UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-24842
MONTEREY BAY BANCORP, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 77-0381362
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
567 AUTO CENTER DRIVE, WATSONVILLE, CALIFORNIA 95076
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(Address of principal executive offices) (Zip Code)
(831) 768-4800
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(Registrant's telephone number, including area code)
Not Applicable
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(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), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the
latest practicable date: 3,535,387 shares of common stock, par value $.01 per share, were outstanding as of
May 12, 1999.
MONTEREY BAY BANCORP, INC.
Index
PART I. FINANCIAL INFORMATION Page
Item 1. Condensed Consolidated Statements of Financial Condition as of
March 31, 1999 and December 31, 1998.................................................. 1
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 1999 and 1998............................................ 2
Condensed Consolidated Statement of Stockholders' Equity for the
Three Months Ended March 31, 1999..................................................... 3
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1999..................................................... 4
Notes to Condensed Consolidated Financial Statements.................................. 6
Item 2.
Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................. 7
Item 3. Quantitative and Qualitative Disclosure of Market Risk................................ 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................................... 18
Item 2. Changes in Securities................................................................. 18
Item 3. Defaults Upon Senior Securities....................................................... 18
Item 4. Submission of Matters to a Vote of Security Holders................................... 18
Item 5. Other Information..................................................................... 18
Item 6. Exhibits and Reports on Form 8-K...................................................... 18
SIGNATURES........................................................................................................ 19
Item 1. Financial Statements.
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
MARCH 31, 1999 (UNAUDITED) AND DECEMBER 31, 1998 (Dollars in thousands)
- -----------------------------------------------------------------------------------------------------------------------
March 31, December 31,
1999 1998
-------------- -------------
ASSETS
Cash and due from depository institutions $ 7,106 $ 11,626
Overnight deposits 2,625 5,325
---------- -----------
Total cash and cash equivalents 9,731 16,951
Loans held for sale, at market 437 2,177
Securities available for sale:
Mortgage-backed securities (amortized cost of $89,080 at March 31, 1999
and $97,158 at December 31, 1998) 89,556 98,006
Corporate trust preferreds (amortized cost, of $15,079 at March 31, 1999
and $18,658 at December 31, 1998 15,571 19,154
Investment securities (amortized cost of $252 at December 31, 1998) - 256
Securities held to maturity:
Mortgage-backed securities (market value of $86 at March 31, 1999
and $96 at December 31, 1998) 87 97
Loans receivable held for investment (net of allowance for loan losses
at March 31, 1999, $2,887; and at December 31, 1998, $2,780) 317,713 298,775
Federal Home Loan Bank stock, at cost 3,089 3,039
Premises and equipment, net 6,234 6,316
Accrued interest receivable 2,596 2,537
Core deposit premiums and other intangibles, net 3,456 3,630
Other assets 2,575 3,881
---------- -----------
TOTAL ASSETS $ 451,045 $ 454,819
========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Savings deposits $ 368,699 $ 370,677
Federal Home Loan Bank advances 33,582 35,182
Securities sold under agreements to repurchase 4,170 4,490
Accounts payable and other liabilities 1,970 2,581
---------- -----------
Total liabilities 408,421 412,930
---------- -----------
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 2,000,000 shares authorized and unissued - -
Common stock, $.01 par value, 9,000,000 shares authorized and 4,378,289
shares issued (3,528,886 shares outstanding at March 31, 1999;
and 3,505,355 shares outstanding at December 31, 1998) 45 45
Additional paid-in capital 27,650 27,586
Unearned shares held by employee stock ownership plan (206,639 at
March 31, 1999; and 215,623 at December 31, 1998) (1,322) (1,380)
Treasury stock, at cost (963,200 shares at March 31, 1999;
and 986,731 shares at December 31, 1998) (12,689) (12,920)
Retained earnings, substantially restricted 28,370 27,764
Accumulated other comprehensive income - unrealized gain on securities 570 794
---------- -----------
Total stockholders' equity 42,624 41,889
---------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 451,045 $ 454,819
========== ===========
<FN>
See notes to condensed consolidated financial statements.
</FN>
1
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 1999 AND 1998 (UNAUDITED)
(Dollars in thousands, except per share amounts)
- ----------------------------------------------------------------------------------------------------------------
Three Months Ended
March 31,
--------------------------
1999 1998
INTEREST INCOME:
Loans receivable $ 6,296 $ 5,416
Mortgage-backed securities 1,528 1,149
Other investment securities 401 760
-------- --------
Total interest income 8,225 7,325
-------- --------
INTEREST EXPENSE:
Savings deposits 3,914 3,864
FHLB advances and other borrowings 537 513
-------- --------
Total interest expense 4,451 4,377
-------- --------
NET INTEREST INCOME BEFORE PROVISION
FOR LOAN LOSSES 3,774 2,948
PROVISION FOR LOAN LOSSES 220 109
-------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,554 2,839
-------- --------
NONINTEREST INCOME:
Gain (loss) on sale of investment securities 217 (17)
Gain on sale of real estate owned 9 9
Commissions from sales of noninsured products 132 123
Customer service charges 233 171
Income from loan servicing 17 46
Other income 76 68
-------- --------
Total noninterest income 684 400
-------- --------
GENERAL AND ADMINISTRATIVE EXPENSE:
Compensation and employee benefits 1,360 1,172
Occupancy and equipment 285 276
Deposit insurance premiums 42 22
Data processing fees 243 183
Legal and accounting expenses 106 96
Stationery, telephone and office expenses 141 107
Advertising and promotion 57 60
Amortization of core deposit premiums 174 179
Other expenses 414 345
-------- --------
Total general and administrative expense 2,822 2,440
-------- --------
INCOME BEFORE INCOME TAX EXPENSE 1,416 799
INCOME TAX EXPENSE 612 360
-------- --------
NET INCOME $ 804 $ 439
======== ========
BASIC EARNINGS PER SHARE $ .24 $ .12
======== ========
DILUTED EARNINGS PER SHARE $ .24 $ .11
======== ========
CASH DIVIDENDS PER SHARE $ .07 $ .06
======== ========
<FN>
See notes to condensed consolidated financial statements.
