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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, 1999
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
445 Pine Street, 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 6,241,793 shares of common stock for the registrant issued and
outstanding as of March 1, 2000. The aggregate market value of the voting
stock, based on the closing price of the stock on the NASDAQ National Market
System on March 1, 2000, held by the nonaffiliates of the registrant was
approximately $24,455,000.
This Form 10-K contains 82 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
ITEM 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . 7
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters 7
ITEM 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . 8
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . 9
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk . . . . . . . . 50
ITEM 8. Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . 52
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure. . . . . . . . . . . . . . . . . . . . . . . . . 80
PART III
ITEM 10. Directors, Executive Officers, Promoters and Control Persons. . . . . . . 80
ITEM 11. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . . . . 80
ITEM 12. Security Ownership of Certain Beneficial Owners and Management. . . . . . 80
ITEM 13. Certain Relationships and Related Transactions. . . . . . . . . . . . . . 80
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. . . . . 81
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
PART I
ITEM 1. DESCRIPTION OF BUSINESS
- - -----------------------------------
General
- - -------
Community West Bancshares was incorporated in the State of California on
November 26, 1996, for the purpose of forming a financial services holding
company. On December 31, 1997, Community West Bancshares acquired a 100%
interest in Goleta National Bank ("Goleta"). Effective that date, shareholders
of Goleta (NASDAQ:GLTB) became shareholders of the Company (NASDAQ:CWBC) in a
one-for-one exchange. Such acquisition was accounted at historical cost in a
manner similar to a pooling-of-interests. On December 14, 1998, the Company
acquired a 100% interest in Palomar Savings & Loan Association, now known, as
Palomar Community Bank ("Palomar"). As of that date, shareholders of Palomar
(OTCBB:PALO) became shareholders of the Company by receiving 2.11 shares of CWBC
for each share of PALO they held. The acquisition was accounted for under the
purchase method. Community West, Goleta and Palomar are collectively referred
to herein as the Company.
The Company offers a full range of commercial and retail financial services,
including the acceptance of demand, savings, and time deposits, and the
origination of commercial, U.S. Small Business Administration ("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 SBA
designated the Company as a Preferred Lender. As a Preferred Lender, the Company
has the ability to move loans through the approval process at the SBA much more
quickly than financial institutions that do not have such a designation. The
Company was granted SBA Preferred Lender status in the California districts of
Los Angeles, Fresno, Sacramento, San Francisco, and Santa Ana. The Company also
has Preferred Lender Status in 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. From 1994 to 1998 the Company originated Title
I loans and sold them into the secondary market and retained the servicing.
During that time 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").
During 1996, the Company began offering second mortgage loans which allows
borrowers to borrow (when combined with the balance of the first mortgage loan)
up to 125% of their home's appraised value for debt consolidation, home
improvement, school tuition, or any worthwhile cash outlay up to a maximum loan
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 second mortgage 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. On June 18, 1999
the Company completed the securitization of a $122 million pool of loans. In
the fourth quarter of 1999 the Company decided to cease securitization
activities. As of December 31, 1999, the Company had accumulated $150 million in
second mortgage loans that will be sold to third parties. On an ongoing basis,
the Company will continue to originate second mortgage loans, which are expected
to be sold to third parties for a premium shortly after origination.
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 made significant investments in the hardware and
software necessary to offer electronic banking services. In addition to the
normal financial services, the Company offers such services as online cash
management, internet banking, automated 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, but they also attract companies with large deposit balances. These
services have helped the Company maintain a competitive advantage over most
institutions of comparable size and many which are significantly larger than the
Company.
On October 16, 1997, the Company purchased a 70% interest in Electronic
Paycheck, LLC, a California Company that is a provider of customized debit card
payment systems and electronic funds transfer services. The Company has
developed an Internet-based transaction processing system using propriety
software that provides complete front-end to back-end electronic funds transfer
processing services. The Company is focusing the marketing of its e-commerce
payment services to consumer lenders, companies with non-banked employees,
network marketing organizations and loyalty reward programs. In addition, the
Company plans to establish a card-based payment system for Internet purchases
particularly focused on teenagers, utilizing its "virtual" pinpad technology.
On November 4, 1999 Electronic Paycheck LLC merged with ePacific.com
Incorporated, a Delaware Corporation, which merger was accounted in a manner
similar to a pooling-of-interests. Subsequent to year-end, ePacific.com
redeemed 1,800,000 of the Company's 2,100,000 shares and repaid a loan from the
Company with a balance of $3,725,000 for $4.5 million in cash. The Company
continues to hold a 10% interest in ePacific.com.
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 Savings & Loan, a
state-chartered full service savings and loan association. During 1999 Palomar
Savings & Loan was converted to a state chartered commercial bank and
subsequently changed the name to Palomar Community Bank ("Palomar"). The
Federal Deposit Insurance Corporation ("FDIC") insures the deposits of Palomar
up to the applicable limits. Palomar is a member of the Federal Home Loan Bank
("FHLB") system. It's main office is located at 355 West Grand Avenue,
Escondido, California 92025. 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, and West Covina in
California; 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 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 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 trained staff 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.
Employees
- - ---------
As of December 31, 1999, the Company employed 234 persons, including 3 principal
officers. The Company's employees are not represented by a union or covered by a
collective bargaining agreement. Management of the Company believes that, in
general, its employee relations are very positive.
ITEM 2. DESCRIPTION OF PROPERTY
- - -----------------------------------
The Company owns the following property:
- - ---------------------------------------------
The Goleta National Bank Main office is located at 5827 Hollister Avenue,
Goleta, California. This 4,000 square foot facility houses the bank's main
office, and a separate 400 square foot building provides additional office
space.
The Company leases the following properties:
- - -------------------------------------------------
The Company leases, under three separate leases, seven suites in an office
building at 5638 Hollister Avenue, Goleta, California. The leases are for terms
expiring May 31, 2003, with a current monthly rent of $24,725 per month for all
seven 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 17,800 square feet of office space. These suites house the
Company's Corporate Offices, Finance, Data Processing, Compliance, Human
Resources, and Electronic Business Services departments as well as the offices
of the Company's subsidiary, ePacific.com. On January 4, 2000, the Company
sublet 6,200 square feet of these suites. The sublease is for a term commencing
May 1, 2000 and expiring May 31, 2003. The sublease does not provide the
sublessor an option to extend the sublease.
On February 1, 2000, the Company leased approximately 20,684 square feet of
office space located at 445 Pine Avenue, Goleta, California. The lease is for a
term expiring March 31, 2007, with a current monthly rent of $26,889. The lease
also provides the Company with two options of five years to extend the lease.
This facility will house the Company's Corporate Offices, Finance, Data
Processing, Compliance, Human Resources, Electronic Business Services, Special
Assets and Loan Collection departments.
The Company leases approximately 1,500 square feet of office space located at
310 South Pine Avenue, Goleta, California. The lease is month to month, with a
current monthly rent of $960 per month. This facility currently houses the
Special Assets and Loan Collection departments of the Company and will be
vacated on June 1, 2000.
The Company leases under two separate leases approximately 3,744 square feet of
office space located at 3891 State Street, Santa Barbara, California. The leases
are for terms expiring April 30, 2002 and March 31, 2001, with a current monthly
rent of $7,715 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. The lease is for a term
expiring July 20, 2002, with a current monthly rent of $5,555 per month. The
lease provides the Company with one option of three years to extend the lease.
This facility houses the Ventura Branch office, as well as the Ventura Mortgage,
SBA and Accounts Receivable Financing departments of the Company.
The Company leases approximately 6,032 square feet of space located at 4025 East
La Palma Avenue Suite 201A, 201B, and 201C Anaheim, California. The lease is for
a term expiring February 29, 2000, with a current monthly rent of $6,746 per
month. This facility houses the Anaheim Loan Production office of the Company.
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 $1,909 per month. This facility houses the Las Vegas, Nevada
Loan Production office of the Company. On February 26, 2000 the Las Vegas Loan
Production office relocated to 4570 S. Eastern, Suite 26 Las Vegas, Nevada with
a monthly rent of $850 per month.
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 $8,718 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. Subsequent to
year-end, the Company sublet the entire space. The sublease does not provide an
option for the sublessor to extend the sublease.
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
has executive suites in Woodstock, Georgia; in Jacksonville and Pensacola,
Florida; and in 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 portions of a parking lot which 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.
