SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
445 Pine Avenue, Goleta, California 93117
(Address of principal executive offices) (Zip code)
(805) 692-5821
(Registrant's telephone number, including area code)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, NO PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained, and will not be contained, to the best of
the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes[ ] No [X]
As of March 23, 2004, 5,710,969 shares of the registrant's common stock were
outstanding. The aggregate market value of common stock, held by non-affiliates
of the registrant as of March 23, 2004, was $37,304,443 based on a closing price
of $8.70 for the common stock, as reported on the Nasdaq Stock Market. For
purposes of the foregoing computation, all executive officers, Directors and 5
percent beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed to be an admission that such executive
officers, Directors or 5 percent beneficial owners are, in fact, affiliates of
the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A in connection with
the 2004 Annual Meeting are incorporated by reference into Part III of this
Report. The proxy statement will be filed with the Securities and Exchange
Commission not later than 120 days after the registrant's fiscal year ended
December 31, 2003.
COMMUNITY WEST BANCSHARES
FORM 10-K
INDEX
PART I PAGE
ITEM 1. Description of Business 3
ITEM 2. Description of Property 5
ITEM 3. Legal Proceedings 6
ITEM 4. Submission of Matters to a Vote of Security Holders 6
PART II
ITEM 5. Market for the Registrant's Common Equity and Related
Shareholder Matters 6
ITEM 6. Selected Financial Data 8
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk 42
ITEM 8. Consolidated Financial Statements and Supplementary Data F-3
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 64
PART III
ITEM 10. Directors and Executive Officers 64
ITEM 11. Executive Compensation 64
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management 64
ITEM 13. Certain Relationships and Related Transactions 64
ITEM 14. Controls and Procedures 64
PART IV
ITEM 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 64
SIGNATURES 67
CERTIFICATIONS 68
PART I
ITEM 1. DESCRIPTION OF BUSINESS
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Community West Bancshares ("CWBC") was incorporated in the State of California
on November 26, 1996, for the purpose of forming a bank holding company. On
December 31, 1997, CWBC acquired a 100% interest in Goleta National Bank
("GNB"). Effective that date, shareholders of GNB became shareholders of CWBC
in a one-for-one exchange. The acquisition was accounted at historical cost in
a manner similar to pooling-of-interests. CWBC and GNB are referred to herein
as "the Company."
Community West Bancshares is a bank holding company. During the fiscal year for
which this report is filed, GNB was the sole bank subsidiary of CWBC. CWBC
provides management and shareholder services to GNB.
GNB offers a range of commercial and retail financial services to professionals,
small to mid-sized businesses and individual households. These services include
various commercial, real estate, Small Business Administration ("SBA"),
construction and consumer loan options as well as deposit products. GNB also
offers cash management, remittance processing, electronic banking, merchant
credit card processing, online banking and other financial services.
Relationship Banking - Relationship banking is conducted at the community level
through two full-service branches, in Goleta and Ventura, California, and a loan
production office in Santa Maria, California opened in January 2004. The
primary customers are small to mid-sized businesses in these communities and
their owners and managers. Our goal is to provide the highest quality service
and the most diverse products to meet the varying needs of this highly sought
customer base.
GNB offers a range of commercial and retail financial services, including the
acceptance of demand, savings and time deposits, and the origination of
commercial, accounts receivable, real estate, construction, home improvement and
other installment and term loans. Our customers are also provided with the
choice of a range of cash management services, remittance banking, merchant
credit card processing, courier service and online banking. Through strategic
alliances, our customers have access to trust services and equipment leasing
programs and international banking services.
In addition to the traditional financial services offered, GNB offers internet
banking, automated clearinghouse origination, electronic data interchange, draft
preparation and processing and check imaging. Not only do these services
generate fee income, but they also tend to attract companies with large deposit
balances.
One of GNB's key strengths and a fundamental difference that enables GNB to
stand apart from its competition is the depth of experience of its personnel in
combining commercial lending and business development skills. These individuals
develop business, structure and underwrite the credit and manage the
relationship. This gives us a competitive advantage as for the most part, our
competitors have a centralized lending function where developing business,
underwriting credit and managing the relationship is split up between three or
more individuals.
The financial services industry as a whole offers a broad range of products and
services. Few companies today can effectively offer all of them. Accordingly,
GNB continues to investigate products and services that it believes can help it
attain a competitive advantage over others in the industry.
As part of GNB's strategic plan to further develop its relationship banking
business, GNB continually evaluates other products and services that address the
needs of its customers and enhance the Company's profitability. The Company
continues to analyze its local markets for potential expansion opportunities.
SBA Lending - GNB has been an approved lender/servicer of loans guaranteed by
the SBA since 1990. The Company primarily originates SBA loans for sale into
the secondary market. The Company continues to service these loans after sale
and is required under the SBA programs to retain specified amounts. The two
primary SBA loan programs GNB offers are the basic 7(a) Loan Guaranty and the
Certified Development Company ("CDC"), a Section 504 ("504") program. The basic
7(a) serves as the SBA's primary business loan program to help qualified small
businesses obtain financing when they might not be eligible for business loans
through normal lending channels. Loan proceeds under this program can be used
for most business purposes including working capital, machinery and equipment,
furniture and fixtures, land and building (including purchase, renovation and
new construction), leasehold improvements and debt refinancing. Loan maturity
is up to 10 years for working capital and generally up to 25 years for fixed
assets. The 7(a) loan is approved and funded by a qualified lender, guaranteed
by the SBA and subject to applicable regulations. The SBA guarantees up to 85%
of the loan amount, depending on the loan size. In January 2004, the SBA
implemented a maximum loan size of $750,000 due to its perceived national budget
constraints. Periodically, the Company may sell some of the unguaranteed
portion of select 7(a)
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program loans into the secondary market. The Company is required by the SBA to
retain a contractual minimum of 5% on all SBA 7(a) loans. The SBA 7(a) loans are
all variable interest rate loans based on the Wall Street Journal prime rate.
The servicing spread is a minimum of 1% on all loans. Income recognized by the
Company on the sales of the guaranteed portion of these loans and the ongoing
servicing income received are significant revenue sources for the Company.
GNB has been offering 504 loans since 1991, but was fairly inactive in this loan
product until 2002. In 2003, GNB increased its 504 loan origination volume.
The 504 program is an economic development-financing program providing
long-term, low down payment loans to healthy and expanding businesses.
Typically, a 504 project includes a loan secured from a private-sector lender
with a senior lien, a loan secured from a CDC (funded by a 100% SBA-guaranteed
debenture) with a junior lien covering up to 40% of the total cost, and a
contribution of at least 10% equity from the borrower. The maximum SBA
debenture generally is $1 million.
In 2001, the GNB began offering Business & Industry ("B & I") loans. These
loans are similar to the SBA product, except they are guaranteed by the U.S.
Department of Agriculture. The guaranteed amount is generally 80%. B&I loans
are made to businesses in designated rural areas and are generally larger loans
to larger businesses than the 7(a) loans. Similar to the SBA 7(a) product, they
can be sold into the secondary market.
GNB originates SBA loans in the states of California, Alabama, Colorado,
Florida, Georgia, North Carolina, Oregon, South Carolina, Tennessee and
Washington. Beginning in 1995, the SBA designated GNB as a "Preferred Lender."
As a Preferred Lender, GNB has been delegated the loan approval, closing and
most servicing and liquidation authority responsibility from the SBA. GNB
currently has SBA Preferred Lender status in the California districts of Los
Angeles, Fresno, Sacramento, San Francisco and Santa Ana as well as the states
of Georgia, North Carolina and Florida. GNB also has Preferred Lender status in
the cities of Seattle, Washington and Portland, Oregon. Due to GNB's Preferred
Lender status in so many states and districts, GNB has achieved competitive
advantage in this product and has been able to increase its loan volume in
recent years.
Mortgage Lending - In 1995, GNB established a Wholesale and Retail Mortgage Loan
Center. The Mortgage Loan Center originates residential real estate loans
primarily in the California counties of Ventura, Santa Barbara and San Luis
Obispo. Some retail loans not fitting GNB's wholesale lending criteria are
brokered to other lenders. After wholesale origination, the real estate loans
are sold into the secondary market.
In 1998, GNB established a financing program for manufactured housing to provide
affordable home ownership to low to moderate-income families that are purchasing
or refinancing their manufactured house in GNB's primary lending areas of Santa
Barbara and Ventura counties. The manufactured housing loans are retained in
GNB's loan portfolio. As of December 31, 2003, GNB held $39.1 million of
manufactured housing loans in its portfolio. GNB has not incurred any loan
losses on this product.
From 1996 to mid-2002, GNB offered high loan-to-value second mortgage loans
("HLTV"). In 1998, GNB accumulated the majority of the HLTV loans for the
purpose of securitization. In December 1998, GNB completed the securitization
of an $81 million pool of loans. In June 1999, GNB completed the securitization
of a $122 million pool of loans. In the fourth quarter of 1999, GNB decided to
cease securitization activities. Until June 2002, GNB originated and sold these
loans on a flow basis with servicing rights released to several investors.
After June 2002, GNB no longer originates HLTV loans. GNB retains a portfolio
with a book value of $352,000 as of December 31, 2003, as well as $35.4 million
of securitized loans.
Short-Term Consumer Lending - From the second quarter of 2000 until the end of
2002, GNB originated short-term consumer loans under an agreement with ACE Cash
Express Incorporated ("ACE"), whereby ACE acted as an agent to originate the
loans at its national retail offices. The Office of the Comptroller of the
Currency ("OCC"), GNB's primary regulator, expressed certain reservations about
GNB and other national banks entering into arrangements with third parties to
make short-term consumer loans and believed this program subjected Goleta and
the Company to significant strategic reputational, compliance and transaction
risks. In October 2002, GNB entered into a Consent Order with the OCC, agreeing
to terminate its short-term consumer lending, effective December 31, 2002. The
Consent Order with the OCC was terminated in October 2003.
GENERAL COMPANY INFORMATION
On August 17, 2001, CWBC sold 100% of its interest in Palomar Community Bank
("Palomar") to Centennial First Financial Services. Palomar was acquired by the
Company in December 1998. Shareholders of Palomar received 2.11 shares of CWBC
for each share of Palomar. The acquisition was accounted for under the purchase
method.
In October 1997, the Company purchased a majority interest in Electronic
Paycheck, LLC, that provided a customized debit card payment system and
electronic funds transfer services. In November 1999, Electronic
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Paycheck, LLC merged with ePacific.com Incorporated ("ePacific"), a Delaware
Corporation. Subsequent to the merger, ePacific purchased the majority of the
Company's shares and repaid a loan from the Company. On October 28, 2002, the
Company sold its remaining shares of stock in ePacific to ACE.
COMPETITION AND SERVICE AREA
The financial services industry is highly competitive with respect to both loans
and deposits. Overall, the industry is dominated by a relatively small number
of major banks with many offices operating over a wide geographic area. In the
markets where the Company's banking branches are present, several de novo banks
have added increased competition. Some of the major commercial banks operating
in the Company's service areas offer types of services that are not offered
directly by the Company. Some of these services include leasing, trust and
investment services and international banking. The Company has taken several
approaches to minimize the impact of competitor's numerous branch offices and
varied products. First, the Company through GNB provides courier services to
business clients, thus discounting the need for multiple branches in one market.
Second, through strategic alliances and correspondents, the Company provides a
full compliment of competitive services. Finally, one of GNB's strategic
initiatives is to establish loan production offices in areas where there is a
high demand for its lending products. These loan production offices currently
exist in the California cities of Santa Maria, Goleta and Ventura. The Company
also maintains SBA loan production offices in the California areas of
Sacramento, San Francisco bay area, Fresno, La Canada-Flintridge and San Diego
as well as the states of Washington, Colorado, North Carolina, Georgia and
Florida.
Competition may adversely affect the Company's performance. The financial
services business in the Company's markets is highly competitive and becoming
increasingly more so due to changing regulations, technology and strategic
consolidations amongst other financial service providers. Other banks and
specialty financial services companies may have more capital than the Company
and can offer lending, leasing and other financial products to the Company's
customer base. In some instances, competitors may offer a financial product
that directly competes with 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 our market share or cause the prices to fall for which the
Company can charge for products and services.
GOVERNMENT POLICIES
The Company's operations are affected by various state and federal legislative
changes and by policies of various regulatory authorities, including those of
the states in which it operates and the United States government. These
policies include, for example, statutory maximum legal lending rates, domestic
monetary policies by the Board of Governors of the Federal Reserve System, U.S.
fiscal policy, U.S. Patriot Act and capital adequacy and liquidity constraints
imposed by bank regulatory agencies. Changes in these laws, regulations and
policies greatly affect our operations. See "Item 7, Management's Discussion
and Analysis of Financial Conditions and Results of Operations - Supervision and
Regulation."
EMPLOYEES
As of December 31, 2003, the Company had 132 full-time and 10 part-time
employees. The Company's employees are not represented by a union or covered by
a collective bargaining agreement. Management of the Company believes that, in
general, its employee relations are good.
ITEM 2. DESCRIPTION OF PROPERTY
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The Company owns the property on which the GNB full-service branch is located in
Goleta, California.
All other property is leased by the Company, including the principal executive
office in Goleta. This facility houses the Company's corporate offices,
comprised of various departments, including finance, data processing,
compliance, human resources, electronic business services, special assets,
operations, loan collection and the mortgage loan center.
The Company continually evaluates the suitability and adequacy of the Company's
offices and has a program of relocating or remodeling them as necessary to
maintain efficient and attractive facilities. Management believes that its
existing facilities are adequate for its present purposes.
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ITEM 3. LEGAL PROCEEDINGS
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The following summarizes the Company's significant legal proceedings.
Short-Term Consumer Lending
Throughout 2000, 2001 and 2002, GNB made short-term consumer loans ("GNB Loans")
using marketing and servicing assistance of ACE at almost all of ACE's retail
locations pursuant to the terms of a Master Loan Agency Agreement between ACE
and GNB ("GNB Agreement").
A number of lawsuits and state regulatory proceedings were filed or initiated
against GNB and/or ACE regarding the GNB Loans. The state regulatory
proceedings were all settled during the prior fiscal year without GNB incurring
any liability for settlement payments. However, together with ACE, GNB remained
a defendant in three class actions, including a nationwide class action brought
in a federal court in Texas and two statewide class actions brought in state
courts in Florida and Maryland. A key issue in the remaining class actions
concerning the GNB Loans was whether GNB or ACE should be considered as the
lender.
GNB and ACE maintained that, as provided by the legal documentation and
marketing materials for the GNB Loans, GNB was the lender and that, because GNB
is a national bank located in California, the GNB Loans, including the interest
that may legally be charged, should be governed by federal and California law.
The plaintiffs, however, maintained that ACE should be regarded as the lender,
because of the services it rendered to GNB under the GNB Agreement and ACE's
purchase of participation interests in the GNB Loans, and that the GNB Loans,
including interest that may legally be charged, should have been governed by the
laws of the respective states in which the borrowers reside. If ACE were held
to be the lender, then the interest charged for the GNB Loans could have
violated most of the applicable states' usury laws, which impose maximum rates
of interest or finance charges that a non-bank lender may charge.
GNB and ACE entered into an agreement in October 2002 to indemnify GNB against
monetary exposure in the nationwide class-action lawsuit, however, GNB could
have been held liable had ACE been unable to pay, or the agreement rendered
invalid or unenforceable. On December 15, 2003, the U.S. District Court in
Dallas, Texas approved the settlement agreement with ACE that provided for the
release of substantially all of the claims that were asserted or could have been
asserted in this lawsuit and/or in other lawsuits against ACE regarding the
former offering of loans at ACE stores.
Other Litigation
The Company is involved in various other litigation of a routine nature that is
being handled and defended in the ordinary course of the Company's business. In
the opinion of management, based in part on consultation with legal counsel, the
resolution of these other litigation matters will not have a material impact on
the Company's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
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None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
- ------- -------------------------------------------------------------------
MATTERS
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(a) Market Information
The Company's common stock is traded on the Nasdaq Stock Market ("Nasdaq") under
the symbol CWBC. The following table sets forth the high and low sales prices
on a per share basis for the Company's common stock as reported by Nasdaq for
the period indicated:
2003 QUARTERS 2002 QUARTERS
-------------------------------- --------------------------------
Fourth Third Second First Fourth Third Second First
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Stock Price Range:
High $ 9.25 $ 7.34 $ 6.50 $ 5.45 $ 4.77 $ 4.69 $ 5.49 $ 6.10
Low $ 6.85 $ 5.90 $ 5.00 $ 4.58 $ 4.15 $ 3.20 $ 4.33 $ 3.95
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As of March 23, 2004, the year to date high and low stock prices were $9.38 and
$8.19, respectively. As of March 23, 2004, the last reported sale price per
share for the Company's common stock was $8.70.
(b) Holders
As of March 23, 2004, the Company had 442 stockholders of record of its common
stock.
(c) Dividends
No cash dividends have been paid to stockholders since January 2000. One source
of funds for the payment of dividends would be from dividends paid by GNB to the
Company. GNB's ability to pay dividends to the Company is limited by California
law and federal banking law. As of December 31, 2003, GNB had $935,000 available
for dividends. The resumption of cash dividend payments to shareholders is
currently under consideration by the Board of the Company. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Supervision and Regulation - Limitations on Dividend Payments."
(d) Securities Authorized for Issuance Under Equity Compensation Plans
The following table summarizes the securities authorized for issuance as of
December 31, 2003:
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Number of
securities to be Number of securities
issued upon Weighted-average remaining available for future
exercise of exercise price of issuance under equity
outstanding outstanding compensation plans
options, warrants options, warrants (excluding securities
Plan Category and rights and rights reflected in column (a)
- ---------------------------------- ------------------ ---------------------- -------------------------------
(a) (b) (c)
- ---------------------------------- ------------------ ---------------------- -------------------------------
Plans approved by shareholders 463,207 $ 6.04 475,651
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Plans not approved by shareholders - N/A -
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Total 463,207 475,651
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-7-
ITEM 6. SELECTED FINANCIAL DATA
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The following selected financial data have been derived from the Company's
consolidated financial condition and results of operations, as of and for the
years ended December 31, 2003, 2002, 2001, 2000 and 1999, and should be read in
conjunction with the consolidated financial statements and the related notes
included elsewhere in this report.
YEAR ENDED DECEMBER 31,
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2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
INCOME STATEMENT: (in thousands, except per share data)
Interest income $ 20,383 $ 29,976 $ 40,794 $ 51,864 $ 48,495
Interest expense 9,342 13,466 20,338 26,337 25,145
----------- ----------- ----------- ----------- -----------
Net interest income 11,041 16,510 20,456 25,527 23,350
Provision for loan losses 1,669 4,899 11,880 6,794 6,133
----------- ----------- ----------- ----------- -----------
Net interest income after provision for loan
losses 9,372 11,611 8,576 18,733 17,217
Non-interest income 10,675 11,398 22,171 16,481 11,021
Non-interest expenses 16,736 24,931 32,006 29,978 30,506
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 3,311 (1,922) (1,259) 5,236 (2,268)
Provision (benefit) for income taxes 1,128 (652) (1,281) 2,539 (622)
----------- ----------- ----------- ----------- -----------
NET INCOME (LOSS) $ 2,183 $ (1,270) $ 22 $ 2,697 $ (1,646)
=========== =========== =========== =========== ===========
PER SHARE DATA:
Income (loss) per common share - Basic $ 0.38 $ (0.22) $ 0.00 $ 0.44 $ (0.30)
Weighted average shares used in income (loss)
per share calculation - Basic 5,693,807 5,690,224 5,947,658 6,017,216 5,494,217
Income (loss) per common share - Diluted $ 0.38 $ (0.22) $ 0.00 $ 0.43 $ (0.30)
Weighted average shares used in income (loss)
per share calculation - Diluted 5,758,200 5,690,224 5,998,003 6,233,245 5,494,217
Book value per share $ 6.02 $ 5.64 $ 5.86 $ 5.90 $ 5.56
BALANCE SHEET:
Net loans $ 244,274 $ 245,856 $ 260,955 $ 329,265 $ 451,664
Total assets 304,250 307,210 323,863 405,255 523,847
Total deposits 224,855 219,083 196,166 228,720 313,131
Total liabilities 269,919 275,123 290,506 369,221 489,915
Total stockholders' equity 34,331 32,087 33,357 36,035 33,932
OPERATING AND CAPITAL RATIOS:
Return on average equity 6.65% (3.99)% 0.07% 7.35% (6.68)%
Return on average assets 0.73% (0.42)% 0.01% 0.61% (0.37)%
Equity to assets ratio 11.28% 10.48% 10.30% 8.89% 6.51%
Tier 1 leverage ratio 11.15% 10.48% 9.07% 7.25% 7.52%
Tier 1 risk-based capital ratio 14.05% 12.66% 11.75% 9.11% 7.17%
Total risk-based capital ratio 15.31% 13.92% 13.02% 11.04% 8.34%
Selected data for the years ended December 31, 1999 and 2000 include Palomar. The income statement for 2001
includes 8.5 months of Palomar operating results.
-8-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------- -------------------------------------------------------------------
RESULTS OF OPERATIONS
-----------------------
INTRODUCTION
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The following discussion is designed to provide insight into management's
assessment of significant trends related to Community West Bancshares ("CWBC")
and its wholly-owned subsidiary Goleta National Bank's ("GNB") consolidated
financial condition, results of operations, liquidity, capital resources and
interest rate risk. Unless otherwise stated, "Company" refers to this
consolidated entity. It should be read in conjunction with the consolidated
financial statements and notes thereto and the other financial information
appearing elsewhere in this report.
Forward-Looking Statements
This 2003 Annual Report on Form 10-K contains statements that 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:
- changes in the interest rate environment reducing interest rate
margins or increasing interest rate risk
- reduction in our earnings by losses on loans
- deterioration in general economic conditions
- the regulation of the banking industry
- dependence on real estate
- risks of natural disasters
- increased competitive pressure among financial services companies
- operational risks
- legislative or regulatory changes adversely affecting the business in
which the Company engages
- the availability of sources of liquidity at a reasonable cost
- other risks and uncertainties that may be detailed herein
OVERVIEW OF EARNINGS PERFORMANCE
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In 2003, the net income of the Company was $2.2 million, or $0.38, per basic and
diluted shares. This represents a $3.5 million increase in net income over
2002. The significant factors impacting net income for 2003 compared to 2002
were:
- the decision in 2002 to exit both the high-loan-to-value ("HLTV") and
the high-yielding short-term consumer ("STCL") lending businesses
impacted the Company both positively, with overall improved credit
quality and a related reduction to the allowance for loan losses, and
negatively, with a reduction to net interest and non-interest income
during 2003
- shifts in the mortgage business, which were positive until rising
rates in the fall of 2003
- increased prepayments in the securitized loan portfolio that decreased
the volume of interest-earning assets and accelerated amortization of
related deferred loan costs
- reduction in expenses due to continued cost control efforts as well as
the changes to business lines made in 2002
The impact to the Company from these items, and others of both a positive and
negative nature, will be discussed in more detail as they pertain to the
Company's performance for 2003 throughout the analysis sections of this report.
EXTERNAL FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
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Economic Conditions
Nationally, the banking industry and the Company have been affected by the
steady growth in the economy and the actions of the Federal Reserve Board to
manage this growth by cutting interest rates to the lowest levels in over 40
years. The changes in interest rates have impacted the Company as market rates
for loans, investments and deposits have remained near an all time-low for a
substantial period.
GNB serves three primary regions. The Tri-Counties region which consists of San
Luis Obispo, Santa Barbara and Ventura counties in the state of California, the
SBA Western Region where GNB originates SBA loans (California,
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Washington, Oregon and Colorado) and the SBA Southeast Region (Georgia, Florida,
Tennessee, Alabama, North Carolina and South Carolina). The forecast for the
Tri-Counties area is generally positive for the coming years, but California has
its own unique problems, as budget, and certain health insurance related matters
have discouraged business investment in California and slowed economic growth.