</FN>
2
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1999 (Dollar amounts in thousands)
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Accumulated
Additional Other
Common Stock Paid in Acquired Treasury Retained Comprehensive
Shares(1) Amount Capital by ESOP Stock(2) Earnings Income, net of tax Total
--------- ------ ---------- -------- -------- -------- ------------------ --------
Balance at
December 31, 1998 3,505,355 $ 45 $27,586 $ (1,380) $(12,920) $27,764 $ 794 $41,889
Options exercised
using treasury stock 23,531 231 47 278
Dividends paid (246) (246)
Earned ESOP shares 64 58 122
Net income 804 804
Change in unrealized gains
on securities available for
sale, net of taxes (97) (97)
Reclassification adjustment
for gains on securities
available for sale included
in income, net of taxes (127) (127)
-------------------------------------------------------------------------------------------------
Balance at
March 31, 1999 3,528,886 $ 45 $27,650 $ (1,322) $(12,689) $28,369 $ 570 $42,623
=================================================================================================
<FN>
(1) The number of shares of common stock includes 359,375 shares which are
pledged as security for a loan to the Bank's ESOP. Shares earned at March
31, 1998 and December 31, 1997 were 152,734 and 143,750, respectively.
(2) The Company held 963,200 shares of repurchased Company common stock as of
March 31, 1999 and 986,731 as of December 31, 1998.
See notes to condensed consolidated financial statements.
</FN>
3
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1999 AND 1998 (Unaudited) (Dollars in thousands)
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Three Months Ended
March 31,
-------------------------------
OPERATING ACTIVITIES: 1999 1998
------------- -------------
Net income $ 804 $ 439
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of premises and equipment 119 115
Amortization of core deposit premiums 174 179
Amortization of purchase premiums, net of discounts 86 243
Loan origination fees deferred, net 36 51
Amortization of deferred loan fees (33) (93)
Provision for loan losses 220 109
Compensation expense related to ESOP shares released 122 145
(Gain) loss on sale of investment securities (217) 17
Gain on sale of real estate owned (10) (9)
Losses on sale of fixed assets - 7
Charge-offs on loans receivable, net of recoveries (113) 2
Originations of loans held for sale (2,455) (2,913)
Proceeds from sales of loans originated for sale 4,195 2,771
Change in income taxes payable and deferred income taxes 136 250
Change in other assets 1,178 (1,817)
Change in interest receivable (59) (400)
Change in accounts payable and other liabilities (454) (327)
---------- ---------
Net cash provided by operating activities 3,729 (1,231)
---------- ---------
INVESTING ACTIVITIES:
Loans originated for the portfolio, net (40,196) (19,688)
Purchases of loans receivable (258) (5,471)
Principal payments on loans receivable 21,376 18,583
Proceeds from sales of corporate securities available for sale 3,807 -
Principal paydowns on mortgage-backed securities 8,023 4,266
Purchases of investment securities available for sale - (5,000)
Proceeds from sales of investment securities available for sale 251 4,971
Proceeds from maturities of investment securities - 8,245
Purchases of FHLB stock (50) (50)
Purchases of premises and equipment, net (36) (1,191)
---------- ---------
Net cash (used in) provided by investing activities (7,083) 4,665
---------- ---------
-continued-
4
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1999 AND 1998 (Unaudited) (Dollars in thousands)
- -----------------------------------------------------------------------------------------------------------------------
Three Months Ended
March 31,
-------------------------------
1999 1998
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FINANCING ACTIVITIES:
Net increase (decrease) in savings deposits $ (1,978) $ 6,170
Proceeds on (repayments) of Federal Home Loan Bank advances, net (1,600) (10,000)
Repayments of reverse repurchase agreements, net (320) (10)
Purchases of treasury stock, net of reissuance for exercise of options 278 (1,290)
Cash dividends paid to stockholders (246) (226)
---------- ---------
Net cash provided by (used in) financing activities (3,866) (5,356)
---------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS (7,220) (1,922)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 16,951 13,514
---------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 9,731 $ 11,592
========== =========
CASH PAID DURING THE PERIOD FOR:
Interest on savings deposits and advances $ 4,465 $ 4,566
Income taxes 411 101
NONCASH INVESTING ACTIVITIES:
Real estate acquired in settlement of loans 280 -
<FN>
See notes to condensed consolidated financial statements.
