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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 AND 12CFR16.3
For the fiscal year ended December 31, 1998
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5638 Hollister Avenue, Goleta, California 93117
(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, including area code) (805)692-1862
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered:
Common Stock, no par value National Market tier of The NASDAQ Stock
Market
Securities registered under Section 12(g) of the Exchange Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act and 12CFR16.3 during the
past 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days. YES [X] NO[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained, and will not be contained, to the best of
the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
There were 5,482,571 shares of common stock for the registrant issued and
outstanding as of March 3, 1999. The aggregate market value of the voting
stock, based on the closing price of the stock on the NASDAQ National Market
System on March 3, 1999, held by the nonaffiliates of the registrant was
approximately $40,000,000.
This Form 10-K contains 70 pages
COMMUNITY WEST BANCSHARES
FORM 10-K
INDEX
PART I PAGES
ITEM 1. Description of Business 3
ITEM 2. Description of Property 5
ITEM 3. Legal Proceedings 6
ITEM 4. Submission of Matters to a Vote of Security Holders 6
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters 7
ITEM 6. Selected Financial Data 8
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk 38
ITEM 8. Consolidated Financial Statements 41
PART III
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 68
ITEM 10. Directors, Executive Officers, Promoters and Control Persons 68
ITEM 11. Executive Compensation 68
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 68
ITEM 13. Certain Relationships and Related Transactions 68
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 10-K 68
SIGNATURES 70
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
- -----------------------------------
General
- -------
Community West Bancshares was incorporated in the State of California on
November 26, 1996, for the purpose of forming a financial services holding
company. On December 31, 1997, Community West Bancshares ("the Company")
acquired a 100% interest in Goleta National Bank ("Goleta"). Effective that
date, shareholders of Goleta (NASDAQ:GLTB) became shareholders of the Company
(NASDAQ:CWBC) in a one-for-one exchange. On December 14, 1998, the Company
acquired a 100% interest in Palomar Savings & Loan Association ("Palomar").
As of that date, shareholders of Palomar (OTCBB:PALO) became shareholders of the
Company by receiving 2.11 shares of CWBC for each share of PALO they held. Both
acquisitions were accounted for under the pooling-of-interests method.
The Company offers a full range of commercial and retail financial services,
including the acceptance of demand, savings, and time deposits, and the
origination of commercial, U.S. Small Business Administration ("SBA"), accounts
receivable, real estate, construction, home improvement, and other installment
and term loans. It also offers cash management, remittance processing,
electronic banking, merchant credit card processing, online banking, and other
financial services to its customers.
The financial services industry as a whole offers a broad range of products. Few
companies today can effectively offer every product and service available.
Accordingly, the Company continually investigates products and services with
which it can attain a competitive advantage over others in the financial
services industry. In this way, management positions the Company to offer those
products and services requested by its customers.
The Company has been an approved lender/servicer of loans guaranteed by the SBA
since late 1990. The Company originates SBA loans, sells the guaranteed portion
into the secondary market, and services the loans. During 1995, the Company was
designated as a Preferred Lender by the SBA. As a Preferred Lender, the Company
has the ability to move loans through the approval process at the SBA much more
quickly than financial institutions which do not have such a designation. As of
December 31, 1998, the Company was the only SBA Preferred Lender headquartered
in Santa Barbara County. The Company was granted SBA Preferred Lender status
in the districts of Los Angeles, Fresno, Sacramento, San Francisco, and Santa
Ana, California, Birmingham, Alabama, Atlanta, Georgia and Miami and
Jacksonville, Florida.
During 1994, the Company established a Mortgage Loan Processing Center. Through
the Mortgage Loan Processing Center, the Company takes applications for
residential real estate loans and processes those loans for a fee for lenders
located throughout the nation. At any point in time, the Company processes loans
for 50-70 such lenders. Because it has so many lenders for which it processes,
the Company can offer many more loan programs than normally offered by any
single institution. By virtue of the large number of loan programs being
offered, the Company has developed the ability to remain ahead of its
competition.
Also in 1994, the Company began offering home improvement loans under Title I of
FHA regulations. This is the oldest government insured loan program in
existence, having begun in 1934. The Company originates Title I loans and sells
them into the secondary market and retains the servicing. In early 1995, the
Company was approved as one of a small number of financial institutions to be
able to sell Title I loans directly to the Federal National Mortgage Association
("FNMA"). This approval has given the Company a competitive advantage over
nonapproved lenders because it can price loans at lower rates to customers and
reduce or eliminate fees normally charged to customers, while at the same time
increasing the profitability to the Company.
During 1996, the Company began offering second mortgage loans ("HLTV") which
allow borrowers to receive up to 125% of their home value for debt
consolidation, home improvement, school tuition, or any worthwhile cash outlay.
There is an upper limit on these loans of $100,000. The Company relies
principally on the creditworthiness of the borrower, and to a lesser extent on
the underlying collateral, for repayment of these HLTV loans. The loan terms
under the program range from one to 25 years. In 1997 and 1998, the Company sold
these loans at a premium to third-parties. In March of 1998, the Company began
accumulating the majority of these loans for the purposes of securitization. On
December 22, 1998, the Company completed the securitization of an $81 million
pool of loans. As of December 31, 1998, the Company had accumulated $24 million
in loans to be securitized in 1999.
3
In 1996, the Company began accounts receivable financing, providing working
capital to small and mid-sized manufacturers, distributors and merchants
throughout Southern California. This division complements the Company's SBA and
commercial lending products, in addition to generating a high annual yield.
Because of the development costs involved, most small community banks have
difficulty providing electronic banking services to their customers. From its
inception, the Company has invested heavily in the hardware and software
necessary to offer today's electronic banking services. In addition to the
normal financial services, the Company offers such services as online cash
management, automated clearinghouse origination, electronic data interchange,
remittance processing, draft preparation and processing, and merchant credit
card processing. Not only do these services generate significant fee income,
they attract companies with large deposit balances. These services have helped
the Company remain at a competitive advantage over most institutions of
comprable size and many which are significantly larger than the Company.
On October 16, 1997, the Company purchased a 70% interest in Electronic
Paycheck, LLC, a California Company that has developed systems to allow
companies to pay their employees by issuing them a card or "electronic
paycheck". The systems were originally developed to pay factory workers in
Kazakhstan. The card is currently being used by companies in the agricultural
sector to pay their workers, many of whom do not have bank accounts. The Company
provides access to ATM and Point-of-Sale (POS) networks so that the cardholders
have access to their cash at thousands of locations virtually worldwide.
In September of 1998, the Company opened its second full service Branch in
Ventura, California. The Company simultaneously consolidated into that location
its Ventura SBA and mortgage loan production office and the accounts receivable
financing department.
On December 14, 1998, the Company acquired 100% of Palomar. Palomar is a
state-chartered full service savings and loan association and is subject to
supervision by the OTS, the FDIC, and the Commissioner of the California
Department of Financial Institutions. The deposits of the Association are
insured up to the applicable limits by the Savings Association Insurance Fund
("SAIF"). The Association is a member of the Federal Home Loan Bank ("FHLB")
system. Their main office is located at 355 West Grand Avenue, Escondido,
California 92025. A second branch is located at 1815 East Valley Parkway, Suite
1, Escondido, California 92027. It is the Company's intent to maintain Palomar
as a separate subsidiary of the Company.
Competition and Service Area
- -------------------------------
The financial service industry in California is highly competitive with respect
to both loans and deposits; and is dominated overall by a relatively small
number of major banks with many offices operating over wide geographic areas.
Some of the major commercial banks operating in the communities nearby the
Company's service areas offer certain services such as trust and investment
services and international banking which are not offered directly by the Company
or any of its subsidiaries, and by virtue of their greater total capitalization,
such institutions have substantially higher lending limits than the Company. To
help offset the numerous branch offices of banks, thrifts, and credit unions, as
well as competition from mortgage brokers, insurance companies, credit card
companies, and brokerage houses within the Company's service areas, the Company,
through its subsidiaries, has established loan production offices in Fresno,
Costa Mesa, San Rafael, Solvang, Santa Barbara, Anaheim, Escondido and West
Covina in California, and in Las Vegas and Reno, Nevada, Woodstock, Georgia, and
Jacksonville, Pensacola, and Panama City Beach, Florida. The Company's online
capabilities allow it to support these offices from its main computer center in
Goleta, California. Part of the Company's strategy is to establish loan
production offices in areas where there is high demand for the loan products
which it originates.
In order to compete for loans and deposits within its primary service area, the
Company uses to the fullest extent possible the flexibility which its
independent status permits. This includes an emphasis on meeting the specialized
banking needs of its customers, including personal contact by the Company's
directors, officers, and employees, newspaper publications, direct mailings and
other local advertising, and by providing experienced management and staff
trained to deal with the specific banking needs of the Company's customers.
Management has established a highly personalized banking relationship with the
Company's customers and is attuned and responsive to their financial and service
requirements. In the event there are customers whose loan demands exceed the
Company's lending limits, the Company seeks to arrange for such loans on a
participation basis with other financial institutions and intermediaries. The
Company also assists those few customers requiring highly specialized services
not offered by the Company to obtain such services from correspondent
institutions.
4
Employees
- ---------
As of December 31, 1998, the Company employed 257 persons, including 2 principal
officers. The Company's employees are not represented by a union or covered by a
collective bargaining agreement. Management of the Company believes that, in
general, its employee relations are very positive.
ITEM 2. DESCRIPTION OF PROPERTY
- -----------------------------------
The Company owns the following property:
- ---------------------------------------------
The Goleta National Bank Main office, located at 5827 Hollister Avenue, Goleta,
California. This 4,000 square foot facility houses the bank's main office, and a
separate 400 square foot building provides additional office space.
The Company leases the following properties:
- -------------------------------------------------
The Company leases, under three separate leases, four suites in an office
building at 5638 Hollister Avenue, Goleta, California, from an independent
third party. The leases are for terms expiring from May 31, 2000 to May 31,
2003, with a current monthly rent of $9,701 per month for all four suites. The
leases also provide the Company with two additional consecutive options of three
years each to extend the leases. The suites consist of approximately 7,590
square feet of office space. These suites house the company's Corporate Office,
Finance, Data Processing, Compliance, Human Resources, and Electronic Business
Services departments of the Company, as well as the offices of the Company's
subsidiary, Electronic Paycheck, LLC.
The Company leases approximately 1,500 square feet of office space located at
310 South Pine Avenue, Goleta, California, from an independent third party. The
lease is month to month, with a current monthly rent of $960 per month. This
facility houses the Special Assets and Loan Collection departments of the
Company.
The Company leases under two separate leases approximately 2,718 square feet of
office space located at 3891 State Street, Santa Barbara, California, from an
independent third party. The leases are for terms expiring November 1, 1999 and
March 31, 2001, with a current monthly rent of $7,195 per month for both leases.
The leases also provide the Company with two additional consecutive options of
three years each to extend the lease. This facility houses the Retail and
Wholesale Mortgage Lending departments of the Company.
The Company leases approximately 3,431 square feet of office space located at
1463 South Victoria Avenue, Ventura, California, from an independent third
party. The lease is for a term expiring July 20, 2002, with a current monthly
rent of $5,555 per month. The lease also provides the Company with one option of
three years to extend the lease. This facility houses the new Ventura Branch
office, as well as Mortgage, SBA Lending and the Accounts Receivable Financing
department of the Company.
The Company leases approximately 4,921 square feet of space located at 4025 East
La Palma Avenue Suite 201A, Anaheim, California, from an independent third
party. The lease is for a term expiring February 28, 2000, with a current
monthly rent of $5,905 per month. This facility houses the Anaheim Loan
Production office of the Company. In addition, the Company also leases
approximately 1,000 square feet of office space located at 100 North Citrus
Street Suite 238 in West Covina, California, from an independent third party
with a current monthly rent of $2,099. The lease is for a term expiring January
31, 2000.
The Company leases approximately 1,032 square feet of storefront space located
at 4170 South Decatur, Unit D-4, Las Vegas, Nevada, from an independent third
party. The lease is for a term expiring February 28, 2000, with a current
monthly rent of $1,858 per month. This facility houses the Las Vegas, Nevada
Loan Production office of the Company.
5
The Company leases approximately 6,380 square feet of space located at 5383
Hollister Avenue, 2nd Floor, Goleta, California, from an independent third
party. The lease is for a term expiring November 30, 2002, with a current
monthly rent of $8,613 per month. The lease also provides the Company with two
options of three years to extend the lease. This facility houses the Alternative
Mortgage lending, and SBA lending departments of the Company.
The Company also leases small executive suites on a month-to-month basis in
Bakersfield, Fresno, Modesto, San Rafael and Costa Mesa, California. The Company
also has executive suites in Woodstock, Georgia, and Jacksonville, Pensacola,
and Panama City Beach, Florida and Reno, Nevada. These offices allow the Company
to have a local presence for the production of loans while controlling the
underwriting and funding of the loans at the main office in Goleta. The Company
also leases on a month-to-month basis two storage units and a portion of a
parking lot, all, are located in Goleta.
The Company also leases approximately 7,000 square feet of office space at 355
West Grand Avenue, Escondido, California, which houses the main branch office of
Palomar. The lease is for a term expiring November 20, 2007, with a ten year
option to renew and a current monthly rent of $12,971. A second Escondido
branch office which is located at 1815 East Valley Parkway, Suite 1 has a
current monthly rent of $1,200 and a lease expiration of August 16, 2002, with
no renewal option. The third Escondido office, which is located at 283 South
Escondido Boulevard Suite E, has approximately 2,482 square feet of office
space, a current monthly rent of $2,200 and a lease that expires on August 9,
2000, with three additional one year periods as renewal options and is used for
mortgage operations. These leases are all with independent third parties.
The Company's total occupancy expense for the year ended December 31, 1998, was
$2,739,000. Management believes that its existing facilities are adequate for
its present purposes.
ITEM 3. LEGAL PROCEEDINGS
- ----------------------------
From time to time the Company is party to claims and legal proceedings arising
in the ordinary course of business. After taking into consideration information
furnished by counsel to the Company, management believes that the ultimate
aggregate liability represented thereby, if any, will not have a material
adverse effect on the Company's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ---------------------------------------------------------------------
A special meeting of security holders of the Company was held October 29, 1998.
The security holders voted on and approved a plan for the acquisition of
Palomar. Under this plan, Palomar becomes a wholly owned subsidiary of
Community West Bancshares. There was a total of 3,077,991, or 75.1%, proxies
voted out of 4,098,062 possible votes. The following indicates how the votes
were cast:
FOR AGAINST ABSTAIN NON-VOTES
Number of Votes Received 3,057,197 13,740 7,054 1,020,071
Percentage of Total Shares 74.6% 0.3% 0.2% 24.9%
The security holders also voted and passed a change in the bylaws to increase
the number of Board members from ten to eleven. This proposal received
3,140,626, or 76.6%, votes out of 4,098,062 possible votes. The following
indicates how the votes were cast:
FOR AGAINST ABSTAIN NON-VOTES
Number of Votes Received 3,021,988 61,064 57,574 957,436
Percentage of Total Shares 73.7% 1.5% 1.4% 23.4%
6
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
----------------------------------------------------------------------
MATTERS
-------
As of the close of business December 31, 1997, the common stock for Goleta
National Bank, symbol "GLTB", was converted to Community West Bancshares common
stock, symbol "CWBC". On January 5, 1998, NASDAQ National Market ("NASDAQ")
listed the new common stock symbol "CWBC" for trading and the old symbol "GLTB"
was removed. On December 18, 1998, the Company acquired Palomar (OTCBB:PALO),
both the table and the paragraph below relate to CWBC and its predecessor GLTB.
Prior to listing on NASDAQ, the stock was traded OTC under the symbol "GLTB".
OTC quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not represent actual transactions. The common stock was
listed on NASDAQ on November 19, 1996, under the symbol "GLTB". During the
secondary stock offering which took place in the third quarter of 1996, warrants
were issued. Each warrant entitled the holder to purchase two shares of common
stock at an exercise price of $4.375 per share. The warrants expired on June 30,
1998, and were traded OTC under the new symbol "CWBCW". The following table
sets forth the high and low sales prices on a per share basis for the common
stock and a per warrant basis for the warrants, as reported by the respective
exchanges for the period indicated:
Common Stock(1) Warrants
Low High Low High
------ ------- ----- ------
1997 First Quarter 5 1/4 8 1/4 3 1/2 7 1/2
Second Quarter 6 5/8 7 5/8 7 1/2 7 1/2
Third Quarter 6 3/8 9 3/4 5 3/4 7
Fourth Quarter 8 3/8 9 1/2 6 1/2 10 1/2
1998 First Quarter 9 1/4 13 1/4 9 5/8 16 1/2
Second Quarter 11 7/8 14 5/16 9 15
Third Quarter 9 1/4 14 N/A N/A
Fourth Quarter 8 1/8 11 N/A N/A
(1) As adjusted by NASDAQ for the 1996 and 1998 2-for-1 stock splits.
On March 26, 1999, the last reported sale price per share for the Company's
stock was $8 1/2.
The Company has declared and paid cash dividends per share of $.03, $.03, and
$.04 in 1994, 1995, and 1996, respectively. The Company declared and issued a
10% stock dividend in 1995, and effected a 2-for-1 stock split in 1996 and again
in 1998. The Company has declared two quarterly dividends of $.04 per share
one which was paid on January 20, 1999 for shareholders of record as of January
5, 1999 and a second to be paid on April 26, 1999, for shareholders of record as
of April 12, 1999.
The Company had 717 shareholders of record of its common stock as of December
31, 1998.
7
ITEM 6. SELECTED FINANCIAL DATA
- -----------------------------------
SUMMARY OF EARNINGS
The following Summary of Earnings of the Company for the years ended December
31, 1998, 1997, 1996, 1995, and 1994 have been derived from the audited
financial statements included elsewhere in this document.
Year Ended December 31,(1)
-----------------------------------------------------------
(Dollars in thousands, except per share data) 1998 1997 1996 1995 1994
---------- ---------- ---------- ----------- ----------
Interest income $ 20,547 $ 13,553 $ 12,460 $ 11,970 $ 9,921
Interest expense 9,257 6,361 5,990 6,255 4,290
---------- ---------- ---------- ----------- ----------
Net interest income 11,290 7,192 6,470 5,715 5,631
Provision for loan losses 429 191 651 1,122 705
---------- ---------- ---------- ----------- ----------
Net interest income after provision for
loan losses 10,861 7,001 5,819 4,593 4,926
Other income 14,036 9,911 6,977 4,661 2,586
Other expenses 20,075 13,446 10,904 8,371 6,062
---------- ---------- ---------- ----------- ----------
Income before provision for income taxes 4,822 3,466 1,892 883 1,450
Provision for income taxes 1,941 1,316 688 (209) 631
---------- ---------- ---------- ----------- ----------
Net income $ 2,881 $ 2,150 $ 1,204 $ 1,092 $ 819
========== ========== ========== =========== ==========
Net income per share - Basic $ 0.57 $ 0.49 $ 0.32 $ .32 $ .24
Number of shares used in net income per
share calculation (2) - Basic 5,069,596 4,383,878 3,723,832 3,446,030 3,415,994
Net income per share - Diluted $ 0.55 $ 0.43 $ 0.31 $ .31 $ .24
Number of shares used in net income per
share calculation (2) - Diluted 5,243,738 4,956,148 3,878,022 3,495,882 3,434,928
Year Ended December 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ----------- ----------
Net Loans $ 165,935 $ 128,385 $ 113,807 $ 109,221 $ 105,180
Total Assets 252,034 173,920 160,937 151,586 142,570
Deposits 223,545 152,691 143,106 137,594 127,913
Total Liabilities 227,481 156,265 145,951 140,645 132,774
Total Equity 24,553 17,655 14,986 10,941 9,796
(1) See Notes to Financial Statements for a summary of significant accounting
policies and other related data.
(2) Earnings per common share information is based on the weighted average
number of common shares outstanding during each period. Earnings per share
amounts have been adjusted to reflect the 2-for-1 stock splits in 1996 and 1998
and the acquisition of Palomar.
The following table sets forth selected ratios for the periods indicated:
Year Ended December 31,
--------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
Net earnings to average stockholder equity 13.65% 13.17% 9.29% 10.53% 8.36%
Net earnings to average total assets 1.35% 1.28% .77% .74% .57%
Total interest expense to total interest income 45.05% 46.93% 48.07% 52.26% 43.24%
Other operating income to other operating expense 69.92% 73.71% 63.99% 55.68% 42.66%
Dividend payout ratio - - 6.25% 4.69% 10.42%
Equity to assets ratio 8.18% 9.76% 8.19% 7.05% 6.87%
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
--------------
Introduction
- ------------
This discussion is designed to provide a better understanding of significant
trends related to the Company's financial condition, results of operations,
liquidity, capital resources, and interest rate sensitivity. It should be read
in conjunction with the audited financial statements and notes thereto and the
other financial information appearing elsewhere in this filing.
Results of Operations
- -----------------------
The following table sets forth for the periods indicated, the increase or
decrease of certain items in the statements of income of the Company as compared
to the prior periods:
For the Year Ended December 31,
----------------------------------------------------------------------------
1998 versus 1997 1997 versus 1996 1996 versus 1995
------------------------ ------------------------ ------------------------
Amount of Percent of Amount of Percent of Amount of Percent of
increase increase increase increase increase increase
(decrease) (decrease) (decrease) (decrease) (decrease) (decrease)
----------- ----------- ----------- ----------- ----------- -----------
INTEREST INCOME:
Loans, including fees $7,116,792 60.50% $1,132,035 10.65% $ 594,911 5.93%
Federal funds sold 56,807 9.22% 187,402 43.70% 24,723 6.12%
Time deposits in other financial institutions (106,353) -46.31% 32,844 16.69% (75,179) -27.64%
Investment securities (73,155) -7.75% (259,702) -21.57% (54,084) -4.30%
Total interest income 6,994,091 51.61% 1,092,579 8.77% 490,371 4.10%
INTEREST EXPENSE ON DEPOSITS 2,895,815 45.53% 370,633 6.19% (264,759) -4.23%
NET INTEREST INCOME 4,098,276 56.99% 721,946 11.16% 755,130 13.21%
PROVISION FOR LOAN LOSSES 238,421 125.12% (459,940) -70.71% (471,144) -42.01%
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,859,855 55.13% 1,181,886 20.31% 1,226,274 26.70%
OTHER INCOME:
Gains from loan sales 2,003,850 45.65% 1,744,565 65.95% 123,016 4.88%
Loan origination fees - sold or brokered loans 684,710 22.78% 909,950 43.42% 1,335,999 175.91%
Document processing fees 828,353 101.10% 309,705 60.77% 425,864 508.28%
Loan servicing fees 249,310 34.96% (54,793) -7.13% 82,032 11.96%
Service charges (74,609) -7.76% 315,544 48.83% 233,171 56.45%
Other income 433,317 2,035.02% (290,651) -93.17% 115,742 58.99%
Total other income 4,124,931 41.62% 2,934,320 42.06% 2,315,824 49.69%
(continued on next page)
9
For the Year Ended December 31,
----------------------------------------------------------------------------
1998 versus 1997 1997 versus 1996 1996 versus 1995
------------------------ ------------------------ ------------------------
Amount of Percent of Amount of Percent of Amount of Percent of
increase increase increase increase increase increase
(decrease) (decrease) (decrease) (decrease) (decrease) (decrease)
----------- ----------- ----------- ----------- ----------- -----------
OTHER EXPENSES:
Salaries and employee benefits 4,747,669 58.46% 1,932,743 31.23% 1,537,462 33.06%
Occupancy expenses 1,003,060 57.79% 337,764 24.16% 198,571 16.56%
Other operating expenses 507,908 44.19% (496,152) -30.15% 383,568 30.40%
Advertising expense 203,548 31.86% 291,175 83.76% 9,245 2.73%
Professional services 334,086 65.91% 155,918 44.43% (74,979) -17.60%
Postage & freight (379,767) -44.69% 279,220 48.94% 378,703 197.42%
Data processing/ATM processing 147,395 60.73% 23,484 10.71% 71,860 48.77%
Office supply expense 64,768 32.01% 18,102 9.83% 28,719 18.47%
Total other expenses 6,628,667 49.30% 2,542,254 23.32% 2,533,149 30.26%
INCOME BEFORE PROVISION FOR INCOME TAXES 1,356,119 39.13% 1,573,952 83.19% 1,008,949 114.25%
PROVISION FOR INCOME TAXES 625,004 47.48% 627,873 91.20% 896,978 -430.21%
NET INCOME $ 731,115 34.01% $ 946,079 78.61% $ 111,971 10.26%
=========== =========== =========== =========== =========== ===========
Net Interest Income and Net Interest Margin
- -------------------------------------------------
The Company's earnings partially depend upon the difference between the income
received from its loan portfolio and investment securities and the interest paid
on its liabilities, including interest paid on deposits. This difference is
"net interest income." The net interest income, when expressed as a percentage
of average total interest-earning assets, is referred to as the net interest
margin on interest-earning assets. The Company's net interest income is
affected by the change in the level and the mix of interest-earning assets and
interest-bearing liabilities, referred to as volume changes. The Company's net
yield on interest-earning assets is also affected by changes in the yields
earned on assets and rates paid on liabilities, referred to as rate changes.
