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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 AND 12CFR16.3
For the fiscal year ended December 31, 2000
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
445 Pine Avenue, Goleta, California 93117
(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, (805)692-1862
including area code)
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered:
Common Stock, no par value National Market tier of
The NASDAQ Stock Market
Securities registered under Section 12(g) of the Exchange Act:
None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act and 12CFR16.3 during the
past 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-B is not contained, and will not be contained, to the best of
the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
There were 6,107,216 shares of common stock for the registrant issued and
outstanding as of March 1, 2001. The aggregate market value of the voting
stock, based on the closing price of the stock on the NASDAQ National Market
System on February 20, 2001, held by the nonaffiliates of the registrant was
approximately $20,911,995.
This Form 10-K contains 74 pages
COMMUNITY WEST BANCSHARES
FORM 10-K
INDEX
PART I PAGES
ITEM 1. Description of Business 3
ITEM 2. Description of Property 5
ITEM 3. Legal Proceedings 6
ITEM 4. Submission of Matters to a Vote of Security Holders 7
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters 7
ITEM 6. Selected Financial Data 8
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk 40
ITEM 8. Consolidated Financial Statements F-2
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 71
PART III
ITEM 10. Directors, Executive Officers, Promoters and Control Persons 71
ITEM 11. Executive Compensation 71
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 71
ITEM 13. Certain Relationships and Related Transactions 71
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 71
SIGNATURES 74
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
- -----------------------------------
General
- -------
Community West Bancshares was incorporated in the State of California on
November 26, 1996, for the purpose of forming a financial services holding
company. On December 31, 1997, Community West Bancshares acquired a 100%
interest in Goleta National Bank, herein referred to as "Goleta". Effective that
date, shareholders of Goleta (NASDAQ:GLTB) became shareholders of Community West
Bancshares (NASDAQ:CWBC) in a one-for-one exchange. Such acquisition was
accounted at historical cost in a manner similar to a pooling-of-interests. On
December 14, 1998, the Company acquired a 100% interest in Palomar Savings &
Loan Association, now known, as Palomar Community Bank, herein referred to as
"Palomar". As of that date, shareholders of Palomar (OTCBB:PALO) became
shareholders of the Company by receiving 2.11 shares of CWBC for each share of
PALO they held. The acquisition was accounted for under the purchase method.
Community West Bancshares, Goleta and Palomar are collectively referred to
herein as the "Company".
The Company offers a full range of commercial and retail financial services,
including the acceptance of demand, savings, and time deposits, and the
origination of commercial, U.S. Small Business Administration, herein referred
to as "SBA", accounts receivable, real estate, construction, home improvement,
short term consumer, and other installment and term loans. It also offers cash
management, remittance processing, electronic banking, merchant credit card
processing, online banking, and other financial services to the public.
The financial services industry as a whole offers a broad range of products. Few
companies today can effectively offer every product and service available.
Accordingly, the Company continually investigates products and services with
which it can attain a competitive advantage over others in the financial
services industry. In this way, management positions the Company to offer
products and services requested by its customers.
The Company has been an approved lender/servicer of loans guaranteed by the SBA
since late 1990. The Company originates SBA loans, sells the guaranteed portion
into the secondary market, and services the loans. During 1995, the SBA
designated the Company as a "Preferred Lender". As a "Preferred Lender", the
Company has the ability to move loans through the approval process at the SBA
much more quickly than financial institutions that do not have such a
designation. The Company was granted SBA "Preferred Lender" status in the
California districts of Los Angeles, Fresno, Sacramento, San Francisco, San
Diego, and Santa Ana. The Company also has "Preferred Lender" Status in Alabama,
Georgia, South Carolina, Tennessee, Colorado, Seattle, Nevada, Portland, and
North and South Florida.
During 1994, the Company established a Mortgage Loan Processing Center. The
Mortgage Loan Processing Center takes residential real estate loan applications
for lenders located throughout the nation and processes them for a fee. At any
point in time, the Company processes loans for 50-70 such lenders. Due to the
volume of loans generated by these lenders, the Company has the ability to offer
significantly more loan programs than normally offered by any single
institution; this has allowed the Company to remain ahead of its competition.
Also in 1994, the Company began offering home improvement loans under the Title
I regulations of the Federal Housing Authority, herein referred to as "FHA".
This is the oldest government insured loan program in existence, having begun in
1934. During the period of 1994 to 1998 the Company originated Title I loans,
sold them into the secondary market, and retained the servicing. Also during
this period, the Company was one of a small number of institutions approved to
sell Title I loans directly to the Federal National Mortgage Association, herein
referred to as the "FNMA".
In 1996, the Company began offering second mortgage loans. Second mortgage loans
allow borrowers to borrow, up to 125% of their home's appraised value, when
combined with the balance of the first mortgage loan, or a maximum of $100,000.
Proceeds are commonly used for debt consolidation, home improvement, or school
tuition. The Company relies primarily on the creditworthiness of the borrower,
combined with the underlying home value as collateral, to help ensure repayment
of these loans. The repayment term on these loans range from one year to 25
years. In 1997 and 1998, the Company sold these loans at a premium to third
parties. In March of 1998, the Company began accumulating the majority of these
loans for the purpose of securitization. Securitization is a process in which
3
the accumulated loans are transferred into a trust in exchange for cash and an
interest in the trust. The loans held in the trust are used as collateral to
issue bonds to third party investors to generate the cash. An insurance policy
is carried on the trust to guarantee full payment of the subordinate bonds. On
December 22, 1998, the Company completed the securitization of an $81 million
pool of loans. On June 18, 1999 the Company completed the securitization of a
$122 million pool of loans. In the fourth quarter of 1999 the Company decided
to cease securitization activities. The Company will continue to originate
second mortgage loans, intended for sale to third parties at a premium
immediately after origination.
Due to the development costs involved, most small community banks have
difficulty providing electronic banking services to their customers. The Company
has continually made significant investments in the hardware and software
necessary to offer electronic banking services. In addition to the normal
financial services, the Company offers such services as online cash management,
Internet banking, automated clearing house origination, electronic data
interchange, remittance processing, draft preparation and processing, and
merchant credit card processing. Not only do these services generate significant
fee income, but they also attract companies with large deposit balances. These
services have helped the Company maintain a competitive advantage over most
institutions of comparable size and many which are significantly larger than the
Company.
On October 16, 1997, the Company purchased a 70% interest in Electronic
Paycheck, LLC, a California Company that is a provider of customized debit card
payment systems and electronic funds transfer services. Electronic Paycheck,
LLC has developed an Internet-based transaction processing system using
propriety software. The system provides complete front-end to back-end
electronic funds transfer processing services. Electronic Paycheck, LLC is
focusing the marketing of its e-commerce payment services to consumer lenders,
companies with employees without banking relationships, network marketing
organizations and loyalty reward programs. In addition, Electronic Paycheck,
LLC plans to establish a card-based payment system for Internet purchases
utilizing its virtual pinpad technology. The product's target market is focused
on teenagers. On November 4, 1999 Electronic Paycheck LLC merged with
ePacific.com Incorporated, a Delaware Corporation; the merger was accounted for
in a manner similar to a pooling-of-interests. On March 30, 2000, ePacific.com
redeemed 1,800,000 of the Company's 2,100,000 shares and repaid a loan from the
Company with a balance of $3,725,000 for $4,500,000 in cash. The Company
continues to hold a 10% interest in ePacific.com but is no longer required to
include ePacifc.com in its consolidated financial statements. ePacific.com is
currently in a deficit position and is retained at a zero value in the
Companies' financial statements.
In September of 1998, the Company opened its second full service Branch in
Ventura, California. The Company simultaneously consolidated into that location
its Ventura SBA, mortgage loan production office, and the accounts receivable
financing department.
On December 14, 1998, the Company acquired 100% of Palomar Savings & Loan, a
state-chartered full service savings and loan association. During 1999 Palomar
Savings & Loan was converted to a state chartered bank and subsequently changed
its name to Palomar Community Bank. The Federal Deposit Insurance Corporation,
herein referred to as the "FDIC" insures the deposits of Palomar up to the
applicable limits. Palomar is a member of the Federal Home Loan Bank system,
herein referred to as the "FHLB". Palomar's main office is located at 355 West
Grand Avenue, Escondido, California 92025. On December 1, 2000, the Company
signed a definitive agreement to sell Palomar Community Bank to Centennial First
Financial Services for $10.5 million. Under the terms of the agreement,
Centennial will acquire all the outstanding stock of Palomar in exchange for
$10.5 million in cash. The sale is expected to be completed in the third
quarter of 2001.
In 1999, the Company entered into a contract with America's Cash Express, herein
referred to as "ACE", and ePacific.com whereby ACE will act as an agent to
originate short-term consumer loans via 1,000 national retail offices. Upon
origination, ACE purchases 95% of the principal and the Company currently
retains 5% ownership in the principal of each loan. Loans currently yield
approximately 390% interest and are for original terms of two weeks. The first
loans of this type were initiated in the second quarter of 2000. ePacific.com
continues to service these loans.
4
Competition and Service Area
- -------------------------------
The financial service industry in California is highly competitive with respect
to both loans and deposits. Overall, the industry is dominated by a relatively
small number of major banks with many offices operating over wide geographic
areas. Some of the major commercial banks operating in the Company's service
areas offer certain services, which are not offered directly by the Company or
any of its subsidiaries. Some of these services include; in-depth trust and
investment services, international banking, and due to their size, a
substantially higher lending limit. To help offset the numerous branch offices
of banks, thrifts, and credit unions, as well as competition from mortgage
brokers, insurance companies, credit card companies, and brokerage houses within
the Company's service areas, the Company, through its subsidiaries, has
established loan production offices in Sacramento, Fresno, Costa Mesa, San
Rafael, Santa Maria, Santa Barbara, Orange County, and Ventura, California; Las
Vegas, Nevada; Woodstock, Georgia; Alamonte Springs, Florida; Beaverton, Oregon;
Bellevue, Washington; Charlotte, North Carolina; Columbia, South Carolina;
Knoxville, Tennessee; and Englewood, Colorado. The Company's online capabilities
allow it to support these offices from its main computer center in Goleta,
California. Part of the Company's strategy is to establish loan production
offices in areas where there is high demand for the loan products that it
originates.
The Company uses the flexibility of its independent status permits to compete
for loans and deposits within its primary service area. Management has
established highly personalized banking relationships with the Company's
customers and is attuned and responsive to their financial and service
requirements. The Company emphasizes its experienced management and trained
staff to handle the specialized banking needs of its customers. In the event
there are customers whose loan demands exceed the Company's lending limits, the
Company works to arrange for such loans on a participation basis with other
financial institutions. The Company also assists those customers requiring
specialized services not offered by the Company to obtain such services through
correspondent institutions.
Employees
- ---------
As of December 31, 2000, the Company employed 265 persons, including 3 principal
officers. The Company's employees are not represented by a union or covered by a
collective bargaining agreement. Management of the Company believes that, in
general, its employee relations are very positive. The Company offers
competitive salaries and benefits in order to attract and retain the most
qualified personnel.
ITEM 2. DESCRIPTION OF PROPERTY
- -----------------------------------
The Company owns the following property:
- ---------------------------------------------
The Goleta National Bank main office is located at 5827 Hollister Avenue,
Goleta, California. This 4,000 square foot facility houses the bank's main
office, and a separate 400 square foot building provides additional office
space.
The Company leases the following properties:
- -------------------------------------------------
The Company leases approximately 20,684 square feet of office space located at
445 Pine Avenue, Goleta, California. The lease is for a term expiring March 31,
2007, with a current monthly rent of $26,889. The lease also provides the
Company with two options of five years each, to extend the lease. This facility
houses the Company's Corporate Offices, comprised of various departments
including but not limited to, Finance, Data Processing, Compliance, Human
Resources, Electronic Business Services, Special Assets, Operations and Loan
Collection.
The Company leases under two separate leases, approximately 3,744 square feet of
office space located at 3891 State Street, Santa Barbara, California. The leases
are for terms expiring April 30, 2002 and April 30, 2003, with a current monthly
rent of $7,890 per month for both leases. Each lease contains an option to
extend the lease for an additional three years. This facility houses the Retail
and Wholesale Mortgage Lending departments of the Company.
5
The Company leases approximately 3,431 square feet of office space located at
1463 South Victoria Avenue, Ventura, California. The lease is for a term
expiring July 20, 2002, with a current monthly rent of $5,555 per month. The
lease provides the Company with one option of three years to extend the lease.
This facility houses the Ventura Branch office, as well as the Ventura Mortgage,
SBA, and Accounts Receivable Financing departments of the Company.
The Company leases approximately 7,570 square feet of space located at 681 South
Parker Street Suite 350, Orange, California. The lease is for a term expiring
September 30, 2003, with a current monthly rent of $9,463 per month. This
facility houses the Orange County Loan Production office of the Company.
The Company leases approximately 1,063 square feet of space located at 1050
Northgate Drive Suite 190, San Rafael, California. The lease is for a term
expiring July 31, 2005, with a current monthly rent of $2,764 per month. This
facility houses the San Rafael SBA Loan Production office of the Company.
The Company leases approximately 2,424 square feet of space located at 665 Molly
Lane Suite 110, Woodstock, Georgia. The lease is for a term expiring July 15,
2005, with a current monthly rent of $2,913 per month. This facility houses the
Georgia SBA Loan Production office of the Company.
The Company leases approximately 6,380 square feet of space located at 5383
Hollister Avenue, 2nd Floor, Goleta, California. The lease is for a term
expiring November 30, 2002, with a current monthly rent of $8,932 per month. The
lease also provides the Company with two options of three years to extend the
lease. On May 18, 2000, the Company sublet the entire space. The sublease does
not provide an option for the sublessor to extend the sublease.
The Company leases three suites in an office building at 5638 Hollister Avenue,
Goleta, California. The leases are for terms expiring May 31, 2003, with a
current monthly rent of $11,177 per month for all three suites. The leases also
provide the Company with two additional consecutive options of three years each
to extend the leases. The suites consist of approximately 8,200 square feet of
office space. The Company sublet these suites to an independent third party.
The sublease is for a term commencing May 1, 2000 and expiring May 31, 2003.
The sublease does not provide the sublessor an option to extend the sublease.
The Company also leases approximately 7,000 square feet of office space at 355
West Grand Avenue, Escondido, California, which houses the main branch office of
Palomar. The lease is for a term expiring November 20, 2007, with a ten-year
option to renew and a current monthly rent of $13,692. The Company also leases
approximately 1600 square feet at 1815 E. Valley Parkway Suite #1, Escondido,
California. The lease is for a term expiring May 5, 2003 and a current monthly
rent of $1,499 per month. The lease also provides the Company with two
additional consecutive options of five years each to extend the lease. The
Company sublet this suite to an independent third party. The sublease is for a
term commencing March 1, 2000 and expiring July 31, 2003. The sublease does not
provide the sublessor an option to extend the sublease.
The Company also leases small executive suites on a month-to-month basis in
Sacramento, Fresno, Santa Maria, and Costa Mesa, California. The Company has
executive suites in Charlotte, North Carolina; Columbia, South Carolina;
Bellevue, Washington; Beaverton, Oregon; Englewood, Colorado; Alamonte Springs,
Florida; Knoxville, Tennessee and in Las Vegas, Nevada. These offices allow the
Company to have a local presence for the production of loans while controlling
the underwriting and funding of the loans at the main office in Goleta. The
Company also leases, on a month-to-month basis, four storage units and portions
of a parking lot which are located in Goleta.
The Company's total occupancy expense, including depreciation, for the year
ended December 31, 2000 was $3,918,668. Management believes that its existing
facilities are adequate for its present purposes.
ITEM 3. LEGAL PROCEEDINGS
- ----------------------------
The Company is involved in various litigation matters through the normal course
of business. In the opinion of management, after taking into consideration
information provided by counsel, the disposition of all pending litigation
should not have a materially effect on the Company's financial position or
results of operations.
On October 10, 2000 the Company filed a lawsuit in Los Angeles Superior Court
against their former auditors and financial consultants, Deloitte and Touche,
LLP. The Company is seeking compensatory damages for deficient audit and
financial consulting services that ultimately resulted in the restatement of the
Company's December 31, 1998 financial statements and regulatory capital ratios.
6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ---------------------------------------------------------------------
An annual meeting of security holders of the Company was held May 25, 2000. The
security holders voted on and approved Board Members for 2000-2001. There were
a total of 5,411,518 or 88.6% proxies voted out of 6,107,216 shares. The
following indicates the votes:
FOR AGAINST NON-VOTES
Number of Votes Received 5,410,718 800 695,698
Percentage of Total Shares 88.60% 0.01% 11.39%
PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
----------------------------------------------------------------------
STOCKHOLDER MATTERS
- -------------------
The following table sets forth the high and low closing sales prices on a per
share basis for the common stock as reported by the respective exchanges for the
period indicated:
Common Stock
------------
Low High
----- -----
1999 First Quarter 7.75 9.25
Second Quarter 7.50 10.50
Third Quarter 10.00 16.88
Fourth Quarter 6.75 16.75
2000 First Quarter 5.50 8.00
Second Quarter 5.38 6.88
Third Quarter 5.13 6.25
Fourth Quarter 3.38 5.25
On March 15, 2001, the last reported sale price per share for the Company's
stock was $4.75.
The Company declared four quarterly dividends of $0.04 per share during 1999.
Each quarterly dividend totaled approximately $220,000.
The Company had 537 shareholders of record of its common stock as of December
31, 2000.
7
ITEM 6. SELECTED FINANCIAL DATA
- -----------------------------------
SUMMARY OF OPERATIONS
The following Summary of Operations of the Company, as of and for the years
ended December 31, 2000, 1999, 1998, 1997, and 1996 has been derived from the
consolidated financial statements included elsewhere in this document:
December 31, (1)
--------------------------------------------------------------
(Dollars in thousands, except per share data) 2000 1999 1998 1997 1996
---------- ----------- ----------- ----------- -----------
Interest income $ 51,781 $ 48,495 $ 15,279 $ 8,009 $ 6,812
Interest expense 26,060 25,145 6,317 2,910 2,425
---------- ----------- ----------- ----------- -----------
Net interest income 25,721 23,350 8,962 5,099 4,387
Provision for loan losses 6,794 6,133 1,759 260 435
---------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 18,927 17,217 7,203 4,839 3,952
Other operating income 16,283 11,021 11,022 9,432 6,620
Other operating expense 29,975 30,506 17,482 11,524 8,667
---------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 5,235 (2,268) 743 2,747 1,905
(Benefit) provision for income taxes 2,538 (622) 289 1,158 800
---------- ----------- ----------- ----------- -----------
Net income (loss) $ 2,697 $ (1,646) $ 454 $ 1,589 $ 1,105
========== =========== =========== =========== ===========
Income (loss) per common share - Basic $ 0.44 $ (0.30) $ 0.12 $ 0.53 $ 0.47
Number of shares used in income (loss)
per share calculation - Basic (2) 6,107,216 5,494,217 3,767,607 3,016,208 2,356,162
Income (loss) per common share - Diluted $ 0.43 $ (0.30) $ 0.12 $ 0.44 $ 0.44
Number of shares used in income (loss)
per share calculation - Diluted (2) 6,233,245 5,494,217 3,941,749 3,588,478 2,510,352
Net loans $ 329,265 $ 451,664 $ 247,411 $ 59,315 $ 54,206
Total assets 405,255 523,847 327,569 87,468 72,718
Deposits 228,720 313,131 223,853 75,962 65,032
Total liabilities 369,221 489,915 298,448 76,623 65,169
Total stockholders' equity 36,035 33,932 29,121 10,845 7,549
(1) See Notes to Consolidated Financial Statements for a summary of significant accounting policies and
other related data.
(2) Earnings per common share information is based on a weighted average number of common shares
outstanding during each period. Earnings per share amounts have been adjusted to reflect the 2-for-1
stock splits in 1996 and 1998.
8
Selected ratios, for the periods set forth, are indicated in the following
table:
Year Ended December 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
Net income (loss) to average stockholder equity 7.35% (6.68)% 3.50% 14.64% 13.67%
---------- ---------- ---------- ---------- ----------
Net income (loss) to average total assets 0.61% (0.37)% 0.20% 1.82% 1.52%
Total interest expense to total interest income 50.33% 51.85% 41.34% 36.33% 35.59%
Other operating income to other operating expense 54.32% 36.13% 63.05% 81.85% 76.39%
Equity to assets ratio 8.89% 6.51% 8.77% 12.73% 12.44%
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- --------------
Introduction
- ------------
This discussion is designed to provide a better understanding of significant
trends related to the Company's financial condition, results of operations,
liquidity, capital resources, and interest rate sensitivity. It should be read
in conjunction with the consolidated financial statements and notes thereto and
the other financial information appearing elsewhere in this filing.
