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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, 2000
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 Identification No.)
of incorporation or organization)
445 Pine Avenue, Goleta, California 93117
(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, (805)692-1862
including area code)
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 6,107,216 shares of common stock for the registrant issued and
outstanding as of March 1, 2001. The aggregate market value of the voting
stock, based on the closing price of the stock on the NASDAQ National Market
System on February 20, 2001, held by the nonaffiliates of the registrant was
approximately $20,911,995.
This Form 10-K contains 74 pages
COMMUNITY WEST BANCSHARES
FORM 10-K
INDEX
PART I PAGES
ITEM 1. Description of Business 3
ITEM 2. Description of Property 5
ITEM 3. Legal Proceedings 6
ITEM 4. Submission of Matters to a Vote of Security Holders 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 40
ITEM 8. Consolidated Financial Statements F-2
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 71
PART III
ITEM 10. Directors, Executive Officers, Promoters and Control Persons 71
ITEM 11. Executive Compensation 71
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 71
ITEM 13. Certain Relationships and Related Transactions 71
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 71
SIGNATURES 74
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
- -----------------------------------
General
- -------
Community West Bancshares was incorporated in the State of California on
November 26, 1996, for the purpose of forming a financial services holding
company. On December 31, 1997, Community West Bancshares acquired a 100%
interest in Goleta National Bank, herein referred to as "Goleta". Effective that
date, shareholders of Goleta (NASDAQ:GLTB) became shareholders of Community West
Bancshares (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, herein referred to as
"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 Bancshares, 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, herein referred
to as "SBA", accounts receivable, real estate, construction, home improvement,
short term consumer, 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 the public.
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
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, San
Diego, and Santa Ana. The Company also has "Preferred Lender" Status in Alabama,
Georgia, South Carolina, Tennessee, Colorado, Seattle, Nevada, Portland, and
North and South Florida.
During 1994, the Company established a Mortgage Loan Processing Center. The
Mortgage Loan Processing Center takes residential real estate loan applications
for lenders located throughout the nation and processes them for a fee. At any
point in time, the Company processes loans for 50-70 such lenders. Due to the
volume of loans generated by these lenders, the Company has the ability to offer
significantly more loan programs than normally offered by any single
institution; this has allowed the Company to remain ahead of its competition.
Also in 1994, the Company began offering home improvement loans under the Title
I regulations of the Federal Housing Authority, herein referred to as "FHA".
This is the oldest government insured loan program in existence, having begun in
1934. During the period of 1994 to 1998 the Company originated Title I loans,
sold them into the secondary market, and retained the servicing. Also during
this period, the Company was one of a small number of institutions approved to
sell Title I loans directly to the Federal National Mortgage Association, herein
referred to as the "FNMA".
In 1996, the Company began offering second mortgage loans. Second mortgage loans
allow borrowers to borrow, up to 125% of their home's appraised value, when
combined with the balance of the first mortgage loan, or a maximum of $100,000.
Proceeds are commonly used for debt consolidation, home improvement, or school
tuition. The Company relies primarily on the creditworthiness of the borrower,
combined with the underlying home value as collateral, to help ensure repayment
of these loans. The repayment term on these loans range from one year 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 purpose of securitization. Securitization is a process in which
3
the accumulated loans are transferred into a trust in exchange for cash and an
interest in the trust. The loans held in the trust are used as collateral to
issue bonds to third party investors to generate the cash. An insurance policy
is carried on the trust to guarantee full payment of the subordinate bonds. 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. The Company will continue to originate
second mortgage loans, intended for sale to third parties at a premium
immediately after origination.
Due to the development costs involved, most small community banks have
difficulty providing electronic banking services to their customers. The Company
has continually 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 clearing house 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. Electronic Paycheck,
LLC has developed an Internet-based transaction processing system using
propriety software. The system provides complete front-end to back-end
electronic funds transfer processing services. Electronic Paycheck, LLC is
focusing the marketing of its e-commerce payment services to consumer lenders,
companies with employees without banking relationships, network marketing
organizations and loyalty reward programs. In addition, Electronic Paycheck,
LLC plans to establish a card-based payment system for Internet purchases
utilizing its virtual pinpad technology. The product's target market is focused
on teenagers. On November 4, 1999 Electronic Paycheck LLC merged with
ePacific.com Incorporated, a Delaware Corporation; the merger was accounted for
in a manner similar to a pooling-of-interests. On March 30, 2000, 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 $4,500,000 in cash. The Company
continues to hold a 10% interest in ePacific.com but is no longer required to
include ePacifc.com in its consolidated financial statements. ePacific.com is
currently in a deficit position and is retained at a zero value in the
Companies' financial statements.
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, 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 bank and subsequently changed
its name to Palomar Community Bank. The Federal Deposit Insurance Corporation,
herein referred to as the "FDIC" insures the deposits of Palomar up to the
applicable limits. Palomar is a member of the Federal Home Loan Bank system,
herein referred to as the "FHLB". Palomar's main office is located at 355 West
Grand Avenue, Escondido, California 92025. On December 1, 2000, the Company
signed a definitive agreement to sell Palomar Community Bank to Centennial First
Financial Services for $10.5 million. Under the terms of the agreement,
Centennial will acquire all the outstanding stock of Palomar in exchange for
$10.5 million in cash. The sale is expected to be completed in the third
quarter of 2001.
In 1999, the Company entered into a contract with America's Cash Express, herein
referred to as "ACE", and ePacific.com whereby ACE will act as an agent to
originate short-term consumer loans via 1,000 national retail offices. Upon
origination, ACE purchases 95% of the principal and the Company currently
retains 5% ownership in the principal of each loan. Loans currently yield
approximately 390% interest and are for original terms of two weeks. The first
loans of this type were initiated in the second quarter of 2000. ePacific.com
continues to service these loans.
4
Competition and Service Area
- -------------------------------
The financial service industry in California is highly competitive with respect
to both loans and deposits. Overall, the industry is dominated by a relatively
small number of major banks with many offices operating over wide geographic
areas. Some of the major commercial banks operating in the Company's service
areas offer certain services, which are not offered directly by the Company or
any of its subsidiaries. Some of these services include; in-depth trust and
investment services, international banking, and due to their size, a
substantially higher lending limit. 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 Sacramento, Fresno, Costa Mesa, San
Rafael, Santa Maria, Santa Barbara, Orange County, and Ventura, California; Las
Vegas, Nevada; Woodstock, Georgia; Alamonte Springs, Florida; Beaverton, Oregon;
Bellevue, Washington; Charlotte, North Carolina; Columbia, South Carolina;
Knoxville, Tennessee; and Englewood, Colorado. 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 that it
originates.
The Company uses the flexibility of its independent status permits to compete
for loans and deposits within its primary service area. Management has
established highly personalized banking relationships with the Company's
customers and is attuned and responsive to their financial and service
requirements. The Company emphasizes its experienced management and trained
staff to handle the specialized banking needs of its customers. In the event
there are customers whose loan demands exceed the Company's lending limits, the
Company works to arrange for such loans on a participation basis with other
financial institutions. The Company also assists those customers requiring
specialized services not offered by the Company to obtain such services through
correspondent institutions.
Employees
- ---------
As of December 31, 2000, the Company employed 265 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. The Company offers
competitive salaries and benefits in order to attract and retain the most
qualified personnel.
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 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 each, to extend the lease. This facility
houses the Company's Corporate Offices, comprised of various departments
including but not limited to, Finance, Data Processing, Compliance, Human
Resources, Electronic Business Services, Special Assets, Operations and Loan
Collection.
