------------- -----------
1,998,954 1,980,125
--------------- -----------
Loans in process (117,803) (147,769)
Allowance for loan losses (18,786) (18,118)
Unearned interest and loan fees (3,032) (2,910)
Premium on purchased loans, net 5,370 1,457
--------------- -----------
$ 1,864,703 $1,812,785
--------------- -----------
Weighted average yield 5.26% 5.52%
--------------- -----------
At June 30, 2003, Coastal had outstanding commitments to originate or
purchase $34.8 million of real estate mortgage and other loans and had
commitments under lines of credit to originate primarily construction and other
loans of approximately $149.0 million. In addition, at June 30, 2003, Coastal
had $15.2 million of outstanding standby letters of credit. Management
anticipates the funding of these commitments through normal operations.
Standby letters of credit are written for conditional commitments issued by
the Bank to guarantee the performance of a customer to a third party. The
Bank's policies generally require that letters of credit arrangements contain
security and debt covenants similar to those contained in loan agreements.
Under the standby letters of credit, the Bank is required to make payments to
the beneficiary of the letters of credit upon request by the beneficiary so long
as all performance criteria have been met. At June 30, 2003, the maximum
potential amount of future payments under standby letters of credit was $15.2
million. As of June 30, 2003, the fair value of these guarantees, which is the
liability recorded when fees are collected, was immaterial to the consolidated
financial statements.
At June 30, 2003 and December 31, 2002, the carrying value of loans that
were considered to be impaired totaled approximately $7.9 million and $8.5
million, respectively, and the related allowance for loan losses on those
impaired loans totaled $2.5 million and $2.4 million at June 30, 2003 and
December 31, 2002, respectively. Of the impaired loans outstanding, three loans
with a balance of $107,000 at June 30, 2003 and eight loans with a balance of
$551,000 at December 31, 2002 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, 2003 and 2002
was $8.2 million and $3.2 million, respectively.
An analysis of activity in the allowance for loan losses for the six months
ended June 30, 2003 and 2002 is as follows (in thousands):
Six Months Ended June 30,
-------------------------
2003 2002
-------- --------
Balance, beginning of period $18,118 $15,385
Provision for loan losses 1,800 1,800
Charge-offs (1,468) (2,274)
Recoveries 336 322
-------- --------
Balance, end of period $18,786 $15,233
-------- --------
Coastal services for others loans receivable which are not included in the
Consolidated Financial Statements. The total amounts of such loans were $58.4
million and $68.8 million at June 30, 2003 and December 31, 2002, respectively.
(5) DEPOSITS
Deposits, their stated rates and the related weighted average interest
rates, at June 30, 2003 and December 31, 2002, 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 $239.6 million ($128.5 million from noninterest-bearing
and $111.1 million from interest-bearing) at June 30, 2003 and $250.9 million
($131.3 million from noninterest-bearing and $119.6 million from
interest-bearing) at December 31, 2002.
Stated Rate June 30, 2003 December 31, 2002
-------------- ------------- -----------------
Noninterest-bearing checking 0.00% $ 58,621 $ 51,029
Interest-bearing checking 0.00 - 1.00 13,632 14,353
Savings accounts 0.50 - 1.24 46,341 44,603
Money market demand accounts 0.00 - 2.13 550,673 530,659
-------------- -----------
669,267 640,644
-------------- -----------
Certificate accounts Less than 2.00 265,661 104,358
2.00 - 2.99 432,627 558,337
3.00 - 3.99 168,050 206,645
4.00 - 4.99 51,598 63,234
5.00 - 5.99 28,114 34,447
6.00 - 6.99 4,215 6,524
7.00 - 7.99 19 106
8.00 - 8.99 30 73
-------------- -----------
950,314 973,724
-------------- -----------
$ 1,619,581 $1,614,368
-------------- -----------
Weighted average interest rate 1.87% 2.12%
-------------- -----------
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, 2003 and December 31, 2002 (in thousands):
June 30, 2003 December 31, 2002
-------------- -----------------
Noninterest-bearing checking $ 187,101 $182,290
Interest-bearing checking 124,721 134,034
Money market demand accounts 311,104 279,717
The scheduled maturities of certificate accounts outstanding at June 30,
2003 were as follows (in thousands):
June 30, 2003
--------------
0 through 12 months $ 755,344
13 through 24 months 120,633
25 through 36 months 22,641
37 through 48 months 22,697
49 through 60 months 28,897
Over 60 months 102
--------------
$ 950,314
--------------
(6) ADVANCES FROM THE FHLB
The weighted average interest rates on advances from the FHLB at June 30,
2003 and December 31, 2002 were 2.38% and 2.71%, respectively. The scheduled
maturities and related weighted average interest rates on advances from the FHLB
at June 30, 2003 are summarized as follows (dollars in thousands):
Weighted Average
Due during the year ending December 31, Interest Rate Amount
- --------------------------------------- ----------------- ------
2003 2.83% $146,022
2004 1.97 175,970
2005 2.16 264,147
2006 1.95 73,519
2007 6.68 1,109
2008 3.88 5,396
2009 7.99 3,332
2010 5.38 2,062
2011 6.64 739
2012 5.76 292
2013 5.64 8,181
2014 5.44 2,882
2015 6.66 1,617
2017 5.43 1,980
2018 5.05 1,421
--------
2.38% $688,669
--------
Advances from the FHLB are secured by certain first-lien mortgage and
multifamily loans and mortgage-backed securities owned by Coastal.
