SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number: 0-26081
SCRIPPS FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
California 33-0855985
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7817 Ivanhoe Avenue, La Jolla, CA 92037
- ----------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 858-456-2265
Not applicable
---------------
(Former name, former address and former fiscal year, if changed since
last report)
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) Yes [X] No [ ], and (2) has been subject to such
filing requirements for the past 90 days. Yes [ ] No [X].
As of 09/30/99 there were 6,895,700 shares of Common Stock outstanding.
1
PART 1 FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SCRIPPS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31,
1999 1998
------------- ------------
ASSETS
Cash and amounts due from banks $ 28,015,000 $ 24,330,000
Federal funds sold 19,480,000 42,790,000
------------ ------------
Cash and cash equivalents 47,495,000 67,120,000
Interest bearing due from banks 1,185,000 4,352,000
Investment securities 143,749,000 162,317,000
Loans and leases, net 381,596,000 336,008,000
Premises and equipment, net 5,776,000 4,985,000
Other assets and accrued interest receivable 10,403,000 7,848,000
------------ ------------
$ 590,204,000 $ 582,630,000
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Demand, non-interest bearing $ 167,990,000 $ 152,697,000
Money market, NOW and savings accounts 269,547,000 290,113,000
Time certificates:
Under $100,000 35,376,000 31,861,000
$100,000 or greater 67,100,000 56,303,000
------------ ------------
Total deposits 540,013,000 530,974,000
Guarantee of loan to ESOP Trust 50,000 76,000
Other liabilities and accrued interest expense 3,622,000 7,825,000
------------ ------------
Total liabilities 543,685,000 538,875,000
Stockholders' equity:
Common stock, no par value; authorized
20,000,000 shares; issued and outstanding
6,896,000 shares at September 30, 1999 and
6,797,000 shares at December 31, 1998 34,641,000 34,092,000
Retained earnings 12,992,000 8,896,000
Guarantee of loan to ESOP Trust (50,000) (76,000)
Accumulated other comprehensive income, net (1,064,000) 843,000
------------ ------------
Total stockholders' equity 46,519,000 43,755,000
------------ ------------
$ 590,204,000 $ 582,630,000
------------ ------------
------------ ------------
The accompanying notes are an integral part of these
consolidated condensed financial statements
2
SCRIPPS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
-------------- -------------- -------------- ---------------
INTEREST INCOME:
Loans and leases, including fees earned $ 9,409,000 $ 8,321,000 $ 26,520,000 $ 23,745,000
Investment securities:
Taxable 1,756,000 1,618,000 5,564,000 4,534,000
Exempt from federal income tax 244,000 229,000 703,000 689,000
Dividends 22,000 16,000 59,000 48,000
Federal funds sold 306,000 619,000 896,000 1,297,000
Balances due from Banks 20,000 94,000 112,000 268,000
----------- ----------- ------------ ------------
Total interest income 11,757,000 10,897,000 33,854,000 30,581,000
Interest expense on deposits (3,296,000) (3,531,000) (9,620,000) (9,767,000)
----------- ----------- ------------ ------------
Net interest income 8,461,000 7,366,000 24,234,000 20,814,000
Provision for possible loan losses (750,000) (520,000) (2,910,000) (1,445,000)
----------- ----------- ------------ ------------
Net interest income after provision for
possible loan losses 7,711,000 6,846,000 21,324,000 19,369,000
Non-interest income 1,417,000 1,494,000 4,219,000 4,775,000
Non-interest expense (6,552,000) (5,861,000) (18,051,000) (16,921,000)
----------- ----------- ------------ ------------
Income before provision for income taxes 2,576,000 2,479,000 7,492,000 7,223,000
Provision for income taxes (1,030,000) (1,006,000) (2,982,000) (2,888,000)
----------- ----------- ------------ ------------
Net income $ 1,546,000 $ 1,473,000 $ 4,510,000 $ 4,335,000
----------- ----------- ------------ ------------
----------- ----------- ------------ ------------
Basic net income per share $ 0.22 $ 0.22 $ 0.66 $ 0.64
----------- ----------- ------------ ------------
----------- ----------- ------------ ------------
Diluted net income per share $ 0.22 $ 0.21 $ 0.65 $ 0.62
----------- ----------- ------------ ------------
----------- ----------- ------------ ------------
The accompanying notes are an integral part of these
consolidated condensed financial statements
3
SCRIPPS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
Three months ended
September 30,
1999 1998
-----------------------------------------------------
NET INCOME $ 1,546,000 $ 1,473,000
Unrealized holding loss
on available-for-sale securities (140,000) 572,000
----------- -----------
Total comprehensive income $ 1,406,000 $ 2,045,000
----------- -----------
----------- -----------
Nine months ended
September 30,
1999 1998
-----------------------------------------------------
Net Income $ 4,510,000 $ 4,335,000
Unrealized holding loss
on available-for-sale securities (1,907,000) 468,000
----------- -----------
Total comprehensive income $ 2,603,000 $ 4,803,000
----------- -----------
----------- -----------
The accompanying notes are an integral part of these
consolidated condensed financial statements
4
SCRIPPS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW
Nine months ended
September 30,
1999 1998
