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 September 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 incorporation (I.R.S. Employer
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.
[X] YES [ ] NO
Number of shares of common stock of the registrant outstanding as of
November 13, 2002: 5,690,223.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
- -------- ----------------------
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS 3
CONSOLIDATED STATEMENTS OF OPERATIONS 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 14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK 33
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.
ITEM 4. CONTROLS AND PROCEDURES 33
PART II. OTHER INFORMATION
- --------- ------------------
ITEM 1. LEGAL PROCEEDINGS 34
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF 35
SECURITY HOLDERS
ITEM 5. OTHER INFORMATION 35
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 38
SIGNATURES
- ----------
PART I - FINANCIAL INFORMATION
COMMUNITY WEST BANCSHARES
CONSOLIDATED BALANCE SHEETS
September 30, 2002 December 31, 2001
(unaudited)
-------------------- ------------------
ASSETS
Cash and due from banks $ 22,535,000 $ 9,806,000
Federal funds sold 4,000,000 19,600,000
-------------------- ------------------
Cash and cash equivalents 26,535,000 29,406,000
Time deposits in other financial institutions 3,069,000 5,938,000
Federal Reserve Bank stock, at cost 775,000 775,000
Investment securities held-to-maturity, at amortized cost; fair value of
9,554,000 at September 30, 2002 and $118,000 at December 31, 2001 9,497,000 118,000
Interest only strips, at fair value 4,845,000 7,693,000
Loans:
Held for sale, at lower of cost or fair value 21,213,000 30,848,000
Held for investment, net of allowance for loan losses of $4,147,000
for September 30, 2002 and $4,086,000 December 31, 2001 140,020,000 104,396,000
Securitized loans, net of allowance for loan losses of $2,999,000
for September 30, 2002 and $4,189,000 for December 31, 2001 72,396,000 125,711,000
Servicing assets, net 2,020,000 2,490,000
Other real estate owned, net 834,000 266,000
Premises and equipment, net 2,117,000 2,726,000
Accrued interest receivable and other assets 14,027,000 13,496,000
-------------------- ------------------
TOTAL ASSETS $ 297,348,000 $ 323,863,000
==================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing demand $ 31,815,000 $ 33,312,000
Interest-bearing demand 31,660,000 22,518,000
Savings 12,281,000 14,371,000
Time certificates of $100,000 or more 28,759,000 67,398,000
Other time certificates 98,539,000 58,567,000
-------------------- ------------------
TOTAL DEPOSITS 203,054,000 196,166,000
Bonds payable in connection with securitized loans 58,202,000 89,351,000
Accrued interest payable and other liabilities 4,984,000 4,989,000
-------------------- ------------------
TOTAL LIABILITIES 266,240,000 290,506,000
-------------------- ------------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized; 5,690,223
shares issued and outstanding at September 30, 2002 and December 31, 2001
29,798,000 29,798,000
Retained earnings 1,310,000 3,559,000
-------------------- ------------------
TOTAL STOCKHOLDERS' EQUITY 31,108,000 33,357,000
-------------------- ------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 297,348,000 $ 323,863,000
==================== ==================
The accompanying notes are an integral part of these consolidated financial
statements.
3
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the Three Months For the Nine Months
Ended September 30 Ended September 30
2002 2001 2002 2001
----------- ------------ ------------ ------------
INTEREST INCOME:
Loans $7,488,000 $10,208,000 $22,382,000 $30,829,000
Federal funds sold 88,000 246,000 294,000 977,000
Investment securities 81,000 43,000 114,000 255,000
Time deposits in other financial institutions 20,000 29,000 88,000 98,000
----------- ------------ ------------ ------------
Total interest income 7,677,000 10,526,000 22,878,000 32,159,000
----------- ------------ ------------ ------------
INTEREST EXPENSE:
Deposits 1,365,000 2,209,000 4,153,000 7,670,000
Bonds payable and other borrowings 1,806,000 2,523,000 6,324,000 8,107,000
----------- ------------ ------------ ------------
Total interest expense 3,171,000 4,732,000 10,477,000 15,777,000
----------- ------------ ------------ ------------
NET INTEREST INCOME 4,506,000 5,794,000 12,401,000 16,382,000
----------- ------------ ------------ ------------
PROVISION FOR LOAN LOSSES 1,180,000 3,626,000 4,731,000 8,629,000
----------- ------------ ------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 3,326,000 2,168,000 7,670,000 7,753,000
----------- ------------ ------------ ------------
OTHER INCOME:
Gains from loan sales, net 1,160,000 2,079,000 4,245,000 5,497,000
Other loan fees - sold or brokered loans 810,000 853,000 2,388,000 2,426,000
Document processing fees 234,000 474,000 1,107,000 1,397,000
Service charges 102,000 133,000 329,000 464,000
Loan servicing fees, net 381,000 552,000 534,000 2,502,000
Other income 65,000 17,000 234,000 677,000
Income for sale of investment subsidiary - 96,000 - 96,000
Proceeds from legal settlement - - - 7,000,000
----------- ------------ ------------ ------------
Total other income 2,752,000 4,204,000 8,837,000 20,059,000
----------- ------------ ------------ ------------
OTHER EXPENSES:
Salaries and employee benefits 2,916,000 4,491,000 10,696,000 13,286,000
Occupancy expense 657,000 967,000 2,333,000 2,800,000
Other operating expenses 479,000 657,000 1,187,000 1,961,000
Professional services 346,000 531,000 1,262,000 1,125,000
Loan servicing and collection expense 287,000 284,000 772,000 867,000
Loss on sale of assets 20,000 3,000 152,000 3,000
Postage & freight 70,000 88,000 223,000 269,000
Advertising expense 119,000 127,000 422,000 439,000
Office supply expense 32,000 91,000 136,000 275,000
Data processing/ ATM processing 18,000 76,000 98,000 282,000
Lower of cost or market provision on loans held for sale (25,000) - 1,315,000 -
Impairment of SBA I/O and Servicing Assets - - 1,788,000 -
Amortization of goodwill and other intangibles - 36,000 - 178,000
Professional expenses associated with legal settlement - - - 2,392,000
----------- ------------ ------------ ------------
Total other expenses 4,919,000 7,351,000 20,384,000 23,877,000
----------- ------------ ------------ ------------
(LOSS) INCOME BEFOREPROVISION FOR
(BENEFIT FROM) INCOME TAXES 1,159,000 (979,000) (3,877,000) 3,935,000
----------- ------------ ------------ ------------
PROVISION FOR (BENEFIT FROM) INCOME TAXES 487,000 142,000 (1,628,000) (5,000)
----------- ------------ ------------ ------------
NET (LOSS) INCOME $ 672,000 $(1,121,000) $(2,249,000) $ 3,940,000
=========== ============ ============ ============
(LOSS) EARNINGS PER SHARE
BASIC $ 0.12 $ (0.19) $ (0.40) $ 0.65
=========== ============ ============ ============
DILUTED $ 0.12 $ (0.19) $ (0.40) $ 0.64
=========== ============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
4
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASHFLOWS
(UNAUDITED)
For the Nine Months Ended
September 30,
2002 2001
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (Loss) Income $ (2,249,000) $ 3,940,000
Adjustments to reconcile net (loss) income to net cash provided (used in) by
operating activities:
Provision for loan losses 4,731,000 8,629,000
Provision for losses on real estate owned 86,000 50,000