(7) COMPANY OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES
On June 23, 2003, Bancorp, through Coastal Capital Trust II (a consolidated
trust subsidiary) ("CCTII"), issued to a private institutional investor, 10,000
floating rate pooled trust preferred securities ("Trust Preferred Securities
II") with a liquidation preference of $1,000 per security. The Trust Preferred
Securities II represent an interest in the related junior subordinated
debentures of Bancorp, which were purchased by the CCTII and have substantially
the same payment terms as these Trust Preferred Securities II. The junior
subordinated notes are the only assets of the CCTII and interest payments from
the notes finance the distributions paid on the Trust Preferred Securities II.
Distributions on the securities are payable quarterly at a variable interest
rate, reset quarterly, equal to LIBOR plus 3.05%, and are included in interest
expense in the consolidated statements of income.
The Trust Preferred Securities II 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 23,
2033, at the option of Bancorp on or after June 23, 2008, 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.
The proceeds from the issuance of the Trust Preferred Securities II were
used on July 31, 2003 in the redemption of Bancorp's 9.12% Series A Cumulative
Preferred Stock (Nasdaq:CBSAO).
On June 18, 2002, Coastal, through Coastal Capital Trust I (a consolidated
trust subsidiary) ("CCTI"), issued 2,000,000 trust preferred securities ("Trust
Preferred Securities I") with a liquidation preference of $25 per security. The
Trust Preferred Securities I represent an interest in Bancorp's junior
subordinated debentures, which were purchased by the CCTI. The junior
subordinated debentures are the only assets of the CCTI and interest payments
from the debentures finance the distributions paid on the Trust Preferred
Securities I. 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 I 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 I were used to repurchase 500,000 shares of common stock for $15.0
million from a director of Bancorp in June 2002. In addition, $28.8 million of
the proceeds were used on July 15, 2002, to redeem the Bank's 9.0% Series A
Noncumulative Preferred Stock (Nasdaq:CBSAP) through a capital contribution to
Coastal Banc ssb.
(8) 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.
(9) 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
and interest rate cap agreements, as described below. For the six months ended
June 30, 2003 and 2002, Coastal recorded a fair value gain (loss) on these
derivative instruments of $13,000 and ($24,000), respectively. As of June 30,
2003 and December 31, 2002, interest rate cap agreements were Coastal's only
derivative instruments and were recorded at fair value.
As of June 30, 2003, Coastal had interest rate cap agreements with third
parties with notional amounts totaling $103.3 million. The current agreements
provide for the 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. All of Coastal's current agreements expire in 2003. 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. No payments
are required to be made upon the expiration of the agreements. The fair value
of the interest rate cap agreements was zero at June 30, 2003 and December 31,
2002, which is the recorded book value of the agreements at such dates. 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
each of the six-month periods ended June 30, 2003 and 2002. No payments were
made to Coastal under the interest rate cap agreements during the six months
ended June 30, 2003 or 2002.
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, including off-balance sheet items, 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.
(10) EARNINGS PER SHARE
The following summarizes information related to the computation of basic
and diluted earnings per share ("EPS") for the six- and three-month periods
ended June 30, 2003 and 2002 (dollars in thousands, except share and per share
data):
Six Months Ended
June 30,
2003 2002
---------- ----------
Net income $ 7,223 $ 9,036
Preferred stock dividends 1,254 1,254
---------- ----------
Net income available to common stockholders $ 5,969 $ 7,782
========== ==========
Weighted average number of common shares
outstanding used in basic EPS calculation 5,154,785 5,768,001
Add assumed exercise of outstanding stock
options as adjusted for dilutive securities 234,409 269,078
---------- ----------
Weighted average number of common shares
outstanding used in diluted EPS calculation 5,389,194 6,037,079
========== ==========
Basic EPS $ 1.16 $ 1.35
========== ==========
Diluted EPS $ 1.11 $ 1.29
========== ==========
Three Months Ended
June 30,
2003 2002
---------- ----------
Net income $ 3,538 $ 4,955
Preferred stock dividends 627 627
---------- ----------
Net income available to common stockholders $ 2,911 $ 4,328
========== ==========
Weighted average number of common shares
outstanding used in basic EPS calculation 5,165,051 5,715,222
Add assumed exercise of outstanding stock
options as adjusted for dilutive securities 226,776 269,214
---------- ----------
Weighted average number of common shares
outstanding used in diluted EPS calculation 5,391,827 5,984,436
========== ==========
Basic EPS $ 0.56 $ 0.76
========== ==========
Diluted EPS $ 0.54 $ 0.72
========== ==========
(11) 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 (Nasdaq:CBSAP). 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 the date fixed for redemption.