</FN>
5
MONTEREY BAY BANCORP, INC.
NOTES TO Condensed CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X for
interim financial information. Accordingly, the adequacy of the disclosure
contained herein has been determined with the presumption that the users of
these interim financial statements have read or have access to the Annual Report
on Form 10-K of Monterey Bay Bancorp, Inc. (the "Company") for the year ended
December 31, 1998. Only material changes in financial condition and results of
operations are discussed in the remainder of Part I of this Quarterly Report.
In the opinion of the management of the Company and its subsidiary,
Monterey Bay Bank (the "Bank"), the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting solely of
normal recurring accruals) necessary for a fair presentation of the Company's
consolidated financial condition at March 31, 1999, and December 31, 1998, the
results of its operations for the three months ended March 31, 1999 and 1998,
and its cash flows for the three months ended March 31, 1999 and 1998. All
significant inter-company balances and transactions have been eliminated in
consolidation. Results of operations for any interim period are not necessarily
indicative of the operating results that may be expected for any other interim
period or for the entire year.
Note 1.
Recently issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133 "Accounting for
Derivative Instruments and Hedging Activities". The statement establishes
accounting and reporting standards for derivative instruments and hedging
activities. The statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company is in the process of determining the
impact of SFAS No. 133 on the Company's financial statements, which is not
expected to be material.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise". The Company adopted this
statement on January 1, 1999. It allows companies that hold mortgage loans for
sale to classify mortgage-backed securities retained in a securitization of such
loans as either held-to-maturity, available for sale, or trading based on
management's intentions. This guidance is consistent with the treatment
established for investments covered by SFAS 115, "Accounting for Certain
Investments in Debt and Equity Securities". The adoption of this statement was
not material to the financial results of the Company.
6
Note 2.
Comprehensive Income
The following tables disclose comprehensive income for the quarter
ended March 31, 1999 and 1998 (dollars in thousands).
Three Months Ended
March 31,
--------------------
1999 1998
Comprehensive income:
Net income $ 804 $ 439
Change in unrealized gains on
securities available for sale,
net of taxes (97) 71
Reclassification adjustment for gains
on securities available for sale
included in income, net of taxes (127) 13
----- -----
Total comprehensive income $ 580 $ 523
===== =====
Note 3.
Use of Estimates in the Preparation of Financial Statements
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the dates of the balance sheets and revenues and
expenses for the periods covered. Actual results could differ significantly from
those estimates and assumptions.
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Monterey Bay Bancorp, Inc. (the "Company") is a savings and loan
holding company incorporated in 1994 under the laws of the State of Delaware.
The Company was organized as the holding company for Monterey Bay Bank ("the
Bank") in connection with the Bank's conversion from the mutual to stock form of
ownership. On February 14, 1995, the Company issued and sold 4,492,086 shares of
its common stock at an issuance price of $6.40 per share, adjusted for splits,
to complete the conversion. Net proceeds to the Company were $27.1 million,
including shares purchased by the employee stock ownership plan, after deduction
of conversion expenses and underwriting fees of $1.6 million. The Company used
$13.5 million of the net proceeds to acquire all of the stock of the Bank. The
Bank owns a subsidiary, Portola Investment Corporation ("Portola"), which sells
insurance and brokerage services.
The Company's primary business is providing conveniently located
deposit facilities to attract checking, money market, savings and certificate of
deposit accounts, and investing such deposits and other available funds in
mortgage loans secured by one-to-four family residences, construction,
commercial real estate, and business loans. The Bank's deposit gathering and
lending markets are primarily concentrated in the communities surrounding its
full service offices located in Santa Cruz, Monterey, and Santa Clara counties,
in California. At March 31, 1999, the Bank had eight full service offices and
one real administrative office.
7
In December 1996, the Company assumed $102.1 million of savings
deposits from Fremont Investment and Loan in exchange for cash and certain
assets. On December 22, 1997, as part of its growth strategy, the Bank entered
into an agreement with Commercial Pacific Bank ("CPB") to assume approximately
$29.0 million in deposits and to acquire certain related assets. The agreement
also calls for the Company to make a $5.0 million loan to the parent holding
company of CPB. Consummation of these transactions was completed April 1998.
Safe Harbor Statement for Forward-Looking Statements
This report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements, which are based on certain assumptions and describe future plans,
strategies, and expectations of the Company, are generally identifiable by use
of the words "believe," "expect," "intend," "anticipate," "estimate," "project"
or similar expressions. The Company's ability to predict results or the actual
effect of future plans or strategies is inherently uncertain. Factors which
could have a material adverse affect on the operations and future prospects of
the Company include, but are not limited to, changes in: interest rates, general
economic conditions, legislative/regulatory changes, monetary and fiscal
policies of the U.S. Government, including policies of the U.S. Treasury and the
Board of Governors of the Federal Reserve System, the quality or composition of
the loan or investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in the Company's market area and
accounting principles, policies and guidelines. These risks and uncertainties
should be considered in evaluating forward-looking statements and undue reliance
should not be placed on such statements.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
Overview
The Company reported net income of $804,000, or $.24 per basic share,
for the quarter ended March 31, 1999, compared to net income of $439,000, or
$.12 per basic share, for the same period last year. Diluted earnings per share
were $.24 for the first quarter of 1999, compared to $.11 a year ago. First
quarter 1999 earnings were 83% higher than earnings for the similar period a
year ago primarily due to substantial increases in net interest income resulting
from higher levels of loans receivable and decreases in the cost of funds.