Deferred income taxes (benefit) - (1,290,000)
Depreciation and amortization 2,429,000 1,011,000
Amortization of goodwll and other intangibles - 178,000
Gain on sale of other real estate owned (14,000) (42,000)
Gain on sale of subsidiary - 96,000
Gain on sale of loans held for sale (4,245,000) (5,497,000)
Change in market valuation of interest only strips 3,088,000 1,301,000
Amortization of servicing assets, net of additions and valuation adjustments 470,000 (204,000)
Changes in operating assets and liabilities:
Accrued interest receivable and other assets (531,000) (6,619,000)
Accrued interest payable and other liabilities (5,000) 855,000
-------------- --------------
Net cash provided by operating activities 3,760,000 2,408,000
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities (9,667,000) (117,000)
Redemption of FHLB stock - 395,000
Maturities and principal paydowns of held-to-maturity securities 288,000 1,901,000
Proceeds from payments and maturities of available-for-sale securities - 4,820,000
Additions to interest only strip assets (240,000) (2,623,000)
Loan originations and principal collections, net 26,112,000 68,233,000
Proceeds from sale of other real estate owned 88,000 352,000
Net decrease (increase) in time deposits in other financial institutions 2,869,000 (7,531,000)
Purchase of premises and equipment (2,000) (314,000)
Net cash proceeds from sale of subsidiary - 10,229,000
-------------- --------------
Net cash provided by investing activities 19,448,000 75,345,000
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits and savings accounts 5,555,000 (25,091,000)
Net increase (decrease)in time certificates of deposit 1,333,000 (14,537,000)
Bond repayments (32,967,000) (33,032,000)
Proceeds from issuance of other borrowings - 5,500,000
Repayment of other borrowings - (10,770,000)
Payment of accrued director dividends - (23,000)
Exercise of stock options - 35,000
Repurchase of outstanding shares - (2,835,000)
-------------- --------------
Net cash (used in) financing activities (26,079,000) (80,753,000)
-------------- --------------
Net Increase in Cash and Cash Equivalents (2,871,000) (3,000,000)
Cash and Cash Equivalents, Beginning of Year 29,406,000 36,484,000
-------------- --------------
Cash and Cash Equivalents, End of Year $ 26,535,000 $ 33,484,000
============== ==============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 10,077,000 $ 15,347,000
Cash paid for income taxes $ 2,000 $ -
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real estate owned $ 728,000 $ 326,000
The accompanying notes are an integral part of these consolidated financial
statements.
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 the fair presentation of the results of operations and
financial condition for the interim period. The unaudited consolidated
financial statements include 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 September 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 to the 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. 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 sold 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 March 31, 2002, the Company determined the present
value of this estimated cash flow stream at the time each loan sale
transaction closed, utilizing assumptions regarding the discount rate and
prepayment rate for each particular transaction. Beginning in the second
quarter of 2002, the Company changed its technique for 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
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:
September 30, 2002
Held to Maturity Securities Gross Gross
--------------------------- Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
---------- ----------- ----------- ----------
Federal Home Loan Bank
Discount Note 2.004% due
January 3, 2003 $ 204,000 $ - $ - $ 204,000
Federal Home Loan Mortgage
4.65% due April 4, 2005 1,000,000 - - 1,000,000
Federal Home Loan Mortgage
4.30% due June 20, 2005 2,000,000 12,000 - 2,012,000
Federal Home Loan Mortgage
4.91% due December 20, 2005 1,005,000 2,000 - 1,007,000
Federal Home Loan Mortgage
4.50% Due February 27, 2006 505,000 - - 505,000
Fannie Mae Pool 6.5%
due June 1, 2032 1,714,000 32,000 - 1,746,000
Fannie Mae Pool 5.0%
due October, 1, 2012 2,055,000 - - 2,055,000
Fannie Mae Pool 4.79%
Due September 1, 2032 1,014,000 11,000 - 1,025,000
---------- ----------- ----------- ----------
$9,497,000 $ 57,000 $ - $9,554,000
========== =========== =========== ==========
At September 30, 2002, the Federal Home Loan Bank security was pledged as
collateral to the U.S. Treasury for the Company's treasury, tax and loan
account.
3. LOAN SALES
Mortgage Loan Sales
---------------------
The Company originates and then sells mortgage loans secured by both first
and second trust deeds. Products are sold on a servicing released basis. As
of September 30, 2002 and December 31, 2001, the Company had $8.1 and $15.5
million, respectively, of mortgage loans held for sale. During the second
quarter of 2002, the Company discontinued originating sub-prime and
high-loan-to-value ("HLTV") mortgage loans for sale into the secondary
market. In addition, the Company transferred the remaining $5.2 million of
HLTV loans held for investment to held for sale. A $1.3 million lower of
cost or market adjustment was recorded as a result of this transfer. On
September 30, 2002, the Company sold $4.8 million of these loans and
transferred the remaining $1.2 million of loans to held for investment at
their fair value of $709,000, representing their new cost basis.
7
Manufactured Housing Sales
----------------------------
In the first quarter of 2002, the Company originated certain manufactured
housing loans for sale into the 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 ("I/O") strips. The fair value of the I/O strips and
servicing assets prior to March 31, 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 assets and I/O 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 an estimated prepayment rate of 25%. Quarterly, the
servicing asset and I/O strip assets are analyzed for impairment. 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 strip
assets. The change in valuation in the second quarter reflected a higher
rate of expected prepayments due in part to the continued low interest rate
environment. There has been no additional impairment.
The SBA program stipulates that the Company retain a minimum of 5% of the
un-guaranteed 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 September 30, 2002 and December 31, 2001, the Company had
approximately $13.1 and $10.5 million, respectively, 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 SBA sponsors a number
of lending programs including 7a, 504 and Star loan programs. The 7a loans
are typically made for business purposes such as working capital,
inventory, building purchase or construction. Terms range from 10 years to
25 years. The 504 loans are typically made for real estate purchases, have
a fixed rate feature and have a term up to twenty years. Star loans are to
assist those businesses adversely impacted by the events of September 11,
2002. The Star loan program is scheduled to expire January 11, 2003.
In the nine months ended September 30, 2002, the Company originated $37.8
million 7a loans, $4.8 million of 504 loans, and $15.2 million of Star
loans. Approximately 65% of the 7a loans originated by the Company during
this nine-month period had a principal amount greater than $500,000.