9
Results of Operations
- -----------------------
The following table sets forth, for the period indicated, the increase or
decrease of certain items in the statements of operations of the Company as
compared to the prior periods:
--------------------------------------------------------------------------------
Year Ended December 31, 2000 versus 1999 1999 versus 1998 1998 versus 1997
------------------------- -------------------------- -------------------------
Amount of Percent of Amount of Percent of Amount of Percent of
increase increase increase increase increase increase
(decrease) (decrease) (decrease) (decrease) (decrease) (decrease)
------------ ----------- ------------ ------------ ----------- ------------
INTEREST INCOME:
Loans, including fees $ 2,767,595 5.89% $32,246,557 218.60% $ 7,401,202 100.70%
Federal funds sold 397,418 39.44% 597,248 145.49% (13,153) (3.10%)
Time deposits in other financial
Institutions 66,107 140.27% (19,195) (28.94%) (54,264) (45.00%)
Investment securities 55,148 12.47% 390,840 758.81% (63,746) (55.31%)
------------ ------------ ------------
Total interest income 3,286,268 6.78% 33,215,450 217.39% 7,270,039 90.77%
------------ ------------ ------------
INTEREST EXPENSE:
Deposits $(3,745,649) (24.84%) $ 9,357,741 163.54% $ 2,811,508 96.60%
Bonds payable and other borrowings 4,660,533 46.30% 9,470,824 1592.52% 594,707 0.00%
------------ ------------ ------------
Total interest expense 914,884 3.64% 18,828,565 298.08% 3,406,215 117.03%
NET INTEREST INCOME 2,371,384 10.16% 14,386,885 160.52% 3,863,824 75.78%
PROVISION FOR LOAN LOSSES 660,853 10.78% 4,373,336 248.54% 1,499,623 576.78%
------------ ------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 1,710,531 9.94% 10,013,549 139.02% 2,364,201 48.86%
------------ ------------ ------------
OTHER INCOME:
Gains from loan sales $ 1,503,300 25.11% $ 1,928,127 47.49% $ (41,406) (1.01%)
Loan servicing fees 2,290,448 458.36% (286,007) (36.40%) 154,159 24.41%
Income from sale of interest in
Subsidiary 2,080,000 100.00% - - - -
Other loan origination fees - sold
or brokered loans (884,235) (32.63%) (969,273) (26.34%) 718,826 24.28%
Document processing fees 43,938 4.10% (150,590) (12.31%) 403,853 49.29%
Service charges 44,352 8.62% (349,759) (40.46%) (31,746) (3.54%)
Gain from sale of servicing assets 186,531 100.00% - - - -
Other income (1,593) (0.68%) (174,318) (42.52%) 386,556 1651.45%
------------ ------------ ------------
TOTAL OTHER INCOME $ 5,262,741 47.75% $ (1,820) (0.02)% $ 1,590,242 16.86%
------------ ------------ ------------
10
------------------------- -------------------------- -------------------------
Year Ended December 31, 2000 versus 1999 1999 versus 1998 1998 versus 1997
------------------------- -------------------------- -------------------------
Amount of Percent of Amount of Percent of Amount of Percent of
increase increase increase increase increase increase
(decrease) (decrease) (decrease) (decrease) (decrease) (decrease)
------------ ----------- ------------ ------------ ----------- ------------
OTHER EXPENSES
Salaries and employee benefits $ (987,213) (6.08%) $ 5,428,596 50.27% $ 3,484,228 47.63%
Occupancy expenses (15,314) (0.63%) 981,684 68.41% 889,490 58.97%
Depreciation expense 89,399 6.26% 464,974 48.30% 962,845 100.00%
Other operating expenses 1,664,860 102.51% (145,639) (8.23%) 245,837 61.20%
Loan servicing & collection expense 137,477 6.28% 1,931,479 752.09% 256,814 100.00%
Impairment of goodwill 2,110,303 100.00% - - - -
Professional services (1,629,713) (63.19%) 2,058,416 395.31% 94,885 22.28%
Advertising expense (445,751) (38.72%) 357,215 44.98% 211,466 36.29%
Amortization of intangible assets 40,529 11.15% 300,008 471.99% 63,562 100.00%
Office supply expense 5,217 1.35% 192,142 99.21% 38,384 24.72%
Data processing/ATM processing (166,570) (32.55%) 262,746 105.52% 95,944 62.69%
Postage & freight (57,020) (16.20%) (84,920) (19.44%) (385,228) (46.86%)
Lower of Cost or Market provision (1,276,709) (100.00%) 1,276,709 100.00% - -
------------ ------------ ------------
TOTAL OTHER EXPENSES $ (530,505) (1.74%) $13,023,410 74.50% $ 5,958,227 51.70%
------------ ------------ ------------
INCOME(LOSS)BEFORE
(BENEFIT)PROVISION FOR
INCOME TAXES 7,503,777 330.83% (3,011,681) (405.06%) (2,003,784) (72.94%)
PROVISION(BENEFIT) FOR
INCOME TAXES 3,160,304 508.22% (911,286) (314.84%) (868,903) (75.01%)
------------ ------------ ------------
NET INCOME(LOSS) $ 4,343,473 263.83% $(2,100,395) (462.58%) $(1,134,881) (71.42%)
------------ ------------ ------------
11
Net Interest Income and Net Interest Margin
- -------------------------------------------------
The Company's earnings partially depend upon the difference between the interest
received from its loan portfolio and investment securities and the interest paid
on its liabilities, primarily interest paid on deposits. This difference is
"net interest income". The net interest income, when expressed as a percentage
of average total interest-earning assets, is referred to as the net interest
margin on interest-earning assets. The Company's net interest income is
affected by the change in the level and the mix of interest-earning assets and
interest-bearing liabilities, referred to as volume changes. The Company's net
yield on interest-earning assets is also affected by changes in the yields
earned on assets and rates paid on liabilities, referred to as rate changes.
Interest rates charged on the Company's loans are affected principally by the
demand for such loans, the supply of money available for lending purposes and
competitive factors. General economic conditions and other factors beyond the
Company's control, such as federal economic policies, the general supply of
money in the economy, legislative tax policies, governmental budgetary matters
and the actions of the Federal Reserve Bank, herein referred to as the "FRB"
also have an affect.
The following table presents the net interest income and net interest margin:
Year Ended December 31,
------------ ------------ ------------
2000 1999 1998
------------ ------------ ------------
Interest Income $51,781,189 $48,494,921 $15,279,471
Interest Expense 26,060,114 25,145,230 6,316,665
------------ ------------ ------------
Net Interest Income $25,721,075 $23,349,691 $ 8,962,806
============ ============ ============
Net Interest Margin 6.3% 5.4% 4.2%
Total interest income increased 6.8% from $48,494,921 in 1999 to $51,781,189 in
2000. Total interest expense increased 3.6% from $25,145,230 in 1999 to
$26,060,114 in 2000. The increase in expense, was primarily due to a shareholder
note acquired at the end of 1999, offset by a net decrease in interest-bearing
liabilities primarily, time certificates of deposits and bonds payable in
connection with securitzed loans. As a result, net interest income increased
10.2% from $23,349,691 in 1999 to $25,721,075 in 2000. The following table sets
forth the changes in interest income and expense attributable to changes in
rates and volumes:
Year Ended December 31,
---------------------------- ---------------------------- ----------------------------
(Dollars in thousands) 2000 Versus 1999 1999 Versus 1998 1998 Versus 1997
---------------------------- ---------------------------- ----------------------------
Change Change Change Change Change Change
Total due to due to Total due to due to Total due to due to
change rate volume change rate volume change rate volume
-------- -------- -------- -------- -------- -------- -------- -------- --------
Time deposits in other
Financial institutions $ 66 $ 1 $ 65 $ (20) $ 48 $ (68) $ (55) $ 5 $ (60)
Federal funds sold 397 195 202 597 16 581 (13) (15) 2
Investment securities 56 102 (46) 391 271 120 (63) (63) -
Loans, net (7,159) (2,039) (5,120) 15,196 (3,299) 18,495 6,962 (1,784) 8,746
Securitized Loans 9,926 7,824 2,102 17,051 16,248 803 440 - 440
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-earning
Assets 3,286 6,083 (2,797) 33,215 13,284 19,931 7,271 (1,857) 9,128
Interest-bearing
Demand 214 29 185 74 (21) 95 60 (9) 69
Savings (172) (159) (13) 396 45 351 97 (32) 129
Time certificates of
Deposit (3,788) (1,875) (1,913) 8,888 1,334 7,554 2,655 (92) 2,747
Federal funds
Purchased (25) 10 (35) (41) - (41) 85 - 85
Bonds payable 4,223 3,734 489 9,428 - 9,428 510 - 510
Other borrowings 463 29 434 83 - 83 - - -
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities 915 1,768 (853) 18,828 1,358 17,470 3,407 (133) 3,540
-------- -------- -------- -------- -------- -------- -------- -------- --------
Net interest income $ 2,371 $ 4,315 $(1,944) $14,387 $11,926 $ 2,461 $ 3,864 $(1,724) $ 5,588
======== ======== ======== ======== ======== ======== ======== ======== ========
12
Provision for Loan Losses
- ----------------------------
The provision for loan losses corresponds directly to the level of the allowance
that management deems sufficient to provide for probable loan losses. The
accumulated balance in the allowance for loan loss reflects the estimated amount
which management determined is adequate to provide for any probable loan losses
after considering the mix of the loan portfolio, current economic conditions,
past loan experience and any other relevant factors.
Management reviews the allowance for loan losses on a monthly basis and records
additional provisions to the allowance, as needed. Management allocated
$6,793,812 as a provision for loan losses in 2000, $6,132,959 in 1999 and
$1,759,623 in 1998. This increase was due to the significant growth in the loan
portfolio. Loans charged off, net of recoveries, in 2000 were $5,576,287, in
1999 were $3,977,108 and in 1998 were $298,685. The increased chargeoffs in 2000
were primarily due to the short-term consumer and securitized loan programs. The
ratio of the allowance for loan losses to total gross loans was 2% at December
3l, 2000, 1.9% at December 31, 1999, and 1.8% at December 31, 1998,
respectively.
In management's opinion, the balance of the allowance for loan losses at
December 31, 2000 was sufficient to absorb known and inherent probable losses in
the loan portfolio at that time.
Other Income
- -------------
Other income remained constant from $11,022,457 in 1998 to $11,020,637 in 1999
but increased 48% to $16,283,378 in 2000. Due to the Company's continuing
emphasis on generating non-interest income, the percentage of non-interest
income to total income also increased significantly from 19% in 1999 to 24% in
2000. This was primarily a result of an increase in loan servicing fees, income
from the sale of interest in subsidiary, and gains from the sale of servicing
assets.
Other Expenses
- ---------------
Other expenses include salaries, employee benefits, occupancy, equipment, and
other operating expenses. As a result of company growth, other expenses rose
74% from $17,482,133 in 1998 to $30,505,543 in 1999, but decreased in 2000 by
1.7% to $29,975,038 due to cost cutting efforts. In addition, operating expenses
decreased due to a $1,276,709 lower of cost or market provision on loans held
for sale in 1999 which was not repeated in 2000. The 1999 provision resulted
from a change in the Company's strategy from the securitization of second
mortgage loans to whole loan sales of this product. Employee compensation
decreased 6% from $16,228,271 in 1999 to $15,241,058 in 2000. The majority of
this decrease in compensation is attributable to a decrease in variable salaries
and benefits, since approximately 40% of the Company personnel derive their
income from loan production, which was lower in 2000 as compared to 1999.
Employee compensation represented 51% of other expenses in 2000. Other expenses
that were also impacted by the change in loan production volume were occupancy,
advertising, marketing, and general office expenditures. Professional fees
increased as a result of activity related to ePacific.com's change in corporate
status and as a result of costs incurred relating to the restatement of the
Company's 1998 financial statements.
Lower of Cost or Market
- ---------------------------
Loans which are originated and sold in the secondary market are carried at the
lower of cost or estimated fair value determined on an aggregate basis. At
December 31, 1999 the Company recorded a valuation adjustment to these loans of
$1,276,709. At December 31, 2000, management determined that carrying value
approximated fair value and thus no valuation adjustment was determined to be
necessary.
13
The following table compares the various elements of other expenses as a
percentage of average assets:
Occupancy
Salaries and and Other
Year Ended December 31, Average Total Other Employee Depreciation Operating
(Dollars in thousands) Assets (1) Expense Benefits Expenses Expenses
------------------------------------------------------------------
December 31, 2000 $ 439,945 6.81% 3.46% 0.89% 0.75%
December 31, 1999 $ 450,041 6.78% 3.61% 0.85% 0.36%
December 31, 1998 $ 225,258 7.76% 4.79% 1.06% 0.79%
(1) Based on the average of daily balances.
Income Taxes
- -------------
Income taxes provision/(benefit) was $2,538,466 in 2000, $(621,838) in 1999, and
$289,448 in 1998. The effective income tax (benefit) rate was 48.5%, (27.4)%
and 38.9% for 2000, 1999 and 1998, respectively.
Net Income (Loss)
- -------------------
The net income (loss) of the Company was $2,697,137 in 2000, $(1,646,336) in
1999, and $454,059 in 1998. Earnings (loss) per share were $0.44 basic and $0.43
diluted in 2000; $(0.30) basic and diluted in 1999; and $0.12 basic and diluted
in 1998, adjusted to reflect the 2-for-1 stock split in 1998. The loss for 1999
was primarily the result of the $2.1 million in losses of ePacific.com and costs
associated with the cessation of the Company's securitization program. In late
1999, the Company decided to cease any further securitization activities. At
the time of that decision, the Company had approximately $150,000,000 in second
mortgage loans accumulated for a third securitization. Those loans were written
down in the fourth quarter of 1999 to fair market value. The adjustment was
approximately $1,300,000. As of December 31, 2000 the Company had $15 million
of these loans remaining. No additional writedowns were needed in 2000.
Capital Resources
- ------------------
The Federal Deposit Insurance Corporation Improvement Act, herein referred to as
the "FDICIA", of 1991 was signed into law on December 19, 1991. FDICIA included
significant changes to the legal and regulatory environment for insured
depository institutions, including reductions in insurance coverage for certain
kinds of deposits, increased supervision by the federal regulatory agencies,
increased reporting requirements for insured institutions, and new regulations
concerning internal controls, accounting, and operations.
The prompt corrective action regulations of FDICIA, define specific capital
categories based on the institutions' capital ratios. The capital categories, in
declining order, are "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized", and "critically
undercapitalized". To be considered "well capitalized" an institution must have
a core capital ratio of at least 5% and a total risk-based capital ratio of at
least 10%. Additionally, FDICIA imposed in 1994 a new Tier I risk-based capital
ratio of at least 6% to be considered "well capitalized". Tier I risk-based
capital is, primarily, common stock and retained earnings net of goodwill and
other intangible assets.
As of December 31, 2000, and 1999 the most recent notification from the FDIC, or
from any regulator, categorized Goleta as "adequately capitalized" under the
regulatory framework for prompt corrective action. At December 31, 2000 and
1999, the most recent notification from the FDIC and the Department of Financial
Institutions respectively categorized Palomar as "well-capitalized" under the
regulatory framework for prompt corrective action. To be categorized as
"adequately capitalized" or "well capitalized", Goleta and Palomar must maintain
minimum Total risk-based, Tier I risk-based, and Tier I leverage ratios as set
forth in the table below. There are no conditions or events since that
notification which management believes have caused Goleta or Palomar's category
to change.
14
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------- -------------------- -------------------
Year Ended December 31, 2000: Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------- ----------- ------
Total Risk-Based Capital
(to Risk Weighted assets)
Consolidated $38,645,337 11.04% $28,013,787 8.00% N/A N/A
Goleta National Bank $35,573,765 12.12% $23,473,626 8.00% $29,342,032 10.00%
Palomar Community Bank $ 7,329,473 13.89% $ 4,223,104 8.00% $ 5,278,879 10.00%
Tier I Capital
(to Risk Weighted assets)
Consolidated $31,898,901 9.11% $14,006,894 4.00% N/A N/A
Goleta National Bank $31,876,965 10.86% $11,736,813 4.00% $17,605,219 6.00%
Palomar Community Bank $ 6,669,613 12.64% $ 2,111,552 4.00% $ 3,167,328 6.00%
Tier I Capital
(to Average Assets)
Consolidated $31,898,901 7.25% $17,597,784 4.00% N/A N/A
Goleta National Bank $31,876,965 8.87% $14,375,225 4.00% $17,969,031 5.00%
Palomar Community Bank $ 6,669,613 8.75% $ 3,048,776 4.00% $ 3,810,970 5.00%
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------- -------------------- -------------------
Year Ended December 31, 1999: Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------- ----------- ------
Total Risk-Based Capital
(to Risk Weighted assets)
Consolidated $39,474,626 8.34% $37,856,951 8.00% N/A N/A
Goleta National Bank $33,099,716 8.01% $33,046,888 8.00% $41,308,610 10.00%
Palomar Community Bank $ 7,184,663 11.94% $ 4,814,290 8.00% $ 6,017,863 10.00%
Tier I Capital
(to Risk Weighted assets)
Consolidated $33,945,328 7.17% $18,928,475 4.00% N/A N/A
Goleta National Bank $28,182,418 6.82% $16,523,444 4.00% $24,785,166 6.00%
Palomar Community Bank $ 6,572,663 10.92% $ 2,407,145 4.00% $ 3,610,718 6.00%
Tier I Capital
(to Average Assets)
Consolidated $33,945,328 7.52% $18,060,691 4.00% N/A N/A
Goleta National Bank $28,182,418 7.27% $15,498,960 4.00% $19,373,700 5.00%
Palomar Community Bank $ 6,572,663 12.22% $ 2,151,381 4.00% $ 2,689,226 5.00%
In November 1999, the Office of the Comptroller of Currency of the United States
of America, herein referred to as the OCC, notified Goleta that it had
incorrectly calculated the amount of regulatory capital required to be held in
respect of residual interests retained by Goleta in two securitizations of loans
that were consummated in the fourth quarter of 1998 and the second quarter of
1999. Accordingly, the OCC informed Goleta that it was significantly
undercapitalized at March 31, 1999, June 30, 1999 and September 30, 1999. On
November 17, 1999, after a new debt and equity investment in the Company of
approximately $11.15 million by certain directors of the Company, the OCC
informed Goleta that it was adequately capitalized.
Under the regulatory framework, until the regulatory agencies notify Goleta that
they are deemed "well capitalized", Goleta may not accept or renew brokered
deposits without prior approval from the regulators. Goleta had no brokered
deposits at December 31, 2000.
15
On March 23, 2000, Goleta signed a formal written agreement with the Comptroller
of the Currency of the United States of America, herein referred to as the
"Agreement". Under the terms of the Agreement, by September 30, 2000, Goleta was
required to achieve and maintain total capital at least equal to 12% of
risk-weighted assets, and Tier 1 capital at least equal to 7% of adjusted total
assets. Goleta was also required to adopt and implement a written asset
diversification program that included specific plans for reduction of the
concentration of second mortgage loans (exclusive of securitized loans) to 100%
of capital. The Agreement also required submission of a capital plan, which
included, among other things, specific plans for meeting the special capital
requirements, projections for growth and a dividend policy. The Agreement placed
limitations on growth and payments of dividends until Goleta was in compliance
with its approved capital plan. Additionally, the Agreement adoption and
improvement in certain policies and procedures as well as development of a
three-year strategic plan. Goleta is required to submit monthly progress reports
to the OCC detailing actions taken, results of those actions, and a description
of actions needed to achieve full compliance with the Agreement. Goleta achieved
the capital requirements under the Agreement by September 30,2000. As of
December 31, 2000 Goleta had total capital equal to 12.12% of risk-weighted
assets. Under the terms of the Agreement, Goleta reduced its concentration of
second mortgage loans below 100% to 90.89% of capital as of May 31, 2000,
thereby, in the opinion of management, complying with all material provisions of
the Agreement. Management believes that it continues to comply with all material
provisions of the Agreement.
16
Schedule of Assets, Liabilities and Stockholders' Equity
- --------------------------------------------------------------
For the periods indicated below, the following schedule shows the average
balances of the Company's assets, liabilities and stockholders' equity accounts
as a percentage of average total assets:
----------------- ----------------- -----------------
December 31, 2000 1999 1998
(Dollars in thousands) ----------------- ----------------- -----------------
Amount % Amount % Amount %
--------- ------ --------- ------ --------- ------
ASSETS
- ------
Cash and due from banks $ 9,550 2.2% $ 8,582 1.9% $ 3,771 1.7%
Federal funds sold 22,833 5.2% 19,287 4.3% 8,161 3.6%
Time deposits in other financial institutions 1,654 0.4% 703 0.2% 1,099 0.5%
FRB/FHLB Stock 926 0.2% 621 0.1% 271 0.1%
Investment securities 6,445 1.5% 7,538 1.7% 6,199 2.8%
Loans:
Commercial 26,293 6.0% 19,545 4.3% 13,045 5.7%
Real estate 35,962 8.1% 43,627 9.7% 19,536 8.7%
Unguaranteed portions of loans insured by SBA 24,023 5.4% 24,139 5.4% 25,455 11.3%
Installment 16,598 3.8% 7,520 1.6% 12,531 5.6%
Loan participations purchased 20,453 4.6% 8,978 2.0% (1,109) (0.5%)
Less: allowance for loan loss (5,698) (1.3%) (2,179) (0.5%) (1,433) (0.6%)
Less: net deferred loan fees and premiums (118) 0.0% (103) 0.0% (21) 0.0%
Less: discount on loan pool purchase (953) (0.2%) (970) (0.2%) (703) (0.3%)
--------- ------ --------- ------ --------- ------
Net loans 116,560 26.4% 100,557 22.3% 67,301 29.9%
Securitized loans 174,245 39.6% 156,900 34.9% 80,231 35.6%
Loans held for sale 79,222 18.0% 140,910 31.3% 48,519 21.5%
Other real estate owned 147 0.0% 361 0.1% 181 0.1%
Premises and equipment, net 4,302 1.0% 4,682 1.0% 3,433 1.5%
Servicing asset 2,051 0.5% 1,813 0.4% 849 0.4%
Accrued interest receivable and other assets 22,010 5.0% 8,087 1.8% 5,243 2.3%
--------- ------ --------- ------ --------- ------
TOTAL ASSETS $439,945 100.0% $450,041 100.0% $225,258 100.0%
========= ====== ========= ====== ========= ======
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Deposits:
Noninterest-bearing demand $ 30,381 6.9% $ 24,761 5.5% $ 20,396 9.1%
Interest-bearing demand 23,548 5.3% 17,975 4.0% 6,385 2.8%
Savings 23,254 5.3% 23,776 5.3% 22,906 10.2%
Time certificates, $100,000 or more 78,342 17.8% 93,668 20.8% 30,338 13.5%
Other time certificates 86,227 19.6% 105,062 23.3% 50,016 22.2%
--------- ------ --------- ------ --------- ------
Total deposits 241,752 54.9% 265,242 58.9% 130,041 57.8%
Bonds payable 151,126 34.4% 144,311 32.1% 76,475 33.9%
Other borrowings 5,795 1.3% 1,128 0.3% - 0.0%
Federal funds purchased 287 0.1% 844 0.2% 1,479 0.7%
Accrued interest payable and other liabilities 4,297 1.0% 5,838 1.3% 4,771 2.1%
--------- ------ --------- ------ --------- ------
Total liabilities 403,257 91.7% 417,363 92.8% 212,766 94.5%
Stockholders' equity
Common stock 26,571 6.0% 22,779 5.0% 8,969 4.0%
Retained earnings 10,163 2.3% 9,941 2.2% 3,523 1.5%
Unrealized loss on AFS securities (46) 0.0% (42) 0.0% - 0.0%
--------- ------ --------- ------ --------- ------
Total stockholders' equity 36,688 8.3% 32,678 7.2% 12,492 5.5%
--------- ------ --------- ------ --------- ------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $439,945 100.0% $450,041 100.0% $225,258 100.0%
========= ====== ========= ====== ========= ======
17
Investment Portfolio
- ---------------------
The following table summarizes the year-end carrying values of the Company's
investment securities:
Year Ended December 31, 2000 1999 1998
---------- ---------- ----------
(Dollars rounded to
thousands)
U.S. Treasury Securities $1,902,000 $ 497,000 $1,256,000
FRB Stock 775,000 302,000 264,000
FHLB Stock 395,000 474,000 546,000
FHLB Bond 1,000,000 - -
FHLMC Bond 491,000 - -
GNMA Securities 2,125,000 2,746,000 4,230,000
FNMA Securities 878,000 1,107,000 1,893,000
FHLMC Securities 325,000 1,044,000 1,420,000
---------- ---------- ----------
Total $7,891,000 $6,170,000 $9,609,000
========== ========== ==========
The following table summarizes the amounts, terms, distributions, and yields of
the Company's investment securities:
After One Year to
-----------------------------
Year Ended December 31, One Year or Less Five Years Over Five Years Total
-------------- ------------- -------------- ----------------
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
------ ------ ------ ----- ------ ------ ------- -------
U.S. Treasury Securities 1,902 4.00% - N/A - N/A 1,902 4.00%
FRB Stock 775 4.13% - N/A - N/A 775 4.13%
FHLB Stock 395 7.85% - N/A - N/A 395 7.85%
FHLB Bond 1,000 6.10% - N/A - N/A 1,000 6.10%
GNMA Securities - N/A - N/A 2,125 8.11% 2,125 8.11%
FNMA Securities - N/A - N/A 878 8.44% 878 8.44%
FHLMC Securities - N/A - N/A 816 7.72% 816 7.72%
-------------- ------------- -------------- ----------------
Total 4,072 5.33% - N/A 3,819 8.09% 7,891 6.62%
============== ============= ============== ================
The Investment Policy of the Company outlines the types and maturities of
investments the Company may hold.