Interest rates charged on the Company's loans are affected principally by the
demand for such loans, the supply of money available for lending purposes and
competitive factors. These factors are in turn affected by general economic
conditions and other factors beyond the Company's control, such as federal
economic policies, the general supply of money in the economy, legislative tax
policies, governmental budgetary matters and the actions of the FRB.
1998 1997 1996
------------ ------------ ------------
Interest Income $20,546,598 $13,552,507 $12,459,928
Interest Expense 9,256,700 6,360,885 5,990,252
Net Interest Income $11,289,898 $ 7,191,622 $ 6,469,676
============ ============ ============
Net Interest Margin 5.5% 4.7% 4.6%
Total interest income increased from $13,552,507 in 1997 to $20,546,598 in 1998,
representing a 51.6% increase in 1998 over 1997. This increase in 1998 over
1997 was reflected by a 35.0% increase because of an increase in
interest-earnings assets added with a 16.6% increase because of higher rates
earned on those assets. Total interest expense increased from $6,360,885 in
1997 to $9,256,700 in 1998, representing a 45.5% increase in 1998 compared to
1997. This increase was reflected by a 41.4% increase in interest-bearing
liabilities and a 4.1% increase in rates paid on deposits. The result of these
changes was net interest income increased from $7,191,622 in 1997 to $11,289,898
in 1998.
10
Total interest income increased from $12,459,928 in 1996 to $13,552,507 in 1997,
representing an 8.8% increase in 1997 over 1996. This increase in 1997 over
1996 was reflected by a 11.4% increase because of an increase in
interest-earnings assets offset with a decrease of 2.6% because of lower rates.
Total interest expense increased from $5,990,252 in 1996 to $6,360,885 in 1997,
representing a 6.2% increase in 1997 compared to 1996. This increase was
reflected by a 4.1% increase in interest-bearing liabilities and a 2.1% increase
in rates paid on deposits. The result of these changes was net interest income
increased from $6,469,676 in 1996 to $7,191,622 in 1997.
The following table sets forth the changes in interest income and expense
attributable to changes in rates and volumes:
Analysis of Changes in Net Interest Income
- ------------------------------------------
Year Ended December 31,
----------------------------------------------------------------------------------------
(Dollars in Thousands) 1998 Versus 1997 1997 Versus 1996 1996 Versus 1995
---------------------------- ---------------------------- ----------------------------
Change Change Change Change Change Change
Total Due to Due to Total Due to Due to Total Due to Due to
Change Rate Volume Change Rate Volume Change Rate Volume
-------- -------- -------- -------- -------- -------- -------- -------- --------
Time deposits in other
financial institutions $ (106) 15 (121) $ 32 10 22 $ (75) (97) 22
Federal funds sold 57 (17) 74 188 25 163 25 (37) 62
Investment securites (73) 114 (187) (259) (325) 66 (54) (143) 89
Loans, net 7,116 1,381 5,735 1,132 60 1,072 595 354 241
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-earning
assets 6,994 1,493 5,501 1,093 (230) 1,323 491 77 414
-------- -------- -------- -------- -------- -------- -------- -------- --------
Interest-bearing demand 71 277 (206) 16 (24) 40 (19) (19) 0
Savings 122 (130) 252 (68) (26) (42) (115) (136) 21
Time certificates of deposit 2,636 58 2,578 511 119 392 (83) (141) 58
Federal funds purchased 85 - 85 - - - - - -
Other borrowings (18) (11) (7) (88) 22 (110) (47) (11) (36)
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities 2,896 194 2,702 371 91 280 (264) (307) 43
-------- -------- -------- -------- -------- -------- -------- -------- --------
Net interest income $ 4,098 $ 1,299 $ 2,799 $ 722 $ (321) $ 1,043 $ 755 $ 384 $ 371
======== ======== ======== ======== ======== ======== ======== ======== ========
The change in interest income or interest expense that is attributable to both
changes in rate and changes in volume has been allocated to the change due to
rate and the change due to volume in proportion to the relationship of the
absolute amounts of changes in each.
Provision for Loan Losses
- ----------------------------
The provision for loan losses corresponds directly to the level of the allowance
that management deems sufficient to offset potential loan losses. The balance in
the loan loss allowance reflects the amount which, in management's judgment, is
adequate to provide for these potential loan losses, after weighing the mix of
the loan portfolio, current economic conditions, past loan experience and such
other factors as deserve recognition in estimating loan losses.
Each month management reviews the allowance for possible loan losses and makes
additional transfers to the allowance, as needed. Management allocated $428,969
as a provision for loan losses in 1998, $190,548 in 1997 and $650,488 in 1996.
Loans charged off, net of recoveries, in 1998 were $367,111, in 1997 were
$503,017 and in 1996 were $625,106. The ratio of the allowance for loan losses
to total gross loans was 1.3% at December 3l, 1998, 1.6% at December 31, 1997,
and 2.0% at December 31, 1996.
In management's opinion, the balance of the allowance for loan losses at
December 31, 1998, was sufficient to absorb foreseeable losses in the loan
portfolio at that time.
Other Income
- -------------
Other income increased from $6,976,637 in 1996, to $9,910,957 in 1997, and to
$14,035,888 in 1998, representing a $2,934,320 or 42.1% increase in 1997 over
1996 and $4,124,931 or a 41.6% increase in 1998 over 1997. The Company continued
to emphasize generating noninterest income. These year to year gains are a
reflection of the increases in SBA loan originations, sales, and servicing, as
well as increased growth in mortgage loan processing over the years. In
addition, fees from electronic banking services have increased dramatically over
the last three years. The Company's percentage coverage of other expenses with
other income was 64.0% in 1996, to 73.7% in 1997 and 69.9% in 1998.
11
Other Expenses
- ---------------
Other expenses include salaries and employee benefits, occupancy and equipment,
and other operating expenses. The continued growth of the Company required
additional staff and overhead expense to support the continued high level of
customer service and the increased cost of occupying the Company's offices.
Although compensation expenses have grown significantly, approximately 40% of
the Company personnel derive some or all of their compensation based on income
production. This means that a significant portion of compensation is tied to
increases in revenues instead of being a fixed expense. Other expenses increased
from $10,903,774 in 1996 to $13,446,028 in 1997 and to $20,074,695 in 1998,
representing a 23.3% in 1997 over 1996 and a 49.3% increase in 1998 over 1997.
The increases in other expenses for the periods compared were primarily because
of compensation related to loan originations and sales, the increase in the
number of loan production and processing offices, the upgrading of data
processing hardware and software, and costs related to the Palomar acquisition
in 1998.
The following table compares the various elements of other expenses as a
percentage of average assets for the three years ended December 31, (in
thousands except percentage amounts.)
Salaries
and Other
Average Total Other Employee Occupancy Operating
Assets (1) Expense Benefits Expenses Expenses
----------- ------------ --------- ---------- ----------
December 31, 1998 $ 224,419 8.94% 5.73% 1.22% 1.99%
December 31, 1997 $ 165,536 8.12% 4.90% 1.05% 2.17%
December 31, 1996 $ 152,871 7.13% 4.05% 0.91% 2.17%
(1) Based on the average of daily balances.
Income Taxes
- -------------
Income taxes were $1,941,355 in 1998, $1,316,351 in 1997, and $688,478 in 1996.
The effective income tax rate was 40.3%, 38% and 36.4% for 1998, 1997 and 1996.
Net Income
- -----------
The net income of the Company was $2,880,767 in 1998, $2,149,652 in 1997, and
$1,203,573 in 1996. Earnings per share were $.57 basic and $.55 diluted in 1998;
$.49 basic and $.43 diluted in 1997; and $.32 basic and $.31 diluted in 1996; as
adjusted to reflect the 1996 and 1998 2-for-1 stock splits and the 1995 10%
stock dividend. The increases in net income for the past three years were the
result of several factors. First, the earning assets of the Company have
increased, resulting in an increase in net interest income. Second, the
origination and sale of SBA loans has continued to grow, resulting in increased
gains on sales and increased servicing income. Third, the increased volume of
business in the Mortgage Loan Processing Center and Home Equity Lending
Department, increased fee income, income from loan sales, and servicing income.
Offsetting the income increase was an overall increase in expenses related to
the production of income.
Capital Resources
- ------------------
The Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 was
signed into law on December 19, 1991. Regulations implementing the prompt
corrective action provisions of FDICIA include significant changes to the legal
and regulatory environment for insured depository institutions, including
reductions in insurance coverage for certain kinds of deposits, increased
supervision by the federal regulatory agencies, increased reporting requirements
for insured institutions, and new regulations concerning internal controls,
accounting, and operations.
12
The prompt corrective action regulations define specific capital categories
based on institution's capital ratios. The capital categories, in defining
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 less goodwill and other intangible assets.
Management believes, as of December 31, 1998, the Company exceeds all capital
adequacy requirements to which it is subject. As of December 31, 1998 and 1997,
the most recent notification from the FDIC categorized the Company as "well
capitalized." There are no conditions or events since that notification which
management believes have changed the Company's category.
The Company's actual capital ratios are presented below.
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
------ -------- -----------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------ ----------- ------
As of December 31, 1998:
Total Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . $26,109,980 15.27% $13,674,814 8.00% $17,093,519 10.00%
Goleta National Bank . . . . . . . . . . . $16,152,794 13.88% $ 9,309,968 8.00% $11,637,460 10.00%
Palomar Savings and Loan . . . . . . . . . $ 6,492,000 12.45% $ 4,172,240 8.00% $ 5,215,300 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . $23,972,867 14.02% $ 6,837,407 4.00% $10,256,111 6.00%
Goleta National Bank . . . . . . . . . . . $14,698,113 12.63% $ 4,654,984 4.00% $ 6,982,476 6.00%
Tier I Capital (to Average Assets)
Consolidated . . . . . . . . . . . . . . . $23,972,867 9.49% $10,102,001 4.00% $12,627,501 5.00%
Goleta National Bank . . . . . . . . . . . $14,698,113 8.07% $ 7,285,310 4.00% $ 9,106,638 5.00%
Core Capital (to Adjusted Tangible Assets)
Palomar Savings and Loan . . . . . . . . . $ 5,865,000 7.11% $ 3,299,000 4.00% $ 4,124,200 5.00%
Tangible Capital (to Tangible Assets)
Palomar Savings and Loan . . . . . . . . . $ 5,865,000 7.11% $ 1,237,260 1.50% N/A N/A
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
------ -------- -----------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ---------- ------ ----------- ------
As of December 31, 1997:
Total Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . $18,535,374 15.88% $9,336,643 8.00% $11,670,804 10.00%
Goleta National Bank . . . . . . . . . . . $12,990,366 17.36% $5,986,344 8.00% $ 7,482,930 10.00%
Palomar Savings and Loan . . . . . . . . . $ 6,055,541 13.49% $3,591,129 8.00% $ 4,488,911 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . $17,071,672 14.63% $4,668,321 4.00% $ 7,002,482 6.00%
Goleta National Bank . . . . . . . . . . . $12,054,016 16.11% $2,992,928 4.00% $ 4,489,391 6.00%
Tier I Capital (to Average Assets)
Consolidated . . . . . . . . . . . . . . . $17,071,672 9.84% $6,939,541 4.00% $ 8,674,427 5.00%
Goleta National Bank . . . . . . . . . . . $12,054,016 12.63% $3,917,582 4.00% $ 4,771,978 5.00%
Core Capital (to Adjusted Tangible Assets)
Palomar Savings and Loan . . . . . . . . . $ 5,494,541 6.99% $3,144,229 4.00% $ 3,930,287 5.00%
Tangible Capital (to Tangible Assets)
Palomar Savings and Loan . . . . . . . . . $ 5,494,541 6.99% $1,179,086 1.50% N/A N/A
Schedule of Assets, Liabilities and Stockholders' Equity
- --------------------------------------------------------------
The following schedule shows the average balances of the Company's assets,
liabilities and stockholders' equity accounts as a percentage of average total
assets for the periods indicated.
13
(Dollars in Thousands) Year Ended December 31,
----------------------------------------------------------
1998 1997 1996
------------------ ------------------ ------------------
Amount Percent Amount Percent Amount Percent
--------- ------- --------- ------- --------- -------
ASSETS
- -----------------------------------------------
Cash and due from banks $ 6,196 2.8% $ 5,354 3.2% $ 4,322 2.8%
Federal funds sold 13,121 5.8% 11,675 7.1% 8,565 5.6%
Time deposits in other financial institutions 2,160 1.0% 4,006 2.4% 3,609 2.4%
FRB/FHLB Stock 791 0.3% 713 0.4% 636 0.4%
Investment securities 16,137 7.2% 16,076 9.7% 18,086 11.8%
Trading securities 44 0.0% - 0.0% - 0.0%
Loans:
Commercial 13,487 6.0% 13,637 8.2% 14,300 9.3%
Real estate 70,125 31.2% 76,642 46.3% 74,476 48.7%
Unguaranteed portions of loans insured by SBA 27,081 12.1% 21,345 12.9% 15,617 10.2%
Installment 12,267 5.5% 5,054 3.1% 6,531 4.3%
Loan participations purchased 4,016 1.8% 1,333 0.8% 746 0.5%
Less: allowance for loan loss (2,092) -0.9% (2,175) -1.3% (2,340) -1.5%
Less: net deferred loan fees and premiums (129) -0.1% (195) -0.1% (175) -0.1%
Less: discount on loan pool purchase (703) -0.3% (488) -0.3% (423) -0.3%
--------- ------- --------- ------- --------- -------
Net loans 124,052 55.3% 115,153 69.6% 108,732 71.1%
Loans held for sale 51,952 23.1% 6,351 3.8% 1,692 1.1%
Other real estate owned 181 0.1% 316 0.2% 715 0.5%
Premises and equipment, net 3,619 1.6% 2,683 1.6% 2,016 1.3%
Servicing asset 1,088 0.5% 788 0.5% 1,705 1.1%
Accrued interest receivable and other assets 5,078 2.4% 2,421 1.5% 2,793 1.9%
TOTAL ASSETS $224,419 100.0% $165,536 100.0% $152,871 100.0%
========= ======= ========= ======= ========= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
- -----------------------------------------------
Deposits:
Noninterest-bearing demand 20,950 9.3% 17,307 10.5% 14,169 9.3%
Interest-bearing demand 20,511 9.1% 17,755 10.7% 16,339 10.7%
Savings 24,404 10.9% 21,906 13.2% 23,259 15.2%
Time certificates, $100,000 or more 44,216 19.7% 27,235 16.4% 22,311 14.6%
Other time certificates 91,907 41.0% 63,673 38.5% 61,601 40.3%
--------- ------- --------- ------- --------- -------
Total deposits 201,988 90.0% 147,876 89.3% 137,679 90.1%
Other Borrowings 234 0.1% 405 0.2% 2,000 1.3%
Federal funds purchased 1,479 0.7% - 0.0% - 0.0%
Accrued interest payable and other liabilities 2,358 1.0% 1,105 0.7% 672 0.4%
--------- ------- --------- ------- --------- -------
Total liabilities 206,059 91.8% 149,386 90.2% 140,351 91.8%
Stockholders' equity
Common stock 13,379 6.0% 12,595 7.6% 10,470 6.8%
Retained earnings 4,968 2.2% 3,556 2.2% 2,076 1.4%
Unrealized gain/(loss) on AFS securities 13 0.0% (1) 0.0% (26) 0.0%
Treasury stock - 0.0% - 0.0% - 0.0%
--------- ------- --------- ------- --------- -------
Total stockholders' equity 18,360 8.2% 16,150 9.8% 12,520 8.2%
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $224,419 100.0% $165,536 100.0% $152,871 100.0%
========= ======= ========= ======= ========= =======
14
Investment Portfolio
- ---------------------
The following table summarizes the year-end carrying value balances and
distributions of the Company's investment securities.
December 31,
------------------------------------
(Dollars rounded to thousands) 1998 1997 1996
---------- ----------- -----------
U.S. Treasury Securities $1,256,000 $ 1,751,000 $ 1,998,000
FRB Stock 264,000 251,000 156,000
FHLB Stock 546,000 512,000 482,000
GNMA Securities 4,228,000 3,874,000 4,171,000
FNMA Securities 1,893,000 7,425,000 5,732,000
FHLMC Securities 1,420,000 1,017,000 1,184,000
Mutual Fund - - 981,000
$9,607,000 $14,830,000 $14,704,000
========== =========== ===========
In addition to the above, as of December 31, 1998 and 1997 the Company holds
interest only strip assets in the amount of $10,914,900 and $2,528,587. These
interest only strips represent the present value of the right to the excess cash
flows generated by the sold loans that represent 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, (ii) stipulated servicing
fees and (iii) estimated loan portfolio losses. The Company determines the
present value of this anticipated cash flow stream at the time of the loan sale
close, utilizing valuation assumptions appropriate for each particular
transaction.
The significant valuation assumptions are related to the anticipated average
lives of the loans sold, the anticipated prepayment speeds and the anticipated
credit losses related thereto. In order to determine the present value of this
excess cash flow, the Company currently applies an estimated market discount
rate of 11% for SBA and FHA Title 1 loans and 13% for HLTV loans to the expected
pro forma gross cash flows, which are calculated utilizing the weighted average
lives of the loans. The annual prepayment rate of the loans is a function of
full and partial prepayments and defaults. In the interest only strips' fair
value estimates, the Company makes assumptions of the prepayment rates of the
underlying loans, which the Company believes are reasonable. During fiscal 1998,
the Company utilized proprietary prepayment curves generated by the Company
reaching an approximate maximum annual rate of 8%, 15% and 18.25% for SBA, FHA
Title 1, and HLTV loans.
The following table summarizes the amounts, terms, distributions, and yields of
the Company's investment securities as of December 31, 1998.
After One Year
One Year or Less to Five Years Over Five Years Total
------------------ ---------------- ------------------ ------------------
Amount Yield Amount Yield Amount Yield Amount Yield
---------- ------ -------- ------ ---------- ------ ---------- ------
U.S. Treasury Securities $1,256,000 6.3% $ - N/A% $ - N/A% $1,256,000 6.9%
FRB Stock - N/A 264,000 6.4 - N/A 264,000 6.4
FHLB Stock - N/A 546,000 5.6 - N/A 546,000 5.6
GNMA Securities - N/A - N/A 4,228,000 6.6 4,228,000 6.6
FNMA Securities - N/A - N/A 1,893,000 6.7 1,893,000 6.7
FHLMC Securities - N/A - N/A 1,420,000 6.7 1,420,000 6.7
---------- ------ -------- ------ ---------- ------ ---------- ------
Totals $1,256,000 6.3% $810,000 5.9% $7,541,000 6.6% $9,607,000 6.6%
========== ====== ======== ====== ========== ====== ========== ======
15
The Investment Policy of the Company sets forth the types and maturities of
investments the Company, and its subsidiaries, may hold.
Loan Portfolio
- ---------------
The Company's largest lending categories are commercial loans, real estate
loans, unguaranteed portion of loans insured by the SBA, installment loans,
loans held for sale and real estate loan participations purchased. Loans are
carried at face amount, less payments collected, the allowance for possible loan
losses, deferred loan fees and discounts on loans purchased. Interest on all
loans is accrued daily on primarily a simple interest basis. It is generally the
Company's policy to place loans on nonaccrual status when they are 90 days past
due. Thereafter, interest income is no longer recognized. Problem loans are
maintained on accrual status only when management of the Company is confident of
full repayment within a very short period of time.
The rates of interest charged on variable rate loans are set at specified
increments in relation to the Company's published prime lending rate or other
appropriate indices and vary as those indices vary. At December 31, 1998,
approximately 63% of the Company's loan portfolio was comprised of variable
interest rate loans. At December 31, 1997, variable rate loans comprised
approximately 71% of the Company's loan portfolio. At December 31, 1996,
variable rate loans comprised approximately 74% of the Company's loan portfolio.
Distribution of Loans
- -----------------------
The distribution of the Company's total loans by type of loan as of the dates
indicated is shown in the following table (dollars in thousands):
December 31,
-----------------------------------------------------------------------
1998 1997 1996
----------------------- ---------------------- ----------------------
Percentage Percentage Percentage
to Gross to Gross to Gross
Type of loan Loan Balance Loans Loan Balance Loans Loan Balance Loans
------------- -------- ------------ -------- ------------ --------
Commercial $ 10,613,000 6.3% $ 13,195,000 10.1% $ 14,017,000 12.0%
Real estate 64,875,000 38.4 76,190,000 58.1 75,214,000 64.4
Unguaranteed portion of loans
insured by SBA 26,687,000 15.8 19,602,000 15.0 14,708,000 12.6
Installment 5,638,000 3.3 4,057,000 3.1 4,306,000 3.7
Loan participations purchased 2,287,000 1.4 2,247,000 1.7 709,000 0.6
Loans held for sale 58,836,000 34.8 15,739,000 12.0 7,767,000 6.7
------------- -------- ------------ -------- ------------ --------
GROSS LOANS 168,936,000 100.0% 131,030,000 100.0% 116,721,000 100.0%
Less:
Allowance for loan losses 2,129,000 2,067,000 2,380,000
Deferred loan fees and premiums 113,000 150,000 190,000
Discount on loan pool purchase 759,000 428,000 344,000
------------- ------------ ------------
NET LOANS $ 165,935,000 $128,385,000 $113,807,000
============= ============ ============
Commercial Loans
- -----------------
In addition to traditional commercial loans made to business customers, the
Company also extends business lines of credit. On business credit lines, the
Company specifies a maximum amount which it stands ready to lend to the customer
during a specified period, in return for which the customer agrees to maintain
its primary banking relationship with the Company. The purpose for which such
loans will be used and the security therefor, if any, are determined before the
Company's commitment is extended. Normally, the Company does not make loan
commitments in material amounts for periods in excess of one year.