The Company's total occupancy expense for the year ended December 31, 1999 was
$3,845,000. 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 materially
adverse effect on the Company's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- - ---------------------------------------------------------------------
An annual meeting of security holders of the Company was held May 27, 1999. The
security holders voted on and approved Board Members for 1999-2000. There was a
total of 5,016,451 or 91.5% proxies voted out of 5,482,571shares. The following
indicates how the votes were cast:
FOR AGAINST ABSTAIN NON-VOTES
Number of Votes Received 4,971,200 45,251 0.0 466,120
Percentage of Total Shares 90.7% 0.8% 0.0% 8.5%
PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
-------------------------------------------------------------------
STOCKHOLDER MATTERSAs 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.
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 over-the-counter under
the new symbol "CWBCW" until that time. 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
----- -------- ----- ----
1998 First Quarter 9.25 13.25 9.63 16.50
Second Quarter 11.88 14.31 9.00 15.00
Third Quarter 9.25 14.00 N/A N/A
Fourth Quarter 8.13 11.00 N/A N/A
1999 First Quarter 7.75 9.25 N/A N/A
Second Quarter 7.50 10.50 N/A N/A
Third Quarter 10.00 16.88 N/A N/A
Fourth Quarter 6.75 16.75 N/A N/A
On March 1, 2000, the last reported sale price per share for the Company's stock
was $6.50.
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 declared three
quarterly dividends of $.04 per share during 1999. Each quarterly dividend
totaled approximately $220,000.
The Company had 557 shareholders of record of its common stock as of December
31, 1999.
ITEM 6. SELECTED FINANCIAL DATA
- - -----------------------------------
SUMMARY OF OPERATIONS
The following Summary of Operations of the Company, as of December 31, 1999 and
1998 and for the years ended December 31, 1999, 1998, 1997, have been derived
from the consolidated financial statements included elsewhere in this document.
AS OF AND FOR YEAR ENDED DECEMBER 31, (1)
---------------------------------------------------------------
(Dollars in thousands, except per share data) 1999 1998 (3) 1997(3) 1996(3) 1995(3)
----------- ----------- ----------- ----------- -----------
Interest income $ 48,495 $ 15,279 $ 8,009 $ 6,812 $ 6,504
Interest expense 25,145 6,317 2,910 2,425 2,451
Net interest income 23,350 8,962 5,099 4,387 4,053
----------- ----------- ----------- ----------- -----------
Provision for loan losses 6,133 1,760 260 435 360
Net interest income
after provision for loan losses 7,202 3,693 17,217 4,839 3,952
Other operating income 11,021 11,023 9,432 6,620 4,481
Other operating expense 30,506 17,482 11,524 8,667 6,436
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes (2,268) 743 2,747 1,905 1,738
Provision for income taxes (622) 289 1,158 800 730
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (1,646) $ 454 $ 1,589 $ 1,105 $ 1,008
=========== =========== =========== =========== ===========
Income (loss) per common share - Basic $ (0.30) $ 0.12 $ 0.53 $ 0.47 $ 0.50
Number of shares used in income (loss)
per share calculation - Basic (2) 5,494,217 3,767,607 3,016,208 2,356,162 2,013,830
Income (loss) per common share - Diluted $ (0.30) $ 0.12 $ 0.44 $ 0.44 $ 0.47
Number of shares used in income (loss)
per share calculation - Diluted (2) 5,494,217 3,941,749 3,588,478 2,510,352 2,128,212
Net Loans $ 451,664 $ 247,411 $ 71,164 $ 57,400 $ 51,574
Total Assets 523,847 327,569 95,312 80,884 70,115
Deposits 313,131 223,853 80,252 70,606 63,592
Total Liabilities 489,915 298,448 83,184 70,824 64,002
Total Stockholders' Equity 33,932 29,121 12,129 10,059 6,113
(1) See Notes to Consolidated Financial Statements for a summary of significant accounting policies and
other related data.
(2) Earnings per common share information is based on a weighted average number of common shares
outstanding during each period. Earnings per share amounts have been adjusted to reflect the 2-for-1 stock
splits in 1996 and 1998, and a 10% stock dividend in 1995.
(3) As restated, see Note 21of Notes to Consolidated Financial Statements.
The following table sets forth selected ratios for the periods indicated:
YEAR ENDED DECEMBER 31,
1999 1998 (1) 1997(1) 1996(1) 19951)
------- ------- ------
Net income (loss) average stockholder equity -6.68% 3.50% 14.65% 13.67% 17.89%
------ -------- ------- ------- ------
Net income (loss) to average total assets -0.37% 0.20% 1.82% 1.52% 1.57%
Total interest expense to total interest income 51.85% 41.34% 36.33% 35.59% 37.69%
Other operating income to other operating expense 36.13% 63.05% 81.85% 76.39% 69.63%
Dividend pay-out ratio 3.37% 0.00% 0.00% 0.00% 0.00%
Equity to assets ratio 6.51% 8.77% 12.73% 12.44% 8.72%
(1) As restated, see Note 21 to Notes to Consolidated Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- - --------------------------------------------------------------------------------
OF OPERATIONS
- - --------------
Introduction
- - ------------
This discussion is designed to provide a better understanding of significant
trends related to the Company's financial condition, results of operations,
liquidity, capital resources, and interest rate sensitivity. It should be read
in conjunction with the consolidated financial statements and notes thereto and
the other financial information appearing elsewhere in this filing.
Restatement
- - -----------
Subsequent to the issuance of the Company's 1998 financial statements, the
Company's management determined that (1) the acquisition of Palomar Community
Bank in December 1998 which was previously accounted for under the
pooling-of-interests method of accounting, should have been accounted for under
the purchase method of accounting, (2) the securitization of loans completed in
December 1998, which was previously accounted for as a sale should have been
accounted for as a secured borrowing with a pledge of collateral, (3) certain
costs related to second mortgage loans which were previously capitalized, should
have been charged to expense as incurred, (4) the prepayment assumption used to
value the I/O strip retained on sales of Title I loans during 1998 was
incorrect, (5) certain loan fees which were previously recognized should have
been deferred and amortized, and (6) the calculation of regulatory capital
amounts and ratios as of December 31, 1998 was incorrect. In addition,
management also identified certain other insignificant errors in the 1998
financial statements. As a result, the 1998 and 1997 financial statements have
been restated from amounts previously reported to properly account for these
transactions. The effects of the restatement are disclosed in Note 21 to the
consolidated financial statements and are included herein.