---- ----
Cash flows from operating activities:
Net income $ 4,510,000 $ 4,335,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,274,000 1,124,000
Provision for possible loan losses 2,160,000 1,445,000
Amortization of loan discounts and fees and
investment securities premiums and discounts (461,000) (275,000)
Gain on sale of real estate owned - (10,000)
Increase in other assets and accrued interest receivable (1,009,000) (552,000)
Increase (decrease) in other liabilities and accrued
interest expense (4,202,000) 253,000
------------ ------------
Net cash provided (used) by operating activities 2,272,000 6,320,000
------------ ------------
Cash flows from investing activities:
Proceeds from maturities and principal payments of investment securities 104,735,000 48,557,000
Proceeds from sale of furniture, fixtures & equip - 155,000
Proceeds from sale (transfer to) real estate owned (252,000) 438,000
Maturities (purchases) of investment certificates of deposit 3,167,000 98,000
Purchases of investment securities (89,695,000) (74,518,000)
Net funding of loans (46,960,000) (40,545,000)
Purchases of premises and equipment, net (2,065,000) (1,377,000)
------------ ------------
Net cash used in investing activities (31,070,000) (67,192,000)
------------ ------------
Cash flows from financing activities:
Net increase (decrease) in demand deposits,
NOW accounts and savings accounts (5,273,000) 75,534,000
Net increase in certificates of deposit 14,312,000 5,072,000
Proceeds from exercise of stock options 548,000 277,000
Dividends paid (414,000) (369,000)
------------ ------------
Net cash provided by financing activities 9,173,000 80,514,000
------------ ------------
Net increase (decrease) in cash and cash equivalents (19,625,000) 19,642,000
------------ ------------
------------ ------------
Cash and cash equivalents at beginning of year 67,120,000 44,499,000
------------ ------------
------------ ------------
Cash and cash equivalents at end of quarter $ 47,495,000 $ 64,141,000
------------ ------------
------------ ------------
The accompanying notes are an integral part of these
consolidated condensed financial statements
5
PART 1 FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
SCRIPPS FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying financial information has been prepared in accordance with
the Securities and Exchange Commission rules and regulations for quarterly
reporting and therefore does not necessarily include all information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles. This information
should be read in conjunction with Scripps Financial Corporation's
registration statement on Form 10 as amended, including notes thereto, filed
July 13, 1999.
Operating results for interim periods are not necessarily indicative of
operating results for an entire fiscal year. In the opinion of management,
the unaudited financial information for the three and nine months ended
September 30, 1999 and 1998, reflect all adjustments, consisting only of
normal recurring accruals and provisions, necessary for a fair presentation
thereof.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Scripps Financial Corporation, a California corporation ("SFC"), was formed
on May 14, 1999 as a federally regulated bank holding company. Scripps Bank,
a California banking corporation ("Scripps"), is a federally insured bank.
Scripps merged with and into a subsidiary of SFC on July 1, 1999. As a result
of the merger, each shareholder of Scripps received a number of shares of SFC
equal to that number of shares such shareholder held in Scripps. SFC
currently holds all of the outstanding stock of Scripps. As SFC is newly
formed, the following discussion will compare financial results of SFC for
the three and nine month periods ended September 30, 1999 to the financial
results of Scripps for the three and nine month periods ended September 30,
1998. Effective with the close of business August 31, 1998 Scripps acquired
Pacific Commerce Bank ("PCB"). All prior period results include the combined
financial results of both entities. The following discussion and analysis
should be read in conjunction with Scripps' December 31, 1998 audited
financial statements provided in SFC's registration statement on Form 10, as
amended, including notes thereto.
FINANCIAL CONDITION
Total assets of SFC increased $7.6 million or 1.3% to $590.2 million at
September 30, 1999, from $582.6 million at December 31, 1998. Gross loans
increased $46.6 million or 13.7% to $387.3 million from $340.7 million at the
end of 1998. Within the loan portfolio, real estate loans increased $38.4
million to $170.0 million and commercial loans increased $2.1 million to
$158.3
6
million at September 30, 1999. Total consumer loans increased by $4.6 million
to $52.9 million. There was a slight change in the loan portfolio mix of
which real estate and commercial loans comprised 44% and 41%, respectively,
at the end of September 1999, a change from 39% and 46%, respectively, at
year end 1998. Consumer loans were unchanged at 14% at the end of both
periods. The loan growth, noted above, has caused Federal funds sold to
decline by $23.3 million to $19.5 million at the end of the third quarter
1999, compared to December 31, 1998. Nonperforming assets of $3.7 million or
.63% of total assets at September 30, 1999 compares to $1.4 million or .23%
of total assets for December 31, 1998.