16
Real Estate Loans
- -------------------
Real estate loans are primarily made for the purpose of purchasing, improving or
constructing single family residences, and commercial and industrial properties.
The majority of the Company's real estate loans are collateralized by first and
second liens on single family homes. Maturities on such loans are generally 15
to 30 years.
A large part of the Company's real estate construction loans are first and
second trust deeds on the construction of owner-occupied single family
dwellings. The Company also makes real estate construction loans on commercial
properties. These consist of first and second trust deeds collateralized by the
related real property. Construction loans are generally written with terms of
six to twelve months and usually do not exceed a loan to appraised value of 80%.
Some real estate loans are secured by nonresidential property. These loans are
often secured by office buildings or other commercial property. Loan-to-value
ratios are generally restricted to 70% of appraised value of the underlying real
property.
Unguaranteed Portion of Loans Guaranteed by the SBA
- ----------------------------------------------------------
The Company is approved as a Preferred Lender by the SBA. Loans made by the
Company under programs offered by the SBA are generally made to small businesses
for the purchase of businesses, purchase or construction of facilities, purchase
of equipment or working capital. The loans generally carry guarantees from the
SBA ranging from 75% - 90% of the balance loaned. Borrowers are required to
provide adequate collateral for these loans, similar to other commercial loans.
The SBA does allow less-collateralized loans for its "Low Doc" program, loans of
less than $100,000. When the Company originates SBA loans, it sells the
guaranteed portion of the loans into the secondary market. The Company retains
the unguaranteed portion of the loans, as well as the servicing on the loans,
for which it is paid a fee. The loans are all variable rate based upon the Wall
Street Journal Prime Rate. The servicing spread is a minimum of 1.00% on all
loans. The gains recognized by the Company on the sales of the guaranteed
portion of these loans and the ongoing servicing income received, are
significant revenue streams for the Company.
Installment Loans
- ------------------
While not a large portion of its loan portfolio, the Company does originate
installment loans, also known as, consumer loans. These loans are comprised of
automobile, small equity lines of credit and general personal loans. These loans
are primarily variable rate with terms of five years or less.
Maturity of Loans and Sensitivity of Loans to Changes in Interest Rates
- --------------------------------------------------------------------------------
The following table sets forth the amount of gross loans outstanding, as of
December 31, 1998, 1997, and 1996, which, based on the remaining scheduled
repayments of principal, have the ability to be repriced or are due in less than
one year, in one to five years, or in more than five years.
1998 1997 1996
------------------------- ------------------------ ------------------------
(Dollars rounded to thousands) Fixed Variable Fixed Variable Fixed Variable
----------- ------------ ----------- ----------- ----------- -----------
Less than One Year $ 5,431,000 $105,173,000 $ 9,307,000 $92,907,000 $ 6,752,000 $85,762,000
One Year to Five Years 10,487,000 775,000 8,166,000 24,000 9,221,000 34,000
After Five Years 47,070,000 - 20,626,000 - 14,952,000 -
----------- ------------ ----------- ----------- ----------- -----------
Total $62,988,000 $105,948,000 $38,099,000 $92,931,000 $30,925,000 $85,796,000
=========== ============ =========== =========== =========== ===========
17
The following table shows the Company's loan commitments outstanding at the
dates indicated:
December 31,
1998 1997 1996
----------- ----------- -----------
Commercial $10,693,000 $12,298,000 $ 7,412,000
Real estate 12,306,000 3,595,000 3,423,000
Loans guaranteed by the SBA 4,230,000 4,177,000 1,195,000
Installment loans 1,502,000 1,473,000 1,576,000
Standby letters of credit 35,000 30,000 2,204,000
Total commitments $28,766,000 $21,573,000 $15,810,000
=========== =========== ===========
Based upon prior experience and prevailing economic conditions, it is
anticipated that approximately 80% of the commitments at December 31, 1998, will
be exercised during 1999.
Summary of Loan Losses Experience
- -------------------------------------
As a natural corollary to the Company's lending activities, some loan losses are
experienced. The risk of loss varies with the type of loan being made and the
creditworthiness of the borrower over the term of the loan. The degree of
perceived risk is taken into account in establishing the structure of, and
interest rates and security for, specific loans and for various types of loans.
The Company attempts to minimize its credit risk exposure by use of thorough
loan application and approval procedures.
The Company maintains a program of systematic review of its existing loans.
Loans are graded for their overall quality. Those loans which the Company's
management determines require further monitoring and supervision are segregated
and reviewed on a periodic basis. Significant problem loans are reviewed on a
monthly basis by the Company's Loan Committee.
The recorded investment in loans that are considered to be impaired under SFAS
No. 114 was as follows:
December 31,
1998 1997 1996
----------- ----------- -----------
Impaired loans without specific valuation allowances $4,450,345 $2,461,168 $1,111,388
Impaired loans with specific valuation allowances 813,652 1,266,964 2,490,435
Specific valuation allowance allocated to impaired loans (464,336) (521,994) (736,853)
Impaired loans, net $4,799,661 $3,206,138 $2,864,970
=========== =========== ===========
Average investment in impaired loans $4,009,400 $3,056,054 $3,620,236
=========== =========== ===========
Interest Income recognized on impaired loans $ 288,607 $ 360,309 $ 190,559
=========== =========== ===========
It is the Company's policy to place loans on nonaccrual status when they are 90
days past due. Thereafter, interest income is no longer recognized. As such,
interest income may be recognized on impaired loans to the extent they are not
past due by 90 days or more.
Upon the adoption of SFAS No. 114, the Company classified all loans on
nonaccrual status as impaired. Accordingly, the impaired loans disclosed above
include all loans that were on nonaccrual status.
Financial difficulties encountered by certain borrowers may cause the Company to
restructure the terms of their loans to facilitate loan payments. In accordance
with the provisions of SFAS No. 114, a troubled loan that is restructured
subsequent to the adoption of SFAS No. 114 would generally be considered
impaired, while a loan restructured prior to adoption would not be considered
impaired if, at the date of measurement, it was probable that the Company would
collect all amounts due under the restructured terms. Accordingly, the balance
of impaired loans disclosed above includes all troubled debt restructured loans
that, as of December 31, 1998, 1997, and 1996 are considered impaired.
18
December 31,
1998 1997 1996
---------- ---------- ----------
Nonaccrual loans $2,971,000 $1,714,000 $ 634,000
Troubled debt restructured loans, gross $1,313,000 $3,289,000 $2,238,000
Interest foregone on nonaccrual loans and troubled debt
restructuring outstanding $ 414,000 $ 203,000 $ 226,000
Loans 30 through 90 days past due with interest accruing $ 678,000 $ 631,000 $ 838,000
The Company charges off that portion of any loan which management considers to
represent a loss. A loan is generally considered by management to represent a
loss in whole or in part when an exposure beyond any collateral value is
apparent, servicing of the unsecured portion has been discontinued or collection
is not anticipated based on the borrower's financial condition and general
economic conditions in the borrower's industry. The principal amount of any loan
which is declared a loss is charged against the Company's allowance for loan
losses.
The following table summarizes the Company's loan loss experience for the
periods indicated:
Year Ended December 31, 1998 1997 1996
------------- ------------- -------------
Balances:
Average gross loans $180,319,000 $124,603,000 $113,556,000
Gross loans at end of period 168,936,000 131,030,000 116,721,000
Loans charged off 402,000 520,000 647,000
Recoveries of loans previously charged off 35,000 17,000 22,000
------------- ------------- -------------
Net loans charged off 367,000 503,000 625,000
------------- ------------- -------------
Allowance for loan losses 2,129,000 2,067,000 2,380,000
Provisions for loan losses 429,000 191,000 650,000
Ratios:
Net loan charge-offs to average loans 0.2% 0.4% 0.5%
Net loan charge-offs to loans at end of period 0.2% 0.4% 0.5%
Allowance for loan losses to average loans 1.2% 1.7% 2.1%
Allowance for loan losses to loans held to maturity at
end of period 2.0% 1.8% 2.2%
Net loan charge-offs to allowance for loan losses at
end of period 17.2% 24.4% 26.2%
Net loan charge-offs to provision for loan losses 85.5% 263.9% 96.0%
The Company's allowance for loan losses is designed to provide for loan losses
which can be reasonably anticipated. The allowance for loan losses is
established through charges to operating expenses in the form of provisions for
loan losses. Actual loan losses or recoveries are charged or credited, directly
to the allowance for loan losses. The amount of the allowance is determined by
management of the Company. Among the factors considered in determining the
allowance for loan losses are the current financial condition of the Company's
borrowers and the value of the security, if any, for their loans. Estimates of
future economic conditions and their impact on various industries and individual
borrowers are also taken into consideration, as are the Company's historical
loan loss experience and reports of banking regulatory authorities. Because
these estimates, factors and evaluations are primarily judgmental, no assurance
can be given as to whether or not the Company will sustain loan losses
substantially higher in relation to the size of the allowance for loan losses or
that subsequent evaluation of the loan portfolio may not require substantial
changes in such allowance.
At December 31, 1998, 1997, and 1996, the allowance was 2.0%, 1.8%, and 2.2%, of
the gross held to maturity loans then outstanding, respectively. Although the
current level of the allowance is deemed adequate by management, future
provisions will be subject to continuing reevaluation of risks in the loan
portfolio.
19
Management of the Company reviews with the Board of Directors the adequacy of
the allowance for possible loan losses on a quarterly basis. The loan loss
provision is adjusted when specific items reflect a need for such an adjustment.
Management believes that there were no material loan losses during the last
fiscal year that have not been charged off. Management also believes that the
Company has adequately reserved for all individual items in its portfolio which
may result in a material loss to the Company. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF THE SUMMARY OF EARNINGS - Provision for Loan Losses".
Interest Rates and Differentials
- -----------------------------------
Certain information concerning interest-earning assets and interest-bearing
liabilities and yields thereon is set forth in the following table. Amounts
outstanding are daily average balances:
(Dollars in thousands) Year Ended December 31,
1998 1997 1996
--------- --------- ---------
Interest-earning assets:
Time deposits in other financial institutions:
Average outstanding $ 2,160 $ 4,006 $ 3,609
Average yield 5.7% 5.7% 5.5%
Interest income $ 123 $ 230 $ 197
Federal funds sold:
Average outstanding $ 13,121 $ 11,675 $ 8,565
Average yield 5.1% 5.3% 5.0%
Interest income $ 673 $ 616 $ 429
U.S. Government investment securities:
Average outstanding $ 13,456 $ 14,234 $ 15,519
Average yield 6.1% 6.3% 6.5%
Interest income $ 824 $ 891 $ 1,014
Federal Reserve Bank/Federal Home Loan
Bank stock investment securities:
Average outstanding $ 791 $ 713 $ 636
Average yield 6.1% 6.5% 5.8%
Dividend income $ 48 $ 46 $ 37
Mutual Funds:
Average outstanding $ - $ 115 $ 2,567
Average yield 0.0% 6.1% 6.0%
Interest income $ - $ 7 $ 153
Loans:
Average outstanding (1) $176,003 $121,505 $110,425
Average yield 10.7% 9.7% 9.6%
Interest income $ 18,879 $ 11,763 $ 10,630
Total interest-earning assets:
Average outstanding $205,531 $152,248 $141,341
Average yield 10.0% 8.9% 8.8%
Interest income $ 20,547 $ 13,553 $ 12,460
(1) includes nonaccrual loans
(continued on next page)
20
(Dollars in thousands) Year Ended December 31,
1998 1997 1996
--------- --------- ---------
Interest-bearing liabilities:
Interest-bearing demand deposits:
Average outstanding $ 20,511 $ 17,755 $ 16,339
Average yield 2.8% 2.9% 3.0%
Interest expense $ 579 $ 508 $ 492
Savings deposits:
Average outstanding $ 24,404 $ 21,906 $ 23,259
Average yield 3.3% 3.2% 3.3%
Interest expense $ 817 $ 695 $ 763
Time certificates of deposit:
Average outstanding $136,123 $ 90,908 $ 83,912
Average yield 5.7% 5.6% 5.5%
Interest expense $ 7,764 $ 5,129 $ 4,619
Federal funds purchased:
Average outstanding $ 1,479 $ - $ -
Average yield 5.7% 0.0% 0.0%
Interest expense $ 85 $ - $ -
Borrowings from FHLB:
Average outstanding $ 234 $ 405 $ 2,000
Average yield 5.1% 6.9% 5.9%
Interest expense $ 12 $ 29 $ 116
Total interest-bearing liabilities:
Average outstanding $182,751 $130,974 $125,510
Average yield 5.1% 4.9% 4.8%
Interest expense $ 9,257 $ 6,361 $ 5,990
Net interest income $ 11,290 $ 7,192 $ 6,470
Average net interest margin on interest-
earning assets 5.5% 4.7% 4.6%
Liquidity Management
- ---------------------
The Company has an asset and liability management program allowing the Company
to maintain its interest margins during times of both rising and falling
interest rates and to maintain sufficient liquidity. Liquidity of the Company at
December 31, 1998, was 51.7%, at December 31, 1997, was 31.3%, based on liquid
assets (consisting of cash and due from banks, deposits in other financial
institutions, security investments, federal funds sold and loans available for
sale) divided by total assets. Management believes it maintains adequate
liquidity levels.
At times when the Company has more funds than it needs for its reserve
requirements or short term liquidity needs, the Company increases its securities
investments and sells federal funds. It is management's policy to maintain a
substantial portion of its portfolio of assets and liabilities on a short-term
or highly liquid basis in order to maintain rate flexibility and to meet loan
funding and liquidity needs. The Company has two federal funds lines of credit
with its correspondent banks totaling $6,500,000. In addition the company,
through its subsidiary Palomar Savings and Loan, has a line of credit with
Federal Home Loan Bank of 25% of its total assets which was $20,600,000 at
December 31, 1998.
21
The following table shows the Company's average deposits for each of the periods
indicated below, based upon average daily balances:
(Dollars in thousands) Year Ended December 31,
-----------------------------------------------------------
1998 1997 1996
------------------ ------------------ -------------------
Average Percent Average Percent Average Percent
Balance of Total Balance of Total Balance of Total
-------- -------- -------- -------- -------- ---------
Noninterest-bearing demand $ 20,951 10.4% $ 17,307 11.7% $ 14,160 10.3%
Interest-bearing demand 20,512 10.1 17,755 12.0 16,339 11.9
Savings 24,404 12.1 21,906 14.8 23,259 16.9
TCDs of $100,000 or more 44,216 21.9 27,235 18.4 22,311 16.2
Other TCDs 91,907 45.5 63,673 43.1 61,601 44.7
Total Deposits $201,990 100.0% $147,876 100.0% $137,670 100.0%
======== ======== ======== ======== ======== ======
Deposits
- --------
The maturities of time certificates of deposit ("TCDs") were as follows:
December 31, 1998 December 31, 1997
----------------- -----------------
TCDs over TCDs over
$100,000 Other TCDs $100,000 Other TCDs
----------- ----------- ----------- -----------
Less than three months $36,080,000 $55,362,000 $14,243,000 $21,629,000
Over three months through six months 7,016,000 12,395,000 5,599,000 10,851,000
Over six months through twelve months 15,911,000 17,558,000 10,956,000 22,120,000
Over twelve months through five years 2,735,000 10,164,000 100,000 6,546,000
Total $61,742,000 $95,479,000 $30,898,000 $61,146,000
=========== =========== =========== ===========
While the deposits of the Company may fluctuate up and down somewhat with local
and national economic conditions, management of the Company does not believe
that such deposits, or the business of the Company in general, are seasonal in
nature. Liability management is monitored by the Chief Financial Officer daily
and by the Asset/Liability Committee of the Company's Board of Directors which
meets quarterly.
Year 2000
- ----------
As the year 2000 approaches, a critical issue has emerged regarding how existing
application software programs and operating systems can accommodate this date
value. In brief, many existing application software products in the marketplace
were designed to only accommodate a two digit date position which represents the
year (for example, '98' is stored on the system and represents the year as
1998). As a result, the year 1999 could be the maximum date value these systems
will be able to accurately process. A time-sensitive software may recognize a
date using "00" as the year 1900 rather than year 2000. This could result in a
system failure or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions or engage in
similar normal business activities.
The Company has adopted a plan of action to minimize the risk of the year 2000
event including the establishment of an oversight committee. This plan is fully
supported by management and the Board of Directors. The committee's goal is to
achieve a year 2000 date conversion with no effect on customers or disruption to
business operations. The plan consists of five phases; awareness, assessment,
renovation, validation, and implementation. In the awareness phase, the
committee was formed consisting of members from all departments within the
Company. This team defined the Year 2000 issue, how and where it would impact
the Company. The assessment phase determined the size of the issue and which
systems were determined as critical to the operations of the Company. During the
renovation phase, systems, hardware, and software were tested for compliance and
any non-compliant systems were replaced. Nothing determined as critical needed
replacement. During the validation phase, further testing is done on any new
equipment or systems installed. At the end of 1998, the Company re-tested all
systems in a mock exercise as if it was January 2000. In 1999, customer
awareness of the Year 2000 issue and what the Company has done to address the
issue will intensify. This will be, but is not limited to, mailings to our
customers, public announcements, and training for Company employees to address
customer concerns.
22
The Company has initiated formal communications with all of its vendors,
including the U.S. Government, to determine their Year 2000 compliance
readiness. The Company is reviewing the extent the interface systems are
vulnerable to any third parties' year 2000 issues. There can be no guarantee
that the systems of other companies on which the Company systems rely will be
timely converted and would not have an adverse effect on the Company's systems.
Many of the Company's systems include new hardware and software purchased from
vendors who have represented that these systems are already year 2000 compliant.
The Company is in the process of obtaining assurances from vendors that timely
updates will be made available to make all remaining systems compliant.
Management does not anticipate the Company will be required to purchase any
additional hardware or software to be year 2000 compliant. However, management
has incurred and will continue to incur some administrative costs relative to
the identification and testing of the Company's electronic data processing
systems. The costs and timing of the year 2000 project is based on management's
best estimates, which were derived utilizing numerous assumptions of future
events, including the continued availability of certain resources, third party
modification plans and other factors. As of December 31, 1998, the Company had
incurred $111,476 in expenses getting Year 2000 compliant and anticipates
spending $100,000 in 1999. However, there can be no guarantee that these
estimates will be achieved and actual results could differ from these plans.
SUPERVISION AND REGULATION - COMMUNITY WEST BANCSHARES
- ------------------------------------------------------------
GENERAL
- -------
Banking is a complex and highly regulated industry. The primary goals of the
regulatory scheme are to maintain a safe and sound banking system and to
facilitate the conduct of sound monetary policy. In furtherance of those goals,
congress has created several largely autonomous regulatory agencies and enacted
numerous laws that govern banks, bank holding companies and the banking
industry. The description of and the references to the status and regulations
below are brief summaries and do not purport to be complete. The descriptions
are qualified in their entirety by reference to the specific statutes and
regulations discussed.
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. Regulations have not yet been proposed or adopted or steps
otherwise taken to implement the Commissioner's powers under this statute.
Community West Bancshares (the "Company") is a bank holding company registered
under the Bank Holding Company Act of 1956, as amended (the "Act"), and is
subject to supervision by the Federal Reserve Board (the "FRB"). As a bank
holding company, the Company is required to file with the FRB an annual report
and such other additional information as the FRB may require pursuant to the
Act. The FRB may also make examinations of the Company and its subsidiaries.
The Act requires prior approval by the FRB for, among other things, the
acquisition by a bank holding company of direct or indirect ownership or control
of more than 5% of the voting shares, or substantially all the assets, of any
bank or for a merger or consolidation by a bank holding company with any other
bank holding company.
Transactions With Affiliates
- ------------------------------
The Company has two wholly-owned banking subsidiaries, Goleta National Bank, a
national banking association (the "Bank"), and Palomar Savings and Loan
Association, a California state-chartered savings bank ("Palomar")(together,
"the Subsidiaries").
23
The Company, the subsidiaries and any other subsidiaries it may acquire, either
by purchase or merger, or subsequently organize, are deemed to be affiliates
within the meaning of the Act. Pursuant thereto, loans by the Subsidiaries to
affiliates, investments by the Subsidiaries in affiliates' stock, and taking
affiliates' stock by the Subsidiaries as collateral for loans to any borrower
will be limited to 10% of an affiliate's capital, in the case of any one
affiliate, and will be limited to 20% of an affiliate'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; in particular, a bank
and its subsidiaries generally may not purchase from an affiliate a low-quality
asset, as defined in the Act. Such restrictions also prevent a bank holding
company and its other affiliates from borrowing from a banking subsidiary of the
bank holding company unless the loans are secured by marketable collateral of
designated amounts. The Company and the Subsidiaries are also subject to certain
restrictions with respect to engaging in the underwriting, public sale and
distribution of securities.
Bank Holding Company Liquidity
- ---------------------------------
The Company is a legal entity, separate and distinct from the Subsidiaries.
Although there exists an ability to raise capital on its own behalf or borrow
from external sources, the Company's primary source of funds is through
dividends paid the Subsidiaries. However, regulatory restraints may restrict or
totally preclude the Subsidiaries from paying dividends to the Company.
The Bank may pay the Company a cash dividend, when and as declared by the Bank's
Board of Directors, out of funds legally available therefore, as specified and
limited by regulations promulgated by the Office of the Comptroller of the
Currency, (the "OCC"). Under OCC regulations, funds available for a national
bank's cash dividends are restricted to the lesser of: (i) a bank's retained
earnings or (ii) a bank's net income for the current and past two fiscal years
(less any dividends made during such 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, it can
prohibit payment of a dividend is an unsafe and unsound banking practice.
Palomar's ability to declare and pay a cash dividend is subject to the Office of
Thrift Supervision's (the "OTS") regulations which impose limitations upon all
capital distributions by savings associations, such as cash dividends, payment
to repurchase or otherwise acquire its shares, payments to shareholders of
another institution in a cash out merger and other distributions charged against
capital. In general, Palomar may not declare or pay a cash dividend on its
capital stock if the payment would cause Palomar to fail to meet one of its
regulatory capital requirements. Palomar must also provide the OTS with 30 days
advance notice of any proposed dividend declaration.
Under OTS regulations, an association that meets its capital requirements, both
before and after the proposed distribution, and has not been notified by the OTS
that it is in need of more than normal supervision (a "Tier 1 association") may,
after prior notice to, but without the approval of the OTS, make capital
distributions during a calendar year up to the higher of: (i)100% of its net
income to date during the calendar year plus the amount that would reduce by
one-half its surplus capital ratio at the beginning of the calendar year, or
(ii) 75% of its net income over the most recent four-quarter period. A Tier 1
association may make capital distributions in excess of the above amount if it
gives notice to the OTS and the OTS does not object to the distribution. At
December 31, 1998 Palomar was deemed to be a Tier 1 association.
On January 19, 1999, the OTS issued Amended Regulations (the "Amended
Regulations") regarding capital distributions, to conform its requirements to
the OTS's prompt corrective action regulation and to conform to the rules of
other banking extent possible. The Amended Regulations are effective April 1,
1999. Under the Amended Regulations, an institution that would at least remain
adequately capitalized after making a capital distribution, and was not owned by
a bank holding company, would no longer be required to provide notice to the OTS
prior to making a capital distribution. "Troubled" associations and
undercapitalized associations would also be allowed to make capital
distributions, but only after filing an application and receiving subsequent OTS
approval. Such applications would only be approved under certain limited
circumstances.