GNB's SBA Western Region has experienced modest growth. Non-planned retail
expenditures should remain stable with modest growth forecasted. In addition, no
significant economic growth is anticipated for the immediate future. The economy
relative to our SBA Southeast region continues to remain sluggish. Also
continuing to impact the Company is the nation's lingering slow recovery in the
tourism and hospitality sectors from the tragedy of September 11, 2001.
Regulatory Considerations
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 types of activities in which it can engage
- the types and amounts of investments it can make
- the locations of its offices
- insurance of the Company's deposits and the premiums paid for this
insurance
- 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. See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations - Supervision and Regulation."
Bank Regulations Could Discourage Changes in the Company's Ownership
Bank regulations could delay or discourage a potential acquirer who might have
been willing to pay a premium price to acquire a large block of common stock.
That possibility could decrease the value of the Company's common stock and the
price that a stockholder will receive if shares are sold in the future. Before
anyone can buy enough voting stock to exercise control over a bank holding
company like CWBC, bank regulators must approve the acquisition. A stockholder
must apply for regulatory approval to own 10 percent or more of the Company's
common stock, unless the stockholder can show that they will not actually exert
control over the Company. Regardless, no stockholder can own more than 25
percent of the Company's common stock without applying for regulatory approval.
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 December 31, 2003, the
market price of its common stock ranged from a low of $3.20 per share to a high
of $9.25 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
- trends in the Company's nonperforming assets
- announcements by competitors
- economic changes
- general market conditions
- perceived strength of the banking industry in general
- 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 can experience
extreme price and trading volume fluctuations that often are 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.
Dependence on Real Estate
Approximately 48% of the loan portfolio of the Company is secured by various
forms of real estate, 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
-10-
loans. The real estate securing the Company's loan portfolio is concentrated in
California. If real estate values decline significantly, especially in
California, the change 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.
Curtailment of Government Guaranteed Loan Programs Could Affect an Important
Segment of the Company's Business
A major segment of the Company's business consists of originating and selling
government guaranteed loans, in particular those guaranteed by the SBA. From
time to time, the government agencies that guarantee these loans reach their
internal limits and cease to guarantee loans. In addition, these agencies may
change their rules for loans or Congress may adopt legislation that would have
the effect of discontinuing or changing the programs. Non-governmental programs
could replace government programs for some borrowers, but the terms might not be
equally acceptable. Therefore, if these changes occur, the volume of loans to
small business, industrial and agricultural borrowers of the types that now
qualify for government guaranteed loans could decline. Also, the profitability
of these loans could decline. As of January 2004, the SBA implemented a maximum
loan size of $750,000 in its 7(a) loan program due to a perceived shortfall in
the program's fiscal 2004 authorized funding, which they anticipate may not meet
funding demands. Ongoing discussions of potential resolutions to the budget
deficit include shrinking the guaranteed percentage on loans and higher fees to
lenders. As the funding and sale of the guaranteed portion of 7(a) loans is a
significant portion of the Company's business, the long-term resolution to the
funding for the 7(a) loan program may have an unfavorable impact on the
Company's future performance and results of operations.
Environmental Laws Could Force the Company to Pay for Environmental Problems
When a borrower defaults on a loan secured by real property, the Company
generally 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 when owners have defaulted on loans. While
GNB has guidelines intended to exclude properties with an unreasonable risk of
contamination, hazardous substances may exist on some of the properties that it
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 default. Resale of contaminated
properties may also be difficult.
EARNINGS PERFORMANCE
- ---------------------
In 2003, the net income of the Company was $2.2 million, or $0.38, per basic and
diluted shares. Return on average assets and average equity were 0.73% and
6.65% in 2003, compared with (0.42)% and (3.99)% for 2002. During 2003, the
Company continued to be positively impacted by its decision in 2002 to reduce
risk and exit the high-yield STCL and HLTV lending businesses. Low interest
rates, shifts in the mortgage business, and the continued rapid paydown in the
securitized loan portfolio also contributed to the 2003 results both positively,
on provision for loan losses and negatively, to net interest margin.
The provision for loan losses decreased by $3.2 million from $4.9 million for
2002 to $1.7 million for 2003. The exit from STCL in 2002 accounted for $2.0
million of this decline. The other significant reason for this decrease was the
$1.1 million reduction in the SBA loan provision from 2002 to 2003. The Company
strengthened its SBA credit underwriting standards at the end of 2001 that has
resulted in a continued decline in problem loans in the SBA portfolio. The
securitized loan loss provision also experienced a decline for 2003 from 2002 of
$452,000 as a result of the reduced principal balances.
The net result in interest income after provision for loan losses was a 2.0%, or
$2.2 million, decline from $11.6 million for the year ended December 31, 2002 to
$9.4 million for 2003. The Company has diligently worked to replace the
high-yield assets it lost.
The Company's net income declined $1.3 million from 2001 to 2002. The primary
reasons for this decline were the $4.6 million net proceeds from a legal
settlement the Company received in 2001 as well as the costs in 2002 associated
with the Company's decision to exit the HLTV and STCL lending businesses and
consolidate the mortgage and SBA lending offices, and included $3.2 million in
asset writedowns.
CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
- -----------------------------------------------------
Net interest income is the difference between the interest and fees earned on
loans and investments and the interest expense paid on deposits and other
liabilities. The amount by which interest income will exceed interest expense
depends on the volume or balance of earning assets compared to the volume or
balance of interest-bearing deposits
-11-
and liabilities and the interest rate earned on those interest-earning assets
compared to the interest rate paid on those interest-bearing liabilities.
Net interest margin is net interest income expressed as a percentage of average
earning assets. It is used to measure the difference between the average rate
of interest earned on assets and the average rate of interest that is paid on
liabilities used to fund those assets. To maintain its net interest margin, the
Company must manage the relationship between interest earned and paid. The
following table sets forth, for the period indicated, the increase or decrease
of certain items in the consolidated income statements of the Company as
compared to the prior periods:
YEAR ENDED DECEMBER 31,
---------------------------------------------------
2003 VS 2002 2002 VS 2001
------------------------- ------------------------
AMOUNT OF PERCENT OF AMOUNT OF PERCENT OF
INCREASE INCREASE INCREASE INCREASE
(DECREASE) (DECREASE) (DECREASE) (DECREASE)
----------- ------------ ----------- -----------
INTEREST INCOME (dollars in thousands)
Loans $ (9,648) (32.9)% $ (9,952) (25.4)%
Investment securities 287 142.1% (67) (24.9)%
Other (232) (49.6)% (799) (63.1)%
----------- ------------ ----------- -----------
Total interest income (9,593) (32.0)% (10,818) (26.5)%
----------- ------------ ----------- -----------
INTEREST EXPENSE
Deposits (924) (16.7)% (3,915) (41.4)%
Bonds payable and other borrowings (3,200) (40.4)% (2,957) (27.2)%
----------- ------------ ----------- -----------
Total interest expense (4,124) (30.6)% (6,872) (33.8)%
----------- ------------ ----------- -----------
NET INTEREST INCOME (5,469) (33.1)% (3,946) (19.3)%
Provision for loan losses (3,230) (65.9)% (6,981) (58.8)%
----------- ------------ ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES (2,239) (19.3)% 3,035 35.4%
NON-INTEREST INCOME
Gains from loan sales, net 72 1.5% (1,828) (27.6)%
Other loan fees (465) (13.7)% (44) (1.3)%
Loan servicing fees, net 183 16.9% (622) (36.5)%
Document processing fees, net (467) (33.3)% (574) (29.0)%
Service charges (64) (14.5)% (135) (23.5)%
Proceeds from legal settlement - - (7,000) (100.0)%
Other 18 6.1% (570) (65.7)%
----------- ------------ ----------- -----------
Total non-interest income (723) (6.3)% (10,773) (48.6)%
----------- ------------ ----------- -----------
NON-INTEREST EXPENSES
Salaries and employee benefits (2,180) (16.0)% (4,108) (23.2)%
Occupancy and equipment expenses (428) (20.2)% (192) (8.3)%
Professional services (939) (59.6)% (663) (29.6)%
Depreciation (190) (24.6)% (648) (45.7)%
Loan servicing and collection (434) (49.8)% (466) (34.8)%
Professional expenses associated with legal settlement - - (2,392) (100.0)%
Impairment of SBA interest only strips and servicing
assets (1,788) (100.0)% 1,788 -
Lower of cost or market provision on loans held for sale (1,381) (100.0)% 1,381 -
Amortization of intangible assets - - (178) (100.0)%
Other (855) (30.2)% (1,597) (36.1)%
----------- ------------ ----------- -----------
Total non-interest expenses (8,195) (32.9)% (7,075) (22.1)%
----------- ------------ ----------- -----------
Income (loss) before provision (benefit) for income taxes 5,233 (663)
Provision (benefit) for income taxes 1,780 629
----------- -----------
NET INCOME (LOSS) $ 3,453 $ (1,292)
=========== ===========
Total interest income decreased 32.0% from $30 million in 2002 to $20.4 million
in 2003. Total interest expense decreased 30.6% from $13.5 million in 2002 to
$9.3 million in 2003. The Company experienced a $9.6 million, or 32.9%, decline
in interest income from loans in 2003 over 2002. This decline was primarily the
result of the Company's exit from short-term consumer lending in 2002, which
contributed $7.6 million in interest income for the year ended December 31,
2002. Also contributing to the decrease in loan interest income was a reduction
of
-12-
$3.8 million, or 38%, in interest income received on the securitized loan
portfolio. The decrease in loan interest from the securitized portfolio is a
result of the $28.8 million net decrease in the portfolio during 2003. This
43.5% decrease in the securitized loan portfolio also indirectly accounted for
80% of the $4.1 million decline in interest expense as the related bonds paid
down by $24.4 million, or 48.3%. The remaining 20% decrease in interest expense
is the result of declines in average effective rates on interest-bearing
deposits of 0.54% on time certificates of deposits and 1.07% on interest-bearing
demand and savings deposits.
Total interest income decreased 26.5% from $40.8 million in 2001 to $30 million
in 2002. Total interest expense decreased 33.8% from $20.3 million in 2001 to
$13.5 million in 2002. The decrease in both interest income and interest
expense was primarily due to a decline in interest rates; the sale of Palomar
which is included in the income statement for 2001 for seven and one-half months
only; and, a prepayment rate of approximately 39% experienced in GNB's
securitized loan portfolio. In addition, the Company was moderately asset
sensitive during this period of declining interest rates. As a result, net
interest income decreased 19.3% from $20.5 million in 2001 to $16.5 in 2002.
The following table sets forth the changes in interest income and expense
attributable to changes in rate and volume:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
2003 VERSUS 2002 2002 VERSUS 2001
---------------------------- -----------------------------
TOTAL CHANGE DUE TO TOTAL CHANGE DUE TO
------------- -------------
CHANGE RATE VOLUME CHANGE RATE VOLUME
-------- ------------------ --------- ------------------
(in thousands)
Interest earning deposits in other financial
institutions (including time deposits) $ (37) $ (14) $ (23) $ (68) $ (58) $ (10)
Federal funds sold (195) (132) (63) (730) (747) 17
Investment securities 287 (29) 316 (67) (104) 37
Loans, net (5,856) (7,044) 1,188 (3,190) (1,057) (2,133)
Securitized loans (3,792) 299 (4,091) (6,763) (1,019) (5,744)
-------- -------- -------- --------- -------- --------
Total interest-earning assets (9,593) (6,920) (2,673) (10,818) (2,985) (7,833)
-------- -------- -------- --------- -------- --------
Interest-bearing demand (229) (255) 26 (225) (286) 61
Savings (89) (106) 17 (159) (79) (80)
Time certificates of deposit (606) (679) 73 (3,531) (3,196) (335)
Bonds payable (3,284) 301 (3,585) (2,490) 1,997 (4,487)
Other borrowings 84 - 84 (467) - (467)
-------- -------- -------- --------- -------- --------
Total interest-bearing liabilities (4,124) (739) (3,385) (6,872) (1,564) (5,308)
-------- -------- -------- --------- -------- --------
Net interest income $(5,469) $(6,181) $ 712 $ (3,946) $(1,421) $(2,525)
======== ======== ======== ========= ======== ========
The Company primarily earns income from the management of its financial assets
and liabilities and from charging fees for services it provides. The Company's
income from managing assets consists of the difference between the interest
income received from its loan portfolio and investments and the interest expense
paid on its liabilities, primarily interest paid on deposits. This difference
or spread is net interest income. Net interest income, when expressed as a
percentage of average total interest-earning assets, is referred to as net
interest margin on interest-earning assets. The Company's net interest income
is affected by the change in the level and the mix of interest-earning assets
and interest-bearing liabilities, referred to as volume changes. The Company's
net yield on interest-earning assets is also affected by changes in the yields
earned on assets and rates paid on liabilities, referred to as rate changes.
Interest rates charged on the Company's loans are affected principally by the
demand for such loans, the supply of money available for lending purposes,
competitive factors and general economic conditions such as federal economic
policies, legislative tax policies and governmental budgetary matters.
The following table presents the net interest income and net interest margin for
the three years indicated:
YEAR ENDED DECEMBER 31,
----------------------------
2003 2002 2001
-------- -------- --------
(dollars in thousands)
Interest income $20,383 $29,976 $40,794
Interest expense 9,342 13,466 20,338
-------- -------- --------
Net interest income $11,041 $16,510 $20,456
======== ======== ========
Net interest margin 3.93% 5.87% 5.86%
-13-
NON-INTEREST INCOME
The following table summarizes the Company's non-interest income for the three
years indicated:
YEAR ENDED DECEMBER 31,
-------------------------
NON-INTEREST INCOME 2003 2002 2001
------- ------- -------
(in thousands)
Gains from loan sales, net: $ 4,860 $ 4,788 $ 6,616
Other loan fees 2,923 3,388 3,432
Loan servicing fees, net 1,264 1,081 1,703
Document processing fees, net: 937 1,404 1,978
Service charges 376 440 575
Proceeds from legal settlement - - 7,000
Other 315 297 867
------- ------- -------
TOTAL NON-INTEREST INCOME $10,675 $11,398 $22,171
======= ======= =======
Total non-interest income for the Company declined by $723,000 from 2002 to
2003. Despite the increased refinance activity experienced in the mortgage
industry, the mortgage division experienced a decline in total loan originations
from 2002 to 2003 of $44.2 million, or 12.6%. The exit from HLTV in 2002 was
responsible for $1.9 million of the decline in non-interest income from 2002 to
2003. This decline was partially offset by an increase in gains on loans sales
for the mortgage and SBA divisions in 2003 over 2002 and a small increase in
document processing fees for the mortgage division in 2003. During 2003, the
Company received higher premiums on SBA loan sales. The mortgage division
activity slowed down significantly in the fourth quarter of 2003.
The following table summarizes these changes:
YEAR ENDED DECEMBER 31,
-------------------------
2003 2002 CHANGE
------ ------- --------
Gains from loan sales (in thousands)
SBA $3,698 $2,593 $ 1,105
Mortgage 1,162 672 490
Alternative mortgage - 1,502 (1,502)
Other - 21 (21)
------ ------- --------
Total $4,860 $4,788 $ 72
====== ======= ========
Other loan fees
Mortgage $2,923 $3,512 $ (589)
Alternative mortgage - (124) 124
------ ------- --------
Total $2,923 $3,388 $ (465)
====== ======= ========
Document processing fees, net
Mortgage $ 937 $ 898 $ 39
Alternative mortgage - 506 (506)
------ ------- --------
Total $ 937 $1,404 $ (467)
====== ======= ========
The Company's non-interest income decreased by $10.8 million, or 48.6%, from
2001 to 2002. The primary factors contributing to this decrease in other income
were the $7 million proceeds from the legal settlement against the Company's
former auditors received in 2001 and the decrease of $1.8 million, or 27.3%, in
gain on loan sales primarily due to GNB's exit from the HLTV loan origination
and sales business in the second quarter of 2002 and management's strategic
decision not to sell any 7(a) SBA loans in the fourth quarter of 2002. The
other $2.0 million decline in other income is attributable to small declines in
loan origination and document processing fees, loan servicing income, service
charges and other income.
-14-
NON-INTEREST EXPENSES
The following table summarizes the Company's non-interest expenses for the three
years indicated:
YEAR ENDED DECEMBER 31,
-------------------------
NON-INTEREST EXPENSES 2003 2002 2001
------- ------- -------
(in thousands)
Salaries and employee benefits $11,416 $13,596 $17,704
Occupancy and equipment expenses 1,691 2,119 2,311
Professional services 636 1,575 2,238
Depreciation 581 771 1,419
Loan servicing and collection 438 872 1,338
Professional expenses associated with legal settlement - - 2,392
Impairment of SBA interest only strips and servicing assets - 1,788
Lower of cost or market provision on loans held for sale - 1,381 -
Amortization of intangible assets - - 178
Other 1,974 2,829 4,426
------- ------- -------
TOTAL NON-INTEREST EXPENSES $16,736 $24,931 $32,006
======= ======= =======
Throughout 2003, the Company continued its efforts to control expenditures.
These efforts, as well as the changes made in 2002 to its business lines,
resulted in an $8.2 million, or 33%, decrease in non-interest expenses. $3.2
million of the decrease was a result of the asset writedowns in 2002.
Non-interest expenses decreased by $7.1 million, or 22.1%, from 2001 to 2002 and
increased by $2.4 million, or 6.3%, from 2000 to 2001. The decrease in 2002 was
primarily due to the Company's reorganization and cost-cutting efforts.
The following table compares the various elements of non-interest expenses as a
percentage of average assets:
TOTAL SALARIES AND OCCUPANCY AND
AVERAGE NON-INTEREST EMPLOYEE DEPRECIATION
YEAR ENDED DECEMBER 31, ASSETS EXPENSES BENEFITS EXPENSES
- ------------------------ -------- ------------- -------------- -------------
(DOLLARS IN THOUSANDS)
2003 $299,661 5.58% 3.81% 0.76%
2002 $301,962 8.25% 4.50% 0.95%
2001 $371,923 8.71% 4.76% 0.97%
INCOME TAXES
Income tax provision (benefit) was $1,128,000 in 2003, $(652,000) in 2002, and
$(1,281,000) in 2001. The effective income tax (benefit) rate was 34.1%,
(33.9%), and (101.8%) for 2003, 2002 and 2001, respectively. See footnote 8,
"Income Taxes", in the notes to the Consolidated Financial Statements.
CAPITAL RESOURCES
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") contains
rules as to the legal and regulatory environment for insured depository
institutions, including reductions in insurance coverage for certain kinds of
deposits, increased supervision by the federal regulatory agencies, increased
reporting requirements for insured institutions and new regulations concerning
internal controls, accounting and operations.
The prompt corrective action regulations of FDICIA define specific capital
categories based on the institutions' capital ratios. The capital categories,
in declining order, are "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized" and "critically
undercapitalized". To be considered "well capitalized", an institution must
have a core capital ratio of at least 5% and a total risk-based capital ratio of
at least 10%. Additionally, FDICIA imposed in 1994 a new Tier I risk-based
capital ratio of at least 6% to be considered "well capitalized". Tier I
risk-based capital is, primarily, common stock and retained earnings net of
goodwill and other intangible assets.
To be categorized as "adequately capitalized" or "well capitalized", GNB must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
and values as set forth in the tables below:
-15-
(DOLLARS IN THOUSANDS) RISK- ADJUSTED TOTAL TIER 1 TIER 1
TOTAL TIER 1 WEIGHTED AVERAGE CAPITAL CAPITAL LEVERAGE
CAPITAL CAPITAL ASSETS ASSETS RATIO RATIO RATIO
-------- --------- --------- -------- -------- -------- ---------
DECEMBER 31, 2003
CWBC (Consolidated) $ 37,150 $ 34,096 $ 242,730 $305,666 15.31% 14.05% 11.15%
GNB 34,695 31,648 242,170 301,024 14.33 13.07 10.51
DECEMBER 31, 2002
CWBC (Consolidated) 35,080 31,897 252,019 304,239 13.92 12.66 10.48
GNB 32,492 29,405 244,207 300,097 13.31 12.04 9.80
Well capitalized ratios 10.00 6.00 5.00
Minimum capital ratios 8.00 4.00 4.00
The Company does not anticipate any material changes in its capital resources.
CWBC has common equity only and does not have any off-balance sheet financing
arrangements. The Company has not reissued any treasury stock nor does it have
any immediate plans or programs to do so. In March 2002, the Company made a
$750,000 capital contribution to GNB.
-16-
SCHEDULE OF AVERAGE ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY
As of the dates indicated below, the following schedule shows the average
balances of the Company's assets, liabilities and stockholders' equity accounts
as a percentage of average total assets:
DECEMBER 31,
---------------------------------------------------------
2003 2002 2001
------------------ ------------------ -----------------
AMOUNT % AMOUNT % AMOUNT %
--------- ------- --------- ------- --------- ------
ASSETS (dollars in thousands)
Cash and due from banks $ 6,431 2.1% $ 6,684 2.2% $ 8,327 2.2%
Interest-earning deposits in other financial institutions 1,359 0.5% - - - -
Federal funds sold 15,462 5.1% 22,903 7.6% 26,696 7.1%
Time deposits in other financial institutions 1,542 0.5% 3,929 1.3% 4,498 1.2%
Federal Reserve Bank stock 812 0.3% 780 0.3% 1,141 0.3%
Investment securities available-for-sale 8,910 3.0% - - - -
Investment securities held-to-maturity 5,036 1.7% 4,264 1.4% 2,861 0.8%
Interest only strips, at fair value 4,054 1.3% 6,104 2.0% 8,560 2.3%
Loans held for sale, net 45,445 15.2% 27,699 9.2% 18,344 4.9%
Loans held for investment, net 147,351 49.2% 132,061 43.7% 159,237 42.8%
Securitized loans, net 50,173 16.7% 83,876 27.8% 132,973 35.8%
Servicing assets 2,062 0.7% 2,213 0.7% 2,654 0.7%
Other real estate owned, net 677 0.2% 554 0.2% 207 0.1%
Premises and equipment, net 1,805 0.6% 2,338 0.8% 3,533 1.0%
Other assets 8,542 2.9% 8,557 2.8% 2,892 0.8%
--------- ------- --------- ------- --------- ------
TOTAL ASSETS $299,661 100.0% $ 301,962 100.0% $ 371,923 100.0%
========= ======= ========= ======= ========= ======
LIABILITIES
Deposits:
Non-interest-bearing demand $ 34,400 11.5% $ 31,388 10.4% $ 39,708 10.7%
Interest-bearing demand 35,768 11.9% 27,439 9.1% 22,476 6.0%
Savings 15,480 5.2% 13,270 4.4% 17,056 4.6%
Time certificates of $100,000 or more 21,076 7.0% 42,970 14.2% 79,195 21.3%
Other time certificates 109,828 36.7% 85,137 28.2% 65,102 17.5%
--------- ------- --------- ------- --------- ------
Total deposits 216,552 72.3% 200,204 66.3% 223,537 60.1%
Securities sold under agreements to repurchase 6,518 2.2% - - - -
Bonds payable in connection with securitized loans 39,000 13.0% 69,251 22.9% 111,327 29.9%
Other liabilities 4,746 1.5% 689 0.2% 3,858 1.0%
--------- ------- --------- ------- --------- ------
Total liabilities 266,816 89.0% 270,144 89.4% 338,722 91.0%
--------- ------- --------- ------- --------- ------
STOCKHOLDERS' EQUITY
Common stock 29,812 10.0% 29,797 9.9% 26,297 7.1%
Retained earnings 3,037 1.0% 2,021 0.7% 6,901 1.9%
Accumulated other comprehensive income (loss) (4) - - - 3 0.0%
--------- ------- --------- ------- --------- ------
Total stockholders' equity 32,845 11.0% 31,818 10.6% 33,201 9.0%
--------- ------- --------- ------- --------- ------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $299,661 100.0% $ 301,962 100.0% $ 371,923 100.0%
========= ======= ========= ======= ========= ======
-17-
INTEREST RATES AND DIFFERENTIALS
- -----------------------------------
The following table illustrates average yields on our interest-earning assets
and average rates on our interest-bearing liabilities for the years indicated.
