SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 2001
Commission File Number: 0-24802
MONTEREY BAY BANCORP, INC.
(Exact Name Of Registrant As Specified In Its Charter)
DELAWARE 77-0381362
(State Or Other Jurisdiction Of (I.R.S. Employer Identification Number)
Incorporation Or Organization)
567 Auto Center Drive, Watsonville, California 95076
(Address Of Principal Executive Offices)(Zip Code)
(831) 768 - 4800
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value per share
(Title Of Class)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, 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. [ ]
The aggregate market value of the Common Stock held by "non-affiliates"
of the registrant, based upon the closing sale price of its Common Stock on
March 4, 2002, as quoted on the Nasdaq National Market System, was approximately
$32,562,000. Shares of common stock held by each officer, director, and holder
of 5% or more of the outstanding Common Stock have been excluded in that such
persons or entities may be deemed to be affiliates. Such determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
The registrant had 3,483,718 shares of Common Stock outstanding as of
March 20, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2002 Annual Meeting
of Stockholders to be filed within 120 days of the fiscal year ended December
31, 2001 are incorporated by reference into Part III of this Form 10-K.
1
INDEX
PAGE
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PART I
Item 1. Business............................................................................................3
Item 2. Properties.........................................................................................66
Item 3. Legal Proceedings..................................................................................67
Item 4. Submission of Matters to a Vote of Security Holders................................................67
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..............................67
Item 6. Selected Financial Data............................................................................68
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..............70
Item 7a. Quantitative and Qualitative Disclosures About Market Risk.........................................96
Item 8. Financial Statements and Supplementary Data.......................................................100
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..............147
PART III
Item 10. Directors and Executive Officers of the Registrant................................................147
Item 11. Executive Compensation............................................................................147
Item 12. Security Ownership of Certain Beneficial Owners and Management....................................147
Item 13. Certain Relationships and Related Transactions....................................................147
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................148
SIGNATURES..................................................................................................150
2
PART I
Discussions of certain matters in this Annual Report on Form 10-K may
constitute forward-looking statements within the meaning of the Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities and
Exchange Act of 1934, as amended (the "Exchange Act"), and as such, may involve
risks and uncertainties. Forward-looking statements, which are based on certain
assumptions and describe future plans, strategies, and expectations, are
generally identifiable by the use of words or phrases such as "believe",
"expect", "intend", "anticipate", "estimate", "project", "forecast", "may
increase", "may fluctuate", "may improve" and similar expressions or future or
conditional verbs such as "will", "should", "would", and "could". These
forward-looking statements relate to, among other things, expectations of the
business environment in which Monterey Bay Bancorp, Inc. operates, opportunities
and expectations regarding technologies, anticipated performance or
contributions from new and existing employees, projections of future
performance, potential future credit experience, possible changes in laws and
regulations, potential risks and benefits arising from the implementation of the
Company's strategic and tactical plans, perceived opportunities in the market,
potential actions of significant stockholders and investment banking firms, the
potential impact of past and possible future terrorist actions upon consumer
confidence, income, and spending, and statements regarding the Company's mission
and vision. The Company's actual results, performance, and achievements may
differ materially from the results, performance, and achievements expressed or
implied in such forward-looking statements due to a wide range of factors. For a
discussion of some of the factors that might cause such a difference, including,
but not limited to, changes in interest rates, general economic conditions,
technology, legislative and regulatory changes, monetary and fiscal policies of
the US Government, US Treasury, and Federal Reserve, real estate valuations, and
competition in the financial services industry, see "Item 1. Business - Risk
Factors That May Affect Future Results." These factors should be considered in
evaluating the forward-looking statements, and undue reliance should not be
placed on such statements. The Company does not undertake, and specifically
disclaims any obligation, to update any forward-looking statements to reflect
occurrences or unanticipated events or circumstances after the date of such
statements.
Item 1. Business.
------------------
General
Monterey Bay Bancorp, Inc. (referred to herein on an unconsolidated
basis as "MBBC" and on a consolidated basis as the "Company") is a unitary
savings and loan holding company incorporated in 1994 under the laws of the
state of Delaware. MBBC currently maintains a single subsidiary company,
Monterey Bay Bank (the "Bank"), formerly Watsonville Federal Savings and Loan
Association. MBBC was organized as the holding company for the Bank in
connection with the Bank's conversion from the mutual to stock form of ownership
in 1995.
At December 31, 2001, the Company had $537.4 million in total assets,
$466.6 million in net loans receivable, and $432.3 million in total deposits.
The Company is subject to regulation by the Office of Thrift Supervision
("OTS"), the Federal Deposit Insurance Corporation ("FDIC"), and the Securities
and Exchange Commission ("SEC"). The principal executive offices of the Company
and the Bank are located at 567 Auto Center Drive, Watsonville, California,
95076, telephone number (831) 768 - 4800, facsimile number (831) 722 - 6794. The
Company may also be contacted via electronic mail at: INFO@MONTEREYBAYBANK.COM.
Information concerning the Company may be accessed at the following Internet
site: WWW.MONTEREYBAYBANK.COM. This Internet site is not a part of this Annual
report on Form 10-K. The Bank is a member of the Federal Home Loan Bank of San
Francisco ("FHLB") and its deposits are insured by the FDIC to the maximum
extent permitted by law.
The Company conducts business from eight branch offices, two stand
alone ATM sites, and its administrative headquarters buildings. In addition, the
Company supports its customers through Internet Banking, 24 hour bilingual
telephone banking, courier service, mail, and ATM access through 11 owned ATM's
and an array of ATM networks including STAR, CIRRUS, and PLUS.
3
Through its network of banking offices, the Bank emphasizes
personalized service focused upon three primary markets: households,
professionals, and businesses. The Bank offers a wide complement of lending
products, including:
o a broad array of residential mortgage products, both fixed and
adjustable rate
o consumer loans, including home equity lines of credit and overdraft
lines of credit
o specialized financing programs to support community development
o mortgages for multifamily real estate
o commercial and industrial real estate loans
o construction lending for single family residences, apartment buildings,
and commercial real estate
o commercial loans to businesses, including both revolving lines of
credit and term loans
The Bank also provides an extensive selection of deposit instruments.
These include:
o multiple checking products for both personal and business accounts,
with imaged statements available
o various savings accounts
o tiered money market accounts offering a variety of access methods
o tax qualified deposit accounts (e.g. IRA's)
o a broad array of certificate of deposit products
Through its wholly-owned subsidiary, Portola Investment Corporation
("Portola"), the Bank provides, on an agency basis, life insurance (term, whole
life, and universal life insurance), fire insurance, and a wide selection of
non-FDIC insured investment products including:
o fixed annuities
o variable annuities
o an extensive inventory of mutual funds
o individual fixed income and equity securities
Please see "Subsidiary Activities" for additional information regarding business
activities by Portola.
The Bank also supports its customers by functioning as a federal tax
depository, selling and purchasing foreign banknotes, issuing debit cards,
providing domestic and international collection services, and supplying various
forms of electronic funds transfer.
The Company participates in the wholesale capital markets through the
management of its security portfolio and its use of various forms of wholesale
funding. The Company's security portfolio contains a variety of instruments,
including collateralized mortgage obligations ("CMO's"). The Company also
participates in the secondary market for loans as both a purchaser and a seller
of various types of loan products.
The Company's revenues are primarily derived from interest on its loan
and mortgage backed securities portfolios, interest and dividends on its
investment securities, and fee income associated with the provision of various
customer services. Interest paid on deposits and borrowings constitutes the
Company's largest type of expense. The Company's primary sources of funds are
deposits, principal and interest payments on its asset portfolios, and various
sources of wholesale borrowings including FHLB advances, federal funds
purchased, and securities sold under agreements to repurchase. The Company's
most significant operating expenditures are its staffing expenses and the costs
associated with maintaining its branch network.
Additional information concerning the Company's business is presented
under "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
4
Company Strategy
During the past several years, the Company has adopted and has been
implementing a business strategy of evolving away from its traditional savings
and loan roots toward a community commercial banking orientation. This business
strategy was selected:
o so that the Company might better and more completely address the
financial needs of the communities it serves
o because of the constrained financial returns associated with the
traditional thrift business of funding residential mortgage loans with
certificates of deposit for entities the size of the Bank
o due to the increasing commoditization of residential mortgages, spurred
by new technologies and revised business practices supported by Federal
Agencies such as the Federal National Mortgage Association ("FNMA" or
"Fannie Mae") and the Federal Home Loan Mortgage Corporation ("FHLMC"
or "Freddie Mac")
o to augment stockholder value, as the Company believes that successful
community commercial banks generally receive a more favorable valuation
in the capital markets than traditional savings and loans
o to develop more robust and recurring sources of income
The Company's community commercial banking strategy incorporates:
o a relationship based approach to customer service, marketing, and
pricing
o a focus on understanding the profile and objectives of the Company's
customers as a means to provide enhanced service while also supporting
credit quality
o a high level of community involvement and visibility by the Company,
its directors, and its employees
o a balance sheet profile presenting loan and deposit portfolios
diversified among multiple products
o a ratio of net loans to total assets of between 85.0% and 90.0%
o income property, construction, and business loans representing a
greater percentage of total loans than has been maintained in the past,
with a reduced concentration in residential mortgages
o a deposit mix with a greater percentage of transaction accounts than
has been maintained in the past, with a lower concentration of
certificates of deposit
o increasing fee income to a greater portion of total revenue than
historically generated
o utilizing new technologies to better meet the financial needs of
individuals, families, professionals, and businesses
As discussed below and throughout this Annual Report, the Company has achieved
progress in these regards over the past several years, including some particular
accomplishments in 2001.
5
In general, the Company's accomplishments in 2001 can be grouped into three
categories:
1. The successful resolution of certain historical issues that have
hindered the Company's progress with the strategic plan, including:
A. the conclusion of a lengthy arbitration proceeding with the
former President and Chief Operating Officer regarding
payments due to him under his employment agreements
B. the significant reduction, without loss, in the outstanding
balance of a pool of loans acquired in 1998 that presented a
credit profile less favorable than the Company's normal
underwriting criteria (see "Special Residential Loan Pool" and
Note 14 to the Consolidated Financial Statements)
C. the elimination in early 2002 of institution specific
regulatory capital requirements for the Bank imposed by the
OTS in early 2000 in response to the Special Residential Loan
Pool
D. the collection in full of several loans with significant
principal balances that were delinquent at December 31, 2000
2. The establishment of the human resource and technology foundations
necessary to successfully implement the Company's strategy, including:
A. a new core data processing system
B. the hiring of additional commercial business relationship
officers
C. the recruitment of veteran bankers to key positions at the
Company, including Chief Administrative Officer, Director of
Information Technology, Director of Community Relations, and
Controller
D. the introduction of new and the redesign of existing financial
products and services
3. The advancement of the Company along its strategic plan, including:
A. improved financial results, including record levels of assets,
loans, deposits, and stockholders' equity at December 31,
2001, combined with record annual net income for 2001
B. increased commercial business loans and the development of an
expanded commercial lending pipeline
C. implementation of various strategies designed to increase
stockholder value
While the market price of the Company's common stock appreciated
favorably in 2001, in part due to the above accomplishments, the Company's Board
of Directors and Management acknowledge that the Company has yet to deliver the
range of return on stockholders' equity produced by higher performing peer
financial institutions. Building on the achievements of 2001 to improve the
Company's return on stockholders' equity is a key objective for 2002.
Additional information regarding the Company's strategic plan and its
accomplishments in relation thereto is presented in the following paragraphs and
throughout this Annual Report.
6
Consistent with the strategic plan, the Company has endeavored to
reduce the level of relatively lower yielding, and often less interest rate
sensitive, residential mortgages in its loan portfolio. At December 31, 2001,
residential mortgage loans comprised 42.2% of total gross loans held for
investment. While this percentage increased from 37.8% at December 31, 2000, it
is lower than the 43.4% at June 30, 2001, 43.4% at December 31, 1999, and is
down significantly from 70.2% at the end of 1997, before the Company's adopted
its transformation strategy.
During the first half of 2001, the Company de-emphasized the
origination of construction loans and added significant amounts of residential
mortgages in response to the slowdown in the national economy, with associated
greater concerns for credit quality, and in order to position the Company to
benefit from the rapidly declining interest rate environment. By the fourth
quarter of 2001, the Company believed that the economy would likely commence
recovery some time in 2002 and that the declining interest rate environment was
nearing an end, with interest rates then at historically low levels. The Company
thus re-commenced actively pursuing a shift toward income property,
construction, and business loans by the end of 2001.
The Company's focus on non-residential lending led to the opening of a
loan production office in Los Angeles County in the first quarter of 2002. This
loan production office is managed by a veteran banker with significant
experience in Southern California, long-standing relationships with area
developers and property investors, and particular expertise in marketing and
underwriting construction and income property credits. The opening of this
office will also advance the geographic diversification of the Company's real
estate loan portfolio, which has been historically concentrated in the
California counties of Santa Cruz, Monterey, and Santa Clara.
At December 31, 2001, certificates of deposits constituted 56.4% of the
deposit portfolio, down from 60.0% at December 31, 2000 and 79.3% at the end of
1997. Certificates of deposit would have reflected a smaller percentage of the
deposit portfolio at December 31, 2001 if not for the Bank's acquiring an
additional net $5.0 million in certificates of deposit through the State of
California Time Deposit Program during 2001, whereby the State of California
makes deposits available to support reinvestment back into California
communities.
Over the past several years, the Company has emphasized checking and
money market accounts in its marketing, new product development, and advertising
as a means of cementing its relationship with its customers, decreasing its
relative cost of funds, and bolstering non-interest income. The Company plans to
introduce Internet banking for businesses in the first quarter of 2002,
complementing its successful consumer Internet banking product.
The Company's strategy of transitioning into more of a community
commercial bank also incorporates increasing the percentage of the Company's
total revenues generated from fees and service charges, as compared to net
interest income. In this regard, the Company has expanded its scope of fee based
services, altered its pricing, and enhanced the product line offered through
Portola.
In order to better serve professionals and businesses in the Company's
market area, new and additional commercial business relationship officers,
branch sales managers, and professional bankers were hired in 2001. These new
employees also enhanced the Company's capacity to better serve its consumer
base. The Company's employee mix also shifted in 2001 to reflect the adoption of
a current generation, internally operated core data processing system,
representing a significant change from the Company's prior external service
bureau environment. The new core data processing system is built upon a leading
relational database, is open architecture and client / server based, and
provides significantly greater customization and flexibility than the prior
legacy system. Employees added to the Company in 2001 included new data
processing professionals and a new Director of Information Technology with over
20 years of operations and technology experience in the banking industry.
In implementing its strategy, the Company also intends to enhance the
services provided to its consumer markets. In 2001, the Company introduced
electronic bill payment, bilingual telephone banking, and more highly tiered
deposit products whereby individuals can earn higher levels of interest by
increasing their balances. In 2002, the Company plans to add one or more
consumer relationship products, whereby individuals benefit from expanding their
overall relationship with the Company.
7
The Company intends to complement the new technology implemented in
2001 during the coming year with a new item processing environment, enhanced
customer statements, and various ancillary systems such as current generation
safe deposit box management software. In addition, the Company plans to actively
work with the vendor of its primary data processing system to add enhancements
to that software and to ensure that the Company is realizing the best
productivity and richest features of that system.
Throughout 2001, the Company maintained its commitment to support the
quality of life in the Greater Monterey Bay Area. Employees are encouraged to be
involved with local community and service organizations. A significant
contribution was made to advance post-secondary education, and other charitable
donations of funds or services were conducted throughout the year. The hiring of
a Director of Community Relations in 2001 further enhanced the Company's
visibility in the Greater Monterey Bay Area, with the Company's being
represented at many local chambers of commerce and Rotary organizations, in
addition to many special community, charity, and educational events.
A key aspect of the Company's business strategy is to enhance
stockholder value. The Company's efforts and achievements in this regard have
included:
o Since 1995, the Company has repurchased over 1.2 million of its common
shares. During the fourth quarter of 2001, the Company announced a new
stock repurchase program with an authorization to acquire an additional
114,035 shares. Under this program, five thousand shares were acquired
during the first quarter of 2002 at $16.25 per share.
o The Company's Directors elected to receive their retainer fees in
Company common stock during 2001.
o The Company's bylaws specify a minimum stock ownership requirement for
all Directors.
o A significant portion of the total compensation for the Company's
senior management is stock-based.
o In 2001, shares of the Company's stock were used in lieu of cash as
incentive compensation for various Bank middle management.
o In 2001, some members of the Bank's senior management volunteered to
accept Company stock in lieu of certain cash base and incentive
compensation.
o The Company's employee stock option plan provides that stock options
are issued at 110% of the fair market value of the Company's stock on
the date of grant, versus the 100% level prevalent in the financial
services industry.
o Incentive stock options have been awarded to the vast majority of
managers in the Company, thus encouraging alignment of employee
interests with those of stockholders.
o Senior management change in control contracts have been modified to
present what the Company believes is a better balance between the need
to attract and retain well qualified employees and stockholder
interests.
o Following the events of September 11, 2001, trading and liquidity in
the Company's common stock was adversely impacted by the multiple
effects upon investment banking firms with New York City operations.
During the fourth quarter of 2001 and early 2002, the Company
successfully added several new market makers to enhance the liquidity
of the Company's common stock. In addition, the Company temporarily
lost equity analyst coverage following September 11, 2001. Coverage by
one equity analyst was reinstated in early 2002, and the Company
anticipates pursuing coverage by a second equity analyst later in 2002.
8
In addition, in early 2002, the Company established an expanded
relationship with an investment banking firm specializing in the financial
services industry as a means of:
o supporting a number of initiatives aimed at increasing stockholder
value
o obtaining advice regarding balance sheet, interest rate risk, and
capital management
o acquiring expanded competitive information and market intelligence
o advising the Board of Directors and Management regarding trends, risks,
and tactical and strategic opportunities within the financial services
industry
The implementation of the Company's strategy presents various costs and
risks. In general, the Company incurred operating and capital expenses in
advance of associated revenues, as the human and technology resources necessary
to implement the strategic plan must be in place before new sales can be
generated. The amount of change concomitant with this strategy, particularly
given the relatively rapid pace of implementation undertaken by the Company,
presents significant execution risks. Some of these execution risks include
exposure in the implementation of new technology and the greater credit risk
inherent in consumer and commercial (versus mortgage) lending. The Company has
endeavored to mitigate these risks, in part, by recruiting the aforementioned
experienced banking professionals and by the hiring of a substantially new
senior management team over the past 18 months.
The new senior management team contains individuals with significant
experience in credit administration, operations and regulatory compliance, and
commercial banking. These senior officers also have prior experience in tactical
and strategic transactions designed to maximize stockholder value. The Company
has also sought to mitigate the risks inherent in its strategic plan by hiring
certain consultants to provide technical assistance and asset quality review.
The Company's Board of Directors has also evolved over the past two
years, with new directors adding skills in corporate governance, an appreciation
of the importance of advancing stockholder value, and the capacity to refer
local business to the Company.
In 2002, the Company intends to continue pursuing the strategy outlined
above. Furthermore, the Company plans to explore avenues for further growth in
product diversification and market share, including the purchase of banking
branches in the Greater Monterey Bay Area or the establishment of one or more de
novo branch offices. During the first quarter of 2002, the Company opened a
stand alone loan production office in Los Angeles. Management believes that the
continued consolidation occurring in the financial services industry may present
opportunities to acquire personnel, branches, and customers from institutions
being sold.
Susan F. Grill resigned from her position as Director of Retail Banking
for Monterey Bay Bank in February, 2002. Ms. Grill's responsibilities were
divided among other members of the Bank's management team, until a successor is
appointed.
Market Area and Competition
Market Area. The Bank is a community-oriented financial institution
that originates residential, multifamily, construction, commercial real estate,
consumer, and business loans within its market area. The Bank's deposit
gathering and lending markets are concentrated primarily in the communities
surrounding its full service offices in the counties of Santa Cruz, Monterey,
and Santa Clara in Central California. In 2001, the Company purchased real
estate loans secured by California real property primarily located between the
San Francisco Bay Area and San Diego as a means of geographically diversifying
its loan portfolio and in conjunction with its asset / liability management
program. The Company conducts only a minor volume of business outside the State
of California.
9
The economy in the Company's primary market areas in Santa Cruz,
Monterey, and Santa Clara Counties has historically been primarily agricultural.
However, in recent years, other economic segments have assumed a larger portion
of total business activity, caused in part by the continuing southward expansion
of the San Francisco Bay Area in general and the technology focused Silicon
Valley community in particular. These newer and in some cases relatively rapidly
expanding segments include:
o an increasing professional presence, both in commercial property and in
residential housing, as the technology companies expand southward,
primarily down the Highway 101 corridor
o light manufacturing
o post-secondary education
o tourism and marine biology, especially in the coastal communities on
Monterey Bay
The Company's primary market areas were adversely impacted during
2001 by:
o the national recession, with an increase in local unemployment rates
o the difficulties experienced by the technology industry following the
significant reduction in the NASDAQ Index in 2000 and 2001 and
constrained venture capital financing
o the 2001 mid-summer State of California energy crisis, with continuing
effects upon the State's budget
o the impacts of the events of September 11, 2001, especially reduced
travel and tourism, which had a particular negative effect upon the
hospitality industry
The above factors led to a slowdown in the demand for real estate,
which in turn moderated the pace of real estate price appreciation in the
Company's primary market areas in 2001 versus the recent past. Certain
communities within the Company's primary market area exhibited a slight
softening of real estate prices in 2001. The above factors were, however,
partially offset by historically low interest rates, limited new construction,
and increasing demand for real estate caused by a growing population. The
largest impact on real estate prices stemming from the above factors was for
very high end residential properties ($1.5 million and above), which the Company
serves but does not target market. Home sale results in early 2002 in the
Company's primary market area indicated an increasing level of activity versus
the same period in 2001. The Company did not foreclose on any real estate
collateral in 2001.
The California energy crisis in mid 2001 had only limited near term
impact, as the State was able to acquire sufficient energy to avoid recurring
and widespread blackouts, consumers and businesses adopted effective
conservation measures, and the economic recession curbed demand for power.
However, businesses that are relatively energy intensive remain concerned about
the long term supply and cost of energy in California, a situation exacerbated
by the bankruptcy of the largest power utility in the Company's market area.
Consumers experiencing higher energy bills also have less disposable income to
spend in the local economy. The energy crisis continues to impact the budget for
the State of California, as certain long term supply contracts were signed by
the State at prices that were above the current market at the end of 2001. To
the extent that the California energy situation continues to affect the State's
budget, spending, and potential level and manner of taxation, the Company will
continue to be impacted.
The Company has taken steps to reduce its energy consumption, including
a reduction in exterior lighting and electric signage, reduced interior lighting
in certain areas, and proactive efforts to power off inactive computers and
other machines. In 2001, the Company installed a larger natural gas fueled
generator at its administrative headquarters that produces sufficient
electricity to power the entire building, including the core computer network,
in the event of an external electricity reduction or outage.
10
Throughout 2001, many large national corporations with operations in
Central California announced significant layoffs. In addition, many local
technology companies shut down due to a combination of weak (or negative)
earnings, limited liquidity, or a lack of access to additional capital. While
the demand for labor in Central California slowed in 2001 versus the immediate
preceding years, unemployment remained moderate by historical standards.
Unlike 1999 and the first half of 2000, the local economy did not
materially benefit in 2001 from a significant rise in stock and stock option
wealth among consumers, including workers in the Silicon Valley area of Santa
Clara County.
Lease rates for many types of commercial real estate declined
significantly in the San Francisco Bay Area during 2001, reversing strong rises
in 1999 and early 2000 fueled by the Internet boom. While the Company originates
and purchases commercial real estate loans in the San Francisco Bay Area,
Management did not generally pursue loans based upon the high lease rates and
market values during 1999 and 2000. The Company had no classified loans at
December 31, 2001 that were secured by commercial real estate in the San
Francisco Bay Area.
Vacancy rates increased and average effective room rates declined for
California hotels and motels in 2001, with the trend worsening after the events
of September 11, 2001. As subsequently discussed, the Company has a
concentration in real estate loans secured by hotels and motels, which the
Company intends to reduce in 2002.
The economy in some segments of the Company's primary market area
remains seasonal. These segments include tourism and agriculture, both of which
slow during the winter months.
Competition. The banking and financial services business in California
generally, and in the Bank's market areas specifically, is highly competitive.
The increasingly competitive environment is a result of many factors including,
but not limited to:
o the rise of the Internet, whereby the Bank must more frequently compete
with remote entities soliciting customers in its primary market areas
via web based advertising and product delivery, especially for
certificates of deposit and residential mortgages
o the significant consolidation among financial institutions which has
occurred over the past several years, resulting in a number of
substantially larger competitors with greater resources than the
Company
o the increasing integration among commercial banks, insurance companies,
securities brokers, and investment banks
o the continued growth and market share of non-bank financial services
providers that often specialize in a single product line such as credit
cards or residential mortgages
o the introduction of new technologies which may bypass the traditional
banking system for funds settlement
o the addition of bank subsidiaries by firms not historically in the
financial services business, but with significant consumer reach
o the continued tax relief enjoyed by credit unions in serving the
consumer market combined with a trend toward loosening restrictions on
credit union activities and requirements for credit union membership
The Company competes for loans, deposits, fee based products, and
customers for financial services with commercial banks, savings and loans,
credit unions, thrift and loans, mortgage bankers, securities and brokerage
companies, insurance firms, finance companies, mutual funds, and other non-bank
financial services providers. Many of these competitors are much larger than the
Bank in total assets, market reach, and capitalization; and enjoy greater access
to capital markets and can offer a broader array of products and services than
the Bank presently markets.
11
Two banks, each with several billion dollars in assets and more
diversified revenue sources, present particular competition to the Company. Both
these banks follow the "super community banking" business model, whereby
multiple community banks are owned and operated under a unified umbrella
organization. Both of these firms have expanded rapidly in recent years and have
acquired community banks in the Company's primary market areas. These firms have
comparatively highly valued common stock and access to far greater amounts of
capital than the Company. These firms also benefit from greater economies of
scale than the Company. One of these banks recently announced the acquisition
and pending consolidation of two branches that compete directly with the
Company's offices in Watsonville and Monterey, California. Acquisitions by these
two banks have resulted in the Company's being the largest truly local financial
institution in many of its markets.
The Company also competes increasingly frequently with another
community bank, which has over the past year opened de novo offices in some of
the same communities served by the Company. In 2001, the Company experienced
particular competition for retail deposits from the three largest thrifts that
operate in California. These large thrifts benefited from the declining interest
rate environment, with expanding net interest margins resulting from their net
liability sensitivity. These thrifts used their expanding margins to bid up
retail deposit rates in an effort to build market share.
In order to compete with other financial services providers, the
Company relies upon:
o local community involvement, contributions, and visibility
o personal service and the resulting personal relationships of its staff
and customers
o referrals from satisfied customers, employees, and directors
o the development and sale of specialized products and services tailored
to meet its customers' needs
o local and fast decision making
In addition, Management considers the Company's reputation for
financial strength and competitive services, as developed over 76 years of local
Company history, as a competitive advantage in attracting and retaining
customers within its primary market area.
Risk Factors That May Affect Future Results
The following discusses certain factors that may affect the Company's
financial results and operations and should be considered in evaluating the
Company. The two general categories of greatest risk faced by the Company are
credit risk and interest rate risk, both of which are inherent to community
banking.
Ability Of The Company To Execute Its Business Strategy. The financial
performance and profitability of the Company will depend, in large part, on its
ability to favorably execute its business strategy in converting from a
relatively traditional savings & loan to a community based financial services
firm. This evolution entails risks in, among other areas, technology
implementation, market segmentation, brand identification, banking operations,
and capital and human resource investments. Accordingly, there can be no
assurance that the Company will be successful in its business strategy.
Economic Conditions And Geographic Concentration. The Company's
operations are located in Central and Northern California and are concentrated
in Santa Cruz, Monterey, and Santa Clara Counties. Although Management has
diversified the Company's loan portfolio into other California counties, the
majority of the Company's credits remain concentrated in the three primary
counties. As a result of this geographic concentration, the Company's results
depend largely upon economic and real estate market conditions in these areas.
Deterioration in economic or real estate market conditions in the Company's
primary market areas could have a material adverse impact on the quality of the
Company's loan portfolio, the demand for its products and services, and its
financial condition and results of operations. In addition, because the Company
does not require earthquake insurance in conjunction with its real estate
lending, an earthquake with an epicenter in or near the Company's primary market
areas could also significantly adversely impact the Company's financial
condition and results of operations.
12
Interest Rates. By nature, all financial institutions are impacted by
changing interest rates, due to the impact of such upon:
o the demand for new loans
o prepayment speeds experienced on various asset classes, particularly
mortgage backed securities and residential loans
o credit profiles of existing borrowers
o rates received on loans and securities
o rates paid on deposits and borrowings
As presented under "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and under "Item 7a. Quantitative and
Qualitative Disclosure of Market Risk", the Company is financially exposed to
parallel shifts in general market interest rates, changes in the relative
pricing of the term structure of general market interest rates, and relative
credit spreads. Therefore, significant fluctuations in interest rates may
present an adverse effect upon the Company's financial condition and results of
operations.
Government Regulation And Monetary Policy. The financial services
industry is subject to extensive federal and state supervision and regulation.
Significant new laws, changes in existing laws, or repeals of present laws could
cause the Company's financial results to materially differ from past results.
Further, federal monetary policy, particularly as implemented through the Board
of Governors of the Federal Reserve System, significantly affects credit
conditions for the Company, and a material change in these conditions could
present an adverse impact on the Company's financial condition and results of
operations.
Competition. The financial services business in the Company's market
areas is highly competitive, and is becoming more so due to technological
advances (particularly Internet-based financial services delivery), changes in
the regulatory environment, and the significant consolidation that has occurred
among financial services providers. Many of the Company's competitors are much
larger in total assets and market capitalization, enjoy greater liquidity in
their equity securities, have greater access to capital and funding, and offer a
broader array of financial products and services. In light of this environment,
there can be no assurance that the Company will be able to compete effectively.
The results of the Company may materially differ in future periods depending
upon the nature or level of competition.
Credit Quality. A significant source of risk arises from the
possibility that losses will be sustained because borrowers, guarantors, and
related parties may fail to perform in accordance with the terms of their loans.
The Company has adopted underwriting and credit monitoring procedures and credit
policies, including the establishment and review of the allowance for loan
losses, that Management believes are appropriate to control this risk by
assessing the likelihood of non performance, tracking loan performance, and
diversifying the credit portfolio. Such policies and procedures may not,
however, prevent unexpected losses that could have a material adverse effect on
the Company's financial condition or results of operations. Unexpected losses
may arise from a wide variety of specific or systemic factors, many of which are
beyond the Company's ability to predict, influence, and control.
State Of California Budget Crisis. In part due to the handling of the
energy crisis and also due to the onset of the national recession, the State of
California is currently facing a substantial budget deficit. A combination of
reductions in State provided services and increases in the level and nature of
taxation might result, which could present an unfavorable impact upon the
Company's business, financial condition, and results of operations. At December
31, 2001, the State of California maintained $19.0 million in deposits with the
Company. If the State were to withdraw these deposits, replacement funding would
likely be more expensive.
Technology Industry And Technological Change. The pace of economic
activity, the demand and pay rates for labor, and real estate valuations in many
of the Company's primary market areas are impacted by the technology industry. A
prolonged slowdown in the technology business would therefore likely have an
adverse impact on the Company's financial condition and results of operations.
New products and delivery mechanisms being developed as a result of new
technologies present the potential for bypassing the historic bank payments
settlement process. As such, the Company is exposed to various associated
financial risks.
13
Terrorism And The War On Terrorism. Tourism constitutes a significant
component of the economy in the Company's primary market areas. In addition, the
Company maintains a concentration of loans extended to the hospitality industry.
Should new terrorist actions or the continued war on terrorism continue to or
more dramatically curtail travel and tourism, the Company's financial condition
and results of operations could be significantly impacted.
Other Risks. From time to time, the Company details other risks with
respect to its business and financial results in its filings with the Securities
and Exchange Commission.
Lending Activities
General. The Company originates a wide variety of loan products. Loans
originated by the Company are subject to federal and state laws and regulations.
Interest rates charged by the Company on loans are affected by the demand for
such loans and the supply of money available for lending purposes and the rates
offered by competitors. These factors are, in turn, affected by, among other
things, economic conditions, monetary policies of the federal government,
including the Federal Reserve Board, and legislative tax policies. The Company
targets certain lending toward low to moderate income borrowers as part of its
commitment to serve its local communities.
At December 31, 2001, the Company's net loan portfolio held for
investment totaled $465.9 million. This represented the highest total in the
Company's history. The vast majority of this portfolio was associated with real
estate of various types. In 2001, real estate loan originations, including
funding commitments for construction loans, totaled $173.2 million and real
estate loan purchases, including funding commitments for construction loans,
totaled $60.2 million. Activity in 2001 was supported by an active mortgage
refinance market throughout most of the year, spurred by the eleven rate
decreases implemented by the Federal Reserve in 2001. Of the $60.2 million in
real estate loan purchases in 2001, $47.3 million occurred in the first half of
the year. All real estate loan purchases in the second half of the year were for
mortgages secured by non-residential properties, as the Company pursued its
targeted loan mix and sought more interest rate sensitive assets.
Net loans as a percentage of total assets increased from 80.6% at
December 31, 2000 to 86.8% at December 31, 2001. Allocating a greater percentage
of its total assets to loans is fundamental to the Company's strategies of
effectively supporting the financing needs of its local communities, increasing
its net interest margin, and effectively leveraging the Company's capital
position.
The Company accepts loan applications generated through brokers for
most of its product line. Broker referred loans are underwritten in the same
manner as direct originations. The Company encourages its employees to refer and
solicit loan business as an integral part of functioning as a community bank.
Employees receive various types of awards or commissions based upon the volume
and nature of business booked.
In purchasing individual loans or pools of loans, the Company
underwrites each loan in a manner similar to its internal originations. The
Company generally purchases income property loans on a servicing released basis
in order to facilitate more effective credit management and in order to acquaint
such borrowers with the other products and services offered by the Company. The
residential mortgages purchased by the Company in 2001 were substantially all
servicing retained by the seller.
The Company also pursues acquiring loan participations from and selling
loan participations to other California community banks and other financial
institutions. In acquiring participations, the Company underwrites each credit
in a manner similar to that followed for its own internal loan production. The
Company sells loan participations in order to diversify its credit risk and in
order to remain below its regulatory limitation for loans to one borrower. In
general, most of the Company's loan participations are for construction loans.
The Company requires title and hazard (fire, and, if applicable, flood)
insurance for all real estate loans. The Company does not require earthquake
insurance for real estate loans. More detailed information regarding the
Company's lending activity is included in the following paragraphs that present
activity by loan product category.
14
Residential One To Four Unit Mortgage Lending. The Company originates
fixed rate, adjustable rate, and hybrid (fixed for a period, and then
adjustable) mortgage loans secured by one to four family residential properties.
Adjustable rate mortgage loans have interest rates that adjust monthly,
semiannually, or annually and reprice based upon various indices, primarily the
11th FHLB District Cost of Funds Index ("COFI") or the US Treasury One Year
Constant Maturities Index ("1 Year CMT"). In 2002, the Company intends to
commence originating residential mortgages tied to the MTA index, which is
equivalent to the twelve month rolling average of the 1 Year CMT index. The MTA
index is utilized by a number of the Company's primary competitors and is often
preferred by consumers due to its limited volatility relative to the 1 Year CMT
index. The Company's hybrid and adjustable rate residential mortgages typically
contain various periodic and lifetime rate caps, and also lifetime rate floors.
The Company regularly adjusts its loan products to meet changing customer needs
and to respond to the marketplace.
The majority of loan originations are to existing or past customers and
members of the Bank's local communities. The Company also originates one to four
family residential construction loans for both owner occupants and developers /
contractors ("speculative construction loans"), and residential mortgages
secured by non-owner occupied one to four family properties acquired as an
investment by the borrower. The Company provides escrow (impounds) services as
requested by its customers and generally for those loans in excess of 80.0% loan
to value.
At December 31, 2001, the Company maintained $204.8 million in
residential permanent mortgages, representing 42.2% of gross loans held for
investment. This compares to $160.2 million in permanent residential mortgages a
year earlier, which then constituted 37.8% of gross loans held for investment.
In 2002, the Company plans to reduce the concentration of residential mortgages
in its loan portfolio in favor of other types of relatively higher yielding, and
often more interest rate sensitive, loans.
The Company generally sells its fixed rate residential production into
the secondary market on a servicing released basis. These sales are conducted as
part of the Company's asset / liability management strategy. The sales are
generally on a servicing released basis because the Company believes the
servicing is more valuable to high volume, low marginal cost servicers.
From time to time, based on its asset / liability strategy, the Company
purchases residential mortgage loans originated by others. In the first half of
2001, the Company purchased residential hybrid loans in order to take advantage
of the declining interest rate environment and in order to more effectively
leverage the Company's capital. In 2002, depending upon loan origination volume
and mix, the Company may consider the sale of certain hybrid or adjustable rate
residential mortgages into the secondary market.
The majority of the residential loans at December 31, 2001 were secured
by properties located within the Company's primary market area in Central
California. At December 31, 2001, 7.4% of the Company's one to four family
mortgage loans had fixed terms and 93.6% had adjustable rates, including
adjustable rate loans that have a fixed rate for an initial period. The Company
offers a variety of adjustable rate residential loan products, including an
"easy qualifier" loan with more limited documentation required than other
mortgages. The Company began originating loans subject to negative amortization
in 1996. Negative amortization involves a greater risk to the Company because
during a period of high interest rates the loan principal may increase above the
amount originally advanced. However, the Company believes that the risk of
default on these loans is mitigated somewhat by negative amortization caps,
underwriting criteria, relatively low loan to value ratios, and the stability
provided by payment schedules. At December 31, 2001, the Company's residential
loan portfolio included $26.3 million of loans subject to negative amortization.
The Company originates one to four family residential mortgage loans in
amounts up to 80% of the lower of the appraised value or the selling price of
the property securing the loan, and up to 97% of the appraised value or selling
price if private mortgage insurance is obtained. Mortgage loans originated by
the Company generally include due on sale clauses which provide the Company with
the contractual right to deem the loan immediately due and payable in the event
the borrower transfers ownership of the property without the Company's consent.
Due on sale clauses are an important means of adjusting the rates on the
Company's mortgage loan portfolio and the Company has generally exercised its
rights under these clauses.
15
The five largest residential loans in the Company's portfolio at
December 31, 2001 are presented in the following table. Original loan to value
ratio equals the loan's original principal balance divided by the original
appraisal amount obtained at the time of loan origination. Current loan to value
ratio equals the December 31, 2001 principal balance divided by the original
appraisal amount obtained at the time of loan origination.
(Dollars In Thousands)
Year
Principal Of Original Current
Balance Origination/ Loan To Loan To
Outstanding Acquisition Property Location Value Ratio Value Ratio
----------- ----------- ----------------- ----------- -----------
$ 3,125 2000 Carmel, California 50% 49%*
$ 2,223 1999 Monte Sereno, California 70% 68%
$ 2,008 2000 Monterey, California 70% 72%*
$ 1,743 2001 Saratoga, California 26% 26%
$ 1,708 2000 Pebble Beach, California 65% 64%
---------------
* Loan product permitting negative amortization
Multifamily Lending. The Company offers hybrid and adjustable rate
permanent multifamily (five or more units) real estate loans secured by real
property in California. The Company also periodically extends construction
financing to builders of multifamily housing. From time to time, the Company
extends loans secured by mixed use property in more urban areas, which typically
present commercial (generally retail) space in one part of the building (often
street level) and residential units in other parts of the building.
Apartment rents and multifamily property valuations have generally
increased in California during the past several years, as supply has not
expanded with the same speed as population growth, leading to greater demand for
units and thus higher market rents and lower vacancies.
Permanent loans on multifamily properties typically present maturities
of up to 30 years. Factors considered by the Company in reaching a lending
decision on such properties include the net operating income of the mortgaged
premises before debt service and depreciation, the debt service ratio (the ratio
of net earnings to debt service), the ratio of the loan amount to appraised
value, and the financial profile of any guarantors. Pursuant to the Company's
underwriting policies, multifamily hybrid and adjustable rate mortgage loans are
generally originated in amounts up to 75% of the appraised value of the
underlying properties. The Company generally requires a debt service ratio of at
least 1.10. Properties securing loans are appraised by an independent appraiser.
Title insurance is required on all loans.
When evaluating the qualifications of the borrower for a multifamily
loan, the Company considers the financial resources and income level of the
borrower, the borrower's experience in owning or managing similar property, and
the Company's lending experience with the borrower. The Company's underwriting
policies require that the borrower provide evidence of ability to repay the
mortgage on a timely basis and maintain the property from current rental income.
In evaluating the creditworthiness of the borrower, the Company generally
reviews the borrower's financial statements, employment, tax returns, and credit
history, as well as other related documentation.
Loans secured by apartment buildings and other multifamily residential
properties are generally larger and involve a greater degree of risk than one to
four family residential loans. Because payments on loans secured by multifamily
properties are often dependent on successful operation or management of the
properties, repayment of such loans may be subject to a greater extent to
adverse conditions in the real estate market or the economy. The Company seeks
to mitigate these risks through its underwriting policies, which require such
loans to be qualified at origination on the basis of the property's income and
debt coverage ratio. The Company also attempts to limit its risk exposure by
requiring annual operating statements on the properties and by acquiring
personal guarantees from the borrowers when available.
16
There is a limited volume of multifamily properties in the Company's
primary market area due to the more rural aspects of many local communities.
Therefore, in conjunction with its business strategy, the Company in 2002
intends to continue increasing its multifamily real estate lending within the
State of California. At December 31, 2001, the Company's portfolio of
multifamily loans totaled $103.9 million, or 21.4% of gross loans receivable
held for investment. This compares to $76.7 million, or 18.1% of gross loans
receivable held for investment, at December 31, 2000. The Company acquired
multifamily loans from direct originations, broker referrals, and pool purchases
during 2001. It is expected that all of these sources will be utilized in 2002.
The five largest multifamily real estate loans in the Company's
portfolio at December 31, 2001 are presented in the following table:
(Dollars In Thousands)
Year
Principal Of Original Current
Balance Origination / Loan To Loan To
Outstanding Acquisition Property Location Value Ratio Value Ratio
----------- ----------- ----------------- ----------- -----------
$ 3,959 2001 Van Nuys, California 64% 64%
$ 2,595 2001 San Francisco, California 69% 68%
$ 2,500 2001 West Hollywood, California 74% 74%
$ 2,298 2001 Oakland, California 74% 74%
$ 1,832 2001 San Francisco, California 74% 73%
Because the primary marketplace the Company serves has a limited volume
of multifamily properties, the Company intends to continue pursuing multifamily
real estate loans secured by properties located throughout California. The
Company's strategy in this regard includes purchasing participations in
multifamily loans originated by experienced, local lenders with a favorable
record of quality loan origination. The acquisition and origination of
multifamily loans throughout California presents the Company with geographic
diversification, but also introduces credit exposure due to the greater demands
of monitoring the demand for and value of multifamily real estate in a greater
number of market areas.
Commercial & Industrial Real Estate Lending. The Company originates
both permanent and construction loans secured by commercial & industrial real
estate located primarily in California. The Company's underwriting procedures
provide that commercial & industrial real estate loans may generally be made in
amounts up to the lesser of 65% of the appraised value of the property or up to
a debt service coverage ratio of 1.20. Permanent loans may be made with terms up
to 25 years and are typically hybrid (fixed for three to five years, then
adjustable) or adjustable based upon the 1 Year CMT or COFI indices. The
Company's underwriting standards and credit review procedures on commercial &
industrial real estate loans are similar to those applicable to multifamily
loans. The Company considers the property's net operating income, the loan to
value ratio, the presence of guarantees, and the borrower's expertise, credit
history, and financial status.
The Company's commercial & industrial real estate loans are typically
secured by properties such as retail stores, retail strip centers, office
buildings, and light manufacturing facilities. The Company typically does not
extend loans for the acquisition or refinance of major manufacturing facilities,
as that type of real estate generally encompasses larger loans than the Company
makes. The Company also takes various steps to attempt to avoid extending loans
secured by commercial & industrial real estate that presents significant
environmental issues, such as groundwater contamination or the presence of toxic
chemicals. However, despite these steps, including environmental reviews, there
can be no assurance that the Company can avoid financial exposure resulting from
environmental issues associated with loan collateral.
The majority of the commercial & industrial real estate loans are
secured by property located in Northern and Central California. However, the
Company has in the past several years pursued participations on and purchases of
commercial & industrial real estate loans with experienced, local lenders in the
greater San Diego and Los Angeles markets as a means of increasing loans
outstanding and geographically diversifying the Company's loan portfolio.
17
At December 31, 2001, the Company's permanent commercial & industrial
real estate loan portfolio totaled $110.0 million, or 22.7% of gross loans held
for investment. This compares to $102.3 million, or 24.1% of gross loans held
for investment, at December 31, 2000. This nominal expansion is consistent with
the Company's business strategies of:
o increasing the percentage of its balance sheet represented by income
property loans
o meeting the real estate and business financing needs of businesses and
individuals whose business is domiciled in real estate owned by the
borrower
o seeking comprehensive relationships with businesses in the Company's
primary market areas, including the placement of deposits with the
Company and the Company's provision of funds transfer services
The five largest commercial & industrial real estate loans in the
Company's portfolio at December 31, 2001 are presented in the following table:
(Dollars In Thousands)
Year Original Current
Principal Of Type Loan To Loan To
Balance Origination / Of Value Value
Outstanding Acquisition Property Property Location Ratio Ratio
----------- ----------- -------- ----------------- ----- -----
$ 4,957 1999 Hotel Dublin, California 57% 55%
$ 3,381 2001 Mini-Storage Facility San Jose, California 65% 64%
$ 2,919 2001 Office Building Simi Valley, California 75% 75%
$ 2,794 1999 Motel Aptos, California 64% 63%
$ 2,720 2000 Office Building Gilroy, California 42% 41%
At December 31, 2001, the Company had $30.8 million in outstanding
loans secured by hotel / motel properties. None of these loans were construction
loans. The Company is actively monitoring these loans, as the hospitality
industry experienced particular difficulties in the second half of 2001 due to
the national recession, a reduction in business travel, and the slowdown in
tourism and travel following the events of September 11, 2001. The $4.96 million
hotel loan in the above table is secured by a nationally branded hotel. During
2002, the Company intends to decrease its lending concentration in loans secured
by hotels / motels.