With a portion of the proceeds from the issuance of the Trust Preferred
Securities I, the Bank redeemed, from the stockholders of record, all of the
9.0% Series A Noncumulative Preferred Stock on July 15, 2002 (see note 7). The
redemption price was $25.185 per share, which represented the stated value of
the Preferred Stock, plus accrued and unpaid dividends to the date of
redemption.
Pursuant to Coastal's tax benefit agreement with the FDIC, Coastal received
a tax benefit for dividends paid on this Preferred Stock. This benefit ceased
upon the redemption of this Preferred Stock.
(12) COASTAL BANCORP, INC. PREFERRED STOCK
On May 11, 1999, Coastal Bancorp, Inc. ("Bancorp") issued 1,100,000 shares
of 9.12% Series A Cumulative Preferred Stock, no par value, at a price of $25
per share (Nasdaq:CBSAO) to the public ("Bancorp Preferred Stock"). Dividends
on the Bancorp Preferred Stock were payable quarterly at the annual rate of
$2.28 per share. The preferred stock was callable on May 15, 2003 at Bancorp's
option.
With the proceeds from the issuance of the Trust Preferred Securities II
(note 7) and a capital distribution of $17.9 million from the Bank, Bancorp
redeemed from the stockholders of record all of the 9.12% Series A Noncumlative
Preferred Stock on July 31, 2003. The redemption price was $25.19633, per share,
which represented the stated value, plus an amount equal to accrued but unpaid
dividends to the date of redemption.
Pursuant to Coastal's tax benefit agreement with the FDIC, Coastal received
a tax benefit for dividends paid on this Bancorp Preferred Stock. This benefit
ceased upon the redemption of the Bancorp Preferred Stock.
(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, 2003, 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) 180,961 7.22% $100,206 4.00% $125,257 5.00%
Tier 1 risk-based 180,961 10.53 68,751 4.00 103,126 6.00
Total risk-based 199,748 11.62 137,502 8.00 171,877 10.00
As of June 30, 2003, 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
-------------------------------------------------------------------
RESULTS OF OPERATIONS
-----------------------
Financial Condition
- --------------------
Total assets increased slightly by $17.6 million from December 31, 2002 to
June 30, 2003. The net increase was primarily comprised of the following
changes: a $51.9 million increase in loans receivable, a $25.9 million increase
in mortgage-backed securities available-for-sale, a $31.4 million decrease in
loans receivable held for sale and a $27.0 million decrease in federal funds
sold. There were also small changes in other asset categories. The increase in
loans receivable was primarily due to the purchase of $252.7 million in
single-family mortgage loans, offset by principal payments received on mortgage
and other types of loans. The increase in mortgage-backed securities was due to
the purchase of $117.8 million of securities, offset by principal payments
received. The decrease in loans receivable held for sale was due primarily to
the sale to third party investors in January 2003 of a loan package purchased in
November of 2002, the majority of which was intended to be sold.
Deposits increased $5.2 million or 0.3% from December 31, 2002 to June 30,
2003 and advances from the FHLB decreased 1.1% or $7.4 million. During the six
months ended June 30, 2003, Coastal issued $10.0 million in Trust Preferred
Securities through a consolidated trust subsidiary (see note 7 to the
Consolidated Financial Statements). Stockholders' equity increased 3.5% or $5.4
million from December 31, 2002 to June 30, 2003 primarily as a result of net
income, a $935,000 increase in accumulated other comprehensive income, offset by
an increase in Treasury Stock of $622,000 and dividends declared.
Results of Operations for the Six Months Ended June 30, 2003 and 2002
- --------------------------------------------------------------------------------
General
-------
For the six months ended June 30, 2003, net income was $7.2 million
compared to $9.0 million for the six months ended June 30, 2002. The decrease
was primarily due to a $6.4 million decrease in net interest income, as a result
of a 0.52% decrease in net interest margin (due to the overall lower interest
rate environment) and a $14.1 million decrease in average net interest-earning
assets when comparing the first six months of 2003 to the same period in 2002.
This decrease in net interest income was partially mitigated by a $2.0 million
increase in noninterest income, a $256,000 decrease in noninterest expense, a
$1.0 million decrease in the provision for Federal income taxes and a $1.3
million decrease in the expense for minority interest (related to preferred
stock of Coastal Banc ssb which was redeemed on July 15, 2002).
Interest Income
----------------
Due to the overall lower interest rate environment and significant
principal payments received on Coastal's mortgage-backed securities and
single-family mortgage loan portfolios, interest income decreased $12.0 million
to $58.6 million for the six months ended June 30, 2003 from $70.6 million for
the six months ended June 30, 2002. The decrease was comprised of a $9.9
million decrease in interest income on loans receivable, a $1.9 million decrease
in interest income on mortgage-backed securities and a $276,000 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
$12.2 million and the average yield decreased 0.97% from 5.83% in 2002 to 4.86%
in 2003. The $12.2 million decrease in average interest-earning assets
consisted primarily of a $13.2 million decrease in the average balance of other
securities available-for-sale resulting from one security maturing during the
2002 period, offset by smaller changes in other asset categories.
