UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________.
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
445 Pine Avenue, Goleta, California 93117
(Address of principal executive offices) (Zip Code)
(805) 692-1862
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Number of shares of common stock of the registrant outstanding as of August
12, 2002: 5,690,223.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
- ------- ---------------------
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS 3
CONSOLIDATED STATEMENTS OF INCOME 4
CONSOLIDATED STATEMENT OF CASH FLOWS 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6
The financial statements included in this Form 10Q should be read
with reference to Community West Bancshares' Annual Report on
Form 10-K for the fiscal year ended December 31, 2001.
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK 31
Quantitative and qualitative disclosures about market risk
are located in Management's Discussion and Analysis of
Financial Condition and Results of Operations in the section
on interest rate sensitivity.
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 1. LEGAL PROCEEDINGS 32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS 34
ITEM 5. OTHER INFORMATION 34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 34
SIGNATURES
- ----------
PART I - FINANCIAL INFORMATION
COMMUNITY WEST BANCSHARES
CONSOLIDATED BALANCE SHEETS
June 30, 2002 December 31, 2001
(unaudited)
--------------- ------------------
ASSETS
Cash and due from banks $ 21,310,000 $ 9,806,000
Federal funds sold 10,000,000 19,600,000
--------------- ------------------
Cash and cash equivalents 31,310,000 29,406,000
Time deposits in other financial institutions 2,377,000 5,938,000
Federal Reserve Bank stock, at cost 775,000 775,000
Investment securities held-to-maturity, at amortized
cost; fair value of $6,110,000 at June 30, 2002
and $118,000 at December 31, 2001 6,107,000 118,000
Interest only strips, at fair value 5,208,000 7,693,000
Loans:
Held for sale, at lower of cost or fair value 23,647,000 30,848,000
Securitized loans, net of allowance for loan losses of $3,227,000
for June 30, 2002 and $4,189,000 for December 31, 2001 80,609,000 104,396,000
Held for investment, net of allowance for loan losses of $4,199,000
for June 30, 2002 and $4,086,000 December 31, 2001 132,834,000 125,711,000
Servicing assets, net 1,929,000 2,490,000
Other real estate owned, net 494,000 266,000
Premises and equipment, net 2,300,000 2,726,000
Accrued interest receivable and other assets 15,542,000 13,496,000
--------------- ------------------
TOTAL ASSETS $ 303,132,000 $ 323,863,000
=============== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing demand $ 31,672,000 $ 33,312,000
Interest-bearing demand 28,166,000 22,518,000
Savings 14,368,000 14,371,000
Time certificates of $100,000 or more 43,415,000 67,398,000
Other time certificates 84,005,000 58,567,000
--------------- ------------------
TOTAL DEPOSITS 201,626,000 196,166,000
Bonds payable in connection with securitized loans 66,386,000 89,351,000
Accrued interest payable and other liabilities 4,684,000 4,989,000
--------------- ------------------
TOTAL LIABILITIES 272,696,000 290,506,000
--------------- ------------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares
authorized; 5,690,223 shares issued and outstanding
at June 30, 2002 and December 31, 2001 29,798,000 29,798,000
Retained earnings 638,000 3,559,000
--------------- ------------------
TOTAL STOCKHOLDERS' EQUITY 30,436,000 33,357,000
--------------- ------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 303,132,000 $ 323,863,000
=============== ==================
The accompanying notes are an integral part of these consolidated financial
statements.
3
COMMUNITY WEST BANCSHARES
(UNAUDITED)
For the Three Months For the Six Months
Ended June 30 Ended June 30
2002 2001 2002 2001
------------ ----------- ------------ ------------
INTEREST INCOME:
Loans $ 7,517,000 $10,312,000 $14,894,000 $20,621,000
Federal funds sold 101,000 277,000 206,000 731,000
Investment securities 23,000 90,000 33,000 212,000
Time deposits in other financial institutions 22,000 44,000 68,000 69,000
------------ ----------- ------------ ------------
Total interest income 7,663,000 10,723,000 15,201,000 21,633,000
------------ ----------- ------------ ------------
INTEREST EXPENSE:
Deposits 1,311,000 2,643,000 2,788,000 5,461,000
Bonds payable and other borrowings 2,131,000 2,699,000 4,518,000 5,584,000
------------ ----------- ------------ ------------
Total interest expense 3,442,000 5,342,000 7,306,000 11,045,000
------------ ----------- ------------ ------------
NET INTEREST INCOME 4,221,000 5,381,000 7,895,000 10,588,000
------------ ----------- ------------ ------------
PROVISION FOR LOAN LOSSES 1,275,000 2,017,000 3,551,000 5,003,000
------------ ----------- ------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,946,000 3,364,000 4,344,000 5,585,000
------------ ----------- ------------ ------------
OTHER INCOME:
Gains from loan sales, net 1,317,000 1,661,000 3,085,000 3,418,000
Other loan fees - sold or brokered loans 719,000 852,000 1,578,000 1,573,000
Document processing fees 410,000 529,000 873,000 923,000
Service charges 93,000 144,000 227,000 331,000
Loan servicing fees, net 74,000 1,196,000 153,000 1,950,000
Other income 97,000 76,000 169,000 657,000
Proceeds from legal settlement - 7,000,000 - 7,000,000
------------ ----------- ------------ ------------
Total other income 2,710,000 11,458,000 6,085,000 15,852,000
------------ ----------- ------------ ------------
OTHER EXPENSES:
Salaries and employee benefits 3,599,000 4,419,000 7,780,000 8,795,000
Occupancy expense 940,000 957,000 1,676,000 1,833,000
Other operating expenses 402,000 819,000 708,000 1,304,000
Professional services 393,000 266,000 916,000 594,000
Loan servicing and collection expense 220,000 284,000 485,000 583,000
Loss on sale of assets 132,000 - 132,000 -
Postage & freight 82,000 100,000 153,000 181,000
Advertising expense 75,000 180,000 303,000 312,000
Office supply expense 55,000 92,000 104,000 184,000
Data processing/ ATM processing 30,000 123,000 80,000 206,000
Lower of cost or market provision on loans held for sale 1,340,000 - 1,340,000 -
Impairment of SBA I/O and Servicing Assets 1,788,000 - 1,788,000 -
Amortization of goodwill and other intangibles - 71,000 - 142,000
Professional expenses associated with legal settlement - 2,392,000 - 2,392,000
------------ ----------- ------------ ------------
Total other expenses 9,056,000 9,703,000 15,465,000 16,526,000
------------ ----------- ------------ ------------
(LOSS) INCOME BEFORE (BENEFIT FROM) PROVISION
FOR INCOME TAXES (3,400,000) 5,119,000 (5,036,000) 4,911,000
------------ ----------- ------------ ------------
(BENEFIT FROM) PROVISION FOR INCOME TAXES (1,428,000) 563,000 (2,115,000) (147,000)
------------ ----------- ------------ ------------
NET (LOSS) INCOME $(1,972,000) $ 4,556,000 $(2,921,000) $ 5,058,000
============ =========== ============ ============
(LOSS) EARNINGS PER SHARE
BASIC $ (0.35) $ 0.75 $ (0.51) $ 0.83
============ =========== ============ ============
DILUTED $ (0.35) $ 0.75 $ (0.51) $ 0.83
============ =========== ============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
4
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASHFLOWS
(UNAUDITED)
For the Six Months Ended
June 30,
2002 2001
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (Loss) Income $ (2,921,000) $ 5,058,000
Adjustments to reconcile net (loss) income to net cash provided (used in) by
operating activities:
Provision for loan losses 3,551,000 5,003,000
Provision for losses on real estate owned 32,000 8,000
Deferred income taxes (benefit) - (1,346,000)
Depreciation and amortization 438,000 696,000
Amortization of goodwll and other intangibles - 142,000
Gain on sale of other real estate owned (32,000) -
Gain on sale of loans held for sale (3,085,000) (3,418,000)
Change in market valuation of interest only strips 2,724,000 92,000
Reductions (additions) to servicing assets, net of amortization and valuation adjustments 562,000 (71,000)
Changes in operating assets and liabilities:
Accrued interest receivable and other assets (2,046,000) 3,598,000
Accrued interest payable and other liabilities (304,000) (420,000)
------------- -------------
Net cash provided (used in) by operating activities (1,081,000) 9,342,000
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities (6,107,000) -
Principal paydown on available-for-sale securities - 630,000
FHLB stock dividend - (13,000)
Redemption of FHLB stock - 99,000
Maturities of held-to-maturity securities - 1,500,000
Proceeds from payments and maturities of available-for-sale securities 118,000 1,000,000
Additions to interest only strip assets (240,000) (1,843,000)
Loan originations and principal collections, net 23,110,000 (14,006,000)
Proceeds from sale of other real estate owned 60,000 307,000
Net decrease (increase) in time deposits in other financial institutions 3,561,000 (1,973,000)
Purchase of premises and equipment (12,000) (275,000)
------------- -------------
Net cash provided (used in) by investing activities 20,490,000 (14,574,000)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits and savings accounts 4,005,000 6,165,000
Net (decrease) increase in time certificates of deposit 1,455,000 12,358,000
Bond repayments (22,965,000) (19,597,000)
Proceeds from issuance of other borrowings - 5,500,000
Repayment of other borrowings - (5,293,000)
Payment of accrued director dividends - (23,000)
Exercise of stock options - 30,000
Repurchase of outstanding shares - (1,104,000)
------------- -------------
Net cash (used in) provided by financing activities (17,505,000) (1,964,000)
------------- -------------
Net Increase in Cash and Cash Equivalents 1,904,000 (7,196,000)
Cash and Cash Equivalents, Beginning of Year 29,406,000 36,484,000
------------- -------------
Cash and Cash Equivalents, End of Year $ 31,310,000 $ 29,288,000
============= =============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 6,906,000 $ 10,908,000
Cash paid for income taxes $ 2,000 $ -
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real estate owned $ 288,000 $ 326,000
5
COMMUNITY WEST BANCSHARES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The interim consolidated financial statements are unaudited and reflect
all adjustments and reclassifications which, in the opinion of management,
are necessary for a fair presentation of the results of operations and
financial condition for the interim period. The unaudited consolidated
financial statements include of Community West Bancshares (the "Company")
and its wholly owned subsidiary, Goleta National Bank ("Goleta"). The
financial information for periods through August 17, 2001, includes the
divested subsidiary, Palomar Community Bank ("Palomar"). All adjustments
and reclassifications in the periods presented are of a normal and
recurring nature. Results for the period ending June 30, 2002 are not
necessarily indicative of results which may be expected for any other
interim period or for the year as a whole. Certain reclassifications have
been made in the audited 2001 financial statements to conform to the
presentation used in the 2002 interim financial statements.