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 April 30, 2003, with a current monthly
rent of $7,890 per month for both leases. Each lease contains an option to
extend the lease for an additional three years. This facility houses the Retail
and Wholesale Mortgage Lending departments of the Company.
5
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 7,570 square feet of space located at 681 South
Parker Street Suite 350, Orange, California. The lease is for a term expiring
September 30, 2003, with a current monthly rent of $9,463 per month. This
facility houses the Orange County Loan Production office of the Company.
The Company leases approximately 1,063 square feet of space located at 1050
Northgate Drive Suite 190, San Rafael, California. The lease is for a term
expiring July 31, 2005, with a current monthly rent of $2,764 per month. This
facility houses the San Rafael SBA Loan Production office of the Company.
The Company leases approximately 2,424 square feet of space located at 665 Molly
Lane Suite 110, Woodstock, Georgia. The lease is for a term expiring July 15,
2005, with a current monthly rent of $2,913 per month. This facility houses the
Georgia SBA Loan Production office of the Company.
The Company leases approximately 6,380 square feet of space located at 5383
Hollister Avenue, 2nd Floor, Goleta, California. The lease is for a term
expiring November 30, 2002, with a current monthly rent of $8,932 per month. The
lease also provides the Company with two options of three years to extend the
lease. On May 18, 2000, the Company sublet the entire space. The sublease does
not provide an option for the sublessor to extend the sublease.
The Company leases three 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 $11,177 per month for all three 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 8,200 square feet of
office space. The Company sublet these suites to an independent third party.
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.
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 $13,692. The Company also leases
approximately 1600 square feet at 1815 E. Valley Parkway Suite #1, Escondido,
California. The lease is for a term expiring May 5, 2003 and a current monthly
rent of $1,499 per month. The lease also provides the Company with two
additional consecutive options of five years each to extend the lease. The
Company sublet this suite to an independent third party. The sublease is for a
term commencing March 1, 2000 and expiring July 31, 2003. The sublease does not
provide the sublessor an option to extend the sublease.
The Company also leases small executive suites on a month-to-month basis in
Sacramento, Fresno, Santa Maria, and Costa Mesa, California. The Company has
executive suites in Charlotte, North Carolina; Columbia, South Carolina;
Bellevue, Washington; Beaverton, Oregon; Englewood, Colorado; Alamonte Springs,
Florida; Knoxville, Tennessee and in Las Vegas, 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, four storage units and portions
of a parking lot which are located in Goleta.
The Company's total occupancy expense, including depreciation, for the year
ended December 31, 2000 was $3,918,668. Management believes that its existing
facilities are adequate for its present purposes.
ITEM 3. LEGAL PROCEEDINGS
- ----------------------------
The Company is involved in various litigation matters through the normal course
of business. In the opinion of management, after taking into consideration
information provided by counsel, the disposition of all pending litigation
should not have a materially effect on the Company's financial position or
results of operations.
On October 10, 2000 the Company filed a lawsuit in Los Angeles Superior Court
against their former auditors and financial consultants, Deloitte and Touche,
LLP. The Company is seeking compensatory damages for deficient audit and
financial consulting services that ultimately resulted in the restatement of the
Company's December 31, 1998 financial statements and regulatory capital ratios.
6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ---------------------------------------------------------------------
An annual meeting of security holders of the Company was held May 25, 2000. The
security holders voted on and approved Board Members for 2000-2001. There were
a total of 5,411,518 or 88.6% proxies voted out of 6,107,216 shares. The
following indicates the votes:
FOR AGAINST NON-VOTES
Number of Votes Received 5,410,718 800 695,698
Percentage of Total Shares 88.60% 0.01% 11.39%
PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
----------------------------------------------------------------------
STOCKHOLDER MATTERS
- -------------------
The following table sets forth the high and low closing sales prices on a per
share basis for the common stock as reported by the respective exchanges for the
period indicated:
Common Stock
------------
Low High
----- -----
1999 First Quarter 7.75 9.25
Second Quarter 7.50 10.50
Third Quarter 10.00 16.88
Fourth Quarter 6.75 16.75
2000 First Quarter 5.50 8.00
Second Quarter 5.38 6.88
Third Quarter 5.13 6.25
Fourth Quarter 3.38 5.25
On March 15, 2001, the last reported sale price per share for the Company's
stock was $4.75.
The Company declared four quarterly dividends of $0.04 per share during 1999.
Each quarterly dividend totaled approximately $220,000.
The Company had 537 shareholders of record of its common stock as of December
31, 2000.
7
ITEM 6. SELECTED FINANCIAL DATA
- -----------------------------------
SUMMARY OF OPERATIONS
The following Summary of Operations of the Company, as of and for the years
ended December 31, 2000, 1999, 1998, 1997, and 1996 has been derived from the
consolidated financial statements included elsewhere in this document:
December 31, (1)
--------------------------------------------------------------
(Dollars in thousands, except per share data) 2000 1999 1998 1997 1996
---------- ----------- ----------- ----------- -----------
Interest income $ 51,781 $ 48,495 $ 15,279 $ 8,009 $ 6,812
Interest expense 26,060 25,145 6,317 2,910 2,425
---------- ----------- ----------- ----------- -----------
Net interest income 25,721 23,350 8,962 5,099 4,387
Provision for loan losses 6,794 6,133 1,759 260 435
---------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 18,927 17,217 7,203 4,839 3,952
Other operating income 16,283 11,021 11,022 9,432 6,620
Other operating expense 29,975 30,506 17,482 11,524 8,667
---------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 5,235 (2,268) 743 2,747 1,905
(Benefit) provision for income taxes 2,538 (622) 289 1,158 800
---------- ----------- ----------- ----------- -----------
Net income (loss) $ 2,697 $ (1,646) $ 454 $ 1,589 $ 1,105
========== =========== =========== =========== ===========
Income (loss) per common share - Basic $ 0.44 $ (0.30) $ 0.12 $ 0.53 $ 0.47
Number of shares used in income (loss)
per share calculation - Basic (2) 6,107,216 5,494,217 3,767,607 3,016,208 2,356,162
Income (loss) per common share - Diluted $ 0.43 $ (0.30) $ 0.12 $ 0.44 $ 0.44
Number of shares used in income (loss)
per share calculation - Diluted (2) 6,233,245 5,494,217 3,941,749 3,588,478 2,510,352
Net loans $ 329,265 $ 451,664 $ 247,411 $ 59,315 $ 54,206
Total assets 405,255 523,847 327,569 87,468 72,718
Deposits 228,720 313,131 223,853 75,962 65,032
Total liabilities 369,221 489,915 298,448 76,623 65,169
Total stockholders' equity 36,035 33,932 29,121 10,845 7,549
(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.
8
Selected ratios, for the periods set forth, are indicated in the following
table:
Year Ended December 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
Net income (loss) to average stockholder equity 7.35% (6.68)% 3.50% 14.64% 13.67%
---------- ---------- ---------- ---------- ----------
Net income (loss) to average total assets 0.61% (0.37)% 0.20% 1.82% 1.52%
Total interest expense to total interest income 50.33% 51.85% 41.34% 36.33% 35.59%
Other operating income to other operating expense 54.32% 36.13% 63.05% 81.85% 76.39%
Equity to assets ratio 8.89% 6.51% 8.77% 12.73% 12.44%
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.