Loans secured by commercial & industrial real estate properties, like
multifamily loans, are generally larger and involve a greater degree of risk
than one to four family residential mortgage loans. Because payments on loans
secured by commercial real estate properties are often dependent on successful
operation or management of the properties, repayment of such loans may be
significantly subject to adverse conditions in the properties' management or
real estate markets in general or particular to a subject property. The Company
seeks to mitigate these risks through its underwriting standards and credit
review policy, which requires annual operating statements for each collateral
property. The Company also participates larger commercial & industrial real
estate loans with other financial institutions as a means of diversifying its
credit risk and remaining below the Bank's regulatory limit on loans to one
borrower.
Commercial & industrial real estate loans can present various
environmental risks, as such properties are sometimes located on sites or in
areas where various types of pollution may have historically occurred. The
Company takes various steps to attempt to avoid extending loans secured by
commercial & industrial real estate that presents significant environmental
issues, such as groundwater contamination or the presence of toxic chemicals.
However, despite these steps, there can be no assurance that the Company can
avoid financial exposure resulting from environmental issues associated with
loan collateral. The Company attempts to mitigate environmental risk via
surveys, reports, and, in some cases, testing; in addition to using a limited
list of pre-approved appraisers. In addition, Company lending staff directly
inspect most commercial & industrial real estate properties on which the Company
lends.
Commercial & industrial real estate can also be impacted by changing
government regulation, with a potential associated impact on the market value of
the collateral securing the Company's loans.
18
Construction Lending. The Company originates construction loans for the
acquisition and development of property. Collateral has been historically
concentrated in residential properties, both owner occupied and speculative
(i.e. not being built by an owner occupant, but perhaps pre-sold to third
parties). In addition, the Company makes construction loans for the development
and rehabilitation of apartments and commercial buildings.
Construction financing is generally considered to involve a higher
degree of risk than long-term financing on improved, occupied real estate. The
Company's risk of loss on construction loans depends largely upon:
o the accuracy of the initial estimate of the property's value at
completion of construction or development
o the accuracy of the estimated cost of construction
o the borrower's ability to complete the construction project within
estimated timeframes
o the market demand for the subject property at the completion of
construction
o the ability of tenants, if any, to honor lease obligations for the
subject property
o the availability of permanent financing for the subject property at the
conclusion of the construction period
If the estimate of construction costs proves to be inaccurate, the
Company may have to advance funds beyond the amount originally committed to
permit completion of the project and to protect its security position. The
Company may also be confronted, at or prior to maturity of the loan, with a
project with insufficient value to ensure full repayment. The Company's
underwriting, monitoring, and disbursement practices with respect to
construction financing are intended to ensure that sufficient funds are
available to complete construction projects. The Company attempts to limit its
risk through its underwriting procedures, by using only approved, qualified
appraisers, and by dealing with qualified builders / borrowers. The Company also
participates larger construction loans with other financial institutions as a
means of diversifying its credit risk and remaining below the Bank's regulatory
limit on loans to one borrower.
The Company's construction loans typically have adjustable rates and
terms of 12 to 18 months. The Company originates one to four family and
multifamily residential construction loans in amounts up to 80% of the appraised
value of the property. Land development loans are determined on an individual
basis, but in general they do not exceed 70% of the actual cost or current
appraised value of the property, whichever is less. Loan proceeds are disbursed
in increments as construction progresses and as inspections warrant.
At December 31, 2001, the Company had gross construction and land
development loans totaling $38.5 million, on which there were undisbursed loan
funds of $12.6 million. At December 31, 2000, the Company had gross construction
and land development loans totaling $59.1 million, on which there were
undisbursed loan funds of $26.6 million. The gross balance of construction loans
as a percentage of gross loans held for investment thus declined from 13.9% at
December 31, 2000 to 7.9% at December 31, 2001.
The decline in construction loans during 2001 resulted from payoffs
from completed projects not being replaced by the inflow of new business. The
Company intentionally curtailed construction lending during most of 2001 in
response to concerns about the national recession. In general, the Company's
business strategy is, however, to increase the construction loan portfolio and
to have construction loans represent a greater portion of total assets. The
Company has strategically targeted increased construction lending because of the
interest rate sensitivity of the loans, the Company's experience in this type of
lending, the yields available from this type of lending, and, in the case of
owner residential construction loans, the strong customer bond developed in
financing the building of someone's home.
19
The five largest construction loans in the Company's portfolio at
December 31, 2001 are presented in the following table:
(Dollars In Thousands)
Year
Construction Of Type
Commitment Origination / Of Disbursed
Amount Acquisition Construction Property Location Balance
------ ----------- ------------ ----------------- -------
$ 5,075 2000 Light Industrial Fremont, California $ 3,007
$ 5,000 2000 Apartments Roseville, California $ 3,956
$ 4,436 2000 Speculative Residential Monterey, California $ 2,931
$ 4,000 2001 Speculative Residential Rancho Mirage, California $ 1,677
$ 2,111 2001 Speculative Residential Hillsborough, California $ 1,381
Because construction loans are generally larger and more complex than
typical residential mortgages, they present a greater degree of credit risk. The
Company attempts to control this credit risk through its underwriting and funds
disbursement processes. In addition, it is the Company's strategy to, over time,
build a series of strong relationships with local developers / builders /
contractors with whom the Company has detailed financial knowledge and receives
a steady stream of repeat business.
Land Lending. The Company offers loans secured by land, generally
located in its immediate marketplace. The types of land generally considered by
the Company are suitable for residential development or are demarcated
residential lots. The Company does not extend loans on agricultural land where
repayment of the loan is dependent upon crop sales.
At December 31, 2001, land loans totaled $11.9 million, or 2.5% of
gross loans held for investment. This compares to land loans totaling $16.3
million, or 3.8% of gross loans held for investment, at December 31, 2000.
The five largest land loans in the Company's portfolio at December 31,
2001 are presented in the following table. These five loans constituted almost
one-half of the Company's total portfolio of land loans, as measured by
principal balance, at December 31, 2001.
(Dollars In Thousands)
Year Original Current
Principal Of Type Loan To Loan To
Balance Origination / Of Value Value
Outstanding Acquisition Land Property Location Ratio Ratio
----------- ----------- ---- ----------------- ----- -----
$ 1,500 2001 Residential Subdivision Monterey, California 50% 50%
$ 1,320 2001 Residential Lots Los Gatos, California 60% 60%
$ 1,200 2000 Residential Lots Morgan Hill, California 50% 50%
$ 929 1999 Residential Subdivision Monterey, California 60% 60%
$ 720 2001 Residential Subdivision Monterey, California 60% 60%
The three land loans in the above table secured by real estate in
Monterey are associated with various parcels within an upscale residential
development. The Company has lent money secured by parcels, lots, and homes
within this development for the past several years.
Because land and lots are generally less readily marketable than
residential real estate, lending on land presents additional risks not present
in residential mortgages. The market value of land and lots can be more
susceptible to changes in interest rates, economic conditions, or local real
estate markets than the market value for homes. Zoning changes by various
government authorities may also impact the value and marketability of certain
types of land. To mitigate these risks, the Company generally restricts land and
lot loans to its primary local market areas, where the Company has the most
thorough understanding of land values and trends in the demand for land.
20
Business Lending. The Company offers a wide variety of business loans,
both in the form of lines of credit and amortizing term loans. The majority of
the Company's business loans are collateralized by business assets. Such
collateral is typically comprised of accounts receivable, inventory, or
equipment. In addition, the Company obtains a deed of trust on real estate as
additional collateral for certain business loans and generally pursues personal
guarantees from principals of closely held businesses. Business lending is
generally considered to involve a higher degree of risk than the financing of
real estate, primarily because security interests in the collateral are more
difficult to perfect and the collateral may be difficult to obtain or liquidate
following an uncured default. Business loans typically offer relatively higher
yields, short maturities, and variable interest rates. The availability of such
loans enables existing and potential business depositors to establish a more
complete financial relationship with the Company.
The Company arranges courier service for the collection of deposits
from business customers, and in 2002 plans to introduce Internet banking for
businesses. For closely held businesses, the Company pursues a marketing
objective of obtaining both the personal and commercial banking business from
the principals. The Company believes that multiple benefits arise from
establishing strong relationships with and thoroughly understanding customers.
These benefits include the ability to offer more proactive and effective
financial solutions and the opportunity to mitigate credit losses through the
timely receipt of key information.
The Company attempts to reduce the risk of loss associated with
business lending by closely monitoring the financial condition and performance
of its customers. Each business loan customer is assigned to a commercial
banking relationship officer. The relationship officer is responsible for
monitoring the financial condition of the borrower, developing solutions to the
financial needs of the customer, facilitating the growth of the customer's
business, and expanding the customer's overall business relationship with the
Company. The Company hired several commercial banking relationship officers in
2001, and the Company's business strategy envisions business loans representing
a greater percentage of total assets in the future.
The Company also attempts to mitigate the risk inherent in business
lending by having third parties review the credits on a periodic basis. In 2002,
the Company plans to participate larger business loans with other community
banks as a means of diversifying credit risk and remaining below the Bank's
regulatory limit on loans to one borrower. The Company also intends to seek
similar participations from other California community banks.
At December 31, 2001, the Company had business term loans totaling $3.2
million and drawn balances against business lines of credit totaling $5.7
million. In the aggregate, business loans comprised 1.8% of gross loans held for
investment at December 31, 2001. In comparison, the Company had a total of $3.1
million in business loans outstanding at December 31, 2000.
The five largest business loans in the Company's portfolio at December
31, 2001 are presented in the following table:
(Dollars In Thousands)
Line Of Year
Credit Of Type
Commitment Origination / Of Outstanding
Amount Acquisition Business Business Location Balance
------ ----------- -------- ----------------- -------
$ 2,000 2001 Semiconductor Equipment Scotts Valley, California $ 400
$ 1,500 2001 Packaging Materials Soquel, California $ 460
$ 1,000 2001 Law Firm Los Angeles, California $ 325
$ 1,000 2001 Industrial Gases Watsonville, California $ 574
$ 600 2001 Fiber Optic Services Santa Cruz, California $ 564
All of the above business loans are associated with firms in the
Company's primary market area with the exception of the loan to the law firm,
which resulted from a longstanding relationship between the principals and
Management.
21
Loan Approval Procedures And Authority. The Board of Directors has
ultimate responsibility for the lending activity of the Company and establishes
the lending policies of the Company, including the appraisal policy and credit
approval authorities. The Board of Directors also approves all appraisers used
by the Company. As of December 31, 2001, the Board of Directors has authorized
the following loan approval authorities:
Real Estate Loans
-----------------
(1) Residential mortgage loans in amounts up to the federal agency
(e.g. Federal National Mortgage Association or "FNMA")
conforming limit may be approved by the Company's staff
underwriters.
(2) Loans in excess of the agency conforming limits and up to
$500,000 may be approved by the underwriting / processing
manager.
(3) Loans in excess of $500,000 and up to $750,000 may be approved
by the real estate loan administrator.
(4) Loans in excess of $750,000 and up to $1,000,000 require the
approval of the Chief Executive Officer / President, Chief
Loan Officer, or the Director of Commercial Banking.
(5) Loans in excess of $1,000,000 and up to $2,000,000 require the
approval of two of the Chief Executive Officer / President,
Chief Loan Officer, or Director of Commercial Banking.
(6) Loans in excess of $2,000,000 require the approval of the
Board of Directors Loan Committee.
Non-Real Estate Loans
---------------------
(1) Overdraft lines of credit of up to $1,500 require the approval
of the underwriting / processing manager or the real estate
loan administrator.
(2) Loans up to $500,000 require the approval of the Chief
Executive Officer / President, Chief Loan Officer, or Director
of Commercial Banking.
(3) Loans in excess of $500,000 require the approval of the Board
of Directors Loan Committee.
The loan origination process requires that upon receipt of a completed
loan application, a credit report is obtained and certain information is
verified. If necessary, additional financial information is obtained from the
prospective borrower. An appraisal of the related real estate is performed by an
independent, licensed appraiser. If the original loan exceeds 80% loan to value
on a first trust deed loan or private mortgage insurance is required, the
borrower is required to make payments to a loan impound account from which the
Company makes disbursements for property taxes and insurance.
22
Loan Portfolio Composition. The following table presents the
composition of the Company's net loans receivable held for investment at the
dates indicated.
At December 31,
-----------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
---------------- ----------------- ----------------- ----------------- ------------------
Amount % Amount % Amount % Amount % Amount %
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
(Dollars In Thousands)
Loans secured by real estate
----------------------------
Residential one to four
unit $204,829 42.2% $160,155 37.8% $168,465 43.4% $181,771 55.8% $201,562 70.2%
Multifamily five or more
units 103,854 21.4% 76,727 18.1% 42,173 10.9% 33,340 10.2% 23,355 8.1%
Commercial and industrial 109,988 22.7% 102,322 24.1% 72,344 18.6% 39,997 12.3% 20,159 7.0%
Construction 38,522 7.9% 59,052 13.9% 79,034 20.3% 51,624 15.9% 35,150 12.3%
Land 11,924 2.5% 16,310 3.9% 13,930 3.6% 7,774 2.4% 1,869 0.7%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Sub-total loans secured by
real estate 469,117 96.7% 414,566 97.8% 375,946 96.8% 314,506 96.6% 282,095 98.3%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Other loans
-----------
Home equity lines of
credit 6,608 1.4% 5,631 1.3% 3,968 1.0% 3,262 1.0% 3,142 1.1%
Other consumer loans 372 0.1% 669 0.2% 587 0.2% 658 0.2% 598 0.2%
Business term loans 3,163 0.6% 1,641 0.4% 6,670 1.7% 6,679 2.0% 943 0.3%
Business lines of credit 5,680 1.2% 1,438 0.3% 1,027 0.3% 595 0.2% 270 0.1%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Sub-total other loans 15,823 3.3% 9,379 2.2% 12,252 3.2% 11,193 3.4% 4,953 1.7%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total gross loans 484,940 100.0% 423,945 100.0% 388,198 100.0% 325,699 100.0% 287,048 100.0%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
(Less) / Plus
-------------
Undisbursed loan funds (12,621) (26,580) (23,863) (24,201) (21,442)
Unamortized premiums &
Discounts 435 21 134 491 556
Deferred loan fees, net (202) (202) (281) (434) (742)
Allowance for loan losses (6,665) (5,364) (3,502) (2,780) (1,669)
-------- -------- -------- -------- --------
Total loans held for
investment, net $465,887 $391,820 $360,686 $298,775 $263,751
======== ======== ======== ======== ========
Loan Maturity Profile. The following table shows the contractual
maturities of the Company's gross loans held for investment at December 31,
2001.
At December 31, 2001
-----------------------------------------
2003 2007 Total
Through And Gross
2002 2006 Thereafter Loans
-------- -------- -------- --------
(Dollars In Thousands)
Residential one to four unit $ -- $ 399 $204,430 $204,829
Multifamily five or more units 19 203 103,632 103,854
Commercial and industrial real estate 354 5,118 104,516 109,988
Construction 35,701 2,821 -- 38,522
Land 2,754 9,170 -- 11,924
Home equity lines of credit -- 132 6,476 6,608
Other consumer loans 223 -- 149 372
Business term loans 175 2,676 312 3,163
Business lines of credit 3,011 2,669 -- 5,680
-------- -------- -------- --------
Total $ 42,237 $ 23,188 $419,515 $484,940
======== ======== ======== ========
23
The following table presents the Company's gross loans held for
investment at December 31, 2001, segregating those with fixed versus adjustable
interest rates and also isolating those loans with contractual maturities less
than or equal to and greater than one year.
Matures In 2002 Matures After 2002 Total Gross Loans
-------------------- -------------------- --------------------------------
Fixed Adjustable Fixed Adjustable Fixed Adjustable All
----- ---------- ----- ---------- ----- ---------- ---
(Dollars In Thousands)
Residential one to four unit $ -- $ -- $ 15,215 $189,614 $ 15,215 $189,614 $204,829
Multifamily five or more units 19 -- 871 102,964 890 102,964 103,854
Commercial and industrial real estate -- 354 2,013 107,621 2,013 107,975 109,988
Construction 3,680 32,021 -- 2,821 3,680 34,842 38,522
Land -- 2,754 -- 9,170 -- 11,924 11,924
Home equity lines of credit -- -- -- 6,608 -- 6,608 6,608
Other consumer loans 223 -- 149 -- 372 -- 372
Business term loans 85 90 89 2,899 174 2,989 3,163
Business lines of credit -- 3,011 -- 2,669 -- 5,680 5,680
-------- -------- -------- -------- -------- -------- --------
Total $ 4,007 $ 38,230 $ 18,337 $424,366 $ 22,344 $462,596 $484,940
======== ======== ======== ======== ======== ======== ========
Percent of gross loans outstanding 0.8% 7.9% 3.8% 87.5% 4.6% 95.4% 100.0%
Loan Commitments. At December 31, 2001, the Company had $24.4 million
in outstanding commitments to originate loans and lines of credit, not all of
which were rate locked at that time. These commitments had expiration dates or
other termination clauses. Because customers do not always accept loan
commitments (e.g. perhaps as a result of applying to more than one lender), the
Company anticipates future cash requirements associated with these commitments
to be less than the $24.4 million total.
At December 31, 2001, the Company had made available various business,
personal, and residential lines of credit totaling $25.8 million, of which the
undisbursed portion was $13.5 million. Of this $13.5 million, $7.9 million was
associated with business lines of credit, $5.2 million was associated with home
equity lines of credit, and $0.4 million was associated with consumer overdraft
lines of credit. The Company's business lines of credit are generally extended
for terms of one year, although the Company does provide two to three year line
of credit facilities in certain cases based upon the customer's business need
and available collateral. The Company's home equity lines of credit generally
revolve for ten years, and then amortize over the following fifteen years. For
additional information regarding the Company's loan commitments, please refer to
Note 15 to the Consolidated Financial Statements.
Originations, Purchases, And Sales Of Loans. The Company's mortgage
lending activities are conducted primarily through Bank employees in its eight
full service branch offices and its Los Angeles loan production office
(commencing in February 2002), and approximately 60 wholesale loan brokers who
deliver completed loan applications to the Company. In addition, the Company has
developed correspondent relationships with a number of financial institutions to
facilitate the origination and sale of real estate loans on a participation
basis. Loans presented to the Company for purchase or participation are
generally underwritten substantially in accordance with the Company's
established lending standards, which consider the financial condition and credit
worthiness of the borrower, the location of the underlying property, and the
cash flow and appraised value of the property, among other factors.
The Company plans to continue actively purchasing individual loans,
loan pools, and loan participations in 2002 as a means of utilizing the Bank's
strong regulatory capital position and supporting the more rapid transformation
of the Company's balance sheet into that more consistent with a California
community commercial bank. The Company anticipates that a majority of loan
purchases and loan participations in 2002 will be associated with loans
collateralized by income property.
24
Depending on its asset / liability strategy, the Company originates one
to four family residential loans for sale in the secondary market. Loan sales
are dependent on the level of loan originations and the relative customer demand
for mortgage loans, which is affected by the current and expected future level
of interest rates. During the years ended December 31, 2001 and 2000, the
Company sold $11.5 million and $2.7 million, respectively, of longer term, fixed
rate residential loans. The Company generally sells its fixed rate residential
loans on a servicing released basis in order to take advantage of comparatively
attractive servicing premiums being offered in the secondary market. While the
level and timing of any future loan sales will depend upon market opportunities
and prevailing interest rates, the Company anticipates selling the vast majority
of its long term, fixed rate residential loan production in 2002 on a servicing
released basis into the secondary market in conjunction with its asset /
liability management program and in order to continue shifting its loan mix away
from the historical concentration in residential mortgages.
From time to time, depending on its asset / liability and capital
management strategies, the Company converts a portion of its mortgages into
readily marketable mortgage backed securities, which can also be utilized in
collateralized borrowings such as securities sold under agreements to
repurchase. The Company's last such securitization occurred in 1998.
Securitization is undertaken primarily to provide greater liquidity for the
assets and thereby augment the Company's ability to manage its interest rate
risk profile and cash flows. The Company may conduct future securitizations and
/ or the sale of hybrid or adjustable rate residential mortgages, depending upon
its asset / liability and capital management strategies, in the future.
Loan Servicing. The Company services its own loans as well as loans
owned by others. Loan servicing includes collecting and remitting loan payments,
accounting for principal and interest, holding escrow funds for the payment of
real estate taxes and insurance premiums, contacting delinquent borrowers, and
supervising foreclosures and property dispositions in the event of unremedied
defaults. Loan servicing income includes servicing fees from investors and
certain charges collected from borrowers, such as late payment fees. At December
31, 2001, the Company was servicing $42.6 million of loans for others.
The Company's strategic plan does not contain a significant expansion
in its loan servicing for others, as Management believes large volume
residential loan servicers enjoy economies of scale and efficiencies in this
business that render it difficult for the Company to compete and generate a
desirable rate of return. The significant consolidation in the residential loan
servicing industry that has occurred over the past several years, in the opinion
of Management, supports this position.
Credit Quality
General. Although Management believes that non-performing loans are
generally well secured and / or reserved, real estate acquired through
foreclosure is properly valued, and inherent losses are provided for in the
allowance for loan losses, there can be no assurance that future deterioration
in local or national economic conditions, collateral values, borrowers'
financial status, or other factors will not result in future credit losses and
associated charges against operations. In regards to real estate acquired via
foreclosure, although all such properties are actively marketed by the Company,
no assurance can be provided regarding when these properties will be sold or
what the terms of sale will be when they are sold. It is the Company's general
policy to obtain appraisals at the time of foreclosure and to periodically
obtain updated appraisals for foreclosed properties that remain unsold.
Non-accrual, Delinquent, And Restructured Loans. Management generally
places loans on non-accrual status when they become 90 days past due, unless
they are well secured and in the process of collection. Management also places
loans on non-accrual status when they are less than 90 days delinquent when
there is concern about the collection of the debt in accordance with the terms
of the loan agreement. When a loan is placed on non-accrual status, any interest
previously accrued but not collected is reversed from income. Loans are charged
off when management determines that collection has become unlikely. Restructured
loans are those where the Company has granted a concession on the interest paid,
principal owed, or the original repayment terms due to financial difficulties of
the borrower or because of issues with the collateral securing the loan.
25
Delinquent Loan Procedures. Specific delinquency procedures vary
depending on the loan type and period of delinquency. However, the Company's
policies generally provide that loans be reviewed at least monthly for
delinquencies, and that if a borrower fails to make a required payment when due,
the Company institutes internal collection procedures. For mortgage loans,
written late charge notices are mailed no later than the 15th day of
delinquency. At 25 days past due, the borrower is contacted by telephone and the
Company makes a verbal request for payment. At 30 days past due, the Company
begins tracking the loan as a delinquency, and at 45 days past due a notice of
intent to foreclose is mailed. When contact is made with the borrower prior to
foreclosure, the Company generally attempts to obtain full payment or develop a
repayment schedule with the borrower to avoid foreclosure.
For business loans, the account relationship officer generally contacts
the borrower within ten days of a delinquency. If the borrower is unable or
unwilling to make contracted payments, the Company initiates collection efforts
that vary by the type of business loan and the nature of the collateral. If the
business loan is real estate secured, the Company follows collection procedures
similar to those described above for mortgage loans. If the business loan is
secured by inventory, equipment, or other non-real estate collateral, the
Company pursues acquisition and liquidation of the pledged collateral. If the
business loan has a personal guarantee, the Company will contact the guarantor
to honor the guarantee and make the contractual loan payments. The Company may
also proceed with various forms of legal action to enforce collection of
delinquent business loans.
Non-performing Assets. Non-performing loans include non-accrual loans,
loans 90 or more days past due and still accruing interest, and restructured
loans. Non-performing assets include all non-performing loans, real estate
acquired via foreclosure, and repossessed consumer assets.
Real estate acquired via foreclosure is recorded at the lower of the
recorded investment in the loan or the fair value of the related asset on the
date of foreclosure, less estimated costs to sell. Fair value is defined as the
amount in cash or cash-equivalent value of other consideration that a real
estate asset would yield in a current sale between a willing buyer and a willing
seller. Development and improvement costs relating to the property are
capitalized to the extent they are deemed to be recoverable upon disposal. The
carrying value of acquired property is regularly evaluated and, if appropriate,
an allowance is established to reduce the carrying value to fair value less
estimated costs to sell. The Company typically obtains appraisals on real estate
acquired through foreclosure at the time of foreclosure. The Company generally
conducts inspections on foreclosed properties and properties deemed in-substance
foreclosures on a quarterly basis.
The following table presents information regarding non-performing
assets at the dates indicated.
At December 31,
----------------------------------------------------------
2001 2000 1999 1998 1997
------ ------ ------ ------ ------
(Dollars In Thousands)
Outstanding Balances Before Valuation Reserves
----------------------------------------------
Non-accrual loans $2,252 $4,666 $6,888 $1,478 $1,598
Loans 90 or more days delinquent and accruing interest -- -- -- -- --
Restructured loans in compliance with modified terms -- 75 1,294 1,437 448
------ ------ ------ ------ ------
Total gross non-performing loans 2,252 4,741 8,182 2,915 2,046
Investment in foreclosed real estate before valuation reserves -- -- 96 322 326
Repossessed consumer assets -- -- -- -- --
------ ------ ------ ------ ------
Total gross non-performing assets $2,252 $4,741 $8,278 $3,237 $2,372
====== ====== ====== ====== ======
Gross non-performing loans to total loans 0.48% 1.19% 2.25% 0.96% 0.77%
Gross non-performing assets to total assets 0.42% 0.98% 1.79% 0.71% 0.58%
Allowance for loan losses $6,665 $5,364 $3,502 $2,780 $1,669
Allowance for loan losses / non-performing loans 295.96% 113.14% 42.80% 95.37% 81.57%
Valuation allowances for foreclosed real estate $ -- $ -- $ -- $ 41 $ 5
26
The decrease in non-accrual loans during 2001 was primarily due to the
repayment in full of two comparatively large non-accrual loans in April 2001,
one of which was a $2.85 million commercial construction loan for which the
Company had established a $600 thousand specific reserve at December 31, 2000.
This specific reserve was recaptured upon the collection in full of the
associated loan.
The following table presents information concerning loans 60 to 89 days
delinquent at the dates indicated.
Loans On Accrual Status And Delinquent 60 - 89 Days At December 31,
--------------------------------------------------------------------------------
2001 2000 1999
------------------------ ------------------------ ------------------------
Number Number Number
(Dollars In Thousands) Of Principal Of Principal Of Principal
Loans Balance Loans Balance Loans Balance
----- ------- ----- ------- ----- -------
Residential one to four unit 1 $ 154 4 $ 857 2 $ 285
Other consumer loans 2 2 -- -- -- --
--- ----- --- ----- --- -----
Total 3 $ 156 4 $ 857 2 $ 285
=== ===== === ===== === =====
60 - 89 day delinquent loans to gross
loans net of undisbursed loan
funds and unamortized yield adjustments 0.03% 0.22% 0.08%
The following table presents information regarding non-accrual loans at
the dates indicated.
Loans On Non-accrual Status At December 31,
--------------------------------------------------------------------------------
2001 2000 1999
------------------------ ------------------------ ------------------------
(Dollars In Thousands) Number Number Number
Of Principal Of Principal Of Principal
Loans Balance Loans Balance Loans Balance
----- ------- ----- ------- ----- -------
Residential one to four unit 3 $ 1,372 2 $ 603 4 $ 543
Commercial and industrial real estate 1 851 2 1,133 2 1,146
Commercial construction -- -- 1 2,852 -- --
Consumer lines of credit 1 1
Business term loans 2 28 3 78 1 5,000
Business lines of credit -- -- -- -- 2 199
--- ----- --- ----- --- -----
Total 7 $ 2,252 8 $ 4,666 9 $ 6,888
=== ===== === ===== === =====
Non-accrual loans to gross loans
net of undisbursed loan funds
and unamortized yield adjustments 0.48% 1.17% 1.89%
Interest income foregone on non-accrual loans outstanding at year-end
totaled $46 thousand, $110 thousand, and $109 thousand for the years ended
December 31, 2001, 2000, and 1999, respectively. At December 31, 2001, the
Company had no commitments to extend additional funds to loans on non-accrual
status.
During early 2002, the Company was in the process of foreclosing upon
the two of the three non-accrual residential mortgages in the above table. The
borrower associated with the third non-accrual residential mortgage is a chronic
delinquent. In addition, the borrower for the $851 thousand commercial real
estate loan on non-accrual status at December 31, 2001 reinstated the loan in
early 2002.
27
The following table presents information concerning restructured loans
that were on accrual status at the dates indicated.
Troubled Debt Restructured Loans On Accrual Status At December 31,
--------------------------------------------------------------------------------
2001 2000 1999
------------------------ ------------------------ ------------------------
Number Number Number
(Dollars In Thousands) Of Principal Of Principal Of Principal
Loans Balance Loans Balance Loans Balance
----- ------- ----- ------- ----- -------
Residential one to four unit -- $ -- 1 $ 75 8 $ 1,294
-- ----- - ----- - -------
Total -- $ -- 1 $ 75 8 $ 1,294
== ===== = ===== = =======
Weighted average interest rate -- 8.95% 7.60%
== ===== =====
Criticized And Classified Assets. To measure the quality of assets, the
Company has established internal asset classification guidelines as part of its
credit monitoring system for identifying and reporting current and potential
problem assets. Under these guidelines, both asset specific and general
portfolio valuation allowances are established.
The Company currently classifies problem and potential problem assets
into one of four categories, presented below in order of increasing severity.
Category Definition
------------------- -----------------------------------------------------
Criticized Assets
-----------------
Special Mention Special Mention loans (sometimes referred to as
"watch list" loans) possess weaknesses, but do not
currently expose the Company to sufficient risk to
warrant categorization as a classified asset or
assignment of a specific valuation allowance.
Weaknesses that might categorize a loan as Special
Mention include, but are not limited to, past
delinquencies or a general decline in business, real
estate, or economic conditions applicable to the
loan.
Classified Assets
-----------------
Substandard Substandard loans have one or more defined weakness
and are characterized by the distinct possibility
that the Company will sustain some loss if the
deficiencies are not corrected.
Doubtful Doubtful loans have the weaknesses of substandard
loans, with the additional characteristic that the
weaknesses make collection or liquidation in full on
the basis of currently existing facts, conditions,
and values questionable; and there is a high
possibility of loss of some portion of the principal
balance.
Loss Loss loans are considered uncollectible and their
continuance as an asset is not warranted.
The Company's methodology for calculating the allowance for loan losses
includes higher formula allowance factors for criticized and classified loans
than for loans not adversely graded ("Pass loans"). The formula allowance factor
for a given type of loan (e.g. commercial & industrial real estate loans) is
progressively higher for loans graded Special Mention, Substandard, and
Doubtful. These amounts represent loss allowances which have been established to
recognize the inherent risk associated with these lending activities, but which,
unlike specific allowances, have not been allocated to particular problem
assets. Judgments regarding the adequacy of valuation allowances are based on
continual evaluation of the nature, volume and quality of the loan portfolio,
collateral assets, borrower financial status, and current economic conditions
that may affect the recoverability of recorded amounts. Assets classified as a
loss require either a specific valuation allowance equal to 100% of the amount
classified or a charge-off of such amount.
28
The following table presents the Company's criticized and classified
assets at the dates indicated:
At December 31,
---------------------------------------------
Outstanding Balances Before Specific Valuation Allowances 2001 2000 1999
--------- --------- ---------
(Dollars In Thousands)
Criticized Assets
-----------------
Special mention $ 6,207 $ 2,283 $ 7,940
========= ========= =========
Classified Assets
-----------------
Substandard loans $ 5,098 $ 6,923 $ 8,678
Real estate acquired via foreclosure -- -- 96
--------- --------- ---------
Total classified assets $ 5,098 $ 6,923 $ 8,774
========= ========= =========
Classified assets to total loans plus other real estate owned (1) 1.08% 1.74% 2.41%
Classified assets to total assets 0.95% 1.42% 1.90%
Classified assets to shareholders' equity 10.16% 15.79% 21.50%
Allowance for loan losses to total classified assets 130.74% 77.48% 39.91%
------------
(1) Total loans equals total gross loans less undisbursed loan funds and
(less) or plus unamortized yield adjustments. Other real estate owned
is included on a gross basis before any valuation allowances.
Substandard assets at December 31, 2001 included a $2.3 million
"mini-perm" mortgage loan participation maturing in 2004 secured by a beach
resort in the Company's primary business area. The resort has experienced lower
occupancy than forecast, contributing to a reduced cash flow and inadequate debt
service coverage. The borrowers have been thirty to sixty days delinquent during
late 2001 and early 2002. In early 2002, the Company learned that a sale of some
or all of the subject property was being pursued. The Company cannot, however,
predict whether the property will be sold and at what price. The loan agreement
contains a due on sale clause that the Company intends to enforce in the event
of a sale.
Substandard loans at December 31, 2001 also included an $851 thousand
commercial real estate loan in the Company's primary market area that was
reinstated in early 2002, and an $845 thousand residential mortgage secured by a
home in the East Bay section of the San Francisco Bay Area.
Special Mention loans at December 31, 2001 included two multifamily
loans with an aggregate principal balance of $2.7 million and three commercial
real estate loans with an aggregate balance of $2.5 million, including one motel
loan with a principal balance of $1.3 million. These three commercial real
estate loans were all secured by real properties in the Company's primary market
area.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS, which can require the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies, has
adopted an interagency policy statement on allowances for loan and lease losses
that provides guidance in determining the adequacy of general valuation
guidelines. The policy statement recommends that savings institutions establish
effective systems and controls to identify, monitor, and address asset quality
problems, analyze significant factors that affect the collectibility of assets,
and establish prudent allowance evaluation processes. Management believes that
the Company's allowance for loan losses is adequate given the composition and
risks of the loan portfolio. However, actual losses are dependent upon future
events and, as such, further additions to the level of specific and general loan
loss allowances may become necessary. In addition, there can be no assurance
that at some time in the future the OTS, in reviewing the Company's loan
portfolio, will not request the Company to increase its allowance for loan
losses, thus negatively impacting the Company's results of operations for that
time period.
29
Impaired Loans. The Company defines a loan as impaired when it meets
one or more of the following criteria:
o It is probable that the Company will be unable to collect all
contractual principal and interest in accordance with the original
terms of the loan agreement.
o The loan is ninety or more days past due.
o The loan is placed on non-accrual status although less than ninety days
past due.
o A specific valuation reserve has been allocated against the loan.
o The loan meets the criteria for a troubled debt restructuring.
The policy of the Company is to review each loan in the portfolio to
identify problem credits. The nature of this review varies by the type of loan
and its underlying collateral. For example, most residential mortgages are
evaluated for impairment following a delinquency, while the Company conducts
credit analysis on each income property loan exceeding certain thresholds at
least annually regardless of payment performance. In reviewing each loan, the
Company evaluates both the amount the Company believes is probable that it will
collect and the timing of such collection. As part of the loan review process,
the Company considers such factors as the ability of the borrower to continue
meeting the debt service requirements, assessments of other sources of
repayment, and the fair value of any collateral. Insignificant delays or
shortfalls in payment amounts, in the absence of other facts and circumstances,
would not alone lead to the conclusion that a loan is impaired.
Each loan identified as impaired is evaluated for the need for a
specific loss reserve. The adequacy of these specific loss reserves is reviewed
regularly, and no less frequently than quarterly. A loan's specific loss reserve
is calculated by comparing the Company's net investment in the loan to one or
more of the following, as applicable to the nature of the loan:
o the present value of the loan's expected future cash flows discounted
at the loan's effective interest rate at the date of initial impairment
o the loan's observable market price
o the fair value of the collateral securing the loan
The Company charges off a portion of an impaired loan against the specific
valuation allowance when it is probable that a part of the loan will not be
recoverable.
At December 31, 2001, the Company had impaired loans totaling $2.3
million, which had no related specific reserves. At December 31, 2000, the
Company had impaired loans of $5.3 million, with related specific reserves of
$600 thousand. Additional information concerning impaired loans is presented
below and in Note 5 to the Consolidated Financial Statements.
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Average investment in impaired loans for the year $ 2,304 $ 7,790 $ 2,511
Interest recognized on impaired loans at December 31 $ 146 $ 461 $ 590
Interest not recognized on impaired loans at December 31 $ 46 $ 110 $ 109
The decrease in the average investment in impaired loans in 2001 versus
2000 primarily resulted from a $5.0 million business term loan originated by
MBBC that was identified as impaired in the fourth quarter of 1999 and paid off
in full in December, 2000.
30
Other than those loans already categorized as non-performing or
classified at December 31, 2001, the Company has not identified any other
potential problem loans, which would result in those loans being included as
non-performing or classified loans at a future date, with the exception of two
business term loans totaling $371 thousand extended to corporate entities
associated with an individual that declared bankruptcy in the first quarter of
2002. In addition, in early 2002, the Company became aware of the transfer of
title of a motel serving as collateral for a $2.4 million commercial real estate
loan, in violation of the Company's due on sale clause in its loan documents.
The motel is in the Company's primary market area. The Company was successful in
collecting in full on this loan in the first quarter of 2002.
The Company had no loans outstanding to foreign entities at December
31, 2001.
Special Residential Loan Pool. During 1998, the Bank purchased a $40.0
million residential mortgage pool comprised of loans secured by homes throughout
the nation (but with a concentration in California) that presented a borrower
credit profile and / or a loan to value ratio outside of (less favorable than)
the Bank's normal underwriting criteria. To mitigate its credit risk for this
portfolio, the Bank obtained at purchase a scheduled principal / scheduled
interest loan servicing agreement from the seller. Further, this agreement also
contains a guaranty by the seller to absorb any principal losses on the
portfolio in exchange for the seller's retention of a portion of the loans'
yield through loan servicing fees. In obtaining these credit enhancements, the
Bank functionally aggregated the credit risk for this loan pool into a single
borrower credit risk to the seller / servicer of the loans. The Bank was
subsequently informed by the OTS that structuring the purchase in this manner
made the transaction an "extension of credit" by the Bank to the seller /
servicer, which, by virtue of its size, violated the OTS' "Loans To One
Borrower" regulation. See "Regulation And Supervision - Loans To One Borrower
Limitation" and Note 14 to the Consolidated Financial Statements. The Bank
continues to report to the OTS in this regard on a monthly basis.
At December 31, 2001, the outstanding principal balance of the Special
Residential Loan Pool was $5.6 million. In comparison, the outstanding principal
balance of the Special Residential Loan Pool was $16.5 million at December 31,
2000. Following the February 20, 2002 regular monthly remittance, the
outstanding balance of the Special Residential Loan Pool declined to $4.75
million. All of the loans within the Special Residential Loan Pool are
adjustable rate mortgages.
While the seller / servicer met all its contractual obligations through
the February 20, 2002 regularly scheduled reporting and remittance date, the
Company has allocated certain loan loss reserves due to concerns regarding the
potential losses by the seller / servicer in honoring the guaranty, the present
delinquency profile of the Special Residential Loan Pool, and the differential
between loan principal balances and current appraisals for foreclosed loans and
loans in the process of foreclosure.
Because the seller / servicer provides scheduled principal and interest
payments regardless of the actual payment performance of the loans and because
the seller / servicer is required to absorb all losses on the disposition of
associated foreclosed real estate, the Company reports all loans within the
Special Residential Loan Pool as performing.
At December 31, 2001, the Special Residential Loan Pool was comprised
of 52 residential mortgages, the largest of which had a principal balance of
$278 thousand. The homes securing the Special Residential Loan Pool at December
31, 2001 were concentrated in California, followed by Utah, Oregon, and
Michigan. The weighted average gross interest rate on the Special Residential
Loan Pool at December 31, 2001 was 9.95%. The differential between the interest
rates on the loans and available refinance rates contributed to the significant
prepayments during 2001.
At December 31, 2001, the Special Residential Loan Pool included four
loans where the underlying collateral had been foreclosed. The aggregate
principal balance of these four loans was $392 thousand, with the largest such
loan having a principal balance of $115 thousand.
31
Management believes additional prepayments are likely to occur in 2002.
However, management also believes that there will be some loans that will not
refinance in the next year due to a lack of available financing for less
creditworthy borrowers or because of borrower inaction. In 2002, the Company may
therefore be particularly dependent upon the financial strength and continued
performance of the seller / servicer, as the remaining portfolio is expected to
be comprised of relatively less creditworthy loans while at the same time having
a smaller remaining total principal balance and thereby providing less periodic
cash flow to the seller / servicer via the retained servicing spread.
The Company monitors the financial performance and condition of the
seller / servicer on a monthly basis. The earnings and capital of the seller /
servicer experienced favorable results during 2001, supported by the strong
mortgage refinance market. In addition, the Company regularly analyzes the
payment performance and credit profile of the remaining outstanding loans.
In conjunction with this Special Residential Loan Pool, during the
first quarter of 2000, the Bank received a letter from the OTS mandating that:
1. all loans associated with the Special Residential Loan Pool would be
required to be assigned to the 100% risk based capital category in
calculating regulatory capital ratios that incorporate risk weighted
assets
2. the Bank's regulatory capital position at December 31, 1999 and
thereafter must reflect the above requirement
3. until further notice, the Bank's regulatory capital ratios were
required to be maintained at levels no lower than the levels at
December 31, 1999
The Bank continually complied with the above requirements through December 31,
2001. In early 2002, the Bank received a letter from the OTS notifying the Bank
that the institution specific regulatory capital requirements imposed in early
2000, as described above in point number three, were eliminated.
Allowance For Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on Management's evaluation of the
risks inherent in the Company's loan portfolio, including unused commitments to
provide financing. The allowance for loan losses is increased by provisions
charged against earnings and reduced by net loan charge-offs. Loans are
charged-off when they are deemed to be uncollectible; recoveries are generally
recorded only when cash payments are received.
The allowance for loan losses is maintained at an amount management
considers adequate to cover losses in loans receivable that are deemed probable
and estimable. The allowance is based upon a number of factors, including, but
not limited to, asset classifications, the size and mix of the loan portfolio,
economic trends and conditions, industry experience and trends, industry and
geographic concentrations, estimated collateral values, management's assessment
of the credit risk inherent in the portfolio, historical loan loss experience,
changes in non-performing and past due loans, and the Company's underwriting
policies. While Management uses the best information available to make these
estimates, future adjustments to allowances may be necessary due to economic,
operating, regulatory, and other conditions that may be beyond the Company's
control or ability to foresee.
32
The allowance for loan losses is comprised of three primary types of
allowances:
1. Formula Allowance
Formula allowances are based upon loan loss factors that reflect
management's estimate of the inherent loss in various segments of or
pools within the loan portfolio. The loss factor is multiplied by the
portfolio segment (e.g. multifamily permanent mortgages) balance (or
credit commitment, as applicable) to derive the formula allowance
amount. The loss factors are updated periodically by the Company to
reflect current information that has an effect on the amount of loss
inherent in each segment. The formula allowance at December 31, 2001
was $6.0 million, compared to $4.0 million at December 31, 2000.
2. Specific Allowance
Specific allowances are established in cases where management has
identified significant conditions or circumstances related to an
individually impaired credit. In other words, these allowances are
specific to the loss inherent in a particular loan. The amount for a
specific allowance is calculated in accordance with SFAS No. 114,
"Accounting By Creditors For Impairment Of A Loan". The Company had no
specific allowance at December 31, 2001 and had $600 thousand in
specific allowance at December 31, 2000.
3. Unallocated Allowance
The Company maintains an unallocated loan loss allowance that is based
upon management's evaluation of conditions that are not directly
measured in the determination of the formula and specific allowances.
The evaluation of inherent loss with respect to these conditions is
subject to a higher degree of uncertainty because they are not
identified with specific problem credits or historical performance of
loan portfolio segments. At December 31, 2001, the Company had $668
thousand in unallocated allowance, compared to $739 thousand at
December 31, 2000. The conditions evaluated in connection with the
unallocated allowance at December 31, 2001 included the following,
which existed at the balance sheet date:
o General business and economic conditions affecting the
Company's key lending areas
o Real estate values in California
o Loan volumes and concentrations
o Seasoning of the loan portfolio
o Status of the current business cycle
o Specific industry or market conditions within portfolio
segments
In addition to the requirements of Accounting Principles Generally
Accepted in the United States of America, or "GAAP", related to loss
contingencies, a federally chartered savings association's determination as to
the classification of its assets and the amount of its valuation allowances is
subject to review by the OTS. The OTS, in conjunction with other federal banking
agencies, provides guidance for financial institutions on both the
responsibilities of management for the assessment and establishment of adequate
allowances and guidance for banking agency examiners to use in determining the
adequacy of general valuation allowances. It is required that all institutions:
o have effective systems and controls to identify, monitor, and address
asset quality problems
o analyze all significant factors that affect the collectibility of the
loan portfolio in a reasonable manner
o establish acceptable allowance evaluation processes that meet the
objectives of the federal regulatory agencies
33
Various regulatory agencies, in particular the OTS, as an integral part
of their examination process, periodically review the Company's allowance for
loan losses. These agencies may require the Company to make additional
provisions for loan losses, based on their judgments of the information
available at the time of the examination. Although Management believes that the
allowance for loan losses is adequate to provide for estimated inherent losses
in the loan portfolio, future provisions charged against operations will be
subject to continuing evaluations of the inherent risk in the loan portfolio. In
addition, if the national or local economy declines or asset quality
deteriorates, additional provisions could be required. Such additional
provisions could negatively and materially impact the Company's financial
condition and results of operations.
The following table presents information concerning the Company's
allowance for loan losses at the dates and for the years indicated.
(Dollars In Thousands) 2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
Period end loans outstanding (1) $ 473,265 $ 397,184 $ 364,188 $ 303,732 $ 265,934
Average loans outstanding (2) 432,020 379,823 339,036 259,358 250,370
Period end non-performing loans outstanding 2,252 4,741 8,182 2,915 2,046
Allowance for loan losses
Balance, at beginning of year $ 5,364 $ 3,502 $ 2,780 $ 1,669 $ 1,311
Charge-offs:
Residential one to four unit real estate loans -- (371) (113) -- (20)
Other consumer loans (4) -- -- -- (1)
Business lines of credit (95) -- -- -- --
--------- --------- --------- --------- ---------
Total charge-offs (99) (371) (113) -- (21)
--------- --------- --------- --------- ---------
Recoveries:
Residential one to four unit real estate loans -- 58 -- 3 4
--------- --------- --------- --------- ---------
Total recoveries -- 58 -- 3 4
--------- --------- --------- --------- ---------
Net (charge-offs) recoveries (99) (313) (113) 3 (17)
--------- --------- --------- --------- ---------
Provision charged to operations 1,400 2,175 835 692 375
Allowance acquired in conjunction with loan purchase -- -- -- 416 --
--------- --------- --------- --------- ---------
Balance, at end of year $ 6,665 $ 5,364 $ 3,502 $ 2,780 $ 1,669
======= ======= ======= ======= =======
Net charge-offs (recoveries) to average loans outstanding (2) 0.02% 0.08% 0.03% -- 0.01%
Allowance as a percent of year end loans outstanding (1) 1.41% 1.35% 0.96% 0.92% 0.63%
Allowance as a percent of non-performing loans 295.96% 113.14% 42.80% 95.37% 81.57%
---------------
(1) net of undisbursed loan funds, unamortized purchase premiums net of
purchase discounts, and deferred loan fees and costs, net
(2) net of undisbursed loan funds, unamortized purchase premiums net of
purchase discounts, deferred loan fees and costs, net, and allowances
for loan losses
The charge-offs recorded by the Company in 2001 for business lines of
credit all stemmed from the Business Express program, which was terminated in
2001. The Business Express program targeted small and / or relatively new local
businesses with lines of credit up to $25,000. These businesses were impacted by
the recession in the second half of 2001, as they did not generally have the
financial strength and number of years of operation that permit businesses to
weather less robust economic environments.