These average yields and rates are derived by dividing interest income by the
average balances of interest-earning assets and by dividing interest expense by
the average balances of interest-bearing liabilities for the years indicated.
Amounts outstanding are averages of daily balances during the period.
YEAR ENDED DECEMBER 31,
-------------------------------
INTEREST-EARNING ASSETS: 2003 2002 2001
--------- --------- ---------
(dollars in thousands)
Interest earning deposits in other financial institutions:
Average outstanding $ 1,359 $ - $ -
Interest income 31 - -
Average yield 2.28% - -
Time deposits in other financial institutions:
Average outstanding 1,542 3,929 4,498
Interest income 36 104 172
Average yield 2.33% 2.65% 3.82%
Federal funds sold:
Average outstanding 15,462 22,903 26,696
Interest income 169 364 1,094
Average yield 1.09% 1.59% 4.09%
Investment securities:
Average outstanding 14,758 5,044 4,002
Interest income 489 202 269
Average yield 3.31% 4.00% 6.72%
Gross loans excluding securitized:
Average outstanding 195,648 164,301 181,122
Interest income 13,554 19,410 22,601
Average yield 6.93% 11.81% 12.48%
Securitized loans:
Average outstanding 52,359 85,134 132,973
Interest income 6,104 9,896 16,658
Average yield 11.66% 11.62% 12.53%
Total interest-earning assets:
Average outstanding 281,128 281,311 349,291
Interest income 20,383 29,976 40,794
Average yield 7.25% 10.66% 11.68%
-18-
YEAR ENDED DECEMBER 31,
-------------------------------
INTEREST-BEARING LIABILITIES: 2003 2002 2001
--------- --------- ---------
(dollars in thousands)
Interest-bearing demand deposits:
Average outstanding $ 35,768 $ 27,438 $ 22,476
Interest expense 371 600 825
Average effective rate 1.04% 2.19% 3.67%
Savings deposits:
Average outstanding 15,480 13,270 17,056
Interest expense 215 304 464
Average effective rate 1.39% 2.29% 2.72%
Time certificates of deposit:
Average outstanding 130,904 128,107 144,297
Interest expense 4,035 4,641 8,171
Average effective rate 3.08% 3.62% 5.66%
Federal funds purchased:
Average outstanding - 22 -
Interest expense - - -
Average effective rate - - -
Bonds payable:
Average outstanding 39,000 69,251 111,327
Interest expense 4,637 7,921 10,411
Average effective rate 11.89% 11.44% 9.35%
Other borrowings:
Average outstanding 6,518 - 3,463
Interest expense 84 - 467
Average effective rate 1.29% - 13.49%
Total interest-bearing liabilities:
Average outstanding 227,670 238,088 298,619
Interest expense 9,342 13,466 20,338
Average effective rate 4.10% 5.66% 6.81%
NET INTEREST INCOME 11,041 16,510 20,456
NET INTEREST SPREAD 3.15% 5.00% 4.87%
AVERAGE NET MARGIN 3.93% 5.87% 5.86%
Nonaccrual loans are included in the average balance of loans outstanding.
LOAN PORTFOLIO
- ---------------
The Company's largest categories of loans held in the portfolio are commercial
loans, real estate loans, SBA loans, installment loans (including manufactured
housing) and second mortgage loans. Loans are carried at face amount, net of
payments collected, the allowance for loan losses, deferred loan fees/costs and
discounts on loans purchased. Interest on all loans is accrued daily, primarily
on a simple interest basis. It is the Company's policy to place a loan on
nonaccrual status when the loan is 90 days past due. Thereafter, previously
recorded interest is reversed and interest income is typically recognized on a
cash basis.
The rates charged on variable rate loans are set at specific increments. These
increments vary in relation to the Company's published prime lending rate or
other appropriate indices. At December 31, 2003, approximately 63% of the
Company's loan portfolio was comprised of variable interest rate loans. At
December 31, 2002 and 2001, variable rate loans comprised approximately 56% and
34%, respectively, of the Company's loan portfolio. Management monitors the
maturity of loans and the sensitivity of loans to changes in interest rates.
-19-
The following table sets forth, as of the dates indicated, the amount of gross
loans outstanding based on the remaining scheduled repayments of principal,
which could either be repriced or remain fixed until maturity, classified by
years until maturity:
DECEMBER 31,
------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------------------------------------------------------------------------------------------
IN YEARS (in thousands)
------------------------------------------------------------------------------------------------------
FIXED VARIABLE FIXED VARIABLE FIXED VARIABLE FIXED VARIABLE FIXED VARIABLE
------- --------- -------- --------- -------- --------- -------- --------- -------- ---------
Less than One $ 2,382 $ 34,108 $ 2,604 $ 8,188 $ 10,346 $ 26,532 $ 1,058 $ 100,717 $ 789 $ 87,313
One to Five 4,128 13,576 3,615 16,224 3,975 6,195 8,250 5,403 8,342 4,628
Over Five (1) 85,390 109,366 105,491 116,322 164,748 58,761 219,213 642 354,282 536
------- --------- -------- --------- -------- --------- -------- --------- -------- ---------
Total $91,900 $ 157,050 $111,710 $ 140,734 $179,069 $ 91,488 $228,521 $ 106,762 $363,413 $ 92,477
------------------------------------------------------------------------------------------------------
(1) Approximately $37.4 million of the fixed rate loans at December 31, 2003 are in the Company's securitized loan
portfolio, which was originally funded by bonds payable, approximately $26.1 million balance of which remains
outstanding at December 31, 2003.
Distribution of Loans
The distribution of the Company's total loans by type of loan, as of the dates
indicated, is shown in the following table:
DECEMBER 31,
-----------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
LOAN LOAN LOAN LOAN LOAN
BALANCE BALANCE BALANCE BALANCE BALANCE
--------- --------- --------- --------- ---------
Commercial $ 24,592 $ 19,302 $ 26,411 $ 36,188 $ 12,102
Real estate 71,010 47,456 44,602 55,083 44,139
SBA 30,698 40,961 31,889 30,888 25,073
Manufactured housing 39,073 28,199 24,135 16,892 *
Other installment 5,770 7,047 4,088 6,006 6,348
Participations purchased - - - - 25,395
Securitized 37,386 66,195 108,584 153,031 184,559
Held for sale 42,038 43,284 30,848 37,195 158,274
--------- --------- --------- --------- ---------
Gross Loans 250,567 252,444 270,557 335,283 455,890
Less:
Allowance for loan losses 4,675 5,950 8,275 6,746 5,529
Deferred fees/costs 69 (318) 222 (2,710) (3,079)
Discount on SBA loans 1,549 956 1,105 1,982 1,776
--------- --------- --------- --------- ---------
Net Loans $244,274 $245,856 $260,955 $329,265 $451,664
========= ========= ========= ========= =========
Percentage to Gross Loans:
Commercial 9.8% 7.6% 9.8% 10.8% 2.7%
Real estate 28.3% 18.8% 16.5% 16.4% 9.7%
SBA 12.3% 16.3% 11.8% 9.2% 5.5%
Manufactured housing 15.6% 11.2% 8.9% 5.0% *
Other installment 2.3% 2.8% 1.5% 1.8% 1.4%
Participations purchased - - - - 5.6%
Securitized 14.9% 26.2% 40.1% 45.7% 40.4%
Held for sale 16.8% 17.1% 11.4% 11.1% 34.7%
--------- --------- --------- --------- ---------
100.0% 100.0% 100.0% 100.0% 100.0%
========= ========= ========= ========= =========
* The information for 1999 is in "Other installment" and is not readily
available.
Commercial Loans
In addition to traditional term commercial loans made to business customers, GNB
grants revolving business lines of credit. Under the terms of the revolving
lines of credit, GNB grants a maximum loan amount, which remains
-20-
available to the business during the loan term. As part of the loan
requirements, the business agrees to maintain its primary banking relationship
with GNB. GNB does not extend material loans of this type in excess of one year.
Real Estate Loans
Real estate loans are primarily made for the purpose of purchasing, improving or
constructing single-family residences, commercial or industrial properties.
The majority of the Company's mortgage loans are collateralized by liens on
single-family homes. A majority of these loans are sold servicing released into
the secondary market.
A substantial portion of the Company's real estate construction loans are first
and second trust deeds on the construction of owner-occupied single family
dwellings. The Company also makes real estate construction loans on commercial
properties. These consist of first and second trust deeds collateralized by the
related real property. Construction loans are generally written with terms of
six to twelve months and usually do not exceed a loan to appraised value of 80%.
Commercial and industrial real estate loans are secured by nonresidential
property. Office buildings or other commercial property primarily secure these
loans. Loan to appraised value ratios on nonresidential real estate loans are
generally restricted to 75% of appraised value of the underlying real property.
Unguaranteed Portion of SBA Loans
Under the SBA 7(a) loan program, the Company is required to retain a minimum of
5% of the unguaranteed portion of loans it originates and sells into the
secondary market. At December 31, 2003, the Company had $26.9 million in
unguaranteed SBA loans.
Manufactured Housing Loans
The mortgage loan center originates loans secured by manufactured housing
primarily located in parks along the Central Coast of California. At December
31, 2003, the Bank had $39.1 million in its portfolio. The loans are serviced
internally and are generally written for terms of 10 to 20 years with balloon
payments ranging from 10 to 15 years.
Other Installment Loans
Installment loans consist of automobile, small equity lines of credit, loans
secured by manufactured housing and general-purpose loans made to individuals.
These loans are primarily fixed rate. Included in this category as of December
31, 2002 is approximately $1.6 million of the Company's short-term consumer
lending product, which consists of 14-day loans to individuals. No such new
loans were originated in 2003 and no loans of this type were in the Company's
loan portfolio as of December 31, 2003.
Second Mortgage Loans
The Company originated second mortgage loans with loan to value ratios as high
as 125%. In 1998 and 1999, the Company transferred $81 million and $122 million
of these loans, respectively, to special purpose trusts ("Trusts"). The Trusts
then sold bonds to third party investors, which were secured by the transferred
loans. The bonds are held in a trust independent of the Company, the trustee of
which oversees the distribution to the bondholders. The mortgage loans are
serviced by a third party ("Servicer"), who receives a stated servicing fee.
There is an insurance policy on the subordinate bonds that guarantees the
payment of the bonds.
As part of the securitization agreements, the Company received an option to
repurchase the bonds when the aggregate principal balance of the mortgage loans
sold declined to 10% or less of the original balance of mortgage loans
securitized. Because the Company has a call option to reacquire the loans
transferred and did not retain the servicing rights, the Company was deemed to
not have surrendered effective control over the loans transferred. Therefore,
the securitizations are accounted for as secured borrowings with a pledge of
collateral. Accordingly, the Company consolidates the Trusts and the financial
statements of the Company include the loans transferred and the related bonds
issued. The securitized loans are classified as held for investment. At
December 31, 2003 and 2002, the net balance of the securitized loan portfolio
was $35.4 million and $63.6 million, respectively. The related net bond
balances were $26.1 million and $50.5 million at December 31, 2003 and 2002,
respectively.
-21-
Loan Commitments Outstanding
The Company's loan commitments outstanding at the dates indicated are summarized
below:
DECEMBER 31,
-------------------------------------------
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
(in thousands)
Commercial $13,867 $11,370 $ 7,450 $ 9,776 $ 6,641
Real estate 11,676 7,664 6,370 8,323 4,135
SBA 9,531 8,675 4,712 4,545 5,266
Installment loans 5,112 2,402 13,339 2,260 2,205
Standby letters of credit 522 380 438 913 713
------- ------- ------- ------- -------
Total commitments $40,708 $30,491 $32,309 $25,817 $18,960
======= ======= ======= ======= =======
The Company makes loans to borrowers in a number of different industries. Other
than Manufactured Housing, no single industry comprises 10% or more of the
Company's loan portfolio. At December 31, 2003, Manufactured Housing comprised
15.7% of the Company's loan portfolio. Commercial real estate loans and SBA
loans comprised over 10% of the Company's loan portfolio as of December 31, 2002
and 2003, but consisted of diverse borrowers. Although the Company does not
have significant concentrations in its loan portfolio, the ability of the
Company's customers to honor their loan agreements is dependent upon, among
other things, the general economy of the Company's market areas.
The following table summarizes the activity in the Company's allowance for loan
losses for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(in thousands)
Average gross loans, held for investment $202,563 $218,317 $267,402 $297,574 $260,709
Gross loans at end of year, held for
investment 206,912 208,522 237,989 302,476 297,616
Allowance for loan losses, beginning of year $ 5,950 $ 8,275 $ 6,746 $ 5,529 $ 3,374
Loans charged off:
Commercial 445 1 614 410 -
Real estate 471 2,474 3,129 1,216 2,093
Installment 3 - - 446 -
Short-term consumer 902 3,162 2,478 2 -
Securitized 2,512 4,012 4,358 3,674 1,943
--------- --------- --------- --------- ---------
Total 4,333 9,649 10,580 5,748 4,036
--------- --------- --------- --------- ---------
Recoveries of loans previously charged off
Commercial 88 71 40 154 -
Real estate 42 396 171 17 32
Short-term consumer 672 1,392 400 - -
Securitized 588 566 378 1 26
--------- --------- --------- --------- ---------
Total 1,390 2,425 990 171 58
--------- --------- --------- --------- ---------
Net loans charged off 2,943 7,224 9,590 5,577 3,977
Provision for loan losses 1,669 4,899 11,881 6,794 6,133
Adjustments due to Palomar purchase/sale - - (762) - -
--------- --------- --------- --------- ---------
Allowance for loan losses, end of year $ 4,676 $ 5,950 $ 8,275 $ 6,746 $ 5,529
========= ========= ========= ========= =========
Ratios:
Net loan charge-offs to average loans 1.5% 3.3% 3.6% 1.9% 1.5%
Net loan charge-offs to loans at end of period 1.4% 3.5% 4.0% 1.8% 1.3%
Allowance for loan losses to loans held for
investment at end of period 2.3% 2.9% 3.5% 2.2% 1.9%
Net loan charge-offs to allowance for loan
losses at beginning of period 49.5% 87.3% 142.2% 100.9% 117.9%
Net loan charge-offs to provision for loan
losses 176.3% 147.5% 80.7% 82.1% 64.8%
-22-
The following table summarizes the allowance for loan losses:
DECEMBER 31,
--------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(dollars in thousands)
PERCENT PERCENT PERCENT PERCENT PERCENT
OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
IN EACH IN EACH IN EACH IN EACH IN EACH
BALANCE AT CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY
END OF PERIOD TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL
APPLICABLE TO: AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
- --------------- ------- --------- ------- --------- ------- --------- ------- --------- ------- ---------
Short-term
consumer $ - 0.0% $ 566 0.6% $ 630 1.2% $ * 0.4% $ - N/A
SBA 1,550 27.0% 1,874 26.6% 1,752 18.8% * 12.5% * *
Manufactured
Housing 372 15.6% 272 11.2% 291 8.9% * 5.0% * *
Securitized 2,024 14.9% 2,571 26.2% 4,189 40.1% 4,042 45.6% 3,516 40.4%
All other loans 730 42.5% 667 35.4% 1,413 31.0% 2,704 36.5% 2,013 59.6%
--------------------------------------------------------------------------------------------------
TOTAL $ 4,676 100% $ 5,950 100% $ 8,275 100% $ 6,746 100% $ 5,529 100%
==================================================================================================
* The detailed information for 1999 and 2000 is not readily available.
Total allowance for loan losses ("ALL") decreased $1.3 million, or 21.4%, from
$6.0 million at December 31, 2002 to $4.7 million at December 31, 2003. Of this
decrease, $566,000, or 43.5%, relates to decrease in the ALL to zero for the
STCL loans; $547,000, or 42.1%, relates to decrease in the ALL for the
securitized loan portfolio; and $202,000 relates to decrease in the ALL for the
SBA loan portfolio. The Relationship Banking and the manufactured housing ALL
increased by a total of $163,000 primarily due to loan growth, which partially
offset the aforementioned decreases.
The securitized loan loss allowance changed primarily due to the significant
principal balance payments in 2003 of $28.8 million, or 43.5%, as well as a
44.5% decrease in net charge-offs from 2002.
The decrease in ALL for the SBA loans is a result of a reduction of $946,000 in
SBA classified loans from $5.4 million at December 31, 2002 to $4.5 million at
December 31, 2003 and a reduction in the related specific ALL reserve deemed
necessary against these loans of $355,000 from 2002 to 2003. The SBA portfolio
has also experienced a decrease in net charge-offs of $833,000, or 56.3%, from
$1.5 million for the year ended December 31, 2002 to $646,000 for the year ended
December 31, 2003.
Loans charged-off, net of recoveries, were $2.9 million in 2003, $7.2 million in
2002 and $9.6 million in 2001. The primary reason for the decline in net
charge-offs in 2003 was the significant paydown in the securitized loan
portfolio and the exit from short-term consumer lending. The Company has also
experienced continued increases in the SBA portfolio credit quality. Towards
the end of 2001, the Company strengthened its underwriting standards in the SBA
program, which management believes has subsequently influenced the decline in
problem loans in the SBA portfolio.
In management's opinion, the balance of the allowance for loan losses was
sufficient to absorb known and inherent probable losses in the loan portfolio as
of December 31, 2003.
The Company recorded $1.7 million as a provision for loan losses in 2003, $4.9
million in 2002 and $11.9 million in 2001. The primary reason for the decrease
in provision expense is the Company's change in portfolio mix to perceived less
risky loans. The Company exited the HLTV and STCL markets and the securitized
loan portfolio paid down by approximately 43.5%.
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
-23-
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. For
collateral dependent loans, the Company uses the fair value of collateral method
to measure impairment. All other loans, except for securitized, are measured for
impairment based on the present value of future cash flows. Impairment is
measured on a loan-by-loan basis for all loans in the portfolio except for the
securitized loans, which are evaluated for impairment on a collective basis.
The recorded investment in loans that are considered to be impaired is as
follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2003 2002 2001 2000 1999
------- -------- -------- -------- --------
(in thousands)
Impaired loans without specific valuation allowances $ - $ - $ - $ 565 $ 3,251
Impaired loans with specific valuation allowances 6,843 8,394 6,587 3,531 1,402
Specific valuation allowance related to impaired loans (640) (1,278) (1,669) (1,207) (1,039)
------- -------- -------- -------- --------
Impaired loans, net $6,203 $ 7,116 $ 4,918 $ 2,889 $ 3,614
======= ======== ======== ======== ========
Average investment in impaired loans $6,584 $ 7,565 $ 5,047 $ 4,677 $ 5,120
======= ======== ======== ======== ========
The following schedule reflects recorded investment at the dates indicated in certain types of loans:
YEAR ENDED DECEMBER 31,
----------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- ------
(in thousands)
Nonaccrual loans $ 7,174 $13,965 $11,413 $ 4,893 **
SBA guaranteed portion of loans included above (4,106) (8,143) (7,825) (2,748) **
-------- -------- -------- -------- ------
Nonaccrual loans, net $ 3,068 $ 5,822 $ 3,588 $ 2,235 $3,091
======== ======== ======== ======== ======
Troubled debt restructured loans $ 193 $ 829 $ 1,093 $ 615 $ 656
Loans 30 through 90 days past due with interest accruing 3,907 5,122 2,607 4,277 2,550
Interest income recognized on impaired loans $ 277 $ 190 $ 1,443 $ 387 $ 244
Interest foregone on nonaccrual loans and
troubled debt restructured loans outstanding 216 1,263 1,146 592 1,585
-------- -------- -------- -------- ------
Gross interest income on impaired loans $ 493 $ 1,453 $ 2,589 $ 979 $1,829
======== ======== ======== ======== ======
** Gross-up information for 1999 comparison not readily available.
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. 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. Interest on nonaccrual 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 nonaccrual loans are impaired.
Total impaired loans decreased by $1.6 million, or 18.5%, in 2003. The specific
valuation allowances allocated to impaired loans also decreased, which resulted
in a net decrease in impaired loans of $913,000, or 12.8%.
Financial difficulties encountered by certain borrowers may cause the Company to
restructure the terms of their loan to facilitate loan repayment. A troubled
debt restructured loan ("TDR") would generally be considered impaired. The
balance of impaired loans disclosed above includes all TDRs that, as of December
31, 2003, 2002 and 2001, are considered impaired. Total TDRs decreased by
76.7%, or $636,000, from $829,000 to $193,000 as of December 31, 2002 and 2003,
respectively.
The Company's net nonaccrual loans also decreased from December 31, 2002 to
December 31, 2003. This decrease is primarily a result in the improvements in
credit quality experienced in the SBA loan portfolio.
-24-
INVESTMENT PORTFOLIO
- ---------------------
The following table summarizes the carrying values of the Company's investment
securities for the years indicated:
YEAR ENDED DECEMBER 31,
-----------------------
2003 2002 2001
------- ------ -----
Held-to-maturity securities (in thousands)
- ---------------------------
U.S. Government and agency $ 200 $ 707 $ 118
Other (1) 4,836 5,035 -
------- ------ -----
Total held-to-maturity securities $ 5,036 $6,012 $ 118
======= ====== =====
Available-for-sale securities
- -----------------------------
U.S. Government and agency $ 7,024
Other (1) 8,408
-------
Total available-for-sale securities $15,432
=======
At December 31, 2003, $200,000 at carrying value of the above held-to-maturity
securities were pledged as collateral to the U.S. Treasury for its treasury, tax
and loan account and $14,680,000 at carrying value were pledged under repurchase
agreements, which are treated as collateralized financing transactions.
The following tables summarize the maturity period and weighted average yields
of the Company's investment securities at December 31, 2003.
LESS THAN ONE ONE TO FIVE FIVE TO TEN
TOTAL AMOUNT YEAR YEARS YEARS OVER TEN YEARS
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------- ------ ------- ------ ------- ------- ------- ------ ------ -----
(dollars in thousands)
Held-to-maturity securities
- ---------------------------
U.S. Government
and agency $ 200 2.5% $ 200 2.5% $ - $ -
Other (1) 4,836 5.2% 1,007 5.0% 2,738 5.2% 1,091 5.5%
------- ------- ------- -------
Total HTM $ 5,036 5.1% $ 1,207 4.6% $ 2,738 5.2% $ 1,091 5.5%
======= ======= ======= =======
Available-for-sale securities
- -----------------------------
U.S. Government
and agency $ 7,024 3.0% $ 3,048 2.3% $ 3,977 3.5%
Other (1) 8,408 3.9% 4,107 4.7% 4,300 3.3%
------- ------- -------
Total AFS $15,432 3.5% $ 7,155 3.7% $ 8,277 3.4%
======= ======= =======
(1) Consists of pass-through mortgage backed securities and collateralized mortgage obligations.
Mortgage-backed securities and collateralized mortgage obligations are
distributed in total based on average expected maturities.
Interest-Only Strips and Servicing Assets
As of December 31, 2003 and 2002, the Company held interest-only strips in the
amount of $3.6 million and $4.6 million, respectively. These interest-only
strips represent the present value of the right to the estimated net cash flows
generated by SBA loans sold. Net cash flows consist of the difference between
(a) interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors and (ii) contractual
servicing fees. The Company also held servicing assets related to SBA loans
sales of $2.5 million and $1.9 million at December 31, 2003 and 2002,
respectively. For loans sold subsequent to March 31, 2002, the initial
servicing assets and resulting gain on sale were calculated based on the
difference between the best actual par and premium bids on an individual loan
basis. The servicing asset balances are subsequently amortized over the
estimated life of the loans using an estimated prepayment rate of 22-25%.
Quarterly, the servicing asset and I/O strip assets are analyzed for impairment.
In 2002, the Company recorded a $1.8 million impairment charge related to the
valuation of the servicing assets and I/O strips. The interest-only strips are
accounted for as investments in debt securities classified as trading
securities. Accordingly, the Company marks them to fair value with the
resulting increase or
-25-
decrease recorded through operations in the current period. At December 31,
2003, all of the servicing assets are related to SBA loan sales.