Interest Only Strips
- ----------------------
At December 31, 2000 and 1999 the Company held interest only strips in the
amount of $7,540,824 and $4,835,999, respectively. These interest only strips
represent the present value of the right to the estimated excess net cash flows
generated by the serviced loans which represents the difference between (a)
interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors; and (ii) contractual
servicing fees. The Company determines the present value of this estimated net
cash flows at the time each loan sale closes, utilizing valuation assumptions as
to discount rate and prepayment rate appropriate for each particular
transaction.
The valuation assumptions include the estimated average lives of the loans sold
and the estimated prepayment speeds related thereto. Present value of the cash
flow is calculated using an estimated market discount rate of 12% - 13% to the
expected gross cash flows, which are calculated utilizing the weighted average
lives of the loans. The annual prepayment rate of the loans is a function of
full and partial prepayments and defaults. In the interest only strips' fair
value estimates, the Company makes assumptions of the prepayment rates of the
underlying loans, which the Company believes are reasonable based on the
Company's own experience and review of rates used in the market. The interest
only strips are accounted for as investments in debt securities classified as
trading securities. Accordingly, the Company marks them to fair value with the
resulting increase or decrease recorded through operations in the current
period. At December 31, 2000 the Company utilized estimated annual prepayment
assumptions of 8% to calculate the fair value of the interest only strips.
18
Loan Portfolio
- ---------------
The Company's largest lending categories are commercial loans, real estate
loans, unguaranteed portion of loans insured by the SBA, installment loans, real
estate loan participations purchased, and second mortgage loans. Loans are
carried at face amount, net of; payments collected, the allowance for possible
loan losses, deferred loan fees and discounts on loans purchased. Interest on
all loans is accrued daily, primarily on a simple interest basis. It is
generally the Company's policy to place a loan on nonaccrual status when the
loan is 90 days past due. Thereafter, interest income is no longer recognized.
Problem loans are maintained on accrual status as long as the management of the
Company remains confident the loan will be repaid in full within a short period
of time.
The rates of interest charged on variable rate loans are set at specified
increments. These increments vary in relation to the Company's published prime
lending rate or other appropriate indices. At December 31, 2000, approximately
32% of the Company's loan portfolio was comprised of variable interest rate
loans. At December 31, 1999, variable rate loans comprised approximately 20% of
the Company's loan portfolio. At December 31, 1998, variable rate loans
comprised approximately 43% of the Company's loan portfolio.
Distribution of Loans
- -----------------------
The distribution of the Company's total loans by type of loan as of the dates
indicated, is shown in the following table:
Year Ended December 31,
(Dollars in thousands)
2000 1999 1998
Percentage Percentage
Loan Percentage to Loan to Gross Loan to Gross
Type of loan Balance Gross Loans Balance Loans Balance Loans
- ------------ ------------ --------------- --------- --------- -------- ---------
Commercial $ 36,188 10.8% $ 12,102 2.7% $ 10,612 4.3%
Real estate 55,083 16.5% 44,139 9.7% 65,348 26.2%
Unguaranteed portion
of loans insured by SBA 30,888 9.2% 25,073 5.5% 26,687 10.7%
Installment 22,898 6.8% 6,348 1.4% 5,638 2.3%
Loan participations purchased - - 25,395 5.6% 2,287 0.9%
Loans held for sale, primarily
second mortgage loans 37,195 11.1% 158,274 34.7% 58,687 23.5%
Securitized Loans 153,031 45.6% 184,559 40.4% 80,232 32.1%
------------ --------------- --------- --------- -------- ---------
GROSS LOANS 335,283 100.0% 455,890 100.0% 249,491 100.0%
Less:
Allowance for loan losses 6,746 5,529 3,374
Deferred loan fees (costs) (2,710) (3,079) (1,995)
Discount on SBA loans 1,982 1,776 701
------------ --------- --------
NET LOANS $ 329,265 $451,664 $247,411
============ ========= ========
Commercial Loans
- -----------------
In addition to traditional term commercial loans made to business customers, the
Company grants revolving business lines of credit. Under the terms of the
revolving line of credit, the Company grants a maximum loan amount, which
remains available to the business during the loan term. As part of the loan
requirements, the business agrees to maintain its primary banking relationship
with the Company. It is the Company's policy not to extend material loans of
this type in excess of one year.
19
Real Estate Loans
- -------------------
Real estate loans are primarily made for the purpose of purchasing, improving,
or constructing, single family residences, commercial, or industrial
properties. The majority of the Company's real estate loans are collateralized
by liens on single family homes. Maturities on such loans are generally 15 to
30 years.
A large part of the Company's real estate construction loans are first and
second trust deeds on the construction of owner-occupied single family
dwellings. The Company also makes real estate construction loans on commercial
properties. These consist of first and second trust deeds collateralized by the
related real property. Construction loans are generally written with terms of
six to twelve months and usually do not exceed a loan to appraised value of 80%.
Commercial and industrial real estate loans are secured by nonresidential
property. Office buildings or other commercial property primarily secure these
loans. Loan to appraised value ratios on nonresidential real estate loans are
generally restricted to 70% of appraised value of the underlying real property.
Unguaranteed Portion of Loans Guaranteed by the SBA
- ----------------------------------------------------------
The Company is approved as a "Preferred Lender" by the SBA. Loans made by the
Company under programs offered by the SBA are generally made to small businesses
for the construction or purchase of facilities, purchase of equipment, working
capital or the initial business purchase. The SBA generally guarantees between
75% and 90% of the funded commitment. Borrowers are required to provide adequate
collateral for these loans, similar to other commercial loans. The SBA allows
less-collateralized loans under its "Low Doc" program for loan commitments under
$100,000. When the Company originates an SBA loan, the guaranteed portion of the
loan is sold into the secondary market. The Company retains the unguaranteed
portion of the loan, as well as the servicing right and related fee income on
the loan. The SBA loans are all variable interest rate loans based upon the Wall
Street Journal Prime Rate. The servicing spread is a minimum of 1.00% on all
loans. Income recognized by the Company on the sales of the guaranteed portion
of these loans and the ongoing servicing income received, are significant
revenue sources for the Company.
Installment Loans
- ------------------
While not a large portion of its loan portfolio, the Company originates
installment loans, also known as consumer loans. These loans are comprised of
automobile, small equity lines of credit and general personal loans. These loans
are primarily fixed rate loans with terms up to five years.
Second Mortgage Loans
- -----------------------
In 1998 and 1999 the Company transferred $81 million and $122 million of these
loans respectively, to special purpose entities, herein referred to as SPE's.
The SPE's, through securitizations, then sold bonds to third party investors,
which were secured by the transferred loans. The bonds are held in a trust
independent of the Company, the trustee of which oversees the distribution to
the bondholders. The mortgage loans are serviced by a third party (the
"Servicer"), who receives a stated servicing fee. There is an insurance policy
on the subordinate bonds that guarantees the payment of the bonds.
As part of the securitization agreements, the Company received an option to
repurchase the bonds when the aggregate principal balance of the mortgage loans
sold declined to 10% or less of the original balance of mortgage loans
securitized Because the Company has a call option to reaquire the loans
transferred and did not retain the servicing rights, the Company has not
surrendered effective control over the loans transferred. Therefore, the
securitizations are accounted for as secured borrowings with a pledge of
collateral. Accordingly, the Company consolidates the SPE's and the financial
statements of the Company include the loans transferred and the related bonds
issued The securitized loans are classified as held for investment.
20
As of December 31, 2000, the Company had accumulated $15 million in second
mortgage loans. These loans are classified as held for sale. It is the
Company's intent to sell these loans with servicing rights released, to third
parties. The Company continues to originate second mortgage loans, which will
be sold to third parties shortly after origination.
Maturity of Loans and Sensitivity of Loans to Changes in Interest Rates
- --------------------------------------------------------------------------------
The following table sets forth the amount of gross loans outstanding which based
on the remaining scheduled repayments of principal, have the ability to be
repriced or mature as defined in the following table:
December 31, 2000 1999 1998
------------------- ------------------- -------------------
(Dollars in thousands) Fixed Variable Fixed Variable Fixed Variable
-------- --------- -------- --------- -------- ---------
Less than One Year $ 1,058 $ 100,717 $ 789 $ 87,313 $ 5,431 $ 105,173
-------- --------- -------- --------- -------- ---------
One Year to Five Years 8,250 5,403 8,342 4,628 10,487 1,272
More than Five Years 219,213 642 354,282 536 127,128 -
-------- --------- -------- --------- -------- ---------
Total $228,521 $ 106,762 $363,413 $ 92,477 $143,046 $ 106,445
======== ========= ======== ========= ======== =========
The Company's loan commitments outstanding at the dates indicated are included
in the following table:
December 31,
(Dollars in thousands) 2000 1999 1998
------- ------- -------
Commercial $ 9,776 $ 6,641 $10,693
------- ------- -------
Real estate 8,323 4,135 12,306
Loans guaranteed by the SBA 4,545 5,266 4,230
Installment loans 2,260 2,205 1,502
Standby letters of credit 913 713 35
Total commitments $25,817 $18,960 $28,766
======= ======= =======
Based upon prior experience and prevailing economic conditions, it is
anticipated that approximately 80% of the commitments at December 31, 2000 will
be exercised during 2001.
Summary of Loan Losses Experience
- -------------------------------------
As is customary in the lending business, the Company experienced some loan
losses during the year. The risk of loss varies depending on the type of loan
granted and the creditworthiness of the borrower. The degree of perceived risk
is addressed during the structure of the loan. The Company attempts to minimize
its credit risk exposure through use of thorough approval procedures and a
comprehensive loan application.
The Company maintains a program of systematic review of its existing loans.
Loans are graded for their overall quality. The Company's management determines
which loans require further monitoring and supervision. These loans are
segregated for periodic review. The Company's Loan Committee reviews any loans
designated as significant problem loans on a monthly basis.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest under the contractual terms of the loan agreement.
Factors considered by management in determining impairment include, payment
status, collateral value, and the probability of collecting scheduled principal
and interest payments. Loans that experience insignificant payment delays or
payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis. When determining the possibility of impairment, management
considers the circumstances surrounding the loan and the borrower, including the
length of the delay, the reasons for the delay, the borrower's prior payment
record and the amount of the shortfall in relation to the principal and interest
owed. The Company uses the fair value of collateral method to measure
impairment. Impairment is measured on a loan by loan basis for all loans in the
portfolio except for the securitized loans, which are collectively evaluated for
impairment.
21
The recorded investment in loans that are considered to be impaired :
December 31, 2000 1999 1998
------------ ------------ -----------
Impaired loans without
specific valuation allowances $ 564,662 $ 3,250,576 $4,450,345
Impaired loans with
specific valuation allowances 3,531,408 1,402,469 813,652
Specific valuation allowances
allocated to impaired loans (1,206,706) (1,038,519) (464,336)
------------ ------------ -----------
Impaired loans, net $ 2,889,364 $ 3,614,526 $4,799,661
============ ============ ===========
Average investment in impaired loans $ 4,676,705 $ 5,119,852 $4,009,400
============ ============ ===========
Interest income recognized on impaired loans $ 386,704 $ 243,913 $ 288,607
============ ============ ===========
It is the Company's policy to place a loan on nonaccrual status when the loan
payment is 90 days past due. Thereafter, interest income is no longer
recognized. As such, interest income may be recognized on impaired loans to the
extent they are not past due by 90 days or more.
The Company classifies all loans on nonaccrual status as impaired. Accordingly,
the impaired loans disclosed above include all loans that were on nonaccrual
status.
Financial difficulties encountered by certain borrowers may cause the Company to
restructure the terms of their loan to facilitate loan repayment. A troubled
loan that is restructured would generally be considered impaired. The balance of
impaired loans disclosed above includes all troubled debt restructured loans
that, as of December 31, 2000, 1999, and 1998 are considered impaired.
The following schedule reflects recorded investment in certain types of loans:
December 31,
---------- ---------- ----------
(Dollars rounded to thousands) 2000 1999 1998
---------- ---------- ----------
Nonaccrual loans $2,095,000 $3,091,000 $2,971,000
Troubled debt restructured loans, gross $ 615,000 $ 656,000 $1,313,000
Interest foregone on nonaccrual loans
And troubled debt restructuring outstanding $ 592,000 $1,585,000 $ 414,000
Loans 30 through 90 days past due with interest accruing $4,277,000 $2,550,000 $ 678,000
The Company charges off that portion of any loan which management considers to
represent a loss. A loan is generally considered to represent a loss when any
of the following events have occurred; a loan balance greater than the
collateral value, servicing of the unsecured portion has been discontinued, or
collection is not anticipated based on the borrower's financial condition and
general economic conditions in the borrower's industry. The principal amount of
any loan, which is declared a loss, is charged against the Company's allowance
for loan losses.
22
The following table summarizes the Company's loan loss experience for the
periods indicated:
Year Ended December 31, 2000 1999 1998
(Dollars rounded to thousands) : ------------- ------------- -------------
Average gross loans, held for investment $297,574,000 $260,709,000 $149,690,000
------------- ------------- -------------
Gross loans at end of year, held for
Investment 302,476,000 297,616,000 190,804,000
------------- ------------- -------------
Loans charged off 5,748,000 4,035,000 360,000
Recoveries of loans previously charged off 171,000 58,000 61,000
------------- ------------- -------------
Net loans charged off 5,577,000 3,977,000 299,000
------------- ------------- -------------
Allowance for loan losses 6,746,000 5,529,000 3,374,000
------------- ------------- -------------
Provisions for loan losses 6,794,000 6,133,000 1,760,000
------------- ------------- -------------
Ratios:
Net loan charge-offs to average loans 1.9% 1.5% 0.2%
Net loan charge-offs to loans at end of period 1.8% 1.3% 0.2%
Allowance for loan losses to average loans 2.3% 2.1% 2.3%
Allowance for loan losses to loans
held for investment at end of period 2.2% 1.9% 1.8%
Net loan charge-offs to allowance
for loan losses at end of period 82.7% 71.9% 8.9%
Net loan charge-offs to provision for loan losses 82.1% 64.8% 17.0%
The Company's allowance for loan losses is maintained at a level believed
adequate by management to absorb known and inherent probable losses on existing
loans. A provision for loan losses is charged to expense. The allowance is
charged for losses when management believes that full recovery on the loan is
unlikely. Subsequent recoveries, if any, are credited to the allowance.
Management's determination of the adequacy of the allowance is based on periodic
evaluations of the loan portfolio, which take into consideration such factors as
changes in the growth, size and composition of the loan portfolio, overall
portfolio quality, review of specific problem loans, collateral, guarantees and
economic conditions that may affect the borrowers' ability to pay and and/or the
value of the underlying collateral. These estimates depend on the outcome of
future events and, therefore, contain inherent uncertainties.
At December 31, 2000, 1999, and 1998, the allowance was 2.2%, 1.9%, and 1.8%
resepectively, of the gross loans held for investment. Although the current
level of the allowance is deemed adequate by management, future provisions will
be subject to review of current risks in the loan portfolio.
Management of the Company reviews with the Board of Directors the adequacy of
the allowance for loan losses on a quarterly basis. The loan loss provision is
adjusted when specific items reflect a need for an adjustment. Management
believes the level of the allowance for loan losses as of December 31, 2000, is
adequate to absorb future losses; however, changes in the local economy, the
ability of borrowers to repay amounts borrowed and other factors may result in
the need to increase the allowance through charges to earnings.
23
Interest Rates and Differentials
- -----------------------------------
Certain information concerning interest-earning assets and interest-bearing
liabilities, and yields thereon, is set forth in the following table. Amounts
outstanding are daily average balances:
Year Ended December 31, -------------------------------
(Dollars in thousands) 2000 1999 1998
--------- --------- ---------
Interest-earning assets:
Time deposits in other financial institutions:
Average outstanding $ 1,654 $ 703 $ 1,099
Average yield 6.8% 6.7% 6.0%
Interest income $ 113 $ 47 $ 66
Federal funds sold:
Average outstanding $ 22,833 $ 19,287 $ 8,161
Average yield 6.2% 5.2% 5.0%
Interest income $ 1,405 $ 1,008 $ 411
Investment securities:
Average outstanding $ 7,371 $ 8,159 $ 6,470
Average yield 6.8% 5.4% 0.8%
Interest income $ 498 $ 442 $ 52
Loans:
Average outstanding $202,551 $244,719 $117,977
Average yield 11.0% 13.1% 12.1%
Interest income $ 22,348 $ 32,065 $ 14,311
Securitized Loans:
Average outstanding $174,245 $156,900 $ 80,231
Average yield 15.7% 9.5% 0.5%
Interest income $ 27,417 $ 14,933 $ 440
Total interest-earning assets:
Average outstanding $408,654 $429,768 $213,938
Average yield 12.7% 11.3% 7.1%
Interest income $ 51,781 $ 48,495 $ 15,280
24
Interest-bearing liabilities:
Interest-bearing demand deposits:
Average outstanding $ 23,548 $ 17,975 $ 6,385
Average yield 3.4% 3.2% 7.9%
Interest expense $ 790 $ 576 $ 502
Savings deposits:
Average outstanding $ 23,254 $ 23,776 $ 22,906
Average yield 3.1% 3.7% 2.1%
Interest expense $ 712 $ 884 $ 488
Time certificates of deposit:
Average outstanding $164,569 $198,730 $ 80,354
Average yield 6.0% 6.9% 5.9%
Interest expense $ 9,832 $ 13,620 $ 4,732
Federal funds purchased:
Average outstanding $ 287 $ 844 $ 1,479
Average yield 6.6% 5.2% 5.7%
Interest expense $ 19 $ 44 $ 85
Bonds Payable:
Average outstanding $151,126 $144,311 $ 6,372
Average yield 9.4% 6.9% 8.0%
Interest expense $ 14,161 $ 9,938 $ 510
Other borrowings:
Average outstanding $ 5,795 $ 1,128 $ -
Average yield 9.4% 7.4% -
Interest expense $ 546 $ 83 $ -
Total interest-bearing liabilities:
Average outstanding $368,579 $386,764 $117,496
Average yield 7.1% 6.5% 5.4%
Interest Expense $ 26,060 $ 25,145 $ 6,317
Net interest income $ 25,721 $ 23,350 $ 8,963
Average net interest margin
On interest-earning assets 6.3% 5.4% 4.2%
Liquidity Management
- ---------------------
The Company has an asset and liability management program allowing the Company
to maintain its interest margins during times of both rising and falling
interest rates and to maintain sufficient liquidity. Liquidity of the Company at
December 31, 2000 and 1999 was 37% and 38% respectively, based on liquid assets.
Liquid assets consist of cash and due from banks, deposits in other financial
institutions, available for sale investments, federal funds sold and loans held
for sale, divided by total assets. Management believes it maintains adequate
liquidity levels.
When the Company has more funds than it needs for its reserve requirements or
short-term liquidity needs, the Company increases its securities investments or
sells federal funds. It is management's policy to maintain a substantial portion
of its portfolio of assets and liabilities on a short-term or highly liquid
basis in order to maintain rate flexibility and to meet loan funding and
liquidity needs.
25
Deposits
- --------
The following table shows the Company's average deposits for each of the periods
indicated below, based upon average daily balances:
Year Ended December 31, 2000 1999 1998
------------------- ------------------- -------------------
Average Percent Average Percent Average Percent
-------- -------- --------
(Dollars in thousands) Balance of Total Balance Of Total Balance of Total
-------- --------- -------- --------- -------- ---------
Noninterest-bearing demand $ 30,381 12.6% $ 24,761 9.3% $ 20,396 15.7%
Interest-bearing demand 23,548 9.7% 17,975 6.8% 6,385 4.9%
Savings 23,254 9.6% 23,776 9.0% 22,906 17.6%
TCDs of $100,000 or more 78,342 32.4% 93,668 35.3% 30,338 23.3%
Other TCDs 86,227 35.7% 105,062 39.6% 50,016 38.5%
Total Deposits $241,752 100.0% $265,242 100.0% $130,041 100.0%
The maturities of time certificates of deposit ("TCDs"):
December 31, 2000 1999
------------------------- ---------------------
TCD's over TCDs over
(Dollars in thousands) $100,000 Other TCD's $100,000 Other TCDs
------------------------------------------------
Less than three months $ 37,299 $ 30,396 $ 60,353 $ 64,553
Over three months through six months 19,389 13,819 31,638 46,955
Over six months through twelve months 19,624 18,772 7,142 22,588
Over twelve months through five years 331 1,717 1,624 6,056
----------- ------------ -------- -----------
Total $ 76,643 $ 64,704 $100,757 $ 140,152
=========== ============ ======== ===========
While the deposits of the Company may fluctuate up and down with local and
national economic conditions, management of the Company does not believe that
the change in deposits or the business of the Company in general is seasonal in
nature. Liquidity management is monitored by the Chief Financial Officer daily
and by the Asset/Liability Committee of the Company's Board of Directors,
quarterly.
Year 2000
- ----------
The Company had in place a plan of action designed to minimize the risk of the
year 2000 event which included the establishment of an oversight committee.
This plan was fully supported by management and the Board of Directors. The
committee achieved a year 2000 date conversion with no effect on customers or
disruption to business operations. No systems, hardware or software determined
as critical needed replacement. The Company incurred no additional year 2000
related costs as of December 31, 2000.
SUPERVISION AND REGULATION
- ----------------------------
Introduction
- ------------
Banking is a complex, highly regulated industry. The primary goals of the
regulatory scheme are to maintain a safe and sound banking system, protect
depositors, the FDIC, and to facilitate the conduct of sound monetary policy.
In furtherance of these goals, Congress and the states have created several
largely autonomous regulatory agencies and enacted numerous laws that govern
banks, bank holding companies, and the banking industry. Consequently, the
Company's growth and earnings performance, as well as those of Goleta and
Palomar collectively, the "Banking Subsidiaries" herein referred to as "Banking
Subsidiaries", may be affected not only by management decisions and general
economic conditions, but also by the requirements of applicable state and
federal statutes, regulations and the policies of various governmental
regulatory authorities, including:
26
- the Board of Governors of the FRB;
- the FDIC;
- the OCC; and
- the California Department of Financial Institutions herein
referred to as the "DFI".
Goleta National Bank, subsidiary of the Company is currently under an agreement
with the OCC as discussed previously in the capital resources section of this
report.