Return on average equity was 7.89% and return on average assets was .72% for the
quarter ended March 31, 1999 compared to 2.79% and .32%, respectively a year
ago.
Net interest income before provision for loan losses and recurring
noninterest income rose $826,000 in 1999, from the comparable period in 1998.
The increase in net interest income was primarily due to growth in loans
receivable and decreases in the cost of funds. Increases in general and
administrative expense for the quarter ended March 31, 1999 compared to the same
period in 1998 was primarily attributable to higher compensation and employee
benefits, as new employees were hired in mid 1998 to support the Company's
deposit growth and the expansion of its branch locations and new product lines
and services. Deposits have grown by approximately $42.0 million since March 31,
1998 with all of the net growth occurring in low cost checking, money market and
passbook accounts. During the second quarter of 1998, the Bank opened its eighth
full service branch location.
The most significant component of the Company's revenue is net interest
income, which represents the difference between interest income, primarily from
loans, mortgage-backed securities, and the investment portfolio, 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
8
divided by average interest-earning assets, are affected by its asset growth and
quality, its asset and liability composition, and the general interest rate
environment.
Service charges, mortgage loan servicing fees, and commissions from the
sale of insurance products and investments through Portola also have significant
effects on the Company's results of operations. General and administrative
expenses consist primarily of employee compensation, occupancy expenses, federal
deposit insurance premiums, data processing fees and other operating expenses.
The Company's results of operations are also significantly affected by general
economic and competitive conditions, particularly changes in market interest
rates, government policies, and actions of regulatory agencies.
Recently, the Company has focused its efforts on becoming more like a
community-based commercial bank by increasing its commercial real estate,
construction, multi-family and business lending activities. As well, the Company
is focusing its deposit gathering efforts on small businesses in-market, which
will complement the business lending function. Separately, the Company will
continue to pursue growth in lower cost transaction deposit accounts (checking,
passbook, and money market accounts).
Interest Income
Interest income for the quarter ended March 31, 1999, increased by
12.3% to $8.2 million, compared to $7.3 million for the first quarter of 1998.
The reason for the increase in interest income for the three months ended March
31, 1999, compared to the same period in 1998, was primarily due to a $44.3
million increase in the average balance of loans receivable, and a $25.1 million
increase in the average balance of mortgage-backed securities, which was
partially offset by a $22.4 million decrease in the average balance of corporate
securities.
The weighted average yield on interest earning assets was 7.57% for the
three months ended March 31, 1999 compared to 7.52% for the same period in 1998.
The average yield on loans receivable was virtually unchanged at 8.05% for the
three months ended March 31, 1999, compared to 8.07% for the three months ended
March 31, 1998. The weighted average yield on interest earning assets increased
compared to the same period in 1998 due to loans receivable for the quarter
ended March 31, 1999 representing a larger percentage of total interest earning
assets. Average loans receivable for the quarter ended March 31, 1999
represented 71.9% of total interest earning assets compared to 68.9% for the
same period in 1998. The Company is continuing to pursue its long-term strategic
goal to increase the net interest margin by replacing lower-yielding securities
with higher-yielding loans.
Interest expense was $4.5 million for the quarter ended March 31, 1999,
compared to $4.4 million for the similar period a year ago. The $100,000
increase in interest expense was due to the higher average outstanding balance
of deposits of $47.3 million, which was almost entirely offset by a 67 basis
point decline in the weighted average cost of funds year over year. The
principal reason for the drop in the cost of funds is the decline in the cost of
deposits, which is the largest category of interest bearing liabilities. The
weighted average cost of deposits dropped to 4.20% for the quarter ended March
31, 1999 compared to 4.86% for the same period in 1998. The decline in the
weighted average cost of deposits is due to the success the Company has had in
achieving its strategic goals of changing the mix of deposits to increase
transaction accounts (checking, passbook, and money market accounts) as well as
a decline in rates paid on time deposits. At March 31, 1998, the company had
$69.9 million in transaction accounts or 21.4% of total deposits with a weighted
average cost of 2.46%. At March 31, 1999 transaction accounts total $127.4
million or 34.6% of total deposits with a weighted average cost of 2.90%.
