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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act
of 1934 For the fiscal year ended December 31, 1999
Commission File Number: 0-24802
MONTEREY BAY BANCORP, INC.
(Exact Name Of Registrant As Specified In Its Charter)
DELAWARE 77-0381362
(State Or Other Jurisdiction Of (I.R.S. Employer Identification Number)
Incorporation Or Organization)
567 Auto Center Drive, Watsonville, California 95076
(Address Of Principal Executive Offices)(Zip Code)
(831) 768-4800
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value per share
(Title Of Class)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ___.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the Common Stock held by "non-affiliates"
of the registrant, based upon the closing sale price of its Common Stock on
March 10, 2000, as quoted on the Nasdaq National Market System, was
approximately $15,712,000. Shares of common stock held by each officer,
director, and holder of 5% or more of the outstanding Common Stock have been
excluded in that such persons or entities may be deemed to be affiliates. Such
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The registrant had 3,308,523 shares of Common Stock outstanding as of
March 10, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2000 Annual Meeting
of Stockholders to be filed within 120 days of the fiscal year ended December
31, 1999 are incorporated by reference into Part III of this Form 10-K.
1
INDEX
PAGE
PART I
Item 1. Business.......................................................................................3
Item 2. Properties....................................................................................47
Item 3. Legal Proceedings.............................................................................48
Item 4. Submission of Matters to a Vote of Security Holders...........................................48
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.........................48
Item 6. Selected Financial Data.......................................................................49
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.........51
Item 7a. Quantitative and Qualitative Disclosures About Market Risk....................................66
Item 8. Financial Statements and Supplementary Data...................................................70
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.........116
PART III
Item 10. Directors and Executive Officers of the Registrant...........................................116
Item 11. Executive Compensation.......................................................................116
Item 12. Security Ownership of Certain Beneficial Owners and Management...............................116
Item 13. Certain Relationships and Related Transactions...............................................116
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................116
2
PART I
Discussions of certain matters in this Annual Report on Form 10-K may
constitute forward-looking statements within the meaning of the Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities and
Exchange Act of 1934, as amended (the "Exchange Act"), and as such, may involve
risks and uncertainties. Forward-looking statements, which are based on certain
assumptions and describe future plans, strategies, and expectations, are
generally identifiable by the use of words such as "believe", "expect",
"intend", "anticipate", "estimate", "project", or similar expressions. These
forward-looking statements relate to, among other things, expectations of the
business environment in which Monterey Bay Bancorp, Inc. operates, projections
of future performance, potential future credit experience, perceived
opportunities in the market, and statements regarding the Company's mission and
vision. The Company's actual results, performance, and achievements may differ
materially from the results, performance, and achievements expressed or implied
in such forward-looking statements. For a discussion of some of the factors that
might cause such a difference, including, but not limited to, changes in
interest rates, general economic conditions, legislative and regulatory changes,
monetary and fiscal policies of the US Government, real estate valuations, and
competition in the financial services industry, see "Item 1. Business - Factors
That May Affect Future Results."
Item 1. Business.
General
Monterey Bay Bancorp, Inc. (referred to herein on an unconsolidated
basis as "MBBC" and on a consolidated basis as the "Company") is a unitary
savings and loan holding company incorporated in 1994 under the laws of the
state of Delaware. MBBC currently maintains a single subsidiary company,
Monterey Bay Bank (the "Bank"), formerly Watsonville Federal Savings and Loan
Association. MBBC was organized as the holding company for the Bank in
connection with the Bank's conversion from the mutual to stock form of ownership
in 1995.
At December 31, 1999, the Company had $462.8 million in total assets,
$360.7 million in net loans receivable, and $367.4 million in total deposits.
The Company is subject to regulation by the Office of Thrift Supervision
("OTS"), the Federal Deposit Insurance Corporation ("FDIC"), and the Securities
and Exchange Commission ("SEC"). The principal executive offices of the Company
and the Bank are located at 567 Auto Center Drive, Watsonville, California,
95076, telephone number (831) 768 - 4800, facsimile number (831) 722 - 6794. The
Company may also be contacted via electronic mail at: INFO@MONTEREYBAYBANK.COM.
The Bank is a member of the Federal Home Loan Bank of San Francisco ("FHLB") and
its deposits are insured by the FDIC to the maximum extent permitted by law.
The Company conducts business from eight branch offices and its
administrative headquarters. In addition, the Company supports its customers
through 24 hour telephone banking and ATM access through an array of networks
including STAR, CIRRUS, and PLUS. During the year 2000, the Bank intends to
introduce Internet banking access to its customers.
Through its network of banking offices, the Bank emphasizes
personalized service focused upon two primary markets: households and small
businesses. The Bank offers a wide complement of lending products, including:
o a broad array of residential mortgage products, both fixed and adjustable
rate
o consumer loans, including home equity lines of credit and overdraft lines
of credit
o specialized financing programs to support community development
o mortgages for multifamily real estate
o commercial and industrial real estate loans
o construction lending for single family residences, apartment buildings, and
commercial real estate
o commercial loans to businesses, including both revolving lines of credit
and term loans
3
The Bank also provides an extensive selection of deposit instruments. These
include:
o multiple checking products for both personal and business accounts, with
imaged statements available
o various savings accounts
o tiered money market accounts
o tax qualified deposit accounts (e.g. IRA's)
o a broad array of certificate products
Through its wholly-owned subsidiary, Portola Investment Corporation
("Portola"), the Bank provides, on an agency basis, mortgage life insurance,
fire insurance, and a wide selection of non-FDIC insured investment products
including:
o fixed annuities
o variable annuities
o an extensive inventory of mutual funds
o individual fixed income and equity securities
Please see "Subsidiary Activities" for additional information regarding business
activities by Portola.
The Bank also supports its customers by functioning as a federal tax
depository, selling and purchasing foreign banknotes, issuing debit cards,
providing domestic and international collection services, and supplying various
forms of electronic funds transfer.
The Company participates in the wholesale capital markets through the
management of its security portfolio and its use of various forms of wholesale
funding. The Company's security portfolio contains a variety of instruments,
including collateralized mortgage obligations ("CMO's"). The Company also
participates in the secondary market for loans as both a purchaser and a seller
of various types of mortgage products.
The Company's revenues are primarily derived from interest on its loan
and mortgage backed securities portfolios, interest and dividends on its
investment securities, and fee income associated with the provision of various
customer services. Interest paid on deposits and borrowings constitutes the
Company's largest type of expense. The Company's primary sources of funds are
deposits, principal and interest payments on its asset portfolios, and various
sources of wholesale borrowings including FHLB advances and securities sold
under agreements to repurchase. The Company's most significant operating
expenditures are its staffing expenses and the costs associated with maintaining
its branch network.
Additional information concerning the Company's business is presented
under "Item 7. Management's Discussion And Analysis Of Financial Condition And
Results Of Operations."
4
Company Strategy
During the past several years, the Company has adopted a business
strategy of evolving away from its traditional savings and loan roots toward
more of a community banking orientation. This evolution was selected so that the
Company might better and more completely serve the financial needs of the
communities it serves and because of the constrained financial returns
associated with the traditional thrift business of funding residential mortgage
loans with certificates of deposit. In conjunction with this strategy, the
Company has diversified both its loan and its deposit portfolios.
At December 31, 1999, residential mortgage loans comprised 43.4% of
total gross loans held for investment, down significantly from 70.2% at the end
of 1997. This shift in mix was accomplished through the Company's emphasis upon
originating, in particular, construction and commercial and industrial real
estate loans. The Company's construction lending has benefited from the strong
demand for housing in the Greater Monterey Bay Area and from the robust economic
growth experienced in the Company's primary market areas over the past several
years.
At December 31, 1999, certificates of deposits constituted 60.5% of the
deposit portfolio, down from 79.3% at the end of 1997. Over the past several
years, the Company has emphasized checking and money market accounts in its
marketing and advertising as a means of cementing its relationship with its
customers, decreasing its relative cost of funds, and bolstering non-interest
income.
The Company's strategy of transitioning into more of a community bank
also incorporates increasing the percentage of the Company's total revenues
generated from fees and service charges, as compared to net interest income. In
this regard, the Company has expanded its scope of fee based services and
significantly enhanced the product line offered through Portola.
Another component of the Company's business strategy has been to
improve its capital management in augmenting its return on equity. To accomplish
this objective, the Company has increased in total assets, accomplished the
aforementioned change in asset mix, declared dividends, and conducted a series
of share repurchases.
The Company intends to continue pursuing this strategy, while seeking
avenues for further growth in market share and product diversification.
Management believes that the continued consolidation occurring in the financial
services industry will present opportunities to acquire personnel, branches, and
customers from institutions being sold.
Market Area and Competition
Market Area. The Bank is a community-oriented financial institution
which originates residential, multifamily, construction, commercial real estate,
consumer, and business loans within its market area. The Bank's deposit
gathering and lending markets are concentrated primarily in the communities
surrounding its full service offices in the counties of Santa Cruz, Monterey,
and Santa Clara in Central California. While the economy in the Company's
primary market area remains predominantly agricultural, in recent years other
economic segments have assumed a larger portion of total business activity.
These newer and in some cases relatively rapidly expanding segments include:
o an increasing professional presence, both in commercial property and in
residential housing, as the technology centered Silicon Valley of California
expands towards and into the Company's market areas
o light manufacturing
o post-secondary education
o tourism, especially in the coastal communities on Monterey Bay
5
The Company believes that the primary market areas in which it operates
have experienced strong growth and favorable economic activity in the past two
years, as reflected in appreciating real estate values and continued significant
consumer demand for housing. The economic performance in the Company's primary
market area typically mirrors the national economy and shows seasonal
fluctuations, with a slowdown during the winter months.
Competition. The banking and financial services business in California
generally, and in the Bank's market areas specifically, is highly competitive.
The increasingly competitive environment is a result of many factors including,
but not limited to:
o the rise of the Internet, whereby the Bank must more frequently compete with
remote entities soliciting customers in its primary market areas via web
based advertising and product delivery, especially for certificates of
deposit and residential mortgages
o the significant consolidation among financial institutions which has occurred
over the past several years, resulting in a number of substantially larger
competitors
o the increasing integration among commercial banks, securities brokers, and
investment banks, from giant institutions such as CitiGroup to the recent
acquisition of TeleBank and pending acquisition of Card Capture Services,
Inc. by E*Trade Group, Inc.
o the continued growth and market share of non-bank financial services
providers, that often specialize in a single product line such as credit
cards or residential mortgages
The Company competes for loans, deposits, fee based products, and
customers for financial services with commercial banks, savings and loans,
credit unions, thrift and loans, mortgage bankers, securities and brokerage
companies, insurance firms, finance companies, mutual funds, and other non-bank
financial services providers. Many of these competitors are much larger than the
Bank in total assets, market reach, and capitalization; and enjoy greater access
to capital markets and can offer a broader array of products and services than
the Bank presently markets.
Two local competing insured depository institutions, Coast Bancorp,
Inc. and San Benito Bank, announced their sale to Greater Bay Bancorp, Inc. and
Pacific Capital Bancorp, Inc., respectively, early in the year 2000. These
transactions continue the consolidation trend that has occurred in the Company's
primary marketplaces over the past several years. The Company is currently
evaluating the potential impacts of these acquisitions, with management
considering various alternatives to acquire business currently served by the
impacted institutions. These latest acquisitions leave the Company as the
largest local financial institution in many of its markets.
In order to compete with other financial services providers, the
Company relies upon local community involvement, personal service and the
resulting personal relationships of its staff and customers, and the development
and sale of specialized products and services tailored to meet its customers'
needs. In addition, management considers the Company's reputation for financial
strength and competitive services, as developed over 75 years of local Company
history, as a competitive advantage in attracting and retaining customers within
its primary market area.
Risk Factors That May Affect Future Results
The following discusses certain factors that may affect the Company's
financial results and operations and should be considered in evaluating the
Company.
Ability Of The Company To Execute Its Business Strategy. The financial
performance and profitability of the Company will depend, in large part, on its
ability to favorably execute its business strategy in converting from a
relatively traditional savings and loan association to a community based
financial services firm. This evolution entails risks in, among other areas,
technology implementation, market segmentation, brand identification, banking
operations, and capital and human resource investments. Accordingly, there can
be no assurance that the Company will be successful in its business strategy and
therefore continue the rise in profitability experienced during 1999.
6
Economic Conditions And Geographic Concentration. The Company's
operations are located in Central and Northern California and are concentrated
in Santa Cruz, Monterey, and Santa Clara Counties. Although management has
diversified the Company's loan portfolio into other California counties, and to
a much lesser extent into other states, the vast majority of the Company's
credits remain concentrated in the three primary counties. As a result of this
geographic concentration, the Company's results depend largely upon economic and
real estate market conditions in these areas. A deterioration in economic or
real estate market conditions in the Company's primary market areas could have a
material adverse impact on the quality of the Company's loan portfolio, the
demand for its products and services, and its financial condition and results of
operations. In addition, because the Company does not require earthquake
insurance in conjunction with its real estate lending, an earthquake with an
epicenter in or near the Company's primary market areas could also significantly
adversely impact the Company's financial condition and results of operations.
Interest Rates. By nature, all financial institutions are impacted by
changing interest rates, due to the impact of such upon:
o the demand for new loans
o prepayment speeds experienced on various asset classes, particularly mortgage
backed securities and residential loans
o credit profiles of existing loans
o rates received on loans and securities
o rates paid on deposits and borrowings
As presented under "Item 7. Management's Discussion And Analysis Of Financial
Condition And The Results Of Operations" and under "Item 7a. Quantitative And
Qualitative Disclosure Of Market Risk", the Company is financially exposed to
parallel shifts in general market interest rates (particularly upward shifts),
changes in the relative pricing of the term structure of general market interest
rates, and relative credit spreads. Therefore, significant fluctuations in
interest rates may present an adverse effect upon the Company's financial
condition and results of operations.
Government Regulation And Monetary Policy. The financial services
industry is subject to extensive federal and state supervision and regulation.
Significant new laws, changes in existing laws, or repeals of present laws could
cause the Company's financial results to materially differ from past results.
Further, federal monetary policy, particularly as implemented through the
Federal Reserve System, significantly affects credit conditions for the Company,
and a material change in these conditions could present an adverse impact on the
Company's financial condition and results of operations.
Competition. The financial services business in the Company's market
areas is highly competitive, and is becoming more so due to technological
advances (particularly Internet based financial services delivery), changes in
the regulatory environment, and the enormous consolidation which has occurred
among financial services providers. Many of the Company's competitors are much
larger in total assets and market capitalization, enjoy greater liquidity in
their equity securities, have greater access to capital and funding, and offer a
broader array of financial products and services. In light of this environment,
there can be no assurance that the Company will be able to compete effectively.
The results of the Company may materially differ in future periods depending
upon the nature or level of competition.
Credit Quality. A significant source of risk arises from the
possibility that losses will be sustained because borrowers, guarantors, and
related parties may fail to perform in accordance with the terms of their loans.
The Company has adopted underwriting and credit monitoring procedures and credit
policies, including the establishment and review of the allowance for loan
losses, that management believes are appropriate to control this risk by
assessing the likelihood of non performance, tracking loan performance, and
diversifying the credit portfolio. Such policies and procedures may not,
however, prevent unexpected losses that could have a material adverse effect on
the Company's financial condition or results of operations. Unexpected losses
may arise from a wide variety of specific or systemic factors, many of which are
beyond the Company's ability to predict, influence, and control.
Other Risks. From time to time, the Company details other risks with
respect to its business and financial results in its filings with the Securities
and Exchange Commission.
7
Lending Activities
General. The Company originates a wide variety of loan products, as
exhibited in the subsequent table. Loans originated by the Company are subject
to federal and state law and regulations. Interest rates charged by the Company
on loans are affected by the demand for such loans and the supply of money
available for lending purposes and the rates offered by competitors. These
factors are, in turn, affected by, among other things, economic conditions,
monetary policies of the federal government, including the Federal Reserve
Board, and legislative tax policies. The following table presents the Company's
loan activity for the years indicated.
For The Years Ended December 31,
----------------------------------------------------
1999 1998 1997
------------- -------------- --------------
(Dollars In Thousands)
Gross Loans (1)
Beginning balance $ 303,732 $ 265,934 $ 234,649
--------- --------- ---------
Originations:
Residential one to four unit 38,402 47,440 22,423
Multifamily 5 or more units 12,129 11,240 1,686
Commercial & industrial real estate 37,663 18,024 13,177
Construction 61,691 32,870 34,724
Land 16,453 6,137 2,169
Consumer 3,524 3,084 1,856
Business 3,405 6,563 1,213
--------- --------- ---------
Total loans originated 173,267 125,358 77,248
--------- --------- ---------
Purchases -- 79,902 14,661
Sales (8,868) (14,223) (3,020)
Transfers to real estate owned (376) (299) (610)
Securitizations -- (48,370) --
Principal repayments (2) (103,567) (104,570) (56,994)
--------- --------- ---------
Ending balance $ 364,188 $ 303,732 $ 265,934
========= ========= =========
- ------------------------
(1) Gross loans includes loans receivable held for investment and loans held
for sale, net of deferred loan fees and unamortized premiums and
discounts.
(2) Principal repayments include amortization of premiums, net of discounts;
amortization of deferred loan fees; net changes in nonmortgage loans
receivable; and other adjustments.
1999 constituted the highest origination volume in the Bank's 75 year
history. The mix of loans originated in 1999 reflected the Company's business
strategy of becoming a broader based, community focused financial services firm
with a balance sheet diversified away from the Bank's historic concentration in
relatively lower yielding residential mortgages. The Company realized particular
progress in 1999 in bolstering its production of commercial & industrial real
estate and construction lending, taking advantage of a strong real estate market
in many of the communities served by the Company. The Company also conducted a
series of loan participations with other financial institutions in 1999 as a
means of both augmenting loan volume and diversifying credit risk. These
participations funded in conjunction with other financial institutions are
displayed in the above table as originations. Loans acquired outright after
origination by other parties are shown in the above table as purchases. The
Company requires title and hazard insurance for all real estate loans. More
detailed information regarding the Company's lending activity is included in the
following paragraphs which present activity by loan product category.
8
Residential One To Four Unit Mortgage Lending. The Company originates
fixed rate, adjustable rate, and hybrid (fixed for a period, and then
adjustable) mortgage loans secured by one to four family residential properties.
Adjustable rate mortgage loans have interest rates that adjust monthly,
semiannually, or annually and reprice based upon various indices, primarily the
11th FHLB District Cost of Funds Index ("COFI") or the US Treasury One Year
Constant Maturities Index ("1 Year CMT") . In the Year 2000, the Company intends
to commence originating residential mortgages tied to the MTA index, which is
equivalent to the twelve month rolling average of the 1 Year CMT index. The MTA
index is utilized by a number of the Company's primary competitors and is often
preferred by consumers due to its limited volatility relative to the 1 Year CMT
index. The majority of loan originations are to existing or past customers and
members of the Bank's local communities. The Company also originates one to four
family residential construction loans for both owner occupants and developers /
contractors ("speculative construction loans"). The Company provides escrow
(impounds) services as requested by its customers and generally for those loans
in excess of 80.0% loan to value.
At December 31, 1999. the Company maintained $168.5 million in
residential permanent mortgages, representing 46.3% of loans held for investment
net of undisbursed loan funds. This compares to $181.8 million in permanent
residential mortgages a year earlier, which then constituted 60.3% of loans held
for investment net of undisbursed loan funds. This decline in residential
mortgage volume and mix was coincident with the Company's business strategy,
reinforced by, in particular, the first half of 1999 being a strong fixed rate
residential lending market, which favors the Company's non bank competitors. The
Company typically enjoys greater relative success during strong markets for
adjustable rate mortgages, when the Company's capacity as a local lender
underwriting and retaining loans for its own balance sheet provides a better
competitive advantage.
The majority of the residential loans at December 31, 1999 were secured
by properties located within the Company's primary market area, and to a lesser
extent the state of California. At December 31, 1999, 12.1% of the Company's
one-to-four family mortgage loans had fixed terms and 87.9% had adjustable
rates. The Company offers a variety of adjustable rate residential loan
products, including an "easy qualifier" loan with more limited documentation
required than other mortgages. The Company began originating loans subject to
negative amortization in 1996. Negative amortization involves a greater risk to
the Company because during a period of high interest rates the loan principal
may increase above the amount originally advanced. However, the Company believes
that the risk of default on these loans is mitigated by negative amortization
caps, underwriting criteria, relatively low loan to value ratios, and the
stability provided by payment schedules. At December 31, 1999, the Company's
residential loan portfolio included $24.1 million of loans subject to negative
amortization.
The Company originates one to four family residential mortgage loans in
amounts up to 80% of the lower of the appraised value or the selling price of
the property securing the loan, and up to 97% of the appraised value or selling
price if private mortgage insurance is obtained. Mortgage loans originated by
the Company generally include due on sale clauses which provide the Company with
the contractual right to deem the loan immediately due and payable in the event
the borrower transfers ownership of the property without the Company's consent.
Due on sale clauses are an important means of adjusting the rates on the
Company's fixed rate mortgage loan portfolio and the Company has generally
exercised its rights under these clauses.
From time to time, based on its asset / liability strategy, the Company
purchases mortgage loans originated by others. In 1998, the Company purchased
$79.9 million of primarily one to four family adjustable rate residential loans,
including a $40.0 million portfolio that presented a weaker credit profile than
those generally pursued by the Company. See "Credit Quality - Special
Residential Loan Pool" and Note 14 to the Consolidated Financial Statements for
additional information.
The largest residential loan in the Company's portfolio at December 31,
1999 totaled $2.3 million, secured by a home in Monte Sereno, California. The
second largest residential loan at December 31, 1999 was $2.2 million, secured
by a home in La Selva Beach, California.
9
Multifamily Lending. The Company offers hybrid and adjustable rate
permanent multifamily real estate loans secured by real property in California.
The Company also periodically extends construction financing to builders of
multifamily housing. Permanent loans on multifamily properties typically present
maturities of 30 years and are secured by apartment buildings containing five or
more units. Factors considered by the Company in reaching a lending decision on
such properties include the net operating income of the mortgaged premises
before debt service and depreciation, the debt service ratio (the ratio of net
earnings to debt service), the ratio of the loan amount to appraised value, and
the financial profile of any guarantors. Pursuant to the Company's underwriting
policies, multifamily adjustable rate mortgage loans are generally originated in
amounts up to 70% of the appraised value of the underlying properties. The
Company generally requires a debt service ratio of at least 1.20. Properties
securing loans are appraised by an independent appraiser. Title insurance is
required on all loans. When evaluating the qualifications of the borrower for a
multifamily loan, the Company considers the financial resources and income level
of the borrower, the borrower's experience in owning or managing similar
property, and the Company's lending experience with the borrower. The Company's
underwriting policies require that the borrower provide evidence of ability to
repay the mortgage on a timely basis and maintain the property from current
rental income. In evaluating the creditworthiness of the borrower, the Company
generally reviews the borrower's financial statements, employment, and credit
history, as well as other related documentation.
Loans secured by apartment buildings and other multifamily residential
properties are generally larger and involve a greater degree of risk than one to
four family residential loans. Because payments on loans secured by multifamily
properties are often dependent on successful operation or management of the
properties, repayment of such loans may be subject to a greater extent to
adverse conditions in the real estate market or the economy. The Company seeks
to minimize these risks through its underwriting policies, which require such
loans to be qualified at origination on the basis of the property's income and
debt coverage ratio. The Company also attempts to limit its risk exposure by
requiring annual operating statements on the properties and by acquiring
personal guarantees from the borrowers.
As part of its operating strategy, the Company intends to moderately
increase its multifamily lending within the state of California. At December 31,
1999, the Company's portfolio of multi-family loans totaled $42.2 million, or
11.6% of loans receivable held for investment less undisbursed loan funds. At
December 31, 1999, the Company's two largest multifamily loans had outstanding
balances of $2.7 million and $2.0 million, respectively. The loans were secured
by apartment buildings located in Oceanside and Stockton, California,
respectively. Because the primary marketplace the Company serves has a limited
volume of multifamily properties, the Company intends to continue pursuing
multifamily real estate loans secured by properties located throughout
California. The Company's strategy in this regard is to purchase participations
in multifamily loans originated by experienced, local lenders with a favorable
record of quality loan origination.
Commercial & Industrial Real Estate Lending. The Company originates
both permanent and construction loans secured by commercial & industrial real
estate located primarily in California. The Company's underwriting procedures
provide that commercial & industrial real estate loans may generally be made in
amounts up to the lesser of 65% of the appraised value of the property or up to
a debt service coverage ratio of 1.20. Permanent loans may be made with terms up
to 25 years and are typically adjustable based upon the 1 Year CMT or COFI
indices. The Company's underwriting standards and credit review procedures on
commercial & industrial real estate loans are similar to those applicable to
multifamily loans. The Company considers the net operating income of the
property, the loan to value ratio, the presence of any guarantees, and the
borrower's expertise, credit history, and financial profile.
At December 31, 1999, the Company's permanent commercial & industrial
real estate loan portfolio totaled $72.3 million, or 19.9% of loans held for
investment net of undisbursed loan funds. The largest permanent commercial real
estate loan in the Company's portfolio at December 31, 1999 was secured by a
nationally branded hotel located in Dublin, California, with an outstanding
principal balance of $5.1 million. The next largest commercial real estate loan
maintained by the Company at December 31, 1999 was $4.3 million, secured by a
church and related facilities located in San Jose, California.
10
As part of its business strategy, the Company has significantly
augmented the nominal and relative levels of its commercial & industrial real
estate lending in California, with the proportion of the loan portfolio
represented by permanent commercial & industrial real estate loans increasing by
approximately 50% during 1999. The majority of the commercial & industrial real
estate loans are secured by property located in Northern and Central California.
However, the Company has in the past year pursued participations on commercial &
industrial real estate loans with experienced, local lenders in the greater San
Diego and Los Angeles markets as a means of increasing loans outstanding and
geographically diversifying the Company's loan portfolio.
Loans secured by commercial & industrial real estate properties, like
multifamily loans, are generally larger and involve a greater degree of risk
than one to four family residential mortgage loans. Because payments on loans
secured by commercial real estate properties are often dependent on successful
operation or management of the properties, repayment of such loans may be
significantly subject to adverse conditions in the properties' management or
real estate markets in general or particular to a subject property. The Company
seeks to mitigate these risks through its underwriting standards and credit
review policy, which requires annual operating statements for each collateral
property. The Company also participates larger commercial & industrial real
estate loans with other financial institutions as a means of diversifying its
credit risk and remaining below the Bank's regulatory limit on loans to one
borrower.
Construction Lending. The Company originates construction loans for the
acquisition and development of property. Collateral has been historically
concentrated in residential properties, both owner occupied and speculative, as
well as commercial real estate, including both retail properties and warehouse /
storage facilities.
Construction financing is generally considered to involve a higher
degree of risk than long-term financing on improved, occupied real estate. The
Company's risk of loss on construction loans depends largely upon the accuracy
of the initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. If the
estimate of construction costs proves to be inaccurate, the Company may have to
advance funds beyond the amount originally committed to permit completion of the
development and to protect its security position. The Company may also be
confronted, at or prior to maturity of the loan, with a project with
insufficient value to ensure full repayment. The Company's underwriting,
monitoring, and disbursement practices with respect to construction financing
are intended to ensure that sufficient funds are available to complete
construction projects. The Company attempts to limit its risk through its
underwriting procedures, by using only approved, qualified appraisers, and by
dealing with qualified builders / borrowers. The Company also participates
larger construction loans with other financial institutions as a means of
diversifying its credit risk and remaining below the Bank's regulatory limit on
loans to one borrower.
The Company's construction loans typically have adjustable rates and
terms of 12 to 18 months. The Company originates one to four family and
multifamily residential construction loans in amounts up to 80% of the appraised
value of the property, subject to loans to one borrower limitations. Land
development loans are determined on an individual basis, but in general they do
not exceed 70% of the actual cost or current appraised value of the property,
whichever is less. Loan proceeds are disbursed in increments as construction
progresses and as inspections warrant.
At December 31, 1999, the Company had gross construction and land
development loans totaling $79.0 million, on which there were undisbursed loan
funds of $23.9 million. The net outstanding balance of $55.2 million represented
15.1% of loans held for investment net of undisbursed loan funds at December 31,
1999. The largest construction credit in the Company's portfolio at year-end was
a $4.5 million gross commitment to fund the building of retail space in Santa
Cruz, California. The second largest construction loan maintained by the Company
at December 31, 1999 was a gross commitment of $4.4 million associated with a
shopping center in Davis, California. The Company's construction loans are
largely concentrated in the Company's primary marketplaces, although a limited
amount of construction lending has occurred throughout Northern California.
11
Land Lending. The Company offers loans secured by land, generally
located in its immediate marketplace. The types of land generally considered by
the Company are suitable for residential development or are demarcated
residential lots. The Company does not extend loans on agricultural land where
repayment of the loan is dependent upon crop sales.
At December 31, 1999, the Company had land loans totaling $13.9
million, or 3.8% of gross loans held for investment net of undisbursed loan
funds. The largest land loan in the Company's portfolio at year-end 1999 was a
$2.8 million credit secured by land targeted for future residential development
located in Los Altos, California. The Company's second largest land loan at
December 31, 1999 was $1.7 million, secured by commercially zoned land located
in Monterey, California.
Business Lending. The Company offers business loans primarily
collateralized by business assets. Such collateral is typically comprised of
accounts receivable, inventory, and equipment. Business lending is generally
considered to involve a higher degree of risk than the financing of real estate,
primarily because security interests in the collateral are more difficult to
perfect and the collateral may be difficult to obtain or liquidate following an
uncured default. Business loans typically offer relatively higher yields, short
maturities, and variable interest rates. The availability of such loans enables
existing and potential business depositors to establish a more complete
financial relationship with the Bank. The Company attempts to reduce the risk of
loss associated with business lending by closely monitoring the financial
condition and performance of its customers.
During 1999, the Company introduced its "Business Express" lending
program, whereby small businesses may obtain lines of credit of up to $25,000
with a relatively brief application and limited supporting documentation,
augmented by a quick credit decision on the part of the Bank. This program was
implemented to strengthen the Company's relationship with the small businesses
in the Company's primary market areas, many of whom have been deposit customers
for some period of time.
At December 31, 1999, the Company had business term loans totaling $6.7
million and drawn balances against business lines of credit totaling $1.0
million. In the aggregate, business loans comprised 2.1% of gross loans held for
investment net of undisbursed loan funds at December 31, 1999. The largest
business loan in the Company's portfolio at year end was a $5.0 million term
loan to a financial institution holding company extended by MBBC. This loan,
which was placed on non-accrual status in December 1999, is primarily secured by
the holding company's ownership interest in an insured depository institution.
The loan was placed on non-accrual status primarily due to concerns regarding
the ability of the holding company to repay the loan at maturity without selling
or liquidating the insured depository institution. The insured depository
institution reported continued profitability during 1999. The loan was current
in its interest payments at December 31, 1999.
Loan Approval Procedures And Authority. The board of directors has
ultimate responsibility for the lending activity of the Company and establishes
the lending policies of the Company. The board of directors has authorized the
following loan approval authorities: mortgage loans in amounts up to the federal
agency (e.g. Federal National Mortgage Association or "FNMA") conforming limit
may be approved by the Company's staff underwriters; mortgage loans in excess of
the agency conforming limits and up to $350,000 may be approved by the
underwriting / processing manager; mortgage loans in excess of $350,000 and up
to $400,000 may be approved by the real estate loan administrator; mortgage
loans in excess of $400,000 and up to $500,000 require the approval of the Chief
Lending Officer; and mortgage loans in excess of $500,000 and up to $750,000
require the approval of the Chief Executive Officer or the President. Mortgage
loans in excess of $750,000 and up to $2.0 million require the approval of the
board of directors Loan Committee. Any loans greater than $2.0 million must be
approved by the full board of directors. The President or Chief Loan Officer may
approve non-real estate loans up to $75,000. The Directors Loan Committee can
approve such loans up to $2.0 million.
The loan origination process requires that upon receipt of a completed
loan application, a credit report is obtained and certain information is
verified by an independent credit agency. If necessary, additional financial
information is obtained from the prospective borrower. An appraisal of the
related real estate is performed by an independent appraiser. The Company's
board of directors approves all independent appraisers used by the Company. If
the original loan exceeds 80% loan to value on a first trust deed loan or
private mortgage insurance is required, the borrower is required to make
payments to a loan impound account from which the Company makes disbursements
for property taxes and insurance.
12
Loan Portfolio Composition. The following table presents the
composition of the Company's net loans receivable held for investment at the
dates indicated.
At December 31,
-----------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
-----------------------------------------------------------------------------------------------
Amount % Amount % Amount % Amount % Amount %
------ - ------ - ------ - ------ - ------ -
(Dollars In Thousands)
Loans secured by real estate
Residential one to four unit $168,465 43.4% $181,771 55.8% $201,562 70.2% $198,255 83.9% $195,852 84.6%
Multifamily five or more units 42,173 10.9% 33,340 10.2% 23,355 8.1% 22,455 9.5% 21,503 9.3%
Commercial and industrial 72,344 18.6% 39,997 12.3% 20,159 7.0% 7,524 3.2% 4,191 1.8%
Construction 79,034 20.3% 51,624 15.9% 35,150 12.3% 4,131 1.7% 5,379 2.3%
Land 13,930 3.6% 7,774 2.4% 1,869 0.7% 95 -- 97 --
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Sub-total loans secured by
real estate 375,946 96.8% 314,506 96.6% 282,095 98.3% 232,460 98.3% 227,022 98.0%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Other loans
Home equity lines of credit 3,968 1.0% 3,262 1.0% 3,142 1.1% 3,194 1.4% 3,973 1.7%
Other consumer loans 587 0.2% 658 0.2% 598 0.2% 763 0.3% 605 0.3%
Business term loans 6,670 1.7% 6,679 2.0% 943 0.3% -- -- -- --
Business lines of credit 1,027 0.3% 595 0.2% 270 0.1% -- -- -- --
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Sub-total other loans 12,252 3.2% 11,193 3.4% 4,953 1.7% 3,957 1.7% 4,578 2.0%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total gross loans 388,198 100.0% 325,699 100.0% 287,048 100.0% 236,417 100.0% 231,600 100.0%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
(Less) / Plus
Undisbursed loan funds (23,863) (24,201) (21,442) (1,822) (1,895)
Unamortized premiums &
discounts 134 491 556 452 651
Deferred loan fees, net (281) (434) (742) (528) (607)
Allowance for loan losses (3,502) (2,780) (1,669) (1,311) (1,362)
------- ------- ------- ------- -------
Total loans held for $360,686 $298,775 $263,751 $233,208 $228,387
investment, net ======== ======== ======== ======== ========
13
Loan Maturity Profile. The following table shows the contractual
maturities of the Company's gross loans at December 31, 1999.
At December 31, 1999
--------------------------------------------------
2001 2005 Total
Through And Gross
2000 2004 Thereafter Loans
---- ---- ---------- -----
(Dollars In Thousands)
Residential one to four unit $ 713 $ 270 $ 167,482 $ 168,465
Multifamily five or more units -- 448 41,725 42,173
Commercial and industrial real estate 1,715 1,901 68,728 72,344
Construction 62,652 14,516 1,866 79,034
Land 1,931 10,870 1,129 13,930
Home equity lines of credit -- 1,294 2,674 3,968
Other consumer loans 580 7 -- 587
Business term loans -- 5,837 833 6,670
Business lines of credit 988 39 -- 1,027
-------- -------- --------- ---------
Total $ 68,579 $ 35,182 $ 284,437 $ 388,198
======== ======== ========= =========
The following table presents the Company's gross loans at December 31,
1999, segregating those with fixed versus adjustable interest rates and also
isolating those loans with contractual maturities less than or equal to and
greater than one year.