Total deposits at September 30, 1999 increased $9.0 million to $540.0 million
or 1.7% from $531.0 million at December 31, 1998. Non-interest bearing
accounts increased $15.3 million or 10.0% to $168.0 million from $152.7
million at December 31, 1998. In the interest-bearing deposit categories, NOW
accounts increased $2.6 million to $40.4 million, savings and money market
accounts decreased $23.2 million to $229.1 million, while net time deposits
increased $14.3 million to $102.5 million. Total stockholders' equity at
September 30, 1999 was $46.5 million compared to $43.8 million at December
31, 1998, an increase of $2.7 million or 6.3% due to earnings of $4.5
million, offset by dividends of $414,000 and an increase in the unrealized
loss on securities available for sale of $1.9 million. SFC's Tier I leverage
capital ratios were 8.12% and 7.63%, at September 30, 1999 and December 31,
1998, respectively. (See CAPITAL RESOURCES.)
RESULTS OF OPERATIONS
SUMMARY
Net earnings were $4.5 million ($.66 per share basic; $.65 per share diluted)
for the nine months ended September 30, 1999, compared with $4.3 million
($.64 per share basic; $.62 per share diluted) for the same period in 1998.
This represents an increase of $175,000 or 4.0%. SFC improved performance
between 1999 and 1998 resulted primarily from an increase in average
interest-earning assets, primarily in loans and investment securities. The
provision for loan and lease losses increased $1.5 million or 101.4% to $2.9
million for the nine months ended September 30, 1999 from $1.4 million for
the nine months ended September 30, 1998. Non-interest income decreased
$538,000, while non-interest expense increased $1.2 million for the nine
months ended September 30, 1999 over the same period in 1998. The provision
for income taxes increased $94,000 to $3.0 million from $2.9 million due to
an increase in pre-tax earnings of $269,000. The annualized return on average
assets and average stockholders' equity decreased during the first nine
months of 1999 to 1.05% and 13.21%, respectively, from 1.18% and 14.40%,
respectively for the same 1998 period. (See RESULTS OF OPERATIONS -- NET
INTEREST INCOME, RESULTS OF OPERATIONS --NON-INTEREST INCOME AND EXPENSE and
RESULTS OF OPERATIONS - PROVISION FOR POSSIBLE LOAN LOSSES.) For the quarter
ended September 30, 1999, SFC reported net income of $1.5 million, $73,000
more than the third quarter of 1998. The provision for income taxes increased
$24,000 to $1.0 million for the third quarter of 1999. The annualized return
on average assets and average stockholders' equity for the quarter ended
September 30, 1999 decreased to 1.05% and 13.35%, respectively, from 1.11%
and 14.02%, respectively, for the third quarter of 1998. Basic and diluted
earnings per share for the third quarters were each $.22 in 1999, compared to
$.22 and $.21, respectively, in 1998.
NET INTEREST INCOME
7
Net interest income, which constitutes one of the principal sources of income
for SFC, represents the difference between interest income on
interest-earning assets and interest expense on interest-bearing liabilities.
The net yield on total interest-earning assets, also referred to as interest
rate margin or net interest margin, represents net interest income divided by
average interest-earning assets. SFC's principal interest-earning assets are
loans, investment securities and Federal funds sold, while its principal
interest-bearing liabilities are interest-bearing demand accounts, savings
deposits and time deposits.
Net interest income was $24.2 million for nine months ended September 30,
1999, an increase of $3.4 million or 16.5% compared with net interest income
of $20.8 million for the same period in 1998. SFC average interest-earning
assets increased to $534.7 million for the nine months ended September 30,
1999 from $454.7 million for the same period in 1998, representing an
increase of $80.0 million, primarily in loans and investment securities.
Average interest-bearing deposits increased to $365.5 million for the nine
months ended September 30, 1999 from $316.0 million in the same period for
1998, representing an increase of $49.4 million, and average
non-interest-bearing demand deposits increased $29.3 million or 22.3%. The
net interest margin of 6.06% for September 30, 1999 reflects a decrease of 6
basis points from 6.12% for the same period in 1998. This decrease in net
interest margin resulted primarily from both the decrease in the prime rate
from an average of 8.50% in the first nine months of 1998 to 7.87% in the
first nine months of 1999 (since a majority of Scripps' loans are tied to the
prime rate, a decrease in the rate immediately affects net interest income),
and continued competitive pressure in pricing loans, partially offset by
declining rates on interest bearing deposits.