As in 2002, during 2003 Coastal has continued to experience significant
principal paydowns on its mortgage-backed securities and single family mortgage
loans receivable portfolios due to the continuing low market rates of interest
and the resulting refinancings of mortgage assets. These paydowns, on an
annualized basis, were approximately 39% on mortgage-backed securities and 48%
on single family mortgage loans during the six months ended June 30, 2003.
Because Coastal's mortgage assets are primarily acquired through purchases (many
at a premium), these significant paydowns resulted in greater premium
amortization (and therefore a lower yield) on those assets. In addition, due to
the lower interest rate environment, Coastal is replacing these paid down assets
with lower yielding assets, again with many being purchased at a premium.
Interest Expense
-----------------
Interest expense on interest-bearing liabilities was $26.5 million for the
six months ended June 30, 2003, as compared to $32.1 million for the same period
in 2002. The decrease in interest expense was again primarily due to the lower
overall market rates of interest that declined throughout 2002 and have
continued to decline during the first six months of 2003, offset by the increase
in interest expense due to the 9.0% Trust Preferred Securities I issued in June
of 2002. When comparing the two periods, the average rate paid on
interest-bearing liabilities decreased to 2.48% for the six months ended June
30, 2003 from 3.01% for the same period in 2002 and average interest-bearing
liabilities increased slightly by $1.9 million. The 0.53% decrease in the
average rate paid on interest-bearing liabilities was due primarily to the 0.67%
decrease in the average rate paid on interest-bearing deposits and a 0.64%
decrease in the average rates paid on advances from the FHLB. The increase in
average interest-bearing liabilities consisted primarily of a $46.9 million
increase in the average balance of Trust Preferred Securities due to the
issuance of $50.0 million of the Trust Preferred Securities I on June 18, 2002
at 9.0% and $10.0 million of the Trust Preferred Securities II on June 23, 2003
at a floating rate (LIBOR plus 3.05%) and an increase of $14.8 million in
advances from the FHLB. These increases were somewhat offset by a $52.3 million
decrease in average interest-bearing deposits (primarily due to the sale of the
Hill Country branches in December 2002) and a $7.5 million decrease in the
average balance of Senior Notes due to their redemption on February 1, 2002.
Net Interest Income
---------------------
Net interest income was $32.0 million for the six months ended June 30,
2003 and $38.4 million for the same period in 2002. As discussed above, the
decrease was due primarily to the overall lower market interest rate
environment, the overall high levels of principal paydowns being received on
mortgage assets and the change in the composition of interest-bearing
liabilities. Net interest margin ("Margin") was 2.65% for the six months ended
June 30, 2003 compared to 3.17% for the six months ended June 30, 2002. Margin
represents net interest income as a percentage of average interest-earning
assets. Net interest spread ("Spread"), defined to exclude noninterest-bearing
deposits, decreased to 2.38% for the six months ended June 30, 2003 from 2.82%
for the six months ended June 30, 2002. Management also calculates an
alternative Spread which includes noninterest-bearing deposits. Under this
calculation, the alternative Spreads for the six months ended June 30, 2003 and
2002 were 2.58% and 3.04%, respectively. Margin and Spread are affected by the
changes in the amount and composition of interest-earning assets and
interest-bearing liabilities. When comparing the two periods, average
interest-earning assets decreased $12.2 million and average interest-bearing
liabilities increased $1.9 million.
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. Management attempts to mitigate margin
compression in a declining interest rate environment by requiring interest rate
floors on certain variable rate loans.
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, 2003 and for the six months ended June 30, 2002. At June 30, 2003,
Coastal had nonperforming loans totaling $14.2 million, which was a decrease of
$4.4 million, or 23%, when compared to December 31, 2002. This decrease was
primarily a result of the decrease in nonperforming single family mortgage loans
due to management's increased focus on ongoing collection efforts.
Nonperforming loans are those loans on nonaccrual status as well as those loans
greater than ninety days delinquent and still accruing interest. The ratio of
nonperforming assets to total assets was 0.72% at June 30, 2003, compared to
0.91% at December 31, 2002. At June 30, 2003 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 132.4% compared to
97.7% at December 31, 2002.