Matures In 2000 Matures After 2000 Total Gross Loans
--------------------- --------------------- ----------------------------------
Fixed Adjustable Fixed Adjustable Fixed Adjustable All
----- ---------- ----- ---------- ----- ---------- ---
(Dollars In Thousands)
Residential one to four unit $ 4 709 $ 20,395 $ 147,357 $ 20,399 $ 148,066 $ 168,465
Multifamily five or more units -- -- 539 41,634 539 41,634 42,173
Commercial and industrial real
estate 5 1,710 5,975 64,654 5,980 66,364 72,344
Construction 17,847 44,805 -- 16,382 17,847 61,187 79,034
Land -- 1,931 -- 11,999 -- 13,930 13,930
Home equity lines of credit -- -- -- 3,968 -- 3,968 3,968
Other consumer loans 580 -- 7 -- 587 -- 587
Business term loans -- -- -- 6,670 -- 6,670 6,670
Business lines of credit -- 988 -- 39 -- 1,027 1,027
-------- -------- -------- --------- -------- --------- ---------
Total $ 18,436 $ 50,143 $ 26,916 $ 292,703 $ 45,352 $ 342,846 $ 388,198
======== ======== ======== ========= ======== ========= =========
Percent of gross loans outstanding 4.8% 12.9% 6.9% 75.4% 11.7% 88.3% 100.0%
Originations, Purchases, and Sales of Loans. The Company's mortgage
lending activities are conducted primarily through its eight branch offices and
approximately 60 wholesale loan brokers who deliver completed loan applications
to the Company. In addition, the Company has developed correspondent
relationships with a number of financial institutions to facilitate the
origination of real estate loans on a participation basis. Loans presented to
the Company for purchase or participation are generally underwritten
substantially in accordance with the Company's established lending standards,
which consider the financial condition of the borrower, the location of the
underlying property, and the appraised value of the property, among other
factors.
14
On an ongoing basis, depending on its asset / liability strategy, the
Company originates one to four family residential loans for sale in the
secondary market. Loan sales are dependent on the level of loan originations and
the relative customer demand for mortgage loans, which is affected by the
current and expected future level of interest rates. During the years ended
December 31, 1999 and 1998, the Company sold $8.9 million and $14.2 million,
respectively, of fixed rate residential loans. The Company has recently been
selling its fixed rate residential loans on a servicing released basis in order
to take advantage of comparatively attractive servicing premiums being offered
in the secondary market. The level and timing of any future loan sales will
depend upon market opportunities and prevailing interest rates. From time to
time, depending on its asset / liability strategy, the Company converts a
portion of its mortgages into readily marketable mortgage backed securities. In
1998, the Company converted approximately $48.4 million of fixed rate
residential loans into mortgage backed securities. The securitization was
undertaken primarily to provide greater liquidity for the assets and thereby
augment the Company's ability to manage its interest rate risk profile and cash
flows.
Loan Servicing. The Company services its own loans as well as loans
owned by others. Loan servicing includes collecting and remitting loan payments,
accounting for principal and interest, holding escrow funds for the payment of
real estate taxes and insurance premiums, contacting delinquent borrowers, and
supervising foreclosures and property dispositions in the event of unremedied
defaults. Loan servicing income includes servicing fees from investors and
certain charges collected from borrowers, such as late payment fees. At December
31, 1999, the Company was servicing $74.2 million of loans for others.
Credit Quality
General. Although management believes that non-performing loans are
generally well secured and / or reserved, real estate acquired through
foreclosure is properly valued, and potential losses are provided for in the
allowance for loan losses, there can be no assurance that future deterioration
in local or national economic conditions, collateral values, borrowers'
financial status, or other factors will not result in future credit losses and
associated charges against operations. In regards to real estate acquired via
foreclosure, although all such properties are actively marketed by the Company,
no assurance can be provided regarding when these properties will be sold or
what the terms of sale will be when they are sold. It is the Company's general
policy to maintain recent (within 18 months) appraisals for all foreclosed
properties.
Non-accrual, Delinquent, And Restructured Loans. Management generally
places loans on non-accrual status when they become 90 days past due, unless
they are well secured and in the process of collection. Management also places
loans on non-accrual status when they are less than 90 days delinquent when
there is concern about the collection of the debt in accordance with the terms
of the loan agreement. When a loan is placed on non-accrual status, any interest
previously accrued but not collected is reversed from income. Loans are charged
off when management determines that collection has become unlikely. Restructured
loans are those where the Company has granted a concession on the interest paid
or the original repayment terms due to financial difficulties of the borrower or
because of issues with the collateral securing the loan.
Delinquent Loan Procedures. Specific delinquency procedures vary
depending on the loan type and period of delinquency. However, the Company's
policies generally provide that loans be reviewed monthly for delinquencies, and
that if a borrower fails to make a required payment when due, the Company
institutes internal collection procedures. For mortgage loans, written late
charge notices are mailed no later than the 15th day of delinquency. At 25 days
past due, the borrower is contacted by telephone and the Company makes a verbal
request for payment. At 30 days past due, the Company begins tracking the loan
as a delinquency, and at 45 days past due a notice of intent to foreclose is
mailed. When contact is made with the borrower prior to foreclosure, the Company
generally attempts to obtain full payment or develop a repayment schedule with
the borrower to avoid foreclosure.
Non-performing Assets. Non-performing loans include non-accrual loans,
loans 90 or more days past due and still accruing interest, and restructured
loans. Non-performing assets include all non-performing loans, real estate
acquired via foreclosure, and repossessed consumer assets.
15
Real estate acquired via foreclosure is recorded at the lower of the
recorded investment in the loan or the fair value of the related asset on the
date of foreclosure, less costs to sell. Fair value is defined as the amount in
cash or cash-equivalent value of other consideration that a real estate asset
would yield in a current sale between a willing buyer and a willing seller.
Development and improvement costs relating to the property are capitalized to
the extent they are deemed to be recoverable upon disposal. The carrying value
of acquired property is regularly evaluated and, if appropriate, an allowance is
established to reduce the carrying value to fair value less costs to sell. The
Company typically obtains appraisals on real estate acquired through foreclosure
at the time of foreclosure. The Company generally conducts inspections on
foreclosed properties and properties deemed in-substance foreclosures on a
quarterly basis.
The following table presents information regarding non-performing
assets at the dates indicated.
At December 31,
-----------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars In Thousands)
Outstanding Balances Before Valuation Reserves
Non-accrual loans $ 6,888 $ 1,478 $ 1,598 $ 1,394 $ 3,200
Loans 90 or more days delinquent and accruing interest -- -- -- --- --
Restructured loans in compliance with modified terms 1,294 1,437 448 354 --
------- ------- ------- ------- -------
Total gross non-performing loans 8,182 2,915 2,046 1,748 3,200
Investment in foreclosed real estate before valuation
reserves 96 322 326 -- --
Repossessed consumer assets -- -- -- -- --
------- ------- ------- ------- -------
Total gross non-performing assets $ 8,278 $ 3,237 $ 2,372 $ 1,748 $ 3,200
======= ======= ======= ======= =======
Gross non-performing loans to total loans 2.25% 0.96% 0.77% 0.74% 1.39%
Gross non-performing assets to total assets 1.79% 0.71% 0.58% 0.41% 0.97%
Allowance for loan losses $ 3,502 $ 2,780 $ 1,669 $ 1,311 $ 1,362
Valuation allowances for foreclosed real estate $ -- $ 41 $ 5 $ -- $ --
The increase in non-accrual loans at December 31, 1999 was concentrated
in a single $5.0 million business term loan. This loan was current in its
interest payments at December 31, 1999. The loan was maintained on non-accrual
status, however, due to concern regarding the borrower's potential sources of
funds to repay the loan at maturity. The loan is primarily secured by the common
stock of an insured depository institution, a relatively illiquid form of
collateral for the Company. At December 31, 1999, the Company had established a
$200,000 specific reserve for this loan.
The following table presents information concerning loans 60 to 89 days
delinquent at the dates indicated.
Loans On Accrual Status And Delinquent 60 - 89 Days At December 31,
--------------------------------------------------------------------------------
1999 1998 1997
------------------------ ------------------------ ------------------------
Number Number Number
(Dollars In Thousands) Of Principal Of Principal Of Principal
Loans Balance Loans Balance Loans Balance
----- ------- ----- ------- ----- -------
Residential one to four unit 2 $ 285 -- $ --- 2 $ 413
Land -- -- 1 144 -- --
Other consumer loans -- -- 1 --
------ ------ ------ ------ ------ ------
3 --
- --
Total 2 $ 285 2 $ 147 2 $ 413
====== ====== ====== ====== ====== ======
Delinquent loans to gross loans
net of undisbursed loan funds 0.08% 0.05% 0.16%
16
The following table presents information regarding non-accrual loans at
the dates indicated.
Loans On Non-accrual Status At December 31,
--------------------------------------------------------------------------------
1999 1998 1997
------------------------ ------------------------ ------------------------
Number Number Number
(Dollars In Thousands) Of Principal Of Principal Of Principal
Loans Balance Loans Balance Loans Balance
----- ------- ----- ------- ----- -------
Residential one to four unit 4 $ 543 9 $ 1,478 5 $ 781
Multifamily five or more units -- -- -- -- 1 817
Commercial and industrial real estate 2 1,146 -- -- -- --
Business term loans 1 5,000 -- -- -- --
Business lines of credit 2 199 -- -- -- --
------ ------ ------ ------ ------ ------
Total 9 $ 6,888 9 $ 1,478 6 $ 1,598
====== ====== ====== ====== ====== ======
Non-accrual loans to gross loans
net of undisbursed loan funds 1.89% 0.49% 0.60%
Interest income foregone on non-accrual loans outstanding at year-end
totaled $109,000, $76,000, and $62,000 for the years ended December 31, 1999,
1998, and 1997, respectively. During early 2000, the two largest non-accrual
loans at December 31, 1999, other than the aforementioned $5.0 million business
term loan, were fully reinstated.
The following table presents information concerning restructured loans
(where the Company grants terms not normally provided because of borrower credit
issues) that were on accrual status at the dates indicated.
Troubled Debt Restructured Loans On Accrual Status At December 31,
--------------------------------------------------------------------------------
1999 1998 1997
------------------------ ------------------------ ------------------------
Number Number Number
(Dollars In Thousands) Of Principal Of Principal Of Principal
Loans Balance Loans Balance Loans Balance
----- ------- ----- ------- ----- -------
Residential one to four unit 8 $ 1,294 7 $ 1,172 4 $ 448
Multifamily five or more units -- -- 1 265 -- --
------ ------ ------ ------ ------ ------
Total 8 $ 1,294 8 $ 1,437 4 $ 448
====== ====== ====== ====== ====== ======
A majority of the Company's restructured loans on accrual status at
December 31, 1999 were restructured in conjunction with the bankruptcy of the
borrower. The following table presents additional information concerning loans
classified as troubled debt restructurings:
At December 31,
--------------------------------------
1999 1998 1997
---- ---- ----
(Dollars In Thousands, Numbers In Whole Units)
Troubled debt restructurings performing per terms:
Number of loans 8 8 4
Principal balance outstanding $ 1,294 $ 1,437 $ 448
Weighted average interest rate 7.60% 7.64% 8.90%
Troubled debt restructurings not performing per terms:
Number of loans 1 -- --
Principal balance outstanding $ 119 $ -- $ --
Weighted average interest rate 7.00% -- --
Total troubled debt restructurings:
Number of loans 9 8 4
Principal balance outstanding $ 1,413 $ 1,437 $ 448
Weighted average interest rate 7.55% 7.64% 8.90%
17
Criticized And Classified Assets. To measure the quality of assets, the
Company has established internal asset classification guidelines as part of its
credit monitoring system for identifying and reporting current and potential
problem assets. Under these guidelines, both asset specific and general
portfolio valuation allowances are established.
The Company currently classifies problem and potential problem assets
into one of four categories, presented below in order of increasing severity.
Category Definition
- -------------------- -----------------------------------------------------
Criticized Assets
- -----------------
Special Mention Special Mention loans (sometimes referred to as
"watch list" loans) possess weaknesses, but do not
currently expose the Company to sufficient risk to
warrant categorization as a classified asset or
assignment of a specific valuation allowance.
Weaknesses that might categorize a loan as Special
Mention include, but are not limited to, past
delinquencies or a general decline in business, real
estate, or economic conditions applicable to the
loan.
Classified Assets
- -----------------
Substandard Substandard loans have one or more defined weakness
and are characterized by the distinct possibility
that the Company will sustain some loss if the
deficiencies are not corrected.
Doubtful Doubtful loans have the weaknesses of substandard
loans, with the additional characteristic that the
weaknesses make collection or liquidation in full on
the basis of currently existing facts, conditions,
and values questionable; and there is a high
possibility of loss of some portion of the principal
balance.
Loss Loss loans are considered uncollectible and their
continuance as an asset is not warranted.
Assets classified as substandard or doubtful require the establishment
of general valuation allowances in amounts considered by management to be
adequate under generally accepted accounting principles. These amounts represent
loss allowances which have been established to recognize the inherent risk
associated with lending activities, but which, unlike specific allowances, have
not been allocated to particular problem assets. Judgments regarding the
adequacy of general valuation allowances are based on continual evaluation of
the nature, volume and quality of the loan portfolio, other assets, and current
economic conditions that may affect the recoverability of recorded amounts.
Assets classified as a loss require either a specific valuation allowance equal
to 100% of the amount classified or a charge-off of such amount.
18
The following table presents the Company's criticized and classified
assets at the dates indicated:
At December 31,
--------------------------------
Outstanding Balances Before Specific Valuation Allowances 1999 1998 1997
---- ---- ----
(Dollars In Thousands)
Criticized Assets
- -----------------
Special mention $7,940 $6,427 $2,290
====== ====== ======
Classified Assets
- -----------------
Substandard loans $8,678 $5,124 $2,505
Real estate acquired via foreclosure 96 322 326
------ ------ ------
Total classified assets $8,774 $5,446 $2,831
====== ====== ======
Classified assets to total loans plus other real estate owned 2.41% 1.79% 1.06%
Classified assets to total assets 1.90% 1.20% 0.70%
Classified assets to shareholders' equity 21.50% 13.25% 6.05%
Allowance for loan losses to total classified assets 39.91% 51.05% 58.95%
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS, which can require the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies, has
adopted an interagency policy statement on allowances for loan and lease losses
which provides guidance in determining the adequacy of general valuation
guidelines. The policy statement recommends that savings institutions establish
effective systems and controls to identify, monitor, and address asset quality
problems, analyze significant factors that affect the collectibility of assets,
and establish prudent allowance evaluation processes. Management believes that
the Company's allowance for loan losses is adequate given the composition and
risks of the loan portfolio. However, actual losses are dependent upon future
events and, as such, further additions to the level of specific and general loan
loss allowances may become necessary. In addition, there can be no assurance
that at some time in the future the OTS, in reviewing the Company's loan
portfolio, will not request the Company to increase its allowance for loan
losses, thus negatively impacting the Company's results of operations for that
time period.
Impaired Loans. The Company defines a loan as impaired when it meets
one or more of the following criteria:
o It is probable that the Company will be unable to collect all contractual
principal and interest in accordance with the terms of the loan agreement.
o The loan is ninety or more days past due.
o The loan is placed on non-accrual status although less than ninety days
past due.
o A specific valuation reserve has been allocated against the loan.
o The loan meets the criteria for a troubled debt restructuring.
19
The policy of the Company is to review each loan in the portfolio to
identify problem credits. The nature of this review varies by the type of loan
and its underlying collateral. For example, most residential mortgages are
evaluated for impairment following a delinquency, while the Company conducts
credit analysis on each income property loan exceeding certain thresholds at
least annually regardless of payment performance. In reviewing each loan, the
Company evaluates both the amount the Company believes is probable that it will
collect and the timing of such collection. As part of the loan review process,
the Company considers such factors as the ability of the borrower to continue
meeting the debt service requirements, assessments of other sources of
repayment, and the fair value of any collateral. Insignificant delays or
shortfalls in payment amounts, in the absence of other facts and circumstances,
would not alone lead to the conclusion that a loan is impaired.
Each loan identified as impaired is evaluated for the need for a
specific loss reserve. The adequacy of these specific loss reserves is reviewed
regularly, and no less frequently than quarterly. A loan's specific loss reserve
is calculated by comparing the Company's net investment in the loan to one or
more of the following, as applicable to the nature of the loan:
o the present value of the loan's expected future cash flows discounted at
the loan's effective interest rate at the date of initial impairment
o the loan's observable market price
o the fair value of the collateral securing the loan
The Company charges off a portion of an impaired loan against the specific
valuation allowance when it is probable that a part of the loan will not be
recoverable.
At December 31, 1999, the Company had impaired loans totaling $8.2
million, which have related specific reserves of $200,000. At December 31, 1998,
the Company maintained impaired loans of $3.8 million, with related specific
reserves of $67,000. A majority of the year to year increase in impaired loans
was associated with the aforementioned $5.0 million non-accrual business term
loan. Of the $8.2 million in impaired loans at December 31, 1999, $1.3 million
were on accrual status due to continued payment performance by the borrowers.
Additional information concerning impaired loans is presented below and in Note
5 to the Consolidated Financial Statements.
1999 1998 1997
------ ------ ------
(Dollars In Thousands)
Average investment in impaired loans for the year $2,511 $3,100 $1,300
Interest recognized on impaired loans at December 31 $ 590 $ 166 $ 49
Interest not recognized on impaired loans at December 31 $ 109 $ 76 $ 62
20
Special Residential Loan Pool. During 1998, the Bank purchased a $40.0
million residential mortgage pool comprised of loans that presented a borrower
credit profile and / or a loan to value ratio outside of (less favorable than)
the Bank's normal underwriting criteria. To mitigate its credit risk for this
portfolio, the Bank obtained a scheduled principal / scheduled interest loan
servicing agreement from the seller. Further, this agreement also contained a
warranty by the seller to absorb any principal losses on the portfolio in
exchange for the seller's retention of a portion of the loans' yield through
loan servicing fees. In obtaining these favorable loan servicing terms, the Bank
functionally aggregated the credit risk for this loan pool into a single
borrower credit risk to the seller / servicer of the loans. The Bank was
subsequently informed by the OTS that structuring the purchase in this manner
made the transaction an "extension of credit" by the Bank to the seller /
servicer, which, by virtue of its size, violated the OTS' "Loans To One
Borrower" regulation. See "Regulation And Supervision - Loans To One Borrower
Limitation."
Following conversations with the OTS, the Bank independently conducted
a new underwriting of each of the pool's residential mortgage loans. Based upon
this new underwriting, appreciation in underlying property values, and continued
payment performance by a vast majority of the borrowers, the majority of the
residential loan pool was, from a regulatory standpoint, reclassified as no
longer dependent upon the warranty of the seller / servicer for repayment and
therefore did not comprise a loan to one borrower.
At December 31, 1999, the outstanding principal balance of this
mortgage loan pool was $33.8 million, net of $1.2 million in December payoffs
receivable from the seller / servicer, of which $7.1 million was still
classified as dependent on the warranty of the seller / servicer for repayment.
This $7.1 million in loans still exceeded the Bank's loans to one borrower limit
of $5.3 million at December 31, 1999. Because the residential loans contain a
substantial upward rate reset feature in the year 2000, the Bank anticipates
that the pool will continue experiencing prepayments and thereby eventually fall
below the Bank's loan to one borrower limitation. The Bank continues to report
to the OTS in this regard on a monthly basis.
Through December 31, 1999, the seller / servicer performed per the loan
servicing agreement, making scheduled principal and interest payments to the
Bank while also absorbing all credit losses on the loan portfolio. Management
believes that the seller / servicer has both the capacity and intent to continue
performing per the terms of the loan servicing agreement and therefore does not
anticipate realizing credit losses on this residential mortgage pool.
During the first quarter of 2000, the Bank was informed by the OTS
that:
1. all loans associated with this loan pool would be required to be assigned
to the 100% risk based capital category in calculating regulatory capital
ratios that incorporate risk weighted assets
2. the Bank's regulatory capital position at December 31, 1999 was mandated to
reflect the above requirement
3. until further notice, the Bank's regulatory capital ratios were required to
maintained at levels no lower than the levels at December 31, 1999
Because remaining a "well capitalized" financial institution is
integral to the Bank's business strategy and due to the planned generation of
additional regulatory capital in 2000 through a combination of net income,
amortization of deferred stock compensation, and amortization of intangible
assets, management does not foresee that the aforementioned requirements will
have a material adverse impact upon the Company in 2000. However, depending upon
the tenure of and any potential modification of the additional requirements, as
determined by the OTS, such requirements could present an unfavorable impact
upon MBBC's liquidity and ability to pay dividends. See "Item 7. Management's
Discussion And Analysis Of Financial Condition And Results Of Operations -
Liquidity".
Allowance For Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in the Company's loan portfolio and the economic and real estate
market conditions in the Company's market areas. The allowance for loan losses
is increased by provisions charged against earnings and reduced by net loan
charge-offs. Loans are charged-off when they are deemed to be uncollectible;
recoveries are generally recorded only when cash payments are received.
21
The allowance for loan losses is maintained at an amount management
considers adequate to cover estimated losses in loans receivable which are
deemed probable and estimable. The allowance is based upon a number of factors,
including asset classifications, economic trends and conditions, industry
experience and trends, industry and geographic concentrations, estimated
collateral values, management's assessment of the credit risk inherent in the
portfolio, historical loan loss experience, changes in non-performing and past
due loans, and the Company's underwriting policies. Various regulatory agencies,
as an integral part of their examination process, periodically review the
Company's allowance for loan losses. These agencies may require the Company to
make additional provisions for loan losses, based on their judgments of the
information available at the time of the examination. Although management
believes that the allowance for loan losses is adequate to provide for both
potential losses and estimated inherent losses in the loan portfolio, future
provisions charged against operations will be subject to continuing evaluations
of the inherent risk in the loan portfolio. In addition, if the national or
local economy declines or asset quality deteriorates, additional provisions
could be required.
The following table presents information concerning the Company's
allowance for loan losses at the dates and for the years indicated.
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(Dollars In Thousands)
Period end loans outstanding(1) $ 364,188 $ 303,732 $ 265,934 $ 234,649 $ 229,841
Average loans outstanding 365,363 313,018 268,479 235,052 228,836
Period end non-performing loans outstanding 8,182 2,915 2,046 1,748 3,200
Allowance for loan losses
Balance, at beginning of year $ 2,780 $ 1,669 $ 1,311 $ 1,362 $ 808
Charge-offs:
Residential one to four unit real estate loans (113) -- (20) (106) (109)
Other consumer loans -- -- (1) (24) --
--------- --------- --------- --------- ---------
Total charge-offs (113) -- (21) (130) (109)
--------- --------- --------- --------- ---------
Recoveries:
Residential one to four unit real estate loans -- 3 4 50 --
Other consumer loans -- -- -- 1 --
--------- --------- --------- --------- ---------
Total recoveries -- 3 4 51 --
--------- --------- --------- --------- ---------
Net (charge-offs) recoveries (113) 3 (17) (79) (109)
--------- --------- --------- --------- ---------
Provision charged to operations 835 692 375 28 663
Allowance acquired in conjunction with loan purchase -- 416 -- -- --
--------- --------- --------- --------- ---------
Balance, at end of year $ 3,502 $ 2,780 $ 1,669 $ 1,311 $ 1,362
========= ========= ========= ========= =========
Net charge-offs (recoveries) to average loans outstanding 0.03% -- 0.01% 0.03% 0.05%
Allowance as a percent of year end loans outstanding 0.96% 0.92% 0.63% 0.56% 0.59%
Allowance as a percent of non-performing loans 42.80% 95.37% 81.57% 75.00% 42.56%
- ------------------------------------------------
(1) net of undisbursed loan funds
22
The following table provides a summary of the allocation of the
allowance for loan losses for specific loan categories at the dates indicated.
The allocation presented should not be interpreted as an indication that charges
to the allowance for loan losses will be incurred in these amounts or
proportions, or that the portion of the allowance allocated to each loan
category represents the total amounts available for future losses that may occur
within these categories. The unallocated portion of the allowance and the total
allowance is applicable to the entire loan portfolio.
At December 31,
------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------------ ----------------- ------------------ ----------------- ------------------
% Of % Of % Of % Of % Of
Loans In Loans In Loans In Loans In Loans In
Category Category Category Category Category
To Gross To Gross To Gross To Gross To Gross
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars In Thousands)
Residential $ 663 43.4% $ 925 56.1% $ 744 70.3% $ 883 83.9% $ 779 84.6%
Multifamily 185 10.9% 277 10.2% 260 8.1% 171 9.5% 107 9.3%
Commercial real estate 918 18.6% 514 12.2% 226 7.0% 173 3.2% 42 1.8%
Construction 960 20.3% 533 15.7% 209 12.2% 19 1.7% 57 2.3%
Land 137 3.6% 101 2.4% 54 0.7% 1 -- 1 --
Home equity lines of
credit 32 1.0% 34 1.0% 38 1.1% 40 1.4% 25 1.7%
Other consumer loans 15 0.2% 11 0.2% 19 0.2% 23 0.3% 3 0.3%
Business term loans 243 1.7% 190 2.0% 19 0.3% -- -- -- --
Business lines of credit 83 0.3% 26 0.2% 19 0.1% -- -- -- --
----- ---- ----- ---- ----- ---- ----- ---- ----- ----
Total allocated 3,236 100.0% 2,611 100.0% 1,588 100.0% 1,310 100.0% 1,014 100.0%
===== ===== ===== ===== =====
Unallocated 266 169 81 1 348
------ ------ ------ ------ ------
Total $3,502 $2,780 $1,669 $1,311 $1,362
====== ====== ====== ====== ======
Other information
- -----------------
Gross loans outstanding $388,198 $327,876 $287,562 $236,547 $231,692
Over the past several years, the Company has increased its allowance
for loan losses in conjunction with three key trends within the loan portfolio:
o The growth in the nominal size of the loan portfolio has led management to
increase the amount of the allowance.
o The greater diversification in the mix of the loan portfolio away from
residential one to four unit permanent mortgages toward other types of
lending, particularly commercial and industrial real estate loans and
construction lending, has led to higher nominal and relative allowance
levels, as these newer types of lending typically present more risk than
residential mortgages. This increased risk stems both from the nature of
the lending and the greater individual credit amounts associated with
commercial real estate and construction loans.
o The increasing concentration of the portfolio in relatively less seasoned
credits, because of the Company's growth rate in recent years, has also led
management to increase the level of the allowance, as less seasoned loans
typically present greater risk than loans which have been performing for
many years.
The Company recorded provisions in 1999 to bring the allowance for loan
losses to a level deemed appropriate by management based upon the Company's loan
loss allowance methodology. To the extent that the Company is successful in its
strategic plan and therefore continues to expand and diversify its loan
portfolio, management anticipates increasing, in future periods, the allowance
for loan losses in a manner consistent with the Company's loan loss allowance
methodology.
23
Investment Activities
Cash Equivalents. The Company does not include certain short term,
highly liquid investments as investment securities, instead classifying these as
cash equivalents. These include:
o federal funds sold
o securities purchased under agreements to resell
o commercial paper
o money market mutual fund investments
o banker's acceptances
o certificates of deposit in federally insured financial institutions
Liquidity Maintenance. Federally chartered savings institutions have
the authority to invest in various types of liquid assets, as defined in
applicable regulations, including United States Treasury obligations, securities
of or guaranteed by various federal agencies, certificates of deposit of insured
banks and savings institutions, bankers' acceptances, repurchase agreements, and
federal funds. Additionally, the Bank must maintain minimum levels of
investments that qualify as liquid assets under OTS regulations. See "Regulation
And Supervision - Liquidity." Historically, the Bank has maintained liquid
assets above the minimum OTS requirements and at a level considered to be
adequate to meet foreseeable operational needs.
Investment Policies. In addition to the above liquid assets, subject to
various restrictions, federally chartered savings institutions may also invest
in various other types of securities, including investment-grade corporate debt
securities, asset-backed securities and collateralized mortgage obligations not
guaranteed by a federal agency, and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. The Company maintains separate internal investment
policies for the Bank and MBBC. These policies are established by the board of
directors with the key objectives of:
o providing and maintaining liquidity
o generating a favorable total return on a risk-adjusted basis
o managing the overall interest rate risk profile of the entities
o maintaining compliance with various associated regulations
o controlling credit risk exposure
Specifically, the Company's policies generally limit investments to publicly
traded securities that are investment grade. These policies prohibit the
Company's maintenance of a trading portfolio as defined under SFAS No. 115.
Accounting And Reporting. Investment securities classified as available
for sale are recorded at fair value, while investment securities classified as
held to maturity are recorded at cost. Unrealized gains or losses on available
for sale securities, net of the deferred tax effect, are reported as increases
or decreases in stockholders' equity.
24
The amortized cost and estimated fair value of securities at each of
the past two year ends is as follows:
December 31, 1999
-------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- -------- -------- --------
(Dollars In Thousands)
Available for sale
Corporate trust preferreds $ 11,456 $ 50 $ (43) $ 11,463
FHLMC certificates 1,930 -- (36) 1,894
FNMA certificates 25,132 95 (379) 24,848
GNMA certificates 4,531 -- (96) 4,435
Collateralized mortgage obligations 28,117 -- (1,578) 26,539
-------- -------- -------- --------
$ 71,166 $ 145 $ (2,132) $ 69,179
======== ======== ======== ========
Held to maturity
FNMA certificates $ 60 $ -- $ -- $ 60
======== ======== ======== ========
December 31, 1998
-------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- -------- -------- --------
(Dollars In Thousands)
Available for sale
Corporate trust preferreds $ 18,658 $ 496 $ -- $ 19,154
FNMA debenture 252 4 -- 256
FHLMC certificates 4,735 28 -- 4,763
FNMA certificates 32,870 891 (10) 33,751
GNMA certificates 11,927 39 (20) 11,946
Collateralized mortgage obligations 47,626 103 (183) 47,546
--------- --------- --------- ---------
$ 116,068 $ 1,561 $ (213) $ 117,416
========= ========= ========= =========
Held to maturity
FNMA certificates $ 97 $ -- $ (1) $ 96
========= ========= ========= =========
At December 31, 1999, the Company's investment in corporate trust
preferred securities was entirely composed of variable rate securities which
reprice quarterly based upon a margin over the three month LIBOR rate. These
corporate trust preferred securities were also all rated "A-" or better by
Standard & Poors ratings agency.
25
The following table presents certain information regarding the
amortized cost, fair value, weighted average yields, and contractual maturities
of the Company's securities as of December 31, 1999.
At December 31, 1999
------------------------------------------------------------------
2001 2005 2010
Through Through And
2000 2004 2009 Thereafter Total
------ ------ ------- ------- -------
(Dollars In Thousands)
Available for sale securities
Corporate trust preferreds $ -- $ -- $ -- $ 11,456 $ 11,456
Agency mortgage backed securities (1) -- -- 4,693 26,900 31,593
Collateralized mortgage obligations (1) -- -- -- 28,117 28,117
------ ------ ------- ------- -------
Total securities available for sale $ -- $ -- $ 4,693 $66,473 $71,166
====== ====== ======= ======= =======
Fair value $ -- $ -- $ 4,606 $64,573 $69,179
====== ====== ======= ======= =======
Held to maturity securities
Agency mortgage-backed securities (1) $ 60 $ -- $ -- $ -- $ 60
====== ====== ======= ======= =======
Fair Value $ 60 $ -- $ -- $ -- $ 60
====== ====== ======= ======= =======
Combined securities portfolio
Total securities $ 60 $ -- $ 4,693 $66,473 $71,226
====== ====== ======= ======= =======
Total market value $ 60 $ -- $ 4,606 $64,573 $69,239
====== ====== ======= ======= =======
Weighted average yield 3.98% -- 6.72% 7.07% 7.04%
- -----------------------------------------------
(1) Mortgage backed securities and collateralized mortgage obligations are
shown at contractual maturity; however, the average life of these
securities and actual maturity of these securities may differ significantly
from the contractual maturity dates due to prepayments and, in the case of
collateralized mortgage obligations, the priority of principal allocation
among the tranches within the securities.
The Company maintained no tax-preferenced securities at December 31, 1999.
For additional information regarding the Company's securities, please refer to
Notes 3 and 4 to the Consolidated Financial Statements.
26
Sources Of Funds
General. The Company's primary sources of funds are customer deposits,
principal, interest, and dividend payments on loans and securities, FHLB
advances and other borrowings, and, to a lesser extent, proceeds from sales of
securities and loans. While maturities and scheduled amortization of loans and
securities are predictable sources of funds, deposit flows and loan and security
prepayments are greatly influenced by general interest rates, economic
conditions, and competition.
Deposits. The Company offers a variety of deposit accounts with a range
of interest rates and terms. The Company's deposits consist of demand deposit
and NOW checking accounts, savings accounts, money market accounts, and
certificates of deposit. The flow of deposits is influenced significantly by
general economic conditions, changes in money market rates, prevailing interest
rates, and competition. The Company's deposits are obtained predominantly from
the areas in which its branch offices are located. The Company relies primarily
on customer service and long standing relationships with customers to attract
and retain these deposits; however, market interest rates and rates offered by
competing financial institutions and mutual funds significantly affect the
Company's ability to attract and retain deposits. While the Bank is currently
eligible to accept brokered deposits, it has not done so. Management continually
monitors the Company's certificate accounts and historically the Company has
retained a large portion of such accounts upon maturity.
In recent years, the Company has introduced a series of money market
accounts specifically designed for certain target markets. For example, the
Company most recently introduced a highly tiered money market account
specifically designed to attract higher average balance depositors who might
otherwise pursue money market mutual funds. As a result, money market deposits
have represented an increasing percentage of total deposits in recent years,
rising from 16.3% of total deposits at December 31, 1998 to 22.1% of total
deposits at December 31, 1999.
The Company's other area of focus in deposit acquisition in recent
years has been checking accounts, coincident with the Company's business
strategy of becoming more of a community based financial services organization,
meeting the primary financial needs of both consumers and small businesses. The
Company has enjoyed particular success with its "40 +" checking product, a NOW
account that provides free checking to customers 40 years of age or older
meeting certain other minimum requirements. The Company also realized success in
attracting business checking accounts during 1999, spurred by both the Company's
sales and marketing efforts and by the continued acquisition and integration of
competitors in the Company's primary market areas. Checking accounts expanded
from 10.1% of total deposits at December 31, 1998 to 13.3% a year later.
During 1999, the Company managed its portfolio of certificates of
deposit with the objectives of minimizing interest expense while maintaining
overall (across all products) deposit balances. As a result, certificates of
deposit declined from $257.1 million at December 31, 1998 with a weighted
average cost of 5.41% to $222.1 million at December 31, 1999 with a weighted
average cost of 4.82%. This performance contributed to a 52 basis point decline
in the Company's weighted average cost of overall deposits between the same two
points in time. This 52 basis point decline compares very favorably to an
increase of almost 20 basis points in the 11th District Cost of Funds index
("COFI") over the same time period.
The following table presents the deposit activity of the Company for
the periods indicated.
For The Year Ended December 31,
-----------------------------------------
1999 1998 1997
----------- ----------- -----------
(Dollars In Thousands)
Deposits $ 1,205,268 $ 988,794 $ 695,432
Purchased deposits -- 29,651 --
Withdrawals (1,223,666) (984,948) (708,545)
----------- ----------- -----------
Net deposits (18,398) 33,497 (13,113)
Interest credited on deposits 15,123 16,621 15,527
----------- ----------- -----------
Total (decrease) increase in deposits $ (3,275) $ 50,118 $ 2,414
=========== =========== ===========
27
The following table summarizes the Company's deposits at the dates
indicated.