9
The changes in net interest income for the three months ended March 3l,
1999 compared with the corresponding periods in 1998 are analyzed in the
following table. The table shows the changes by major component, setting forth
changes attributable to changes in volume, changes attributable to changes in
interest rates and the net effect of both (in thousands):
Three Months Ended March 31,
1999 Compared with 1998
Increase (Decrease)
------------------------------------
Volume Rate Net
------- ------- -------
Interest income:
Loans $ 894 $ (14) $ 880
Mortgage-backed securities 418 (40) 378
Investment securities (360) 2 (358)
----- ----- -----
952 (52) 900
----- ----- -----
Interest expense:
On customer deposits 290 (240) 50
On borrowings 82 (58) 24
----- ----- -----
372 (298) 74
----- ----- -----
Change in net interest income $ 580 $ 246 $ 826
===== ===== =====
Average assets and liabilities together with average interest rates
earned and paid for the three months ended March 31, 1999 and 1998 are
summarized as follows (dollars in millions):
Three Months Ended March 31,
-------------------------------------------------------
1999 1998
------------------------- --------------------------
Average Yield/ Average Yield/
Balance Rate Balance Rate
----------- ----------- ----------- ----------
Interest earning assets:
Loans $ 313 8.05% $ 268 8.07%
Mortgage-backed securities 94 6.50 69 6.66
Investment securities 28 5.74 53 5.86
----- -----
Total interest earning assets 435 7.57 390 7.52
Noninterest earning assets 18 16
----- -----
Total assets $ 453 $ 406
===== =====
Interest bearing liabilities:
Deposits $ 370 4.20% $ 323 4.86%
Borrowings 39 5.42 34 6.12
----- -----
Total interest bearing liabilities 409 4.31 357 4.98
Noninterest bearing liabilities 2 2
Stockholders' equity 42 47
----- -----
Total liabilities and
stockholders' equity $ 453 $ 406
===== =====
Net interest rate spread 3.26% 2.54%
Net interest margin 3.47% 3.03%
Ratio of interest bearing assets to
interest bearing liabilities 106% 109%
10
Provision for Loan Losses
The allowance for loan losses is maintained at a level considered
appropriate by management and is based on an ongoing assessment of the risks
inherent in the loan portfolio. The allowance is increased by the provision for
estimated loan losses, which is charged against operations, and is decreased by
the amount of net loans charged off during the period. In evaluating the
adequacy of the allowance for loan losses, management incorporates such factors
as collateral value, portfolio composition and concentration, and trends in
local and national economic conditions and the related impact on the financial
strength of the Company's borrowers. (See "-Asset Quality.")
For the three months ended March 31, 1999, the provision for loan
losses was $220,000, compared to $109,000 for the same quarter in 1998. The
Company increased its provision for loan losses largely due to an increase in
higher risk forms of lending. At March 31, 1999, the Company's allowance for
loan losses totaled $2.9 million or .90% of loans receivable, compared to $2.8
million or .92% of loans receivable at December 31, 1998. At March 31, 1999, the
Company had real estate owned totaling $204,300, consisting of two one-to
four-family residential properties acquired through foreclosure in 1998.
Nonperforming loans totaled $204,363 or .06% of loans receivable at March 31,
1999 compared to $752,000, or .28% of loans receivable at March 31, 1998 and
$1.5 million, or .50% of loans receivable at December 31, 1998.
Noninterest Income
Noninterest income increased by 71% to $684,000 for the first quarter
of 1999 compared to $400,000 a year ago, primarily due to a $234,000 increase in
gain on the sale of an investment securities. Excluding the increase in gain on
investment sales, noninterest income increased $50,000, or 13%, primarily from
customer service charges stemming from a larger customer base and an increased
number of checking accounts.
For the three months ended March 31, 1999, customer service charges
amounted to $233,000 compared to $171,000 for the corresponding period a year
earlier. The increase in customer service fee income reflects continuing growth
in the number of customer checking accounts resulting primarily from the
continued consolidation of financial institutions in the Company's market.
General and Administrative Expenses
General and administrative expenses were $2.8 million, for the first
quarter of 1999, compared to $2.4 million for the similar period in 1998. The
increase in 1999 was primarily attributable to higher compensation and employee
benefits, as new employees were hired in mid 1998 to support the Company's
deposit growth and the expansion of its branch locations and new product lines
and services. General and administrative expense as a percentage of average
assets increased slightly during the quarter ended March 31, 1999 to 2.48%
compared to 2.35% for the first quarter of 1998. More importantly, the
efficiency ratio, which is general and administrative expense divided by net
interest income before provision for loan losses plus noninterest revenue,
declined during the quarter ended March 31, 1999. The efficiency ratio for the
quarter ended March 31, 1999 was 63% compared to 73% for the first quarter of
1998. The improvement in the efficiency ration for the quarter ended March 31,
1999 was primarily due to improvements in net interest income and to a lesser
extent efforts to contain growth in general and administrative expenses.
11
COMPARISON OF CHANGES IN FINANCIAL CONDITION
Total assets of the Company were $451.0 million at March 31, 1999,
compared to $454.8 million at December 31, 1998, a decrease of $3.8 million. The
slight decrease in assets during the first quarter of 1999 was primarily due to
the sale of mortgage-backed securities and corporate securities and prepayments
on mortgage-backed securities, with the utilization of a majority of the
proceeds to fund net loan growth and to pay down short-term borrowings.
Mortgage-backed securities and investment securities decreased $12.3
million, or 10.5%, during the three months ended March 31, 1999. These decreases
were offset by an increase of $18.9 million, or 6.3%, in loans receivable during
the same period.