These unaudited consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
of Community West Bancshares included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2001.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Loan Sales and Servicing - The Company originates certain loans for the
purpose of selling either a portion or the entire loan into the secondary
market. Such loans are carried at the lower of cost or fair value on an
aggregate basis. The guaranteed portion of Small Business Administration
("SBA") loans is typically sold into the secondary market with servicing
retained. Mortgage loans are typically sold into the secondary market with
servicing released. The Company may also retain interest only ("I/O")
strips on its SBA loan sales, which represent the present value of the
right to the excess cash flows generated by the serviced loans and is
based on 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. Prior to the second
quarter of 2002, the Company determined the present value of this
estimated cash flow stream at the time each loan sale transaction closed,
utilizing valuation assumptions regarding the discount rate and prepayment
rate for each particular transaction. Beginning in the second quarter of
2002, the Company changed its technique determining the relative fair
value of the I/O strips and the loans to a method that compares the quoted
sales price for the loans to be sold with and without these future cash
flow streams. The loan sales are discussed in detail in Note 4.
The I/O strips are accounted for as investments in debt securities and are
classified as trading securities. Accordingly, the Company carries these
securities at fair value with the resulting increases or decreases in fair
market value being recorded in operations in the current period.
6
2. INVESTMENT SECURITIES
The Company's debt securities other than I/O strips are classified as
"held-to-maturity". The amortized cost and estimated fair value of
investment securities is as follows:
June 30, 2002
Gross Gross
Amortized Unrealized Unrealized Fair
Held to Maturity Securities Cost Gain Loss Value
- --------------------------------- ---------- ----------- ----------- ----------
Federal Home Loan Bank
Discount Note par value $205,000
2.004% due January 3, 2003 $ 203,000 $ - $ - $ 203,000
Federal Home Loan Mortgage 4.65%
due April 4, 2005 1,006,000 - - 1,006,000
Federal Home Loan Mortgage 4.30%
due June 20, 2005 2,000,000 - - 2,000,000
Federal Home Loan Mortgage 4.91%
due December 20, 2005 1,010,000 3,000 - 1,013,000
Fannie Mae Pool 6.5%
due June 1, 2032 1,888,000 - - 1,888,000
---------- ----------- ----------- ----------
$6,107,000 $ 3,000 $ - $6,110,000
========== =========== =========== ==========
At June 30, 2002, the FHLB security was pledged as collateral to the U.S.
Treasury for its treasury, tax and loan account
3. LOAN SALES
Mortgage Loan Sales
-------------------
The Company originates and then sells wholesale mortgage loans secured by
both first and second trust deeds. As of June 30, 2002 and December 31,
2001, the Company had $2.4 and $15.5 million, respectively, of wholesale
mortgage loans held for sale. During the second quarter of 2002, the
Company discontinued originating sub-prime and high-loan-to-value mortgage
loans for sale into the secondary market. In addition, the Company
transferred the remaining $5.2 million of high-loan-to-value loans held
for investment to held for sale. A $1.3 million lower of cost or market
reserve was recorded as a result of this transfer. As of June 30, 2002 and
December 31, 2001, the Company had $9.0 and $4.9 million, respectively, of
sub-prime and high-loan-to-value mortgage loans held for sale. Both
products are sold on a servicing released basis.
Manufactured Housing Sales
--------------------------
In the first quarter of 2002, the Company originated certain manufactured
housing loans for sale into a secondary market. These loans were
subsequently transferred to held for investment. All newly originated
manufactured housing loans are held for investment.
SBA Loan Sales
--------------
The Company sells the guaranteed portion of SBA loans into the secondary
market in exchange for a combination of a cash premium, servicing assets,
and/or interest only strips. Fair value of the interest only strips and
7
servicing assets prior to second quarter 2002 was determined using a 9.25%
to 10.25% discount rate based on the term of the underlying loan
instrument, and a 13.44% prepayment rate. For loans sold after March 31,
2002, the initial values of the servicing and interest only strip assets
and resulting gain on sale were calculated based on the difference between
the best actual par and premium bids received for each individual loan.
The balance of all servicing assets are subsequently amortized over the
estimated life of the loans using estimated prepayment of 22%. During the
second quarter of 2002, the Company recorded a $1.8 million impairment
charge relating to the valuation of its servicing assets and I/O strips.
The change in valuation reflects a higher rate of expected prepayments due
in part to the continued low interest rate environment.
The SBA program stipulates that the Company retain a minimum of 5% of the
unguaranteed portion of the loan balance. The percentage of each
unguaranteed loan in excess of 5% can be sold to a third party from time
to time for a cash premium.
As of June 30, 2002 and December 31, 2001, the Company had approximately
$12.2 and $10.5 million in SBA loans held for sale.
Funding for SBA programs depends on annual appropriations by the U.S.
Congress, and accordingly, the sale of loans under these programs is
dependent on the continuation of such programs.
The balances of servicing assets and interest only strips for the six
months ended June 30, 2002 and year ended December 31, 2001 are as
follows:
June 30, 2002 December 31, 2001
---------------------- ----------------------
Servicing Servicing
Asset I/O Strip Asset I/O Strip
---------- ---------- ---------- ----------
Guaranteed Portion of SBA $1,929,000 $5,208,000 $2,173,000 $7,693,000
FHA Title 1 - - 317,000 -
---------- ---------- ---------- ----------
Total $1,929,000 $5,208,000 $2,490,000 $7,693,000
========== ========== ========== ==========
The following is a summary of activity in I/O Strips and Servicing Assets
for the six months ended June 30, 2002 and June 30, 2001:
I/O Strips June 30, 2002 June 30, 2001
--------------- ---------------
Balance, beginning of year $ 7,693,000 $ 7,541,000
Additions through loan sales 240,000 1,843,000
Valuation adjustment (2,725,000) (92,000)
--------------- ---------------
Balance, end of year $ 5,208,000 $ 9,292,000
=============== ===============
8
Servicing Assets June 30, 2002 June 30, 2001
--------------- ---------------
Balance, beginning of year $ 2,490,000 $ 2,605,000
Additions through loan sales 382,000 411,000
Amortization (181,000) (97,000)
Valuation adjustment (762,000) (243,000)
--------------- ---------------
Balance, end of year $ 1,929,000 $ 2,676,000
=============== ===============
4. COMPREHENSIVE INCOME
Comprehensive income, which encompasses net income and the net change in
unrealized gains or losses on investment securities available-for-sale, is
presented below:
For the three months ended
-------------------------------
June 30, 2002 June 30, 2001
--------------- --------------
Net (loss) income $ (2,921,000) $ 5,058,000
Other comprehensive income - 35,000
Reclassification adjustment for realized
gains previously recognized in
comprehensive income - -
--------------- --------------
Comprehensive (loss) income $ (2,921,000) $ 5,093,000
=============== ==============
Other comprehensive income consists of unrealized gain on investment
securities available-for-sale, net of tax effect of $0 and $9,000, for the
six months ended June 30, 2002 and 2001, respectively.
5. COMMITMENTS AND CONTINGENCIES
Commitments
-----------
In the ordinary course of business, the Company enters into commitments to
extend credit to its customers. These commitments are not reflected in the
accompanying financial statements. As of June 30, 2002, the Company had
entered into commitments with certain customers amounting to $20.1 million
compared to $20.3 million at December 31, 2001. There were $424,000 of
letters of credit outstanding at June 30, 2002; there were $438,000 of
letters of credit outstanding at December 31, 2001.
Contingencies
-------------
Goleta makes short-term consumer loans ("Bank Loans") using certain
marketing and servicing assistance of ACE at certain ACE retail locations
pursuant to the terms of a Master Loan Agency Agreement. A number of
lawsuits and state regulatory proceedings have been filed or initiated
against Goleta and/or ACE regarding the Bank Loans. Based on advice from
legal counsel, management does not consider it probable that the
resolution of these matters will have a material adverse impact on the
Company's financial condition or results of operations. However, it is
possible that adverse determinations in one or more of these actions could
ultimately have a material adverse financial impact on the Company and
could also result in adverse actions by the regulatory agencies with
authority over Goleta.