The Amended Regulations only apply to OTS regulated institutions which are not
bank holding company subsidiaries. Currently, it is not contemplated that
Palomar will cease to be the Company's subsidiary and would, therefore, continue
to be the Company's subsidiary and would, therefore, continue to be exempt from
the Amended Regulations.
24
Under the Financial Institutions Supervisory Act, the FDIC also has the
authority to prohibit an insured institution from making distributions it
considers to be unsafe and unsound. Since the Subsidiaries are FDIC insured
institutions, it is therefore possible, depending upon their financial
conditions and other relevant factors, that the FDIC could prohibit payment of
dividends to the Company.
Limitations on Business Activities
- -------------------------------------
With certain limited exceptions, a bank holding company is prohibited from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company which is not a bank or bank holding company and from
engaging directly or indirectly in any activity other than banking or managing
or controlling banks or furnishing services to or performing services for its
authorized subsidiaries. A bank holding company may, however, engage or acquire
an interest in a company that engages in activities which the FRB has determined
to be closely related to banking or managing or controlling banks as to be
properly incident thereto. In making such a determination, the FRB is required
to consider whether the performance of such activities can reasonably be
expected to produce benefits to the public, such as greater convenience,
increased competition, or gains in efficiency, that outweigh possible adverse
effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interests, or unsound banking practices. Although the
future scope of permitted activities is uncertain and cannot be predicted, some
of the activities that the FRB has determined by regulation to be closely
related to banking are: (i) making or acquiring loans or other extensions of
credit for its own account or for the account of others; (ii) servicing loans
and other extensions of credit for any person; (iii) operating an industrial
bank, Morris Plan bank, or industrial loan company, as authorized under state
law, so long as the institution is not a bank; (iv) operating a trust company in
the manner authorized by federal or state law, so long as the institution is not
a bank and does not make loans or investments or accept deposits, except as
permitted under the FRB's Regulation Y; (v) subject to certain limitations,
acting as an investment or financial adviser to investment companies and other
persons; (vi) leasing personal and real property or acting as agent, broker, or
adviser in leasing such property in accordance with various restrictions imposed
by Regulation Y, including a restriction that it is reasonably anticipated that
each lease will compensate the lessor for not less than the lessor's full
investment in the property; (vii) making equity and debt investments in
corporations or projects designed primarily to promote community welfare; (viii)
providing financial, banking, or economic data processing and data transmission
services, facilities, data bases, or providing access to such services,
facilities, or data bases; (ix) acting as principal, agent, or broker for
insurance directly related to extensions of credit which are limited to assuring
the repayment of debts in the event of death, disability, or involuntary
unemployment of the debtor; (x) acting as agent or broker for insurance directly
related to extensions of credit by a finance company subsidiary; (xi) owning,
controlling, or operating a savings association provided that the savings
association engages only in activities permitted for bank holding companies
under Regulation Y; (xii) providing courier services of limited character;
(xiii) providing management consulting advice to non-affiliated bank and nonbank
depository institutions, subject to the limitations imposed by Regulation Y;
(xiv) selling money orders, travelers' checks and U.S. Savings Bonds; (xv)
appraisal of real estate and personal property; (xvi) acting as an intermediary
for the financing of commercial or industrial income-producing real estate;
(xvii) providing securities brokerage services, related securities credit
activities pursuant to Regulation T, and other incidental activities; (xviii)
underwriting and dealing in obligations of the U.S., general obligations of
states and their political subdivisions, and other obligations authorized for
state member banks under federal law; and (xix) providing general information
and statistical forecasting, advisory and transactional services with respect to
foreign exchange through a separately incorporated subsidiary.
Federal law prohibits a holding company and any subsidiary banks from engaging
in certain tie-in arrangements in connection with the extension of credit.
Thus, for example, the Subsidiaries may not extend credit, lease or sell
property, or furnish any services, or fix or vary the consideration for any of
the foregoing on the condition that: (i) the customer must obtain or provide
some additional credit, property or services from or to the subsidiaries other
than a loan, discount, deposit or trust services; or (ii) the customer must
obtain or provide some additional credit, property or service from or to the
Company or any of the subsidiaries; or (iii) the customer may not obtain some
other credit, property or services from competitors, except reasonable
requirements to assure soundness of credit extended.
Capital Adequacy
- -----------------
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 - THE SUBSIDIARIES - RECENT LEGISLATION AND REGULATORY CHANGES - 2.
Risk-Based Capital Guidelines"), assign various risk percentages to different
categories of assets, and capital is measured as a percentage of risk assets.
While in many cases total risk assets calculated in accordance with the
guidelines is less than total assets calculated absent the rating, certain
non-balance sheet assets, including loans sold with recourse, legally binding
loan commitments and standby letters of credit, are treated as risk assets, with
the assigned rate varying with the type of asset. As a result, it is possible
that total risk assets for purposes of the guidelines exceeds total assets under
generally accepted accounting principles, thereby reducing the capital-to-assets
ratio. Under the terms of the guidelines, bank holding companies are expected
to meet capital adequacy guidelines based both on total assets and on total risk
assets.
25
SUPERVISION AND REGULATION - THE SUBSIDIARIES
GENERAL
- -------
The Bank is a national banking association chartered under the laws of the
United States and is also a member of the Federal Reserve System. As such, it
is subject to regulation, supervision and regular examination by the FRB and the
OCC. Palomar is a California state-chartered full-service savings and loan
association and is therefore to regulation, supervision and regular examination
by the California Department of Financial Institutions (the "DFI") and the OTS.
Palomar is also a member of the Federal Home Loan Bank System (the "FHLB") and
is therefore subject to the FHLB's regulations, supervision and regular
examinations. The deposit of the Bank and Palomar are also insured by the
maximum applicable limits by the Bank Insurance Fund ("BIF") and by the Savings
Association Insurance Fund ("SAIF"), respectively, of the FDIC. Consequently,
both are subject to regulation, supervision and regular examination by the FDIC.
The regulations of these agencies govern most aspects of the subsidiaries'
business, including capital adequacy ratios, reserves against deposits,
restrictions on the rate of interest which may be paid on some deposit
instruments, limitations on the nature and amount of loans which may be made,
the location of branch offices, borrowings, and dividends. Supervision,
regulation and examination of the Subsidiaries by the regulatory agencies are
generally intended to protect depositors and are not intended for the protection
of the Subsidiaries' shareholder. California law also exempts all banks from
usury limitations on interest rates.
RECENT LEGISLATION AND REGULATORY CHANGES
- ---------------------------------------------
1. Introduction
------------
General. From time to time legislation is proposed or enacted which has the
- --------
effect of increasing the cost of doing business and changing the competitive
balance between banks and other financial and non-financial institutions.
Various federal laws enacted over the past several years have provided, among
other things, for the maintenance of mandatory reserves with the Federal Reserve
Bank on deposits by depository institutions (state reserve requirements have
been eliminated); the phasing-out of the restrictions on the amount of interest
which financial institutions may pay on certain of their customers' accounts;
and the authorization of various types of new deposit accounts, such as NOW
accounts, "Money Market Deposit" accounts and "Super NOW" accounts, designed to
be competitive with money market mutual funds and other types of accounts and
services offered by various financial and non-financial institutions. The
lending authority and permissible activities of certain non-bank financial
institutions such as savings and loan associations and credit unions have been
expanded, and federal regulators have been given increased authority and means
for providing financial assistance to insured depository institutions and for
effecting interstate and cross-industry mergers and acquisitions of failing
institutions. These laws have generally had the effect of altering competitive
relationships existing among financial institutions, reducing the historical
distinctions between the services offered by banks, savings and loan
associations and other financial institutions, and increasing the cost of funds
to banks and other depository institutions.
Other legislation has been proposed or is pending before the United States
Congress which would effect the financial institutions industry. Such
legislation includes wide-ranging proposals to further alter the structure,
regulation and competitive relationships of the nation's financial institutions,
to reorganize the federal regulatory structure of the financial institutions
industry, to subject banks to increased disclosure and reporting requirements,
and to expand the range of financial services which banks and bank holding
companies can provide. Other proposals which have been introduced or are being
discussed would equalize the relative powers of savings and loan holding
companies and bank holding companies, and authorize such holding companies to
engage in insurance underwriting and brokerage, real estate development and
brokerage, and certain securities activities, including underwriting and dealing
in United States Government securities and municipal securities, sponsoring and
managing investment companies and underwriting the securities thereof. It
cannot be predicted whether or in what form any of these proposals will be
adopted, or to what extent they will effect the various entities comprising the
financial institutions industry.
26
Certain of the potentially significant changes which have been enacted in the
past several years are discussed below.
Interstate Banking. The Riegle-Neal Interstate Banking and Branching Efficiency
- -------------------
Act of 1994 (the "Riegle-Neal Act"), enacted on September 29, 1994, repealed the
McFadden Act of 1927, which required states to decide whether national or state
banks could enter their state, and, effective June 1, 1997, allows banks to open
branches across state lines. The Riegle-Neal Act also repealed the 1956 Douglas
Amendment to the Bank Holding Company Act, which placed the same requirements on
bank holding companies. The repeal of the Douglas Amendment made it possible
for bank holding companies to buy out-of-state banks in any state after
September 29, 1995, which, after June 1, 1997, may now be converted into
interstate branches.
The Riegle-Neal Act permitted interstate banking to begin effective September
29, 1995. The amendment to the Bank Holding Company Act permits bank holding
companies to acquire banks in other states provided that the acquisition does
not result in the bank holding company controlling more than 10 percent of the
deposits in the United States, or 30 percent of the deposits in the state in
which the bank to be acquired is located. However, the Riegle-Neal Act also
provides that states have the authority to waive the state concentration limit.
Individual states may also require that the bank being acquired be in existence
for up to five years before an out-of-state bank or bank holding company may
acquire it.
The Riegle-Neal Act provides that, since June 1, 1997, interstate branching and
merging of existing banks is permitted, provided that the banks are at least
adequately capitalized and demonstrate good management. Interstate mergers and
branch acquisitions were permitted at an earlier time if the state chose to
enact a law allowing such activity. The states were also authorized to enact
laws to permit interstate banks to branch de novo.
On September 28, 1995, the California Interstate Banking and Branching Act of
1995 ("CIBBA") was enacted and signed into law. CIBBA authorized 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 5 years, unless the California bank is
in danger of failing or in certain other emergency situations. CIBBA allows a
California state bank to have agency relationships with affiliated and
unaffiliated insured depository institutions and allows a bank subsidiary of a
bank holding company to act as an agent to receive deposits, renew time
deposits, service loans and receive payments for a depository institution
affiliate.
Proposed Expansion of Securities Underwriting Authority. Various bills have
- ------------------------------------------------------------
been introduced in the United States Congress which would expand, to a lesser or
greater degree and subject to various conditions and limitations, the authority
of bank holding companies to engage in the activity of underwriting and dealing
in securities. Some of these bills would authorize securities firms (through
the holding company structure) to own banks, which could result in greater
competition between banks and securities firms. No prediction can be made as to
whether any of these bills will be passed by the United States Congress and
enacted into law, what provisions such a bill might contain, or what effect it
might have on the Bank.
Expansion of Investment Opportunities for California State-Chartered Banks.
- --------------------------------------------------------------------------------
Legislation enacted by the State of California has substantially expanded the
authority of California state-chartered banks to invest in real estate,
corporate stock and other corporate securities. National banks are governed in
these areas by federal law, the provisions of which are more restrictive than
California law. However, provisions of the Federal Deposit Insurance Corporation
Improvement Act of 1991, discussed below, limit state-authorized activities to
that available to national banks, unless approved by the FDIC.
Recent Accounting Pronouncements: In June 1997, the FASB issued SFAS No. 130,
- -----------------------------------
"Reporting Comprehensive Income," effective for fiscal years beginning after
December 15, 1997. This statement requires that all items that are required to
be recognized under accounting standards as components of comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements. This Statement further requires that an entity
display an amount representing total comprehensive income for the period in that
financial statement. This Statement also requires that an entity classify items
of other comprehensive income by their nature in a financial statement. For
example, other comprehensive income may include foreign currency items, minimum
pension liability adjustments, and unrealized gains and losses on certain debt
and equity securities. Reclassification of financial statements for earlier
periods, provided for comparative purposes, is required. The adoption of this
statement did not have a material impact on the Company's consolidated financial
statements.
27
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," effective for financial statements for
periods beginning after December 15, 1997. This statement establishes standards
for reporting information about operating segments in annual financial
statements and requires that enterprises report selected information about
operating segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The adoption of this statement did not
have a material impact on the Company's financial statements.
2. Financial Institutions Reform, Recovery, and Enforcement Act of 1989
-------------------------------------------------------------------------
General. On August 9, 1989, the Financial Institutions Reform, Recovery, and
- --------
Enforcement Act of 1989 ("FIRREA") was signed into law. This legislation has
resulted in major changes in the regulation of insured financial institutions,
including significant changes in the authority of government agencies to
regulate insured financial institutions.
Under FIRREA, the Federal Savings and Loan Insurance Corporation ("FSLIC") and
the Federal Home Loan Bank Board were abolished and the FDIC was authorized to
insure savings associations, including federal savings associations, state
chartered savings and loans and other corporations determined to be operated in
substantially the same manner as a savings association. FIRREA established two
deposit insurance funds to be administered by the FDIC. The money in these two
funds is separately maintained and not commingled. The FDIC Permanent Insurance
Fund was replaced by the Bank Insurance Fund (the "BIF") and the FSLIC deposit
insurance fund was replaced by the Savings Association Insurance Fund (the
"SAIF").
The Bank's deposit accounts are insured by the BIF, as administered by the FDIC,
up to the maximum amount permitted by law. Palomar's deposit accounts are
insured by the SAIF, as administered by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations, or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the institution's
primary regulator.
Deposit Insurance Assessments. Under FIRREA, the premium assessments made on
- -------------------------------
banks and savings associations for deposit insurance were initially increased,
with rates set separately for banks and savings associations, subject to
statutory restrictions. The Omnibus Budget Reconciliation Act of 1990, designed
to address the federal budget deficit, increased the insurance assessment rates
for members of the BIF and the SAIF over that provided by FIRREA, and eliminated
FIRREA's maximum reserve-ratio constraints on the BIF. The FDIC raised BIF
premiums to 23 per $100 in insured deposits for 1993 from a base of 12 in
1990.
Effective January 1, 1994, the FDIC implemented a risk-based assessment system,
under which an institution's premium assessment is based on the probability that
the deposit insurance fund will incur a loss with respect to the institution,
the likely amount of such loss, and the revenue needs of the deposit insurance
fund. As long as BIF's reserve ratio is less than a specified "designated
reserve ratio," 1.25%, the total amount raised from BIF members by the
risk-based assessment system may not be less than the amount that would be
raised if the assessment rate for all BIF members were 23 per $100 in insured
deposits. The FDIC determined that the designated reserve ratio was achieved on
May 31, 1995. Accordingly, on August 8, 1995, the FDIC issued final regulations
adopting an assessment rate schedule for BIF members of 4 to 31 per $100 in
insured deposits that became effective June 1, 1995. On November 14, 1995, the
FDIC further reduced the BIF assessment rates by 4 so that effective January 1,
1996, the premiums ranged from zero to 27 per $100 in insured deposits, but in
any event not less than $2,000 per year. The Deposit Insurance Funds Act of
1996, signed into law on September 30, 1996, eliminated the minimum assessment,
commencing with the fourth quarter of 1996.
28
Under the risk-based assessment system, as of December 31, 1995, SAIF members
paid within a range of $.23 to $.31 per $100 insured deposits, depending upon
the institution's risk classification. Pursuant to the Economic Growth and
Paperwork Reduction Act of 1996 (the "EGPRA"), the FDIC imposed a special
assessment on SAIF members to capitalize the SAIF at the "designated reserve
ratio" of 1.25% as of October 1, 1996. Based on Palomar's deposits as of March
31, 1995, the date for measuring the amount of the special assessment pursuant
to the EGPRA, Palomar paid a special assessment of $506,000 in October, 1996 to
recapitalize the SAIF. This expense was recognized during the third quarter of
1996.
Under the risk-based assessment system, a BIF member institution such as the
Bank is categorized into one of three capital categories (well capitalized,
adequately capitalized, and undercapitalized) and one of three categories based
on supervisory evaluations by its primary federal regulator (in the Bank's case,
the OCC). The three supervisory categories are: financially sound with only a
few minor weaknesses (Group A), demonstrates weaknesses that could result in
significant deterioration (Group B), and poses a substantial probability of loss
(Group C). The capital ratios used by the OCC to define well-capitalized,
adequately capitalized and undercapitalized are the same as in the OCC's and
FRB's prompt corrective action regulations (discussed below). The BIF
assessment rates since January 1, 1997, are summarized below; assessment figures
are expressed in terms of cents per $100 in insured deposits. The capital and
supervisory group ratings for SAIF institutions are the same as for BIF
institutions. Accordingly, Palomar's deposit insurance assessment rate is also
derived from the following table:
ASSESSMENT RATES EFFECTIVE JANUARY 1, 1997
SUPERVISORY GROUP
CAPITAL GROUP GROUP A GROUP B GROUP C
------- ------- -------
Well Capitalized 0 3 10
Adequately Capitalized 3 10 24
Undercapitalized 17 24 27
Pursuant to the EGPRA, Palomar pays its normal deposit insurance premium as a
member of the SAIF. In addition, Palomar also pays an amount equal to $.064 per
$100 in deposits towards the retirement of the Financing Corporation Bonds
("FICO Bonds") issued in the 1980's to assist in the recovery of the savings and
loan industry.
Furthermore, after December 31, 1996, banks are required to share in the payment
of interest on FICO bonds. Previously, the FICO debt was paid out of the SAIF
assessment base. The assessments imposed on insured depository institutions with
respect to any BIF-assessable deposit will be assessed at a rate equal to 1/5 of
the rate of the assessments imposed on insured depository institutions with
respect to any SAIF-assessable deposit. Although the FICO assessment rates are
annual rates, they are subject to change quarterly. Since the FICO bonds do not
mature until the year 2019, it is conceivable that banks will continue to share
in the payment of the interest on the bonds until then.
The following table shows the quarterly assessment rates for SAIF and BIF
insured deposits, expressed in cents per $100 in insured deposits:
FICO ASSESSMENT RATES
-----------------------
SAIF BIF
---- -----
First Quarter, 1997 6.48 1.296
Second Quarter, 1997 6.50 1.300
Third Quarter, 1997 6.30 1.260
Fourth Quarter, 1997 6.32 1.264
First Quarter, 1998 6.28 1.256
Second Quarter, 1998 6.22 1.244
Third Quarter, 1998 6.10 1.220
Fourth Quarter, 1998 5.82 1.164
Under the EGPRA, the FDIC is not permitted to establish SAIF assessment rates
that are lower than comparable BIF assessment rates. Beginning no later than
January 1, 2000, the rate paid to retire the FICO Bonds will be equal for
members of the BIF and the SAIF. The EGPRA also provides for the merging of the
BIF and the SAIF by January 1, 2000, provided that there are no financial
institutions chartered as savings associations at that time. Should the
insurance funds be merged before January 1, 2000, the rate paid by all members
of this new find to retire the FICO Bonds will be equal.
29
With certain limited exceptions, FIRREA prohibits a bank from changing its
status as an insured depository institution with the BIF to the SAIF and
prohibits a savings association from changing its status as an insured
depository institution with the SAIF to the BIF, without the prior approval of
the FDIC.
FDIC Receiverships. Pursuant to FIRREA, the FDIC may be appointed conservator
- --------------------
or receiver of any insured bank or savings association. In addition, FIRREA
authorized the FDIC to appoint itself as sole conservator or receiver of any
insured state bank or savings association for any, among others, of the
following reasons: (i) insolvency of such institution; (ii) substantial
dissipation of assets or earnings due to any violation of law or regulation or
any unsafe or unsound practice; (iii) an unsafe or unsound condition to transact
business, including substantially insufficient capital or otherwise; (iv) any
willful violation of a cease and desist order which has become final; (v) any
concealment of books, papers, records or assets of the institution; (vi) the
likelihood that the institution will not be able to meet the demands of its
depositors or pay its obligations in the normal course of business; (vii) the
incurrence or likely incurrence of losses by the institution that will deplete
all or substantially all of its capital with no reasonable prospect for the
replenishment of the capital without federal assistance; or (viii) any violation
of any law or regulation, or an unsafe or unsound practice or condition which is
likely to cause insolvency or substantial dissipation of assets or earnings, or
is likely to weaken the condition of the institution or otherwise seriously
prejudice the interest of its depositors.
As a receiver of any insured depository institution, the FDIC may liquidate such
institution in an orderly manner and make such other disposition of any matter
concerning such institution as the FDIC determines is in the best interests of
such institution, its depositors and the FDIC. Further, the FDIC shall as the
conservator or receiver, by operation of law, succeed to all rights, titles,
powers and privileges of the insured institution, and of any stockholder,
member, account holder, depositor, officer or director of such institution with
respect to the institution and the assets of the institution; may take over the
assets of and operate such institution with all the powers of the members or
shareholders, directors and the officers of the institution and conduct all
business of the institution; collect all obligations and money due to the
institution and preserve; and conserve the assets and property of such
institution.
Enforcement Powers. Some of the most significant provisions of FIRREA were the
- --------------------
expansion of regulatory enforcement powers. FIRREA has given the federal
regulatory agencies broader and stronger enforcement authorities reaching a
wider range of persons and entities. Some of those provisions included those
which: (i) expanded the category of persons subject to enforcement under the
Federal Deposit Insurance Act; (ii) expanded the scope of cease and desist
orders and provided for the issuance of a temporary cease and desist orders;
(iii) provided for the suspension and removal of wrongdoers on an expanded basis
and on an industry-wide basis; (iv) prohibited the participation of persons
suspended or removed or convicted of a crime involving dishonesty or breach of
trust from serving in another insured institution; (v) required regulatory
approval of new directors and senior executive officers in certain cases; (vi)
provided protection from retaliation against "whistleblowers" and establishes
rewards for "whistleblowers" in certain enforcement actions resulting in the
recovery of money; (vii) required the regulators to publicize all final
enforcement orders; (viii) required each insured financial institution to
provide its independent auditor with its most recent Report of Condition ("Call
Report"); (ix) significantly increased the penalties for failure to file
accurate and timely Call Reports; and (x) provided for extensive increases in
the amounts and circumstances for assessment of civil money penalties, civil and
criminal forfeiture and other civil and criminal fines and penalties.
Crime Control Act of 1990. The Crime Control Act of 1990 further strengthened
- ----------------------------
the authority of federal regulators to enforce capital requirements, increased
civil and criminal penalties for financial fraud, and enacted provisions
allowing the FDIC to regulate or prohibit certain forms of golden parachute
benefits and indemnification payments to officers and directors of financial
institutions.
30
3. Risk-Based Capital Guidelines
-------------------------------
The federal banking agencies have established risk-based capital guidelines. The
risk-based capital guidelines include both a new definition of capital and a
framework for calculating risk weighted assets by assigning assets and
off-balance sheet items to broad credit risk categories. A bank's risk-based
capital ratio is calculated by dividing its qualifying capital (the numerator of
the ratio) by its risk weighted assets (the denominator of the ratio).