8
The balances of servicing assets and I/O strips for the nine months ended
September 30, 2002 and year ended December 31, 2001 are as follows:
September 30, 2002 December 31, 2001
----------------------- -----------------------
Servicing Servicing
Asset I/O Strip Asset I/O Strip
---------- ----------- ---------- -----------
Guaranteed portion of
SBA $2,020,000 $ 4,845,000 $2,173,000 $ 7,693,000
FHA Title 1 - - 317,000 -
---------- ----------- ---------- -----------
Total $2,020,000 $ 4,845,000 $2,490,000 $ 7,693,000
========== =========== ========== ===========
The following is a summary of activity in I/O strips and servicing assets
for the nine months ended September 30, 2002 and September 30, 2001:
I/O Strips Sept 30, 2002 Sept 30, 2001
---------------- ----------------
Balance, beginning of year $ 7,693,000 $ 7,541,000
Additions through loan sales 240,000 2,623,000
Valuation adjustments (3,088,000) (1,301,000)
---------------- ----------------
Balance, end of year $ 4,845,000 $ 8,863,000
================ ================
Servicing Assets Sept 30, 2002 Sept 30, 2001
---------------- ----------------
Balance, beginning of year $ 2,490,000 $ 2,605,000
Additions through loan sales 597,000 631,000
Amortization (304,000) (142,000)
Valuation adjustments (763,000) (285,000)
---------------- ----------------
Balance, end of year $ 2,020,000 $ 2,809,000
================ ================
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 nine months ended
--------------------------------
Sept 30, 2002 Sept 30, 2001
--------------- ---------------
Net (loss) income $ (2,249,000) $ 3,940,000
Other comprehensive income - 38,000
Reclassification adjustment for realized gains
previously recognized in comprehensive
income - (17,000)
--------------- ---------------
Comprehensive (loss) income $ (2,249,000) $ 3,961,000
=============== ===============
Other comprehensive income consists of unrealized gain on investment
securities available for sale, net of tax effect, for the nine months ended
September 30, 2001.
9
5. COMMITMENTS AND CONTINGENCIES
Commitments
-----------
In the ordinary course of business, the Company enters into commitments to
extend credit to its customers. The Company has not reflected these
committments in the accompanying financial statements. As of September 30,
2002, the Company had entered into commitments with certain customers
amounting to $26.4 million compared to $20.3 million at December 31, 2001.
There were $480,000 of letters of credit outstanding at September 30, 2002;
there were $438,000 of letters of credit outstanding at December 31, 2001.
Contingencies
-------------
Goleta makes short-term consumer loans using certain marketing and
servicing assistance of ACE Cash Express, Inc. ("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. See Note 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
--------------------------------
Sept 30, 2002 Sept 30, 2001
--------------- ---------------
Basic weighted average shares outstanding 5,690,223 5,917,800
Dilutive effect of options 5,078 -
--------------- ---------------
Diluted weighted average shares outstanding 5,695,301 5,917,800
=============== ===============
Net income (loss) $ 672,000 $ (1,118,000)
Earnings (loss) per share - Basic $ 0.12 $ (0.19)
Earnings (loss) per share - Diluted $ 0.12 $ (0.19)
For the nine months ended
--------------------------------
Sept 30, 2002 Sept 30, 2001
--------------- ---------------
Basic weighted average shares outstanding 5,690,223 6,042,197
Dilutive effect of options 0 66,902
--------------- ---------------
Diluted weighted average shares outstanding 5,690,223 6,109,099
=============== ===============
Net (loss) income $ (2,249,000) $ 3,940,000
(Loss) Earnings per share - Basic $ (0.40) $ 0.65
(Loss) Earnings per share - Diluted $ (0.40) $ 0.64
Shares used in per-share calculation - basic 5,690,223 6,042,197
Shares used in per-share calculation-diluted(1) 5,690,223 6,109,099
(1) Diluted net loss per share for the thee months ended September 30, 2001
and the nine months ended September 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.
10
7. CAPITAL
At September 30, 2002, Goleta is operating under a formal written agreement
(the "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 both the Agreement and 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 September 30, 2002 and
December 31, 2001, Goleta had total capital to risk weighted assets of
12.88% and 11.84%, respectively, and Tier 1 capital to risk-weighted assets
of 11.61% and 10.40%, respectively. As further discussed in Note 9, on
October 28, 2002 Goleta entered into a Consent Order with the OCC, which
replaces the Agreement and imposes substantially similar capital
requirements and reporting requirements to those in the Agreement.
Management believes that Goleta is in compliance with all material
provisions of the Agreement and the Consent Order regarding capital
requirements.
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 SBA 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, $280,000 remained as an accrued liability at
September 30, 2002. The effect of this decision is not considered
significant to the Company's revenues or results of operation. See Note 3
for changes to SBA operations.
9. SUBSEQUENT EVENTS
On October 28, 2002, Goleta entered into a Consent Order ("the Order") with
its principal regulator, the Office of the Comptroller of the Currency
("OCC"), agreeing to terminate the short-term consumer loan arrangement
with ACE by December 31, 2002, to audit loan files related to short-term
consumer loans and, without admitting or denying any wrongdoing, to pay a
$75,000 civil money penalty.
The Order provides, among other things, for the following:
11
- Goleta will submit monthly progress reports to the OCC.
- On or before December 31, 2002, Goleta will cease all actions related
to the origination, renewal or rollover of short-term consumer loans,
and on or before November 1, 2002, ACE will assume, indemnify and hold
Goleta harmless for 100% of the costs, expenses, legal fees, damages
and related liabilities from third-party claims in accordance with the
terms of Goleta's agreement with ACE.
- Goleta will provide written notice to 641 short-term consumer loan
applicants whose files are missing from one ACE store. No later than
February 15, 2003, Goleta will begin a loan file audit, first randomly
sampling 5% of the loan files at each ACE store (except those already
reviewed by Goleta's Quality Assurance Department) to verify the
physical presence of applicants' loan files. If sampling reveals more
than one file missing at a store, Goleta will physically verify the
presence of all of the files generated at that store since June 30,
2002. If any applicant files are not located, Goleta will notify the
applicant in writing of the missing documents.
- Without admitting or denying any wrongdoing, Goleta will pay a civil
money penalty of $75,000 to the OCC within ten days of the Consent
Order.
- Within 90 days of the Consent Order, Goleta will adopt a written
strategic plan covering at least a three-year period.
- Goleta will 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; develop a three-year capital program to
maintain adequate capital; and refrain from paying dividends without
the approval of the OCC.
- Goleta will develop a written profit plan and submit quarterly
performance reports.
- Goleta will develop and implement a written risk management program
and adopt general procedures addressing compliance management,
internal control systems and education of employees regarding laws,
rules and regulations.