The system of supervision and regulation applicable to the Company and the
Banking Subsidiaries governs most aspects of their business, including:
- the scope of permissible business activities;
- investments;
- reserves that must be maintained against deposits;
- capital levels that must be maintained;
- the nature and amount of collateral that may be taken to secure
loans;
- the establishment of new branches;
- mergers and consolidations with other financial institutions; and
- the payment of dividends
From time to time legislation is enacted which has the effect of increasing the
cost of doing business and changing the competitive balance between banks and
other financial and non-financial institutions. Various federal laws enacted
over the past several years have provided, among other things, for:
- the maintenance of mandatory reserves with the FRB on deposits by
depository institutions;
- the phasing-out of the restrictions on the amount of interest
which financial institutions may pay on certain types of
accounts; and
- the authorization of various types of new deposit accounts, such
as "NOW" accounts, "Money Market Deposit" accounts and "Super
NOW" accounts, designed to be competitive with money market
mutual funds and other types of accounts and services offered by
various financial and non-financial institutions.
The lending authority and permissible activities of certain non-bank financial
institutions such as savings and loan associations and credit unions have been
expanded, and federal regulators have been given increased enforcement
authority. These laws have generally had the effect of altering competitive
relationships existing among financial institutions, reducing the historical
distinctions between the services offered by banks, savings and loan
associations and other financial institutions, and increasing the cost of funds
to banks and other depository institutions.
The following discussion of statutes and regulations affecting banks is only a
summary, does not purport to be complete, and is qualified in its entirety by
reference to the actual statutes and regulations. No assurance can be given
that the statutes and regulations will not change in the future. Moreover, any
changes may have a material effect on our business.
27
Supervision and Regulation - The Company
- ---------------------------------------------
General
- -------
The Company, as a bank holding company registered under the Bank Holding Company
Act of 1956, as amended herein referred to the "BHCA", is subject to regulation
by the FRB. According to FRB policy, the Company is expected to act as a source
of financial strength for the Banking Subsidiaries and to commit resources to
support them in circumstances where the Company might not otherwise do so. Under
the BHCA, the Company and the Banking Subsidiaries are subject to periodic
examination by the FRB. The Company is also required to file periodic reports
of its operations and any additional information regarding its activities and
those of its subsidiaries with the FRB, as may be required.
The Company is also a bank holding company within the meaning of Section 3700 of
the California Financial Code. As such, the Company and its subsidiaries are
subject to examination by, and may be required to file reports with, the
Commissioner of the DFI herein referred to as the "Commissioner". Regulations
have not yet been proposed or adopted or steps otherwise taken to implement the
Commissioner's powers under this statute.
Bank Holding Company Liquidity
- ---------------------------------
The Company is a legal entity, separate and distinct from the Banking
Subsidiaries. Although there exists the ability to raise capital on its own
behalf or borrow from external sources, it may also obtain additional funds
through dividends paid by, and fees for services provided to, the Banking
Subsidiaries. However, regulatory constraints may restrict or totally preclude
its Banking Subsidiaries from paying dividends to the Company.
Regarding Goleta, the Company is entitled to receive dividends when and as
declared by Goleta's Board of Directors, out of funds legally available for
dividends, as specified and limited by the OCC's regulations. Pursuant to the
OCC's regulations, funds available for a national bank's dividends are
restricted to the lesser of the bank's: (i) retained earnings; or (ii) net
income for the current and past two fiscal years (less any dividends paid during
that period), unless approved by the OCC. Furthermore, if the OCC determines
that a dividend would cause a bank's capital to be impaired or that payment
would cause it to be undercapitalized, the OCC can prohibit payment of a
dividend notwithstanding that funds are legally available.
Regarding Palomar, the California Financial Code restricts the payment of
dividends by California-chartered banks. Funds available for paying cash
dividends is limited to the lesser of retained earnings or net income for the
last three fiscal years, reduced by any other distributions to shareholders.
Also, under certain circumstances, dividends may be paid with the prior approval
of the Commissioner. However, if the Commissioner determines that paying a
dividend would be unsafe or unsound, notwithstanding that funds are legally
available, the Commissioner can prohibit the bank from paying a dividend.
Since the Banking Subsidiaries are FDIC insured institutions, it is also
possible, depending upon their financial condition and other factors, that the
FDIC could assert that the payment of dividends or other payments might, under
some circumstances, constitute an unsafe or unsound practice and, thus, prohibit
those payments.
Transactions With Affiliates
- ------------------------------
The Company and any subsidiaries it may purchase or organize are deemed to be
affiliates of the Banking Subsidiaries within the meaning of Sections 23A and
23B of the Federal Reserve Act herein referred to as the "FRA", as amended.
Pursuant thereto, loans by the Banking Subsidiaries to affiliates, investments
by the Banking Subsidiaries in affiliates' stock, and taking affiliates' stock
as collateral for loans to any borrower will be limited to 10% of the Banking
Subsidiary's capital, in the case of any one affiliate, and will be limited to
20% of the Banking Subsidiaries' capital in the case of all affiliates. In
addition, such transactions must be on terms and conditions that are consistent
with safe and sound banking practices. Specifically, a bank and its
subsidiaries generally may not purchase from an affiliate a low-quality asset,
as defined in the FRA. Such restrictions also prevent a bank holding company
and its other affiliates from borrowing from a banking subsidiary of the bank
holding company unless the loans are secured by marketable collateral of
designated amounts. The Company and the Banking Subsidiaries are also subject
to certain restrictions with respect to engaging in the underwriting, public
sale and distribution of securities. (See "Supervision and Regulation of the
Banking Subsidiaries - Recent Legislation" herein.)
28
Limitations on Businesses and Investment Activities
- --------------------------------------------------------
Under the BHCA, a bank holding company must obtain the FRB's approval before:
- directly or indirectly acquiring more than 5% ownership or
control of any voting shares of another bank or bank holding
company;
- acquiring all or substantially all of the assets of another bank;
or
- merging or consolidating with another bank holding company.
The FRB may allow a bank holding company to acquire banks located in any state
of the United States without regard to whether the acquisition is prohibited by
the law of the state in which the target bank is located. In approving
interstate acquisitions, however, the FRB must give effect to applicable state
laws limiting the aggregate amount of deposits that may be held by the acquiring
bank holding company and its insured depository institutions in the state in
which the target bank is located, provided that those limits do not discriminate
against out-of-state depository institutions or their holding companies, and
state laws which require that the target bank have been in existence for a
minimum period of time, not to exceed five years, before being acquired by an
out-of-state bank holding company.
In addition to owning or managing banks, bank holding companies may own
subsidiaries engaged in certain businesses that the FRB has determined to be "so
closely related to banking as to be a proper incident thereto." The Company,
therefore, is permitted to engage in a variety of banking-related businesses.
Some of the activities that the FRB has determined, pursuant to its Regulation
Y, to be related to banking are:
- making or acquiring loans or other extensions of credit for its
own account or for the account of others;
- servicing loans and other extensions of credit;
- operating a trust company in the manner authorized by federal or
state law under certain circumstances;
- leasing personal and real property or acting as agent, broker, or
adviser in leasing such property in accordance with various
restrictions imposed by FRB regulations;
- providing financial, banking, or economic data processing and
data transmission services;
- owning, controlling, or operating a savings association under
certain circumstances;
- selling money orders, travelers' checks and U.S. Savings Bonds;
- providing securities brokerage services, related securities
credit activities pursuant to Regulation T, and other incidental
activities; and
- underwriting and dealing in obligations of the United States,
general obligations of states and their political subdivisions,
and other obligations authorized for state member banks under
federal law.
Generally, the BHCA does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
29
Federal law prohibits a bank holding company and any subsidiary banks from
engaging in certain tie-in arrangements in connection with the extension of
credit. Thus, for example, the Banking Subsidiaries may not extend credit,
lease or sell property, or furnish any services, or fix or vary the
consideration for any of the foregoing on the condition that:
- the customer must obtain or provide some additional credit,
property or services from or to the Banking Subsidiaries other
than a loan, discount, deposit or trust service;
- the customer must obtain or provide some additional credit,
property or service from or to the Company or any of the Banking
Subsidiaries; or
- the customer may not obtain some other credit, property or
services from competitors, except reasonable requirements to
assure soundness of credit extended d
In late 1999, the Gramm-Leach-Bliley Act herein referred to as the "GLB Act",
was enacted. The GLB Act significantly changed the regulatory structure and
oversight of the financial services industry. The GLB Act permits banks and
bank holding companies to engage in previously prohibited activities under
certain conditions. Also, banks and bank holding companies may affiliate with
other financial service providers such as insurance companies and securities
firms under certain conditions. Consequently, a qualifying bank holding company,
called a financial holding company herein referred to as "FHC", can engage in a
full range of financial activities, including banking, insurance, and securities
activities, as well as merchant banking and additional activities that are
beyond those traditionally permitted for bank holding companies. Moreover,
various non-bank financial service providers who were previously prohibited from
engaging in banking can now acquire banks while also offering services such as
securities underwriting and underwriting and brokering insurance products. The
GLB Act also expands passive investment activities by FHCs, permitting them to
indirectly invest in any type of company, financial or non-financial, through
merchant banking activities and insurance company affiliations. (See
"Supervision and Regulation of the Banking Subsidiaries - Recent Legislation"
herein.)
Capital Adequacy
- -----------------
Bank holding companies must maintain minimum levels of capital under the FRB's
risk based capital adequacy guidelines. If capital falls below minimum
guideline levels, a bank holding company, among other things, may be denied
approval to acquire or establish additional banks or non-bank businesses.
The FRB's risk-based capital adequacy guidelines for bank holding companies and
state member banks, discussed in more detail below (See "Supervision and
Regulation of the Banking Subsidiaries - Risk-Based Capital Guidelines"
herein.), assign various risk percentages to different categories of assets, and
capital is measured as a percentage of those risk assets. Under the terms of
the guidelines, bank holding companies are expected to meet capital adequacy
guidelines based both on total risk assets and on total assets, without regard
to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will
be required if warranted by the particular circumstances or risk profiles of
individual organizations. For example, the FRB's capital guidelines contemplate
that additional capital may be required to take adequate account of, among other
things, interest rate risk, the risks posed by concentrations of credit, risks
associated nontraditional banking activities or securities trading activities.
Moreover, any banking organization experiencing or anticipating significant
growth or expansion into new activities, particularly under the expanded powers
of the GLB Act, may be expected to maintain capital ratios, including tangible
capital positions, well above the minimum levels.
Limitations on Dividend Payments
- -----------------------------------
As a California corporation, the Company's ability to pay dividends is subject
to the dividend limitations of the California Corporations Code herein referred
to as the "CCC". Section 500 of the CCC allows the Company to pay a dividend to
its shareholders only to the extent that the Company has retained earnings and,
after the dividend, the Company's:
30
- assets (exclusive of goodwill and other intangible assets) would
be 1.25 times its liabilities (exclusive of deferred taxes,
deferred income and other deferred credits); and
- current assets would be at least equal to its current liabilities
Additionally, the FRB's policy regarding dividends provides that a bank holding
company should not pay cash dividends exceeding its net income or which can only
be funded in ways, such as by borrowing, that weaken the bank holding company's
financial health or its ability to act as a source of financial strength to its
subsidiary banks. The FRB also possesses enforcement powers over bank holding
companies and their non-bank subsidiaries to prevent or remedy actions that
represent unsafe or unsound practices or violations of applicable statutes and
regulations.
Supervision and Regulation of The Banking Subsidiaries
- ------------------------------------------------------------
General
- -------
Palomar, as a state-chartered bank that is not a member of the Federal Reserve
System and whose deposits are insured by the FDIC, is subject to regulation,
supervision, and regular examination by the DFI, and the FDIC. Goleta, as a
national banking association member, which is also a member of the Federal
Reserve System, is subject to regulation, supervision, and regular examination
by the OCC, the FDIC and the FRB. The Banking Subsidiaries' deposits are
insured by the FDIC up to the maximum extent provided by law. The regulations
of these agencies govern most aspects of the Banking Subsidiaries' business.
California law exempts all banks from usury limitations on interest rates.
Recent Legislation
- -------------------
On November 12, 1999 the GLB Act was signed into law, significantly changing the
regulatory structure and oversight of the financial services industry.
Effective March 12, 2000, the GLB Act repealed the provisions of the
Glass-Steagall Act that restricted banks and securities firms from affiliating.
It also revised the BHCA to permit an FHC to engage in a full range of financial
activities, including banking, insurance, securities, and merchant banking
activities. It also permits FHCs to acquire many types of financial firms
without the FRBs prior approval.
The GLB Act thus provides expanded financial affiliation opportunities for
existing bank holding companies and permits other financial service providers to
acquire banks and become bank holding companies without ceasing any existing
financial activities. Previously, a bank holding company could only engage in
activities that were "closely related to banking." This limitation no longer
applies to bank holding companies that qualify to be treated as FHCs. To
qualify as an FHC, a bank holding company's subsidiary depository institutions
must be "well-capitalized," "well-managed" and have at least a "satisfactory"
Community Reinvestment Act herein referred to as "CRA" examination rating.
"Non-qualifying" bank holding companies are limited to activities that were
permissible under the Bank Holding Company Act as of November 11, 1999.
Also, effective on March 12, 2000, the GLB Act changed the powers of national
banks and their subsidiaries, and made similar changes in the powers of
state-chartered banks and their subsidiaries. National banks may now
underwrite, deal in and purchase state and local revenue bonds. Subsidiaries of
national banks may now engage in financial activities that the bank cannot
itself engage in, except for general insurance underwriting and real estate
development and investment. In order for a subsidiary of a national bank to
engage in these new financial activities, the national bank and its depository
institution affiliates must be "well capitalized," have at least "satisfactory"
general, managerial and CRA examination ratings, and meet other qualification
requirements relating to total assets, subordinated debt, capital, risk
management, and affiliate transactions. Subsidiaries of state-chartered banks
can exercise the same powers as national bank subsidiaries if they satisfy the
same qualifying rules that apply to national banks, except that state-chartered
banks do not have to satisfy the managerial and debt rating requirements
applicable to national banks.
31
The GLB Act also reformed the overall regulatory framework of the financial
services industry. In order to implement its underlying purposes, the GLB Act
preempted conflicting state laws that would restrict the types of financial
affiliations that are authorized or permitted under the GLB Act, subject to
specified exceptions for state insurance laws and regulations. With regard to
securities laws, effective May 12, 2001, the GLB Act will remove the current
blanket exemption for banks from being considered brokers or dealers under the
Securities Exchange Act of 1934 and will replace it with a number of more
limited exemptions. Thus, previously exempted banks may become subject to the
broker-dealer registration and supervision requirements of the Securities
Exchange Act of 1934. The exemption that prevented bank holding companies and
banks that advise mutual funds from being considered investment advisers under
the Investment Advisers Act of 1940 will also be eliminated.
Separately, the GLB Act imposes customer privacy requirements on any company
engaged in financial activities. Under these requirements, a financial company
is required to protect the security and confidentiality of customer nonpublic
personal information. Also, for customers that obtain a financial product such
as a loan for personal, family or household purposes, a financial company is
required to disclose its privacy policy to the customer at the time the
relationship is established and annually thereafter, including its policies
concerning the sharing of the customer's nonpublic personal information with
affiliates and third parties. If an exemption is not available, a financial
company must provide consumers with a notice of its information sharing
practices that allows the consumer to reject the disclosure of its nonpublic
personal information to third parties. Third parties that receive such
information are subject to the same restrictions as the financial company on the
reuse of the information. Finally, a financial company is prohibited from
disclosing an account number or similar item to a third party for use in
telemarketing, direct mail marketing or other marketing through electronic mail.
Risk-Based Capital Guidelines
- -------------------------------
General. The federal banking agencies have established minimum capital
standards known as risk-based capital guidelines. These guidelines are intended
to provide a measure of capital that reflects the degree of risk associated with
a bank's operations. The risk-based capital guidelines include both a new
definition of capital and a framework for calculating the amount of capital that
must be maintained against a bank's assets and off-balance sheet items. The
amount of capital required to be maintained is based upon the credit risks
associated with the various types of a bank's assets and off-balance sheet
items. A bank's assets and off-balance sheet items are classified under several
risk categories, with each category assigned a particular risk weighting from 0%
to 100%. The bank's risk-based capital ratio is calculated by dividing its
qualifying capital, which is the numerator of the ratio, by the combined risk
weights of its asserts and off-balance sheet items, which is the denominator of
the ratio.
Qualifying Capital. A bank's total qualifying capital consists of two types of
- -------------------
capital components: "core capital elements," known as Tier 1 capital, and
"supplementary capital elements," known as Tier 2 capital. The Tier 1 component
of a bank's qualifying capital must represent at least 50% of total qualifying
capital and may consist of the following items that are defined as core capital
elements:
- common stockholders' equity;
- qualifying non-cumulative perpetual preferred stock (including
related surplus); and
- minority interests in the equity accounts of consolidated
subsidiaries.
The Tier 2 component of a bank's total qualifying capital may consist of the
following items:
- a portion of the allowance for loan and lease losses;
- certain types of perpetual preferred stock and related surplus;
- certain types of hybrid capital instruments and mandatory
convertible debt securities; and
- a portion of term subordinated debt and intermediate-term
preferred stock, including related surplus.
32
Risk Weighted Assets and Off-Balance Sheet Items. Assets and credit equivalent
- -------------------------------------------------
amounts of off-balance sheet items are assigned to one of several broad risk
classifications, according to the obligor or, if relevant, the guarantor or the
nature of the collateral. The aggregate dollar value of the amount in each risk
classification is then multiplied by the risk weight associated with that
classification. The resulting weighted values from each of the risk
classifications are added together. This total is the bank's total risk weighted
assets.
A two-step process determines risk weights for off-balance sheet items, such as
unfunded loan commitments, letters of credit and recourse arrangements. First,
the "credit equivalent amount" of the off-balance sheet items is determined, in
most cases by multiplying the off-balance sheet item by a credit conversion
factor. Second, the credit equivalent amount is treated like any balance sheet
asset and is assigned to the appropriate risk category according to the obligor
or, if relevant, the guarantor or the nature of the collateral. This result is
added to the bank's risk-weighted assets and comprises the denominator of the
risk-based capital ratio.
Minimum Capital Standards. The supervisory standards set forth below specify
- ---------------------------
minimum capital ratios based primarily on broad risk considerations. The
risk-based ratios do not take explicit account of the quality of individual
asset portfolios or the range of other types of risks to which banks may be
exposed, such as interest rate, liquidity, market or operational risks. For
this reason, banks are generally expected to operate with capital positions
above the minimum ratios.
All banks are required to meet a minimum ratio of qualifying total capital to
risk weighted asserts of 8%. At least 4% must be in the form of Tier 1 capital,
net of goodwill. The maximum amount of supplementary capital elements that
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of
goodwill. In addition, the combined maximum amount of subordinated debt and
intermediate-term preferred stock that qualifies as Tier 2 capital is limited to
50% of Tier 1 capital. The maximum amount of the allowance for loan and lease
losses that qualifies as Tier 2 capital is limited to 1.25% of gross risk
weighted asserts. The allowance for loan and lease losses in excess of this
limit may, of course, be maintained, but would not be included in a bank's
risk-based capital calculation.
The federal banking agencies also require all banks to maintain a minimum amount
of Tier 1 capital to total assets, referred to as the leverage ratio. For a
bank rated in the highest of the five categories used by regulators to rate
banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For
all banks not rated in the highest category, the minimum leverage ratio must be
at least 4% to 5%. These uniform risk-based capital guidelines and leverage
ratios apply across the industry. Regulators, however, have the discretion to
set minimum capital requirements for individual institutions, which may be
significantly above the minimum guidelines and ratios.
Other Factors Affecting Minimum Capital Standards
- ------------------------------------------------------
The federal banking agencies have established certain benchmark ratios of loan
loss reserves to be held against classified assets. The benchmark by federal
banking agencies is the sum of:
- 100% of assets classified loss;
- 50% of assets classified doubtful;
- 15% of assets classified substandard; and
- estimated credit losses on other assets over the upcoming twelve
months.
The federal banking agencies have recently revised their risk-based capital
rules to take account of concentrations of credit and the risks of engaging in
non-traditional activities. Concentrations of credit refers to situations where
a lender has a relatively large proportion of loans involving a single borrower,
industry, geographic location, collateral or loan type. Non-traditional
activities are considered those that have not customarily been part of the
banking business, but are conducted by a bank as a result of developments in,
for example, technology, financial markets or other additional activities
permitted by law or regulation. The regulations require institutions with high
or inordinate levels of risk to operate with higher minimum capital standards.
The federal banking agencies also are authorized to review an institution's
management of concentrations of credit risk for adequacy and consistency with
safety and soundness standards regarding internal controls, credit underwriting
or other operational and managerial areas.
33
The federal banking agencies also limit the amount of deferred tax assets that
are allowable in computing a bank's regulatory capital. Deferred tax assets
that can be realized for taxes paid in prior carry back years and from future
reversals of existing taxable temporary differences are generally not limited.
However, deferred tax assets that can only be realized through future taxable
earnings are limited for regulatory capital purposes to the lessor of:
- the amount that can be realized within one year of the
quarter-end report date; or
- 10% of Tier 1 capital.
The amount of any deferred tax in excess of this limit would be excluded from
Tier 1 capital, total assets and regulatory capital calculations.
The federal banking agencies have also adopted a joint agency policy statement
which provides that the adequacy and effectiveness of a bank's interest rate
risk management process, and the level of its interest rate exposure is a
critical factor in the evaluation of the bank's capital adequacy. A bank with
material weaknesses in its interest rate risk management process or high levels
of interest rate exposure relative to its capital will be directed by the
federal banking agencies to take corrective actions. Financial institutions
which have significant amounts of their assets concentrated in high risk loans
or nontraditional banking activities, and who fail to adequately manage these
risks, may be required to set aside capital in excess of the regulatory
minimums.
Prompt Corrective Action
- --------------------------
The federal banking agencies possess broad powers to take prompt corrective
action to resolve the problems of insured banks. Each federal banking agency
has issued regulations defining five capital categories: "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized,"
and "critically undercapitalized." Under the regulations, a bank shall be
deemed to be:
- "well capitalized" if it has a total risk-based capital ratio of
10.0% or more, has a Tier 1 risk- based capital ratio of 6.0% or
more, has a leverage capital ratio of 5.0% or more, and is not
subject to specified requirements to meet and maintain a specific
capital level for any capital measure;
- "adequately capitalized" if it has a total risk-based capital
ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0%
or more, and a leverage capital ratio of 4.0% or more (3.0% under
certain circumstances) and does not meet the definition of "well
capitalized;"
- "undercapitalized" if it has a total risk-based capital ratio
that is less than 8.0%, a Tier 1 risk-based capital ratio that is
less than 4.0%, or a leverage capital ratio that is less than
4.0% (3.0% under certain circumstances);
- "significantly undercapitalized" if it has a total risk-based
capital ratio that is less than 6.0%, a Tier 1 risk-based capital
ratio that is less than 3.0% or a leverage capital ratio that is
less than 3.0%; and
- "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2.0%.