As of December 31, 2001 and prior to April 1, 2002, the Company utilized a CPR
assumption of 13.44%, which is the weighted average actual prepayment speed
experienced by all serviced loans that have been in the portfolio for more than
two years. This prepayment speed assumption is applied to all loans including
those that have been in the portfolio for less than two years. During the same
period, the Company used discount rates of 9.25% to 10.25%.
LIQUIDITY MANAGEMENT
- ---------------------
The Company has established policies as well as analytical tools to manage
liquidity. Proper liquidity management ensures that sufficient funds are
available to meet normal operating demands in addition to unexpected customer
demand for funds, such as high levels of deposit withdrawals or increased loan
demand, in a timely and cost effective manner. The most important factor in the
preservation of liquidity is maintaining public confidence that facilitates the
retention and growth of core deposits. Ultimately, public confidence is gained
through profitable operations, sound credit quality and a strong capital
position. The Company's liquidity management is viewed from both a long-term
and short-term perspective as well as from an asset and liability perspective.
Management monitors liquidity through regular reviews of maturity profiles,
funding sources and loan and deposit forecasts to minimize funding risk. The
Company has asset/liability committees ("ALCO") at the Board and Bank management
level to review asset/liability management and liquidity issues. The Company
maintains strategic liquidity and contingency plans. Periodically, the Company
has significantly used short-term time certificates from other financial
institutions to meet projected liquidity needs. Recently, the Company has
invested more resources in the purchase of government-guaranteed investment
securities and obtained a financing arrangement, repurchase agreements ("Repos")
that allow it to pledge these securities as collateral for short-term borrowing
in case of increased liquidity needs. Repos give the Company improved
flexibility in managing its liquidity resources. As of December 31, 2003, the
Company had $14.4 million of outstanding Repos, with interest rates of 1.25% to
1.43%, all of which mature within one year.
The Company has recently been approved for membership in the Federal Home Loan
Bank ("FHLB"), which will allow for certain loans to be pledged as collateral to
use as an additional, and generally less expensive, funding source. The Company
also has obtained from another financial institution a $6 million Federal Funds
Purchased borrowing line.
The Company, through the Bank, also has the ability as a member of the Federal
Reserve System, to borrow at the discount window up to 50% of what is pledged at
the Federal Reserve Bank. On January 9, 2003, the Reserve Bank replaced the
existing discount window program with new primary and secondary credit programs.
GNB qualifies for primary credit as it has been deemed to be in sound financial
condition. The rate on primary credit will be 50 basis points less than the
secondary credit rate and will generally be granted on a "no questions asked
basis" at a rate that initially will be at 100 basis points above the Federal
Open Market Committee's (FOMC) target federal funds rate (currently at 1.00%).
As the rate is currently not attractive, it is unlikely it will be used as a
regular source of funding, but is noted as available as an alternative funding
source.
The Company has not experienced disintermediation and does not believe this is a
potentially probable occurrence. GNB's core deposits (excluding certificates of
deposit) grew by approximately $10.7 million during 2003. The liquidity ratio of
the Company has steadily increased and was 21%, 25% and 26% at December 31, 2001
and 2002 and 2003, respectively. The liquidity ratio consists of cash and due
from banks, deposits in other financial institutions, available for sale
investments, federal funds sold and loans held for sale, divided by total
assets.
CWBC's routine funding requirements primarily consist of certain operating
expenses. Normally, CWBC obtains funding to meet its obligations from dividends
collected from its subsidiaries and has the capability to issue debt securities.
Federal banking laws regulate the amount of dividends that may be paid by
banking subsidiaries without prior approval.
Interest Rate Risk
The Company is exposed to different types of interest rate risks. These risks
include: lag, repricing, basis and prepayment risk.
- Lag Risk- lag risk results from the inherent timing difference between
the repricing of the Company's adjustable rate assets and liabilities.
For instance, certain loans tied to the prime rate index may only
reprice on a quarterly basis. However, at a community bank such as
GNB, when rates are rising, funding sources tend to reprice more
slowly than the loans. Therefore, for GNB, the effect of this timing
-26-
difference is generally favorable during a period of rising interest
rates and unfavorable during a period of declining interest rates.
This lag can produce some short-term volatility, particularly in times
of numerous prime rate changes. The last prime rate change was
effected on June 27, 2003.
- Repricing Risk - repricing risk is caused by the mismatch in the
maturities / repricing periods between interest-earning assets and
interest-bearing liabilities. If GNB was perfectly matched, the net
interest margin would expand during rising rate periods and contract
during falling rate periods. This is so since loans tend to reprice
more quickly than do funding sources. Typically, since GNB is somewhat
asset sensitive, this would also tend to expand the net interest
margin during times of interest rate increases.
- Basis Risk - item pricing tied to different indices may tend to react
differently, however, all GNB's variable products are priced off the
prime rate.
- Prepayment Risk - prepayment risk results from borrowers paying down /
off their loans prior to maturity. Prepayments on fixed-rate products
increase in falling interest rate environments and decrease in rising
interest rate environments. Since a majority of GNB's loan
originations are adjustable rate and set based on prime, and there is
little lag time on the reset, GNB does not experience significant
prepayments. However, GNB does have more prepayment risk on its
securitized and manufactured housing loans and its mortgage-backed
investment securities. Offsetting the prepayment risk on the
securitized loans are the related bonds payable, which were issued at
a fixed rate. When the bonds payable prepay, given the current
interest rate environment, this reduces GNB's interest expense as a
higher, fixed rate is, in effect, traded for a lower, variable rate
funding source.
Management of Interest Rate Risk
To mitigate the impact of changes in market interest rates on the Company's
interest-earning assets and interest-bearing liabilities, the amounts and
maturities are actively managed. Short-term, adjustable-rate assets are
generally retained as they have similar repricing characteristics as our funding
sources. GNB sells mortgage products and a portion of its SBA loan
originations. While the Company has some interest rate exposure in excess of
five years, it has internal policy limits designed to minimize risk should
interest rates rise. Currently, the Company does not use derivative instruments
to help manage risk, but will consider such instruments in the future if the
perceived need should arise.
Loan sales- The Company's ability to originate, purchase and sell loans is also
significantly impacted by changes in interest rates. Increases in interest
rates may also reduce the amount of loan and commitment fees received by GNB. A
significant decline in interest rates could also decrease the size of the GNB's
servicing portfolio and the related servicing income by increasing the level of
prepayments.
-27-
Operational Risk
Operational risk represents the risk of loss resulting from the Company's
operations, including but not limited to, the risk of fraud by employees or
persons outside the Company, the execution of unauthorized transactions by
employees, transaction processing errors and breaches of internal control system
and compliance requirements. This risk of loss also includes the potential
legal actions that could arise as a result of an operational deficiency or as a
result of noncompliance with applicable regulatory standards, adverse business
decisions or their implementation and customer attrition due to potential
negative publicity.
Operational risk is inherent in all business activities and the management of
this risk is important to the achievement of the Company's objectives. In the
event of a breakdown in the internal control system, improper operation of
systems or improper employee actions, the Company could suffer financial loss,
face regulatory action and suffer damage to its reputation. The Company manages
operational risk through a risk management framework and its internal control
processes. The framework involves business units, corporate risk management
personnel and executive management. Under this framework, the business units
have direct and primary responsibility and accountability for identifying,
controlling and monitoring operational risk. Business unit managers maintain a
system of controls with the objective of providing proper transaction
authorization and execution, proper system operations, safeguarding of assets
from misuse or theft and ensuring the reliability of financial and other data.
Business unit managers ensure that the controls are appropriate and are
implemented as designed. Business continuation and disaster recovery planning
is also critical to effectively manage operational risks. The Company's
internal audit function (currently outsourced to a third party) validates the
system of internal controls through risk-based regular and ongoing audit
procedures and reports on the effectiveness of internal controls to executive
management and the Audit Committee of the Board.
While the Company believes that it has designed effective methods to minimize
operational risks, there is no absolute assurance that business disruption or
operational losses would not occur in the event of disaster.
DEPOSITS
- --------
The following table shows the Company's average deposits for each of the periods
indicated below:
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2003 2002 2001
------------------- ------------------- -------------------
AVERAGE PERCENT AVERAGE PERCENT AVERAGE PERCENT
BALANCE OF TOTAL BALANCE OF TOTAL BALANCE OF TOTAL
-------- --------- -------- --------- -------- ---------
(dollars in thousands)
Noninterest-bearing demand $ 34,400 15.9% $ 31,560 15.6% $ 39,708 17.8%
Interest-bearing demand 35,768 16.5% 29,347 14.5% 22,476 10.1%
Savings 15,480 7.2% 13,270 6.6% 17,056 7.6%
TCDs of $100,000 or more 21,076 9.7% 42,970 21.2% 79,195 35.4%
Other TCDs 109,828 50.7% 85,137 42.1% 65,102 29.1%
-------- --------- -------- --------- -------- ---------
Total Deposits $216,552 100.0% $202,284 100.0% $223,537 100.0%
======== ========= ======== ========= ======== =========
The maturities of time certificates of deposit ("TCD's") were as follows:
DECEMBER 31,
--------------------------------------------
2003 2002
--------------------- ---------------------
TCD'S OVER OTHER TCD'S OVER OTHER
-----------
$100,000 TCD'S $100,000 TCD'S
----------- -------- ----------- --------
(in thousands)
Less than three months $ 7,376 $ 18,824 $ 11,043 $ 20,107
Over three months through six months 5,071 25,209 5,981 17,709
Over six months through twelve months 5,315 43,743 5,265 17,050
Over twelve months through five years 1,911 21,315 3,036 52,648
----------- -------- ----------- --------
Total $ 19,673 $109,091 $ 25,325 $107,514
=========== ======== =========== ========
The deposits of the Company may fluctuate up and down with local and national
economic conditions. However, management does not believe that deposit levels
are significantly influenced by seasonal factors.
-28-
The Company manages its money desk in accordance with its liquidity and
strategic planning. Such deposits increased by $9.0 million during 2003 as the
Company's general funding needs increased due to the increase in loan
originations. The Company can obtain funds when necessary in a short timeframe,
however, it is more expensive as there is substantial competition for these
deposits.
CONTRACTUAL OBLIGATIONS
- ------------------------
The Company has contractual obligations that include long-term debt, deposits,
operating leases and purchase obligations for service providers. The following
table is summary of those obligations at December 31, 2003:
OVER 5
TOTAL < 1 YEAR 1-3 YEARS 3-5 YEARS YEARS
-------- --------- ---------- ---------- -------
(in thousands)
Bonds payable in connection with securitized loans $ 27,440 $ 493 $ 1,116 $ 1,315 $24,516
Time certificates of deposits 128,764 105,538 19,276 3,950 -
Operating lease obligations 2,583 611 1,294 678 -
Purchase obligations for service providers 316 107 166 43 -
-------- --------- ---------- ---------- -------
Total $159,103 $ 106,749 $ 21,852 $ 5,986 $24,516
======== ========= ========== ========== =======
SUPERVISION AND REGULATION OF THE COMPANY
The following discussion of statutes and regulations affecting banks and their
holding companies is only a summary, does not purport to be complete and is
qualified in its entirety by reference to the actual statutes and regulations.
No assurance can be given that the statutes and regulations will not change in
the future. Moreover, any changes may have a material adverse effect on our
business.
GENERAL
The Company, as a bank holding company registered under the Bank Holding Company
Act of 1956, as amended ("BHCA"), and is subject to regulation by the Board of
Governors of the Federal Reserve System ("FRB"). Under FRB regulation, the
Company is expected to act as a source of managerial and financial strength for
its bank subsidiary. It cannot conduct operations in an unsafe or unsound
manner and must commit resources to support its banking subsidiary in
circumstances where the Company might not otherwise do so. Under the BHCA, the
Company and its banking subsidiary are subject to periodic examination by the
FRB. The Company is also required to file periodic reports of its operations
and any additional information regarding its activities and those of its
subsidiaries with the FRB, as may be required.
The Company is also a bank holding company within the meaning of Section 3700 of
the California Financial Code. As such, the Company and its subsidiaries are
subject to examination by, and may be required to file reports with, the
Commissioner of the California Department of Financial Institutions ("DFI").
Regulations have not yet been proposed or adopted or steps otherwise taken to
implement the DFI's powers under this statute.
The Company has a class of securities registered with the Securities Exchange
Commission ("SEC") under Section 12 of the Securities Exchange Act of 1934
("1934 Act") and has its common stock listed on the National Association of
Securities Dealers ("Nasdaq"). Consequently, the Company is subject to
supervision and regulation of the SEC and compliance with the listing
requirements of the Nasdaq.
RECENT LEGISLATION
THE SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act of 2002 ("SOX") became effective in July 2002 for all
public companies. SOX is designed to protect investors in capital markets by
improving the accuracy and reliability of corporate disclosures of public
companies. It is designed to address weaknesses in the audit process, financial
reporting systems and controls and broker-dealer networks surrounding companies
that have a class of securities registered under Section 12 of the 1934 Act or
are otherwise reporting to the SEC pursuant to Section 15(d) of the 1934 Act
(collectively, "public companies"). It is intended that by addressing these
weaknesses, public companies will be able to avoid the problems previously
encountered by many notable public companies.
The provisions of SOX and regulations issued by the SEC and the National
Association of Securities Dealers has a direct and significant impact on banks
and bank holding companies that are public companies. Sox has resulted in the
following:
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Enhanced Financial Disclosure and Reports
- Certification of financial statements
- Disclosure of material information
Enhanced Accounting Oversight, Board Independence and Conflicts of Interest
Rules
- Public Accounting Oversight Board
- Auditor independence
- Independent Audit Committees
- Code of ethics
- Independent Board of Directors
- Independent Nominating and Compensation Committees
- Director and executive officer loans
- Stock option plans
- Attorney conduct
Enhanced Enforcement Powers and Penalties
- Document destruction
- Forfeiture for restated financial statements
- No discharge in bankruptcy
- Power to freeze funds
- Whistleblower protection
- Securities fraud felony
- Extended statue of limitation
Compliance with SOX is expected to continue to result in additional expenditures
by the Company in auditor's fees, director's fees, attorney's fees, outside
advisor fees, increased errors and omissions premium costs and other costs to
satisfy the new requirements for corporate governance imposed by the rules and
regulations of SOX.
THE CALIFORNIA CORPORATE DISCLOSURE ACT
On January 1, 2003, the California Corporate Disclosure Act ("CCD") became
effective. The new law requires that all "publicly traded companies" file with
the California Secretary of State a statement on an annual basis that includes
at least the following information:
- The name of the independent auditor for the publicly traded company, a
description of the services rendered by the auditor during the
previous 24 months, the date of the last audit and a copy of the
report
- The annual compensation paid to each director and executive officer
including options or shares granted to them that were not available to
other employees of the company
- A description of any loans made to any director at a preferential loan
rate during the previous 24 months including the amount and terms
- A statement indicating whether any bankruptcy has been filed by the
company's executive officers or directors during the past 10 years
- The statement indicating whether any member of the Board of Directors
or executive officer was convicted of fraud during the past 10 years
- A statement indicating whether the corporation has been adjudicated as
guilty of having violated any federal securities laws or any banking
or securities laws of California during the past 10 years which a
judgment of over $10,000 was imposed
For purposes of the CCD, a "publicly traded company" is any company whose
securities are listed on a national or foreign exchange or which is the subject
of a two-way quotation system that is regularly published.
BANK HOLDING COMPANY LIQUIDITY
The Company is a legal entity, separate and distinct from GNB. Although it has
the ability to raise capital on its own behalf or borrow from external sources,
the Company may also obtain additional funds through dividends paid by, and fees
for services provided to, GNB. However, regulatory constraints may restrict or
totally preclude GNB from paying dividends to the Company. See "- Limitations
on Dividend Payments."
The FRB's policy regarding dividends provides that a bank holding company should
not pay cash dividends
-30-
exceeding its net income or which can only be funded in ways, such as by
borrowing, that weaken the bank holding company's financial health or its
ability to act as a source of financial strength to its subsidiary banks. The
FRB also possesses enforcement powers over bank holding companies and their
non-bank subsidiaries to prevent or remedy actions that represent unsafe or
unsound practices or violations of applicable statutes and regulations.
TRANSACTIONS WITH AFFILIATES
The Company and any subsidiaries it may purchase or organize are deemed to be
affiliates of the bank subsidiary within the meaning of Sections 23A and 23B of
the Federal Reserve Act, herein referred to as the "FRA," as amended. Pursuant
thereto, loans by GNB to affiliates, investments by GNB in affiliates' stock and
taking affiliates' stock as collateral for loans to any borrower will be limited
to 10% of GNB's capital, in the case of any one affiliate, and will be limited
to 20% of GNB's capital in the case of all affiliates. In addition, such
transactions must be on terms and conditions that are consistent with safe and
sound banking practices. Specifically, a bank and its subsidiaries generally
may not purchase from an affiliate a low-quality asset, as defined in the FRA.
Such restrictions also prevent a bank holding company and its other affiliates
from borrowing from a banking subsidiary of the bank holding company unless the
loans are secured by marketable collateral of designated amounts. The Company
and GNB are also subject to certain restrictions with respect to engaging in the
underwriting, public sale and distribution of securities. See -"Supervision and
Regulation of the Bank Subsidiary - Significant Legislation."
LIMITATIONS ON BUSINESSES AND INVESTMENT ACTIVITIES
Under the BHCA, a bank holding company must obtain the FRB's approval before:
- directly or indirectly acquiring more than 5% ownership or control of
any voting shares of another bank or bank holding company
- acquiring all or substantially all of the assets of another bank
- merging or consolidating with another bank holding company
The FRB may allow a bank holding company to acquire banks located in any state
of the United States without regard to whether the acquisition is prohibited by
the law of the state in which the target bank is located. In approving
interstate acquisitions, however, the FRB must give effect to applicable state
laws limiting the aggregate amount of deposits that may be held by the acquiring
bank holding company and its insured depository institutions in the state in
which the target bank is located, provided that those limits do not discriminate
against out-of-state depository institutions or their holding companies, and
state laws which require that the target bank have been in existence for a
minimum period of time, not to exceed five years, before being acquired by an
out-of-state bank holding company.
In general, the BHCA prohibits a bank holding company from acquiring direct or
indirect ownership or control of more than 5% of the voting securities of a
company that is not a bank or a bank holding company. However, with FRB
consent, a bank holding company may own subsidiaries engaged in certain
businesses that the FRB has determined to be "so closely related to banking as
to be a proper incident thereto". The Company, therefore, is permitted to
engage in a variety of banking-related businesses. Some of the activities that
the FRB has determined, pursuant to its Regulation Y, to be related to banking
are:
- making or acquiring loans or other extensions of credit for its own
account or for the account of others
- servicing loans and other extensions of credit
- operating a trust company in the manner authorized by federal or state
law under certain circumstances
- leasing personal and real property or acting as agent, broker, or
adviser in leasing such property in accordance with various
restrictions imposed by FRB regulations
- acting as investment or financial advisor
- providing management consulting advice under certain circumstances
- providing support services, including courier services and printing
and selling MICR-encoded items
- acting as a principal, agent or broker for insurance under certain
circumstances
- making equity and debt investments in corporations or projects
designed primarily to promote community welfare or jobs for residents
- providing financial, banking or economic data processing and data
transmission services
- owning, controlling or operating a savings association under certain
circumstances
- selling money orders, travelers' checks and U.S. Savings Bonds
- providing securities brokerage services, related securities credit
activities pursuant to Regulation T and
-31-
other incidental activities
- underwriting and dealing in obligations of the United States, general
obligations of states and their political subdivisions and other
obligations authorized for state member banks under federal law
Generally, the BHCA does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
Federal law prohibits a bank holding company and any subsidiary banks from
engaging in certain tie-in arrangements in connection with the extension of
credit. Thus, for example, GNB may not extend credit, lease or sell property,
or furnish any services, or fix or vary the consideration for any of the
foregoing on the condition that:
- the customer must obtain or provide some additional credit, property
or services from or to GNB other than a loan, discount, deposit or
trust service
- the customer must obtain or provide some additional credit, property
or service from or to the Company or GNB
- the customer may not obtain some other credit, property or services
from competitors, except reasonable requirements to assure soundness
of credit extended
In 1999, the Gramm-Leach-Bliley Act ("GLB") was enacted. GLB significantly
changed the regulatory structure and oversight of the financial services
industry. GLB permits banks and bank holding companies to engage in previously
prohibited activities under certain conditions. Also, under certain conditions,
banks and bank holding companies may affiliate with other financial service
providers such as insurance companies and securities firms. Consequently, a
qualifying bank holding company, called a financial holding company ("FHC"), can
engage in a full range of financial activities, including banking, insurance and
securities activities, as well as merchant banking and additional activities
that are beyond those traditionally permitted for bank holding companies.
Moreover, various non-bank financial service providers who were previously
prohibited from engaging in banking can now acquire banks while also offering
services such as securities underwriting and underwriting and brokering
insurance products. GLB also expands passive investment activities by FHCs,
permitting them to indirectly invest in any type of company, financial or
non-financial, through merchant banking activities and insurance company
affiliations. See "- Supervision and Regulation of the Bank Subsidiary -
Significant Legislation."
CAPITAL ADEQUACY
Bank holding companies must maintain minimum levels of capital under the FRB's
risk based capital adequacy guidelines. If capital falls below minimum
guideline levels, a bank holding company, among other things, may be denied
approval to acquire or establish additional banks or non-bank businesses.
The FRB's risk-based capital adequacy guidelines for bank holding companies and
state member banks, discussed in more detail below (see "- Supervision and
Regulation of the Bank Subsidiary - Risk-Based Capital Guidelines"), assign
various risk percentages to different categories of assets and capital is
measured as a percentage of those risk assets. Under the terms of the
guidelines, bank holding companies are expected to meet capital adequacy
guidelines based both on total risk assets and on total assets, without regard
to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will
be required if warranted by the particular circumstances or risk profiles of
individual organizations. For example, the FRB's capital guidelines contemplate
that additional capital may be required to take adequate account of, among other
things, interest rate risk, the risks posed by concentrations of credit or risks
associated with nontraditional banking activities or securities trading
activities. Moreover, any banking organization experiencing or anticipating
significant growth or expansion into new activities, particularly under the
expanded powers of GLB, may be expected to maintain capital ratios, including
tangible capital positions, well above the minimum levels.
LIMITATIONS ON DIVIDEND PAYMENTS
The Company is entitled to receive dividends when and as declared by GNB's
Board, out of funds legally available for dividends, as specified and limited by
the OCC's regulations. Pursuant to the OCC's regulations, funds available for a
national bank's dividends are restricted to the lesser of the bank's: (i)
retained earnings; or (ii) net income for the current and past two fiscal years
(less any dividends paid during that period), unless approved by the OCC.
Furthermore, if the OCC determines that a dividend would cause a bank's capital
to be impaired or that payment would cause it to be undercapitalized, the OCC
can prohibit payment of a dividend notwithstanding that funds are legally
available.
-32-
Since GNB is an FDIC insured institution, it is also possible, depending upon
its financial condition and other factors, that the FDIC could assert that the
payment of dividends or other payments might, under some circumstances,
constitute an unsafe or unsound practice and, thus, prohibit those payments.
As a California corporation, the Company's ability to pay dividends is subject
to the dividend limitations of the California Corporations Code ("CCC").
Section 500 of the CCC allows the Company to pay a dividend to its shareholders
only to the extent that the Company has retained earnings and, after the
dividend, the Company meets the following criteria:
- its assets (exclusive of goodwill and other intangible assets) would
be 1.25 times its liabilities (exclusive of deferred taxes, deferred
income and other deferred credits); and
- its current assets would be at least equal to its current liabilities.
SUPERVISION AND REGULATION OF THE BANK SUBSIDIARY
GENERAL
Banking is a complex, highly regulated industry. The primary goals of the
regulatory scheme are to maintain a safe and sound banking system, protect
depositors and the FDIC's insurance fund and facilitate to 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 financial services industry.