Net interest income for the third quarter of 1999 increased $1.1 million or
15.0% from $7.4 million, for the third quarter of 1998. Interest income for
the third quarter for loans increased by $1.1 million or 13.2% from $8.3
million in 1998. Average loans in the third quarter 1999 were $380.8 million,
an increase of $62.0 million or 19.5% compared to $318.7 million for 1998.
Yields for the third quarter 1999 were 9.19%, significantly lower than the
1998 yield of 9.78%, due primarily to the change in the average prime rate
from 8.50% in 1998 to 8.10% in 1999. The increase in prime to 8.00% in early
July 1999 and to 8.25% in late August 1999 should improve loan yields in the
fourth quarter of 1999. Interest income from investment securities increased
$159,000 or 8.5% in third quarter 1999 compared to 1998. Interest income from
Federal funds sold for the third quarter 1999 decreased $313,000 or 102%, due
to a volume decrease in Federal funds sold, as a result of an increase in
average loans in the third quarter. Interest expense for the third quarter
1999 was $3.3 million, a decrease of $235,000 or 6.7% compared to 1998, due
to lower overall rates on interest bearing accounts, partially offset by the
fact that average interest bearing deposits increased by $26.9 million or
7.9% in the third quarter 1999 from $339.1 million in 1998. With market
interest rates rising during the third quarter of 1999, management expects
interest expense yields to increase for the balance of 1999. Net interest
margin was 6.12% and 5.93% for the three months ended September 30, 1999 and
1998, respectively.
NON-INTEREST INCOME
Non-interest income was $4.2 million for the nine months ended September 30,
1999, a decrease of $538,000 or 11.3% compared with non-interest income of
$4.8 million for the same period in 1998. The primary reasons for the
decreases in non-interest income over the period presented are: (1) in 1998,
PCB, prior to
8
the merger with Scripps, sold its merchant Mastercard/Visa program and
certain SBA loans; (2) in May 1998, Scripps outsourced its merchant
Mastercard/Visa program which reduced the gross income recognized for the
program, (the expenses associated with the old program were reflected in the
non-interest expense category); and (3) deposit service charge income
declined due primarily to the collection of fewer non-sufficient fund ("NSF")
charges. Fewer NSF charges collected was as a result of the former PCB
branches adopting Scripps's more conservative policy regarding collection of
NSF fees and an overall effort in all offices to maintain fewer accounts with
habitual NSF activity. Third quarter non-interest income decreased $57,000 or
3.9% in 1999 compared to 1998 due to items (2) and (3) as described above.
NON-INTEREST EXPENSE
Non-interest expense was $18.1 million for the nine months ended September
30, 1999, an increase of $1.2 million or 6.8% compared with non-interest
expense of $16.9 million for the same period in 1998. Personnel expense was
$10.4 million for 1999, an increase of $1.5 million or 16.6% compared with
personnel expense of $8.9 million for 1998. Occupancy expense was $3.2
million for the nine months ended September 30, 1999, an increase of $207,000
or 6.8% compared with occupancy expense of $3.0 million for the same period
in 1998. The aggregate increases over the period principally reflect the
additional costs associated with an increase in staff due to growth in loans
and deposits, additional rent and moving costs associated with moving the La
Jolla office from Ivanhoe Ave. to Girard Ave., and in the second quarter, the
start up of additional lines of business such as Investment Services and
Property Management Banking.
Data processing expense was $158,000 for the nine months ended September 30,
1999, a decrease of $440,000 or 73.6% compared with data processing expense
of $598,000 for the same period in 1998. The decrease in data processing
expense over the period resulted principally from converting the acquired PCB
offices over to the in-house data processing system of Scripps in November
1998; and in part by enhanced technical functionality from equipment acquired
in 1998.
Other expense was $4.3 million for the nine months ended September 30, 1999,
a decrease of $96,000 or 2.2% compared with other expense of $4.4 million for
the same period in 1998. The decrease in other expense resulted primarily
from the fact that 1998 included legal and professional fees associated with
the PCB merger and the outsourcing of Scripps merchant Mastercard/Visa
program, which were partially offset by increased other expense related to
deposit account customer services expense. Third quarter non-interest expense
increased $691,000 or 11.8% in 1999 compared to 1998. This increase is
attributable to the start-up of the bank holding company (SFC), for which
there was $121,000 in expenses incurred, as well as to the reasons noted in
the first paragraph of this section.