- Goleta will document the information it has relied on to value loans
held on its books, servicing rights, deferred tax assets and
liabilities and interest-only assets, and submit the documentation to
the OCC on a quarterly basis.
- Goleta will correct each violation of law, rule or regulation cited in
any report of examination.
- Goleta will prepare, and submit to the OCC for its prior approval, a
written analysis of any new product or service or significant
expansion of any existing product or service.
12
ACE has agreed to indemnify Goleta for 100% of future losses related to
third-party claims on short-term consumer loans, with certain limitations.
Based on this indemnification and advice from legal counsel, management
does not consider it probable that the resolution of pending claims related
to short-term consumer loans will have a material adverse impact on the
Company's financial condition or results of operations. However,
termination of the short-term consumer loan program and Goleta's compliance
with the Consent Order may have a material adverse impact on the Company's
financial condition or results of operation.
13
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 Community West Bancshares (the "Company") and its wholly owned
subsidiary, Goleta National Bank ("Goleta")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, those factors described below under "Factors that
May Affect Future Results of Operations "or in the Company's other reports filed
with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
The Company experienced a net loss of $2,249,000 in the first nine months of
2002, or $0.40 per share, compared to net earnings of $3,940,000 or $0.65 per
share during the comparable period of 2001. The earnings for the nine months
ended September 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.
For the three and nine months ended September 30, 2002, the Company's short-term
consumer lending program contributed $1.2 million and $3.0 million to indirect
and overhead expenses and pretax profits, respectively. On October 28, Goleta
entered into a Consent Order with the OCC, in which Goleta agreed to (i)
terminate by December 31, 2002, the arrangement under which ACE Cash Express
Inc. ("ACE") acts as an agent of Goleta for short-term consumer loans offered at
ACE's stores, and (ii) without admitting or denying wrongdoing, pay a civil
penalty of $75,000. See "Part II - Item 5 - Other Information - Subsequent
Events."
The Company is developing a strategic plan to replace the income derived from
short-term consumer loans. Management believes that this strategy will result in
products that are less complex to manage than short-term consumer loans and will
reduce the Company's risk of litigation, regulatory compliance burdens and
exposure to negative publicity and reputational damage. However, this strategy
will take time to accomplish, and the Company cannot give any assurance that it
will ultimately succeed.
During the quarter ended September 30, 2002, the Company established a reserve
of $200,000 for civil money penalties and other costs to be incurred in
connection with Goleta's compliance with the Consent Order in withdrawing from
the short-term consumer loan program. However, it is anticipated that other
non-recoverable costs may be incurred. Management believes that it will not be
able to estimate the full amount of these other costs to be incurred in
connection with the termination of the arrangement with ACE and complying with
the Consent Order until it begins the process of auditing the ACE loan files as
required in the Consent Order. Accordingly, at this time the Company cannot
accurately estimate all costs of ending the short-term consumer loan program.
14
The loss of income derived from short-term consumer loans and the costs of
terminating the arrangement with ACE and complying with the Consent Order may
materially harm the Company's financial results.
In October, 2002, the SBA placed a $ 500,000 maximum cap on the size of a 7a
Loan. It is impossible to determine how long this cap will remain. The
ramifications of the cap on future 7(a) volume is uncertain.
The Company was already in the process of re-examining its strategy with respect
to its focus on different SBA loan products. The Company will attempt to expand
it's emphasis on the 504 loans and increase it's emphasis on the Star loan
program until it expires. The Company is unable to predict the degree of success
it will have with these efforts or the impact of which these new market
circumstances will have on future operating results.
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 Nine Months Ended
-------------------------- Amount of Percent of
Sept 30, Sept 30, Increase Increase
2002 2001 (Decrease) (Decrease)
------------ ------------ ------------- ----------
Interest income $22,878,000 $32,159,000 $ (9,281,000) (28.9%)
Interest expense 10,477,000 15,777,000 (5,300,000) (33.6%)
------------ ------------ -------------
Net interest income 12,401,000 16,382,000 (3,981,000) (24.3%)
Provision for loan losses 4,731,000 8,629,000 (3,898,000) (45.2%)
------------ ------------ -------------
Net interest income
after provision for loan
losses 7,670,000 7,753,000 (83,000) (1.1%)
other income 8,837,000 20,059,000 (11,222,000) (55.9%)
other expense 20,384,000 23,877,000 (3,493,000) (14.6%)
------------ ------------ -------------
(Loss) before (benefit)
for income taxes (3,877,000) 3,935,000 (7,812,000) (198.5%)
(Benefit) from income
taxes (1,628,000) (5,000) (1,623,000) 32460.0%
------------ ------------ -------------
Net (loss) income $(2,249,000) $ 3,940,000 $ (6,189,000) (157.1%)
============ ============ =============
Earnings per share -
Basic $ (0.40) $ 0.65 $ (1.05) (161.5%)
============ ============ =============
Earnings per share -
Diluted $ (0.40) $ 0.64 $ (1.04) (160.9%)
============ ============ =============
Shares used in per-share calculation - basic 5,690,223 6,042,197
Shares used in per-share calculation - diluted(1) 5,690,223 6,109,099
15
(1) Diluted net loss per share for the nine months ended September 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.
The annualized loss on average equity was 9.4% for the nine months ended
September 30, 2002, compared to annualized return on average equity of 13.9% 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 5.6% for the nine months ended September
30, 2002, compared to an annualized net interest margin of 5.8% for the nine
months ended September 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 loans. The Company does
not expect to receive these higher yields in the future because it has agreed
with the OCC to terminate by December 31, 2002 the consumer loan program. See
"Supervision and Regulation" and "Part II - Item 5 - Other Information -
Subsequent Events."
Net interest income declined by $3,981,000 as the result of a $120,232,000 (or
28.9%) decline in average earning assets from $415,842,000 for the nine months
ended September 30, 2001 to $295,610,000 for the nine months ended September 30,
2002. The decrease in earning assets was due to the sale of Palomar Community
Bank in August 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
investment securities. The following table summarizes the interest income and
corresponding yields for loans only:
For the Three Months Ended For the Nine Months Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
--------------- --------------- --------------- ---------------
Interest Income $ 7,488,000 $ 10,208,000 $ 22,382,000 $ 30,829,000
Average Loans 237,460,000 330,294,000 243,815,000 336,555,000
Annualized Yield 12.6% 12.4% 12.2% 12.2%
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
16
types of loans. The Company attempts to minimize its credit risk exposure
through the use of 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.
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 $6,858,000 in impaired
loans as of September 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
that 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
$12,370,000 in non-accrual loans as of September 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, $7,816,000 and $6,934,000 as of September 30, 2002
and September 30, 2001, respectively, are SBA guaranteed loans which 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.
17
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 $1,382,000 and $1,093,000 as of September 30, 2002 and
December 31, 2001, respectively. These balances are included in the balances of
impaired loans disclosed above.