Results of Operations
- - -----------------------
The following table sets forth, for the period indicated, the increase or
decrease of certain items in the statements of operations of the Company as
compared to the prior periods:
For the Year Ended December 31,
----------------------------------------------------------------------------
1999 versus 1998 1998 versus 1997 1997 versus 1996
------------------------ ------------------------ ------------------------
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 . . . . . . . . . . . . . . $32,246,557 218.60% $ 7,401,202 100.70% $1,009,083 15.91%
Federal funds sold. . . . . . . . . . . . . . . . 597,248 145.49% (13,153) -3.10% 140,529 49.63%
TCD's in other financial instutions . . . . . . . (19,195) -28.94% (54,264) -45.00% 32,795 37.35%
Investment securities . . . . . . . . . . . . . . 390,840 758.81% (63,746) -55.31% 14,953 14.91%
------------ ---------- ------------ ---------- ----------- -----------
Total interest income. . . . . . . . . . . . . 33,215,450 217.39% 7,270,039 90.77% 1,197,360 17.58%
INTEREST EXPENSE:
Deposits. . . . . . . . . . . . . . . . . . . . . $ 9,357,741 163.54% $ 2,811,508 96.60% $ 485,450 20.02%
Bonds payable . . . . . . . . . . . . . . . . . . 9,470,824 1592.52% 594,707 0.00% - 0.00%
------------ ---------- ------------ ---------- ----------- -----------
Total interest expense. . . . . . . . . . . . . . 18,828,565 298.08% 3,406,215 117.03% 485,450 20.02%
NET INTEREST INCOME . . . . . . . . . . . . . . . . 14,386,885 160.52% 3,863,824 75.78% 711,910 16.23%
PROVISION FOR LOAN LOSSES . . . . . . . . . . . . . 4,373,336 248.54% 1,499,623 576.78% (175,000) -40.23%
------------ ---------- ------------ ---------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,013,549 139.02% 2,364,201 48.86% 886,910 22.44%
------------ ---------- ------------ ---------- ----------- -----------
OTHER INCOME:
Gains from loan sales . . . . . . . . . . . . . . 1,928,127 47.49% (41,406) -1.01% 1,486,862 56.87%
Loan origination fees - sold or brokered loans. . (969,273) -26.34% 718,826 24.28% 903,103 43.90%
Document processing fees. . . . . . . . . . . . . (150,590) -12.31% 403,853 49.29% 309,705 60.77%
Loan servicing fees . . . . . . . . . . . . . . . (286,007) -36.40% 154,159 24.41% (43,047) -6.38%
Service charges . . . . . . . . . . . . . . . . . (349,759) -40.46% (31,746) -3.54% 306,056 51.85%
Other income. . . . . . . . . . . . . . . . . . . (174,318) -42.52% 386,556 1651.45% (150,955) -86.58%
------------ ---------- ------------ ---------- ----------- -----------
Total other income . . . . . . . . . . . . . . (1,820) -0.02% 1,590,242 16.86% 2,811,724 42.47%
OTHER EXPENSES:
Salaries and employee benefits. . . . . . . . . . 5,428,596 50.27% 3,484,228 47.63% 1,862,466 34.16%
Occupancy expenses. . . . . . . . . . . . . . . . 1,446,658 60.33% 889,490 58.97% 322,933 27.24%
Other operating expenses. . . . . . . . . . . . . 1,785,840 88.12% 1,465,496 261.20% (72,945) -9.27%
Advertising expense . . . . . . . . . . . . . . . 357,215 44.98% 211,466 36.29% 271,449 87.23%
Professional services . . . . . . . . . . . . . . 2,058,416 395.31% 94,885 22.28% 180,062 73.27%
Postage & freight . . . . . . . . . . . . . . . . (84,920) -19.44% (385,228) -46.86% 279,272 51.44%
Data processing/ATM processing. . . . . . . . . . 262,746 105.52% 95,944 62.69% 36,211 30.99%
Amortization of Goodwill & Excess . . . . . . . . 300,008 100.00% 63,562 0.00% - 0.00%
LOCOM Expense . . . . . . . . . . . . . . . . . . 1,276,709 100.00% - 0.00% - 0.00%
Office supply expense . . . . . . . . . . . . . . 192,142 99.21% 38,384 24.72% 13,736 9.70%
------------ ---------- ------------ ---------- ----------- -----------
Total other expenses . . . . . . . . . . . . . 13,023,410 74.50% 5,958,227 51.70% 2,893,184 33.38%
INCOME BEFORE PROVISION FOR INCOME TAXES. . . . . . (3,011,681) -405.06% (2,003,784) -72.94% 841,661 44.17%
PROVISION FOR INCOME TAXES. . . . . . . . . . . . . (911,286) -314.84% (868,903) -75.01% 357,873 44.71%
------------ ---------- ------------ ---------- ----------- -----------
NET INCOME. . . . . . . . . . . . . . . . . . . . . $(2,100,395) -462.58% $(1,134,881) -71.42% $ 483,788 43.78%
============ ========== ============ ========== =========== ===========
Net Interest Income and Net Interest Margin
- - -------------------------------------------------
The Company's earnings partially depend upon the difference between the interest
received from its loan portfolio and investment securities and the interest paid
on its liabilities, 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.
1999 1998 1997
------------ ------------ -----------
Interest Income $48,494,921 $15,279,471 $8,009,432
------------ ------------ -----------
Interest Expense 25,145,230 6,316,665 2,910,450
Net Interest Income $23,349,691 $ 8,962,806 $5,098,982
Net Interest Margin 5.6% 4.1% 6.6%
============ ============ ===========
Total interest income increased 217% from $15,279,471 in 1998 to $48,494,921 in
1999. This increase in 1999 over 1998 was due to an increase in
interest-earnings assets. Total interest expense increased 298% from $6,316,665
in 1998 to $25,145,230 in 1999. The increase was due to an increase in
interest-bearing liabilities and an increase in rates paid on deposits. As a
result, net interest income increased 161% from $8,962,806 in 1998 to
$23,349,691 in 1999.
Total interest income increased 91% from $8,009,432 in 1997 to $15,279,471 in
1998. The increase was due to an increase in interest-earnings assets offset
with a decrease due to lower rates. Total interest expense increased 117% from
$2,910,450 in 1997 to $6,316,665 in 1998. This increase was due to an increase
in interest-bearing liabilities and an increase in rates paid on deposits. As a
result, net interest income increased 76% from $5,098,982 in 1997 to $8,962,806
in 1998.
The following table sets forth the changes in interest income and expense
attributable to changes in rates and volumes:
Year Ended December 31,
Dollars in Thousands 1999 Versus 1998 1998 Versus 1997 1997 Versus 1996
--------------------------- ---------------------------- ---------------------------
Total Change Change Total Change Change Total Change Change
Change Due to Due to Change Due to Due to Change Due to Due to
Rate Volume Rate Volume Rate Volume Volume Rate Volume
-------- -------- -------- -------- -------- ------- -------- -------- --------
Time deposits in other 5 0 33
financial institutions $ (20) 48 (68) $ (55) (60) $ 33
-------- -------- -------- -------- -------- ------- -------- -------- --------
Federal funds sold 597 16 581 (13) (15) 2 141 11 130
Investment securities 391 271 120 (63) (64) 0 15 (32) 47
Loans, net 32,247 12,949 19,298 7,401 (1,784) 9,186 1,009 (169) 1,178
Total interest-earning assets 33,215 13,284 19,931 7,270 (1,858) 9,128 1,198 (189) 1,387
-------- -------- -------- -------- -------- ------- -------- -------- --------
Interest-bearing 74 (21) 95 60 (9) 69 8 (14) 22
demand
Savings 396 45 351 97 (32) 129 (23) (12) (11)
Time certificates of 8,888 1,334 7,554 2,655 (92) 2,746 500 66 434
deposit
Federal funds (41) - (41) 85 - 85 - - -
purchased
Bonds payable 9,428 - 9,428 510 - 510 - - -
Other borrowings 83 - 83 - - - - - -
Total interest-bearing 18,828 1,358 17,470 3,407 (133) 3,540 485 39 446
liabilities
Net interest income $14,387 $11,926 $ 2,461 $ 3,863 $(1,725) $ 5,587 $ 713 $ (228) $ 941
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 provide for probable loan losses. The
balance in the allowance for loan loss reflects the amount which, in
management's judgment, is adequate to provide for these probable loan losses,
after considering the mix of the loan portfolio, current economic conditions,
past loan experience and other factors deemed relevant in estimating loan
losses.
Each month, management reviews the allowance for loan losses and records
additional provisions to the allowance, as needed. Management allocated
$6,132,959 as a provision for loan losses in 1999, $1,759,623 in 1998 and
$260,000 in 1997. This increase was due to the significant growth in the loan
portfolio. Loans charged off, net of recoveries, in 1999 were $3,977,108, in
1998 were $298,685 and in 1997 were $383,469. The increased chargeoffs in 1999
were due to two commercial loans in the accounts receivable financing program,
which program has since been curtailed. The ratio of the allowance for loan
losses to total gross loans was 1.3% at December 3l, 1999, 1.6% at December 31,
1998, and 1.8% at December 31, 1997.
In management's opinion, the balance of the allowance for loan losses at
December 31, 1999 was sufficient to absorb known and inherent probable losses in
the loan portfolio at that time.
Other Income Other income increased 17% from $9,432,215 in 1997 to $11,022,457
- - ------------
in 1998 and remained flat to $11,020,637 in 1999. Although the Company continues
to emphasize the generation of non-interest income, the percentage of
non-interest income to total income dropped significantly from 42% in 1998 to
18% in 1999. This was primarily a result of the decrease in fees on sold or
brokered loans, and in loan servicing fees and other service charges.
Other Expenses
- - ---------------
Other expenses include salaries and employee benefits, occupancy and equipment,
and other operating expenses. As a result of continued Company growth, other
expenses rose 55% from $11,523,906 in 1997 to $17,482,133 in 1998 and 74% in
1999. Employee compensation increased from $10,799,675 in 1998 to $16,228,271
in 1999. Most of this increase in compensation can be attributed to variable
pay, since 40% of the Company personnel derive their income from loan
production. The majority of other expenses are variable expenses since employee
compensation represents 54% of other expenses in 1999. Other expenses that were
also impacted by loan production included occupancy due to the increase in
locations, advertising and marketing and general office expenditures.
Professional fees increased as a result of activity related to ePacific.com's
change in corporate status and a three-year audit of its accounting records.
There was also a $1.3 million lower of cost or market provision on loans held
for sale in 1999. This provision resulted from a change in the company's
strategy from the securitization of second mortgage loans to whole loan sales.