A bank's qualifying total capital consists of two types of capital components:
"core capital elements" (comprising Tier 1 capital) and "supplementary capital
elements" (comprising Tier 2 capital). The Tier 1 component of a bank's
qualifying capital must represent at least 50% of qualifying total capital and
may consist of the following items that are defined as core capital elements:
(i) common stockholders' equity; (ii) qualifying noncumulative perpetual
preferred stock (including related surplus); and (iii) minority interest in the
equity accounts of consolidated subsidiaries. The Tier 2 component of a bank's
qualifying total capital may consist of the following items: (i) allowance for
loan and lease losses (subject to limitations); (ii) perpetual preferred stock
and related surplus (subject to conditions); (iii) hybrid capital instruments
(as defined) and mandatory convertible debt securities; and (iv) term
subordinated debt and intermediate-term preferred stock, including related
surplus (subject to limitations).
Assets and credit equivalent amounts of off-balance sheet items are assigned to
one of several broad risk categories, according to the obligor, or, if relevant,
the guarantor or the nature of collateral. The aggregate dollar value of the
amount in each category is then multiplied by the risk weight associated with
that category. The resulting weighted values from each of the risk categories
are added together, and this sum is the bank's total risk weighted assets that
comprise the denominator of the risk-based capital ratio.
Risk weights for all off-balance sheet items are determined by a two-step
process. First, the "credit equivalent amount" of off-balance sheet items such
as letters of credit and recourse arrangements 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
generally is assigned to the appropriate risk category according to the obligor,
or, if relevant, the guarantor or the nature of the collateral.
The supervisory standards set forth below specify minimum supervisory 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%, of which at least 4% should be in the form of Tier 1
capital net of goodwill, and a minimum ratio of Tier 1 capital to risk weighted
assets of 4%. The maximum amount of supplementary capital elements that
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital net of
goodwill. In addition, the combined maximum amount of subordinated debt and
intermediate-term preferred stock that qualifies as Tier 2 capital is limited to
50% of Tier 1 capital. The maximum amount of the allowance for loan and lease
losses that qualifies as Tier 2 capital is limited to 1.25% of gross risk
weighted assets. 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.
In addition to the risk-based guidelines, the federal banking agencies 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%. In addition to
these uniform risk-based capital guidelines and leverage ratios that apply
across the industry, the regulators have the discretion to set individual
minimum capital requirements for specific institutions at rates significantly
above the minimum guidelines and ratios.
In December, 1993, the federal banking agencies issued an interagency policy
statement on the allowance for loan and lease losses which, among other things,
establishes certain benchmark ratios of loan loss reserves to classified assets.
The benchmark set forth by the policy statement is the sum of: (a) assets
classified loss; (b) 50% of assets classified doubtful; (c) 15% of assets
classified substandard; and (d) estimated credit losses on other assets over the
upcoming twelve months.
31
The federal banking agencies have recently revised their risk-based capital
rules to take account of concentrations of credit and the risks of
non-traditional activities. Concentrations of credit refers to situations where
a lender has a relatively large proportion of loans involving one borrower,
industry, location, collateral or loan type. Non-traditional activities are
considered those that have not customarily been part of the banking business but
that start to be conducted as a result of developments in, for example,
technology or financial markets. 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.
Further, the banking agencies recently have adopted modifications to the
risk-based capital rules to include standards for interest rate risk exposures.
Interest rate risk is the exposure of a bank's current and future earnings and
equity capital arising from adverse movements in interest rates. While interest
rate risk is inherent in a bank's role as financial intermediary, it introduces
volatility to bank earnings and to the economic value of the bank. The banking
agencies have addressed this problem by implementing changes to the capital
standards to include a bank's exposure to declines in the economic value of its
capital due to changes in interest rates as a factor that the banking agencies
will consider in evaluating an institution's capital adequacy. Bank examiners
consider a bank's historical financial performance and its earnings exposure to
interest rate movements as well as qualitative factors such as the adequacy of a
bank's internal interest rate risk management. The federal banking agencies
recently considered adopting a uniform supervisory framework for all
institutions to measure and assess each bank's exposure to interest rate risk
and establish an explicit capital charge based on the assessed risk, but
ultimately elected not to adopt such a uniform framework. Even without such a
uniform framework, however, each bank's interest rate risk exposure is assessed
by its primary federal regulator on an individualized basis, and it may be
required by the regulator to hold additional capital for interest rate risk if
it has a significant exposure to interest rate risk or a weak interest rate risk
management process.
Effective April 1, 1995, the federal banking agencies issued rules which limit
the amount of deferred tax assets that are allowable in computing a bank's
regulatory capital. The standard had been in effect on an interim basis since
March, 1993. 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. Deferred tax assets that can only be
realized through future taxable earnings are limited for regulatory capital
purposes to the lesser of: (i) the amount that can be realized within one year
of the quarter-end report date; or (ii) 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.
4. Federal Deposit Insurance Corporation Improvement Act of 1991
--------------------------------------------------------------------
General. The Federal Deposit Insurance Corporation Improvement Act of 1991
- --------
("FDICIA") was signed into law on December 19, 1991. FDICIA recapitalized the
BIF, granted broad authorization to the FDIC to increase deposit insurance
premium assessments and to borrow from other sources, and continued the
expansion of regulatory enforcement powers, along with many other significant
changes.
Prompt Corrective Action. FDICIA established five categories of bank
- --------------------------
capitalization: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized" and mandated the establishment of a system of "prompt
corrective action" for institutions falling into the lower capital categories.
Under FDICIA, 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, which 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%, including the appointment of a receiver or
conservator after 90 days, even if the bank is still solvent.
32
The federal banking agencies have promulgated substantially similar regulations
to implement this system of prompt corrective action. Under the regulations, a
bank shall be deemed to be: (i) "well capitalized" if it has a total risk-based
capital ratio of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or
more, has a leverage capital ratio of 5.0% or more and is not subject to
specified requirements to meet and maintain a specific capital level for any
capital measure; (ii) "adequately capitalized" if it has a total risk-based
capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more
and a leverage capital ratio of 4.0% or more (3.0% under certain circumstances)
and does not meet the definition of "well capitalized"; (iii) "undercapitalized"
if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1
risk-based capital ratio that is less than 4.0%, or a leverage capital ratio
that is less than 4.0% (3.0% under certain circumstances); (iv) "significantly
undercapitalized" if it has a total risk-based capital ratio that is less than
6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a leverage
capital ratio that is less than 3.0%; and (v) "critically undercapitalized" if
it has a ratio of tangible equity to total assets that is equal to or less than
2.0%.
Information concerning the Company's capital adequacy at December 31, 1998, is
discussed in the capital adequacy section.
FDICIA and the implementing regulations also provide that a federal banking
agency may, after notice and an opportunity for a hearing, reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category if the institution
is in an unsafe or unsound condition or engaging in an unsafe or unsound
practice. (The federal banking agency may not, however, reclassify a
significantly undercapitalized institution as critically undercapitalized.)
Operational Standards. FDICIA also granted the regulatory agencies authority to
- ----------------------
prescribe standards relating to internal controls, credit underwriting, asset
growth and compensation, among others, and required the regulatory agencies to
promulgate regulations prohibiting excessive compensation or fees. Many
regulations have been adopted by the regulatory agencies to implement these
provisions and subsequent legislation (the Riegal Community Development Act,
discussed below) gave the regulatory agencies the option of prescribing the
safety and soundness standards as guidelines rather than regulations.
Regulatory Accounting Reports. Each bank with $500 million or more in assets is
- ------------------------------
required to submit an annual report to the FDIC, as well as any other federal
banking agency with authority over the bank, and any appropriate state banking
agency; in the Bank's case, the OCC. This report must contain a statement
regarding management's responsibilities for: (i) preparing financial statements;
(ii) establishing and maintaining adequate internal controls; and (iii)
complying with applicable laws and regulations. In addition to having an audited
financial statement by an independent accounting firm on an annual basis, the
accounting firm must determine and report as to whether the financial statements
are presented fairly and in accordance with generally accepted accounting
principles and comply with other requirements of the applicable federal banking
authority. In addition, the accountants must attest to and report to the
regulators separately on management's compliance with internal controls.
Truth in Savings. FDICIA further established a new truth in savings scheme,
- -------------------
providing for clear and uniform disclosure of terms and conditions on which
interest is paid and fees are assessed on deposits. The FRB's Regulation DD,
implementing the Truth in Savings Act, became effective June 21, 1993.
Brokered Deposits. Effective June 16, 1992, FDICIA placed restrictions on the
- -------------------
ability of banks to obtain brokered deposits or to solicit and pay interest
rates on deposits that are significantly higher than prevailing rates. FDICIA
provides that a bank may not accept, renew or roll over brokered deposits
unless: (i) it is "well capitalized"; or (ii) it is adequately capitalized and
receives a waiver from the FDIC permitting it to accept brokered deposits paying
an interest rate not in excess of 75 basis points over certain prevailing market
rates. FDIC regulations define brokered deposits to include any deposit
obtained, directly or indirectly, from any person engaged in the business of
placing deposits with, or selling interests in deposits of, an insured
depository institution, as well as any deposit obtained by a depository
institution that is not "well capitalized" for regulatory purposes by offering
rates significantly higher (generally more than 75 basis points) than the
prevailing interest rates offered by depository institutions in such
institution's normal market area. In addition to these restrictions on
acceptance of brokered deposits, FDICIA provides that no pass-through deposit
insurance will be provided to employee benefit plan deposits accepted by an
institution which is ineligible to accept brokered deposits under applicable law
and regulations.
33
Lending. New regulations have been issued in the area of real estate lending,
- -------
prescribing standards for extensions of credit that are secured by real property
or made for the purpose of the construction of a building or other improvement
to real estate. In addition, the aggregate of all loans to executive officers,
directors and principal shareholders and related interests may now not exceed
100% (200% in some circumstances) of the depository institution's capital.
State Authorized Activities. The new legislation also created restrictions on
- -----------------------------
activities authorized under state law. FDICIA generally restricts activities
through subsidiaries to those permissible for national banks, unless the FDIC
has determined that such activities would pose no risk to the insurance fund of
which it is a member and the bank is in compliance with applicable regulatory
capital requirements, thereby effectively eliminating real estate investment
authorized under California law, and provided for a five-year divestiture period
for impermissible investments. Insurance activities were also limited, except
to the extent permissible for national banks.
Qualified Thrift Lender Test. Savings associations, like Palomar, must meet a
QTL test, which test may be met either by maintaining a specified level of
assets in qualified thrift investments as specified in the Home Owners Loans Act
("HOLA") or by meeting the definition of a "domestic building and loan
association" in Section 7701 of the California Financial Code ("CFC"). If
Palomar maintains an appropriate level of certain specified investments
(primarily residential mortgages and related investments, including certain
mortgage-related securities) and otherwise qualifies as a QTL or a domestic
building and loan association, it will continue to enjoy full borrowing
privileges from the FHLB. The required percentage of investments under HOLA is
65% of assets while the CFC requires investments of 60% of assets. An
association must be in compliance with the QTL test or the definition of
domestic buildings and loan association on a monthly basis in nine out of every
twelve months. Associations that fail to meet the QTL test will generally be
prohibited from engaging in any activity not permitted for both a national bank
and a savings association. As of December 31, 1998, Palomar was in compliance
with its QTL requirements and met the definition of a domestic building and loan
association.
Activities of Subsidiaries. A savings association seeking to establish a new
subsidiary, acquire control of an existing company or conduct a new activity
through a subsidiary must provide 30 days prior notice to the FDIC and the OTS
and conduct any activities of the subsidiary in accordance with regulations and
orders of the OTS. The OTS has the power to require a savings association to
divest any subsidiary or terminate any activity conducted by a subsidiary that
the OTS determines to post a serious threat to the financial safety, soundness
or stability of the savings association or to be otherwise inconsistent with
sound banking practices.
Federal Home Loan Bank System. Palomar is a member of the FHLB system. Among
other benefits, each FHLB serves as a reserve or center bank for its members
within its assigned region. Each FHLB is financed primarily from the sale of
consolidated obligations of the FHLB system. Each FHLB makes available to its
members, loans (i.e., advances) in accordance with the policies and procedures
established by the Board of Directors of the individual FHLB.
5. Riegle Community Development and Regulatory Improvement Act of 1994
-------------------------------------------------------------------------
The Riegle Community Development and Regulatory Improvement Act of 1994 (the
"1994 Act"), which has been viewed as the most important piece of banking
legislation since the enactment of FDICIA, was signed into law on September 23,
1994. In addition to providing funding for the establishment of a Community
Development Financial Institutions Fund (the "Fund"), which provides assistance
to new and existing community development lenders to help meet the needs of low-
and moderate-income communities and groups; the 1994 Act mandated changes to a
wide range of banking regulations. These changes included modifications to the
publication requirements for Call Reports, less frequent regulatory examination
schedules for small institutions, small business and commercial real estate loan
securitization, amendments to the money laundering and currency transaction
reporting requirements of the Bank Secrecy Act, clarification of the coverage of
the Real Estate Settlement Procedures Act for business, commercial and
agricultural real estate secured transactions, amendments to the national flood
insurance program, and amendments to the Truth in Lending Act to provide greater
protection for consumers by reducing discrimination against the disadvantaged.
34
The "Paperwork Reduction and Regulatory Improvement Act," Title III of the 1994
Act, required the federal banking agencies to consider the administrative
burdens that new regulations will impose before their adoption and requires a
transition period in order to provide adequate time for compliance. This Act
also requires the federal banking agencies to work together to establish uniform
regulations and guidelines as well as to work together to eliminate duplicative
or unnecessary requests for information in connection with applications or
notices. This Act reduces the frequency of examinations for well-rated
institutions, simplifies the quarterly Call Reports and eliminated the
requirement that financial institutions publish their Call Reports in local
newspapers. This Act also established an internal regulatory appeal process and
independent ombudsman to provide a means for review of material supervisory
determinations. The Paperwork Reduction and Regulatory Improvement Act also
amended the Bank Holding Company Act and Securities Act of 1933 to simplify the
formation of bank holding companies.
Title IV of the 1994 Act amended the Bank Secrecy Act by reducing the reporting
requirements imposed on financial institutions for large currency transactions,
expanding the ability of financial institutions to provide exemptions to the
reporting requirements for businesses that regularly deal in large amounts of
currency, and providing for the delegation of civil money penalty enforcement
from the Treasury Department to the individual federal banking agencies.
6. Safety and Soundness Standards
---------------------------------
In July, 1995, the federal banking agencies adopted final guidelines
establishing standards for safety and soundness, as required by FDICIA and the
1994 Act. The guidelines set forth operational and managerial standards relating
to internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth and
compensation, fees and benefits. Guidelines for asset quality and earnings
standards will be adopted in the future. The guidelines establish the safety
and soundness standards that the agencies will use to identify and address
problems at insured depository institutions before capital becomes impaired. 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 enforcement action.
The federal banking agencies 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.
Appraisals for "real estate related financial transactions" must be conducted by
either state certified or state licensed appraisers for transactions in excess
of certain amounts. State certified appraisers are required for all
transactions with a transaction value of $1,000,000 or more; for all
nonresidential transactions valued at $250,000 or more; and for "complex" 1- 4
family residential properties of $250,000 or more. A state licensed appraiser
is required for all other appraisals. However, appraisals performed in
connection with "federally related transactions" must now comply with the
agencies' appraisal standards. Federally related transactions include the sale,
lease, purchase, investment in, or exchange of, real property or interests in
real property, the financing or refinancing of real property, and the use of
real property or interests in real property as security for a loan or
investment, including mortgage-backed securities.
7. 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 monitor carefully compliance with various consumer protection
laws and their implementing regulations. Banks are subject to many federal
consumer protection laws and their regulations including, but not limited to,
the Community Reinvestment Act (the "CRA"), the Truth in Lending Act (the
"TILA"), the Fair Housing Act (the "FH Act"), the Equal Credit Opportunity Act
(the "ECOA"), the Home Mortgage Disclosure Act ("HMDA"), and the Real Estate
Settlement Procedures Act ("RESPA").
The CRA, enacted into law in 1977, is intended to encourage insured depository
institutions, while operating safely and soundly, to help meet the credit needs
of their communities. The CRA specifically directs the federal bank regulatory
agencies, in examining insured depository institutions, to assess their record
of helping to meet the credit needs of their entire community, including low-
and moderate-income neighborhoods, consistent with safe and sound banking
practices. The CRA further requires the agencies to take a financial
institution's record of meeting its community credit needs into account when
evaluating applications for, among other things, domestic branches, consummating
mergers or acquisitions, or holding company formations.
35
The federal banking agencies have adopted regulations which measure a bank's
compliance with its CRA obligations on a performance-based evaluation system.
This system bases CRA ratings on an institution's actual lending service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements. The ratings range from "outstanding" to a low of
"substantial noncompliance."
The ECOA, enacted into law in 1974, prohibits discrimination in any credit
transaction, whether for consumer or business purposes, on the basis of race,
color, religion, national origin, sex, marital status, age (except in limited
circumstances), receipt of income from public assistance programs, or good faith
exercise of any rights under the Consumer Credit Protection Act. In March,
1994, the Federal Interagency Task Force on Fair Lending issued a policy
statement on discrimination in lending. The policy statement describes the
three methods that federal agencies will use to prove discrimination: overt
evidence of discrimination, evidence of disparate treatment and evidence of
disparate impact. This means that if a creditor's actions have had the effect
of discriminating, the creditor may be held liable - even when there is no
intent to discriminate.
The FH Act, enacted into law in 1968, regulates many practices, including making
it unlawful for any lender to discriminate in its housing-related lending
activities against any person because of race, color, religion, national origin,
sex, handicap, or familial status. The FH Act is broadly written and has been
broadly interpreted by the courts. A number of lending practices have been
found to be, or may be considered, illegal under the FH Act, including some that
are not specifically mentioned in the FH Act itself. Among those practices that
have been found to be, or may be considered, illegal under the FH Act are:
declining a loan for the purposes of racial discrimination; making excessively
low appraisals of property based on racial considerations; pressuring,
discouraging, or denying applications for credit on a prohibited basis; using
excessively burdensome qualifications standards for the purpose or with the
effect of denying housing to minority applicants; imposing on minority loan
applicants more onerous interest rates or other terms, conditions or
requirements; and racial steering, or deliberately guiding potential purchasers
to or away from certain areas because of race.
The TILA, enacted into law in 1968, is designed to ensure that credit terms are
disclosed in a meaningful way so that consumers may compare credit terms more
readily and knowledgeably. As a result of the TILA, all creditors must use the
same credit terminology and expressions of rates, the annual percentage rate,
the finance charge, the amount financed, the total payments and the payment
schedule. HMDA, enacted into law in 1975, 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 loans, home
improvement loans, and multifamily loans, as well as information concerning
originations and purchases of such 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, enacted into law in 1974, requires lenders to provide borrowers with
disclosures regarding the nature and costs of real estate settlements. Also,
RESPA prohibits certain abusive practices, such as kickbacks, and places
limitations on the amount of escrow accounts.
Violations of these various consumer protection laws and regulations can result
in civil liability to the aggrieved party, regulatory enforcement including
civil money penalties, and even punitive damages.
8. Recent California Developments
- -- --------------------------------
In August, 1997, Governor Wilson of California signed Assembly Bill 1432 ("AB
1432"), which provides for certain changes in the Banking Laws of California.
Effective January 1, 1998, AB 1432 eliminated the provisions regarding
impairment of contributed capital and the assessment of shares when there is an
impairment in a bank's capital. AB 1432 permits the Commission of the DFI ("the
Commissioner") to close a bank if the Commissioner finds that the bank's
tangible shareholders' equity is less than the greater of 3% of the bank's total
assets of $1 million.
36
In addition, California law, in general, provides the Commissioner with certain
additional enforcement powers. For example, if it appears to the Commissioner
that a bank is violating its articles of incorporation or state law, or is
engaging in unsafe or unsound business practices, the Commissioner can order the
bank to comply with law or to cease unsafe or injurious practices. The
Commissioner also has the power to suspend or remove a bank's officers,
directors and employees who: (i) violate any law, regulation or fiduciary duty
to the bank; (ii) engage in any unsafe or unsound practices related to the
business of the bank; (iii) are charged with or convicted of a crime involving
dishonesty or breach of trust.
9. Conclusion
----------
As a result of the recent federal and California legislation, there has been a
competitive impact on commercial banking. There has been a lessening of the
historical distinction between the services offered by banks, savings and loan
associations, credit unions, and other financial institutions, banks have
experienced increased competition for deposits and loans which may result in
increases in their cost of funds, and banks have experienced increased costs.
Further, the federal banking agencies have increased enforcement authority over
banks and their directors and officers.
Future legislation is also likely to impact the companies and the subsidiaries'
business. Consumer legislation has been proposed in Congress which may require
banks to offer basic, low-cost, financial services to meet minimum consumer
needs. Various proposals to restructure the federal bank regulatory agencies
are currently pending in Congress, some of which include proposals to expand the
ability of banks to engage in previously prohibited businesses. Further, the
regulatory agencies have proposed and may propose a wide range of regulatory
changes, including the calculation of capital adequacy and limiting business
dealings with affiliates. These and other legislative and regulatory changes
may have the impact of increasing the cost of business or otherwise impacting
the earnings of financial institutions. However, the degree, timing and full
extent of the impact of these proposals cannot be predicted.
Management of the Company and the Subsidiaries cannot predict what other
legislation might be enacted or what other regulations might be adopted or the
effects thereof.
37
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- --------------------------------------------------------------------------
The Company's primary market risk is interest rate risk. Interest rate risk is
the potential of economic losses caused by future interest rate change. These
economic losses can be reflected as a loss of future net interest income and/or
a loss of current fair market values. The objective is to measure the effect on
net interest income and to adjust the balance sheet to minimize the risks.
Community West Bancshares' exposure to market risk is reviewed on a regular
basis by the Asset/Liability committee. Tools used by management include the
standard GAP report. The Company has no market risk instruments held for trading
purposes except for its interest only strip. Management believes the Company's
market risk is reasonable at this time. The Company currently does not enter
into derivative financial instruments.
See "Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations - Asset and Liability Management".