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/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
September 30, December 31, Increase Increase
2002 2001 (Decrease) (Decrease)
--------------- -------------- ------------- -----------
BALANCES:
Gross loans $ 240,775,000 $ 269,230,000 $(28,455,000) (10.6%)
Allowance for loan losses 7,146,000 8,275,000 (1,129,000) (13.6%)
Nonaccrual loans(1)
Repurchased SBA guaranteed
loans(1) 7,816,000 7,509,000 307,000 4.1%
Other nonaccrual loans 4,554,000 3,904,000 650,000 16.6%
--------------- -------------- -------------
Total 12,370,000 11,413,000 957,000 8.4%
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 Goleta 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 Goleta.
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.
An analysis of the loan losses for securitized loans as follows:
18
For the nine months ended September 30, 2002 2001
------------ ------------
Balance, beginning of year $ 4,189,000 $ 4,042,000
Provisions for loan losses 1,485,000 2,720,000
Loans charged off (3,036,000) (3,126,000)
Recoveries on loans previously charged off 361,000 194,000
------------ ------------
Balance, at September 30 $ 2,999,000 $ 3,830,000
============ ============
An analysis of the allowance for loan losses for loans held for investment is as
follows:
For the nine months ended September 30, 2002 2001
------------ ------------
Balance, beginning of year $ 4,086,000 $ 2,704,000
Provisions for loan losses 3,246,000 5,910,000
Loans charged off (4,454,000) (4,221,000)
Recoveries on loans previously charged off 1,269,000 332,000
Transfers and reductions due to the sale of Palomar, net (762,000)
------------ ------------
Balance, at September 30 $ 4,147,000 $ 3,963,000
============ ============
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 September 30, 2002 is
adequate to absorb known and inherent losses; however, changes in the 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.
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 nine months ended September 30, 2002 decreased by
$11.2 million or 55.9% compared to the nine months ended September 30, 2001. The
decrease was primarily due to $7 million of proceeds from a legal settlement in
2001 as well as a reduction of $2 million in loan servicing fees and $1.2
million in gain on loan sales 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 nine months ended September
30, 2002 decreased by $3.5 million or 14.6% compared to the nine months ended
September 30, 2001. This decrease is principally a result of the $2.4 million in
expenses associated with the legal settlement in 2001, the sale of Palomar in
August 2001, and the Company's efforts to cut operating expenses.
19
TAXES
Taxes include a benefit based upon the pre-tax loss the Company incurred in the
first nine months of 2002.
BALANCE SHEET ANALYSIS
- ------------------------
Average assets for the nine months ended September 30, 2002 were $302,537,000
compared to $415,708,000 for the same period in 2001; average equity decreased
to $32,016,000 for the nine months ended September 30, 2002, from $37,685,000
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.
The book value per share decreased to $5.47 at September 30, 2002 from $6.56 at
September 30, 2001 as a result of a net loss.
Amount of Percent of
(Selected balance sheet September 30, December 31, Increase Increase
accounts) 2002 2001 (Decrease) (Decrease)
-------------- ------------- ------------- -----------
Cash and cash equivalents $ 26,535,000 $ 29,406,000 $ (2,871,000) (9.8%)
Time deposits in other
financial institutions 3,069,000 5,938,000 (2,869,000) (48.3%)
Federal reserve bank stock 775,000 775,000 - (0.0%)
Investment securities 9,497,000 118,000 9,379,000 7948.3%
I/O strips 4,845,000 7,693,000 (2,848,000) (37.0%)
Loans - Held for sale 21,213,000 30,848,000 (9,635,000) (31.2%)
Securitized Loans, net 72,396,000 104,396,000 (32,000,000) (30.7%)
Loans - Held for
investment, net 140,020,000 125,711,000 14,309,000) 11.4%
Total Assets $ 297,348,000 $ 323,863,000 $(26,515,000) (8.2%)
============== ============= ============= ===========
Total Deposits $ 203,054,000 $ 196,166,000 $ 6,888,000 3.5%
============== ============= ============= ===========
Total Stockholders' Equity $ 31,108,000 $ 33,357,000 $ (2,249,000) (6.7%)
============== ============= ============= ===========
CASH AND CASH EQUIVALENTS
Cash and cash equivalents are made up of cash, cash due from banks and federal
funds sold. Cash and cash equivalents decreased from $29,406,000 at December 31,
2001 to $26,535,000 at September 30, 2002, a decrease of 9.8% due to a (i) $15.6
million reduction in federal funds sold offset by a $12.7 million increase in
cash and cash due from banks and (ii) a draw down to satisfy normal cash needs
associated with the Company's lending, deposit taking, and investment portfolio
activities.
TIME DEPOSITS
Time deposits in other financial institutions decreased from $5,938,000 to
$3,069,000, a decrease of $2,869,000 or 48.3%. This change was a result of a
change in the Company's investment strategy to shift some investments from time
deposits and overnight federal funds sold to investment securities.
20
INVESTMENT SECURITIES
Investment securities consist of Federal Reserve Bank stock, agency, and
mortgage backed securities. The increase of $9,379,000 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 ("I/O") 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.
I/O strips declined $2,848,000 or 37% due to the write down of the fair value of
the I/O 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.
LOANS
Loans held for sale decreased by $9,635,000 to $21,213,000 as of September 30,
2002 from $30,848,000 as of December 31, 2001, representing a decrease of
31.23%. This decrease is principally due to a $3.6 million reduction in the
amount of wholesale mortgage loans held for sale at the end of the period and an
$8.6 million reduction in alternative mortgage loans due to the Company's exit
from this business. These loans are originated and sold on a flow basis to an
identified investor group. The decrease in mortgage and alternative mortgage
loans was partially offset by an increase in SBA loans of $2.6 million.
Net loans held for investment decreased by $17.7 million from $230,107,000 at
December 31, 2001 to $212,416,000 at September 30, 2002. This decrease was
primarily a result of a $32,000,000 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 relationship
banking and SBA loans.
DEPOSITS
The following schedule shows the balance and percentage change in the various
deposits:
Amount of Percent of
September 30, December 31, Increase Increase
2002 2001 (Decrease) (Decrease)
-------------- ------------- ------------- -----------
Noninterest-bearing deposits $ 31,815,000 $ 33,312,000 $ (1,497,000) (4.5%)
Interest-bearing deposits 31,660,000 22,518,000 9,142,000 40.6%
Savings 12,281,000 14,371,000 (2,090,000) (14.5%)
Time certificates of $100,000
or more 28,759,000 67,398,000 (38,639,000) (57.3%)
Other time certificates 98,539,000 58,567,000 39,972,000 68.3%
-------------- ------------- -------------
Total deposits $ 203,054,000 $ 196,166,000 $ 6,888,000 3.5%
============== ============= =============
21
The Company's deposits increased slightly by 3.5% or $6,888,000 through the
period of September 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 $28,759,000, or 57.3%, while other
time certificates increased from $58,567,000 to $98,539,000, or 43.4%. This
change is principally a result of the Company's 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 September 30, 2002 was 20.3% 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.