34
The following table provides a summary of the allocation of the
allowance for loan losses for specific loan categories at the dates indicated.
The allocation presented should not be interpreted as an indication that charges
to the allowance for loan losses will be incurred in these amounts or
proportions, or that the portion of the allowance allocated to each loan
category represents the total amounts available for future losses that may occur
within these categories. The unallocated portion of the allowance and the total
allowance is applicable to the entire loan portfolio.
At December 31,
------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------------ ------------------ ------------------ ----------------- -------------------
% Of % Of % Of % Of % Of
Loans In Loans In Loans In Loans In Loans In
Category Category Category Category Category
To Gross To Gross To Gross To Gross To Gross
(Dollars In Thousands) Amount Loans(1) Amount Loans(1) Amount Loans(1) Amount Loans(1) Amount Loans(1)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Residential $ 1,710 42.2% $ 1,143 37.8% $ 663 43.4% $ 925 56.1% $ 744 70.3%
Multifamily 713 21.4% 470 18.1% 185 10.9% 277 10.2% 260 8.1%
Commercial real estate 2,374 22.7% 1,232 24.1% 918 18.6% 514 12.2% 226 7.0%
Construction 525 7.9% 1,164 13.9% 960 20.3% 533 15.7% 209 12.2%
Land 336 2.5% 400 3.9% 137 3.6% 101 2.4% 54 0.7%
Home equity lines of
credit 30 1.4% 32 1.3% 32 1.0% 34 1.0% 38 1.1%
Other consumer loans 11 0.1% 11 0.2% 15 0.2% 11 0.2% 19 0.2%
Business term loans 111 0.6% 148 0.4% 243 1.7% 190 2.0% 19 0.3%
Business lines of credit 187 1.2% 25 0.3% 83 0.3% 26 0.2% 19 0.1%
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total allocated 5,997 100.0% 4,625 100.0% 3,236 100.0% 2,611 100.0% 1,588 100.0%
======== ======== ======== ======== ========
Unallocated 668 739 266 169 81
-------- -------- -------- -------- --------
Total $ 6,665 $ 5,364 $ 3,502 $ 2,780 $ 1,669
======== ======== ======== ======== ========
Other information
Gross loans outstanding
held for investment $484,940 $423,945 $388,198 $327,876 $287,562
----------------
(1) Gross loans held for investment
Over the past several years, the Company has increased its allowance
for loan losses in conjunction with three key trends within the loan portfolio:
o The growth in the nominal size of the loan portfolio has led Management to
increase the amount of the allowance.
o The greater diversification in the mix of the loan portfolio away from
residential one to four unit permanent mortgages toward other types of
lending, particularly income property loans, has led to higher nominal and
relative allowance levels, as these newer types of lending typically
present more risk than residential mortgages. This increased risk stems
both from the nature of the lending and the greater individual credit
amounts associated with income property loans.
o The increasing concentration of the portfolio in relatively less seasoned
credits, because of the Company's growth rate in recent years, has also led
Management to increase the level of the allowance, as less seasoned loans
typically present greater risk than loans which have been performing for
many years.
The Company's loan portfolio at December 31, 2001 presented significant
geographic concentration, consistent with the Company's focus of serving local
individuals and businesses as a community commercial bank. The majority of the
Company's loans outstanding at December 31, 2001 were secured by real estate
located in the three counties that constitute the Company's primary market area:
o Santa Cruz County
o Monterey County
o Santa Clara County
35
This concentration provides certain benefits. For example, the Company
becomes well known in its local area and therefore attracts more business. In
addition, Management develops a more comprehensive knowledge of real estate
values and business trends in markets where lending is regularly conducted.
However, this concentration also presents certain risks. A natural disaster such
as an earthquake centered in the Greater Monterey Bay Area would impact the
Company more significantly than firms with loans geographically dispersed over a
wider area. Another concentration risk is that a downturn in the economy or real
estate values in the Greater Monterey Bay Area would disproportionately
unfavorably impact the Company versus a State-wide or national lender. The
geographic concentration of the Company's loans is an important factor that
Management considers in determining appropriate levels of loan loss reserves.
At December 31, 2001, the Company had outstanding less than $5.0
million in loans outside the State of California, with a majority of such loans
associated with the Special Residential Loan Pool (see Note 14 to the
Consolidated Financial Statements). The Company's strategic plan does not
include substantial lending in 2002 outside the State of California. The Company
does, however, intend to pursue the purchase of loans, particularly income
property loans, throughout much of California during 2002, in addition to
directly originating income property and construction loans through the new Los
Angeles loan production office. Over time, the Company intends to reduce its
real estate loan concentration in the three counties comprising its primary
market area, somewhat offset by increased extensions of credit to businesses
domiciled in the three counties.
During 2001, among the changes implemented to the Company's loan loss
reserve methodology were increases in the formula allowances for real estate
loans secured by hotels / motels and for the Business Express portfolio. General
allowance levels were increased for hotel / motel loans due to the increase in
vacancies and reduction in average room rates caused by the national recession
and the reduced volume of travel after the events of September 11, 2001. Loan
reviews during late 2000 for hotel / motel loans and third party reports
suggested a systemic reduction in net cash flows for the hospitality industry.
Increased charge-off experience and the onset of the national recession led
management to increase the formula allowance for Business Express loans during
2001. At December 31, 2001, the Company had $30.8 million in real estate loans
outstanding secured by hotel / motel properties and $543 thousand of Business
Express loans outstanding.
During the first quarter of 2002, the Company intends to undertake a
special credit review of its hotel / motel portfolio in order to identify
borrowers that might be particularly adversely impacted by events and trends in
that industry.
The $668 thousand in unallocated allowance at December 31, 2001 reflected
the Company's consideration of the following factors, as well as more general
factors including the national recession, increased layoffs and unemployment,
the weak equity markets, a significant California State budget deficit, and
consumer and business reactions to the events of September 11, 2001:
o The adverse effects of a decline in tourism impacting the local economies
in Santa Cruz and Monterey counties, with a concomitant impact upon net
cash flows for local commercial enterprises, commercial real estate
properties, and owner / operators of small businesses, which could be in
the range of $100 thousand to $400 thousand.
o The adverse impacts of the weakening technology industry upon commercial
real estate values. The Company's primary lending area is near the Silicon
Valley area of the San Francisco Bay Area, which has been impacted by the
slump in various technology and technology related businesses. This impact
could be in the range of $100 thousand to $800 thousand.
As subsequently discussed (see "Provision For Loan Losses"), the lower
provision for loan losses recorded during 2001 versus 2000 resulted from
multiple factors, including lower net charge-offs and the recapture of a $600
thousand specific reserve during the second quarter of 2001.
36
Management anticipates that should the Company accomplish its strategic
plan and be successful in:
o generating further growth in loans receivable held for investment,
o emphasizing the origination and purchase of income property real estate
loans,
o continuing expansion of commercial business lending, and
o reducing the portfolio concentration in relatively lower risk residential
mortgages,
future provisions will result and the ratio of the allowance for loan losses to
loans outstanding will increase in a manner consistent with the Company's loan
loss allowance methodology. Experience across the financial services industry
indicates that commercial business and income property loans present greater
risks than residential real estate loans, and therefore should be accompanied by
suitably higher levels of reserves.
Investment Activities
Cash Equivalents. The Company does not include certain short term, highly
liquid investments as investment securities, instead classifying these as cash
equivalents. These include:
o federal funds sold
o securities purchased under agreements to resell
o commercial paper
o money market mutual fund investments
o banker's acceptances
o certificates of deposit in federally insured financial institutions
Liquidity Maintenance. Federally chartered savings institutions have
the authority to invest in various types of liquid assets, as defined in
applicable regulations, including United States Treasury obligations, securities
of or guaranteed by various federal agencies, certificates of deposit of insured
banks and savings institutions, bankers' acceptances, repurchase agreements, and
federal funds. Additionally, under OTS regulations, the Bank must maintain a
safe and sound level of liquidity at all times. Management agrees that
maintaining an adequate level of liquidity at all times is fundamental to
effective guidance of a financial institution. Management believes that the Bank
at all times in 2001 maintained a level of available liquidity considered to be
adequate to meet foreseeable operational needs.
Investment Policies. In addition to the above liquid assets, subject to
various restrictions, federally chartered savings institutions may also invest
in various other types of securities, including investment-grade corporate debt
securities, asset-backed securities, collateralized mortgage obligations not
guaranteed by a federal agency, and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. The Company maintains separate internal investment
policies for the Bank and MBBC. These policies are established by the Board of
Directors with the key objectives of:
o providing and maintaining liquidity
o generating a favorable total return on a risk-adjusted basis
o managing the overall interest rate risk profile of the entities
o maintaining compliance with various associated regulations
o controlling credit risk exposure
Specifically, the Company's policies generally limit investments to publicly
traded securities that are investment grade. These policies prohibit the
Company's maintenance of a trading portfolio as defined under SFAS No. 115.
Accounting And Reporting. Investment securities classified as available
for sale are recorded at fair value, while investment securities classified as
held to maturity are recorded at cost. Unrealized gains or losses on available
for sale securities, net of the deferred tax effect, are reported as a component
of other comprehensive income and are included in stockholders' equity.
37
The amortized cost and estimated fair value of securities are presented
in the following tables. "PT" represents "pass-through" and "CMO" represents
"collateralized mortgage obligation".
December 31, 2001
---------------------------------------------------------------------
(Dollars In Thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Available for sale Cost Gains Losses Value
------------------ ---- ----- ------ -----
Variable rate corporate trust
preferred securities $ 7,707 $ -- $ (407) $ 7,300
Fixed rate FHLMC PT's 1,551 34 -- 1,585
Fixed rate FNMA PT's 585 38 -- 623
Fixed rate GNMA PT's 744 31 -- 775
Variable rate FNMA PT's 4,629 62 -- 4,691
Fixed rate FHLMC balloons 1,956 -- -- 1,956
Fixed rate CMO's:
Agency issuance 17,062 86 -- 17,148
Non Agency issuance 3,831 35 -- 3,866
------- ----- ------- -------
$38,065 $ 286 $ (407) $37,944
======= ===== ======= =======
December 31, 2000
---------------------------------------------------------------------
(Dollars In Thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Available for sale Cost Gains Losses Value
------------------ ---- ----- ------ -----
Variable rate corporate trust
preferred securities $ 7,696 $ -- $ (336) $ 7,360
Fixed rate FHLMC PT's 1,090 13 -- 1,103
Fixed rate FNMA PT's 3,649 25 (2) 3,672
Fixed rate GNMA PT's 1,060 -- (11) 1,049
Variable rate FNMA PT's 571 5 -- 576
Fixed rate CMOs:
Agency issuance 19,095 5 (266) 18,834
Non Agency issuance 18,210 4 (498) 17,716
------- ----- ------- -------
$51,371 $ 52 $(1,113) $50,310
======= ===== ======= =======
December 31, 1999
---------------------------------------------------------------------
(Dollars In Thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Available for sale Cost Gains Losses Value
------------------ ---- ----- ------ -----
Variable rate corporate trust
preferred securities $11,456 $ 50 $ (43) $11,463
Fixed rate FHLMC PT's 1,930 -- (36) 1,894
Fixed rate FNMA PT's 24,371 95 (375) 24,091
Fixed rate GNMA PT's 4,531 -- (96) 4,435
Variable rate FNMA PT's 761 -- (4) 757
Fixed rate CMO's:
Agency issuance 11,152 -- (974) 10,178
Non Agency issuance 16,965 -- (604) 16,361
------- ----- -------- -------
$71,166 $ 145 $(2,132) $69,179
======= ===== ======== =======
Held to maturity
----------------
Fixed rate FNMA balloons $ 60 $ -- $ -- $ 60
======= ===== ======== =======
38
At December 31, 2001, the Company's investment in corporate trust
preferred securities was entirely composed of variable rate securities which
reprice every three months based upon a margin over the three month LIBOR rate.
These corporate trust preferred securities were all rated "A-" or better by
Standard & Poors ratings agency at December 31, 2001.
Over the past two years, the Company has restructured its security
portfolio in pursuing the following objectives:
o generating a steady stream of cash flows to provide liquidity in support of
the expanding loan portfolio
o increasing the interest rate sensitivity of the portfolio in conjunction
with the Company's asset / liability management program
o maintaining sufficient US Agency CMO's to provide collateral for various
types of secured deposits, primarily funds placed with the Bank by the
State of California under its time deposit program
o increasing the investment in CMO's versus PT's in order to better tailor
the portfolio's cash flows to the projected liquidity needs of the Company
o classifying all securities as available for sale in order to provide
additional flexibility in balance sheet management
o reducing the size of the security portfolio relative to total assets in
order to allocate a greater percentage of the balance sheet to loans in
conformity with the Company's strategic plan
The following table presents certain information regarding the
amortized cost, estimated fair value, weighted average yields, and contractual
maturities of the Company's securities as of December 31, 2001. Actual
maturities may differ from contractual maturities due to principal prepayments,
priority of principal allocation within collateralized mortgage obligations, or
rights of issuers to call obligations prior to maturity.
At December 31, 2001
--------------------------------------------------------------------------
(Dollars In Thousands) 2003 2007 2012
Through Through And
Available for sale securities 2002 2006 2011 Thereafter Total
----------------------------- ---- ---- ---- ---------- -----
Variable rate corporate trust
preferred securities $ -- $ -- $ -- $ 7,707 $ 7,707
Fixed rate FHLMC PT's -- -- -- 1,551 1,551
Fixed rate FNMA PT's -- -- -- 585 585
Fixed rate GNMA PT's -- -- 601 143 744
Variable rate FNMA PT's -- -- -- 4,629 4,629
Fixed rate FHLMC balloons -- -- 1,956 -- 1,956
Fixed rate CMO's:
Agency issuance -- 900 -- 16,162 17,062
Non Agency issuance -- -- -- 3,831 3,831
----- ------ ------- -------- -------
Total amortized cost $ -- $ 900 $ 2,557 $ 34,608 $38,065
===== ====== ======= ======== =======
Estimated fair value $ -- $ 907 $ 2,582 $ 34,455 $37,944
===== ====== ======= ======== =======
Weighted average yield (1) -- 5.90% 5.28% 4.56% 4.64%
----------
(1) Weighted average yield is calculated based upon estimated fair value.
The Company maintained no tax-preferenced securities at December 31, 2001.
At December 31, 2001, the Company did not own debt securities issued by any one
issuer other than US Agencies that exceeded ten percent of stockholders' equity.
For additional information regarding the Company's securities, please refer to
Notes 3 and 4 to the Consolidated Financial Statements.
39
Sources Of Funds
General. The Company's primary sources of funds are customer deposits,
principal, interest, and dividend payments on loans and securities, FHLB
advances and other borrowings, and, to a lesser extent, proceeds from sales of
securities and loans. While maturities and scheduled amortization of loans and
securities are predictable sources of funds, deposit flows and loan and security
prepayments are greatly influenced by general interest rates, economic
conditions, and competition.
Deposits. The Company offers a variety of deposit accounts with a range
of interest rates, features, and terms. The Company's deposits consist of demand
deposit and NOW checking accounts, savings accounts, money market accounts, and
certificates of deposit. The flow of deposits is influenced significantly by
general economic conditions, events in the capital markets, money supply,
prevailing interest rates, and competition. The Company's deposits are obtained
predominantly from the areas in which its full service branch offices are
located. The Company relies primarily on customer service and long standing
relationships with customers to attract and retain these deposits; however,
market interest rates and rates offered by competing financial institutions and
mutual funds significantly affect the Company's ability to attract and retain
deposits. While the Bank is currently eligible to accept brokered deposits, it
has not done so. The Bank participates in the State of California Time Deposit
Program, whereby the State places certificates of deposit with banks as a means
of encouraging lending back into California's communities. Management regularly
monitors the Company's certificate accounts and historically the Company has
retained a large portion of such accounts upon maturity.
The Company's strategic plan incorporates increasing the percentage of
deposits represented by transaction accounts. Management believes that
transaction accounts present the opportunity to strengthen customer
relationships, build franchise value, generate fee income, and lower the
Company's relative cost of funds. In addition, an expansion in transaction
accounts supports the Company's asset / liability management program, as
transaction accounts are generally less interest rate sensitive than most
alternative sources of funding.
In recent years, the Company has offered a series of money market
deposit accounts specifically designed for certain target markets. Customers
wishing to avoid account maintenance fees and maintain low minimum balances are
marketed the Company's Easy Access money market account. Customers planning to
maintain particularly high average balances are marketed the Company's highly
tiered and more aggressively priced Money Market Plus account. Customers in
between these two profiles are marketed the competitively priced Lighthouse
money market account. All three of these money market products offer check
writing, 24 hour bilingual telephone banking, Internet banking, ATM access, bank
by mail, and in-branch service. As a result of this target marketing, money
market deposit balances have increased in recent years, from $81.2 million at
December 31, 1999 to $87.7 million at December 31, 2000 to $105.8 million at
December 31, 2001. Expansion in money market balances during 2001 benefited from
the interest rate environment, as certain customers were less interested in
committing to term certificates of deposit with interest rates at historically
low levels.
The Company's other area of focus in deposit acquisition in recent
years has been checking accounts, coincident with the Company's business
strategy of becoming more of a community based financial services organization,
meeting the primary financial needs of both consumers and small businesses.
Total checking balances expanded from $58.9 million at December 31, 2000 to
$63.6 million at December 31, 2001. In addition, checking accounts expanded
13.3% of total deposits at December 31, 1999 to 14.4% at December 31, 2000 to
14.7% at December 31, 2001.
The rise in checking account balances during 2001 was supported by
increased checking account balances maintained by local businesses with which
the Company established comprehensive relationships in 2001, including such
services as lines of credit, courier service, real estate financing, and
dedicated account relationship officers. The Company plans to further augment
its business checking product line in 2002 with the introduction of Internet
banking for businesses.
The Company also plans to augment its line of consumer checking
products in 2002, with improved customer statements and continued marketing of
Internet banking for consumers, including electronic bill payment. Consumer
checking promotions for 2002 are planned for the Company's Interest Checking
Plus product, which provides relatively higher, tiered interest rates for those
consumers who maintain more substantial balances in their checking accounts.
40
At December 31, 2001, all of the Company's deposit products were
statement based (i.e. no passbooks). Management believes that statement based
products integrate more effectively with the increasingly numerous and varied
means of customer electronic access to their funds; e.g. Internet banking,
electronic bill payment, debit / point of sale, ATM networks, and telephone
banking.
During 2001, the Company's certificate of deposit portfolio decreased
by $945 thousand despite a $5.0 million increase in funds from the State of
California Time Deposit Program. A portion of the decrease in certificate of
deposit balances during 2001 was associated with customer transfers of funds
into money market accounts due to the historically low interest rate
environment. During the past several years, the Company has focused its deposit
related sales efforts on transaction accounts as a means of increasing net
interest margins, bolstering fee income, and building more comprehensive
customer relationships. In addition, during 2001, the Company encountered
significant price competition for certificates of deposit from two very large
thrifts in particular, and from new or Internet banks seeking to build their
customer bases through aggressive pricing without regard to short term
profitability.
The Company's weighted average cost of deposits at December 31, 2001
was 2.87%, equal to 20 basis points below the 11th District Cost Of Funds Index
("COFI") for December 2001 of 3.07%. While COFI contains funding components
other than deposits, the Company uses a comparison to COFI as a benchmark of its
success in managing its cost of deposits. The Company seeks to manage its cost
of deposits both via pricing for individual products and through the deposit
portfolio product mix.
The Company maintained no deposits in foreign banking offices at
December 31, 2001 or December 31, 2000.
The Company's weighted average cost of deposits decreased significantly
in 2001 primarily due to the 11 interest rate cuts totaling 475 basis points
implemented by the Federal Reserve, and to a lesser extent because of a shift in
deposit mix. The following table summarizes the Company's deposits at the dates
indicated.
December 31, 2001 December 31, 2000
------------------------------- -------------------------------
Weighted Weighted
(Dollars In Thousands) Average Average
Balance Rate Balance Rate
------- ---- ------- ----
Demand deposit accounts $ 21,062 -- $ 17,065 --
NOW accounts 42,557 0.41% 41,859 1.53%
Savings accounts 19,127 0.57% 16,503 1.96%
Money market accounts 105,828 2.31% 87,651 4.78%
Certificates of deposit < $100,000 156,351 4.02% 166,905 5.68%
Certificates of deposit $100,000 or more 87,414 3.86% 77,805 5.97%
-------- ---- -------- ----
$432,339 $407,788
======== ========
Weighted average nominal interest rate 2.87% 4.72%
The weighted average interest rates are at the end of the period and are based
upon stated interest rates without giving consideration to daily compounding of
interest or forfeiture of interest because of premature withdrawal.
41
The following table presents the amount and weighted average rate of
time deposits equal to or greater than $100,000 at December 31, 2001. The amount
maturing in three months or less includes $16.1 million associated with the
State of California Time Deposit Program.
At December 31, 2001
----------------------------------
(Dollars In Thousands) Weighted
Average
Maturity Period Amount Rate
------ ----
Three months or less $ 36,273 3.83%
Over three through 6 months 15,944 3.31%
Over 6 through 12 months 18,100 4.28%
Over 12 months 17,097 4.01%
-------- ----
Total $ 87,414 3.86%
========
The following table presents the amount and weighted average rate of
time deposits less than $100,000 at December 31, 2001.
At December 31, 2001
----------------------------------
(Dollars In Thousands) Weighted
Average
Maturity Period Amount Rate
------ ----
Three months or less $ 44,749 4.19%
Over three through 6 months 37,684 3.73%
Over 6 through 12 months 40,313 4.18%
Over 12 months 33,605 3.93%
--------- ----
Total $ 156,351 4.02%
=========
The following table presents the distribution of the Company's average
balances of deposit accounts for the periods indicated and the weighted average
interest rates on each category of deposits presented.
For The Year Ended December 31,
-------------------------------------------------------------------------------------------
2001 2000 1999
----------------------------- ----------------------------- -----------------------------
% Of % Of % Of
Average Weighted Average Weighted Average Weighted
Average Total Average Average Total Average Average Total Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars In Thousands)
Demand deposits $ 19,104 4.6% -- $ 16,719 4.3% -- $ 17,610 4.8% --
NOW accounts 40,944 9.8% 0.89% 36,317 9.4% 1.51% 25,205 6.8% 1.54%
Savings accounts 19,370 4.6% 1.12% 15,803 4.1% 1.78% 15,583 4.2% 1.80%
Money market accounts 92,237 22.1% 3.74% 87,733 22.7% 4.60% 82,006 22.2% 4.15%
Certificates of deposit 246,315 58.9% 5.04% 230,099 59.5% 5.37% 229,493 62.0% 4.82%
-------- ----- ---- -------- ----- ---- -------- ----- ----
Total $417,970 100.0% 3.93% $386,671 100.0% 4.45% $369,897 100.0% 4.09%
======== ===== ==== ======== ===== ==== ======== ===== ====
Please refer to Note 10 to the Consolidated Financial Statements for
additional information concerning deposits.
42
Borrowings
From time to time, the Company obtains borrowed funds through FHLB
advances, federal funds purchased, MBBC's line of credit, and securities sold
under agreements to repurchase. Borrowings are used to supplement deposits as a
source of funding. Borrowings are also used as a tool in the Company interest
rate risk management process.
FHLB advances are collateralized by the Bank's pledged mortgage loans,
pledged mortgage backed securities, and investment in the capital stock of the
FHLB. See "Regulation And Supervision - Federal Home Loan Bank System." FHLB
advances are made pursuant to several different credit programs with varying
interest rate, embedded option (callable / putable), amortization, and maturity
terms. All of the Bank's FHLB advances outstanding at December 31, 2001 were
fixed rate, non-amortizing advances with single individual maturity dates
("bullet advances"). The maximum amount that the FHLB will advance to member
institutions, including the Bank, fluctuates from time to time in accordance
with the policies of the FHLB. During 2001, the Bank periodically used FHLB
advances to provide needed liquidity and to manage the term structure and
maturities of its liabilities.
From time to time, the Company enters into reverse repurchase
agreements (securities sold under agreements to repurchase) with approved
security dealers. Over the past several years, MBBC has in particular utilized
securities sold under agreements to repurchase, as the holding company is not
eligible for obtaining FHLB advances.
The Bank maintains federal funds lines of credit with four
correspondent banks. These lines are not committed lines, but rather function on
a funds availability basis. From time to time, the Bank borrows federal funds
from its correspondent banks as a source of short term liquidity.
MBBC maintains a committed $3.0 million revolving line of credit with
one of the Bank's correspondent banks. This line of credit expires in December
2002, and is collateralized by 800,000 shares of the Company's treasury stock.
Funds drawn on the line are priced based upon either the London Inter-Bank Offer
Rate curve ("LIBOR") or the correspondent bank's reference rate. This line of
credit contains various financial performance covenants on the part of the
Company. The line of credit agreement does not restrict the Company's ability to
declare and pay cash or stock dividends. The line of credit agreement also
contains no restrictions on the use of funds to repurchase Company common stock.
The following table sets forth information regarding the Company's
borrowed funds at or for the indicated years.
(Dollars In Thousands) At Or For The Year Ended December 31,
--------------------------------------------
2001 2000 1999
---- ---- ----
FHLB Advances
Average balance outstanding $ 47,526 $ 43,946 $ 37,600
Weighted average rate on average balance outstanding 5.30% 5.72% 5.53%
Year end balance outstanding $ 53,582 $ 32,582 $ 49,582
Weighted average rate on year end balance outstanding 4.46% 5.48% 5.65%
Maximum amount outstanding at any month end during the year $ 65,582 $ 50,582 $ 49,582
Securities Sold Under Agreements To Repurchase
Average balance outstanding $ -- $ 155 $ 3,182
Weighted average rate on average balance outstanding -- 6.45% 5.65%
Year end balance outstanding $ -- $ -- $ 2,410
Weighted average rate on year end balance outstanding -- -- 6.08%
Maximum amount outstanding at any month end during the year $ -- $ -- $ 4,350
Please refer to Notes 11 and 12 to the Consolidated Financial
Statements for additional information regarding borrowings and lines of credit.
43
Subsidiary Activities
Portola, a California corporation wholly owned by the Bank, is engaged,
on an agency basis, in the sale of insurance, mutual funds, individual
securities, and annuity products, primarily to the Bank's customers and members
of the local communities which the Bank serves. During 2001, gross commission
income generated through Portola included $73 thousand for variable annuity
sales, $78 thousand for mutual fund sales, and $22 thousand for fixed annuity
sales. Portola also functions as trustee for the Bank's deeds of trust. At
December 31, 2001, Portola had $101 thousand in total assets. Portola's revenues
in 2001 were constrained by the capital markets environment, customer inaction
following the events of September 11, 2001, and by turnover in investment sales
representatives.
Personnel
As of December 31, 2001, the Company had 119 full-time employees and 16
part-time employees. The employees are not represented by a collective
bargaining unit. The Company considers its relationship with its employees to be
good.
REGULATION AND SUPERVISION
General
Savings and loan holding companies and savings associations are
extensively regulated under both federal and state law. This regulation is
intended primarily for the protection of depositors and the Savings Association
Insurance Fund ("SAIF") and not for the benefit of stockholders of the Company.
The following information describes certain aspects of that regulation
applicable to the Company and the Bank, and does not purport to be complete. The
following discussion is qualified in its entirety by reference to all particular
statutory or regulatory provisions.
Regulation of the Company
General. The Company is a unitary savings and loan holding company
subject to regulatory oversight by the Office of Thrift Supervision ("OTS"). As
such, the Company is required to register and file reports with the OTS and is
subject to regulation and examination by the OTS. In addition, the OTS has
enforcement authority over the Company and its subsidiaries, which also permits
the OTS to restrict or prohibit activities that are determined to be a serious
risk to the subsidiary savings association.
Although savings and loan holding companies are not, at December 31,
2001, subject to specific capital requirements or specific restrictions on the
payment of dividends or other capital distributions, the Home Owners Loan Act
("HOLA") does prescribe such restrictions on subsidiary savings institutions, as
described below. The Bank must notify the OTS 30 days before declaring any
dividend to MBBC.
The HOLA prohibits a savings and loan holding company directly, or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5% of a non-subsidiary company engaged in activities other
than those permitted by the HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the deposit insurance funds, the convenience and needs of the community, and
competitive factors.
44
Activities Restriction Test. As a unitary savings and loan holding
company, the Company generally is not subject to activity restrictions, provided
the Bank satisfies the Qualified Thrift Lender ("QTL") test or meets the
definition of domestic building and loan association pursuant to the Internal
Revenue Code of 1986, as amended (the "Code"). The Company presently intends to
continue to operate as a unitary savings and loan holding company. Federal
legislation terminated the "unitary thrift holding company exemption" for all
companies that apply to acquire savings associations after May 4, 1999. Since
the Company is grandfathered, its unitary holding company powers and authorities
were not affected. See "Financial Services Modernization Legislation." However,
if the Company acquires control of another savings association as a separate
subsidiary, it would become a multiple savings and loan holding company, and the
activities of the Company and any of its subsidiaries (other than the Bank or
any other SAIF-insured savings association) would become subject to restrictions
applicable to bank holding companies unless such other associations each also
qualify as a QTL or domestic building and loan association and were acquired in
a supervisory acquisition. Furthermore, if the Company were in the future to
sell control of the Bank to any other company, such company would not succeed to
the Company grandfathered status under and would be subject to the same business
activity restrictions. See "Regulation of the Bank - Qualified Thrift Lender
Test."
Restrictions on Acquisitions. MBBC must obtain approval from the OTS
before acquiring control of any other SAIF-insured association. Such
acquisitions are generally prohibited if they result in a multiple savings and
loan holding company controlling savings institutions in more than one state.
However, such interstate acquisitions are permitted based on specific state
authorization or in a supervisory acquisition of a failing savings association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may acquire
"control," as that term is defined in OTS regulations, of a federally insured
savings association without giving at least 60 days written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition. In
addition, no company may acquire control of such an institution without prior
OTS approval. These provisions also prohibit, among other things, any director
or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of a savings and loan holding
company, from acquiring control of any savings association not a subsidiary of
the savings and loan holding company, unless the acquisition is approved by the
OTS. For additional restrictions on the acquisition of a unitary thrift holding
company, see "- Financial Services Modernization Legislation."
USA Patriot Act of 2001
On October 26, 2001, President Bush signed the USA Patriot Act of 2001.
Enacted in response to the terrorist attacks in New York, Pennsylvania, and
Washington, D.C. on September 11, 2001, the Patriot Act is intended is to
strengthen U.S law enforcement's and the intelligence communities' abilities to
work cohesively to combat terrorism on a variety of fronts. The potential impact
of the Act on financial institutions of all kinds is significant and wide
ranging. The Act contains sweeping anti-money laundering and financial
transparency laws and requires various regulations, including:
o due diligence requirements for financial institutions that administer,
maintain, or manage private banks accounts or correspondent accounts for
non-US persons
o standards for verifying customer identification at account opening
o rules to promote cooperation among financial institutions, regulators, and
law enforcement entities in identifying parties that may be involved in
terrorism or money laundering
o reports by non-financial trades and businesses filed with the Treasury
Department's Financial Crimes Enforcement Network for transactions
exceeding $10,000, and
o filing of suspicious activities reports securities by brokers and dealers
if they believe a customer may be violating U.S. laws and regulations.
45
Financial Services Modernization Legislation
General. On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act of 1999 (the "GLB"). The GLB repealed the law prohibiting
affiliations banks and securities companies. In addition, the GLB expressly
preempted any state law restricting the establishment of financial affiliations
primarily related to insurance.
The general effect of the law is to establish a comprehensive framework
to permit affiliations among commercial banks, insurance companies, securities
firms, and other financial service providers by revising and expanding the Bank
Holding Company Act framework to permit a holding company system to engage in a
full range of financial activities through a new entity known as a "Financial
Holding Company." "Financial activities" is broadly defined to include not only
banking, insurance, and securities activities, but also merchant banking and
additional activities that the Federal Reserve Board, in consultation with the
Secretary of the Treasury, determines to be financial in nature, incidental to
such financial activities, or complementary activities that do not pose a
substantial risk to the safety and soundness of depository institutions or the
financial system generally.
The GLB provides that no company may acquire control of an insured
savings association unless that company engages, and continues to engage, only
in the financial activities permissible for a Financial Holding Company, unless
grandfathered as a unitary savings and loan holding company. The GLB
grandfathers any company that was a unitary savings and loan holding company on
May 4, 1999 or became a unitary savings and loan holding company pursuant to an
application pending on that date. Such a company may continue to operate under
present law as long as the company continues to meet the two tests: it can
control only one savings institution, excluding supervisory acquisitions, and
each such institution must meet the QTL test. Such a grandfathered unitary
savings and loan holding company also must continue to control at least one
savings association, or a successor institution, that it controlled on May 4,
1999.
The GLB also permits national banks to engage in expanded activities
through the formation of financial subsidiaries. A national bank may have a
subsidiary engaged in any activity authorized for national banks directly or any
financial activity, except for insurance underwriting, insurance investments,
real estate investment or development, or merchant banking, which may only be
conducted through a subsidiary of a Financial Holding Company. Financial
activities include all activities permitted under new sections of the Bank
Holding Company Act or permitted by regulation.
The Company and the Bank do not believe that the GLB has had or will
have a material adverse effect on their operations in the near-term. However, to
the extent that the act permits banks, securities firms, and insurance companies
to affiliate, the financial services industry may experience further
consolidation. The GLB is intended to grant to community banks certain powers as
a matter of right that larger institutions have accumulated on an ad hoc basis
and which unitary savings and loan holding companies already possess.
Nevertheless, this Act may have the result of increasing the amount of
competition that the Company and the Bank face from larger institutions and
other types of companies offering financial products, many of which may have
substantially more financial resources than the Company and the Bank.
46
Privacy. Under the GLB, federal banking regulators adopted rules that
limit the ability of banks and other financial institutions to disclose
non-public information about consumers to nonaffiliated third parties. Pursuant
to these rules, effective July 1, 2001, financial institutions must provide:
o initial notices to customers about their privacy policies, describing the
conditions under which they may disclose nonpublic personal information to
nonaffiliated third parties and affiliates;
o annual notices of their privacy policies to current customers; and
o a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
These privacy provisions affect how consumer information is transmitted through
diversified financial companies and conveyed to outside vendors.
Consumer Protection Rules - Sale of Insurance Products. In December
2000, pursuant to the requirements of the GLB, the federal bank and thrift
regulatory agencies adopted consumer protection rules for the sale of insurance
products by depository institutions. The rules were effective on April 1, 2001.
The final rule applies to any depository institution or any person selling,
soliciting, advertising, or offering insurance products or annuities to a
consumer at an office of the institution or on behalf of the institution. Before
an institution can complete the sale of an insurance product or annuity, the
regulation requires oral and written disclosure that such product:
o is not a deposit or other obligation of, or guaranteed by, the depository
institution or its affiliate;
o is not insured by the FDIC or any other agency of the United States, the
depository institution or its affiliate; and
o has certain risks in investment, including the possible loss of value.
Finally, the depository institution may not condition an extension of credit:
o on the consumer's purchase of an insurance product or annuity from the
depository institution or from any of its affiliates, or
o on the consumer's agreement not to obtain, or a prohibition on the consumer
from obtaining, an insurance product or annuity from an unaffiliated
entity.
The rule also requires formal acknowledgement from the consumer that disclosures
were received.
In addition, to the extent practicable, a depository institution must
keep insurance and annuity sales activities physically segregated from the areas
where retail deposits are routinely accepted from the general public.
47
Regulation of the Bank
General. As a federally chartered, SAIF insured savings association,
the Bank is subject to extensive regulation, examination, and supervision by the
OTS, as its primary federal regulator, and the FDIC, as the insurer of customer
deposits. Lending activities and other investments of the Bank must comply with
various statutory and regulatory requirements. The Bank is also subject to
certain reserve requirements promulgated by the Board of Governors of the
Federal Reserve System ("Federal Reserve Board").
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the consideration of the Bank's Board of Directors on any
deficiencies found in the operations of the Bank. The relationship between the
Bank and depositors and borrowers is also regulated by federal and state laws,
especially in such matters as the ownership of deposit accounts and the form and
content of mortgage documents utilized by the Bank.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition, in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with or
acquisitions of other financial institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the SAIF and depositors.
The OTS and / or the FDIC conduct periodic examinations to test the
Bank's safety and soundness, its operations (including technology utilization),
and its compliance with applicable laws and regulations, including, but not
limited to:
o the Community Reinvestment Act ("CRA")
o the Real Estate Settlement Procedures Act ("RESPA")
o the Bank Secrecy Act ("BSA")
o the Fair Credit Reporting Act ("FCRA")
o the Home Mortgage Disclosure Act ("HMDA")
The regulatory structure provides the regulatory authorities extensive
discretion, in connection with their supervisory and enforcement activities and
examination policies, across a wide range of the Bank's operations, including,
but not limited to:
o loss reserve adequacy
o capital requirements
o credit classification
o limitation or prohibition on dividends
o assessment levels for deposit insurance and examination costs
o permissible branching
Any change in regulatory requirements and policies, whether by the OTS,
the FDIC, the Federal Reserve Board, or Congress, could have a material adverse
impact on the Company.
Regulatory Capital Requirements And Capital Categories
The following discussion regarding regulatory capital requirements is
applicable to the Bank.
Regulatory Capital Requirements. OTS capital regulations require
savings institutions to meet three minimum capital standards (as defined by
applicable regulations):
o tangible capital equal to 1.5% of adjusted total assets
o leverage capital (core capital) equal to 3.0% of adjusted total assets
o risk-based capital equal to 8.0% of total risk-based assets
48
The Bank must meet each of these three standards in order to be deemed in
compliance with OTS capital requirements. The capital standard applicable to
savings institutions must be no less stringent than those for national banks. In
addition, the prompt corrective action ("PCA") standards discussed below also
establish, in effect, the following minimum standards:
o a 2.0% tangible capital ratio
o a 4.0% leverage (core) capital ratio (3.0% for institutions receiving
the highest regulatory rating under the CAMELS rating system)
o a 4.0% Tier One risk based capital ratio
Tangible capital is composed of:
o common stockholders' equity (including retained earnings)
o certain noncumulative perpetual preferred stock and related earnings
o minority interests in equity accounts of consolidated subsidiaries
less:
o intangible assets other than certain asset servicing rights and certain
nonsecurity financial instruments
o investments in and loans or advances to subsidiaries engaged in
activities as principal, not permissible for a national bank, with
certain limited exceptions
o servicing assets in excess of certain thresholds
o deferred tax assets in excess of certain thresholds
o accumulated unrealized gains on certain available for sale securities
o accumulated gains related to qualifying cash flow hedges
plus:
o accumulated unrealized losses on certain available for sale securities
o accumulated losses related to qualifying cash flow hedges
Core capital consists of tangible capital plus various adjustments for
certain intangible assets. At December 31, 2001 and 2000, the Bank's tangible
capital was equivalent to its core capital, as the Bank did not maintain any
qualifying adjustments. In general, total assets calculated for regulatory
capital purposes exclude those assets deducted from capital in determining the
applicable capital ratio.
The risk based capital standard for savings institutions requires the
maintenance of Tier One capital (core capital) and total capital (defined as
core capital plus supplementary capital) to risk weighted assets of 4.0% and
8.0%, respectively. In determining the amount of an institution's risk weighted
assets, all assets, including certain off balance sheet positions, are
multiplied by a risk weight of 0.0% to 100.0%, as assigned by OTS regulations
based upon the amount of risk perceived as inherent in each type of asset. The
components of supplementary capital include:
o cumulative preferred stock
o long term perpetual preferred stock
o mandatory convertible securities
o certain subordinated debt
o intermediate preferred stock
o the general allowance for loan and lease losses, subject to a limit of
1.25% of risk weighted assets
Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100.0% of core capital.
49
These regulatory capital requirements are viewed as minimum standards
by the OTS, and most institutions are expected to maintain capital levels well
above the minimum. In addition, the OTS regulations provide that minimum capital
levels higher than those provided in the regulations may be established by the
OTS for individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others:
o a savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks or a high
proportion of off-balance sheet risk;
o a savings association is growing, either internally or through
acquisitions, at such a rate that supervisory problems are presented that
are not dealt with adequately by OTS regulations; or
o a savings association may be adversely affected by activities or condition
of its holding company, affiliates, subsidiaries, or other persons, or
savings associations with which it has significant business relationships.
The Home Owners' Loan Act ("HOLA") permits savings associations not in
compliance with the OTS capital standards to seek an exemption from certain
penalties or sanctions for noncompliance. Such an exemption will be granted only
if certain strict requirements are met, and must be denied under certain
circumstances. If an exemption is granted by the OTS, the savings association
still may be subject to enforcement actions for other violations of law or
unsafe or unsound practices or conditions.
As disclosed in Note 14 to the Consolidated Financial Statements, at
December 31, 2001, the Bank exceeded all minimum and institution specific
regulatory capital requirements.
Prompt Corrective Action Regulations. The OTS can levy sanctions
against institutions that are not adequately capitalized, with the severity of
the sanctions increasing as the institution's capital declines. The OTS has
established specific capital ratios under the Prompt Corrective Action ("PCA")
Regulations for five separate capital categories:
1. Well Capitalized 3. Under Capitalized
-------------------- ---------------------
Total risk based capital ratio of at least 10.0% Total risk based capital ratio of less than 8.0%
Tier One risk based capital ratio of at least 6.0% Tier One risk based capital ratio of less than 4.0%
Leverage ratio of at least 5.0% Leverage ratio of less than 4.0%
2. Adequately Capitalized 4. Significantly Under Capitalized
-------------------------- -----------------------------------
Total risk based capital ratio of at least 8.0% Total risk based capital ratio of less than 6.0%
Tier One risk based capital ratio of at least 4.0% Tier One risk based capital ratio of less than 3.0%
Leverage ratio of at least 4.0% Leverage ratio of less than 3.0%
5. Critically Under Capitalized
--------------------------------
Tangible capital of less than 2.0%
In general, the prompt corrective action regulation prohibits an
insured depository institution from declaring any dividends, making any other
capital distribution, or paying a management fee to a controlling person if,
following the distribution or payment, the institution would be within any of
the three undercapitalized categories. In addition, adequately capitalized
institutions may accept brokered deposits only with a waiver from the FDIC and
are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew, or roll-over
brokered deposits.
50
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions. Finally, pursuant to an interagency
agreement, the FDIC can examine any institution that has a substandard
regulatory examination score or is considered undercapitalized - without the
express permission of the institution's primary regulator.
As disclosed in Note 14 to the Consolidated Financial Statements, at
December 31, 2001, the Bank met the requirements to be classified as a "well
capitalized" institution under Prompt Corrective Action regulations. At December
31, 2001, the Bank was eligible to acquire brokered deposits, but had none.
Special OTS Capital Requirements. During the first quarter of 2000, the
Bank was informed by the OTS that:
1. All loans associated with the pool of residential mortgages acquired from a
seller / servicer that guaranteed the pool (the "Special Residential Loan
Pool") be assigned to the 100% risk based capital category in calculating
capital ratios that incorporate risk weighted assets. See "Credit Quality -
Special Residential Loan Pool" and Note 14 to the Consolidated Financial
Statements.
2. The Bank's regulatory capital position at December 31, 1999 was required to
reflect this requirement.
3. Until further notice, the Bank's regulatory capital ratios were required to
be maintained at levels no lower than the levels at December 31, 1999.
The Bank continually complied with the above special requirements through
December 31, 2001. In early 2002, the Bank received notification from the OTS
that the institution specific regulatory capital requirements described above
have been eliminated.
Regulatory Capital Requirements Associated With Subprime Lending. As a
result of a number of federally insured financial institutions extending their
risk selection standards to attract lower credit quality accounts due to such
credits having higher interest rates and fees, the federal banking regulatory
agencies jointly issued Interagency Guidelines on Subprime Lending. Subprime
lending involves extending credit to individuals with less than perfect credit
histories.
The agencies' guidelines provide that if the risks associated with
subprime lending are not properly controlled, the agencies consider subprime
lending a high-risk activity that is unsafe and unsound. Specifically, the
guidelines direct examiners to expect regulatory capital one and one-half to
three times higher than that typically set aside for prime assets for
institutions that:
o have subprime assets equal to 25% or higher of Tier 1 capital; or
o have subprime portfolios experiencing rapid growth or adverse performance
trends, administered by inexperienced management, or having inadequate or
weak controls.
The Bank does not normally engage in subprime lending. However,
substantially all of the Special Residential Loan Pool (see "Credit Quality -
Special Residential Loan Pool" and Note 14 to the Consolidated Financial
Statements), if owned without the credit guaranty of the seller / servicer,
would qualify as subprime lending. Management believes that the seller /
servicer of the Special Residential Loan Pool has considerable experience in
administering subprime residential mortgages.
51
Predatory Lending. The term "predatory lending", much like the terms
"safety and soundness" and "unfair and deceptive practices," is far-reaching and
covers a potentially broad range of behavior. As such, it does not lend itself
to a concise or a comprehensive definition. But typically predatory lending
involves at least one, and perhaps all three, of the following elements:
o making unaffordable loans based on the assets of the borrower rather than
on the borrower's ability to repay an obligation ("asset-based lending")
o inducing a borrower to refinance a loan repeatedly in order to charge high
points and fees each time the loan is refinanced ("loan flipping")
o engaging in fraud or deception to conceal the true nature of the loan
obligation from an unsuspecting or unsophisticated borrower.