Consequently, GNB's growth and earnings performance can be affected not only by
management decisions and general economic conditions, but also by the
requirements of applicable state and federal statutes, regulations and the
policies of various governmental regulatory authorities, including the OCC, FDIC
and FRB.
The system of supervision and regulation applicable to GNB governs most aspects
of GNB's business, including:
- the scope of permissible business
- investments
- reserves that must be maintained against deposits
- capital levels that must be maintained
- the nature and amount of collateral that may be taken to secure loans
- the establishment of new branches
- mergers and consolidations with other financial institutions
- the payment of dividends
GNB, as a national banking association member, is also a member of the Federal
Reserve System, and is subject to regulation, supervision and regular
examination by the OCC, FDIC and FRB. GNB's deposits are insured by the FDIC up
to the maximum extent provided by law. The regulations of these agencies govern
most aspects of the GNB's business. California law exempts all banks from usury
limitations on interest rates.
The following summarizes the material elements of the regulatory framework that
applies to GNB. It does not describe all of the statutes, regulations and
regulatory policies that are applicable. Also, it does not restate all of the
requirements of the statutes, regulations and regulatory policies that are
described. Consequently, the following summary is qualified in its entirety by
reference to the applicable statutes, regulations and regulatory policies may
have material effect on GNB's business.
SIGNIFICANT LEGISLATION
In 1999, GLB was signed into law, significantly changing the regulatory
structure and oversight of the financial services industry. GLB repealed the
provisions of the Glass-Steagall Act that restricted banks and securities firms
from affiliating. It also revised the BHCA to permit an FHC to engage in a full
range of financial activities, including banking, insurance, securities and
merchant banking activities. It also permits FHCs to acquire many types of
financial firms without the FRB's prior approval.
GLB thus provides expanded financial affiliation opportunities for existing bank
holding companies and permits other financial service providers to acquire banks
and become bank holding companies without ceasing any existing financial
activities. Previously, a bank holding company could only engage in activities
that were "closely related to banking." This limitation no longer applies to
bank holding companies that qualify to be treated as FHC's. To qualify as an
FHC, a bank holding company's subsidiary depository institutions must be
"well-capitalized," "well-managed" and have at least a "satisfactory" Community
Reinvestment Act, herein referred to as "CRA,"
-33-
examination rating. "Non-qualifying" bank holding companies are limited to
activities that were permissible under the BHCA as of November 11, 1999.
GLB changed the powers of national banks and their subsidiaries and made similar
changes in the powers of state-chartered banks and their subsidiaries. National
banks may now underwrite, deal in and purchase state and local revenue bonds.
Subsidiaries of national banks may now engage in financial activities that the
bank cannot itself engage in, except for general insurance underwriting and real
estate development and investment. For a subsidiary of a national bank to
engage in these new financial activities, the national bank and its depository
institution affiliates must be "well capitalized," have at least "satisfactory"
general, managerial and CRA examination ratings and meet other qualification
requirements relating to total assets, subordinated debt, capital, risk
management and affiliate transactions. Subsidiaries of state-chartered banks
can exercise the same powers as national bank subsidiaries if they satisfy the
same qualifying rules that apply to national banks, except that state-chartered
banks do not have to satisfy the managerial and debt rating requirements
applicable to national banks.
GLB also reformed the overall regulatory framework of the financial services
industry. To implement its underlying purposes, GLB preempted conflicting state
laws that would restrict the types of financial affiliations that are authorized
or permitted under GLB, subject to specified exceptions for state insurance laws
and regulations. With regard to securities laws, effective May 12, 2001, GLB
removed the current blanket exemption for banks from being considered brokers or
dealers under the Securities Exchange Act of 1934 and replaced it with a number
of more limited exemptions. Thus, previously exempted banks may become subject
to the broker-dealer registration and supervision requirements of the Securities
Exchange Act of 1934. The exemption that prevented bank holding companies and
banks that advised mutual funds from being considered investment advisers under
the Investment Advisers Act of 1940 was also eliminated.
Separately, GLB imposes customer privacy requirements on any company engaged in
financial activities. Under these requirements, a financial company is required
to protect the security and confidentiality of customer nonpublic personal
information. Also, for customers that obtain a financial product such as a loan
for personal, family or household purposes, a financial company is required to
disclose its privacy policy to the customer at the time the relationship is
established and annually thereafter, including its policies concerning the
sharing of the customer's nonpublic personal information with affiliates and
third parties. If an exemption is not available, a financial company must
provide consumers with a notice of its information sharing practices that allows
the consumer to reject the disclosure of its nonpublic personal information to
third parties. Third parties that receive such information are subject to the
same restrictions as the financial company on the reuse of the information. A
financial company is prohibited from disclosing an account number or similar
item to a third party for use in telemarketing, direct mail marketing or other
marketing through electronic mail.
RISK-BASED CAPITAL GUIDELINES
General. The federal banking agencies have established minimum capital standards
- -------
known as risk-based capital guidelines. These guidelines are intended to provide
a measure of capital that reflects the degree of risk associated with a bank's
operations. The risk-based capital guidelines include both a new definition of
capital and a framework for calculating the amount of capital that must be
maintained against a bank's assets and off-balance sheet items. The amount of
capital required to be maintained is based upon the credit risks associated with
the various types of a bank's assets and off-balance sheet items. A bank's
assets and off-balance sheet items are classified under several risk categories,
with each category assigned a particular risk weighting from 0% to 100%. The
bank's risk-based capital ratio is calculated by dividing its qualifying capital
(numerator) by the combined risk weights of its assets and off-balance sheet
items (denominator). A bank's total qualifying capital consists of two types of
capital components: "core capital elements," known as Tier 1 capital, and
"supplementary capital elements," known as Tier 2 capital. The Tier 1 component
of a bank's qualifying capital must represent at least 50% of total qualifying
capital and may consist of the following items that are defined as core capital
elements:
- common stockholders' equity and qualifying non-cumulative perpetual
preferred stock (including related surplus)
- minority interests in the equity accounts of consolidated subsidiaries
The Tier 2 component of a bank's total qualifying capital may consist of the
following items:
- a portion of the allowance for loan and lease losses
- certain types of perpetual preferred stock and related surplus
-34-
- certain types of hybrid capital instruments and mandatory convertible
debt securities
- a portion of term subordinated debt and intermediate-term preferred
stock, including related surplus
Risk Weighted Assets and Off-Balance Sheet Items. Assets and credit equivalent
- --------------------------------------------------
amounts of off-balance sheet items are assigned to one of several broad risk
classifications, according to the obligor or, if relevant, the guarantor or the
nature of the collateral. The aggregate dollar value of the amount in each risk
classification is then multiplied by the risk weight associated with that
classification. The resulting weighted values from each of the risk
classifications are added together. This total is the bank's total risk
weighted assets.
A two-step process determines risk weights for off-balance sheet items, such as
unfunded loan commitments, letters of credit and recourse arrangements. First,
the "credit equivalent amount" of the off-balance sheet items is determined, in
most cases by multiplying the off-balance sheet item by a credit conversion
factor. Second, the credit equivalent amount is treated like any balance sheet
asset and is assigned to the appropriate risk category according to the obligor
or, if relevant, the guarantor or the nature of the collateral. This result is
added to the bank's risk-weighted assets and comprises the denominator of the
risk-based capital ratio.
Minimum Capital Standards. The supervisory standards set forth below specify
- ---------------------------
minimum capital ratios based primarily on broad risk considerations. The
risk-based ratios do not take explicit account of the quality of individual
asset portfolios or the range of other types of risks to which banks may be
exposed, such as interest rate, liquidity, market or operational risks. For
this reason, banks are generally expected to operate with capital positions
above the minimum ratios.
All banks are required to meet a minimum ratio of qualifying total capital to
risk weighted assets of 8%. At least 4% must be in the form of Tier 1 capital,
net of goodwill. The maximum amount of supplementary capital elements that
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of
goodwill. In addition, the combined maximum amount of term subordinated debt
and intermediate-term preferred stock that qualifies as Tier 2 capital for
risk-based capital purposes is limited to 50% of Tier 1 capital. The maximum
amount of the allowance for loan and lease losses that qualifies as Tier 2
capital is limited to 1.25% of gross risk weighted assets. The allowance for
loan and lease losses in excess of this limit may, of course, be maintained, but
would not be included in a bank's risk-based capital calculation.
The federal banking agencies also require all banks to maintain a minimum amount
of Tier 1 capital to total assets, referred to as the leverage ratio. For a
bank rated in the highest of the five categories used by regulators to rate
banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For
all banks not rated in the highest category, the minimum leverage ratio must be
at least 4% to 5%. These uniform risk-based capital guidelines and leverage
ratios apply across the industry. Regulators, however, have the discretion to
set minimum capital requirements for individual institutions, which may be
significantly above the minimum guidelines and ratios.
OTHER FACTORS AFFECTING MINIMUM CAPITAL STANDARDS
The federal banking agencies have established certain benchmark ratios of loan
loss reserves to be held against classified assets. The benchmark by federal
banking agencies is the sum of:
- 100% of assets classified loss
- 50% of assets classified doubtful
- 15% of assets classified substandard and
- estimated credit losses on other assets over the upcoming 12 months
The federal risk-based capital rules adopted by banking agencies take into
account bank's concentrations of credit and the risks of engaging in
non-traditional activities. Concentrations of credit refers to situations where
a lender has a relatively large proportion of loans involving a single borrower,
industry, geographic location, collateral or loan type. Non-traditional
activities are considered those that have not customarily been part of the
banking business, but are conducted by a bank as a result of developments in,
for example, technology, financial markets or other additional activities
permitted by law or regulation. The regulations require institutions with high
or inordinate levels of risk to operate with higher minimum capital standards.
The federal banking agencies also are authorized to review an institution's
management of concentrations of credit risk for adequacy and consistency with
safety and soundness standards regarding internal controls, credit underwriting
or other operational and managerial areas.
The federal banking agencies also limit the amount of deferred tax assets that
are allowable in computing a bank's regulatory capital. Deferred tax assets
that can be realized for taxes paid in prior carryback years and from future
reversals of existing taxable temporary differences are generally not limited.
However, deferred tax assets that can
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only be realized through future taxable earnings are limited for regulatory
capital purposes to the lesser of:
- the amount that can be realized within one year of the quarter-end
report date, or
- 10% of Tier 1 capital
The amount of any deferred tax in excess of this limit would be excluded from
Tier 1 capital, total assets and regulatory capital calculations.
The federal banking agencies have also adopted a joint agency policy statement
that provides that the adequacy and effectiveness of a bank's interest rate risk
management process and the level of its interest rate exposure is a critical
factor in the evaluation of the bank's capital adequacy. A bank with material
weaknesses in its interest rate risk management process or high levels of
interest rate exposure relative to its capital will be directed by the federal
banking agencies to take corrective actions. Financial institutions which have
significant amounts of their assets concentrated in high risk loans or
nontraditional banking activities, and who fail to adequately manage these
risks, may be required to set aside capital in excess of the regulatory
minimums.
PROMPT CORRECTIVE ACTION
The federal banking agencies possess broad powers to take prompt corrective
action ("PCA") to resolve the problems of insured banks. Each federal banking
agency has issued regulations defining five capital categories: "well
capitalized", "adequately capitalized", "undercapitalized", "significantly
undercapitalized" and "critically undercapitalized". Under the regulations, a
bank shall be deemed to be:
- "well capitalized" if it has a total risk-based capital ratio of 10%
or more, has a Tier 1 risk-based capital ratio of 6% or more, has a
leverage capital ratio of 5% or more and is not subject to specified
requirements to meet and maintain a specific capital level for any
capital measure
- "adequately capitalized" if it has a total risk-based capital ratio of
8% or more, a Tier 1 risk-based capital ratio of 4% or more and a
leverage capital ratio of 4% or more (3% under certain circumstances)
and does not meet the definition of "well capitalized"
- "undercapitalized" if it has a total risk-based capital ratio that is
less than 8%, a Tier 1 risk-based capital ratio that is less than 4%,
or a leverage capital ratio that is less than 4% (3% under certain
circumstances)
- "significantly undercapitalized" if it has a total risk-based capital
ratio that is less than 6%, a Tier 1 risk-based capital ratio that is
less than 3% or a leverage capital ratio that is less than 3%; and
- "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2%
Banks are prohibited from paying dividends or management fees to controlling
persons or entities if, after making the payment, the bank would be
"undercapitalized," that is, the bank fails to meet the required minimum level
for any relevant capital measure. Asset growth and branching restrictions apply
to "undercapitalized" banks. Banks classified as "undercapitalized" are
required to submit acceptable capital plans guaranteed by its holding company,
if any. Broad regulatory authority was granted with respect to "significantly
undercapitalized" banks, including forced mergers, growth restrictions, ordering
new elections for directors, forcing divestiture by its holding company, if any,
requiring management changes and prohibiting the payment of bonuses to senior
management. Even more severe restrictions are applicable to "critically
undercapitalized" banks, those with capital at or less than 2%. Restrictions
for these banks include the appointment of a receiver or conservator after 90
days, even if the bank is still solvent. All of the federal banking agencies
have promulgated substantially similar regulations to implement this system of
PCA.
A bank, based upon its capital levels, that is classified as "well capitalized,"
"adequately capitalized" or "undercapitalized" may be treated as though it were
in the next lower capital category if the appropriate federal banking agency,
after notice and opportunity for hearing, determines that an unsafe or unsound
condition, or an unsafe or unsound practice, warrants such treatment. At each
successive lower capital category, an insured bank is subject to more
restrictions. The federal banking agencies, however, may not treat an
institution as "critically undercapitalized" unless its capital ratios actually
warrant such treatment.
DEPOSIT INSURANCE ASSESSMENTS
The FDIC has implemented a risk-based assessment system in which the deposit
insurance premium relates to the probability that the deposit insurance fund
will incur a loss. The FDIC sets semi-annual assessments in an amount necessary
to maintain or increase the reserve ratio of the insurance fund to at least
1.25% of insured deposits or a higher percentage as determined to be justified
by the FDIC.
Under the risk-based assessment system adopted by the FDIC, banks are
categorized into one of three capital categories, "well capitalized",
"adequately capitalized" and "undercapitalized". Assignment of a bank into a
particular capital category is based on supervisory evaluations by its primary
federal regulator. After being assigned to a
-36-
particular capital category, a bank is classified into one of three supervisory
categories. The three supervisory categories are:
- Group A - financially sound with only a few minor weaknesses
- Group B - demonstrates weaknesses that could result in significant
deterioration
- Group C - poses a substantial probability of loss
The capital ratios used by the FDIC to define "well-capitalized", "adequately
capitalized" and "undercapitalized" are the same as in the prompt corrective
action regulations.
The assessment rates are summarized below, expressed in terms of cents per $100
in insured deposits:
Assessment Rates Supervisory Group
----------------------------------
Capital Group Group A Group B Group C
- ------------------------ ---------- ---------- ----------
1-Well Capitalized 0 3 17
2-Adequately Capitalized 3 10 24
3-Undercapitalized 10 24 27
GNB is currently risk rated a 1B, which translates to well capitalized, group B.
INTERSTATE BANKING AND BRANCHING
Bank holding companies from any state may generally acquire banks and bank
holding companies located in any other state, subject in some cases to
nationwide and state-imposed deposit concentration limits and limits on the
acquisition of recently established banks. Banks also have the ability, subject
to specific restrictions, to acquire by acquisition or merger branches located
outside their home state. The establishment of interstate branches is also
possible in those states with laws that expressly permit it. Interstate
branches are subject to many of the laws of the states in which they are
located.
California law authorizes out-of-state banks to enter California by the
acquisition of, or merger with, a California bank that has been in existence for
at least five years, unless the California bank is in danger of failing or in
certain other emergency situations. Interstate branching into California is,
however, limited to the acquisition of an existing bank.
ENFORCEMENT POWERS
In addition to measures taken under the PCA provisions, insured banks may be
subject to potential enforcement actions by the federal regulators for unsafe or
unsound practices in conducting their businesses, or for violation of any law,
rule, regulation or condition imposed in writing by the regulatory agency or
term of a written agreement with the regulatory agency. Enforcement actions may
include:
- the appointment of a conservator or receiver for the bank
- the issuance of a cease and desist order that can be judicially
enforced
- the termination of the bank's deposit insurance
- the imposition of civil monetary penalties;
- the issuance of directives to increase capital;
- the issuance of formal and informal agreements
- the issuance of removal and prohibition orders against officers,
directors and other institution-affiliated parties
- the enforcement of such actions through injunctions or restraining
orders based upon a judicial determination that the deposit insurance
fund or the bank would be harmed if such equitable relief was not
granted
SAFETY AND SOUNDNESS GUIDELINES
The federal banking agencies have adopted guidelines to assist in identifying
and addressing potential safety and soundness concerns before capital becomes
impaired. These guidelines establish operational and managerial standards
relating to:
- internal controls, information systems and internal audit systems
- loan documentation - credit underwriting
- asset growth
- compensation, fees and benefits
-37-
Additionally, the federal banking agencies have adopted safety and soundness
guidelines for asset quality and for evaluating and monitoring earnings to
ensure that earnings are sufficient for the maintenance of adequate capital and
reserves. If an institution fails to comply with a safety and soundness
standard, the appropriate federal banking agency may require the institution to
submit a compliance plan. Failure to submit a compliance plan or to implement
an accepted plan may result in a formal enforcement action.
The federal banking agencies have issued regulations prescribing uniform
guidelines for real estate lending. The regulations require insured depository
institutions to adopt written policies establishing standards, consistent with
such guidelines, for extensions of credit secured by real estate. The policies
must address loan portfolio management, underwriting standards and loan-to-value
limits that do not exceed the supervisory limits prescribed by the regulations.
CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are focusing greater attention on compliance with
consumer protection laws and their implementing regulations. Examination and
enforcement have become more intense in nature and insured institutions have
been advised to carefully monitor compliance with various consumer protection
laws and their implementing regulations. Banks are subject to many federal
consumer protection laws and their regulations, including:
- Community Reinvestment Act ("CRA")
- Truth in Lending Act ("TILA")
- Fair Housing Act ("FH Act")
- Equal Credit Opportunity Act ("ECOA")
- Home Mortgage Disclosure Act ("HMDA")
- Real Estate Settlement Procedures Act ("RESPA")
- Gramm-Leach-Bliley Act
CRA is intended to encourage insured depository institutions, while operating
safely and soundly, to help meet the credit needs of their communities. CRA
specifically directs the federal bank regulatory agencies, in examining insured
depository institutions, to assess their record of helping to meet the credit
needs of their entire community, including low- and moderate-income
neighborhoods, consistent with safe and sound banking practices. CRA further
requires the agencies to take a financial institution's record of meeting its
community credit needs into account when evaluating applications for, among
other things, domestic branches, consummating mergers or acquisitions or holding
company formations.
The federal banking agencies have adopted regulations that measure a bank's
compliance with its CRA obligations on a performance-based evaluation system.
This system bases CRA ratings on an institution's actual lending service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements. The ratings range from a high of "outstanding" to a
low of "substantial noncompliance".
ECOA prohibits discrimination in any credit transaction, whether for consumer or
business purposes, on the basis of race, color, religion, national origin, sex,
marital status, age (except in limited circumstances), receipt of income from
public assistance programs or good faith exercise of any rights under the
Consumer Credit Protection Act. The Federal Interagency Task Force on Fair
Lending issued a policy statement on discrimination in lending. The policy
statement describes the three methods that federal agencies will use to prove
discrimination:
- overt evidence of discrimination
- evidence of disparate treatment
- evidence of disparate impact
If a creditor's actions have had the effect of discriminating, the creditor may
be held liable even when there is no intent to discriminate.
FH Act regulates many practices, including making it unlawful for any lender to
discriminate against any person in its housing-related lending activities
because of race, color, religion, national origin, sex, handicap or familial
status. FH Act is broadly written and has been broadly interpreted by the
courts. A number of lending practices have been found to be, or may be
considered, illegal under FH Act, including some that are not specifically
mentioned in FH Act itself. Among those practices that have been found to be,
or may be considered, illegal under FH Act are:
- declining a loan for the purposes of racial discrimination
- making excessively low appraisals of property based on racial
considerations
-38-
- pressuring, discouraging or denying applications for credit on a
prohibited basis
- using excessively burdensome qualifications standards for the purpose
or with the effect of denying housing to minority applicants
- imposing on minority loan applicants more onerous interest rates or
other terms, conditions or requirements
- racial steering or deliberately guiding potential purchasers to or
away from certain areas because of race
TILA is designed to ensure that credit terms are disclosed in a meaningful way
so that consumers may compare credit terms more readily and knowledgeably. As a
result of TILA, all creditors must use the same credit terminology and
expressions of rates, the annual percentage rate, the finance charge, the amount
financed, the total payments and the payment schedule. HMDA grew out of public
concern over credit shortages in certain urban neighborhoods. One purpose of
HMDA is to provide public information that will help show whether financial
institutions are serving the housing credit needs of the neighborhoods and
communities in which they are located. HMDA also includes a "fair lending"
aspect that requires the collection and disclosure of data about applicant and
borrower characteristics as a way of identifying possible discriminatory lending
patterns and enforcing anti-discrimination statutes. HMDA requires institutions
to report data regarding applications for one-to-four family real estate loans,
home improvement loans and multifamily loans, as well as information concerning
originations and purchases of those types of loans. Federal bank regulators
rely, in part, upon data provided under HMDA to determine whether depository
institutions engage in discriminatory lending practices.
RESPA requires lenders to provide borrowers with disclosures regarding the
nature and costs of real estate settlements. Also, RESPA prohibits certain
abusive practices, such as kickbacks, and places limitations on the amount of
escrow accounts.
GLB required disclosure of the bank's privacy policy at the time the customer
relationship is established and annually thereafter. Under the provisions of
GLB, financial institutions must put systems in place to safeguard the
non-public personal information of its customers.
Violations of these various consumer protection laws and regulations can result
in civil liability to the aggrieved party, regulatory enforcement including
civil money penalties and even punitive damages.
OTHER ASPECTS OF BANKING LAW
GNB is also subject to federal and state statutory and regulatory provisions
covering, among other things, security procedures, currency and foreign
transactions reporting, insider and affiliated party transactions, management
interlocks, electronic funds transfers, funds availability and truth-in-savings.
There are also a variety of federal statutes that regulate acquisitions of
control and the formation of bank holding companies.
IMPACT OF MONETARY POLICIES
Banking is a business that depends on rate differentials. In general, the
difference between the interest rate paid by a bank on its deposits and its
other borrowings and the interest rate earned on its loans, securities and other
interest-earning assets comprises the major source of GNB's earnings. These
rates are highly sensitive to many factors which are beyond GNB's control and,
accordingly, the earnings and growth of GNB are subject to the influence of
economic conditions generally, both domestic and foreign, including inflation,
recession and unemployment and also to the influence of monetary and fiscal
policies of the United States and its agencies, particularly the FRB. The FRB
implements national monetary policy, such as seeking to curb inflation and
combat recession, by:
- Open-market dealings in U.S. government securities
- Adjusting the required level of reserves for financial institutions
subject to reserve requirements
- Placing limitations upon savings and time deposit interest rates
- Adjusting the discount rate applicable to borrowings by banks which
are members of the FRB
The actions of the FRB in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates. Since January 2001,
the FRB has decreased interest rates numerous times. The nature and timing of
any future changes in the FRB's policies and their impact on the Company and GNB
cannot be predicted, however, depending on the degree to which our
interest-earning assets and interest-bearing liabilities are rate sensitive,
increases in rates would have a temporary effect of increasing our net interest
margin, while decreases in interest rates would have the opposite effect. In
addition, adverse economic conditions could make a higher provision for loan
losses a prudent course and could cause higher loan charge-offs, thus adversely
affecting our net income or other operating costs. See Interest Rate Risk- page
26.
-39-
CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are more fully described in Note 1 of the
Consolidated Financial Statements. As disclosed in Note 1, the preparation of
financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and assumptions about
future events that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ significantly from those
estimates. The Company believes that the following discussion addresses the
Company's most critical accounting policies, which are those that are most
important to the portrayal of the Company's financial condition and results of
operations and require management's most difficult, subjective and complex
judgments.