December 31, 1999 December 31, 1998
------------------------------- -------------------------------
Weighted Weighted
Average Average
(Dollars In Thousands) Balance Rate Balance Rate
------- ---- ------- ----
Demand deposit accounts $ 17,316 -- $ 18,498 --
NOW accounts 31,385 1.53% 18,964 1.50%
Savings accounts 15,312 1.80% 15,561 1.83%
Money market accounts 81,245 4.13% 60,528 4.03%
Certificates of deposit < $100,000 169,646 4.78% 194,669 5.47%
Certificates of deposit $100,000 or more 52,498 4.97% 62,457 5.23%
-------- --------
$367,402 $370,677
======== ========
Weighted average nominal interest rate 4.04% 4.56%
The weighted average interest rates are at the end of the period and are based
upon stated interest rates without giving consideration to daily compounding of
interest or forfeiture of interest because of premature withdrawal.
The following table presents the amount and weighted average rate of
time deposits equal to or greater than $100,000 at December 31, 1999.
At December 31, 1999
--------------------------
Weighted
(Dollars In Thousands) Average
Amount Rate
-------- -----
Maturity Period
- ---------------
Three months or less $ 13,558 4.85%
Over three through 6 months 16,565 5.22%
Over 6 through 12 months 11,168 4.71%
Over 12 months 11,207 4.98%
-------- -----
Total $ 52,498 4.97%
========
The following table presents the distribution of the Company's deposit
accounts for the periods indicated and the weighted average interest rates on
each category of deposits presented.
For The Year Ended December 31,
-------------------------------------------------------------------------------------------
1999 1998 1997
----------------------------- ----------------------------- -----------------------------
% Of % Of % Of
Average Weighted Average Weighted Average Weighted
Average Total Average Average Total Average Average Total Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
------- ----- ----- ------- ----- ----- ------- ----- -----
(Dollars In Thousands)
Demand deposits $ 17,610 4.8% -- $ 15,401 4.4% -- $ 9,346 2.9% --
NOW accounts 25,205 6.8% 1.54% 14,534 4.1% 1.56% 8,579 2.7% 1.01%
Savings accounts 15,583 4.2% 1.80% 15,204 4.3% 1.83% 13,396 4.2% 1.90%
Money market accounts 82,006 22.2% 4.15% 42,603 12.0% 4.03% 34,612 10.9% 3.88%
Certificates of deposit 229,493 62.0% 4.82% 266,225 75.2% 5.41% 251,855 79.3% 5.50%
-------- ------ ----- -------- ------ ----- -------- ------ -----
Total $369,897 100.0% 4.09% $353,967 100.0% 4.70% $317,788 100.0% 4.89%
======== ====== ======== ====== ======== ======
Please refer to Note 10 to the Consolidated Financial Statements for additional information concerning deposits.
28
Borrowings
From time to time, the Company obtains borrowed funds through FHLB
advances and securities sold under agreements to repurchase as alternatives to
retail deposit funds, and may do so in the future as part of its operating
strategy. Borrowings are also utilized to acquire certain other assets as deemed
appropriate by management for investment purposes and to better utilize the
capital resources of the Bank and Company.
FHLB advances are collateralized by the Bank's pledged mortgage loans,
pledged mortgage backed securities, and investment in the capital stock of the
FHLB. See "Regulation And Supervision - Federal Home Loan Bank System." FHLB
advances are made pursuant to several different credit programs with varying
interest rate and maturity terms. The maximum amount that the FHLB will advance
to member institutions, including the Bank, fluctuates from time to time in
accordance with the policies of the OTS and the FHLB. During 1999, the Bank
periodically used FHLB advances to provide needed liquidity and to supplement
retail deposit gathering activity.
The Company's securities sold under agreements to repurchase at
December 31, 1999 were collateralized by mortgage backed securities. Over the
past several years, MBBC has in particular utilized securities sold under
agreements to repurchase, as the holding company is not eligible for obtaining
FHLB advances.
The following table sets forth information regarding the Company's
borrowed funds at or for the indicated years.
At Or For The Year Ended December 31,
--------------------------------------
1999 1998 1997
---- ---- ----
(Dollars In Thousands)
FHLB Advances
- -------------
Average balance outstanding $ 37,600 $ 28,059 $ 40,520
Weighted average rate on average balance outstanding 5.53% 5.93% 5.92%
Year end balance outstanding $ 49,582 $ 35,182 $ 32,282
Weighted average rate on year end balance outstanding 5.65% 5.54% 6.09%
Maximum amount outstanding at any month end during the year $ 49,582 $ 73,787 $ 46,432
Securities Sold Under Agreements To Repurchase
- ----------------------------------------------
Average balance outstanding $ 3,182 $ 5,007 $ 8,234
Weighted average rate on average balance outstanding 5.65% 5.92% 5.91%
Year end balance outstanding $ 2,410 $ 4 490 $ 5,200
Weighted average rate on year end balance outstanding 6.08% 5.69% 5.95%
Maximum amount outstanding at any month end during the year $ 4,350 $ 5,200 $ 13,000
Please refer to Notes 11 and 12 to the Consolidated Financial
Statements for additional information regarding borrowings.
Subsidiary Activities
Portola, a California corporation wholly owned by the Bank, is engaged,
on an agency basis, in the sale of insurance, mutual funds, and annuity
products, primarily to the Bank's customers and members of the local communities
which the Bank serves. Portola also functions as trustee for the Bank's deeds of
trust. At December 31, 1999, Portola had $198,000 in total assets. Portola
recorded a net loss of $11,000 for the year ended December 31, 1999.
29
Personnel
As of December 31, 1999, the Company had 118 full-time employees and 5
part-time employees. The employees are not represented by a collective
bargaining unit and the Company considers its relationship with its employees to
be good.
REGULATION AND SUPERVISION
General
Financial institution holding companies and insured depository
institutions are extensively regulated under both federal and state law. Set
forth below is a summary description of certain laws and regulations which
relate to the operation of the Company. The following description does not
purport to be complete and is qualified in its entirety by reference to the
applicable laws and regulations.
MBBC, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of,
the OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition,
the activities of the Bank are governed by the HOLA and the Federal Deposit
Insurance Act ("FDIA").
The Bank is subject to extensive regulation, examination, and
supervision by the OTS, as its primary federal regulator, and the FDIC, as the
insurer of customer deposits. The Bank must file reports with the OTS and the
FDIC concerning its activities and financial condition. In addition, the Bank
must obtain various regulatory approvals prior to conducting certain types of
business or entering into selected transactions; e.g. mergers with, or
acquisitions of, other financial institutions. The OTS and / or the FDIC conduct
periodic examinations to test the Bank's safety and soundness, its operations
(including technology utilization), and its compliance with applicable laws and
regulations, including, but not limited to:
o the Community Reinvestment Act ("CRA")
o the Real Estate Settlement Procedures Act ("RESPA")
o the Bank Secrecy Act ("BSA")
o the Fair Credit Reporting Act ("FCRA")
o the Home Mortgage Disclosure Act ("HMDA")
The examinations are primarily conducted for the protection of the FDIC
insurance fund, and are not intended to provide any assurance to investors in
the Company's common stock.
The regulatory structure provides the supervisory authorities extensive
discretion across a wide range of the Company's operations, including, but not
limited to:
o loss reserve adequacy
o capital requirements
o credit classification
o limitation or prohibition on dividends
o assessment levels for deposit insurance and examination costs
o permissible branching
Any change in regulatory requirements and policies, whether by the OTS, the
FDIC, the FRB, or Congress, could have a material adverse impact on the Company.
Certain of the regulatory requirements applicable to the Bank and to MBBC are
discussed below or presented elsewhere herein.
30
Holding Company Regulation
MBBC is a nondiversified unitary savings and loan holding company
within the meaning of the HOLA. As such, MBBC will generally not be restricted
under existing laws as to the types of business activities in which it may
engage, provided that the Bank continues to be a qualified thrift lender
("QTL"). See "Qualified Thrift Lender Test." Because MBBC was a non-diversified
savings and loan holding company on May 4, 1999, its ability to engage in such
activities was "grandfathered", or preserved, under the Gramm-Leach-Bliley Act
of 1999. However, the Gramm-Leach-Bliley Act does prohibit a commercial company
from acquiring MBBC. See "Financial Industry Modernization / Gramm-Leach-Bliley
Act". In addition, upon any non-supervisory acquisition by the Company of
another savings institution or savings bank that meets the QTL test and is
deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"),
subject to the prior approval of the OTS, and activities authorized by OTS
regulation.
The HOLA prohibits a savings and loan holding company directly, or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5% of a nonsubsidiary company engaged in activities other
than those permitted by the HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result
in a multiple savings and loan holding company controlling savings institutions
in more than one state, subject to two exceptions: (i) the approval of
interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions, as described below. The Bank must notify the OTS 30 days
before declaring any dividend to MBBC. In addition, the financial impact of a
holding company on its subsidiary insured depository institution is a matter
that is evaluated by the OTS, and the agency has authority to order cessation of
activities or divestiture of subsidiaries deemed to pose a threat to the safety
and soundness of the financial institution.
31
Capital Requirements And Capital Categories
The following discussion regarding regulatory capital requirements is
applicable to the Bank. As a unitary thrift holding company, MBBC is not subject
to any specific regulatory capital requirements.
FIRREA Capital Requirements. OTS capital regulations, as mandated by
the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
("FIRREA"), require savings institutions to meet three minimum capital standards
(as defined by applicable regulations):
o a 1.5% tangible capital ratio
o a 3.0% leverage (core) capital ratio
o an 8.0% risk-based capital ratio
The capital standard applicable to savings institutions must be no less
stringent than those for national banks. In addition, the prompt corrective
action ("PCA") standards discussed below also establish, in effect, the
following minimum standards:
o a 2.0% tangible capital ratio
o a 4.0% leverage (core) capital ratio (3.0% for institutions receiving the
highest regulatory rating under the CAMELS rating system)
o a 4.0% Tier One risk based capital ratio
The OTS also has the authority, after giving the affected institution
notice and an opportunity to respond, to establish specific minimum capital
requirements for a single institution which are higher than the general industry
minimum requirements presented above. The OTS can take this action upon a
determination that a higher minimum capital requirement is appropriate in light
of an institution's particular circumstances.
Tangible capital is composed of:
o common stockholders' equity (including retained earnings)
o certain noncumulative perpetual preferred stock and related earnings
o minority interests in equity accounts of consolidated subsidiaries
less:
o intangible assets other than certain asset servicing rights
o investments in and loans to subsidiaries engaged in activities as principal,
not permissible for a national bank
o deferred tax assets as defined under Statement of Financial Accounting
Standards ("SFAS") Number 109 - "Accounting for Income Taxes" in excess
of certain thresholds
Core capital consists of tangible capital plus various adjustments for
certain intangible assets. At December 31, 1999 and 1998, the Bank's tangible
capital was equivalent to its core capital, as the Bank did not maintain any
qualifying adjustments. In general, total assets calculated for regulatory
capital purposes exclude those assets deducted from capital in determining the
applicable capital ratio.
32
The risk based capital standard for savings institutions requires the
maintenance of Tier One capital (core capital) and total capital (defined as
core capital plus supplementary capital) to risk weighted assets of 4.0% and
8.0%, respectively. In determining the amount of an institution's risk weighted
assets, all assets, including certain off balance sheet positions, are
multiplied by a risk weight of 0.0% to 100.0%, as assigned by OTS regulations
based upon the amount of risk perceived as inherent in each type of asset. The
components of supplementary capital include:
o cumulative preferred stock
o long term perpetual preferred stock
o mandatory convertible securities
o certain subordinated debt
o intermediate preferred stock
o the general allowance for loan and lease losses, subject to a limit of 1.25%
of risk weighted assets
Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100.0% of core capital.
As disclosed in Note 14 to the Consolidated Financial Statements, at
December 31, 1999, the Bank exceeded all minimum regulatory capital
requirements.
FDICIA PCA Regulations. The Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") dictated that the OTS implement a system
requiring regulatory sanctions against institutions that are not adequately
capitalized, with severity of the sanctions increasing as the institution's
capital declines. The OTS has established specific capital ratios under the PCA
Regulations for five separate capital categories:
1. well capitalized
2. adequately capitalized
3. under capitalized
4. significantly under capitalized
5. critically undercapitalized
Under the OTS regulations implementing FDICIA, an insured depository
institution will be classified in the following categories based, in part, on
the following capital measures:
Well Capitalized Under Capitalized
- ---------------- -----------------
Total risk based capital ratio of at least 10.0% Total risk based capital ratio of less than 8.0%
Tier One risk based capital ratio of at least 6.0% Tier One risk based capital ratio of less than 4.0%
Leverage ratio of at least 5.0% Leverage ratio of less than 4.0%
Adequately Capitalized Significantly Under Capitalized
- ---------------------- -------------------------------
Total risk based capital ratio of at least 8.0% Total risk based capital ratio of less than 6.0%
Tier One risk based capital ratio of at least 4.0% Tier One risk based capital ratio of less than 3.0%
Leverage ratio of at least 4.0% Leverage ratio of less than 3.0%
Critically Under Capitalized
----------------------------
Tangible capital of less than 2.0%
33
An institution that, based upon its capital levels, is classified in
one of the top three categories may be regulated as though it were in the next
lower capital category if the appropriate federal banking agency, after notice
and an opportunity for hearing, determines that the operation or status of the
institution warrants such treatment. There are numerous mandatory supervisory
restrictions on the activities of under capitalized institutions. An institution
that is under capitalized must submit a capital restoration plan to the OTS that
the OTS may approve only if it determines that the plan is likely to succeed in
restoring the institution's capital and will not appreciably increase the risks
to which the institution is exposed. In addition, the institution's performance
under the capital restoration plan must be guaranteed by every company that
controls the institution. Under capitalized institutions may not acquire an
interest in any company, open a new branch office, or engage in a new line of
business without OTS or FDIC approval. An under capitalized institution is also
limited in its ability to increase average assets, accept brokered deposits, pay
management fees, set deposit rates, and make capital distributions. Additional
restrictions apply to significantly and critically under capitalized
institutions. In addition, the OTS maintains extensive discretionary sanctions
which may be applied to under capitalized institutions, including the issuance
of a capital directive and replacement of officers and directors.
As disclosed in Note 14 to the Consolidated Financial Statements, at
December 31, 1999, the Bank met the requirements to be classified as a "well
capitalized" institution under PCA regulations.
Special OTS Capital Requirements. On March 6, 2000, the Bank was
informed by the OTS that:
1. All loans associated with the pool of residential mortgages acquired from a
seller / servicer that guaranteed the pool be assigned to the 100% risk
based capital category in calculating capital ratios that incorporate risk
weighted assets. See "Credit Quality - Special Residential Loan Pool" and
Note 14 to the Consolidated Financial Statements.
2. The Bank's regulatory capital position at December 31, 1999 was required to
reflect this requirement.
3. Until further notice, the Bank's regulatory capital ratios were required to
be maintained at levels no lower than the levels at December 31, 1999.
Management does not foresee any significant problem resulting from
these requirements given the Bank's continued generation of regulatory capital
through retained earnings, the amortization of deferred stock compensation, and
the amortization of intangible assets. Furthermore, the Company's maintenance of
a "well capitalized" regulatory capital position is integral to its business
plan. However, depending upon the tenure of and any potential future
modification of these requirements by the OTS, MBBC's ability to pay dividends
could be impacted. See "Item 7. Management's Discussion And Analysis Of
Financial Condition And Results Of Operations - Liquidity."
In specifying the above requirements, the OTS did not request that the
Bank restate any of its historic regulatory capital ratios for prior periods,
before December 31, 1999, during which the Bank owned the specifically
identified pool of purchased residential mortgages.
Safety and Soundness Standards
In addition to the PCA provisions discussed above based on an
institution's regulatory capital ratios, FDICIA contains several measures
intended to promote early identification of management problems at depository
institutions and to ensure that regulators intervene promptly to require
corrective action by institutions with inadequate operational and managerial
controls. The OTS has established minimum standards in this regard related to:
o internal controls, information systems, and internal audit systems
o loan documentation
o credit underwriting
o asset growth
o earnings
o interest rate risk exposure
o compensation, fees, and benefits
34
If the OTS determines that an institution fails to meet any of these
minimum standards, the agency may require the institution to submit to the
agency an acceptable plan to achieve compliance with the standard. In the event
the institution fails to submit an acceptable plan within the time allowed by
the agency or fails in any material respect to implement an accepted plan; the
agency must, by order, require the institution to correct the deficiency and may
implement a series of supervisory sanctions.
Effective October 1, 1996, the federal banking agencies (including the
OTS) promulgated safety and soundness regulations and accompanying interagency
compliance guidelines on asset quality and earnings standards. These guidelines
provide six standards for establishing and maintaining a system to identify
problem assets and prevent those assets from deteriorating. The institution
should:
1. conduct periodic asset quality reviews to identify problem assets
2. estimate the inherent losses in those assets and establish reserves that are
sufficient to absorb estimated losses
3. compare problem asset totals to capital
4. take appropriate corrective action to resolve problem assets
5. consider the size and potential risks of material asset concentrations
6. provide periodic asset reports with adequate information for management and
the board of directors to assess the level of asset risk
These guidelines also set forth standards for evaluating and monitoring
earnings and for ensuring that earnings are sufficient for the maintenance of
adequate capital and reserves. If the institution fails to comply with a safety
and soundness standard, the appropriate federal banking agency may require the
institution to submit a compliance plan. Failure to submit a compliance plan or
to implement an accepted plan may result in enforcement action.
Potential Enforcement Actions
The OTS has primary enforcement responsibility over savings
institutions and maintains the authority to bring actions against the
institution and all institution affiliated parties, as defined under the
applicable regulations, for unsafe or unsound practices in conducting their
businesses or for violations of any law, rule, regulation, condition imposed in
writing by the agency, or any written agreement with the agency. Enforcement
actions may include the imposition of a conservator or receiver, the issuance of
a cease and desist order that can be judicially enforced, the termination of
insurance of deposits (in the case of the Bank), the imposition of civil money
penalties, the issuance of directives to increase capital, the issuance of
formal and informal agreements, the issuance of removal or prohibition orders
against institution affiliated parties, and the imposition of restrictions under
the PCA provisions of FDICIA. Federal law also establishes criminal penalties
for certain violations.
Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to be taken with respect to a particular
savings institution. If action is not taken by the Director of the OTS, the FDIC
has authority to take such action under certain circumstances.
Additionally, a holding company's inability to serve as a source of
strength to its subsidiary financial institutions could serve as an ancillary
basis for regulatory action against the holding company. Neither MBBC, the Bank,
or any subsidiary thereof are currently subject to any enforcement actions,
other than the requirements for the Bank to allocate additional regulatory
capital against one specific pool of purchased residential mortgages and to
maintain regulatory capital ratios at levels no lower than the levels at
December 31, 1999 until further notice. See "Credit Quality - Special
Residential Loan Pool" and Note 14 to the Consolidated Financial Statements.
35
Insurance of Deposit Accounts
The Bank's deposit accounts are presently insured by the SAIF, except
for certain acquired deposits which are insured by the BIF, up to the maximum
permitted by law. The SAIF and the BIF are administered by the FDIC. Insurance
of deposits may be terminated by the FDIC upon a finding that the institution
has engaged in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operation, or has violated any applicable law, regulation, rule,
order, or condition imposed by the FDIC or the institution's primary regulator.
The management of the Bank does not know of any practice, condition, or
violation that might lead to the termination of deposit insurance.
The FDIC currently assesses its premiums based upon the insured institution's
position on two factors:
1. the institution's capital category under PCA regulations
2. the institution's supervisory category as determined by the FDIC based upon
supervisory information provided by the institution's primary federal
regulator and other information deemed pertinent by the FDIC
The supervisory categories are:
o Group A: financially sound with only a few minor weaknesses
o Group B: demonstrates weaknesses that could result in significant
deterioration
o Group C: poses a substantial probability of loss
Annual FDIC deposit insurance assessment rates as of January 1, 2000 were as
follows:
FDIC Deposit Insurance Rates Expressed In Terms
As Of January 1, 2000 Of Annual Cents Per $100 of Assessed Deposits
-----------------------------------------------
Group A Group B Group C
------- ------- -------
PCA Capital Category
- --------------------
Well capitalized 0 3 17
Adequately capitalized 3 10 24
Under capitalized 10 24 27
As of January 1, 2000, the Bank had been notified by the FDIC that its
deposit insurance assessment rate during the first half of calendar 2000 would
be 3 basis points.
In addition to the deposit insurance premiums presented in the above
table, both BIF and SAIF insured institutions must also pay FDIC premiums
related to the servicing of Financing Corporation ("FICO") bonds which were
issued to help fund the federal government costs associated with the savings &
loan problems of the late 1980's. The current annual assessment rate for the
FICO bonds is approximately 2 basis points per annum on insured deposits.
Various legislative initiatives are being considered by Congress which
might lead to the potential rebate of FDIC insurance premiums, based upon both
the SAIF and the BIF currently exceeding their designated reserve ratios of
1.25% of insured deposits. The Company cannot predict what legislation, if any,
might be approved, and what the impact of such legislation might be upon the
Company.
Branching
OTS regulations permit nationwide branching by federally chartered
savings institutions to the extent allowed by federal statute. This permits
federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions. At this time, the Company's management has no plans to
establish physical branches outside of California, although the Bank does serve
customers domiciled outside of California via alternative delivery channels such
as telephone, mail, and ATM networks.
36
Transactions With Related Parties
The Bank's authority to engage in transactions with related parties or
"affiliates" (e.g., any company that controls or is under common control with an
institution, including the Company and its non-savings institution subsidiaries)
is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section
23A limits the aggregate amount of covered transactions with any individual
affiliate to 10% of the capital and surplus of the savings institution. The
aggregate amount of covered transactions with all affiliates is limited to 20%
of the savings institution's capital and surplus. Certain transactions with
affiliates are required to be secured by collateral in an amount and of a type
described in Section 23A and the purchase of low quality assets from affiliates
is generally prohibited. Section 23B generally provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings institutions are prohibited from lending to any
affiliate that is engaged in activities that are not permissible for bank
holding companies and no savings institution may purchase the securities of any
affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors,
and 10% shareholders, ("insiders"), as well as entities such persons control, is
governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. Specific legislation created an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees. Regulation O also places individual and aggregate
limits on the amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain Board approval procedures to be
followed. For information concerning loans to executive officers and directors
of the Company, please refer to Note 5 to the Consolidated Financial Statements.
Community Reinvestment Act
The Community Reinvestment Act ("CRA") generally requires most insured
depository institutions to:
o identify and delineate the communities served through and by the
institution's offices
o affirmatively meet the credit needs of their delineated communities,
including low and moderate income neighborhoods
o market the types of credit the institution is prepared to extend within such
communities
The CRA also requires the OTS to assess the performance of the institution
in meeting the credit needs of its communities and to take such assessment into
consideration in reviewing applications for mergers, acquisitions, and other
transactions. An unsatisfactory CRA rating may be the basis for denying such an
application. In addition, federal banking agencies may take compliance with CRA
into account when regulating and supervising other activities.
An institution's CRA performance is assessed on the basis of the
institution's actual lending, service, and investment performance. In connection
with its assessment of the Bank's CRA performance, the OTS assigns one of the
following ratings:
o outstanding
o satisfactory
o needs improvement
o substantial noncompliance
Based upon its most recent CRA examination, the Bank received a "satisfactory"
CRA rating.
37
Qualified Thrift Lender Test
The HOLA requires thrift institutions to meet a qualified thrift lender
("QTL") test. A thrift institution is permitted to meet the QTL test in one of
two alternative ways. Under the first method, in at least nine out of every
twelve months, the thrift institution is required to maintain at least 65% of
its "portfolio assets," defined as total assets less (i) specified liquid assets
up to 20% of total assets, (ii) intangible assets, including goodwill and (iii)
the value of property used to conduct business, in certain "qualified thrift
investments." Assets constituting qualified thrift investments include
residential mortgages, qualifying mortgage backed securities, educational loans,
small business loans, and credit card loans. Certain other types of assets also
qualify as "qualified thrift investments" up to certain limitations. These
limited other types of assets include home equity lines of credit and consumer
loans. Alternatively, savings institutions are permitted to meet the QTL test by
qualifying as a "domestic building and loan association" under the Internal
Revenue Code.
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a commercial bank
charter. At December 31, 1999, the Bank maintained 70.4% of its portfolio assets
in qualified thrift investments and, therefore, met the QTL test.
Loans To One Borrower Limitation
Under the HOLA, thrift institutions are generally subject to the limits
on loans to one borrower applicable to national banks. Generally, thrift
institutions may not make a loan or extend credit to a single or related group
of borrowers in excess of 15% of its unimpaired capital and surplus. The term
"unimpaired capital and surplus" is defined as an institution's regulatory
capital, plus that portion of an institution's general valuation allowances that
is not includable in the institution's regulatory capital. An additional amount
may be lent, equal to 10% of unimpaired capital and surplus, if such loan is
secured by readily marketable collateral, which is defined to include certain
financial instruments and specifically excludes real estate. At December 31,
1999, the Bank's limit on loans to one borrower was $5.3 million. At December
31, 1999, the Bank's largest aggregate outstanding balance of loans to one
borrower totaled approximately $7.1 million. This position arose as the result
of a credit guarantee by a seller / servicer of a pool of residential mortgages,
as more fully detailed under "Credit Quality - Special Residential Loan Pool"
and Note 14 to the Consolidated Financial Statements.
Limitations On Capital Distributions
OTS regulations impose limitations upon all capital distributions by
savings institutions, such as cash dividends, payments to repurchase or
otherwise acquire its shares, payments to shareholders of another institution in
a cash-out merger, and other distributions charged against capital. The
regulators separate institutions into three tiers, which are based primarily on
an institution's capital level. An institution that exceeds all capital
requirements before and after a proposed capital distribution ("Tier 1
Institution") and has not been advised by the OTS that it is in need of more
than normal supervision, could, after prior notice but without obtaining
approval of the OTS, make capital distributions during a calendar year equal to
the greater of (i) 100% of its net earnings to date during the calendar year
plus the amount that would reduce by one-half its "surplus capital ratio" (the
excess capital over its fully phased-in capital requirements) at the beginning
of the calendar year or (ii) 75% of its net income for the previous four
quarters. Any additional capital distributions would require prior regulatory
approval. In the event the Bank's capital fell below its regulatory requirements
or the OTS notified it that it was in need of more than normal supervision, the
Bank's ability to make capital distributions could be restricted. In addition,
the OTS could prohibit a proposed capital distribution by any institution, which
would otherwise be permitted by the regulation, if the OTS determines that such
distribution would constitute an unsafe or unsound practice. In January 1999,
the OTS adopted amendments to its capital distribution regulation, effective
April 1999, that generally authorize the payment of capital distributions
without OTS approval if the institution met the requirement of the OTS for
expedited treatment of applications, and the total capital distributions for
calendar year did not exceed certain limits. However, institutions in a holding
company structure, such as the Bank, still have a prior notice requirement. At
December 31, 1999, the Bank was a Tier 1 Bank.
38
Liquidity
Federal regulations currently require thrift institutions to maintain
an average daily balance of liquid assets (including cash, certain cash
equivalents, certain mortgage-related securities, certain mortgage loans with
the security of a first lien on residential property, and specified US
Government, state, and federal agency obligations) equal to at least 4.0% of
either (i) the average daily balance of its net withdrawable accounts plus short
term borrowings (the "liquidity base") during the preceding calendar quarter, or
(ii) the amount of the liquidity base at the end of the preceding calendar
quarter. This liquidity requirement may be changed from time to time by the OTS
to an amount within a range of 4.0% to 10.0% of such accounts and borrowings
depending upon economic conditions and the deposit flows of thrift institutions.
In addition, the Bank must comply with a general non-quantitative requirement to
maintain a safe and sound level of liquidity. Throughout 1999, the regulatory
liquidity ratio of the Bank exceeded regulatory requirements.
Restrictions On Investments And Loans
In addition to those restrictions presented above in reference to
Liquidity and QTL Test requirements of federal thrift institutions, OTS
regulations do not permit the Bank to invest directly in equity securities (with
certain very limited exceptions), non investment grade debt securities, or real
estate, other than real estate used for the institution's offices and
facilities. Indirect equity investment in real estate through a subsidiary, such
as Portola, is permissible, but is subject to certain limitations and deductions
from regulatory capital. The Company's management has no plans to pursue real
estate development or investment activity through Portola.
The OTS and other federal banking agencies have jointly adopted uniform
rules on real estate lending and related Interagency Guidelines for Real Estate
Lending Policies (the "Guidelines"). The uniform rules require that institutions
adopt and maintain comprehensive written policies for real estate lending. The
policies must reflect consideration of the Guidelines and must address relevant
lending procedures, such as loan to value limitations, loan administration
procedures, portfolio diversification standards and documentation, and approval
and reporting requirements. Although the uniform rules do not impose specific
maximum loan to value ratios, the related Guidelines state that such ratio
limits established by an individual institution's board of directors generally
should not exceed levels set forth in the Guidelines, which range from a maximum
of 65% for loans secured by unimproved land to 85% for improved property. No
limit is set for single family residential mortgages, but the Guidelines state
that such loans equal to or exceeding a 90.0% loan to value ratio should have
private mortgage insurance or some other form of credit enhancement. The
Guidelines further permit a limited amount of loans that do not conform to these
criteria.
Aggregate loans secured by non residential real property are generally
limited to 400% of a thrift institution's total capital, as defined.
Federal regulators have recently proposed various restrictions and / or
increased regulatory capital requirements for "sub-prime" loans, including those
secured by single family residences. Among the uncertainties regarding this
proposed regulatory action is what criteria will be used to define a loan as
"sub-prime". While the Company does not generally originate loans with below
industry standard credit quality, in 1998 it did purchase a portfolio of
residential loans that might be described as "sub-prime", augmenting the
Company's credit position with a guarantee by the seller / servicer. See "Credit
Quality - Special Residential Loan Pool" and Note 14 to the Consolidated
Financial Statements. The Company is unable to predict what, if any, new
regulations will be approved and the impact of such regulations upon the
Company's financial condition and results of operations.
39
Classification Of Assets
Thrift institutions are required to classify their assets on a regular
basis, to establish appropriate allowances for losses, and to report the results
of such classifications quarterly to the OTS. A thrift institution is also
required to set aside adequate valuation allowances, and to establish
liabilities for off balance sheet items, such as letters of credit, when loss
becomes probable and estimable. The OTS has the authority to review the
institution's classification of its assets and to determine whether and to what
extent (i) additional assets must be classified, and (ii) whether the
institution's allowances must be increased. Such instruction by the OTS to
increase valuation allowances could have a material impact upon both the Bank's
reported earnings and its financial condition.
Current or potential problem assets are segregated into one of four
categories:
Category Description
- -------- -----------
Special Mention These assets, also called "criticized assets",
present weaknesses or deficiencies deserving
continued monitoring and heightened management
attention.
Substandard These assets, or portions thereof, possess well
defined weaknesses which could jeopardize the
timely liquidation of the asset or the realization
of the collateral at values at least equal to the
Company's investment in the asset. These assets are
therefore characterized by the possibility that the
institution will sustain some loss if the
deficiencies or weaknesses are not corrected.
Prudent general valuation and specific valuation
allowances, as applicable, are required to be
established for such assets. The Company classifies
all real estate acquired through foreclosure as
substandard.
Doubtful These assets, or portions thereof, present probable
loss of principal, but the amount of loss, if any,
is subject to the outcome of future events which
are not fully determinable at the time of
classification. The Company allocates specific
reserves against all assets classified as doubtful.
Loss These assets, or portions thereof, present
quantified losses to the institution. These assets
are considered uncollectible and of such little
value that their continuance as bankable assets is
not warranted. The institution must either
establish a specific reserve equal to the
institution's investment in the asset or charge off
the asset.
The OTS and the other federal banking regulatory agencies have adopted
an interagency policy statement regarding the appropriate levels of general
valuation allowances for loan and lease losses that insured depository
institutions should maintain. Under this policy statement, examiners will
generally accept management's evaluation of the adequacy of general valuation
allowances if the institution has:
o maintained effective systems and controls for identifying and addressing
asset quality problems
o analyzed in a reasonable manner all significant factors that affect the
collectibility of the portfolio
o established an acceptable process for evaluating the adequacy of general
valuation allowances
However, the policy statement also provides that OTS examiners will review
management's analysis more closely if general valuation allowances do not at
least equal the following benchmarks:
o 15% of assets classified as substandard
o 50% of assets classified as doubtful
o for the portfolio of unclassified loans and leases, an estimate of credit
losses over the upcoming twelve months based upon the institution's recent
average rate of net charge-offs on similar loans, adjusted for current
trends and conditions
The Company's internal credit policy is to comply with the interagency
policy statement and to maintain adequate reserves for estimable losses.
However, the determination of estimable losses is by nature an uncertain
practice, and hence no assurance can be given that the Company's loss allowances
will prove adequate to cover future losses.
40
Assessments
Thrift institutions are required to pay assessments to the OTS to fund
the agency's operations. The general assessment, paid on a semi-annual basis, is
computed based upon a three component equation. The components are total assets,
regulatory rating, and amount and nature of off balance sheet activities. The
Bank's general assessment for the six month period commencing January 1, 2000
was $46,000. The general assessments paid by the Bank for the fiscal year ended
December 31, 1999 totaled $91,000.
Federal Home Loan Bank ("FHLB") System
The FHLB provides a comprehensive credit facility to member
institutions. As a member of the FHLB-San Francisco, the Bank is required to own
capital stock in an amount at least equal to the greater of:
o 1.0% of the aggregate principal amount of outstanding residential loans, as
defined, at the beginning of each year
o 5.0% of its advances from the FHLB
o 0.3% of total assets
At its most recent evaluation, the Bank was in compliance with this
requirement. FHLB advances must be secured by specific types of collateral,
including various types of mortgage loans and securities. It is the policy of
the Bank to maintain an excess of pledged collateral with the FHLB at all times
to serve as a ready source of additional liquidity.
The FHLB's are required to provide funds to contribute toward the payment
of certain bonds issued in the past to fund the resolution of insolvent thrifts.
In addition, FHLB's are required by statute to contribute funds toward
affordable housing programs. These requirements could reduce the amount of
dividends the FHLB's pay on their capital stock and could also negatively impact
the pricing offered for on and off balance sheet credit products - events which
could unfavorably impact the profitability of the Company.
Federal Reserve System
The Federal Reserve Board ("FRB") requires insured depository
institutions to maintain non-interest-earning ("sterile") reserves against
certain of their transactional accounts (primarily deposit accounts that may be
accessed by writing unlimited checks). At December 31, 1999, the regulations
generally required that reserves be maintained against qualified net transaction
accounts as follows:
First $5.0 million Exempt
Next $39.3 million 3.0%
Above $44.3 million 10.0%
The reserve requirement may be met by certain qualified cash balances.
The balances maintained to meet the reserve requirements of the FRB may be used
to satisfy OTS liquidity requirements. For the calculation period including
December 31, 1999, the Bank was not required to maintain reserves with the
Federal Reserve because it maintained sufficient levels of cash on hand at its
branches and ATM's.
As a creditor and an insured depository institution, the Bank is
subject to certain regulations promulgated by the FRB, including, but not
limited to:
Regulation B Equal Credit Opportunity Act Regulation F Limits On Interbank Liabilities
Regulation C Home Mortgage Disclosure Act Regulation Z Truth In Lending Act
Regulation D Reserves Regulation X Real Estate Settlement Procedures Act
Regulation E Electronic Funds Transfers Act Regulation CC Expedited Funds Availability Act
Regulation DD Truth In Savings Act
41
Financial Industry Modernization / Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act, enacted into law during November, 1999, is
the result of a decade of Congressional debate regarding a fundamental
reformation of the nation's financial system. The new law is subdivided into
seven titles, by functional area.
Title I acts to facilitate affiliations among banks, insurance
companies, and securities firms.
Title II narrows the exemptions from the securities laws previously
enjoyed by banks, requires the Federal Reserve and the SEC to work together to
draft rules governing certain securities activities, and creates a new,
voluntary investment bank holding company.
Title III restates the proposition that the states are the functional
regulators for all insurance activities, including the insurance activities of
federally chartered banks. The law bars states from prohibiting insurance
activities by depository institutions. The law encourages the states to develop
uniform or reciprocal rules for the licensing of insurance agents.