On December 14, 2001, the Federal Reserve Board amended its regulations
aimed at curbing predatory lending. Compliance is not mandatory until October 1,
2002. The rule significantly widens the pool of high-cost home-secured loans
covered by the Home Ownership and Equity Protection Act of 1994 ("HOPEA"), a
federal law that requires extra disclosures and consumer protections to
borrowers. The following triggers coverage under HOPEA:
o interest rates for first lien mortgage loans in excess of 8 percentage
points above comparable term Treasury securities;
o subordinate-lien loans of 10 percentage points above comparable term
Treasury securities; or
o fees such as optional insurance and similar debt protection costs paid in
connection with the credit transaction, when combined with points and fees
if deemed excessive.
In addition, the regulation bars loan flipping by the same lender or loan
servicer within a year. Lenders also will be presumed to have violated the law
-- which says loans shouldn't be made to people unable to repay them -- unless
they document that the borrower has the ability to repay. Lenders that violate
the rules face cancellation of loans and penalties equal to the finance charges
paid.
Because the Bank does not engage in the various practices generally
referenced as "predatory lending", management does not anticipate any material
impact from these rule changes and potential state action in this area on its
financial condition or results of operation.
Safety and Soundness Standards
The OTS has established minimum standards to promote early
identification of management problems at depository institutions and to ensure
that regulators intervene promptly to require corrective action by institutions
with inadequate operational and managerial controls related to:
o internal controls, information systems, and internal audit systems
o loan documentation
o credit underwriting
o asset growth
o earnings
o interest rate risk exposure
o compensation, fees, and benefits
52
If the OTS determines that an institution fails to meet any of these
minimum standards, the agency may require the institution to submit to the
agency an acceptable plan to achieve compliance with the standard. In the event
the institution fails to submit an acceptable plan within the time allowed by
the agency or fails in any material respect to implement an accepted plan; the
agency must, by order, require the institution to correct the deficiency and may
implement a series of supervisory sanctions.
The federal banking agencies (including the OTS) have promulgated
safety and soundness regulations and accompanying interagency compliance
guidelines on asset quality and earnings standards. These guidelines provide six
standards for establishing and maintaining a system to identify problem assets
and prevent those assets from deteriorating. The institution should:
1. conduct periodic asset quality reviews to identify problem assets
2. estimate the inherent losses in those assets and establish reserves
that are sufficient to absorb estimated losses
3. compare problem asset totals to capital
4. take appropriate corrective action to resolve problem assets
5. consider the size and potential risks of material asset concentrations
6. provide periodic asset reports with adequate information for management
and the board of directors to assess the level of asset risk
These guidelines also set forth standards for evaluating and monitoring
earnings and for ensuring that earnings are sufficient for the maintenance of
adequate capital and reserves. If the institution fails to comply with a safety
and soundness standard, the appropriate federal banking agency may require the
institution to submit a compliance plan. Failure to submit a compliance plan or
to implement an accepted plan may result in enforcement action.
Potential Enforcement Actions
The OTS has primary enforcement responsibility over savings
institutions and maintains the authority to bring actions against the
institution and all institution affiliated parties, as defined under the
applicable regulations, for unsafe or unsound practices in conducting their
businesses or for violations of any law, rule, regulation, condition imposed in
writing by the agency, or any written agreement with the agency. Enforcement
actions may include the imposition of a conservator or receiver, the issuance of
a cease and desist order that can be judicially enforced, the termination of
insurance of deposits (in the case of the Bank), the imposition of civil money
penalties, the issuance of directives to increase capital, the issuance of
formal and informal agreements, the issuance of removal or prohibition orders
against institution affiliated parties, and the imposition of restrictions under
the PCA provisions of FDICIA. Federal law also establishes criminal penalties
for certain violations.
Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to be taken with respect to a particular
savings institution. If action is not taken by the Director of the OTS, the FDIC
has authority to take such action under certain circumstances.
Additionally, a holding company's inability to serve as a source of
strength to its subsidiary financial institutions could serve as an ancillary
basis for regulatory action against the holding company. Neither MBBC, the Bank,
or any subsidiary thereof are currently subject to any enforcement actions
53
Insurance of Deposit Accounts
The Bank's deposit accounts are presently insured by the SAIF, except
for certain acquired deposits that are insured by the BIF, up to the maximum
permitted by law. The SAIF and the BIF are administered by the FDIC. Insurance
of deposits may be terminated by the FDIC upon a finding that the institution:
o has engaged in unsafe or unsound practices;
o is in an unsafe or unsound condition to continue operations; or
o has violated any applicable law, regulation, rule, order, or condition
imposed by the FDIC or the institution's primary regulator.
The management of the Bank does not know of any practice, condition, or
violation that might lead to the termination of deposit insurance.
The FDIC currently assesses its premiums based upon the insured institution's
position on two factors:
1. the institution's capital category under PCA regulations
2. the institution's supervisory category as determined by the FDIC based
upon supervisory information provided by the institution's primary
federal regulator and other information deemed pertinent by the FDIC
The supervisory categories are:
o Group A: financially sound with only a few minor weaknesses
o Group B: demonstrates weaknesses that could result in significant
deterioration
o Group C: poses a substantial probability of loss
Annual FDIC deposit insurance assessment rates as of January 1, 2002 were as
follows:
FDIC Deposit Insurance Rates Expressed In Terms
As Of January 1, 2002 Of Annual Cents Per $100 of Assessed Deposits
--------------------------------------------------
Group A Group B Group C
------- ------- -------
PCA Capital Category
Well capitalized 0 3 17
Adequately capitalized 3 10 24
Under capitalized 10 24 27
As of January 1, 2002, the Bank had been notified by the FDIC that its
deposit insurance assessment rate during the first half of calendar 2002 would
be 3 basis points. The Bank anticipates its deposit insurance assessment rate to
decrease to zero basis points during the second half of calendar 2002, subject
to possible changes in the FDIC insurance premium formula.
In addition to the deposit insurance premiums presented in the above
table, both BIF and SAIF insured institutions must also pay FDIC premiums
related to the servicing of Financing Corporation ("FICO") bonds. FICO is an
agency of the federal government that was established to recapitalize the
predecessor to the SAIF. These assessments will continue until the FICO bonds
mature in 2017. The current annual assessment rate for the FICO bonds is
approximately 2 basis points per annum on insured deposits.
In early 2002, Congress was considering various new laws applicable to
FDIC insurance premiums and insurance coverage. See "Potential Federal
Legislation and Regulation".
54
Branching
OTS regulations permit nationwide branching by federally chartered
savings institutions to the extent allowed by federal statute. This permits
federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions. At this time, the Company's management has no plans to
establish physical branches outside of California, although the Bank does serve
customers domiciled outside of California via alternative delivery channels such
as telephone, mail, the Internet, and ATM networks.
Transactions With Related Parties
Transactions between a savings association and its "affiliates" are
quantitatively and qualitatively restricted under the Federal Reserve Act.
Affiliates of a savings association include, among other entities, the savings
association's holding company and companies that are under common control with
the savings association. In general, a savings association or its subsidiaries
are limited in their ability to engage in "covered transactions" with
affiliates:
o to an amount equal to 10% of the association's capital and surplus, in the
case of covered transactions with any one affiliate; and
o to an amount equal to 20% of the association's capital and surplus, in the
case of covered transactions with all affiliates.
In addition, a savings association and its subsidiaries may engage in
covered transactions and other specified transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction"
includes:
o a loan or extension of credit to an affiliate
o a purchase of investment securities issued by an affiliate
o a purchase of assets from an affiliate, with some exceptions
o the acceptance of securities issued by an affiliate as collateral for a
loan or extension of credit to any party
o the issuance of a guarantee, acceptance, or letter of credit on behalf of
an affiliate
In addition, under the OTS regulations:
o a savings association may not make a loan or extension of credit to an
affiliate unless the affiliate is engaged only in activities permissible
for bank holding companies;
o a savings association may not purchase or invest in securities of an
affiliate other than shares of a subsidiary;
o a savings association and its subsidiaries may not purchase a low-quality
asset from an affiliate;
o covered transactions and other specified transactions between a savings
association or its subsidiaries and an affiliate must be on terms and
conditions that are consistent with safe and sound banking practices; and
o with some exceptions, each loan or extension of credit by a savings
association to an affiliate must be secured by collateral with a market
value ranging from 100% to 130%, depending on the type of collateral, of
the amount of the loan or extension of credit.
55
OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or Federal Reserve decides to treat these
subsidiaries as affiliates. The regulation also requires savings associations to
make and retain records that reflect affiliate transactions in reasonable detail
and provides that specific classes of savings associations may be required to
give the OTS prior notice of affiliate transactions.
The Bank's authority to extend credit to executive officers, directors,
and 10% shareholders, ("insiders"), as well as entities such persons control, is
governed by the Federal Reserve Act and Regulation O thereunder. Among other
things, such loans are required to be made on terms substantially the same as
those offered to unaffiliated individuals and to not involve more than the
normal risk of repayment. Specific legislation created an exception for loans
made pursuant to a benefit or compensation program that is widely available to
all employees of the institution and does not give preference to insiders over
other employees. Regulation O also places individual and aggregate limits on the
amount of loans the Bank may make to insiders based, in part, on the Bank's
capital position and requires certain Board approval procedures to be followed.
For information concerning loans to executive officers and directors of the
Company, please refer to Note 5 to the Consolidated Financial Statements.
Community Reinvestment Act and Fair Lending Laws
Savings associations have a responsibility under the Community
Reinvestment Act ("CRA") and related regulations of the OTS to help meet the
credit needs of their communities. The CRA generally requires most insured
depository institutions to:
o identify and delineate the communities served through and by the
institution's offices
o affirmatively meet the credit needs of their delineated communities,
including low and moderate income neighborhoods
o market the types of credit the institution is prepared to extend within
such communities
The CRA requires the OTS to assess the performance of the institution
in meeting the credit needs of its communities and to take such assessment into
consideration in reviewing applications for mergers, acquisitions, and other
transactions. An unsatisfactory CRA rating may be the basis for denying such an
application. In addition, federal banking agencies may take compliance with CRA
into account when regulating and supervising other activities.
The Equal Credit Opportunity Act and the Fair Housing Act prohibit
lenders from discriminating in their lending practices on the basis of
characteristics specified in those statutes. In addition, an institution's
failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act
could result in the OTS, other federal regulatory agencies, or the Department of
Justice taking enforcement actions.
An institution's CRA performance is assessed on the basis of the
institution's actual lending, service, and investment performance. In connection
with its assessment of the Bank's CRA performance, the OTS assigns one of the
following ratings:
o outstanding
o satisfactory
o needs improvement
o substantial noncompliance
Based upon its most recent CRA examination, the Bank received a "satisfactory"
CRA rating.
Effective January 1, 2002, the OTS raised the dollar amount limit in
the definition of small business loans from $500,000 to $2.0 million, if used
for commercial, corporate, business, or agricultural purposes. Furthermore, the
rule raises the aggregate level that a thrift can invest directly in community
development funds, community centers, and economic development initiatives in
its communities from the greater of a quarter of one percent of total capital or
$100,000 to one percent of total capital or $250,000.
56
Qualified Thrift Lender Test
The HOLA requires savings associations to meet a qualified thrift
lender ("QTL") test. A savings association is permitted to meet the QTL test in
one of two alternative ways. Under the first method, in at least nine out of
every twelve months, the thrift institution is required to maintain at least 65%
of its "portfolio assets," defined as total assets less (i) specified liquid
assets up to 20% of total assets, (ii) intangible assets, including goodwill and
(iii) the value of property used to conduct business, in certain "qualified
thrift investments." Assets constituting qualified thrift investments include
residential mortgages, qualifying mortgage backed securities, educational loans,
small business loans, and credit card loans. Certain other types of assets also
qualify as "qualified thrift investments" up to certain limitations. These
limited other types of assets include home equity lines of credit and consumer
loans. Alternatively, savings institutions are permitted to meet the QTL test by
qualifying as a "domestic building and loan association" under the Internal
Revenue Code by meeting the Code's 60% of assets test in nine out of every
twelve months.
Savings associations that fail to meet the QTL test will generally be
prohibited from engaging in any activity not permitted for both a national bank
and a savings association. A savings association that fails the QTL test may be
required to convert to a commercial bank charter. At December 31, 2001, the Bank
maintained 74.5% of its portfolio assets in qualified thrift investments and,
therefore, met the QTL test.
Loans To One Borrower Limitations
Savings associations generally are subject to the lending limits
applicable to national banks. With certain limited exceptions, the maximum
amount that a savings association or a national bank may lend to any borrower
(including certain related entities of the borrower) at one time may not exceed
15% of the unimpaired capital and surplus of the institution, plus an additional
10% of unimpaired capital and surplus for loans fully secured by readily
marketable collateral. The term "unimpaired capital and surplus" is defined as
an institution's regulatory capital, plus that portion of an institution's
general valuation allowances that is not includable in the institution's
regulatory capital. "Readily marketable collateral" is defined to include
certain financial instruments and specifically excludes real estate.
Savings associations are additionally authorized to make loans to one
borrower, for any purpose, in an amount not to exceed $500,000 or, by order of
the Director of OTS, in an amount not to exceed the lesser of $30,000,000 or 30%
of unimpaired capital and surplus to develop residential housing, provided:
o the purchase price of each single-family dwelling in the development does
not exceed $500,000;
o the savings association is in compliance with its regulatory capital
requirements;
o the loans comply with applicable loan-to-value requirements; and
o the aggregate amount of loans made under this authority does not exceed
150% of unimpaired capital and surplus.
At December 31, 2001, the Bank's limit on loans to one borrower was
$7.6 million. At December 31, 2001, the Bank's largest aggregate outstanding
balance of loans to one borrower totaled approximately $6.4 million. These loans
were associated with an upscale residential development in the Bank's primary
market area, and were all performing in accordance with their terms. The Bank
has conducted significant lending in this residential development for the past
several years. The Bank's second largest aggregate outstanding balance of loans
to one borrower at December 31, 2001 totaled approximately $5.6 million. This
position arose as the result of a credit guarantee by a seller / servicer of a
pool of residential mortgages, as more fully detailed under "Credit Quality -
Special Residential Loan Pool" and Note 14 to the Consolidated Financial
Statements.
57
Limitations On Capital Distributions
OTS regulations impose limitations upon all capital distributions by
savings institutions, such as cash dividends, payments to repurchase or
otherwise acquire its shares, payments to shareholders of another institution in
a cash-out merger, and other distributions charged against capital. Under
current regulations, a savings association in some circumstances may:
o be required to file an application and await approval from the OTS before
it makes a capital distribution
o be required to file a notice 30 days before the capital distribution
o be permitted to make the capital distribution without notice or application
to the OTS
The OTS regulations require a savings association to file an application
if:
o it is not eligible for expedited treatment of its other applications under
OTS regulations
o the total amount of all of capital distributions, including the proposed
capital distribution, for the applicable calendar year exceeds its net
income for that year to date plus retained net income for the preceding two
years
o it would not be at least adequately capitalized, under the prompt
corrective action regulations of the OTS, following the distribution
o the association's proposed capital distribution would violate a prohibition
contained in any applicable statute, regulation, or agreement between the
savings association and the OTS, or the FDIC, or violate a condition
imposed on the savings association in an OTS-approved application or notice
In addition, a savings association must give the OTS notice of a
capital distribution if the savings association is not required to file an
application, but:
o would not be well capitalized under the prompt corrective action
regulations of the OTS following the distribution
o the proposed capital distribution would reduce the amount of or retire any
part of the savings association's common or preferred stock or retire any
part of debt instruments like notes or debentures included in capital,
other than regular payments required under a debt instrument approved by
the OTS
o the savings association is a subsidiary of a savings and loan holding
company (applicable to the Bank)
The OTS may prohibit a proposed capital distribution that would
otherwise be permitted if the OTS determines that the distribution would
constitute an unsafe or unsound practice. Further, a federal savings
association, like the Bank, cannot distribute regulatory capital that is needed
for its liquidation account.
Activities of Subsidiaries
A savings association seeking to establish a new subsidiary, acquire
control of an existing company or conduct a new activity through a subsidiary
must provide 30 days prior notice to the FDIC and the OTS and conduct any
activities of the subsidiary in compliance with regulations and orders of the
OTS. The OTS has the power to require a savings association to divest any
subsidiary or terminate any activity conducted by a subsidiary that the OTS
determines to pose a serious threat to the financial safety, soundness, or
stability of the savings association or to be otherwise inconsistent with sound
banking practices.
58
Restrictions On Investments And Loans
OTS regulations do not permit the Bank to invest directly in equity
securities (with certain very limited exceptions), non investment grade debt
securities, or real estate, other than real estate used for the institution's
offices and facilities. Indirect equity investment in real estate through a
subsidiary, such as Portola, is permissible, but is subject to certain
limitations and deductions from regulatory capital. The Company's management has
no plans to pursue real estate development or real estate investment activity
through Portola.
The OTS and other federal banking agencies have jointly adopted uniform
rules on real estate lending and related Interagency Guidelines for Real Estate
Lending Policies (the "Guidelines"). The uniform rules require that institutions
adopt and maintain comprehensive written policies for real estate lending. The
policies must reflect consideration of the Guidelines and must address relevant
lending procedures, such as loan to value limitations, loan administration
procedures, portfolio diversification standards and documentation, and approval
and reporting requirements. Although the uniform rules do not impose specific
maximum loan to value ratios, the related Guidelines state that such ratio
limits established by an individual institution's board of directors generally
should not exceed levels set forth in the Guidelines, which range from a maximum
of 65% for loans secured by unimproved land to 85% for improved property. No
limit is set for single family residential mortgages, but the Guidelines state
that such loans equal to or exceeding a 90.0% loan to value ratio should have
private mortgage insurance or some other form of credit enhancement. The
Guidelines further permit a limited amount of loans that do not conform to these
criteria. In addition, aggregate loans secured by non-residential real property
are generally limited to 400% of a thrift institution's total capital, as
defined.
Classification Of Assets
Thrift institutions are required to classify their assets on a regular
basis, to establish appropriate allowances for losses, and to report the results
of such classifications quarterly to the OTS. A thrift institution is also
required to set aside adequate valuation allowances, and to establish
liabilities for off balance sheet items, such as letters of credit, when loss
becomes probable and estimable. The OTS has the authority to review the
institution's classification of its assets and to determine whether and to what
extent (i) additional assets must be classified, and (ii) whether the
institution's allowances must be increased. Such instruction by the OTS to
increase valuation allowances could have a material impact upon both the
Company's reported earnings and its financial condition.
The OTS and the other federal banking regulatory agencies have adopted
an interagency policy statement regarding the appropriate levels of valuation
allowances for loan and lease losses that insured depository institutions should
maintain. Under this policy statement, examiners will generally accept
management's evaluation of the adequacy of valuation allowances if the
institution has:
o maintained effective systems and controls for identifying and addressing
asset quality problems
o analyzed in a reasonable manner all significant factors that affect the
collectibility of the portfolio
o established an acceptable process for evaluating the adequacy of valuation
allowances
However, the policy statement also provides that OTS examiners will review
management's analysis more closely if valuation allowances do not at least equal
the following benchmarks:
o 15% of assets classified as substandard
o 50% of assets classified as doubtful
o for the portfolio of unclassified loans and leases, an estimate of credit
losses over the upcoming twelve months based upon the institution's recent
average rate of net charge-offs on similar loans, adjusted for current
trends and conditions
59
The Company's internal credit policy is to comply with the interagency
policy statement and to maintain adequate reserves for estimable losses.
However, the determination of estimable losses is by nature an uncertain
practice, and hence no assurance can be given that the Company's loss allowances
will prove adequate to cover future losses.
Assessments
Thrift institutions are required to pay assessments to the OTS to fund
the agency's operations. The general assessment, paid on a semi-annual basis, is
computed based upon a three component equation. The components are total assets,
regulatory rating, and amount and nature of off balance sheet activities. The
Bank's general assessment for the six month period commencing January 1, 2002
was $56 thousand. The general assessments paid by the Bank for the fiscal year
ended December 31, 2001 totaled $141 thousand.
Federal Home Loan Bank ("FHLB") System
The Bank is a member of the Federal Home Loan Bank of San Francisco
("FHLB-SF"). Each Federal Home Loan Bank serves as a reserve or central bank for
its members within its assigned geographic region. Each Federal Home Loan Bank
is financed primarily from the sale of consolidated obligations of the FHLB
system. The FHLB-SF provides a comprehensive credit facility and various
correspondent services to member institutions. Each FHLB makes available loans
or advances to its members in compliance with the policies and procedures
established by the Board of Directors of the individual FHLB. As a member of the
FHLB-SF, the Bank is required to own capital stock in an amount at least equal
to the greater of:
o 1.0% of the aggregate principal amount of outstanding residential loans and
mortgage backed securities, as defined, at the beginning of each calendar
year
o 5.0% of its advances from the FHLB
At its most recent evaluation, the Bank was in compliance with this
requirement. FHLB advances must be secured by specific types of collateral,
including various types of mortgage loans and securities, and the Bank's
investment in the capital stock of the FHLB. It is the policy of the Bank to
maintain an excess of pledged collateral with the FHLB-SF at all times to serve
as a ready source of additional liquidity.
The FHLB's are required to provide funds to contribute toward the
payment of certain bonds issued in the past to fund the resolution of insolvent
thrifts. In addition, FHLB's are required by statute to contribute funds toward
affordable housing programs. These requirements could reduce the amount of
dividends the FHLB's pay on their capital stock and could also negatively impact
the pricing offered for on and off balance sheet credit products - events that
could unfavorably impact the profitability of the Company.
The Gramm-Leach-Bliley Act made significant reforms to the FHLB system,
including:
o Expanded Membership - (i) expands the uses for, and types of, collateral
for advances; (ii) eliminates bias toward QTL lenders; and (iii) removes
capital limits on advances using real estate related collateral (e.g.,
commercial real estate and home equity loans)
o New Capital Structure - each FHLB is allowed to establish two classes of
stock: Class A is redeemable within six months of notice; and Class B is
redeemable within five years notice. Class B is valued at 1.5 times the
value of Class A stock. Each FHLB will be required to maintain minimum
capital equal to 5% of equity.
o Voluntary Membership - federally chartered savings associations, such as
the Bank, are no longer required to be members of the system.
o REFCorp Payments - changes the amount paid by the system on debt incurred
in connection with the thrift crisis in the late 1980s from a fixed amount
to 20% of net earnings after deducting certain expenses.
60
As required by the FHLB System Modernization Act of 1999, the FHLB-SF
has recently submitted its proposed capital plan to the Federal Housing Finance
Board for approval. In early 2002, the Federal Housing Finance Board was
evaluating the FHLB-SF's proposed capital plan, as well as the proposed capital
plans of the other 11 Federal Home Loan Banks. Following the approval of the
FHLB-SF's capital plan as submitted or as required to be modified, the FHLB-SF
will give members at least 240 days written notice of the implementation date
for the final capital plan. This advance notice period is designed to provide
members with sufficient time to evaluate the final plan and make any associated
decisions or elections involving their membership. Based upon a review of the
most recent proposed FHLB-SF capital plan, management does not anticipate a
material impact to the Company's results of operations, financial condition, or
investment requirement in FHLB capital stock if the most recent FHLB-SF proposed
capital plan is approved as submitted.
Federal Reserve System
The Federal Reserve Board ("FRB") requires insured depository
institutions to maintain non-interest-earning ("sterile") reserves against
certain of their transactional accounts (primarily deposit accounts that may be
accessed by writing unlimited checks). At December 31, 2001, the regulations
generally required that reserves be maintained against qualified net transaction
accounts as follows:
First $5.7 million Exempt
Next $35.6 million 3.0%
Amount above $41.3 million 10.0%
The reserve requirement may be met by certain qualified cash balances.
For the calculation period including December 31, 2001, the Bank was in
compliance with its FRB reserve requirements. As a creditor and an insured
depository institution, the Bank is subject to certain regulations promulgated
by the FRB, including, but not limited to:
Regulation B Equal Credit Opportunity Act
Regulation C Home Mortgage Disclosure Act
Regulation D Reserve Requirements
Regulation E Electronic Funds Transfers Act
Regulation F Limits On Interbank Liabilities
Regulation O Extensions Of Credit To Insiders
Regulation P Privacy Of Consumer Financial Information
Regulation X Real Estate Settlement Procedures Act
Regulation Z Truth In Lending Act
Regulation CC Expedited Funds Availability Act
Regulation DD Truth In Savings Act
Potential Federal Legislation and Regulation
The US Congress continues to consider a broad range of legislative
initiatives that might impact the financial services industry. Among these
initiatives are:
o the potential merger of the BIF and SAIF insurance funds of the FDIC
o potential FDIC deposit insurance reforms, including an increase in the
amount of coverage, indexing of coverage limits for inflation, changes in
coverage for municipal deposits and retirement accounts, and modifications
in the assessment formula for FDIC insurance, perhaps to include granting
the FDIC greater latitude in setting deposit insurance premium rates and
determining an adequate level of designated reserve coverage
o the potential for insured depository institutions to pay interest on
business checking deposits, perhaps in conjunction with authorization for
the Federal Reserve to pay interest on sterile reserves
o the potential relaxation of transaction count restrictions on money market
demand deposits, thereby facilitating internal fund "sweeps" (of particular
benefit to smaller financial institutions such as the Bank)
o possible modifications in federal bankruptcy laws, including potential
revisions that would encourage Chapter 13 filings (with payment
requirements) versus Chapter 7 filings (debt forgiveness)
61
US financial institution regulatory agencies were considering at
December 31, 2001 a series of potential regulatory changes or additions,
including:
o increased information reporting requirements under Regulation C
o enhanced enforcement procedures associated with Regulation X
o expanded investment powers for federally chartered credit unions
o revisions to bank regulatory capital requirements
o modifications to CRA compliance rules
The Company cannot predict what legislation and regulation, if any,
might emerge from Congress and the various federal regulatory agencies, and the
potential impact of such legislation and regulation upon the Company.
Environmental Regulation
The Company's business and properties are subject to federal and state
laws and regulations governing environmental matters, including the regulation
of hazardous substances and wastes. For example, under the federal Comprehensive
Environmental Response, Compensation, and Liability Act ("CERCLA") and similar
state laws, owners and operators of contaminated properties may be liable for
the costs of cleaning up hazardous substances without regard to whether such
persons actually caused the contamination. Such laws may affect the Company as
an owner or operator of properties used in its business, and through the Bank,
as a secured lender of property that is found to contain hazardous substances or
wastes.
Although CERCLA and similar state laws generally exempt holders of
security interests, the exemption may not be available if a secured party
engages in the management of its borrower or the securing property in a manner
deemed beyond the protection of the secured party's interest. Recent federal and
state legislation, as well as guidance issued by the United State Environmental
Protection Agency and a number of court decisions, have provided assurance to
lenders regarding the activities they may undertake and remain within CERCLA's
secured party exemption. However, these assurances are not absolute and
generally will not protect a lender or fiduciary that participates or otherwise
involves itself in the management of its borrower, particularly in foreclosure
proceedings. As a result, CERCLA and similar state statutes may influence the
Bank's decision whether to foreclose on property that may be or is found to be
contaminated. The Bank has adopted environmental underwriting requirements for
commercial and industrial real estate loans. The Bank's general policy is to
obtain an environmental assessment prior to foreclosure on commercial and
industrial real estate. See "Business - General" and "Lending Activities - Loan
Portfolio Composition" regarding the recent expansion in the Bank's commercial
and industrial real estate loan portfolio. The existence of hazardous substances
or wastes on commercial and industrial real estate properties could cause the
Bank to elect not to foreclose on the property, thereby limiting, and in some
cases precluding, the Bank from realizing on the related loan. Should the Bank
foreclose on property containing hazardous substances or wastes, the Bank could
become subject to other environmental statutes, regulations, and common law
relating to matters such as, but not limited to, asbestos abatement, lead-based
paint abatement, hazardous substance investigation and remediation, air
emissions, wastewater discharges, hazardous waste management, and third party
claims for personal injury and property damage.
Federal Securities Laws
The Company's common stock is registered with the SEC under Section
12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
The Company is subject to periodic reporting requirements, proxy solicitation
rules, insider trading restrictions, tender offer rules, and other requirements
under the Exchange Act. In addition, certain activities of the Company, its
executive officers, and directors are covered under the Securities Act of 1933,
as amended (the "Securities Act").
62
Non-Banking Regulation
The Company is impacted by many other laws and regulations, not
necessarily unique to insured depository institutions. Among these other laws
and regulations are federal bankruptcy laws.
Federal Taxation
General. The Bank and the Company report their income on a consolidated
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS during the last
five years. For its 2001 taxable year, the Bank is subject to a maximum federal
income tax rate of 35%.
Bad Debt Reserve. For fiscal years beginning prior to December 31,
1995, thrift institutions which qualified under certain definitional tests and
other conditions of the Internal Revenue Code of 1986 (the "Code") were
permitted to use certain favorable provisions to calculate their deductions from
taxable income for annual additions to their bad debt reserve. A reserve could
be established for bad debts on qualifying real property loans (generally
secured by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which
was enacted on August 20, 1996, requires savings institutions to recapture
(i.e., take into income) certain portions of their accumulated bad debt
reserves. The 1996 Act repeals the reserve method of accounting for bad debts
effective for tax years beginning after 1995. Thrift institutions that would be
treated as small banks are allowed to utilize the Experience Method applicable
to such institutions, while thrift institutions that are treated as large banks
(those generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of computing
reserves for bad debts will treat such change as a change in method of
accounting, initiated by the taxpayer, and having been made with the consent of
the IRS. Any Section 481 (a) adjustment required to be taken into income with
respect to such change generally will be taken into income ratably over a
six-taxable year period, beginning with the first taxable year beginning after
1995, subject to the residential loan requirement.
Under the residential loan requirement provision, the recapture
required by the 1996 Act will be suspended for each of two successive taxable
years, beginning with the Bank's current taxable year, in which the Bank
originates a minimum of certain residential loans based upon the average of the
principal amounts of such loans made by the Bank during its six taxable years
preceding its current taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank
is permitted to make additions to its tax bad debt reserves. In addition, the
Bank is required to recapture (i.e., take into income) over a six year period
the excess of the balance of its tax bad debt reserves as of December 31, 1995
over the balance of such reserves as of December 31, 1987.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
63
The amount of additional taxable income triggered by a non-dividend is
an amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Thus, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion its bad debt reserves.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986,
as amended (the "Code") imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using
the percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current earnings
exceeds its AMTI (determined without regard to this preference and prior to
reduction for net operating losses). In addition, for taxable years beginning
after December 31, 1986 and before January 1, 1996, an environmental tax of
0.12% of the excess of AMTI (with certain modifications) over $2.0 million is
imposed on corporations, including the Company, whether or not an Alternative
Minimum Tax ("AMT") is paid. The Bank does not expect to be subject to the AMT,
but may be subject to the environmental tax liability.
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank own more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
State and Local Taxation
State of California. The California franchise tax rate applicable to
the Bank equals the franchise tax rate applicable to corporations generally,
plus an "in lieu" rate approximately equal to personal property taxes and
business license taxes paid by such corporations (but not generally paid by
banks or financial corporations such as the Bank); however, the total tax rate
cannot exceed 10.84%. Under California regulations, bad debt deductions are
available in computing California franchise taxes using a three or six year
weighted average loss experience method. The Bank and its California subsidiary
file California State franchise tax returns on a combined basis. The Company, as
a savings and loan holding company commercially domiciled in California, is
treated as a financial corporation and subject to the general corporate tax rate
plus the "in lieu" rate as discussed previously for the Bank.
Please refer to Note 13 to the Consolidated Financial Statements for
additional information regarding income taxes.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
64
Additional Item. Executive Officers of the Registrant
The following table sets forth certain information with respect to each
executive officer of the Company or Bank who is not also a director of the
Company. The Board of Directors appoints or reaffirms the appointment of all of
the Company's executive officers each year. Each executive officer serves until
the following year or until a respective successor is appointed.
Date
Age At Position(s) With Company Started In Previous Experience If Less
Name 12/31/01 And / or Bank Position Than Five Years In Current Position
---- -------- ------------- -------- -----------------------------------
Carlene F. Anderson 49 Assistant Corporate 6/11/99 Corporate Secretary
Secretary Monterey Bay Bancorp, Inc.
Monterey Bay Bancorp, Inc. 1994 - 1999
Assistant Corporate 6/11/99 Corporate Secretary
Secretary 8/15/98 Monterey Bay Bank
Vice President, Compliance 1994 - 1999
Monterey Bay Bank.
Mark R. Andino 42 Chief Financial Officer 1/26/00 Treasurer
Treasurer Chela Financial
Monterey Bay Bancorp, Inc. 1999
Senior Vice President 1/26/00 Senior Vice President
Chief Financial Officer Chief Financial Officer
Treasurer HF Bancorp, Inc.
Monterey Bay Bank Hemet Federal
1996 - 1999
Susan M. Carlson 49 Senior Vice President 6/28/01 Principal
Chief Administrative C&S Carlson Enterprises, Inc.
Officer Financial Institution Consulting
Monterey Bay Bank 1996 - 2001
Vice President
Director of Marketing
American Bank, NA
1981 - 1996
Mary Anne Carson 34 Corporate Secretary 5/9/01 Vice President
Monterey Bay Bancorp, Inc. Assistant To The President
Coast Commercial Bank
Corporate Secretary 5/9/01 1996 - 2001
Vice President
Director Of Community
Relations
Monterey Bay Bank
David E. Porter 52 Senior Vice President 10/30/00 Executive Vice President
Director of Commercial Chief Credit Officer
Banking Southern Pacific Bank
Monterey Bay Bank 1996 - 2000
Ben A. Tinkey 49 Senior Vice President 9/20/94
Chief Loan Officer
Director of Real Estate
Lending
Monterey Bay Bank
65
Item 2. Properties.
The following table sets forth information relating to each of the
Company's offices and stand alone ATM locations as of December 31, 2001:
Lease Original Date Date of
Or Leased or Lease
Location Owned Acquired Expiration
------------------------------ ------------- --------------- -----------
Administrative Offices:
15 Brennan Street
Watsonville, California 95076 Owned 12-31-65 N/A
567 Auto Center Drive
Watsonville, California 95076 Owned 03-23-98 N/A
Full Service Branch Offices:
35 East Lake Avenue
Watsonville, California 95076 Owned 12-31-65 N/A
805 First Street
Gilroy, California 95020 Owned 12-01-76 N/A
1400 Munras Avenue
Monterey, California 93940 Owned 07-07-93 N/A
1890 North Main Street
Salinas, California 93906 Owned 07-07-93 N/A
1127 South Main Street
Salinas, California 93901 Leased 08-08-93 06-30-05
8071 San Miguel Canyon Road
Prunedale, California 93907 Leased 12-24-93 12-31-03
601 Bay Avenue
Capitola, California 95020 Owned 12-10-96 N/A
6265 Highway 9
Felton, California 95018 Leased 05-01-98 04-30-03
Effective February 2002
-----------------------
Loan Production Office:
6080 Center Drive Month
6th Floor To
Los Angeles, CA. 90045 Leased 02-01-02 Month
Agreement Agreement
Stand Alone ATM's: Commencement Expiration
------------- ----------
601 Wave Street
Monterey, California 93940 4/11/00 4/10/03
104 Stockton Street
Capitola, California 95010 9/1/97 8/31/02
66
Item 3. Legal Proceedings.
---------------------------
From time to time, the Company is party to claims and legal proceedings
in the ordinary course of business. Management believes that the ultimate
aggregate liability represented thereby, if any, will not have a material
adverse effect on the Company's consolidated financial position or results of
operations.
Item 4. Submission of Matters to a Vote of Security Holders.
-------------------------------------------------------------
No matter was submitted during the quarter ended December 31, 2001 to a
vote of Monterey Bay Bancorp, Inc.'s security holders through the solicitation
of proxies or otherwise.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
-------------------------------------------------------------------------------
The Common Stock of Monterey Bay Bancorp, Inc. is traded on the NASDAQ
National Market under the symbol "MBBC." The stock commenced trading on February
15, 1995, when the Company went public and sold 4,492,085 shares at a price of
$6.40 per share (adjusted for a 5:4 stock split on July 31, 1998).
As of March 20, 2002, there were 3,483,718 shares of the Company's
common stock outstanding. As of February 28, 2002, there were 289 stockholders
of record, not including persons or entities who hold their stock in nominee or
"street" name.
The following table sets forth the high and the low daily closing
prices of the Company's common stock for each of the following calendar
quarters.
High Low
---- ---
Year Ended December 31, 2001:
Fourth quarter $ 15.500 $ 12.750
Third quarter $ 16.500 $ 11.400
Second quarter $ 11.970 $ 9.750
First quarter $ 11.875 $ 10.000
Year Ended December 31, 2000:
Fourth quarter $ 10.750 $ 9.125
Third quarter $ 10.000 $ 8.250
Second quarter $ 9.375 $ 7.813
First quarter $ 10.625 $ 7.875
The Company paid no cash dividends in 2001. The Board of Directors has
indefinitely suspended the declaration and payment of cash dividends in favor of
alternative uses for the Company's capital and liquidity. The Company declared
and paid a cash dividend of $0.08 per share during 2000.
The Company is subject to certain restrictions and limitations on the
payment of dividends pursuant to existing and applicable laws and regulations
(see "Item 1. Business - Regulation And Supervision - Limitation On Capital
Distributions" and Note 14 to the Consolidated Financial Statements).
67
Item 6. Selected Financial Data.
---------------------------------
Set forth below are selected consolidated financial and other data of
the Company for the periods and the dates indicated. This financial data is
derived in part from, and should be read in conjunction with, the Consolidated
Financial Statements and related Notes of the Company presented elsewhere
herein. All per share information has been adjusted to reflect a five for four
stock split paid to stockholders of record in July 1998.
At December 31,
-----------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(Dollars In Thousands)
Selected Financial Condition Data:
Total assets $ 537,391 $ 486,190 $ 462,827 $ 454,046 $ 406,960
Investment securities available for sale 7,300 7,360 11,463 19,410 40,355
Investment securities held to maturity -- -- -- -- 145
Mortgage backed securities available for sale 30,644 42,950 57,716 98,006 70,465
Mortgage backed securities held to maturity -- -- 60 97 142
Loans receivable held for investment, net 465,887 391,820 360,686 298,775 263,751
Loans held for sale 713 -- -- 2,177 514
Allowance for loan losses 6,665 5,364 3,502 2,780 1,669
Deposits 432,339 407,788 367,402 370,677 320,559
FHLB advances 53,582 32,582 49,582 35,182 32,282
Securities sold under agreements to repurchase -- -- 2,410 4,490 5,200
Stockholders' equity 50,162 43,837 40,803 41,116 46,797
Non-performing loans 2,252 4,741 8,182 2,915 2,046
Real estate acquired by foreclosure, net -- -- 96 281 321
For The Year Ended December 31,
-----------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(Dollars In Thousands, Except Share Data)
Selected Operating Data:
Interest and dividend income $ 38,731 $ 37,757 $ 33,417 $ 30,911 $ 29,677
Interest expense 18,990 19,777 17,388 18,588 18,413
------ ------ ------ ------ ------
Net interest income before provision for
loan losses 19,741 17,980 16,029 12,323 11,264
Provision for loan losses 1,400 2,175 835 692 375
------ ------ ------ ------ ------
Net interest income after provision for loan losses 18,341 15,805 15,194 11,631 10,889
Non-interest income 2,566 2,340 2,505 2,177 1,614
Non-interest expense 14,369 13,676 11,887 11,144 9,507
------ ------ ------ ------ ------
Income before provision for income taxes 6,538 4,469 5,812 2,664 2,996
Provision for income taxes 2,787 1,946 2,511 1,228 1,230
------ ------ ------ ------ ------
Net income $ 3,751 $ 2,523 $ 3,301 $ 1,436 $ 1,766
====== ====== ====== ====== ======
Shares applicable to basic earnings per share 3,275,303 3,110,910 3,231,162 3,501,738 3,632,548
Basic earnings per share $ 1.15 $ 0.81 $ 1.02 $ 0.41 $ 0.49
====== ====== ====== ====== ======
Shares applicable to diluted earnings per share 3,343,233 3,123,552 3,320,178 3,638,693 3,763,038
Diluted earnings per share $ 1.12 $ 0.81 $ 0.99 $ 0.39 $ 0.47
====== ====== ====== ====== ======
Cash dividends per share $ -- $ 0.08 $ 0.15 $ 0.12 $ 0.09
====== ====== ====== ====== ======
68
At Or For The Year Ended December 31,
-----------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Selected Financial Ratios and Other Data (1):
Performance Ratios
Return on average assets (2) 0.73% 0.53% 0.73% 0.33% 0.43%
Return on average stockholders' equity (3) 7.94% 6.24% 8.05% 3.29% 3.99%
Average stockholders' equity to average assets 9.16% 8.52% 9.04% 10.06% 10.70%
Stockholders' equity to total assets at
end of period 9.33% 9.02% 8.82% 9.06% 11.50%
Interest rate spread during the period (4) 3.67% 3.54% 3.27% 2.43% 2.31%
Net interest margin (5) 4.04% 3.96% 3.69% 2.96% 2.83%
Interest rate margin on average total assets (6) 3.83% 3.79% 3.53% 2.84% 2.72%
Average interest-earning assets /
average interest-bearing liabilities 109.44% 109.62% 110.61% 112.00% 111.29%
Non-interest expense / average total assets 2.79% 2.88% 2.62% 2.57% 2.30%
Efficiency ratio (7) 64.41% 67.30% 64.14% 76.86% 73.82%
Regulatory Capital Ratios (8)
Tangible capital 8.24% 8.03% 7.11% 6.53% 9.13%
Core capital 8.24% 8.03% 7.11% 6.53% 9.14%
Tier one risk based capital 11.38% 11.03% 9.58% 10.42% 16.07%
Total risk based capital 12.64% 12.28% 10.56% 11.35% 16.82%
Asset Quality Ratios
Non-performing loans / gross loans
receivable (9) 0.48% 1.19% 2.25% 0.96% 0.77%
Non-performing assets / total assets (10) 0.42% 0.98% 1.79% 0.71% 0.58%
Net charge-offs / average gross loans receivable 0.02% 0.08% 0.03% -- 0.01%
Allowance for loan losses / gross
loans receivable (9) 1.41% 1.35% 0.96% 0.92% 0.63%
Allowance for loan losses / non-performing loans 295.96% 113.14% 42.80% 95.37% 81.57%
Allowance for total estimated losses /
non-performing assets 295.96% 113.14% 42.30% 87.15% 70.57%
Other Data
Number of full-service customer facilities 8 8 8 8 7
Number of ATM's 11 11 10 10 9
------------------------------------------------------
(1) Regulatory Capital Ratios and Asset Quality Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based on
average daily balances during the indicated periods.
(2) Return on average assets is net income divided by average total assets.
(3) Return on average stockholders' equity is net income divided by average
stockholders' equity.
(4) Interest rate spread during the period represents the difference between
the weighted average yield on interest-earning assets and the weighted
average cost of interest-bearing liabilities.
(5) Net interest margin equals net interest income as a percent of average
interest-earning assets.
(6) Interest rate margin on average total assets equals net interest income as
a percent of average total assets.
(7) The efficiency ratio is calculated by dividing non-interest expense by the
sum of net interest income and non-interest income. The efficiency ratio
measures how much in expense the Company invests in order to generate each
dollar of net revenue.
(8) Regulatory capital ratios are defined in Item 1. - "Business - Supervision
And Regulation - Regulatory Capital Requirements And Capital Categories."
(9) Gross loans receivable includes loans held for investment and loans held
for sale, less undisbursed loan funds and unamortized yield adjustments.
(10) Non-performing assets includes all nonperforming loans (nonaccrual loans
and restructured loans) and real estate acquired via foreclosure or by
acceptance of a deed in lieu of foreclosure.
69
Item 7. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations.
The following discussion and analysis should be read in conjunction
with the Company's Consolidated Financial Statements and Notes to the
Consolidated Financial Statements presented elsewhere in this Annual Report.
Certain matters discussed or incorporated by reference in this Annual Report
including, but not limited to, matters described in this Item 7., are forward
looking statements that are subject to risks and uncertainties that could cause
actual results to differ materially from those projected or implied in such
statements.
General
The Company's primary business is providing financial services to
individuals and businesses. The Company is headquartered in Watsonville,
California, along the Central Coast. The Bank's history dates to 1925.
The Company pursues its business through conveniently located branch
offices, where it attracts checking, money market, savings, and certificate of
deposit accounts. These deposits, and other available funds, are invested in a
variety of loans and securities. The vast majority of the Company's loans at
December 31, 2001 were secured by various types of real estate. The Bank's
deposit gathering and lending markets are concentrated in the communities
surrounding its eight full service branch offices located in Santa Cruz,
northern Monterey, and southern Santa Clara Counties, in California. The Company
also conducts its business by a variety of electronic means, including Internet
banking, telephone banking, and automated teller machine ("ATM") networks.
The most significant component of the Company's revenue is net interest
income. Net interest income is the difference between interest and dividend
income, primarily from loans, mortgage backed securities, and investment
securities, and interest expense, primarily on deposits and borrowings. The
Company's net interest income and net interest margin, which is defined as net
interest income as a percent of average interest-earning assets, are affected by
its asset growth and quality, its asset and liability composition, and the
general interest rate environment.
The Company's service charges on deposits, mortgage loan servicing
fees, and commissions from the sale of non-FDIC insured insurance products and
investments through Portola also have significant effects on the Company's
results of operations. An additional major factor in determining the Company's
results of operations are non-interest expenses, which consist primarily of
employee compensation, occupancy and equipment expenses, data and item
processing fees, and other operating expenses. The Company's results of
operations are also significantly affected by the level of provisions for loan
losses and general economic and competitive conditions, particularly absolute
and relative levels and changes in market interest rates, government policies,
and actions of regulatory agencies.
As discussed under "Item 1. Business - Company Strategy", the Company
is in the process of transforming itself from a savings & loan association that
was historically focused upon funding residential mortgage loans with
certificates of deposit into a community based commercial bank offering a far
wider scope of financial services to individuals and businesses. This
transformation is being undertaken to enhance stockholder value while at the
same time better meeting the financial needs of the individuals, families,
professionals, and businesses in the Greater Monterey Bay Area of Central
California. This transformation presents significant execution risk, as the
strategic profile being pursued by the Company requires much greater human and
technological resources to accomplish than the Company's historical operations.
In addition, community commercial banking is by nature a higher risk activity
than traditional savings & loan business, with increased credit and operational
risks, among other risk factors.
70
Activities Not Conducted By The Company
At December 31, 2001, the Company did not have:
o foreign currency risk, as all of the Company's operations are conducted in
US dollars
o interest rate swap, cap, floor, or collar agreements; or other freestanding
or embedded derivatives
o off balance sheet activity other than normal commitments to fund loans and
lines of credit
o special purpose entities
o debt securities convertible into equity
In conjunction with its interest rate risk management program, the Company may,
however, in the future enter into interest rate swap, cap, floor, collar, or
similar arrangements. In addition, the Company may pursue different types and
sources of capital in the future to support its growth, including trust
preferred securities or convertible securities.