9
6. EARNINGS PER SHARE
Earnings per share - Basic have been computed based on the weighted
average number of shares outstanding during each period. Earnings per
share - Diluted has been computed based on the weighted average number of
shares outstanding during each period plus the dilutive effect of granted
options. Earnings per share were computed as follows:
For the three months ended
----------------------------
June 30, 2002 June 30, 2002
------------- -------------
Basic weighted average shares outstanding 5,690,223 6,094,710
Dilutive effect of options 28,750 64,231
------------- -------------
Diluted weighted average shares outstanding 5,718,973 6,158,941
============= =============
Net (loss) income $ (1,972,000) $ 4,556,000
(Loss) Earnings per share - Basic $ (0.35) $ 0.75
(Loss) Earnings per share - Diluted $ (0.35) $ 0.75
For the six months ended
-----------------------------------
June 30, 2002 June 30, 2001
------------------- --------------
Basic weighted average shares outstanding 5,690,223 6,100,913
Dilutive effect of options 33,625 12,784
------------------- --------------
Diluted weighted average shares outstanding 5,723,848 6,113,697
=================== ==============
Net (loss) income $ (2,921,000) $ 5,058,000
(Loss) Earnings per share - Basic $ (0.51) $ 0.83
(Loss) Earnings per share - Diluted $ (0.51) $ 0.83
Shares used in per-share calculation - basic 5,690,223 6,100,913
Shares used in per-share calculation-diluted(1) 5,690,223 6,113,697
(1) Diluted net loss per share for the three and six months ended June 30, 2002
is computed using the weighted-average number of common shares outstanding
during the period and excludes common-equivalent shares, as their effect is
anti-dilutive.
7. CAPITAL
Goleta is operating under a formal written agreement (the "Formal
Agreement") with the Office of the Comptroller of the Currency (the
"OCC"). Under the terms of the Agreement, among other things, Goleta is
required to 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.
The Agreement also places limitations on growth and payments of dividends
until Goleta is in compliance with the Formal Agreement, its approved
capital plan and receives the appropriate approval from the OCC. 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. As of June 30, 2002 and
December 31, 2001, Goleta had total capital equal to 12.01% and 11.84%,
respectively, of risk-weighted assets and Tier 1 capital to risk-weighted
assets of 10.73% and 10.40%, respectively. Management believes that Goleta
is in compliance with all material provisions of the Agreement regarding
capital requirements.
10
In addition, the Company is operating under a Memorandum of Understanding
with the Federal Reserve Bank which requires, among other things, that the
Company refrain from paying dividends without the approval of the Federal
Reserve Bank.
8. CHANGES TO OPERATIONS
In the second quarter of 2002, the Company decided to exit the
High-Loan-To-Value and
Subprime Mortgage Lending origination and sale activities, centralize the
support functions of the Small Business Administration Division and its
Conventional Mortgage Lending Division into the Goleta, California
headquarters and close related facilities. As a result, the Company
terminated 44 employees and recorded charges of $131,000, $332,000 and
$264,000 respectively, relating to employee termination, lease
abandonment, and other costs relating to disposal of assets. These charges
were recorded in salaries and employee benefits and in occupancy expense
during the period. Of these amounts, $432,000 remained as accrued
liability at June 30, 2002. The effect of this decision is not considered
significant to the Company's revenues or results of operation.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------- ---------------------------------------------------------------
RESULTS OF OPERATION
--------------------
This discussion is designed to provide a better understanding of significant
trends related to the Company's consolidated financial condition, results of
operations, liquidity and capital resources. It should be read in conjunction
with the unaudited interim consolidated financial statements and notes thereto
and the other financial information appearing elsewhere in this report.
This Quarterly Report on Form 10-Q contains statements which constitute
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Those forward-looking statements include statements regarding the
intent, belief or current expectations of the Company and its management. Any
such forward-looking statements are not guarantees of future performance and
involve risks and uncertainties, and actual results may differ materially from
those projected in the forward-looking statements. Such risks and uncertainties
include, among other things, the reduction in our earnings by losses on loans,
the recent decline in our interest income, the risk that our borrowers will fail
to perform, the regulation of the banking industry, our compliance with our
Formal Agreement with the OCC and our Memorandum of Understanding with the
Federal Reserve Bank, our dependence on real estate, risks associated with high
loan-to-value real estate loans, risks of natural disasters, the effect of
interest rate fluctuations, competition, operations risks, adverse publicity and
legal proceedings pertaining to (among other things) the Company's Short Term
Consumer Lending Program, curtailment of government guaranteed loan programs,
the Company's expectation not to pay dividends, volatility of the Company's
stock price, security risks related to online banking services, dependence on
key employees, environmental laws, and other risk and uncertainties that may be
detailed herein and in the Company's other reports filed with the Securities and
Exchange Commission. See "Factors that May Affect Future Results of
Operations."
RESULTS OF OPERATIONS
The Company experienced a net loss of $2,921,000 in the first half of 2002, or
$0.51 per share, compared to net earnings of $5,058,000 or $0.83 per share
during the comparable period of 2001. The six months ended June 30, 2001
included the receipt of a $7.0 million legal settlement from the Company's
former accountants and $2.4 million of related expenses.
The June 30, 2002 quarter results were influenced by the decision to: (1)
discontinue the High-Loan-To-Value ("HLTV") and Subprime Mortgage Lending
origination and sale activities; and (2) relocate the Conventional Mortgage
Lending activities and the support functions of our Southeastern Region Small
Business Administration Division into our Goleta, California headquarters
office. As part of the decision to exit HLTV origination business, the Company
decided to sell approximately $5.2 million of previously "held to maturity" HLTV
loans. The one-time pretax financial impact of these changes totaled
approximately $1.6 million, the amount of the Company's pre-tax loss for the
quarter. These charges included:
a) Approximately $487,000 of personnel, occupancy and other expenses
associated with the withdrawal from the HLTV and Subprime loan
origination and sale activities, the closure of facilities, and the
centralization of certain SBA Administration Division activities.
b) A loan loss related "net" expense of :
12
o A $1.34 million mark to market valuation adjustment to the
Company's $5.2 million previously "Held to Maturity" HLTV loan
portfolio, and
o A $489,000 reduction of the Company's required provision for
loan losses (as a result of the reclassification of the HLTV
loans), and
o The write-off of a $227,000 servicing asset.
Finally, the Company changed it's method of valuing sold SBA loan related I/O
Strip and Servicing Assets. The new methodology reflects a higher rate of future
expected SBA loan pre-payments. This change generated an additional pre-tax
impairment charge of approximately $ 1.8 million.
The following table sets forth for the periods indicated, certain items in the
consolidated statements of income of the Company and the related changes between
those periods:
For the Six Months Ended
---------------------------- Amount of Percent of
June 30, June 30, Increase Increase
2002 2001 (Decrease) (Decrease)
------------ ------------ ------------ ----------
Interest Income $15,201,000 $21,633,000 $ 6,432,000) (29.7%)
Interest Expense 7,306,000 11,045,000 (3,739,000) (33.9%)
------------ ------------ ------------
Net Interest Income 7,895,000 10,588,000 (2,693,000) (25.4%)
Provision for Loan Losses 3,551,000 5,003,000 (1,452,000) (29.0%)
------------ ------------ ------------
Net Interest Income After
Provision for Loan Losses 4,344,000 5,585,000 (1,241,000) (22.2%)
Other Income 6,085,000 15,852,000 (9,767,000) (61.6%)
Other Expense 15,465,000 16,526,000 (1,061,000) (6.4%)
------------ ------------ ------------
(Loss) Before (Benefit) for Income Taxes (5,036,000) 4,911,000 (9,947,000) 202.5%
(Benefit) for Income Taxes (2,115,000) (147,000) 1,968,000 1338.8%
------------ ------------ ------------
Net (Loss) Income $(2,921,000) $ 5,058,000 $(7,979,000) (157.8%)
============ ============ ============
Earnings Per Share - Basic $ (0.51) $ 0.83 $ (1.34) (161.4%)
============ ============ ============
Earnings Per Share - Diluted $ (0.51) $ 0.83 $ (1.34) (161.4%)
============ ============ ============
Shares used in per-share calculation - basic 5,690,223 6,100,913
Shares used in per-share calculation-diluted(1) 5,690,223 6,113,697
(1) Diluted net loss per share for the six months ended June 30, 2002 is
computed using the weighted-average number of common shares outstanding during
the period and excludes common-equivalent shares, as their effect is
anti-dilutive.
13
The annualized loss on average equity was 17.9% for the six months ended June
30, 2002, compared to annualized return on average equity of 28% for the same
period in 2001.
NET INTEREST INCOME/NET INTEREST MARGIN
One component of the Company's earnings is net interest income, which is the
difference between the interest and fees earned on loans and investments and the
interest paid for deposits and borrowed funds. The net interest margin is net
interest income expressed as a percentage of average earning assets.
The annualized net interest margin was 5.2% for the six months ended June 30,
2002, compared to an annualized net interest margin of 5.6% for the six months
ended June 30, 2001.
Changes in the Company's net interest margin are due in part to the decline in
interest rates as the Company's variable rate loans repriced faster than the
corresponding deposits. The decline was offset by an increase in loan
balances from the Company's higher-yielding Short-Term Consumer Lending program.
The Company cannot be assured of receiving these higher yields in the future
because regulatory activity and litigation may restrict the Company's ability to
originate short-term consumer loans or make them less profitable. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Supervision and Regulation" and "Part II - Item 1. Legal
Proceedings."