Loans receivable held for investment were $317.7 million at March 31,
1999, compared to $298.8 million at December 31, 1998. Residential real estate
loans continue to represent the largest category of collateral in the loan
portfolio. At March 31, 1999, total one-to-four family residential real estate
loans were $176.3 million, or 56.0% of loans receivable, compared to $183.9
million, or 61.0% of total loans, at December 31, 1998. The Company successfully
continued to focus its efforts on changing its mix of interest earning assets by
emphasizing construction, commercial real estate, and business lending
activities, resulting in increased loan yields. Loans other than one to four
residential loans comprise 44% or $141.4 million of loans receivable at March
31, 1999 compared to 39% or $119.8 million at December 31, 1998 and 29% or $80.2
million at March 31, 1998. During the quarter ended March 31, 1999, the Company
originated $41.7 million in loans of which 76% were other than one-to-four
family residential loans. Loans originated and funded during the first quarter
were earning a weighted average yield of 8.39%. The Company originated $19.7,
$26.4, $22.3, and $36.4 million, respectively of portfolio loans during the
first, second, third, and fourth quarters of 1998, respectively. The growth in
portfolio loan fundings was due to a low interest rate environment, which
promotes loan production, additions to sales staff, and the expansion of the
Company's portfolio lending into construction, commercial, multi-family, and
business lending.
At March 31, 1999, the Company's permanent commercial real estate loan
portfolio was $43.6 million, or 13.7% of total loans receivable, up from $37.9
million, or 12.7% of total loans receivable at December 31, 1998. At March 31,
1999, the Company $38.6 million or 12.2% of net construction loans compared to
$27.5 million, or 9.2%, at December 31, 1998. Construction loans are made
primarily to residential builders and to commercial property developers. At
March 31, 1999, the Company had $37.0 million of multi-family residential loans,
or 11.7% of total loans receivable, up from $35.4 million, or 11.9%, at December
31, 1998. The remainder of the loans receivable was comprised primarily of
business loans totaling $22.2 million, or 7.0%, of total loans receivable, at
March 31, 1999, compared to $19.0 million, or 6.4%, at December 31, 1998.
During the three months ended March 31, 1999, the Company's liabilities
decreased by $4.5 million to $408.4 million, from $412.9 million at December 31,
1998. The decrease in liabilities was primarily attributable a slight decline in
deposits of $2.0 million and a $1.6 million decline in advances from the FHLB.
Total savings deposits decreased during the three-month period ended March 31,
1999 to $368.7 million, or by 0.5% from $370.7 million at December 31, 1998.
Continued emphasis has been placed on growth of low-cost transaction deposit
accounts. Transaction deposit accounts are made up of passbook savings,
checking, and money market accounts. Transaction accounts increased from $113.6
million, or 30.6%, of total deposits at December 31, 1998 to $127.4 million, or
34.6%, of total deposits at March 31, 1999. Time deposits declined from $257.1
million at December 31, 1998 to $241.3 million at March 31, 1999. Average
transaction deposits at March 31, 1999, bore a weighted average interest rate of
2.90%.
12
At March 31, 1999, shareholders' equity was $42.6 million, compared to
$41.9 million at December 31, 1998. Equity increased by $0.7 million due to
first quarter net income of $0.8 million, partially offset by the payment of
cash dividends totaling $246,000, or $.07 per share, on the Company's
outstanding common stock. Tangible book value per share of Monterey Bay Bancorp,
Inc. common stock was $11.80 at March 31, 1999, compared to $11.60 at December
31, 1998.
Interest Rate Sensitivity and Market Risk Analysis
Market risk is the risk of losses resulting from adverse changes in
market pricing and rates. The Company's market risk is primarily interest rate
risk associated with its lending, deposit and borrowing functions. Interest rate
risk arises when interest rates on assets change in a different time period or
in a different proportion from that of liabilities. Management actively monitors
its interest rate sensitivity position with the primary objective of prudently
structuring the balance sheet so that movements of interest rates on assets and
liabilities are highly correlated and produce reasonable net interest margin
even in periods of volatile interest rates. Interest rate risk is considered by
management to be the Company's most significant market risk in terms of
potential for material impact upon the Company's financial position and results
of operations. In the normal course of business, the Company is not exposed to
other types of market risk such as risk associated with commodity prices or
foreign currencies.
Management seeks to manage its asset and liability portfolios to help
reduce any adverse impact on its net interest income caused by fluctuating
interest rates. A key objective of asset/liability management is to manage
interest rate risk associated with changing asset and liability cash flows and
market interest rate movements. Interest rate risk occurs when interest rate
sensitive assets and liabilities do not reprice simultaneously and in equal
volumes. The Company's asset/liability committee provides oversight to the
interest rate risk management process and recommends policy guidelines regarding
exposure to interest rates for approval by the Board of Directors. Adherence to
these policies is monitored on an ongoing basis, and decisions related to the
management of interest rate exposure due to changes in balance sheet structure
and/or market interest rates are made when appropriate and agreed to by this
committee.
The Company manages interest rate risk principally through emphasizing
the origination of adjustable rate loans and short or intermediate term fixed
rate loans and the matching of these assets with short and intermediate term
certificates of deposit and adjustable rate borrowings. The Company's monitoring
activities related to managing interest rate risk include both interest rate
sensitivity "gap" analysis and the use of a simulation model. While gap analysis
provides a picture of the interest rate risk embedded in the balance sheet, it
provides only a static view of interest rate sensitivity at a specific point in
time, and does not measure the potential volatility in forecasted results
relating to changes in market interest rates over time. Accordingly, the Company
combines the use of gap analysis with use of a simulation model, which provides
a dynamic assessment of interest rate sensitivity. The simulation model is
designed to enable the Company to generate a forecast of net interest income and
market value of equity given various interest rate forecasts and alternative
strategies. The model is also designed to measure the anticipated impact that
prepayment risk, basis risk, customer maturity preferences, volumes of new
business and changes in the relationship between long- and short-term interest
rates have on the performance of the Company.