The table below provides information about the Company's financial instruments
that are sensitive to changes in interest rates. For all outstanding financial
instruments, the table presents the outstanding principle balance at December
31, 1998, and the weighted average interest yield/rate of the instruments by
either the date the instrument can be repriced for variable rate financial
instruments or the expected maturity date for fixed rate financial instruments,
At December 31, 1998
Expected maturity dates or repricing dates by year
2003 and Fair Value
(Dollars in thousands) 1999 2000 2001 2002 beyond Total at 12/31/98
Balance sheet financial instruments:
Assets:
Time deposits in other
financial institutions: $ 1,500 - - - - $ 1,500 $ 1,500
Average Yield 5.7%
Federal Funds Sold: $ 43,355 - - - - $ 43,355 $ 43,355
Average Yield 5.1%
Investment securities,
held to maturity: $ 501 - - - - $ 501 $ 502
Average Yield 6.8%
Investment securities,
available-for-sale: $ 754 - - - $ 7,541 $ 8,295 $ 8,295
Average Yield 6.0% 6.7%
Federal Reserve
Bank/Federal Home Loan
Bank stock: - - - - $ 810 $ 810 $ 810
Average Yield 6.1%
Interest only strip: $ 10,915 - - - - $ 10,915 $ 10,915
Average Yield 11.0%
Servicing asset: $ 1,472 - - - - $ 1,472 $ 1,472
Average Yield 11.0%
Liabilities:
Non-interest bearing
demand: $ 19,487 - - - - $ 19,487 $ 19,487
Average Yield 0.0%
Interest- bearing
demand: $ 19,976 - - - - $ 19,976 $ 19,976
Average Yield 2.8%
Savings: $ 26,860 - - - - $ 26,860 $ 26,860
Average Yield 3.3%
Time certificates of
deposit: $157,221 - - - - $157,221 $ 162,260
Average Yield 5.7%
(continued on next page)
38
At December 31, 1997
Expected maturity dates or repricing dates by year
2002 and Fair Value
(Dollars in thousands) 1998 1999 2000 2001 beyond Total at 12/31/97
Balance sheet financial instruments:
Assets:
Time deposits in other
financial institutions: $ 2,477 - - - - $ 2,477 $ 2,477
Average Yield 5.7%
Federal Funds Sold: $12,540 - - - - $12,540 $ 12,540
Average Yield 5.3%
Investment securities,
held to maturity: $ 998 - - - $ 4,156 $ 5,154 $ 4,964
Average Yield 6.0% 6.2%
Investment securities,
available-for-sale: $ 752 - - - $ 8,160 $ 8,912 $ 8,912
Average Yield 6.0% 6.7%
Federal Reserve
Bank/Federal Home Loan
Bank stock: - - - - $ 763 $ 763 $ 763
Average Yield 6.5%
Interest only strip: $ 2,529 - - - - $ 2,529 $ 2,529
Average Yield 11.0%
Servicing asset: $ 664 - - - - $ 664 $ 664
Average Yield 11.0%
Liabilities:
Non-interest bearing
demand: $15,597 - - - - $15,597 $ 15,597
Average Yield 0.0%
Interest- bearing
demand: $19,203 - - - - $19,203 $ 19,203
Average Yield 2.9%
Savings: $25,847 - - - - $25,847 $ 25,847
Average Yield 3.2%
Time certificates of
deposit: $92,044 - - - - $92,044 $ 92,198
Average Yield 5.6%
39
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Community West Bancshares
We have audited the consolidated balance sheets of Community West Bancshares and
subsidiaries (the "Company") as of December 31, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statements based on our
audits. The consolidated financial statements give retroactive effect to the
merger of the Company and Palomar Savings and Loan Association ("Palomar"),
which has been accounted for as a pooling of interests as described in Note 8
to the consolidated financial statements. We did not audit the balance sheet of
Palomar as of December 31, 1997, or the related statements of income,
stockholders' equity, and cash flows of Palomar for the years ended December 31,
1997 and 1996, which statements reflect total assets of $78,607,165 as of
December 31, 1997, and total revenues of $6,009,798 and $6,004,002 for the years
ended December 31, 1997 and 1996, respectively. Those statements were audited
by other auditors whose report has been furnished to us, and our opinion,
insofar as it relates to the amounts included for Palomar for 1997 and 1996, is
based solely on the report of such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Community West Bancshares and
subsidiaries at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998 in conformity with generally accepted accounting principles.
March 19, 1999
40
COMMUNITY WEST BANCSHARES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
- ---------------------------------------------------------------------------------------------------
ASSETS 1998 1997
Cash and due from banks $ 6,124,128 $ 6,296,534
Federal funds sold 43,355,000 12,540,000
------------- ------------
Cash and cash equivalents (Note 1) 49,479,128 18,836,534
Time deposits in other financial institutions 1,500,000 2,477,000
Federal Reserve Bank and Federal Home Loan Bank stock, at cost 810,350 763,300
Investment securities held to maturity, at amortized cost; fair value
of $502,656 in 1998 and $4,963,528 in 1997 (Note 2) 501,094 5,154,479
Investment securities available for sale, at fair value (Note 2) 8,295,099 8,911,878
Investment securities held for trading, at fair value (Note2 and 3) 10,914,900 2,528,587
Servicing assets (Note 3) 1,472,453 664,402
Loans (Notes 3 and 4)
Held for investment, net of allowance for loan
losses of $2,128,710 in 1998 and $2,066,852 in 1997 107,099,184 112,645,496
Held for sale, at lower of cost or fair value 58,835,944 15,739,244
Other real estate owned, net 241,363 -
Premises and equipment, net (Note 6) 4,538,999 2,852,624
Accrued interest receivable and other assets 8,345,538 3,346,066
------------- ------------
TOTAL $252,034,052 $173,919,610
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits: (Note 7)
Noninterest-bearing demand $ 19,487,328 $ 15,596,582
Interest-bearing demand 19,976,138 19,203,356
Savings 26,860,381 25,847,070
Time certificates of $100,000 or more 61,742,177 30,898,437
Other time certificates 95,478,775 61,145,627
------------- ------------
Total deposits 223,544,799 152,691,072
Accrued interest payable and other liabilities (Note 11) 3,935,857 3,573,964
------------- ------------
Total liabilities 227,480,656 156,265,036
------------- ------------
COMMITMENTS AND CONTINGENCIES (Note 10)
STOCKHOLDERS' EQUITY (Notes 8, 9 and 12)
Common stock, no par value; 10,000,000 shares authorized; 5,479,710
and 4,380,475 shares issued and outstanding at December 31, 1998
and 1997 17,303,590 12,833,315
Less: Treasury stock, at cost (14,807 shares) (140,739) -
Retained earnings 7,392,992 4,790,090
Accumulated other comprehensive (loss) income (2,447) 31,169
------------- ------------
Total stockholders' equity 24,553,396 17,654,574
------------- ------------
TOTAL $252,034,052 $173,919,610
============= ============
See notes to consolidated financial statements.
41
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF INCOME
THREE YEARS ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------
1998 1997 1996
INTEREST INCOME:
Loans, including fees $18,879,280 $11,762,488 $10,630,453
Federal funds sold 673,004 616,197 428,795
Time deposits in other financial institutions 123,317 229,670 196,826
Investment securities 870,997 944,152 1,203,854
----------- ----------- -----------
Total interest income 20,546,598 13,552,507 12,459,928
INTEREST EXPENSE ON DEPOSITS 9,256,700 6,360,885 5,990,252
----------- ----------- -----------
NET INTEREST INCOME 11,289,898 7,191,622 6,469,676
PROVISION FOR LOAN LOSSES (Note 4) 428,969 190,548 650,488
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,860,929 7,001,074 5,819,188
----------- ----------- -----------
OTHER INCOME:
Gains from loan sales 6,393,786 4,389,936 2,645,371
Loan origination fees - sold or brokered loans 3,690,118 3,005,408 2,095,458
Document processing fees 1,647,708 819,355 509,650
Loan servicing fees 962,478 713,168 767,961
Service charges 887,188 961,797 646,253
Other income 454,610 21,293 311,944
----------- ----------- -----------
Total other income 14,035,888 9,910,957 6,976,637
OTHER EXPENSES:
Salaries and employee benefits (Note 13) 12,868,205 8,120,536 6,187,793
Occupancy expenses (Note 10) 2,738,790 1,735,730 1,397,966
Other operating expenses 1,657,226 1,149,318 1,645,470
Advertising expense 842,362 638,814 347,639
Professional services 840,931 506,845 350,927
Postage & freight 469,979 849,746 570,526
Data processing/ATM processing 390,091 242,696 219,212
Office supply expense 267,111 202,343 184,241
----------- ----------- -----------
Total other expenses 20,074,695 13,446,028 10,903,774
INCOME BEFORE PROVISION FOR INCOME TAXES 4,822,122 3,466,003 1,892,051
PROVISION FOR INCOME TAXES (Note 11) 1,941,355 1,316,351 688,478
----------- ----------- -----------
NET INCOME $ 2,880,767 $ 2,149,652 $ 1,203,573
=========== =========== ===========
NET INCOME PER SHARE -- BASIC $ 0.57 $ 0.49 $ 0.32
=========== =========== ===========
NET INCOME PER SHARE -- DILUTED $ 0.55 $ 0.43 $ 0.31
=========== =========== ===========
See notes to consolidated financial statements.
42
COMMUNITY WEST BANCSHARES
- ---------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER, 31
- ------------------------------------------------------------------------------------------------------------------------
Accum.
Common Stock Treasury Stock Other
----------------------- ------------------ Retained Comprehensive
Shares Amount Shares Amount Earnings Income (loss)
--------- ------------ ------ ---------- ----------- ---------
BALANCE, JANUARY 1, 1996 3,335,759 $ 9,440,419 - $ - $1,508,300 $ (7,816)
Secondary offering of common stock and warrants 859,368 2,788,048 - - - -
Cash Dividend - - - - (71,435) -
Exercise of Warrants 3,848 16,835 - - - -
Exercise of Stock Options 47,168 107,230 - - - -
Change in unrealized gains/(losses) on securities
available-for-sale, net - - - - - 1,416
Net Income - - - - 1,203,573 -
--------- ------------ ------ ---------- ----------- ---------
BALANCE DECEMBER 31, 1996 4,246,143 12,352,532 - - 2,640,438 (6,400)
Issuance of founders stock - 10,000 - - - -
Exercise of Warrants 63,692 278,653 - - - -
Exercise of Stock Options 70,640 192,130 - - - -
Change in unrealized gains/(losses) on securities
available-for-sale, net - - - - - 37,569
Net Income - - - - 2,149,652 -
--------- ------------ ------ ---------- ----------- ---------
BALANCE DECEMBER 31, 1997 4,380,475 12,833,315 - - 4,790,090 31,169
Retirement of founders stock - (10,000) - - - -
Palomar Stock Dividend 68,383 276,381 - - (276,381) -
Cash in lieu of fractional shares-stock dividend - - - - (1,484) -
Exercise of Warrants 875,140 3,828,738 - - - -
Exercise of Stock Options 155,712 375,156 - - - -
Change in unrealized gains/(losses) on securities
available-for-sale, net - - - - - (33,616)
Treasury Stock Purchase - - 14,807 (140,739) - -
Net Income - - - - 2,880,767 -
--------- ------------ ------ ---------- ----------- ---------
BALANCE DECEMBER 31, 1998 5,479,710 $17,303,590 14,807 $(140,739) $7,392,992 $ (2,447)
========= ============ ====== ========== =========== =========
Total
Stockholders' Comprehensive
Equity Income
------------ -----------
BALANCE, JANUARY 1, 1996 $10,940,903 $ (7,816)
Secondary offering of common stock and warrants 2,788,048 -
Cash Dividend (71,435) -
Exercise of Warrants 16,835 -
Exercise of Stock Options 107,230 -
Change in unrealized gains/(losses) on securities
available-for-sale, net 1,416 1,416
Net Income 1,203,573 1,203,573
------------ -----------
BALANCE DECEMBER 31, 1996 14,986,570 1,204,989
Issuance of founders stock 10,000 -
Exercise of Warrants 278,653 -
Exercise of Stock Options 192,130 -
Change in unrealized gains/(losses) on securities
available-for-sale, net 37,569 37,569
Net Income 2,149,652 2,149,652
------------ -----------
BALANCE DECEMBER 31, 1997 17,654,574 2,187,221
Retirement of founders stock (10,000) -
Palomar Stock Dividend - -
Cash in lieu of fractional shares-stock dividend (1,484) -
Exercise of Warrants 3,828,738 -
Exercise of Stock Options 375,156 -
Change in unrealized gains/(losses) on securities
available-for-sale, net (33,616) (33,616)
Treasury Stock Purchase (140,739) -
Net Income 2,880,767 2,880,767
------------ -----------
BALANCE DECEMBER 31, 1998 $24,553,396 $2,847,151
============ ===========
Disclosure of reclassification amount for December 31: 1998 1997 1996
--------- ------- ---------
Unrealized holding gains (losses) arising during the period, net
of tax expense (benefit) of ($69,763) in 1998,
$18,502 in 1997, and $10,832 in 1996 $(96,340) $25,550 $ 14,959
Less: Reclassification adjustment for gains (losses) included in net
income, net of tax (expense) benefit of
($45,421) in 1998, ($8,703) in 1997, and $9,807 in 1996 62,724 12,019 (13,543)
--------- ------- ---------
Net change in unrealized loss on investment securities available
for sale, net of tax (expense) or benefit of
$24,342 in 1998, ($27,205) in 1997, and ($1,025) in 1996 $(33,616) $37,569 $ 1,416
========= ======= =========
See notes to consolidated financial statements.
43
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
------------- ------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,880,767 $ 2,149,652 $ 1,203,573
Adjustments to reconcile net income to net cash used in operating activities:
Provision for loan losses 428,969 190,548 650,488
Provision for losses on real estate owned - 70,211 15,784
Deferred income taxes provision 2,124,385 147,890 317,094
Depreciation and amortization 954,129 625,672 516,539
Gain on sale of other real estate owned (25,283) (37,273) (65,163)
Gain on sale of loans held for sale (6,393,786) (4,389,936) (2,645,371)
Losses (gains) on sale of securities, available-for-sale 108,145 20,722 (23,350)
Sale of held to maturity security 0 - -
Gain on sale of real estate investment (8,312) (10,740) (112,494)
FHLB capital stock dividends (34,300) (30,400) (30,200)
Origination of servicing and interest only strip assets, net of amortization (6,963,281) (294,947) (1,191,149)
Net change in deferred loan fees and premiums (38,406) (39,500) 7,094
Changes in operating assets and liabilities:
Accrued interest receivable and other assets (4,999,472) (1,174,846) 1,347,187
Accrued interest payable and other liabilities 361,893 2,650,848 (408,510)
------------- ------------- ------------
Net cash (used in) provided by operating activities (11,604,552) (122,099) (418,478)
------------- ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities and FRB/FHLB stock (515,394) (1,096,395) (3,747,374)
Maturities of held-to-maturity securities 1,736,143 2,996,191 1,000,000
Purchase of securities, Available-for-Sale (3,029,374) (6,838,572) (5,954,473)
Proceeds from sale of securities, Available-for-Sale 3,296,112 4,100,377 12,190,353
Principal repayment on investments 3,582,559 778,187 1,409,900
Net increase in loans and loans held for sale (78,861,135) (28,284,029) (9,330,577)
Proceeds from sale of loans 42,928,431 17,630,810 3,370,489
Purchase of loan servicing (319,152) - -
Cash disbursement from real estate ventures, net 79,775 9,198 99,842
Proceeds from sale of real estate investments - - 94,995
Proceeds from sale of other real estate owned 112,591 725,603 1,193,385
Redemption of FHLB stock - - 195,000
Net decrease (increase) in time deposits in other financial institutions 977,000 (99,000) (1,000,000)
Purchase of premises and equipment (2,645,808) (921,801) (1,340,793)
------------- ------------- ------------
Net cash used in investing activities (32,658,252) (10,999,431) (1,819,253)
------------- ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand deposits, and savings accounts 5,676,839 6,616,271 (522,502)
Net increase in time certificates 65,176,888 2,969,193 6,033,882
Net decrease in borrowings from FHLB - (2,000,000) -
Proceeds from the secondary offering of common stock and warrants - - 2,788,048
Purchase of treasury stock (140,739) - -
Issuance of founder's stock
Retirement of founder's stock (10,000) 10,000
Exercise of Stock options and warrants 4,203,894 470,783 124,065
Cash paid in lieu of fractional shares - stock dividend (1,484) - -
Cash dividend paid - - (71,435)
------------- ------------- ------------
Net cash provided by financing activities 74,905,398 8,066,247 8,352,058
------------- ------------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 30,642,594 (3,055,283) 6,114,327
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 18,836,534 21,891,817 15,777,490
------------- ------------- ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 49,479,128 $ 18,836,534 $21,891,817
============= ============= ============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 7,499,017 $ 6,331,494 $ 5,991,836
Cash paid for income taxes 1,040,529 558,256 1,279,300
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real-estate owned $ 370,937 $ 272,369 $ 1,014,175
Decrease (increase) in net unrealized losses on securities, available-for-sale 51,336 (56,869) (4,047)
See notes to consolidated financial statements.
44
COMMUNITY WEST BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Community West Bancshares (the
"Company") and its wholly-owned subsidiaries, Goleta National Bank and Palomar
Savings and Loan, are in accordance with generally accepted accounting
principles and general practices within the financial services industry. All
material intercompany transactions and accounts have been eliminated. The
following are descriptions of the more significant of those policies.
Nature of Operations - The Company's primary operations are related to
traditional financial services, including the acceptance of deposits and the
lending and investing of money. In addition, the Company also engages in
electronic services. The Company's customers consist of small to mid-sized
businesses and individuals. The Company also originates and sells U. S. Small
Business Administration ("SBA"), FHA Title I and first and second mortgage loans
through its normal operations and fifteen loan production offices.
Business Combinations - On December 14, 1998, the Company merged with
Palomar Savings & Loan Association ("Palomar"). As of that date, shareholders of
Palomar (OTCBB:PALO) became shareholders of the Company by receiving 2.11 shares
of CWBC for each share of PALO they held. This acquisition was accounted for as
a pooling-of-interests. Palomar is a state-chartered full service savings and
loan association. It is the Company's intent to maintain Palomar as a separate
subsidiary of the Company.
Cash and Cash Equivalents - For purposes of reporting cash flows, cash and
cash equivalents include cash on hand, amounts due from banks and federal funds
sold. Generally, federal funds are purchased for one day periods.
Loans - Generally, loans are stated at amounts advanced less payments
collected. Interest on loans is accrued daily on a simple-interest basis, except
where serious doubt exists as to collectibility of the loan, in which case the
accrual of interest income is discontinued.
Loans Held for Sale - Loans which are originated and are intended for sale
in the secondary market, are carried at the lower of cost or fair value on an
aggregate basis. Funding for SBA and FHA programs depends on annual
appropriations by the U.S. Congress, and accordingly, the sale of loans under
these programs is dependent on the continuation of such programs.
Investment Securities - The Company classifies as held to maturity those
debt securities it has the positive intent and ability to hold to maturity.
Securities held to maturity are accounted for at cost and adjusted for
amortization of premiums and accretion of discounts. Securities to be held for
indefinite periods of time, but not necessarily to be held-to-maturity or on a
long term basis are classified as available-for-sale and carried at fair value
with unrealized gains or losses reported as a separate component of accumulated
other comprehensive income, net of any applicable income taxes. Realized gains
or losses on the sale of securities available-for-sale, if any, are determined
on a identification basis.
Investment Securities, Held for Trading -Interest Only Strips and Residual
Asset - The Company originates certain loans for the purpose of selling either a
portion or all of the loan into either the secondary market or a securitization.
The guaranteed portion of SBA loans and FHA Title 1 loans are sold into the
secondary market, servicing retained. Second mortgages ("HLTV") loans are sold
into a securitization. On these sales, the Company retains interest only
("I/O") strips, which represent the present value of the right to the excess
cash flows generated by the serviced loans which represents the difference
between (a) interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors, (ii) trustee fees, (iii)
FHA insurance fees (if applicable), (iv) third-party credit enhancement fees (if
applicable), and (v) stipulated servicing fees. The Company determines the
present value of this anticipated cash flow stream at the time each loan sale
transaction closes, utilizing valuation assumptions appropriate for each
particular transaction. Loan sales are discussed in detail in Note 3.
45
The I/O Strips and Residual Assets are accounted for under Statement of
Financial Accounting Standards ("SFAS") No. 65 "Accounting for Certain Mortgage
Banking Activities". These assets are subject to significant prepayment risk,
and accordingly have an undetermined maturity date; and therefore cannot be
classified as held to maturity. The Company has chosen to classify these assets
as trading securities. Based on this classification, the Company is required to
mark these securities to fair value with the accompanying increases or decreases
in fair value being recorded as earnings in the current period. The
determination of fair value is based on the previously mentioned basis.
As the gain recognized in the year of sale is equal to the net estimated
future cash flows from the I/O Strips and Residual Assets, discounted at a
market interest rate, the amount of cash actually received over the lives of the
loans is expected to exceed the gain previously recognized at the time the loans
are sold. The I/O Strips are amortized based on an accelerated method against
the cash flows resulting in income recognition that is not materially different
from the interest method. The Company generally retains the right to service
loans it originates, or purchases, and subsequently sells.
Provision and Allowance for Loan Losses - The allowance for loan losses is
maintained at a level believed adequate by management to absorb possible losses
on existing loans through a provision for loan losses charged to expense. The
allowance is charged for losses when management believes that full recovery on
loans is unlikely. Management's determination of the adequacy of the allowance
is based on periodic evaluations of the loan portfolio, which take into
consideration such factors as changes in the growth, size and composition of the
loan portfolio, overall portfolio quality, review of specific problem loans,
collateral, guarantees and economic conditions that may affect the borrowers'
ability to pay and/or the value of the underlying collateral. These estimates
depend on the outcome of future events and, therefore, contain inherent
uncertainties.
Management believes the level of the allowance for loan losses as of
December 31, 1998, is adequate to absorb future losses; however, changes in the
local economy, the ability of borrowers to repay amounts borrowed and other
factors may result in the need to increase the allowance through charges to
earnings.
Loan Fees and Costs - Loan origination fees and costs are deferred and
recognized as an adjustment to the loan yield over the contractual life of the
loan using the straight-line or level yield method.
Other Real Estate Owned - Real estate acquired by foreclosure is recorded
at fair value at the time of foreclosure, less estimated selling costs. Any
subsequent operating expenses or income, reduction in estimated values, and
gains or losses on disposition of such properties are charged to current
operations.
Premises and Equipment - Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, which range
from 2 to 31.5 years. Leasehold improvements are amortized over the term of the
lease or the estimated useful lives, whichever is shorter.
Income Taxes - Deferred income taxes are recognized for the tax
consequences in future years of differences between the tax basis of assets and
liabilities and their financial reporting amounts at each year-end based on
enacted tax laws and statutory tax rates applicable to the periods in which the
differences are expected to affect taxable income.
46
Net Income per Share and Share Equivalent - Net income per share - basic
has been computed based on the weighted average number of shares outstanding
during each year. Net income per share - diluted has been computed based on the
weighted average number of shares outstanding during each year plus the dilutive
effect of outstanding warrants and options. Net income per share amounts have
been retroactively restated to reflect, the pooling of interests which resulted
from the acquisition of Palomar Savings & Loan, and the two-for-one stock splits
in 1996 and 1998. Earnings per share were computed as follows:
1998 1997 1996
---------- ---------- ----------
Basic weighted average shares outstanding 5,069,596 4,383,878 3,723,832
Dilutive effect of options 174,142 209,970 127,384
Dilutive effect of warrants - 362,300 26,806
---------- ---------- ----------
Diluted weighted average shares outstanding 5,243,738 4,956,148 3,878,022
========== ========== ==========
Net Income $2,880,767 $2,149,652 $1,203,573
Net income per share - Basic $ 0.57 $ 0.49 $ 0.32
Net income per share - Diluted $ 0.55 $ 0.43 $ 0.31
Reserve Requirements - All depository institutions are required by law to
maintain reserves on transaction accounts and nonpersonal time deposits in the
form of cash balances at the Federal Reserve Bank. These reserve requirements
can be offset by cash balances held at the Company. At December 31, 1998, the
Company's cash balance was sufficient to offset the Federal Reserve requirement.
Use of Estimates in the Preparation of Financial Statements - The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Current Accounting Pronouncements - In June 1997, the FASB issued SFAS No.