Primary Risks Experienced By The Company
The greatest single source of risk to the Company is credit risk.
Credit risk is the financial exposure to borrowers' not repaying the loans
extended by the Company. Other significant risks experienced by the Company are
interest rate risk and operational risk. Interest rate risk is the financial
exposure resulting from changes in nominal and relative interest rates, as more
fully discussed under "Item 7a. Quantitative and Qualitative Disclosure of
Market Risk". Operational risk results from the Company's funds transfer and
related activities, whereby the Company could experience loss if funds were
inappropriately transferred and not recovered. The Company maintains extensive
policies and procedures and certain insurance policies designed to mitigate
these primary risks. However, no set of practices can eliminate every potential
current and future source of these risks. In addition, the Company creates
economic value and earns income in part through the effective management, but
not elimination, of these primary risks.
Critical Accounting Policies
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). The Company's significant accounting policies are presented in Note 1
to the Consolidated Financial Statements, which are included in this Annual
Report. The Company follows accounting policies typical to the community
commercial banking industry and in compliance with various regulations and
guidelines as established by the Financial Accounting Standards Board ("FASB")
and the Bank's primary federal regulator, the OTS.
71
The Company's most significant management accounting estimate is the
appropriate level for the allowance for loan losses. As discussed under "Item 1.
Business - Credit Quality - Allowance For Loan Losses", the Company follows a
methodology for calculating the appropriate level for the allowance for loan
losses. However, various factors, many of which are beyond the control of the
Company, could lead to significant revisions in the amount of allowance for loan
losses in future periods, with a corresponding impact upon the results of
operations. In addition, the calculation of the allowance for loan losses is by
nature inexact, as the allowance represents Management's best estimate of the
loan losses inherent in the Company's credit portfolios at the reporting date.
These loan losses will occur in the future, and as such cannot be determined
with absolute certainty at the reporting date.
Other estimates that the Company utilizes in its accounting include the
expected useful lives of depreciable assets, such as buildings, building
improvements, equipment, and furniture. The useful lives of various technology
related hardware and software can be subject to change due to advances in
technology and the general adoption of new standards for technology or
interfaces among computer or telecommunication systems.
The Company applies Accounting Principles Board ("APB") Opinion No. 25
and related interpretations in accounting for stock options. Under APB No. 25,
compensation cost for stock options is measured as the excess, if any, of the
fair market value of the Company's stock at the date of grant over the amount
the employee or director must pay to acquire the stock. Because the Company's
stock option Plans provide for the issuance of options at a price of no less
than the fair market value at the date of grant, no compensation cost is
required to be recognized for the stock option Plans.
Had compensation costs for the stock option Plans been determined based
upon the fair value at the date of grant consistent with SFAS No. 123,
"Accounting For Stock Based Compensation", the Company's net income and earnings
per share would have been reduced as disclosed in Note 18 to the Consolidated
Financial Statements, based upon the assumptions listed therein.
GAAP itself may change over time, impacting the reporting of the
Company's financial activity. Although the economic substance of the Company's
transactions would not change, alterations in GAAP could affect the timing or
manner of accounting or reporting.
72
Interest Rate Environment
The table below presents an overview of the interest rate environment
during the two years ended December 31, 2001. During the first half of 2000, the
Federal Reserve continued the series of interest rate increases it commenced in
mid-1999, with the final rate increase implemented in May 2000. These increases
were implemented by the Federal Reserve in response to strong economic growth
and tight labor markets, among other factors. The Federal Reserve did not adjust
its benchmark interest rates (including the target rate for overnight federal
funds) again until January 2001. In January 2001, the Federal Reserve commenced
what would become a historically large and rapid decrease in interest rates, as
the economy slowed and eventually fell into recession. During 2001, the Federal
Reserve cut interest rates a total of 11 times for an aggregate decrease of 475
basis points. By the end of 2001, short term interest rates were at low nominal
levels that had not been seen for decades.
While the Federal Reserve took no formal rate adjustment action between
June 2000 and December 2000, the capital markets did reflect the changing
economic environment. Many capital markets interest rates, such as the London
InterBank Offer Rate ("LIBOR") curve, peaked about May, 2000, and then commenced
a gradual decline throughout the remainder of the year. For example, the one
year LIBOR rate at May 31, 2000 was 7.50%, declining to 6.00% by December 31,
2000.
The Treasury yield curve shifted from a more traditional positively
sloped curve at the beginning of 2000 to significantly negatively sloped curve
by the end of the year. Inverted yield curves often present challenges to
financial institutions, as short term funding rates can be higher than longer
term investment rates. By mid 2001, the Treasury yield curve had returned to its
more traditional positive slope. By the end of 2001, the Treasury yield was the
steepest in the past two years, with a 333 basis point differential between the
three month and ten year Treasury instruments. Steep, positively sloped yield
curves are generally favorable for financial institutions, including the
Company, as near term cash flows from intermediate to longer term higher
yielding assets can be funded at comparatively low interest rates.
The past two years thus represented a period of substantial interest
rate volatility, with significant changes in the nominal and relative levels of
interest rates. This magnitude of interest rate volatility presents additional
challenges to financial institutions, including the Company, in managing cash
flows and interest rate risk exposure.
The 11th District Cost Of Funds Index ("COFI") and the 12 MTA Index
("12 MTA" - the 12 month cumulative average of the 1 year Treasury Constant
Maturities Index or "1 Year CMT") are by nature lagging indices that trail
changes in more responsive interest rate indices such as those associated with
the spot Treasury or LIBOR markets.
Index/ Rate (1) 12/31/99 3/31/00 6/30/00 9/30/00 12/31/00 3/31/01 6/30/01 9/30/01 12/31/01
--------------- -------- ------- ------- ------- -------- ------- ------- ------- --------
3 month Treasury bill 5.31% 5.87% 5.85% 6.20% 5.89% 4.28% 3.65% 2.37% 1.72%
6 month Treasury bill 5.73% 6.14% 6.22% 6.27% 5.70% 4.13% 3.64% 2.35% 1.79%
2 year Treasury note 6.24% 6.47% 6.36% 5.97% 5.09% 4.18% 4.24% 2.85% 3.02%
5 year Treasury note 6.34% 6.31% 6.18% 5.85% 4.97% 4.56% 4.95% 3.80% 4.30%
10 year Treasury note 6.44% 6.00% 6.03% 5.80% 5.11% 4.92% 5.41% 4.59% 5.05%
Target federal funds 5.50% 6.00% 6.50% 6.50% 6.50% 5.00% 3.75% 3.00% 1.75%
Prime rate 8.50% 9.00% 9.50% 9.50% 9.50% 8.00% 6.75% 6.00% 4.75%
3 month LIBOR 6.00% 6.29% 6.77% 6.81% 6.40% 4.88% 3.84% 2.59% 1.88%
12 month LIBOR 6.50% 6.94% 7.18% 6.80% 6.00% 4.67% 4.18% 2.64% 2.44%
1 Year CMT (2) 5.84% 6.22% 6.17% 6.13% 5.60% 4.30% 3.58% 2.82% 2.22%
12 MTA (2) 5.08% 5.46% 5.79% 6.04% 6.11% 5.71% 5.10% 4.40% 3.48%
COFI (2) 4.85% 5.00% 5.36% 5.55% 5.62% 5.20% 4.50% 3.97% 3.07%
------------------------------------------------------
(1) Indices / rates are spot values unless otherwise noted.
(2) These indices / rates are monthly averages.
73
Business Strategy
The Company's overall business objective is to maximize stockholder
value. The Company's Directors and Management believe that the best approach to
achieving that key objective is to continue the Company's strategic
transformation from a traditional savings & loan into a community commercial
bank offering a broader range of financial services, products, and solutions to
individuals and businesses in California. The Company's Directors and Management
also believe that following a relationship focused approach to helping customers
attain their financial goals progresses the Company toward its key strategic
objective while also improving the quality of life in the communities served by
the Company and making the Company a desirable employer. The Company's business
strategy thus integrates advancing the interests of its three key
constituencies: stockholders, local communities, and employees.
Specific elements of the Company's business strategy include:
o Increasing the ratio of loans to assets as a means of enhancing net
interest income, serving more customers, moderating exposure to changes in
interest rates, and better utilizing the Company's capital resources.
o Diversifying the product mix within the loan portfolio to reduce the high
concentration in residential mortgages while also meeting the financing
needs of consumers and businesses within the Company's market areas.
o Enhancing the delivery of relationship banking, where the Company's
employees invest time and resources in thoroughly understanding their
customers and thereby provide a comprehensive financial services solution.
o Expanding services for businesses, including improved deposit courier
service, Internet business banking, funds sweep, and cash management
products.
o Acquiring customers disaffected by the acquisition of their financial
services provider or branch office.
o Capitalizing on the Company's position as one of the largest independent
financial institutions in the Greater Monterey Bay Area and on the Bank's
76 year history.
o Bolstering non-interest income as a percent of total revenues, with such
non-interest income sourced from an expanding list of fee based products
and services, including ATM surcharges, deposit account and branch service
charges, and sales of non-FDIC insured investment products including mutual
funds and annuities.
o Changing the Company's deposit mix to emphasize transaction accounts as a
means of cementing customer relationships, lowering the Company's relative
cost of funds, generating fee income, and increasing the duration of the
Company's funding.
o Capitalizing on business opportunities unique to the Company's primary
service areas; for example, installing remote ATM's at highly trafficked
tourist attractions.
o Pursuing alternative forms of delivery and new technologies for financial
products and services as a means of attracting a greater volume of business
while also improving the Company's efficiency ratio.
o Adding additional branch or loan production office facilities to better and
more completely serve the Company's key market areas.
o Increasing the Company's visibility in and contributions to its local
communities through the donation of equipment, funds, and employee time to
a wide range of organizations committed to improving the quality of life in
the Greater Monterey Bay Area.
For additional information regarding the Company's strategy, please see "Item 1.
Business - Company Strategy".
74
The Company intends to continue pursuing this business strategy in
2002, with specific goals of adding a Southern California loan production office
(opened in February, 2002), seeking sites for a de novo retail branch or
opportunities for the acquisition of existing bank branches, expanding the
Commercial Banking group, increasing customer use of Internet banking and
electronic bill payment, pursuing additional remote ATM sites, implementing new
technologies complementary to the new core data processing system installed in
2001, and effectively managing the Company's strong capital position. However,
there can be no assurance that any such steps will be implemented, or if
implemented, whether such steps will improve the Company's financial
performance.
Analysis Of Results Of Operations For The Years Ended December 31, 2001 And
December 31, 2000
Overview
For the year ended December 31, 2001, net income was $3.75 million,
equivalent to $1.15 basic earnings per share and $1.12 diluted earnings per
share. This compares to net income of $2.52 million, or $0.81 basic and diluted
earnings per share, for the year 2000. The $3.75 million in 2001 net income was
the highest annual level in the Company's history. Return on average
stockholders' equity increased from 6.24% in 2000 to 7.94% in 2001. Return on
average assets increased from 0.53% in 2000 to 0.73% in 2001.
The Company's financial performance increased sequentially from the
first quarter of 2001 through to the fourth quarter, which represented the
highest quarterly earnings in the Company's history. The continued
implementation of the Company's strategic plan was a primary factor in the
Company's improved financial performance in 2001 versus 2000. Other factors
included a more favorable credit experience in 2001 versus 2000, and better
results on the sale of securities.
Net Interest Income
Net interest income increased from $18.0 million in 2000 to $19.7
million in 2001 due to both expanded spreads and greater average balances of
interest earnings assets. The Company's ratio of net interest income to average
total assets increased from 3.79% in 2000 to 3.83% in 2001 despite the Company's
difficulty in decreasing NOW and Savings deposit rates at the same pace as the
declines in indices used for adjustable rate loans. The Company's NOW and
Savings deposit rates were already at low nominal levels before the significant
interest rate cuts (totaling 475 basis points) implemented by the Federal
Reserve throughout 2001. The Company moderated the impact of these factors in
2001 through its proactive asset / liability management program and a shift in
balance sheet composition.
The Company's ratio of net interest income to average total assets rose
to 3.92% during the fourth quarter of 2001, as the new commercial banking
customers attracted during 2001 commenced having a more significant, positive
impact upon the Company's spreads.
The expansion in the Company's net interest margin on average interest
earning assets from 3.69% in 1999 to 3.96% in 2000 to 4.04% in 2001 constitutes
a key trend in the Company's financial performance. This trend has resulted from
the actions taken by the Company coincident with its strategic plan.
75
The $1.7 million, or 9.8%, increase in net interest income generated in
2001 versus 2000 primarily resulted from four factors:
1. Change In Asset Mix
Average net loans receivable increased from 80.0% of average total assets in
2000 to 83.8% of average total assets in 2001. Lower yielding cash equivalents,
investment securities, and mortgage backed securities all declined as a
percentage of average total assets in 2001 versus 2000. The benefits from this
shift in asset mix were significant, as the average rate earned on net loans
receivable in 2001 was 8.21%, substantially above the 4.13% earned on cash
equivalents, 5.55% earned on investment securities, and 6.08% earned on mortgage
backed securities.
2. Change in Liability Mix
Average transaction deposit accounts (DDA, NOW, Savings, and Money Market
combined) as a percentage of average total deposits rose from 40.5% in 2000 to
41.1% in 2001. Transaction deposit accounts present a lower cost of funding than
most alternative sources. Non-interest bearing demand deposit accounts ("DDA")
rose from 4.3% of average total deposits in 2000 to 4.6% in 2001. The Company
has targeted increased DDA balances, particularly from business customers, as an
important component of its business strategy.
3. Increased Average Balance Sheet
Average total assets increased by 8.6% from 2000 to 2001. The larger average
balances of interest earning assets and interest bearing liabilities, combined
with expanding spreads, contributed toward greater nominal net interest income.
4. Asset / Liability Management
Net interest income in 2001 benefited from positions taken by the Company as a
result of its asset / liability management program, as more fully discussed
under "Item 7a. Quantitative and Qualitative Disclosure of Market Risk". Early
in 2001, the Company moderately increased the net liability sensitivity of the
balance sheet in order to benefit from the rapid and significant interest rate
cuts being implemented by the Federal Reserve. This was accomplished, in part,
by adding intermediate term, fixed rate assets during the first half of the
year, primarily in the form of residential hybrid mortgages.
Net interest income was also benefited in 2001 versus 2000 by an
increase in average stockholders' equity, which was substantially offset by an
increase in average non-interest earning assets, primarily deferred tax assets.
As presented in Note 13 to the Consolidated Financial Statements, net deferred
tax assets increased in 2001 primarily due to the rise in the Company allowance
for loan losses and because of the differential between book and tax
amortization periods for core deposit intangibles.
In conjunction with its business strategy, the Company plans to expand
net interest income in future periods by:
o continuing to increase the percentage of its assets allocated to loans
o shifting the loan mix toward higher yielding types of loans and away from
comparatively lower yielding residential mortgages
o raising the percentage of its total deposits represented by transaction
accounts and decreasing the percentage of total deposits represented by
certificates of deposit
o increasing the volume of interest earning assets
o continuing to proactively manage the Company's exposure to changes in the
nominal and relative levels of general market interest rates
76
Average Balances, Average Rates, And Net Interest Margin
The following table presents the average amounts outstanding for the
major categories of the Company's assets and liabilities, the average rate
earned upon each major category of interest earning assets, the average rate
paid for each major category of interest bearing liabilities, and the resulting
net interest spread, net interest margin, and average interest margin on total
assets for the years indicated.
Year Ended December 31, 2001 Year Ended December 31, 2000 Year Ended December 31, 1999
----------------------------- ------------------------------ -----------------------------
Average Avg. Average Avg. Average Avg.
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars In Thousands)
Assets
Interest earning assets:
Cash equivalents (1) $ 7,598 $ 314 4.13% $ 8,533 $ 540 6.33% $ 5,837 $ 280 4.80%
Investment securities (2) 7,318 406 5.55% 8,915 689 7.73% 13,620 871 6.40%
Mortgage backed securities (3) 38,795 2,360 6.08% 53,822 3,755 6.98% 73,122 4,884 6.68%
Loans receivable, net (4) 432,020 35,485 8.21% 379,823 32,556 8.57% 339,036 27,218 8.03%
FHLB stock 3,065 166 5.42% 3,003 217 7.23% 3,139 164 5.22%
-------- ------ ---- -------- ------ ---- -------- ------ ----
Total interest earning assets 488,796 38,731 7.92% 454,096 37,757 8.31% 434,754 33,417 7.69%
------ ------ ------
Non-interest earnings assets 26,555 20,391 18,691
-------- -------- --------
Total assets $515,351 $474,487 $453,445
======== ======== ========
Liabilities & Equity
Interest bearing liabilities:
NOW accounts $40,944 366 0.89% $ 36,317 550 1.51% $ 25,205 388 1.54%
Savings accounts 19,370 216 1.12% 15,803 281 1.78% 15,583 280 1.80%
Money market accounts 92,237 3,452 3.74% 87,733 4,040 4.60% 82,006 3,402 4.15%
Certificates of deposit 246,315 12,415 5.04% 230,099 12,360 5.37% 229,493 11,060 4.82%
-------- ------ -------- ------ -------- ------
Total interest-bearing deposits 398,866 16,449 4.12% 369,952 17,231 4.66% 352,287 15,130 4.29%
FHLB advances 47,526 2,518 5.30% 43,946 2,514 5.72% 37,600 2,078 5.53%
Other borrowings (5) 244 23 9.43% 359 32 8.91% 3,182 180 5.65%
-------- ------ -------- ------ -------- ------
Total interest-bearing 446,636 18,990 4.25% 414,257 19,777 4.77% 393,069 17,388 4.42%
------ ------ ------
liabilities
Demand deposit accounts 19,104 16,720 17,610
Other non-interest bearing liabilities 2,396 3,104 1,776
-------- -------- --------
Total liabilities 468,136 434,081 412,455
Stockholders' equity 47,215 40,406 40,990
-------- -------- --------
Total liabilities & equity $515,351 $474,487 $453,445
======== ======== ========
Net interest income $19,741 $17,980 $16,029
======= ======= =======
Interest rate spread (6) 3.67% 3.54% 3.27%
Net interest earning assets 42,160 39,839 41,685
Net interest margin (7) 4.04% 3.96% 3.69%
Net interest income /
average total assets 3.83% 3.79% 3.53%
Interest earnings assets /
interest bearing liabilities 1.09 1.10 1.11
Average balances in the above table were calculated using average daily figures.
Interest income is reflected on an actual basis, as the Company maintained no
tax preferenced securities during the periods reported.
-----------------------------------------
(1) Includes federal funds sold, money market fund investments, banker's
acceptances, commercial paper, interest earning deposit accounts, and
securities purchased under agreements to resell.
(2) Includes investment securities both available for sale and held to
maturity.
(3) Includes mortgage backed securities, including CMOs, both available for
sale and held to maturity.
(4) In computing the average balance of loans receivable, non-accrual loans and
loans held for sale have been included. Amount is net of deferred loan
fees, premiums and discounts, undisbursed loan funds, and allowances for
loan losses. Interest income on loans includes amortized loan fees and
costs, net, of $223,000, $250,000, and $293,000 in 2001, 2000, and 1999,
respectively.
(5) Includes federal funds purchased, securities sold under agreements to
repurchase, and borrowings under MBBC's line of credit.
(6) Interest rate spread represents the difference between the average rate on
interest earning assets and the average rate on interest bearing
liabilities.
(7) Net interest margin equals net interest income before provision for
estimated loan losses divided by average interest earning assets.
77
Rate/Volume Analysis
The most significant impact on the Company's net interest income
between periods is derived from the interaction of changes in the volumes of and
rates earned or paid on interest-earning assets and interest-bearing
liabilities. The following table utilizes the figures from the preceding table
to present a comparison of interest income and interest expense resulting from
changes in the volumes and the rates on average interest earning assets and
average interest bearing liabilities for the years indicated. Changes in
interest income or interest expense attributable to volume changes are
calculated by multiplying the change in volume by the prior year average
interest rate. The changes in interest income or interest expense attributable
to interest rate changes are calculated by multiplying the change in interest
rate by the prior year average volume. The changes in interest income or
interest expense attributable to the combined impact of changes in volume and
changes in interest rate are calculated by multiplying the change in rate by the
change in volume.
Year Ended December 31, 2001 Year Ended December 31, 2000
Compared To Compared To
Year Ended December 31, 2000 Year Ended December 31, 1999
----------------------------------------- -----------------------------------------
Increase (Decrease) Due To Increase (Decrease) Due To
----------------------------------------- -----------------------------------------
Volume Volume
Volume Rate / Rate Net Volume Rate / Rate Net
------ ---- ------ --- ------ ---- ------ ---
(Dollars In Thousands)
Interest-earning assets
-----------------------
Cash equivalents $ (59) $ (187) $ 20 $ (226) $ 129 $ 89 $ 42 $ 260
Investment securities (123) (194) 34 (283) (301) 182 (63) (182)
Mortgage backed securities (1,048) (481) 134 (1,395) (1,289) 218 (58) (1,129)
Loans receivable, net 4,474 (1,358) (187) 2,929 3,274 1,842 222 5,338
FHLB Stock 4 (54) (1) (51) (7) 63 (3) 53
------ ------ ----- ------ ------ ----- ----- ------
Total interest-earning assets 3,248 (2,274) 0 974 1,806 2,394 140 4,340
------ ------ ----- ------ ------ ----- ----- ------
Interest-bearing liabilities
----------------------------
NOW Accounts 70 (225) (29) $ (184) 171 (6) (3) 162
Savings accounts 63 (105) (23) (65) 4 (3) -- 1
Money market accounts 207 (757) (38) (588) 238 374 26 638
Certificates of deposit 871 (762) (54) 55 29 1,267 4 1,300
------ ------ ----- ------ ------ ----- ----- ------
Total interest-bearing deposits 1,211 (1,849) (144) (782) 442 1,632 27 2,101
FHLB advances 205 (186) (15) 4 351 73 12 436
Other borrowings (10) 2 (1) (9) (159) 104 (93) (148)
------ ------ ----- ------ ------ ----- ----- ------
Total interest-bearing liabilities 1,406 (2,033) (160) (787) 634 1,809 (54) 2,389
------ ------ ----- ------ ------ ----- ----- ------
Increase (decrease) in net interest income $1,842 $ (241) $ 160 $1,761 $1,172 $ 585 $ 194 $1,951
====== ====== ===== ====== ====== ===== ===== ======
Interest Income
Interest income for the year ended December 31, 2001 totaled $38.7
million, an increase of $0.9 million from $37.8 million in the prior year. This
2.6% increase resulted from the effects of greater average balances of interest
earning assets and a shift in the earning asset mix more than offsetting the
impact of a lower interest rate environment in 2001 versus 2000.
Interest income on loans increased 9.0% from $32.6 million in 2000 to
$35.5 million in 2001, as the effect of greater average balances more than
offset a decline in average rate from 8.57% in 2000 to 8.21% in 2001. Because
the vast majority of the Company's loans are either adjustable rate or fixed
rate for a limited period of time and then adjustable rate, the declining
interest rate environment prevalent throughout 2001 reduced the Company's yield
on its loan portfolio. The drop in this yield was, however, moderated by
periodic caps and lifetime floors on certain loan products.
78
Interest income on mortgage backed securities declined from $3.8
million in 2000 to $2.4 million in 2001 due to both lower average balances and
reduced average rates. The reduction in average balances was intentional, as the
Company used scheduled principal payments, principal prepayments, and sales of
mortgage backed securities to support the expansion in the loan portfolio and
achieve the targeted shift in asset mix. The decline in average rates was caused
by:
o a shift in the mix of mortgage backed securities away from long term, fixed
rate pass-though certificates to lower duration collateralized mortgage
obligations and adjustable rate pass through certificates in conjunction
with the Company's asset / liability management program
o a shift in the mix of collateralized mortgage obligations away from Non
Agency issued securities toward Agency issued securities in order to obtain
greater liquidity and to increase the amount of securities eligible for use
a collateral for various types of deposits
o the general decline in interest rates, as adjustable rate mortgage backed
securities repriced downwards and as new security purchases during 2001
generally had lower effective rates than the securities in the portfolio at
the end of 2000
Please refer to Note 4 to the Consolidated Financial Statements for
additional information regarding mortgage backed securities.
Interest income on investment securities decreased from $689 thousand in
2000 to $406 thousand in 2001. This decline was due to lower average balances
and lower average rates. Because all of the Company's investment securities in
2000 and 2001 were variable rate corporate trust preferred securities that
adjust quarterly based upon the 3 Month LIBOR Index, these securities repriced
downwards rapidly in 2001 in conjunction with the interest rate cuts implemented
by the Federal Reserve. Please refer to Note 3 to the Consolidated Financial
Statements for additional information regarding investment securities.
Interest income on cash equivalents declined from $540 thousand in 2000
to $314 thousand in 2001 due to both lower average balances and lower average
rates. An objective of the Company is to minimize its cash & cash equivalent
position, subject to ensuring the maintenance of sufficient liquidity, in order
to allocate investable funds toward higher yielding types of assets. Because
cash equivalents are of limited term, they repriced downward quickly in 2001.
Dividend income on FHLB stock decreased from $217 thousand in 2000 to
$166 thousand in 2001 due to lower effective rates. The lower effective rates
were due to the lower interest rate environment in 2001 versus 2000 and due to
the FHLB-SF's decision to pay particularly high dividend rates during the first
half of 2000 in conjunction with its capital management program.
Interest Expense
Interest expense for the year ended December 31, 2001 totaled $19.0
million, representing a decrease of $0.8 million, or 4.0%, from $19.8 million in
the prior year. This decrease resulted from the change in the mix of interest
bearing liabilities and the effect of lower average rates more than offsetting
the impact of greater average balances of interest bearing liabilities.
Interest expense on interest bearing deposits decreased from $17.2
million in 2000 to $16.4 million in 2001, as the change in composition and the
effect of lower effective rates more than offset the impact of greater average
balances. The increased average balances were in conformity with the Company's
strategic plan of increasing market share in its local communities and better
meeting the savings, funds management, and investment needs of individuals and
businesses in the Greater Monterey Bay Area. The lower average rates in 2001
versus 2000 resulted from the lower interest rate environment and a shift in
deposit mix away from relatively higher cost certificates of deposit toward
relatively lower cost transaction accounts. Certificates of deposit constituted
58.9% of average total deposits in 2001, compared to 59.5% the prior year. The
weighted average cost of interest bearing deposits declined from 4.66% in 2000
to 4.12% in 2001. A rise in attractively priced funds in conjunction with the
State of California Time Deposit program also contributed to the decrease in
average deposit costs in 2001.
79
Interest expense on borrowings was nearly constant in 2000 and 2001, as
the effect of an increase in average balances was offset by the impact of lower
average rates. While the Company has access to various types of borrowings, most
borrowings in 2001 were concentrated in FHLB advances. The various credit
programs from the FHLB-SF provide the Company with the opportunity to undertake
specific borrowings designed to meet current and projected funding needs while
also facilitating the asset / liability management program. The average
effective rate on borrowings other than FHLB advances was inflated in 2000 and
2001 by the amortization of the commitment fee associated with MBBC's line of
credit from a correspondent bank.
Provision For Loan Losses
Implicit in lending activities is the risk that losses will occur and
that the amount of such losses will vary over time. Consequently, the Company
maintains an allowance for loan losses by charging a provision to operations.
Loans determined to be losses are charged against the allowance for loan losses.
The allowance for loan losses is maintained at a level considered by Management,
at a point in time and with then available information, to be adequate to
provide for estimable and probable losses inherent in the existing portfolio.
In evaluating the adequacy of the allowance for loan losses, Management
estimates the amount of probable loss for each individual loan that has been
identified as having greater than standard credit risk, including loans
identified as criticized ("Special Mention"), classified ("Substandard" or lower
graded), impaired, troubled debt restructured, and non-performing. In
determining specific and formula loss estimates, Management incorporates such
factors as collateral value, portfolio composition and concentration, trends in
local and national economic and real estate conditions, the duration of the
current business cycle, seasoning of the loan portfolio, historical credit
experience, and the financial status of borrowers. While the overall allowance
is segmented by broad portfolio categories to analyze its adequacy, the
allowance is general in nature and is available for the loan portfolio in its
entirety. Although Management believes that the allowance is adequate, future
provisions are subject to continuing evaluation of inherent risk in the loan
portfolio, as conducted by both Management and the Bank's regulators.
Provisions for loan losses declined from $2.2 million in 2000 to $1.4
million in 2001. The change in provisions was due to the result of the Company's
methodology for calculating the level of allowance for loan losses. Factors that
contributed to the reduction in provisions in 2001 versus the prior year
included:
o a lower level of net charge-offs in 2001 versus 2000
o a decrease in the amount of classified loans at December 31, 2001 versus
the prior year end
o a reduced concentration of relatively higher risk construction and land
loans in 2001 versus 2000
o the reduction in specific reserves of $600 thousand associated with a
commercial real estate construction loan that was collected in full during
the second quarter of 2001
o an increased concentration of relatively lower risk residential and
multifamily mortgages in 2001 versus 2000
The above factors more than offset the impact of a larger loan
portfolio, including growth in commercial business loans outstanding, which
increased from $3.1 million at December 31, 2000 to $8.8 million at December 31,
2001. The above factors also more than offset higher reserve factors for the
Company's portfolios of hotel / motel real estate loans and Business Express
loans (see "Item 1. Business - Credit Quality").
To the extent that the Company is successful in its business strategy
and thereby continues building the size of its loan portfolio while also
extending increased volumes of construction, income property, and business
lending, Management anticipates that additional provisions will be required and
charged against operations in 2002, with the ratio of allowance for loan losses
to loans receivable increasing to reflect the greater credit exposure inherent
in the loan mix.
80
Non-Interest Income
Non-interest income totaled $2.6 million in 2001, comparing favorably
to $2.3 million in 2000. The Company recorded $190 thousand in pre-tax gains on
security sales in 2001, versus a pre-tax loss of $55 thousand during 2000. As
discussed below, customer service charges and mortgage banking income also
increased in 2001 versus the prior year, offset by reduced loan servicing income
and decreased commissions from sales of non-FDIC insured investments.
Service charge income rose from $1.3 million during 2000 to $1.7
million during 2001. This increase primarily resulted from the revised fee and
service charge schedule implemented with the new core processing system in 2001.
Loan servicing income totaled $101 thousand during 2001, compared to
$118 thousand during 2000. The Company continues to sell the vast majority of
its long term, fixed rate residential loan production into the secondary market
on a servicing released basis. As a result, the portfolio of loans serviced for
others is declining as loans pay off. At December 31, 2001, the Company serviced
$42.6 million in various types of loans for other investors, compared to $62.0
million at December 31, 2000.
Commissions from sale of non-FDIC insured investments totaled $244
thousand during 2001, compared to $676 thousand during 2000. Less favorable
general capital market conditions, the events of September 11, 2001, and
investment staff turnover and vacancies contributed to the lower revenues in
2001 versus 2000. During early 2002, the Company continued to be challenged in
recruiting licensed investment sales representatives.
Gains on the sale of loans increased from $23 thousand during 2000 to
$88 thousand during 2001. The lower general interest rate environment in 2001
led to a strong residential loan refinance market, which in turn bolstered the
Company's mortgage banking activity. In 2001, the Company implemented new
technology designed to speed the processing, funding, and delivery into the
secondary market of fixed rate residential mortgages, thus lower operating costs
and providing enhanced customer service.
Further augmenting non-interest income, both nominally and a percentage
of total revenue, constitutes a primary component of the Company's business
strategy. In 2002, the Company plans to enhance its fee income by continuing to
market electronic bill payment and debit card services, increasing the number of
transaction deposit accounts, and selling depository and cash management
services to business customers who would be charged via account analysis.
Non-Interest Expense
Non-interest expense rose $0.7 million, or 5.1%, from $13.7 million in
2000 to $14.4 million in 2001. Total non-interest expense in 2001 was increased
by costs for the March 2001 data processing conversion ($447 thousand) and legal
and other expenses associated with the arbitration of claims by a former
executive ($284 thousand). Total non-interest expenses in 2000 included $108
thousand in costs for the data processing conversion and $250 thousand accrued
for settlement of the claims by the former executive. Costs for the data
processing conversion included de-conversion fees to the prior service bureau,
printing and postage costs for additional customer communications, employee
training and travel costs, and consulting fees for technology professionals
retained to assist with and speed the implementation of the new system.
Throughout 2001, the Company adjusted its staffing to advance the
strategic plan, primarily through the hiring of commercial loan officers and
professional bankers. Staffing was also increased in the data processing
function, coincident with the Company's shifting from an external service bureau
to in-house data processing. The change in the Company's systems environment
also impacted various other operating expenses. Data processing fees were much
lower in 2001 versus 2000, while equipment expense was higher due to the added
depreciation from the new hardware and software installed in 2001.
81
Compensation and employee benefit costs also increased in 2001 versus
2000 for payments under certain incentive compensation plans. These expenses
rose in 2001 in conjunction with the Company's improved financial performance.
Costs for the Bank's employee stock ownership plan ("ESOP") increased in 2001
versus 2000 because of the higher average price of Monterey Bay Bancorp, Inc.
common stock.
Advertising and promotion costs during 2001 were $249 thousand, down
from $361 thousand in 2000 primarily due to the Company's reducing certain
marketing efforts early in 2001 while the core processing conversion was being
completed. Advertising during 2001 included local radio ads that focused on
attracting business customers through the communication of the Bank's
"relationship banking" approach to customer service. The Bank also continued to
promote its 2001 theme of "Monterey Bay Bank. Expect More. Get The Best."
While the Company's efficiency ratio improved from 67.30% in 2000 to
64.41% in 2001, Management acknowledges that this ratio remains above levels
produced by higher performing peer companies. This ratio has been unfavorably
impacted during the past two years by the up front operating costs and other
expenses that the Company has incurred in advance of associated revenues as the
Company has implemented its strategic plan. The Company has made investments in
new staff and new systems that are necessary to successfully market a broader
range of financial products to a greater segment of individuals and businesses
in its primary market areas. These investments by nature had to precede the
associated revenues. By the fourth quarter of 2001, the financial benefits of
these investments became more prominent, as the efficiency ratio during the
fourth quarter of 2001 declined to 59.59%.
The Company plans to continue making investments to support its
strategic plan in 2002; in particular, the hiring of additional business
relationship officers, real estate loan originators, and professional bankers.
However, these investments are likely to be of lesser relative magnitude that
those conducted in 2000 and 2001. In addition, management has commenced a series
of initiatives designed to both improve customer service and satisfaction while
also improving profitability. These initiatives, planned for implementation in
2002, include:
o increasing emphasis on variable, performance based compensation, with
measurement criteria directly related to financial contribution, economic
value created, customer retention, and new customer development
o implementing technology complementary to the new core processing system
installed in 2001 to improve productivity and enhance customer service
o using new technology to foster the re-allocation of employee time and costs
from operational or administrative functions toward revenue generation and
customer service
However, there can be no assurance that the Company will be successful
in implementing the above initiatives or that the Company's will be able to
improve its profitability or efficiency ratio.
Stock Based Compensation
In 2001, the Company extensively utilized stock based compensation for
Directors, Officers, and a significant number of non-officer employees. The
Company believes that the use of stock based compensation aligns Director,
Officer, and employee interests with those of stockholders. The Company's stock
based compensation programs are discussed in Note 18 to the Consolidated
Financial Statements. Several of the Company's stock based compensation programs
provide for vesting periods of up to five years, thereby also encouraging
Management and employees to work in the best long term interests of the Company
and its stockholders. Director retainer fees during 2001 were paid in Company
common stock. In addition, a number of the Bank's Officers voluntarily accepted
Company common stock in lieu of certain cash compensation during 2001. These
decisions included the election by the Chief Executive Officer and Chief
Financial Officer to each receive a significant component of his 2001 incentive
compensation in Company common stock.
The Company intends to continue extensively utilizing stock based
compensation and incentives in 2002, including the issuance of additional stock
options, as approved by stockholders, at 110% of the fair market value of the
stock on the date of grant. This compares to the 100% ratio generally prevalent
among similar financial institution holding companies.
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Provision For Income Taxes
The provision for income taxes increased from $1.9 million in 2000 to
$2.8 million in 2001 due to a rise in pre-tax income. The Company's effective
book tax rate decreased slightly in 2001 versus the prior year. The Company's
effective book tax rate in recent years has been above the statutory rate due to
the fair market value adjustment arising from the ESOP. The Company recognizes
operating expense for the ESOP based upon fair market value at the date shares
are committed to be released. The differential between fair market value and the
Company's historical basis in the ESOP shares committed to be released comprises
the fair market value adjustment that is added to pre-tax income in determining
the Company's provision for income taxes.
Comparison Of Financial Condition At December 31, 2001 And December 31, 2000
Total assets of the Company were $537.4 million at December 31, 2001,
compared to $486.2 million at December 31, 2000, an increase of $51.2 million,
or 10.5%.
Cash & cash equivalents decreased from $25.2 million at December 31,
2000 to $13.1 million at December 31, 2001 due to the Company's using cash
equivalents to fund an expansion in the loan portfolio.
Investment securities at December 31, 2000 and 2001 were composed of
the same two variable rate corporate trust preferred securities issued by major
US banks that reprice quarterly based upon a margin over the 3 month LIBOR rate.
These two securities were rated "A-" or better by Standards & Poors rating
agency at December 31, 2001. Management may consider selling these two
securities in 2002 to bolster the Bank's QTL ratio, shift funds into assets that
function as more effective collateral under secured borrowing arrangements, and
provide funds for further expansion in loans receivable. Increasing the QTL
ratio would provide additional time before the Bank would be forced by
regulation to allocate the management time and incur the operating expense
associated with a change in charter from a federal thrift to either a California
State or national commercial bank. For additional information regarding
investment securities, please refer to Note 3 to the Consolidated Financial
Statements.
Mortgage backed securities decreased from $43.0 million at December 31,
2000 to $30.6 million at December 31, 2001. During 2001, the Company utilized
cash flows from sales and principal payments on mortgage related securities to
fund an increase in the loan portfolio. All of the Company's mortgage backed
securities at December 31, 2001 were rated "AAA" by at least one nationally
recognized ratings agency.
As highlighted in Note 4 to the Consolidated Financial Statements,
during 2001, the Company also continued altering the mix of its mortgage backed
securities. Long term, fixed rate pass-through securities were decreased, while
variable rate and balloon mortgage backed securities were increased. CMO's were
shifted to higher cash flow, shorter term securities with less extension risk.
These instruments provide more periodic funds that can be used to support
further expansion in net loans receivable. These changes were conducted in
conjunction with the Company's asset / liability and liquidity management
programs. In 2001, Management reallocated some of the Company's capacity for
longer term, fixed rate assets from the security portfolio to the loan
portfolio, where better yields were available for the same level of interest
rate risk.
The Company also shifted the mix in CMO issuers in 2001 toward Agency
issuance and away from private label, "AAA" rated securities. This alteration in
mix was conducted to provide additional eligible collateral for various types of
deposits, including time deposits placed by the State of California.
In 2002, the Company plans to continue emphasizing the use of CMO's in
its mortgage backed security portfolio, as the Company can use certain CMO's
(e.g. Planned Amortization Classes, or "PAC's") to target future cash flows in
conjunction with its asset / liability, liquidity, and balance sheet management
programs. The Company does, however, plan to purchase additional longer term,
fixed rate mortgage backed securities in 2002 as part of its proactive efforts
to increase investment in low to moderate income housing.
83
Loans held for sale, carried at the lower of cost or market, totaled
$713 thousand at December 31, 2001. The Company sells most of its long term,
fixed rate residential mortgage production into the secondary market on a
servicing released basis, and purchases more interest rate sensitive loans as
part of its interest rate risk management program.
Loans held for investment, net, increased from $391.8 million at
December 31, 2000 to a record $465.9 million at December 31, 2001. The increase
resulted from a combination of strong internal loan originations and from pool
purchases of various types of California real estate loans. Net loans as a
percentage of total assets increased from 80.6% at December 31, 2000 to 86.8% at
December 31, 2001, in conjunction with the Company's strategy of supporting its
interest margin, fostering economic activity in its local communities, and
effectively utilizing the Bank's capital. Management has targeted increasing the
net loan to asset ratio to 90.0% in 2002 should market conditions prove
favorable.
In conjunction with its strategic plan, the Company intends to pursue
both an expansion in net loans receivable in 2002 and a shift in loan mix away
from residential mortgages toward income property, construction, and business
lending. The establishment of the Los Angeles loan production office in the
first quarter of 2002 is expected to advance that change in mix, as that office
will focus on construction and income property lending.
While just 1.8% of gross loans outstanding at December 31, 2001, the
Company's commercial business lending gained momentum during the fourth quarter
of 2001, ending the year with a record loan pipeline. The new commercial banking
relationship officers hired during 2001 had a positive impact in the fourth
quarter of the year, generating a rise in deposit balances in addition to the
expansion in the business loan portfolio.
The Company's investment in the capital stock of the FHLB increased
from $2.9 million at December 31, 2000 to $3.0 million at December 31, 2001.
Stock dividends and capital stock purchases during 2001 were partially offset by
a mandatory capital stock redemption.
The Company's balance of premises and equipment, net, increased by $243
thousand in 2001 primarily due to hardware and software purchased in support of
the new core processing system. Premises and equipment balances may increase
more substantially in 2002 if the Company is successful in acquiring or opening
de novo one or more new branch locations. For additional information regarding
premises and equipment, please refer to Note 8 to the Consolidated Financial
Statements.
The Company continued to amortize its core deposit intangibles during
2001, reducing their balance from $2.2 million at December 31, 2000 to $1.5
million at December 31, 2001. This amortization, which is a non-cash charge to
operations, bolsters the Bank's regulatory capital ratios (all else held
constant), as intangible assets are deducted from GAAP capital in determining
regulatory capital. This amortization also increases the Company's tangible book
value per share. For additional information regarding core deposit intangibles,
please refer to Note 9 to the Consolidated Financial Statements.
At December 31, 2001, the Company maintained $75 thousand in originated
mortgage servicing rights, down from $165 thousand a year earlier. Because the
Company has adopted a program of generally selling its loans on a servicing
released basis, Management anticipates that the balance of originated mortgage
servicing rights will continue to decline as the existing portfolio of loans
serviced for others pays off.
Total liabilities rose 10.1% from $442.4 million at December 31, 2000
to $487.2 million at December 31, 2001. This $44.8 million increase was
approximately split between an increase in deposits and an increase in
borrowings. Accounts payable and other liabilities decreased by $0.9 million
during 2001 primarily due to the timing of interest payments on borrowings, a
reduction in accrued liabilities for deferred compensation and non-qualified
retirement plans, and the 2001 settlement of claims by a former executive which
had been accrued at December 31, 2000. In 2002, the Company intends to pursue
the conclusion of all non-qualified retirement plans through the negotiation of
lump sum payments. Such conclusion accelerates tax deductions for the Company,
saves a minor amount of administrative overhead, and reduces other liabilities.
This conclusion is expected to have only a minor, if any, impact on the results
of operations.
84
Deposits increased from $407.8 million at December 31, 2000 to a record
$432.3 million at December 31, 2001. The Company experienced strong growth in
money market deposits during 2001 due to a combination of sales and marketing
focus and the historically low interest rate environment's leading certain
customers to delay committing funds to term certificates of deposit. Deposit
growth during 2001 was, however, restrained by a small number of very large
competitors that conducted aggressive promotional campaigns based on paying
interest rates significantly above levels offered by most money center,
regional, and California community banks. Deposit growth during 2001 was also
restrained by customer response to the new systems environment, as the Company
eliminated passbooks in favor of statement accounts and as certain deposit
products were repriced upwards to reflect competitive market conditions or the
Company's costs of providing the accounts.
The Company continues to focus on attracting new transaction deposit
accounts in conjunction with its strategic plan, with the additional objective
of continuing to reduce the percentage of the deposit mix represented by
relatively higher cost certificates of deposit. Certificates of deposit declined
from 60.0% of total deposits at December 31, 2000 to 56.4% of total deposits at
December 31, 2001, despite a $5.0 million increase in funds from the State of
California Time Deposit Program. For additional information regarding deposits,
please refer to Note 10 to the Consolidated Financial Statements.
FHLB advances increased from $32.6 million at December 31, 2000 to
$53.6 million at December 31, 2001. During 2001, the Company utilized FHLB
advances to fund some of the expansion in the loan portfolio. All of the
Company's FHLB advances at December 31, 2001 were fixed rate, fixed term
borrowings without call or put option features. During the fourth quarter of
2001, the Company prepaid $10.0 million in FHLB advances due in the first
quarter of 2002 in order to extend the term structure of that debt in
conjunction with the Company's asset / liability management program. Despite the
Company's strong capital position in 2001, Management did not pursue extensive
leveraging via wholesale assets and liabilities, such as FHLB advances.
Management believes the Company's capital is better deployed in meeting the
financial needs of individuals, families, and businesses, and that much lesser
economic value is created by engaging in wholesale leveraging strategies.
Consolidated stockholders' equity increased from $43.8 million at
December 31, 2000 to $50.2 million at December 31, 2001 due to a combination of:
o net income
o continued amortization of deferred stock compensation
o Directors receiving their fees in Company stock
o appreciation in the portfolio of securities classified as available for
sale, recorded in other comprehensive income
o the exercise of vested stock options
The Company did not declare or pay any cash dividends in 2001. In 2000,
the Company announced the indefinite suspension of the declaration and payment
of cash dividends. The Board of Directors believes that, at this time, the
Company's capital is better utilized in growing the balance sheet, expanding the
Bank's franchise value, and repurchasing shares versus paying a cash dividend.
In addition, paying a nominal cash dividend would cause the Company to incur
additional operating costs for processing, mailing, and tax information
reporting. The Company has no current plans to commence paying cash dividends in
2002.
The Company did not conduct any share repurchases during 2001. However,
as previously announced during the fourth quarter of 2001, the Company's Board
of Directors has authorized a 114,035 share stock repurchase program commencing
in December 2001.
The Company's tangible book value per share increased from $12.54 at
December 31, 2000 to $14.08 at December 31, 2001. The Company's tangible book
value per share benefits from the amortization of deferred stock compensation
and core deposit intangibles, in addition to periodic earnings and other factors
that add to stockholders' equity without increasing the number of shares
outstanding.
85
Analysis Of Results Of Operations For The Years Ended December 31, 2000 And
December 31, 1999
Overview
The Company reported net income of $2.5 million for the year ended
December 31, 2000, down from net income of $3.3 million for the prior year.