Management analyzes the loan portfolio to determine the adequacy of the
allowance for loan losses and the appropriate provision required to maintain an
adequate allowance. Estimating the allowance for loan losses is a critical
accounting policy. It is subjective in nature and requires material estimates
that may be subject to revision as facts and circumstances warrant. In
assessing the adequacy of the allowance, management reviews the type, size,
quality and risk of loans in the portfolio and considers such factors as
specific known risks, historical and peer group experience, the existing
nonperforming loans and the underlying collateral value on those loans, general
economic conditions, particularly as they relate to Coastal's lending areas and
other factors related to the collectibility of Coastal's loan portfolio. Based
on the ongoing assessment by management, provisions for loan losses are charged
to earnings to bring the total allowance for loan losses to a level deemed
appropriate by management based on probable losses in the loan portfolio. While
management uses the best information available at the time to recognize losses
on loans, there can be no assurance that future additions to the allowance will
not be necessary.
Noninterest Income
-------------------
For the six months ended June 30, 2003, noninterest income increased $2.0
million to $7.5 million, compared to $5.5 million for the six months ended June
30, 2002. The $2.0 million increase in noninterest income was primarily due to
the $1.7 million increase in service charges on deposit accounts and a $752,000
gain on the sale of loans receivable held for sale. The increased income from
service charges on deposit accounts is due to Coastal's continued focus on
increasing transaction-type accounts and the related fee income, including
Coastal's Free Checking and Bounce Protection features on retail checking
accounts introduced during August 2002. The increase in the gain on the sale of
mortgage loans held for sale was due to routine sales transactions by Coastal
Banc ssb (the "Bank"), which were facilitated by Coastal Banc Mortgage Corp.
("CBMC"), an affiliate of the Bank. The loans sold were purchased by the Bank
in packages with the intention to resell all or part of the loans in the
packages to third party investors. CBMC was formed during the third quarter of
2002 for the purpose of facilitating the purchase and sale of whole loans and
participations to third parties. These increases in other noninterest income
were somewhat offset by a $336,000 decrease in the gain on the sale of real
estate owned and a $200,000 decrease in loan fees. The decrease in loan fees
was due to decreased construction loan activity, no warehouse activity in 2003
and decreased single family mortgage loan fees due to the fact that the number
of Coastal's mortgage loans that are being serviced by Coastal has decreasesd.
Noninterest Expense
--------------------
For the six months ended June 30, 2003, noninterest expense decreased
$256,000 from the six months ended June 30, 2002. When comparing the six months
ended June 30, 2003 to the same period in 2002, the $256,000 net decrease in
noninterest expense was comprised primarily of a decrease in compensation,
payroll taxes and benefits of $399,000, a decrease of $501,000 in office
occupancy and a $281,000 decrease in advertising, somewhat offset by an $891,000
increase in other noninterest expense. The $399,000 decrease in compensation
related expense is primarily comprised on the following: a $257,000 decrease in
incentive and bonus expense because of the overall lower net income results, a
$293,000 decrease due to the sale of the five Hill Country branches in December
2002, a $252,000 decrease due to the outsourcing of the internal audit
department in 2002, offset by a $314,000 increase in compensation paid to CBMC
employees including brokerage commissions related to the loan sales mentioned
previously. The decrease in office occupancy was due to various assets becoming
fully depreciated in 2002 and in 2003, the sale of the five Hill Country
branches and the decrease in advertising expense was due to management's
decision to reduce this spending in 2003. The increase in other noninterest
expense was primarily comprised of the following: a $235,000 increase in audit
and accounting fees, a $228,000 increase in legal fees and insurance premiums, a
$144,000 increase in the provision for losses on deposit accounts and a $128,000
increase in expenses related to loans and real estate owned.
Provision for Federal Income Taxes
--------------------------------------
The provision for Federal income taxes for the six months ended June 30,
2003 was $3.2 million compared to $4.2 million for the six months ended June 30,
2002. The $1.0 million decrease was due to the lower amount of income before
provision for Federal income taxes and minority interest, with the effective tax
rate for the periods being approximately 31% for six months ended June 30, 2003
and 32% for the same period in 2002 (when taking into account the tax benefit
for the minority interest expense in 2002). As discussed in the notes to the
Consolidated Financial Statements, Coastal received a tax benefit for the
dividends paid on the Bancorp Preferred Stock pursuant to an agreement with the
FDIC. The effective tax rate for the six months ended June 30, 2003 would have
been 35% without this tax benefit related to the Bancorp Preferred Stock. The
ongoing tax benefit ceased upon the redemption of the Bancorp Preferred Stock.
Results of Operations for the Three Months Ended June 30, 2003 and 2002
- --------------------------------------------------------------------------------
General
-------
For the three months ended June 30, 2003, net income was $3.5 million
compared to $5.0 million for the three months ended June 30, 2002. The decrease
was primarily due to a $3.9 million decrease in net interest income, as a result
of a 0.63% decrease in net interest margin (due to the overall lower interest
rate environment) and a $14.7 million decrease in average net interest-earning
assets when comparing the second quarter of 2003 to the same period in 2002.
This decrease in net interest income was partially mitigated by a $552,000
increase in noninterest income, a $460,000 decrease in noninterest expense, a
$782,000 decrease in the provision for Federal income taxes and a $647,000
decrease in the expense for minority interest (related to the preferred stock of
Coastal Banc ssb which was redeemed on July 15, 2002).