9
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:
--------------------------------------------------------------------------------
Year Ended December 31, 2000 versus 1999 1999 versus 1998 1998 versus 1997
------------------------- -------------------------- -------------------------
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 $ 2,767,595 5.89% $32,246,557 218.60% $ 7,401,202 100.70%
Federal funds sold 397,418 39.44% 597,248 145.49% (13,153) (3.10%)
Time deposits in other financial
Institutions 66,107 140.27% (19,195) (28.94%) (54,264) (45.00%)
Investment securities 55,148 12.47% 390,840 758.81% (63,746) (55.31%)
------------ ------------ ------------
Total interest income 3,286,268 6.78% 33,215,450 217.39% 7,270,039 90.77%
------------ ------------ ------------
INTEREST EXPENSE:
Deposits $(3,745,649) (24.84%) $ 9,357,741 163.54% $ 2,811,508 96.60%
Bonds payable and other borrowings 4,660,533 46.30% 9,470,824 1592.52% 594,707 0.00%
------------ ------------ ------------
Total interest expense 914,884 3.64% 18,828,565 298.08% 3,406,215 117.03%
NET INTEREST INCOME 2,371,384 10.16% 14,386,885 160.52% 3,863,824 75.78%
PROVISION FOR LOAN LOSSES 660,853 10.78% 4,373,336 248.54% 1,499,623 576.78%
------------ ------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 1,710,531 9.94% 10,013,549 139.02% 2,364,201 48.86%
------------ ------------ ------------
OTHER INCOME:
Gains from loan sales $ 1,503,300 25.11% $ 1,928,127 47.49% $ (41,406) (1.01%)
Loan servicing fees 2,290,448 458.36% (286,007) (36.40%) 154,159 24.41%
Income from sale of interest in
Subsidiary 2,080,000 100.00% - - - -
Other loan origination fees - sold
or brokered loans (884,235) (32.63%) (969,273) (26.34%) 718,826 24.28%
Document processing fees 43,938 4.10% (150,590) (12.31%) 403,853 49.29%
Service charges 44,352 8.62% (349,759) (40.46%) (31,746) (3.54%)
Gain from sale of servicing assets 186,531 100.00% - - - -
Other income (1,593) (0.68%) (174,318) (42.52%) 386,556 1651.45%
------------ ------------ ------------
TOTAL OTHER INCOME $ 5,262,741 47.75% $ (1,820) (0.02)% $ 1,590,242 16.86%
------------ ------------ ------------
10
------------------------- -------------------------- -------------------------
Year Ended December 31, 2000 versus 1999 1999 versus 1998 1998 versus 1997
------------------------- -------------------------- -------------------------
Amount of Percent of Amount of Percent of Amount of Percent of
increase increase increase increase increase increase
(decrease) (decrease) (decrease) (decrease) (decrease) (decrease)
------------ ----------- ------------ ------------ ----------- ------------
OTHER EXPENSES
Salaries and employee benefits $ (987,213) (6.08%) $ 5,428,596 50.27% $ 3,484,228 47.63%
Occupancy expenses (15,314) (0.63%) 981,684 68.41% 889,490 58.97%
Depreciation expense 89,399 6.26% 464,974 48.30% 962,845 100.00%
Other operating expenses 1,664,860 102.51% (145,639) (8.23%) 245,837 61.20%
Loan servicing & collection expense 137,477 6.28% 1,931,479 752.09% 256,814 100.00%
Impairment of goodwill 2,110,303 100.00% - - - -
Professional services (1,629,713) (63.19%) 2,058,416 395.31% 94,885 22.28%
Advertising expense (445,751) (38.72%) 357,215 44.98% 211,466 36.29%
Amortization of intangible assets 40,529 11.15% 300,008 471.99% 63,562 100.00%
Office supply expense 5,217 1.35% 192,142 99.21% 38,384 24.72%
Data processing/ATM processing (166,570) (32.55%) 262,746 105.52% 95,944 62.69%
Postage & freight (57,020) (16.20%) (84,920) (19.44%) (385,228) (46.86%)
Lower of Cost or Market provision (1,276,709) (100.00%) 1,276,709 100.00% - -
------------ ------------ ------------
TOTAL OTHER EXPENSES $ (530,505) (1.74%) $13,023,410 74.50% $ 5,958,227 51.70%
------------ ------------ ------------
INCOME(LOSS)BEFORE
(BENEFIT)PROVISION FOR
INCOME TAXES 7,503,777 330.83% (3,011,681) (405.06%) (2,003,784) (72.94%)
PROVISION(BENEFIT) FOR
INCOME TAXES 3,160,304 508.22% (911,286) (314.84%) (868,903) (75.01%)
------------ ------------ ------------
NET INCOME(LOSS) $ 4,343,473 263.83% $(2,100,395) (462.58%) $(1,134,881) (71.42%)
------------ ------------ ------------
11
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, primarily 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. 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 Federal Reserve Bank, herein referred to as the "FRB"
also have an affect.
The following table presents the net interest income and net interest margin:
Year Ended December 31,
------------ ------------ ------------
2000 1999 1998
------------ ------------ ------------
Interest Income $51,781,189 $48,494,921 $15,279,471
Interest Expense 26,060,114 25,145,230 6,316,665
------------ ------------ ------------
Net Interest Income $25,721,075 $23,349,691 $ 8,962,806
============ ============ ============
Net Interest Margin 6.3% 5.4% 4.2%
Total interest income increased 6.8% from $48,494,921 in 1999 to $51,781,189 in
2000. Total interest expense increased 3.6% from $25,145,230 in 1999 to
$26,060,114 in 2000. The increase in expense, was primarily due to a shareholder
note acquired at the end of 1999, offset by a net decrease in interest-bearing
liabilities primarily, time certificates of deposits and bonds payable in
connection with securitzed loans. As a result, net interest income increased
10.2% from $23,349,691 in 1999 to $25,721,075 in 2000. 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) 2000 Versus 1999 1999 Versus 1998 1998 Versus 1997
---------------------------- ---------------------------- ----------------------------
Change Change Change Change Change Change
Total due to due to Total due to due to Total due to due to
change rate volume change rate volume change rate volume
-------- -------- -------- -------- -------- -------- -------- -------- --------
Time deposits in other
Financial institutions $ 66 $ 1 $ 65 $ (20) $ 48 $ (68) $ (55) $ 5 $ (60)
Federal funds sold 397 195 202 597 16 581 (13) (15) 2
Investment securities 56 102 (46) 391 271 120 (63) (63) -
Loans, net (7,159) (2,039) (5,120) 15,196 (3,299) 18,495 6,962 (1,784) 8,746
Securitized Loans 9,926 7,824 2,102 17,051 16,248 803 440 - 440
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-earning
Assets 3,286 6,083 (2,797) 33,215 13,284 19,931 7,271 (1,857) 9,128
Interest-bearing
Demand 214 29 185 74 (21) 95 60 (9) 69
Savings (172) (159) (13) 396 45 351 97 (32) 129
Time certificates of
Deposit (3,788) (1,875) (1,913) 8,888 1,334 7,554 2,655 (92) 2,747
Federal funds
Purchased (25) 10 (35) (41) - (41) 85 - 85
Bonds payable 4,223 3,734 489 9,428 - 9,428 510 - 510
Other borrowings 463 29 434 83 - 83 - - -
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities 915 1,768 (853) 18,828 1,358 17,470 3,407 (133) 3,540
-------- -------- -------- -------- -------- -------- -------- -------- --------
Net interest income $ 2,371 $ 4,315 $(1,944) $14,387 $11,926 $ 2,461 $ 3,864 $(1,724) $ 5,588
======== ======== ======== ======== ======== ======== ======== ======== ========
12
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
accumulated balance in the allowance for loan loss reflects the estimated amount
which management determined is adequate to provide for any probable loan losses
after considering the mix of the loan portfolio, current economic conditions,
past loan experience and any other relevant factors.