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, 1999 $ 450,041 6.78% 3.61% 0.85% 0.85%
December 31, 1998 $ 225,258 7.76% 4.79% 1.06% 0.90%
December 31, 1997 $ 87,468 13.18% 8.36% 1.72% 0.64%
(1) Based on the average of daily balances.
Income Taxes
- - -------------
Income taxes provision/(benefit) was $(621,838) in 1999, $289,488 in 1998, and
$1,158,351 in 1997. The effective income tax (benefit) rate was (27.4)%, 38.9%
and 42.2% for 1999, 1998 and 1997, respectively.
Net (Loss) Income
- - -------------------
The net (loss) income of the Company was ($1,646,336) in 1999, $454,059 in 1998,
and $1,588,940 in 1997. Loss (earnings) per share were $(0.30) basic and diluted
in 1999; $0.12 basic and diluted in 1998; and $.53 basic and $.44 diluted in
1997 adjusted to reflect the 2-for-1 stock split in 1998. The loss for 1999 was
primarily the result of the $2.1 million in losses of ePacific.com and the LOCOM
provision. The Company decided to cease any further securitization activities.
At the time of that decision the Company had approximately $150,000,000 in
second mortgage loans accumulated for a third securitization. Those loans were
written down in the fourth quarter of 1999 to fair market value.
Income Taxes
- - -------------
Income taxes/(benefits) were $(621,838) in 1999, $289,488 in 1998, and
$1,158,351 in 1997. The effective income tax rate was (24.7)%, 38.9% and 42.2%
for 1999, 1998 and 1997, respectively.
Net (Loss) Income
- - -------------------
The net (loss) income of the Company was ($1,646,336) in 1999, $454,059 in 1998,
and $1,588,940 in 1997. Loss (earnings) per share were $(0.30) basic in 1999;
$(0.12) basic in 1998; and $.53 basic and $.44 diluted in 1997 adjusted to
reflect the 2-for-1 stock split in 1998. The loss for 1999 was primarily the
result of the Company's accounting for securitizations as secured borrowings as
opposed to sales. The Company decided to cease any further securitization
activities. At the time of that decision the Company had approximately
$150,000,000 in second mortgage loans accumulated for a third securitization.
Those loans were written down in the fourth quarter of 1999 to fair market
value. The adjustment was approximately $4.3 million.
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.
The prompt corrective action regulations define specific capital categories
based on institutions' capital ratios. The capital categories, in declining
order, are "well capitalized", "adequately capitalized", "undercapitalized",
"significantly undercapitalized", and "critically undercapitalized". To be
considered "well capitalized" an institution must have a core capital ratio of
at least 5% and a total risk-based capital ratio of at least 10%. Additionally,
FDICIA imposed in 1994 a new Tier I risk-based capital ratio of at least 6% to
be considered "well capitalized". Tier I risk-based capital is, primarily,
common stock and retained earnings less goodwill and other intangible assets.
As of December 31, 1999, and 1998 the most recent notification from the FDIC
categorized Goleta as "adequately capitalized" under the regulatory framework
for prompt corrective action. At December 31, 1999 and 1998, the most recent
notification from the FDIC and the OTS, respectively, categorized Palomar as
"well-capitalized" under the regulatory framework for prompt corrective action.
To be categorized as "well capitalized" Goleta and Palomar must maintain minimum
Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in
the table below. There are no conditions or events since that notification which
management believes have caused Goleta's or Palomar's category to decline.
To Be Well
For Capitalized
Capital Adequacy Under Prompt
Actual Purposes Corrective Action
------------------- ------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------ ----------- ------
As of December 31, 1999:
Total Risk-Based Capital (to Risk Weighted assets)
Consolidated. . . . . . . . . . . . . . . . . . . . $39,474,626 8.34% $37,856,951 8.00% $47,321,188 10.00%
Goleta National Bank. . . . . . . . . . . . . . . . $33,099,716 8.01% $33,046,888 8.00% $41,308,610 10.00%
Palomar Community Bank. . . . . . . . . . . . . . . $ 7,184,663 11.94% $ 4,814,290 8.00% $ 6,017,863 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated. . . . . . . . . . . . . . . . . . . . $33,945,328 7.17% $18,928,475 4.00% $28,392,713 6.00%
Goleta National Bank. . . . . . . . . . . . . . . . $28,182,418 6.82% $16,523,444 4.00% $24,785,166 6.00%
Palomar Community Bank. . . . . . . . . . . . . . . $ 6,572,663 10.92% $ 2,407,145 4.00% $ 3,610,718 6.00%
Tier I Capital (to Average Assets)
Consolidated. . . . . . . . . . . . . . . . . . . . $33,945,328 7.52% $18,928,475 4.00% $23,660,594 5.00%
Goleta National Bank. . . . . . . . . . . . . . . . $28,182,418 7.27% $15,498,960 4.00% $20,654,305 5.00%
Palomar Community Bank. . . . . . . . . . . . . . . $ 6,572,663 12.22% $ 2,407,145 4.00% $ 3,668,931 5.00%
To Be Well
For Capitalized Under
Capital Adequacy Prompt Corrective
Actual Purposes Action Provisions
--------------------- ------------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ------- ----------- ------ ----------- ------
As of December 31, 1998:
Total Risk-Based Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . $ 32,209,386 13.05% $19,738,737 8.00% $24,673,422 10.00%
Goleta National Bank . . . . . . . . . . . . . . . $ 15,648,459 8.14% $15,384,392 8.00% $19,230,490 10.00%
Palomar Savings and Loan . . . . . . . . . . . . . $ 6,968,279 12.98% $ 4,293,471 8.00% $ 5,366,838 10.00%
Tier I Capital (to Risk Weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . $ 29,121,426 11.80% $ 9,869,369 4.00% $14,804,053 6.00%
Goleta National Bank . . . . . . . . . . . . . . . $ 13,240,206 6.89% $ 7,692,196 4.00% $11,538,294 6.00%
Tier I Capital (to Average Assets)
Consolidated . . . . . . . . . . . . . . . . . . . $ 29,121,426 9.12% $12,775,029 4.00% $15,968,787 5.00%
Goleta National Bank . . . . . . . . . . . . . . . $ 13,240,206 5.90% $ 8,972,680 4.00% $11,215,850 5.00%
Core Capital (to Adjusted Tangible Assets)
Palomar Savings and Loan . . . . . . . . . . . . . $ 6,297,424 11.73% $ 2,146,735 4.00% $ 2,683,419 5.00%
Tangible Capital (to Tangible Assets)
Palomar Savings and Loan . . . . . . . . . . . . . $ 6,297,424 7.61% $ 1,240,914 1.50% N/A N/A
In November 1999, the OCC notified Goleta that Goleta had not properly
calculated the amount of regulatory capital required to be held in respect of
residual interests retained by Goleta in two securitizations of loans that were
consummated by Goleta in the fourth quarter of 1998 and the second quarter of
1999. Accordingly the OCC informed Goleta that it was deemed adequately
capitalized at December 31, 1998 and significantly undercapitalized at March 31,
1999, June 30,1999 and September 30, 1999. On November 17, 1999, after a new
debt and equity investment in the Company of approximately $11.15 million by
certain directors of the Company, the proceeds of which were contributed to
Goleta as equity, the OCC informed Goleta that it was adequately capitalized.
The 1998 regulatory capital amounts and ratios have been restated from amounts
and ratios previously reported to properly reflect Goleta's capital position at
December 31, 1998.
Under the regulatory framework, the Goleta's capital levels do not allow it to
accept or renew brokered deposits without prior approval from the regulators.
Goleta had approximately $1,090,896 of brokered deposits at December 31, 1999.
This prohibition is not expected to materially impact Goleta.
On March 23, 2000, Goleta signed a formal written agreement with the Comptroller
of the Currency of the United States of America (the Agreement). Under the
terms of the Agreement, by September 30, 2000, and thereafter, Goleta is
required to maintain total capital at least equal to 12% of risk-weighted
assets, and Tier 1 capital at least equal to 7% of adjusted total assets.
Goleta is required to adopt and implement a written asset diversification
program that includes specific plans to reduce the concentration of second
mortgage loans (exclusive of securitized loans bought back from the
securitization) to 100% of capital by September 30, 2000. The Agreement
requires Goleta to submit within 60 days a capital plan, which is to include,
among other things, specific plans for meeting the special capital requirements,
projections for growth and a dividend policy. The Agreement places limitations
on growth and payments of dividends until Goleta is in compliance with its
approved capital plan. The Agreement also requires that Goleta adopt and
improve certain policies and procedures and develop a three-year strategic plan.