Interest Income
----------------
Due to the overall lower interest rate environment and significant
principal payments received on Coastal's mortgage-backed securities and
single-family mortgage loan portfolios, interest income decreased $6.2 million
to $29.0 million for the three months ended June 30, 2003 from $35.2 million for
the three months ended June 30, 2002. The decrease was comprised of a $5.5
million decrease in interest income on loans receivable, a $577,000 decrease in
interest income on mortgage-backed securities and a $91,000 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
$3.4 million and the average yield decreased 1.01% from 5.76% in 2002 to 4.75%
in 2003. The $3.4 million decrease in average interest-earning assets consisted
primarily of a $21.6 million decrease in the average balance of loans
receivable, an $8.2 million decrease in the average balance of Federal funds
sold, offset by a $25.9 million increase in the average balance of
mortgage-backed securities.
As in 2002, during 2003 Coastal has continued to experience significant
principal paydowns on its mortgage-backed securities and single family mortgage
loans receivable portfolios due to the continuing low market rates of interest
and the resulting refinancings of mortgage assets. These paydowns, on an
annualized basis, were approximately 38% on mortgage-backed securities and over
50% on single family mortgage loans during the three months ended June 30, 2003.
Because Coastal's mortgage assets are primarily acquired through purchases (many
at a premium), these significant paydowns resulted in greater premium
amortization (and therefore a lower yield) on those assets. In addition, due to
the lower interest rate environment, Coastal is replacing these paid down assets
with lower yielding assets, again with many being purchased at a premium.
Interest Expense
-----------------
Interest expense on interest-bearing liabilities was $13.1 million for the
three months ended June 30, 2003, as compared to $15.5 million for the same
period in 2002. The decrease in interest expense was again primarily due to the
lower overall market rates of interest that declined throughout 2002 and have
continued to decline during the first six months of 2003, offset by the increase
in interest expense due to the 9.0% Trust Preferred Securities I issued in June
of 2002. When comparing the two periods, the average rate paid on
interest-bearing liabilities decreased to 2.42% for the six months ended June
30, 2003 from 2.87% for the same period in 2002 and average interest-bearing
liabilities increased $11.3 million. The 0.45% decrease in the average rate
paid on interest-bearing liabilities was due primarily to the 0.60% decrease in
the average rate paid on interest-bearing deposits and a 0.55% decrease in the
average rates paid on advances from the FHLB. The increase in average
interest-bearing liabilities consisted primarily of a $43.7 million increase in
the average balance of Trust Preferred Securities due to the issuance of $50.0
million of the Trust Preferred Securities I on June 18, 2002 at 9.0% and $10.0
million of the Trust Preferred Securities II on June 23, 2003 at a floating rate
(LIBOR plus 3.05%) and an increase of $11.0 million in advances from the FHLB.
These increases were somewhat offset by a $43.4 million decrease in average
interest-bearing deposits, primarily due to the December 2002 branch sale.
Net Interest Income
---------------------
Net interest income was $15.9 million for the three months ended June 30,
2003 and $19.7 million for the same period in 2002. As discussed above, the
decrease was due primarily to the overall lower market interest rate
environment. Net interest margin ("Margin") was 2.60% for the three months
ended June 30, 2003 compared to 3.23% for the three months ended June 30, 2002.
Margin represents net interest income as a percentage of average
interest-earning assets. Net interest spread ("Spread"), defined to exclude
noninterest-bearing deposits, decreased to 2.33% for the three months ended June
30, 2003 from 2.89% for the three months ended June 30, 2002. Management also
calculates an alternative Spread which includes noninterest-bearing deposits.
Under this calculation, the alternative Spreads for the three months ended June
30, 2003 and 2002 were 2.52% and 3.10%, respectively. Margin and Spread are
affected by the changes in the amount and composition of interest-earning assets
and interest-bearing liabilities. When comparing the two periods, average
interest-earning assets decreased $3.4 million and average interest-bearing
liabilities increased $11.3 million.
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. Management attempts to mitigate margin
compression in a declining interest rate environment by requiring interest rate
floors on certain variable rate loans.
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, 2003 and for the three months ended June 30, 2002. At June 30, 2003,
Coastal had nonperforming loans totaling $14.2 million, which is a decrease of
$4.4 million, or 23%, when compared to December 31, 2002. This decrease was
primarily a result of the decrease in nonperforming single family mortgage loans
due to management's increased focus on ongoing collection efforts.
Nonperforming loans are those loans on nonaccrual status as well as those loans
greater than ninety days delinquent and still accruing interest. The ratio of
nonperforming assets to total assets was 0.72% at June 30, 2003, compared to
0.91% at December 31, 2002. At June 30, 2003 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 132.4% compared to
97.7% at December 31, 2002.