130, "Reporting Comprehensive Income." This Statement establishes standards for
reporting and presenting comprehensive income and its components in a full set
of financial statements. The term "comprehensive income" describes the total of
all components of comprehensive income including net income. "Other
comprehensive income" refers to revenues, expenses, and gains and losses that
are included in comprehensive income but are excluded from net income as they
have been recorded directly in equity under the provisions of other FASB
statements. The Company presents the comprehensive income disclosure as a part
of the statements of changes in stockholders' equity, by identifying each
element of other comprehensive income including net income. SFAS No. 130 is
effective for fiscal years beginning after December 15, 1997. Comparative
financial statements provided for earlier periods have been reclassified to
reflect application of the provisions of SFAS No. 130. SFAS No. 130 is effective
for fiscal years beginning after December 15, 1997. Comparative financial
statements provided for earlier periods have been reclassified to reflect
application of the provisions of SFAS No. 130.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," effective for financial statements for
periods beginning after December 15, 1997. This statement establishes standards
for reporting information about operating segments in annual financial
statements and requires that enterprises report selected information about
operating segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The disclosures required by this
statement are presented in Note 15.
47
Accounting for Derivative Instruments and Hedging Activities - In June
1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", was issued and is effective for fiscal years beginning after June
15, 1999. SFAS No. 133 requires companies to record derivatives on the balance
sheet as assets and liabilities, measured at fair value. Gains or losses
resulting from the changes in the values of those derivatives would be accounted
for depending on the use of the derivative and whether it qualifies for hedge
accounting. The key criterion for hedge accounting is that the hedging
relationship must be highly effective in achieving offsetting changes in fair
value or cash flows. The Company early adopted FAS 133 on October 1, 1998. At
the date of initial application of FAS 133, a company may transfer any held to
maturity security into the available for sale category.
In October 1998, FASB issued SFAS No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise." SFAS No. 134 amends SFAS No. 65, "Accounting
for Certain Mortgage Banking Activities," which establishes accounting and
reporting standards for certain activities of mortgage banking enterprises and
other enterprises that conduct operations that are substantially similar. SFAS
No. 134 requires that after the securitization of mortgage loans held for sale,
the resulting mortgage-backed securities and other retained interests should be
classified in accordance with SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," based on the company's ability and intent to
sell or hold those investments. SFAS No. 134 is effective for the first fiscal
quarter beginning after December 15, 1998. Management of the Bank does not
believe that the adoption of SFAS No. 134 will have a material impact on the
Bank's results of operations or financial position when adopted.
Statement of Position 98-1 "Accounting for the Costs of Computer Software
Developed and Obtained for Internal Use", issued in March 1998 requires
capitalization of certain costs of computer software developed or obtained for
internal use. The SOP describes three stages of software development projects:
the preliminary project stage where all costs are expensed, the application
development state where some costs are capitalized, while others are expensed,
and the post-implementation/operation state where all costs are expensed. Other
costs associated with the development and implementation of internal-use
software systems projects are expensed as incurred. The SOP does not change the
requirement that the external and internal costs associated with modifying
internal use software currently in use for the year 2000 should be charged to
expense as incurred. The SOP is effective for financial statements for fiscal
years beginning after December 15, 1998 with earlier application encouraged.
The Company early adopted SOP 98-1 effective January 1, 1998 and has capitalized
certain costs, amounting to $470,566, related to the development of internal use
software as required by the SOP.
Reclassifications - Certain amounts in the accompanying financial
statements for 1997 and 1996 have been reclassified to conform to the 1998
presentation.
48
2. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities at
December 31 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
----------- ----------- ----------- ----------
1998
Available-for-Sale Securities
- -------------------------------------------
Government National Mortgage Association
participation certificates $ 4,208,179 $ 19,724 $ - $4,227,903
Federal National Mortgage Association
and Federal Home Loan Mortgage Corporation
participation certificates 2,841,118 - 25,815 2,815,303
Federal Home Loan Mortgage Corporation Bond 500,000 - 2,170 497,830
U.S. Treasury Securities 750,000 4,063 - 754,063
----------- ----------- ----------- ----------
$ 8,299,297 $ 23,787 $ 27,985 $8,295,099
=========== =========== =========== ==========
Held to Maturity
- -------------------------------------------
Due in less than one year:
U.S. Treasury note, par value $500,000,
5.875% due 7/31/99 $ 501,094 $ 1,562 $ - $ 502,656
----------- ----------- ----------- ----------
$ 501,094 $ 1,562 $ - $ 502,656
=========== =========== =========== ==========
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
----------- ----------- ----------- ----------
1997
Available-for-Sale Securities
- -------------------------------------------
Government National Mortgage Association
participation certificates $ 3,838,357 $ 35,396 $ - $3,873,753
Federal National Mortgage Association
and Federal Home Loan Mortgage Corporation
participation certificates 4,276,174 9,585 - 4,285,759
U.S. Treasury Securities 750,178 2,188 - 752,366
----------- ----------- ----------- ----------
$ 8,864,709 $ 47,169 $ - $8,911,878
=========== =========== =========== ==========
49
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
---------- ----------- ----------- ----------
Held to Maturity
- ---------------------------------------
Due in less than one year:
U.S. Treasury note, par value $500,000,
5.125% due 2/28/98 $ 499,700 $ - $ 3,200 $ 496,500
U.S. Treasury note, par value $500,000,
5.125%, due 6/30/98 498,751 - 2,400 496,351
Federal National Mortgage
Association REMICs 3,419,885 - 187,021 3,232,864
Federal National Mortgage Association
Bonds 736,143 1,670 - 737,813
---------- ----------- ----------- ----------
$5,154,479 $ 1,670 $ 192,621 $4,963,528
========== =========== =========== ==========
The following table presents contractual maturity information for
investment securities at December 31, 1998.
Amortized Fair
Held-to-Maturity Cost Value
- ----------------------- ---------- ----------
Due in one year or less $ 501,094 $ 502,656
---------- ----------
$ 501,094 $ 502,656
========== ==========
Available-for-Sale
- -----------------------
Due in one year or less $ 750,000 $ 754, 064
Due after ten years 7,549,297 $7,541,035
---------- ----------
$8,299,297 $8,295,099
========== ==========
Held-for-Trading
- ----------------
The Company retains servicing spreads on loan sales that creates servicing
assets. The servicing spreads are separated into three assets. A servicing asset
is recorded for the present value of the excess of the contractual servicing
spread over the expected cost of servicing the portfolio for the expected life
of the loans sold. An interest-only strip asset is recorded for the present
value of the servicing spread less the contractual servicing for the estimated
expected life of the loans. A residual asset is recorded which represents the
present value of the excess collateral less anticipated losses. The Company
uses industry prepayment statistics and its own prepayment experience in
estimating the expected life of the loans. The present value asset is amortized
as an offset to loan servicing income over the estimated expected life of the
servicing assets. The interest-only strips and residual asset are recorded as
investments, held-for-trading at their fair market value. The sale of loans
creating these assets is discussed in detail in Note 3.
At December 31, 1998, a U.S. Treasury Note with a face value of $500,000
was pledged as collateral to the U.S. Treasury for its Treasury, Tax, and Loan
account with the Company.
50
The Company early adopted FAS 133 on October 1, 1998. At the date of
initial application of FAS 133, a company may transfer any held to maturity
security into the available for sale category. As of October 1, 1998, the
Company transferred securities with a carrying value $3,418,478 from investment
securities held to maturity to investment securities available for sale. The
securities were transferred at fair market value with an unrealized loss of
$78,224 which was reported as a component of accumulated other comprehensive
income.
3. LOAN SALES
HLTV Loan Sales
-----------------
During the year ended December 31, 1998, the Company completed the
securitization of an $81 million pool of HLTV loans. These HLTV loans allow
borrowers to receive up to 125% of their home value for debt consolidation, home
improvement, school tuition, or any worthwhile cash outlay. There is an upper
limit on these loans of $100,000. The Company retained a residual participation
interest in the investor trust, reflecting the excess of the total amount of
loans transferred to the trust over the portion represented by certificates sold
to investors. As a result of the securitization, the Company also recorded
interest-only strips (I/O Strips). The present value of these assets was
calculated assuming a 13% discount rate, annual losses of 2.25%, and an 18.25%
constant prepayment rate (CPR). As of December 31, 1998, the Company recorded a
receivable from the underwriter of the securitization for $3 million, which
represents the amount due to the Company upon the final sale of the remaining
bonds. As of December 31, 1998, the Company had $24 million in loans held for
sale in future securitizations.
SBA Loan Sales
----------------
The Company sells the guaranteed portion of Small Business Administration
("SBA") loans into the secondary market in exchange for cash premium, servicing
assets, and I/O strips. The Company retains the servicing rights. The present
value of the interest only strips and servicing assets was calculated assuming
an 11% discount rate, and an 8% CPR. As of December 31, 1998, the Company
had $5 million in SBA loans held for sale.
FHA Title 1 Loan Sales
--------------------------
Since 1995, the Company has sold FHA Title 1 loans into the secondary
market, on a whole loan basis, in exchange for cash premium, servicing assets,
and I/O strips. The Company retains the servicing rights. In 1998 the present
value of the interest only strips was calculated assuming a 11% discount rate,
and a 15% CPR. As of December 31, 1998, the Company
had $1 million in FHA Title 1 loans held for sale.
Traditional Mortgages
---------------------
Amount represents servicing purchased by Palomar in 1998.
The balance of these assets are as follows:
December 31, 1998 December 31, 1997
------------------------------- ----------------------------
Servicing Asset I/O Strip(1) Servicing Asset I/O Strip
---------------- ------------- ---------------- ----------
HLTV $ - $ 8,150,000 $ - $ -
Guaranteed Portion of SBA 1,194,000 1,030,000 611,000 462,000
FHA Title 1 22,000 1,735,000 53,000 2,067,000
Traditional Mortgages 256,000 - - -
---------------- ------------- ---------------- ----------
Total $ 1,472,000 $ 10,915,000 $ 664,000 $2,529,000
================ ============= ================ ==========
(1) Includes the residual asset recorded on the securitization of the HLTV loans.
51
4. LOANS
The composition of the Company's loan portfolio at December 31 was as
follows:
(rounded to the thousand)
1998 1997
------------ ------------
Installment $ 5,637,827 $ 4,056,774
Commercial 10,612,861 13,195,325
Real estate 64,874,706 76,190,139
Loan participations purchased - real estate 2,287,036 2,246,855
Unguaranteed portion of SBA loans 26,686,850 19,602,136
------------ ------------
110,099,280 115,291,229
Less:
Allowance for loan losses 2,128,710 2,066,852
Net deferred loan fees and premiums 112,199 150,605
Other discount on SBA loans 759,187 428,276
------------ ------------
Loans held for investment, net $107,099,184 $112,645,496
============ ============
Loans held for sale $ 58,835,944 $ 15,739,244
============ ============
Loans held for sale include the guaranteed and unguaranteed portion of SBA
loans and loans insured by the FHA, and first and second mortgages. Loans are
held for sale and are recorded at the lower of cost or fair value.
Transactions in the allowance for loan losses for the years ended December
31 are summarized as follows:
1998 1997 1996
----------- ----------- -----------
Balance, beginning of year $2,066,852 $2,379,321 $2,353,939
Provision for loan losses 428,969 190,548 650,488
Loans charged off (402,452) (520,293) (646,982)
Recoveries on loans previously charged off 35,341 17,276 21,876
----------- ----------- -----------
Balance, end of year $2,128,710 $2,066,852 $2,379,321
=========== =========== ===========
52
The recorded investment in loans that are considered to be impaired under
SFAS No. 114 was as follows:
December 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
Impaired loans without specific valuation
allowances $4,450,345 $2,461,168 $1,111,388
Impaired loans with specific valuation allowances 813,652 1,266,964 2,490,435
Specific valuation allowance allocated to
impaired loans (464,336) (521,994) (736,853)
Impaired loans, net $4,799,661 $3,206,138 $2,864,970
=========== =========== ===========
Average investment in impaired loans $4,009,400 $3,056,054 $3,620,236
=========== =========== ===========
Interest income recognized on impaired loans $ 288,607 $ 360,309 $ 190,559
=========== =========== ===========
Nonaccrual loans $2,971,000 $1,714,000 $ 634,000
=========== =========== ===========
Troubled debt restructured loans, gross $1,313,000 $3,289,000 $1,238,000
=========== =========== ===========
Interest foregone on nonaccrual loans and troubled
debt restructuring outstanding $ 414,000 $ 203,000 $ 226,000
=========== =========== ===========
Loans 30 through 90 days past due with
interest accruing $ 678,000 $ 631,000 $ 838,000
=========== =========== ===========
It is generally the Company's policy to place loans on nonaccrual status
when they are 90 days past due, and any unpaid, but accrued interest is
reversed. Thereafter, interest income is no longer recognized. As such, interest
income may be recognized on impaired loans to the extent they are not past due
by 90 days or more.
Upon the adoption of SFAS No. 114, the Company classified all loans on
nonaccrual status as impaired. Accordingly, the impaired loans disclosed above
include all loans that were on nonaccrual status.
Financial difficulties encountered by certain borrowers may cause the
Company to restructure the terms of their loans to facilitate loan payments. In
accordance with the provisions of SFAS No. 114, a troubled loan that is
restructured subsequent to the adoption of SFAS No. 114 would generally be
considered impaired, while a loan restructured prior to adoption would not be
considered impaired if, at the date of measurement, it was probable that the
Company will collect all amounts due under the restructured terms. Accordingly,
the balance of impaired loans disclosed above includes all troubled debt
restructured loans that, as of December 31, 1998, 1997, and 1996, are considered
impaired.
The Company makes loans to borrowers in a number of different industries.
No single industry comprises 10% or more of the Company's loan portfolio.
Although the Company has a diversified loan portfolio, the ability of the
Company's customers to honor their loan agreements is dependent upon, among
other things, the general economy of the Company's market area. Approximately
60% on the Company's loans are secured by real estate located in California.
53
5. TRANSACTIONS INVOLVING DIRECTORS AND EMPLOYEES
In the ordinary course of business, the Company has extended credit to
directors and employees of the Company. Such loans are subject to approval by
the Loan Committee and ratification by the Board of Directors, exclusive of the
borrowing director. The following is an analysis of the activity of all such
loans:
1998 1997 1996
------------ ----------- -----------
Outstanding balance, beginning of year $ 2,554,699 $2,784,834 $1,860,382
Credit granted, including renewals 1,454,000 751,534 973,305
Repayments (1,252,630) (981,669) (48,853)
------------ ----------- -----------
Outstanding balance, end of year $ 2,756,069 $2,554,699 $2,784,834
============ =========== ===========
6. PREMISES AND EQUIPMENT
Premises and equipment as of December 31 was as follows:
1998 1997
---------- ----------
Furniture, fixtures and equipment $5,114,683 $3,565,851
Building & land 782,423 782,423
Leasehold improvements 1,389,749 932,232
Construction in progress 705,116 65,657
---------- ----------
7,991,971 5,346,163
Less accumulated depreciation and amortization 3,452,972 2,493,539
---------- ----------
Premises and equipment, net $4,538,999 $2,852,624
========== ==========
7. DEPOSITS
At December 31, 1998, the scheduled maturities of time certificates of
deposits are as follows:
1999 $144,321,583
2000 8,612,738
2001 4,195,927
2002 and thereafter 90,704
------------
$157,220,952
============
8. BUSINESS COMBINATION
Effective December 18, 1998, the Company issued 1,367,542 common shares to
facilitate a merger with Palomar Savings and Loan ("Palomar"). The Company
exchanged 2.11 shares of its common stock for each share of Palomar common
stock. The transaction constituted a tax-free reorganization and has been
accounted for as a pooling-of-interests under Accounting Principles Board
Opinion No. 16. Accordingly, all prior period consolidated financial statements
have been restated to include the operations and financial position of Palomar
as though it had always been a part of the Company. The combined Company had
assets of $250 million and deposits of $226 million as of the date of the
merger.
Prior to the merger, Palomar's fiscal year-end was September 30. In
recording the business combination, Palomar's prior period financial statements
have been restated to a year-end of December 31, to conform with the Company's
fiscal year-end.
54
Revenue and Net Income for the years December 31, 1998, 1997 and 1996 are
as follows:
Nine Months
Ended
(Unaudited) September 30, Year Ended December 31,
---------- ----------------------
1998 1997 1996
---------- ----------- -----------
Community West
- ---------------------
Net Interest Income $6,341,000 $ 5,098,982 $ 4,387,342
Net Income $1,801,000 $ 1,588,940 $ 1,105,422
Palomar
- ---------------------
Net Interest Income $1,631,000 $ 2,092,640 $ 2,082,334
Net Income $ 521,000 $ 560,712 $ 98,151
Combined
- ---------------------
Net Interest Income $7,972,000 $ 7,191,622 $ 6,469,676
Net Income $2,322,000 $ 2,149,652 $ 1,203,573
There were no transactions between the Company and Palomar prior to the
business combination other than loan participations. These participations were
transacted in the normal course of business. Immaterial adjustments were
recorded to conform Palomar's accounting policies. Certain reclassifications
were made to the Palomar financial statements to conform to the Company's
presentations.
9. STOCKHOLDERS' EQUITY
Common Stock
In 1996, cash dividends of $.04 per share, were declared and paid.
In the first quarter of 1996, the shareholders of the Company approved a
two-for-one stock split effective for shareholders of record on February 18,
1996.
During the third quarter of 1996, the Company successfully completed a
secondary stock offering which resulted in the issuance of 472,653 warrants and
859,368 additional shares of common stock. Net proceeds of $2,788,048 were
realized on this offering after issuance costs of $219,740. Each warrant
entitled the holder to purchase two shares of common stock for $4.375 per share,
and expired on June 30, 1998. Warrant exercises resulted in net proceeds of
$4,124,226 and the issuance of 942,680 shares of common stock. 1,313 warrants
expired unexercised.
In conjunction with the secondary stock offering, the Company listed its
common stock on the NASDAQ National Market and is currently traded under the
symbol 'CWBC'.
Prior to the business combination of Community West Bancshares and Palomar
Savings and Loan; on October 27, 1997, the Board of Directors of Palomar
approved a 5% stock dividend on issued and outstanding shares. The dividend was
issued on February 18, 1998, to the shareholders of record at the close of
business on February 2, 1998.
55
On January 22, 1998, the Company declared a two-for-one stock split for
shareholders of record on February 3, 1998, which was paid on February 27, 1998.
All share and per share amounts included in the accompanying financial
statements and related notes have been retroactively restated for the effect of
this split.
On December 18, 1998, the Company declared a quarterly cash divided of
$.04 per share for shareholders of record on January 5, 1999, which was paid on
January 20, 1999. Additionally, on December 28, 1998, the Board of Directors of
the Company authorized a stock buy-back plan. Under this plan management is
authorized to repurchase up to $2,000,000 worth of the outstanding shares of its
common stock . As of December 31, 1998, management had repurchased 14,807
shares of common stock at a cost of $140,739.
Stock Options
Under the terms of the Company's stock option plan, full-time salaried
employees may be granted nonqualified stock options or incentive stock options,
and directors may be granted nonqualified stock options. Options may be granted
at a price not less than 100% of the fair market value of the stock on the date
of grant. Options are generally exercisable in cumulative 20% installments.
However, in certain circumstances, the vesting of these options may be adjusted,
as determined by the Board of Directors. All options expire no later than ten
years from the date of grant. As of December 31, 1998, all options are
outstanding at prices of $2.28 - $14.00 per share with 287,766 options
exercisable and 353,320 options available for future grant. As of 12-31-98 the
weighted average life of the outstanding options was 8 years. Stock option
activity is as follows:
1998 1997 1996
--------- ----------- -------------------- --------------------
Shares Price (1) Shares Price (1) Shares Price (1)
--------- ---------- -------- ---------- -------- ----------
Options outstanding, January 1, 359,652 $ 3.10 427,812 $ 2.78 398,680 $ 2.27
Granted 218,986 10.11 20,000 8.30 93,740 4.24
Canceled (7,560) 3.21 (17,520) 2.67 (17,440) 2.93
Exercised (155,712) 2.90 (70,640) 2.72 (47,168) 2.28
--------- ---------- -------- ---------- -------- ----------
Optons outstanding, December 31, 415,366 $ 6.95 359,652 $ 3.10 427,812 $ 2.78
========= ========== ======== ========== ======== ==========
Options exercisable, December 31, 287,766 $ 4.11 280,132 $ 2.73 311,372 $ 2.73
========= ========== ======== ========== ======== ==========
(1) Weighted Average
56
The estimated fair value of options granted ranged from $2.93 - $4.69 per
share in 1998, from $3.78 - $5.11 per share in 1997, and from $2.34 - $3.05 per
share in 1996. 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 and earnings per
share for the years ended December 31, 1998, 1997, and 1996 would have been
reduced to the pro forma amounts indicated below:
Net income 1998 1997 1996
As reported $2,880,767 $2,149,652 $1,203,573
Pro forma $2,374,582 $2,114,304 $1,095,713
Net income per common share - Basic
As reported $ .57 $ .49 $ .32
Pro forma $ .47 $ .48 $ .28
Net income per common share - assuming dilution
As reported $ .55 $ .43 $ .31
Pro forma $ .44 $ .43 $ .29
The fair value of options granted under the Company's fixed stock option
plan during 1998, 1997 and 1996 was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
1998 1997 1996
----- ----- -----
Annual dividend yield 5.0% 8.5% 8.5%
Expected volatility 47% 53% 18%
Risk free interest rate 6.0% 6.5% 6.5%
Expected life (in years) 6 6 6
10. COMMITMENTS AND CONTINGENCIES
The Company leases twenty office facilities under various operating lease
agreements with terms that expire at various dates between March 1999, and
November 2007, plus options to extend the lease terms for periods of up to ten
years. The minimum lease commitments as of December 31, 1998, under all
operating lease agreements are as follows:
For the Year Ending December 31,
1999 $ 706,537
2000 510,559
2001 340,056
2002 299,497
2003 155,652
Thereafter 605,097
----------
Total $2,617,398
==========
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
$674,893, $446,430 and $368,187.
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet. The Company's exposure to credit loss in the event of nonperformance by
the other party to commitments to extend credit and standby letters of credit is
represented by the contractual notional amount of those instruments. At December
31, 1998, the Company had commitments to extend credit of $28,731,000 and
obligations under standby letters of credit of $35,000.
57
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.
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 $100,000,000 at December 31, 1998.
The Company is involved in various litigation matters through the normal
course of business. In the opinion of management, based upon the advice of the
Company's legal counsel, the disposition of all pending litigation should not
have a material effect on the Company's financial position or results of
operations.
11. INCOME TAXES
The provision for income taxes consists of the following:
1998 1997 1996
----------- ----------- ---------
Current:
Federal $ (72,894) $ 914,400 $219,370
State (110,136) 254,061 152,014
----------- ----------- ---------
(183,030) 1,168,461 371,384
Deferred:
Federal 1,708,853 309,153 399,518
State 415,532 (161,263) (82,424)
----------- ----------- ---------
2,124,385 147,890 317,094
----------- ----------- ---------
Total provision $1,941,355 $1,316,351 $688,478
=========== =========== =========
58
Significant components of the Company's net deferred tax account at December 31,
are as follows:
1998 1997
------------ -----------
Deferred tax assets:
Allowance for loan loss $ 867,051 $ 775,488
Depreciation 52,323 2,000
Deferred transaction costs 739,860 -
State taxes 151,927 101,589
Unrealized loss on investment securities 1,750 21,000
State NOL 92,271 87,000
Other 170,212 101,421
Total 2,075,394 1,088,498
------------ -----------
Deferred tax liabilities:
Deferred loan fees (1,762,793) (521,189)
Depreciation - (8,087)
FHLB stock dividends (89,111) (69,000)
Deferred loan costs (1,962,944) (34,823)
Other (235,804) (115,022)
Total (4,050,652) (748,121)
------------ -----------
Valuation allowance - (172,000)
------------ -----------
Net deferred tax asset (liability) $(1,975,258) $ 168,377
============ ===========
The federal income tax provision for the years ended December 31 differs
from the applicable statutory rate as follows:
1998 1997 1996
----- ----- -----
Federal income tax at statutory rate 35.0% 35.0% 35.0%
State franchise tax, net of federal 7.0 6.8 7.5
Change in valuation allowance (3.6) (7.5) (8.4)
Other 1.9 3.7 2.3
40.3% 38.0% 36.4%
===== ===== =====
12. REGULATORY MATTERS
The Company is 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 financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company must meet specific capital guidelines that involve quantitative measures
of the Company's assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Company's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios of Total and Tier I
capital (primarily common stock and retained earnings less goodwill) to
risk-weighted assets, and of Tier I capital to average assets. Management
believes, as of December 31, 1998, that the Company meets all capital adequacy
requirements to which it is subject.