Title IV prohibits the creation of additional unitary thrift holding
companies. This section is particularly applicable to the Company, as
subsequently discussed.
Title V imposes significant requirements on financial institutions
related to the transfer of non public personal information. These provisions
require each institution to develop and distribute to accountholders an
information disclosure policy, and requires that the policy allow customers to,
and for the institution to, honor a customer's request to "opt-out" of the
proposed transfer of specified non-public information to third parties.
Title VI reforms the Federal Home Loan Bank system to allow broader
access among depository institutions to the systems advance programs, and to
improve the corporate governance and capital maintenance requirements for the
system.
Title VII addresses a multitude of issues including disclosure of ATM
surcharging practices, disclosure of agreements among non-government entities
and insured depository institutions which donate to non-governmental entities
regarding donations made in connection with the Community Reinvestment Act, and
disclosure by the recipient non-governmental entities of how such funds are
used.
Under the Gramm-Leach-Bliley Act, no company may acquire control of a
savings and loan holding company after May 4, 1999, unless the acquiring entity
is engaged only in activities traditionally permitted to a multiple savings and
loan holding company or newly permitted to a financial holding company under
Section 4 (k) of the Bank Holding Company Act. Existing savings and loan holding
companies, such as MBBC, and those formed pursuant to an application filed with
the Office of Thrift Supervision before May 4, 1999, may engage in any activity
including non-financial or commercial activities provided such companies control
only one savings and loan association that meets the Qualified Thrift Lender
test. Corporate reorganizations are permitted, but the transfer of grandfathered
unitary thrift holding company status through acquisition is not permitted.
At this time, the Company cannot predict what specific changes in or
new regulations will be promulgated as a result of the Gramm-Leach-Bliley Act,
and the impact of such regulations upon the Company.
42
Potential Federal Legislation and Regulation
The US Congress continues to consider a broad range of legislative
initiatives that might impact the financial services industry. Among these
initiatives are:
o the potential merger of the Bank Insurance Fund ("BIF") and Savings
Association Insurance Fund ("SAIF") of the FDIC
o the possible merger of the OTS and the Office of the Comptroller of the
Currency ("OCC")
o legislation that would permit the rebate of FDIC insurance funds under
certain circumstances
o the potential for insured depository institutions to pay interest on
business checking deposits, perhaps in conjunction with authorization for
the Federal Reserve to pay interest on sterile reserves
o a possible rise in the FHA loan limit ceiling to that of the Government
Sponsored Enterprises (e.g. the Federal National Mortgage Association and
the Federal Home Loan Mortgage Corporation)
o potential reform legislation applicable to the Federal Home Loan Bank System
o potential restrictions on the sharing of customer information pursuant to
heightened concerns regarding consumer privacy and associated segments of
the Gramm-Leach-Bliley Act
o the possible adoption of legislation that would permit "digital signatures"
in the conduct of commerce and financial transactions over the Internet and
via other electronic means
The Company cannot predict what legislation and regulation, if any, might emerge
from Congress and the various federal regulatory agencies, and the potential
impact of such legislation and regulation upon the Company.
Potential State And Local Legislation And Regulation
The State of California has held hearings regarding the potential
adoption of State laws restricting the sharing of customer information by
financial services firms. These potential State laws could be in addition to the
federal restrictions being considered by Congress. Various localities in the
State of California have enacted laws restricting the ability of financial
services providers to charge certain fees in conjunction with ATM transactions.
Federally chartered financial institutions, such as the Bank, have so far
successfully argued in courts that federal law pre-empts such local ordinances.
The Company cannot predict what State and local legislation and regulation, if
any, might be adopted, and the potential impact of such legislation and
regulation upon the Company.
Environmental Regulation
The Company's business and properties are subject to federal and state
laws and regulations governing environmental matters, including the regulation
of hazardous substances and wastes. For example, under the federal Comprehensive
Environmental Response, Compensation, and Liability Act ("CERCLA") and similar
state laws, owners and operators of contaminated properties may be liable for
the costs of cleaning up hazardous substances without regard to whether such
persons actually caused the contamination. Such laws may affect the Company as
an owner or operator of properties used in its business, and through the Bank,
as a secured lender of property that is found to contain hazardous substances or
wastes.
43
Although CERCLA and similar state laws generally exempt holders of
security interests, the exemption may not be available if a secured party
engages in the management of its borrower or the securing property in a manner
deemed beyond the protection of the secured party's interest. Recent federal and
state legislation, as well as guidance issued by the United State Environmental
Protection Agency and a number of court decisions, have provided assurance to
lenders regarding the activities they may undertake and remain within CERCLA's
secured party exemption. However, these assurances are not absolute and
generally will not protect a lender or fiduciary that participates or otherwise
involves itself in the management of its borrower, particularly in foreclosure
proceedings. As a result, CERCLA and similar state statutes may influence the
Bank's decision whether to foreclose on property that may be or is found to be
contaminated. The Bank has adopted environmental underwriting requirements for
commercial and industrial real estate loans. The Bank's general policy is to
obtain an environmental assessment prior to foreclosure on commercial and
industrial real estate. See "Business - General" and "Lending Activities - Loan
Portfolio Composition" regarding the recent and rapid expansion in the Bank's
commercial and industrial real estate loan portfolio. The existence of hazardous
substances or wastes on commercial and industrial real estate properties could
cause the Bank to elect not to foreclose on the property, thereby limiting, and
in some cases precluding, the Bank from realizing on the related loan. Should
the Bank foreclose on property containing hazardous substances or wastes, the
Bank would become subject to other environmental statutes, regulations, and
common law relating to matters such as, but not limited to, asbestos abatement,
lead-based paint abatement, hazardous substance investigation and remediation,
air emissions, wastewater discharges, hazardous waste management, and third
party claims for personal injury and property damage.
Federal Securities Laws
The Company's common stock is registered with the SEC under Section
12(g) of the securities Exchange Act of 1934, as amended (the "Exchange Act").
The Company is subject to periodic reporting requirements, proxy solicitation
rules, insider trading restrictions, tender offer rules, and other requirements
under the Exchange Act. In addition, certain activities of the Company, its
executive officers, and directors are covered under the Securities Act of 1933,
as amended (the "Securities Act").
Non-Banking Regulation
The Company is impacted by many other laws and regulations, not
necessarily unique to insured depository institutions. Among these other laws
and regulations are federal bankruptcy laws, which have been a recent topic of
federal legislative discussion.
Federal Taxation
General. The Bank and the Company report their income on a consolidated
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS during the last
five years. For its 1999 taxable year, the Bank is subject to a maximum federal
income tax rate of 35%.
Bad Debt Reserve. For fiscal years beginning prior to December 31,
1995, thrift institutions which qualified under certain definitional tests and
other conditions of the Internal Revenue Code of 1986 (the "Code") were
permitted to use certain favorable provisions to calculate their deductions from
taxable income for annual additions to their bad debt reserve. A reserve could
be established for bad debts on qualifying real property loans (generally
secured by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
44
The Small Business Job Protection Act of 1996 (the "1996 Act"), which
was enacted on August 20, 1996, requires savings institutions to recapture
(i.e., take into income) certain portions of their accumulated bad debt
reserves. The 1996 Act repeals the reserve method of accounting for bad debts
effective for tax years beginning after 1995. Thrift institutions that would be
treated as small banks are allowed to utilize the Experience Method applicable
to such institutions, while thrift institutions that are treated as large banks
(those generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of computing
reserves for bad debts will treat such change as a change in method of
accounting, initiated by the taxpayer, and having been made with the consent of
the IRS. Any Section 481 (a) adjustment required to be taken into income with
respect to such change generally will be taken into income ratably over a
six-taxable year period, beginning with the first taxable year beginning after
1995, subject to the residential loan requirement.
Under the residential loan requirement provision, the recapture
required by the 1996 Act will be suspended for each of two successive taxable
years, beginning with the Bank's current taxable year, in which the Bank
originates a minimum of certain residential loans based upon the average of the
principal amounts of such loans made by the Bank during its six taxable years
preceding its current taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank
is permitted to make additions to its tax bad debt reserves. In addition, the
Bank is required to recapture (i. e., take into income) over a six year period
the excess of the balance of its tax bad debt reserves as of December 31, 1995
over the balance of such reserves as of December 31, 1987.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
The amount of additional taxable income triggered by an non-dividend is
an amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Thus, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion its bad debt reserves.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986,
as amended (the "Code") imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using
the percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current earnings
exceeds its AMTI (determined without regard to this preference and prior to
reduction for net operating losses). In addition, for taxable years beginning
after December 31, 1986 and before January 1, 1996, an environmental tax of .12%
of the excess of AMTI (with certain modifications) over $2.0 million is imposed
on corporations, including the Company, whether or not an Alternative Minimum
Tax ("AMT") is paid. The Bank does not expect to be subject to the AMT, but may
be subject to the environmental tax liability.
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank own more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
45
State and Local Taxation
State of California. The California franchise tax rate applicable to
the Bank equals the franchise tax rate applicable to corporations generally,
plus an "in lieu" rate approximately equal to personal property taxes and
business license taxes paid by such corporations (but not generally paid by
banks or financial corporations such as the Bank); however, the total tax rate
cannot exceed 10.84%. Under California regulations, bad debt deductions are
available in computing California franchise taxes using a three or six year
weighted average loss experience method. The Bank and its California subsidiary
file California State franchise tax returns on a combined basis. The Company, as
a savings and loan holding company commercially domiciled in California, is
treated as a financial corporation and subject to the general corporate tax rate
plus the "in lieu" rate as discussed previously for the Bank.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
Additional Item. Executive Officers of the Registrant
The following table sets forth certain information with respect to each
executive officer of the Company or Bank who is not also a director of the
Company. The board of directors appoints or reaffirms the appointment of all of
the Company's executive officers each year. Each executive officer serves until
the following year or until a respective successor is appointed.
Date
Age At Position(s) With Company Started In Previous Experience If Less
Name 12/31/99 And / or Bank Position Than Five Years In Current Position
- ---- -------- ------------------------ ---------- -----------------------------------
Margaret A. Green 37 Corporate Secretary, 6/11/99 Assistant Corporate Secretary,
Monterey Bay Bancorp, Inc. Monterey Bay Bancorp, Inc., 1999
Corporate Secretary, 6/11/99 Assistant Corporate Secretary,
Monterey Bay Bank Monterey Bay Bank, 1999
Carlene F. Anderson 47 Assistant Corporate 6/11/99 Corporate Secretary, Monterey Bay
Secretary Bancorp, Inc.
Monterey Bay Bancorp, Inc. 1994 - 1999
Assistant Corporate 6/11/99 Corporate Secretary, Monterey Bay Bank
Secretary
Vice President, Compliance 8/15/98 1994 - 1999
Monterey Bay Bank.
Mark R. Andino 40 Senior Vice President 1/26/00 Treasurer, Chela Financial, 1999
Chief Financial Officer Senior Vice President, Chief Financial
Monterey Bay Bancorp, Inc. Officer
HF Bancorp, Inc., Hemet Federal, 1996 -
1999
Senior Vice President 1/26/00
Chief Financial Officer
Monterey Bay Bank
Ben A. Tinkey 47 Senior Vice President 9/20/94
Chief Loan Officer
Monterey Bay Bank
Gary C. Tyack 54 Senior Vice President 5/16/94
Director of Retail Banking
Monterey Bay Bank
46
Item 2. Properties.
The following table sets forth information relating to each of the
Company's offices as of December 31, 1999:
Original
Lease Date Date of
Or Leased or Lease
Location Owned Acquired Expiration
- ----------------------------------- ------- ------------ ----------
Administrative Offices:
15 Brennan Street
Watsonville, California 95076 Owned 12-31-65 N/A
567 Auto Center Drive
Watsonville, California 95076 Owned 03-23-98 N/A
Branch Offices:
35 East Lake Avenue
Watsonville, California 95076 Owned 12-31-65 N/A
805 First Street
Gilroy, California 95020 Owned 12-01-76 N/A
1400 Munras Avenue
Monterey, California 93940 Owned 07-07-93 N/A
1890 North Main Street
Salinas, California 93906 Owned 07-07-93 N/A
1127 South Main Street
Salinas, California 93901 Leased 08-08-93 06-30-05
8071 San Miguel Canyon Road
Prunedale, California 93907 Leased 12-24-93 12-24-03
601 Bay Avenue
Capitola, California 95020 Owned 12-10-96 N/A
6265 Highway 9
Felton, California 95018 Leased 04-07-98 04-30-03
47
Item 3. Legal Proceedings.
From time to time, the Company is party to claims and legal proceedings
in the ordinary course of business. Management believes that the ultimate
aggregate liability represented thereby, if any, will not have a material
adverse effect on the Company's consolidated financial position or results of
operations.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Common Stock of Monterey Bay Bancorp, Inc. is traded over the
counter on the National Association Of Securities Dealers Automated Quote
("NASDAQ") system under the symbol "MBBC." The stock commenced trading on
February 15, 1995, when the Company went public and sold 4,492,085 shares at a
price of $6.40 per share (adjusted for a 5:4 stock split on July 31, 1998).
As of March 10, 2000, there were 3,308,523 shares of the Company's
common stock outstanding. As of February 29, 2000, there were 283 stockholders
of record, not including persons or entities who hold their stock in nominee or
"street" name.
The following table sets forth the high and the low daily closing
prices of the Company's common stock for each of the following calendar
quarters. Share prices prior to July 31, 1998 have been restated to reflect a
5:4 stock split effective on that date.
High Low
---- ---
Year Ended December 31, 1999:
Fourth quarter $ 15.000 $ 9.375
Third quarter $ 15.625 $ 10.500
Second quarter $ 15.000 $ 10.000
First quarter $ 14.750 $ 11.000
Year Ended December 31, 1998:
Fourth quarter $ 14.875 $ 10.750
Third quarter $ 17.000 $ 13.250
Second quarter $ 21.000 $ 14.800
First quarter $ 21.406 $ 14.800
The board of directors declared, and the Company paid, cash dividends
of $0.15 and $0.12 per share during the years ended December 31, 1999 and 1998,
respectively.
The Company is subject to certain restrictions and limitations on the
payment of dividends pursuant to existing and applicable laws and regulations
(see "Item 1. Business - Regulation And Supervision - Limitation On Capital
Distributions" and Note 14 to the Consolidated Financial Statements).
48
Item 6. Selected Financial Data.
Set forth below are selected consolidated financial and other data of
the Company for the periods and the dates indicated. This financial data is
derived in part from, and should be read in conjunction with, the Consolidated
Financial Statements and related Notes of the Company presented elsewhere
herein. The 1995 through 1998 financial information is presented as restated.
See Note 24 to the Consolidated Financial Statements.
At December 31,
-----------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars In Thousands)
Selected Financial Condition Data:
Total assets $ 462,827 $ 454,046 $ 406,960 $ 424,275 $ 328,178
Investment securities available for sale 11,463 19,410 40,355 49,955 30,990
Investment securities held to maturity -- -- 145 404 790
Mortgage backed securities available for sale 57,716 98,006 70,465 116,610 52,417
Mortgage backed securities held to maturity 60 97 142 173 205
Loans receivable held for investment, net 360,686 298,775 263,751 233,208 228,387
Loans held for sale -- 2,177 514 130 92
Allowance for estimated loan losses 3,502 2,780 1,669 1,311 1,362
Deposits 367,402 370,677 320,559 318,145 215,284
FHLB advances 49,582 35,182 32,282 46,807 46,520
Securities sold under agreements to repurchase 2,410 4,490 5,200 13,000 17,361
Stockholders' equity 40,803 41,116 46,797 44,272 46,014
Non-performing loans 8,182 2,915 2,046 1,748 3,200
Real estate acquired by foreclosure, net 96 281 321 -- --
For The Year Ended December 31,
-----------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars In Thousands, Except Share Data)
Selected Operating Data:
Interest income $ 33,417 $ 30,911 $ 29,677 $ 23,986 $ 22,544
Interest expense 17,388 18,588 18,413 14,333 14,227
--------- --------- --------- --------- ---------
Net interest income before provision for
loan losses 16,029 12,323 11,264 9,653 8,317
Provision for estimated loan losses 835 692 375 28 663
--------- --------- --------- --------- ---------
Net interest income after provision for loan 15,194 11,631 10,889 9,625 7,654
losses
Non-interest income 2,505 2,177 1,614 941 573
General and administrative expenses (1) 11,887 11,144 9,507 9,091 7,140
--------- --------- --------- --------- ---------
Income before income tax expense 5,812 2,664 2,996 1,475 1,087
Income tax expense 2,511 1,228 1,230 623 414
--------- --------- --------- --------- ---------
Net income $ 3,301 $ 1,436 $ 1,766 $ 852 $ 673
========= ========= ========= ========= =========
Shares applicable to basic earnings per share 3,231,162 3,501,738 3,632,548 3,688,599 4,101,385
Basic earnings per share $ 1.02 $ 0.41 $ 0.49 $ 0.23 $ 0.16
========= ========= ========= ========= =========
Shares applicable to diluted earnings per share 3,320,178 3,638,693 3,763,038 3,734,226 4,108,631
Diluted earnings per share & 0.99 $ 0.39 $ 0.47 $ 0.23 $ 0.16
========= ========= ========= ========= =========
Cash dividends per share $ 0.15 $ 0.12 $ 0.09 $ 0.04 $ 0.00
========= ========= ========= ========= =========
(footnotes at end of table)
49
At Or For The Year Ended December 31,
-----------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars In Thousands)
Selected Financial Ratios and Other Data (2):
Performance Ratios
Return on average assets (3) 0.73% 0.33% 0.43% 0.26% 0.21%
Return on average stockholders' equity (4) 8.05% 3.29% 3.99% 1.89% 1.49%
Average equity to average assets 9.04% 10.06% 10.70% 13.58% 13.99%
Equity to total assets at end of period 8.82% 9.06% 11.50% 10.43% 14.02%
Interest rate spread during the period (5) 3.27% 2.43% 2.31% 2.29% 1.98%
Net interest margin (6) 3.69% 2.96% 2.83% 3.00% 2.65%
Interest rate margin on average total assets (7) 3.53% 2.84% 2.72% 2.92% 2.58%
Average interest-earning assets /
average interest-bearing liabilities 110.61% 112.00% 111.29% 116.09% 116.03%
General and administrative expenses /
average total assets 2.62% 2.57% 2.30% 2.75% 2.22%
Efficiency ratio (8) 64.14% 76.86% 73.82% 85.82% 80.32%
Regulatory Capital Ratios
Tangible capital 7.11% 6.53% 9.13% 7.95% 11.20%
Core capital 7.11% 6.53% 9.14% 8.03% 11.40%
Risk based capital 10.56% 11.35% 16.82% 18.58% 23.66%
Asset Quality Ratios
Non-performing loans / gross loans receivable (9) 2.25% 0.96% 0.77% 0.74% 1.39%
Non-performing assets / total assets (10) 1.79% 0.71% 0.58% 0.41% 0.97%
Net charge-offs / average gross loans receivable 0.03% -- 0.01% 0.03% 0.05%
Allowance for loan losses / gross
loans receivable (9) 0.96% 0.92% 0.63% 0.56% 0.59%
Allowance for loan losses / non-performing
loans 42.80% 95.37% 81.57% 75.00% 42.56%
Allowance for total estimated losses /
nonperforming assets 42.30% 87.15% 70.57% 75.00% 42.56%
Other Data
Number of full-service customer facilities 8 8 7 6 6
Number of deposit accounts 27,831 26,124 21,780 20,271 15,574
Number of ATM's 10 10 9 6 6
- ------------------------------------------------------
(1) General and administrative expenses for 1996 include a non-recurring
special FDIC insurance premium assessment of $1.4 million.
(2) Regulatory Capital Ratios and Asset Quality Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based on
average daily balances during the indicated periods and are annualized
where appropriate.
(3) Return on average assets is net income divided by average total assets.
(4) Return on average stockholders' equity is net income divided by average
stockholders' equity.
(5) Interest rate spread during the period represents the difference between
the weighted average yield on interest-earning assets and the weighted
average cost of interest-bearing liabilities.
(6) Net interest margin equals net interest income as a percent of average
interest-earning assets.
(7) Interest rate margin on average total assets equals net interest income as
a percent of average total assets.
(8) The efficiency ratio is calculated by dividing the general & administrative
expense by the sum of net interest income and non-interest income. The
efficiency ratio measures how much in expense the Company invests in order
to generate each dollar of net revenue.
(9) Gross loans receivable includes loans held for investment and loans held
for sale, less undisbursed loan funds and unamortized yield adjustments.
(10) Non-performing assets includes all nonperforming loans (nonaccrual loans
and restructured loans) and real estate acquired via foreclosure or by
acceptance of a deed in lieu of foreclosure.
50
Item 7. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations.
General
The Company's primary business is providing conveniently located branch
offices to attract checking, money market, savings, and certificate of deposit
accounts, and investing such deposits and other available funds in loans,
primarily those secured by various types of real estate. The Bank's deposit
gathering and lending markets are concentrated in the communities surrounding
its eight full service branch offices located in Santa Cruz, northern Monterey,
and southern Santa Clara Counties, in California.
The most significant component of the Company's revenue is net interest
income. Net interest income is the difference between interest and dividend
income, primarily from loans, mortgage backed securities, and investment
securities, and interest expense, primarily on deposits and borrowings. The
Company's net interest income and net interest margin, which is defined as net
interest income divided by average interest-earning assets, are affected by its
asset growth and quality, its asset and liability composition, and the general
interest rate environment.
The Company's deposit service charges, mortgage loan servicing fees,
and commissions from the sale of non-FDIC insured insurance products and
investments through Portola also have significant effects on the Company's
results of operations. An additional major factor in determining the Company's
results of operations are general and administrative expenses, which consist
primarily of employee compensation, occupancy and equipment expenses, data and
item processing fees, and other operating expenses. The Company's results of
operations are also significantly affected by general economic and competitive
conditions, particularly absolute and relative levels and changes in market
interest rates, government policies, and actions of regulatory agencies.
Subsequent to the issuance of the Company's 1998 consolidated financial
statements, the Company's management determined that costs associated with
shares purchased in 1995 and 1996 for future distribution under its stock award
programs should have been recorded as a contra-equity account rather than an
asset. Furthermore, such shares were inappropriately included in the weighted
average shares outstanding used in earnings per share calculations. As a result,
other assets and total stockholders' equity as of December 31, 1998, and
earnings per share for the years ended December 31, 1998 and 1997, have been
restated from amounts previously reported in order to conform with generally
accepted accounting principles. In addition, prior years' compensation expense
was understated by a cumulative amount of approximately $96,000 ($57,000 net of
tax) or $0.02 diluted earnings per share which is insignificant and has been
charged to 1999 operations. The effects of the restatement are presented in Note
24 to the Consolidated Financial Statement.
Interest Rate Environment
The table below presents an overview of the interest rate environment
during the three years ended December 31, 1999. Market interest rates generally
trended upward in 1999, with an acceleration in the latter half of the year as
the Federal Reserve implemented three separate 25 basis point increases in its
target federal funds rate. The Treasury yield curve also became steeper during
1999, after starting the year with just a 63 basis point yield differential
between a three month Treasury bill and a 30 year Treasury bond. Note that the
11th District Cost Of Funds Index ("COFI") is by nature a lagging index that
trails changes in more responsive interest rate indices such as those associated
with the Treasury or LIBOR markets. The significant rate decreases during the
latter half of 1998 occurred as the Federal Reserve implemented three rounds of
rate cuts in response to concerns regarding:
o economic performance by certain countries, particularly those located in
Asia
o the potential impacts of financial difficulties by large hedge funds
o the maintenance of sufficient liquidity to ensure smooth operation of the
capital markets
Index 12/31/96 6/30/97 12/31/97 6/30/98 12/31/98 3/31/99 6/30/99 9/30/99 12/31/99
- ----- -------- ------- -------- ------- -------- ------- ------- ------- --------
3 month Treasury bill 5.19% 5.17% 5.34% 5.09% 4.46% 4.47% 4.76% 4.85% 5.31%
6 month Treasury bill 5.30% 5.25% 5.44% 5.23% 4.54% 4.52% 5.03% 4.96% 5.73%
1 year Treasury bill 5.49% 5.65% 5.48% 5.37% 4.52% 4.71% 5.05% 5.18% 5.96%
2 year Treasury note 5.87% 6.06% 5.64% 5.48% 4.53% 4.98% 5.52% 5.60% 6.24%
5 year Treasury note 6.21% 6.37% 5.71% 5.47% 4.54% 5.10% 5.65% 5.76% 6.34%
30 year Treasury bond 6.64% 6.78% 5.92% 5.63% 5.09% 5.62% 5.97% 6.05% 6.48%
Prime rate 8.25% 8.50% 8.50% 8.50% 7.75% 7.75% 7.75% 8.25% 8.50%
COFI 4.84% 4.85% 4.96% 4.88% 4.66% 4.52% 4.50% 4.61% 4.85%
51
Business Strategy
During 1999, the Company achieved progress in its business strategy of
converting an almost 75 year old savings and loan into an effective community
based financial services company. The objective of this business strategy is to
increase long term shareholder returns while also enhancing the Company's
involvement in and contributions to the communities it serves. The steps
identified to achieve this objective include:
o Increasing the Company's ratio of loans to deposits as a means of enhancing
net interest income, serving more customers, moderating exposure to change
in general market interest rates, and better utilizing the Company's
capital resources.
o Diversifying the product mix within the loan portfolio to reduce the
historic high concentration in relatively commoditized residential
mortgages while also meeting the financing needs of consumers and small
businesses within the Company's market areas.
o Acquiring customers disaffected by the recent or pending acquisition of
their financial services provider.
o Capitalizing on the Company's position as one of the largest independent
financial institutions in the Greater Monterey Bay Area.
o Bolstering non-interest income from an expanding list of fee based products
and services, including ATM surcharges, deposit account and branch service
charges, and sales of non-FDIC insured investment products including mutual
funds and annuities.
o Changing the Company's deposit mix to emphasize transaction accounts as a
means of cementing customer relationships, lower the Company's relative
cost of funds, generating fee income, and increasing the duration of the
Company's funding.
o Capitalizing on the continued strength of the economy and real estate
markets in the Company's primary business areas, particularly through
construction lending.
o Continuing to aggressively manage the Company's capital position, balancing
opportunities for investment in the Company's business with an ongoing
pattern of share repurchases and dividend payments.
o Pursuing alternative forms of delivery for financial products and services
as a means of attracting a greater volume of business while also improving
the Company's efficiency ratio.
The Company intends to continue pursuing this business strategy in
2000, with specific goals of pursuing one or more additional remote ATM sites,
introducing Internet based banking, and expanding the Company's market coverage
through either additional traditional, stand alone, full service branches or
other alternatives, possibly including supermarket banking. However, there can
be no assurance that any such steps will be implemented, or if implemented,
whether such steps will improve the Company's financial performance.
52
Analysis Of Results Of Operations For The Years Ended December 31, 1999 And
December 31, 1998
Overview
The Company reported record net income of $3.3 million for the twelve
months ended December 31, 1999, up significantly from net income of $1.4 million
realized during the prior year. These figures translate to $1.02 basic and $0.99
diluted earnings per share in 1999, respectively, and $0.41 basic and $0.39
diluted earnings per share in 1998, respectively. The Company's return on
average assets improved from 0.33% in 1998 to 0.73% in 1999. Due to the
Company's equity management program, return on average equity improved more
dramatically, rising from 3.29% in 1998 to 8.05% in 1999. The increase in 1999
net income resulted from the Company's continued progress and success in
implementing its business strategy, complemented by a strong economy and vibrant
local real estate markets, which helped constrain loan delinquencies, net
charge-offs, and expenses associated with foreclosed real estate.
Net Interest Income
During the years ended December 31, 1999, 1998, and 1997, net interest
income before the provision for estimated loan losses was $16.0 million, $12.3
million, and $11.3 million, respectively. The volume of average interest-earning
assets over the same years was $434.8 million, $416.2 million, and $397.5
million, respectively. The net interest spread was 3.27 %, 2.43%, and 2.31%,
respectively, during the years ended December 31, 1999, 1998, and 1997. During
these same periods, the ratio of net interest income to average total assets was
3.53%, 2.84%, and 2.72%, respectively.
The $3.7 million, or 30.1%, increase in net interest income generated
in 1999 versus the prior year was primarily produced by three key changes in the
Company's balance sheet composition:
1. On the asset side of the balance sheet, the Company significantly
redirected its asset mix towards loans receivable, reducing the proportion
of the balance sheet comprised of lower yielding cash equivalents,
investment securities, and mortgage backed securities. Loans receivable
produced a weighted average yield rate of 8.03% during 1999, comparing
quite favorably to 4.80% on cash equivalents, 6.40% on investment
securities, and 6.68% on mortgage backed securities. This change in asset
mix was enabled by a record loan origination volume of $173.3 million
accomplished in 1999; primarily funded by the sale of securities and
increased borrowings.
2. On the liability side of the balance sheet, the Company significantly
reduced the percentage of deposits represented by relatively higher cost
certificates in favor of a larger proportion of transaction accounts.
Certificates of deposit, which generated a weighted average cost of 4.82%
in 1999 and 5.41% in 1998, declined from 78.6% of average interest bearing
deposits in 1998 to 65.1% in 1999. The Company successfully offset the
decline in certificates of deposit with increases in lower cost checking
and money market accounts. By comparison, money market accounts produced an
average cost of funds of 4.03% in 1998 and 4.15% in 1999. At December 31,
1999, certificates of deposit comprised 60.5% of total deposits, down from
69.4% a year earlier.
3. The Company increased its average balance of interest earning assets by
$18.5 million, or 4.5%. The Company fueled this balance sheet expansion
largely with an increase in borrowings, as overall deposit growth was
limited by the Company's objective of decreasing its cost of deposits
relative to key capital market indices such as COFI and the 1 year Treasury
yield. The Company was successful in this regard, as the weighted average
cost of deposits declined from 4.56% at December 31, 1998 to 4.04% at
December 31, 1999, while at the same time the COFI index rose from 4.66% to
4.85% and the 1 year Treasury yield rose from 4.52% to 5.96%.
53
Average Balances, Average Rates, And Net Interest Margin
The following table presents the average rate earned upon each major
category of interest earning assets, the average rate paid for each major
category of interest bearing liabilities, and the resulting net interest spread,
net interest margin, and average interest margin on total assets for the years
indicated.
Year Ended December 31, 1999 Year Ended December 31, 1998 Year Ended December 31, 1997
------------------------------- ------------------------------ -----------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ----- ------- -------- ------- ------- -------- -------
(Dollars In Thousands)
Assets
- ------
Interest earning assets:
Cash equivalents (1) $ 5,837 $ 280 4.80% $ 10,721 $ 578 5.39% $ 4,272 $ 231 5.41%
Investment securities (2) 13,620 871 6.40% 37,397 2,335 6.24% 46,248 2,899 6.27%
Mortgage backed securities(3) 73,122 4,884 6.68% 105,223 6,910 6.57% 92,842 6,510 7.01%
Loans receivable, net (4) 339,036 27,218 8.03% 259,358 20,882 8.05% 250,370 19,804 7.91%
FHLB stock 3,139 164 5.22 3,512 206 5.87% 3,793 233 6.14%
------- ------ ---- ------- ------ ---- ------- ------ ----
Total interest earning assets 434,754 33,417 7.69% 416,211 30,911 7.43% 397,525 29,677 7.47%
------- ------ ------- ------ ------- ------
Non-interest earnings assets 18,691 17,424 16,036
-------- -------- --------
Total assets $453,445 $433,635 $413,561
======== ======== ========
Liabilities & Equity
Interest bearing liabilities:
NOW accounts $ 25,205 388 1.54% 14,534 227 1.56% 8,579 87 1.01%
Savings accounts 15,583 280 1.80% 15,204 278 1.83% 13,396 254 1.90%
Money market accounts 82,006 3,402 4.15% 42,603 1,716 4.03% 34,612 1,344 3.88%
Certificates of deposit 229,493 11,060 4.82% 266,225 14,407 5.41% 251,855 13,842 5.50%
------- ------ ---- ------- ------ ---- ------- ------ ----
Total interest-bearing 352,287 15,130 4.29% 338,566 16,628 4.91% 308,442 15,527 5.03%
deposits
FHLB advances 37,600 2,078 5.53% 28,059 1,663 5.93% 40,520 2,400 5.92%
Other borrowings (5) 3,182 180 5.65% 5,007 297 5.93% 8,234 486 5.90%
------- ------ ---- ------- ------ ---- ------- ------ ----
Total interest-bearing
liabilities 393,069 17,388 4.42% 371,632 18,588 5.00% 357,196 18,413 5.16%
------- ------ ------ ------
Non-interest bearing
liabilities 19,386 18,379 12,096
-------- -------- --------
Total liabilities 412,455 390,011 369,292
Stockholders' equity 40,990 43,624 44,269
-------- -------- --------
Total liabilities & equity $453,445 $433,635 $413,561
======== ======== ========
Net interest income $16,029 $12,323 $11,264
======= ======= =======
Interest rate spread (6) 3.27% 2.43% 2.31%
Net interest earning assets 41,685 44,579 40,329
Net interest margin (7) 3.69% 2.96% 2.83%
Net interest income /
average total assets 3.53% 2.84% 2.72%
Interest earnings assets /
interest bearing
liabilities 1.11 1.12 1.11
Average balances in the above table were calculated using average daily figures.
- -----------------------------------------
(1) Includes federal funds sold, money market fund investments, banker's
acceptances, commercial paper, interest earning deposit accounts, and
securities purchased under agreements to resell.
(2) Includes investment securities both available for sale and held to
maturity.
(3) Includes mortgage backed securities, including CMO's, both available for
sale and held to maturity.
(4) In computing the average balance of loans receivable, non-accrual loans and
loans held for sale have been included. Amount is net of deferred loan
fees, premiums and discounts, undisbursed loan funds, and allowances for
estimated loan losses. Interest income on loans includes amortized loan
fees of $293,000, $233,000, and $243,000 in 1999, 1998, and 1997,
respectively.
(5) Includes federal funds purchased and securities sold under agreements to
repurchase.
(6) Interest rate spread represents the difference between the average rate on
interest earning assets and the average rate on interest bearing
liabilities.
(7) Net interest margin equals net interest income before provision for
estimated loan losses divided by average interest earning assets.
54
Rate/Volume Analysis
The most significant impact on the Company's net interest income
between periods is derived from the interaction of changes in the volume of and
rate earned or paid on interest-earning assets and interest-bearing liabilities.
The following table utilizes the figures from the preceding table to present a
comparison of interest income and interest expense resulting from changes in the
volumes and the rates on average interest earning assets and average interest
bearing liabilities for the years indicated. Changes in interest income or
interest expense attributable to volume changes are calculated by multiplying
the change in volume by the prior year average interest rate. The changes in
interest income or interest expense attributable to interest rate changes are
calculated by multiplying the change in interest rate by the prior year average
volume. The changes in interest income or interest expense attributable to the
combined impact of changes in volume and changes in interest rate are calculated
by multiplying the change in rate by the change in volume.