Net interest income declined by $2,693,000 as the result of a $79,056,000 (or
20.8%) decline in average earning assets from $378,951,000 for the six months
ended June 30, 2001 to $299,895,000 for the six months ended June 30, 2002. The
decrease in earning assets was due to the sale of Palomar in August of 2001 and
the continued pay down of the Company's securitized loan portfolio.
The net interest income amounts above include income from the Company's
securities. The following table summarizes the interest and fees and
corresponding yields for loans only:
For the Three Months Ended For the Six Months Ended
June 30 2002 June 30, 2001 June 30 2002 June 30, 2001
-------------- --------------- -------------- ---------------
Interest and Fees $ 7,517,000 $ 10,312,000 $ 14,894,000 $ 20,621,000
Average Loans 244,736,000 344,000,000 247,739,000 340,662,000
Annualized Yield 12.3% 12.0% 12.0% 12.1%
CREDIT LOSS EXPERIENCE
As is customary in the lending business, the Company experienced loan losses
during the quarter. The risk of loss varies depending on the type of loan
granted and the creditworthiness of the borrower over the term of the loan. The
Company takes into account the degree of perceived risk in establishing the
structure of, interest rates and security for, specific loans and for various
types of loans. The Company attempts to minimize its credit risk exposure
through the use of thorough approval and underwriting procedures and a
comprehensive loan application process.
The Company maintains a program of systematic review of its existing loans.
Loans are graded for their overall quality. Those loans that management
determines require further monitoring and supervision are segregated and
reviewed on a periodic basis. Significant problem loans are reviewed on a
monthly basis by the Company's Loan Committee.
14
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 and short-term consumer loans, which are evaluated
for impairment on a collective basis. The Company held $6,327,000 in impaired
loans as of June 30, 2002 compared to $6,587,000 as of December 31, 2001.
Goleta charges off: (a) any loan classified as a "Loss"; (b) portions of loans
which are deemed to be uncollectible; (c) short-term consumer loans which are
past due 60 or more days; (d) overdrafts which have been outstanding for more
than 30 days; (e) consumer finance loans which are past due 120 or more days;
and (f) all other unsecured loans past due 120 or more days. Charge offs are
applied as a reduction to Goleta's allowance for loan losses. Recoveries of
previously charged off loans are applied as increases to Goleta's allowance for
loan losses.
The accrual of interest is discontinued when substantial 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. All of the
impaired loans disclosed above are on nonaccrual status. The Company held
$12,871,000 in non-accrual loans as of June 30, 2002 compared to $11,413,000 as
of December 31, 2001. Of the non-accrual loans that the Company carries on its
balance sheet, $7,988,000 and $6,055,000 as of June 30, 2002 and June 30, 2001,
respectively, are SBA guaranteed loans, that the Company repurchases on the
behalf of the SBA. The Company generally repurchases the guaranteed portion of
SBA loans from investors when those loans become 120 days past due. After the
foreclosure and collection process is complete, the SBA reimburses the Bank for
this principal balance. Therefore, although these balances do not earn interest
during this period, they generally do not represent risk of principal loss to
the Company.
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. Troubled debt
restructured loans were $1,307,000 and $1,093,000 as of June 30, 2002 and
December 31, 2001, respectively. These balances are included in the balances of
impaired loans disclosed above.
15
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.
The following table summarizes the Company's allowance for loan loss for the
dates indicated:
Amount of Percent of
Increase Increase
June 30, 2002 December 31, 2001 (Decrease) (Decrease)
--------------- ------------------- ------------- -----------
BALANCES:
Gross Loans $ 244,517,000 $ 269,230,000 $(24,713,000) (9.2%)
Allowance for Loan Losses 7,426,000 8,275,000 (849,000) (10.3%)
Nonaccrual Loans(1)
Repurchased SBA Guaranteed
Loans(1) 7,988,000 7,509,000 479,000 6.4%
Other Nonaccrual Loans 4,883,000 3,904,000 979,000 25.0%
--------------- ------------------- -------------
Total 12,871,000 11,413,000 1,458,000 12.8%
RATIOS:
Allowance for Loan Losses to Gross Loans 3.0% 3.1% (0.1%)
(1) The Bank generally repurchases the guaranteed portion of SBA loans from investors when those loans become
past-due 120 days. After the foreclosure and collection process is complete, the SBA reimburses the Bank for
this principal balance. Therefore, although these balances do not earn interest during this period, they
generally do not result in a loss of principal to the Bank.
It should be noted that the Company's securitized loan portfolios are serviced
by a third party and collectively evaluated for impairment. Therefore the above
table does not include non-accrual loans for the securitized loan portfolios.
Furthermore, the allowance for loan losses for these loans decreased by $962,000
from $4,189,000 at December 31, 2001 to $3,227,000 at June 30, 2002.
The provision for loan losses was $3,551,000 for the six months ended June 30,
2002. This is a decrease of $1,452,000 or 29%, compared to $5,003,000 for the
six months ended June 30, 2001. The decrease was due in part to a reduction of
losses from the securitized and SBA loan portfolios. For the six months ended
June 30, 2002, losses charged to the allowance for loan losses totaled
$5,290,000. This was offset by $867,000 of recoveries resulting in net
charge-offs of $4,423,000 against the allowance. For the six months ended June
30, 2001, losses charged to the allowance for loan losses totaled $5,168,000,
which was offset by $414,000 in recoveries; with the net effect being $4,754,000
of loans charged to the allowance.
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 June 30, 2002 is
adequate to absorb known and inherent 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.
16
OTHER INCOME
Other income includes service charges on deposit accounts, gains on sale of
loans, servicing fees, and other revenues not derived from interest on earning
assets. Other income for the six months ended June 30, 2002 decreased by $9.8
million or 61.6% compared to the six months ended June 30, 2001. The decrease
was primarily due to $7 million of proceeds from a legal settlement in 2001 as
well as a reduction of $1.8 million in loan servicing fees due to lower loan
originations and sales activities in the Company's mortgage, alternative
mortgage and SBA lending programs.
OTHER EXPENSES
Other expenses include salaries and employee benefits, occupancy and equipment,
and other operating expenses. Other expenses for the six months ended June 30,
2002 decreased by $1 million or 6.4% compared to the six months ended June 30,
2001. This decrease is principally a result of the sale of Palomar in August
2001 and the Company's efforts to cut operating expenses.
TAXES
Taxes include a benefit based upon the pre-tax loss the Company incurred in the
first half of 2002.
BALANCE SHEET ANALYSIS
Average assets for the six months ended June 30, 2002 were $307,020,000 compared
to $418,408,000 for the same period in 2001; average equity decreased to
$32,656,000 for the six months ended June 30, 2002, from $36,359,000 for the
same period in 2001. These decreases principally resulted from the sale of
Palomar and the reduction in the Company's securitized loan portfolio.
17
The book value per share decreased to $5.35 at June 30, 2002 from $6.75 at June
30, 2001 as a result of a net loss.
Amount of Percent of
December 31, Increase Increase
(Selected balance sheet accounts) June 30, 2002 2001 (Decrease) (Decrease)
-------------- ------------- ------------- -----------
Cash and Cash Equivalents $ 31,310,000 $ 29,406,000 $ 1,904,000 6.5%
Time Deposits in other financial institutions 2,377,000 5,938,000 (3,561,000) (60.0%)
Federal Reserve Bank Stock 775,000 775,000 - (0.0%)
Investment Securities 6,107,000 118,000 5,989,000 5075.4%
Interest only strips 5,208,000 7,693,000 (2,485,000) (32.3%)
Loans - Held for sale 23,647,000 30,848,000 (7,201,000) (23.3%)
Securitized Loans, net 80,609,000 104,396,000 (23,787,000) (22.8%)
Loans - Held for investment, net 132,834,000 125,711,000 7,123,000) 5.7%
Total Assets $ 303,132,000 $ 323,863,000 $(19,694,000) (6.4%)
============== ============= ============= ===========
Total Deposits $ 201,626,000 $ 196,166,000 $ 5,460,000 2.8%
============== ============= ============= ===========
Total Stockholders' Equity $ 30,436,000 $ 33,357,000 $ (1,884,000) (8.8%)
============== ============= ============= ===========
CASH AND CASH EQUIVALENTS
Cash and cash equivalents are made up of cash and federal funds sold. Cash and
cash equivalents increased from $29,406,000 at December 31, 2001 to $33,310,000
at June 30, 2002, an increase of 6.5% due to normal cash needs associated with
the Company's lending and deposit taking activities.
TIME DEPOSITS
Time deposits in other financial institutions decreased from $5,938,000 to
$2,377,000, a decrease of $3,561,000 or 60%. This change was a result of a
change in the Company's investment strategy to invest in other types of
investments.
INVESTMENT SECURITIES
Investment securities consist of Federal Reserve Bank stock and agency
securities. The increase of $5,989,000 was a result of a change in the
Company's investment strategy to invest in more securities and other types of
investments.
INTEREST ONLY STRIPS
Interest only strips represent the present value of excess net cash flows
generated by the difference between interest at the stated rate paid by
borrowers and the sum of pass-through interest paid to third-party investors.
Interest only strips declined $2,485,000 or 32% due to the write down of the
fair value of the interest only strips and a decrease in par loan sales which
increase the value of the interest only strips. During the second quarter
of 2002, the Company recorded a $1.8 million impairment charge relating to the
valuation of its servicing assets and I/O strips. The change in valuation
reflects a higher rate of expected prepayments due in part to the continued low
interest rate environment.