Interest rate sensitivity estimated by management, as measured by the
change in the market value of equity as a percentage of the present value of
assets if interest rate levels were to increase by 2%, was negative 1.92% at
December 31, 1998 indicating that the Company is vulnerable to increases in
interest rates and advantaged if interest rates decline. At December 31, 1997
the change in the market value of equity as a percentage of the present value of
assets if interest rate levels were to
13
increase by 2% was negative 3.11%. While progress in reducing interest rate
sensitivity has been made, management continues to pursue strategies to reduce
the impact of changes in interest rates on its market value of equity, primarily
by shortening asset maturities, and lengthening maturities of interest-bearing
liabilities when possible, and by originating and retaining variable-rate
consumer, business, construction, and commercial real estate loans, which
generally have higher yields than permanent residential loans.
Asset Quality
At March 31, 1999, the Company had no nonaccrual loans past due 90 days
or more compared to $1.5 million of nonaccrual loans at December 31, 1998. At
March 31, 1999, impaired loans totaled $1.7 million, compared to $3.8 million at
December 31, 1998.
At March 31, 1999, the Company had real estate owned totaling $204,300,
consisting of two one-to-four family residential properties acquired through
foreclosure in 1998.
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 problem assets and determining provisions for
anticipated loan losses. The Company classifies assets it considers of
questionable quality using the classification categories of substandard,
doubtful, and loss. The Company's classified assets consist of foreclosed
residential properties, nonperforming assets, and assets that are performing in
accordance with their contractual terms but are adversely classified because
they exhibit one or more well-defined weaknesses. Management monitors the
Company's assets regularly, classifies any problem assets, and provides specific
or general valuation allowances when necessary and appropriate.
Total classified assets of the Company decreased to $3.0 million, or
0.66% of total assets, at March 31, 1999 from $5.4 million, or 1.19% of assets,
at December 31, 1998. At March 31, 1999, the Company had $3.0 million of assets
classified as substandard and no assets classified as doubtful or loss.
Substandard assets was comprised of loans with identified risk characteristics
indicating the asset maybe inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged. The largest
substandard loan at March 31, 1999 was a one-to-four family residential mortgage
with an outstanding principal balance of $309,739.
All of the Company's mortgage loans are secured by real estate located
within the state of California. The majority of such loans are secured by real
estate in Santa Cruz, Monterey, Santa Clara, and San Benito counties; therefore,
the Company's credit risk is primarily related to the economic conditions of
this region.
Capital and Regulatory Standards
In connection with the insurance of its deposits by the Federal Deposit
Insurance Corporation ("FDIC") and general regulatory oversight by the Office of
Thrift Supervision ("OTS"), the Bank is required to maintain minimum levels of
regulatory capital, including tangible, core and risk-based capital. At March
31, 1999 and December 31, 1998, the Bank was in compliance with all regulatory
capital requirements. OTS prompt corrective action (PCA) regulations include
five capital tiers ranging from well capitalized to critically undercapitalized.
At March 31, 1999 and December 31, 1998, the Bank met the definition of a
well-capitalized institution.
14
The following table sets forth the Bank's capital amounts and ratios
regarding actual and minimum tangible, core, and risk-based capital
requirements, together with the amounts and ratios required in order to meet the
definition of a "well capitalized" institution.
Minimum Capital Well Capitalized
Requirements Requirements Actual
--------------------- --------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
-------- --------- --------- --------- --------- ---------
As of March 31, 1999:
Total capital
(to risk-weighted assets) $22,290 8.00% $27,862 10.00% $32,937 11.82%
Tier 1 capital
(to risk-weighted assets) N/A N/A 16,556 6.00% 30,240 10.96%
Tier 1 capital
(to adjusted assets) 17,382 4.00% 21,728 5.00% 30,240 6.96%
Tangible capital
(to tangible assets) 6,518 1.50% N/A N/A 30,240 6.96%
As of December 31, 1998:
Total capital
(to risk-weighted assets) $21,980 8.00% $27,475 10.00% $31,882 11.60%
Tier 1 capital
(to risk-weighted assets) N/A N/A 16,334 6.00% 29,319 10.77%
Tier 1 capital
(to adjusted assets) 17,522 4.00% 21,902 5.00% 29,319 6.69%
Tangible capital
(to tangible assets) 6,571 1.50% N/A N/A 29,319 6.69%
Liquidity
The Company's primary sources of funds are customer deposits,
principal, and interest payments on loans and mortgage-backed 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 are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions, and competition.