Year Ended December 31, 1999 Year Ended December 31, 1998
Compared To Compared To
Year Ended December 31, 1998 Year Ended December 31, 1997
------------------------------------------ -----------------------------------------
Increase (Decrease) Due To Increase (Decrease) Due To
------------------------------------------ -----------------------------------------
Volume Volume
Volume Rate / Rate Net Volume Rate / Rate Net
------ ---- ------ --- ------ ---- ------ ---
(Dollars In Thousands)
Interest-earning assets
Cash equivalents $ (264) $ (61) $ 28 $ (297) $ 349 $ (1) $ (2) $ 346
Investment securities (1,484) 55 (35) (1,464) (555) (13) 3 (565)
Mortgage backed securities (2,108) 118 (36) (2,026) 868 (410) (57) 401
Loans receivable, net 6,415 (56) (24) 6,335 711 350 17 1,078
FHLB Stock (22) (22) 2 (42) (17) (11) 1 (27)
------ ------ ------ ------ ------ ----- ------ ------
Total interest-earning 2,537 34 (65) 2,506 1,356 (85) (38) 1,233
assets ------ ------ ------ ------ ------ ----- ------ ------
Interest-bearing liabilities
NOW Accounts 167 (3) (3) 161 61 47 32 140
Savings accounts 7 (5) -- 2 34 (9) (1) 24
Money market accounts 1,587 52 47 1,686 310 51 11 372
Certificates of deposit (1,988) (1,575) 216 (3,347) 790 (217) (8) 565
------ ------ ------ ------ ------ ----- ------ ------
Total interest-bearing (227) (1,531) 260 (1,498) 1,195 (128) 34 1,101
deposits
FHLB advances 565 (111) (39) 415 (738) 3 (2) (737)
Other borrowings (108) (14) 5 (117) (191) 1 - (190)
------ ------ ------ ------ ------ ----- ------ ------
Total interest-bearing 230 (1,656) 226 (1,200) 266 (124) 32 174
liabilities ------ ------ ------ ------ ------ ----- ------ ------
Increase (decrease) in net
interest income $2,307 $1,690 $ (291) $3,706 $1,090 $ 39 $ (70) $1,059
====== ====== ======= ====== ====== ===== ======= ======
55
Interest Income
For the year ended December 31, 1999, interest income was $33.4
million, an increase of $2.5 million, or 8.1%, over the amount recorded for the
year ended December 31, 1998. The primary reason for the increase in interest
income during 1999 was growth in average outstanding balances of loans
receivable, which in turn stemmed from the record level of loan production
recorded during 1999. Interest income on loans receivable, which accounted for
81.4% of total interest income for the year ended December 31, 1999, grew by
$6.3 million in 1999 compared to 1998. Interest income on mortgage backed
securities during 1999 declined by $2.0 million from the prior year due to
reduced average volumes outstanding. During 1999, the Company used scheduled
payments, prepayments, and sales of mortgage backed securities as sources of
cash to fund the expanding portfolio of loans receivable. Similarly, lower
average volumes of investment securities during 1999 versus the prior year led
to a $1.5 million year to year decline in interest income on investment
securities.
The weighted average yield on interest-earning assets was 7.69% for the
year ended December 31, 1999, compared to 7.43% for the prior year. The increase
in the yield on interest-earning assets was principally due to loans receivable
increasing as a percentage of interest-earning assets, from 62.3% during 1998 to
78.0% during 1999. Yields on mortgage backed and investment securities increased
slightly during 1999, but represented a significantly smaller portion of total
interest-earning assets. The increase in general market interest rates that
occurred in 1999 also bolstered the Company's yield on interest earning assets,
particularly those portfolios such as construction loans and corporate trust
preferred securities that reprice based upon relatively responsive indices such
as Prime and LIBOR, respectively. The weighted average nominal rate on the
Company's loan portfolio increased from 7.92% at December 31, 1998 to 8.17% at
December 31, 1999.
Interest Expense
Interest expense for the year ended December 31, 1999 was $17.4
million, compared to $18.6 million for the prior year, a decrease of $1.2
million, or 6.5%. The decline in interest expense was primarily attributable to
a reduction in the Company's average cost of deposits, which in turn stemmed
from a combination of the aforementioned change in deposit mix and from the
Company's adopting a less aggressive pricing strategy, particularly for
certificates of deposit, than had been employed in prior periods. The Company's
average cost of interest-bearing deposits declined to 4.29% in 1999, from 4.91%
in 1998. Interest expense on FHLB advances rose from $1.7 million in 1998 to
$2.1 million in 1999, as the impact of greater average balances outstanding more
than offset the effect of a decline in the average rate paid.
Provision For Loan Losses
Implicit in lending activities is the risk that losses will occur and
that the amount of such losses will vary over time. Consequently, the Company
maintains an allowance for loan losses by charging a provision to operations.
Loans determined to be losses are charged against the allowance for loan losses.
The allowance for loan losses is maintained at a level considered by management,
at a point in time and with then available information, to be adequate to
provide for estimated losses inherent in the existing portfolio.
In evaluating the adequacy of the allowance for loan losses, management
estimates the amount of potential loss for each individual loan that has been
identified as having greater than standard credit risk, including loans
identified as criticized ("Special Mention"), classified ("Substandard" or lower
graded), impaired per SFAS No. 114, troubled debt restructured, and
non-performing. In determining specific and general loss estimates, management
incorporates such factors as collateral value, portfolio composition and
concentration, trends in local and national economic and real estate conditions,
historical credit experience, and the financial status of borrowers. While the
allowance is segmented by broad portfolio categories to analyze its adequacy,
the allowance is general in nature and is available for the loan portfolio in
its entirety. Although management believes that the allowance is adequate,
future provisions are subject to continuing evaluation of inherent risk in the
loan portfolio, as conducted by both management and the Bank's regulators.
56
For the year ended December 31, 1999 the provision for loan losses was
$835,000, compared to $692,000 for the year ended December 31, 1998. During
1999, the amount and timing of provisions for loan losses were primarily
generated the following key factors:
o the increasing absolute size of the loan portfolio
o the continuing change in mix within the loan portfolio, away from
residential mortgages to other types of lending, particularly construction
loans and mortgages secured by commercial and industrial real estate
o a rise in criticized assets and classified assets from $6.4 million and
$5.4 million, respectively, at December 31, 1998 to $7.9 million and $8.8
million, respectively, at December 31, 1999
o net charge-offs of $113,000 recorded in 1999, versus net recoveries of
$3,000 in 1998
Construction, commercial real estate, multifamily, and business lending
generally involve a greater risk of loss than do mortgages on single family
residences.
The Company's allowance for loan losses totaled $3.5 million at
December 31, 1999, comprised of $3.3 million in general reserves and $200,000 in
specific reserves. This compares to an allowance of $2.8 million at December 31,
1998, all but $67,000 of which was in general reserves. The allowance
represented 0.96% of loans receivable at December 31, 1999, compared to 0.92% a
year earlier.
To the extent that the Company is successful in its business strategy
and thereby continues building the size of its loan portfolio while also
extending increased volumes of construction, income property, and business
lending, management anticipates that additional provisions will be charged
against operations in 2000, with the ratio of allowance to loans receivable
rising to reflect the greater credit exposure inherent in the loan mix. The
level of provision in 2000 will also likely be impacted by:
o the resolution of the $5.0 million non-accrual business term loan
maintained by MBBC
o the borrower performance and the guarantor financial status associated with
a pool of residential mortgages acquired in 1998 that present a weaker
credit profile than that typically pursued by the Company (see "Item 1.
Business - Credit Quality - Special Residential Loan Pool" and Note 14 to
the Consolidated Financial Statements)
Non-interest Income
Non-interest income increased by 15.1% to $2.5 million for the year
ended December 31, 1999, compared to $2.2 million for the year ended December
31, 1998, primarily due:
o a rise in net gains on the sale of mortgage backed and investment
securities from $283,000 in 1998 to $496,000 in 1999
o customer service charges increasing from $824,000 in 1998 to $1,032,000 in
1999
o commissions from the sale of non-FDIC insured products expanding from
$537,000 in 1998 to $626,000 in 1999
The Company sold mortgage backed and investment securities in 1999 as a
means of funding expansion in the loan portfolio and in order to moderate the
Company's exposure to increases in general market interest rates. The increase
in customer service charges in 1999 was primarily due to a larger customer base
and a higher number of transaction related customer deposit accounts. The
increase in commission income from sales of noninsured products reflects more
effective cross-selling of these products to the Company's customer base.
57
Further augmenting non-interest income constitutes a primary component
of the Company's business strategy. In 2000, the Company plans to enhance its
results from the sale of non-FDIC insured investment products by reviewing third
party contracts, considering the licensing of additional staff, broadening its
product line, and hiring a new program manager. Also in 2000, the Company plans
to augment customer service charges by reviewing the Bank's fee and service
charge schedule, introducing Internet Banking and electronic bill payment
services, further increasing the number of transaction accounts, installing an
additional off premises ATM, and continuing to increase the proportion of its
customer base using debit cards. Debit card income constituted a growing source
of revenue for the Company in 1999. No assurance can, however, be provided that
the Company will be successful in its plans to increase non-interest income.
General And Administrative Expense
General and administrative expense totaled $11.9 million and $11.1
million, respectively, for the years ended December 31, 1999 and 1998. Factors
contributing to the rise in 1999 included:
o The operation of the Felton branch for all of 1999, versus eight months in
1998.
o The addition of staff to support the Company's greater volumes of loan
origination, loan servicing, and deposit account transactions
o Increased commission expense associated with greater sales of non-FDIC
insured investment products
o Higher incentive payments associated with the Company's sales and financial
success in 1999
o Greater postage and data and item processing costs driven by an increased
volume of transaction deposit accounts
o Non-recurring costs of $86,000 associated with a single operating loss
stemming from the operation of non-qualified benefit plans
The Company anticipates a further increase in general and
administrative costs in 2000 due to:
o the planned continued growth in transaction deposit accounts
o the cost of implementing Internet banking, bill payment, and an additional
off-premises ATM
o the expiration of its existing contract for third party data processing
services
o the hiring of additional key staff positions, including a new Chief
Financial Officer
o increased promotional costs associated with the introduction of new
products and services combined with a special marketing program integrated
with the Company's 75th anniversary
Management plans to moderate the financial impact of the above
increases in general and administrative expenses with greater revenues and
higher productivity in the conduct of the Company's operations. However, no
assurance can be provided that the Company will be successful in this regard.
Income Tax Expense
The Company recorded income tax expense of $2.5 million for the year
ended December 31, 1999 compared to $1.2 million during 1998. This rise was
entirely associated with an increase in pre-tax income in 1999 versus 1998, as
the Company's effective tax rate declined modestly in 1999 versus the prior
year.
58
Comparison Of Financial Condition At December 31, 1999 And December 31, 1998
Total assets of the Company were $462.8 million at December 31, 1999,
compared to $454.0 million at December 31, 1998, an increase of $8.8 million, or
1.9%.
Investment securities declined from $19.4 million at December 31, 1998
to $11.5 million at December 31, 1999 due to sales conducted in order to
generate funding for the Company's increasing loan portfolio. The Company's
investment security portfolio at December 31, 1999 was entirely composed of
variable rate trust preferred securities. To the extent that the Company is
successful with its business strategy in 2000, management anticipates selling
the remainder of these securities in order to bolster the Bank's Qualified
Thrift Lender ratio, shift funds into assets that function as more effective
collateral under secured borrowing arrangements, and provide funds for further
expansion in loans receivable.
Mortgage backed securities declined from $98.1 million at December 31,
1998 to $57.8 million at December 31, 1999. This reduction stemmed from ongoing
principal repayments and $17.6 million in sales. This decrease was accomplished
in conjunction with management's strategy of reducing interest rate risk and
increasing the overall yield of interest-earning assets by selling longer
duration and comparatively lower yielding mortgage backed securities and
reinvesting into shorter duration and higher yielding loans receivable.
Loans receivable held for investment, net of allowances for estimated
loan losses, were $360.7 million at December 31, 1999, compared to $298.8
million at December 31, 1998. This 20.7% increase stemmed from $173.3 million in
originations during 1999, of which the largest category was construction loans
with $61.7 million in new credit commitments. Construction loans net of
undisbursed loan funds rose from $27.4 million at December 31, 1998 to $55.2
million at December 31, 1999, thereby accounting for 31.0% of the overall rise
in net loans receivable accomplished during 1999. Because construction loans are
by nature short term (generally twelve to eighteen months in term), the Company
has become increasingly exposed to fluctuations in the size of its loan
portfolio. More specifically, should higher general market interest rates or
some other factor diminish the demand for new construction lending, the
Company's position in construction loans would thereby likely quickly diminish
as existing projects are completed.
Commercial and industrial real estate loans increased from $40.0
million at December 31, 1998 to $72.3 million at December 31, 1999 in
conjunction with the Company's business strategy. At December 31, 1999,
residential mortgages continued to be the largest single category of the
Company's net loans receivable held for investment, totaling $168.5 million, or
46.7% of the portfolio. This percentage compares to 60.8% one year earlier.
The Company continued to amortize its intangible assets during 1999,
reducing their balance from $3.6 million at December 31, 1998 to $2.9 million
one year later. This amortization, which is a non-cash charge to operations,
bolsters the Bank's regulatory capital ratios, as intangible assets are deducted
from GAAP capital in determining regulatory capital.
During the year ended December 31, 1999, the Company's liabilities
increased by $9.1 million to $422.0 million, from $412.9 million at December 31,
1998. The increase in liabilities was primarily attributable to an increase of
$14.4 million, or 40.9 %, in advances from the FHLB. The increase in advances
was used primarily to fund the growth in loans receivable. None of the Company's
advances at December 31, 1999 were "putable", thereby exposing the Company to
increased funding costs in a rising interest rate environment. Deposits
decreased to $367.4 million at December 31, 1999 from $370.7 million at December
31, 1998, as the Company focused upon changing its deposit mix and reducing its
average cost of deposits in priority over building nominal deposit balances.
59
Shareholders equity declined $0.3 million from $41.1 million at
December 31, 1998 to $40.8 million one year later. The decrease in equity
occurred despite record earnings by the Company, as, during 1999:
o the Company repurchased 116,500 of its outstanding shares, which decreased
shareholders' equity by $1.7 million
o accumulated other comprehensive income declined by $2.0 million due to
reduced market values for the Company's security portfolios, which in turn
stemmed from the increasing interest rate environment and the relatively
high duration of a significant portion of the mortgage backed securities
portfolio
o the Company paid $530,000 in cash dividends
o the Company acquired $682,000 worth of its stock in conjunction with its
non-qualified stock compensation plans
Results Of Operations For The Years Ended December 31, 1998 And December 31,
1997
Overview
The Company recorded net income of $1.4 million, or $0.41 basic
earnings per share ($0.39 diluted earnings per share) for the year ended
December 31, 1998, compared to $1.8 million, or $0.49 basic earnings per share
($0.47 diluted earnings per share) for the year ended December 31, 1997. The
Company's return on average assets for 1998 was 0.33%, compared to 0.43% in
1997. The return on average equity for 1998 was 3.29%, compared with 3.99% in
1997.
Net income for the year ended December 31, 1998 reflected higher net
interest income and non-interest income compared to the year ended December 31,
1997, offset by a higher provision for estimated loan losses and increases in
general and administrative expenses. The operating results of the Company for
the year ended December 31, 1998 reflect the assumption of approximately $30.0
million in deposits and the purchase of an equal amount of loans from Commercial
Pacific Bank, the opening of an eighth branch (Felton), and strong in-market
growth of low cost deposits. Net interest income before provision for estimated
loan losses was $12.3 million for the year ended December 31, 1998, compared to
$11.3 million for the year ended December 31, 1997. During the same periods, the
average volume of interest-earning assets was $416.2 million and $397.5 million,
respectively. The increase in net interest income reflects the growth in higher
yielding loans and mortgage backed securities, funded primarily by growth in
relatively low cost deposits.
The Company has, for the last two years, focused its efforts on
becoming more like a community based commercial bank by increasing its
commercial real estate, construction, multifamily, and business lending
activities. Additionally, the Bank focused its deposit gathering efforts on
low-cost transaction accounts, consisting of checking, savings, and money market
accounts, partly by pursuing small businesses in-market, which complements the
business lending function.
Continued implementation of the Company's strategic decision to
transition from a traditional savings institution to a community banking
orientation, and the expansion of the Company's branch locations and product
lines, resulted in an increase in general and administrative expenses during
1998. Expansion activity included the Company's opening of a branch site in
Felton, California, which began operations as a full service Bank branch in May
1998, and the assumption of approximately $30.0 million in deposits and the
purchase of an approximately equal amount of loans in April 1998 from Commercial
Pacific Bank.
60
Net Interest Income
For the year ended December 31, 1998, the $1.0 million, or 9.4%,
increase in net interest income versus the prior year was primarily due to the
acquisition of approximately $30.0 million in deposits during the second quarter
of 1998, which fueled an increase in the average outstanding balance of mortgage
backed securities and loans receivable. Spreads improved somewhat in 1998 versus
1997, as the Company was then in the earlier stages of implementing its current
business strategy. Net interest income to average total assets expanded from
2.72% in 1997 to 2.84% in 1998.
Interest Income
For the year ended December 31, 1998, interest income was $30.9
million, an increase of $1.2 million, or 4.2%, over the amount recorded for the
year ended December 31, 1997. The primary reason for the increase in interest
income during 1998 was growth in average outstanding balances of mortgage backed
securities and loans receivable, which in turn was fueled by the purchase of
approximately $30.0 million in loans from Commercial Pacific Bank as well as
in-market growth of loans receivable. Interest income on loans receivable, which
accounted for 67.6% of total interest income for the year ended December 31,
1998, grew by $1.1 million in 1998 compared to 1997. The growth in interest
income on loans receivable during 1998 was due to a higher average balance of
outstanding loans receivable and an increase in the average yield earned.
Interest income on mortgage backed securities grew by $0.4 million, for the year
ended December 31, 1998. Interest income from other investment securities and
cash equivalents declined by $0.2 million, for the year ended December 31, 1998,
due to lower average volumes and rates on investment securities in 1998 compared
to 1997.
The weighted average yield on interest-earning assets was 7.43% for the
year ended December 31, 1998, compared to 7.47% for the year ended December 31,
1997. Despite a declining interest rate environment, the average yield on
interest-earning assets declined only 4 basis points in 1998 compared to 1997.
The magnitude of the decline in the yield on interest-earning assets was limited
due to an increase in the average balance of the highest interest-earning
category: loans receivable. The average yield on loans receivable increased 14
basis points, primarily due to the fact that 73% of the loans originated for the
portfolio during 1998 were higher yielding construction, commercial real estate,
multifamily, and business loans. Yields on mortgage backed securities declined
during 1998 due to higher prepayments and a corresponding increase in premium
amortization.
Interest Expense
Interest expense for the year ended December 31, 1998 was $18.6
million, compared to $18.4 million for the year ended December 31, 1997, an
increase of $0.2 million. The increase in interest expense was primarily
attributable to a higher average balance of deposits resulting from the
assumption of approximately $29 million in deposits from Commercial Pacific Bank
and the opening of the Felton branch office. The Company's average cost of
interest-bearing deposits declined to 4.91% in 1998, from 5.03% in 1997,
primarily due to the effects of a more favorable mix of deposits and a lower
interest rate environment. The declining interest rate environment allowed
management to lower, on average, interest rates paid to its customers on
maturing and renewing term deposit accounts. Interest expense on FHLB advances
and other borrowings declined by $0.9 million due to a lower average outstanding
balance of borrowings in 1998.
Provision For Loan Losses
For the year ended December 31, 1998 the provision for loan losses was
$692,000, compared to $375,000 for the year ended December 31, 1997. During
1998, the Company increased its provision for loan losses in connection with
implementing its strategy to increase the amount of construction, commercial
real estate, multifamily, and business lending. These types of loans generally
involve a greater risk of loss than do one-to-four family residential mortgage
loans. The $692,000 provision, as well as the $416,000 of allowance for loan
losses provided on loans acquired from Commercial Pacific Bank, resulted in a
total allowance for loan losses of $2,780,000, or 0.92% of loans receivable, at
December 31, 1998, compared to an allowance for loan losses of $1,669,000, or
0.63% of loans receivable, at December 31, 1997. Non-performing loans were $2.9
million, or 0.96% of gross loans receivable, at December 31, 1998, compared to
$2.0 million, or 0.77% of gross loans receivable, a year earlier.
61
Non-interest Income
Non-interest income increased by 34.9% to $2.2 million for the year
ended December 31, 1998, compared to $1.6 million for the year ended December
31, 1997, primarily due to increases in customer service charges and commissions
from sales of noninsured products during 1998. Customer service charges consist
primarily of service charges on deposit accounts and fees for certain customer
services. The increase in customer service charges in 1998 was primarily due to
a larger customer base, a higher number of transaction-related customer deposit
accounts, and a full year of surcharging foreign ATM cardholders. The increase
in commission income from sales of noninsured products reflects a more effective
job of cross-selling these products to the Company's customer base.
During the years ended December 31, 1998 and 1997, the Company sold
$78.0 million and $38.6 million, respectively, of securities held for sale,
including mortgage backed securities and investment securities, and recorded net
gains of $283,000 and $213,000, respectively, on the sales.
General And Administrative Expense
General and administrative expense was $11.1 million and $9.5 million,
respectively, for the years ended December 31, 1998 and 1997. The increases in
1998 were partially attributable to higher compensation and employee benefits,
as new employees were hired to support the Company's deposit growth and the
expansion of its branch locations and new product lines and services. In
addition, general and administrative expenses for 1998 included higher data
processing costs, increased professional fees and advertising expenses, higher
stationery, telephone, and office expenses.
The increases in certain categories of general and administrative
expenses for the year ended December 31,1998 were partially offset by lower
amortization of core deposit premium and reduced deposit insurance premiums
compared to 1997. Amortization of core deposit premium was $144,000 lower in
1998 and deposit insurance premiums were $94,000 lower, compared to 1997.
Income Tax Expense
The Company recorded income tax expense of $1.2 million for both the years ended
December 31, 1998 and 1997. Income tax expense remained the same in 1998,
compared to 1997, despite a decline in 1998 income before income tax due to an
increase in the effective tax rate in 1998, compared to the previous year. The
effective tax rate for the year ended December 31, 1998 was 46.1%, compared to
41.0% for the year ended December 31, 1997.
Liquidity
Liquidity is actively managed to ensure sufficient funds are available
to meet the ongoing needs of both the Company in general and the Bank in
particular. Liquidity management includes projections of future sources and uses
of funds to ensure the availability of sufficient liquid reserves to provide for
unanticipated circumstances. The Bank's primary sources of liquidity are
deposits, principal and interest payments (including prepayments) on its asset
portfolios, retained earnings, FHLB advances, other borrowings, and, to a lesser
extent, sales of loans originated for sale and securities classified as
available for sale. The Bank's primary uses of funds include loan originations,
customer drawdowns on lines of credit and undisbursed construction loan
commitments, loan purchases, customer withdrawals of deposits, interest paid on
liabilities, and operating expenses. In the year 2000, the Bank intends to
pursue additional sources of liquidity, including the capacity to purchase
federal funds and an expansion in the number of counterparties with whom the
Bank may conduct securities sold under agreements to repurchase transactions.
62
The Bank pledges excess collateral to the FHLB in order to have ready
access to additional liquidity. At December 31, 1999, the Bank maintained
untapped borrowing capacity of approximately $106.8 million at the FHLB. In
addition, at December 31, 1999, the Company owned a significant volume of
unpledged loans and securities which could be used for either liquidation or
secured borrowings in order to meet future liquidity requirements.
From time to time, depending upon its asset and liability strategy, the
Company converts a portion of its residential whole loans into mortgage backed
securities. These conversions provide increased liquidity because the mortgage
backed securities are typically more readily marketable than the underlying
loans and because they can more effectively be used as collateral for
borrowings. During 1998, the Company converted approximately $48.4 million of
its fixed rate residential loans into mortgage backed securities. The Company
did not securitize any portion of its residential mortgages during 1999.
During recent years, the Company's surplus liquidity position has
declined in conjunction with a rise in the Company's ratio of loans to deposits.
This ratio increased from 81.2% at December 31, 1998 to 98.2% at December 31,
1999, as the Company experienced record loan originations during 1999. During
2000, the Bank intends to pursue the acquisition of short term, unsecured lines
of credit from correspondent financial institutions as another source of
liquidity. In addition, the Bank also plans on altering the mix within its
security portfolio in order to generate enhanced borrowing capacity. No
assurance, however, can be provided that the Bank will be successful in these
objectives.
MBBC, as a company separate from the Bank, must provide for its own
liquidity. Substantially all of MBBC's cash inflows are obtained from principal
and interest payments on loans, interest on its security and cash equivalent
positions, repayment of the funds advanced for the ESOP, and dividends declared
and paid by the Bank. There are statutory and regulatory provisions that limit
the ability of the Bank to pay dividends to MBBC. As of December 31, 1999, MBBC
did not have any commitments for capital expenditures or to fund loans. As
discussed under "Item 1. Business - Capital Requirements And Capital
Categories", the Bank was informed by the OTS during the first quarter of 2000
that it would be required to maintain its regulatory capital ratios at levels
equal to or above those reported at December 31, 1999. This additional
regulatory capital requirement may limit the Bank's ability to pay dividends to
MBBC until the requirement is terminated by the OTS.
Throughout 1999, the Bank maintained a regulatory liquidity ratio in
excess of that required by the OTS. The Bank's strategy generally is to maintain
its liquidity ratio slightly above the required minimum in order to maximize its
yield on alternative investments. At December 31, 1999, the Company maintained
$6.8 million in commitments to fund loans. The Company anticipates that it will
have sufficient funds available to meet these commitments, not all of which will
necessarily be drawn upon.
Capital Resources
The Bank's position as a "well capitalized" financial institution under
the PCA regulatory framework is further enhanced by the financial resources
present at the MBBC holding company level. At December 31, 1999, the
consolidated GAAP capital position of the Bank was $34.0 million, while the
consolidated GAAP capital position of the Company was $40.8 million. Note 14 to
the Consolidated Financial Statements provides additional information concerning
the Bank's regulatory capital position, including amounts by which the Bank
exceeds minimum and "well capitalized" thresholds for regulatory capital.
Management believes the Bank's regulatory capital position in 2000 will
continue to benefit from three key factors:
o the continued amortization of intangible assets
o the continued amortization of deferred stock compensation
o the Bank's earnings for the year
63
The potential continued increase in the size of the loan portfolio,
combined with the ongoing planned shift in mix toward construction and
commercial and industrial real estate lending, may result in the Bank's having
higher levels of risk weighted assets during 2000, thereby possibly offsetting
some of the effect of the above three factors upon regulatory capital ratios
incorporating risk weighted assets.
During the first quarter of 2000, the Bank received a letter from the
OTS mandating that the Bank not permit its regulatory capital ratios to decline
below the levels existing at December 31, 1999 (see "Item 1. Business - Credit
Quality - Special Residential Loan Pool" and Note 14 to the Consolidated
Financial Statements). Management does not foresee any significant problem with
this request given the favorable impact of the aforementioned three factors upon
the Bank's regulatory capital.
The Company has conducted share repurchases since 1995. Through
December 31, 1999, the Company had repurchased 1,069,448 shares of its common
stock, leaving 3,422,637 shares then outstanding. During the first quarter of
2000, the Company purchased an additional 120,000 shares in the open market
under its most recently announced share repurchase plan. While these share
repurchases contributed to a reduction in shareholders' equity from $41.1
million at December 31, 1998 to $40.8 million at December 31, 1999, they
provided a beneficial impact upon earnings per share.
The Company paid dividends of $0.15 per share in 1999 and $0.12 per
share in 1998. The board of directors periodically reviews the level of the
Company's dividends, and has historically declared such semi-annually in order
to constrain operating costs. The ability of MBBC to fund additional share
repurchases and to pay dividends in 2000 will depend, in part, upon the
performance of the holding company's loan portfolio and the amount of dividends,
if any, that might be received from the Bank. As previously discussed, due to
additional regulatory capital requirement imposed upon the Bank by the OTS
during the first quarter of 2000, the Bank's ability to pay dividends to MBBC
may be limited until the additional requirement is terminated by the OTS.
Year 2000 Issue
The Year 2000 Issue concerned the potential impact of historic computer
software code that only utilizes two digits to represent the calendar year (e.g.
"99" for "1999"). Software so developed, and not corrected, could produce
inaccurate or unpredictable results commencing on January 1, 2000, when current
and future dates present a lower two digit year number than dates in the prior
century.
The Company experienced no material adverse consequences as a result of
the Year 2000 Issue, either in early January, 2000 or on February 29, 2000
(special leap year date). None of the key vendors or suppliers to the Company
reported significant problems related to the Year 2000 Issue. Through early
March, 2000, the Company was not aware of any customers with significant
borrowings or deposits that experienced material difficulties arising from the
Year 2000 Issue.
The Company maintained various contingency plans related to the Year
2000 Issue. However, none of these plans was activated due to the lack of
problems.
As of December 31, 1999, the Company had incurred (cumulatively)
approximately $36,000 in costs related to the Year 2000 Issue, of which $26,000
were recorded in 1999. These costs, which included software diagnostic tools and
consulting services, were expensed as incurred. These costs did not include the
value of the time allocated by Company employees to Year 2000 Issue related
work. These costs also did not include expenditures for capital investments made
in the normal course of the Company's business (e.g. new personal computers)
that, by nature, provided benefits related to the Year 2000 Issue. The Company's
Year 2000 Issue costs were moderated by the fact that the Company outsources
most of its data and item processing, and therefore did not have extensive
internally developed or maintained software to address. The Company does not
anticipate incurring additional expenses associated with the Year 2000 Issue in
future periods.
64
Certain technology projects, most prominent of which is an Internet
Banking Product, were deferred as a result of the Company's Year 2000 compliance
efforts and concerns about potential resource requirements to deal with various
contingencies related to possible third party or customer problems. However,
these deferrals did not have a material adverse effect upon the Company's
financial condition or results of operations. The Company anticipates
introducing its Internet Banking Product in 2000, utilizing software developed
and maintained by a third party firm.
Impact of Inflation And Changing Prices
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with generally accepted accounting
principles ("GAAP"), which requires the measurement of most financial positions
and operating results in terms of historical dollar amounts without considering
the changes in the relative purchasing power of money over time due to
inflation. Unlike industrial companies, the Company's assets and liabilities are
nearly all monetary in nature. Consequently, relative and absolute levels of
interest rates present a greater impact on the Company's performance and
condition than do the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or to the same extent as the prices
of goods and services. The Company's operating costs, however, are subject to
the impact of inflation, particularly in the case of salaries and benefits
costs, which typically constitute almost one-half of the Company's total general
& administrative expenses. During 1999, relatively low unemployment rates
contributed to increased salary and benefits costs, especially as the Company
sought to continue expanding its loan production while also attracting
experienced financial services industry employees to facilitate and accelerate
its strategic transformation into a community based financial services firm.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The
Statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
securities or contracts, and hedging activities. As originally issued, SFAS No.
133 is effective for all fiscal quarters of fiscal years beginning after June
15, 1999. In July, 1999, the FASB issued SFAS No. 137, Accounting For Derivative
Instruments And Hedging Activities - Deferral Of The Effective Date Of FASB
Statement No. 133. In general, SFAS No. 137 delays for one year the effective
date of SFAS No. 133. The Company anticipates adopting SFAS No. 133 effective
January 1, 2001. Because the Company did not maintain any derivatives at
December 31, 1999, the impact of the adoption of SFAS No. 133 is not expected to
be material.
On January 1, 1999 the Company adopted SFAS No. 134, Accounting For
Mortgage Backed Securities Retained After The Securitization Of Mortgage Loans
Held For Sale By A Mortgage Banking Enterprise. This Statement conforms the
subsequent accounting for securities retained after the securitization of
mortgage loans with the subsequent accounting for securities retained after the
securitization of other types of assets. The primary impact upon the Company is
to permit securities resulting from the securitization of mortgage loans held
for sale to be classified based upon the ability and intent of the Company, in a
manner consistent with SFAS No. 115, Accounting For Certain Investments In Debt
And Equity Securities. The adoption of SFAS No. 134 did not have a material
impact upon the Company's financial condition or results of operations.
65
Item 7a. Quantitative And Qualitative Disclosure Of Market Risk.
The results of operations for financial institutions such as
the Company may be materially and adversely affected by changes in prevailing
economic conditions, including rapid changes in interest rates, declines in real
estate market values, and the monetary and fiscal policies of the federal
government. Interest rate risk ("IRR") and credit risk typically constitute the
two greatest sources of financial exposure for banks and thrifts. For a
discussion of the Company's credit risk, please see "Item 7. Management's
Discussion And Analysis Of Financial Condition And Results Of Operations -
Provision For Loan Losses". The Company utilizes no derivatives to mitigate
either its credit risk or its IRR, instead relying on loan review and adequate
loan loss reserves in the case of credit risk and portfolio management
techniques in the case of IRR. The Company is not significantly exposed to
foreign currency exchange rate risk, commodity price risk, or other market risks
other than interest rate risk.
IRR represents the impact that changes in absolute and relative levels
of general market interest rates might have upon the Company's net interest
income, results of operations, and theoretical liquidation value, also called
net portfolio value ("NPV"). Interest rate changes impact earnings and NPV in
many ways, including effects upon the yields generated by variable rate assets,
the cost of deposits and other sources of funds, the exercise of options
embedded in various financial instruments, and customer demand for and market
supply of different financial assets, liabilities, and positions.
In order to manage IRR, the Company has established an Asset /
Liability Management Committee ("ALCO"), which includes representatives from
senior management and the board of directors. ALCO is responsible for managing
the Company's financial assets and liabilities in a manner which balances
profitability, IRR, and various other risks (e.g. liquidity). ALCO operates
under policies and within risk limits prescribed by and regularly reviewed and
approved by the board of directors.
The primary objective of the Company's IRR management program is to
maximize net interest income while controlling IRR exposure to within prudent
levels. Financial institutions are subject to IRR whenever assets and
liabilities mature or reprice at different times (repricing, or gap, risk),
based upon different capital markets indices (basis risk), for different terms
(yield curve risk), or are subject to various embedded options, such as the
right of mortgage borrowers to refinance their loans when general market
interest rates decline. Companies with high concentrations of real estate
lending, such as the Company, are significantly impacted by prepayment rates on
loans, as such prepayments generally return investable funds to the Company at a
time of relatively lower prevailing general market interest rates.
Decisions to control or accept IRR are analyzed with consideration of
the probable occurrence of future interest rate changes. Stated another way, IRR
management encompasses the evaluation of the likely additional return associated
with an incremental change in the IRR profile of the Company. For example,
having liabilities that mature or reprice faster than assets can be beneficial
when interest rates decline, but may be detrimental when interest rates rise.
Assessment of potential changes in market interest rates and the relative
financial impact to earnings and NPV is used by the Company to help quantify and
manage IRR. As with credit risk, the complete elimination of IRR would curtail
the Company's profitability, as the Company generates a return, in part, through
effective risk management.
The Company monitors its interest rate risk using various analytical
methods that include participation in the OTS net portfolio value interest rate
risk modeling, third party simulation modeling of the Company's balance sheet,
and other analyses and management reports. The Company's exposure to IRR as of
December 31, 1999 was within the limits established by the board of directors.
A common, if analytically limited, measure of financial institution IRR
is the institution's "static gap". Static gap is the difference between the
amount of assets and liabilities (adjusted by off balance sheet positions, if
any) which are expected to mature or reprice within a specified period. A static
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities in a given time period
or cumulatively through that time period. The converse is true for a negative
static gap.
66
The following table presents the maturity and rate sensitivity of
interest-earning assets and interest-bearing liabilities as of December 31,
1999. The "repricing gap" figures in the table reflect the estimated difference
between the amount of interest-earning assets and interest-bearing liabilities
that are contractually scheduled to mature or reprice (whichever occurs first)
during future periods.