Banks are prohibited from paying dividends or management fees to controlling
persons or entities if, after making the payment the bank would be
"undercapitalized," that is, the bank fails to meet the required minimum level
for any relevant capital measure. Asset growth and branching restrictions apply
to "undercapitalized" banks. Banks classified as "undercapitalized" are
required to submit acceptable capital plans guaranteed by its holding company,
if any. Broad regulatory authority was granted with respect to "significantly
undercapitalized" banks, including forced mergers, growth restrictions, ordering
new elections for directors, forcing divestiture by its holding company, if any,
requiring management changes, and prohibiting the payment of bonuses to senior
management. Even more severe restrictions are applicable to "critically
undercapitalized" banks, those with capital at or less than 2%. Restrictions
for these banks include the appointment of a receiver or conservator after 90
days, even if the bank is still solvent. All of the federal banking agencies
have promulgated substantially similar regulations to implement this system of
prompt corrective action.
34
A bank, based upon its capital levels, that is classified as "well capitalized,"
"adequately capitalized" or "undercapitalized" may be treated as though it were
in the next lower capital category if the appropriate federal banking agency,
after notice and opportunity for hearing, determines that an unsafe or unsound
condition, or an unsafe or unsound practice, warrants such treatment. At each
successive lower capital category, an insured bank is subject to more
restrictions. The federal banking agencies, however, may not treat an
institution as "critically undercapitalized" unless its capital ratios actually
warrant such treatment.
The Commissioner has the power to close a California-chartered bank if its
tangible shareholders' equity falls below the greater of 3% of total assets or
$1,000,000.
Deposit Insurance Assessments
- -------------------------------
The FDIC has implemented a risk-based assessment system in which the deposit
insurance premium relates to the probability that the deposit insurance fund
will incur a loss. The FDIC sets semi-annual assessments in an amount necessary
to maintain or increase the reserve ratio of the insurance fund to at least
1.25% of insured deposits or a higher percentage as determined to be justified
by the FDIC.
Under the risk-based assessment system adopted by the FDIC, banks are
categorized into one of three capital categories, "well capitalized,"
"adequately capitalized," and "undercapitalized". Assignment of a bank into a
particular capital category is based on supervisory evaluations by its primary
federal regulator. After being assigned to a particular capital category, a
bank is classified into one of three supervisory categories. The three
supervisory categories are:
- Group A - financially sound with only a few minor weaknesses;
- Group B - demonstrates weaknesses that could result in
significant deterioration; and
- Group C - poses a substantial probability of loss.
The capital ratios used by the FDIC to define "well-capitalized," "adequately
capitalized" and "undercapitalized" are the same as in the prompt corrective
action regulations.
The assessment rates are summarized below, expressed in terms of cents per $100
in insured deposits:
Assessment Rates
-----------------
Supervisory Group
-------------------------
Capital Group Group A Group B Group C
------- ------- -------
Well Capitalized . . . . 0 3 17
Adequately Capitalized . 3 10 24
Undercapitalized . . . . 10 24 27
Interstate Banking and Branching
- -----------------------------------
Banks have the ability, subject to specific restrictions, to acquire by
acquisition or merger branches located outside their home state. The
establishment of new interstate branches is also possible in those states with
laws that expressly permit it. Interstate branches are subject to many of the
laws of the states in which they are located.
California law authorizes out-of-state banks to enter California by the
acquisition of or merger with a California bank that has been in existence for
at least five years, unless the California bank is in danger of failing or in
certain other emergency situations. Interstate branching into California is,
however, limited to the acquisition of an existing bank.
35
Enforcement Powers
- -------------------
In addition to measures taken under the prompt corrective action provisions,
insured banks may be subject to potential enforcement actions by the federal
regulators for unsafe or unsound practices in conducting their businesses, or
for violation of any law, rule, regulation, condition imposed in writing by the
regulatory agency, or term of a written agreement with the regulatory agency.
Enforcement actions may include:
- the appointment of a conservator or receiver for the bank;
- the issuance of a cease and desist order that can be judicially
enforced;
- the termination of the bank's deposit insurance;
- the imposition of civil monetary penalties;
- the issuance of directives to increase capital;
- the issuance of formal and informal agreements;
- the issuance of removal and prohibition orders against officers,
directors and other institution-affiliated parties; and
- the enforcement of such actions through injunctions or
restraining orders based upon a judicial determination that the
deposit insurance fund or the bank would be harmed if such
equitable relief was not granted.
FDIC Receivership
- ------------------
The FDIC may be appointed as conservator or receiver of any insured bank or
savings association. In addition, the FDIC may appoint itself as sole
conservator or receiver of any insured state bank or savings association for
any, among others, of the following reasons:
- insolvency;
- substantial dissipation of assets or earnings due to any
violation of law or regulation or any unsafe or unsound practice;
- an unsafe or unsound condition to transact business, including
substantially insufficient capital or otherwise;
- any willful violation of a cease and desist order which has
become final;
- any concealment of books, papers, records or assets of the
institution;
- the likelihood that the institution will not be able to meet the
demands of its depositors or pay its obligations in the normal
course of business;
- the incurrence or likely incurrence of losses by the institution
that will deplete all or substantially all of its capital with no
reasonable prospect for the replenishment of the capital without
federal assistance; or
- any violation of any law or regulation, or an unsafe or unsound
practice or condition which is likely to cause insolvency or
substantial dissipation of assets or earnings, or is likely to
weaken the condition of the institution or otherwise seriously
prejudice the interests of its depositors.
36
As a receiver of any insured depository institution, the FDIC may liquidate such
institution in an orderly manner and dispose of any matter concerning such
institution as the FDIC determines is in the best interests of that institution,
its depositors and the FDIC. Further, the FDIC shall, as the conservator or
receiver, by operation of law, succeed to all rights, titles, powers and
privileges of the insured institution, and of any shareholder, member, account
holder, depositor, officer or director of that institution with respect to the
institution and the assets of the institution; may take over the assets of and
operate the institution with all the powers of the members or shareholders,
directors and the officers of the institution and conduct all business of the
institution; collect all obligations and money due to the institution and
preserve and conserve the assets and property of the institution.
Safety and Soundness Guidelines
- ----------------------------------
The federal banking agencies have adopted guidelines to assist in identifying
and addressing potential safety and soundness concerns before capital becomes
impaired. These guidelines establish operational and managerial standards
relating to:
- internal controls, information systems and internal audit
systems;
- loan documentation;
- credit underwriting;
- asset growth; and
- compensation, fees and benefits
Additionally, the federal banking agencies have adopted safety and soundness
guidelines for asset quality and for evaluating and monitoring earnings to
ensure that earnings are sufficient for the maintenance of adequate capital and
reserves. If an 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 a formal enforcement action.
The federal banking agencies have issued regulations prescribing uniform
guidelines for real estate lending. The regulations require insured depository
institutions to adopt written policies establishing standards, consistent with
such guidelines, for extensions of credit secured by real estate. The policies
must address loan portfolio management, underwriting standards and loan to value
limits that do not exceed the supervisory limits prescribed by the regulations.
Consumer Protection Laws and Regulations
- --------------------------------------------
The bank regulatory agencies are focusing greater attention on compliance with
consumer protection laws and their implementing regulations. Examination and
enforcement have become more intense in nature, and insured institutions have
been advised to carefully monitor compliance with various consumer protection
laws and their implementing regulations. Banks are subject to many federal
consumer protection laws and their regulations, including:
- the CRA;
- the Truth in Lending Act herein referred to as the "TILA";
- the Fair Housing Act herein referred to as the "FH Act";
- the Equal Credit Opportunity Act herein referred to ass the
"ECOA";
- the Home Mortgage Disclosure Act herein referred to as the
"HMDA"; and
37
- the Real Estate Settlement Procedures Act herein referred to as
the "RESPA".
The CRA is intended to encourage insured depository institutions, while
operating safely and soundly, to help meet the credit needs of their
communities. The CRA specifically directs the federal bank regulatory agencies,
in examining insured depository institutions, to assess their record of helping
to meet the credit needs of their entire community, including low- and
moderate-income neighborhoods, consistent with safe and sound banking practices.
The CRA further requires the agencies to take a financial institution's record
of meeting its community credit needs into account when evaluating applications
for, among other things, domestic branches, consummating mergers or
acquisitions, or holding company formations.
The federal banking agencies have adopted regulations which measure a bank's
compliance with its CRA obligations on a performance-based evaluation system.
This system bases CRA ratings on an institution's actual lending service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements. The ratings range from a high of "outstanding" to a
low of "substantial noncompliance."
The ECOA prohibits discrimination in any credit transaction, whether for
consumer or business purposes, on the basis of race, color, religion, national
origin, sex, marital status, age (except in limited circumstances), receipt of
income from public assistance programs, or good faith exercise of any rights
under the Consumer Credit Protection Act. In March, 1994, the Federal
Interagency Task Force on Fair Lending issued a policy statement on
discrimination in lending. The policy statement describes the three methods
that federal agencies will use to prove discrimination:
- overt evidence of discrimination;
- evidence of disparate treatment; and
- evidence of disparate impact.
This means that if a creditor's actions have had the effect of discriminating,
the creditor may be held liable even when there is no intent to discriminate.
The FH Act regulates may practices, including making it unlawful for any lender
to discriminate against any person in its housing-related lending activities
because of race, color, religion, national origin, sex, handicap, or familial
status. The FH Act is broadly written and has been broadly interpreted by the
courts. A number of lending practices have been found to be, or may be
considered, illegal under the FH Act, including some that are not specifically
mentioned in the FH Act itself. Among those practices that have been found to
be, or may be considered, illegal under the FH Act are:
- declining a loan for the purposes of racial discrimination;
- making excessively low appraisals of property based on racial
considerations;
- pressuring, discouraging, or denying applications for credit on a
prohibited basis;
- using excessively burdensome qualifications standards for the
purpose or with the effect of denying housing to minority
applicants;
- imposing on minority loan applicants more onerous interest rates
or other terms, conditions or requirements; and
- racial steering, or deliberately guiding potential purchasers to
or away from certain areas because of race.
38
The TILA is designed to ensure that credit terms are disclosed in a meaningful
way so that consumers may compare credit terms more readily and knowledgeably.
As a result of the TILA, all creditors must use the same credit terminology and
expressions of rates, the annual percentage rate, the finance charge, the amount
financed, the total payments and the payment schedule.
HMDA grew out of public concern over credit shortages in certain urban
neighborhoods. One purpose of HMDA is to provide public information that will
help show whether financial institutions are serving the housing credit needs of
the neighborhoods and communities in which they are located. HMDA also includes
a "fair lending" aspect that requires the collection and disclosure of data
about applicant and borrower characteristics as a way of identifying possible
discriminatory lending patterns and enforcing anti-discrimination statutes.
HMDA requires institutions to report data regarding applications for one-to-four
family real estate loans, home improvement loans, and multifamily loans, as well
as information concerning originations and purchases of those types of loans.
Federal bank regulators rely, in part, upon data provided under HMDA to
determine whether depository institutions engage in discriminatory lending
practices.
RESPA requires lenders to provide borrowers with disclosures regarding the
nature and costs of real estate settlements. Also, RESPA prohibits certain
abusive practices, such as kickbacks, and places limitations on the amount of
escrow accounts.
Violations of these various consumer protection laws and regulations can result
in civil liability to the aggrieved party, regulatory enforcement including
civil money penalties, and even punitive damages.
Other Aspects of Banking Law
- --------------------------------
The Banking Subsidiaries are also be subject to federal and state statutory and
regulatory provisions covering, among other things, security procedures,
currency and foreign transactions reporting, insider and affiliated party
transactions, management interlocks, electronic funds transfers, funds
availability, and truth-in-savings. There are also a variety of federal
statutes which regulate acquisitions of control and the formation of bank
holding companies.
Impact of Monetary Policies
- ------------------------------
Banking is a business that depends on rate differentials. In general, the
difference between the interest rate paid by a bank on its deposits and its
other borrowings and the interest rate earned on its loans, securities and other
interest-earning assets comprises the major source of the bank's earnings.
These rates are highly sensitive to many factors which are beyond the bank's
control and, accordingly, the earnings and growth of the bank are subject to the
influence of economic conditions generally, both domestic and foreign, including
inflation, recession, and unemployment; and also to the influence of monetary
and fiscal policies of the United States and its agencies, particularly the FRB.
The FRB implements national monetary policy, such as seeking to curb inflation
and combat recession, by:
- Open-market dealings in United States government securities;
- Adjusting the required level of reserves for financial
institutions subject to reserve requirements;
- Placing limitations upon savings and time deposit interest rates;
and
- Adjusting the discount rate applicable to borrowings by banks
which are members of the Federal Reserve System
The actions of the FRB in these areas influence the growth of bank loans,
investments, and deposits and also affect interest rates. The nature and timing
of any future changes in the FRB's policies and their impact on the Company and
the Banking Subsidiaries cannot be predicted; however, depending on the degree
to which our interest-earning assets and interest-bearing liabilities are rate
sensitive, increases in rates would have a temporary effect of increasing our
net interest margin, while decreases in interest rates would have the opposite
effect. In addition, adverse economic conditions could make a higher provision
for loan losses a prudent course and could cause higher loan charge-offs, thus
adversely affecting our net income.
39
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- --------------------------------------------------------------------------
The Company's primary market risk is interest rate risk. Interest rate risk is
the potential of economic losses caused by future interest rate change. These
economic losses can be reflected as a loss of future net interest income and/or
a loss of current fair market values. The objective is to measure the effect on
net interest income and to adjust the balance sheet to minimize the risks.
Community West Bancshares' exposure to market risks is reviewed on a regular
basis by the Asset/Liability committee. Tools used by management include the
standard GAP report. The Company has no market risk instruments held for trading
purposes except for its interest only strip. Management believes the Company's
market risk is reasonable at this time. The Company currently does not enter
into derivative financial instruments.
See "Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations - Asset and Liability Management".
The table below provides information about the Company's financial instruments
that are sensitive to changes in interest rates. For all outstanding financial
instruments, the tables present the outstanding principal balance at December
31, 2000 and 1999, and the weighted average interest yield/rate of the
instruments by either the date the instrument can be repriced for variable rate
financial instruments or the expected maturity date for fixed rate financial
instruments,
At December 31, 2000
Expected maturity dates or repricing dates by year
--------------------------------------------------
2005 and Fair Value
(Dollars in thousands) 2001 2002 2003 2004 beyond Total at 12/31/00
--------- ---- ---- ---- ---------- -------- ------------
Assets:
Time deposits in other
Financial institutions: $ 1,582 - - - - $ 1,582 $ 1,582
Average Yield 3.3% - - - -
Federal Funds Sold: $ 21,525 - - - - $ 21,525 $ 21,525
Average Yield 3.5% - - - -
Investment securities, held to maturity: $ 1,902 - - - - $ 1,902 $ 1,902
Average Yield 4.0% - - - -
Investment securities, available-for-sale: - - - - $ 4,819 $ 4,819 $ 4,819
Average Yield - - - - 8.1%
Federal Reserve Bank/Federal Home
Loan Bank stock: $ 1,170 - - - - $ 1,170 $ 1,170
Average Yield 6.0% - - - -
Interest only strip: $ 7,541 - - - - $ 7,541 $ 7,541
Average Yield 12.5% - - - -
Servicing asset: $ 2,605 - - - - $ 2,605 $ 2,605
Average Yield 12.5% - - - -
Securitized Loans: - - - - $ 152,044 $152,044 $ 185,048
Average Yield - - - - 13.2%
Liabilities: -
Non-interest bearing demand: $ 28,057 - - - - $ 28,057 $ 28,057
Average Yield 0.0% - - - -
Interest- bearing demand: $ 34,638 - - - - $ 34,638 $ 34,638
Average Yield 3.3% - - - - -
Savings: $ 24,679 - - - - $ 24,679 $ 24,679
Average Yield 3.1% - - - - -
Time certificates of deposit: $141,346 - - - - $141,346 $ 141,715
Average Yield 6.2% - - - - -
Bonds Payable: - - - - $ 130,755 $130,755 $ 164,363
Average Yield - - - - 8.0% -
40
At December 31, 2000
Expected maturity dates or repricing dates by year
--------------------------------------------------
2004 and Fair Value
(Dollars in thousands) 2000 2001 2002 2003 beyond Total at 12/31/99
--------- ---- ---- ---- ---------- -------- ------------
Assets:
Time deposits in other financial
institutions: - - - - - $ - $ -
Average Yield
Federal Funds Sold: $ 8,707 - - - - $ 8,707 $ 8,707
Average Yield 5.2% - - - -
Investment securities,
Held to maturity: $ 497 - - - - $ 497 $ 494
Average Yield 5.3%
Investment securities,
Available-for-sale: - - - - $ 4,896 $ 4,896 $ 4,897
Average Yield 7.7%
Federal Reserve Bank/
Federal Home Loan Bank stock: - - - - $ 776 $ 776 $ 776
Average Yield 5.6%
Interest only strip: $ 4,836 - - - - $ 4,836 $ 4,836
Average Yield 11.0%
Servicing asset: $ 2,503 - - - - $ 2,503 $ 2,503
Average Yield 11.0%
Securitized Loans: - - - - $ 184,268 $184,268 $ 184,821
Average Yield 13.2%
Liabilities:
Non-interest bearing demand: $ 19,391 - - - - $ 19,391 $ 19,391
Average Yield 0.0%
Interest- bearing demand: $ 24,887 - - - - $ 24,887 $ 24,887
Average Yield 3.2%
Savings: $ 27,944 - - - - $ 27,944 $ 27,944
Average Yield 3.7%
Time certificates of deposit: $240,909 - - - - $240,909 $ 243,095
Average Yield 6.9%
Bonds Payable: - - - - $ 167,332 $167,332 $ 172,686
Average Yield 8.0%
41
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Community West Bancshares:
We have audited the accompanying consolidated balance sheets of Community West
Bancshares and subsidiaries (the "Company") for the years ended December 31,
2000 and 1999, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2000. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 financial position of Community West
Bancshares and subsidiaries as of December 31, 2000 and 1999, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States.
/s/ Arthur Andersen LLP
Los Angeles, California
February 20, 2001
F-1
COMMUNITY WEST BANCSHARES 2000 1999
- --------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS DECEMBER 31,
ASSETS
- ------
Cash and due from banks $ 14,957,879 $ 27,396,464
Federal funds sold 21,525,771 8,706,798
Cash and cash equivalents 36,483,650 36,103,262
------------- -------------
Time deposits in other financial institutions 1,582,000 -
Federal Reserve Bank and Federal Home Loan Bank stock, at cost 1,170,073 775,650
Investment securities held-to-maturity, at amortized cost;
fair value of $1,905,155 in 2000 and $494,375 in 1999 1,901,615 496,647
Investment securities available-for-sale, at fair value; amortized cost
of $4,855,426 in 2000 and $4,985,539 in 1999 4,819,666 4,897,242
Interest only strips, at fair value 7,540,824 4,835,999
Loans
Held for sale, at lower of cost or fair value 37,195,127 158,273,597
Securitized loans, net of allowance for loan losses
of $4,042,446 in 2000 and $3,516,000 in 1999 152,043,650 184,268,425
Held for investment, net of allowance for loan losses
of $2,703,990 in 2000 and $2,013,298 in 1999 140,025,820 109,121,814
Servicing assets 2,605,477 2,503,261
Other real estate owned, net 226,688 346,483
Premises and equipment, net 4,067,817 4,466,454
Intangible assets, net 3,443,344 6,249,955
Accrued interest receivable and other assets 12,149,569 11,507,978
------------- -------------
TOTAL ASSETS $405,255,320 $523,846,767
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing demand $ 28,056,602 $ 19,390,661
Interest-bearing demand 34,638,076 24,886,947
Savings 24,679,041 27,943,582
Time certificates of $100,000 or more 76,642,309 100,757,394
Other time certificates 64,703,951 140,152,131
------------- -------------
Total deposits 228,719,979 313,130,715
Bonds payable in connection with securitized loans, net of issuance costs 130,754,823 167,331,665
Other borrowings 5,293,072 7,307,303
Accrued interest payable and other liabilities 4,452,838 2,144,942
------------- -------------
Total liabilities 369,220,712 489,914,625
------------- -------------
COMMITMENTS AND CONTINGENCIES (Notes 12 and 14)
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized; 6,107,216 and
6,104,356 shares issued and outstanding at December 31, 2000 and 1999 32,517,989 32,492,203
Retained earnings 3,537,379 1,495,272
Accumulated other comprehensive loss (20,760) (55,333)
Total stockholders' equity 36,034,608 33,932,142
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $405,255,320 $523,846,767
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
F-2
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE YEARS ENDED DECEMBER 31, 2000 1999 1998
- -------------------------------------------------------------------------------------------
INTEREST INCOME:
Loans, including fees $ 49,765,279 $46,997,684 $14,751,127
Federal funds sold 1,405,179 1,007,761 410,513
Time deposits in other financial institutions 113,236 47,129 66,324
Investment securities 497,495 442,347 51,507
------------- ------------ -----------
Total interest income 51,781,189 48,494,921 15,279,471
------------- ------------ -----------
INTEREST EXPENSE:
Deposits 11,334,050 15,079,699 5,721,958
Bonds payable and other borrowings 14,726,064 10,065,531 594,707
------------- ------------ -----------
Total interest expense 26,060,114 25,145,230 6,316,665
------------- ------------ -----------
NET INTEREST INCOME 25,721,075 23,349,691 8,962,806
PROVISION FOR LOAN LOSSES 6,793,812 6,132,959 1,759,623
------------- ------------ -----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 18,927,263 17,216,732 7,203,183
OTHER INCOME:
Gains from loan sales, net 7,491,243 5,987,943 4,059,816
Loan servicing fees 2,790,151 499,703 785,710
Income from sale of interest in subsidiary 2,080,000 - -
Other loan fees - sold or brokered loans 1,825,703 2,709,938 3,679,211
Document processing fees 1,116,556 1,072,618 1,223,208
Service charges 559,142 514,790 864,549
Gain from sale of servicing asset 186,531 - -
Other income 234,052 235,645 409,963
------------- ------------ -----------
Total other income 16,283,378 11,020,637 11,022,457
------------- ------------ -----------
OTHER EXPENSES:
Salaries and employee benefits 15,241,058 16,228,271 10,799,675
Occupancy expenses 2,401,450 2,416,764 1,435,080
Depreciation expense 1,517,218 1,427,819 962,845
Other operating expenses 3,288,969 1,624,109 1,769,748
Loan servicing & collection expense 2,325,770 2,188,293 256,814
Professional services 949,416 2,579,129 520,713
Advertising expense 705,566 1,151,317 794,102
Amortization of intangible assets 404,099 363,570 63,562
Impairment of goodwill 2,110,303 - -
Office supply expense 391,022 385,805 193,663
Data processing/ATM processing 345,173 511,743 248,997
Postage & freight 294,994 352,014 436,934
Lower of cost or market provision - 1,276,709 -
------------- ------------ -----------
Total other expenses 29,975,038 30,505,543 17,482,133
------------- ------------ -----------
INCOME (LOSS) BEFORE PROVISION
(BENEFIT) FOR INCOME TAXES 5,235,603 (2,268,174) 743,507
PROVISION (BENEFIT) FOR INCOME TAXES 2,538,466 (621,838) 289,448
------------- ------------ -----------
NET INCOME (LOSS) $ 2,697,137 $(1,646,336) $ 454,059
============= ============ ===========
EARNINGS (LOSS) PER SHARE - BASIC $ 0.44 $ (0.30) $ 0.12
============= ============ ===========
EARNINGS (LOSS) PER SHARE - DILUTED $ 0.43 $ (0.30) $ 0.12
============= ============ ===========
The accompanying notes are an integral part of these consolidated financial statements.