These amounts translate to $0.81 basic and diluted earnings per share in 2000,
compared to $1.02 basic and $0.99 diluted earnings per share in 1999. The
Company's return on average assets decreased from 0.73% in 1999 to 0.53% in
2000. The Company's average return on equity also fell, from 8.05% in 1999 to
6.24% in 2000. The overall reduction in net income during 2000 resulted from a
number of factors, including a higher provision for loan losses, greater
operating expenses, and less favorable results from the sale of securities.
These factors more than offset increases in net interest income and most sources
of non-interest income other than results from the sale of securities.
Net Interest Income
During the years ended December 31, 2000 and 1999, net interest income
before the provision for loan losses was $18.0 million and $16.0 million,
respectively. The level of average interest-earning assets over the same years
was $454.1 million and $434.8 million, respectively. The net interest spread was
3.54% and 3.27%, respectively, for the years ended December 31, 2000 and 1999.
During these same periods, the ratio of net interest income to average total
assets was 3.79% and 3.53%, respectively.
The $2.0 million, or 12.2%, increase in net interest income generated
in 2000 versus the prior year was primarily produced by three key changes in the
Company's balance sheet composition:
1. On the asset side of the balance sheet, the Company redirected its
earning asset mix towards loans receivable, reducing the proportion of
earning assets comprised of relatively lower yielding cash equivalents,
investment securities, and mortgage backed securities. Loans
receivable, net, increased from 78.0% of average interest earning
assets in 1999 to 83.6% of average interest earning assets in 2000.
Loans receivable, net, earned a weighted average rate of 8.57% during
2000, comparing favorably to 6.33% on cash equivalents, 7.73% on
investment securities, and 6.98% on mortgage backed securities.
2. On the liability side of the balance sheet, the Company increased the
percentage of average interest bearing liabilities composed of
transaction deposit accounts (NOW, savings, and money market) from
31.2% in 1999 to 33.8% in 2000. Transaction deposit accounts present a
relatively lower cost of funding than most alternative sources. The
proportional increase in average transaction accounts was offset by a
decline in the percentage of average interest bearing liabilities
represented by certificates of deposit. Certificates of deposit
represented 55.5% of average interest bearing liabilities in 2000,
versus 58.4% the prior year.
3. The Company increased its average balance of interest earning assets by
$19.3 million, or 4.4%, in 2000 versus 1999. Due to the deposit growth
the Company achieved during 2000, this rise in average interest earning
assets was accomplished with only a slight increase in the proportion
of funding provided by comparatively higher cost borrowings. Borrowings
as a percentage of average interest bearing liabilities increased from
10.4% in 1999 to 10.7% in 2000. The Company's larger average balance
sheet in 2000 versus 1999 contributed to the $2.0 million rise in net
interest income.
Average non-interest bearing liabilities increased from $19.4 million
during 1999 to $19.8 million during 2000. Increases in average non-interest
bearing liabilities, which primarily consist of demand deposit accounts,
favorably impact the Company's net interest income.
86
Interest Income
Interest income for the year ended December 31, 2000 totaled $37.8
million, an increase of $4.3 million from the prior year. The increase resulted
from a shift in asset mix toward higher yielding assets, the generally higher
interest rate environment in 2000 versus 1999, a decision by the FHLB-SF to pay
particularly high dividend rates during the first half of 2000 in conjunction
with its capital management program, and a larger average balance of interest
earning assets. The larger average balance of interest earning assets stemmed
from the Company's desire to effectively utilize the Bank's regulatory capital
and liquidity in building the size of the loan portfolio. The weighted average
yield on interest earning assets increased from 7.69% during 1999 to 8.31%
during 2000. The yield on the Company's assets generally benefits from a higher
interest rate environment, as the vast majority of the Company's assets are
either adjustable rate or fixed rate with limited duration.
Interest income on loans increased 18.9% from $27.2 million in 1999 to
$32.6 million in 2000. This rise was due to a greater average balance of loans
outstanding and higher average rates. The higher average rates stemmed from both
the higher general interest rate environment and the shift in loan mix away from
relatively lower yielding residential mortgages and toward generally higher
yielding multifamily and commercial real estate loans.
Interest income on mortgage backed securities decreased from $4.9
million in 1999 to $3.8 million in 2000, as the impact of lower average balances
more than offset the effect of higher average rates. A similar pattern applied
to interest income on investment securities, which decreased from $871 thousand
in 1999 to $689 thousand in 2000. The average rate on the Company's investments
in corporate trust preferred securities rose relatively rapidly during 2000 due
to their repricing quarterly based on the responsive three month LIBOR index.
The increase in rate was, however, insufficient to offset the impact of lower
average volumes resulting from the sale of corporate trust securities with a
face value of $4.0 million during 2000.
Interest income on cash equivalents rose during 2000, as a greater
average balance was complemented by higher average rates resulting from the
increases in the target federal funds rate implemented by the Federal Reserve.
The Company maintained a higher average balance of cash equivalents during 2000
primarily due to the periodic build up of excess liquidity in support of pending
loan originations and purchases. In addition, during 2000, the Company placed
$180 thousand in short term certificates of deposit with minority focused
financial institutions in conjunction with its proactive program under the
Community Reinvestment Act.
Interest Expense
Interest expense on deposits increased from $15.1 million during 1999
to $17.2 million during 2000 due to a combination of greater average balances
and higher average rates. The greater average balances stemmed from the
Company's deposit marketing initiatives throughout the year to attract more
consumer and business deposit accounts. The average rate paid on deposits during
2000 increased from the prior year, despite a favorable shift in deposit mix,
due to the higher general interest rate environment. The average cost of
interest bearing deposits rose from 4.29% during 1999 to 4.66% during 2000.
Interest expense on borrowings increased from $2.3 million during 1999
to $2.5 million during 2000. Higher average volumes and greater average rates
each contributed to the rise in interest expense. The Company primarily used
FHLB advances as a source of borrowings during 2000, with MBBC far less active
in selling securities under agreements to repurchase during 2000 versus prior
years due to the sale of MBBC's security portfolio in early 2000.
87
Provision For Loan Losses
Provision for loan losses increased from $835 thousand during 1999 to
$2.2 million during 2000. This increase resulted from the following factors:
1. The growth in the size of the loan portfolio during 2000.
2. Net charge-offs of $313 thousand in 2000 versus $113 thousand in 1999.
3. The continued shift in loan mix away from residential mortgages and toward
income property loans, which typically present more credit risk than
residential mortgages.
4. Specific reserves rose from $200 thousand at December 31, 1999 to $600
thousand at December 31, 2000. The $600 thousand specific reserve at
December 31, 2000 was associated with a $2.85 million commercial
construction loan located in the Company's primary market area. This loan
was collected in full in April 2001.
5. The increasing credit concentrations in the Company's loan portfolio
associated with a smaller number of comparatively larger income property
loans versus a larger number of comparatively smaller residential mortgages
6. An increase in unallocated general reserves from $266 thousand at December
31, 1999 to $739 thousand at December 31, 2000. This increase in
unallocated reserves resulted from Management's concerns about several key
factors which Management believes have negatively impacted the inherent
loss in the Company's credit portfolio, including:
o the California energy crisis, with impacts upon the availability and
price of electricity, business costs, consumer spending and disposable
income, and the pace of economic activity in the State
o the financial difficulties experienced by many technology related
companies in the Silicon Valley area adjacent to the Bank's primary
market areas
o the impact of lower technology stock prices on consumer spending,
liquidity, and investment, with a particular concern regarding effects
on the demand and pricing for real estate in the Bank's primary market
areas
o the general reduction in national economic growth and the increased
volume of layoffs being announced by major corporations
Non-Interest Income
Non-interest income declined from $2.5 million in 1999 to $2.3 million
in 2000. This decrease was primarily due to less favorable results on the sale
of securities more than offsetting increased non-interest income from most other
components of the Company's fee based businesses.
The Company experienced a net pre-tax loss of $55 thousand on the sale
of mortgage backed and investment securities during 2000, versus a gain of $496
thousand in 1999. The gains realized in 1999 occurred during the first half of
that year, in a comparatively low general interest rate environment that
increased the market value of the Company's securities.
88
Customer service charges increased from $1.0 million during 1999 to
$1.3 million during 2000 due to the growth in the customer base reflected in the
increased number of transaction accounts combined with the implementation of a
new fee & service charge schedule in mid 2000.
Commissions from the sale of non-insured products rose from $626
thousand in 1999 to $676 thousand in 2000. Income from loan servicing increased
from $84 thousand in 1999 to $118 thousand in 2000.
Non-Interest Expense
Non-interest expense totaled $13.7 million in 2000, up $1.8 million
from $11.9 million the prior year. Factors contributing to the rise in 2000
included:
1. Compensation and employee benefits increased from $5.6 million during 1999
to $6.6 million during 2000. This increase resulted from a number of
factors, including:
o The hiring of additional staff to support the Company's strategic
plan, including the Bank's first experienced commercial loan officer.
o Changes in the Company's senior management team.
o The settlement of certain non-qualified benefits obligations.
o A $250 thousand accrual for a settlement package for the former
President and Chief Operating Officer, arising from the employment
agreements between the individual and the Company. This matter was
finalized via binding arbitration in 2001.
o The implementation of an expanded performance based incentive
compensation program.
2. Data processing expense increased from $1.0 million in 1999 to $1.14
million in 2000 due to servicing a greater volume of loan and deposit
accounts and processing a greater number of transactions, and because of
costs associated with the planned data processing conversion. The greater
number of accounts and transaction also led to increased spending on
supplies, printing, and postage costs.
3. The payment of $108 thousand in expenses during the fourth quarter of 2000
in support of the planned data processing conversion. These expenses
included costs for travel, training, deconversion services from the
existing data processor, and consultants assisting with the technology
implementation.
4. Recruitment and relocation expenses for hiring new members of the Company's
management team, including a new Chief Executive Officer, Chief Financial
Officer, Controller, and Director of Commercial Lending.
5. The adoption of a Directors Emeritus program that provides cash recognition
payments to retiring directors meeting certain eligibility requirements.
6. Higher outside professional costs. The Company incurred significant legal
costs, in aggregate, during 2000 in conjunction with the successful
collection of a $5.0 million non-performing loan, a review of charter
alternatives, and addressing the potential settlement of claims by the
former President & Chief Operating Officer. The Company also incurred
higher accounting related costs in 2000 due to an expansion of its
co-sourced internal audit program.
89
Primarily because of the higher operating costs described above, the
Company's average efficiency ratio for 2000 increased to 67.3%, up from 64.1%
during 1999. The transformation of the Company has also contributed to increases
in the efficiency ratio, as up front operating costs and other expenses must
often be incurred prior to the realization of associated revenues as the Company
changes its business mix and redirects its sales efforts.
The Company's new management team commenced a series of initiatives to
improve the Company's efficiency ratio during the second half of 2000. However,
due to the time required to conclude existing contractual obligations, implement
these initiatives (including employee training), and conduct required customer
notification, many of these initiatives provided little economic benefit during
2000, but were expected to have a greater impact in 2001.
Provision For Income Taxes
The provision for income taxes decreased from $2.5 million during 1999
to $1.9 million during 2000 due to a reduction in pre-tax income. The Company's
effective book tax rate increased slightly in 2000, in part due to the greater
impact of non-deductible expenses and other tax related adjustments on a lower
base of pre-tax income.
Comparison Of Financial Condition At December 31, 2000 And December 31, 1999
Total assets of the Company were $486.2 million at December 31, 2000,
compared to $462.8 million at December 31, 1999, an increase of $23.4 million,
or 5.0%.
Investment securities declined from $11.5 million at December 31, 1999
to $7.4 million at December 31, 2000 due to the sale of a corporate trust
preferred security during 2000 in order to generate funding for the Company's
increasing loan portfolio. The Company's investment security portfolio at
December 31, 2000 was composed of two variable rate, quarterly repricing,
corporate trust preferred securities issued by major US banks. These two
securities were rated "A-" or better by Standard & Poors rating agency at
December 31, 2000.
Mortgage backed securities declined from $57.8 million at December 31,
1999 to $43.0 million at December 31, 2000. This reduction stemmed from ongoing
principal repayments (including prepayments), maturities, and the sale of
mortgage backed securities with a face value of $24.5 million, partially offset
by purchases during the year. The Company decreased the size of its mortgage
backed security portfolio during 2000 to raise funds for investment into higher
yielding loans receivable, improve the interest rate risk profile of the
Company, and generate additional liquidity for MBBC.
The Company significantly altered the mix of its mortgage backed
securities portfolio during 2000. Traditional Agency pass-through certificates
declined from 54.1% of total mortgage backed securities at December 31, 1999 to
14.9% at December 31, 2000. In contrast, CMOs increased from 45.9% of total
mortgage backed securities at December 31, 1999 to 85.1% at December 31, 2000.
The Company undertook this change in mix:
o to reallocate the Company's capacity for longer term, fixed rate assets
from the security portfolio to the loan portfolio, where management
believes better yields are obtainable for the same level of interest rate
risk
o to acquire CMOs that present relatively more certain cash flows (e.g.
Planned Amortization Classes, or "PACs") than traditional pass-through
certificates and thereby facilitate the Company's cash management
o to take advantage of the generally higher yields available in non-Agency
CMOs versus those presented by similar profile Agency securities
All of the CMOs were rated "AAA" by at least one nationally recognized ratings
agency at December 31, 2000.
90
Loans receivable held for investment, net, were $391.8 million at
December 31, 2000, compared to $360.7 million at December 31, 1999. This 8.6%
increase stemmed from $169.7 million in credit commitments during 2000,
partially offset by repayments and sales. The mix in the portfolio of loans
receivable held for investment, net, changed significantly during 2000, with a
reduced concentration in residential mortgages and a significant increase in the
proportion of income property loans (multifamily and commercial real estate).
This change in loan mix was pursued in conjunction with the Company's strategic
plan of transforming itself into a community commercial bank, and thereby
financing a broader range of credit needs in the communities served. This change
in mix also supports a greater yield on the loan portfolio and an increase in
deposits, as the Company seeks to acquire operating accounts for income
properties financed and for businesses receiving a line of credit or term
business loan.
The Company's investment in the capital stock of the FHLB declined in
2000 due to a mandatory redemption required by the FHLB.
The Company's balance of premises and equipment, net, increased by $333
thousand in 2000 primarily due to leasehold improvements at one branch. This
branch was remodeled to enable the leasing of the second floor to a tenant,
thereby increasing the Company's future monthly rental income.
The Company continued to amortize its intangible assets during 2000,
reducing their balance from $2.9 million at December 31, 1999 to $2.2 million at
December 31, 2000. This amortization, which is a non-cash charge to operations,
bolsters the Bank's regulatory capital ratios (all else held constant), as
intangible assets are deducted from GAAP capital in determining regulatory
capital. This amortization also increases the Company's tangible book value per
share.
During 2000, the liabilities increased by $20.4 million to $442.4
million, from $422.0 million at December 31, 1999. An increase in deposits more
than offset declines in other types of liabilities. Total deposits rose from
$367.4 million at December 31, 1999 to $407.8 million at December 31, 2000. This
increase resulted from multiple factors, including the introduction of new
checking and money market products and the acquisition of $14.0 million in
certificates of deposit through the State of California Time Deposit Program.
The Bank was also successful in attracting some deposit customers during 2000
from local competitors undergoing a merger or acquisition.
FHLB advances declined from $49.6 million at December 31, 1999 to $32.6
million at December 31, 2000. Securities sold under agreements to repurchase
declined from $2.4 million at December 31, 1999 to none at December 31, 2000.
The inflow of deposits and the reduction in securities provided sufficient funds
to fund the growth in loans receivable, retire maturing borrowings, and prepay
certain borrowings during 2000. The Company did not pursue extensive leveraging
via wholesale assets and liabilities during 2000, as Management determined that
available risk adjusted spreads in the capital markets did not support the
associated allocation of capital.
Stockholders' equity increased $3.0 million from $40.8 million at
December 31, 1999 to $43.8 million at December 31, 2000, even with the
repurchase of $1.25 million in Treasury shares during 2000 and the payment of
$274 thousand in cash dividends during the first quarter of 2000. The rise in
equity resulted from net income, continued amortization of deferred stock
compensation, Company directors receiving their fees in Company stock, and an
improvement in the fair value of securities classified as available for sale.
The Company reduced its aggregate deferred stock compensation by $1.3 million
during 2000. This significant reduction was caused by:
o ESOP shares continuing to be committed to be released under the terms of
that tax qualified plan
o the distribution of certain non-qualified deferred compensation payable in
Company stock
o the acceleration of benefits under the Recognition and Retention Plan for
outside directors leading to the termination of that plan and the savings
of future related administrative expense
o continued vesting of shares previously awarded under the Performance Equity
Plan for officers and employees
o the use of Company stock for incentive payments in lieu of cash under
certain employee incentive plans
91
Liquidity
Liquidity is actively managed to ensure sufficient funds are available
to meet the ongoing needs of both the MBBC and the Bank. Liquidity management
includes projections of future sources and uses of funds to ensure the
availability of sufficient liquid reserves to provide for unanticipated
circumstances. The Bank's primary sources of liquidity are deposits, principal
and interest payments (including prepayments) on its asset portfolios, retained
earnings, FHLB advances, other borrowings, and, to a lesser extent, sales of
loans originated for sale and securities classified as available for sale. The
Bank's primary uses of funds include loan originations, customer drawdowns on
lines of credit and undisbursed construction loan commitments, loan purchases,
customer withdrawals of deposits, interest paid on liabilities, and operating
expenses.
Specific steps the Bank has taken to maintain strong liquidity include:
o Arranging four federal funds lines of credit with correspondent banks in an
aggregate amount of $25.5 million. Funds under these lines are provided on
an available, as opposed to on a committed, basis.
o Completing agreements to be able to issue "DTC" or publicly traded
certificates of deposit through two large investment banks with significant
national client bases. The Bank intends to enter into a third such
agreement in 2002.
o Signing PSA agreements with a greater number of approved counterparties to
facilitate the sale of securities under agreements to repurchase.
o Enrolling in the specific loan pledging program with the FHLB-SF and
pledging multifamily and commercial real estate loans in addition to
residential mortgages to the FHLB-SF to increase the Bank's borrowing
capacity.
o Participating in the State of California Time Deposit Program.
o Reducing the duration of its security portfolio during 2001 to provide
greater monthly cash flows.
The Bank pledges excess collateral to the FHLB in order to have ready
access to additional liquidity. At December 31, 2001, the Bank maintained
available borrowing capacity in excess of $125 million at the FHLB. In addition,
at December 31, 2001, the Bank owned unpledged loans and securities that could
be used for either liquidation or secured borrowings in order to meet future
liquidity requirements.
From time to time, depending upon its asset and liability strategy, the
Bank considers converting a portion of its residential whole loans into mortgage
backed securities. These conversions provide increased liquidity because the
mortgage backed securities are typically more readily marketable than the
underlying loans and because they can more effectively be used as collateral for
borrowings. The Bank did not securitize any portion of its residential mortgages
during the years 1999 - 2001.
The Company's ratio of net loans to deposits was 107.92% at December
31, 2001. In 2002, the Company intends to actively manage this ratio by:
o introducing new deposit products and related services, including Internet
banking for businesses
o modifying staff incentive programs to more strongly focus on expanding
deposit relationships
o pursuing opportunities for additional branch locations
o directing a higher percentage of the advertising and promotion budget to
deposit generation
92
At December 31, 2001, the Bank maintained $24.4 million in commitments
to originate loans and lines of credit. Management anticipates that the Bank
will have sufficient funds available to meet these commitments, not all of which
will necessarily be drawn upon. For additional information regarding commitments
and contingencies, including available customer balances under committed lines
of credit, please refer to Note 15 to the Consolidated Financial Statements.
MBBC, as a company separate from the Bank, must provide for its own
liquidity. Substantially all of MBBC's cash inflows are obtained from interest
on its security and cash equivalent positions, repayment of the funds advanced
for the ESOP, exercise of vested stock options, sales of treasury shares to the
Bank for subsequent payment as director fees, and dividends declared and paid by
the Bank. There are statutory and regulatory provisions that limit the ability
of the Bank to pay dividends to MBBC. As of December 31, 2001, MBBC did not have
any commitments for capital expenditures or to fund loans.
At December 31, 2001, MBBC maintained a revolving $3.0 million line of
credit from a correspondent bank of the Bank. This line of credit is secured by
800,000 shares of MBBC's treasury stock. There were no outstanding balances on
this line of credit at December 31, 2001. During 2001, MBBC renegotiated this
line of credit to increase the facility from $2.0 million to $3.0 million and
eliminate restrictions on the use of the line of credit to repurchase MBBC's
common stock. The line of credit agreement contains various financial
performance and reporting covenants. The terms of the line of credit do not
impact or restrict MBBC's ability to pay cash dividends. The line of credit
expires in December 2002. Management obtained this line of credit as a source of
additional liquidity for MBBC, and, through MBBC, for the Bank. The Company
expects to renew this line of credit or establish a similar line of credit with
another bank at the end of 2002.
At December 31, 2001, MBBC had cash and cash equivalents of $4.6
million. This sum is sufficient to provide for approximately ten years of MBBC's
current operating expenses in the absence of any cash inflows. Management knows
of no factors that would restrict or eliminate the normally recurring cash
inflows obtained by MBBC.
Capital Resources
The Bank's position as a "well capitalized" financial institution under
the PCA regulatory framework is further enhanced by the financial resources
present at the MBBC holding company level. At December 31, 2001, the
consolidated GAAP capital position of the Bank was $45.6 million, while the
consolidated GAAP capital position of the Company was $50.2 million. Note 14 to
the Consolidated Financial Statements provides additional information concerning
the Bank's regulatory capital position, including amounts by which the Bank
exceeds minimum and "well capitalized" thresholds for regulatory capital.
Management believes the Bank's regulatory capital position in 2002 will
continue to benefit from three key factors:
o the continued amortization of intangible assets
o the continued amortization of deferred stock compensation
o the Bank's earnings for the year
The potential continued increase in the size of the loan portfolio,
combined with the ongoing planned shift in mix toward construction, income
property, and business lending, may result in the Bank's having higher levels of
nominal and risk weighted assets during 2002, thereby possibly offsetting the
effect of the above factors upon regulatory capital ratios.
The Company has conducted share repurchases since 1995. Through
December 31, 2001, the Company had repurchased 1,269,600 shares of its common
stock. No share repurchases occurred in 2001, and 120,000 shares were
repurchased in 2000. At December 31, 2001, there were 3,456,097 shares
outstanding. In December 2001, the Company announced a repurchase authorization
for an additional 114,035 shares, five thousand of which were acquired during
the first quarter of 2002.
93
Transactions With Related And Certain Other Parties
The Company's conduct of business with Directors, Officers, significant
stockholders, and other related parties (collectively, "Related Parties") is
restricted and governed by various laws and regulations, including Regulation O
as promulgated and enforced by the Federal Reserve. Furthermore, it is the
Company's policy to conduct business with Related Parties only on an arms-length
basis at current market prices with terms and conditions no more favorable than
the Company provides in its normal course of business.
The Bank extends loans to its Directors and their related interests
only after approval of a majority of disinterested Directors and with the
associated Director abstaining from voting. The Bank also extends loans,
primarily residential mortgages and home equity lines of credit, to its
employees under its employee loan program. The Bank's Officers are eligible to
participate in the employee loan program. Note 5 to the Consolidated Financial
Statements presents the Company's credit commitments to Directors and executive
officers.
The Company leases space in one of its owned administrative buildings
to a partnership conducting a retail business. The spouse of one of the
Company's Directors is a partner in the retail business. The associated month to
month lease was negotiated on an arms length basis by disinterested Officers and
approved by disinterested Directors. In early 2002, the Company received
notification that the retail business was ceasing operations and terminating the
lease in compliance with its terms.
The Company periodically utilizes the professional services of a
marketing and advertising corporation with which one executive officer is
affiliated. All business orders and all invoices associated with this
corporation are approved by disinterested executive officers. Total payments to
this marketing and advertising corporation in 2001 were $243 thousand, which
included certain pass-through payments for media advertising.
The Company employs various individuals that are related to other
employees, such as spouses, siblings, children, and other relatives. It is
Company policy to disallow related employees to have a direct reporting or
supervisory relationship. At December 31, 2001, the spouses of two executive
officers were also employees of the Company.
The Company does not believe that the above transactions with related
parties were conducted on other than an arms-length basis with normal terms and
conditions. The Company also does not believe that the above transactions with
related parties impaired stockholder value or presented any actual or potential
conflicts of interest that were not appropriately addressed by disinterested
parties.
Impact of Inflation And Changing Prices
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP"), which requires the
measurement of most financial positions and operating results in terms of
historical dollar amounts without considering the changes in the relative
purchasing power of money over time due to inflation. Unlike industrial
companies, the Company's assets and liabilities are nearly all monetary in
nature. Consequently, relative and absolute levels of interest rates present a
greater impact on the Company's performance and condition than do the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and services. The
Company's operating costs, however, are subject to the impact of inflation,
particularly in the case of salaries and benefits costs, which typically
constitute almost one-half of the Company's total non-interest expense.
94
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 141, "Business
Combinations", and SFAS No.142, "Goodwill and Other Intangible Assets". SFAS No.
141 requires that all business combinations initiated after June 30, 2001 be
accounted for under the purchase method of accounting and addresses the initial
recognition and measurement of goodwill and other intangible assets acquired in
a business combination. SFAS No. 142 addresses the initial recognition and
measurement of intangible assets acquired outside of a business combination
whether acquired individually or with a group of other assets. SFAS No. 142 also
addresses the recognition and measurement of goodwill and other intangibles
assets subsequent to their acquisition. SFAS No. 142 provides that intangible
assets with finite useful lives will be amortized and that goodwill and
intangible assets with indefinite lives will not be amortized, but will be
required to be tested at least annually for impairment. The Company is required
to adopt SFAS No. 142 beginning January 1, 2002. Early adoption is not
permitted. The Company does not expect the adoption of SFAS No. 142 to have a
material effect on its financial position, results of operations, or cash flows,
as the Company had no goodwill as of December 31, 2001 and as all of the
Company's intangible assets at December 31, 2001 were comprised of core deposit
intangibles that will continue to amortize.
In August 2001, the Financial Accounting Standards Board ("FASB")
approved for issuance Statement of Financial Accounting Standard (SFAS) No. 144,
"Accounting For The Impairment Or Disposal Of Long-Lived Assets". SFAS No. 144
supersedes SFAS No. 121, "Accounting For The Impairment Of Long-Lived Assets And
For Long-Lived Assets To Be Disposed Of" and the accounting and reporting
provisions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting The
Results Of Operations - Reporting The Effects Of Disposal Of A Segment Of A
Business, And Extraordinary, Unusual and Infrequently Occurring Events And
Transactions". SFAS No. 144 unifies the accounting treatment for various types
of long-lived assets to be disposed of, and resolves implementation issues
related to SFAS No. 121. SFAS No. 144 is effective for financial statements
issued for fiscal years beginning after December 15, 2001, and interim periods
within those fiscal years. The Company will adopt SFAS No. 144 beginning January
1, 2002. The Company does not expect the adoption of SFAS No. 144 to have a
material effect on its financial position, results of operations, or cash flows,
as the Company had no long-lived assets that were impaired or that were to be
disposed of as of December 31, 2001.
95
Item 7a. Quantitative And Qualitative Disclosure Of Market Risk.
The results of operations for financial institutions such as the
Company may be materially and adversely affected by changes in prevailing
economic conditions, including rapid changes in interest rates, declines in real
estate market values, and the monetary and fiscal policies of the federal
government. Interest rate risk ("IRR") and credit risk typically constitute the
two greatest sources of financial exposure for banks and thrifts. For a
discussion of the Company's credit risk, please see "Item 7. Management's
Discussion And Analysis Of Financial Condition And Results Of Operations -
Provision For Loan Losses". The Company utilizes no derivatives to mitigate
either its credit risk or its IRR, instead relying on loan review and adequate
loan loss reserves in the case of credit risk and portfolio management
techniques in the case of IRR. The Company is not significantly exposed to
foreign currency exchange rate risk, commodity price risk, or other market risks
other than interest rate risk.
IRR represents the impact that changes in absolute and relative levels
of general market interest rates might have upon the Company's net interest
income, results of operations, and theoretical liquidation value, also called
net portfolio value ("NPV"). Interest rate changes impact earnings and NPV in
many ways, including effects upon the yields generated by variable rate assets,
the cost of deposits and other sources of funds, the exercise of options
embedded in various financial instruments (especially residential mortgages),
and customer demand for and market supply of different financial assets,
liabilities, and positions.
In order to manage IRR, the Company has established an Asset /
Liability Management Committee ("ALCO"), which includes representatives from
senior management and the Board of Directors. ALCO is responsible for managing
the Company's financial assets and liabilities in a manner that balances
profitability, IRR, and various other risks (e.g. liquidity). ALCO operates
under policies and within risk limits prescribed by and periodically reviewed
and approved by the Board of Directors.
The primary objective of the Company's IRR management program is to
maximize net interest income while controlling IRR exposure to within prudent
levels. Financial institutions are subject to IRR whenever assets and
liabilities mature or reprice at different times (repricing, or gap, risk),
based upon different capital markets indices (basis risk), for different terms
(yield curve risk), or are subject to various embedded options, such as the
right of mortgage borrowers to refinance their loans when general market
interest rates decline. Companies with high concentrations of real estate
lending, such as the Company, are significantly impacted by prepayment rates on
loans, as such prepayments generally return investable funds to the Company at a
time of relatively lower prevailing general market interest rates.
Decisions to control or accept IRR are analyzed with consideration of
the probable occurrence of future interest rate changes. Stated another way, IRR
management encompasses the evaluation of the likely additional return associated
with an incremental change in the IRR profile of the Company. For example,
having liabilities that mature or reprice faster than assets can be beneficial
when interest rates decline, but may be detrimental when interest rates rise.
Assessment of potential changes in market interest rates and the relative
financial impact to earnings and NPV is used by the Company to help quantify and
manage IRR. As with credit risk, the complete elimination of IRR would curtail
the Company's profitability, as the Company generates a return, in part, through
effective risk management.
The Company monitors its interest rate risk using various analytical
methods that include participation in the OTS net portfolio value interest rate
risk modeling. The Company's exposure to IRR as of December 31, 2001 was within
the limits established by the Board of Directors.
A common, if analytically limited, measure of financial institution IRR
is the institution's "static gap". Static gap is the difference between the
amount of assets and liabilities (adjusted by off balance sheet positions, if
any) that are expected to mature or reprice within a specified period. A static
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities in a given time period
or cumulatively through that time period. The converse is true for a negative
static gap.
96
The following table presents the maturity and rate sensitivity of
interest-earning assets and interest-bearing liabilities as of December 31,
2001. The "repricing gap" figures in the table reflect the estimated difference
between the amount of interest-earning assets and interest-bearing liabilities
that are contractually scheduled to mature or reprice (whichever occurs first)
during future periods.
At December 31, 2001
-------------------------------------------------------------------------------------
More Than More Than More Than Non-
3 Months 3 Months 1 Year 3 Years Over Interest
Or Less To 1 Year To 3 Years To 5 Years 5 Years Bearing Total
------- --------- ---------- ---------- ------- ------- -----
(Dollars In Thousands)
Assets
------
Interest earning cash equivalents $ 898 $ -- $ -- $ -- $ -- $ -- $ 898
Investment securities 7,300 -- -- -- -- -- 7,300
Mortgage backed securities 4,691 -- -- 907 25,046 -- 30,644
Loans held for sale -- -- -- -- 713 -- 713
Loans receivable, net of LIP 124,687 104,420 101,237 121,020 20,955 -- 472,319
FHLB stock 2,998 -- -- -- -- -- 2,998
---------- ----------- ----------- ----------- ----------- ----------- ----------
Gross interest-earning assets 140,574 104,420 101,237 121,927 46,714 -- 514,872
Plus / (Less):
Unamortized yield adjustments -- -- -- -- -- 233 233
Allowance for loan losses -- -- -- -- -- (6,665) (6,665)
---------- ----------- ----------- ----------- ----------- ----------- ----------
Interest-earning assets 140,574 104,420 101,237 121,927 46,714 (6,432) 508,440
Non-interest-earning assets -- -- -- -- -- 28,951 28,951
---------- ----------- ----------- ----------- ----------- ----------- ----------
Total assets $140,574 $104,420 $101,237 $121,927 $ 46,714 $ 22,519 $537,391
========== =========== =========== =========== =========== =========== ==========
Liabilities and Equity
----------------------
NOW accounts $ 42,557 $ -- $ -- $ -- $ -- $ -- $ 42,557
Savings accounts 19,127 -- -- -- -- -- 19,127
Money market accounts 105,828 -- -- -- -- -- 105,828
Certificates of deposit 81,022 112,041 46,160 4,542 -- -- 243,765
---------- ----------- ----------- ----------- ----------- ----------- ----------
Total interest-bearing deposits 248,534 112,041 46,160 4,542 -- -- 411,277
Borrowings 218 13,000 33,282 6,300 1,000 -- 53,800
---------- ----------- ----------- ----------- ----------- ----------- ----------
Total interest bearing liabilities 248,752 125,041 79,442 10,842 1,000 -- 465,077
Non-interest bearing liabilities -- -- -- -- -- 22,152 22,152
Stockholders' equity -- -- -- -- -- 50,162 50,162
---------- ----------- ----------- ----------- ----------- ----------- ----------
Total liabilities and equity $248,752 $125,041 $ 79,442 $ 10,842 $ 1,000 $ 72,314 $537,391
========== =========== =========== =========== =========== =========== ==========
Periodic repricing gap (108,178) (20,621) 21,795 111,085 45,714
Cumulative repricing gap (108,178) (128,799) (107,004) 4,081 49,795
Periodic repricing gap as a
% of interest earning assets (21.3%) (4.2%) 4.3% 21.8% 9.0%
Cumulative repricing gap as a
% of interest earning assets (21.3%) (25.3%) (21.0%) 0.8% 9.8%
Cumulative net interest-earning
assets as a % of cumulative
interest-bearing liabilities 56.5% 65.5% 76.4% 100.9% 110.7%
97
As presented in the prior table, at December 31, 2001, the Company's
cumulative one year and three year static gaps, based upon contractual repricing
and maturities (i.e. ignoring prepayments and other non-contractual factors)
were (25.3%) and (21.0%), respectively, of total interest earning assets. These
figures suggest that net interest income would increase if general market
interest rates were to decline (and vice-versa), reflecting a "net liability
sensitive" position.
However, static gap analysis such as that presented above fails to
capture material components of IRR, and therefore provides only a limited, point
in time view of the Company's IRR exposure. The assumptions and factors that are
by definition excluded from static gap analysis prepared on a contractual basis
encompass:
o prepayments on assets
o how rate movements and the shape of the Treasury curve, or the LIBOR swap
curve, affect borrower behavior
o that all loans and deposits repricing at a given time will not adjust to
the same degree or by the same magnitude
o that the nature of rate changes for assets and liabilities in the over
one-year category have a greater long term economic impact than those for
shorter term assets and liabilities
o transaction deposit accounts (significant to the Company) do not have
scheduled repricing dates or contractual maturities, and therefore may
respond to interest rate changes differently than other financial
instruments
o potential Company strategic and operating responses to changes in absolute
and relative interest rate levels
o the financial impact of options embedded in various financial instruments
Another measure of IRR, required to be performed by insured depository
institutions regulated by the OTS, is a procedure specified by Thrift Bulletin
13a, "Interest Rate Risk Management". This test measures the impact upon NPV of
an immediate and sustained change in interest rates in 100 basis point
increments. The following table presents the estimated impacts of such changes
in interest rates upon the Company as of December 31, 2001, calculated in
compliance with Thrift Bulletin 13a. However, the results from any cash flow
simulation model are dependent upon a lengthy series of assumptions about
current and future economic, behavioral, and financial conditions, including
many factors over which the Company has no control. These assumptions include,
but are not limited to, prepayment rates on various asset portfolios and decay
rates on core deposits, including savings, checking, and money market accounts.
Because of the uncertainty regarding the accuracy of assumptions utilized and
because such an analytical technique does not contemplate any actions the
Company might undertake in response to changes in interest rates, no assurance
can be provided that the valuations presented in the following table are
representative of what might actually be obtainable. In addition, the following
figures are by definition not indicative of the Company's economic value as a
going concern or of the Company's market value.
Projected Change From Base Scenario In
--------------------------------------
(Dollars In Thousands) NPV Dollars Percent
--- ------- -------
Change In Interest Rates (In Basis Points)
+300 $ 62,594 $(11,593) (15.6%)
+200 67,775 (6,412) (8.6%)
+100 71,415 (2,772) (3.7%)
Base Scenario 74,187 -- --
-100 75,861 1,674 2.3%
--------------------------------------------------------------------------------
Note: NPV results for downward rate changes of more than 100 basis points were
not calculated at 12/31/01 due to the low level of interest rates.
The level of interest rate risk exposure presented in the above table
is generally considered "low" in the financial services industry.
98
The prior table results show that the Company's liquidation value
benefits from declining interest rates, and is reduced by rising interest rates.
Such results are directionally consistent with the static gap analysis presented
above. The reduction in net portfolio value associated with rising interest rate
scenarios in part results from the embedded options, held by borrowers, within
most mortgage related products, as described in the following two paragraphs.
Under rising interest rates, the Company's assets experience a
lengthening of duration and slower repricing relative to the liability side,
resulting in a reduction of NPV. This occurs due to the slower prepayment
behavior (under rising rates) the analysis assumed on mortgage related assets,
and in conjunction with embedded options such as periodic and lifetime rate
adjustment caps on adjustable rate loans. This prepayment behavior is a result
of borrowers behaving in their economic self interests by more slowly (or not at
all) curtailing or prepaying loans with interest rates at or below current
market rates.
Under falling interest rates, the increase in the Company's net
portfolio value is constrained by a shortening of asset duration. This occurs
due to the faster prepayment behavior (under falling rates) the analysis assumed
on mortgage related assets, as borrowers take advantage of a lower interest rate
environment to refinance their loans. This assumed refinancing provides cash
flow into the Company at a time when reinvestment alternatives present lower
rates than the assets being paid off. Therefore, due to borrower use of embedded
options in mortgage loans, the Company's net portfolio value increases less in a
declining rate scenario than it falls in a similar rising rate scenario. This
financial pattern is typical of community banks that have residential mortgages
as a significant component of their loan portfolios.
A considerable portion of the total IRR exposure at December 31, 2001
was concentrated in two portfolios:
1. hybrid (i.e. fixed for 3 - 5 years, then variable) residential mortgages
2. long term, fixed rate residential mortgages held for investment
The Company added significant volumes of hybrid residential mortgages to its
balance sheet early in 2001, including loan pool purchases, in order to take
advantage of the rapidly declining interest rate environment and better leverage
the Bank's capital position. In addition, customer demand for hybrid mortgages
was strong in 2001, fueled in the latter half of the year by the steeper
Treasury yield curve that rendered these products comparatively attractively
priced versus longer term, fixed rate mortgages. During 2001, the Company
continued selling the vast majority of its long term, fixed rate residential
mortgage originations, leading to a decline in that portfolio segment throughout
the year as older loans amortized and prepaid.
As general market interest rates appeared to be approaching a cyclical
bottom in the latter part of 2001, the Company implemented various steps to
reduce its net liability sensitivity. These actions included:
o decreasing the duration of the securities portfolio
o pricing loan products to more strongly encourage customer selection of more
interest rate sensitive loans
o extending the term structure of borrowings
o actively marketing longer term certificates of deposit
In addition, the Company's strategic plan encompasses a reduced net
liability sensitivity through the growth of transaction deposit account
balances, particularly comparatively interest rate insensitive checking
accounts, and the expansion of commercial banking. Commercial banking is by
nature an asset sensitive business, as loans are generally variable rate,
frequently based upon the Prime Rate, while deposits often include a significant
non-interest bearing demand deposit component. In addition, the planned shift in
loan mix away from the historical concentration in residential mortgages toward
generally more interest rate sensitive, and higher yielding, income property and
construction loans is also planned to reduce the Company's net liability
sensitivity.
Despite the Company's IRR management program and the initiatives
detailed above, due to the multiple factors which influence the Company's
exposure to IRR, many of which are beyond the control of the Company, there can
be no assurance that the Company's earnings or economic value will be maintained
in future periods, nor that the Company will be successful in continuing to
maintain a relatively low level of IRR exposure.
99
Item 8. Financial Statements And Supplementary Data.
-----------------------------------------------------
Index To Consolidated Financial Statements
Page(s)
-------
Independent Auditors' Report 101
Consolidated Statements Of Financial Condition
As Of December 31, 2001 and 2000 102
Consolidated Statements Of Income For The Years Ended
December 31, 2001, 2000, and 1999 103
Consolidated Statements Of Changes In Stockholders' Equity
For The Years Ended December 31, 2001, 2000, and 1999 104 - 106
Consolidated Statements Of Cash Flows For The Years Ended
December 31, 2001, 2000, and 1999 107 - 108
Notes To Consolidated Financial Statements 109 - 146
100
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Monterey Bay Bancorp, Inc.
Watsonville, California
We have audited the accompanying consolidated statements of financial condition
of Monterey Bay Bancorp, Inc. and subsidiary as of December 31, 2001 and 2000,
and the related consolidated statements of income, changes in stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Monterey Bay Bancorp, Inc. and
subsidiary as of December 31, 2001 and 2000, and the results of their operations
and their cash flows, for each of the three years in the period ended December
31, 2001 in conformity with accounting principles generally accepted in the
United States of America.