Management reviews the allowance for loan losses on a monthly basis and records
additional provisions to the allowance, as needed. Management allocated
$6,793,812 as a provision for loan losses in 2000, $6,132,959 in 1999 and
$1,759,623 in 1998. This increase was due to the significant growth in the loan
portfolio. Loans charged off, net of recoveries, in 2000 were $5,576,287, in
1999 were $3,977,108 and in 1998 were $298,685. The increased chargeoffs in 2000
were primarily due to the short-term consumer and securitized loan programs. The
ratio of the allowance for loan losses to total gross loans was 2% at December
3l, 2000, 1.9% at December 31, 1999, and 1.8% at December 31, 1998,
respectively.
In management's opinion, the balance of the allowance for loan losses at
December 31, 2000 was sufficient to absorb known and inherent probable losses in
the loan portfolio at that time.
Other Income
- -------------
Other income remained constant from $11,022,457 in 1998 to $11,020,637 in 1999
but increased 48% to $16,283,378 in 2000. Due to the Company's continuing
emphasis on generating non-interest income, the percentage of non-interest
income to total income also increased significantly from 19% in 1999 to 24% in
2000. This was primarily a result of an increase in loan servicing fees, income
from the sale of interest in subsidiary, and gains from the sale of servicing
assets.
Other Expenses
- ---------------
Other expenses include salaries, employee benefits, occupancy, equipment, and
other operating expenses. As a result of company growth, other expenses rose
74% from $17,482,133 in 1998 to $30,505,543 in 1999, but decreased in 2000 by
1.7% to $29,975,038 due to cost cutting efforts. In addition, operating expenses
decreased due to a $1,276,709 lower of cost or market provision on loans held
for sale in 1999 which was not repeated in 2000. The 1999 provision resulted
from a change in the Company's strategy from the securitization of second
mortgage loans to whole loan sales of this product. Employee compensation
decreased 6% from $16,228,271 in 1999 to $15,241,058 in 2000. The majority of
this decrease in compensation is attributable to a decrease in variable salaries
and benefits, since approximately 40% of the Company personnel derive their
income from loan production, which was lower in 2000 as compared to 1999.
Employee compensation represented 51% of other expenses in 2000. Other expenses
that were also impacted by the change in loan production volume were occupancy,
advertising, marketing, and general office expenditures. Professional fees
increased as a result of activity related to ePacific.com's change in corporate
status and as a result of costs incurred relating to the restatement of the
Company's 1998 financial statements.
Lower of Cost or Market
- ---------------------------
Loans which are originated and sold in the secondary market are carried at the
lower of cost or estimated fair value determined on an aggregate basis. At
December 31, 1999 the Company recorded a valuation adjustment to these loans of
$1,276,709. At December 31, 2000, management determined that carrying value
approximated fair value and thus no valuation adjustment was determined to be
necessary.
13
The following table compares the various elements of other expenses as a
percentage of average assets:
Occupancy
Salaries and and Other
Year Ended December 31, Average Total Other Employee Depreciation Operating
(Dollars in thousands) Assets (1) Expense Benefits Expenses Expenses
------------------------------------------------------------------
December 31, 2000 $ 439,945 6.81% 3.46% 0.89% 0.75%
December 31, 1999 $ 450,041 6.78% 3.61% 0.85% 0.36%
December 31, 1998 $ 225,258 7.76% 4.79% 1.06% 0.79%
(1) Based on the average of daily balances.
Income Taxes
- -------------
Income taxes provision/(benefit) was $2,538,466 in 2000, $(621,838) in 1999, and
$289,448 in 1998. The effective income tax (benefit) rate was 48.5%, (27.4)%
and 38.9% for 2000, 1999 and 1998, respectively.
Net Income (Loss)
- -------------------
The net income (loss) of the Company was $2,697,137 in 2000, $(1,646,336) in
1999, and $454,059 in 1998. Earnings (loss) per share were $0.44 basic and $0.43
diluted in 2000; $(0.30) basic and diluted in 1999; and $0.12 basic and diluted
in 1998, 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 costs
associated with the cessation of the Company's securitization program. In late
1999, 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 $1,300,000. As of December 31, 2000 the Company had $15 million
of these loans remaining. No additional writedowns were needed in 2000.
Capital Resources
- ------------------
The Federal Deposit Insurance Corporation Improvement Act, herein referred to as
the "FDICIA", of 1991 was signed into law on December 19, 1991. FDICIA included
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 of FDICIA, define specific capital
categories based on the institutions' capital ratios. The capital categories, in
declining order, are "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized", and "critically
undercapitalized". To be considered "well capitalized" an institution must have
a core capital ratio of at least 5% and a total risk-based capital ratio of at
least 10%. Additionally, FDICIA imposed in 1994 a new Tier I risk-based capital
ratio of at least 6% to be considered "well capitalized". Tier I risk-based
capital is, primarily, common stock and retained earnings net of goodwill and
other intangible assets.
As of December 31, 2000, and 1999 the most recent notification from the FDIC, or
from any regulator, categorized Goleta as "adequately capitalized" under the
regulatory framework for prompt corrective action. At December 31, 2000 and
1999, the most recent notification from the FDIC and the Department of Financial
Institutions respectively categorized Palomar as "well-capitalized" under the
regulatory framework for prompt corrective action. To be categorized as
"adequately capitalized" or "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 or Palomar's category
to change.
14
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------- -------------------- -------------------
Year Ended December 31, 2000: Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------- ----------- ------
Total Risk-Based Capital
(to Risk Weighted assets)
Consolidated $38,645,337 11.04% $28,013,787 8.00% N/A N/A
Goleta National Bank $35,573,765 12.12% $23,473,626 8.00% $29,342,032 10.00%
Palomar Community Bank $ 7,329,473 13.89% $ 4,223,104 8.00% $ 5,278,879 10.00%
Tier I Capital
(to Risk Weighted assets)
Consolidated $31,898,901 9.11% $14,006,894 4.00% N/A N/A
Goleta National Bank $31,876,965 10.86% $11,736,813 4.00% $17,605,219 6.00%
Palomar Community Bank $ 6,669,613 12.64% $ 2,111,552 4.00% $ 3,167,328 6.00%
Tier I Capital
(to Average Assets)
Consolidated $31,898,901 7.25% $17,597,784 4.00% N/A N/A
Goleta National Bank $31,876,965 8.87% $14,375,225 4.00% $17,969,031 5.00%
Palomar Community Bank $ 6,669,613 8.75% $ 3,048,776 4.00% $ 3,810,970 5.00%
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------- -------------------- -------------------
Year Ended December 31, 1999: Amount Ratio Amount Ratio Amount Ratio
----------- ------ ----------- ------- ----------- ------
Total Risk-Based Capital
(to Risk Weighted assets)
Consolidated $39,474,626 8.34% $37,856,951 8.00% N/A N/A
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% N/A N/A
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% $18,060,691 4.00% N/A N/A
Goleta National Bank $28,182,418 7.27% $15,498,960 4.00% $19,373,700 5.00%
Palomar Community Bank $ 6,572,663 12.22% $ 2,151,381 4.00% $ 2,689,226 5.00%
In November 1999, the Office of the Comptroller of Currency of the United States
of America, herein referred to as the OCC, notified Goleta that it had
incorrectly 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 in the fourth quarter of 1998 and the second quarter of
1999. Accordingly, the OCC informed Goleta that it was 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 OCC
informed Goleta that it was adequately capitalized.
Under the regulatory framework, until the regulatory agencies notify Goleta that
they are deemed "well capitalized", Goleta may not accept or renew brokered
deposits without prior approval from the regulators. Goleta had no brokered
deposits at December 31, 2000.