F-3
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31
Accumulated
Other
Comprehensive Total
Common Stock Retained Income Stockholders Comprehensive
Shares Amount Earnings ------------- Equity Income (loss)
(loss)
------------ ------------- ------------- ------------- ------------- --------------
BALANCE JANUARY 1, 1998,
(As restated see note 21) 3,081,316 $ 8,570,310 $ 3,558,554 $ - $ 12,128,864
Retirement of founders stock - (10,000) - - (10,000)
Exercise of warrants 875,140 3,828,738 - - 3,828,738
Exercise of stock options 155,712 375,156 - - 375,156
Stock repurchase (14,807) (140,739) - - (140,739)
Purchase of
Palomar Community Bank 1,367,542 12,485,347 - - 12,485,347
Comprehensive income: - - - - -
Net income - - 454,059 - 454,059 $ 454,059
Other comprehensive income - - - - -
----------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 1998, 5,464,903 25,108,812 4,012,613 - 29,121,425 $ 454,059
==============
Issuance of stock to directors 582,924 7,522,698 - - 7,522,698
Exercise of stock options 179,159 955,710 - - 955,710
Cash dividends paid
($0.16 per share) - - (871,005) - (871,005)
Stock repurchase (122,630) (1,095,017) - - (1,095,017)
Comprehensive loss: - - - - -
Net loss - - (1,646,336) - (1,646,336) $ (1,646,336)
Other comprehensive loss - - - (55,333) (55,333) (55,333)
----------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 1999, 6,104,356 32,492,203 1,495,272 (55,333) 33,932,142 $ (1,701,669)
==============
Exercise of stock options 2,860 25,786 - - 25,786
Cash dividend paid ($0.04 per
share) - - (245,654) - (245,654)
Effect of unconsolidation of sold
subsidiary - - (409,376) - (409,376)
Comprehensive income: - - - - -
Net income - - 2,697,137 - 2,697,137 $ 2,697,137
Other comprehensive income - - - 34,573 34,573 34,573
----------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 2000, 6,107,216 $ 32,517,989 $ 3,537,379 $ (20,760) $ 36,034,608 $ 2,731,710
========================================================================================
The accompanying notes are an integral part of these consolidated financial statements.
F-4
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31,
- --------------------------------------------------------------------------------------------------------------------------------
2000 1999 1998
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 2,697,137 $ (1,646,336) $ 454,059
Adjustments to reconcile net income (loss) to net cash provided by (used
in) operating activities:
Provision for loan losses 6,793,812 6,132,959 1,759,623
Writedown of real estate owned 85,240 130,643 48,929
Losses on sale of premises and equipment (17,488) - 12,979
Deferred income taxes (benefit) provision (1,543,598) (3,745,819) 845,197
Depreciation and amortization 1,290,296 1,568,060 976,845
Amortization of intangibles 404,099 363,570 -
Impairment of goodwill 2,110,303 - -
Gain on sale of other real estate owned (26,878) - (42,092)
Gain on disposal of servicing asset (186,531) - -
Amortization of discount on available-for-sale securities 12,653 42,109 -
Gain on sale of loans held for sale (7,491,243) (5,987,943) (4,059,816)
Lower of cost or market provision - 1,276,709 -
Change in market valuation of interest only strips (857,995) (187,000) 543,000
Additions to interest only strip assets, net of amortization (1,846,830) (2,974,094) (236,313)
Additions to servicing assets, net of amortization (250,213) (583,813) (451,662)
Changes in operating assets and liabilities:
Accrued interest receivable and other assets 1,014,998 (3,001,411) (1,447,229)
Accrued interest payable and other liabilities 2,307,896 (378,845) (2,360,222)
-------------- -------------- --------------
Net cash provided by (used in) operating activities 4,495,658 (8,991,211) (3,956,702)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities (1,902,656) (495,553) -
Purchase of available-for-sale securities (1,014,970) - -
Purchase of Federal reserve stock (473,523) (37,500) (12,750)
Proceeds from sale of servicing asset 334,528 - -
Proceeds from sale of subsidiary 775,000 - -
Principal paydown on available-for-sale securities 1,114,466 - -
Redemption of FHLB stock 109,200 72,200 -
FHLB stock dividend (30,100) - -
Maturities of held-to-maturity securities 497,688 500,000 497,357
Proceeds from payments and maturities of available-for-sale securities - 3,279,214 -
Loan originations and principal collections, net 122,645,116 (205,959,393) (111,716,941)
Proceeds from sale of other real estate owned 512,987 - 171,666
Net cash acquired from acquisition of Palomar Community Bank - - 8,747,755
Net (increase) decrease in time deposits in other financial institutions (1,582,000) 1,500,000 2,477,000
Purchase of premises and equipment (1,388,383) (1,621,395) (2,434,286)
-------------- -------------- --------------
Net cash provided by (used in) investing activities 119,597,353 (202,762,427) (102,270,199)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits and savings accounts 15,152,529 5,897,343 7,516,709
Net (decrease) increase in time certificates of deposit (99,644,835) 83,380,573 59,982,154
Bonds issued - 116,876,000 77,388,000
Bond repayments (36,576,842) (21,595,833) (5,336,502)
Proceeds from issuance of other borrowings - 7,307,303 -
Repayment of other borrowings (2,014,231) - -
Stock repurchase - (1,095,017) (140,739)
Retirement of founder's stock - - (10,000)
Exercise of stock options and warrants 25,786 955,710 4,203,894
Effect of unconsolidation of sold subsidiary (409,376) - -
Issuance of common stock - 7,522,698 -
F-5
Cash dividend paid (245,654) (871,005) -
-------------- -------------- --------------
Net cash (used in) provided by financing activities (123,712,623) 198,377,772 143,603,516
-------------- -------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 380,388 (13,375,866) 37,376,615
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 36,103,262 49,479,128 12,102,513
-------------- -------------- --------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 36,483,650 $ 36,103,262 $ 49,479,128
============== ============== ==============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 25,940,918 $ 24,401,341 $ 6,021,378
Cash paid for income taxes 1,312,379 4,061,182 2,301,261
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real estate owned $ 451,554 $ 284,692 $ 370,937
Transfers from loans held for sale to securitized loans - 123,328,043 82,463,072
Transfers from loans held for sale to loans held for investment 3,338,776 1,042,453 374,237
The accompanying notes are an integral part of these consolidated financial statements.
F-6
COMMUNITY WEST BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Community West Bancshares, a California
Corporation, and its wholly-owned subsidiaries, Goleta National Bank ("Goleta")
and Palomar Community Bank ("Palomar"), herein referred to as (the "Company"),
are in accordance with accounting principles generally accepted in the United
States of America and general practices within the financial services industry.
All material intercompany transactions and accounts have been eliminated. The
following are descriptions of the more significant of those policies:
Nature of Operations - The Company's primary operations are related to
traditional financial services which include the acceptance of deposits and the
lending and investing of money. The Company also engages in electronic
services. The Company's customers consist of small to mid-sized businesses, as
well as individuals. The Company also originates and sells U. S. Small Business
Administration ("SBA") and first and second mortgage loans through its normal
operations and seventeen loan production offices.
Business Combinations - On December 14, 1998, the Company acquired Palomar (then
known as Palomar Savings and Loan). As of that date, shareholders of Palomar
became shareholders of the Company by receiving 2.11 shares of Community West
Bancshares stock for each share of Palomar stock they held. This acquisition
was accounted for under the purchase method of accounting. Palomar was
chartered as a state-chartered full service savings and loan association. On
November 4, 1999, Palomar changed both its charter and name. The charter was
changed from that of a state-chartered savings and loan to a state-chartered
bank, and the name was changed to Palomar Community Bank. On December 1, 2000,
the Company signed a definitive agreement to sell Palomar Community Bank to
Centennial First Financial Services for $10.5 million. Under the terms of the
agreement, Centennial will acquire all the outstanding stock of Palomar in
exchange for $10.5 million in cash. The sale is expected to be completed in the
third quarter of 2001.
Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks, and federal funds
sold. Generally, federal funds are sold for one-day periods.
Reserve Requirements - All depository institutions are required by law to
maintain reserves on transaction accounts and nonpersonal time deposits in the
form of cash balances at the Federal Reserve Bank. These reserve requirements
can be offset by cash balances held at the Company. At December 31, 2000 and
1999, the Company's cash balance was sufficient to offset the Federal Reserve
requirement.
Investment Securities - The Company classifies as held to maturity those debt
securities it has the positive intent and ability to hold to maturity.
Securities held to maturity are accounted for at amortized cost. Debt
securities to be held for indefinite periods of time, but not necessarily to be
held-to-maturity or on a long term basis, and equity securities are classified
as available-for-sale and carried at fair value with unrealized gains or losses
reported as a separate component of accumulated other comprehensive income, net
of any applicable income taxes. Realized gains or losses on the sale of
securities available-for-sale, if any, are determined on a specific
identification basis. Purchase premiums and discounts are recognized in
interest income using the interest method over the terms of the securities.
Declines in the fair value of held-to-maturity and available-for-sale securities
below their cost that are deemed to be other than temporary, if any, are
reflected in income as realized losses.
Loans - Generally, loans are stated at amounts advanced less payments collected.
Interest on loans is accrued daily on a simple-interest basis. The accrual of
interest is discontinued when doubt exists as to collectibility of the loan,
generally at the time the loan is 90 days delinquent, unless the credit is well
secured and in process of collection. Any unpaid, but accrued interest is
reversed at that time. Thereafter, interest income is no longer recognized on
the loan. As such, interest income may be recognized on impaired loans to the
extent they are not past due by 90 days or more. Interest on non-accrual loans
is accounted for on the cash-basis or cost-recovery method, until qualifying for
return to accrual. Loans are returned to accrual status when all of the
principal and interest amounts contractually due are brought current and future
payments are reasonably assured.
F-7
Loan Fees and Costs - Loan origination fees, certain direct origination costs,
purchase premiums and discounts, are deferred and recognized as an adjustment to
the loan yield over the life of the loan using the level yield method.
Securitized Loans and Bonds Payable - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
entities ("SPE"s). The transfers have been accounted for as secured borrowings
with a pledge of collateral, and accordingly the mortgage loans and related
bonds issued are included in the Company's balance sheet. The transferred loans
are recorded on the balance sheet as securitized loans and the bonds issued are
recorded as bonds payable. Deferred debt issuance costs related to the bonds
are amortized on a level yield basis over the estimated life of the bonds.
Loan Sales and Servicing - The Company originates certain loans for the purpose
of selling either a portion of, or the entire loan, into the secondary market.
FHA Title 1 loans and the guaranteed portion of SBA loans are sold into the
secondary market, servicing retained. Servicing assets are recognized as
separate assets when loans are sold with servicing retained. Servicing assets
are amortized in proportion to, and over the period of, estimated future net
servicing income. Also, at the time of the loan sale, it is the Company's policy
to recognize the related gain on the loan sale in accordance with generally
accepted accounting principles. The Company uses industry prepayment statistics
and its own prepayment experience in estimating the expected life of the loans.
Management periodically evaluates servicing assets for impairment. Servicing
assets are evaluated for impairment based upon the fair value of the rights as
compared to amortized cost and are generally stratified on a loan by loan basis.
Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market-based assumptions. Impairment is recognized through a valuation allowance
for an individual stratum, to the extent that fair value is less than the
capitalized amount for the stratum.
On loan sales, the Company also retains interest only ("I/O") strips, which
represent the present value of the right to the estimated excess net cash flows
generated by the serviced loans which represents the difference between (a)
interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors and (ii) contractual
servicing fees. The Company determines the present value of this estimated cash
flow at the time each loan sale transaction closes, utilizing valuation
assumptions as to discount rate and prepayment rate appropriate for each
particular transaction.
The I/O strips are accounted for like investments in debt securities classified
as trading securities. Accordingly, the Company marks the I/O's to fair value
with the resulting increase or decrease in fair value being recorded through
operations in the current period. For the years ended December 31, 2000, 1999,
and 1998, net unrealized (losses) gains of $(858,000), $187,000, and $(543,000),
respectively, are included in results of operations.
Provision and Allowance for Loan Losses - The allowance for loan losses is
maintained at a level believed adequate by management to absorb known and
inherent probable losses on existing loans through a provision for loan losses
charged to expense. The allowance is charged for losses when management believes
that full recovery on loans is unlikely. Subsequent recoveries, if any, are
credited to the allowance. Management's determination of the adequacy of the
allowance is based on periodic evaluations of the loan portfolio, which take
into consideration such factors as changes in the growth, size and composition
of the loan portfolio, overall portfolio quality, review of specific problem
loans, collateral, guarantees and economic conditions that may affect the
borrowers' ability to pay and/or the value of the underlying collateral. These
estimates depend on the outcome of future events and, therefore, contain
inherent uncertainties.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses. Such agencies may require the Company to recognize additions to the
allowance based on judgments different from those of management.
Management believes the level of the allowance for loan losses as of December
31, 2000, is adequate to absorb known and inherent probable losses; however,
changes in the local economy, the ability of borrowers to repay amounts borrowed
and other factors may result in the need to increase the allowance through
charges to earnings.
F-8
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest under the contractual terms of the loan agreement.
Factors considered by management in determining impairment include, payment
status, collateral value, and the probability of collecting scheduled principal
and interest payments. Loans that experience insignificant payment delays or
payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays or payment shortfalls on a
case-by-case basis. When determining the possibility of impairment, management
considers all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower's
prior payment record and the amount of the shortfall in relation to the
principal and interest owed. The Company uses the fair value of collateral
method to measure impairment. Impairment is measured on a loan-by-loan basis
for all loans in the portfolio except for the securitized loans, which are
collectively evaluated for impairment.
Loans Held for Sale - Loans which are originated and intended for sale in the
secondary market are carried at the lower of cost or estimated fair value
determined on an aggregate basis. Net unrealized losses, if any, are recognized
through a valuation allowance by charges to income. Loans held for sale are
primarily comprised of SBA loans, second mortgage loans, and residential
mortgage loans. Funding for SBA programs depends on annual appropriations by
the U.S. Congress, and accordingly, the continued sale of loans under these
programs is dependent on the continuation of such programs. At December 31,
2000, there was no valuation allowance. As of December 31, 1999 loans held for
sale are net of a valuation allowance of $1,276,709.
Other Real Estate Owned - Real estate acquired by foreclosure is recorded at
fair value at the time of foreclosure, less estimated selling costs. Any
subsequent operating expenses or income, reduction in estimated values, and
gains or losses on disposition of such properties are charged to current
operations.
Premises and Equipment - Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, which range
from 2 to 31.5 years. Leasehold improvements are amortized over the term of the
lease or the estimated useful lives, whichever is shorter.
Intangible Assets - Intangible assets include goodwill, which is the excess of
the purchase price of Palomar over the fair value of net assets acquired, and
core deposit intangible, which is the long-term deposit relationships resulting
from deposit liabilities assumed in an acquisition. Goodwill is amortized using
the straight-line method over the estimated useful life, not to exceed 20 years.
Core deposit intangible is amortized using a method that approximates the
expected run-off of the deposit base, which averages 7 years. The Company
periodically evaluates whether events and circumstances have occurred that may
affect the estimated useful lives or the recoverability of the remaining balance
of the intangible assets. An asset is deemed impaired if the sum of the
expected future cash flows is less than the carrying amount of the asset and any
excess of the carrying value over fair value will be written off through a
charge to current operations. Management does not believe that the value of the
core deposit intangible has been impaired. In December 2000, as a result of the
Company's agreement to sell Palomar to Centennial First Financial Services, the
Company recorded a goodwill impairment charge of $2.1 million. Based upon the
sale price established in the definitive agreement, management does not believe
that the remaining goodwill is impaired. Accumulated amortization of intangible
assets is $831,230 and $427,132 as of December 31, 2000 and 1999, respectively.
Income Taxes - Deferred income taxes are recognized for the tax consequences in
future years of differences between the tax basis of assets and liabilities and
their financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income.
Earnings per Share - Earnings (loss) per share - Basic is computed based on the
weighted average number of shares outstanding during each year divided into net
income. Earnings (loss) per share - Diluted, is computed based on the weighted
average number of shares outstanding during each year plus the dilutive effect
of outstanding warrants and options divided into net income. Earnings (loss)
per share amounts have been retroactively restated to reflect the two-for-one
stock split in 1998.
F-9
Earnings (loss) per share:
Year Ended December 31, 2000 1999 1998
---------- ------------ ----------
Basic weighted average shares outstanding 6,107,216 5,494,217 3,767,607
Dilutive effect of stock options 126,029 - 174,142
---------- ------------ ----------
Diluted weighted average shares outstanding 6,233,245 5,494,217 3,941,749
========== ============ ==========
Net income (loss) $2,697,137 $(1,646,336) $ 454,059
Earnings (loss) per share - basic $ 0.44 $ (0.30) $ 0.12
Earnings (loss) per share - diluted $ 0.43 $ (0.30) $ 0.12
Stock options on 78,161 shares in 1999 and 274,616 shares in 2000 were excluded
from the computations due to the anti-dilutive effect. In 1998, there was no
anti-dilutive effect.
Use of Estimates in the Preparation of Financial Statements - The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Recent Accounting Pronouncements - SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", was issued in June 1998 and establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133 was effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. SFAS 133 was
subsequently amended by statements No. 137 and No. 138 which deferred the
effective date of SFAS No. 133 and addressed certain issues causing
implementation difficulties in the application of SFAS No. 133. Collectively,
these statements establish accounting and reporting standards requiring that
every derivative instrument (including certain derivative instruments embedded
in other contracts) be recorded in the balance sheet as either an asset or a
liability measured at its fair value. The statements require that changes in
the derivatives fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allow a derivative's gain and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. The statements are effective in all fiscal quarters and all
fiscal years beginning after June 15, 2000. The Company early adopted SFAS No.
133 on October 1, 1998. The impact of the adoption did not have an effect on
the Company's financial position or results of operations.
In September of 2000, the FASB issued SFAS No. 140 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities - a replacement
of FASB Statement No. 125." As of December 31, 2000, the Company has adopted
accounting and disclosure requirements of SFAS No. 140 as set forth in
paragraphs 15 and 17 of the Statement, respectively. The adoption of SFAS No.
140 did not have an impact on the financial condition or the results of
operations of the Company.
Reclassifications - Certain amounts in the accompanying financial statements for
1999 and 1998 have been reclassified to conform to the 2000 presentation.
F-10
2. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities is as
follows:
December 31, 2000 Gross Gross
Amortized Unrealized Unrealized Fair
Available-for-Sale Securities Cost Gain Loss Value
- ----------------------------- ---------- ----------- ------------ ----------
Government National Mortgage Association
participation certificates $2,141,586 $ 2,746 $ (19,393) $2,124,939
Federal National Mortgage Association 884,101 - (5,920) 878,181
Federal Home Loan Mortgage Corporation
bond and participation certificates 1,829,739 731 (13,924) 1,816,546
---------- ----------- ------------ ----------
$4,855,426 $ 3,477 $ (39,237) $4,819,666
========== =========== ============ ==========
Held-to-Maturity Securities
- ---------------------------
U.S. Treasury Note, par value $1,500,000
6.25% due April 30, 2001 $1,499,792 $ 2,083 $ - $1,501,875
Federal Home Loan Bank bond par value
400,000 4.5% due August 10, 2001 401,823 1,457 - 403,280
---------- ----------- ------------ ----------
$1,901,615 $ 3,540 $ - $1,905,155
========== =========== ============ ==========
December 31, 1999 Gross Gross
Amortized Unrealized Unrealized Fair
Available-for-Sale Securities Cost Gain Loss Value
- ----------------------------- ---------- ----------- ------------ ----------
Government National Mortgage Association
participation certificates $2,781,163 $ 9,317 $ (44,174) $2,746,306
Federal National Mortgage Association 1,113,977 317 (7,557) 1,106,737
Federal Home Loan Mortgage Corporation
bond and participation certificates 1,090,399 - (46,200) 1,044,199
---------- ----------- ------------ ----------
$4,985,539 $ 9,634 $ (97,931) $4,897,242
========== =========== ============ ==========
Held-to-Maturity Securities
- ---------------------------
Due in less than one year:
- --------------------------
U.S. Treasury note, par value $500,000,
4.5% due September 30, 2000 $ 496,647 $ - $ (2,272) $ 494,375
========== =========== ============ ==========
The Company's available-for-sale securities consist of mortgage backed
securities with varying maturities based upon the underlying collateral
mortgages.
At December 31, 2000, the U.S. Treasury note, with a par value of $1,500,000,
and the Federal Home Loan bond with a par value of $400,000 were pledged as
collateral on the Company's federal funds account, and to the U.S. Treasury for
its treasury, tax and loan account, respectively.
F-11
3. LOAN SALES AND SERVICING
SBA Loan Sales
- ----------------
The Company sells the guaranteed portion of SBA loans into the secondary market,
on a servicing retained basis, in exchange for cash, retained servicing assets,
and I/O strips. Fair value of the I/O strips and servicing assets was
determined using a 12-13% discount rate and an 8% prepayment rate at December
31, 2000 and an estimated 11% discount rate and an 8% prepayment rate at
December 31, 1999. As of December 31, 2000, the Company had $10,893,137 in SBA
loans held for sale.
FHA Title 1 Loan Sales
- --------------------------
The Company has retained servicing rights on FHA Title 1 loans sold in the
secondary market from 1995 to 1997. At December 31, 2000 and 1999, the fair
value of the related servicing asset was estimated using a weighted average
prepayment rate of 18% and 30% respectively.