PROVISION AND ALLOWANCE FOR LOAN LOSSES -The Company maintains a detailed,
systematic analysis and procedural discipline to determine the amount of the
allowance for loan losses ("ALL"). The ALL is based on estimates and is
intended to be adequate to provide for probable losses inherent in the loan
portfolio. This process involves deriving probable loss estimates that are
based on individual loan loss estimation, migration analysis/historical loss
rates and management's judgment.
The Company employs several methodologies for estimating probable losses.
Methodologies are determined based on a number of factors, including type of
asset, risk rating, concentrations, collateral value and the input of the
Special Assets group, functioning as a workout unit.
The ALL calculation for the different major loan types is as follows:
- SBA - All loans are reviewed and classified loans are assigned a
specific allowance. Those not assigned to a "watch list" category are
classified as "pass". A migration analysis is then used to calculate
the required allowance on those pass loans.
- Relationship Banking - Includes commercial and real estate mortgage
loans originated by the two branch locations. Classified loans are
assigned a specific allowance. A migration analysis is then used to
calculate the required allowance on the remaining pass loans.
- Manufactured Housing - An allowance is prudently calculated on the
basis of risk rating, which is a combination of delinquency, value of
collateral on classified loans and perceived risk in the product line.
- Securitized Loans - The Company considers this a homogeneous portfolio
and calculates the allowance based on statistical information provided
by the servicer. Charge-off history is calculated based on three
methodologies; a 3-month and a 12-month historical trend and by
delinquency information. The highest requirement of the three methods
is used.
Management reviews the ALL on a monthly basis and records an adjustment as
deemed necessary. The review of the adequacy of the allowance takes into
consideration such factors as changes in the growth, size and composition of the
loan portfolio, overall portfolio quality, review of specific problem loans,
collateral, guarantees and economic conditions that may affect the borrowers'
ability to pay and and/or the value of the underlying collateral. These
estimates depend on the outcome of future events and, therefore, contain
inherent uncertainties.
The Company's ALL 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. Generally, the
Company charges off any loan classified as a "loss"; portions of loans which are
deemed to be uncollectible; overdrafts which have been outstanding for more than
30 days; and, all other unsecured loans past due 120 or more days. Subsequent
recoveries, if any, are credited to the ALL.
INTEREST ONLY STRIPS AND SERVICING ASSETS - The Company originates certain loans
for the purpose of selling either a portion of, or the entire loan, into the
secondary market. SBA loans can be sold into the secondary market. Servicing
assets are recognized as separate assets when loans are sold with servicing
retained. Servicing assets are amortized in proportion to, and over the period
of, estimated future net servicing income. Also, at the time of the loan sale,
it is the Company's policy to recognize the related gain on the loan sale in
accordance with generally accepted accounting principles. The Company uses its
prepayment experience and industry statistics in estimating the expected life of
the loans. Quarterly, management evaluates servicing assets for impairment.
Servicing assets are evaluated for impairment based on the fair value of the
rights as compared to amortized cost on a loan-by-loan basis. Fair value is
determined using discounted future cash flows calculated on a loan-by-loan basis
and aggregated
-40-
to the total asset level. Impairment to the asset is recorded if the aggregate
fair value calculation drops below net book value of the asset.
Additionally, on certain SBA loan sales, the Company has retained interest only
("I/O Strips"), which represent the present value of excess net cash flows
generated by 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 April 1, 2002, the
Company determined the present value of this estimated cash flow at the time
each loan sale transaction closed, utilizing valuation assumptions as to
discount rate, prepayment rate and default rate appropriate for each particular
transaction. For loans sold after March 31, 2002, the initial servicing assets
and resulting gain on sale were calculated based on the difference between the
best actual par and premium bids on an individual loan basis. This same
methodology would apply to the initial valuation of any new I/O strip assets.
As the Company did not sell any loans for par during 2003, there were no
additions to the I/O strips using the new assumptions. Periodically, the
Company verifies the reasonableness of its valuation estimates by comparison to
the results of an independent third party valuation analysis.
The I/O strips are classified as trading securities. Accordingly, the Company
records the I/O's strips at fair value with the resulting increase or decrease
in fair value being recorded through operations in the current period. For the
years ended December 31, 2003, 2002 and 2001, net decreases in fair value of
$1,000,000, $3,385,000 and $2,694,000, respectively, are included in the income
statement as reductions to loan servicing income.
SECURITIZED LOANS AND BONDS PAYABLE - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
trusts ("Trusts"). The transfers have been accounted for as secured borrowings
with a pledge of collateral and, accordingly, the mortgage loans and related
bonds issued are included on the Company's balance sheet. Such loans are
accounted for in the same manner as loans held to maturity. Deferred debt
issuance costs and bond discount related to the bonds are amortized on a method
that approximates the level yield basis over the estimated life of the bonds.
OTHER REAL ESTATE OWNED AND IMPAIRED LOANS - The fair value of other real estate
owned or collateral supporting impaired loans is determined from appraisals
obtained from independent appraisers. The Company must also estimate the costs
to dispose of the property. This is generally done based on experience with
similar properties. Subsequent to foreclosure, management periodically performs
a new valuation and the asset is carried at the lower of carrying amount or fair
value. Operating expenses or income, and gains or losses on disposition of such
properties, are charged to current operations.
STOCK OPTIONS - When the Company adopted Statement of Financial Accounting
Standards No. 123 ("SFAS 123), it elected to continue to use the method of
accounting for stock options that did not require recognition of compensation
expense at the time options are granted. Instead, as required by SFAS 123, pro
forma amounts of compensation expense and the pro forma impact on net income and
earnings per share are disclosed each year as if the Company had recognized
compensation expense. The pro forma compensation expense is calculated using
the Black-Scholes model for pricing. For the year 2003, the alternative method
of accounting for stock options would have reduced net income by $208,000, or
$.04 per share, fully diluted.
NEW ACCOUNTING PRONOUNCEMENTS - In January 2003, the Financial Accounting
Standards Board ("FASB") issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51"
which addresses consolidation by business enterprises of variable interest
entities ("VIEs") either: 1) that do not have sufficient equity investment at
risk to permit the entity to refinance its activities without additional
subordinated financial support, or 2) in which the equity investors lack an
essential characteristic of a controlling financial interest. In December 2003,
FASB completed deliberations of proposed modifications to FIN 46 (Revised
Interpretations) resulting in multiple effective dates based on the nature as
well as the creation date of the VIE. VIEs created after January 31, 2003, but
prior to January 1, 2004, may be accounted for either based on the original
interpretation or the Revised Interpretations. However, the Revised
Interpretations must be applied no later than the first quarter of fiscal year
2004. The adoption of FIN 46 as revised is not anticipated to have an impact on
the Company's financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45). FIN 45 changed current practice in the
accounting for, and disclosure of, guarantees. Guarantees meeting the
characteristics described (and not included in a long list of exceptions) are
required to be initially recorded at fair value, which is different from the
general current practice of recording a liability only when a loss is probable
and reasonably estimable, as those terms are defined in FASB Statement No. 5,
Accounting for Contingencies. FIN 45 also requires a guarantor to make
-41-
significant new disclosures for virtually all guarantees. FIN 45 disclosure
requirements are effective for financial statements of interim or annual periods
ended after December 15, 2002, while the initial recognition and initial
measurement provisions are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002 and existing guarantees for the
interim period beginning July 1, 2003. Management does not believe that the
impact of the adoption of this pronouncement will have a material impact on the
Company or its financial statements.
REGULATORY MATTERS
From October 2002 until October 2003, GNB was operating under a Consent Order
with the OCC. In addition, from March 2000 until November 2003, the Company was
operating under a Memorandum of Understanding with the FRB. Under these
agreements, both GNB and the Company were precluded from certain activities.
Among other things, the Company will now be able to pay dividends without prior
approval from the FRB, GNB is no longer subject to specialr risk-based capital
guidelines, GNB may now pursue new products without prior approval of the OCC,
GNB may accept broker deposits and is no longer subject to interest rate caps on
deposits. Also, the termination of these agreements will result in certain
expense savings.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- -------- ---------------------------------------------------------------
The Company's primary market risk is interest rate risk ("IRR"). To minimize
the volatility of net interest income at risk ("NII") and the impact on economic
value of equity ("EVE"), the Company manages its exposure to changes in interest
rates through asset and liability management activities within guidelines
established by the Board's ALCO. ALCO has the responsibility for approving and
ensuring compliance with asset/liability management policies, including IRR
exposure.
To mitigate the impact of changes in interest rates on the Company's
interest-earning assets and interest-bearing liabilities, the Company actively
manages the amounts and maturities. The Company generally retains short-term,
adjustable-rate assets as they have similar re-pricing characteristics as
funding sources. The Company sells substantially all of its mortgage products
and a portion of its SBA loan originations. While the Company has some assets
and liabilities in excess of five years, it has internal policy limits designed
to minimize risk should interest rates rise. Currently, the Company does not
use derivative instruments to help manage risk, but will consider such
instruments in the future if the perceived need should arise.
In 2003, the Company implemented software that enhanced the capabilities to
analyze IRR. Through the ability to download detailed information from various
application programs, combined with assumptions regarding interest rates,
lending and deposit trends and other key factors, the Company is able to
forecast/simulate the effects of both higher and lower interest rates. The
results detailed below indicate the impact, in dollars and percentages, on NII
and EVE of an increase in interest rates of 200 basis points and a decline of
100 basis points compared to a flat interest rate scenario.
- -----------------------------------------------------------------------------------
INTEREST RATE SENSITIVITY 200 BP INCREASE 100 BP DECREASE
---------------- ---------------
2003 2002 2003 2002
------ -------- ------- ------
(dollars in thousands)
Anticipated impact over the next twelve months:
Net interest income (NII) $ 871 $ 959 $ (844) *
6.4% 5.5% (6.2%) *
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
Economic value of equity (EVE) $ 260 $(1,261) $ (815) *
0.7% (2.8%) (2.3%) *
- -----------------------------------------------------------------------------------
* The information for a 100 basis point decline is not available for 2002 from
the outsourced service. For a 200 basis point decline, the results for NII were
a decline in net interest income of $598,000 with an associated percentage
decline of 3.4%, and an increase of $977,000 in EVE with an associated
percentage increase of 2.2%.
In the current interest rate environment, the 100 basis point decline creates a
possible distortion in the resulting decline in EVE due to deposit rate "floors"
established in the model. These floors result in a higher valuation for
deposits and, correspondingly, a negative change to EVE.
For further discussion of interest rate risk, see Item 7.
-42-
Report of Independent Auditors
The Board of Directors and Stockholders
Community West Bancshares:
We have audited the accompanying consolidated balance sheet of Community West
Bancshares and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of income, stockholders' equity, and cash flows for the
years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Community West
Bancshares and subsidiaries at December 31, 2003 and 2002, and the consolidated
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States.
/s/Ernst & Young LLP
Los Angeles, California
February 2, 2004
F-1
THE FOLLOWING REPORT IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN
LLP AND HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Community West Bancshares:
We have audited the accompanying consolidated balance sheets of Community West
Bancshares and subsidiaries (the "Company") as of December 31, 2001 and 2000,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Community West Bancshares and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
Arthur Andersen LLP /s/
Los Angeles, California
March 8, 2002
F-2
COMMUNITY WEST BANCSHARES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------------
2003 2002
------------- -----------
(DOLLARS IN
THOUSANDS)
ASSETS
Cash and due from banks $ 5,758 $ 10,714
Interest-earning deposits in other financial institutions 5,031 -
Federal funds sold 11,267 20,380
------------- -----------
Cash and cash equivalents 22,056 31,094
Time deposits in other financial institutions 792 2,277
Federal Reserve Bank stock, at cost 812 812
Investment securities available-for-sale, at fair value; amortized cost of
$15,455 at December 31, 2003 15,432 -
Investment securities held-to-maturity, at amortized cost; fair value of
$5,035 at December 31, 2003 and $6,071 at December 31, 2002 5,036 6,012
Interest only strips, at fair value 3,548 4,548
Loans:
Loans held for sale, at lower of cost or fair value 42,038 43,284
Loans held for investment, net of allowance for loan losses of $2,652 at December 31,
2003 and $3,379 at December 31, 2002 166,874 138,948
Securitized loans, net of allowance for loan losses of $2,024 at December 31, 2003 and
$2,571 at December 31, 2002 35,362 63,624
------------- -----------
Total loans 244,274 245,856
Servicing assets 2,499 1,897
Other real estate owned, net 527 571
Premises and equipment, net 1,632 1,959
Other assets 7,642 12,184
------------- -----------
TOTAL ASSETS $ 304,250 $ 307,210
============= ===========
LIABILITIES
Deposits:
Non-interest-bearing demand $ 42,417 $ 39,698
Interest-bearing demand 38,115 35,169
Savings 15,559 11,377
Time certificates of $100,000 or more 19,673 25,325
Other time certificates 109,091 107,514
------------- -----------
Total deposits 224,855 219,083
Securities sold under agreements to repurchase 14,394 -
Bonds payable in connection with securitized loans 26,100 50,473
Other liabilities 4,570 5,567
------------- -----------
Total liabilities 269,919 275,123
------------- -----------
Commitments and contingencies-See Note 14
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized; shares issued and outstanding,
5,706,769 at December 31, 2003 and 5,690,224 at December 31, 2002 29,874 29,798
Retained earnings 4,472 2,289
Accumulated other comprehensive loss (15) -
------------- -----------
Total stockholders' equity 34,331 32,087
------------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 304,250 $ 307,210
============= ===========
See accompanying notes.
F-3
COMMUNITY WEST BANCSHARES
CONSOLIDATED INCOME STATEMENTS
YEAR ENDED DECEMBER 31,
---------------------------
2003 2002 2001
------- -------- --------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
INTEREST INCOME
Loans $19,658 $29,306 $39,258
Investment securities 489 202 269
Other 236 468 1,267
------- -------- --------
Total interest income 20,383 29,976 40,794
------- -------- --------
INTEREST EXPENSE
Deposits 4,621 5,545 9,460
Bonds payable and other borrowings 4,721 7,921 10,878
------- -------- --------
Total interest expense 9,342 13,466 20,338
------- -------- --------
NET INTEREST INCOME 11,041 16,510 20,456
Provision for loan losses 1,669 4,899 11,880
------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 9,372 11,611 8,576
NON-INTEREST INCOME
Gains from loan sales, net 4,860 4,788 6,616
Other loan fees 2,923 3,388 3,432
Loan servicing fees, net 1,264 1,081 1,703
Document processing fees, net 937 1,404 1,978
Service charges 376 440 575
Proceeds from legal settlement - - 7,000
Other 315 297 867
------- -------- --------
Total non-interest income 10,675 11,398 22,171
------- -------- --------
NON-INTEREST EXPENSES
Salaries and employee benefits 11,416 13,596 17,704
Occupancy and equipment expenses 1,691 2,119 2,311
Professional services 636 1,575 2,238
Depreciation 581 771 1,419
Loan servicing and collection 438 872 1,338
Professional expenses associated with legal settlement - - 2,392
Impairment of SBA interest only strips and servicing assets - 1,788 -
Lower of cost or market provision on loans held for sale - 1,381 -
Amortization of intangible assets - - 178
Other 1,974 2,829 4,426
------- -------- --------
Total non-interest expenses 16,736 24,931 32,006
------- -------- --------
Income (loss) before provision (benefit) for income taxes 3,311 (1,922) (1,259)
Provision (benefit) for income taxes 1,128 (652) (1,281)
------- -------- --------
NET INCOME (LOSS) $ 2,183 $(1,270) $ 22
======= ======== ========
INCOME (LOSS) PER SHARE - BASIC $ 0.38 $ (0.22) $ 0.00
INCOME (LOSS) PER SHARE - DILUTED $ 0.38 $ (0.22) $ 0.00
See accompanying notes.
F-4
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED
OTHER TOTAL
COMMON STOCK RETAINED COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT EARNINGS INCOME (LOSS) EQUITY
-------------- -------- ---------- -------------- --------
BALANCES AT (IN THOUSANDS)
JANUARY 1, 2001 6,107 $32,518 $ 3,537 $ (21) $36,034
Exercise of stock options 34 115 - - 115
Stock repurchase (451) (2,835) - - (2,835)
Comprehensive income:
Net income 22 - 22
Other comprehensive income 21 21
--------
Comprehensive income 43
-------------- -------- ---------- -------------- --------
BALANCES AT
DECEMBER 31, 2001 5,690 29,798 3,559 - 33,357
Comprehensive income:
Net loss (1,270) - (1,270)
BALANCES AT -------------- -------- ---------- -------------- --------
DECEMBER 31, 2002 5,690 29,798 2,289 - 32,087
Exercise of stock options 17 76 - - 76
Comprehensive income:
Net income 2,183 - 2,183
Other comprehensive loss (15) (15)
--------
Comprehensive income 2,168
BALANCES AT -------------- -------- ---------- -------------- --------
DECEMBER 31, 2003 5,707 $29,874 $ 4,472 $ (15) $34,331
============== ======= =========== ============== ========
See accompanying notes.
F-5
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 2,183 $ (1,270) $ 22
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Provision for loan losses 1,669 4,899 11,880
Provision for losses on real estate owned 25 86 50
Losses on sale of premises and equipment - 132 -
Deferred income taxes 474 1,219 605
Depreciation and amortization 1,589 3,031 1,597
Net amortization of discounts and premiums on securities 189 - -
Gains on:
Sale of other real estate owned (79) (14) (42)
Sale of subsidiary - - (96)
Sale of available-for-sale securities - - (21)
Sale of loans held for sale (4,401) (4,788) (6,616)
Changes in:
Fair value of interest only strips, net of accretion 1,000 3,385 2,694
Servicing assets, net of amortization and valuation adjustments (602) 593 116
Other assets 4,068 108 1,451
Other liabilities (1,062) 726 537
--------- --------- ---------
Net cash provided by operating activities 5,053 8,107 12,177
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities (7,337) (11,904) (118)
Purchase of available-for-sale securities (24,197) - -
Purchase of Federal Reserve Bank stock - (37) -
Principal paydowns and maturities of available-for-sale securities 8,670 - 4,820
Principal paydowns and maturities of held-to-maturity securities 8,219 6,010 1,901
Redemption of FHLB stock - - 395
Additions to interest only strip assets - (240) (2,846)
Loan originations and principal collections, net 2,744 14,049 62,505
Proceeds from sale of other real estate owned 1,718 399 492
Net decrease (increase) in time deposits in other financial institutions 1,485 3,661 (4,356)
Purchase of premises and equipment, net of sales (254) (136) (76)
--------- --------- ---------
Net cash (used in) provided by investing activities (8,952) 11,802 62,717
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of stock options 76 - 115
Net increase (decrease) in demand deposits and savings accounts 9,847 16,043 (17,172)
Net (decrease) increase in time certificates of deposit (4,075) 6,874 (15,382)
Proceeds from securities sold under agreements to repurchase 20,041 - -
Repayments of securities sold under agreements to repurchase (5,647) - -
Repayment of other borrowings - - (5,293)
Repurchase of outstanding shares - - (2,835)
Repayments of bonds payable in connection with securitized loans (25,381) (41,138) (41,404)
--------- --------- ---------
Net cash (used in) financing activities (5,139) (18,221) (81,971)
--------- --------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (9,038) 1,688 (7,078)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 31,094 29,406 36,484
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 22,056 $ 31,094 $ 29,406
========= ========= =========
See accompanying notes.
F-6
COMMUNITY WEST BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Community West Bancshares, a California
Corporation ("Company or CWBC"), and its wholly-owned subsidiary, Goleta
National Bank ("GNB"), are in accordance with accounting principles generally
accepted in the United States ("GAAP") and general practices within the
financial services industry. All material intercompany transactions and
accounts have been eliminated. The following are descriptions of the most
significant of those policies:
NATURE OF OPERATIONS - The Company's primary operations are related to
commercial banking and financial services through GNB which include the
acceptance of deposits and the lending and investing of money. The Company also
engages in electronic banking services. The Company's customers consist of
small to mid-sized businesses, as well as individuals. The Company also
originates and sells U. S. Small Business Administration ("SBA") and first and
second mortgage loans through its normal operations and loan production offices.
USE OF ESTIMATES - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities as well as disclosures of contingent assets and
liabilities at the date of the financial statements. These estimates and
assumptions also affect the reported amounts of revenues and expenses during the
reporting period. Although management believes these estimates to be reasonably
accurate, actual results may differ.
Certain amounts in the 2001 and 2002 financial statements have been reclassified
to be comparable with classifications in the 2003.
BUSINESS SEGMENTS - Reportable business segments are determined using the
"management approach" and are intended to present reportable segments consistent
with how the chief operating decision maker organizes segments within the
company for making operating decisions and assessing performance. As of
December 31, 2003 and 2002, the Company had only one reportable business
segment.
RESERVE REQUIREMENTS - All depository institutions are required by law to
maintain reserves on transaction accounts and non-personal time deposits in the
form of cash balances at the Federal Reserve Bank ("FRB"). These reserve
requirements can be offset by cash balances held at GNB. At December 31, 2003
and 2002, GNB's cash balance was sufficient to offset the FRB requirement.
INVESTMENT SECURITIES - The Company currently holds securities classified as
both available-for-sale ("AFS") and held-to-maturity ("HTM"). Securities
classified as HTM are accounted for at amortized cost as the Company has the
positive intent and ability to hold them to maturity. Securities not classified
as HTM are considered AFS and are carried at fair value with unrealized gains or
losses reported as a separate component of accumulated other comprehensive
income (loss), net of any applicable income taxes. Realized gains or losses on
the sale of AFS securities, if any, are determined on a specific identification
basis. Purchase premiums and discounts are recognized in interest income using
the effective interest method over the terms of the related securities, or to
earlier call dates, if appropriate. Declines in the fair value of AFS or HTM
securities below their cost that are deemed to be other than temporary, if any,
are reflected in earnings as realized losses. There is no recognition of
unrealized gains or losses for HTM securities.
INTEREST ONLY STRIPS AND SERVICING ASSETS - The guaranteed portion of certain
SBA loans can be sold into the secondary market. Servicing assets are
recognized as separate assets when loans are sold with servicing retained.
Servicing assets are amortized in proportion to, and over the period of,
estimated future net servicing income. Also, at the time of the loan sale, it
is the Company's policy to recognize the related gain on the loan sale in
accordance with GAAP. The Company uses industry prepayment statistics and its
own prepayment experience in estimating the expected life of the loans.
Management periodically evaluates servicing assets for impairment. Servicing
assets are evaluated for impairment based upon the fair value of the rights as
compared to amortized cost on a loan-by-loan basis. Fair value is determined
using discounted future cash flows calculated on a loan-by-loan basis and
aggregated to the total asset level. Impairment to the asset is recorded if the
aggregate fair value calculation drops below net book value of the asset.
Additionally, on certain SBA loan sales, the Company has retained interest only
("I/O Strips"), which represent the present value of excess net cash flows
generated by 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 April 1, 2002, the
Company determined the present value of this estimated cash flow at the time
each loan sale transaction closed, utilizing valuation assumptions as to
discount rate, prepayment rate and default rate
F-7
appropriate for each particular transaction. For loans sold after March 31,
2002, the initial servicing assets and resulting gain on sale were calculated
based on the difference between the best actual par and premium bids on an
individual loan basis. This same methodology would apply to the initial
valuation of any new I/O strip assets. As the Company did not sell any loans for
par during 2003, there were no additions to the I/O strips using the new
assumptions. Periodically, the Company verifies the reasonableness of its
valuation estimates by comparison to the results of an independent third party
valuation analysis.
The I/O strips are classified as trading securities. Accordingly, the Company
records the I/O's strips at fair value with the resulting increase or decrease
in fair value being recorded through operations in the current period. For the
years ended December 31, 2003, 2002 and 2001, net decreases in fair value of
$1,000,000, $3,385,000 and $2,694,000, respectively, are included in the income
statement as reductions to loan servicing income.