At December 31, 1999
-------------------------------------------------------------------------------------
More Than More Than More Than Non-
3 Months 3 Months 1 Year 3 Years Over Interest
Or Less To 1 Year To 3 Years To 5 Years 5 Years Bearing Total
------- --------- ---------- ---------- ------- ------- -----
(Dollars In Thousands)
Assets
- ------
Interest earning cash
equivalents $ 1,103 $ -- $ -- $ -- $ -- $ -- $ 1,103
Investment securities 11,463 -- -- -- -- -- 11,463
Mortgage backed securities 60 -- -- -- 57,716 -- 57,776
Loans receivable, net of LIP 153,116 81,166 33,454 61,905 34,694 -- 364,335
FHLB stock 3,213 -- -- -- -- -- 3,213
--------- -------- -------- -------- -------- -------- --------
Gross interest-earning assets 168,955 81,166 33,454 61,905 92,410 -- 437,890
Less:
Unamortized yield adjustments -- -- -- -- -- (147) (147)
Allowance for loan losses -- -- -- -- -- (3,502) (3,502)
--------- -------- -------- -------- -------- -------- --------
Interest-earning assets 168,955 81,166 33,454 61,905 92,410 (3,649) 434,241
Non-interest-earning assets -- -- -- -- -- 28,586 28,586
--------- -------- -------- -------- -------- -------- --------
Total assets $ 168,955 $ 81,166 $ 33,454 $ 61,905 $ 92,410 $ 24,937 $462,827
========= ======== ======== ======== ======== ======== ========
Liabilities and Equity
NOW accounts $ 31,385 $ -- $ -- $ -- $ -- $ -- $ 31,385
Savings accounts 15,312 -- -- -- -- -- 15,312
Money market accounts 81,245 -- -- -- -- -- 81,245
Certificates of deposit 60,798 122,534 36,156 2,656 -- -- 222,144
--------- -------- -------- -------- -------- -------- --------
Total interest-bearing deposits 188,740 122,534 36,156 2,656 -- -- 350,086
FHLB advances 17,000 -- -- 25,282 7,300 -- 49,582
Other borrowings 2,410 -- -- -- -- -- 2,410
--------- -------- -------- -------- -------- -------- --------
Total interest bearing
liabilities 208,150 122,534 36,156 27,938 7,300 -- 402,078
Non-interest bearing liabilities -- -- -- -- -- 19,946 19,946
Shareholders' equity -- -- -- -- -- 40,803 40,803
--------- -------- -------- -------- -------- -------- --------
Total liabilities and equity $208,150 $122,534 $ 36,156 $ 27,938 $ 7,300 $ 60,749 $462,827
======== ======== ======== ======== ======== ======== ========
Periodic repricing gap (39,195) (41,368) (2,702) 33,967 85,110
Cumulative repricing gap (39,195) (80,563) (83,265) (49,298) 35,182
Periodic repricing gap as a %
of interest earning assets (9.0%) (9.6%) (0.6%) 7.8% 19.6%
Cumulative repricing gap as a
% of interest earning assets (9.0%) (18.6%) (19.2%) (11.4%) 8.2%
Cumulative net interest-earning
assets as a % of cumulative
interest-bearing liabilities 81.2% 75.6% 77.3% 87.5% 108.9%
67
As presented in the prior table, at December 31, 1999, the Company's
cumulative one year and three year static gaps, based upon contractual repricing
and maturities (i.e. ignoring prepayments and other non-contractual factors)
were (18.6%) and (19.2%), respectively, of total interest earning assets. These
figures suggest that net interest income would increase if general market
interest rates were to decline (and vice-versa) , reflecting a "net liability
sensitive" position.
However, static gap analysis such as that presented above fails to
capture material components of IRR, and therefore provides only a limited, point
in time view of the Company's IRR exposure. The assumptions and factors which
are by definition excluded from static gap analysis prepared on a contractual
basis encompass:
o prepayments on assets
o how rate movements and the shape of the Treasury curve, or the LIBOR swap
curve, affect borrower behavior
o that all loans and deposits repricing at a given time will not adjust to the
same degree or by the same magnitude
o that the nature of rate changes for assets and liabilities in the over
one-year category have a greater long term economic impact than those for
shorter term assets and liabilities
o transaction deposit accounts (significant to the Company) do not have
scheduled repricing dates or contractual maturities, and therefore may
respond to interest rate changes differently than other financial
instruments
o potential Company strategic and operating responses to changes in absolute
and relative interest rate levels
o the financial impact of options embedded in various financial instruments
Another measure of IRR, required to be performed by insured depository
institutions regulated by the OTS, is a procedure specified by Thrift Bulletin
13a, "Interest Rate Risk Management". This test measures the impact upon NPV of
an immediate and sustained change in interest rates in 100 basis point
increments. The following table presents the estimated impacts of such changes
in interest rates upon the Company as of December 31, 1999, calculated in
compliance with Thrift Bulletin 13a. However, the results from any cash flow
simulation model are dependent upon a lengthy series of assumptions about
current and future economic, behavioral, and financial conditions, including
many factors over which the Company has no control. These assumptions include,
but are not limited to, prepayment rates on various asset portfolios and decay
rates on core deposits, including savings, checking, and money market accounts.
Because of the uncertainty regarding the accuracy of assumptions utilized and
because such an analytical technique does not contemplate any actions the
Company might undertake in response to changes in interest rates, no assurance
can be provided that the valuations presented in the following table are
representative of what might actually be obtainable. In addition, the following
figures are by definition not indicative of the Company's economic value as a
going concern or of the Company's market value.
Projected Change In
------------------------------------------------------
Change In Interest Rates (In Basis Points) NPV Dollars Percent
- ------------------------------------------ --- ------- -------
(Dollars In Thousands)
+300 $ 39,397 $ (13,851) (26.0%)
+200 44,683 (8,565) (16.1%)
+100 49,718 (3,530) (6.6%)
Base scenario 53,248 -- --
- -100 55,450 2,202 4.1%
- -200 55,552 2,304 4.3%
- -300 55,730 2,482 4.7%
68
The above table results show that the Company's liquidation value is
significantly more sensitive under rising interest rates versus falling interest
rates. Under rising interest rates, the Company's assets experience a
lengthening of duration relative to the liability side, resulting in a reduction
of NPV. This occurs due to the slower prepayment behavior (under rising rates)
the analysis assumed on mortgage related assets, in conjunction with embedded
options such as periodic and lifetime rate adjustment caps on adjustable rate
loans, all of which work to constrain aggregate asset repricing (relative to
liabilities) and reduce NPV. Such results are directionally consistent with the
static gap analysis presented above.
Under falling interest rates, the table results show NPV to have
limited sensitivity, indicating a relatively well-matched balance sheet under
falling rate scenarios. This occurs mainly due to the faster prepayment behavior
(under falling rates) the analysis assumes on mortgage related assets, which
works to accelerate asset repricing (shorten asset duration) to levels matched
by liabilities, causing NPV sensitivity to remain relatively stable under
falling interest rate scenarios.
A technical term for balance sheets which exhibit this IRR profile is
"negatively convex", a description typical of balance sheets containing a
significant percentage of assets related to residential mortgages (in whole loan
or security form). Negatively convex means that that the balance sheet may
suffer comparatively large reductions in NPV when interest rates rise, offset
with relatively small increases in NPV when interest rates fall. In capital
markets, the asymmetric nature of this relationship is typically compensated for
with higher rates of return in the current or "base case" scenario.
A significant portion of the Company's total IRR exposure at December
31, 1999 was concentrated in two asset portfolios: mortgage backed securities
and long term, fixed rate residential mortgages held for investment. Over the
past year, the Company's IRR exposure has been reduced through a combination of
several strategies, including:
o increasing core deposits, particularly checking accounts, as a means of
increasing the weighted average duration of the Company's funding
o originating and retaining variable-rate loans, including those tied to
relatively responsive capital markets indices such as the 1 Year CMT and the
Wall Street Journal Prime Rate
o selling fixed-rate mortgage-backed securities from the available for sale
portfolio to fund loan growth
o selling the new production of fixed rate, residential mortgages into the
secondary market
o continuing to diversify the loan portfolio away from its historic
concentration in residential mortgages towards increased construction and
commercial real estate lending, which typically generates more interest
sensitive, and higher yielding, assets
Despite the Company's IRR management program and the initiatives detailed
above, due to the multiple factors which influence the Company's exposure to
IRR, many of which are beyond the control of the Company, there can be no
assurance that the Company's earnings or economic value will be maintained in
future periods, nor that the Company will be successful in continuing to reduce
its IRR exposure.
69
Item 8. Financial Statements And Supplementary Data.
Index To Consolidated Financial Statements
Page(s)
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Independent Auditors' Report 71
Consolidated Statements Of Financial Condition As Of December 31, 1999 and 1998 (Restated) 72
Consolidated Statements Of Operations For The Years Ended
December 31, 1999, 1998 (Restated), and 1997 (Restated) 73
Consolidated Statements Of Changes In Stockholders' Equity For The Years Ended 74 - 76
December 31, 1999, 1998 (Restated), and 1997 (Restated)
Consolidated Statements Of Cash Flows For The Years Ended
December 31, 1999, 1998, and 1997 77 - 78
Notes To Consolidated Financial Statements 79 - 115
70
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Monterey Bay Bancorp, Inc.
Watsonville, California
We have audited the accompanying consolidated statements of financial condition
of Monterey Bay Bancorp, Inc. and subsidiary (the "Company") as of December 31,
1999 and 1998, and the related consolidated statements of operations, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Monterey Bay Bancorp, Inc. and subsidiary as of December 31, 1999 and 1998, and
the results of their operations and their cash flows, for each of the three
years in the period ended December 31, 1999, in conformity with generally
accepted accounting principles.
As discussed in Note 24, the accompanying 1998 and 1997 financial statements
have been restated.
/s/ Deloitte & Touche LLP
San Francisco, California
February 11, 2000 (March 6, 2000 as to Note 14)
71
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1999 AND 1998
(Dollars In Thousands, Except Per Share Amounts)
- -------------------------------------------------------------------------------------------------------------------
December 31,
----------------------------------
ASSETS 1999 1998
---- ----
(As Restated,
see Note
24)
Cash and cash equivalents (Note 2) $ 12,833 $ 16,951
Securities available for sale, at estimated fair value:
Investment securities (Note 3) 11,463 19,410
Mortgage backed securities (Note 4) 57,716 98,006
Securities held to maturity, at amortized cost:
Mortgage backed securities (Note 4) 60 97
Loans held for sale -- 2,177
Loans receivable held for investment (net of allowances for loan losses of
$3,502 at December 31, 1999 and $2,780 at December 31, 1998) (Note 5) 360,686 298,775
Investment in capital stock of the Federal Home Loan Bank, at cost (Note 8) 3,213 3,039
Accrued interest receivable (Note 6) 2,688 2,537
Premises and equipment, net (Note 9) 7,042 6,316
Core deposit premiums and other intangible assets, net 2,918 3,630
Real estate acquired via foreclosure, net (Note 7) 96 281
Other assets 4,112 2,827
-------- --------
TOTAL ASSETS $462,827 $454,046
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits (Note 10) $367,402 $370,677
Advances from the Federal Home Loan Bank (Note 11) 49,582 35,182
Securities sold under agreements to repurchase (Note 12) 2,410 4,490
Accounts payable and other liabilities 2,630 2,581
-------- --------
Total liabilities 422,024 412,930
-------- --------
Commitments and contingencies (Note 15)
STOCKHOLDERS' EQUITY (Notes 14 and 18)
Preferred stock, $0.01 par value, 2,000,000 authorized; none issued)
Common stock, $0.01 par value, 9,000,000 shares authorized;
4,492,085 issued at December 31, 1999 and December 31, 1998;
3,422,637 outstanding at December 31, 1999 and
3,505,355 outstanding at December 31, 1998 45 45
Additional paid-in capital 28,237 27,826
Retained earnings, substantially restricted 30,473 27,702
Unallocated ESOP shares (1,150) (1,380)
Treasury shares designated for compensation plans, at cost
(126,330 shares at December 31, 1999 and 98,904 shares
at December 31, 1998) (1,376) (951)
Treasury stock, at cost (1,069,448 shares at December 31, 1999 and
986,730 shares at December 31, 1998) (14,257) (12,920)
Accumulated other comprehensive income, net of taxes (Note 17) (1,169) 794
-------- --------
Total stockholders' equity 40,803 41,116
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $462,827 $454,046
======== ========
See Notes to Consolidated Financial Statements
72
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(Dollars In Thousands, Except Per Share Amounts)
- ----------------------------------------------------------------------------------------------------
Year Ended December 31,
---------------------------
INTEREST AND DIVIDEND INCOME: 1999 1998 1997
---- ---- ----
Loans receivable $27,218 $20,882 $19,804
Mortgage backed securities 4,884 6,911 6,510
Investment securities 1,315 3,363 3,118
------- ------- -------
Total interest income 33,417 30,911 29,677
------- ------- -------
INTEREST EXPENSE:
Deposit accounts 15,130 16,628 15,527
FHLB advances and other borrowings 2,258 1,960 2,886
------- ------- -------
Total interest expense 17,388 18,588 18,413
------- ------- -------
NET INTEREST INCOME BEFORE PROVISION
FOR ESTIMATED LOAN LOSSES 16,029 12,323 11,264
PROVISION FOR ESTIMATED LOAN LOSSES 835 692 375
------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR ESTIMATED LOAN LOSSES 15,194 11,631 10,889
------- ------- -------
NON-INTEREST INCOME:
Gains on sale of mortgage backed securities
and investment securities, net 496 283 213
Commissions from sales of noninsured products 626 537 355
Customer service charges 1,032 824 642
Income from loan servicing 84 227 229
Other income 267 306 175
------- ------- -------
Total 2,505 2,177 1,614
------- ------- -------
GENERAL AND ADMINISTRATIVE EXPENSE:
Compensation and employee benefits 5,648 5,310 4,358
Occupancy and equipment 1,173 1,112 1,070
Deposit insurance premiums 164 139 233
Data processing fees 990 833 685
Legal and accounting expenses 423 523 421
Supplies, postage, telephone, and office expenses 601 561 490
Advertising and promotion 310 359 257
Amortization of intangible assets 712 695 839
Other expenses 1,866 1,612 1,154
------- ------- -------
Total 11,887 11,144 9,507
------- ------- -------
INCOME BEFORE INCOME TAX EXPENSE 5,812 2,664 2,996
INCOME TAX EXPENSE (Note 13) 2,511 1,228 1,230
------- ------- -------
NET INCOME $ 3,301 $ 1,436 $ 1,766
======= ======= =======
EARNINGS PER SHARE (Note 16) (1998 and 1997 As Restated, see Note 24):
BASIC EARNINGS PER SHARE $ 1.02 $ 0.41 $ 0.49
======= ======= =======
DILUTED EARNINGS PER SHARE $ 0.99 $ 0.39 $ 0.47
======= ======= =======
See Notes to Consolidated Financial Statements
73
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (1998 and 1997 As Restated, see Note 24)
(Dollars And Shares In Thousands)
- ------------------------------------------------------------------------------------------------------------------------
Shares
Desig-
nated Accum-
For ulated
Addi- Unal- Com- Other
Common Stock tional Re- located pen- Compre-
--------------- Paid-In tained ESOP sation Treasury hensive
Shares Amount Capital Earnings Shares Plans Stoc Income Total
------ ------ ------- -------- ------ ------- ------- ------ --------
Balance At December 31, 1996 4,054 $45 $ 27,106 $ 25,320 $(1,840) $(1,488) $(4,374) $(497) $ 44,272
Purchase of treasury stock (28) (376) (376)
Options exercised using treasury 11 12 108 120
stock
Dividends paid ($0.09 per share) (357) (357)
Amortization of stock
compensation 229 230 278 737
Comprehensive income:
Net income 1,766 1,766
Other comprehensive income:
Change in net
unrealized gain
on securities
available for
sale, net of taxes of $540 760 760
Reclassification adjustment for
Gains on securities available
for sale included
in income,
net of taxes of $(89) (125) (125)
-----
Other comprehensive income, net 635
---
Total comprehensive income 2,401
----- --- -------- -------- ------- ------- ------- ---- --------
Balance at December 31, 1997 4,037 $45 $ 27,347 $ 26,729 $(1,610) $(1,210) $(4,642) $138 $ 46,797
----- --- -------- -------- ------- ------- ------- ---- --------
See Notes to Consolidated Financial Statements
74
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Continued) YEARS
ENDED DECEMBER 31, 1999, 1998 AND 1997 (1998 and 1997 As Restated, see Note 24)
(Dollars And Shares In Thousands)
- ------------------------------------------------------------------------------------------------------------------------
Shares
Desig-
nated Accum-
For ulated
Addi- Unal- Com- Other
Common Stock tional Re- located pen- Compre-
------------ Paid-In tained ESOP sation Treasury hensive
Shares Amount Capital Earnings Shares Plans Stock Income Total
------ ------ -------- -------- ------- ------- ------- ------ --------
Balance At December 31, 1997 4,037 $45 $ 27,347 $ 26,729 $(1,610) $(1,210) $(4,642) $138 $ 46,797
Purchase of treasury stock (567) (8,624) (8,624)
Options exercised using treasury 35 50 346 396
stock
Dividends paid ($0.12 per share) (463) (463)
Amortization of stock
compensation 429 230 259 918
Comprehensive income:
Net income 1,436 1,436
Other comprehensive income:
Change in net
unrealized gain
on securities
available for
sale, net of taxes of $583 822 822
Reclassification
adjustment for
Gains on
securities available
for sale included
in income,
net of taxes of $(118) (166) (166)
-----
Other comprehensive income, net 656
---
Total comprehensive income 2,092
-----
----- --- -------- -------- ------- ----- -------- ---- --------
Balance at December 31, 1998 3,505 $45 $ 27,826 $ 27,702 $(1,380) $(951) $(12,920) $794 $ 41,116
----- --- -------- -------- ------- ----- -------- ---- --------
See Notes to Consolidated Financial Statements
75
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Continued) YEARS
ENDED DECEMBER 31, 1999, 1998 AND 1997 (1998 and 1997 As Restated, see Note 24)
(Dollars And Shares In Thousands)
- -------------------------------------------------------------------------------------------------------------------
Shares
Desig-
nated Accum-
For ulated
Addi- Unal- Com- Other
Common Stock tional Re- located pen- Compre-
------------ Paid-In tained ESOP sation Treasury hensive
Shares Amount Capital Earnings Shares Plans Stock Income Total
------ ------ -------- -------- ------- ----- -------- ------ --------
Balance At December 31, 1998 3,505 $45 $ 27,826 $ 27,702 $(1,380) $(951) $(12,920) $794 $ 41,116
Purchase of treasury stock (116) (1,668) (1,668)
Options exercised using treasury 34 60 331 391
stock
Dividends paid ($0.15 per share) (530) (530)
Amortization of stock
compensation 351 230 257 838
Purchase of stock for stock
compensation plans (682) (682)
Comprehensive income:
Net income 3,301 3,301
Other comprehensive income:
Change in net
unrealized gain
on securities
available for
sale, net of taxes of $(1,168) (1,671) (1,671)
Reclassification
adjustment for
Gains on securities
available
for sale included
in income,
net of taxes of $(204) (292) (292)
-----
Other comprehensive income, net (1,963)
-------
Total comprehensive income 1,338
-----
----- --- -------- -------- ------- -------- -------- ------- --------
Balance at December 31, 1999 3,423 $45 $ 28,237 $ 30,473 $(1,150) $ (1,376) $(14,257) $(1,169) $ 40,803
===== === ======== ======== ======= ======== ======== ======= ========
See Notes to Consolidated Financial Statements
76
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(Dollars In Thousands)
- -------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
-----------------------------------
1999 1998 1997
---- ---- ----
OPERATING ACTIVITIES:
Net income $ 3,301 $ 1,436 $ 1,766
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization of premises and equipment 472 456 440
Amortization of intangible assets 712 695 839
Amortization of purchase premiums, net of accretion of discounts 516 953 573
Amortization of deferred loans fees (293) (233) (243)
Provision for loan losses 835 692 375
Provision for real estate losses 12 -- --
Federal Home Loan Bank stock dividends (174) (202) (242)
Gross ESOP expense before dividends received on unallocated shares 486 555 495
Compensation expense associated with stock compensation plans 297 326 314
Gain on sale of investment and mortgage-backed securities (496) (284) (214)
Gain on sale of real estate acquired via foreclosure (18) (12) --
Loss (gain) on sale of fixed assets 2 (23) 4
Origination of loans held for sale (6,693) (15,886) (3,405)
Proceeds from sales of loans held for sale 8,869 14,223 3,020
Deferred income taxes (743) (279) (692)
(Increase) decrease in accrued interest receivable (151) (197) 217
(Increase) decrease in other assets (1,285) 1,380 (2,051)
Increase in accounts payable and other liabilities 49 459 71
Other, net 1,526 (2,397) (181)
------- ------- -------
Net cash provided by operating activities 7,224 1,662 1,086
------- ------- -------
INVESTING ACTIVITIES:
Net increase in loans held for investment (61,911) (35,025) (30,544)
Purchases of investment securities available for sale (7) (34,643) (21,249)
Proceeds from maturities of investment securities -- 26,344 31,559
Proceeds from sales of investment securities available for sale 8,005 29,976 --
Purchases of mortgage backed securities available for sale -- (102,981) (6,900)
Principal repayments on mortgage backed securities available for sale 19,645 27,913 14,989
Proceeds from sales of mortgage backed securities available for sale 17,643 48,036 38,613
Redemptions (purchases) of FHLB stock, net -- 545 1,900
Purchases of premises and equipment (1,200) (2,352) (374)
Proceeds from the sale of premises and equipment -- 419 --
------- ------- -------
Net cash (used in) provided by investing activities (17,825) (41,768) 27,994
------- ------- -------
See Notes to Consolidated Financial Statements
77
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(Dollars In Thousands)
- -------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
-----------------------------------
1999 1998 1997
---- ---- ----
FINANCING ACTIVITIES:
Net (decrease) increase in deposits (3,275) 50,118 2,414
Proceeds (repayments) of FHLB advances, net 14,400 2,900 (14,525)
Repayments of securities sold under agreements to repurchase, net (2,080) (710) (7,800)
Cash dividends paid to stockholders (530) (463) (357)
Purchases of treasury stock (1,668) (8,624) (376)
Sales of treasury stock 318 322 100
Purchase of stock for stock compensation plans (682) -- --
-------- -------- --------
Net cash provided by (used in) financing activities 6,483 43,543 (20,544)
-------- -------- --------
NET (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS (4,118) 3,437 8,536
CASH & CASH EQUIVALENTS AT BEGINNING OF YEAR 16,951 13,514 4,978
-------- -------- --------
CASH & CASH EQUIVALENTS AT END OF YEAR $ 12,833 $ 16,951 $ 13,514
======== ======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid during the period for:
Interest on deposits and borrowings 17,380 18,957 18,601
Income taxes 3,163 1,037 1,740
SUPPLEMENTAL DISCLOSURES OF NON CASH
INVESTING AND FINANCING ACTIVITIES
Loans transferred to held for investment, at market value 171 -- 69
Mortgage backed securities acquired in exchange for securitized
loans, net of deferred fees -- 47,703 --
Real estate acquired in settlement of loans 376 299 610
See Notes to Consolidated Financial Statements
78
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
- --------------------------------------------------------------------------------
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization And Nature Of Operations
Monterey Bay Bancorp, Inc. ("MBBC") is a unitary savings and loan holding
company incorporated in 1994 under the laws of the state of Delaware. MBBC was
organized to function as the holding company for Monterey Bay Bank (the "Bank")
in connection with the Bank's conversion from the mutual to the stock form of
ownership. On February 14, 1995, MBBC issued and sold 4,492,085 shares of its
common stock at an issuance price of $6.40 per share (figures adjusted for the
July, 1998 stock split as detailed below) to complete the conversion. Net
proceeds to the MBBC, including shares purchased by the employee stock ownership
plan, were $27.1 million, after deduction of conversion expenses and
underwriting fees of $1.6 million. MBBC used $13.5 million of the net proceeds
to acquire all of the stock of the Bank. The Bank owns a subsidiary, Portola
Investment Corporation ("Portola"), which sells various non-FDIC insured
investment products and provides trustee services to the Bank. MBBC, the Bank,
and Portola are hereinafter collectively referred to as the "Company".
The Company's primary business is providing conveniently located branch
facilities to attract checking, money market, savings, and certificate of
deposit accounts, and investing such deposits and other available funds in
various types of loans, including real estate mortgages, business loans,
construction loans, and consumer loans. The Company also provides a range of fee
based services. The Bank's deposit gathering and lending markets are primarily
concentrated in the communities surrounding its full service offices located in
Santa Cruz, Northern Monterey, and Southern Santa Clara Counties, in California.
At December 31, 1999, the Bank maintained eight full service branch offices.
Summary Of Significant Accounting Policies
Basis of Consolidation - The consolidated financial statements include the
accounts of Monterey Bay Bancorp, Inc. and its wholly-owned subsidiary, Monterey
Bay Bank, and the Bank's wholly-owned subsidiary, Portola Investment
Corporation. All significant inter-company transactions and balances are
eliminated in consolidation.
Financial Statement Presentation And Use Of Estimates - The financial statements
have been prepared in accordance with generally accepted accounting principles.
In preparing the financial statements, management is required to make estimates
and assumptions that affect the reported amounts of assets, liabilities, and
contingent assets and liabilities as of the balance sheet dates and revenues and
expenses for the reporting years. Actual results could differ from those
estimates.
Cash And Cash Equivalents - Cash and cash equivalents include cash on hand,
amounts due from banks, federal funds sold, securities purchased under
agreements to resell, certificates of deposit, and United States Treasury
securities with original maturities of 90 days or less.
Securities Available For Sale - Securities to be held for indefinite periods of
time, including securities that management intends to use as part of its asset /
liability management strategy that may be sold in response to changes in
interest rates, loan prepayments, or other factors, are classified as available
for sale as defined under Statement of Financial Accounting Standards No. 115
("SFAS No. 115"), Accounting for Certain Investments in Debt and Equity
Securities. Securities available for sale are carried at estimated fair value.
Gains or losses on the sale of securities are determined using the specific
identification method. Premiums and discounts are recognized in interest income
using the interest method over the period to contractual maturity. Unrealized
holding gains or losses, net of tax, for securities available for sale are
reported as a component of other comprehensive income per SFAS No. 130,
Reporting Comprehensive Income.
Any permanent decline in the fair value of individual securities held to
maturity and securities available for sale below their cost would be recognized
through a write down of the investment securities to their fair value by a
charge to earnings as a realized loss.
79
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Securities Held To Maturity - Securities held to maturity are recorded at
amortized cost, with any premium or discount recognized in interest income using
the interest method over the period to contractual maturity. The Company has the
ability and management has the positive intent to hold these securities to
maturity. The Company designates securities as held to maturity or available for
sale upon acquisition.
Mortgage Backed Securities - The Company's mortgage backed securities include
collateralized mortgage obligations ("CMO's") issued by both federal Agencies
and private entities ("private label CMO's"). Private label CMO's expose the
Company to credit and liquidity risks not typically present in federal Agency
issued securities. Because of these added risks, private label CMO's have
historically paid a greater rate of interest than similar Agency CMO's,
enhancing the yield of the Company's mortgage backed securities portfolio.
Loans Held For Sale - Loans originated and intended for sale in the secondary
market are accounted for under SFAS No. 65, Accounting For Certain Mortgage
Banking Activities, and SFAS No. 125, Accounting For Transfers And Servicing Of
Financial Assets And Extinguishments Of Liabilities. Loans held for sale are
carried at the lower of aggregate cost, including qualified loan origination
costs and related fees, or estimated fair value, grouped by category. Unrealized
losses by category are recognized via a charge against operations. Realized
gains and losses on loans held for sale are accounted for under the specific
identification method. Qualified loan origination fees and costs are retained
and not amortized during the period the loans are held for sale. Transfers of
loans held for sale to the held for investment portfolio are recorded at the
lower of cost or estimated fair value on the transfer date.
Loans Receivable Held For Investment - Loans receivable held for investment are
stated at unpaid principal balances less undisbursed loan funds for
constructions loans, unearned discounts, deferred loan origination fees, and
allowances for estimated loan losses, plus unamortized premiums (including
purchase premiums) and qualified deferred loan origination costs. These loans
are not adjusted to the lower of cost or market because it is management's
intention, and the Company has the ability, to hold these loans to maturity.
Interest Income On Loans - Interest income on loans is accrued and credited to
income as it is earned. However, interest is generally not accrued on loans over
90 days contractually delinquent. In addition, interest is not accrued on loans
that are less than 90 days contractually delinquent, but where management has
identified concern over future collection. Accrued interest income is reversed
when a loan is placed on non-accrual status. Discounts, premiums, and net
deferred loan origination fees are amortized into interest income over the
contractual lives of the related loans using a procedure approximating the
interest method, except when a loan is in non-accrual status. When a loan pays
off or is sold, any unamortized balance of any related premiums, discounts, and
qualified net deferred loan origination fees is recognized in income. Payments
received on non-accrual loans are allocated between principal and interest based
upon the terms of the underlying promissory note.
Sales Of Loans - The Company accounts for sales of loans in accordance with SFAS
No. 125. Gains or losses resulting from sales of loans are recorded at the time
of sale and are determined by the difference between (i) the net sales proceeds
plus the estimated fair value of any interests retained in the loans, such as
loan servicing rights, and (ii) the carrying value of the assets sold. The
difference between the adjusted carrying value of the interests retained and the
face amount of the interests retained is amortized to operations over the
estimated remaining life of the associated loans using a method that
approximates the interest method. The fair value of any interests retained is
periodically evaluated, with any shortfall in estimated fair value versus
carrying amount being charged against operations.
80
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Securitization Of Loans - Effective January 1, 1999, the Company adopted SFAS
No. 134, Accounting For Mortgage-Backed Securities Retained After The
Securitization Of Mortgage Loans Held for Sale By A Mortgage Banking Enterprise.
SFAS No. 134 permits companies that hold mortgage loans for sale to classify
mortgage-backed securities retained in a securitization of such loans as either
held-to-maturity, available for sale, or trading based on the Company's capacity
and management's intent, unless the Company has already committed to sell the
security before or during the securitization process. This guidance is
consistent with the treatment established for investments covered by SFAS 115,
Accounting For Certain Investments In Debt And Equity Securities. The adoption
of SFAS No. 134 did not have a material effect upon the Company.
Troubled Debt Restructured - A loan is considered "troubled debt restructured"
when the Company provides the borrower certain concessions that it would not
normally consider. The concessions are provided with the objective of maximizing
the recovery of the Company's investment. Troubled debt restructured includes
situations in which the Company accepts a note (secured or unsecured) from a
third party in payment of its receivable from the borrower, other assets in
payment of the loan, an equity interest in the borrower or its assets in lieu of
the Company's receivable, or a modification of the terms of the debt including,
but not limited to, (i) a reduction in the stated interest rate to below market
rates, (ii) an extension of maturity at an interest rate or other terms below
market, (iii) a reduction in the face amount of the debt, and / or (iv) a
reduction in the accrued interest receivable.
Impaired Loans - The Company accounts for impaired loans in accordance with SFAS
No. 114, Accounting By Creditors For Impairment Of A Loan, as amended by SFAS
No. 118, Accounting By Creditors For Impairment Of A Loan - Income Recognition
And Disclosures. SFAS No. 114 generally requires all creditors to account for
impaired loans, except those loans that are accounted for at fair value or at
the lower of cost or fair value, at the present value of the expected future
cash flows discounted at the loan's effective interest rate at the date of
initial impairment, or, as a practical expedient, at the loan's observable
market price or fair value of the collateral if the loan is collateral
dependent. SFAS No. 114 indicates that a creditor should evaluate the
collectability of both contractual interest and contractual principal when
assessing the need for a loss accrual.
The Company considers a loan to be impaired when it is deemed probable by
management that the Company will be unable to collect all contractual interest
and contractual principal payments in accordance with the terms of the original
loan agreement. However, when determining whether a loan is impaired, management
also considers the loan documentation, the current ratio of the loan's balance
to collateral value, other sources of repayment, and the borrower's present
financial position. In evaluating whether a loan is considered impaired,
insignificant delays or shortfalls in payments, in the absence of other facts
and circumstances, would not alone lead to the conclusion that a loan is
impaired. The Company includes among impaired loans all loans that (i) are
contractually delinquent 90 days or more, (ii) meet the definition of a troubled
debt restructuring, (iii) are classified in part or in whole as either doubtful
or loss, (iv) the Company has suspended accrual of interest, and (v) have a
specific loss allowance applied to adjust the loan to fair value.
The Company applies the measurement provisions of SFAS No. 114 to all loans in
its portfolio, and utilizes the cash basis method of accounting for payments
received on impaired loans.
Allowances For Loan Losses - Specific valuation allowances are established for
loans that are deemed impaired if the fair value of the loan or the collateral
is estimated to be less than the Company's investment in the loan. In developing
specific valuation allowances, the Company considers (i) the estimated cash
payments expected to be received by the Company, (ii) the estimated net sales
proceeds from the loan or its collateral, (iii) cost of refurbishment, (iv)
certain operating income and expenses, and (v) the costs of acquiring and
holding the collateral. The Company charges off a portion of an impaired loan
against the specific valuation allowance when that portion is deemed probable to
not be recoverable.
81
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
General valuation allowances are maintained at levels that management believes
adequate to cover inherent losses in the loan portfolio and are continually
reviewed and adjusted. The Company adheres to an internal asset review system
and an established loan loss reserve methodology. Management evaluates factors
such as the prevailing and anticipated economic conditions, historic loss
experiences, composition of the loan portfolio by collateral and product types,
levels and trends of criticized and classified loans, and loan delinquencies in
assessing overall valuation allowance levels to be maintained. While management
uses currently available information to provide for estimated losses on loans,
additions to or recoveries from the general valuation allowance may be necessary
based upon a number of factors including, but not limited to, changes in
economic conditions, borrower financial status, the regulatory environment, real
estate values, and loan portfolio size and composition. Many of these factors
are beyond the Company's control and, accordingly, periodic provisions for
estimated loan losses may vary from time to time. In addition, various
regulatory agencies, as an integral part of the examination process,
periodically review the Bank's allowance for estimated loan losses. Such
regulatory agencies may develop judgements different from those of management
and may require the Bank to recognize additional provisions against operations.
Real Estate Owned - Real estate acquired through foreclosure is initially
recorded at the lower of amortized cost or fair value less estimated costs to
sell. If the fair value less estimated costs to sell is less than amortized
cost, a charge against the allowance for estimated loan losses is recorded at
property acquisition. Declines in property fair value less estimated costs to
sell subsequent to acquisition are charged to operations.
Recognition of gains on the sale of real estate is dependent upon the
transaction meeting certain criteria relating to the nature of the property and
the terms of the sale and potential financing. These criteria are presented
within SFAS No. 66, Accounting For Sales Of Real Estate, and Accounting
Principles Board ("APB") No. 21, Interest On Receivables And Payables. Under
certain circumstances, a gain on sale of real estate, or a portion thereof, may
be deferred until the criteria are met. Losses on disposition of real estate,
including expenses incurred in connection with the disposition, are charged to
operations.
Allowances For Real Estate Losses - Allowances for real estate acquired by
foreclosure are established based upon management's estimates of fair value less
costs to sell. Such estimates may change from time to time based upon a number
of factors, including, but not limited to, general economic conditions and the
level of local demand for the specific properties. The Bank's allowances for
real estate assets are also subject to review and adjustment by various
regulatory agencies.
Premises And Equipment - Land is carried at cost. Other premises and equipment
are stated at cost, less accumulated depreciation and amortization. The
Company's policy is to depreciate or amortize premises and equipment on a
straight-line basis over the estimated useful lives of the various assets, and
to amortize leasehold improvements over the shorter of the asset's useful life
or the term of the lease. The useful lives for the principal classes of assets
are:
Asset Useful Life
- ----- -----------
Buildings 30 to 40 years
Leasehold improvements Shorter of term on lease or life of improvement
Furniture and equipment 3 to 10 years
The cost of repairs and maintenance is charged to operations as incurred,
whereas expenditures that improve or extend the service lives of assets are
capitalized.
82
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Impairment Of Long-Lived Assets - The Company periodically evaluates the
recoverability of long-lived assets in accordance with SFAS No. 121, Accounting
For Impairment Of Long-Lived Assets And For Long-Lived Assets To Be Disposed Of.
Long-lived assets and certain identifiable intangibles to be held and used are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of assets may not be recoverable. Determination of
recoverability is based on an estimate of undiscounted future cash flows
resulting from the use of the asset and its eventual disposition. Measurement of
an impairment loss for long-lived assets and identifiable intangibles that
management expects to hold and use are based on the fair value of the asset.