PROVISION FOR POSSIBLE LOAN LOSSES
The provision for possible loan losses was $2.9 million for the nine months
ended September 30, 1999, compared to $1.4 million for the same period in
1998, an increase of $1.5 million or 101.4%. The provision amount reflects
management's judgment of the adequacy of the reserve for loan losses and is
determined by the periodic review and assessment of the overall risk in the
loan portfolio, the Bank's loan loss experience, and the current and expected
economic conditions. The increase in provision for possible loan losses for
the period in 1999 was primarily to replenish the allowance for loan losses,
due to $2.0 million in net loan charge-offs for the nine months ended
September 30,
9
1999. The $2.0 million is comprised of one loan for $1.9 million and several
small loans of less than $50,000 each. The allowance for loan losses was $5.7
million and $4.7 million for September 30, 1999 and 1998, respectively. As a
percent of gross loans, it was 1.47% and 1.44%, respectively, for September
30, 1999 and 1998. Management expects the allowance for possible loan losses
to range between 1.40% and 1.50% of gross loans for the remainder of 1999.
The provision for possible loan losses for the three months ended September
30, 1999 was $750,000 compared to $520,000 for the third quarter of 1998. The
provision for possible loan losses during the third quarter of 1999 reflected
an increased provision of $230,000 or 44.2%; as noted in the preceding
paragraph, this increase was to replenish the allowance for loan losses.
LIQUIDITY
The objective of liquidity management is to maintain a balance between
sources and uses of funds in such a way that the cash requirements of
customers for loans and deposit withdrawals are met in the most economical
manner. Management monitors its liquidity position continuously in relation
to trends of loans and deposits for short term as well as long term
requirements. Liquid resources are monitored on a daily basis to assure
maximum availability. Liquidity requirements are managed by maintaining an
adequate level of readily marketable assets (primarily Federal funds and
available for sale investment securities) and access to short term funding
sources. Currently, Scripps has a line of credit of $20.0 million from a
non-affiliated financial institution, which enables it to borrow Federal
funds on an unsecured basis. Scripps also has a secured discount window
borrowing facility with the Federal Reserve Bank of $53 million and a secured
borrowing facility with the Federal Home Loan Bank of approximately $25
million. The increase in borrowing facilities of $70 million over the second
quarter was a result of management's decision to provide increased liquidity
to cover potential customer Y2K liquidity needs. At September 30, 1999,
Scripps had no amounts outstanding in connection with any of its borrowing
facilities.
Management uses several tools and processes to monitor liquid resources:
semi-monthly liquidity projection reports, liquidity and volatile deposit
dependency ratios, deposit product trends, weekly deposit rate management,
and daily large balance fluctuation reports, among others. Management uses a
bank liquidity ratio, defined as the sum of unpledged marketable securities,
Federal funds sold, and cash and balances due from banks divided by total
deposits, as a measurement tool indicating the volume of liquid resources.
This ratio will increase or decrease in response to general economic
conditions, loan demand, the phases of the interest rate cycle, and deposit
growth or contraction, among other things. The ratio was approximately 35% at
September 30, 1999, and 42% at December 31, 1998. SFC management strives to
maintain liquidity levels between 20% and 35%. Additionally, SFC closely
monitors its loan-to-deposit ratio. This ratio (calculated as gross loans
divided by total deposits) was 71.7% at September 30, 1999, an increase from
64.2% at December 31, 1998, primarily as a result of loan growth. Management
anticipated this ratio increase in 1999 due to increased loan demand from the
expanding local economy; however, there can be no assurances that the economy
will continue to expand or that loans will outpace deposit growth.
SFC's ratio of core deposits (defined as customers' deposits less time
certificates of deposit of $100,000 or more) to total deposits was 87.6% for
September 30, 1999 and 88.8% for December 31, 1998. A significant portion of
SFC's core deposits is concentrated in the Scripps Money Fund, a higher
10
interest-bearing demand deposit product that comprised $165.9 million or
30.7% of total deposits at September 30, 1999. This represents a decrease of
$28.8 million or 14.8% from the balance of $194.7 million or 36.7% of
deposits at December 31, 1998. Management believes this decrease is cyclical,
due primarily to a build up of balances at year end versus deposit outflow in
September to cover IRS tax payments. Another significant portion of SFC's
core deposits is non-interest bearing demand deposits. These deposits
increased to $168.0 million or 31.1% of total deposits at September 30, 1999
from $152.7 million or 28.8% at December 31, 1998. Management attempts to
actively monitor its liquidity position and deposit composition; however,
there can be no assurance that SFC's overall liquidity position and deposit
base will continue to be satisfactory in the future.