18
LOANS
Loans held for sale decreased by $7,201,000 to $23,647,000 as of June 30, 2002
from $30,848,000 as of December 31, 2001, representing a decrease of 23.3%.
This decrease is principally due to a $13.1 million reduction in the number of
wholesale mortgage loans held for sale at the end of the period. These loans
are originated and sold on a flow basis to an identified investor group. The
decrease in mortgage loans was partially offset by an increase in SBA loans of
$1.7 million and the transfer of the $5.2 million of HLTV loans from held for
investment.
Net loans held for investment decreased by $16.7 million from $230,107,000 at
December 31, 2001 to $213,443,000 at June 30, 2002. This decrease was primarily
a result of a $23.8 million decrease in the securitized loan portfolio due to
the continued high volume of prepayments in a low interest rate environment.
This decrease was partially offset by an increase in the relationship banking
loans.
DEPOSITS
The following schedule shows the balance and percentage change in the various
deposits:
Amount of Percent of
Increase Increase
June 30, 2002 December 31, 2001 (Decrease) (Decrease)
-------------- ------------------ ------------- -----------
Noninterest-Bearing Deposits $ 31,672,000 $ 33,312,000 $ (1,640,000) (4.9%)
Interest-Bearing Deposits 28,166,000 22,518,000 5,648,000 25.1%
Savings 14,368,000 14,371,000 (3,000) 0.0%
Time Certificates of $100,000 or more 43,415,000 67,398,000 (23,983,000) (35.6%)
Other Time Certificates 84,005,000 58,567,000 25,438,000 43.4%
-------------- ------------------ -------------
Total Deposits $ 201,626,000 $ 196,166,000 $ 5,460,000 2.8%
============== ================== =============
The Company's deposits increased slightly by 2.8% or $5,460,000 through the
period of June 30, 2002 over December 31, 2001, due to increased deposits
acquired through the normal course of business. Time certificates over $100,000
experienced a decrease from $67,398,000 to $43,415,000, or 35.6%, while other
time certificates increased from $58,567,000 to $84,005,000, or 43.4%.
Management believes that this change is principally a result of its efforts to
move customers from time certificate deposit accounts with slightly more than
$100,000 to similar accounts with balances slightly less than $100,000.
LIQUIDITY
The Company has an asset and liability management program that aids management
in maintaining its interest margins during times of both rising and falling
interest rates and in maintaining sufficient liquidity. Liquidity of the Company
as of June 30, 2002, was 20.9% compared to 20.5% as of December 31, 2001, based
on liquid assets (consisting of cash and due from banks, federal funds sold,
time deposits in other financial institutions, investments securities, and loans
held for sale) divided by total assets. Management believes it maintains
adequate liquidity levels.
19
At times when the Company has more funds than it needs for its reserve
requirements or short-term liquidity needs, the Company increases its securities
investments and 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. The Company has a federal funds line of credit
with a correspondent bank totaling $5,000,000.
CAPITAL RESOURCES
The Company's equity capital was $30,436,000 at June 30, 2002. Under the Prompt
Corrective Action provisions of the Federal Deposit Insurance Act, national
banks are assigned regulatory capital classifications based on specified capital
ratios of the institutions. The capital classifications are "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
and "critically undercapitalized."
The relevant capital ratios of the institution in this determination are (i) the
ratio of Tier I capital (primarily common stock and retained earnings less
goodwill and other intangible assets) to adjusted average total assets (the
"Tier I capital to average assets ratio"), (ii) the ratio of Tier I capital to
risk-weighted assets (the "Tier I risk-based capital ratio"), and (iii) the
ratio of qualifying total capital to risk-weighted assets (the "total risk-based
capital ratio"). To be considered "well capitalized," an institution must have
a Tier I capital to average assets ratio of at least 5%, a Tier I risk-based
capital ratio of at least 6%, and a total risk-based capital ratio of at least
10%. Generally, for an institution to be considered "adequately capitalized"
these three ratios must be at least 4%, 4% and 8%, respectively. An institution
will generally be considered (1) "undercapitalized" if any one of these three
ratios is less than 4%, 4% and 8%, respectively, and (2) "significantly
undercapitalized" if any one of these three ratios is less than 3%, 3% and 6%,
respectively.
Additionally, an institution may not be deemed to be well capitalized if its is
operating under an agreement with its principal regulator, as is the case of
Goleta. See "Supervision and Regulation of the Company-Formal Agreement with
the OCC"
20
The Company's actual capital amounts and ratios for the periods indicated are as
follows:
To Be Well Capitalized
CAPITAL AMOUNTS AND RATIOS For Capital Under Prompt Corrective
AS OF JUNE 30, 2002: Actual Adequacy Purposes Action Provisions
------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------ ----------- ------
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
Consolidated $33,520,000 12.99% $20,642,000 8.00% N/A N/A
Goleta National Bank $30,352,000 12.01% $20,226,000 8.00% $25,282,000 10.00%
TIER I CAPITAL (TO RISK WEIGHTED ASSETS)
Consolidated $30,243,000 11.72% $10,321,000 4.00% N/A N/A
Goleta National Bank $27,132,000 10.73% $10,113,000 4.00% $15,169,000 6.00%
TIER I CAPITAL (TO AVERAGE ASSETS)
Consolidated $30,243,000 9.85% $12,281,000 4.00% N/A N/A
Goleta National Bank $27,132,000 8.90% $12,199,000 4.00% $15,248,000 5.00%
To Be Well Capitalized
CAPITAL AMOUNTS AND RATIOS For Capital Under Prompt Corrective
AS OF DECEMBER 31, 2001: Actual Adequacy Purposes Action Provisions
------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------ ----------- ------
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
Consolidated $36,689,000 13.02% $22,546,000 8.00% N/A N/A
Goleta National Bank $32,623,000 11.84% $22,049,000 8.00% $27,562,000 10.00%
TIER I CAPITAL (TO RISK WEIGHTED ASSETS)
Consolidated $33,107,000 11.75% $11,273,000 4.00% N/A N/A
Goleta National Bank $29,122,000 10.40% $11,025,000 4.00% $16,537,000 6.00%
TIER I CAPITAL (TO AVERAGE ASSETS)
Consolidated $33,108,000 9.07% $14,602,000 4.00% N/A N/A
Goleta National Bank $29,122,000 9.05% $12,874,000 4.00% $16,093,000 5.00%
SUPERVISION AND REGULATION OF THE COMPANY
-----------------------------------------
Banking is a complex, highly regulated industry. The banking regulatory scheme
serves not to protect investors, but is designed to maintain a safe and sound
banking system, to protect depositors and the FDIC insurance fund, 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 that of Goleta, may be affected not only by management
decisions and general economic conditions, but also by the requirements of
applicable state and federal statutes and regulations and the policies of
various governmental regulatory authorities, including the Board of Governors of
the Federal Reserve Bank ("FRB"), the Federal Deposit Insurance Corporation
("FDIC"), the Office of the Comptroller of the Currency ("OCC") and the
California Department of Financial Institutions ("DFI"). For a detailed
discussion of the regulatory scheme governing the Company and Goleta, please see
the discussion in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2001 under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operation - Supervision and Regulation."
21
FORMAL AGREEMENT WITH THE OCC
In March 2000, Goleta entered into an agreement (the "Formal Agreement") with
its principal regulator, the OCC. The Formal Agreement requires that Goleta
maintain certain capital levels and adhere to certain operational and reporting
requirements, including the following:
- submitting monthly progress reports;
- adopting a written asset diversification program to identify and
control any concentration of credit;
- maintaining total capital at least equal to 12% of risk-weighted
assets and Tier 1 capital at least equal to 7% of adjusted total
assets and developing a three year capital program to maintain
adequate capital and raise any required additional capital,
including a prohibition on the payment of dividends without the
approval of the OCC;
- refrain from permitting its average total assets in any quarter to
exceed its average total assets during the preceding quarter except
as specified;
- establishing a program to maintain an adequate allowance for loan
and lease losses;
- ensuring that it has adequate, full-time management;
- adopting a written strategic plan covering at least a three-year
period;
- developing a written risk management program;
- refiling certain amended regulatory reports and adopting policies
and procedures to ensure that all regulatory reports accurately
reflect its condition;
- adopting a written program to ensure compliance with all applicable
consumer protection laws, rules and regulations;
- appointing a capable officer vested with sufficient authority to
ensure compliance with the Bank Secrecy Act;
- documenting the support used to value loans held on its books,
servicing rights and interest-only assets;
- preparing a written analysis of its short-term consumer loan program
which fully assesses the risks and benefits of this program and,
thereafter, preparing a written analysis of any new product or
service; and correcting each violation of law, rule or regulation
cited in any report of examination.
Compliance with the provisions of the Formal Agreement could limit Goleta's
business activity and increase expense. Management has been informed by the
regulators that they do not believe that Goleta is in full compliance with the
following provisions of the Formal Agreement:
22
- implementing and demonstrating the effectiveness of its written risk
management program;
- implementing a program to ensure compliance with consumer protection
laws applicable to Goleta's short-term consumer loan program;
- accurately valuing, and documenting the valuations of, interest-only
assets, servicing assets, deferred tax assets and deferred tax
liabilities; and
- ensuring compliance with applicable laws and regulations,
particularly as related to the short-term consumer loan program.