Management analyzes the loan portfolio to determine the adequacy of the
allowance for loan losses and the appropriate provision required to maintain an
adequate allowance. Estimating the allowance for loan losses is a critical
accounting policy. It is subjective in nature and requires material estimates
that may be subject to revision as facts and circumstances warrant. In
assessing the adequacy of the allowance, management reviews the type, size,
quality and risk of loans in the portfolio and considers such factors as
specific known risks, historical and peer group experience, the existing
nonperforming loans and the underlying collateral value on those loans, general
economic conditions, particularly as they relate to Coastal's lending areas and
other factors related to the collectibility of Coastal's loan portfolio. Based
on the ongoing assessment by management, provisions for loan losses are charged
to earnings to bring the total allowance for loan losses to a level deemed
appropriate by management based on probable losses in the loan portfolio. While
management uses the best information available at the time to recognize losses
on loans, there can be no assurance that future additions to the allowance will
not be necessary.
Noninterest Income
-------------------
For the three months ended June 30, 2003, noninterest income increased
$552,000 to $3.5 million, compared to $3.0 million for the three months ended
June 30, 2002. The $552,000 increase in noninterest income was primarily due to
the $806,000 increase in service charges on deposit accounts. The increased
income from service charges on deposit accounts is due to Coastal's continued
focus on increasing transaction-type accounts and the related fee income,
including Coastal's Free Checking and Bounce Protection features on retail
checking accounts introduced during August 2002. This increase in service
charges on deposit accounts was somewhat offset by a $184,000 decrease in the
gain on the sale of real estate owned and a $112,000 decrease in loan fees.
Noninterest Expense
--------------------
For the three months ended June 30, 2003, noninterest expense decreased
$460,000 from the three months ended June 30, 2002. When comparing the second
quarter of 2003 to the same period in 2002, the $460,000 net decrease in
noninterest expense was comprised primarily of a decrease in compensation,
payroll taxes and benefits of $546,000, and decreases of $238,000 and $127,000
in office occupancy and advertising, respectively. These decreases were
somewhat offset by a $378,000 increase in other noninterest expense, a $62,000
increase in data processing and a small increase in postage and delivery
expense. The decrease in compensation related expenses was primarily comprised
of the following: decreased incentive and bonus expense of $177,000 because of
the overall lower net income results, a $142,000 decrease due to the outsourcing
of the internal audit department in 2002, a $144,000 decrease due to the sale of
the five Hill Country branches in December 2002, in addition to other overall
staffing changes to gain efficiencies throughout Coastal. The decrease in
office occupancy was primarily due to certain assets becoming fully depreciated
in 2002 and 2003, in addition to decreases in rent and repair expenses. The
decrease in advertising expense was due to management's decision to reduce this
spending in 2003. The $378,000 increase in other noninterest expense was
primarily comprised of a $114,000 increase in audit and accounting fees related
to the outsourcing of the internal audit department, a $108,000 increase in
legal fees and insurance premiums and a $103,000 increase in expenses related to
software and network communications costs.
Provision for Federal Income Taxes
--------------------------------------
The provision for Federal income taxes for the three months ended June 30,
2003 was $1.6 million compared to $2.4 million for the three months ended June
30, 2002. The $782,000 decrease was due to the lower amount of income before
provision for Federal income taxes and minority interest, with the effective tax
rate for the periods being approximately 31% for the quarter ended June 30, 2003
and 32% for the same period in 2002 (when taking into account the tax benefit
for the minority interest expense in 2002). As discussed in the notes to the
Consolidated Financial Statements, Coastal received a tax benefit for the
dividends paid on the Bancorp Preferred Stock pursuant to an agreement with the
FDIC. The effective tax rate for the three months ended June 30, 2003 would have
been 35% without this tax benefit related to the Bancorp Preferred Stock. The
ongoing tax benefit ceased upon redemption of the Bancorp Preferred Stock.
Liquidity and Capital Resources
----------------------------------
Coastal's primary sources of funds consist of deposits bearing market rates of
interest, advances from the FHLB, principal payments on loans receivable and
mortgage-backed securities and other types of borrowings. 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 dividends and stock
purchases and acquisitions of other banks and thrifts, either on a branch office
or whole bank acquisition basis. At June 30, 2003, Coastal had binding
commitments to originate or purchase loans totaling approximately $34.8 million
and had $117.8 million of undisbursed loans in process. Scheduled maturities of
certificates of deposit during the 12 months following June 30, 2003, totaled
$755.3 million at June 30, 2003. Management believes that Coastal has adequate
resources to fund all of its commitments.
During the six months ended June 30, 2003, Coastal opened a new branch in
the City of Rosenberg, Texas. As of June 30, 2003, Coastal operated 44 retail
banking offices in Texas cities, including Houston, Austin, Corpus Christi, the
Rio Grande Valley and small cities in the southeast quadrant of Texas (including
this new branch in Rosenberg).
Forward-Looking Information
----------------------------
The Management's Discussion and Analysis of Financial Condition and Results
of Operations set forth in this 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 and commercial construction 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, 2002, as filed with the SEC on March 25, 2003.