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 and a borrowing facility secured by
marketable securities with a brokerage firm.
CAPITAL RESOURCES
The Company's equity capital was $31,108,000 at September 30, 2002. In addition,
the Holding Company contributed $500,000 in capital to Goleta in the third
quarter. 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.
22
Additionally, an institution may not be deemed to be well capitalized if its is
operating under an agreement with its principal regulator, as in the case of
Goleta. See "Supervision and Regulation of the Company-Consent Order with the
OCC."
The Company's actual capital amounts and ratios for the periods indicated are as
follows:
CAPITAL AMOUNTS AND RATIOS
AS OF SEPTEMBER 30, 2002: To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
-------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------ ----------- ------
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
Consolidated $34,141,000 13.39% $20,393,000 8.00% N/A N/A
Goleta National Bank $31,438,000 12.88% $19,527,000 8.00% $24,409,000 10.00%
TIER I CAPITAL (TO RISK WEIGHTED ASSETS)
Consolidated $30,906,000 12.12% $10,197,000 4.00% N/A N/A
Goleta National Bank $28,338,000 11.61% $ 9,764,000 4.00% $14,645,000 6.00%
TIER I CAPITAL (TO AVERAGE ASSETS)
Consolidated $30,906,000 10.37% $11,916,000 4.00% N/A N/A
Goleta National Bank $28,338,000 9.69% $11,695,000 4.00% $14,619,000 5.00%
CAPITAL AMOUNTS AND RATIOS
AS OF DECEMBER 30, 2002: To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual 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%
23
SUPERVISION AND REGULATION
- --------------------------
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."
CONSENT ORDER WITH THE OCC
On October 28, 2002, Goleta entered into a stipulation for the entry of a
consent order (the "Order") with its principal regulator, the OCC. As of this
date, the Order replaces the Formal Agreement Goleta was previously under with
the OCC. The Order requires that Goleta maintain certain capital levels and
adhere to certain operational and reporting requirements, including the
following:
- Goleta will submit monthly progress reports to the OCC.
- On or before December 31, 2002, Goleta will cease all actions related
to the origination, renewal or rollover of short-term consumer loans,
and on or before November 1, 2002, ACE will assume, indemnify and hold
Goleta harmless for 100% of the costs, expenses, legal fees, damages
and related liabilities from third-party claims in accordance with the
terms of Goleta's agreement with ACE.
- Goleta will provide written notice to 641 short-term consumer loan
applicants whose files are missing from one ACE store. No later than
February 15, 2003, Goleta will begin a loan file audit, first randomly
sampling 5% of the loan files at each ACE store (except those already
reviewed by Goleta's Quality Assurance Department) to verify the
physical presence of applicants' loan files. If sampling reveals more
than one file missing at a store, Goleta will physically verify the
presence of all of the files generated at that store since June 30,
2002. If any applicant files are not located, Goleta will notify the
applicant in writing of the missing documents.
- Without admitting or denying any wrongdoing, Goleta will pay a civil
money penalty of $75,000 to the OCC within ten days of the Consent
Order.
24
- Within 90 days of the Consent Order, Goleta will adopt a written
strategic plan covering at least a three-year period.
- Goleta will 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; develop a three-year capital program to
maintain adequate capital; and refrain from paying dividends without
the approval of the OCC.
- Goleta will develop a written profit plan and submit quarterly
performance reports.
- Goleta will develop and implement a written risk management program
and adopt general procedures addressing compliance management,
internal control systems and education of employees regarding laws,
rules and regulations.
- Goleta will document the information it has relied on to value loans
held on its books, servicing rights, deferred tax assets and
liabilities and interest-only assets, and submit the documentation to
the OCC on a quarterly basis.
- Goleta will correct each violation of law, rule or regulation cited in
any report of examination.
Compliance with the provisions of the Order could limit Goleta's business
activity and increase expense.
Goleta achieved and maintained both of the 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 Holding 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. The Holding
Company made a $500,000 capital contribution to Goleta on August 27, 2002.
Goleta's risk based capital ratio was 12.88% as of September 30, 2002.
Management believes that it continues to comply with all material provisions of
the Order regarding capital requirements.
Failure to comply with the provisions of the Consent Order 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 its offices throughout the nation. Such
loans were being offered in 19 states and the District of Columbia at September
30, 2002. Upon origination, ACE purchases 90% of the principal and Goleta
currently retains 10% ownership in the principal of each loan. Loans currently
yield approximately 253% 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. In accordance with the Consent Order, the program will be terminated on
or before December 31, 2002 except as to ACE's contractual servicing of
outstanding loans.
25
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."
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.
26
NET INTEREST INCOME HAS RECENTLY DECLINED SIGNIFICANTLY
Net interest income declined by approximately $4 million, or 24.4%, from $16.4
million as of September 30, 2001 to $12.4 million as of September 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 nine months ended September 30, 2002 was
$2,133,000 down from net income of $3,940,000 for the nine months ended
September 30, 2001. The Company's provision for loan losses was approximately
$4.7 million for the nine months ended September 30, 2002 and $8.6 million for
the nine months ended September 30, 2001.
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.
27
CONSENT ORDER
In October 2002, Goleta entered into the Order with its principal regulator, the
Office of the Comptroller of the Currency (the "OCC"). The failure to fully
comply with the requirements of the Order 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. See "Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Supervision and Regulation -
Consent Order with the OCC" and "Part II - Item 5 - Subsequent Events."
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. Under the Consent Order, Goleta will terminate its
arrangement with ACE on or before December 31, 2002. However, the Company will
continue to be exposed to some of the risks of short-term consumer lending for
some time in the future. These risks could have a materially adverse effect on
Goleta's and the Company's results of operations.
DEPENDENCE ON REAL ESTATE
Approximately 69% of the loan portfolio of the Company is secured by various
forms of real estate and manufactured housing, including residential and
commercial real estate. 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.
On September 30, 2002 the Company sold $4.8 million of these loans and
transferred the remaining $1.2 million to held for investment. As of September
30, 2002 the Company holds a lower of cost or market reserve of $491,000 against
the remaining HLTV loans.
28
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
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
29
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 "Legal Proceedings".
Although Goleta has agreed to terminate the short-term consumer loan program in
a Consent Order and Stipulation with the OCC, a number of other actions remain
pending. 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 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.
On November 1, 2002, Goleta and ACE entered into Amendment Number 3 (the
"Amendment") to Master Loan Agency Agreement, dated August 11, 1999. Under the
Amendment, if Goleta incurs losses after November 1, 2002 as a result of
third-party claims related to short-term consumer loans, ACE will indemnify
Goleta for 100% of the losses (including all costs and legal fees), regardless
of when the short-term consumer loan was made or when the claim was brought.