Goleta is required to submit monthly progress reports to the OCC detailing
actions taken, results of those actions and a description of actions needed to
achieve full compliance with the Agreement.
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.
Year Ended December 31, 1999 1998 1997
------------------ ------------------ -----------------
Amount % Amount % Amount %
------------------ ------------------ -----------------
ASSETS
- - ----------------------------------------------- --------- ------- --------- ------- -------- -------
Cash and due from banks $ 8,582 1.9% $ 3,771 1.7% $ 3,203 3.7%
Federal funds sold 19,287 4.3% 8,161 3.6% 8,129 9.3%
Time deposits in other financial institutions 328 0.1% 1,099 0.5% 2,092 2.4%
FRB/FHLB Stock 621 0.1% 271 0.1% 215 0.2%
Investment securities 7,913 1.8% 3,473 1.5% 3,672 4.2%
Loans:
Commercial 19,545 4.3% 13,045 5.8% 13,637 15.6%
Real estate 43,627 9.7% 19,536 8.7% 20,612 23.6%
Unguaranteed portions of loans insured by SBA 24,139 5.4% 25,455 11.3% 21,345 24.4%
Installment 7,520 1.7% 12,531 5.6% 4,239 4.8%
Loan participations purchased 8,978 2.0% (1,109) -0.5% 1,333 1.5%
Less: allowance for loan loss (2,179) -0.5% (1,433) -0.6% (1,333) -1.5%
Less: net deferred loan fees and premiums (103) 0.0% (21) 0.0% (30) 0.0%
Less: discount on loan pool purchase (970) -0.2% (703) -0.3% (488) -0.6%
Net loans 100,557 22.3% 67,302 29.9% 59,315 67.8%
Securitized Loans 156,900 34.9% 80,231 35.6% - 0.0%
Loans held for sale 140,910 31.3% 48,519 21.5% 5,428 6.2%
Other real estate owned 361 0.1% 181 0.1% 216 0.3%
Premises and equipment, net 4,682 1.0% 3,433 1.5% 2,547 2.9%
Servicing asset 1,813 0.4% 849 0.4% 788 0.9%
Accrued interest receivable and other assets 4,618 1.0% 5,243 2.3% 1,863 2.1%
--------- ------- --------- ------- -------- ------
TOTAL ASSETS $450,041 100.0% $225,258 100.0% $87,468 100.0%
========= ======= ========= ======= ======== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand 24,761 5.5% 20,396 9.1% 16,915 19.3%
Interest-bearing demand 17,975 4.0% 6,385 2.8% 12,936 14.8%
Savings 23,776 5.3% 22,906 10.2% 10,413 11.9%
Time certificates, $100,000 or more 93,668 20.8% 30,338 13.5% 14,533 16.6%
Other time certificates 105,062 23.3% 50,016 22.2% 21,165 24.2%
Total deposits 265,242 58.9% 130,040 57.7% 75,962 86.8%
Bonds Payable 144,311 32.1% 76,475 33.9% - 0.0%
Other Borrowings 1,128 0.3% - 0.0% - 0.0%
Federal funds purchased 844 0.2% 1,479 0.7% - 0.0%
Accrued interest payable and other liabilities 5,839 1.3% 4,773 2.1% 661 0.8%
Total liabilities 417,363 92.7% 212,767 94.5% 76,623 87.6%
--------- ------- --------- ------- -------- ------
Stockholders' equity
Common stock 23,941 5.3% 8,969 4.0% 8,332 9.5%
Retained earnings 9,941 2.2% 3,523 1.6% 2,513 2.9%
Unrealized Gain/(Loss) on AFS securities (42) 0.0% - 0.0% - 0.0%
Treasury stock (1,162) -0.3% - 0.0% - 0.0%
Total stockholders' equity 32,678 7.3% 12,491 5.5% 10,845 12.4%
--------- ------- --------- ------- -------- ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $450,041 100.0% $225,258 100.0% $87,468 100.0%
========= ======= ========= ======= ======== ======
Investment Portfolio
- - ---------------------
The following table summarizes the year-end carrying value balances of the
Company's investment securities.
December 31,
---------------------------------
1999 1998 1997
------------- ---------- ------
U.S. Treasury Securities $ 497,000 $1,256,000 $ 998
------------- ---------- ------
FRB Stock 302,000 264,000 251
FHLB Stock 474,000 546,000 -
GNMA Securities 2,746,000 4,230,000 -
FNMA Securities 1,107,000 1,893,000 -
FHLMC Securities 1,044,000 1,420,000 -
$ 6,170,000 $9,609,000 $1,249
The following table summarizes the amounts, terms, distributions, and yields of
the Company's investment securities as of December 31, 1999.
After One Year to
One Year or Less Five Years Over Five Years Total
----------------- ----------- ------------- -----
Amount Yield Amount Yield Amount Yield Amount Yield
----------------- ----------- --------------- ----- ------ ------ ------- ------
U.S. Treasury Securities 497 5.40% - N/A - N/A 497 5.40%
FRB Stock 302 5.63% - N/A - N/A 302 5.63%
FHLB Stock 474 5.27% - N/A - N/A 474 5.27%
GNMA Securities - N/A - N/A 2,746 6.79% 2,746 6.79%
FNMA Securities - N/A - N/A 1,107 6.72% 1,107 6.72%
FHLMC Securities - N/A - N/A 1,044 6.80% 1,044 6.80%
Total 1,273 5.43% - N/A 4,897 6.78% 6,170 5.70%
The Investment Policy of the Company sets forth the types and maturities of
investments the Company and its subsidiaries may hold.
Interest Only Strips
- - ----------------------
At December 31, 1999 and 1998 the Company held interest only strips in the
amount of $5,382,994 and $2,221,900, respectively. These interest-only strips
represent the present value of the right to the estimated excess net 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; and (ii) stipulated servicing fees. The
Company determines the present value of this estimated cash flow at the time of
the closing of the loan sale, utilizing valuation assumptions appropriate for
each particular transaction.
The significant valuation assumptions include the estimated average lives of the
loans sold and the estimated prepayment speeds related thereto. Present value of
the cash flow is calculated using an estimated market discount rate of 11% to
the expected gross cash flows, which are calculated utilizing the weighted
average lives of the loans. The annual prepayment rate of the loans is a
function of full and partial prepayments and defaults. In the interest-only
strips' fair value estimates, the Company makes assumptions of the prepayment
rates of the underlying loans, which the Company believes are reasonable. The
interest only strips are accounted for as investments in debt securities
classified as trading securities. Accordingly, the Company marks them to fair
value with the resulting increase or decrease recorded through operations in the
current period. At December 31, 1999 the Company utilized estimated annual
prepayment assumptions of 8% for SBA loans and 30% for FHA Title 1 loans to
estimate the fair value of the interest-only strips.
Loan Portfolio
- - ---------------
The Company's largest lending categories are commercial loans, real estate
loans, unguaranteed portion of loans insured by the SBA, installment loans, real
estate loan participations purchased and second mortgage loans. Loans are
carried at face amount, less payments collected, the allowance for possible loan
losses, deferred loan fees and discounts on loans purchased. Interest on all
loans is accrued daily, primarily on a simple interest basis. It is generally
the Company's policy to place 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, 1999,
approximately 60% of the Company's loan portfolio was comprised of variable
interest rate loans. At December 31, 1998, variable rate loans comprised
approximately 63% of the Company's loan portfolio. At December 31, 1997,
variable rate loans comprised approximately 72% 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):
1999 1998 1997
Commercial 12,102 2.6% 10612 4.2% 13195 18.1%
Real Estate 44,139 9.6% 65348 26.0% 19924 27.3%
Unguaranteed portion of loans insured by SBA 25,073 5.5% 26687 10.6% 19602 26.9%
Installment 6,348 1.4% 5638 2.2% 3467 4.8%
Loan participations purchased 25,395 5.5% 2287 0.9% 2247 3.1%
Loans held for sale,
primarily second mortgage loans 158,274 34.5% 58687 23.3% 14440 19.8%
Securitized Loans 187,784 40.9% 82339 32.7% 0 0.0%
GROSS LOANS 459,115 100.0% 251,598 100.0% 72,875 100.0%
Less:
Allowance for loan losses 5,529 3374 1286
Deferred loan fees (premium) 146 112 -3
Discount on loan pools purchased 1,777 700 428
451,663 247,412 71,164
Commercial Loans
- - -----------------
In addition to traditional commercial loans made to business customers, the
Company also extends business lines of credit. On business lines of credit, the
Company establishes 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. Prior to extending
credit to a borrower, the purpose and security are clearly established.