Goleta achieved and maintained both of the aforementioned required 12% and 7%
capital ratios from September 30, 2000 to the end of 2001. As the result of
fourth quarter 2001 losses, Goleta's risk-based capital ratio declined to 11.84%
at December 31, 2001. On March 8, 2002, the Company made a $750,000 capital
contribution to Goleta, and as a result Goleta achieved and has maintained the
required 12% total capital ratio and 7% Tier 1 capital ratio. Goleta's risk
based capital ratio was 12.01% as of June 30, 2002. Management believes that it
continues to comply with all material provisions of the Agreement regarding
capital requirements.
Failure to comply with the provisions of the Formal Agreement could adversely
affect the safety or soundness of Goleta. The OCC possesses broad powers to take
corrective and other supervisory action and bring enforcement actions to resolve
unsafe or unsound practices.
Short-Term Consumer Loan Program. In 1999, Goleta entered into a contract with
- --------------------------------
America's Cash Express ("ACE") and ePacific.com, whereby ACE acts as an agent to
originate short-term consumer loans at over 1,100 national retail offices. Upon
origination, ACE purchases 90% of the principal and Goleta currently retains 10%
ownership in the principal of each loan. Loans currently yield approximately
294% interest and are for original terms of two weeks. The first loans of this
type were initiated in the second quarter of 2000. ACE and ePacific.com service
these loans. While this business activity makes significant contributions to
Goleta's net profit, it does experience high levels of loan losses. The OCC has
also expressed strong reservations about Goleta and other national banks
entering into arrangements with third parties to make short-term consumer loans
and believe this program subjects Goleta and the Company to significant
strategic, reputational, compliance and transaction risks
Representatives of the Company and ACE have had discussions between themselves
and with representatives of the OCC regarding the particular concerns of the
OCC, and the actions that might be taken to address those concerns. The Company
believes that some significant modifications of the current policies and
procedures for short-term consumer loans and in the Company's relationship with
ACE may be required to address these concerns. However, the discussions with
the OCC have not yet resulted in the determination of any particular
modifications. Until the Company and ACE determine, through further discussions
with the OCC, what modifications will be required to satisfy the OCC's concerns,
the Company cannot state whether the modifications might be material to the
results of the Company's operations.
In connection with the short-term consumer loan program, the Company has been
named, along with ACE, in a number of lawsuits initiated by state authorities or
joined by them. These are described in detail in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001, under the caption "Item
3. Legal Proceedings." In May of 2002, ACE completed a settlement agreement
with the Colorado Attorney General to terminate a pending lawsuit with the State
of Colorado and, as a part of the settlement, has agreed to be licensed as, and
conform to, the Colorado Deferred Deposit Loan Act in Colorado and to cease
offering loans originated by Goleta, effective July 1, 2002. As a result, the
Company will likely exit the short-term consumer loan market in Colorado. For a
more detailed description of the ACE Colorado settlement see "Part II - Item 1.
Litigation. - Subsequent Event." The Company continues to believe that the
National Bank Act preempts state law on allowable interest and related charges
for banking activities, such as Goleta's origination of loans at ACE locations.
However, the other state law legal proceedings involving Ace and the Company
could result in Goleta modifying its short-term consumer lending program in
those states.
23
MEMORANDUM OF UNDERSTANDING WITH THE FEDERAL RESERVE BANK
In March 2000, the Company entered into an agreement (the "Memorandum of
Understanding") with its principal regulator, the Federal Reserve Bank of San
Francisco (the "Reserve Bank"). The Memorandum of Understanding requires that
the Company maintain certain capital levels and adhere to certain operational
and reporting requirements, including the following:
- refrain from declaring any dividends or redeeming any of its stock
without the approval of the Reserve Bank;
- adopting a written plan to maintain a sufficient capital position
for the consolidated organization;
- refrain from increasing its borrowings or incurring or renewing any
debt without the approval of the Reserve Bank;
- correcting any violations of applicable laws, rules or regulations
and developing a written program to ensure compliance in the future;
- developing written policies and procedures to strengthen the
Company's records, systems and internal controls;
- developing a written plan to enhance management information systems
and the Board of Director's supervision of operations;
- developing a written consolidated strategic plan;
- developing a written plan to address weaknesses in the Company's
audit program;
- complying with applicable laws with respect to the appointment of
any new directors or the hiring of any senior executive officers;
and
- submitting quarterly progress reports.
The Company believes that it is in substantial compliance with the memorandum of
understanding.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
The short and long-term success of the Company is subject to certain risks, many
of which are substantial in nature. Shareholders and prospective shareholders
in the Company should consider carefully the following risk factors, in addition
to other information contained herein. This Quarterly Report on Form 10-Q
contains forward-looking statements which are subject to a variety of risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of various factors,
including those set forth below.
24
NET INTEREST INCOME HAS RECENTLY DECLINED SIGNIFICANTLY
Net interest income declined by approximately $2.7 million, or 25.4%, from $10.6
million as of June 30, 2001 to $7.9 million as of June 30, 2002. This decrease
is partially due to the declining interest rate environment, the sale of Palomar
and continued high prepayment rates on the Company's securitized loan portfolio,
which is expected to continue into the near future.
EARNINGS HAVE RECENTLY BEEN REDUCED BY LOSSES ON LOANS
The Company's net loss for the six months ended June 30, 2002, was $2,921,000
down from net income of $5,058,000 for the six months ended June 30, 2001. The
Company's provision for loan losses was approximately $3.6 million for the six
months ended June 30, 2002 and $5.0 million for the six months ended June 30,
2001. If the performance of the Company's loan portfolio does not improve, the
Company may not be able to return to profitability in the near future.
BORROWERS COULD FAIL TO PERFORM
Larger than expected loan losses could result if a significant number of
Goleta's borrowers and guarantors fail to perform their obligations as required
by the terms of their loans,. This risk increases when the economy is weak.
The Company has established an evaluation process designed to determine the
adequacy of the allowance for loan losses. This evaluation process uses
historical and other objective information, the classification of loans and the
establishment of loan losses are dependent to a great extent on experience and
judgment. The Company cannot assure that its allowance for loan losses will be
sufficient to absorb future loan losses or prevent a material adverse effect on
its business, profitability or financial condition. Earnings will continue to
be at risk as long as weak economic conditions persist.
REGULATION
The financial services industry is heavily regulated. The Company is subject to
federal and state regulation designed to protect the deposits of consumers, not
to benefit shareholders. These regulations include the following:
- the amount of capital the Company must maintain;
- the kinds of activities it can engage in;
- the kinds and amounts of investments it can make;
- the locations of its offices;
- how much interest Goleta can pay on demand deposits;
- insurance of the Company's deposits and the premiums paid for this
insurance; and
- how much cash the Company must set aside as reserves for deposits.
The regulations impose significant limitations on operations, and may be changed
at any time, possibly causing future results to vary significantly from past
results. Government policy and regulation, particularly as implemented through
the Federal Reserve System, significantly affects credit conditions.
25
FORMAL AGREEMENT
In March 2000, Goleta entered into the Formal Agreement with its principal
regulator, the Office of the Comptroller of the Currency (the "OCC"). The
Formal Agreement requires Goleta to maintain certain capital levels and adhere
to certain operational and reporting requirements which could limit Goleta's
business activity and increase expense. Management has been informed by the
regulators that they do not believe Goleta is in full compliance with certain
provisions of the Formal Agreement, including (i) implementing and demonstrating
the effectiveness of its written risk management program, (ii) implementing a
program to ensure compliance with consumer protection laws applicable to
Goleta's short-term consumer loan program, (iii) accurately valuing, and
documenting the valuations of, interest-only assets, servicing assets, deferred
tax assets and deferred tax liabilities and (iv) ensuring compliance with
applicable laws and regulations, particularly as related to the short-term
consumer loan program. The failure to fully comply with such requirements could
adversely affect the safety or soundness of Goleta. The OCC possesses broad
powers to take corrective and other supervisory action and bring enforcement
actions to resolve unsafe or unsound practices. The OCC has also expressed
strong reservations about Goleta and other national banks entering into
arrangements with third parties to make short-term consumer loans and believe
this program subjects Goleta and the Company to significant strategic,
reputational, compliance and transaction risks. See "Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Supervision and Regulation - Formal Agreement with the OCC."
SHORT-TERM CONSUMER LOAN PROGRAM
The OCC has expressed strong reservations about Goleta and other national banks
entering into arrangements with third parties to make these loans and believe
this program subjects Goleta and the Company to significant strategic,
reputational, compliance and transaction risks. Some of these risks include:
(i) reliance on the automated processes of ACE, (ii) the difficulty of
monitoring transaction volume because of the geographic expanse and number of
stores maintained by ACE, (iii) the difficulty of managing an adequate system to
ensure compliance by ACE with consumer protection laws, (iv) the importance of
this program to the Company's growth plans, (v) the adverse publicity arising
from recent lawsuits associated with this program, and (vi) the risk of loss
from such lawsuits. These risks could have a materially adverse effect on
Goleta's and the Company's results of operations. Moreover, the OCC has the
regulatory authority to determine how or if the Company's short-term consumer
loan production will continue.
Representatives of the Company and ACE have had discussions between themselves
and with representatives of the OCC regarding the particular concerns of the
OCC, and the actions that might be taken to address those concerns. The Company
believes that some significant modifications of the current policies and
procedures for short-term consumer loans and in the Company's relationship with
ACE may be required to address these concerns. However, the discussions with
the OCC have not yet resulted in the determination of any particular
modifications. Until the Company and ACE determine, through further discussions
with the OCC, what modifications will be required to satisfy the OCC's concerns,
the Company cannot state whether the modifications might be material to the
results of the Company's operations.