Long-lived assets and certain identifiable intangibles to be disposed of are
reported at the lower of carrying amount or fair value less estimated cost to
sell.
Core Deposit Intangibles - These assets arise from the acquisition of deposits
and are amortized on a straight-line basis over the estimated life of the
deposit base acquired, generally seven years. The Company continually evaluates
the periods of amortization to determine whether later events and circumstances
warrant revised estimates.
Stock Based Compensation - The Company accounts for its stock option and stock
award plans under SFAS No. 123, Accounting For Stock-Based Compensation. This
Statement establishes financial accounting and reporting standards for
stock-based compensation plans. These standards include the recognition of
compensation expense over the vesting period of the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS. No 123 also
permits entities to continue to apply the provisions of APB No. 25, Accounting
For Stock Issued To Employees, and provide pro forma net earnings (loss) and pro
forma net earnings (loss) per share disclosures as if the fair value based
method defined in SFAS No. 123 had been applied. The Company has elected to
continue to apply the provisions of APB No. 25, using the intrinsic value method
of accounting for stock based compensation, and provide the pro forma disclosure
requirements of SFAS No. 123 in the footnotes to its audited financial
statements.
Employee Stock Ownership Plan ("ESOP") - The Company accounts for shares
acquired by its ESOP in accordance with the guidelines established by the
American Institute of Certified Public Accountants Statement of Position 93-6,
Employers' Accounting for Employee Stock Ownership Plans ("SOP 93-6"). Under SOP
93-6, the Company recognizes compensation cost equal to the fair value of the
ESOP shares during the periods in which they become committed to be released. To
the extent that the fair value of the Company's ESOP shares committed to be
released differ from the cost of such shares, the differential is charged or
credited to equity. Employers with internally leveraged ESOPs such as the
Company do not report the loan receivable from the ESOP as an asset and do not
report the ESOP debt from the employer as a liability. The Company's ESOP is a
tax-qualified plan. Non-vested shares owned by the ESOP are accounted for via a
contra-equity account based upon historic cost.
Income Taxes - The Company accounts for income taxes under SFAS No. 109,
Accounting For Income Taxes. Accordingly, deferred tax assets and deferred tax
liabilities are recognized for future tax consequences attributable to temporary
differences between the financial statement carrying amounts of certain existing
assets and liabilities, and their respective bases for Federal income and
California franchise taxes. Deferred tax assets and liabilities are calculated
by applying current effective tax rates against future deductible or taxable
amounts. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in operations in the period that includes the enactment
date. Future tax benefits attributable to temporary differences are recognized
to the extent the realization of such benefits is more likely than not.
Commissions From Sales Of Non-FDIC Insured Products - The Company realizes
commissions from the sales of various non-FDIC insured products, including
mutual funds, annuities, and specific securities, as a result of business
conducted through Portola. Commission income is typically based upon a
percentage of sales. Periodic commission income varies based on the volume and
mix of investment products sold and is recognized as income upon receipt.
Stock Split - In July, 1998, the Company authorized a five for four stock split
thereby increasing the number of issued and outstanding shares. All references
in the accompanying financial statements to the number of common shares and per
share amounts have been restated to reflect the stock split.
83
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Earnings Per Share - The Company follows SFAS No. 128, Earnings Per Share, in
calculating basic and diluted earnings per share. Basic earnings per share
excludes dilution and is computed by dividing net income available to common
shareholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflects the potential dilution that
could occur if contracts to issue common stock or securities convertible into
common stock were exercised or converted. Dilution resulting from the Company's
stock option and stock award plans is calculated per SFAS No. 128 using the
treasury stock method.
Comprehensive Income - On January 1, 1998, the Company adopted SFAS No. 130,
Reporting Comprehensive Income. This Statement requires that all items
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. Comprehensive income includes (i) net income and
(ii) other comprehensive income. The Company's only source of other
comprehensive income is derived from unrealized gains and losses on securities
available for sale. The Company displays comprehensive income within the
consolidated statements of changes in shareholders' equity. Reclassification
adjustments result from gains or losses on securities that were realized and
included in net income of the current period that also had been included in
other comprehensive income as unrealized holding gains or losses in the period
in which they arose. Such adjustments are excluded from current period
comprehensive income in order to avoid double counting. Financial statements for
all prior periods have been restated.
Segment Disclosure - On January 1, 1998, the Company adopted SFAS No. 131,
Disclosures About Segments Of An Enterprise And Related Information, which
establishes annual and interim reporting standards for an enterprise's business
segments and related disclosures about its products, services, geographic areas,
and major customers. This Statement will not impact the Company's consolidated
financial position, results of operations, or cash flows. Because the Company
operates a single line of business (financial services) and manages its
operation under a unified management and reporting structure, no additional
segment disclosures are provided.
Reclassifications - Certain reclassifications have been made to prior period
financial statements to conform them to the current year presentation.
Recent Accounting Developments
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. The Statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other securities or
contracts, and hedging activities. As originally issued, SFAS No. 133 is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
In July, 1999, the FASB issued SFAS No. 137, Accounting For Derivative
Instruments And Hedging Activities - Deferral Of The Effective Date Of FASB
Statement No. 133. In general, SFAS No. 137 delays for one year the effective
date of SFAS No. 133. The Company anticipates adopting SFAS No. 133 effective
January 1, 2001. Because the Company did not maintain any derivatives at
December 31, 1999, the impact of the adoption of SFAS No. 133 is not expected to
be material.
84
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
2. CASH AND CASH EQUIVALENTS
Cash and cash equivalents are summarized as follows:
December 31,
-----------------------------------
1999 1998
---- ----
(Dollars In Thousands)
Cash on hand $ 3,667 $ 1,080
Due from banks 9,066 10,546
Overnight deposits 100 5,325
-------- --------
$ 12,833 $ 16,951
======== ========
3. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are
presented below. All securities held are publicly traded.
December 31, 1999
---------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- ------ ------ --------
(Dollars In Thousands)
Available for sale
Corporate trust preferreds $ 11,456 $ 50 $ (43) $ 11,463
======== ==== ====== ========
December 31, 1998
---------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- ------ ------ --------
(Dollars In Thousands)
Available for sale
Corporate trust preferreds $ 18,658 $ 496 $ -- $ 19,154
FNMA bond 252 4 -- 256
-------- ------ ------ --------
$ 18,910 $ 500 $ -- $ 19,410
======== ====== ====== ========
The following table shows the amortized cost, estimated fair value, and weighted
average yield of the Company's investment securities by year of contractual
maturity. Actual maturities may differ from contractual maturities due to rights
of issuers to call obligations.
December 31, 1999
-----------------------------------------------------------------
Weighted
Amortized Fair Average
Cost Value Yield
---- ----- -----
(Dollars In Thousands)
Due in 2010 and thereafter $ 11,456 $ 11,463 6.83%
======== ======== =====
85
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Proceeds from and realized gains and losses on sales of investment securities
available for sale are summarized as follows:
Year Ended December 31,
-----------------------------------------------------------------
1999 1998 1997
---- ---- ----
(Dollars In Thousands)
Proceeds from sales $ 8,005 $ 29,976 $ --
Gross realized gains on sales 518 48 --
Gross realized losses on sales -- 70 --
4. MORTGAGE BACKED SECURITIES
The amortized cost and estimated fair value of mortgage backed securities are
presented below. All securities held are publicly traded.
December 31, 1999
---------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------- ----- ------- -------
(Dollars In Thousands)
Available for sale
FHLMC certificates $ 1,930 $ -- $ (36) $ 1,894
FNMA certificates 25,132 95 (379) 24,848
GNMA certificates 4,531 -- (96) 4,435
Collateralized mortgage obligations 28,117 -- (1,578) 26,539
------- ----- ------- -------
$59,710 $ 95 $(2,089) $57,716
======= ===== ======== =======
Held to maturity
FNMA certificates $ 60 $ -- $ -- $ 60
======= ===== ======== =======
December 31, 1998
---------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------- ----- ------- -------
(Dollars In Thousands)
Available for sale
FHLMC certificates $ 4,735 $ 28 $ -- $ 4,763
FNMA certificates 32,870 891 (10) 33,751
GNMA certificates 11,927 39 (20) 11,946
Collateralized mortgage obligations 47,626 103 (183) 47,546
------- ----- ------- -------
$97,158 $ 1,061 $ (213) $98,006
======= ======= ======= =======
Held to maturity
FNMA certificates $ 97 $ -- $ (1) $ 96
======= ======= ======= =======
86
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
The following table shows the amortized cost, estimated fair value, and weighted
average yield of the Company's mortgage backed securities by year of contractual
maturity. Actual maturities may differ from contractual maturities due to
principal prepayments or rights of issuers to call obligations.
December 31, 1999
----------------------------------
Weighted
Amortized Fair Average
Cost Value Yield
------- ------- -------
(Dollars In Thousands)
Available for sale
Due in 2005 through 2009 $ 4,693 $ 4,606 6.72%
Due in 2010 and thereafter 55,017 53,110 7.12%
------- ------- -------
$59,710 $57,716 7.09%
======= ======= =======
Held to maturity
Due in 2000 $ 60 $ 60 3.98%
======= ======= =======
Proceeds from and realized gains and losses on sales of mortgage backed
securities available for sale are summarized as follows:
Year Ended December 31,
---------------------------------
1999 1998 1997
------- ------- -------
(Dollars In Thousands)
Proceeds from sales $17,643 $48,036 $38,613
Gross realized gains on sales 30 373 236
Gross realized losses on sales 52 68 23
The Company pledges securities to the Federal Home Loan Bank as collateral for
advances. At December 31, 1999 and December 31, 1998, respectively, mortgage
backed securities with a carrying value of $39.9 million and $86.9 million were
pledged to the Federal Home Loan Bank.
87
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
5. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans receivable at December 31, 1999 and 1998 are summarized as follows:
December 31,
----------------------
1999 1998
--------- ---------
(Dollars In Thousands)
Held for investment:
Loans secured by real estate:
Residential one to four unit $ 168,465 $ 181,771
Multifamily five or more units 42,173 33,340
Commercial and industrial 72,344 39,997
Construction 79,034 51,624
Land 13,930 7,774
--------- ---------
Sub-total loans secured by real estate 375,946 314,506
Other loans:
Home equity lines of credit 3,968 3,262
Loans secured by deposits 385 519
Consumer lines of credit, unsecured 202 138
Business term loans 6,670 6,679
Business lines of credit 1,027 595
--------- ---------
Sub-total other loans 12,252 11,193
Sub-total gross loans held for investment 388,198 325,699
(Less) / Plus:
Undisbursed construction loan funds (23,863) (24,201)
Unamortized purchase premiums, net of purchase discounts 134 491
Deferred loan fees and costs, net (281) (434)
Allowance for estimated loan losses (3,502) (2,780)
--------- ---------
Loans receivable held for investment, net $ 360,686 $ 298,775
========= =========
Held for sale:
Residential one to four unit $ -- $ 2,177
========= =========
88
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
The Company serviced loans for others in the unpaid principal balance amounts
summarized below:
December 31,
-----------------------------------
1999 1998 1997
------- ------- -------
(Dollars In Thousands)
Loans serviced for others $74,225 $75,407 $52,141
Activity in the allowance for loan losses is summarized as follows:
Year Ended December 31,
----------------------------
1999 1998 1997
------- ------- -------
(Dollars In Thousands)
Balance, beginning of year $ 2,780 $ 1,669 $ 1,311
Provision for loan losses 835 692 375
Acquired allowance associated with
Commercial Pacific Bank loans -- 416 --
Charge-offs:
Residential one to four family real estate loans (113) -- (20)
Other consumer loans -- -- (1)
------- ------- -------
Total charge-offs (113) -- (21)
------- ------- -------
Recoveries:
Residential one to four family real estate loans -- 3 4
------- ------- -------
Balance, end of year $ 3,502 $ 2,780 $ 1,669
======= ======= =======
89
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
The following tables summarizes the Company's recorded investment in impaired
loans by type as of December 31, 1999 and 1998:
Accrual Status Non-Accrual Status Total Impaired Loans
------------------------- ------------------------- -------------------------
Specific Specific Specific
Principal Allowances Principal Allowances Principal Allowances
--------- ---------- --------- ---------- --------- ----------
(Dollars In Thousands)
December 31, 1999
Residential one to four
unit $1,294 $ -- $ 543 $ -- $1,837 $ --
Commercial real estate -- -- 1,146 -- 1,146 --
Business term loans -- -- 5,000 200 5,000 200
Business lines of credit -- -- 199 -- 199 --
------ ------ ------ ------ ------ ------
Total $1,294 $ -- $6,888 $ 200 $8,182 $ 200
====== ====== ====== ====== ====== ======
December 31, 1998
Residential one to four
unit $1,483 $ 42 $1,478 $ -- $2,961 $ 42
Multifamily five or more
units 648 20 -- -- 648 20
Land 145 5 -- -- 145 5
------ ------ ------ ------ ------ ------
Total $2,276 $ 67 $1,478 $ -- $3,754 $ 67
====== ====== ====== ====== ====== ======
Additional information concerning impaired loans is as follows:
1999 1998 1997
------ ------ ------
(Dollars In Thousands)
Average investment in impaired loans for the year $2,511 $3,100 $1,300
Interest recognized on impaired loans at December 31 $ 590 $ 166 $ 49
Interest not recognized on impaired loans at December 31 $ 109 $ 76 $ 62
Additional information concerning non-accrual loans is as follows:
1999 1998 1997
---- ---- ----
(Dollars In Thousands)
Interest recognized on non-accrual loans at December 31 $ 80 $ 55 $ 57
==== ==== ====
Interest not recognized on non-accrual loans at December 31 $109 $ 76 $ 62
==== ==== ====
The Company extends loans to executive officers and directors in the ordinary
course of business. An analysis of the activity of these loans is as follows:
Year Ended December 31,
----------------------
1999 1998
------- -------
(Dollars In Thousands)
Balance, beginning of year $ 644 $ 780
New loans and line of credit advances 2 1,104
Repayments (15) (530)
Other -- (710)
------- -------
Balance, end of period $ 631 $ 644
======= =======
90
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Under Office of Thrift Supervision ("OTS") regulations, the Bank may not make
real estate loans to one borrower in an amount exceeding 15% of the Bank's
unimpaired capital and surplus, plus an additional 10% for loans secured by
readily marketable collateral. At December 31, 1999 and 1998, such limitation
would have been approximately $5,329,000 and $4,783,000, respectively.
The majority of the Company's loans are secured by real estate primarily located
in Santa Cruz, Monterey, Santa Clara, and San Benito counties. The Company's
credit risk is therefore primarily related to the economic conditions and real
estate valuations of this region. Loans are generally made on the basis of a
secure repayment source which is based on a detailed cash flow analysis;
however, collateral is generally a secondary source for loan qualification. It
is the Company's policy to originate loans with a loan to value ratio on secured
loans greater than 80% with private mortgage insurance. Management believes this
practice mitigates the Company's risk of loss.
6. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable as of December 31, 1999 and 1998 is summarized as
follows:
December 31,
--------------------
1999 1998
------ ------
(Dollars In Thousands)
Interest receivable on investments $ 159 $ 177
Interest receivable on mortgage backed securities 347 583
Interest receivable on loans 2,182 1,777
------ ------
$2,688 $2,537
====== ======
7. REAL ESTATE ACQUIRED VIA FORECLOSURE
Real estate acquired by foreclosure is summarized as follows:
December 31,
--------------------
1999 1998
----- -----
(Dollars In Thousands)
Residential real estate acquired through foreclosure $ 96 $ 322
Less allowance for estimated real estate losses -- (41)
----- -----
$ 96 $ 281
===== =====
The Company's inventory of foreclosed real estate was comprised of one single
family residence at December 31, 1999, and three single family residences at
December 31, 1998.
91
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
8. INVESTMENT IN CAPITAL STOCK OF THE FEDERAL HOME LOAN BANK
As a member of the Federal Home Loan Bank of San Francisco, the Bank is required
to own capital stock in an amount specified by regulation. As of December 31,
1999 and 1998, the Bank owned 32,131 and 30,393 shares, respectively, of $100
par value FHLB stock. The amount of stock owned meets the most recent annual
regulatory determination.
9. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31, 1999 and 1998:
December 31,
------------------------
1999 1998
------- -------
(Dollars In Thousands)
Land $ 3,213 $ 2,312
Buildings and improvements 4,091 3,953
Equipment 2,340 2,284
------- -------
Total, at cost 9,644 8,549
Less accumulated depreciation (2,602) (2,233)
------- -------
Premises and equipment, net $ 7,042 $ 6,316
======= =======
Depreciation expense was $472,000, $456,000, and $440,000 for the years ended
December 31, 1999, 1998, and 1997, respectively.
92
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
10. DEPOSITS
Deposits as of December 31, 1999 and 1998 are as follows:
(Dollars In Thousands) December 31, December 31,
1999 1998
-------- --------
Demand deposit accounts $ 17,316 $ 18,498
NOW accounts 31,385 18,964
Savings accounts 15,312 15,561
Money market accounts 81,245 60,528
Certificates of deposit < $100,000 169,646 194,669
Certificates of deposit $100,000 or more 52,498 62,457
-------- --------
$367,402 $370,677
======== ========
The following table sets forth the maturity distribution of certificates of
deposit at December 31, 1999:
December 31, 1999
-------------------------------------------
Balance Balance
Less Than $100,000
$100,000 And Over Total
-------- -------- --------
(Dollars In Thousands)
Three months or less $ 47,240 $ 13,558 $ 60,798
Over three through six months 54,963 16,565 71,528
Over six through twelve months 39,838 11,168 51,006
Over twelve months through two years 23,075 10,713 33,788
Over two years through three years 2,106 262 2,368
Over three years 2,424 232 2,656
-------- -------- --------
$169,646 $ 52,498 $222,144
======== ======== ========
At December 31, 1999 and 1998, respectively, total accounts with balances of
$100,000 or greater in deposit products other than certificates of deposit
amounted to $40,809,000 and $29,125,000.
Interest expense on deposits is summarized as follows:
Year Ended December 31,
-----------------------------------
1999 1998 1997
------- ------- -------
(Dollars In Thousands)
NOW accounts $ 388 $ 227 $ 87
Savings accounts 280 278 254
Money market accounts 3,402 1,716 1,344
Certificates of deposit 11,060 14,407 13,842
------- ------- -------
$15,130 $16,628 $15,527
======= ======= =======
93
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
11. ADVANCES FROM THE FEDERAL HOME LOAN BANK
The Bank is a member of the Federal Home Loan Bank ("FHLB") of San Francisco and
borrows from the FHLB through various types of collateralized advances,
including, at various times, bullet, amortizing, and structured advances. Assets
pledged to the FHLB to collateralize advances include the Bank's ownership
interest in the capital stock of the FHLB, investment and mortgage backed
securities, and various types of qualifying whole loans.
A summary of advances from the FHLB and related maturities at December 31, 1999
and 1998 follows:
December 31,
-----------------------
Year Of Maturity 1999 1998
- ---------------- ---- ----
(Dollars In Thousands)
1999 $ -- $ 2,600
2000 17,000 --
2003 25,000 25,000
2004 282 282
2005 1,500 1,500
2006 4,800 4,800
2010 1,000 1,000
------- -------
$49,582 $35,182
======= =======
Weighted average nominal rate 5.65% 5.54%
Additional information concerning advances from the FHLB includes:
Year Ended December 31,
-----------------------------
1999 1998
------- -------
(Dollars In Thousands)
Average amount outstanding during the year $37,600 $28,059
Maximum amount outstanding at any
month-end during the year $49,582 $73,787
Weighted average interest rate during the year 5.53% 5.93%
Collateral pledged to secured advances from the FHLB is comprised of the
following (amortized cost):
December 31,
----------------------
1999 1998
-------- --------
(Dollars In Thousands)
Investment and mortgage backed securities $ 39,922 $ 86,900
Capital stock in the Federal Home Loan Bank 3,213 3,039
Mortgage loans 120,598 134,000
94
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
12. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
From time to time, the Company sells investment and mortgage backed securities
under agreements to repurchase. At December 31, 1999 and 1998, all such
agreements matured in less than one year. The following is a summary of
securities sold under agreements to repurchase during the past two years:
Year Ended December 31,
-------------------------
1999 1998
------ ------
(Dollars In Thousands)
Amount outstanding at the end of the year $2,410 $4,490
Average amount outstanding during the year 3,182 5,007
Maximum amount outstanding at any
month-end during the year 4,350 5,200
Weighted average interest rate during the year 5.65% 5.92%
Weighted average interest rate at the end of the year 6.08% 5.69%
Securities sold under agreements to repurchase are conducted with a limited list
of security dealers approved and monitored by the Company. The lender maintains
possession of the collateral securing these agreements.
13. INCOME TAXES
The components of the provision for income taxes for the years ended December
31, 1999, 1998 and 1997 are as follows:
Year Ended December 31,
-----------------------------------
1999 1998 1997
------- ------- -------
(Dollars In Thousands)
Current tax expense:
Federal $ 2,453 $ 1,150 $ 1,473
State 801 357 449
------- ------- -------
Total current 3,254 1,507 1,922
------- ------- -------
Deferred tax expense:
Federal (605) (244) (566)
State (138) (35) (126)
------- ------- -------
Total deferred (743) (279) (692)
------- ------- -------
Total tax expense $ 2,511 $ 1,228 $ 1,230
======= ======= =======
95
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
A reconciliation from the statutory federal income and state franchise tax rates
to the consolidated effective tax rates, expressed as a percentage of income
before income taxes, follows:
Year Ended December 31,
----------------------------------------
1999 1998 1997
---- ---- ----
(Dollars In Thousands)
Statutory federal income tax rate 34.0% 34.0% 34.0%
California franchise tax, net of federal income tax benefit 7.5% 8.0% 7.1%
Other 1.7% 4.1% (0.1%)
---- ---- ----
Effective income tax rate 43.2% 46.1% 41.0%
==== ==== ====
Deferred income taxes reflect the net tax effects of temporary differences, as
accounted for under SFAS No. 109, between the carrying amount of assets and
liabilities for financial reporting purposes and the amount used for income tax
purposes. Net deferred tax assets are included within other assets on the
consolidated statements of financial condition. The tax effects of temporary
differences that gave rise to significant portions of the deferred tax assets
and liabilities as of December 31, 1999 and 1998 are as follows:
December 31,
------------------
1999 1998
------- -------
(Dollars In Thousands)
Deferred tax assets:
Allowance for loan losses $ 1,115 $ 797
Intangible assets 835 716
Deferred compensation 485 575
Unrealized loss on securities available for sale 818 --
State franchise taxes 40 (10)
Other 172 58
------- -------
Total gross deferred tax assets 3,465 2,136
------- -------
Deferred tax liabilities:
FHLB stock dividends (392) (545)
Unrealized gain on securities available for sale -- (554)
Other (108) (186)
------- -------
Total gross deferred tax liabilities (500) (1,285)
------- -------
Net deferred tax asset $ 2,965 $ 851
======= =======
Legislation regarding bad debt recapture was signed into law by the President
during the third quarter of 1996. The law requires recapture of reserves
accumulated after 1987, and required that the recapture tax on post-1987
reserves be paid over a six year period starting in 1996. The Company will
complete this recapture in 2001.
The Bank maintains a tax bad debt reserve of approximately $5.0 million that
arose in tax years that began prior to December 31, 1987. This tax bad debt
reserve will, in future years, be subject to recapture in whole or in part upon
the occurrence of certain events, including, but not limited to:
o a distribution to stockholders in excess of the Bank's current and
accumulated post-1951 earnings and profits
o distributions to shareholders in a partial or complete redemption or
liquidation of the Bank
o the Bank ceases to be a "bank" or "thrift" as defined under the Internal
Revenue Code
The Bank does not intend to make distributions to stockholders that would result
in recapture of any portion of its tax bad debt reserve if such recapture would
create an additional tax liability. As a result, an associated deferred tax
liability has not been recorded for the $5.0 million pre-1988 tax bad debt
reserve.
96
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
14. REGULATORY CAPITAL REQUIREMENTS AND OTHER REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
result in certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could present a direct material effect upon the
Bank's and the Company's financial statements.
The Financial Institution Reform, Recovery, and Enforcement Act of 1989
("FIRREA") includes regulations that require the Bank to maintain a minimum
regulatory tangible capital ratio (as defined) of 1.50%, a minimum regulatory
core capital ratio (as defined) of 4.00%, and a regulatory risk based capital
ratio (as defined) of 8.00%. The following table presents a reconciliation as of
December 31, 1999 and 1998, between the Bank's capital under generally accepted
accounting principles ("GAAP") and regulatory capital as presently defined under
FIRREA, in addition to a review of the Bank's compliance with the FIRREA
mandated capital requirements:
(Dollars In Thousands)
Tangible Capital Core (Tier One) Capital Risk Based Capital
----------------------- ----------------------- -----------------------
As Of December 31, 1999 Amount Percent Amount Percent Amount Percent
--------- ---------- --------- ---------- --------- ----------
Capital of the Bank presented on a GAAP
basis $ 34,022 $ 34,022 $ 34,022
Adjustments to GAAP capital to derive
regulatory capital:
Net unrealized loss on debt
securities classified as
available for sale 1,123 1,123 1,123
Non-qualifying intangible assets (2,918) (2,918) (2,918)
Qualifying general allowance for
estimated loan losses -- -- 3,302
--------- --------- ---------
Bank regulatory capital 32,227 7.11% 32,227 7.11% 35,529 10.56%
Less FIRREA minimum capital requirement 6,800 1.50% 18,134 4.00% 26,906 8.00%
--------- ---------- --------- ---------- --------- ----------
Regulatory capital in excess of minimums $ 25,427 5.61% $ 14,093 3.11% $ 8,623 2.56%
========= ========== ========= ========== ========= ==========
Additional information:
Bank regulatory total assets $ 453,345
Bank regulatory risk based assets $ 336,323
As Of December 31, 1998
Capital of the Bank presented on a GAAP
basis $ 32,959 $ 32,959 $ 32,959
Adjustments to GAAP capital to derive
regulatory capital:
Net unrealized loss on debt
securities classified as
available for sale (783) (783) (783)
Non-qualifying intangible assets (3,630) (3,630) (3,630)
Qualifying general allowance for
estimated loan losses -- -- 2,563
--------- --------- ---------
Bank regulatory capital 28,546 6.53% 28,546 6.53% 31,109 11.35%
Less FIRREA minimum capital requirement 6,559 1.50% 17,491 4.00% 21,918 8.00%
--------- ---------- --------- ---------- --------- ----------
Regulatory capital in excess of minimums $ 21,987 5.03% $ 11,055 2.53% $ 9,191 3.35%
========= ========== ========= ========== ========= ==========
Additional information:
Bank regulatory total assets $ 437,275
Bank regulatory risk based assets $ 273,975
97
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Federal thrift institutions such as the Bank are also subject to various
provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"). Among these provisions are requirements for prompt corrective action
in the event an insured institution fails to meet certain regulatory capital
thresholds. The prompt corrective action regulations define five specific
capital categories based upon an institution's regulatory capital ratios. These
five capital categories, in declining order, are "well capitalized", "adequately
capitalized", "undercapitalized", "significantly undercapitalized", and
"critically undercapitalized". Institutions categorized as "undercapitalized" or
worse are subject to certain restrictions, including the requirement to file a
capital plan with the OTS, prohibitions on the payment of dividends and
management fees, restrictions on executive compensation, and increased
supervisory monitoring, among other things. Other restrictions may be imposed on
the institution either by the OTS or by the FDIC, including requirements to
raise additional capital, sell assets, or sell the entire institution.
As of December 31, 1999, the most recent notification from the OTS categorized
the Bank as "well capitalized" under the regulatory framework for prompt
corrective action. To be categorized as "well capitalized", the Bank must
maintain minimum core capital, tier one risk based, and total risk based capital
ratios as presented in the following table. There are no conditions or events
since that notification that management believes have changed the Bank's
category.
To Be Well
Capitalized
Under Prompt
For Capital Adequacy Corrective
Actual Purposes Action Provisions
--------------------- ---------------------- ----------------------
As Of December 31, 1999 Amount Ratio Amount Ratio Amount Ratio
- ----------------------- ------ ----- ------ ----- ------ -----
Total Capital (to risk weighted assets) $ 35,529 10.56% $ 26,906 8.00% $ 33,632 10.00%
Tier One Capital (to risk weighted
assets) 32,227 9.58% N/A N/A 20,179 6.00%
Core Capital (to adjusted tangible
assets) 32,227 7.11% 18,134 4.00% 22,667 5.00%
Tangible Capital (to tangible assets) 32,227 7.11% 6,800 1.50% N/A N/A
As Of December 31, 1998
- -----------------------
Total Capital (to risk weighted assets) $ 31,109 11.35% $ 21,918 8.00% $ 27,398 10.00%
Tier One Capital (to risk weighted
assets) 28,546 10.42% N/A N/A 16,439 6.00%
Core Capital (to adjusted tangible
assets) 28,546 6.53% 17,491 4.00% 21,864 5.00%
Tangible Capital (to tangible assets) 28,546 6.53% 6,559 1.50% N/A N/A
The above figures for December 31, 1999 reflect a 100% risk-based capital
category classification for a specific portfolio of residential mortgage loans,
as discussed below.
Management believes that, under current regulations, the Bank will continue to
meet its minimum capital requirements in the coming year. However, events beyond
the control of the Bank, such as changing interest rates or a downturn in the
economy and / or real estate markets where the Bank maintains most of its loans,
could adversely affect future earnings and, consequently, the ability of the
Bank to meet its future minimum regulatory capital requirements.
OTS rules impose certain limitations regarding stock repurchases and
redemptions, cash-out mergers, and any other distributions charged against an
institution's capital accounts. The payment of dividends by Monterey Bay Bank to
Monterey Bay Bancorp, Inc. is subject to OTS regulations. "Safe-harbor" amounts
of capital distributions can be made after providing notice to the OTS, but
without needing prior approval. For Tier 1 institutions such as the Bank, the
safe harbor amount is the greater of (1) net income earned during the year or
(2) the sum of net income earned during the year plus one-half of the
institution's capital in excess of the OTS capital requirement as of the end of
the prior year. Distributions beyond these amounts are allowed only with the
specific, prior approval of the OTS. An additional requirement by the OTS that
the Bank not permit any reduction in its regulatory capital ratios from their
levels of December 31, 1999 until notification is received from the OTS may
constrain the Bank's ability to pay dividends to MBBC during 2000.
98
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Special Residential Loan Pool
During 1998, the Bank purchased a $40.0 million residential mortgage pool
comprised of loans that presented a borrower credit profile and / or a loan to
value ratio outside of (less favorable than) the Bank's normal underwriting
criteria. To mitigate its credit risk for this portfolio, the Bank obtained a
scheduled principal and scheduled interest loan servicing agreement from the
seller. Further, this agreement also contained a warranty by the seller to
absorb any principal losses on the portfolio in exchange for the seller's
retention of a portion of the loans' yield through loan servicing fees. In
obtaining these credit enhancements, the Bank functionally aggregated the credit
risk for this loan pool into a single borrower credit risk to the seller /
servicer of the loans. The Bank was subsequently informed by the OTS that
structuring the purchase in this manner made the transaction an "extension of
credit" by the Bank to the seller / servicer, which, by virtue of its size,
violated the OTS' "Loans To One Borrower" regulation.
Following conversations with the OTS, the Bank independently conducted a new
underwriting of each of the pool's residential mortgage loans. Based upon this
new underwriting, appreciation in underlying property values, and continued
payment performance by a vast majority of the borrowers, the majority of the
residential loan pool was, from a regulatory standpoint, reclassified as no
longer dependent upon the warranty of the seller / servicer for repayment and
therefore did not comprise a loan to one borrower.
At December 31, 1999, the outstanding principal balance of this mortgage loan
pool was $33.8 million, net of $1.2 million in December payoffs receivable from
the servicer, of which $7.1 million was still classified as dependent on the
warranty of the seller / servicer for repayment. This $7.1 million in loans
still exceeded the Bank's loans to one borrower limit of $5.3 million at
December 31, 1999. Because the residential loans contain a substantial upward
rate reset feature in the year 2000, the Company anticipates that the pool will
continue experiencing prepayments and thereby eventually fall below the Bank's
loan to one borrower limitation. The Bank continues to report to the OTS in this
regard on a monthly basis.
Through December 31, 1999, the seller / servicer performed per the loan
servicing agreement, making scheduled principal and interest payments to the
Bank while also absorbing all credit losses on the loan portfolio. Management
believes that the seller / servicer has both the capacity and intent to continue
performing per the terms of the loan servicing agreement and therefore does not
anticipate realizing credit losses on this residential mortgage pool.
In conjunction with this Special Residential Loan Pool, on March 6, 2000, the
Bank received a letter from the OTS mandating that the Bank (i) assign all of
the loans in the pool a 100% risk based capital weighting, and (ii) not permit
its regulatory capital ratios to decline below the levels existing at December
31, 1999. Management does not foresee any significant problem with this request
given the Bank's continued generation of regulatory capital through retained
earnings, the amortization of deferred stock compensation, and the amortization
of intangible assets.
99
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES
The Company is involved in legal proceedings arising in the normal course of
business. In the opinion of management, the outcomes of such proceedings should
not have a material adverse effect on the Company's financial position or
results of operations.
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments represent commitments to originate fixed and
variable rate loans, letters of credit, lines of credit, and loans in process,
and involve, to varying degrees, elements of interest rate risk and credit risk
in excess of the amount recognized in the Consolidated Statements of Financial
Condition. The Company uses the same credit policies in making commitments to
originate loans, lines of credit, and letters of credit as it does for
on-balance sheet instruments.
At December 31, 1999, the Company had outstanding commitments to originate $6.8
million of real estate loans, including $433,000 for fixed rate loans and $6.33
million for adjustable rate loans. Commitments to fund loans are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Commitments generally have expiration dates or other
termination clauses. In addition, external market forces may impact the
probability of commitments being exercised; therefore, total commitments
outstanding do not necessarily represent future cash requirements.
At December 31, 1999, the Company had made available various business, personal,
and residential lines of credit totaling approximately $8.5 million, of which
the undisbursed portion was approximately $4.4 million.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. At December 31, 1999,
the Company maintained outstanding letters of credit totaling $2.0 million
compared to $4.1 million at December 31, 1998.
At December 31, 1999, 1998, and 1997, the Company was obligated under
non-cancelable operating leases for office space. Certain leases contain
escalation clauses providing for increased rentals based primarily on increases
in real estate taxes or on the average consumer price index. Rent expense under
operating leases, included in occupancy and equipment expense, was approximately
$121,000, $170,000, and $147,000 for the years ended December 31, 1999, 1998,
and 1997, respectively. The decline in rent during 1999 stemmed from the
Company's purchase of the portion of the Monterey Branch facility not previously
owned.
Certain branch offices are leased under the terms of operating leases expiring
at various dates through the year 2005. At December 31, 1999, future minimum
rental commitments under non-cancelable operating leases were as follows:
(Dollars In Thousands)
2000 $ 126
2001 126
2002 126
2003 102
2004 59
Thereafter 29
-----
Total $ 568
=====
The Company and Bank have negotiated an employment agreement with the President.
The employment agreement provides for the payment of severance benefits upon
termination. The Company and Bank also maintain change in control agreements
with six executive officers. These agreements result in severance payments
following certain events associated with a change in control of the Bank or
Company.