CAPITAL RESOURCES
Management seeks to maintain capital adequate to support anticipated asset
growth and credit risks and to ensure that SFC is within established
regulatory guidelines and industry standards. The 1992 risk-based capital
guidelines adopted by the FRB and FDIC require SFC to maintain certain
minimum ratios of capital to risk-weighted assets. In addition, the FRB and
FDIC have adopted a leverage ratio that requires a minimum ratio of Tier 1
capital to total assets. Higher minimum requirements for an institution may
be established if, for example, a bank has previously received special
attention or has a higher susceptibility to interest rate risk. These
risk-based capital guidelines require state banks to have a ratio of Tier 1
capital to total risk-weighted assets of four percent and a ratio of total
capital to total risk-weighted assets of eight percent. As depicted in the
following table, the capital ratios of SFC have continuously exceeded the
federal minimum regulatory requirements for a well-capitalized institution.
The following table sets forth the actual capital ratios of SFC as of the
dates indicated.
CAPITAL RATIOS
WELL MINIMUM
CAPITAL RATIOS(1): SEPTEMBER 30, DECEMBER 31, CAPITALIZED CAPITAL
1999 1998 RATIOS RATIOS
------------- ------------ ----------- -------
Leverage (2) 8.12% 7.63% 5.0% 4.0%
Tier 1 risk-based 10.26% 10.19% 6.0% 4.0%
Total risk-based 11.50% 11.32% 10.0 8.0%
- -----------------------------------------
(1) Computed in accordance with 1992 Federal guidelines, which were initially
effective January 1, 1990.
(2) Leverage ratio is defined as the ratio of Tier 1 capital to the most recent
quarterly average asset total.
YEAR 2000 READINESS DISCLOSURE
The Year 2000 issue (Y2K) exists because many computer programs use only
two-digit dates to reference years. Some computer systems infer the century
11
1900, rather than 2000.
Unless they are changed, interpreting the 00 as 1900 will result in
miscalculations when processing critical dates. To the extent that the
problem is not successfully addressed, the consequences, the extent of which
are unknown, could impact Scripps' business operations, customers and
vendors. In 1997 Scripps formed a task force to supervise all issues
associated with the century date change, consisting of representatives from
all divisions of Scripps. The Scripps board of directors has given this
project top priority and has dedicated resources, both staffing and
financial, to support the efforts necessary to provide Year 2000 readiness. A
comprehensive plan has been established to ensure compliance with regulations
regarding preparation of computer systems for the year 2000 and its status is
reported to the Scripps board on a monthly basis. Scripps completed Awareness
and Assessment phases in 1998. The Y2K team, under the oversight of the task
force, identified all critical functions performed and the hardware, software
and supplies necessary to perform these functions. First, high-level test
plans were developed, then detailed test plans and scripts were written to
use for testing mission critical systems. Scripps substantially completed
testing of mission critical systems and processes during the first quarter of
1999. The testing encompassed our Unisys ClearPath host computer, the COMPAQ
Alpha used by the trust accounting system, our Information Technology Inc.
banking application software, Sunguard Trustware II accounting system, the
servers and PCs on our network, numerous PC applications software, and online
testing with Federal Reserve Bank. These systems were tested using the
thirteen critical dates identified by the Federal Financial Institutions
Examination Council.
All mission critical systems have been tested and certified Y2K compliant.
Very little renovation has been required. Early on, Scripps recognized that
our voice response unit was not compliant. It has been replaced with a Year
2000 compliant version. Network servers were upgraded or replaced in the
first quarter of 1999. Another product, BankLink, a business cash management
system, is not compliant and was retired, effective September 30, 1999.
Customers using that product were offered the choice of existing, compliant
products offered by Scripps Bank. All non-compliant PCs (approximately 50)
have been upgraded or replaced. The telephone system was upgraded in the
third quarter to ensure that voice mail will be Y2K compliant. Any new
software and hardware will be certified Year 2000 ready and tested by Scripps
prior to implementation. New software purchases are expected to be
insignificant. New releases of existing software will be tested before being
brought on line. Contingency plans have been developed to contend with a wide
array of situations from a single process failure, to a power outage at a
regional office, to a liquidity crisis due to substantial customer
withdrawals. To fulfill the FDIC requirement of an independent audit review
of Y2K contingency plans, the Bank's internal auditor, who is not a member of
the Y2K task force, reviewed the plans to ensure that all critical functions
were covered and that the plans adequately covered the potential problem. All
contingency plans were tested in early September, necessary revisions made
and all re-testing completed by the end of September 1999. In late November
and early December, walk-throughs will be performed again to verify that the
then current staff is trained. As a final readiness check, on January 1, 2000
all departments will be checked to determine if each software application is
operational at each site. The results of this readiness check will be
reported to executive management that day.