LOANS HELD FOR SALE - Loans which are originated and intended for sale in the
secondary market are carried at the lower of cost or estimated fair value
determined on an aggregate basis. Valuation adjustments, if any, are recognized
through a valuation allowance by charges to lower of cost or market provision.
Loans held for sale are primarily comprised of SBA loans, second mortgage loans
and residential mortgage loans. For the year ended December 31, 2002, the
Company recorded a lower of cost or market provision of $1,381,000. The Company
did not incur a lower of cost or market provision in the years ended December
31, 2003 and 2001.
LOANS HELD FOR INVESTMENT - Loans are carried at amounts advanced to the
borrowers less the payments collected. Interest on loans is accrued daily on a
simple-interest basis. 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. 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. Impaired loans are
identified as impaired when it is probable that interest and principal will not
be collected according to the contractual terms of the loan agreement. All of
the Company's nonaccrual loans were also classified as impaired at December 31,
2003 and 2002.
REPURCHASE AGREEMENTS - Securities sold under repurchase agreements are treated
as collateralized financing transactions and carried at the amount at which the
securities will be subsequently repurchased
SECURITIZED LOANS AND BONDS PAYABLE - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
trusts ("Trusts"). The transfers have been accounted for as secured borrowings
and, accordingly, the mortgage loans and related bonds issued are included in
the Company's Balance Sheet. Such loans are accounted for in the same manner as
loans held to maturity. Deferred debt issuance costs and bond discount related
to the bonds are amortized on a method that approximates the level yield method
over the estimated life of the bonds.
LOAN FEES AND COSTS - Loan origination fees, certain direct origination costs
and purchase premiums and discounts are deferred and recognized as an adjustment
to the loan yield over the life of the loan using the level-yield method.
ALLOWANCE FOR LOAN LOSSES - The Company maintains a detailed, systematic
analysis and procedural discipline to determine the amount of the allowance for
loan losses ("ALL"). The ALL is based on estimates and is intended to be
adequate to provide for probable losses inherent in the loan portfolio. This
process involves deriving probable loss estimates that are based on individual
loan loss estimation, migration analysis/historical loss rates and management's
judgment.
The Company employs several methodologies for estimating probable losses.
Methodologies are determined based on a number of factors, including type of
asset, risk rating, concentrations, collateral value and the input of the
Special Assets group, functioning as a workout unit.
OTHER REAL ESTATE OWNED - Other real estate owned ("OREO") is real estate
acquired through foreclosure on the collateral property and is recorded at fair
value at the time of foreclosure less estimated costs to sell. Any excess of
loan balance over the fair value of the OREO is charged-off against the
allowance for loan losses. Subsequent to foreclosure, management periodically
performs a new valuation and the asset is carried at the lower of carrying
amount or fair value. Operating expenses or income, and gains or losses on
disposition of such properties, are charged to current operations.
PREMISES AND EQUIPMENT - Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the terms of the leases or the estimated useful
lives of the improvements, whichever is shorter. Generally, the estimated
useful lives of other items of premises and equipment are as follows:
F-8
Building and improvements 31.5 years
Furniture and equipment 5 - 7 years
Electronic equipment and software 2 - 3 years
INCOME TAXES - Deferred income taxes are recognized for the tax effect of
differences between the tax basis of assets and liabilities and their financial
reporting amounts at each period end based on enacted tax laws and statutory tax
rates applicable to the periods in which the differences are expected to affect
taxable income. A valuation allowance is established for deferred tax assets
if, based on weight of available evidence, it is more likely than not that some
portion or all of the deferred tax assets may not be realized.
INCOME (LOSS) PER SHARE - Basic income (loss) per share is computed based on the
weighted average number of shares outstanding during each year divided into net
income (loss). Diluted income per share is computed based on the weighted
average number of shares outstanding during each year plus the dilutive effect,
if any, of outstanding options divided into net income (loss).
STATEMENT OF CASH FLOWS- For purposes of reporting cash flows, cash and cash
equivalents include cash, due from banks, interest-earning deposits in other
financial institutions and federal funds sold. Federal funds sold are one-day
transactions with GNB's funds being returned the following business day.
STOCK-BASED COMPENSATION- GAAP permits the Company to use either of two
methodologies to account for compensation cost in connection with employee stock
options. The first method requires issuers to record compensation expense over
the period the options are expected to be outstanding prior to exercise,
expiration or cancellation. The amount of compensation expense to be recognized
over this term is the "fair value" of the options at the time of the grant as
determined by the Black-Scholes valuation model. Black-Scholes computes fair
value of the options based on the length of their term, the volatility of the
stock price in past periods and other factors. Under this method, the issuer
recognizes compensation expense regardless of whether or not the employee
eventually exercises the options.
Under the second methodology, if options are granted at an exercise price equal
to the market value of the stock at the time of the grant, no compensation
expense is recognized. The Company believes that this method better reflects
the motivation for its issuance of stock options, as they are intended as
incentives for future performance rather than compensation for past performance.
GAAP requires that issuers electing the second method must present pro forma
disclosure of net income (loss) and earnings per share as if the first method
had been elected.
Under the terms of the Company's stock option plan, full-time salaried employees
may be granted qualified stock options or incentive stock options and directors
may be granted nonqualified stock options. Options may be granted at a price not
less than 100% of the market value of the stock on the date of grant. Qualified
options are generally exercisable in cumulative 20% installments. All options
expire no later than ten years from the date of grant. As of December 31, 2003,
options were outstanding at prices ranging from $3.00 to $14.88 per share with
256,327 options exercisable and 475,651 options available for future grant. As
of December 31, 2002, options were outstanding at prices ranging from $3.00 to
$14.88 per share with 208,992 options exercisable and 154,551 options available
for future grant. As of December 31, 2003, the average life of the outstanding
options was approximately 7.3 years. Stock option activity is as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
2003 2002 2001
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
2003 EXERCISE 2002 EXERCISE 2001 EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- --------- --------- ---------- ---------- ----------
Options outstanding, January 1, 350,852 6.30 432,624 $ 6.31 392,196 $ 7.35
Granted 198,000 5.51 88,128 4.60 186,228 1.08
Canceled (69,100) 6.22 (169,900) 5.77 (111,700) 8.03
Exercised (16,545) 4.63 - - (34,100) 3.36
---------- --------- --------- ---------- ---------- ----------
Options outstanding, December 31, 463,207 6.04 350,852 $ 6.30 432,624 $ 6.31
========== ========= ========= ========== ========== ==========
Options exercisable, December 31, 256,327 6.53 208,992 $ 6.49 282,824 $ 5.81
========== ========= ========= ========== ========== ==========
The grant date estimated fair value of options was $2.83 per share in 2003,
$2.90 per share in 2002, and $4.67 per share in 2001. The Company applies
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its stock option plan. Accordingly, no compensation cost has
been recognized for its stock option plan. Had compensation cost for the
Company's stock option plan been determined based on the fair value at the grant
dates for awards under the plan consistent with the method prescribed by SFAS
No. 123, the Company's net income (loss) and income (loss) per share for the
years ended December 31, 2003, 2002 and 2001 would have been adjusted to the pro
forma amounts indicated below:
F-9
YEAR ENDED DECEMBER 31,
---------------------------------------------
2003 2002 2001
------------- -------------- --------------
Income (loss): (IN THOUSANDS, EXCEPT PER SHARE DATA)
As reported $ 2,183 $ ( 1,270) $ 22
Pro forma 1,975 ( 1,434) (151)
Income (loss) per common share - basic
As reported 0.38 ( 0.22) 0.00
Pro forma 0.35 ( 0.25) 0.00
Income (loss) per common share - diluted
As reported 0.38 ( 0.22) 0.00
Pro forma 0.34 ( 0.25) 0.00
The fair value of options granted under the Company's stock option plan during
2003, 2002 and 2001 was estimated on the date of grant using Black-Scholes with
the following weighted-average assumptions:
YEAR ENDED DECEMBER 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
Annual dividend yield 0.0% 0.0% 0.0%
Expected volatility 32.4% 45.1% 37.0%
Risk free interest rate 3.9% 4.0% 5.9%
Expected life (in years) 7.3 7.3 6.0
RECENT ACCOUNTING PRONOUNCEMENTS - In January 2003, the Financial Accounting
Standards Board ("FASB") issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51"
which addresses consolidation by business enterprises of variable interest
entities ("VIE's") either: 1) that do not have sufficient equity investment at
risk to permit the entity to refinance its activities without additional
subordinated financial support, or 2) in which the equity investors lack an
essential characteristic of a controlling financial interest. In December 2003,
FASB completed deliberations of proposed modifications to FIN 46 ("Revised
Interpretations") resulting in multiple effective dates based on the nature as
well as the creation date of the VIE. VIE's created after January 31, 2003 but
prior to January 1, 2004, may be accounted for either based on the original
interpretation or the Revised Interpretations. However, the Revised
Interpretations must be applied no later than the first quarter of fiscal year
2004. The adoption of FIN 46 as revised is not anticipated to have an impact on
the Company's financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45). FIN 45 changed current practice in the
accounting for, and disclosure of, guarantees. Guarantees meeting the
characteristics described (and not included in a long list of exceptions) are
required to be initially recorded at fair value, which is different from the
general current practice of recording a liability only when a loss is probable
and reasonably estimable, as those terms are defined in FASB Statement No. 5,
Accounting for Contingencies. FIN 45 also requires a guarantor to make
significant new disclosures for virtually all guarantees. FIN 45 disclosure
requirements are effective for financial statements of interim or annual periods
ended after December 15, 2002, while the initial recognition and initial
measurement provisions are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002 and existing guarantees for the
interim period beginning July 1, 2003. Management does not believe that the
impact of the adoption of this pronouncement will have a material impact on the
Company or its financial statements.
2. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities is as
follows:
DECEMBER 31, 2003 (IN THOUSANDS)
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
Available-for-sale securities COST GAINS LOSSES VALUE
- ----------------------------------- --------------- ----------- ------------ -------
U.S. Government and agency $ 7,064 $ - $ (40) $ 7,024
Other securities 8,391 17 - 8,408
--------------- ----------- ------------ -------
Total available-for-sale securities $ 15,455 $ 17 $ (40) $15,432
=============== =========== ============ =======
F-10
Held-to-maturity securities
- ---------------------------
U.S. Government and agency $ 200 $ - $ - $ 200
Other securities 4,836 - (1) 4,835
--------------- ----------- ------------ -------
Total held-to-maturity securities $ 5,036 $ - $ (1) $ 5,035
=============== =========== ============ =======
DECEMBER 31, 2002 (IN THOUSANDS)
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
Held-to-maturity securities COST GAINS LOSSES VALUE
- ----------------------------------- --------------- ----------- ------------ -------
U.S. Government and agency $ 707 $ - $ - $ 707
Other Securities 5,305 59 - 5,364
--------------- ----------- ------------ -------
$ 6,012 $ 59 $ - $ 6,071
=============== =========== ============ =======
At December 31, 2003, $200,000, at carrying value, of the above securities were
pledged as collateral to the U.S. Treasury for its treasury, tax and loan
account and $14,680,000, at carrying value, were pledged under repurchase
agreements which are treated as collateralized financing transactions.
3. LOAN SALES AND SERVICING
SBA Loan Sales
- ----------------
The Company sells the guaranteed portion of selected SBA loans into the
secondary market, on a servicing retained basis, in exchange for a combination
of a cash premium, servicing assets and/or I/O strips. The Company retains the
unguaranteed portion of these loans and services the loans as required under the
SBA programs to retain specified yield amounts. The SBA program stipulates that
the Company retain a minimum of 5% of the unguranteed portion of the loan
balance. The percentage of each unguaranteed loan in excess of 5% can be
periodically sold to a third party for a cash premium. A portion of the yield
is recognized as servicing fee income as it occurs and the remainder is
capitalized as excess servicing and is included in the gain on sale
calculation. The fair value of the I/O strips and servicing assets prior to
April 1, 2002 was determined using a 9.25%-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
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 22-25%. Quarterly, the servicing
asset and I/O strip assets are analyzed for impairment. In 2002, the Company
recognized impairment charges of $1.8 million. As of December 31, 2003, all
servicing assets are related to SBA loan sales. As of December 31, 2003 and
2002, the Company had $36.9 million and $26.2 million, respectively, in SBA
loans held for sale.
The following is a summary of activity in I/O Strips:
YEAR ENDED DECEMBER 31,
----------------------------
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $ 4,548 $ 7,693 $ 7,541
Additions through loan sales - 240 2,846
Valuation adjustment, net (1,000) (3,385) (2,694)
-------- -------- --------
Balance, end of year $ 3,548 $ 4,548 $ 7,693
======== ======== ========
The following is a summary of activity in Servicing Assets:
YEAR ENDED DECEMBER 31,
----------------------------
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $ 1,897 $ 2,489 $ 2,605
Additions through loan sales 1,116 597 689
Amortization (514) (426) (197)
Valuation adjustment - (763) (607)
-------- -------- --------
Balance, end of year $ 2,499 $ 1,897 $ 2,490
======== ======== ========
Loans serviced for others are not included in the accompanying consolidated
balance sheets. The principal balance of loans serviced for others at December
31, 2003 and 2002 totaled $168.4 million and $171.0 million, respectively.
Loans serviced for others are not included in the accompanying consolidated
balance sheets.
F-11
4. LOANS HELD FOR INVESTMENT
The composition of the Company's loans held for investment portfolio, excluding
securitized loans is as follows:
DECEMBER 31,
-------------------
2003 2002
-------- ---------
(IN THOUSANDS)
Commercial $ 24,592 $ 26,256
Real estate 71,010 51,666
SBA 30,698 34,073
Manufactured housing 39,073 28,199
Other installment 5,770 2,772
-------- ---------
171,143 142,966
Less:
Allowance for loan losses 2,651 3,379
Deferred fees, net of costs 69 (318)
Discount on unguaranteed portion of SBA loans 1,549 957
-------- ---------
Loans held for investment, net $166,874 $138,948
======== =========
An analysis of the allowance for loan losses for loans held for investment is as
follows:
YEAR ENDED DECEMBER 31,
----------------------------
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $ 3,379 $ 4,086 $ 2,704
Provision for loan losses 293 3,071 7,754
Loans charged off (1,822) (5,637) (6,222)
Recoveries on loans previously charged off 802 1,859 612
Transfers and reductions due to sale of subsidiary, net - - (762)
-------- -------- --------
Balance, end of year $ 2,652 $ 3,379 $ 4,086
======== ======== ========
The recorded investment in loans that are considered to be impaired is as
follows:
YEAR ENDED DECEMBER 31,
------------------------------
2003 2002 2001
---------- -------- --------
(IN THOUSANDS)
Impaired loans without specific valuation allowances $ - $ - $ -
Impaired loans with specific valuation allowances 6,843 8,394 6,587
Specific valuation allowance related to impaired loans (640) (1,278) (1,669)
---------- -------- --------
Impaired loans, net $ 6,203 $ 7,116 $ 4,918
========== ======== ========
Average investment in impaired loans $ 6,584 $ 7,565 $ 5,047
========== ======== ========
The following schedule reflects recorded investment at the dates indicated in
certain types of loans:
YEAR ENDED DECEMBER 31,
-------------------------------
2003 2002 2001
----------- -------- --------
(IN THOUSANDS)
Nonaccrual loans $ 7,174 $13,965 $11,413
SBA guaranteed portion of loans included above (4,106) (8,143) (7,825)
----------- -------- --------
Nonaccrual loans, net $ 3,068 $ 5,822 $ 3,588
=========== ======== ========
Troubled debt restructured loans $ 193 $ 829 $ 1,093
Loans 30 through 90 days past due with interest accruing $ 3,907 $ 5,122 $ 2,607
Interest income recognized on impaired loans $ 277 $ 190 $ 1,443
Interest foregone on nonaccrual loans and troubled debt restructured
loans outstanding 216 1,263 1,146
----------- -------- --------
Gross interest income on impaired loans $ 493 $ 1,453 $ 2,589
=========== ======== ========
F-12
The Company makes loans to borrowers in a number of different industries.
Although the Company does not have significant concentrations in its loan
portfolio, the ability of customers to honor their loan agreements is dependent
upon, among other things, the general economy of the Company's market area.
5. SECURITIZED LOANS
The Company originated and purchased second mortgage loans that allowed
borrowers to borrow up to 125% of their home's appraised value, when combined
with the balance of the first mortgage loan, up to a maximum loan of $100,000.
In 1998 and 1999, the Company transferred $81 million and $122 million,
respectively, of these loans to two special purpose trusts. These loans were
both originated and purchased by the Company. The trusts, then sold bonds to
third party investors that were secured by the transferred loans. The loans and
bonds are held in the trusts independent of the Company, the trustee of which
oversees the distributions to the bondholders. The mortgage loans are serviced
by a third party ("Servicer"), who receives a stated servicing fee. There is an
insurance policy on the bonds that guarantees the payment of the bonds. The
Company did not surrender effective control over the loans transferred at the
time of securitization. Accordingly, the securitizations are accounted for as
secured borrowings and both the loans and bonds in the trusts are consolidated
into the financial statements of the Company.
At December 31, 2003 and 2002, respectively, securitized loans are net of an
allowance for loan losses as set forth below, and include purchase premiums and
deferred fees/costs of $ 823,000 and $1,464,000, respectively.
An analysis of the allowance for loan losses for securitized loans is as
follows:
YEAR END DECEMBER 31,
------------------------------
2003 2002 2001
---------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $ 2,571 $ 4,189 $ 4,042
Provisions for loan losses 1,376 1,828 4,126
Loans charged off (2,511) (4,012) (4,358)
Recoveries on loans previously charged off 588 566 379
---------- -------- --------
Balance, end of year $ 2,024 $ 2,571 $ 4,189
========== ======== ========
6. PREMISES AND EQUIPMENT
DECEMBER 31,
--------------------
2003 2002
---------- --------
(IN THOUSANDS)
Furniture, fixtures and equipment $ 6,851 $ 6,846
Building and land 888 784
Leasehold improvements 771 805
---------- --------
8,510 8,435
Less: accumulated depreciation and amortization (6,878) (6,476)
---------- --------
Premises and equipment, net $ 1,632 $ 1,959
========== ========
The Company leases office facilities under various operating lease agreements
with terms that expire at various dates between February 2004 and April 2008,
plus options to extend the lease terms for periods of up to ten years. The
minimum lease commitments as of December 31, 2003 under all operating lease
agreements are as follows:
YEAR ENDED DECEMBER 31,
-----------------------
(IN THOUSANDS)
2004 $ 611
2005 632
2006 662
2007 654
2008 24
---------------
Total $ 2,583
===============
Rent expense for the years ended December 31, 2003, 2002 and 2001, included in
occupancy expense was $680,000, $951,000 and $895,000, respectively.
7. DEPOSITS
At December 31, 2003, the maturities of time certificates of deposits are as
follows:
F-13
(IN THOUSANDS)
2004 $ 105,538
2005 15,828
2006 3,448
2007 105
2008 3,845
---------------
$ 128,764
===============
8. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
YEAR ENDED DECEMBER 31,
-----------------------------
2003 2002 2001
--------- -------- --------
(IN THOUSANDS)
Current:
Federal $ 647 $(1,873) $(1,385)
State 7 2 (501)
--------- -------- --------
654 (1,871) (1,886)
Deferred:
Federal 712 1,223 343
State (238) (4) 262
--------- -------- --------
474 1,219 605
--------- -------- --------
Total provision (benefit) $ 1,128 $ (652) $(1,281)
========= ======== ========
The federal income tax provision (benefit) differs from the applicable statutory
rate as follows:
YEAR ENDED DECEMBER 31,
------------------------
2003 2002 2001
------ ------- --------
Federal income tax at statutory rate 34.0% (34.0)% (34.0)%
State franchise tax, net of federal benefit 7.0% (7.1)% (12.9)%
Amortization and impairment of goodwill - - 3.4%
Taxable gain on sale of subsidiary - - 81.8%
Capital recovery proceeds - - (137.4)%
Other 0.1% 3.2% (2.7)%
Valuation allowance (7.0)% 4.0% -
------ ------- --------
34.1% (33.9)% (101.8)%
====== ======= ========
Significant components of the Company's net deferred taxes as of December 31 are
as follows:
2003 2002
-------- ---------
(IN THOUSANDS)
Deferred tax assets:
Allowance for loan losses $ 263 $ 1,171
Depreciation 516 471
Net operating loss 194 482
Deferred loan costs 193 -
Other 931 350
-------- ---------
2,097 2,474
-------- ---------
Less: valuation allowance (193) (486)
-------- ---------
1,904 1,988
-------- ---------
Deferred tax liabilities:
Deferred loan fees (2,801) (2,286)
Deferred loan costs - (214)
Other (383) -
-------- ---------
(3,184) (2,500)
-------- ---------
Net deferred taxes $(1,280) $ (512)
======== =========
9. STOCKHOLDERS' EQUITY
Common Stock
- -------------
On December 28, 1998, the Board of Directors of the Company authorized a stock
buy-back plan. Under this plan, the Company is authorized to repurchase up to
$2,000,000 worth of the outstanding shares of the Company's
F-14
common stock on the open market. As of December 31, 2003 and 2002, pursuant to
this plan, the Company had repurchased 138,937 shares at a cost of $1,240,148.
In addition during 2001, the Company repurchased 449,592 shares in a privately
negotiated transaction at a cost of $2,830,682.
Earnings per share-Calculation of Weighted Average Shares Outstanding
- ---------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------
2003 2002 2001
-------- ----- -------
(IN THOUSANDS)
Basic weighted average shares outstanding 5,694 5,690 5,948
Dilutive effect of stock options 64 - 50
-------- ----- -------
Diluted weighted average shares outstanding 5,758 5,690 5,998
======== ===== =======
The incremental shares from assumed conversions of stock options on 13,674
shares in 2002 were excluded from the computations of diluted earnings per share
because the Company had a net loss for 2002, which made them anti-dilutive.
10. BORROWINGS
Repurchase Agreements
- ----------------------
The Company has entered into various repurchase/borrowing arrangements with
interest rates of 1.25% to 1.43%, all of which mature in 2004.
Bonds Payable
- --------------
The following is a summary of the outstanding bonds payable:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
2003 2002 RANGES OF INTEREST RATES STATED MATURITY DATE
----------- ----------- ------------------------- ---------------------
(DOLLARS IN THOUSANDS)
Series 1998-1 $ 5,205 $ 14,490 7.06%-7.95% November 25, 2024
Series 1999-1 22,235 38,662 6.46%-8.75% May 25, 2025
----------- -----------
27,440 53,152
Less:Bond issuance 477 926
Bond discount 863 1,753
----------- -----------
Bonds payable, net $ 26,100 $ 50,473
=========== ===========
The bonds are collateralized by securitized loans with an outstanding principal
balance of $11,387,000 and $25,176,000 as of December 31, 2003 for Series 1998-1
and Series 1999-1, respectively. There is no cross collateralization between the
bond issues.
Financial data pertaining to bonds payable were as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------
2003 2002 2001
------------- ----------- ---------
(DOLLARS IN THOUSANDS)
Weighted average coupon interest rate, end of year 8.26% 8.02% 7.64%
Annual weighted average interest rate (including discount amortization) 11.89% 11.44% 9.02%
Average balance of bonds payable, net $ 39,000 $69,251 $ 111,327
Maximum amount of bonds payable, net outstanding at any month end $ 50,473 $84,910 $ 128,762
As of December 31, 2003, the annual scheduled bond repayments were as follows:
2004 2005 2006 2007 2008 THEREAFTER TOTAL
------- ----- ----- ----- ----- ----------- --------
(IN THOUSANDS)
Bond repayments $ 493 $ 535 $ 581 $ 631 $ 684 $ 24,516 $ 27,440
The Company has the option to call and pay off the remaining bond balance when
the related loan balances are reduced to 10% of the original pool balance.
11. EMPLOYEE BENEFIT PLAN
The Company has established a 401(k) plan for the benefit of its employees.