100
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
16. EARNINGS PER SHARE
The Company calculates Basic and Diluted Earnings Per Share ("EPS") in
accordance with SFAS No. 128, Earnings Per Share. Basic EPS are computed by
dividing net income available to common stockholders by the weighted average
number of common shares outstanding during each period. During the years 1997
through 1999, all of the Company's net income was available to common
stockholders. The weighted average number of common shares outstanding for the
Company is decreased in each reporting period by:
o shares associated with the Company's ESOP which have not been committed to
be released, in conformity with the American Institute of Certified Public
Accountants ("AICPA") Statement of Position 93-6, Employers' Accounting For
Employee Stock Ownership Plans
o shares associated with the Company's stock grant programs for Officers and
Directors which are not vested to Plan participants
o the weighted average number of Treasury shares maintained by the Company
during each period
The computation of Diluted EPS also considers, via the treasury stock method of
calculation, the impact of shares issuable upon the assumed exercise of
outstanding stock options (both incentive stock options and non-statutory stock
options) and stemming from the grant of time-based stock awards under the
Company's associated Plans for officers and directors. Per SFAS No. 128, no
anti-dilutive calculations are permitted and diluted share counts are applicable
only in the event of positive earnings. For the years 1997 through 1999, there
was no difference in the Company's income applicable to basic and diluted
earnings per share.
The following table reconciles the calculation of the Company's Basic and
Diluted EPS for the periods indicated.
For The Year Ended December 31,
---------------------------------------------------------
(In Whole Dollars And Whole Shares) 1999 1998 1997
----------- ----------- -----------
Net income $ 3,301,000 $ 1,436,000 $ 1,766,000
=========== =========== ===========
Average shares issued 4,492,085 4,492,085 4,492,085
Less weighted average:
Uncommitted ESOP shares (197,657) (233,594) (269,531)
Non-vested stock award shares (88,689) (118,630) (144,742)
Treasury shares (974,577) (638,123) (445,264)
----------- ----------- -----------
Sub-total (1,260,923) (990,347) (859,537)
----------- ----------- -----------
Weighted average BASIC shares outstanding 3,231,162 3,501,738 3,632,548
Add dilutive effect of:
Stock options 83,730 125,536 116,933
Stock awards 5,286 11,419 13,557
----------- ----------- -----------
Sub-total 89,016 136,955 130,490
----------- ----------- -----------
Weighted average DILUTED shares outstanding 3,320,178 3,638,693 3,763,038
=========== =========== ===========
Earnings per share:
BASIC $ 1.02 $ 0.41 $ 0.49
=========== =========== ===========
DILUTED $ 0.99 $ 0.39 $ 0.47
=========== =========== ===========
101
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
17. OTHER COMPREHENSIVE INCOME
Reclassification adjustments, as defined by SFAS No. 130, for the change in net
gains (losses) included in other comprehensive income from investment and
mortgage backed securities classified as available for sale under SFAS No. 115
during the past three years are summarized as follows:
Year Ended December 31,
---------------------------
1999 1998 1997
----- ----- -----
(Dollars In Thousands)
Gross reclassification adjustment $ 496 $ 284 $ 214
Tax expense (204) (118) (89)
----- ----- -----
Reclassification adjustment, net of tax $ 292 $ 166 $ 125
===== ===== =====
A reconciliation of the net unrealized gain or loss on available for sale
securities recognized in other comprehensive income is as follows:
Year Ended December 31,
-----------------------------
1999 1998 1997
------- ------- -------
(Dollars In Thousands)
Holding (loss) gain arising during the year, net of tax $(1,671) $ 822 $ 760
Reclassification adjustment, net of tax (292) (166) (125)
------- ------- -------
Net unrealized (loss) gain recognized in other comprehensive income $(1,963) $ 656 $ 635
======= ======= =======
102
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
18. STOCK BENEFIT PLANS
Stock Option Programs - On August 24, 1995, the stockholders of the Company
approved the 1995 Incentive Stock Option Plan (the "Stock Option Plan"). Under
the Stock Option Plan, the Company may grant to officers of the Company and its
affiliate, the Bank, both nonstatutory and incentive stock options, as defined
under the Internal Revenue Code, to purchase shares of the Company's common
stock. Each option entitles the holder to purchase one share of the common stock
at the fair market value of the common stock on the date of grant. The Stock
Option Plan provides that options granted thereunder begin to vest one year
after the date of grant ratably over five years and expire no later than ten
years after the date of grant. However, all options become 100% exercisable in
the event that the employee terminates his employment due to death, disability,
or, to the extent not prohibited by the OTS, in the event of a change in control
of the Company or the Bank.
The Company also maintains the 1995 Stock Option Plan for Outside Directors (the
"Directors' Option Plan"), approved by the stockholders of the Company on August
24, 1995. Under the Directors' Option Plan, directors who are not officers or
employees of the Company or Bank may be granted nonstatutory stock options to
purchase shares of the Company's common stock. Each option entitles the holder
to purchase one share of the common stock at the fair market value of the common
stock on the date of grant. Options begin to vest one year after the date of
grant ratably over five years and expire no later than ten years after the date
of grant. However, all options become 100% exercisable in the event that the
Director terminates membership on the board of directors due to death,
disability, or, to the extent not prohibited by the OTS, in the event of a
change in control of the Company or the Bank.
The Company applies Accounting Principles Board ("APB") Opinion No. 25 and
related interpretations in accounting for stock options. Under APB No. 25,
compensation cost for stock options is measured as the excess, if any, of the
fair market value of the Company's stock at the date of grant over the amount
the employee or director must pay to acquire the stock. Because the Company's
stock option Plans provide for the issuance of options at a price of no less
than the fair market value at the date of grant, no compensation cost has been
recognized for the stock option Plans.
Had compensation costs for the stock option Plans been determined based upon the
fair value at the date of grant consistent with SFAS No. 123, Accounting For
Stock Based Compensation, the Company's net income and earnings per share would
have been reduced to the pro forma amounts indicated below. The pro forma
amounts presented below were calculated utilizing the Black-Scholes option
pricing model, incorporating the assumptions detailed on the following page.
Year Ended December 31,
---------------------------------------
1999 1998 1997
---- ---- ----
(Dollars In Thousands, Except Share Data)
Net income:
As reported $ 3,301 $ 1,436 $ 1,766
Pro forma $ 3,022 $ 1,177 $ 1,538
Basic earnings per share:
As reported $ 1.02 $ 0.41 $ 0.49
Pro forma $ 0.94 $ 0.34 $ 0.42
Diluted earnings per share:
As reported $ 0.99 $ 0.39 $ 0.47
Pro forma $ 0.91 $ 0.32 $ 0.41
Shares utilized in Basic EPS calculations 3,231,162 3,501,738 3,632,548
Shares utilized in Diluted EPS calculations 3,320,178 3,638,693 3,763,038
103
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
The original volume of stock options approved under the Plans in 1995 was
449,687 shares. Pursuant to the terms of the Plans, the Board of Directors
authorized increases in allowable shares of 28,123 in 1998 and 34,226 in 1999,
bringing the total options authorized to 512,036 at December 31, 1999.
The status of the stock options under the associated Plans as of December 31,
1999, 1998, and 1997, and changes during the years then ended, consist of the
following:
December 31,
------------------------------------------------------------------------------
1999 1998 1997
--------------------- ---------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Options outstanding at the
beginning of the year 418,311 $ 9.19 381,279 $ 9.21 443,757 $ 9.19
Granted 5,000 $ 14.75 85,498 $ 14.90 -- --
Canceled 26,932 $ 13.59 13,117 $ 9.10 51,459 $ 9.10
Exercised 33,782 $ 9.40 35,349 $ 9.10 11,019 $ 9.10
------- ------- -------
Options outstanding at the
end of the year 362,597 $ 10.30 418,311 $ 10.38 381,279 $ 9.21
======= ======= =======
Options exercisable at year end 239,853 $ 9.51 191,569 $ 9.19 151,642 $ 9.15
Weighted average remaining
contractual life of options
outstanding at year end 6.2 years 7.3 years 7.7 years
Weighted average information
for options granted during
the year:
Fair value $ 7.76 $ 7.74 --
Assumptions utilized in the
Black-Scholes option-pricing
model:
Dividend Yield 1.00% 1.00% --
Expected stock price volatility 45.00% 45.00% --
Risk-free interest rate 5.73% 6.49% --
Expected option lives 8 years 8 years --
Options available for future
grants 69,289 13,131 57,389
On January 26, 2000, 40,000 options for the purchase of shares were granted at
the then current market price of Monterey Bay Bancorp, Inc. common stock
($10.125), thereby leaving 29,289 shares available for future option grants.
104
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
The following table summarizes information about the stock options outstanding
at December 31, 1999:
Weighted
Average
Remaining
Exercise Number Life Number
Price Outstanding In Years Exercisable
- ----- ----------- -------- -----------
$ 9.10 281,816 5.7 218,836
$10.70 9,658 6.5 5,794
$16.60 7,373 8.2 1,473
$14.80 58,750 8.5 13,750
$14.75 5,000 9.5 0
------- --- -------
$9.10 - $16.60 362,597 6.2 239,853
======= === =======
Stock Award Programs - The Company maintains a Performance Equity Program
("PEP") for Officers and a Recognition and Retention Plan for Outside Directors
("RRP"). The purpose of the stock award plans is to provide Directors and
Officers with a proprietary interest in the Company in a manner designed to
encourage such persons to remain with the Company and to improve the financial
performance of the Company.
The Bank contributed $1.7 million from available liquid assets during the fourth
quarter of 1995 and the first quarter of 1996 to purchase 179,687 shares in the
open market at a weighted average cost of $9.62 per share. This contribution is
initially recorded as a reduction in stockholders' equity and then is ratably
charged to compensation over the vesting period of the actual stock awards. Of
the 179,687 shares acquired, 38,010 were allocated to the RRP, with the
remaining 141,677 allocated to the PEP.
The PEP provides for two types of stock awards: time-based grants and
performance-based grants. Time-based grants vest pro-rata on each anniversary of
the grant date and become fully vested over the applicable time period as
determined by the board of directors, typically five years. Vesting of
performance-based grants is dependent upon achievement of criteria established
by the board of directors for each stock award. Under the RRP, outside directors
of the Company receive exclusively time-based grants.
All stock awards granted will be immediately vested in the event the recipient
terminates his employment due to death, disability, or a change in control of
Monterey Bay Bank or Monterey Bay Bancorp, Inc. In the event the award recipient
terminates his employment due to any reason other than death, disability, or a
change in control, all unvested stock awards become null and void. In addition,
to the extent that criteria for performance-based stock awards are not achieved,
associated awards are forfeited and become available for re-issuance.
Periodic operating expense for time-based stock awards is recognized based upon
fair market value at date of grant. Periodic operating expense for
performance-based stock awards is recognized based upon fair market value at the
earlier of the reporting date or the performance measurement date.
105
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
A summary of the status of the PEP as of December 31, 1999, 1998, and 1997, and
changes and related expense during the years ended on those dates, is presented
below:
1999 1998 1997
--------- --------- ---------
Stock awards outstanding at the beginning of the year 56,772 71,503 102,628
Stock award activity during the year:
Time based shares granted -- 14,000 --
Performance based shares granted -- -- --
Time based shares canceled (1,450) (1,798) (4,992)
Performance based shares canceled (4,781) (6,276) (4,790)
Time based shares vested (12,668) (11,095) (11,095)
Performance based shares vested (7,009) (9,562) (10,248)
--------- --------- ---------
Stock awards outstanding at the end of the year 30,864 56,772 71,503
========= ========= =========
Available for future awards at the end of the year 31,775 25,544 31,470
========= ========= =========
PEP compensation expense (In Whole Dollars) $ 227,093 $ 259,397 $ 248,972
========= ========= =========
On January 26, 2000, 15,000 PEP shares were awarded, thereby leaving 16,775
available for future grants.
A summary of the status of the RRP as of December 31, 1999, 1998, and 1997, and
changes and related expense during the years ended on those dates, is presented
below:
1999 1998 1997
-------- -------- --------
Stock awards outstanding at the beginning of the year 16,588 18,661 30,408
Stock award activity during the year:
Time based shares granted 0 4,146 0
Time based shares canceled 0 0 (4,146)
Time based shares vested (7,047) (6,219) (7,601)
-------- -------- --------
Stock awards outstanding at the end of the year 9,541 16,588 18,661
======== ======== ========
Available for future awards at the end of the year 0 0 4,146
======== ======== ========
RRP compensation expense (In Whole Dollars) $ 70,042 $ 66,594 $ 64,620
======== ======== ========
106
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Employee Stock Ownership Plan and Trust - The Company established for eligible
employees an Employee Stock Ownership Plan and Trust ("ESOP"), which became
effective upon the conversion of the Bank from a mutual to a stock association.
Eligible full-time employees employed with the Bank who have been credited with
at least 1,000 hours during a twelve month period, have attained age twenty-one,
and were employed on the last business day of the calendar year are eligible to
participate.
The ESOP subscribed for 8.0% (or 359,375) of the shares of Company common stock
issued in the Conversion at an adjusted price of $6.40 per share. On February
14, 1995, the ESOP borrowed $2.3 million from Monterey Bay Bancorp, Inc. in
order to fund the purchase of common stock. This loan is to be repaid pro-rata
over an approximately ten year period concluding on December 31, 2004, with the
funds for repayment sourced primarily from the Bank's contributions to the ESOP
over a similar time period. The loan is collateralized by the shares of common
stock held by the ESOP.
As an internally leveraged ESOP, no interest income or interest expense is
recognized on the loan in the consolidated financial statements of the Company.
Annual principal payments of $230,000 are scheduled for the conclusion of each
calendar year in conjunction with a release of shares for allocation to
individual employee accounts. Shares are allocated on the basis of eligible
compensation, as defined in the ESOP plan document, in the year of allocation.
Benefits generally become 100% vested after seven years of credited service.
Employees with at least three, but fewer than seven, years of credited service
receive a partial vesting according to a sliding schedule. However, in the event
of retirement, disability, or death, any unvested portion of benefits shall vest
immediately. Any share forfeitures are allocated among participating employees
in the same proportion as annual share allocations. Benefits are payable upon
separation from service based on vesting status and share allocations made.
As of December 31, 1999, 179,687 shares were allocated to participants and
committed to be released. As of December 31, 1999, the fair market value of the
179,688 unearned shares was $1.8 million based upon a closing market price per
share of $10.125.
Periodic operating expense associated with the ESOP is recognized based upon:
o the number of Company common shares pro-rata allocated
o the fair market value of the Company's common stock at the dates shares are
committed to be released
o any dividends received on unallocated shares as a reduction to periodic
operating expense
The benefits expenses, not including administrative costs, related to the ESOP
for the years ended December 31, 1999, 1998, and 1997 were $454,000, $526,000,
and $468,000, respectively. At December 31, 1999 and 1998, the unearned
compensation related to the ESOP was $1.15 million and $1.38 million,
respectively. These amounts are shown as a reduction of stockholders' equity in
the accompanying Consolidated Statements Of Financial Condition.
19. 401(K) PLAN
The Company maintains a tax deferred employee savings plan under Section 401(k)
of the Internal Revenue Code. All employees are eligible to participate who are
21 years of age, have been employed by the Company for 90 days, and are
scheduled to complete 1,000 hours of service or more per calendar year. The
Company does not provide periodic or matching contributions to the 401(k) Plan.
However, the Plan contains a profit sharing component under which the Company
may elect to contribute. Through December 31, 1999, the Company has not made
such an election.
The trust that administers the 401(k) Plan maintained assets of approximately
$1.9 million and $1.6 million at other financial institutions as of December 31,
1999 and 1998, respectively.
107
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
20. OFFICERS SALARY CONTINUATION PLAN
The Company historically maintained a non-qualified Salary Continuation Plan for
the benefit of certain officers of the Bank. Officers participating in the Plan
are entitled to receive a fixed monthly payment for a period of ten years upon
retirement. The Plan provides that payments will be accelerated upon the death
of the Participant or in the event of a change in control of Monterey Bay
Bancorp, Inc. or Monterey Bay Bank. The Plan was closed to new participants in
1999. In addition, during 1999, the Plan was amended to allow participants to
make an irrevocable election to convert their benefits into shares of Company
common stock.
As a non-qualified Plan, no Company assets are segregated to meet the future
obligations of the Company. The Plan participants are general creditors of the
Company.
At December 31, 1999, there were three remaining participants in the Plan. One
of these participants elected to convert their benefit to Company stock. At
December 31, 1999, the Company maintained 3,098 shares in conjunction with its
future obligations to this participant under the Plan. At December 31, 1999, the
Company maintained an accrued liability of $256,000 in conjunction with its cash
payment obligations to the other two participants in the Plan, both of whom are
currently receiving periodic benefits. This figure represents the present value
of the future payments committed to by the Company discounted at 7.0%. At
December 31, 1998, the Company maintained an accrued liability of $328,000 for
the future cash benefits payable under the Plan, which included the liability
for the participant who elected to convert their benefits to shares of common
stock during 1999. Periodic expense associated with the Plan was $44,000 in
1999, $19,000 in 1998, and $14,000 in 1997. Such expense amounts approximated
the computed actuarial net periodic Plan costs for each period.
21. DIRECTORS RETIREMENT PLAN
The Company historically maintained a non-qualified Directors Retirement Plan
for the benefit of certain directors of the Bank. Under this Plan, directors of
the Bank who have served on the board of directors for a minimum of nine years
are entitled to receive a quarterly payment equal to the amount of the quarterly
retainer fee in effect at the date of retirement, continuing for a period of ten
years. The Plan provides that payments will be accelerated upon the death of the
participant or in the event of a change in control of the Monterey Bay Bancorp,
Inc. or Monterey Bay Bank. The Plan was closed to new participants in 1999. In
addition, during 1999, the Plan was amended to allow participants to make an
irrevocable election to convert their benefits into shares of Company common
stock.
As a non-qualified Plan, no Company assets are segregated to meet the future
obligations of the Company. The Plan participants are general creditors of the
Company.
At December 31, 1999, there were five remaining participants in the Plan. Three
of these participants elected to convert their benefits to Company stock. At
December 31, 1999, the Company maintained 29,788 shares in conjunction with its
future obligations to these participants under the Plan. At December 31, 1999,
the Company maintained an accrued liability of $196,000 in conjunction with its
cash payment obligations to the other two participants in the Plan, one of which
is currently receiving periodic benefits. This figure represents the present
value of the future payments committed to by the Company discounted at 7.0%. At
December 31, 1998, the Company maintained an accrued liability of $585,000 for
the future cash benefits payable under the Plan, which included the liabilities
for the participants who elected to convert their benefits to shares of common
stock during 1999. Periodic expense associated with the Plan was $68,000 in
1999, $33,000 in 1998, and $22,000 in 1997. Such expense amounts approximated
the computed actuarial net periodic Plan costs for each period.
108
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
22. PARENT COMPANY FINANCIAL INFORMATION
The Parent Company and its subsidiary, the Bank, file consolidated federal
income tax returns in which the taxable income or loss of the Parent Company is
combined with that of the Bank. The Parent Company's share of income tax expense
is based on the amount which would be payable if separate returns were filed.
Accordingly, the Parent Company's equity in the net income of its subsidiaries
(distributed and undistributed) is excluded from the computation of the
provision for income taxes for stand alone financial statement purposes.
The following are the Parent Company's stand alone summary statements of
financial condition for the years ended December 31, 1999 and 1998:
SUMMARY STATEMENTS OF FINANCIAL CONDITION
December 31,
-----------------------------
1999 1998
------- -------
(Dollars In Thousands)
ASSETS:
Cash and due from depository institutions $ 62 $ 428
Overnight deposits 100 725
------- -------
Total cash & cash equivalents 162 1,153
Mortgage-backed securities available for sale 3,750 6,664
Loan receivable, net 4,800 4,850
Other assets 524 58
Investment in subsidiary 34,022 32,959
------- -------
TOTAL ASSETS $43,258 $45,684
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Securities sold under agreements to repurchase $ 2,410 $ 4,490
Other liabilities 45 78
------- -------
Total Liabilities 2,455 4,568
Stockholders' equity 40,803 41,116
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $43,258 $45,684
======= =======
109
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
The following are the Parent Company's stand alone summary statements of
operations for the years ended December 31, 1999, 1998, and 1997:
SUMMARY STATEMENTS OF OPERATIONS
Year Ended December 31,
---------------------------------------
1999 1998 1997
------- ------- -------
(Dollars In Thousands)
Interest income:
Interest on mortgage backed securities and investment securities $ 380 $ 641 $ 569
Interest on loan receivable 414 306 --
Other interest income -- 129 147
------- ------- -------
Total interest income 794 1,076 716
Interest expense:
Interest on securities sold under agreements to repurchase 180 297 61
------- ------- -------
Total interest expense 180 297 61
Net interest income before provision for estimated loan losses 614 779 655
Provision for estimated loan losses 50 150 --
------- ------- -------
Net interest income after provision for estimated loan losses 564 629 655
Non-interest revenue (7) (1) --
General & administrative expense 552 503 476
------- ------- -------
Income before income tax expense 5 125 179
Income tax expense 3 50 74
------- ------- -------
Income before undistributed net income of subsidiary 2 75 105
Undistributed net income of subsidiary 3,299 1,361 1,661
------- ------- -------
Net income $ 3,301 $ 1,436 $ 1,766
======= ======= =======
110
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
The following are the Parent Company's stand alone summary statements of cash
flows for the years ended December 31, 1999, 1998, and 1997:
SUMMARY STATEMENTS OF CASH FLOWS
Year Ended December 31,
-------------------------------------
1999 1998 1997
------- ------- -------
(Dollars In Thousands)
OPERATING ACTIVITIES:
Net income $ 3,301 $ 1,436 $ 1,766
Adjustments to reconcile net income to net cash
Provided by operating activities:
Undisbursed net income of subsidiary (3,299) (1,361) (1,661)
Amortization of premiums on securities 64 102 50
Provision for estimated loan losses 50 150 --
Loss on sale of securities 7 -- --
Cash receipts associated with ESOP 257 555 386
(Increase) decrease in other assets (466) 46 (60)
Other, net 310 84 11
------- ------- -------
Net cash provided by operating activities 224 1,012 492
------- ------- -------
INVESTING ACTIVITIES:
Loans originated -- (5,000) --
Dividend from subsidiary -- 8,500 --
Purchases of mortgage backed securities available for sale -- -- (6,899)
Principal repayments on mortgage backed securities available for sale 2,021 3,199 3,094
Proceeds from sales of mortgage backed securities available for sale 724 975 --
Proceeds from maturities of investment securities -- 100 --
------- ------- -------
Net cash provided by (used in) investing activities 2,745 7,774 (3,805)
------- ------- -------
FINANCING ACTIVITIES:
(Repayments) proceeds from reverse repurchase agreements, net (2,080) (710) 5,200
Cash dividends paid to stockholders (530) (463) (357)
Sales of treasury stock 318 322 100
Purchases of treasury stock (1,668) (8,624) (376)
------- ------- -------
Net cash (used in) provided by financing activities (3,960) (9,475) 4,567
------- ------- -------
NET (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS (991) (689) 1,254
CASH & CASH EQUIVALENTS AT BEGINNING OF YEAR 1,153 1,842 588
------- ------- -------
CASH & CASH EQUIVALENTS AT END OF YEAR $ 162 $ 1,153 $ 1,842
======= ======= =======
111
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
23. ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of the Company's financial
instruments is in accordance with the provisions of SFAS No. 107, Disclosures
about Fair Value of Financial Instruments ("SFAS 107"). The estimated fair value
amounts have been determined by the Company, using available market information
and appropriate valuation methodologies. However, considerable judgement is
necessarily required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different assumptions and / or estimation methodologies may
have a material effect on the estimated fair value amounts.
The following methods and assumptions were used by the Company in computing the
estimated fair values:
Cash And Cash Equivalents - Current carrying amounts approximate estimated fair
value.
Capital Stock Of The Federal Home Loan Bank - Fair value is based upon its
redemption value, which equates to current carrying amounts.
Investment Securities and Mortgage Backed Securities - Fair values of these
securities are based on year-end market prices or dealer quotes. If quoted
market prices are not available, estimated fair values were based upon quoted
market prices of comparable instruments.
Loans Held For Sale - The fair value of these loans has been based on market
prices of similar loans traded in the secondary market.
Loans Receivable Held For Investment - For fair value estimation purposes, these
loans have been categorized by type of loan (e.g., one to four unit residential)
and then further segmented between adjustable or fixed rates. Where possible,
the fair value of these groups of loans has been based on secondary market
prices for loans with similar characteristics. The fair value of the remaining
loans has been estimated by discounting the future cash flows using current
interest rates being offered for loans with similar remaining terms to borrowers
of similar credit quality. Prepayment estimates were based on historical
experience and published data for similar loans.
Transaction Deposit Accounts - The estimated fair value of checking, savings,
and money market deposit accounts is the amount payable on demand at the
reporting dates.
Certificates Of Deposit - Fair value has been estimated by discounting the
contractual cash flows using current market rates offered in the Company's
market area for similar time deposits with comparable remaining terms.
FHLB Advances - Fair value was estimated by discounting the contractual cash
flows using current market rates offered for advances with comparable conditions
and remaining terms.
Securities Sold Under Agreements To Repurchase - Fair value was estimated by
discounting the contractual cash flows using current market rates offered for
borrowings with comparable conditions and remaining terms.
112
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
Commitments To Extend Credit - The estimated fair values of commitments to fund
loans are estimated using the fees currently charged to enter into similar
agreements, considering the remaining terms of the agreements and the present
cerditworthiness of the counterparties. For fixed rate loan commitments, the
estimated fair values also incorporate the difference between current levels of
interest rates for similar commitments and the committed rates.
Standby Letters Of Credit - The estimated fair values of standby letters of
credit were determined by using the fees currently charged taking into
consideration the remaining terms of the agreements and the creditworthiness of
the counterparties.
The carrying amounts and estimated fair values of the Company's financial
instruments as of December 31, 1999 and 1998 were as follows:
December 31, 1999 December 31, 1998
--------------------- ---------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
(Dollars In Thousands)
ASSETS:
Cash and cash equivalents $ 12,833 $ 12,833 $ 16,951 $ 16,951
Investment securities available for sale 11,463 11,463 19,410 19,410
Mortgage backed securities available for sale 57,716 57,716 98,006 98,006
Mortgage backed securities held to maturity 60 60 97 96
Loans receivable held for investment, net 360,686 364,129 298,775 306,215
Loans held for sale -- -- 2,177 2,177
FHLB stock 3,213 3,213 3,039 3,039
LIABILITIES:
Transaction deposit accounts 145,258 145,258 113,551 113,551
Certificates of deposit 222,144 221,734 257,126 257,975
Advances from the Federal Home Loan Bank 49,582 48,009 35,182 35,780
Securities sold under agreements to repurchase 2,410 2,410 4,990 4,990
OFF-BALANCE SHEET
Commitments to fund loans -- -- -- --
Standby letters of credit -- -- -- --
The fair value estimates presented herein are based upon pertinent information
available to management as of December 31, 1999 and 1998. The fair value amounts
have not been comprehensively reevaluated since the reporting date. Therefore,
current estimates of fair value and the amounts realizable in current secondary
market transactions may differ significantly from the amounts presented herein.
113
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
24. RESTATEMENT
Subsequent to the issuance of the Company's 1998 consolidated financial
statements, the Company's management determined that costs associated with
shares purchased in 1995 and 1996 for future distribution under its stock award
programs were recorded as a contra-equity account rather than an asset.
Furthermore, such shares were inappropriately included in the weighted average
shares outstanding used in earnings per share calculations. As a result, other
assets and total stockholders' equity as of December 31, 1998, and earnings per
share for the years ended December 31, 1998 and 1997, have been restated from
amounts previously reported in order to conform with generally accepted
accounting principles. In addition, prior years' compensation expense was
understated by a cumulative amount of approximately $96,000 ($57,000 net of tax)
or $0.02 diluted earnings per share which is insignificant and has been charged
to 1999 operations. The following table summarizes the effects of the
restatement by major financial statement line item.
1998 1997
------------------------ -----------------------
As As
Previously As Previously As
Reported Restated Reported Restated
-------- -------- -------- --------
(Dollars In Thousands, Except Per Share Data)
At December 31:
Other assets $ 3,600 $ 2,827
Total assets 454,819 454,046
Stockholders' equity 41,889 41,116 $47,933 $46,797
For The Year Ended December 31:
BASIC earnings per share $ 0.40 $ 0.41 $ 0.47 $ 0.49
DILUTED earnings per share $ 0.38 $ 0.39 $ 0.45 $ 0.47
114
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999 (Continued)
- --------------------------------------------------------------------------------
25. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of quarterly results:
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars In Thousands, Except Share Data)
For The Year Ended December 31, 1999:
Interest income $8,225 $ 8,173 $ 8,578 $ 8,442
Interest expense 4,451 4,268 4,218 4,453
Provision for loan losses 220 200 265 150
Non-interest revenue 684 778 564 479
General & administrative expenses 2,822 2,890 2,971 3,203
Income tax expense 612 691 738 470
Net income 804 902 950 645
Shares applicable to Basic earnings per share 3,213,941 3,235,190 3,256,419 3,219,098
Basic earnings per share $ 0.25 $ 0.28 $ 0.29 $0.20
Shares applicable to Diluted earnings per share 3,308,823 3,323,205 3,359,124 3,289,561
Diluted earnings per share $ 0.24 $ 0.27 $0.28 $0.20
Cash dividends paid per share $ 0.07 $ 0.00 $ 0.08 $ 0.00
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars In Thousands, Except Share Data)
For The Year Ended December 31, 1998:
Interest income $ 7,325 $ 7,547 $7,749 $8,290
Interest expense 4,377 4,591 4,621 4,999
Provision for loan losses 109 496 77 10
Non-interest revenue 400 492 498 787
General & administrative expenses 2,440 2,986 2,718 3,000
Income tax expense 360 31 371 466
Net income 439 (65) 460 602
Shares applicable to Basic earnings per share (1) 3,631,389 3,578,417 3,480,227 3,316,916
Basic earnings (loss) per share (1) $ 0.12 $ (0.02) $ 0.13 $ 0.18
Shares applicable to Diluted earnings per share (1) 3,787,948 3,578,417 3,613,173 3,407,916
Diluted earnings (loss) per share (1) $ 0.12 $ (0.02) $ 0.13 $ 0.18
Cash dividends paid per share $ 0.06 $ 0.00 $ 0.06 $ 0.00
- -----------------------------------------
(1) As Restated, see Note 24
115
Item 9. Changes In And Disagreements With Accountants On Accounting And
Financial Disclosures
None.
PART III
Item 10. Directors And Executive Officers Of The Registrant
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 25, 2000,
which will be filed no later than 120 days following Registrant's fiscal year
end. Information concerning Executive Officers who are not Directors is also
contained in Part I of this report pursuant to paragraph (b) of Item 401 of
Regulation S-K in reliance on Instruction G.
Item 11. Executive Compensation
The information relating to Director and Executive Officer compensation
is incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 25, 2000, excluding the
Compensation Committee Report on Executive Compensation and the Stock
Performance Graph, which will be filed no later than 120 days following the
Registrant's fiscal year end.
Item 12. Security Ownership Of Certain Beneficial Owners And Management.
The information relating to security ownership of certain beneficial
owners and management is incorporated herein by reference to the Registrant's
Proxy Statement for the Annual Meeting of Stockholders to be held on May 25,
2000, which will be filed no later than 120 days following the Registrant's
fiscal year end.
Item 13. Certain Relationships And Related Transactions.
The information relating to certain relationships and related
transactions is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 25, 2000,
which will be filed no later than 120 days following the Registrant's fiscal
year end.
PART IV
Item 14. Exhibits, Financial Statement Schedules, And Reports On Form 8-K.
(a)(1) Financial Statements
The following consolidated financial statements of the Registrant are
filed as a part of this document under Item 8. Financial Statements and
Supplementary Data.
Consolidated Statements Of Financial Condition At December 31, 1999
And 1998.
Consolidated Statements of Operations For Each Of The Years In The
Three Year Period Ended December 31, 1999.
Consolidated Statements Of Changes In Stockholders' Equity For Each Of
The Years In The Three Year Period Ended December 31, 1999.
Consolidated Statements Of Cash Flows For Each Of The Years In The
Three Year Period Ended December 31, 1999.
Notes To Consolidated Financial Statements.
Independent Auditors' Report.
116
(a)(2) Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated Financial
Statements or Notes thereto.
(a)(3) Management Contracts (see Item 14 (c), below)
(b) Reports on Form 8-K Filed During the Quarter Ended December 31,
1999
None.
(c) Exhibits Required by Securities and Exchange Commission Regulation
S-K
Exhibit Number
- --------------
3.1 Certificates Of Incorporation Of Monterey Bay Bancorp, Inc.*
3.2 Bylaws Of Monterey Bay Bancorp, Inc. *
4.0 Stock Certificate Of Monterey Bay Bancorp, Inc.*
10.1 Employment Agreement Between Monterey Bay Bancorp, Inc. And Marshall Delk
10.2 Change In Control Agreement Between Monterey Bay Bancorp, Inc. And Carlene Anderson
10.3 Change In Control Agreement Between Monterey Bay Bancorp, Inc. And Susan Davis
10.4 Change In Control Agreement Between Monterey Bay Bancorp, Inc. And Cynthia Girard
10.5 Change In Control Agreement Between Monterey Bay Bancorp, Inc. And Denis Poole
10.6 Change In Control Agreement Between Monterey Bay Bancorp, Inc. And Ben Tinkey
10.7 Change In Control Agreement Between Monterey Bay Bancorp, Inc. And Gary Tyack
10.8 Form Of Monterey Bay Bank Of Employee Severance Compensation Plan.*
10.9 Monterey Bay Bank 401(k) Plan.*
10.10 Monterey Bay Bank 1995 Retirement Plan For Executive Officers And Directors.*
10.11 Form Of Monterey Bay Bank Performance Equity Program For Executives.**
10.12 Form Of Monterey Bay Bank Recognition And Retention Plan For Outside Directors.**
10.13 Form Of Monterey Bay Bancorp, Inc. 1995 Incentive Stock Option Plan.**
10.14 Form Of Monterey Bay Bancorp, Inc. 1995 Stock Option Plan For Outside Directors.**
21 Subsidiary information is incorporated herein by reference to "Part I - Subsidiaries."
23 Consent Of Deloitte & Touche LLP, Independent Auditors.
27 Financial Data Schedule.
* Incorporated herein by reference from the Exhibits to the Registration
Statement on Form S-1, as amended, filed on September 21, 1994,
Registration No. 33-84272.
** Incorporated herein by reference from the Proxy Statement for the
Annual Meeting of Stockholders' filed on July 26, 1995.
117
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MONTEREY BAY BANCORP, INC.
By: /s/ Marshall G. Delk
---------------------------
Marshall G. Delk
Date: March 29, 2000 President, Chief Operating
Officer, Director
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities and
on the dates indicated.
Name Title Date
- ---- ----- ----
/s/ Gene R. Friend Chairman of the Board of Directors March 29, 2000
- ------------------------- and Chief Executive Officer
Gene R. Friend
/s/ Marshall G. Delk President, Chief Operating Officer, Director March 29, 2000
- -------------------------
Marshall G. Delk
/s/ Mark R. Andino Chief Financial Officer (Principal Financial March 29, 2000
- ------------------------- and Accounting Officer)
Mark R. Andino
/s/ P. W. Bachan Director March 29, 2000
- -------------------------
P. W. Bachan
/s/ Edward K. Banks Director March 29, 2000
- -------------------------
Edward K. Banks
/s/ Nicholas C. Biase Director March 29, 2000
- -------------------------
Nicholas C. Biase
/s/ Diane S. Bordoni Director March 29, 2000
- -------------------------
Diane S. Bordoni
/s/ Steven Franich Director March 29, 2000
- -------------------------
Steven Franich
/s/ Donald K. Henrichsen Director March 29, 2000
- -------------------------
Donald K. Henrichsen
/s/ Stephen G. Hoffmann Director March 29, 2000
- -------------------------
Stephen G. Hoffmann
/s/ Gary L. Manfre Director March 29, 2000
- -------------------------
Gary L. Manfre
/s/ McKenzie Moss Director March 29, 2000
- -------------------------
McKenzie Moss
/s/ Louis Resetar, Jr. Director March 29, 2000
- -------------------------
Louis Resetar, Jr.
/s/ Joseph Austin Director March 29, 2000
- -------------------------
Joseph Austin
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