See "Part II - Item 5 - Other Information - Subsequent Events - 2. Amendment
Number 3 to Master Loan Agency Agreement."
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
30
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. In October 2002, the SBA placed a $ 500,000 maximum cap on
the size of a 7a loan. It is impossible to determine how long this cap will
remain in existence. The ramifications of the cap on future 7(a) volume is
uncertain.
Goleta was already in the process of re-examining its strategy with respect to
its focus on different SBA loan products. Goleta will attempt to expand it's
emphasis on the Star loan program until it expires, and increase it's emphasis
on 504 loans combined. Goleta is unable to predict the degree of success it will
have with these efforts or the impact of which these new market circumstances
will have on future operating results.
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 the Company, 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 the Company
would be from dividends paid by Goleta to the Company. Goleta's ability to pay
dividends to the Company is limited by California law, federal banking law, and
the terms of the Order. See "Item 3. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Supervision and Regulation -
Consent Order 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 September 30, 2002, the
closing market price of its common stock ranged from a low of $3.28 per share to
a high of $6.07 per share. Fluctuations may occur, among other reasons, in
response to:
- Short-term or long-term operating results;
- Regulatory action or adverse publicity;
- Perceived value of the Company's loan portfolio;
31
- 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 the Company, Stephen W.
Haley, and the President of Goleta, Lynda Nahra.
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.
32
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.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report, the Chief Executive
Officer and the Chief Financial Officer of the Company, with the participation
of the Company's management, carried out an evaluation of the effectiveness of
the Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based upon that evaluation, the Chief Executive Officer and the Chief
Financial Officer believe that, as of the date of the evaluation, the Company's
disclosure controls and procedures are effective in making known to them
material information relating to the Company (including its consolidated
subsidiaries) required to be included in this report.
Disclosure controls and procedures, no matter how well designed and implemented,
can provide only reasonable assurance of achieving an entity's disclosure
objectives. The likelihood of achieving such objections is affected by
limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls, known to the Chief
Executive Officer or the Chief Financial Officer, subsequent to the date of the
evaluation.
33
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.
On November 1, 2002, Goleta and ACE entered into Amendment Number 3 (the
"Amendment") to Master Loan Agency Agreement, dated August 11, 1999. Under the
Amendment, if Goleta incurs losses after November 1, 2002 as a result of
third-party claims related to short-term consumer loans, ACE will indemnify
Goleta for 100% of the losses (including all costs and legal fees), regardless
of when the short-term consumer loan was made or when the claim was brought. See
"Part II - Item 5 - Other Information - Subsequent Events - 2. Amendment Number
3 to Master Loan Agency Agreement."
THE FOLLOWING PARAGRAPHS SUMMARIZE SOME OF THE SIGNIFICANT RECENT DEVELOPMENTS
REGARDING THE COMPANY'S LITIGATION MATTERS.
1. VONNIE T. HUDSON V. ACE CASH EXPRESS, INC. ET AL.
-------------------------------------------------
This lawsuit on behalf of borrowers who received short-term consumer 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 Goleta, ACE and certain ACE executives. In her original
complaint, the plaintiff alleged that the short-tem consumer loans violate
the Indiana Uniform Consumer Credit Code ("UCCC") and the Indiana
"loansharking" statute, because the interest exceeds the finance charges
permitted by those statutes; that the short-term consumer 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 short-term consumer loans also violate the
Racketeer Influenced and Corrupt Organizations Act ("RICO.") The
defendants moved to dismiss this lawsuit on the ground that the short-term
consumer loans are made by Goleta 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 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 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 short-term
consumer 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. The defendants moved to dismiss the
amended complaint, asserting that the amended complaint did not allege
34
sufficient new facts to justify relief and that the Court's initial
decision in the case is dispositive. The court granted defendants' motion
to dismiss and the plaintiff has appealed to the Seventh Circuit of the
U.S. Court of Appeals.
2. HALE V. ACE CASH EXPRESS, INC. (CASE NO. 6:02CV0068 (W.D. VA.).
---------------------------------------------------------------
On or about October 24, 2002, a lawsuit was filed in federal district court
in the Western District of Virginia against ACE on behalf of a putative
class of persons who obtained short-term consumer loans at ACE's Virginia
stores. On the theory that ACE, not Goleta, is the true lender, the
complaint alleges violations of RICO, the Virginia Consumer Finance Act,
the Virginia Payday Loan Act, the Virginia Consumer Protection Act and
Virginia common law. ACE has not yet responded to this complaint.
ITEM 2. CHANGES IN SECURTIES AND USE OF PROCEEDS
- ------- ----------------------------------------
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
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Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
Not applicable
ITEM 5. OTHER INFORMATION
- ------- -----------------
Subsequent Events
-----------------
1. Consent Order
- -----------------
On October 28, 2002, Goleta entered into a stipulation agreeing to the entry of
a consent order (the "Consent Order") with its principal regulator, the OCC.
Among other things, the Consent Order requires Goleta to (i) terminate by
December 31, 2002 the arrangement under which ACE acts as an agent of Goleta for
short-term consumer loans offered at ACE's stores, and (ii) without admitting or
denying wrongdoing, pay a civil money penalty of $75,000.
Background of the Consent Order. On March 23, 2000, Goleta entered into a
-------------------------------
formal agreement with the OCC (the "Formal Agreement"). The Formal Agreement
required Goleta to maintain specified capital levels and adhere to specified
operational and reporting requirements. In addition, in the past the OCC has
expressed strong reservations about national banks, including Goleta, entering
into arrangements with third parties to make short-term consumer loans, and
believes that these arrangements expose the banks to significant strategic,
reputational, compliance and transactional risks.
As a result of a loss of loan application files for short-term consumer loans at
one ACE store and allegations that the short-term consumer loan program involved
excessive exceptions to Goleta's policies and procedures, the OCC recently
examined the program to determine whether Goleta engaged in unsafe or unsound
practices or failed to comply with applicable laws, rules or regulations. The
OCC notified Goleta that it intended to charge Goleta with the following: (i)
violations of the consumer protection provisions of the Equal Credit Opportunity
Act, which requires that loan documents be retained for 25 months; (ii)
violations of 12 C.F.R. Part 226, which requires that evidence of Truth in
Lending Act disclosures be preserved for 24 months; (iii) violations of certain
35
of the safety and soundness guidelines in the Interagency Guidelines
Establishing Standards for Safety and Soundness (Appendix A of 12 C.F.R. Part
30) and the customer privacy protections set forth in the Gramm-Leach-Bliley Act
(Appendix B of 12 C.F.R. Part 30 and Part 40); and (iv) unsafe or unsound
banking practices related to Goleta's short-term consumer loans, including
Goleta's management of ACE as the provider of services for the short-term
consumer loans.