/s/ Deloitte & Touche LLP
San Francisco, California
January 29, 2002
101
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2001 AND 2000
--------------------------------------------------------------------------------
(Dollars In Thousands, Except Per Share Amounts)
December 31,
-------------------------------
2001 2000
---- ----
ASSETS
Cash and cash equivalents $ 13,079 $ 25,159
Securities available for sale, at estimated fair value:
Investment securities 7,300 7,360
Mortgage backed securities 30,644 42,950
Loans held for sale, at lower of cost or market 713 --
Loans receivable held for investment (net of allowances for loan losses of
$6,665 at December 31, 2001 and $5,364 at December 31, 2000) 465,887 391,820
Investment in capital stock of the Federal Home Loan Bank, at cost 2,998 2,884
Accrued interest receivable 2,915 2,901
Premises and equipment, net 7,618 7,375
Core deposit intangibles, net 1,514 2,195
Other assets 4,723 3,546
-------- --------
TOTAL ASSETS $537,391 $486,190
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits $432,339 $407,788
Advances from the Federal Home Loan Bank and other borrowings 53,800 32,582
Accounts payable and other liabilities 1,090 1,983
-------- --------
Total liabilities 487,229 442,353
-------- --------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value, 2,000,000 authorized; none issued Common
stock, $0.01 par value, 9,000,000 shares authorized;
4,492,085 issued at December 31, 2001 and December 31, 2000;
3,456,097 outstanding at December 31, 2001 and
3,321,210 outstanding at December 31, 2000 45 45
Additional paid-in capital 28,584 28,278
Retained earnings, substantially restricted 36,473 32,722
Unallocated ESOP shares (690) (920)
Treasury shares designated for compensation plans, at cost (17,969 shares
at December 31, 2001 and 35,079 shares at December 31, 2000) (173) (338)
Treasury stock, at cost (1,035,988 shares at December 31, 2001 and
1,170,875 shares at December 31, 2000) (14,006) (15,326)
Accumulated other comprehensive loss, net of taxes (71) (624)
-------- --------
Total stockholders' equity 50,162 43,837
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $537,391 $486,190
======== ========
See Notes to Consolidated Financial Statements
102
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
(Dollars In Thousands, Except Per Share Amounts)
--------------------------------------------------------------------------------
Year Ended December 31,
-----------------------------------------------
INTEREST AND DIVIDEND INCOME: 2001 2000 1999
---- ---- ----
Loans receivable $ 35,485 $ 32,556 $ 27,218
Mortgage backed securities 2,360 3,755 4,884
Investment securities and cash equivalents 886 1,446 1,315
-------- -------- --------
Total interest and dividend income 38,731 37,757 33,417
-------- -------- --------
INTEREST EXPENSE:
Deposit accounts 16,449 17,231 15,130
Advances from the Federal Home Loan Bank and other borrowings 2,541 2,546 2,258
-------- -------- --------
Total interest expense 18,990 19,777 17,388
-------- -------- --------
NET INTEREST INCOME BEFORE PROVISION
FOR LOAN LOSSES 19,741 17,980 16,029
PROVISION FOR LOAN LOSSES 1,400 2,175 835
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 18,341 15,805 15,194
NON-INTEREST INCOME:
Gains (losses) on sale of mortgage backed securities
and investment securities, net 190 (55) 496
Commissions from sales of noninsured products 244 676 626
Customer service charges 1,688 1,306 1,032
Income from loan servicing 101 118 84
Gain on sale of loans 88 23 54
Other income 255 272 213
-------- -------- --------
Total 2,566 2,340 2,505
-------- -------- --------
NON-INTEREST EXPENSE:
Compensation and employee benefits 6,857 6,569 5,648
Occupancy and equipment 1,652 1,278 1,173
Deposit insurance premiums 198 188 164
Data processing fees 876 1,142 990
Legal and accounting expenses 863 661 423
Supplies, postage, telephone, and office expenses 663 679 601
Advertising and promotion 249 361 310
Amortization of intangible assets 681 723 712
Consulting 333 212 119
Other expenses 1,997 1,863 1,747
-------- -------- --------
Total 14,369 13,676 11,887
-------- -------- --------
INCOME BEFORE PROVISION FOR INCOME TAXES 6,538 4,469 5,812
PROVISION FOR INCOME TAXES 2,787 1,946 2,511
-------- -------- --------
NET INCOME $ 3,751 $ 2,523 $ 3,301
======== ======== ========
EARNINGS PER SHARE:
BASIC EARNINGS PER SHARE $ 1.15 $ 0.81 $ 1.02
======== ======== ========
DILUTED EARNINGS PER SHARE $ 1.12 $ 0.81 $ 0.99
======== ======== ========
See Notes to Consolidated Financial Statements
103
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
--------------------------------------------------------------------------------
(Dollars And Shares In Thousands)
Treasury
Shares
Desig- Accum-
nated ulated
For Other
Addi- Unal- Com- Compre-
Common Stock tional Re- located pen- hensive
------------ Paid-In tained ESOP sation Treasury Income/
Shares Amount Capital Earnings Shares Plans Stock (Loss) Total
------ ------ ------- -------- ------ ----- ----- ------ -----
Balance At January 1, 1999 3,505 $45 $ 27,826 $ 27,702 $(1,380) $ (951) $(12,920) $794 $ 41,116
Purchase of treasury stock (116) (1,668) (1,668)
Options exercised using treasury stock 34 60 331 391
Dividends paid ($0.15 per share) (530) (530)
Amortization of stock compensation 351 230 257 838
Purchase of stock for stock
compensation plans (682) (682)
Comprehensive income:
Net income 3,301 3,301
Other comprehensive income:
Change in net unrealized
gain / (loss) on securities
available for sale, net of
taxes of $(1,168) (1,671) (1,671)
Reclassification adjustment
for gains on securities
available for sale included
in income, net of taxes
of $(204) (292) (292)
--------
Other comprehensive income, net (1,963)
--------
Total comprehensive income 1,338
--------
------ ------ ------- -------- ------ ----- ----- ------ -----
Balance at December 31, 1999 3,423 $45 $ 28,237 $ 30,473 $(1,150) $(1,376) $(14,257) $(1,169) $ 40,803
====== ====== ======= ======== ====== ===== ===== ====== =====
See Notes to Consolidated Financial Statements
104
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Continued)
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
--------------------------------------------------------------------------------
(Dollars And Shares In Thousands)
Treasury
Shares
Desig- Accum-
nated ulated
For Other
Addi- Unal- Com- Compre-
Common Stock tional Re- located pen- hensive
------------ Paid-In tained ESOP sation Treasury Income/
Shares Amount Capital Earnings Shares Plans Stock (Loss) Total
------ ------ ------- -------- ------- ------- -------- ------- --------
Balance At December 31, 1999 3,423 $45 $ 28,237 $ 30,473 $(1,150) $(1,376) $(14,257) $(1,169) $ 40,803
Purchase of treasury stock (120) (1,251) (1,251)
Cash dividends paid ($0.08 per
share) (274) (274)
Director fees paid using treasury
stock 18 9 182 191
Amortization of stock compensation 32 230 822 1,084
Sale of stock for stock
compensation plans 216 216
Comprehensive income:
Net income 2,523 2,523
Other comprehensive income:
Change in net unrealized gain /
(loss) on securities available
for sale, net of taxes of $359 513 513
Reclassification adjustment for
losses on securities available
for sale included in income,
net of taxes of $23 32 32
--------
Other comprehensive income, net 545
--------
Total comprehensive income 3,068
--------
------ ------ ------- -------- ------- ------- -------- ------- --------
Balance at December 31, 2000 3,321 $45 $ 28,278 $ 32,722 $ (920) $ (338) $(15,326) $(624) $ 43,837
====== ====== ======= ======== ======= ======= ======== ======= ========
See Notes to Consolidated Financial Statements
105
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Continued)
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
--------------------------------------------------------------------------------
(Dollars And Shares In Thousands)
Treasury
Shares
Desig- Accum-
nated ulated
For Other
Addi- Unal- Com- Compre-
Common Stock tional Re- located pen- hensive
------------ Paid-In tained ESOP sation Treasury Income/
Shares Amount Capital Earnings Shares Plans Stock (Loss) Total
------ ------ ------- -------- ------ ------ -------- ----- --------
Balance At December 31, 2000 3,321 $45 $ 28,278 $ 32,722 $ (920) $ (338) $(15,326) $(624) $ 43,837
Options exercised using treasury
stock 116 (5) 1,132 1,127
Director fees paid using treasury
stock 19 47 188 235
Amortization of stock compensation 264 230 165 659
Comprehensive income:
Net income 3,751 3,751
Other comprehensive income:
Change in net unrealized gain /
(loss) on securities available
for sale, net of taxes of $465 665 665
Reclassification adjustment for
gains on securities available
for sale included in income,
net of taxes of $(78) (112) (112)
--------
Other comprehensive income, net 553
--------
Total comprehensive income 4,304
--------
------ ------ ------- -------- ------ ------ -------- ----- --------
Balance at December 31, 2001 3,456 $45 $ 28,584 $ 36,473 $ (690) $ (173) $(14,006) $ (71) $ 50,162
====== ====== ======= ======== ====== ====== ======== ===== ========
See Notes to Consolidated Financial Statements
106
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
--------------------------------------------------------------------------------
(Dollars In Thousands)
Year Ended December 31,
---------------------------------------
2001 2000 1999
---- ---- ----
OPERATING ACTIVITIES:
Net income $ 3,751 $ 2,523 $ 3,301
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of premises and equipment 663 441 472
Amortization of intangible assets 681 723 712
Amortization of purchase premiums, net of accretion of discounts 241 104 516
Amortization of deferred loans fees and costs, net (223) (250) (293)
Provision for loan losses 1,400 2,175 835
Provision for real estate losses -- -- 12
Federal Home Loan Bank stock dividends (184) (214) (174)
Gross ESOP expense before dividends received on unallocated shares 437 334 486
Compensation expense related to stock compensation plans 200 296 297
Director retainer fees paid in stock 219 112 --
(Gain) loss on sale of investment and mortgage-backed securities (190) 55 (496)
Gain on the sale of loans held for sale (88) (23) (54)
Loss (gain) on sale of real estate acquired via foreclosure -- 5 (18)
(Gain) loss on sale of fixed assets (8) -- 2
Origination of loans held for sale (12,112) (2,652) (6,693)
Proceeds from sales of loans held for sale 11,487 2,674 8,923
Deferred income taxes (521) (595) (743)
Increase in accrued interest receivable (14) (213) (151)
(Increase) decrease in other assets (1,177) 566 (1,285)
(Decrease) increase in accounts payable and other liabilities (893) (647) 49
Other, net (830) (1,209) 1,526
------- ------ ------
Net cash provided by operating activities 2,839 4,205 7,224
------- ------ ------
INVESTING ACTIVITIES:
Net increase in loans held for investment (74,067) (31,134) (61,911)
Purchases of investment securities available for sale -- -- (7)
Proceeds from sales of investment securities available for sale -- 3,730 8,005
Purchases of mortgage backed securities available for sale (29,250) (26,818) --
Principal repayments on mortgage backed securities available for sale 30,337 18,422 19,645
Proceeds from maturities of mortgage backed securities held to maturity -- 60 --
Proceeds from sales of mortgage backed securities available for sale 12,287 24,425 17,643
Redemptions (purchases) of FHLB stock, net 70 543 --
Purchases of premises and equipment (1,129) (774) (1,200)
Proceeds from the sale of premises and equipment 11 -- --
------- ------ ------
Net cash used in investing activities (61,741) (11,546) (17,825)
------- ------ ------
See Notes to Consolidated Financial Statements
107
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
--------------------------------------------------------------------------------
(Dollars In Thousands)
Year Ended December 31,
---------------------------------------
2001 2000 1999
---- ---- ----
FINANCING ACTIVITIES:
Net increase (decrease) in deposits 24,551 40,386 (3,275)
Proceeds (repayments) of FHLB advances, net 21,000 (17,000) 14,400
Proceeds (repayments) of other borrowings, net 218 (2,410) (2,080)
Cash dividends paid to stockholders -- (274) (530)
Purchases of treasury stock -- (1,251) (1,668)
Sales of treasury stock for exercise of stock options 1,053 --- 318
Sales (purchases) of stock for stock compensation plans, net -- 216 (682)
-------- -------- --------
Net cash provided by financing activities 46,822 19,667 6,483
-------- -------- --------
NET (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS (12,080) 12,326 (4,118)
CASH & CASH EQUIVALENTS AT BEGINNING OF YEAR 25,159 12,833 16,951
-------- -------- --------
CASH & CASH EQUIVALENTS AT END OF YEAR $ 13,079 $ 25,159 $ 12,833
======== ======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid during the period for:
Interest on deposits and borrowings 19,147 19,655 17,380
Income taxes 4,150 3,060 3,163
SUPPLEMENTAL DISCLOSURES OF NON CASH
INVESTING AND FINANCING ACTIVITIES:
Loans transferred to held for investment, at market value 85 385 171
Real estate acquired in settlement of loans -- -- 376
See Notes to Consolidated Financial Statements
108
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
--------------------------------------------------------------------------------
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization And Nature Of Operations
Monterey Bay Bancorp, Inc. ("MBBC") is a unitary savings and loan holding
company incorporated in 1994 under the laws of the state of Delaware. MBBC
operates as the holding company for its wholly owned subsidiary Monterey Bay
Bank (the "Bank"), a federally chartered savings and loan association. The Bank
has one wholly owned subsidiary, Portola Investment Corporation ("Portola"),
which sells various non-FDIC insured investment products and provides trustee
services to the Bank. Portola operates within the Bank's facilities in
segregated areas. MBBC, the Bank, and Portola are hereinafter collectively
referred to as the "Company".
The Company's primary business is attracting checking, money market, savings,
and certificate of deposit accounts through its branch facilities and various
electronic means, and investing such deposits and other available funds in
various types of loans, including real estate mortgages, business loans,
construction loans, and consumer loans. The Company also provides a range of fee
based services. The Bank's deposit gathering and lending markets are primarily
concentrated in the communities surrounding its full service offices located in
Santa Cruz, Northern Monterey, and Southern Santa Clara Counties, in California.
At December 31, 2001, the Bank maintained eight full service branch offices, two
administrative buildings, and eleven ATM's, two of which were stand-alone.
Summary Of Significant Accounting Policies
Basis of Consolidation - The consolidated financial statements include the
accounts of Monterey Bay Bancorp, Inc. and its wholly-owned subsidiary, Monterey
Bay Bank, and the Bank's wholly-owned subsidiary, Portola Investment
Corporation. All significant inter-company transactions and balances are
eliminated in consolidation.
Financial Statement Presentation And Use Of Estimates - The financial statements
have been prepared and presented in accordance with accounting principles
generally accepted in the United States of America, or "GAAP" and general
practices within the banking and savings and loan industry. The preparation of
the financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, and contingent assets and liabilities, and disclosure of contingent
assets and liabilities, as of the balance sheet dates and revenues and expenses
for the reporting periods. Actual results could differ from those estimates.
Cash And Cash Equivalents - Cash and cash equivalents include cash on hand,
amounts due from banks, federal funds sold, investments in money market mutual
funds, securities purchased under agreements to resell with original maturities
of three months of less, certificates of deposit with original maturities of
three months or less, and highly liquid debt instruments purchased with
remaining terms to maturity of three months or less from the date of
acquisition.
Securities Available For Sale - Securities to be held for indefinite periods of
time, including securities that management intends to use as part of its asset /
liability management strategy that may be sold in response to changes in
interest rates, loan prepayments, or other factors, are classified as available
for sale. Securities available for sale are carried at estimated fair value.
Gains or losses on the sale of securities are determined using the specific
identification method. Premiums and discounts are recognized in interest income
using the interest method over the period to contractual maturity. Unrealized
holding gains or losses, net of tax, for securities available for sale are
reported within accumulated other comprehensive income, which is a separate
component of stockholders' equity, until realized.
A decline in the fair value of individual securities available for sale below
their cost that is deemed other than temporary would be recognized through a
write down of the investment securities to their fair value by a charge to
earnings as a realized loss.
All of the Company's securities were classified as available for sale at
December 31, 2001 and 2000.
109
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Mortgage Backed Securities - The Company's mortgage backed securities include
collateralized mortgage obligations ("CMO's") issued by both federal Agencies
and private entities ("private label CMO's"). Private label CMO's expose the
Company to credit and liquidity risks not typically present in federal Agency
issued securities.
Loans Held For Sale - Loans held for sale are carried at the lower of aggregate
cost, including qualified loan origination costs and related fees, or estimated
market value, grouped by category. Unrealized losses by category are recognized
via a charge against operations. Realized gains and losses on loans held for
sale are accounted for under the specific identification method. Qualified loan
origination fees and costs are retained and not amortized during the period the
loans are held for sale. Transfers of loans held for sale to the held for
investment portfolio are recorded at the lower of cost or estimated market value
on the transfer date. The Company had $713 thousand in loans held for sale at
December 31, 2001 and none at December 31, 2000. However, the Company did
originate and hold loans for sale during each of the three years ended December
31, 2001, 2000, and 1999.
Loans Receivable Held For Investment - Loans receivable held for investment are
stated at unpaid principal balances less undisbursed loan funds for
constructions loans, unearned discounts, deferred loan origination fees, and
allowances for estimated loan losses, plus unamortized premiums (including
purchase premiums) and qualified deferred loan origination costs. These loans
are not adjusted to the lower of cost or market because it is management's
intention, and the Company has the ability, to hold these loans to maturity.
Interest Income On Loans - Interest income on loans is accrued and credited to
income as it is earned. However, interest is generally not accrued on loans over
90 days contractually delinquent. In addition, interest is not accrued on loans
that are less than 90 days contractually delinquent, but where management has
identified concern over future collection. Accrued interest income is reversed
when a loan is placed on non-accrual status. Discounts, premiums, and net
deferred loan origination fees and costs are amortized into interest income over
the contractual lives of the related loans using a procedure approximating the
interest method, except when a loan is in non-accrual status. When a loan pays
off or is sold, any unamortized balance of any related premiums, discounts, and
qualified net deferred loan origination fees and costs is recognized in income.
Payments received on non-accrual loans are allocated between principal and
interest based upon the terms of the underlying note.
Sales Of Loans - Gains or losses resulting from sales of loans are recorded at
the time of sale and are determined by the difference between (i) the net sales
proceeds plus the estimated fair value of any interests retained in the loans,
such as loan servicing rights, and (ii) the carrying value of the assets sold.
The difference between the adjusted carrying value of the interests retained and
the face amount of the interests retained is amortized to operations over the
estimated remaining life of the associated loans using a method that
approximates the interest method. The fair value of any interests retained is
periodically evaluated, with any shortfall in estimated fair value versus
carrying amount being charged against operations.
Troubled Debt Restructured - A loan is considered "troubled debt restructured"
when the Company provides the borrower certain concessions that it would not
normally consider. The concessions are provided with the objective of maximizing
the recovery of the Company's investment. Troubled debt restructured includes
situations in which the Company accepts a note (secured or unsecured) from a
third party in payment of its receivable from the borrower, other assets in
payment of the loan, an equity interest in the borrower or its assets in lieu of
the Company's receivable, or a modification of the terms of the debt including,
but not limited to, (i) a reduction in the stated interest rate to below market
rates, (ii) an extension of maturity at an interest rate or other terms below
market, (iii) a reduction in the face amount of the debt, and / or (iv) a
reduction in the accrued interest receivable.
110
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Impaired Loans - The Company considers a loan to be impaired when it is deemed
probable by management that the Company will be unable to collect all
contractual interest and contractual principal payments in accordance with the
terms of the original loan agreement. However, when determining whether a loan
is impaired, management also considers the current ratio of the loan's balance
to collateral value, other sources of repayment, and the borrower's present
financial position. In evaluating whether a loan is considered impaired,
insignificant delays or shortfalls in payments, in the absence of other facts
and circumstances, would not alone lead to the conclusion that a loan is
impaired. The Company includes among impaired loans all loans that (i) are
contractually delinquent 90 days or more, (ii) meet the definition of a troubled
debt restructuring, (iii) are classified in part or in whole as either doubtful
or loss, (iv) the Company has suspended accrual of interest, and (v) have a
specific loss allowance applied to adjust the loan to fair value. The Company
may also classify other loans as impaired based upon their specific
circumstances.
The Company accounts for impaired loans, except those loans that are accounted
for at market value or at the lower of cost or market value, at the present
value of the expected future cash flows discounted at the loan's effective
interest rate at the date of initial impairment, or, as a practical expedient,
at the loan's observable market price or fair value of the collateral if the
loan is collateral dependent. The Company evaluates the collectibility of both
contractual interest and contractual principal when assessing the need for a
loss accrual for impaired loans. Interest income received on impaired
non-accrual loans is recognized on a cash basis. Interest income on other
impaired loans is recognized on an accrual basis. The Company uses the cash
basis method of accounting for payments received on impaired loans.
Allowances For Loan Losses - The Company maintains an allowance for loan losses
to absorb probable losses inherent in the loan portfolio. The allowance is based
on ongoing assessments of the probable estimated inherent losses. Loans are
charged against the allowance when management believes the principal to not be
recoverable. The allowance is increased by the provision for loan losses. The
provision for loan losses is charged against current period operating results.
The allowance is decreased by the amount of charge-offs, net of recoveries. The
Company's methodology for assessing the appropriateness of the allowance
consists of several key elements, which include the formula allowance, specific
allowances, and the unallocated allowance.
The formula allowance is calculated by applying loss factors to outstanding
loans and certain unused commitments. Loss factors reflect management's estimate
of the inherent loss in various segments of the loan portfolio. Loss factors are
determined based upon various information, including the Company's historical
loss experience. Loss factors may be adjusted for factors that, in management's
judgment, affect the collectibility of the portfolio as of the evaluation date.
Specific allowances are established for loans that are deemed impaired if the
fair value of the loan or the collateral or the present value of expected future
cash flows is estimated to be less than the Company's investment in the loan. In
developing specific valuation allowances, the Company considers (i) the
estimated cash payments expected to be received by the Company, (ii) the
estimated net sales proceeds from the loan or its collateral, (iii) cost of
refurbishment, (iv) certain operating income and expenses, and (v) the costs of
acquiring and holding the collateral. The Company charges off a portion of an
impaired loan against the specific allowance when that portion is deemed
probable to not be recoverable.
The unallocated allowance is based upon management's evaluation of various
conditions that are not directly measured in the determination of the formula
and specific allowances. The evaluation of the inherent loss with respect to
these conditions is subject to a higher degree of uncertainty because they are
not identified with specific problem credits or portfolio segments. The
conditions evaluated in connection with the unallocated allowance may include
existing general economic and business conditions affecting key lending areas of
the Company, the status of the real estate market in California, credit quality
trends, delinquencies, collateral values, loan volumes, concentrations, and
seasoning, specific industry conditions, recent loss experience, and the
duration of the business cycle.
111
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
While management uses currently available information to determine the allowance
for loan losses, additions to or recoveries from the allowance may be necessary
based upon a number of factors including, but not limited to, changes in
economic conditions and credit quality trends, particularly in the real estate
market, borrower financial status, the regulatory environment, real estate
values, and loan portfolio size and composition. Many of these factors are
beyond the Company's control and, accordingly, periodic provisions for loan
losses may vary from time to time. In addition, various regulatory agencies, as
an integral part of the examination process, periodically review the Bank's
allowance for loan losses. Such regulatory agencies may develop judgements
different from those of management and may require the Bank to recognize
additional provisions against operations.
Premises And Equipment - Land is carried at cost. Other premises and equipment
are stated at cost, less accumulated depreciation and amortization. The Company
depreciates or amortizes premises and equipment on a straight-line basis over
the estimated useful lives of the various assets, and amortizes leasehold
improvements over the shorter of the asset's useful life or the remaining term
of the lease. The useful lives for the principal classes of assets are:
Asset Useful Life
----- -----------
Buildings 30 to 40 years
Leasehold improvements Shorter of remaining term of lease or life of
improvement
Furniture and equipment 3 to 10 years
The cost of repairs and maintenance is charged to operations as incurred,
whereas expenditures that improve or extend the service lives of assets are
capitalized.
Impairment Of Long-Lived Assets Other Than Core Deposit Intangibles - The
Company's primary long-lived assets other than core deposit intangibles are its
branches and administrative buildings. The Company periodically evaluates the
recoverability of these long-lived assets. Long-lived assets to be held and used
are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of assets may not be recoverable. Determination of
recoverability is based on an estimate of undiscounted future cash flows
resulting from the use of the asset and its eventual disposition. Measurement of
an impairment loss for long-lived assets that management expects to hold and use
are based on the fair value of the asset. Long-lived assets to be disposed of
are reported at the lower of carrying amount or fair value less estimated cost
to sell.
Core Deposit Intangibles - These assets arise from the acquisition of deposits
and are amortized on a straight-line basis over the estimated life of the
deposit base acquired, generally seven years. The Company periodically evaluates
the periods of amortization to determine whether later events and circumstances
warrant revised estimates.
Stock Based Compensation - The Company accounts for its stock option and stock
award plans under Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting For Stock-Based Compensation". This Statement establishes financial
accounting and reporting standards for stock-based compensation plans. These
standards include the recognition of compensation expense over the vesting
period of the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No 123 also permits entities to continue to apply the
provisions of APB No. 25, Accounting For Stock Issued To Employees, and provide
pro forma net earnings (loss) and pro forma net earnings (loss) per share
disclosures as if the fair value based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the provisions of APB No.
25, using the intrinsic value method of accounting for stock based compensation,
and provide the pro forma disclosure requirements of SFAS No. 123 in the
footnotes to its audited financial statements.
112
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Employee Stock Ownership Plan ("ESOP") - The Company accounts for shares
acquired by its ESOP in accordance with the guidelines established by the
American Institute of Certified Public Accountants Statement of Position 93-6,
Employers' Accounting for Employee Stock Ownership Plans ("SOP 93-6"). Under SOP
93-6, the Company recognizes compensation cost equal to the fair value of the
ESOP shares during the periods in which they become committed to be released. To
the extent that the fair value of the Company's ESOP shares committed to be
released differ from the cost of such shares, the differential is charged or
credited to equity. Employers with internally leveraged ESOPs such as the
Company do not report the loan receivable from the ESOP as an asset and do not
report the ESOP debt from the employer as a liability. The Company's ESOP is a
tax-qualified plan. Non-vested shares owned by the ESOP are accounted for via a
contra-equity account based upon historic cost. ESOP shares that have not been
committed to be released (uncommitted shares) are excluded from outstanding
shares on a weighted average basis for earnings per share calculations.
Income Taxes - The Company accounts for income taxes under the liability method.
Under this method, deferred tax assets and deferred tax liabilities are
recognized for future tax consequences attributable to temporary differences
between the financial statement carrying amounts of certain existing assets and
liabilities, and their respective bases for Federal income and California
franchise taxes. Deferred tax assets and liabilities are calculated by applying
current effective tax rates against future deductible or taxable amounts. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in operations in the period that includes the enactment date. Future
tax benefits attributable to temporary differences are recognized to the extent
the realization of such benefits is more likely than not.
Commissions From Sales Of Non-FDIC Insured Products - The Company realizes
commissions from the sales of various non-FDIC insured products, including
mutual funds, annuities, and specific securities, as a result of business
conducted through Portola. Commission income is typically based upon a
percentage of sales. Periodic commission income varies based on the volume and
mix of investment products sold, and is recognized on a cash basis.
Earnings Per Share - The Company calculates and discloses basic earnings per
share and diluted earnings per share. Basic earnings per share excludes dilution
and is computed by dividing net income available to common shareholders by the
weighted average number of common shares outstanding during the period. Diluted
earnings per share reflects the potential dilution that could occur if contracts
to issue common stock or securities convertible into common stock were exercised
or converted. Dilution resulting from the Company's stock option and stock award
plans is calculated using the treasury stock method.
Comprehensive Income - Comprehensive income includes (i) net income and (ii)
other comprehensive income. The Company's only source of other comprehensive
income is derived from unrealized gains and losses on securities available for
sale. The Company displays comprehensive income within the Consolidated
Statements of Changes in Stockholders' Equity. Reclassification adjustments
result from gains or losses on securities that were realized and included in net
income of the current period that also had been included in other comprehensive
income as unrealized holding gains or losses in the period in which they arose.
Such adjustments are excluded from current period comprehensive income in order
to avoid double counting.
Derivative Instruments And Hedging Activities - Effective January 1, 2001, the
Company adopted Statement of Financial Accounting Standards ("SFAS") No 133,
"Accounting for Derivative Instruments and hedging Activities", which
establishes accounting and reporting standards for derivative instruments and
hedging activities. The adoption of this statement did not have any impact on
the Company's consolidated financial position or results of operations or cash
flows. The Company did not enter into freestanding derivative contracts during
2001 and did not identify any embedded derivatives requiring bifurcation and
separate valuation at December 31, 2001.
Segment Disclosure - The Company operates a single line of business (financial
services) with no customer accounting for more than 10.0% of its revenue and
manages its operation under a unified management and reporting structure.
Therefore, no additional segment disclosures are provided.
Reclassifications - Certain reclassifications have been made to prior period
financial statements to conform them to the current year presentation.
113
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Recent Accounting Developments
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard (SFAS) No. 141, "Business Combinations", and
SFAS No.142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that
all business combinations initiated after June 30, 2001 be accounted for under
the purchase method of accounting and addresses the initial recognition and
measurement of goodwill and other intangible assets acquired in a business
combination. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired outside of a business combination whether acquired
individually or with a group of other assets. SFAS No. 142 also addresses the
recognition and measurement of goodwill and other intangibles assets subsequent
to their acquisition. SFAS No. 142 provides that intangible assets with finite
useful lives will be amortized and that goodwill and intangible assets with
indefinite lives will not be amortized, but will be required to be tested at
least annually for impairment. The Company is required to adopt SFAS No. 142
beginning January 1, 2002. Early adoption is not permitted. The Company does not
expect the adoption of SFAS No. 142 to have a material effect on its financial
position, results of operations, or cash flows, as the Company had no goodwill
as of December 31, 2001 and as all of the Company's intangible assets at
December 31, 2001 were comprised of core deposit intangibles that will continue
to amortize.
In August 2001, the Financial Accounting Standards Board ("FASB") approved for
issuance Statement of Financial Accounting Standard (SFAS) No. 144, "Accounting
For The Impairment Or Disposal Of Long-Lived Assets". SFAS No. 144 supersedes
SFAS No. 121, "Accounting For The Impairment Of Long-Lived Assets And For
Long-Lived Assets To Be Disposed Of" and the accounting and reporting provisions
of Accounting Principles Board ("APB") Opinion No. 30, "Reporting The Results Of
Operations - Reporting The Effects Of Disposal Of A Segment Of A Business, And
Extraordinary, Unusual and Infrequently Occurring Events And Transactions". SFAS
No. 144 unifies the accounting treatment for various types of long-lived assets
to be disposed of, and resolves implementation issues related to SFAS No. 121.
SFAS No. 144 is effective for financial statements issued for fiscal years
beginning after December 15, 2001, and interim periods within those fiscal
years. The Company will adopt SFAS No. 144 beginning January 1, 2002. The
Company does not expect the adoption of SFAS No. 144 to have a material effect
on its financial position, results of operations, or cash flows, as the Company
had no long-lived assets that were impaired or that were to be disposed of as of
December 31, 2001.
114
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
2. CASH AND CASH EQUIVALENTS
Cash and cash equivalents are summarized as follows:
December 31,
------------------------
2001 2000
------- -------
(Dollars In Thousands)
Cash on hand $ 1,444 $ 1,483
Due from banks 10,891 13,544
Certificates of deposit 194 187
Federal funds sold 550 6,735
Money market mutual funds -- 3,210
------- -------
$13,079 $25,159
======= =======
3. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are
presented below. All securities held are publicly traded.
December 31, 2001
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars In Thousands)
Available for sale
------------------
Variable rate corporate trust
preferred securities $ 7,707 $ -- $ (407) $ 7,300
======= ==== ======= =======
December 31, 2000
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars In Thousands)
Available for sale
------------------
Variable rate corporate trust
preferred securities $ 7,696 $ -- $ (336) $ 7,360
======= ==== ======= =======
The following table shows the amortized cost, estimated fair value, and weighted
average yield of the Company's investment securities by year of contractual
maturity. Actual maturities may differ from contractual maturities due to rights
of issuers to call obligations.
December 31, 2001
----------------------------------------
Estimated Weighted
Amortized Fair Average
Cost Value Yield
---- ----- -----
(Dollars In Thousands)
Available for sale
------------------
Variable rate corporate trust
preferred securities
Due in 2012 and thereafter $ 7,707 $ 7,300 2.94%
======= ======= =====
115
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Proceeds from and realized gains and losses on sales of investment securities
available for sale are summarized as follows:
Year Ended December 31,
-----------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Proceeds from sales $ -- $ 3,730 $ 8,005
Gross realized gains on sales -- -- 518
Gross realized losses on sales -- 44 --
4. MORTGAGE BACKED SECURITIES
The amortized cost and estimated fair value of mortgage backed securities
("MBS") are presented below. Types of mortgage backed securities include pass
through certificates ("PT's"), balloon MBS ("Balloon's"), and collateralized
mortgage obligations ("CMO's"). All securities held are publicly traded.
December 31, 2001
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars In Thousands)
Available for sale
------------------
Fixed rate FHLMC PT's $ 1,551 $ 34 $ -- $ 1,585
Fixed rate FNMA PT's 585 38 -- 623
Fixed rate GNMA PT's 744 31 -- 775
Variable rate FNMA PT's 4,629 62 -- 4,691
Fixed rate FHLMC balloons 1,956 -- -- 1,956
Fixed rate CMO's:
Agency issuance 17,062 86 -- 17,148
Non Agency issuance 3,831 35 -- 3,866
------- ----- ------ -------
$30,358 $ 286 $ -- $30,644
======= ===== ====== =======
December 31, 2000
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars In Thousands)
Available for sale
------------------
Fixed rate FHLMC PT's $ 1,090 $ 13 $ -- $ 1,103
Fixed rate FNMA PT's 3,649 25 (2) 3,672
Fixed rate GNMA PT's 1,060 -- (11) 1,049
Variable rate FNMA PT's 571 5 -- 576
Fixed rate CMOs:
Agency issuance 19,095 5 (266) 18,834
Non Agency issuance 18,210 4 (498) 17,716
------- ----- ------- -------
$43,675 $ 52 $ (777) $42,950
======= ===== ======= =======
116
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
The following table shows the amortized cost, estimated fair value, and weighted
average yield of the Company's mortgage backed securities by year of contractual
maturity. Actual maturities may differ from contractual maturities due to
principal prepayments, priority of principal allocation within collateralized
mortgage obligations, or rights of issuers to call obligations prior to
maturity.
December 31, 2001
-------------------------------------------------------
Estimated Weighted
Amortized Fair Average
Cost Value Yield
---- ----- -----
(Dollars In Thousands)
Available for sale
------------------
Due in 2003 through 2006 $ 900 $ 907 5.90%
Due in 2007 through 2011 2,557 2,582 5.28%
Due in 2012 and thereafter 26,901 27,155 4.99%
------- ------- ----
$30,358 $30,644 5.04%
======= ======= =====
Proceeds from and realized gains and losses on sales of mortgage backed
securities available for sale are summarized as follows:
Year Ended December 31,
------------------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Proceeds from sales $ 12,287 $ 24,425 $ 17,643
Gross realized gains on sales 190 72 30
Gross realized losses on sales -- 83 52
The Company pledges mortgage backed securities to the Federal Home Loan Bank as
collateral for advances, to the State of California as collateral for certain
deposits, to public entities as collateral for certain deposits, and to the
Federal Reserve as collateral for certain customer payments. The following table
details the amortized cost of mortgage backed securities not pledged and pledged
for various purposes:
December 31,
-------------------------
2001 2000
---- ----
(Dollars In Thousands)
Not pledged $ -- $ 7,010
Pledged to the Federal Home Loan Bank 3,831 18,210
Pledged to the State of California 24,962 17,487
Pledged to public funds 470 571
Pledged to the Federal Reserve 1,095 397
-------- --------
$ 30,358 $ 43,675
======== ========
117
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
5. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans receivable, net are summarized as follows:
December 31,
--------------------------
2001 2000
---- ----
(Dollars In Thousands)
Held for investment:
Loans secured by real estate:
Residential one to four unit $204,829 $160,155
Multifamily five or more units 103,854 76,727
Commercial and industrial 109,988 102,322
Construction 38,522 59,052
Land 11,924 16,310
-------- --------
Sub-total loans secured by real estate 469,117 414,566
Other loans:
Home equity lines of credit 6,608 5,631
Loans secured by deposits 202 494
Consumer lines of credit, unsecured 170 175
Business term loans 3,163 1,641
Business lines of credit 5,680 1,438
-------- --------
Sub-total other loans 15,823 9,379
Sub-total gross loans held for investment 484,940 423,945
(Less) / Plus:
Undisbursed construction loan funds (12,621) (26,580)
Unamortized purchase premiums, net of purchase discounts 435 21
Deferred loan fees and costs, net (202) (202)
Allowance for loan losses (6,665) (5,364)
-------- --------
Loans receivable held for investment, net $465,887 $391,820
======== ========
118
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
The Company serviced various types of loans for others, primarily residential
mortgages, with the outstanding principal balance amounts summarized below:
December 31,
--------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Loans serviced for others $ 42,637 $ 62,031 $ 74,225
Activity in the allowance for loan losses is summarized as follows:
Year Ended December 31,
-------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Balance, beginning of year $ 5,364 $ 3,502 $ 2,780
Provision for loan losses 1,400 2,175 835
Charge-offs:
Residential one to four unit real estate loans -- (371) (113)
Consumer lines of credit, unsecured (4) -- --
Business lines of credit (95) -- --
------- ------- -------
Total charge-offs (99) (371) (113)
Recoveries:
Residential one to four family real estate loans -- 58 --
------- ------- -------
Balance, end of year $ 6,665 $ 5,364 $ 3,502
======= ======= =======
119
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
The following tables summarizes the Company's recorded investment in impaired
loans by type:
Accrual Status Non-Accrual Status Total Impaired Loans
---------------------------- --------------------------- ---------------------------
Specific Specific Specific
Principal Allowances Principal Allowances Principal Allowances
--------- ---------- --------- ---------- --------- ----------
(Dollars In Thousands)
December 31, 2001
Residential one to four unit $ -- $ -- $ 1,372 $ -- $ 1,372 $ --
Commercial real estate -- -- 851 -- 851 --
Consumer lines of credit -- -- 1 -- 1 --
Business term loans -- -- 28 -- 28 --
------ ------ ------- ------ ------- ------
Total $ -- $ -- $ 2,252 $ --- $ 2,252 $ --
====== ====== ======= ====== ======= ======
December 31, 2000
Residential one to four unit $ 677 $ -- $ 603 $ -- $ 1,280 $ --
Commercial real estate -- -- 1,133 -- 1,133 --
Construction -- -- 2,852 600 2,852 600
Business term loans -- -- 78 -- 78 --
------ ------ ------- ------ ------- ------
Total $ 677 $ -- $ 4,666 $ 600 $ 5,343 $ 600
====== ====== ======= ===== ======= =====
Additional information concerning impaired loans is as follows:
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Average investment in impaired loans for the year $2,304 $7,790 $2,511
====== ====== ======
Interest recognized on impaired loans at December 31 $ 146 $ 461 $ 590
====== ====== ======
Interest not recognized on impaired loans at December 31 $ 46 $ 110 $ 109
====== ====== ======
Additional information concerning non-accrual loans is as follows:
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Interest recognized on non-accrual loans at December 31 $146 $400 $ 80
==== ==== ====
Interest not recognized on non-accrual loans at December 31 $ 46 $110 $109
==== ==== ====
The Company extends loans to executive officers and directors in the ordinary
course of business. These transactions were on substantially the same terms as
those prevailing at the time for comparable transactions with unrelated parties
and do not involve more than normal risk or unfavorable terms for the Company.
An analysis of the activity of these loans is as follows:
Year Ended December 31,
------------------------
2001 2000
---- ----
(Dollars In Thousands)
Credit commitments, beginning of year $ 1,724 $ 631
New term loans and lines of credit 1,781 2,119
Repayments (1,195) (728)
Other (350) (298)
------- -------
Credit commitments, end of year $ 1,960 $ 1,724
======= =======
120
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Under Office of Thrift Supervision ("OTS") regulations, the Bank may not make
real estate loans to one borrower in an amount exceeding 15% of the Bank's
unimpaired capital and surplus, plus an additional 10% for loans secured by
readily marketable collateral. At December 31, 2001 and 2000, such limitation
would have been approximately $7,623,000 and $6,520,000, respectively.
The vast majority of the Company's loans are secured by real estate located in
California. The Company's credit risk is therefore primarily related to the
economic conditions and real estate valuations of this state. Loans are
generally made on the basis of a secure repayment source, which is based on a
detailed cash flow analysis; however, collateral is generally a secondary source
for loan qualification. Under the Company's policy, private mortgage insurance
is required for all residential real estate secured loans with an initial loan
to value ratio greater than 80%.
6. INVESTMENT IN CAPITAL STOCK OF THE FEDERAL HOME LOAN BANK
As a member of the Federal Home Loan Bank of San Francisco, the Bank is required
to own capital stock in an amount specified by regulation. As of December 31,
2001 and 2000, the Bank owned 29,977 and 28,838 shares, respectively, of $100
par value FHLB stock. The amount of stock owned at December 31, 2001 meets the
most recent regulatory determination.
7. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows:
December 31,
--------------------
2001 2000
---- ----
(Dollars In Thousands)
Interest receivable on cash equivalents $ -- $ 13
Interest receivable on investment securities 39 102
Interest receivable on mortgage backed securities 161 246
Interest receivable on capital stock of the Federal Home Loan Bank 29 48
Interest receivable on loans 2,686 2,492
------ ------
$2,915 $2,901
====== ======
8. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
December 31,
---------------------
2001 2000
---- ----
(Dollars In Thousands)
Land $ 3,213 $ 3,213
Buildings and improvements 4,257 4,373
Equipment 3,733 2,832
-------- --------
Total, at cost 11,203 10,418
Less accumulated depreciation (3,585) (3,043)
-------- --------
Premises and equipment, net $ 7,618 $ 7,375
======== ========
Depreciation expense was $663 thousand, $441 thousand, and $472 thousand for the
years ended December 31, 2001, 2000, and 1999, respectively.
121
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
9. CORE DEPOSIT INTANGIBLES
Core deposit intangibles, net, totaled approximately $1.5 million at December
31, 2001. This balance was comprised of two assets that were generated as a
result of the purchase of deposit accounts by the Bank from other financial
institutions in December 1996 and April 1998. Each of these assets is being
amortized on a straight-line basis over seven years. At December 31, 2001, the
Company maintained no other intangible assets, including goodwill.
Additional information regarding the Company's core deposit intangibles is as
follows:
Original Current
Carrying Accumulated Carrying
Amount Amortization Amount
------ ------------ ------
(Dollars In Thousands)
1996 Core Deposit Intangible
----------------------------
Balance at December 31, 2000 $ 3,670 $ 2,141 $ 1,529
2001 amortization expense 524
-------
Balance at December 31, 2001 $ 3,670 $ 2,665 $ 1,005
1998 Core Deposit Intangible
----------------------------
Balance at December 31, 2000 $ 1,096 $ 430 $ 666
2001 amortization expense 157
-------
Balance at December 31, 2001 $1,096 $ 587 $ 509
Total Core Deposit Intangibles
------------------------------
Balance at December 31, 2000 $ 4,766 $ 2,571 $ 2,195
2001 amortization expense 681
-------
Balance at December 31, 2001 $ 4,766 $ 3,252 $ 1,514
Estimated future amortization expense for the Company's core deposit intangibles
as of December 31, 2001 is as follows:
1996 1998
Deposit Deposit
Acquisition Acquisition Total
----------- ----------- -----
(Dollars In Thousands)
2002 $ 524 $ 157 $ 681
2003 481 157 638
2004 -- 157 157
2005 -- 38 38
2006 -- -- --
------- ----- -------
Total $ 1,005 $ 509 $ 1,514
======= ===== =======
122
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
10. DEPOSITS
Deposits are as follows:
December 31,
----------------------------------
(Dollars In Thousands) 2001 2000
---- ----
Demand deposit accounts $ 21,062 $ 17,065
NOW accounts 42,557 41,859
Savings accounts 19,127 16,503
Money market accounts 105,828 87,651
Certificates of deposit < $100,000 156,351 166,905
Certificates of deposit $100,000 or more 87,414 77,805
-------- --------
$432,339 $407,788
======== ========
The following table sets forth the maturity distribution of certificates of
deposit:
December 31, 2001
-----------------------------------------------------------------
Balance Balance
Less Than $100,000
$100,000 And Over Total
-------- -------- -----
(Dollars In Thousands)
Three months or less $ 44,749 $ 36,273 $ 81,022
Over three through six months 37,684 15,944 53,628
Over six through twelve months 40,313 18,100 58,413
Over twelve months through two years 27,634 14,996 42,630
Over two years through three years 2,619 911 3,530
Over three years 3,352 1,190 4,542
--------- -------- ---------
$ 156,351 $ 87,414 $ 243,765
========= ======== =========
At December 31, 2001 and 2000, respectively, total accounts with balances of
$100,000 or greater in deposit products other than certificates of deposit
amounted to $72,814,000 and $52,447,000.
Interest expense on deposits is summarized as follows:
Year Ended December 31,
------------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
NOW accounts $ 366 $ 550 $ 388
Savings accounts 216 281 280
Money market accounts 3,452 4,040 3,402
Certificates of deposit 12,415 12,360 11,060
------ ------ ------
$16,449 $17,231 $15,130
======= ======= =======
123
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
11. ADVANCES FROM THE FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
The Bank is a member of the Federal Home Loan Bank ("FHLB") of San Francisco and
borrows from the FHLB through various types of collateralized advances. Assets
pledged to the FHLB to collateralize advances include the Bank's ownership
interest in the capital stock of the FHLB, mortgage backed securities, and
various types of qualifying whole loans.
A summary of advances from the FHLB and related maturities follows. All FHLB
advances outstanding at December 31, 2001 and December 31, 2000 were term,
bullet maturity, and non-structured advances.
December 31,
----------------------------------
Year Of Maturity 2001 2000
---------------- ---- ----
(Dollars In Thousands)
2002 $ 13,000 $ --
2003 33,000 25,000
2004 282 282
2005 1,500 1,500
2006 4,800 4,800
2010 1,000 1,000
------- -------
$53,582 $32,582
======= =======
Weighted average nominal rate 4.46% 5.48%
Additional information concerning advances from the FHLB includes:
2001 2000
---- ----
(Dollars In Thousands)
Average amount outstanding during the year $47,526 $43,946
Maximum amount outstanding at any month-end during the year $65,582 $50,582
Weighted average interest rate during the year 5.30% 5.72%
Collateral pledged to secured advances from the FHLB is comprised of the
following (amortized cost):
December 31,
-------------------------------
2001 2000
---- ----
(Dollars In Thousands)
Mortgage backed securities $ 3,831 $ 18,210
Capital stock in the Federal Home Loan Bank 2,998 2,884
Mortgage loans 279,539 232,604
Other borrowings at December 31, 2001 included certain impound accounts totaling
$218 thousand that bear interest at a rate of 2.00%. These accounts are used to
pay various costs associated with real property, including property taxes and
insurance.
124
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
12. LINES OF CREDIT
At December 31, 2001, Monterey Bay Bancorp, Inc. had a revolving line of credit
from a correspondent bank of Monterey Bay Bank. The line of credit is for $3.0
million and expires on December 30, 2002. There was no balance outstanding on
the line of credit at December 31, 2001. The line of credit is collateralized by
eight hundred thousand shares of Monterey Bay Bancorp, Inc.'s treasury stock,
which is in the custody of the correspondent bank. The line of credit contains
various covenants regarding the maintenance of certain financial conditions and
the provision of financial and operating information. This line of credit
provides an additional source of liquidity to the Monterey Bay Bancorp, Inc.
holding company.
13. INCOME TAXES
The components of the provision for income taxes are as follows:
Year Ended December 31,
----------------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Current:
Federal $ 2,544 $ 1,889 $ 2,453
State 764 652 801
------- ------- -------
Total current 3,308 2,541 3,254
------- ------- -------
Deferred:
Federal (495) (457) (605)
State (26) (138) (138)
------- ------- -------
Total deferred (521) (595) (743)
------- ------- -------
Provision for income taxes $ 2,787 $ 1,946 $ 2,511
======= ======= =======
A reconciliation from the statutory federal income and state franchise tax rates
to the consolidated effective tax rates, expressed as a percentage of income
before income taxes, follows:
Year Ended December 31,
----------------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Statutory federal income tax rate 34.0% 34.0% 34.0%
California franchise tax, net of federal income tax benefit 7.4% 7.6% 7.5%
Other 1.2% 1.9% 1.7%
---- ---- ----
Effective income tax rate 42.6% 43.5% 43.2%
===== ===== =====
125
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Deferred income taxes reflect the net tax effects of temporary differences,
between the carrying amount of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. Net deferred tax assets
are included within other assets on the Consolidated Statements of Financial
Condition. The tax effects of temporary differences that gave rise to
significant portions of the deferred tax assets and liabilities are as follows:
December 31,
----------------------------------
2001 2000
---- ----
(Dollars In Thousands)
Deferred tax assets:
Allowance for loan losses $ 2,706 $ 1,864
Intangible assets 1,057 969
Deferred compensation 46 319
Unrealized loss on securities available for sale 50 437
Other 41 75
------- -------
Total gross deferred tax assets 4,000 3,664
------- -------
Deferred tax liabilities:
FHLB stock dividends (441) (419)
Other (245) (66)
------- -------
Total gross deferred tax liabilities (686) (485)
------- -------
Net deferred tax asset $ 3,314 $ 3,179
======= =======
The Company believes that it is more likely than not that it will realize the
above deferred tax assets in future periods; therefore, no valuation allowance
has been provided against its deferred tax assets.
Legislation regarding bad debt recapture became law in 1996. The law requires
recapture of reserves accumulated after 1987, and required that the recapture
tax on post-1987 reserves be paid over a six year period starting in 1996. The
Company completed this recapture in 2001.
The Bank maintains a tax bad debt reserve of approximately $5.0 million that
arose in tax years that began prior to December 31, 1987. This tax bad debt
reserve will, in future years, be subject to recapture in whole or in part upon
the occurrence of certain events, including, but not limited to:
o a distribution to stockholders in excess of the Bank's current and
accumulated post-1951 earnings and profits
o distributions to shareholders in a partial or complete redemption or
liquidation of the Bank
o the Bank ceases to be a "bank" or "thrift" as defined under the Internal
Revenue Code
The Bank does not intend to make distributions to stockholders that would result
in recapture of any portion of its tax bad debt reserve if such recapture would
create an additional tax liability. As a result, an associated deferred tax
liability has not been recorded for the $5.0 million pre-1988 tax bad debt
reserve.
126
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
14. REGULATORY CAPITAL REQUIREMENTS AND OTHER REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
result in certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could present a direct material effect upon the
Bank's and the Company's financial statements.