The following table represents the balances of the aforementioned assets:
December 31, 2000 December 31, 1999
---------------------------- -------------------------------
Servicing Asset I/O Strip Servicing Asset I/O Strip
---------------- ---------- ---------------- -------------
SBA $ 2,090,777 $7,540,824 $ 1,771,007 $4,835,999
FHA Title 1 514,700 - 546,813 -
Traditional Mortgages - - 185,441 -
---------------- ---------- ---------------- -------------
$ 2,605,477 $7,540,824 $ 2,503,261 $4,835,999
================ ========== ================ =============
The following is a summary of activity in servicing assets:
December 31, 2000 1999 1998
----------- ------------ ------------
Balance, beginning of year $2,503,261 $ 2,444,130 $ 3,003,931
Additions through loan sales 854,009 1,136,212 1,218,337
Reductions, sale of servicing assets (147,997) - -
Amortization (581,947) (1,207,648) (1,015,138)
Valuation adjustment (21,849) 130,567 (763,000)
----------- ------------ ------------
Balance, end of year $2,605,477 $ 2,503,261 $ 2,444,130
=========== ============ ============
The principal balance of loans serviced for others at December 31, 2000, 1999
and 1998 totaled $136,420,048, $121,935,031 and $86,601,390 respectively.
4. SECURITIZED LOANS
The Company offers second mortgage loans that allow borrowers to borrow up to
125% of their home's appraised value, when combined with the balance of the
first mortgage loan, up to a maximum loan of $100,000. Proceeds are commonly
used for debt consolidation, home improvement, or school tuition. During 1998,
the Company sold these loans for cash to third parties no servicing released.
In 1998 and 1999, the Company transferred $81 million and $122 million,
respectively, of these loans to two special purposes entities ("SPE's"). These
loans were both originated and purchased by the Company. The SPE's, through
securitizations, then sold bonds to third party investors which were secured by
the transferred loans. The bonds are held in a trust independent of the Company,
the trustee of which oversees the distributions to the bondholders. The mortgage
loans are serviced by a third party (the "Servicer"), who receives a stated
servicing fee. There is an insurance policy on the subordinate bonds that
guarantees the payment of the bonds.
F-12
As part of the securitization agreements, the Company received an option to
repurchase the bonds when the aggregate principal balance of the mortgage loans
sold declined to 10% or less of the original balance of mortgage loans
securitized. Because the Company has a call option to reacquire the loans
transferred and did not retain the servicing rights, the Company has not
surrendered effective control over the loans transferred. Therefore, the
securitizations are accounted for as secured borrowings with a pledge of
collateral. Accordingly, the Company consolidates the SPE's and the financial
statements of the Company include the loans transferred and the related bonds
issued.
At December 31, 2000 and 1999, respectively, securitized loans are net of an
allowance for loan losses as set forth below, and include purchase premiums (net
of deferred fees/costs) of $3,055,206 and $3,225,443.
An analysis of the allowance for loan losses for securitized loans is as
follows:
Year Ended December 31, 2000 1999 1998
------------ -------------------------
Balance, beginning of year $ 3,516,000 $ 1,219,623 $ -
Provisions for loan losses 4,199,409 3,547,720 1,219,623
Loans charged off (3,673,965) (1,942,342) -
Recoveries on loans previously charged off 1,002 26,000 -
Transfers from loans held for investment - 665,000 -
------------ -------------------------
Balance, end of year $ 4,042,446 $ 3,516,000 $1,219,623
============ =========================
As of December 31, 1999, the Company had accumulated over $150 million in second
mortgage loans. As of December 31, 2000 the Company has $15 million remaining.
These loans are classified as held for sale. It is the Company's intent to
sell these loans, servicing released, to third parties. On an ongoing basis,
the Company will continue to originate second mortgage loans, which are expected
to be sold to third parties shortly after origination.
5. LOANS HELD FOR INVESTMENT
The composition of the Company's loans held for investment portfolio:
Year Ended December 31, 2000 1999
------------ ------------
Installment $ 22,898,456 $ 6,347,963
------------ ------------
Commercial 36,188,496 12,102,289
Real estate 55,082,680 69,534,280
Unguaranteed portion of SBA loans 30,888,172 25,073,030
------------ ------------
145,057,804 113,057,562
Less:
Allowance for loan losses 2,703,990 2,013,298
Net deferred loan fees (costs) 345,293 145,758
Discount on SBA loans 1,982,701 1,776,692
------------ ------------
Loans held for investment, net $140,025,820 $109,121,814
============ ============
F-13
An analysis of the allowance for loan losses for loans held for investment is at
follows:
Year Ended December 31, 2000 1999 1998
------------ ------------ -----------
Balance, beginning of year $ 2,013,298 $ 2,154,167 $1,285,852
Provision for loan losses 2,594,403 2,585,239 540,000
Loans charged off (2,074,129) (2,093,159) (359,500)
Recoveries on loans previously charged off 170,418 32,051 60,815
Transfers to securitized loans - (665,000) -
Increase in allowance from Palomar acquisition - - 627,000
------------ ------------ -----------
Balance, end of year $ 2,703,990 $ 2,013,298 $2,154,167
============ ============ ===========
The recorded investment in loans that are considered to be impaired:
Year Ended December 31, 2000 1999 1998
Impaired loans without specific valuation allowances $ 564,662 $ 3,250,576 $4,450,345
Impaired loans with specific valuation allowances 3,531,408 1,402,469 813,652
Specific valuation allowance related to impaired loans (1,206,706) (1,038,519) (464,336)
------------ ------------ -----------
Impaired loans, net $ 2,889,364 $ 3,614,526 $4,799,661
============ ============ ===========
Average investment in impaired loans $ 4,676,705 $ 5,119,852 $4,009,400
============ ============ ===========
Interest income recognized on impaired loans $ 386,704 $ 243,913 $ 288,607
============ ============ ===========
Non-accrual loans (included in impaired loans) $ 2,095,020 $ 3,090,684 $2,971,000
============ ============ ===========
Troubled debt restructured loans, gross $ 614,770 $ 655,597 $1,313,000
============ ============ ===========
Interest forgone on nonaccrual loans and
Troubled debt restructured loans outstanding $ 591,928 $ 1,584,546 $ 414,000
============ ============ ===========
Loans 30 through 90 days past due with interest accruing $ 4,276,860 $ 2,549,632 $ 678,000
============ ============ ===========
The Company makes loans to borrowers in a number of different industries. No
single industry comprises 10% or more of the Company's loan portfolio. At
December 31, 2000, approximately 50% of the Company's loans are high loan to
value second mortgages. Although the Company has a diversified loan portfolio,
the ability of the Company's customers to honor their loan agreements is
dependent upon, among other things, the general economy of the Company's market
area. At December 31, 2000, the Company originates loans nationwide across 45
states with approximately 46% located in California.
6. TRANSACTIONS INVOLVING RELATED PARTIES
In the ordinary course of business, the Company has extended credit to directors
and employees of the Company. Such loans are extended at current market rates
and are subject to approval by the Loan Committee as well as ratification by the
Board of Directors, exclusive of the borrowing director. The following is an
analysis of the activity of these loans:
F-14
Year Ended December 31, 2000 1999 1998
----------- ----------- ------------
Balance, beginning of year $5,120,585 $2,756,069 $ 2,554,699
Credit granted, including renewals 586,733 2,649,419 1,454,000
Repayments (299,723) (284,903) (1,252,630)
----------- ----------- ------------
Balance, end of year $5,407,595 $5,120,585 $ 2,756,069
=========== =========== ============
In November 1999, the Company obtained a $3,600,000 loan from a shareholder, who
is also a director, the proceeds of which were contributed to Goleta National
Bank as capital. A principal reduction of $300,000 was made in December of
1999. Under the terms and conditions of the loan the Company accrues interest
monthly at a fixed rate of 8.25%. The note matures on May 16, 2001; interest is
due and payable upon maturity. At December 31, 2000, the outstanding principal
and interest was $3,600,000.
7. PREMISES AND EQUIPMENT
December 31, 2000 1999
------------ ------------
Furniture, fixtures and equipment
(including capitalized software) $ 7,200,432 $ 6,606,235
------------ ------------
Building and land 782,423 782,423
Leasehold improvements 1,862,601 1,595,854
Construction in progress 123,931 133,653
------------ ------------
9,969,387 9,118,165
Less: accumulated depreciation and amortization (5,901,570) (4,651,711)
------------ ------------
Premises and equipment, net $ 4,067,817 $ 4,466,454
============ ============
8. DEPOSITS
At December 31, 2000, the scheduled maturities of time certificates of deposits
are as follows:
2001 $139,298,741
2002 1,947,919
2003 84,600
2004 15,000
2005 and thereafter -
------------
$141,346,260
============
F-15
9. BONDS PAYABLE
The following is a summary of the outstanding bonds payable, by class :
Fixed
December 31, 2000 1999 Interest rate Stated Maturity date
----------------------------------------------------------------
Series 1998-1:
Class A $ 28,026,497 $ 42,654,078 7.057% November 25, 2024
Class B 19,994,000 19,994,000 7.950% November 25, 2024
--------------------------
48,020,497 62,648,078
--------------------------
Series 1999-1:
Class A1 1,862,132 10,893,583 6.455% May 25, 2025
Class A2 52,989,528 66,681,000 7.050% May 25, 2025
Class M1 14,335,000 14,335,000 7.850% May 25, 2025
Class M2 15,860,000 15,860,000 8.750% May 25, 2025
--------------------------
85,046,660 107,769,583
--------------------------
$133,067,157 $170,417,661
============ ============
The bonds are collateralized by securitized loans with an aggregate outstanding
principal balance of $50,420,497 and $89,546,660 as of December 31, 2000 for
Series 1998-1 and Series 1999-1, respectively. There is no cross
collateralization between the bond issues. Unamortized debt issuance costs
are approximately $2,312,000 and $3,086,000 at December 31, 2000 and 1999,
respectively.
Amounts collected by the servicer of the mortgage loans are distributed by the
trustee each month to the bondholders, net of fees paid to the servicer,
trustee, and insurance on the bonds. Interest collected each month on the
mortgage loans will generally exceed the amount of interest accrued on the
bonds. A portion of such excess interest will initially be distributed as
principal to the bonds. As a result of such principal distributions, the excess
of the unpaid principal balance of the loans over the unpaid principal balance
of the bonds ("overcollateralization") will increase. The securitization
agreements require that a certain level of overcollateralization be maintained.
Once the required level has been reached, excess interest will no longer be used
to accelerate the amortization of the bonds. Whenever the level of
overcollateralization falls below the required level, excess interest will again
be paid as principal to the bonds until the required level has been
re-established. Excess interest that is not paid to the bonds is used to make
certain other payments or is passed through to the Company. As a result of
excess interest payments, the bonds are expected to pay off prior to the stated
maturity date.
Although bondholders receive monthly interest payments, the various classes of
bonds have different priorities for the timing of receipt of principal
repayments. The classes of bonds presented table are shown in order of
repayment priority.
10. OTHER BORROWINGS
From time to time, the Company will access funds on an overnight basis to manage
its liquidity or reserve needs. These funds consist of three federal lines of
credit with the Banking subsidiaries' correspondent banks. The combined total
availability is $6,500,000, which is used by management on a discretionary
basis. The credit lines are renewed annually with various maturity dates and
borrowing rates. The Company must comply with certain conditions in order to
retain these lines. At December 31, 2000 and 1999, no amounts were outstanding
on these lines. Through Palomar, the Company has an additional line of credit
with Federal Home Loan Bank for up to 25% of Palomar's total assets. This line
had approximately $19,600,000 available at December 31, 2000, with no
outstanding borrowing under this facility.
F-16
The following summarizes the combined activity in the lines of credit:
Year Ended December 31, 2000 1999
----------- -----------
Average balance: $ 287,440 $ 119,863
Maximum amount outstanding at any month-end: $3,000,000 $1,750,000
Weighted average interest rate: 6.32% 5.49%
Other borrowings include a $2,000,000 loan collateralized by stock of the
subsidiaries. Interest payments are due and payable on a monthly basis, and are
calculated at a variable interest rate. The rate used during 2000 was prime
plus 1%. At December 31, 2000, the interest rate was 10.5%. The note matures
on April 3, 2001. At December 31, 2000 the outstanding principal and interest
were $2,100,000.
11. BUSINESS COMBINATION AND DISPOSITION
ePacific.com
- ------------
On March 30, 2000, ePacific.com redeemed 1,800,000 of the Company's 2,100,000
shares and repaid a loan from the Company with a balance of $3,725,000 for
$4,500,000 in cash. As a result of this, the Company reversed previously
consolidated losses and now reflects the remaining 10% investment at cost.
Palomar Community Bank
- ----------------------
On December 14, 1998, the Company issued 1,367,542 common shares with a market
value of approximately $12.5 million to consummate a merger with Palomar. The
Company exchanged 2.11 shares of its common stock for each share of Palomar
common stock. The transaction constituted a tax-free reorganization and has been
accounted for using the purchase method of accounting. The Company's total cost
for the acquisition was approximately $12.5 million which was allocated to the
fair value of the assets acquired and liabilities assumed. The amount paid in
excess of the fair value of the net tangible and intangible assets acquired,
approximately $6.2 million, was recorded as goodwill and is being amortized on a
straight-line basis over 20 years. Approximately $571,000 of the purchase price
was allocated to core deposit intangible and is being amortized on an
accellerated basis over seven years.
On December 1, 2000, the Company signed a definitive agreement to sell Palomar
Community Bank to Centennial First Financial Services for $10.5 million.
Under the terms of the agreement, Centennial will acquire all the outstanding
stock of Palomar in exchange for $10.5 million in cash. In December 2000, as a
result of the Company's commitment to sell Palomar, the Company recorded a
goodwill impairment charge of $2.1 million, which represents the difference
between the book value of the asset and the sales price discussed below. The
sale is expected to be completed in the third quarter of 2001.
There were no transactions between the Company and Palomar prior to the business
combination other than loan participations. These participations were transacted
in the normal course of business. Immaterial adjustments and reclassifications
were recorded to conform Palomar's accounting policies to those of the Company.
On a proforma basis, the results of operation for Palomar for the year ended
December 31 , 1998 is presented below as if the companies had been combined as
of the beginnning of the year:
Pro forma information
(Dollars in thousands) (Unaudited)
1998 1997
------- --------
Net interest income $11,202 $ 7,192
Net income $ 507 $ 1,806
Earnings per share - basic $ 0.10 $ 0.41
F-17
12. STOCKHOLDERS' EQUITY
Common Stock
- -------------
On January 22, 1998, the Company declared a two-for-one stock split for
shareholders of record on February 3, 1998, which was issued on February 27,
1998. All share and per share amounts included in the accompanying financial
statements and related notes have been retroactively restated for the effect of
this split.
On December 28, 1998, the Board of Directors of the Company authorized a stock
buy-back plan. Under this plan, management is authorized to repurchase up to
$2,000,000 worth of the outstanding shares of the Company's common stock. As of
December 31, 2000, management had repurchased 137,437 shares of common stock at
a cost of $1,235,756.
Stock Options
- --------------
Under the terms of the Company's stock option plan, full-time salaried employees
may be granted nonqualified stock options or incentive stock options and
directors may be granted nonqualified stock options. Options may be granted at a
price not less than 100% of the fair market value of the stock on the date of
grant. Options are generally exercisable in cumulative 20% installments. All
options expire no later than ten years from the date of grant. As of December
31, 2000, options are outstanding at prices of $2.275 to $16.875 per share with
158,796 options exercisable and 194,471 options available for future grant. As
of December 31, 2000, the average life of the outstanding options was
approximately 6 years. Stock option activity is as follows:
Year Ended December 31, 2000 1999 1998
-------------------- --------------------- ---------------------
Shares Price (1) Shares Price (1) Shares Price (1)
-------- ---------- --------- ---------- --------- ----------
Options outstanding, January 1, 269,027 $ 8.48 415,366 $ 6.95 359,652 $ 3.10
Granted 167,800 6.13 85,000 10.51 218,986 10.11
Canceled (41,771) 9.88 (52,180) 10.39 (7,560) 3.21
Exercised (2,860) 4.56 (179,159) 5.33 (155,712) 2.90
-------- ---------- --------- ---------- --------- ----------
Options outstanding, December 31, 392,196 $ 7.35 269,027 $ 8.48 415,366 $ 6.95
======== ========== ========= ========== ========= ==========
Options exercisable, December 31, 158,796 $ 7.15 139,456 $ 6.90 287,766 $ 4.11
======== ========== ========= ========== ========= ==========
(1) Weighted Average Exercise Price
The weighted average grant date estimated fair value of options was $6.13 per
share in 2000, $5.11 per share in 1999, and $3.94 per share in 1998. The
Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option plan. Accordingly, no
compensation cost has been recognized for its stock option plan. Had
compensation cost for the Company's stock option plan been determined based on
the fair value at the grant dates for awards under the plan consistent with the
method prescribed by SFAS No. 123 "Accounting for Stock Compensation", the
Company's net income (loss) and income (loss) per share for the years ended
December 31, 2000, 1999, and 1998 would have been adjusted to the pro forma
amounts indicated below:
Earnings (loss): 2000 1999 1998
---------- ------------ ---------
As reported $2,697,137 $(1,646,336) $454,059
Pro forma $2,497,545 $(1,812,788) $(52,126)
Earnings (loss) per common share - basic
As reported $ 0.44 $ (0.30) $ 0.12
Pro forma $ 0.41 $ (0.33) $ (0.01)
Earnings (loss) per common share - assuming dilution
As reported $ 0.43 $ (0.30) $ 0.12
Pro forma $ 0.41 $ (0.33) $ (0.01)
F-18
The fair value of options granted under the Company's fixed stock option plan
during 2000, 1999 and 1998 was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
2000 1999 1998
----- ----- -----
Annual dividend yield 0.0% 2.0% 5.0%
Expected volatility 39.0% 54.0% 47.0%
Risk free interest rate 6.5% 6.5% 6.0%
Expected life (in years) 6 6 6
13. COMMITMENTS AND CONTINGENCIES
The Company leases office facilities under various operating lease agreements
with terms that expire at various dates between January 2001 and March 2007,
plus options to extend the lease terms for periods of up to ten years. The
minimum lease commitments as of December 31, 2000, under all operating lease
agreements are as follows:
For the Year Ending December 31,
2001 $1,095,825
2002 1,017,398
2003 693,884
2004 429,249
2005 398,866
Thereafter 454,890
----------
Total $4,090,112
==========
Rent expense for the years ended December 31, 2000, 1999, and 1998 included in
occupancy expense was $902,735, $953,022 and $504,985, respectively.
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet. The Company's exposure to credit loss in the event of nonperformance by
the other party to commitments to extend credit and standby letters of credit is
represented by the contractual notional amount of those instruments. At December
31, 2000 and 1999, the Company had commitments to extend credit of approximately
$25,817,000 and $18,960,000, respectively, including obligations to extend
standby letters of credit of approximately $913,000 and $713,000, respectively.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support private borrowing arrangements. All guarantees are
short term and expire within one year.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for extending loan facilities to customers. The Company
evaluates each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company upon extension of
credit, is based on management's credit evaluation of the counterparty.
Collateral held varies but may include accounts receivable, inventory, property,
plant and equipment and income-producing commercial properties.
F-19
The Company has sold loans that are guaranteed or insured by government agencies
for which the Company retains all servicing rights and responsibilities. The
Company is required to perform certain monitoring functions in connection with
these loans to preserve the guarantee by the government agency and prevent loss
to the Company in the event of nonperformance by the borrower. Management
believes that the Company is in compliance with these requirements. The
outstanding balance of the sold portion of such loans was approximately
$145,673,000 and $121,935,000 at December 31, 2000 and 1999, respectively.
Although the Company sells without recourse substantially all of the mortgage
loans it originates or purchases, the Company retains some degree of risk on
substantially all of the loans it sells. In addition, during the period of time
that the loans are held for sale, the Company is subject to various business
risks associated with the lending business, including borrower default,
foreclosure, and the risk that a rapid increase in interest rates would result
in a decline of the value of loans held for sale to potential purchasers. In
connection with its loan sales, the Company enters agreements which generally
require the Company to repurchase or substitute loans in the event of a breach
of a representation or warranty made by the Company to the loan purchaser, any
misrepresentation during the mortgage loan origination process or, in some
cases, upon any fraud or early default on such mortgage loans.
The Company's ability to originate, purchase and sell loans is also
significantly impacted by changes in interest rates. Increases in interest
rates may also reduce the amount of loan and commitment fees received by the
Company. A significant decline in interest rates could also decrease the size
of the Company's servicing portfolio and the related servicing income by
increasing the level of prepayments. The Company does not currently utilize any
specific hedging instruments to minimize exposure to fluctuations in the market
price of loans and interest rates with regard to loans held for sale in the
secondary mortgage market. Therefore, between the time the Company originates
and sells the loans, the Company is exposed to downward movements in the market
price of such loans due to upward movements in interest rates.
The Company entered into a salary continuation agreement with an officer of the
Company who is currently on the Board of Directors. The agreement provides
monthly cash payments to the officer or beneficiaries in the event of death or
disability, beginning in the month after retirement date or death and extending
for a period of fifteen years. The commitment is funded by a life insurance
policy owned by the Company with a cash surrender value of $781,128 and $750,411
at December 31, 2000 and 1999, respectively. The present value of the Company's
liability under the agreement is included in accrued interest payable and other
liabilities in the accompanying consolidated balance sheets.
The Company is involved in various litigation matters through the normal course
of business. In the opinion of management, after taking into consideration
information provided by counsel, the disposition of all pending litigation
should not have a material effect on the Company's financial position or results
of operations.
14. INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31
consists of the following:
2000 1999 1998
---------- ------------ ----------
Current:
Federal $ 836,458 $ 2,456,745 $(460,457)
State 158,410 667,236 (95,292)
---------- ------------ ----------
994,868 3,123,981 (555,749)
Deferred:
Federal 1,036,494 (2,889,569) 671,611
State 507,104 (856,250) 173,586
---------- ------------------------
1,543,598 (3,745,819) 845,197
---------- ------------------------
Total provision (benefit) $2,538,466 $ (621,838) $ 289,448
========== ============ ==========
F-20
Significant components of the Company's net deferred tax account at December 31
are as follows:
2000 1999
------------ ------------
Deferred tax assets:
Allowance for loan losses $ 1,752,814 $ 3,471,456
Depreciation 374,652 130,482
State taxes 227,410 9,497
Unrealized loss on investment securities 15,000 37,100
State NOL - 32,049
Investment in ePacific.com 75,776 655,601
Accrued professional fees 315,365 -
Other 611,383 330,791
------------ ------------
3,372,400 4,666,976
------------ ------------
Deferred tax liabilities:
Deferred loan fees (795,281) (417,096)
Purchase accounting (281,700) (327,928)
FHLB stock dividends (60,200) (76,423)
Deferred loan costs (814,232) (796,416)
Other (80,237) (142,666)
------------ ------------
(2,031,650) (1,760,529)
------------ ------------
Net deferred tax asset $ 1,340,750 $ 2,906,447
============ ============
At December 31, 2000 and 1999, respectively, the deferred tax asset is included
in other assets in the accompanying consolidated balance sheets.