Normally the Company does not make loan commitments in material amounts for
periods in excess of one year.
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. Office buildings
or other commercial property often secures these loans. 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 SBA generally guarantees between 75% and
90% of the funded commitment. Borrowers are required to provide adequate
collateral for these loans, similar to other commercial loans. The SBA does
allow less-collateralized loans for its "Low Doc" program for commitments 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 originates
installment loans, also known as consumer loans. These loans are comprised of
automobile, small equity lines of credit and general personal loans. These loans
are primarily variable rate with terms of five years or less.
Second Mortgage Loans
- - -----------------------
In 1996 the Company began offering second mortgage loans which allow borrowers
to receive up to 125% of their home value for debt consolidation, home
improvement, or any other worthwhile cash outlay. During 1997 and the first
quarter of 1998 the Company sold these loans for a premium to third parties. No
servicing was retained on these loans.
In 1998 and 1999 the Company transferred $81 million and $122 million of these
loans to special purpose entities (SPE's). The SPE's, through securitizations,
then sold bonds to third party investors, which were secured by the transferred
loans. The bonds are held in a trust independent of the Company, the trustee of
which oversees the distributions to the bondholders. The mortgage loans are
serviced by a third party (the servicer), who receives a stated servicing fee.
There is an insurance policy on the bonds that unconditionally guarantees the
ultimate payment of the bonds. As part of the securitization agreement, the
Company received an option to repurchase the bonds when the aggregate principal
balance of the mortgage loans sold has declined to 10% or less of the original
balance of mortgage loans securitized. Because the Company has a repurchase
option to reacquire the loans transferred and has not retained the servicing
rights, the Company has not surrendered effective control over the loans
transferred. Therefore, the securitizations are accounted for as secured
borrowings with a pledge of collateral in accordance with SFAS No. 125
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities". Accordingly, the Company is required to consolidate the SPE's,
and the financial statements of the Company include the loans transferred and
the related bonds issued. The securitized loans are classified as held for
investment.
In the fourth quarter of 1999, the Company decided to cease future
securitization activities. As of December 31, 1999, the Company had accumulated
$150 million in second mortgage loans. These loans are classified as held for
sale. It is the Company's intent to sell these loans, servicing released, to
third parties. On an ongoing basis, the Company will continue to originate
second mortgage loans, which will be sold to third parties shortly after
origination.
Maturity of Loans and Sensitivity of Loans to Changes in Interest Rates
- - --------------------------------------------------------------------------------
The following table sets forth the amount of gross loans outstanding, as of
December 31, 1999, 1998, and 1997, 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.
1999 1998 1997
---------------- ------------------ -----------------
(Dollars in thousands) Fixed Variable Fixed Variable Fixed Variable
------- ------- -------- -------- ------- -------
Less than One Year $ 789 $87,313 $ 5,431 $105,173 $ 8,319 $43,676
------- ------- -------- -------- ------- -------
One Year to Five Years 8,342 4,628 10,487 1,272 7,996 -
More than Five Years 357,253 536 128,361 - 12,884 -
Total $ 366,384 $92,477 $ 44,279 $106,445 $29,199 $43,676
The following table shows the Company's loan commitments outstanding at the
dates indicated:
December 31,
(Dollars in thousands) 1999 1998 1997
-------- ------- -------
Commercial $ 6,641 $10,693 $12,298
Real estate 4,135 12,306 2,015
Loans guaranteed by the SBA 5,266 4,230 4,177
Installment loans 2,205 1,502 1,171
Standby letters of credit 713 35 30
-------- ------- -------
Total commitments $ 18,960 $28,766 $19,691
======== ======= =======
Based upon prior experience and prevailing economic conditions, it is
anticipated that approximately 80% of the commitments at December 31, 1999 will
be exercised during 2000.
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 that the Company's
management determines require further monitoring and supervision are segregated
and reviewed on a periodic basis. The Company's Loan Committee reviews
significant problem loans on a monthly basis.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record and the amount of the
shortfall in relation to the principal and interest owed. The Company uses the
fair value of collateral method to measure impairment. Impairment is measured
on a loan by loan basis for all loans in the portfolio except for the
securitized loans, which are collectively evaluated for impairment.
The recorded investment in loans that are considered to be impaired under
Statement of Financial Accounting Standards ("SFAS") No. 114 was as follows:
December 31,
----------------------------------------
1999 1998 1997
-------------- ----------- -----------
Impaired loans without
specific valuation allowances $ 3,250,576 $4,450,345 $1,547,168
-------------- ----------- -----------
Impaired loans with
specific valuation allowances 1,402,469 813,652 1,250,964
Specific valuation allowance
allocated to impaired loans (1,038,519) (464,336) (505,994)
Impaired loans, net $ 3,614,526 $4,799,661 $2,292,138
============== =========== ===========
Average investment in impaired loans $ 5,119,852 $4,009,400 $1,901,054
============== =========== ===========
Interest income recognized on impaired loans $ 243,913 $ 288,607 $ 287,309
============== =========== ===========
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, 1999 1998, and 1997 are considered impaired.
The recorded investment in loans that are considered to be impaired is as
follows:
December 31,
-------------------------------------
(Dollars rounded to thousands) 1999 1998 1997
------------- ---------- ----------
Nonaccrual loans $ 3,091,000 $2,971,000 $1,259,000
Troubled debt restructured loans, gross $ 656,000 $1,313,000 $2,375,000
Interest foregone on nonaccrual loans $ 1,585,000 $ 414,000 $ 190,000
and troubled debt restructuring outstanding
Loans 30 through 90 days past due with interest accruing $ 2,550,000 $ 678,000 $ 631,000
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, 1999 1998 1997
------------- ------------- ------------
Balances:
Average gross loans $409,765,000 $132,485,000 $66,595,000
Gross loans at end of period 458,861,000 250,724,000 72,875,000
Loans charged off 4,035,000 359,000 401,000
Recoveries of loans previously charged off 143,000 78,000 17,000
------------------------------------------
Net loans charged off 3,344,000 281,000 384,000
------------------------------------------
Allowance for loan losses 6,114,000 3,989,000 1,286,000
Provisions for loan losses 5,330,000 2,985,000 260,000
Ratios:
Net loan charge-offs to average loans 0.8% 0.2% 0.6%
Net loan charge-offs to loans at end of period 0.7% 0.1% 0.5%
Allowance for loan losses to average loans 1.5% 3.0% 1.9%
Allowance for loan losses to loans
held to maturity at end of period 2.1% 2.1% 1.8%
Net loan charge-offs to allowance
for loan losses at end of period 54.7% 7.1% 29.9%
Net loan charge-offs to provision for loan losses 62.7% 9.4% 147.7%
The Company's allowance for loan losses is designed to provide for loan losses
which are known and inherent in the portfolio. 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. Management of the Company determines the
amount of the allowance. 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 different 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, 1999, 1998, and 1997, the allowance was 2.0%, 2.1%, and 2.3% of
the gross loans held for investment then outstanding. 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.
Management of the Company reviews with the Board of Directors the adequacy of
the allowance for loan losses on a quarterly basis. The loan loss provision is
adjusted when specific items reflect a need for 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 provided for all individual items in its portfolio, which may result
in a material loss to the Company.