26
DEPENDENCE ON REAL ESTATE
Approximately 69% of the loan portfolio of the Company is secured by various
forms of real estate, including residential and commercial real estate and
manufactured housing. A decline in current economic conditions or rising
interest rates could have an adverse effect on the demand for new loans, the
ability of borrowers to repay outstanding loans, and the value of real estate
and other collateral securing loans. The real estate securing the Company's
loan portfolio is concentrated in California. If real estate values decline
significantly, especially in California, higher vacancies and other factors
could harm the financial condition of the Company's borrowers, the collateral
for its loans will provide less security, and the Company would be more likely
to suffer losses on defaulted loans.
RISKS ASSOCIATED WITH HIGH LOAN-TO-VALUE REAL ESTATE LOANS
Until June 2000, the Company derived revenue from the origination and sale of
high loan-to-value or "HLTV" second mortgage home loans. In the second quarter
of 2002, Goleta reclassified $5.2 million of previously held to maturity high
loan to value loans to available for sale. Goleta established a $1,340,000
fair market value reserve for the ultimate sale of these loans at a discount.
No assurance can be given that the ultimate sale discount will not exceed the
established reserve.
RELIANCE ON LOAN SALES FOR FUTURE EARNINGS
The Company sells loans to a limited number of secondary market investors. The
Company plans to continue such sales. However, there is no assurance that these
secondary market investors will continue to purchase loans at terms which are
favorable to the Company. The withdrawal of these investors from the
marketplace, and an inability to replace them with other similar investors,
would have a materially adverse effect on the Company's financial condition and
results of operations.
RISKS OF NATURAL DISASTERS
The Company's operations and much of the collateral for its real estate loans
are concentrated in California, an area that experiences earthquakes, fires,
floods and other natural disasters. The San Andreas Fault runs through the
Company's service area. The Company has a disaster recovery plan, with off-site
data processing facilities located in Scottsdale, Arizona. However, many of the
Company's borrowers could suffer uninsured property damage, experience
interruption of their businesses or lose their jobs after an earthquake or other
natural disaster. Those borrowers might not be able to repay their loans, and
the collateral for loans could decline significantly in value. Unlike a bank
holding company with operations that are more geographically diversified, the
Company is vulnerable to greater losses if an earthquake, fire, flood or other
natural disaster occurs in the Company's service region.
INTEREST RATE CHANGES
A major portion of the Company's net income comes from its interest rate margin
or "spread," which is the difference between the interest rates paid by the
Company on interest-bearing liabilities, such as deposits and other borrowings,
and the interest rates the Company receives on interest-earning assets, such as
loans extended to clients and securities held in the Company's investment
portfolio. Interest rates are highly sensitive to many factors that are beyond
the Company's control, such as inflation, recession, global economic
disruptions, and unemployment. In addition to the effect on income from the
27
Company's interest margin, changes in interest rates affect the demand for new
loans, the credit profile of existing loans, the rates received on loans and
securities and the rates Goleta must pay on deposits and borrowings. Changes in
interest rates can also impact the speed of the repayment of sold loans. Goleta
has recorded servicing and interest-only assets in connection with its sold
loans. The faster the borrowers pay off these sold loans, the less benefit
Goleta may derive from these financial assets and the lower their value. Under
these circumstances, earnings are adversely affected by both the increased
amortization expense and the loss of loan servicing income. Goleta has also
recorded bond discount and deferred issuance costs which must be amortized as an
expense as the proceeds from the payment of securitized loans are used to pay
down related bonds. High levels of prepayments of the securitized loans will
accelerate the amortization of these expenses. Finally, changes in interest
rates can adversely affect the ultimate sale price of certain fixed-rate loans
held for sale.
COMPETITION
Competition may adversely affect Goleta's performance. The financial services
business in Goleta's markets is highly competitive, and becoming more so due to
changes in regulation, technology and the accelerating pace of consolidation
among financial service providers. Other banks and specialty and diversified
financial services companies, many of which are larger and have more capital
than the Company, offer lending, leasing and other financial products to the
Company's customer base. In some cases, competitors may offer a financial
product that provides an alternative to one of the products the Company offers
to its clients. When new competitors seek to enter one of the Company's
markets, or when existing market participants seek to increase their market
share, they sometimes undercut the pricing or credit terms prevalent in that
market. Increasing levels of competition in the banking and financial services
businesses may reduce market share or cause the prices the Company can charge
for products and services to fall.
OPERATIONS RISKS
Goleta is subject to operations risks, including, but not limited to, data
processing system failures and errors, customer or employee fraud and
catastrophic failures resulting from terrorist acts or natural disasters.
Goleta maintains a system of internal controls to mitigate against such
occurrences and maintains insurance coverage for many of these risks. However,
should an event occur that is not prevented or detected by Goleta's internal
controls, or is uninsured or in excess of applicable insurance limits, it could
have a significant adverse impact on the Company's business, financial condition
or results of operations.
ADVERSE PUBLICITY AND LEGAL PROCEEDINGS
Goleta has been named in a number of lawsuits regarding its short-term consumer
lending program. These lawsuits, in general, claim that Goleta has violated
various state usury lending laws. In addition to the potential of loss
associated with these lawsuits, Goleta has been, and is likely to continue to
be, the subject of adverse publicity surrounding this business activity, with
resulting harm to Goleta's reputation. These proceedings are discussed in
detail in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2001, under the caption.
28
Adverse determinations in one or more of these actions could have a material
adverse impact on the Company's financial condition or results of operations and
continuation of the short-term consumer lending business, and could result in
adverse actions by the regulatory agencies with authority over Goleta and the
Company, including the OCC and the Board of Governors of the Federal Reserve
System. The OCC has expressed strong reservations about Goleta and other
national banks entering into arrangements with third parties to make short-term
consumer loans and has implemented regulatory actions against two of these
banks.
CURTAILMENT OF GOVERNMENT GUARANTEED LOAN PROGRAMS COULD CUT OFF AN IMPORTANT
SEGMENT OF THE COMPANY'S BUSINESS
A major part of the Company's business consists of originating and selling
government guaranteed loans, in particular those guaranteed by the Small
Business Administration. From time to time, the government agencies that
guarantee these loans reach their internal limits, and cease to guarantee loans
for a stated time period. In addition, these agencies may change their rules
for loans. Also, Congress may adopt legislation that would have the effect of
discontinuing or changing the programs. Non-governmental programs could replace
government programs for some borrowers, but the terms might not be equally
acceptable. Therefore, if these changes occur, the volume of loans to small
business, industrial and agricultural borrowers of the types that now qualify
for government guaranteed loans could decline. Also, the profitability of these
loans could decline.
BANK REGULATIONS COULD DISCOURAGE CHANGES IN THE COMPANY'S OWNERSHIP
Bank regulations would delay and possibly discourage a potential acquirer who
might have been willing to pay a premium price to amass a large block of common
stock. That in turn could decrease the value of the Company's common stock and
the price that you will receive if you sell your shares in the future. Before
anyone can buy enough voting stock to exercise control over a bank holding
company like Bancshares, bank regulators must approve the acquisition. A
shareholder must apply for regulatory approval to own 10 percent or more of the
Company's common stock, unless the shareholder can show that he or she will not
actually exert control over the Company. In no case can a shareholder own more
than 25 percent of the Company's common stock without applying for regulatory
approval.
THE COMPANY DOES NOT EXPECT TO PAY DIVIDENDS
The Company does not intend to pay dividends on its common stock for the
foreseeable future. Instead, it intends to reinvest earnings in its business.
In addition, Bancshares would need the approval of the Reserve Bank (under the
terms of the Company's Memorandum of Understanding) to pay dividends to its
shareholders. One source of funds for the payment of dividends by Bancshares
would be from dividends paid by Goleta to Bancshares. Goleta's ability to pay
dividends to Bancshares is limited by California law, federal banking law, and
the terms of Goleta's Formal Agreement with the OCC. See "Item 3. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Supervision and Regulation - Formal Agreement With the OCC" and "- Memorandum of
Understanding With the Federal Reserve Bank."
THE PRICE OF THE COMPANY'S COMMON STOCK MAY CHANGE RAPIDLY AND SIGNIFICANTLY
The market price of the Company's common stock could change rapidly and
significantly at any time. The market price of the Company's common stock has
fluctuated in recent years. Between January 1, 2002 and June 30, 2002, the
closing market price of its common stock ranged from a low of $3.95 per share to
a high of $6.07 per share. Fluctuations may occur, among other reasons, in
response to:
29
- Short-term or long-term operating results;
- Regulatory action or adverse publicity;
- Perceived value of the Company's loan portfolio;
- Trends in the Company's nonperforming assets or the nonperforming
assets of other financial institutions;
- Announcements by competitors;
- Economic changes;
- General market conditions; or
- Legislative and regulatory changes.
The trading price of the Company's common stock may continue to be subject to
wide fluctuations in response to the factors set forth above and other factors,
many of which are beyond the Company's control. The stock market in recent
years has experienced extreme price and trading volume fluctuations that often
have been unrelated or disproportionate to the operating performance of
individual companies. The Company believes that investors should consider the
likelihood of these market fluctuations before investing in the Company's common
stock.
SECURITY RISKS RELATED TO ONLINE BANKING SERVICES
Goleta offers online banking services to its clients and other services on its
Web site. The secure transmission of confidential information over the Internet
is essential to maintain clients' confidence in the Company's online services.