Scripps has identified fifty-six critical vendors. Vendors have been
contacted to ascertain their level of readiness and those identified as
critical to the day-to-day operation of the Bank are monitored. Early in the
process, critical
12
vendors were assigned a probability of failure factor of low, medium or high.
Those vendors that are currently not certified to be compliant had all been
assigned a risk factor of "low". Of the fifty-six vendors identified, all
fifty-six have certified that they are compliant. The monitoring process
includes verification by phone, letter and web-site. A tracking report is
maintained and reviewed by the task force. Vendor status will be monitored
monthly through year-end. Vendors that provided products to the Bank have
been tested. Those that provide services, such as the phone company, the gas
and electric company, and the US Postal Service are not testable.
The Bank has taken proactive measures to work together with our customers to
ensure their own Year 2000 readiness and has a program in place for risk
analysis and monitoring of significant borrowers and depositors. To date,
significant borrowers have been assessed and none have been identified as
having a significant Y2K risk that would materially impact the operations of
the Bank. Scripps has included Y2K risk ratings as part of the loan
application and credit review process since the first quarter of 1999. While
Y2K compliance is not being required on an absolute basis, it is considered
in each lending decision and is an integral part of the risk rating used to
determine credit worthiness. Based on interviews with customers and on
account officer knowledge, a Y2K risk assessment was completed for all
existing borrowers with balances of $250,000 or more. This is an ongoing
process as borrowers continue to meet the criteria. The assessment of large
depositors continues. Through a questionnaire or personal interview, the Bank
is evaluating these customers' level of comfort with the banking industry and
with Scripps. Also, all depositors were sent a survey to capture their Y2K
perceptions and intentions. A statistically valid response was received and
was used to assist Scripps in writing the Y2K liquidity contingency plan. The
survey was sent again in early October 1999 to monitor any change in
customers' perceptions or intentions. Results from that survey will be
tabulated by late November. Based on interviews and survey results to date,
Scripps' customers appear satisfied with the Bank's Y2K readiness.
The related costs of Y2K, which are expensed as incurred or capitalized, if
appropriate, are primarily included in professional services, equipment
repairs or depreciation and salary expense. Y2K expenses incurred through the
end of 1998 amounted to approximately $126,000 and the remaining costs of the
project are estimated to be $600,000. Scripps holds directors' and officers'
liability and product liability policies, none of which include exclusions
for Y2K claims; however, there can be no assurances that any Y2K claims will
be covered by insurance or that the insurance coverage will be adequate.
Scripps does not believe that the costs associated with the Y2K issue will
have a material effect on the results of its operations; nonetheless, since
the outcome of the century date change is unknown, there can be no assurances
that the Bank will not be materially affected, particularly by events that
are not within the Bank's control.
FORWARD-LOOKING STATEMENTS
The Management's Discussion and Analysis of Financial Conditions and Results
of Operations contains forward-looking statements that involve substantial
risks and uncertainties. You can identify these statements by
forwarded-looking words such as "may", "will", "expect'" "anticipate,"
"believe," "estimate," "project" and "continue" or similar words. You should
read statements that contain these words carefully because they: (1) discuss
our future expectations; (2) contain projections of our future results of
operations or of our financial condition; or (3) state other
"forward-looking" information. We believe it is important to communicate our
expectations; however, there may be events in the future that we
13
are not able to predict accurately or over which we have no control. Our
actual results may differ materially from the expectations we describe in
forward-looking statements. Factors that could cause actual results to differ
materially from those we describe include, but are not limited to, local
economic conditions in Southern California and particularly in San Diego, the
ability to manage growth of SFC and Scripps, business conditions, interest
rate fluctuation, competition, a decline in real estate prices, new product
development, federal and state regulation and Year 2000 issues.
Forward-looking statements should be read in light of these factors.
Potential risks and uncertainties include, but are not limited to, those
listed below under "Quantitative and Qualitative Disclosures about Market
Risk" as well as other risks and uncertainties detailed in our Registration
Statement on Form 10, as amended, filed with the Securities and Exchange
Commission on July 13, 1999.
The above Management's Discussion and Analysis should be read in conjunction
with the consolidated financial statements and notes thereto included in
SFC's Registration Statement on Form 10, as amended, filed with the
Securities and Exchange Commission on July 13, 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
SFC's balance sheet consists of interest-earning assets, primarily loans and
investment securities, which are principally funded by interest-bearing
liabilities, primarily deposits. These financial instruments have varying
levels of sensitivity to changes in market interest rates resulting in market
risk. In evaluating the exposure of SFC to market risk, management relies on
gap analysis and rate shock analysis. Gap analysis provides information on
the timing and repricing differences between rate sensitive assets and rate
sensitive liabilities. Rate shock analysis provides management with estimates
of the impact of immediate changes in interest rates both in terms of the
change in net interest income and the change in fair market value of these
instruments. There are certain shortcomings inherent in these methods and in
the following table that must be considered in evaluating market risk.