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,
1999 1998 1997
---------- --------- --------
INTEREST-EARNING ASSETS:
Time deposits in other financial institutions:
Average outstanding $ 328 $ 1,099 $ 2,092
Average yield 14.2% 6.0% 5.8%
Interest income $ 47 $ 66 $ 121
Federal funds sold:
Average outstanding $ 19,287 $ 8,161 $ 8,129
Average yield 5.2% 5.0% 5.2%
Interest income $ 1,008 $ 411 $ 424
Investment securities:
Average outstanding $ 8,534 $ 3,788 $ 3,887
Average yield 5.2% 1.4% 3.0%
Interest income $ 442 $ 52 $ 115
Loans:
Average outstanding $397,074 $203,873 $66,594
Average yield 11.8% 7.2% 11.0%
Interest income $ 46,998 $ 14,751 $ 7,350
TOTAL INTEREST-EARNING ASSETS:
Average outstanding $425,224 $216,921 $80,702
Average yield 11.4% 7.0% 9.9%
Interest income $ 48,495 $ 15,279 $ 8,010
INTEREST-BEARING LIABILITIES:
Interest-bearing demand deposits:
Average outstanding $ 18,006 $ 15,020 $12,936
Average yield 3.2% 3.3% 3.4%
Interest expense $ 576 $ 502 $ 442
Savings deposits:
Average outstanding $ 23,776 $ 14,267 $10,413
Average yield 3.7% 3.4% 3.8%
Interest expense $ 884 $ 488 $ 391
Time certificates of deposit:
Average outstanding $198,730 $ 85,272 $35,698
Average yield 6.9% 5.5% 5.8%
Interest expense $ 13,620 $ 4,732 $ 2,077
Federal funds purchased:
Average outstanding $ 844 $ 1,479 $ -
Average yield 5.2% 5.7% 0.0%
Interest expense $ 44 $ 85 $ -
Bonds Payable:
Average outstanding $144,311 $ 6,372 $ -
Average yield 6.9% 8.0%
Interest expense $ 9,938 $ 510 $ -
Other borrowings:
Average outstanding $ 1,128 $ - $ -
Average yield 7.4%
Interest expense $ 83 $ - $ -
TOTAL INTEREST-BEARING LIABILITIES:
Average outstanding $386,795 $192,513 $59,047
Average yield 6.5% 3.3% 4.9%
Interest Expense $ 25,145 $ 6,317 $ 2,910
Net interest income $ 23,350 $ 8,963 $ 5,100
AVERAGE NET INTEREST MARGIN 5.5% 4.1% 6.3%
ON INTEREST-EARNING ASSETS
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, 1999, was 38.4%, at December 31, 1998, was 35.7%, based on liquid
assets (consisting of cash and due from banks, deposits in other financial
institutions, available for sale investments, federal funds sold and loans held
for sale) divided by total assets. Management believes it maintains adequate
liquidity levels.
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.
Deposits
- - --------
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,
-----------------------
1999 1998 1997
------------------- ------------------- -------------------
Average Percent Average Percent Average Percent
Balance of Total Balance of Total Balance of Total
-------- --------- -------- --------- -------- ---------
Noninterest-bearing demand $ 24,761 9.3% $ 20,454 15.7% $ 16,915 22.3%
Interest-bearing demand 18,006 6.8% 15,020 4.9% 12,936 17.0%
Savings 23,776 9.0% 14,267 17.6% 10,413 13.7%
TCDs of $100,000 or more 93,668 35.3% 31,456 23.3% 14,533 19.1%
Other TCDs 105,062 39.6% 53,816 38.5% 21,165 27.9%
-------- --------- -------- --------- -------- ---------
Total Deposits $265,273 100.0% $135,013 100.0% $ 75,962 100.0%
-------- --------- -------- --------- -------- ---------
The maturities of time certificates of deposit ("TCDs") were as follows:
(Dollars in thousands) December 31, 1999 December 31, 1998
------------------ ------------------
TCD's over TCDs over
$100,000 Other TCD's $100,000 Other TCDs
----------------------------------------------
Less than three months $ 60,353 $ 64,553 $ 36,080 $ 55,362
Over three months through six months 31,638 46,955 7,016 12,395
Over six months through twelve months 7,142 22,588 15,911 17,558
Over twelve months through five years 1,624 6,056 2,735 10,472
Total $ 100,757 $ 140,152 $ 61,742 $ 95,787
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. Liquidity 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
- - ----------
The Company had in place a plan of action designed to minimize the risk of the
year 2000 event including the establishment of an oversight committee. This
plan was fully supported by management and the Board of Directors. The committee
achieved a year 2000 date conversion with no effect on customers or disruption
to business operations. No systems, hardware or software determined as critical
needed replacement.
The Company was not required to purchase any additional hardware or software to
be year 2000 compliant. However, management has incurred and may continue to
incur some administrative costs relative to the identification and testing of
the Company's electronic data processing systems. As of December 31, 1999, the
Company had incurred $465,646 in expenses becoming Year 2000 compliant and
anticipates minimal spending in 2000.
SUPERVISION AND REGULATION
- - ----------------------------
INTRODUCTION
Banking is a complex, highly regulated industry. The primary goals of the
regulatory scheme are to maintain a safe and sound banking system, protect
depositors and the Federal Deposit Insurance Corporation's insurance fund, and
facilitate the conduct of sound monetary policy. In furtherance of these goals,
Congress has created several largely autonomous regulatory agencies and enacted
numerous laws that govern banks, bank holding companies and the banking
industry. Consequently, the growth and earnings performance of the Company, as
well as Goleta and Palomar (collectively, the "Banking Subsidiaries") can be
affected not only by management decisions and general economic conditions, but
also by the requirements of applicable state and federal statutes, regulations
and the policies of various governmental regulatory authorities, including:
- the Board of Governors of the Federal Reserve System (the "FRB");
- the Federal Deposit Insurance Corporation (the "FDIC");
- the Office of the Comptroller of the Currency (the "OCC"); and
- the California Department of Financial Institutions (the "DFI").
The system of supervision and regulation applicable to the Company and the
Banking Subsidiaries establishes a comprehensive framework for their respective
operations. Federal and state laws and regulations generally applicable to
financial institutions, such as the Company and the Banking Subsidiaries,
regulate, among other things:
- the scope of business that they may conduct;
- investments that they can make;
- reserves that must be maintained against deposits;
- capital levels that must be maintained relative to the amount and
risks associated with assets;
- the nature and amount of collateral that may be taken to secure loans;
- the establishment of new branches;
- mergers and consolidations with other financial institutions; and
- the amount of dividends that the Company and the Banking Subsidiaries
may pay.
The following summarizes the material elements of the regulatory framework that
applies to the Company and any subsidiaries, including the Banking Subsidiaries.
It does not describe all of the statutes, regulations and regulatory policies
that are applicable. Also, it does not restate all of the requirements of the
statutes, regulations and regulatory policies that are described. Consequently,
the following summary is qualified in its entirety by reference to the
applicable statutes, regulations and regulatory policies. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on the business of the Company and the Banking Subsidiaries.
SUPERVISION AND REGULATION - THE COMPANY
GENERAL. The Company, as a bank holding company registered under the Bank
- - -------
Holding Company Act of 1956 (the "BHCA"), is subject to regulation by the FRB.
According to FRB policy, the Company is expected to act as a source of financial
strength for the Banking Subsidiaries and to commit resources to support them in
circumstances where the Company might not otherwise do so. Under the BHCA, the
Company and its subsidiaries are subject to periodic examination by the FRB.
The Company is also required to file periodic reports of its operations and any
additional information regarding its activities and those of its subsidiaries
with the FRB, as may be required.
The Company is also a bank holding company within the meaning of Section 3700 of
the California Financial Code. As such, the Company and its subsidiaries are
subject to examination by, and may be required to file reports with, the
Commissioner of the California Department of Financial Institutions (the
"Commissioner"). Regulations have not yet been proposed or adopted or steps
otherwise taken to implement the Commissioner's powers under this statute.
BANK HOLDING COMPANY LIQUIDITY. The Company is a legal entity, separate and
- - ---------------------------------
distinct from its subsidiaries. Although there exists the ability to raise
capital on its own behalf or borrow from external sources, it may also obtain
additional funds through dividends paid by, and fees for services provided to,
its subsidiaries. However, regulatory constraints may restrict or totally
preclude the Banking Subsidiaries from paying dividends to the Company.
Regarding Goleta, the Company is entitled to receive dividends when and as
declared by the Goleta's Board of Directors, out of funds legally available
therefore, as specified and limited by the OCC's regulations. Pursuant to the
OCC's regulations, funds available for a national bank's cash dividends are
restricted to the lesser of the bank's: (i) retained earnings; or (ii) net
income for the current and past two fiscal years (less any dividends paid during
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; the OCC can prohibit payment of a
dividend if it is an unsafe and unsound banking practice.
Regarding Palomar, the Company is entitled to receive dividends, when and as
declared by Palomar's Board of Directors, out of funds legally available
therefor, as specified and limited by the California Financial Code. Under the
California Financial Code, funds available for cash dividend payments by a
California state-chartered bank are restricted to the lesser of: (i) a bank's
retained earnings; or (ii) a bank's net income for its last three fiscal years
(less any distributions to shareholders made during such period). With the
prior approval of the Commissioner, cash dividends may also be paid out of the
greater of: (i) a bank's retained earnings; (ii) net income for a bank's last
preceding fiscal year; or (iii) net income for a bank's current fiscal year. If
the Commissioner finds that the shareholders' equity of the bank is not adequate
or that the payment of a dividend would be unsafe or unsound for the bank, the
Commissioner may order the bank not to pay a dividend to the bank's
shareholders.