Advances in computer capabilities, new discoveries or other developments could
result in a compromise or breach of the technology used by us to protect client
transaction data. Although the Company has developed systems and processes that
are designed to prevent security breaches, failure to mitigate breaches of
security could expose the Company to liability or inhibit its ability to expand
online services, which would adversely affect its financial condition.
Financial services customers are generally sensitive to security and privacy on
the Internet and any publicized security problems could inhibit the growth of
the Internet in general as a means of conducting commercial transactions. The
Company's ability to provide financial services over the Internet would be
severely impeded if clients became unwilling to transmit confidential
information online. As a result, the Company's operations and financial
condition could be adversely affected.
THE COMPANY DEPENDS ON KEY EMPLOYEES
If the Company lost key employees temporarily or permanently, the Company's
business could suffer material harm. The Company could be particularly hurt if
key employees went to work for competitors. The Company's future success
depends on the continued contributions of existing senior management personnel,
including the President and Chief Operating Officer of Bancshares, Stephen W.
Haley, and the President of Goleta, Lynda Nahra.
30
ENVIRONMENTAL LAWS COULD FORCE THE COMPANY TO PAY FOR ENVIRONMENTAL PROBLEMS
When a borrower defaults on a loan secured by real property, the Company often
purchases the property in foreclosure or accepts a deed to the property
surrendered by the borrower. The Company may also take over the management of
commercial properties whose owners have defaulted on loans. While Goleta has
guidelines intended to exclude properties with an unreasonable risk of
contamination, hazardous substances may exist on some of the properties that
Goleta owns, manages or occupies. The Company faces the risk that environmental
laws could force it to clean up the properties at the Company's expense. It may
cost much more to clean a property than the property is worth. The Company
could also be liable for pollution generated by a borrower's operations if the
Company took a role in managing those operations after a default. The Company
may also find it difficult or impossible to resell contaminated properties.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
There has been no material change in the Company's market risk since the end of
the last fiscal year. For information about the Company's market risk, see the
information contained in the Company's Annual Report on Form 10-K under the
caption "Item 7A. Quantitative And Qualitative Disclosure about Market Risk,"
which is incorporated herein by this reference.
31
PART II
ITEM 1. LEGAL PROCEEDINGS
- ------ -----------------
Goleta has been named in a number of lawsuits regarding its short-term consumer
lending program. For a full description, see the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001 under the caption "Item 3.
Legal Proceedings," which is incorporated herein by this reference.
SUBSEQUENT EVENTS
THE FOLLOWING PARAGRAPHS SUMMARIZE SOME OF THE SIGNIFICANT RECENT DEVELOPMENTS
REGARDING THE COMPANY'S LITIGATION MATTERS.
1. STATE OF COLORADO, EX REL. KEN SALAZAR, ATTORNEY GENERAL FOR THE STATE OF
-------------------------------------------------------------------------
COLORADO, AND LAURA E. UDIS, ADMINISTRATOR, UNIFORM CONSUMER CREDIT CODE
------------------------------------------------------------------------
V. ACE CASH EXPRESS, INC.
-------------------------
In May of 2002, ACE completed a settlement agreement with the Colorado
Attorney General to terminate the pending lawsuit with the State of
Colorado and, as a part of the settlement, has agreed to be licensed as,
and conform to, the Colorado Deferred Deposit Loan Act in Colorado. ACE
agreed to the settlement to avoid the cost of continued litigation. ACE
admitted to no wrongdoing in this matter, and the State agreed that no
fines or penalties would be assessed against ACE. Both ACE and the Company
continue to believe that the National Bank Act preempts state law on
allowable interest and related charges for banking activities, such as
Goleta's at ACE locations.
As a part of the settlement agreement:
1. ACE agreed to pay a total of $1.3 million in refunds to
Colorado borrowers. As previously disclosed in the Company's
Annual Report on Form 10-K for the fiscal year ended December
31, 2001, ACE is solely liable for all costs and payments in
connection with this litigation.
2. ACE discontinued offering Goleta's loans in Colorado effective
July 1, 2002.
2. VONNIE T. HUDSON V. ACE CASH EXPRESS, INC. ET AL.
-------------------------------------------------
This lawsuit on behalf of borrowers who received Bank Loans offered and
made at ACE's locations in Indiana was filed in September 2001 in federal
court for the Southern District of Indiana. The defendants initially
included GNB, ACE and certain ACE executives. In her original complaint,
the plaintiff alleged that the Bank Loans violate the Indiana Uniform
Consumer Credit Code and the Indiana "loansharking" statute, because the
interest exceeds the finance charges permitted by those statutes; that the
Bank Loans violate the federal Truth in Lending Act ("TILA") and the
Indiana UCCC because the disclosures to borrowers do not comply with the
disclosure requirements of those laws; and that the Bank Loans also
violate RICO. The defendants moved to dismiss this lawsuit on the ground
that the Bank Loans are made by GNB and not ACE and, accordingly, the
interest charges are governed by federal and California law and not
Indiana law. In the second quarter of 2002, the Court granted this motion
and dismissed the original complaint without prejudice. The plaintiff
32
filed an amended complaint against ACE and the same four ACE executives
(but not Goleta), alleging Indiana usury violations and a RICO claim (but
not a TILA claim). The defendants moved to dismiss the amended complaint,
asserting that the amended complaint did not allege sufficient new facts
to justify relief and that the Court's initial decision in the case is
dispositive. The briefing on this new motion to dismiss is not yet
complete and no decision has been reached with respect thereto. The
plaintiff seeks relief of various kinds, including: (a) for the members of
the class of plaintiffs who were allegedly charged excessive interest, an
order declaring the Bank Loans "void," the refund of all finance charges
or interest paid by them in excess of the maximum finance charges
permitted under the Indiana UCCC, and a penalty (to be determined by the
court) in a maximum amount equal to the greater of either all of the
finance charges or interest received from them or up to ten times the
amount of all excess finance charges or interest received from them; and
(b) for the members of the class of plaintiffs allegedly damaged because
of RICO violations, an amount equal to three times those damages; and (c)
the plaintiff's attorneys' fees and court costs.
3. GOLETA NATIONAL BANK AND ACE CASH EXPRESS, INC. V. HAL D. LINGERFELT, IN
------------------------------------------------------------------------
HIS OFFICIAL CAPACITY AS THE COMMISSIONER OF BANKS OF NORTH CAROLINA, ET
------------------------------------------------------------------------
AL.
---
In January 2002, GNB and ACE instituted suit against defendants for
declaratory and injunctive relief with respect to defendants' threatened
initiation of state court proceedings against ACE. GNB and ACE allege that
defendants threatened to impair GNB's federally created rights to make
Bank Loans to North Carolina residents, to charge the interest allowed by
the laws of California, where Goleta is located, to obtain assistance from
ACE in making its Bank Loans and to sell interests in its Bank Loans. In
the second quarter of 2002, the Court granted a motion to dismiss filed by
the State on the ground that the federal court does not have the power to
hear the case, and GNB and ACE filed a notice of appeal.
Also in January 2002, immediately after the filing of the GNB/ACE lawsuit,
the State of North Carolina initiated the threatened lawsuit in North
Carolina state court against ACE (but not GNB), alleging that ACE and not
GNB is the lender and that the Bank Loans accordingly are usurious. The
State alleged in addition or in the alternative that ACE has violated
North Carolina loan broker and check cashing statutes. ACE removed the
State lawsuit to federal court and the State moved to remand the case to
state court. In the second quarter of 2002, the Court granted the State's
remand motion. Discovery has commenced in this case, which remains in
preliminary stages.
4. OTHER MATTERS.
--------------
In addition, as a result of changes in state laws, ACE discontinued
offering the Goleta loan product at its stores in Louisiana effective May
1, 2002 and discontinued offering the Goleta loan product at its stores in
Maryland effective June 1, 2002. In whole or in part as a result of
changes in state laws and/or proceedings brought or threatened against ACE
by State regulatory authorities, Goleta has also discontinued making Bank
Loans in Missouri and South Carolina and anticipates that it will
discontinue making Bank Loans in Arizona, Indiana and Virginia.
ITEM 2. CHANGES IN SECURTIES AND USE OF PROCEEDS
- ------- ----------------------------------------
Not applicable
33
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ------- -------------------------------
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
(a) The date of the meeting and whether it was an annual or special
meeting.
May 23, 2002 Annual Meeting
(b,c) Election of Directors, directors elected at the meeting:
For Withheld
Michael A. Alexander 4,626,465 99,486
Rober H. Bartlein 4,617,665 108,286
Jean W. Blois 4,625,665 100,286
Stephen W. Haley 4,618,268 107,683
John D. Illgen 4,627,868 98,083
Lynda Nahra 4,531,368 194,583
William R. Peeples 4,627,868 98,083
James R. Sims 4,626,465 99,486
ITEM 5. OTHER INFORMATION
- ------- -----------------
Not applicable
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
- ------- -------------------------------
(a) Exhibits.
Exhibit 99.1 Certification pursuant to 18 U.S.C. 1350 adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
-------------------
Change in Community West Bancshares independent auditors to Ernst & Young
LLP Filed June 27, 2002
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COMMUNITY WEST BANCSHARES
-------------------------
(Registrant)
Date: August 13, 2002 /s/ Phillip E. Guldeman
--------------------------
Phillip E. Guldeman
Executive Vice President
Chief Financial Officer
35