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, 2002. Coastal's principal market risk exposure is to
interest rates. See note 9 of the Notes to Consolidated Financial Statements.
ITEM 4. CONTROLS AND PROCEDURES
-------------------------
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Coastal's
management has reviewed the disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) of Coastal or caused such disclosure controls and
procedures to be designed under management's supervision, particularly during
the period in which this quarterly report was being prepared. Disclosure
controls and procedures are the controls and other procedures of Coastal that
are designed to ensure that the information required to be disclosed by Coastal
in its reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the SEC's rules
and forms. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed by Coastal in its reports filed under the Exchange Act is accumulated
and communicated to Coastal's management, including the principal executive
officer and principal financial officer, as appropriate to allow timely
decisions regarding required disclosure. Management believes that such
disclosure controls and procedures as of the end of the period covered by this
report were adequate to ensure that material information relating to Coastal,
including its consolidated subsidiaries, is made known to management by others
within Coastal and its consolidated subsidiaries. To management's knowledge,
there were no significant changes in internal control over financial reporting
or in other factors that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting.
Coastal intends to continually review and evaluate the design and
effectiveness of its disclosure controls and procedures and to improve its
controls and procedures over time and to correct any deficiencies that it may
discover in the future. The goal is to ensure that senior management has timely
access to all material financial and non-financial information concerning
Coastal's business. While Coastal believes that the present design of its
disclosure controls and procedures is effective to achieve this goal, further
events affecting its business may cause Coastal to modify its disclosure
controls and procedures.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
------------------
Coastal is, and has been involved, from time to time, in various claims,
complaints, proceedings and litigation relating to activities arising from the
normal course of its operations. Based on the facts currently available to
management, management believes that the matters pending at June 30, 2003 are
without merit, or will be covered by insurance and any other matters are of such
amounts, which upon resolution, are not likely to have a material adverse effect
on Coastal's consolidated financial condition, results of operations or cash
flows.
Item 2. Changes in Securities and Use of Proceeds
-----------------------------------------------
On June 23, 2003, Bancorp, through Coastal Capital Trust II (a consolidated
trust subsidiary) ("CCTII"), issued to a private institutional investor, 10,000
floating rate pooled trust preferred securities ("Trust Preferred Securities
II") with a liquidation preference of $1,000 per security. The Trust Preferred
Securities II represent an interest in the related junior subordinated
debentures of Bancorp, which were purchased by the CCTII and have substantially
the same payment terms as these Trust Preferred Securities II. The junior
subordinated notes are the only assets of the CCTII and interest payments from
the notes finance the distributions paid on the Trust Preferred Securities II.
Distributions on the securities are payable quarterly at a variable interest
rate, reset quarterly, equal to LIBOR plus 3.05%, and are included in interest
expense in the consolidated statements of income.
The Trust Preferred Securities II 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 23,
2033, at the option of Bancorp on or after June 23, 2008, 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.
The proceeds from the issuance of the Trust Preferred Securities II were
used on July 31, 2003 in the redemption of Bancorp's 9.12% Series A Cumulative
Preferred Stock (Nasdaq:CBSAO).
Item 3. Defaults Upon Senior Securities
----------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
-----------------------------------------------------------
On April 24, 2003, at the Annual Meeting of Stockholders of Coastal Bancorp,
Inc. (the "Company"), the stockholders voted upon and approved the election of
two directors and the ratification of the appointment of KPMG LLP as the
Company's independent public accountants for the fiscal year ending December 31,
2003.
With respect to such matters, the results of the votes were as follows:
1) Election of directors:
Number of Votes
-----------------
In favor Withheld
-------- ----------
Manuel J. Mehos 4,217,263 327,871
Clayton T. Stone 4,461,205 83,929
2) Ratification of KPMG LLP as the Company's independent public accountants
for the fiscal year ending December 31, 2003:
Number of votes in favor: 4,374,680
Number of votes against: 169,704
Number of votes abstaining 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 17, 2003 concerning the announcement
that the Company. had issued a press release regarding the results of operations
and financial condition for the quarterly period ended March 31, 2003.
2) Form 8-K filed with the SEC on May 16, 2003 concerning the announcement
that the Company requested Moody's Investor Services to withdraw all ratings on
the Company.
3) Form 8-K filed with the SEC on May 27, 2003 concerning the announcement
that Clayton T. Stone, a Director of the Company, passed away.
Exhibits.
31.1 Certification of the Chief Executive Officer pursuant to Rules 13a-14
and 15d-14 of the Securities Exchange Act of 1934 and Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Rules 13a-14
and 15d-14 of the Securities Exchange Act of 1934 and Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 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.
99.1 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: 8/8/03 By /s/ Manuel J. Mehos
------ ---------------------
Manuel J. Mehos
Chairman of the Board
Chief Executive Officer
(Principal Executive Officer)
Dated: 8/8/03 By /s/ Catherine N. Wylie
------ -------------------------
Catherine N. Wylie
Chief Financial Officer
(Principal Financial and
Accounting Officer)