Although certain assets may have similar maturities or periods to reprice,
they may react in different degrees to changes in interest rates or they may
precede or lag behind changes in market interest rates. In addition, certain
interest rate sensitive assets may have contractual limitations to changes in
interest rates. SFC considers these various factors and their anticipated
effects in managing the bank's exposure to interest rate risk.
Management seeks to maintain a reasonably balanced interest rate risk
position within one year to protect its financial condition and net interest
margin from market fluctuations in interest rates. Overall management
strategies to reduce SFC's interest rate risk consist of: (i) maintaining a
majority of its loan assets and deposit liabilities on an adjustable rate
basis, (ii) limiting the volume of its loans with terms-to-maturity in excess
of five years and (iii) maintaining a portion of its investment securities
with varied terms to maturity. Additionally, SFC maintains a Management
Asset/Liability Committee and a Directors Asset/Liability Committee, both of
which review on a regular and periodic basis such matters as earnings, asset
quality, asset and liability mix, liquidity and funding sources, investment
resources, capital, interest rate risk, and economic events and trends, among
other matters. Both Committees review bank compliance with a set of
Board-approved directives with which SFC should comply to meet its asset and
liability management objectives.
14
INTEREST-SENSITIVE FINANCIAL INSTRUMENTS
(Dollars in thousands)
Expected Maturity Date as of September 30, 1999
AFTER 1 YEAR AFTER 2 YEARS AFTER 3 YEARS AFTER 4 YEARS
WITHIN BUT WITHIN BUT WITHIN BUT WITHIN BUT WITHIN
ONE YEAR TWO YEARS THREE YEARS FOUR YEARS FIVE YEARS THEREAFTER TOTAL FAIR VALUE
-------------------------------------------------------------------------------------------------------
FINANCIAL ASSETS:
Loans:
Variable rate $152,686 $26,787 $10,883 $24,605 $17,584 $32,210 $264,755 $264,755
Average interest rate 9.52% 9.27% 9.53% 9.30% 10.39% 9.52% 9.53%
Fixed rate 19,269 16,438 17,201 30,078 12,446 27,107 122,539 122,133
Average interest rate 8.84% 8.61% 9.08% 8.91% 8.58% 8.72% 8.81%
Investment securities:
CMO's 7,073 8,119 7,043 3,873 2,993 4,507 33,608 33,280
Average interest rate 6.03% 6.06% 5.98% 6.10% 6.12% 6.16% 6.04%
MBS 5,570 4,917 4,283 3,690 3,198 13,748 35,407 34,783
Average interest rate 7.07% 7.06% 7.05% 6.92% 7.15% 6.89% 7.03%
SBA's 167 2,741 3,418 6,326 6,299
Average interest rate 9.23% 5.63% 5.71% 5.77%
U.S. Treasury and
Agency 7,996 14,800 18,388 7,108 48,292 47,667
Average interest rate 6.47% 6.34% 6.35% 5.85% 6.29%
States and political
subdivisions 38 1,669 7,425 9,551 18,683 18,641
Average interest rate 8.10% 5.58% 5.22% 5.26% 5.28%
Equity 1,461 1,769 3,230 3,079
Average interest rate 4.27% 5.12% 4.76%
Interest bearing due from
banks 1,185 1,185 1,185
Average interest rate 5.89% 5.89%
Federal funds sold 19,480 19,480 19,480
Average interest rate 5.09% 5.09%
FINANCIAL LIABILITIES:
Interest bearing deposits:
Non-maturing deposits 268,887 268,887 268,887
Average interest rate 3.33% 3.33%
Time deposits 100,078 2,947 84 27 103,136 103,105
Average interest rate 4.66% 4.78% 4.54% 5.25% 4.66%
Guarantee of loan to
ESOP Trust $38 $10 $3 $50 $50
Average interest rate 7.75% 7.75% 7.75% 7.75%
15
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Since SFC is recently formed, no matters have been submitted to a vote of the
security holders.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as
part of this report:
* 3.1 Articles of Incorporation of SFC
* 3.2 Bylaws of SFC
* 4.1 Specimen Common Stock Certificate
27.01 Financial Data Schedule
- ----------------------------------
* Incorporated by reference to the Registrant's Registration Statement on
Form 10 (File No. 0-26081)
(b) THERE WERE NO REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED
SEPTEMBER 30, 1999
SIGNATURES
Pursuant to the requirements 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.
SCRIPPS FINANCIAL CORPORATION
Date: November 12, 1999 By: /s/ Ronald J. Carlson
----------------- ---------------------
Ronald J. Carlson
President
16