The federal income tax provision (benefit) for the years ended December 31
differs from the applicable statutory rate as follows:
2000 1999 1998
------- ------- ------
Federal income tax at statutory rate 34.0% (35.0)% 35.0%
State franchise tax, net of federal 7.1% (5.5)% 7.0%
Amortization and impairment of goodwill 19.2% 5.6% 0.7%
Disallowed losses on ePacific.com - 3.9% -
Other (11.8)% 3.6% (3.8)%
------- ------- ------
48.5% (27.4)% 38.9%
======= ======= ======
15. REGULATORY MATTERS
The Company (on a consolidated basis), Goleta and Palomar are subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory -
and possibly additional discretionary - actions by regulators that, if
undertaken, could have a direct material effect on the Company's, Goleta's and
Palomar's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company, Goleta and
Palomar must meet specific capital guidelines that involve quantitative measures
of the Company's, Goleta's and Palomar's, assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
The Company's, Goleta's and Palomar's capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings and other factors. Prompt corrective action provisions are not
applicable to bank holding companies.
F-21
Quantitative measures established by regulation to ensure capital adequacy
require the Company, Goleta and Palomar, to maintain minimum amounts and ratios
(set forth in the following table) of Total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I capital to
average assets (as defined). Management believes, as of December 31, 2000 and
1999, that the Company, Goleta and Palomar meet all capital adequacy
requirements to which they are subject.
As of December 31, 2000 and 1999, the most recent notification from the Federal
Deposit Insurance Corporation ("FDIC") categorized Goleta as "adequately
capitalized" under the regulatory framework for prompt corrective action. At
December 31, 2000 and 1999, the most recent notification from the FDIC
categorized Palomar as "well capitalized" under the regulatory framework for
prompt corrective action. To be categorized as "adequately capitalized" or
"well capitalized", Goleta and Palomar must maintain minimum Total risk-based,
Tier I risk-based, and Tier I leverage ratios as set forth in the table below.
There are no conditions or events since that notification which management
believes have caused Goleta's or Palomar's category to change.
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------- -------------------- -------------------
Year Ended December 31, 2000: Amount Ratio Amount Ratio Amount Ratio
------------------- -------------------- -------------------
Total Risk-Based Capital
(to Risk Weighted assets)
Consolidated $38,645,337 11.04% $28,013,787 8.00% N/A N/A
Goleta National Bank $35,573,765 12.12% $23,473,626 8.00% $29,342,032 10.00%
Palomar Community Bank $ 7,329,473 13.89% $ 4,223,104 8.00% $ 5,278,879 10.00%
Tier I Capital
(to Risk Weighted assets)
Consolidated $31,898,901 9.11% $14,006,894 4.00% N/A N/A
Goleta National Bank $31,876,965 10.86% $11,736,813 4.00% $17,605,219 6.00%
Palomar Community Bank $ 6,669,613 12.64% $ 2,111,552 4.00% $ 3,167,328 6.00%
Tier I Capital
(to Average Assets)
Consolidated $31,898,901 7.25% $17,597,784 4.00% N/A N/A
Goleta National Bank $31,876,965 8.87% $14,375,225 4.00% $17,969,031 5.00%
Palomar Community Bank $ 6,669,613 8.75% $ 3,048,776 4.00% $ 3,810,970 5.00%
F-22
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------- -------------------- -------------------
Year Ended December 31, 1999: Amount Ratio Amount Ratio Amount Ratio
------------------- -------------------- -------------------
Total Risk-Based Capital
(to Risk Weighted assets)
Consolidated $39,474,626 8.34% $37,856,951 8.00% N/A N/A
Goleta National Bank $33,099,716 8.01% $33,046,888 8.00% $41,308,610 10.00%
Palomar Community Bank $ 7,184,663 11.94% $ 4,814,290 8.00% $ 6,017,863 10.00%
Tier I Capital
(to Risk Weighted assets)
Consolidated $33,945,328 7.17% $18,928,475 4.00% N/A N/A
Goleta National Bank $28,182,418 6.82% $16,523,444 4.00% $24,785,166 6.00%
Palomar Community Bank $ 6,572,663 10.92% $ 2,407,145 4.00% $ 3,610,718 6.00%
Tier I Capital
(to Average Assets)
Consolidated $33,945,328 7.52% $18,060,691 4.00% N/A N/A
Goleta National Bank $28,182,418 7.27% $15,498,960 4.00% $19,373,700 5.00%
Palomar Community Bank $ 6,572,663 12.22% $ 2,151,381 4.00% $ 2,689,226 5.00%
In November 1999, the Office of Comptroller of the Currency ("OCC") notified
Goleta that it had incorrectly calculated the amount of regulatory capital
required to be held in respect of residual interests retained by Goleta in two
securitizations of loans that were consummated in the fourth quarter of 1998 and
the second quarter of 1999. Accordingly the OCC informed Goleta that it was
significantly undercapitalized at March 31, 1999, June 30, 1999 and September
30, 1999. On November 17, 1999, after a new debt and equity investment in the
Company of approximately $11.15 million by certain directors of the Company, the
OCC informed Goleta that it was adequately capitalized.
Under the regulatory framework, until the regulatory agencies notify Goleta that
they are deemed "well capitalized", Goleta may not accept or renew brokered
deposits without prior approval from the regulators. Goleta had no brokered
deposits at December 31, 2000.
On March 23, 2000, Goleta signed a formal written agreement with the OCC (the
"Agreement"). Under the terms of the Agreement, by September 30, 2000, Goleta
was required to achieve and maintain total capital at least equal to 12% of
risk-weighted assets, and Tier 1 capital at least equal to 7% of adjusted total
assets. Goleta was also required to adopt and implement a written asset
diversification program that included specific plans for reduction of the
concentration of second mortgage loans (exclusive of securitized loans) to 100%
of capital. The Agreement also required submission of a capital plan, which
included, among other things, specific plans for meeting the special capital
requirements, projections for growth and a dividend policy. The Agreement placed
limitations on growth and payments of dividends until Goleta was in compliance
with its approved capital plan. Additionaly the Agreement required adoption and
improvement in certain policies and procedures as well as development of a
three-year strategic plan. Goleta is required to submit monthly progress reports
to the OCC detailing actions taken results of those actions, and a description
of actions needed to achieve full compliance with the Agreement. Goleta achieved
the capital requirements under the Agreement by September 30, 2000. As of
December 31, 2000 Goleta had total capital equal to 12.12% of risk-weighted
assets. Under the terms of the Agreement, Goleta reduced its concentraton of
second mortgage loans below 100% to 90.89% of capital as of May 31, 2000. As of
December 31, 2000, the concentration of such loans was 36.64%. Management
believes that it continues to comply with all material provisions of the
Agreement.
F-23
16. EMPLOYEE BENEFIT PLAN
On September 1, 1995, the Company established a 401(k) plan for the benefit of
its employees. Employees are eligible to participate in the plan if the Company
employed them on September 1, 1995, or after 3 months of consecutive service.
Employees may make contributions to the plan under the plan's 401(k) component,
and the Company may make contributions under the plan's profit sharing
component, subject to certain limitations. The Company's contributions were
determined by the Board of Directors and amounted to $164,125, $149,037, and
$122,767, in 2000, 1999, and 1998 respectively.
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required to interpret market
data to develop 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 market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
The following table represents the estimated fair values:
December 31, 2000 December 31, 1999
----------------------------------------------
Carrying Estimated Carrying Estimated
(Dollars in thousands) Amount Fair Value Amount Fair Value
----------------------------------------------
Assets:
Cash and cash equivalents $ 36,484 $ 36,484 $ 36,103 $ 36,103
Time deposits in other financial institutions 1,582 1,582 - -
Investment securities 7,891 7,895 6,170 6,167
Interest-only strips 7,541 7,541 4,836 4,836
Accrued interest receivable 3,841 3,841 6,195 6,195
Net Loans 329,265 374,272 451,664 453,019
Liabilities:
Deposits (other than time deposits) 87,374 87,374 72,221 72,221
Time deposits 141,346 141,715 240,910 243,095
Accrued interest payable 1,036 1,036 1,247 1,247
Bonds payable 130,755 164,363 167,332 172,686
Other borrowings 5,293 5,293 7,307 7,307
The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below:
Cash and cash equivalents - The carrying amounts approximate fair values because
of the short-term nature of these instruments.
Investment securities - The fair value is based on quoted market prices from
security brokers or dealers if available. If a quoted market price is not
available, fair value is estimated using the quoted market price for similar
securities.
Federal Reserve and Federal Home Loan Bank stock carrying value approximates the
fair value because the stock can be sold back to the Federal Reserve and Federal
Home Loan Bank at anytime.
Loans - Fair values of loans are estimated for portfolios of loans with similar
financial characteristics, primarily fixed and adjustable rate interest terms.
The fair values of fixed rate mortgage loans are based upon discounted cash
flows utilizing the rate that the Company currently offers as well as
anticipated prepayment schedules. The fair values of adjustable rate loans are
also based upon discounted cash flows utilizing discount rates that the Company
currently offers, as well as anticipated prepayment schedules. No adjustments
have been made for changes in credit within the loan portfolio. It is
management's opinion that the allowance for estimated loan losses pertaining to
performing and non-performing loans results in a fair valuation of such loans.
The fair value of loans held for sale is determined based on quoted market
prices or dealer quotes.
F-24
Interest Only Strip - The fair value of the interest-only strip has been
determined by discounted cash flow methods, using market discount and prepayment
rates.
Deposits - The fair values of deposits are estimated based upon the type of
deposit products. Demand accounts, which include savings and transaction
accounts, are presumed to have equal book and fair values, since the interest
rates paid on these accounts are based on prevailing market rates. The estimated
fair values of time deposits are determined by discounting the cash flows of
segments of deposits that have similar maturities and rates, utilizing a yield
curve that approximates the prevailing rates offered to depositors as of the
measurement date.
Bonds Payable - The fair value is estimated using discounted cash flow analysis
based on rates for similar types of borrowing arrangements.
Other Borrowings - The carrying amount is assumed to be the fair value because
the interest rate is the same as rates currently offered for borrowings with
similar remaining maturities and characteristics.
Accrued Interest - The carrying amounts approximate fair value.
Commitments to Extend Credit, Commercial and Standby Letters of Credit - Fair
values of commitments are immaterial to the financial statements.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 2000, and 1999 Although management is
not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since those dates, and therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
18. SEGMENT INFORMATION
Company management, while managing the overall company, reviews individual areas
considered "significant" to revenue and net income. These significant areas, or
segments, are: SBA Lending, Consumer Financing, the Mortgage Division, Goleta
National Bank Branch Operations, and Palomar Community Bank. For this
discussion, the remaining divisions are considered immaterial and are
consolidated into "Other". Other includes the holding company administration
areas, human resources and technology support, along with others. The accounting
policies of the individual segments are the same as those described in the
summary of significant accounting policies. The SBA Lending, Consumer Financing
and Mortgage Divisions from Goleta National Bank are considered individual
segments because of the different loan products involved and the significance of
the associated revenue. Goleta National Bank Branch Operations, includes the
deposits and commercial lending. Management analyzes Palomar separately from
Goleta National Bank, as they are two different subsidiaries under Community
West Bancshares.
All of the Company's assets and operations are located within the United States.
F-25
The following tables sets forth the revenue and expense items that management relies on to make decisions:
As of and for
the year ended SBA Consumer Mortgage GNB Branch Consolidated
December 31, 2000 Lending Financing Division Operations Palomar Other Total
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars rounded to
thousands)
Interest Income $ 4,299,000 $ 33,537,000 $ 295,000 $ 7,777,000 $ 5,873,000 $ - $ 51,781,000
Interest Expense 2,203,000 17,189,000 151,000 3,440,000 2,531,000 546,000 26,060,000
--------------------------------------------------------------------------------------------------------
Net Interest Income 2,096,000 16,348,000 144,000 4,337,000 3,342,000 (546,000) 25,721,000
--------------------------------------------------------------------------------------------------------
Provision
For Loan Losses 617,000 4,810,000 42,000 1,115,000 210,000 - 6,794,000
Non-interest Income 4,556,000 5,843,000 2,632,000 2,496,000 538,000 219,000 16,284,000
Non-interest Expense 4,362,000 6,965,000 2,792,000 3,030,000 5,043,000 7,783,000 29,975,000
--------------------------------------------------------------------------------------------------------
Segment Profit (Loss) $ 1,673,000 $ 10,416,000 $ (58,000) $ 2,688,000 $ (1,373,000) $(8,110,000) $ 5,236,000
========================================================================================================
Segment Assets $ 50,071,000 $172,681,000 $ 30,681,000 $ 63,137,000 $ 78,274,000 $10,411,000 $405,255,000
========================================================================================================
As of and for
the year ended Consumer Mortgage GNB Branch Consolidated
December 31, 1999 SBA Lending Financing Division Operations Palomar Other Total
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars rounded to
thousands)
Interest Income $ 3,046,000 $ 35,735,000 $ 569,000 $ 2,816,000 $ 5,889,000 $ 440,000 $ 48,495,000
Interest Expense 1,578,000 18,517,000 295,000 1,459,000 2,884,000 412,000 25,145,000
--------------------------------------------------------------------------------------------------------
Net Interest Income 1,468,000 17,218,000 274,000 1,357,000 3,005,000 28,000 23,350,000
--------------------------------------------------------------------------------------------------------
Provision
For Loan Losses 434,000 5,093,000 81,000 401,000 115,000 9,000 6,133,000
Non-interest Income 5,369,000 412,000 4,266,000 241,000 733,000 - 11,021,000
Non-interest Expense 3,307,000 9,158,000 4,061,000 2,057,000 3,466,000 8,457,000 30,506,000
--------------------------------------------------------------------------------------------------------
Segment Profit (Loss) $ 3,096,000 $ 3,379,000 $ 398,000 $ (860,000) $ 157,000 $(8,438,000) $ (2,268,000)
========================================================================================================
Segment Assets $ 30,114,000 $349,221,000 $ 5,339,000 $ 62,507,000 $ 76,076,000 $ 590,000 $523,847,000
========================================================================================================
F-26
19. COMMUNITY WEST BANCSHARES (PARENT COMPANY ONLY)
(Dollars in thousands) December 31, December 31,
Balance sheets 2000 1999
- --------------- ------------- --------------
Assets
Cash and equivalents $ 82 $ -
Investment in subsidiaries 42,593 41,009
Other assets 91 231
------------- --------------
Total assets $ 42,766 $ 41,240
============= ==============
Liabilities and shareholders' equity
Other liabilities $ 6,776 $ 7,308
Common stock 32,518 32,492
Retained earnings 3,493 1,495
Accumulated other comprehensive loss (21) (55)
------------- --------------
Total liabilities and shareholders' equity $ 42,766 $ 41,240
============= ==============
For the year ended December 31, 2000 1999 1998
------------- -------------- --------------
(Dollars in thousands)
Statements of operations
- ------------------------
Total income $ - $ - $ 60
Total expense (1,137) (1,167) (195)
Equity in undistributed
net income(loss) from subsidiaries
subsidiaries 3,949 (969) 531
------------- -------------- --------------
Income(loss) before
income tax provision(benefit) 2,812 (2,136) 396
Income tax provision (benefit) 115 (490) (58)
------------- -------------- --------------
Net income(loss) $ 2,697 $ (1,646) $ 454
============= ============== ==============
F-27
COMMUNITY WEST BANCSHARES
STATEMENT OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31,
- ----------------------------------------------------------------------------------
(Dollars in thousands) 2000 1999 1998
-------- --------- -------
Cash Flows from operating activities:
Net Income(loss) $ 2,697 $ (1,646) $ 454
Adjustments to reconcile net (income) loss to
cash provided by(used in) operating activities:
Equity in undistributed
(income) loss from subsidiaries (3,949) 969 (531)
Net change in other liabilities 1,411 7,167 (125)
Net change in other assets (32) (148) (358)
-------- --------- -------
Net cash provided by (used in) operating activities 127 6,342 (560)
Cash flows from investing activities:
-------- --------- -------
Net payments and investments in subsidiaries 2,167 (16,025) (576)
-------- --------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock 26 8,478 4,193
Principal payments on borrowings (2,016) - -
Dividends (222) (871) -
Payments to repurchase common stock - (1,095) (141)
-------- --------- -------
Net cash provided by financing activities (2,212) 6,512 4,052
Net increase (decrease) in cash and
Cash equivalents 82 (3,171) 2,916
Cash and cash equivalents at beginning of year - 3,171 255
-------- --------- -------
Cash and cash equivalents, at end of year $ 82 $ - $3,171
======== ========= =======
F-28
20. QUARTERLY FINANCIAL DATA (unaudited)
Summarized quarterly financial data follows:
(All amounts in thousands except per share data)
Quarter Ended
Mar 31, 2000 Jun 30, 2000 Sep 30, 2000 Dec 31, 2000
------------------------------------------------------------
Net interest income $ 7,203 $ 4,913 $ 6,317 $ 7,288
Provision for loan losses 896 628 2,043 3,227
Net income (loss) 2,677 1,137 300 (1,417)
Net income (loss) per share - basic $ 0.44 $ 0.18 $ 0.05 $ (0.23)
- diluted $ 0.44 $ 0.18 $ 0.05 $ (0.23)
Quarter Ended
Mar 31, 1999 Jun 30, 1999 Sep 30, 1999 Dec 31, 1999
------------------------------------------------------------
Net interest income $ 3,735 $ 4,750 $ 5,891 $ 8,974
Provision for loan losses 271 2,677 1,509 1,676
Net income(loss) 454 220 (131) (2,189)
Net income(loss) per share - basic $ 0.08 $ 0.04 $ (0.02) $ (0.38)
- diluted $ 0.08 $ 0.04 $ (0.02) $ (0.38)
21. SUBSEQUENT EVENT
Subsequent to year-end, the Company obtained a loan of $5,500,000 from Union
Bank of California and used the proceeds to repay the shareholder loan and the
Zion's First National Bank loan. The loan is for a term of one year. Interest
only payments are due monthly at a rate of Libor plus 1.5%.
F-30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- --------------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- ---------------------
Effective May 12, 2000, the Registrant's Audit Committee of the Board of
Directors approved the dismissal of the Registrant's former independent
accountants. During the last two years, reports issued by the former accountants
did not contain any adverse opinion or a disclaimer of opinion, and were not
qualified or modified as to uncertainty, audit scope or accounting principles.
During the two most recent fiscal years preceding the dismissal, there were no
disagreements with the former independent accountants on any matter of
accounting principles or practices, financial statement disclosures, or auditing
scope or procedures which disagreements, if not resolved to the satisfaction of
the former independent accountants, would have caused them to make reference to
the subject matter of the disagreements in connection with its reports, except
that, subsequent to the issuance of the Registrants fiscal year 1998 financial
statements, which had been audited by the former accountants, information came
to the attention of the Registrant that caused it to conclude that those
financial statements were materially erroneous. The information caused the
Registrant to disagree with the audited accounting treatment of certain matters
in its previously issued fiscal year 1998 financial statements. Accordingly, the
registrant restated its 1998 financial statements as previously reported in the
Registrant's Form 8-K dated May 12, 2000. In the subsequent interim period,
there were no disagreements with the Registrants former accountants.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- ------------------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
- --------------------------------------------------------
Reference is made to the information contained in the Registrant's definitive
Proxy Statement for the Annual Meeting of shareholders to be held in 2001. Such
information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
- ----------------------------------
Reference is made to the Registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held in 2001. Such information is incorporated
herein by reference.
ITEM 12. SECURITY OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ---------------------------------------------------------------------
Reference is made to the information contained in the Registrant's definitive
Proxy Statement for the Annual Meeting of shareholders to be held in 2001. Such
information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------------
Reference is made to the information contained in the Registrant's definitive
Proxy Statement for the Annual Meeting of shareholders to be held in 2001. Such
information is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------------
(a)(1) The following consolidated financial statements of Community West
Bancshares are filed as part of this Annual Report.
Independent Auditors' Report 42
Consolidated Balance Sheets as of December 31, 2000 and 1999 43
Consolidated Statements of Operations for each of the three years
in the period ended December 31, 2000 44
Consolidated Statements of Stockholders' Equity for each
of the three years ended in the period ended December 31, 2000 45
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 2000 46
Notes to Consolidated Financial Statements 48
(a)(2)
Financial statement schedules other than those listed above have been
omitted because they are either not applicable or the information is
otherwise included.
(a)(3) Exhibits
(2) Plan of reorganization (1)
(3)(i) Articles of Incorporation (3)
(3)(ii) Bylaws (3)
(4)(i) Common Stock Certificate (2)
(4)(ii) Warrant Certificate (2)
(10)(i) 1997 Stock Option Plan and Form of Stock Option Agreement (1)
(10)(ii) Employment Contract between Goleta National Bank and Llewellyn
Stone, President and CEO (3)
(10)(iii) Salary Continuation Agreement between Goleta National Bank and
Llewellyn Stone, President and CEO (3)
(10)(iv) Definitive Agreeement to sell Palomar (5)
(16)(i) Letter re Change in Certifying Accountant (4)
(21) (i) Subsidiaries of the Registrant
COMMUNITY WEST BANCSHARES
(A California Corporation)
GOLETA NATIONAL BANK PALOMAR COMMUNITY BANK EPACIFIC
(A Nationally Chartered (A State Chartered INCORPORATED
Bank) Commercial Bank) (A Delaware
100% wholly owned 100% wholly owned Corporation)
Subsidiary Subsidiary 10% Interest
(27) Financial Data Schedule
(1) Filed as and exhibit to the Registrant's registration Statement on
Form S-8 filed with the Commission on December 31, 1997 and
incorporated herein by reference.
(2) Filed as an exhibit to the Registrant's Amendment to Registration
Statement on Form 8-A filed with the Commission on March 12, 1998 and
incorporated herein by reference.
(3) Filed as an exhibit to the Registrant's Form 10-K filed with the
Commission on March 26, 1998 and incorporated herein by reference.
(4) Filed as an exhibit to the Registrant's Form 8-K/A filed with the
Commission on May 23, 2000 and incorporated herein by reference.
(5) Filed as an exhibit to the Registrant's Form 8-K filed with the
Commission on December 5, 2000
SIGNATURES
----------
Pursuant to the requirements of Section 13 of 15(d) of the Securities and
Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, on the 28th day of
March, 2001.
COMMUNITY WEST BANCSHARES
(Registrant)
By
---------------------------------
Llewellyn W. Stone
President and
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated
Signature Title Date
________________________________ Director and Chairman of the Board
Michael A. Alexander March 28, 2001
________________________________ Director March 28, 2001
Mounir R. Ashamalla
________________________________ Director March 28, 2001
Robert H. Bartlein
________________________________ Director March 28, 2001
Jean W. Blois
________________________________ Director March 28, 2001
John D. Illgen
________________________________ Director March 28, 2001
Lynda J. Nahra
________________________________ Director and Secretary March 28, 2001
Michel Nellis
________________________________ Director March 28, 2001
William R. Peeples
_______________________________ Senior Vice President and Chief March 28, 2001
Lynda Pullon Radke Financial Officer (Principal
Financial and Accounting Officer)
________________________________ Director March 28, 2001
Richard M. Sanborn
________________________________ Director March 28, 2001
James R. Sims Jr.
_______________________________ Director, President and Chief March 28, 2001
Executive Officer
Llewellyn W. Stone