Employees are eligible to participate in the plan after three months of
consecutive service. Employees may make contributions to the plan and the
Company
F-15
may make discretionary profit sharing contributions, subject to certain
limitations. The Company's contributions were determined by the Board of
Directors and amounted to $129,000, $171,000 and $177,000, in 2003, 2002 and
2001, respectively.
12. FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required to interpret market
data to develop estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Company could realize
in a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
The following table represents the estimated fair values:
DECEMBER 31,
-----------------------------------------------
2003 2002
--------------------- ------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
--------------------- ------------------------
(IN THOUSANDS)
Assets:
Cash and cash equivalents $ 22,056 $ 22,056 $ 31,094 $ 31,094
Time deposits in other financial institutions 792 792 2,277 2,277
Federal Reserve Bank stock 812 812 812 812
Investment securities 20,468 20,467 6,012 6,071
Interest-only strips 3,548 3,548 4,548 4,548
Net loans 244,274 247,460 245,856 270,425
Servicing assets 2,499 2,695 1,897 1,897
Liabilities:
Deposits (other than time deposits) 96,091 96,091 86,244 86,244
Time deposits 128,764 129,564 132,839 137,089
Securities sold under agreements to repurchase 14,394 14,401 - -
Bonds payable 26,100 27,114 50,473 56,830
The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below:
Cash and cash equivalents - The carrying amounts approximate fair value because
of the short-term nature of these instruments.
Time deposits in other financial institutions - The carrying amounts approximate
fair value because of the relative short-term nature of these instruments.
Federal Reserve Stock - The carrying value approximates the fair value because
the stock can be sold back to the Federal Reserve at anytime.
Investment securities - The fair value is based on quoted market prices from
security brokers or dealers.
Interest Only Strips - The fair value of the interest-only strips has been
determined by the discounted cash flow method, using market discount and
prepayment rates.
Loans - The fair value of loans is estimated for portfolios of loans with
similar financial characteristics, primarily fixed and adjustable rate interest
terms. The fair value of fixed-rate mortgage loans is based upon discounted cash
flows utilizing the rate that the Company currently offers as well as
anticipated prepayment schedules. The fair value of adjustable rate loans is
also based upon discounted cash flows utilizing discount rates that the Company
currently offers, as well as anticipated prepayment schedules.
Servicing Assets - Fair value is determined using discounted future cash flows
calculated on a loan-by-loan basis and aggregated to the total asset level.
Deposits - The fair values of deposits are estimated based upon the type of
deposit products. Demand accounts, which include savings and transaction
accounts, are presumed to have equal book and fair values, since the interest
rates paid on these accounts are based on prevailing market rates. The estimated
fair values of time deposits are determined by discounting the cash flows of
segments of deposits that have similar maturities and rates, utilizing a yield
curve that approximates the prevailing rates offered to depositors as of the
measurement date.
F-16
Securities sold under agreements to repurchase - The fair value is estimated
using discounted cash flow analysis based on rates for similar types of
borrowing arrangements.
Bonds Payable - The fair value is estimated using discounted cash flow analysis
based on rates for similar types of borrowing arrangements.
Commitments to Extend Credit, Commercial and Standby Letters of Credit - Due to
the proximity of the pricing of these commitments to the period end, the fair
values of commitments are immaterial to the financial statements.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 2003 and 2002. Although management
is not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since those dates and, therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
13. REGULATORY MATTERS
The Company (on a consolidated basis) and GNB are subject to various regulatory
capital requirements administered by the Federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could have
a direct material effect on the Company's and GNB's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and GNB must meet specific capital guidelines that involve
quantitative measures of the Company's and GNB's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
The Company's and GNB's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors. Prompt corrective action provisions are not applicable to bank
holding companies.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") contains
rules as to the legal and regulatory environment for insured depository
institutions, including reductions in insurance coverage for certain kinds of
deposits, increased supervision by the federal regulatory agencies, increased
reporting requirements for insured institutions and new regulations concerning
internal controls, accounting and operations. The prompt corrective action
regulations of FDICIA define specific capital categories based on the
institutions' capital ratios. The capital categories, in declining order, are
"well capitalized", "adequately capitalized", "undercapitalized", "significantly
undercapitalized" and "critically undercapitalized". To be considered "well
capitalized", an institution must have a core capital ratio of at least 5% and a
total risk-based capital ratio of at least 10%. Additionally, FDICIA imposes
Tier I risk-based capital ratio of at least 6% to be considered "well
capitalized". Tier I risk-based capital is, primarily, common stock and
retained earnings, net of goodwill and other intangible assets.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as
defined) to average assets (as defined). The Company's and GNB's actual capital
amounts and ratios as of December 31, 2003 and 2002 are also presented in the
table below:
RISK- ADJUSTED TOTAL TIER 1 TIER 1
(dollars in thousands) TOTAL TIER 1 WEIGHTED AVERAGE CAPITAL CAPITAL LEVERAGE
CAPITAL CAPITAL ASSETS ASSETS RATIO RATIO RATIO
-------- -------- --------- --------- -------- -------- ---------
DECEMBER 31, 2003
- -----------------
CWBC (Consolidated) $ 37,150 $ 34,096 $ 242,730 $ 305,666 15.31% 14.05% 11.15%
GNB 34,695 31,648 242,170 301,024 14.33 13.07 10.51
DECEMBER 31, 2002
- ------------------------
CWBC (Consolidated) 35,080 31,897 252,019 304,239 13.92 12.66 10.48
GNB 32,492 29,405 244,207 300,097 13.31 12.04 9.80
Well capitalized ratios 10.00 6.00 5.00
Minimum capital ratios 8.00 4.00 4.00
As of December 31, 2003, management believed that GNB met all applicable capital
adequacy requirements and is correctly categorized as "well capitalized" under
the regulatory framework for prompt corrective action.
14. COMMITMENTS AND CONTINGENCIES
Commitments
- -----------
In the normal course of business, the Company is a party to financial
instruments with off-balance-sheet risk to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
standby
F-17
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet. The Company's exposure to credit loss in the event of nonperformance by
the other party to commitments to extend credit and standby letters of credit is
represented by the contractual notional amount of those instruments. As of
December 31, 2003 and 2002, the Company had commitments to extend credit of
approximately $40.7 million and $30.5 million, respectively, including
obligations to extend standby letters of credit of approximately $522,000 and
$380,000, respectively.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support private borrowing arrangements. All guarantees are
short-term and expire within one year.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for extending loan facilities to customers. The Company
evaluates each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company upon extension of
credit, is based on management's credit evaluation of the counterparty.
Collateral held varies but may include accounts receivable, inventory, property,
plant and equipment and income-producing commercial properties.
Loans Sold
- -----------
The Company has sold loans that are guaranteed or insured by government agencies
for which the Company retains all servicing rights and responsibilities. The
Company is required to perform certain monitoring functions in connection with
these loans to preserve the guarantee by the government agency and prevent loss
to the Company in the event of nonperformance by the borrower. Management
believes that the Company is in compliance with these requirements. The
outstanding balance of the sold portion of such loans was approximately $126.8
million and $150.2 million at December 31, 2003 and 2002, respectively.
The Company retains a substantial degree of risk relating to the servicing
activities and retained interest in sold SBA loans. In addition, during the
period of time that the loans are held for sale, the Company is subject to
various business risks associated with the lending business, including borrower
default, foreclosure and the risk that a rapid increase in interest rates would
result in a decline of the value of loans held for sale to potential purchasers.
In connection with its loan sales, the Company enters agreements which generally
require the Company to repurchase or substitute loans in the event of a breach
of a representation or warranty made by the Company to the loan purchaser, any
misrepresentation during the mortgage loan origination process or, in some
cases, upon any fraud or early default on such mortgage loans.
Executive Salary Continuation
- -------------------------------
The Company has an agreement with a former officer/director, which provides for
a monthly cash payment to the officer or beneficiaries in the event of death,
disability or retirement, beginning in the month after the retirement date
(December 2003) or death and extending for a period of fifteen years. The
Company purchased a life insurance policy as an investment. The income from the
policy investment will help fund this liability. The cash surrender value of
the policy was $693,000 and $668,000 at December 31, 2003 and 2002,
respectively, and is included in other assets. The present value of the
Company's liability under the agreement was calculated using a discount rate of
6% and is included in accrued interest payable and other liabilities in the
accompanying consolidated balance sheets. The accrued executive salary
continuation liability was $499,000 and $449,000 at December 31, 2003 and 2002,
respectively.
The Company also has certain Key Man life insurance policies related to a former
officer/director. The combined cash surrender value of the policies was
$178,000 and $171,000 at December 31, 2003 and 2002, respectively.
Litigation
- ----------
Short-Term Consumer Lending
Throughout 2000, 2001 and 2002, GNB made short-term consumer loans ("GNB Loans")
using marketing and servicing assistance of ACE at almost all of ACE's retail
locations pursuant to the terms of a Master Loan Agency Agreement between ACE
and GNB ("GNB Agreement").
GNB and ACE entered into an agreement in October 2002 to indemnify GNB against
monetary exposure in the nationwide class-action lawsuit, however, GNB could
have been held liable had ACE been unable to pay, or the agreement rendered
invalid or unenforceable. On December 15, 2003, the U.S. District Court in
Dallas, Texas approved the settlement agreement with ACE that provided for the
release of substantially all of the claims that were
F-18
asserted or could have been asserted in this lawsuit and/or in other lawsuits
against ACE regarding the former offering of loans at ACE stores.
Other Litigation
The Company is involved in litigation of a routine nature that is handled and
defended in the ordinary course of the Company's business. In the opinion of
management, based in part on consultation with legal counsel, the resolution of
these other litigation matters will not have a material impact on the Company's
financial position or results of operations.
15. COMMUNITY WEST BANCSHARES (PARENT COMPANY ONLY)
DECEMBER 31,
------------------------------
BALANCE SHEETS 2003 2002
------------------------------
Assets (IN THOUSANDS)
Cash and equivalents $ 2,776 $ 1,965
Time deposits in financial institutions 297 1,188
Investment in subsidiary 31,898 29,595
Loan participation purchased, net of allowance for loan losses of $17,000 in 2003 and
140,000 in 2002 225 295
Other assets 302 228
-------------- --------------
Total assets $ 35,498 $ 33,271
============== ==============
Liabilities and stockholders' equity
Other liabilities $ 1,152 $ 1,184
Common stock 29,874 29,798
Retained earnings 4,472 2,289
-------------- --------------
Total stockholders equity 34,346 32,087
-------------- --------------
Total liabilities and stockholders' equity $ 35,498 $ 33,271
============== ==============
YEAR ENDED DECEMBER 31,
----------------------------------------
INCOME STATEMENT 2003 2002 2001
----------------------------------------
(IN THOUSANDS)
Total income $ 17 $ 105 $ 5,263
Total expense 198 474 1,522
Equity in undistributed subsidiaries: Net income (loss) from subsidiaries 2,303 (1,026) (2,483)
----------------------------------------
Income (loss) before income tax provision (benefit) 2,122 (1,395) 1,258
Income tax provision (benefit) 61 (125) 1,236
----------------------------------------
Net income (loss) $ 2,183 $ (1,270) $ 22
============== ============== ========
F-20
COMMUNITY WEST BANCSHARES (PARENT COMPANY ONLY)
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)
Cash flows from operating activities:
Net (loss) income $ 2,183 $(1,270) $ 22
Adjustments to reconcile net income (loss) to cash provided by(used in) operating activities:
Equity in undistributed (income) loss from subsidiaries (2,303) 1,026 2,483
Net change in other liabilities (33) (1,828) 1,505
Net change in other assets (3) (13) (419)
-------- -------- --------
Net cash provided by (used in) operating activities (156) (2,085) 3,591
Cash flows from investing activities:
Net decrease (increase) in time deposits in other financial institutions 891 3,299 (4,405)
Net payments and investments in subsidiaries - (1,250) 10,726
-------- -------- --------
Net cash provided by investing activities 891 2,049 6,321
Cash flows from financing activities:
Proceeds from issuance of common stock 76 - 112
Principal payments on borrowings - - (5,270)
Payments to repurchase common stock - - (2,835)
-------- -------- --------
Net cash provided by (used in) financing activities 76 - (7,993)
Net increase (decrease)in cash and cash equivalents 811 (36) 1,919
Cash and cash equivalents at beginning of year 1,965 2,001 82
-------- -------- --------
Cash and cash equivalents, at end of year $ 2,776 $ 1,965 $ 2,001
======== ======== ========
16. SUPPLEMENTAL DISCLOSURE TO THE CONSOLDIATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENT OF CASH FLOWS
Listed below are the supplemental disclosures to the Consolidated Statement of
Cash Flows:
YEAR ENDED DECEMBER 31,
------------------------
2003 2002 2001
------ ------- -------
(IN THOUSANDS)
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $9,006 $10,864 $18,950
Cash paid for income taxes 947 3 2
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real estate owned 1,570 939 -
Transfers from loans held for sale to loans held for investment - 1,587 $ 5,023
F-21
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
Results of operations on a quarterly basis were as follows:
YEAR ENDED DECEMBER 31, 2003
------------------------------------------------------------
Q4 Q3 Q2 Q1 TOTALS
---------- ---------- ---------- ---------- ------------
(IN THOUSANDS, EXPECT SHARE DATA)
Interest income $ 4,985 $ 5,020 $ 5,199 $ 5,179 $ 20,383
Interest expense 2,099 2,198 2,427 2,618 9,342
---------- ---------- ---------- ---------- ------------
Net interest income 2,886 2,822 2,772 2,561 11,041
Provision for loan losses 664 298 363 344 1,669
---------- ---------- ---------- ---------- ------------
Net interest income after provsion for
loan losses 2,222 2,524 2,409 2,217 9,372
Non-interest income 2,476 3,013 2,517 2,669 10,675
Non-interest expenses 4,014 4,196 4,171 4,355 16,736
---------- ---------- ---------- ---------- ------------
Income (loss) before income taxes 684 1,341 755 531 3,311
Provision (benefit) for income taxes 232 456 257 183 1,128
---------- ---------- ---------- ---------- ------------
NET INCOME (LOSS) $ 452 $ 885 $ 498 $ 348 $ 2,183
========== ========== ========== ========== ============
Earnings (loss) per share - basic $ .08 $ 0.16 $ 0.09 $ 0.06 $ .38
Earnings (loss) per share - diluted .08 0.15 0.09 0.06 .38
Weighted average shares:
Basic 5,701,932 5,692,732 5,690,224 5,690,224 5,693,807
Diluted 5,827,918 5,773,400 5,734,690 5,711,031 5,758,200
YEAR ENDED DECEMBER 31, 2002
------------------------------------------------------------
Q4 Q3 Q2 Q1 TOTALS
---------- ---------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
Interest income $ 7,098 $ 7,677 $ 7,663 $ 7,538 $ 29,976
Interest expense 2,989 3,171 3,442 3,864 13,466
---------- ---------- ----------- ----------- -----------
Net interest income 4,109 4,506 4,221 3,674 16,510
Provision for loan losses 168 1,180 1,275 2,276 4,899
---------- ---------- ----------- ----------- -----------
Net interest income after provsion for
loan losses 3,941 3,326 2,946 1,398 11,611
Non-interest income 2,561 2,752 2,710 3,375 11,398
Non-interest expenses 4,547 4,919 9,056 6,409 24,931
---------- ---------- ----------- ----------- -----------
Income (loss) before income taxes 1,955 1,159 (3,400) (1,636) (1,922)
Provision (benefit) for income taxes 976 487 (1,428) (687) (652)
---------- ---------- ----------- ----------- -----------
NET INCOME (LOSS) $ 979 $ 672 $ (1,972) $ (949) $ (1,270)
========== ========== ========== ========== ============
Earnings (loss) per share - basic $ 0.17 $ 0.12 $ (0.35) $ (0.17) $ (0.22)
Earnings (loss) per share - diluted 0.17 0.12 (0.35) (0.17) (0.22)
Weighted average shares:
Basic 5,690,224 5,690,224 5,690,224 5,690,224 5,690,224
Diluted 5,703,459 5,695,301 5,690,224 5,690,224 5,690,224
F-22
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
- -------- ----------------------------------------------
The Company's consolidated financial statements begin on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- -------- -------------------------------------------------------------------
FINANCIAL DISCLOSURE
- ---------------------
None
ITEM 9A. CONTROLS AND PROCEDURES
- -------- -------------------------
Under the supervision and with the participation of the Company's management,
the Chief Executive Officer and the Chief Financial Officer evaluated the
effectiveness of the design and operation of the Company's disclosure controls
and procedures as of December 31, 2003. Based on and as of the time of such
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiary) required to be included in the Company's reports that
it files with or submits to the Securities and Exchange Commission under the
Securities Exchange Act of 1934. There have been no changes in the Company's
internal control over financial reporting that occurred during the Company's
quarter ended December 31, 2003, that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- --------- ------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
--------------------------------------------------------
The information concerning the directors and executive officers of the Company
is incorporated herein by reference from the section entitled "Proposal 1 -
Election of Directors" contained in the definitive proxy statement ("Proxy
Statement") of the Company to be filed pursuant to Regulation 14A within 120
days after the end of the Company's last fiscal year.
The Company has adopted a code of ethics that applies to all its principal
executive officer, principal financial officer, principal accounting officer or
controller and persons performing similar functions. A copy of the code of
ethics is available on the Company's website at www.communitywest.com.
ITEM 11. EXECUTIVE COMPENSATION
- --------- -----------------------
Information concerning executive compensation is incorporated herein by
reference from the section entitled "Proposal 1 - Election of Directors"
contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- --------- ------------------------------------------------------------------
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the section entitled
"Proposal 1 - Election of Directors" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------- --------------------------------------------------
Information concerning certain relationships and related transactions is
incorporated herein by reference from the section entitled "Proposal 1 -
Election of Directors" contained in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
- --------- ------------------------------------------
Information concerning principal accountant fees and services is incorporated
herein by reference from the section entitled "Proposal - Independent Auditors"
contained in the Proxy Statement.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- -------- ---------------------------------------------------------------
(a)(1) The following consolidated financial statements of Community West
Bancshares are filed as part of this Annual Report.
64
Report of Independent Public Accountants F-1
Consolidated Balance Sheets as of December 31, 2003 and 2002 F-2
Consolidated Income Statements for each of the three years
in the period ended December 31, 2003 F-3
Consolidated Statements of Stockholders' Equity for each
of the three years ended in the period ended December 31, 2003 F-4
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 2003 F-5
Notes to Consolidated Financial Statements F-6
(a)(2) Financial Statement Schedules
Financial statement schedules other than those listed above have been omitted
because they are either not applicable or the information is otherwise included.
(b) A report on Form 8-K was filed as follows:
March 4, 2003. Item 5 - Other Events
October 28, 2003, Item 5 - Other Events
(c) Exhibits. The following is a list of exhibits filed as a part of this
report.
2.1 Plan of reorganization (1)
2.2 Definitive Agreement to sell Palomar (5)
3.1 Articles of Incorporation (3)
3.2 Bylaws (3)
4.1 Common Stock Certificate (2)
10.1 1997 Stock Option Plan and Form of Stock Option Agreement (1)
10.2 Employment Contract between Goleta National Bank and Llewellyn Stone,
President and CEO (3)
10.3 Salary Continuation Agreement between Goleta National Bank and
Llewellyn Stone, President and CEO (3)
10.4 Agreement between the Company's subsidiary, Goleta National Bank, and
ACE Cash Express Inc (6)
10.5 Formal Agreement between Goleta National Bank and the Office of the
Comptroller of the Currency, dated March 23, 2000 (7)
10.6 Memorandum of Understanding between the Company and the Federal
Reserve Bank of San Francisco, dated February 22, 2001 (7)
10.7 Consulting Agreement between the Goleta National Bank and Llewellyn
Stone (7)
10.8 Indemnification Agreement between the Company and Stephen W. Haley,
dated December 20, 2001 (7)
10.9 Indemnification Agreement between the Company and Lynda Nahra, dated
December 20, 2001 (7)
10.10 Indemnification Agreement between the Company and Phillip E.
Guldeman,dated April 1, 2002 (7)
10.11 At-will agreement between the Company and Stephen W. Haley, dated
March 29, 2001 (7)
10.12 At-will agreement between the Company and Phillip E. Guldeman, dated
March 14, 2002 (7)
10.13 Consent Order between Goleta National Bank and the Comptroller of the
Currency of the United States, dated October 28, 2002 (8)
10.14 Stipulation and Consent to the Issuance of a Consent Order by the
Office of the Comptroller of the Currency, dated October 28,
2002 (8)
65
10.15 Amendment Number 3 to Master Loan Agency Agreement between Goleta
National Bank and Ace Cash Express, Inc., dated as of November 1,
2002 (8)
10.16 Amendment Number 1 to Collection Servicing Agreement between Goleta
National Bank and Ace Cash Express, Inc., dated as of November 1,
2002 (8)
10.17 Indemnification Agreement between the Company and Charles G.
Baltuskonis, dated March 18, 2003 (9)
10.18 Letter issued by the Comptroller of the Currency and Order Terminating
the Consent Order, dated October 21, 2003.
10.19 Letter dated November 6, 2003 from the Federal Reserve Bank of
San Francisco rescinding the Memorandum of Understanding, dated
February 2001.
10.20 Employment and Confidentiality Agreement, Goleta National
Bank, between the Company and Lynda J. Nahra dated April 23,2003.
21 Subsidiaries of the Registrant
23.1 Consent of Ernst and Young LLP
31.1 Certification of the Chief Executive Officer
31.2 Certification of the Chief Financial Officer
32.1 Certification pursuant to 18 U.S.C. Section 1350
- ----------------------------------------------------------------
(1) Incorporated by reference from the Registrant's Registration Statement
on Form S-8 filed with the Commission on December 31, 1997.
(2) Incorporated by reference from the Registrant's Amendment to
Registration Statement on Form 8-A filed with the Commission on March
12, 1998.
(3) Incorporated by reference from the Registrant's Annual Report on Form
10-K filed with the Commission on March 26, 1998.
(4) Incorporated by reference from the Registrant's Form 8-K/A filed with
the Commission on May 23, 2000.
(5) Filed as an exhibit to the Registrant's Form 8-K filed with the
Commission on December 5, 2000.
(6) Incorporated by reference from the Registrant's quarterly report on Form
10-Q for the quarter ended September 30, 2001 filed by the Registrant
with the Commission on November 16, 2001.
(7) Incorporated by reference from the Registrant's Annual Report on Form
10-K for the year ended December 31, 2001 filed by the Registrant
with the Commission on April 16, 2002.
(8) Incorporated by reference from the Registrant's Form 8-K filed with the
Commission on November 4, 2002.
(9) Incorporated by reference from the Registrants Annual Report on Form
10-K for the year ended December 31, 2002 filed with the Commission on
March 31, 2003.
66
SIGNATURES
- ----------
Pursuant to the requirements of Section 13 of 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 25th day of
March, 2004.
COMMUNITY WEST BANCSHARES
(Registrant)
By
/s/ William R. Peeples
-------------------------
William R. Peeples
Acting Chairman of the Board
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated
Signature Title Date
- --------- ----- ----
/s/ William R. Peeples Director and March 25, 2004
- ------------------------- Acting Chairman of the Board
William R. Peeples
/s/ Charles B. Baltuskonis Executive Vice President and March 25, 2004
- -------------------------- Chief Financial Officer
Charles G. Baltuskonis
/s/ Robert H. Bartlein Director and Secretary March 25, 2004
- ------------------------- of the Board
Robert H. Bartlein
/s/ Jean W. Blois Director March 25, 2004
- --------------------
Jean W. Blois
/s/ John D. Illgen Director March 25, 2004
- ---------------------
John D. Illgen
/s/ Lynda J. Nahra Director, President and March 25, 2004
- ------------------ Chief Executive Officer
Lynda J. Nahra
/s/ James R. Sims Jr. Director March 25, 2004
- -----------------------
James R. Sims Jr.
/s/ Kirk B. Stovesand Director March 25, 2004
- -----------------------
Kirk B. Stovesand
67