15
On March 23, 2000, Goleta signed a formal written agreement with the Comptroller
of the Currency of the United States of America, herein referred to as the
"Agreement". Under the terms of the Agreement, by September 30, 2000, Goleta was
required to achieve and 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 was also required to adopt and implement a written asset
diversification program that included specific plans for reduction of the
concentration of second mortgage loans (exclusive of securitized loans) to 100%
of capital. The Agreement also required submission of a capital plan, which
included, among other things, specific plans for meeting the special capital
requirements, projections for growth and a dividend policy. The Agreement placed
limitations on growth and payments of dividends until Goleta was in compliance
with its approved capital plan. Additionally, the Agreement adoption and
improvement in certain policies and procedures as well as development of 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. Goleta achieved
the capital requirements under the Agreement by September 30,2000. As of
December 31, 2000 Goleta had total capital equal to 12.12% of risk-weighted
assets. Under the terms of the Agreement, Goleta reduced its concentration of
second mortgage loans below 100% to 90.89% of capital as of May 31, 2000,
thereby, in the opinion of management, complying with all material provisions of
the Agreement. Management believes that it continues to comply with all material
provisions of the Agreement.
16
Schedule of Assets, Liabilities and Stockholders' Equity
- --------------------------------------------------------------
For the periods indicated below, the following schedule shows the average
balances of the Company's assets, liabilities and stockholders' equity accounts
as a percentage of average total assets:
----------------- ----------------- -----------------
December 31, 2000 1999 1998
(Dollars in thousands) ----------------- ----------------- -----------------
Amount % Amount % Amount %
--------- ------ --------- ------ --------- ------
ASSETS
- ------
Cash and due from banks $ 9,550 2.2% $ 8,582 1.9% $ 3,771 1.7%
Federal funds sold 22,833 5.2% 19,287 4.3% 8,161 3.6%
Time deposits in other financial institutions 1,654 0.4% 703 0.2% 1,099 0.5%
FRB/FHLB Stock 926 0.2% 621 0.1% 271 0.1%
Investment securities 6,445 1.5% 7,538 1.7% 6,199 2.8%
Loans:
Commercial 26,293 6.0% 19,545 4.3% 13,045 5.7%
Real estate 35,962 8.1% 43,627 9.7% 19,536 8.7%
Unguaranteed portions of loans insured by SBA 24,023 5.4% 24,139 5.4% 25,455 11.3%
Installment 16,598 3.8% 7,520 1.6% 12,531 5.6%
Loan participations purchased 20,453 4.6% 8,978 2.0% (1,109) (0.5%)
Less: allowance for loan loss (5,698) (1.3%) (2,179) (0.5%) (1,433) (0.6%)
Less: net deferred loan fees and premiums (118) 0.0% (103) 0.0% (21) 0.0%
Less: discount on loan pool purchase (953) (0.2%) (970) (0.2%) (703) (0.3%)
--------- ------ --------- ------ --------- ------
Net loans 116,560 26.4% 100,557 22.3% 67,301 29.9%
Securitized loans 174,245 39.6% 156,900 34.9% 80,231 35.6%
Loans held for sale 79,222 18.0% 140,910 31.3% 48,519 21.5%
Other real estate owned 147 0.0% 361 0.1% 181 0.1%
Premises and equipment, net 4,302 1.0% 4,682 1.0% 3,433 1.5%
Servicing asset 2,051 0.5% 1,813 0.4% 849 0.4%
Accrued interest receivable and other assets 22,010 5.0% 8,087 1.8% 5,243 2.3%
--------- ------ --------- ------ --------- ------
TOTAL ASSETS $439,945 100.0% $450,041 100.0% $225,258 100.0%
========= ====== ========= ====== ========= ======
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Deposits:
Noninterest-bearing demand $ 30,381 6.9% $ 24,761 5.5% $ 20,396 9.1%
Interest-bearing demand 23,548 5.3% 17,975 4.0% 6,385 2.8%
Savings 23,254 5.3% 23,776 5.3% 22,906 10.2%
Time certificates, $100,000 or more 78,342 17.8% 93,668 20.8% 30,338 13.5%
Other time certificates 86,227 19.6% 105,062 23.3% 50,016 22.2%
--------- ------ --------- ------ --------- ------
Total deposits 241,752 54.9% 265,242 58.9% 130,041 57.8%
Bonds payable 151,126 34.4% 144,311 32.1% 76,475 33.9%
Other borrowings 5,795 1.3% 1,128 0.3% - 0.0%
Federal funds purchased 287 0.1% 844 0.2% 1,479 0.7%
Accrued interest payable and other liabilities 4,297 1.0% 5,838 1.3% 4,771 2.1%
--------- ------ --------- ------ --------- ------
Total liabilities 403,257 91.7% 417,363 92.8% 212,766 94.5%
Stockholders' equity
Common stock 26,571 6.0% 22,779 5.0% 8,969 4.0%
Retained earnings 10,163 2.3% 9,941 2.2% 3,523 1.5%
Unrealized loss on AFS securities (46) 0.0% (42) 0.0% - 0.0%
--------- ------ --------- ------ --------- ------
Total stockholders' equity 36,688 8.3% 32,678 7.2% 12,492 5.5%
--------- ------ --------- ------ --------- ------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $439,945 100.0% $450,041 100.0% $225,258 100.0%
========= ====== ========= ====== ========= ======
17
Investment Portfolio
- ---------------------
The following table summarizes the year-end carrying values of the Company's
investment securities:
Year Ended December 31, 2000 1999 1998
---------- ---------- ----------
(Dollars rounded to
thousands)
U.S. Treasury Securities $1,902,000 $ 497,000 $1,256,000
FRB Stock 775,000 302,000 264,000
FHLB Stock 395,000 474,000 546,000
FHLB Bond 1,000,000 - -
FHLMC Bond 491,000 - -
GNMA Securities 2,125,000 2,746,000 4,230,000
FNMA Securities 878,000 1,107,000 1,893,000
FHLMC Securities 325,000 1,044,000 1,420,000
---------- ---------- ----------
Total $7,891,000 $6,170,000 $9,609,000
========== ========== ==========
The following table summarizes the amounts, terms, distributions, and yields of
the Company's investment securities:
After One Year to
-----------------------------
Year Ended December 31, One Year or Less Five Years Over Five Years Total
-------------- ------------- -------------- ----------------
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
------ ------ ------ ----- ------ ------ ------- -------
U.S. Treasury Securities 1,902 4.00% - N/A - N/A 1,902 4.00%
FRB Stock 775 4.13% - N/A - N/A 775 4.13%
FHLB Stock 395 7.85% - N/A - N/A 395 7.85%
FHLB Bond 1,000 6.10% - N/A - N/A 1,000 6.10%
GNMA Securities - N/A - N/A 2,125 8.11% 2,125 8.11%
FNMA Securities - N/A - N/A 878 8.44% 878 8.44%
FHLMC Securities - N/A - N/A 816 7.72% 816 7.72%
-------------- ------------- -------------- ----------------
Total 4,072 5.33% - N/A 3,819 8.09% 7,891 6.62%
============== ============= ============== ================
The Investment Policy of the Company outlines the types and maturities of
investments the Company may hold.
Interest Only Strips
- ----------------------
At December 31, 2000 and 1999 the Company held interest only strips in the
amount of $7,540,824 and $4,835,999, respectively. These interest only strips
represent the present value of the right to the estimated excess net cash flows
generated by the serviced loans which represents the difference between (a)
interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors; and (ii) contractual
servicing fees. The Company determines the present value of this estimated net
cash flows at the time each loan sale closes, utilizing valuation assumptions as
to discount rate and prepayment rate appropriate for each particular
transaction.