The OTS maintains regulations that require the Bank to maintain a minimum
regulatory tangible capital ratio (as defined) of 1.50%, a minimum regulatory
core capital ratio (as defined) of 4.00% (unless the Bank has been assigned the
highest composite rating under the Uniform Financial Institutions Rating System,
in which case 3.00%), and a regulatory risk based capital ratio (as defined) of
8.00%. The following table presents a reconciliation as of December 31, 2001 and
2000, between the Bank's capital under accounting principles generally accepted
in the United States of America ("GAAP") and regulatory capital as presently
defined under OTS regulations, in addition to a review of the Bank's compliance
with OTS capital requirements:
(Dollars In Thousands)
Tangible Capital Core (Tier One) Capital Risk Based Capital
------------------------ ------------------------ ------------------------
As Of December 31, 2001 Amount Percent Amount Percent Amount Percent
----------------------- ------ ------- ------ ------- ------ -------
Capital of the Bank presented on a GAAP basis $ 45,597 $ 45,597 $ 45,597
Adjustments to GAAP capital to derive
regulatory capital:
Net unrealized loss on debt
securities classified as
available for sale 71 71 71
Non-qualifying intangible assets (1,514) (1,514) (1,514)
Qualifying general allowance for
loan losses -- -- 4,871
-------- -------- --------
Bank regulatory capital 44,154 8.24% 44,154 8.24% 49,025 12.64%
Less minimum capital requirement 8,040 1.50% 21,440 4.00% 31,031 8.00%
-------- ---- -------- ---- -------- ----
Regulatory capital in excess of minimums $ 36,114 6.74% $ 22,714 4.24% $ 17,994 4.64%
======== ===== ======== ===== ======== =====
Additional information:
Bank regulatory total assets $ 535,998
Bank regulatory risk based assets $ 387,892
(Dollars In Thousands)
Tangible Capital Core (Tier One) Capital Risk Based Capital
------------------------ ------------------------ ------------------------
As Of December 31, 2000 Amount Percent Amount Percent Amount Percent
----------------------- ------ ------- ------ ------- ------ -------
Capital of the Bank presented on a GAAP basis $ 40,274 $ 40,274 $ 40,274
Adjustments to GAAP capital to derive
regulatory capital:
Net unrealized loss on debt
securities classified as
available for sale 624 624 624
Non-qualifying intangible assets (2,195) (2,195) (2,195)
Qualifying general allowance for
loan losses -- -- 4,393
-------- -------- --------
Bank regulatory capital 38,703 8.03% 38,703 8.03% 43,096 12.28%
Less minimum capital requirement 7,227 1.50% 19,272 4.00% 28,083 8.00%
-------- ---- -------- ---- -------- ----
Regulatory capital in excess of minimums $ 31,476 6.53% $ 19,431 4.03% $ 15,013 4.28%
======== ===== ======== ===== ======== =====
Additional information:
Bank regulatory total assets $ 481,795
Bank regulatory risk based assets $ 351,038
127
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
The OTS can take prompt corrective action against thrift institutions such as
the Bank in the event the institution fails to meet certain regulatory capital
thresholds. The prompt corrective action regulations define five specific
capital categories based upon an institution's regulatory capital ratios. These
five capital categories, in declining order, are "well capitalized", "adequately
capitalized", "undercapitalized", "significantly undercapitalized", and
"critically undercapitalized". Institutions categorized as "undercapitalized" or
worse are subject to certain restrictions, including the requirement to file a
capital plan with the OTS, prohibitions on the payment of dividends and
management fees, restrictions on executive compensation, and increased
supervisory monitoring, among other things. Other restrictions may be imposed on
the institution either by the OTS or by the FDIC, including requirements to
raise additional capital, sell assets, or sell the entire institution.
As of December 31, 2001 and 2000, the most recent notification from the OTS
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. To be categorized as "well capitalized", the Bank must
maintain minimum core capital, tier one risk based, and total risk based capital
ratios as presented in the following table. There are no conditions or events
since that notification that management believes have changed the Bank's
category.
To Be Well
Capitalized
Under Prompt
For Capital Adequacy Corrective
Actual Purposes Action Provisions
--------------------- ---------------------- ----------------------
As Of December 31, 2001 Amount Ratio Amount Ratio Amount Ratio
----------------------- ------ ----- ------ ----- ------ -----
Total Capital (to risk weighted assets) $ 49,025 12.64% $ 31,031 8.00% $ 38,789 10.00%
Tier One Capital (to risk weighted assets) 44,154 11.38% N/A N/A 23,274 6.00%
Core Capital (to adjusted tangible assets) 44,154 8.24% 21,440 4.00% 26,800 5.00%
Tangible Capital (to tangible assets) 44,154 8.24% 8,040 1.50% N/A N/A
As Of December 31, 2000 Amount Ratio Amount Ratio Amount Ratio
----------------------- ------ ----- ------ ----- ------ -----
Total Capital (to risk weighted assets) $ 43,096 12.28% $ 28,083 8.00% $ 35,104 10.00%
Tier One Capital (to risk weighted assets) 38,703 11.03% N/A N/A 21,062 6.00%
Core Capital (to adjusted tangible assets) 38,703 8.03% 19,272 4.00% 24,090 5.00%
Tangible Capital (to tangible assets) 38,703 8.03% 7,227 1.50% N/A N/A
The above amounts for December 31, 2001 and 2000 reflect a 100% risk-based
capital category classification for a specific portfolio of residential mortgage
loans, as discussed below.
At December 31, 2001, the Bank was under institution specific requirements from
the OTS that regulatory capital ratios not decline below their levels at
December 31, 1999. At December 31, 2001, the Bank was in compliance with these
institution specific requirements and maintained $6.1 million in regulatory
capital in excess of these institution specific requirements.
Management believes that, under current regulations, the Bank will continue to
meet its minimum capital requirements in the coming year. However, events beyond
the control of the Bank, such as changing interest rates or a downturn in the
economy and / or real estate markets where the Bank maintains most of its loans,
could adversely affect future earnings and, consequently, the ability of the
Bank to meet its future minimum regulatory capital requirements.
OTS rules impose certain limitations regarding stock repurchases and
redemptions, cash-out mergers, and any other distributions charged against an
institution's capital accounts. The payment of dividends by Monterey Bay Bank to
Monterey Bay Bancorp, Inc. is subject to OTS regulations. "Safe-harbor" amounts
of capital distributions can be made after providing notice to the OTS, but
without needing prior approval. For Tier 1 institutions such as the Bank, an
application is not required if the total amount of all capital distributions
(including any proposed distribution) for any particular calendar year does not
exceed net income for the year to date plus the institution's retained net
income for the preceding two years, subject to the Bank's remaining classified
as at least "adequately capitalized" following the proposed distribution.
Distributions beyond this amount are allowed only with the prior approval of the
OTS.
128
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Special Residential Loan Pool
During 1998, the Bank purchased a $40.0 million residential mortgage pool
comprised of loans that presented a borrower credit profile and / or a loan to
value ratio outside of (less favorable than) the Bank's normal underwriting
criteria. To mitigate its credit risk for this portfolio, concurrent with the
purchase, the Bank obtained a scheduled principal / scheduled interest loan
servicing agreement from the seller. Further, this agreement also contains a
guaranty by the seller to absorb any principal losses on the portfolio in
exchange for the seller's retention of a portion of the loans' yield through
loan servicing fees. As a result of obtaining these credit enhancements, the
Bank functionally aggregated the credit risk for this loan pool into a single
borrower credit risk to the seller / servicer of the loans. The Bank was
subsequently informed by the OTS that structuring the purchase in this manner
made the transaction an "extension of credit" by the Bank to the seller /
servicer, which, by virtue of its size, violated the OTS' "Loans To One
Borrower" regulation.
At December 31, 2001, the outstanding principal balance of this mortgage loan
pool was $5.6 million, with an additional $0.5 million in December payoffs
received from the seller / servicer in January, 2002. While the seller /
servicer met all its contractual obligations through December 31, 2001, the
Company has allocated certain loan loss reserves due to concerns regarding the
potential losses by the seller / servicer in honoring the guaranty, the present
delinquency profile of the special residential mortgage pool, and the
differential between certain loan principal balances for foreclosed loans and
loans in the process of foreclosure and the estimated amounts to be recovered
from the sales of such properties.
Because the seller / servicer provides scheduled principal and interest payments
regardless of the actual payment performance of the loans and because the seller
/ servicer absorbs all losses on the disposition of associated foreclosed real
estate, the Company reports all loans within the special residential loan pool
as performing.
In conjunction with this Special Residential Loan Pool, on March 6, 2000, the
Bank received a letter from the OTS mandating that the Bank (i) assign all of
the loans in the pool a 100% risk based capital weighting, and (ii) not permit
its regulatory capital ratios to decline below the levels existing at December
31, 1999. The Bank has continually complied with both conditions requested by
the OTS.
129
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES
The Company is involved in certain legal proceedings arising in the normal
course of business. In the opinion of management, the outcomes of such
proceedings should not have a material adverse effect on the Company's financial
position or results of operations.
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments represent commitments to originate fixed and
variable rate loans, lines of credit, and loans in process, and involve, to
varying degrees, elements of interest rate risk and credit risk in excess of the
amount recognized in the Consolidated Statements of Financial Condition. The
Company uses the same credit policies in making commitments to originate loans
and lines of credit as it does for on-balance sheet instruments.
At December 31, 2001, the Company had outstanding the following commitments to
originate loans and lines of credit:
(Dollars In Thousands) December 31, 2001
Outstanding
Loan Category Commitments
------------- -----------
Residential fixed rate mortgages $ 3,239
Residential variable rate mortgages 7,542
Multifamily five or more units 3,480
Commercial and industrial real estate 1,315
Construction 4,377
Land 100
Home equity lines of credit 238
Business term loans 1,096
Business lines of credit 3,030
--------
Total $ 24,417
========
Commitments to fund loans are agreements to lend to a customer as long as there
is no violation of any condition established in the contract. Commitments
generally have expiration dates or other termination clauses. In addition,
external market forces may impact the probability of commitments being
exercised; therefore, total commitments outstanding do not necessarily represent
future cash requirements.
At December 31, 2001, the Company had optional commitments totaling $2.2 million
to sell fixed rate residential mortgages to various secondary market purchasers
on a servicing released basis. These optional commitments do not expose the
Company to financial loss in the event of non-delivery.
At December 31, 2001, the Company had made available various business, personal,
and residential lines of credit totaling $25.8 million, of which the undisbursed
portion was $13.5 million.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. At December 31, 2001,
the Company maintained no outstanding letters of credit, compared to $136
thousand outstanding at December 31, 2000.
130
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
At December 31, 2001, the Company had recourse liability on $895 thousand of
sold residential loans. No losses stemming from this recourse liability were
recorded during 2001 or 2000. Management includes a consideration of this
recourse liability in establishing the allowance for loan losses.
At December 31, 2001, 2000, and 1999, the Company was obligated under
non-cancelable operating leases for office space. Certain leases contain
escalation clauses providing for increased rentals based primarily on increases
in real estate taxes or on the average consumer price index. Rent expense under
operating leases, included in occupancy and equipment expense, was $136
thousand, $133 thousand, and $121 thousand for the years ended December 31,
2001, 2000, and 1999, respectively.
Certain branch offices are leased under the terms of operating leases expiring
at various dates through the year 2005. At December 31, 2001, future minimum
rental commitments under non-cancelable operating leases were as follows:
(Dollars In Thousands)
2002 $ 138
2003 114
2004 64
2005 32
2006 --
Thereafter --
-----
Total $ 348
=====
At December 31, 2001, the Company sub-leased space within its facilities to a
total of four parties. Three of these parties were on month to month leases at
December 31, 2001. The following table presents the scheduled rent obligation by
the fourth party under a non-cancelable operating lease:
(Dollars In Thousands)
2002 $ 75
2003 77
2004 80
2005 68
2006 --
Thereafter --
-----
Total $ 300
=====
In the normal course of business, the Company and Bank have negotiated
employment agreements with the Chief Executive Officer / President and the Chief
Financial Officer / Treasurer.
In addition, at December 31, 2001, the Company and Bank also maintained change
in control agreements with five officers. These agreements result in severance
payments following certain events associated with a change in control of the
Company or the Bank.
131
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
16. EARNINGS PER SHARE
Basic Earnings Per Share ("EPS") are computed by dividing net income available
to common stockholders by the weighted average number of common shares
outstanding during each period. During the years 1999 through 2001, all of the
Company's net income was available to common stockholders. The weighted average
number of common shares outstanding for the Company is decreased in each
reporting period by:
o shares associated with the Company's ESOP which have not been committed to
be released
o shares associated with the Company's stock grant programs which are not yet
vested to Plan participants
o the weighted average number of Treasury shares maintained by the Company
during each period
The computation of Diluted EPS also considers, via the treasury stock method of
calculation, the impact of shares issuable upon the assumed exercise of
outstanding stock options (both incentive stock options and non-statutory stock
options) and stemming from the grant of time-based stock awards under the
Company's associated Plans for officers and directors. In calculating diluted
earnings per share, no anti-dilutive calculations are permitted and diluted
share counts are applicable only in the event of positive earnings. For the
years 1999 through 2001, there was no difference in the Company's income used in
calculating basic and diluted earnings per share.
The following table reconciles the calculation of the Company's Basic and
Diluted EPS for the periods indicated.
For The Year Ended December 31,
----------------------------------------------------
(In Whole Dollars And Whole Shares) 2001 2000 1999
---- ---- ----
Net income $ 3,751,000 $ 2,523,000 $ 3,301,000
=========== =========== ===========
Average shares issued 4,492,085 4,492,085 4,492,085
Less weighted average:
Uncommitted ESOP shares (125,781) (161,719) (197,657)
Non-vested stock award shares (28,413) (60,612) (88,689)
Treasury shares (1,062,588) (1,158,844) (974,577)
----------- ----------- -----------
Sub-total (1,216,782) (1,381,175) (1,260,923)
----------- ----------- -----------
Weighted average BASIC shares outstanding 3,275,303 3,110,910 3,231,162
Add dilutive effect of:
Stock options 67,121 12,483 83,730
Stock awards 809 159 5,286
----------- ----------- -----------
Sub-total 67,930 12,642 89,016
----------- ----------- -----------
Weighted average DILUTED shares outstanding 3,343,233 3,123,552 3,320,178
=========== =========== ===========
Earnings per share:
BASIC $ 1.15 $ 0.81 $ 1.02
=========== =========== ===========
DILUTED $ 1.12 $ 0.81 $ 0.99
=========== =========== ===========
132
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
17. OTHER COMPREHENSIVE INCOME
The Company's only source of other comprehensive income has been derived from
unrealized gains and losses on the portfolios of investment and mortgage backed
securities classified as available for sale.
Reclassification adjustments for the change in net gains (losses) included in
other comprehensive income from investment and mortgage backed securities
classified as available for sale during the past three years are summarized as
follows:
Year Ended December 31,
----------------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Gross reclassification adjustment $ 190 $ (55) $ 496
Tax (expense) benefit (78) 23 (204)
------ ------ -----
Reclassification adjustment, net of tax $ 112 $ (32) $ 292
====== ======= =====
A reconciliation of the net unrealized gain or loss on available for sale
securities recognized in other comprehensive income is as follows:
Year Ended December 31,
--------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Holding gain (loss) arising during the year, net of tax $ 665 $ 513 $ (1,671)
Reclassification adjustment, net of tax (112) 32 (292)
------ ------ -------
Net unrealized gain (loss) recognized in other comprehensive income $ 553 $ 545 $(1,963)
====== ====== ========
133
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
18. STOCK BENEFIT PLANS
Stock Option Programs - The Company's stock option programs have all been
approved by the Company's stockholders and provide for the issuance of options
to directors and employees only, and not to any unaffiliated individuals or
entities.
On August 24, 1995, the stockholders of the Company approved the 1995 Incentive
Stock Option Plan (the "Stock Option Plan"). Under the Stock Option Plan, the
Company may grant to officers and employees of the Company and its subsidiary,
the Bank, both non-statutory and incentive stock options, as defined under the
Internal Revenue Code, to purchase shares of the Company's common stock.
On August 24, 1995, the stockholders of the Company also approved the 1995 Stock
Option Plan For Outside Directors (the "Directors Option Plan"). Under the
Directors' Option Plan, directors who are not officers or employees of the
Company or Bank may be granted non-statutory stock options to purchase up to
97,929 shares of the Company's common stock.
On May 25, 2000, the stockholders of the Company approved amendments to the
Stock Option Plan. These amendments included:
o an increase in the number of shares reserved for issuance under the Stock
Option Plan to 660,000 shares
o an increase in the strike price of options granted under the Stock Option
Plan from not less than 100% of the fair market value of the common stock
on the date of grant (except that the exercise price for beneficial owners
of more than 10.0% of the outstanding voting stock of the Company must be
equal to 110% of the fair market value of the common stock on the date of
grant) to at least 110% of the fair market value of the common stock on the
date of grant for all grants occurring on or after May 25, 2000
o providing additional flexibility in the vesting schedule for both incentive
stock options and non-statutory stock options
o allowing non-employee directors to be eligible for the grant of
non-statutory stock options under the Stock Option Plan
Options granted under the Stock Option Plan prior to May 25, 2000 entitle the
holder to purchase one share of the common stock at the fair market value of the
common stock on the date of grant. Options granted under the Stock Option Plan
prior to May 25, 2000 begin to vest one year after the date of grant ratably
over five years and expire no later than ten years after the date of grant.
Options granted under the Stock Option Plan after May 24, 2000 entitle the
holder to purchase one share of the common stock at 110% of the fair market
value of the common stock on the date of grant. Options granted under the Stock
Option Plan after May 24, 2000 vest at various times as specified under each
individual option agreement and expire no later than ten years after the date of
grant.
Options granted under the Directors Option Plan entitle the holder to purchase
one share of the common stock at the fair market value of the common stock on
the date of grant. Options begin to vest one year after the date of grant
ratably over five years and expire no later than ten years after the date of
grant.
As of December 31, 2001, there were 1,500 non-statutory stock options issued
under the Stock Option Plan granted to an individual owning more than 10.0% of
the Company's common shares then outstanding. However, restrictions contained in
the Company's Articles Of Incorporation limit the combined voting power of the
Company common stock owned by this individual, who was a Director of the Company
at December 31, 2001, to no more than 10.0% of the total combined voting power
of the Company's common stock.
134
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
During the years ended December 31, 2001, 2000, and 1999, the Company did not
amend the terms or conditions of any existing stock option grant. The Company
has never repriced a stock option following its issuance.
All options under the Stock Option Plan become 100% exercisable in the event
that the employee terminates his employment due to death, disability, or, to the
extent not prohibited by the OTS, in the event of a change in control of the
Company or the Bank.
All options under the Directors Option Plan become 100% exercisable in the event
that the director terminates membership on the board of directors due to death,
disability, or, to the extent not prohibited by the OTS, in the event of a
change in control of the Company or the Bank.
The Company applies Accounting Principles Board ("APB") Opinion No. 25 and
related interpretations in accounting for stock options. Under APB No. 25,
compensation cost for stock options is measured as the excess, if any, of the
fair market value of the Company's stock at the date of grant over the amount
the employee or director must pay to acquire the stock. Because the Company's
stock option Plans provide for the issuance of options at a price of no less
than the fair market value at the date of grant, no compensation cost is
required to be recognized for the stock option Plans.
Had compensation costs for the stock option Plans been determined based upon the
fair value at the date of grant consistent with SFAS No. 123, Accounting For
Stock Based Compensation, the Company's net income and earnings per share would
have been reduced to the pro forma amounts indicated below. The pro forma
amounts presented below were calculated utilizing the Black-Scholes option
pricing model, with forfeitures recognized as they occur, incorporating the
assumptions detailed on the following page.
Year Ended December 31,
----------------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands, Except Share Data)
Net income:
As reported $ 3,751 $ 2,523 $ 3,301
Pro forma $ 3,522 $ 2,223 $ 3,022
Basic earnings per share:
As reported $ 1.15 $ 0.81 $ 1.02
Pro forma $ 1.08 $ 0.71 $ 0.94
Diluted earnings per share:
As reported $ 1.12 $ 0.81 $ 0.99
Pro forma $ 1.05 $ 0.71 $ 0.91
Shares utilized in Basic EPS calculations 3,275,303 3,110,910 3,231,162
Shares utilized in Diluted EPS calculations 3,343,233 3,123,552 3,320,178
135
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
The status of the aggregate stock options under the two Plans as of December 31,
2001, 2000, and 1999, and changes during the years then ended, are presented
below. The abbreviation "FMV" represents "fair market value" and the
abbreviation "N/A" represents "not applicable".
December 31,
--------------------------------------------------------------------------------------
2001 2000 1999
------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Options outstanding at the
beginning of the year 550,236 $10.19 362,597 $10.30 418,311 $10.38
Granted 82,750 $15.19 197,865 $10.00 5,000 $14.75
Forfeited 92,271 $12.03 10,226 $10.49 26,932 $13.59
Exercised 115,611 $9.11 -- $ -- 33,782 $9.40
------- ------- -------
Options outstanding at year end 425,104 $11.02 550,236 $10.19 362,597 $10.30
======= ======= =======
Options outstanding at year end:
Granted at 100% FMV 270,354 $9.71 464,236 $10.04 362,597 $10.30
Granted at 110% FMV 154,750 $13.32 86,000 $10.98 -- --
------- ------- -------
Total 425,104 $11.02 550,236 $10.19 362,597 $10.30
======= ======= =======
Options exercisable at year end:
Granted at 100% FMV 184,932 $9.65 308,262 $9.65 239,853 $9.51
Granted at 110% FMV 70,292 $14.10 17,240 $11.76 -- --
------- ------- -------
Total 255,224 $10.88 325,502 $9.76 239,853 $9.51
======= ======= =======
Options available for future grants 137,064 127,543 69,289
Weighted average remaining
contractual life of options
outstanding at year end 6.2 years 6.6 years 6.2 years
Weighted average fair value for
options granted during the year
at 100% of FMV: N/A $4.68 $7.76
Weighted average fair value for
options granted during the year
at 110% of FMV: $5.08 $4.41 N/A
Weighted average assumptions
utilized in the Black-Scholes
option-pricing model
for all options granted each year
Dividend Yield 0.00% 0.00% 1.00%
Expected stock price volatility 35.00% 35.00% 45.00%
Average risk-free interest rate 4.44% 6.11% 5.73%
Expected option lives 6 years 8 years 8 years
136
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
The following table summarizes information about the stock options outstanding
at December 31, 2001:
Options Granted At 100% Of Fair Market Value:
Weighted
Average
Remaining
Exercise Number Contractual Life Number
Price Outstanding In Years Exercisable
----- ----------- -------- -----------
$ 8.19 45,000 8.3 9,000
$ 9.10 140,616 3.6 140,616
$ 9.50 9,658 4.5 9,658
$ 9.69 9,941 8.2 1,987
$ 10.13 40,000 8.1 8,000
$ 14.80 18,750 6.5 11,250
$ 16.60 6,389 6.2 4,421
$ 8.19 - $16.60 270,354 5.5 184,932
======= =======
Options Granted At 110% Of Fair Market Value:
Weighted
Average
Remaining
Exercise Number Contractual Life Number
Price Outstanding In Years Exercisable
----- ----------- -------- -----------
$ 9.90 10,000 8.4 2,000
$11.21 42,500 8.9 8,500
$11.76 20,000 4.7 17,792
$12.62 8,000 9.5 --
$12.65 10,000 9.1 --
$14.74 3,000 9.8 --
$15.88 51,250 5.8 42,000
$16.26 3,000 9.7 --
$16.64 5,000 10.0 --
$16.82 2,000 10.0 --
$9.90 - $16.82 154,750 7.4 70,292
======= ======
TOTAL 425,104 6.2 255,224
======= =======
137
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Stock Award Programs - The Company maintains a Performance Equity Program
("PEP") for officers and employees. In addition, prior to the end of 2000, the
Company maintained a Recognition and Retention Plan for Outside Directors
("RRP"). The Company accelerated the vesting of the remaining RRP shares,
distributed the remaining shares, and terminated the RRP during 2000. These two
stock award Plans (PEP and RRP) were designed to provide directors, officers,
and employees with a proprietary interest in the Company in a manner designed to
encourage such persons to remain with the Company and to improve the financial
performance of the Company. The two stock award plans were approved by the
Company's stockholders.
The Bank contributed $1.7 million during the fourth quarter of 1995 and the
first quarter of 1996 to purchase 179,687 shares of Company common stock in the
open market at a weighted average cost of $9.62 per share. This contribution was
initially recorded as a reduction in stockholders' equity and then is ratably
charged to compensation expense over the vesting period of the actual stock
awards. Of the 179,687 shares acquired, 38,010 were allocated to the RRP, with
the remaining 141,677 allocated to the PEP.
The PEP provides for two types of stock awards: time-based grants and
performance-based grants. Time-based grants vest pro-rata on each anniversary of
the grant date and become fully vested over the applicable time period as
determined by the board of directors, typically five years. Vesting of
performance-based grants is dependent upon achievement of criteria established
by the board of directors for each stock award. Under the RRP, outside directors
of the Company received exclusively time-based grants.
All stock awards granted will be immediately vested in the event the recipient
terminates his employment (or in the case of a director, his service, including
service as a Director Emeritus) due to death, disability, or a change in control
of Monterey Bay Bank or Monterey Bay Bancorp, Inc. In the event the award
recipient terminates his employment or service due to any reason other than
death, disability, or a change in control, all unvested stock awards become null
and void. In addition, to the extent that criteria for performance-based stock
awards are not achieved, associated awards are forfeited and become available
for re-issuance.
Periodic operating expense for time-based stock awards is recognized based upon
fair market value at date of grant. Periodic operating expense for
performance-based stock awards is recognized based upon fair market value at the
earlier of the reporting date or the performance measurement date.
During 2001 and 2000, the Company utilized previously unallocated shares under
the PEP to compensate certain employees for their favorable performance. These
shares were granted in lieu of cash incentive compensation and vested
immediately.
During the years ended December 31, 2001, 2000, and 1999, the Company made no
changes to the terms or conditions of existing stock award grants.
138
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
A summary of the PEP as of December 31, 2001, 2000, and 1999, and changes and
related expense during the years ended on those dates, is presented below:
2001 2000 1999
---- ---- ----
Stock awards outstanding at the beginning of the year 35,079 30,864 56,772
Stock award activity during the year:
Time based shares granted -- 11,576 --
Performance based shares granted -- 18,168 --
Performance based shares granted in lieu of cash compensation 9,438 3,160 --
Performance based shares immediately vested upon grant (9,438) (3,160) --
Time based shares forfeited (6,329) -- (1,450)
Performance based shares forfeited (3,109) (1,129) (4,781)
Time based shares vested (4,298) (11,860) (12,668)
Performance based shares vested (3,374) (12,540) (7,009)
----- ------ ------
Stock awards outstanding at the end of the year 17,969 35,079 30,864
===== ====== ======
Available for future awards at the end of the year -- -- 31,775
===== ====== ======
PEP compensation expense (Dollars In Thousands) $ 200 $ 230 $ 227
===== ====== ======
A summary of the status of the RRP as of December 31, 2001, 2000, and 1999, and
changes and related expense during the years ended on those dates, is presented
below:
2001 2000 1999
---- ---- ----
Stock awards outstanding at the beginning of the year -- 9,541 16,588
Stock award activity during the year:
Time based shares granted -- -- --
Time based shares canceled -- -- --
Time based shares vested -- (9,541) (7,047)
----- ----- -----
Stock awards outstanding at the end of the year -- -- 9,541
===== ===== =====
Available for future awards at the end of the year -- -- --
===== ===== =====
RRP compensation expense (Dollars In Thousands) $ -- $ 66 $ 70
===== ===== =====
139
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
Employee Stock Ownership Plan and Trust - The Company established for eligible
employees an Employee Stock Ownership Plan and Trust ("ESOP"), which became
effective upon the conversion of the Bank from a mutual to a stock association.
Eligible full-time employees employed with the Bank who have been credited with
at least 1,000 hours during a twelve month period, have attained age twenty-one,
and were employed on the last business day of the calendar year are eligible to
participate.
The ESOP subscribed for 8.0% (or 359,375) of the shares of Company common stock
issued in the Conversion at an adjusted price of $6.40 per share. On February
14, 1995, the ESOP borrowed $2.3 million from Monterey Bay Bancorp, Inc. in
order to fund the purchase of the common stock. This loan is being repaid
pro-rata over an approximately ten year period concluding on December 31, 2004,
with the funds for repayment primarily coming from the Bank's contributions to
the ESOP over a similar time period. The loan is collateralized by the shares of
common stock held by the ESOP.
As an internally leveraged ESOP, no interest income or interest expense is
recognized on the loan in the consolidated financial statements of the Company.
Annual principal payments of $230,000 are scheduled for the conclusion of each
calendar year in conjunction with a release of shares for allocation to
individual employee accounts. Shares are allocated on the basis of eligible
compensation, as defined in the ESOP plan document, in the year of allocation.
Benefits generally become 100% vested after seven years of credited service.
Employees with at least three, but fewer than seven, years of credited service
receive a partial vesting according to a sliding schedule. However, in the event
of retirement, disability, or death, any unvested portion of benefits shall vest
immediately. Any share forfeitures are allocated among participating employees
in the same proportion as annual share allocations. Benefits are payable upon
separation from service based on vesting status and share allocations made.
As of December 31, 2001, 251,562 shares had been cumulatively allocated to
participants and committed to be released. As of December 31, 2001, the fair
market value of the 107,813 unearned shares was $1.7 million based upon a
closing market price per share of $15.50. The outstanding ESOP loan balance,
which is not a component of the Company's consolidated financial statements, was
$690 thousand at December 31, 2001.
Periodic operating expense associated with the ESOP is recognized based upon:
o the number of Company common shares pro-rata allocated
o the fair market value of the Company's common stock at the dates shares are
committed to be released
o any dividends received on unallocated shares as a reduction to periodic
operating expense
The benefits expenses, not including administrative costs, related to the ESOP
for the years ended December 31, 2001, 2000, and 1999 were $437 thousand, $317
thousand, and $454 thousand, respectively. At December 31, 2001 and 2000, the
unearned compensation related to the ESOP was $690 thousand and $920 thousand,
respectively. These amounts are shown as a reduction of stockholders' equity in
the Consolidated Statements Of Financial Condition.
19. 401(K) PLAN
The Company maintains a tax deferred employee savings plan under Section 401(k)
of the Internal Revenue Code. All employees are eligible to participate who are
21 years of age, have been employed by the Company for at least 30 days, and are
scheduled to complete 1,000 hours of service or more per calendar year. While
the 401(k) Plan allows the Company to provide periodic or matching contributions
to employee accounts within the 401(k) Plan, no such contributions were made in
the years 1999 through 2001.
The trust that administers the 401(k) Plan had assets of approximately $1.7
million and $1.8 million as of December 31, 2001 and 2000, respectively. None of
these assets have been maintained at the Company or its subsidiary. At December
31, 2001, 401(k) Plan participants were able to invest in one or more of a total
of twelve different investment alternatives at their discretion. The 401(k) Plan
also allows participants to borrow funds, subject to certain limitations.
140
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
20. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
The Parent Company (Monterey Bay Bancorp, Inc.) and its subsidiary, the Bank,
file consolidated federal income tax returns in which the taxable income or loss
of the Parent Company is combined with that of the Bank. The Parent Company's
share of income tax expense is based on the amount which would be payable if
separate returns were filed. Accordingly, the Parent Company's equity in the net
income of its subsidiaries (distributed and undistributed) is excluded from the
computation of the provision for income taxes for stand alone financial
statement purposes.
The condensed financial statements of Monterey Bay Bancorp, Inc. (parent company
only) are as follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
December 31,
-----------------------
2001 2000
---- ----
(Dollars In Thousands)
ASSETS:
Cash and due from depository institutions $ 4,619 $ 558
Overnight deposits -- 3,210
------- -------
Total cash & cash equivalents 4,619 3,768
Other assets 1 51
Investment in subsidiary 45,597 40,274
------- -------
TOTAL ASSETS $50,217 $44,093
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Other liabilities 55 256
------- -------
Total Liabilities 55 256
Stockholders' equity 50,162 43,837
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $50,217 $44,093
======= =======
141
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
Year Ended December 31,
---------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
Interest income:
Interest on mortgage backed securities and investment securities $ -- $ 19 $ 334
Interest on loan receivable -- 560 414
Other interest income 130 46 46
------ ------ ------
Total interest income 130 625 794
Interest expense:
Borrowings 9 31 180
------ ------ ------
Total interest expense 9 31 180
Net interest income before (benefit) provision for loan losses 121 594 614
(Benefit) provision for loan losses -- (200) 50
------ ------ ------
Net interest income after (benefit) provision for loan losses 121 794 564
Loss on sale of mortgage backed securities available for sale -- 79 7
Non-interest expense 612 817 552
------ ------ ------
Income before (benefit) provision for income taxes (491) (102) 5
(Benefit) provision for income taxes (202) (42) 3
------ ------ ------
(Loss) income before undistributed net income of subsidiary (289) (60) 2
Undistributed net income of subsidiary 4,040 2,583 3,299
------ ------ ------
Net income $3,751 $2,523 $3,301
====== ====== ======
Other comprehensive income (loss) 553 545 (1,963)
------ ------ ------
Total comprehensive income $4,304 $3,068 $1,338
====== ====== ======
142
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31,
---------------------------------------
2001 2000 1999
---- ---- ----
(Dollars In Thousands)
OPERATING ACTIVITIES:
Net income $ 3,751 $ 2,523 $ 3,301
Adjustments to reconcile net income to net cash provided by operating
activities:
Undisbursed net income of subsidiary (4,040) (2,583) (3,299)
Amortization of premiums on securities -- -- 64
(Benefit) provision for loan losses -- (200) 50
Loss on sale of securities -- 79 7
Cash receipts associated with ESOP 230 460 257
Decrease (increase) in other assets 50 473 (466)
Other, net 107 138 310
------- ------- -----
Net cash provided by operating activities 98 890 224
------- ------- -----
INVESTING ACTIVITIES:
Proceeds from repayments of loans -- 5,000 --
Investment in subsidiary (300) (2,100) --
Principal repayments on mortgage backed securities available for sale -- 49 2,021
Proceeds from sales of mortgage backed securities available for sale -- 3,702 724
------- ------- -----
Net cash (used in) provided by investing activities (300) 6,651 2,745
------- ------- -----
FINANCING ACTIVITIES:
(Repayments) proceeds of borrowings, net -- (2,410) (2,080)
Cash dividends paid to stockholders -- (274) (530)
Sales of treasury stock for exercise of stock options 1,053 -- 318
Purchases of treasury stock -- (1,251) (1,668)
------- ------- -----
Net cash provided by (used in) financing activities 1,053 (3,935) (3,960)
------- ------- -----
NET INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS 851 3,606 (991)
CASH & CASH EQUIVALENTS AT BEGINNING OF YEAR 3,768 162 1,153
------- ------- -----
CASH & CASH EQUIVALENTS AT END OF YEAR $ 4,619 $ 3,768 $ 162
======= ======= =====
143
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
21. ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company, using
available market information and appropriate valuation methodologies. However,
considerable judgement is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different assumptions and / or estimation
methodologies may have a material effect on the estimated fair value amounts.
The following methods and assumptions were used by the Company in computing the
estimated fair values:
Cash And Cash Equivalents - Current carrying amounts approximate estimated fair
value.
Investment Securities and Mortgage Backed Securities - Fair values of these
securities are based on year-end market prices or dealer quotes. If quoted
market prices are not available, estimated fair values were based upon quoted
market prices of comparable instruments.
Loans Receivable Held For Investment - For fair value estimation purposes, these
loans have been categorized by type of loan (e.g., one to four unit residential)
and then further segmented between adjustable or fixed rates. Where possible,
the fair value of these groups of loans has been based on secondary market
prices for loans with similar characteristics. The fair value of the remaining
loans has been estimated by discounting the future cash flows using current
interest rates being offered for loans with similar remaining terms to borrowers
of similar credit quality. Prepayment estimates were based on historical
experience and published data for similar loans.
Capital Stock Of The Federal Home Loan Bank - Fair value is based upon its
redemption value, which equates to current carrying amounts.
Transaction Deposit Accounts - The estimated fair value of checking, savings,
and money market deposit accounts is the amount payable on demand at the
reporting dates.
Certificates Of Deposit - Fair value has been estimated by discounting the
contractual cash flows using current market rates offered in the Company's
market area for similar time deposits with comparable remaining terms.
FHLB Advances - Fair value was estimated by discounting the contractual cash
flows using current market rates offered for advances with comparable conditions
and remaining terms.
Other Borrowings - Current carrying amounts approximate estimated fair value.
Commitments To Extend Credit - The estimated fair values of commitments to fund
loans are estimated using the fees currently charged to enter into similar
agreements, considering the remaining terms of the agreements and the present
creditworthiness of the counterparties. For fixed rate loan commitments, the
estimated fair values also incorporate the difference between current levels of
interest rates for similar commitments and the committed rates.
Standby Letters Of Credit - The estimated fair values of standby letters of
credit were determined by using the fees currently charged taking into
consideration the remaining terms of the agreements and the creditworthiness of
the counterparties.
144
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
The carrying amounts and estimated fair values of the Company's financial
instruments are as follows:
December 31, 2001 December 31, 2000
--------------------------- ---------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
(Dollars In Thousands)
ASSETS:
Cash and cash equivalents $ 13,079 $ 13,079 $ 25,159 $ 25,159
Investment securities available for sale 7,300 7,300 7,360 7,360
Mortgage backed securities available for sale 30,644 30,644 42,950 42,950
Loans held for sale 713 717 -- --
Loans receivable held for investment, net 465,887 477,117 391,820 398,257
FHLB stock 2,998 2,998 2,884 2,884
LIABILITIES:
Transaction deposit accounts 188,574 188,574 163,078 163,078
Certificates of deposit 243,765 245,574 244,710 244,400
Advances from the Federal Home Loan Bank 53,582 55,165 32,582 32,501
Other borrowings 218 218 -- --
OFF-BALANCE SHEET
Commitments to fund loans -- -- -- --
Standby letters of credit -- -- -- --
The fair value estimates presented herein are based upon pertinent information
available to management as of December 31, 2001 and 2000. The fair value amounts
have not been comprehensively reevaluated since the reporting date. Therefore,
current estimates of fair value and the amounts realizable in current secondary
market transactions may differ significantly from the amounts presented herein.
145
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Continued)
--------------------------------------------------------------------------------
22. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of quarterly results:
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars In Thousands, Except Share Data)
Year Ended December 31, 2001:
Interest and dividend income $ 9,996 $ 9,710 $ 9,758 $ 9,267
Interest expense 5,244 4,937 4,743 4,066
Provision for loan losses 500 300 275 325
Non-interest income 643 695 690 538
Non-interest expense 3,843 3,520 3,586 3,420
Provision for income taxes 450 699 787 851
Net income 602 949 1,057 1,143
Shares applicable to Basic earnings per share 3,227,241 3,262,003 3,293,853 3,318,113
Basic earnings per share $ 0.19 $ 0.29 $ 0.32 $0.34
Shares applicable to Diluted earnings per share 3,274,559 3,300,595 3,385,556 3,412,222
Diluted earnings per share $ 0.18 $ 0.29 $0.31 $0.33
Cash dividends paid per share $ -- $ -- $ -- $ --
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars In Thousands, Except Share Data)
Year Ended December 31, 2000:
Interest and dividend income $ 9,050 $ 9,411 $ 9,514 $ 9,782
Interest expense 4,557 4,859 5,115 5,246
Provision for loan losses 250 775 650 500
Non-interest income 501 583 630 626
Non-interest expense 3,337 3,369 3,552 3,418
Provision for income taxes 608 437 366 535
Net income 799 554 461 709
Shares applicable to Basic earnings per share 3,138,424 3,075,153 3,100,164 3,129,897
Basic earnings per share $ 0.25 $ 0.18 $ 0.15 $0.23
Shares applicable to Diluted earnings per share 3,150,825 3,076,403 3,103,799 3,163,182
Diluted earnings per share $ 0.25 $ 0.18 $0.15 $0.22
Cash dividends paid per share $ 0.08 $ -- $ -- $ --
146
Item 9. Changes In And Disagreements With Accountants On Accounting And
Financial Disclosure
None.
PART III
Item 10. Directors And Executive Officers Of The Registrant
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 23, 2002,
which will be filed no later than 120 days following Registrant's fiscal year
end. Information concerning Executive Officers who are not Directors is also
contained in Part I of this report pursuant to paragraph (b) of Item 401 of
Regulation S-K in reliance on Instruction G.
Item 11. Executive Compensation
The information relating to Director and Executive Officer compensation
is incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 23, 2002, excluding the
Compensation Committee Report on Executive Compensation and the Stock
Performance Graph, which will be filed no later than 120 days following the
Registrant's fiscal year end.
Item 12. Security Ownership Of Certain Beneficial Owners And Management.
The information relating to security ownership of certain beneficial
owners and management is incorporated herein by reference to the Registrant's
Proxy Statement for the Annual Meeting of Stockholders to be held on May 23,
2002, which will be filed no later than 120 days following the Registrant's
fiscal year end.
Item 13. Certain Relationships And Related Transactions.
The information relating to certain relationships and related
transactions is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 23, 2002,
which will be filed no later than 120 days following the Registrant's fiscal
year end.
147
PART IV
Item 14. Exhibits, Financial Statement Schedules, And Reports On Form 8-K.
(a)(1) Financial Statements
The following consolidated financial statements of the Registrant are
filed as a part of this document under Item 8, "Financial Statements and
Supplementary Data."
Consolidated Statements Of Financial Condition At December 31, 2001 And
2000.
Consolidated Statements of Income For Each Of The Years In The Three
Year Period Ended December 31, 2001.
Consolidated Statements Of Changes In Stockholders' Equity For Each Of
The Years In The Three Year Period Ended December 31, 2001.
Consolidated Statements Of Cash Flows For Each Of The Years In The
Three Year Period Ended December 31, 2001.
Notes To Consolidated Financial Statements.
Independent Auditors' Report.
(a)(2) Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated Financial
Statements or Notes thereto under Item 8, "Financial Statements and
Supplementary Data."
(a)(3) Management Contracts (see Item 14 (c), below)
(b) Reports On Form 8-K Filed During The Last Quarter Of The
Registrant's Fiscal Year Ended December 31, 2001
(1) Form 8-K dated October 22, 2001 which includes the
announcement of financial and operating results for
the three and nine month periods ended September 30,
2001 and the continuing arbitration of claims by a
former executive.
(2) Form 8-K dated November 7, 2001 which includes the
announcement of the conclusion and results of binding
arbitration conducted to address claims by the former
President and Chief Operating Officer regarding
payments due under his employment contracts.
(3) Form 8-K dated November 20, 2001 which includes the
announcement of the resignation of Mr. Nicholas C.
Biase from the Board of Directors of the Company and
its subsidiary, Monterey Bay Bank.
(4) Form 8-K dated December 21, 2001 which includes the
announcement of the Company's adoption of a stock
repurchase program, with a total of 114,035 shares
authorized for repurchase.
(5) Form 8-K dated January 29, 2002 which includes the
announcement of financial and operating results for
the quarter and year ended December 31, 2001, the
date for the 2002 annual meeting of stockholders, and
the record date for voting at the 2002 annual meeting
of stockholders.
148
(6) Form 8-K dated March 15, 2002 that includes the
announcement of the establishment of a loan
production office in Southern California, the
elimination of institution specific regulatory
capital requirements, the repurchase of additional
shares of the Company's common stock, and the
resignation of Susan F. Grill as Director of Retail
Banking for Monterey Bay Bank.
(c) Exhibits Required by Securities and Exchange Commission
Regulation S-K
Exhibit Number
--------------
3.1 Certificate Of Incorporation Of Monterey Bay Bancorp, Inc. (1)
3.3 Bylaws Of Monterey Bay Bancorp, Inc. As Amended And Restated Effective
March 22, 2001 (2)
4.0 Stock Certificate Of Monterey Bay Bancorp, Inc. (1)
10.8 Monterey Bay Bank Employee Severance Compensation Plan (1)
10.9 Monterey Bay Bank 401(k) Plan (1)
10.10 Monterey Bay Bank 1995 Retirement Plan For Executive Officers And
Directors. (1)
10.11 Monterey Bay Bank Performance Equity Program (3)
10.12 Monterey Bay Bank Recognition And Retention Plan For Outside Directors
(3)
10.13 Monterey Bay Bancorp, Inc. 1995 Incentive Stock Option Plan As Amended
And Restated Effective May 25, 2000 (4)
10.14 Monterey Bay Bancorp, Inc. 1995 Stock Option Plan For Outside
Directors (3)
10.17 Form Of Amended Change In Control Agreement Between Monterey Bay
Bancorp, Inc., Monterey Bay Bank, And Certain Officers Effective March
22, 2001 (2)
10.18 Employment Agreement With C. Edward Holden (5)
10.19 Employment Agreement With Mark R. Andino (5)
10.20 Change In Control Agreement Between Monterey Bay Bancorp, Inc.,
Monterey Bay Bank, And Susan M. Carlson Effective March 22, 2002
21 Subsidiary information is incorporated herein by reference to "Part I
- Subsidiaries"
23 Consent Of Deloitte & Touche LLP, Independent Auditors
--------------------------------------------------------------------------------
(1) Incorporated herein by reference from the Exhibits to the Registration
Statement on Form S-1, as amended, filed on September 21, 1994,
Registration No. 33-84272.
(2) Incorporated herein by reference from the Exhibits to the Annual
Report on Form 10-K for December 31, 2000 filed on March 22, 2001
(3) Incorporated herein by reference from the Proxy Statement for the
Annual Meeting of Stockholders' filed on July 26, 1995.
(4) Incorporated herein by reference from the Proxy Statement for the
Annual Meeting of Stockholders' filed on April 14, 2000.
(5) Incorporated herein by reference from the Exhibits to the Quarterly
Report on Form 10-Q for March 31, 2001 filed on May 14, 2001.
149
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MONTEREY BAY BANCORP, INC.
Date: March 28, 2002 By: /s/ C. Edward Holden
--------------------- -----------------------------
C. Edward Holden
Vice Chairman, Director,
Chief Executive Officer, President
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ McKenzie Moss Chairman of the Board of Directors March 28, 2002
----------------------------------- --------------
McKenzie Moss
/s/ C. Edward Holden Vice Chairman, Director, Chief Executive Officer, March 28, 2002
----------------------------------- President --------------
C. Edward Holden
/s/ Mark R. Andino Chief Financial Officer, Treasurer March 28, 2002
----------------------------------- (Principal Financial and Accounting Officer) --------------
Mark R. Andino
/s/ Josiah T. Austin Director March 28, 2002
----------------------------------- --------------
Josiah T. Austin
/s/ Edward K. Banks Director March 28, 2002
----------------------------------- --------------
Edward K. Banks
/s/ Diane S. Bordoni Director March 28, 2002
----------------------------------- --------------
Diane S. Bordoni
/s/ Larry A. Daniels Director March 28, 2002
----------------------------------- --------------
Larry A. Daniels
/s/ Steven Franich Director March 28, 2002
----------------------------------- --------------
Steven Franich
/s/ Stephen G. Hoffmann Director March 28, 2002
----------------------------------- --------------
Stephen G. Hoffmann
/s/ Gary L. Manfre Director March 28, 2002
----------------------------------- --------------
Gary L. Manfre
150