Since the Banking Subsidiaries are also FDIC insured institutions, it is
therefore possible, depending upon their financial condition and other factors,
that the FDIC could assert that the payment of dividends or other payments
might, under some circumstances, constitute an unsafe or unsound practice and
thereby prohibit such payments.
TRANSACTIONS WITH AFFILIATES. The Company and any subsidiaries it may purchase
- - -----------------------------
or organize are deemed to be affiliates of the Banking Subsidiaries within the
meaning of Sections 23A and 23B of the BHCA. Pursuant thereto, loans by the
Banking Subsidiaries to affiliates, investments by the Banking Subsidiaries in
affiliates' stock, and taking affiliates' stock by the Banking Subsidiaries as
collateral for loans to any borrower will be limited to 10% of the Banking
Subsidiary's capital, in the case of any one affiliate, and will be limited to
20% of the Banking Subsidiaries' capital in the case of all affiliates. In
addition, such transactions must be on terms and conditions that are consistent
with safe and sound banking practices; in particular, a bank and its
subsidiaries generally may not purchase from an affiliate a low-quality asset,
as defined in the Federal Reserve 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 Banking
Subsidiaries are also subject to certain restrictions with respect to engaging
in the underwriting, public sale and distribution of securities. (See
"Supervision and Regulation - The Banking Subsidiaries - Recent Legislation and
Regulatory Developments - 1. Gramm-Leach-Bliley Act - Facilitating Affiliations
and Expansion of Financial Activities" herein.)
LIMITATIONS ON BUSINESSES AND INVESTMENT ACTIVITIES. Under the BHCA, a bank
- - -------------------------------------------------------
holding company must obtain the FRB's approval before:
- directly or indirectly acquiring more than 5% ownership or control of
any voting shares of another bank or bank holding company;
- acquiring all or substantially all of the assets of another bank; or
- merging or consolidating with another bank holding company.
The FRB may allow a bank holding company to acquire banks located in any state
of the United States without regard to whether the acquisition is prohibited by
the law of the state in which the target bank is located. In approving
interstate acquisitions, however, the FRB must give effect to applicable state
laws limiting the aggregate amount of deposits that may be held by the acquiring
bank holding company and its insured depository institutions in the state in
which the target bank is located, provided that those limits do not discriminate
against out-of-state depository institutions or their holding companies, and
state laws which require that the target bank have been in existence for a
minimum period of time, not to exceed five years, before being acquired by an
out-of-state bank holding company.
In addition to owning or managing banks, bank holding companies may own
subsidiaries engaged in certain businesses that the FRB has determined to be "so
closely related to banking as to be a proper incident thereto." The Company
therefore is permitted to engage in a variety of banking-related businesses.
Some of the activities that the FRB has determined, pursuant to its Regulation
Y, to be related to banking are:
- making or acquiring loans or other extensions of credit for its own
account or for the account of others;
- servicing loans and other extensions of credit;
- operating a trust company in the manner authorized by federal or state
law under certain circumstances;
- leasing personal and real property or acting as agent, broker, or
adviser in leasing such property in accordance with various
restrictions imposed by FRB regulations;
- providing financial, banking, or economic data processing and data
transmission services;
- owning, controlling, or operating a savings association under certain
circumstances;
- selling money orders, travelers' checks and U.S. Savings Bonds;
- providing securities brokerage services, related securities credit
activities pursuant to Regulation T, and other incidental activities;
and
- underwriting and dealing in obligations of the U.S., general
obligations of states and their political subdivisions, and other
obligations authorized for state member banks under federal law.
Federal law prohibits a bank holding company and any subsidiary banks from
engaging in certain tie-in arrangements in connection with the extension of
credit. Thus, for example, the Banking Subsidiaries may not extend credit,
lease or sell property, or furnish any services, or fix or vary the
consideration for any of the foregoing on the condition that:
- the customer must obtain or provide some additional credit, property
or services from or to the Banking Subsidiaries other than a loan,
discount, deposit or trust service;
- the customer must obtain or provide some additional credit, property
or service from or to the Company or any of the Banking Subsidiaries;
or
- The customer may not obtain some other credit, property or services
from competitors, except reasonable requirements to assure soundness
of credit extended.
- Generally, the BHCA does not place territorial restrictions on the
domestic activities of non-bank subsidiaries of bank holding
companies.
On November 12, 1999, the President signed into law the Gramm-Leach-Bliley Act
(the "GLB Act" or the "Financial Modernization Act"). The GLB Act
significantly changed the regulatory structure and oversight of the financial
services industry. The GLB Act permits banks and bank holding companies to
engage in previously prohibited activities under certain conditions. Also,
banks and bank holding companies may affiliate with other financial service
providers such as insurance companies and securities firms under certain
conditions. Consequently, a qualifying bank holding company, called a financial
holding company ("FHC"), can engage in a full range of financial activities,
including banking, insurance, and securities activities, as well as merchant
banking and additional activities that are beyond those permitted for
traditional bank holding companies. Moreover, various non-bank financial
service providers who were previously prohibited from engaging in banking can
now acquire banks while also offering services such as securities underwriting
and underwriting and brokering insurance products. The GLB Act also expands
passive investment activities by FHCs, permitting them to indirectly invest in
any type of company, financial or nonfinancial, through merchant banking
activities and insurance company affiliations. (See "Supervision and Regulation
- - - The Banking Subsidiaries - Recent Legislation and Regulatory Developments - 1.
Gramm-Leach-Bliley Act" herein.)
CAPITAL ADEQUACY. Bank holding companies must maintain minimum levels of
- - -----------------
capital under the FRB's risk based capital adequacy guidelines. If capital
falls below minimum guideline levels, a bank holding company, among other
things, may be denied approval to acquire or establish additional banks or
non-bank businesses.
The FRB's risk-based capital adequacy guidelines for bank holding companies and
state member banks, discussed in more detail below (see "Supervision and
Regulation - The Banking Subsidiaries - Recent Legislation and Regulatory
Developments - Risk-Based Capital Guidelines" herein), assign various risk
percentages to different categories of assets, and capital is measured as a
percentage of risk assets. Under the terms of the guidelines, bank holding
companies are expected to meet capital adequacy guidelines based both on total
risk assets and on total assets, without regard to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will
be required if warranted by the particular circumstances or risk profiles of
individual organizations. For example, the FRB's capital guidelines contemplate
that additional capital may be required to take adequate account of, among other
things, interest rate risk, or the risks posed by concentrations of credit,
nontraditional activities or securities trading activities. Moreover, any
banking organization experiencing or anticipating significant growth or
expansion into new activities, particularly under the expanded powers under the
GLB Act, would be expected to maintain capital ratios, including tangible
capital positions, well above the minimum levels.
LIMITATIONS ON DIVIDEND PAYMENTS. California Corporations Code Section 500
- - -----------------------------------
allows the Company to pay a dividend to its shareholders only to the extent that
the Company has retained earnings and, after the dividend, the Company's:
assets (exclusive of goodwill and other intangible assets) would be 1.25
times its liabilities (exclusive of deferred taxes, deferred income and other
deferred credits); and
- current assets would be at least equal to its current liabilities.
Additionally, the FRB's policy regarding dividends provides that a bank holding
company should not pay cash dividends exceeding its net income or which can only
be funded in ways that weaken the bank holding company's financial health, such
as by borrowing. The FRB also possesses enforcement powers over bank holding
companies and their non-bank subsidiaries to prevent or remedy actions that
represent unsafe or unsound practices or violations of applicable statutes and
regulations.
SUPERVISION AND REGULATION - THE BANKING SUBSIDIARIES
GENERAL. Palomar, as a state-chartered bank that is not a member of the Federal
- - -------
Reserve System and whose deposits are insured by the FDIC, is subject to
regulation, supervision, and regular examination by the DFI, and the FDIC.
Goleta, as a national banking association, which is also a member of the Federal
Reserve System, is subject to regulation, supervision, and regular examination
by the OCC, the FDIC and the FRB. The Banking Subsidiaries' deposits are
insured by the FDIC up to the maximum extent provided by law. The regulations
of these agencies govern most aspects of the Banking Subsidiaries' business and
establish a comprehensive framework governing their operations. California law
exempts all banks from usury limitations on interest rates.
RECENT LEGISLATION AND REGULATORY DEVELOPMENTS. 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 on deposits by depository
institutions (state reserve requirements have been eliminated) and the
phasing-out of the restrictions on the amount of interest which financial
institutions may pay on certain of their customers' accounts. Federal
regulators have been gi