The 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 12% - 13% 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 based on the
Company's own experience and review of rates used in the market. 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, 2000 the Company utilized estimated annual prepayment
assumptions of 8% to calculate the fair value of the interest only strips.
18
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, net of; 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 a loan on nonaccrual status when the
loan is 90 days past due. Thereafter, interest income is no longer recognized.
Problem loans are maintained on accrual status as long as the management of the
Company remains confident the loan will be repaid in full within a short period
of time.
The rates of interest charged on variable rate loans are set at specified
increments. These increments vary in relation to the Company's published prime
lending rate or other appropriate indices. At December 31, 2000, approximately
32% of the Company's loan portfolio was comprised of variable interest rate
loans. At December 31, 1999, variable rate loans comprised approximately 20% of
the Company's loan portfolio. At December 31, 1998, variable rate loans
comprised approximately 43% 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:
Year Ended December 31,
(Dollars in thousands)
2000 1999 1998
Percentage Percentage
Loan Percentage to Loan to Gross Loan to Gross
Type of loan Balance Gross Loans Balance Loans Balance Loans
- ------------ ------------ --------------- --------- --------- -------- ---------
Commercial $ 36,188 10.8% $ 12,102 2.7% $ 10,612 4.3%
Real estate 55,083 16.5% 44,139 9.7% 65,348 26.2%
Unguaranteed portion
of loans insured by SBA 30,888 9.2% 25,073 5.5% 26,687 10.7%
Installment 22,898 6.8% 6,348 1.4% 5,638 2.3%
Loan participations purchased - - 25,395 5.6% 2,287 0.9%
Loans held for sale, primarily
second mortgage loans 37,195 11.1% 158,274 34.7% 58,687 23.5%
Securitized Loans 153,031 45.6% 184,559 40.4% 80,232 32.1%
------------ --------------- --------- --------- -------- ---------
GROSS LOANS 335,283 100.0% 455,890 100.0% 249,491 100.0%
Less:
Allowance for loan losses 6,746 5,529 3,374
Deferred loan fees (costs) (2,710) (3,079) (1,995)
Discount on SBA loans 1,982 1,776 701
------------ --------- --------
NET LOANS $ 329,265 $451,664 $247,411
============ ========= ========
Commercial Loans
- -----------------
In addition to traditional term commercial loans made to business customers, the
Company grants revolving business lines of credit. Under the terms of the
revolving line of credit, the Company grants a maximum loan amount, which
remains available to the business during the loan term. As part of the loan
requirements, the business agrees to maintain its primary banking relationship
with the Company. It is the Company's policy not to extend material loans of
this type in excess of one year.
19
Real Estate Loans
- -------------------
Real estate loans are primarily made for the purpose of purchasing, improving,
or constructing, single family residences, commercial, or industrial
properties. The majority of the Company's real estate loans are collateralized
by 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%.
Commercial and industrial real estate loans are secured by nonresidential
property. Office buildings or other commercial property primarily secure these
loans. Loan to appraised value ratios on nonresidential real estate loans are
generally restricted to 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 construction or purchase of facilities, purchase of equipment, working
capital or the initial business purchase. 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 allows
less-collateralized loans under its "Low Doc" program for loan commitments under
$100,000. When the Company originates an SBA loan, the guaranteed portion of the
loan is sold into the secondary market. The Company retains the unguaranteed
portion of the loan, as well as the servicing right and related fee income on
the loan. The SBA loans are all variable interest rate loans based upon the Wall
Street Journal Prime Rate. The servicing spread is a minimum of 1.00% on all
loans. Income recognized by the Company on the sales of the guaranteed portion
of these loans and the ongoing servicing income received, are significant
revenue sources for the Company.
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 fixed rate loans with terms up to five years.
Second Mortgage Loans
- -----------------------
In 1998 and 1999 the Company transferred $81 million and $122 million of these
loans respectively, to special purpose entities, herein referred to as 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 distribution 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 subordinate bonds that guarantees the payment of the bonds.
As part of the securitization agreements, the Company received an option to
repurchase the bonds when the aggregate principal balance of the mortgage loans
sold declined to 10% or less of the original balance of mortgage loans
securitized Because the Company has a call option to reaquire the loans
transferred and did not retain 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. Accordingly, the Company consolidates 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.
20
As of December 31, 2000, the Company had accumulated $15 million in second
mortgage loans. These loans are classified as held for sale. It is the
Company's intent to sell these loans with servicing rights released, to third
parties. The Company continues 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 which based
on the remaining scheduled repayments of principal, have the ability to be
repriced or mature as defined in the following table:
December 31, 2000 1999 1998
------------------- ------------------- -------------------
(Dollars in thousands) Fixed Variable Fixed Variable Fixed Variable
-------- --------- -------- --------- -------- ---------
Less than One Year $ 1,058 $ 100,717 $ 789 $ 87,313 $ 5,431 $ 105,173
-------- --------- -------- --------- -------- ---------
One Year to Five Years 8,250 5,403 8,342 4,628 10,487 1,272
More than Five Years 219,213 642 354,282 536 127,128 -
-------- --------- -------- --------- -------- ---------
Total $228,521 $ 106,762 $363,413 $ 92,477 $143,046 $ 106,445
======== ========= ======== ========= ======== =========
The Company's loan commitments outstanding at the dates indicated are included
in the following table:
December 31,
(Dollars in thousands) 2000 1999 1998
------- ------- -------
Commercial $ 9,776 $ 6,641 $10,693
------- ------- -------
Real estate 8,323 4,135 12,306
Loans guaranteed by the SBA 4,545 5,266 4,230
Installment loans 2,260 2,205 1,502
Standby letters of credit 913 713 35
Total commitments $25,817 $18,960 $28,766
======= ======= =======
Based upon prior experience and prevailing economic conditions, it is
anticipated that approximately 80% of the commitments at December 31, 2000 will
be exercised during 2001.
Summary of Loan Losses Experience
- -------------------------------------
As is customary in the lending business, the Company experienced some loan
losses during the year. The risk of loss varies depending on the type of loan
granted and the creditworthiness of the borrower. The degree of perceived risk
is addressed during the structure of the loan. The Company attempts to minimize
its credit risk exposure through use of thorough approval procedures and a
comprehensive loan application.
The Company maintains a program of systematic review of its existing loans.
Loans are graded for their overall quality. The Company's management determines
which loans require further monitoring and supervision. These loans are
segregated for periodic review. The Company's Loan Committee reviews any loans
designated as 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 under the contractual terms of the loan agreement.
Factors considered by management in determining impairment include, payment
status, collateral value, and the probability of collecting scheduled principal
and interest payments. Loans that experience insignificant payment delays or
payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis. When determining the possibility of impairment, management
considers the circumstances surrounding the loan and the borrower, including the
length of the delay, the reasons for the delay, the borrower's prior payment
record and the amount of the shortfall in relation to the principal and interest
owed. The Company uses the fair value of collateral method to measure
impairment. Impairment is measured on a loan by loan basis for all loans in the
portfolio except for the securitized loans, which are collectively evaluated for
impairment.
21
The recorded investment in loans that are considered to be impaired :
December 31, 2000 1999 1998
------------ ------------ -----------
Impaired loans without
specific valuation allowances $ 564,662 $ 3,250,576 $4,450,345
Impaired loans with
specific valuation allowances 3,531,408 1,402,469 813,652
Specific valuation allowances
allocated to impaired loans (1,206,706) (1,038,519) (464,336)
------------ ------------ -----------
Impaired loans, net $ 2,889,364 $ 3,614,526 $4,799,661
============ ============ ===========
Average investment in impaired loans $ 4,676,705 $ 5,119,852 $4,009,400
============ ============ ===========
Interest income recognized on impaired loans $ 386,704 $ 243,913 $ 288,607
============ ============ ===========
It is the Company's policy to place a loan on nonaccrual status when the loan
payment is 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.