In the interest of cooperation, compromise and settlement, and without any
admission or denial of wrongdoing by Goleta, the OCC and Goleta entered into a
Stipulation and Consent to the Issuance of a Consent Order dated October 28,
2002. The Consent Order replaces the Formal Agreement.
ACE entered into its own stipulation for the entry of a consent order with the
OCC, which has provisions that are similar in some respects to the provisions of
the Consent Order but differ in other respects, on October 25, 2002.
Summary of the Consent Order. The following summary of the Consent Order
-----------------------------
does not purport to be a complete statement of its terms, and is qualified in
its entirety by reference to the text of the Consent Order and the related
Stipulation, which are attached to the Company's Current Report on Form 8-K
filed on November 4, 2002 as Exhibits 10.13 and 10.14, respectively, and are
incorporated herein by this reference.
The Consent Order provides, among other things, for the following:
- Goleta will submit monthly progress reports to the OCC.
- On or before December 31, 2002, Goleta will cease all actions related
to the origination, renewal or rollover of short-term consumer loans,
and on or before November 1, 2002, ACE will assume, indemnify and hold
Goleta harmless for 100% of the costs, expenses, legal fees, damages
and related liabilities from third-party claims in accordance with the
terms of Goleta's agreement with ACE.
- Goleta will provide written notice to 641 short-term consumer loan
applicants whose files are missing from one ACE store. No later than
February 15, 2003, Goleta will begin a loan file audit, first randomly
sampling 5% of the loan files at each ACE store (except those already
reviewed by Goleta's Quality Assurance Department) to verify the
physical presence of applicants' loan files. If sampling reveals more
than one file missing at a store, Goleta will physically verify the
presence of all of the files generated at that store since June 30,
2002. If any applicant files are not located, Goleta will notify the
applicant in writing of the missing documents.
- Without admitting or denying any wrongdoing, Goleta will pay a civil
money penalty of $75,000 to the OCC within ten days of the Consent
Order.
- Within 90 days of the Consent Order, Goleta will adopt a written
strategic plan covering at least a three-year period.
- Goleta will 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; develop a three-year capital program to
maintain adequate capital; and refrain from paying dividends without
the approval of the OCC.
36
- Goleta will develop a written profit plan and submit quarterly
performance reports.
- Goleta will develop and implement a written risk management program
and adopt general procedures addressing compliance management,
internal control systems and education of employees regarding laws,
rules and regulations.
- Goleta will document the information it has relied on to value loans
held on its books, servicing rights, deferred tax assets and
liabilities and interest-only assets, and submit the documentation to
the OCC on a quarterly basis.
- Goleta will correct each violation of law, rule or regulation cited in
any report of examination.
- Goleta will prepare, and submit to the OCC for its prior approval, a
written analysis of any new product or service or significant
expansion of any existing product or service.
2. Amendment Number 3 to Master Loan Agency Agreement
- -----------------------------------------------------
On November 1, 2002, to accomplish the termination of their short-term consumer
loan arrangement that is required by the Consent Order, Goleta and ACE entered
into Amendment Number 3 (the "Amendment") to Master Loan Agency Agreement, dated
August 11, 1999, as amended by Amendment No. 1 thereto dated March 29, 2001, and
Amendment No. 2 thereto dated June 30, 2001 (the "Master Loan Agency
Agreement").
The following summary of the Amendment does not purport to be a complete
statement of its terms, and is qualified in its entirety by reference to the
text of the Amendment, which is attached to the Company's Current Report on Form
8-K filed on November 4, 2002 as Exhibit 10.15, and Amendment No. 1 to the
Collection Servicing Agreement between Goleta and ACE, which is attached to the
Company's Current Report on Form 8-K filed on November 4, 2002 as Exhibit 10.16,
each of which is incorporated herein by this reference, and to the text of the
Master Loan Agency Agreement, which was filed as Exhibit 10 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, and is
incorporated herein by this reference.
The principal terms of the Amendment are as follows:
- The Master Loan Agency Agreement, except for specified provisions,
will terminate on the later of December 31, 2002, or such later date
as the OCC may permit.
- If Goleta incurs losses after November 1, 2002 as a result of
third-party claims related to short-term consumer loans, ACE will
indemnify Goleta for 100% of the losses (including all costs and legal
fees), regardless of when the short-term consumer loan was made or
when the claim was brought.
- If Goleta incurred losses before November 1, 2002 as a result of
third-party claims related to short-term consumer loans, ACE will
indemnify Goleta for 95% of the losses related to loans originally
made before April 1, 2001, and 90% of the losses related to loans
originally made after April 1, 2001. Goleta will be responsible for
the remaining 5% or 10% of such losses.
37
- Goleta will remain responsible for any losses that might arise from
willful misconduct by Goleta, violations of third-party intellectual
property rights in the use of Goleta's loan-scoring software, and
fines and penalties imposed by regulators.
- If ACE incurred losses before November 1, 2002 as a result of
third-party claims related to short-term consumer loans, Goleta will
indemnify ACE for 5% of the losses related to loans originally made
before April 1, 2001, and 10% of the losses related to loans
originally made after April 1, 2001.
- ACE will continue to service and collect the existing short-term
consumer loans after December 31, 2002, under the terms of Amendment
No. 1 to the Collection Servicing Agreement.
- Goleta will sell to ACE Goleta's loan-scoring software, for which ACE
will pay $10,000.
- The Company will sell to ACE 100% of the Company's interest in
ePacific, Incorporated, a transaction processing company, for which
ACE will pay $15,000. The percentage of the Company's interest sold to
ACE may be reduced if other stockholders of ePacific, Incorporated
exercise their co-sale rights and participate in the sale.
- After December 31, 2002, ACE and Goleta will each provide the other
access to information about the existing short-term consumer loans.
ACE can continue to use confidential information to the extent
reasonably necessary to collect the loans.
- The Amendment specifies procedures for ACE to provide loan account
documentation to Goleta, and for the preservation or destruction of
loan documents. Costs of delivering documents requested by Goleta for
the loan file audit required under the Consent Order will be paid by
ACE.
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
- ------- -------------------------------
(a) Exhibits.
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.
The Company filed no reports on Form 8-K during the three month period
ended September 30, 2002.
The Company filed a Form 8-K report on November 4, 2002.
38
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: November 13, 2002 /s/ Phillip E. Guldeman
--------------------------
Phillip E. Guldeman
Executive Vice President
Chief Financial Officer
On Behalf of Registrant and as
Principal Financial Officer
39
CERTIFICATIONS
I, Stephen W. Haley, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Community West
Bancshares;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing of this quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
November 13, 2002
/s/Stephen W. Haley
-------------------
Stephen W. Haley
President and Chief Operating
Officer
40
I, Philip E. Guldeman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Community West
Bancshares;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing of this quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
November 13, 2002
/s/Philip E. Guldeman
---------------------
Philip E. Guldeman
Chief Financial Officer
41