59
As of December 31, 1998 and 1997, the most recent notification from the
Federal Deposit Insurance Corporation ("FDIC") categorized the Company as "well
capitalized" under the regulatory framework for prompt corrective action. To be
categorized as "well capitalized" the Company must maintain minimum Total
risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the
table below. There are no conditions or events since that notification which
management believes have changed the Company's category.
The Company's actual capital amounts and ratios at December 31 are as
follows:
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
------ -------- -----------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------ ----------- ------
As of December 31, 1998:
Total Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . $26,109,980 15.27% $13,674,814 8.00% $17,093,519 10.00%
Goleta National Bank . . . . . . . . . . . $16,152,794 13.88% $ 9,309,968 8.00% $11,637,460 10.00%
Palomar Savings and Loan . . . . . . . . . $ 6,492,000 12.45% $ 4,172,240 8.00% $ 5,215,300 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . $23,972,867 14.02% $ 6,837,407 4.00% $10,256,111 6.00%
Goleta National Bank . . . . . . . . . . . $14,698,113 12.63% $ 4,654,984 4.00% $ 6,982,476 6.00%
Tier I Capital (to Average Assets)
Consolidated . . . . . . . . . . . . . . . $23,972,867 9.49% $10,102,001 4.00% $12,627,501 5.00%
Goleta National Bank . . . . . . . . . . . $14,698,113 8.07% $ 7,285,310 4.00% $ 9,106,638 5.00%
Core Capital (to Adjusted Tangible Assets)
Palomar Savings and Loan . . . . . . . . . $ 5,865,000 7.11% $ 3,299,000 4.00% $ 4,124,200 5.00%
Tangible Capital (to Tangible Assets)
Palomar Savings and Loan . . . . . . . . . $ 5,865,000 7.11% $ 1,237,260 1.50% N/A N/A
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
------ -------- -----------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ---------- ------ ----------- ------
As of December 31, 1997:
Total Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . $18,535,374 15.88% $9,336,643 8.00% $11,670,804 10.00%
Goleta National Bank . . . . . . . . . . . $12,990,366 17.36% $5,986,344 8.00% $ 7,482,930 10.00%
Palomar Savings and Loan . . . . . . . . . $ 6,055,541 13.49% $3,591,129 8.00% $ 4,488,911 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . $17,071,672 14.63% $4,668,321 4.00% $ 7,002,482 6.00%
Goleta National Bank . . . . . . . . . . . $12,054,016 16.11% $2,992,928 4.00% $ 4,489,391 6.00%
Tier I Capital (to Average Assets)
Consolidated . . . . . . . . . . . . . . . $17,071,672 9.84% $6,939,541 4.00% $ 8,674,427 5.00%
Goleta National Bank . . . . . . . . . . . $12,054,016 12.63% $3,917,582 4.00% $ 4,771,978 5.00%
Core Capital (to Adjusted Tangible Assets)
Palomar Savings and Loan . . . . . . . . . $ 5,494,541 6.99% $3,144,229 4.00% $ 3,930,287 5.00%
Tangible Capital (to Tangible Assets)
Palomar Savings and Loan . . . . . . . . . $ 5,494,541 6.99% $1,179,086 1.50% N/A N/A
13. EMPLOYEE BENEFIT PLAN
On September 1, 1995, the Company established a 401(k) plan for the benefit
of its employees. Employees are eligible to participate in the plan if they were
employed by the Company on September 1, 1995, or after 3 months of consecutive
service. Employees may make contributions to the plan under the plan's 401(k)
component, and the Company may make contributions under the plan's profit
sharing component, subject to certain limitations. The Company's contributions
are determined by the Board of Directors and amounted to $122,767, $112,592 and
$49,466 in 1998, 1997, and 1996, respectively.
60
14. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires the Company disclose estimated fair values for its financial
instruments. The estimated fair value amounts 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
amounts.
December 31, 1998 December 31, 1997
-------------------- --------------------
Carrying Estimated Carrying Esimated
(in thousands) Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
Assets:
Cash and cash equivalents $ 49,479 $ 49,479 $ 18,837 $ 18,837
Investment Securities 20,521 20,226 17,359 17,168
Net Loans 165,935 178,115 128,385 129,937
Liabilities:
Deposits (other than TDs) 66,324 66,324 60,647 60,647
Time deposits 157,221 162,260 92,044 92,198
Off-balance Sheet Financial Instruments: - - - -
Commercial letters of credit - - - -
Standby letters of credit - - - -
Commitments to extend credit - - - -
The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below:
Cash and cash equivalents - The carrying amounts approximate fair
values because of the short-term nature of these investments.
Investment securities - The fair value is based on quoted market prices
from security brokers or dealers if available. If a quoted market price is not
available, fair value is estimated using the quoted market price for similar
securities. Securities held for trading are carried at fair value
Federal Reserve and Federal Home Loan Bank stock carrying value
approximates the fair value because the stock can be sold back to the Federal
Reserve and Federal Home Loan Bank at anytime.
Loans, net - Fair values are estimated for portfolios of loans with
similar financial characteristics, primarily fixed and adjustable rate interest
terms. The fair values of fixed rate mortgage loans are based upon discounted
cash flows utilizing the rate that the Company currently offers as well as
anticipated prepayment schedules. The fair values of adjustable rate loans are
also based upon discounted cash flows utilizing discount rates that the Company
currently offers, as well as anticipated prepayment schedules. No adjustments
have been made for changes in credit within the loan portfolio. It is
management's opinion that the allowance for estimated loan losses pertaining to
performing and nonperforming loans results in a fair valuation of such loans.
Loans available for sale are recorded at fair market value and are included at
their carrying value.
61
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.
Commitments to Extend Credit, Commercial and Standby Letters of Credit -
The fair values of commitments are estimated using the fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the counterparty's credit standing.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1998 and 1997. 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.
15. SEGMENT PROFIT (LOSS)
The Company adopted Statement of Financial Accounting Standards No. 131
("SFAS 131"), Disclosures about Segments of an Enterprise and Related
Information in 1998. SFAS 131 established standards for reporting information
about operating segments. The 1998 information is presented below; prior year
information is not presented because the data is not available and would be
impracticable to develop.
The Company's management, while managing the overall company, also, looks
at individual areas considered "significant" to revenue and net income. These
significant areas, or segments, are: SBA Lending, Alternative Lending, the
Mortgage Division, Goleta National Bank Branch Operations, and Palomar Savings
and Loan. For this discussion, the remaining divisions are considered immaterial
and are consolidated into "Other." The Other segment includes the administration
areas, human resources, and tech support, along with others. The accounting
policies of the individual segments are the same as those described in the
summary of significant accounting policies.
The SBA Lending, Alternative Lending, and Mortgage Divisions from Goleta
National Bank are considered individual segments because of the different loan
products involved and the significance of the associated revenue. Goleta
National Bank Branch Operation, includes the deposits and commercial lending.
Management analyzes Palomar separately from Goleta National Bank, as they are
two different subsidiaries under Community West Bancshares.
62
All of the Company's assets and operations are located within the United
States. The assets shown below for each segment, other than Palomar, are
estimates.
The following table sets forth various revenue and expense items that
management relies on in decision making.
Goleta
Year Ended National Palomar
December 31, Alternative Mortgage Bank Branch Savings and Consolidated
1998 SBA Lending Lending Division Operations Loan Other Total
------------ ----------- ------------ ------------ -------------- ------------ ------------
Interest Income $ 2,833,717 $ 5,019,338 $ 734,133 $ 6,270,687 $ 5,688,723 $ - $ 20,546,598
Interest Expense 1,107,459 1,961,632 286,910 2,450,679 3,450,020 - 9,256,700
------------ ----------- ------------ ------------ -------------- ------------ ------------
Net Interest
Income 1,726,258 3,057,706 447,223 3,820,008 2,238,703 - 11,289,898
Provision/(credit)
For Loan Losses 245,374 179,452 - 115,174 (111,031) - 428,969
Noninterest
Income 2,920,173 2,302,168 5,200,837 360,554 901,635 2,350,521 14,035,888
Noninterest
Expense 2,047,855 3,634,531 4,332,755 762,420 2,682,306 6,614,828 20,074,695
------------ ----------- ------------ ------------ -------------- ------------ ------------
Segment Profits 2,353,202 1,545,891 1,315,305 3,302,968 569,063 (4,264,307) 4,822,122
============ =========== ============ ============ ============== ============ ============
Segment Assets $ 32,141,624 $28,608,780 $ 22,099,164 $ 60,902,038 $ 82,507,801 $25,774,645 $252,034,052
============ =========== ============ ============ ============== ============ ============
16. COMMUNITY WEST BANCSHARES (PARENT COMPANY ONLY)
(DOLLARS IN THOUSANDS) December 31, December 31,
BALANCE SHEET 1998 1997
-------------- -------------
ASSETS
- -------------------------------------------
Cash and equivalents $ 3,171 $ 255
Investment in the Subsidiaries 21,144 17,644
Other Assets 379 21
-------------- -------------
TOTAL ASSETS $ 24,694 $ 17,920
============== =============
LIABILITIES AND SHAREHOLDER EQUITY
- -------------------------------------------
Other Liabilities $ 141 $ 266
Common Stock 17,303 12,833
Retained Earnings 7,393 4,790
Treasury Stock (141) -
AFS Gain/Loss Unrealized (2) 31
-------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 24,694 $ 17,920
============== =============
For the year ended December 31, 1998 1997 1996
-------- -------- --------
STATEMENT OF INCOME
- ------------------------------------------------
Dividends from subsidiary $ - $ - $ -
-------- -------- --------
Total Income - - -
Other Expense 195 5 -
-------- -------- --------
Total Expense 195 5 -
Equity in undistributed income from subsidiary 2,994 2,155 1,204
Income before income taxes 2,799 2,150 1,204
-------- -------- --------
Income taxes (82) - -
-------- -------- --------
Net Income $ 2,881 $ 2,150 $ 1,204
======== ======== ========
63
STATEMENT OF CASHFLOWS 1998 1997 1996
-------- -------- --------
Cash Flows from Operating Activities:
Net Income $ 2,881 $ 2,150 $ 1,204
Adjustments to reconcile net income to net
Cash used by operating activities:
Equity in undistributed income from
subsidiary (2,994) (2,155) (1,204)
Net change in other liabilities 125 - -
Net change in other assets (448) - -
-------- -------- --------
Total adjustments (3,317) (2,155) (1,204)
-------- -------- --------
Net cash used by operating activities: (436) (5) -
Cash flows from investing activities
Payments for investments in and advances
to subsidiaries
(700) -
-------- -------- --------
Net cash used by investing activities: (700) - -
Cash flows from financing activities
Proceeds from issuance of common stock 4,193 10 -
Bridge loan from nonbank subsidiary 250
Payments to repurchase common stock (141) -
-------- -------- --------
Net cash provided by financing activities 4,052 260 -
Cash and cash equivalents:
Net increase in cash and cash equivalents 2,916 255 -
Cash and cash equivalents at beginning
of year 255 - -
-------- -------- --------
Cash and Cash Equivalents, at end of year $ 3,171 $ 255 $ -
======== ======== ========
Community West Bancshares was created for the purposes of forming a
financial services holding company. Prior to the acquisition of Goleta National
Bank, which became effective on December 31, 1997, the Company had minimal
activity.
64
17. CONSOLIDATING INFORMATION
The tables below show the consolidating Balance Sheet and Statement of
Income.
December 31, 1998
Community West Goleta Palomar
Bancshares National Savings
ASSETS (parent-only) Bank and Loan Eliminations Consolidated
- ----------------------------------------- ---------------- ------------ ------------ -------------- --------------
Cash and due from banks $ 3,170,966 $ 4,476,373 $ 1,647,755 $ (3,170,966) $ 6,124,128
Federal funds sold - 36,255,000 7,100,000 - 43,355,000
---------------- ------------ ------------ -------------- --------------
Cash and cash equivalents 3,170,966 40,731,373 8,747,755 (3,170,966) 49,479,128
Time deposits in other financial
institutions - - 1,500,000 - 1,500,000
FRB and FHLB stock - 264,050 546,300 - 810,350
Investment securities, held to maturity - 501,094 - - 501,094
Investment securities, available for sale - - 8,295,099 - 8,295,099
Investment securities, held for trading - 10,914,900 - - 10,914,900
Investment in subsidiary 21,143,524 - - (21,143,524) -
Loans, held for investment, net - 49,179,918 57,919,266 - 107,099,184
Loans, held for sale - 54,661,250 4,174,694 - 58,835,944
Other real estate owned, net - 241,363 - - 241,363
Premises and equipment, net 64,976 4,183,951 290,072 - 4,538,999
Servicing assets - 1,216,064 256,389 - 1,472,453
Other assets 314,669 7,252,643 778,226 - 8,345,538
---------------- ------------ ------------ -------------- --------------
TOTAL $ 24,694,135 $169,146,606 $82,507,801 $ (24,314,490) $ 252,034,052
================ ============ ============ ============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
- -----------------------------------------
LIABILITIES:
Deposits:
Noninterest-bearing demand $ - $ 21,932,636 $ 725,658 $ (3,170,966) $ 19,487,328
Interest-bearing demand - 14,372,467 5,603,671 - 19,976,138
Savings - 16,105,995 10,754,386 - 26,860,381
Time certificates of $100,000 or
more - 48,395,302 13,346,875 - 61,742,177
Other time certificates - 50,115,868 45,362,907 - 95,478,775
---------------- ------------ ------------ -------------- --------------
Total deposits - 150,922,268 75,793,497 (3,170,966) 223,544,799
Other liabilities 140,739 2,968,887 826,231 - 3,935,857
---------------- ------------ ------------ -------------- --------------
Total liabilities 140,739 153,891,155 76,619,728 (3,170,966) 227,480,656
---------------- ------------ ------------ -------------- --------------
STOCKHOLDERS' EQUITY
Common stock 17,303,590 4,051,645 2,592,744 (6,644,389) 17,303,590
Surplus - 5,448,665 1,946,642 (7,395,307) -
Treasury stock (140,739) - - - (140,739)
Retained earnings 7,392,992 5,755,141 1,351,134 (7,106,275) 7,392,992
Unrealized gain/(loss) on available
for sale securities (2,447) - (2,447) 2,447 (2,447)
---------------- ------------ ------------ -------------- --------------
Total stockholders' equity 24,553,396 15,255,451 5,888,073 (21,143,524) 24,553,396
---------------- ------------ ------------ -------------- --------------
---------------- ------------ ------------ -------------- --------------
TOTAL $ 24,694,135 $169,146,606 $82,507,801 $ (24,314,490) $ 252,034,052
================ ============ ============ ============== ==============
65
Community West Goleta Palomar
STATEMENT OF INCOME Bancshares National Savings
For the year ended December 31, 1998 (Parent Only) Bank and Loan Eliminations Consolidated
---------------- ----------- ----------- -------------- -------------
INTEREST INCOME:
Loans, including fees $ - $14,329,531 $4,549,749 $ - $ 18,879,280
Federal funds sold - 410,513 262,491 - 673,004
Time deposits in other financial institutions - 66,324 56,993 - 123,317
Investment securities - 51,507 819,490 - 870,997
---------------- ----------- ----------- -------------- -------------
Total interest income - 14,857,875 5,688,723 - 20,546,598
INTEREST EXPENSE ON DEPOSITS - 5,806,680 3,450,020 - 9,256,700
---------------- ----------- ----------- -------------- -------------
NET INTEREST INCOME - 9,051,195 2,238,703 - 11,289,898
PROVISION FOR LOAN LOSSES - 540,000 (111,031) - 428,969
---------------- ----------- ----------- -------------- -------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES - 8,511,195 2,349,734 - 10,860,929
---------------- ----------- ----------- -------------- -------------
OTHER INCOME:
Gains from loan sales - 5,763,921 629,865 - 6,393,786
Loan origination fees - 3,679,211 10,907 - 3,690,118
Document processing fees - 1,647,708 - - 1,647,708
Loan servicing income - 785,710 176,768 - 962,478
Service charges - 864,549 22,639 - 887,188
Other income 60 393,094 61,456 - 454,610
---------------- ----------- ----------- -------------- -------------
Total other income 60 13,134,193 901,635 - 14,035,888
OTHER EXPENSES:
Salaries and employee benefits 1,415 11,666,003 1,200,787 - 12,868,205
Occupancy expenses 3,216 2,394,709 340,865 - 2,738,790
Other operating expenses 22,211 1,175,426 459,589 - 1,657,226
Advertising 1,910 727,192 113,260 - 842,362
Professional fees 163,747 356,966 320,218 - 840,931
Postage and freight 57 436,877 33,045 - 469,979
Data processing/ATM processing 1,770 247,227 141,094 - 390,091
Office supply expense 1,025 192,638 73,448 - 267,111
---------------- ----------- ----------- -------------- -------------
Total other expenses 195,351 17,197,038 2,682,306 - 20,074,695
---------------- ----------- ----------- -------------- -------------
INCOME BEFORE PROVISION FOR INCOME TAXES (195,291) 4,448,350 569,063 - 4,822,122
PROVISION FOR INCOME TAXES (82,022) 1,851,777 171,600 - 1,941,355
---------------- ----------- ----------- -------------- -------------
INCOME BEFORE EQUITY IN SUBSIDIARY (113,269) 2,596,573 397,463 - 2,880,767
Equity in subsidiaries 2,994,036 - - (2,994,036) -
---------------- ----------- ----------- -------------- -------------
NET INCOME $ 2,880,767 $ 2,596,573 $ 397,463 $ (2,994,036) $ 2,880,767
================ =========== =========== ============== =============
66
18. QUARTERLY FINANCIAL DATA (unaudited)
Summarized quarterly financial data follows:
(All amounts in thousands except per share data)
Quarter Ended
March 31 June 30 September 30 December 31
--------- -------- ------------- ------------
1998
Net interest income $ 1,872 $ 2,958 $ 3,152 $ 3,308
Provision for loan losses 61 103 175 90
Net income 554 962 806 559
Net income per share - basic $ .10 $ .20 $ .18 $ .10
- diluted $ .09 $ .19 $ .18 $ .10
Quarter Ended
March 31 June 30 September 30 December 31
--------- -------- ------------- ------------
1997
Net interest income $ 1,683 $ 1,860 $ 1,831 $ 1,818
Provision for loan losses 81 10 100 -
Net income 384 534 640 592
Net income per share - basic $ .09 $ .12 $ .14 $ .14
- diluted $ .09 $ .11 $ .12 $ .12
******
67
PART III
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- --------------------------------------------------------------------------------
FINANCIAL DISCLOSURE
---------------------
None
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- ------------------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
--------------------------------------------------------
Reference is made to the information contained in the Registrant's definitive
Proxy Statement for the Annual Meeting of shareholders to be held in 1999. Such
information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
- ----------------------------------
Reference is made to the Registrant's definitive Proxy Statement for the Annual
Meeting of shareholders to be held in 1999. Such information is incorporated
herein by reference
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- --------------------------------------------------------------------------------
Reference is made to the information contained in the Registrant's definitive
Proxy Statement for the Annual Meeting of shareholders to be held in 1999. Such
information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------------
Reference is made to the information contained in the Registrant's definitive
Proxy Statement for the Annual Meeting of shareholders to be held in 1999. Such
information is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K
- --------------------------------------------------------------------------------
(a)(1) The following consolidated financial statements of Community West
Bancshares are filed as part of this Annual Report.
Report of Independent Accountants 40
Consolidated Balance Sheets as of December 31, 1998 and 1997 41
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1998 42
Consolidated Statements of Changes in Shareholders' Equity for each
of the three years ended in the period ended December 31, 1998 43
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1998 44
Notes to Consolidated Financial Statements 45
(a)(2)
Financial statement schedules other than those listed above have been omitted
because they are either not applicable or the information is otherwise included.
(a)(3) Exhibits
(2) Plan of Reorganization (1)
(3)(i) Articles of Incorporation (3)
(3)(ii) By-laws (3)
68
(4)(i) Common Stock Certificate (2)
(4)(ii) Warrant Certificate (2)
(10)(i) 1997 Stock Option Plan and Form of Stock Option Agreement (1)
(10)(ii) Employment Contract between Goleta National Bank and Llewellyn
Stone, President & CEO (3)
(10)(iii) Salary Continuation Agreement between Goleta National Bank and
Llewellyn Stone, President & CEO (3)
(21) Subsidiaries of the Registrant (3)
(23) Consent of Deloitte & Touche, LLP
(27) Financial Data Schedule
(1) Filed as an exhibit to the Registrant's registration Statement on Form
S-8 filed with the Commission on 12-31-97 and incorporated herein by reference.
(2) Filed as an exhibit to the Registrant's Amendment to Registration
Statement on Form 8-A filed with the Commission on 3-12-98 and incorporated
herein by reference.
(3) Filed as an exhibit to the Registrant's Form 10-K filed with the
Commission on March 26, 1998 and incorporated herein by reference.
69
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, 1999.
COMMUNITY WEST BANCSHARES
(Registrant)
By: /S/ Llewellyn W. Stone
---------------------------------
Llewellyn W. Stone
President and
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated
Signature Title Date
/S/ Michael A. Alexander Director March 25, 1999
- --------------------------------
Michael A. Alexander
/S/ Mounir R. Ashamalla Director March 25, 1999
- --------------------------------
Mounir R. Ashamalla
/S/ Robert H. Bartlein Director and Vice Chairman of the Board March 25, 1999
- --------------------------------
Robert H. Bartlein
/S/ Jean W. Blois Director March 25, 1999
- --------------------------------
Jean W. Blois
/S/ John D. Illgen Director March 25, 1999
- --------------------------------
John D. Illgen
/S/ John D. Markel Chairman of the Board March 25, 1999
- --------------------------------
John D. Markel
/S/ Michel Nellis Director and Secretary March 25, 1999
- --------------------------------
Michel Nellis
/S/ William R. Peeples Director March 25, 1999
- --------------------------------
William R. Peeples
/S/ James Rady Director March 25, 1999
- --------------------------------
James Rady
/S/ C. Randy Shaffer Director, Executive Vice President and Chief March 25, 1999
- --------------------------------
C. Randy Shaffer Financial Officer (Principal Financial and
Accounting Officer)
/S/ James R. Sims Jr. Director March 25, 1999
- --------------------------------
James R. Sims Jr.
/S/ Llewellyn W. Stone Director, President and Chief Executive Officer March 25, 1999
- --------------------------------
Llewellyn W. Stone
70