The Company classifies 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 loan to facilitate loan repayment. A troubled
loan that is restructured would generally be considered impaired. The balance of
impaired loans disclosed above includes all troubled debt restructured loans
that, as of December 31, 2000, 1999, and 1998 are considered impaired.
The following schedule reflects recorded investment in certain types of loans:
December 31,
---------- ---------- ----------
(Dollars rounded to thousands) 2000 1999 1998
---------- ---------- ----------
Nonaccrual loans $2,095,000 $3,091,000 $2,971,000
Troubled debt restructured loans, gross $ 615,000 $ 656,000 $1,313,000
Interest foregone on nonaccrual loans
And troubled debt restructuring outstanding $ 592,000 $1,585,000 $ 414,000
Loans 30 through 90 days past due with interest accruing $4,277,000 $2,550,000 $ 678,000
The Company charges off that portion of any loan which management considers to
represent a loss. A loan is generally considered to represent a loss when any
of the following events have occurred; a loan balance greater than the
collateral value, 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.
22
The following table summarizes the Company's loan loss experience for the
periods indicated:
Year Ended December 31, 2000 1999 1998
(Dollars rounded to thousands) : ------------- ------------- -------------
Average gross loans, held for investment $297,574,000 $260,709,000 $149,690,000
------------- ------------- -------------
Gross loans at end of year, held for
Investment 302,476,000 297,616,000 190,804,000
------------- ------------- -------------
Loans charged off 5,748,000 4,035,000 360,000
Recoveries of loans previously charged off 171,000 58,000 61,000
------------- ------------- -------------
Net loans charged off 5,577,000 3,977,000 299,000
------------- ------------- -------------
Allowance for loan losses 6,746,000 5,529,000 3,374,000
------------- ------------- -------------
Provisions for loan losses 6,794,000 6,133,000 1,760,000
------------- ------------- -------------
Ratios:
Net loan charge-offs to average loans 1.9% 1.5% 0.2%
Net loan charge-offs to loans at end of period 1.8% 1.3% 0.2%
Allowance for loan losses to average loans 2.3% 2.1% 2.3%
Allowance for loan losses to loans
held for investment at end of period 2.2% 1.9% 1.8%
Net loan charge-offs to allowance
for loan losses at end of period 82.7% 71.9% 8.9%
Net loan charge-offs to provision for loan losses 82.1% 64.8% 17.0%
The Company's allowance for loan losses is maintained at a level believed
adequate by management to absorb known and inherent probable losses on existing
loans. A provision for loan losses is charged to expense. The allowance is
charged for losses when management believes that full recovery on the loan is
unlikely. Subsequent recoveries, if any, are credited to the allowance.
Management's determination of the adequacy of the allowance is based on periodic
evaluations of the loan portfolio, which take into consideration such factors as
changes in the growth, size and composition of the loan portfolio, overall
portfolio quality, review of specific problem loans, collateral, guarantees and
economic conditions that may affect the borrowers' ability to pay and and/or the
value of the underlying collateral. These estimates depend on the outcome of
future events and, therefore, contain inherent uncertainties.
At December 31, 2000, 1999, and 1998, the allowance was 2.2%, 1.9%, and 1.8%
resepectively, of the gross loans held for investment. Although the current
level of the allowance is deemed adequate by management, future provisions will
be subject to review of current 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 an adjustment. Management
believes the level of the allowance for loan losses as of December 31, 2000, is
adequate to absorb future losses; however, changes in the local economy, the
ability of borrowers to repay amounts borrowed and other factors may result in
the need to increase the allowance through charges to earnings.
23
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:
Year Ended December 31, -------------------------------
(Dollars in thousands) 2000 1999 1998
--------- --------- ---------
Interest-earning assets:
Time deposits in other financial institutions:
Average outstanding $ 1,654 $ 703 $ 1,099
Average yield 6.8% 6.7% 6.0%
Interest income $ 113 $ 47 $ 66
Federal funds sold:
Average outstanding $ 22,833 $ 19,287 $ 8,161
Average yield 6.2% 5.2% 5.0%
Interest income $ 1,405 $ 1,008 $ 411
Investment securities:
Average outstanding $ 7,371 $ 8,159 $ 6,470
Average yield 6.8% 5.4% 0.8%
Interest income $ 498 $ 442 $ 52
Loans:
Average outstanding $202,551 $244,719 $117,977
Average yield 11.0% 13.1% 12.1%
Interest income $ 22,348 $ 32,065 $ 14,311
Securitized Loans:
Average outstanding $174,245 $156,900 $ 80,231
Average yield 15.7% 9.5% 0.5%
Interest income $ 27,417 $ 14,933 $ 440
Total interest-earning assets:
Average outstanding $408,654 $429,768 $213,938
Average yield 12.7% 11.3% 7.1%
Interest income $ 51,781 $ 48,495 $ 15,280
24
Interest-bearing liabilities:
Interest-bearing demand deposits:
Average outstanding $ 23,548 $ 17,975 $ 6,385
Average yield 3.4% 3.2% 7.9%
Interest expense $ 790 $ 576 $ 502
Savings deposits:
Average outstanding $ 23,254 $ 23,776 $ 22,906
Average yield 3.1% 3.7% 2.1%
Interest expense $ 712 $ 884 $ 488
Time certificates of deposit:
Average outstanding $164,569 $198,730 $ 80,354
Average yield 6.0% 6.9% 5.9%
Interest expense $ 9,832 $ 13,620 $ 4,732
Federal funds purchased:
Average outstanding $ 287 $ 844 $ 1,479
Average yield 6.6% 5.2% 5.7%
Interest expense $ 19 $ 44 $ 85
Bonds Payable:
Average outstanding $151,126 $144,311 $ 6,372
Average yield 9.4% 6.9% 8.0%
Interest expense $ 14,161 $ 9,938 $ 510
Other borrowings:
Average outstanding $ 5,795 $ 1,128 $ -
Average yield 9.4% 7.4% -
Interest expense $ 546 $ 83 $ -
Total interest-bearing liabilities:
Average outstanding $368,579 $386,764 $117,496
Average yield 7.1% 6.5% 5.4%
Interest Expense $ 26,060 $ 25,145 $ 6,317
Net interest income $ 25,721 $ 23,350 $ 8,963
Average net interest margin
On interest-earning assets 6.3% 5.4% 4.2%
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, 2000 and 1999 was 37% and 38% respectively, based on liquid assets.
Liquid assets consist 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.
When the Company has more funds than it needs for its reserve requirements or
short-term liquidity needs, the Company increases its securities investments or
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.
25
Deposits
- --------
The following table shows the Company's average deposits for each of the periods
indicated below, based upon average daily balances:
Year Ended December 31, 2000 1999 1998
------------------- ------------------- -------------------
Average Percent Average Percent Average Percent
-------- -------- --------
(Dollars in thousands) Balance of Total Balance Of Total Balance of Total
-------- --------- -------- --------- -------- ---------
Noninterest-bearing demand $ 30,381 12.6% $ 24,761 9.3% $ 20,396 15.7%
Interest-bearing demand 23,548 9.7% 17,975 6.8% 6,385 4.9%
Savings 23,254 9.6% 23,776 9.0% 22,906 17.6%
TCDs of $100,000 or more 78,342 32.4% 93,668 35.3% 30,338 23.3%
Other TCDs 86,227 35.7% 105,062 39.6% 50,016 38.5%
Total Deposits $241,752 100.0% $265,242 100.0% $130,041 100.0%
The maturities of time certificates of deposit ("TCDs"):
December 31, 2000 1999
------------------------- ---------------------
TCD's over TCDs over
(Dollars in thousands) $100,000 Other TCD's $100,000 Other TCDs
------------------------------------------------
Less than three months $ 37,299 $ 30,396 $ 60,353 $ 64,553
Over three months through six months 19,389 13,819 31,638 46,955
Over six months through twelve months 19,624 18,772 7,142 22,588
Over twelve months through five years 331 1,717 1,624 6,056
----------- ------------ -------- -----------
Total $ 76,643 $ 64,704 $100,757 $ 140,152
=========== ============ ======== ===========
While the deposits of the Company may fluctuate up and down with local and
national economic conditions, management of the Company does not believe that
the change in deposits or the business of the Company in general is 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,
quarterly.
Year 2000
- ----------
The Company had in place a plan of action designed to minimize the risk of the
year 2000 event which included 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 incurred no additional year 2000
related costs as of December 31, 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, the FDIC, and to facilitate the conduct of sound monetary policy.
In furtherance of these goals, Congress and the states have created several
largely autonomous regulatory agencies and enacted numerous laws that govern
banks, bank holding companies, and the banking industry. Consequently, the
Company's growth and earnings performance, as well as those of Goleta and
Palomar collectively, the "Banking Subsidiaries" herein referred to as "Banking
Subsidiaries", may 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:
26
- the Board of Governors of the FRB;
- the FDIC;
- the OCC; and
- the California Department of Financial Institutions herein
referred to as the "DFI".
Goleta National Bank, subsidiary of the Company is currently under an agreement
with the OCC as discussed previously in the capital resources section of this
report.
The system of supervision and regulation applicable to the Company and the
Banking Subsidiaries governs most aspects of their business, including:
- the scope of permissible business activities;
- investments;
- reserves that must be maintained against deposits;
- capital levels that must be maintained;
- the nature and amount of collateral that may be taken to secure
loans;
- the establishment of new branches;
- mergers and consolidations with other financial institutions; and
- the payment of dividends
From time to time legislation is 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 FRB on deposits by
depository institutions;
- the phasing-out of the restrictions on the amount of interest
which financial institutions may pay on certain types of
accounts; and
- the authorization of various types of new deposit accounts, such
as "NOW" accounts, "Money Market Deposit" accounts and "Super
NOW" accounts, designed to be competitive with money market
mutual funds and other types of accounts and services offered by
various financial and non-financial institutions.
The lending authority and permissible activities of certain non-bank financial
institutions such as savings and loan associations and credit unions have been
expanded, and federal regulators have been given increased enforcement
authority. These laws have generally had the effect of altering competitive
relationships existing among financial institutions, reducing the historical
distinctions between the services offered by banks, savings and loan
associations and other financial institutions, and increasing the cost of funds
to banks and other depository institutions.
The following discussion of statutes and regulations affecting banks is only a
summary, does not purport to be complete, and is qualified in its entirety by
reference to the actual statutes and regulations. No assurance can be given
that the statutes and regulations will not change in the future. Moreover, any
changes may have a material effect on our business.
27
Supervision and Regulation - The Company
- ---------------------------------------------
General
- -------
The Company, as a bank holding company registered under the Bank Holding Company
Act of 1956, as amended herein referred to 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 the Banking 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 DFI herein referred to as 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 the Banking
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, the Banking
Subsidiaries. However, regulatory constraints may restrict or totally preclude
its Banking Subsidiaries from paying dividends to the Company.
Regarding Goleta, the Company is entitled to receive dividends when and as
declared by Goleta's Board of Directors, out of funds legally available for
dividends, as specified and limited by the OCC's regulations. Pursuant to the
OCC's regulations, funds available for a national bank's dividends are
restricted to the lesser of the bank's: (i) retained earnings; or (ii) net
income for the current and past two fiscal years (less any dividends paid during
that period), unless approved by the OCC. Furthermore, if the OCC determines
that a dividend would cause a bank's capital to be impaired or that payment
would cause it to be undercapitalized, the OCC can prohibit payment of a
dividend notwithstanding that funds are legally available.
Regarding Palomar, the California Financial Code restricts the payment of
dividends by California-chartered banks. Funds available for paying cash
dividends is limited to the lesser of retained earnings or net income for the
last three fiscal years, reduced by any other distributions to shareholders.
Also, under certain circumstances, dividends may be paid with the prior approval
of the Commissioner. However, if the Commissioner determines that paying a
dividend would be unsafe or unsound, notwithstanding that funds are legally
available, the Commissioner can prohibit the bank from paying a dividend.
Since the Banking Subsidiaries are FDIC insured institutions, it is also
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, thus, prohibit
those 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 Federal Reserve Act herein referred to as the "FRA", as amended.
Pursuant thereto, loans by the Banking Subsidiaries to affiliates, investments
by the Banking Subsidiaries in affiliates' stock, and taking affiliates' stock
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. Specifically, a bank and its
subsidiaries generally may not purchase from an affiliate a low-quality asset,
as defined in the FRA. Such restrictions also prevent a bank holding company
and its other affiliates from borrowing from a banking subsidiary of the bank
holding company unless the loans are secured by marketable collateral of
designated amounts. The Company and 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 of the
Banking Subsidiaries - Recent Legislation" herein.)
28
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 United States,
general obligations of states and their political subdivisions,
and other obligations authorized for state member banks under
federal law.
Generally, the BHCA does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
29
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 d
In late 1999, the Gramm-Leach-Bliley Act herein referred to as the "GLB Act",
was enacted. 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 herein referred to as "FHC", can engage in a
full range of financial activities, including banking, insurance, and securities
activities, as well as merchant banking and additional activities that are
beyond those traditionally permitted for bank holding companies. Moreover,
various non-bank financial service providers who were previously prohibited from
engaging in banking can now acquire banks while also offering services such as
securities underwriting and underwriting and brokering insurance products. The
GLB Act also expands passive investment activities by FHCs, permitting them to
indirectly invest in any type of company, financial or non-financial, through
merchant banking activities and insurance company affiliations. (See
"Supervision and Regulation of the Banking Subsidiaries - Recent Legislation"
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 of the Banking Subsidiaries - Risk-Based Capital Guidelines"
herein.), assign various risk percentages to different categories of assets, and
capital is measured as a percentage of those risk assets. Under the terms of
the guidelines, bank holding companies are expected to meet capital adequacy
guidelines based both on total risk assets and on total assets, without regard
to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will
be required if warranted by the particular circumstances or risk profiles of
individual organizations. For example, the FRB's capital guidelines contemplate
that additional capital may be required to take adequate account of, among other
things, interest rate risk, the risks posed by concentrations of credit, risks
associated nontraditional banking activities or securities trading activities.
Moreover, any banking organization experiencing or anticipating significant
growth or expansion into new activities, particularly under the expanded powers
of the GLB Act, may be expected to maintain capital ratios, including tangible
capital positions, well above the minimum levels.
Limitations on Dividend Payments
- -----------------------------------
As a California corporation, the Company's ability to pay dividends is subject
to the dividend limitations of the California Corporations Code herein referred
to as the "CCC". Section 500 of the CCC allows the Company to pay a dividend to
its shareholders only to the extent that the Company has retained earnings and,
after the dividend, the Company's:
30
- 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, such as by borrowing, that weaken the bank holding company's
financial health or its ability to act as a source of financial strength to its
subsidiary banks. The FRB also possesses enforcement powers over bank holding
companies and their non-bank subsidiaries to prevent or remedy actions that
represent unsafe or unsound practic