The Company is required by OTS regulations to maintain an average daily
balance of liquid assets in each calendar quarter of not less than 4% of either
the amount of its liquidity base at the end of the preceding calendar quarter or
the average daily balance of its liquidity base during the preceding calendar
quarter. In addition to this minimum requirement, the Bank is required to
maintain sufficient liquidity to ensure its safe and sound operations. The
minimum liquidity requirement may be changed by the OTS to any amount within the
range of 4% to 10%, depending upon economic conditions and the savings deposit
flows of savings institutions. Monetary penalties may be imposed for failure to
meet these liquidity requirements. The Bank's average liquidity ratio for the
quarter ended March 31, 1999 was 7.3%, which exceeded the then-applicable
requirements. The Bank has never been subject to monetary penalties for failure
to meet its liquidity requirements. The Company's strategy generally is to
maintain its liquidity ratio at or near the required minimum in order to
maximize its yield on alternative investments.
Year 2000
The "Year 2000 issue" relates to the fact that many computer programs
use only two digits to represent a year, such as "98" to represent "1998," which
means that in the Year 2000 such programs could incorrectly treat the Year 2000
as the year 1900. This issue has grown in importance as the use of
15
computers and microchips have become more pervasive throughout the economy, and
interdependencies between systems have multiplied. The issue must be recognized
as a business problem, rather than simply a computer problem, because of the way
its effects could ripple through the economy. The Year 2000 issue could
materially and adversely affect the Company either directly or indirectly. This
could happen if any of its critical computer systems or equipment containing
embedded logic fail, if the local infrastructure (electric power, phone system,
or water system) fails, if its significant vendors are adversely impacted, or if
its borrowers or depositors are adversely impacted by their internal systems or
those of their customers or suppliers. Failure of the Company to complete
testing and renovation of its critical systems on a timely basis, could have a
material adverse effect on the Company's financial condition and results of
operations, as could Year 2000 problems faced by others with whom the Company
does business.
Federal banking regulators have responsibility for supervision and
examination of banks to determine whether each institution has an effective plan
for identifying, renovating, testing and implementing solutions for Year 2000
processing and coordinating Year 2000 processing capabilities with its
customers, vendors and payment system partners. Bank examiners are also required
to assess the soundness of a bank's internal controls and to identify whether
further corrective action may be necessary to assure an appropriate level of
attention to Year 2000 processing capabilities.
The Company has a written plan to mitigate the risks associated with
the impact of the Year 2000. The plan directs the Company's Year 2000 activities
under the framework of the Federal Financial Institutions Examination Council
(FFIEC) five-step program. The FFIEC's five-step program includes the following
phases: awareness, assessment, renovation, validation, and implementation. The
awareness phase, which the Company has completed, discusses the Year 2000
problem and gains executive level support for the necessary resources to prepare
the Company for Year 2000 compliance. The assessment phase, which the Company
has also completed, assesses the size and complexity of the problem and details
the magnitude of the effort necessary to address the Year 2000 issues. Although
the awareness and assessment phases are completed, the Company will continue to
evaluate any new issues as they arise. In the renovation phase, which the
Company has substantially completed, the required incremental changes to
hardware and software components are tested. In the validation stage, which the
Company has also substantially completed, the hardware and software components
are tested.
The Company is utilizing both internal and external sources to
identify, correct or reprogram, and test its systems for Year 2000 compliance.
The Company has identified fifteen applications which management believes are
material to the Company's operations. Based on information received from its
vendors and testing results, the Company believes approximately 90% of such
applications are Year 2000 compliant as of March 31, 1999. The testing of the
critical system applications for core banking product provided by the Company's
primary vendor was completed, and results verified during November and December
1998.
The core banking product includes software solutions for checking,
savings, time certificates of deposit, general ledger, accounts payable,
automated clearing house, individual retirement accounts, commercial, mortgage
and installment loans, proof of deposit and ancillary supporting products.
The Company has identified two vendors that the Company does not
believe are fully Year 2000 compliant as of March 31, 1999. Each of those
vendors have advised the Company that it has completed the evaluation and
renovation stages of Year 2000 compliance and is scheduled to begin
implementation and validation beginning in January 1999, and all are scheduled
to complete final validation by June 30, 1999.
16
The Company is also making efforts to ensure that its customers,
particularly its significant customers, are aware of the Year 2000 problem. The
Company has sent Year 2000 correspondence to the Bank's significant deposit and
loan customers. A customer of the bank is deemed significant if the customer
possesses any of the following characteristics:
o Total indebtedness to the bank of $750,000 or more.
o Credit risk rating of five (substandard) or higher.
o The customers business is dependent on the use of high technology
and/or the electronic exchange of information.
o The customer's business is dependent on third party providers of
data processing services or products.
o An average ledger deposit balance greater than $100,000 and more
than 12 transactions during the month.
The Company has amended its credit authorization documentation to
include consideration regarding the Year 2000 problem. The Company assesses its
significant customer's Year 2000 readiness and assigns an assessment of "low",
"medium", or "high" risks. Risk evaluation of the Bank's significant customers
was substantially completed by December 31, 1998. Any depositor determined to
have a high risk is scheduled for an evaluation by the Bank every 90 days until
the customer can be assigned a low risk assessment.
Because of the range of possible issues and large number of variables
involved, it is impossible to quantify the total potential cost of the Year 2000
problems, or to determine the Company's worst-case scenario in the event the
Company's Year 2000 remediation efforts or the efforts of those with whom it
does business are not successful. In order to deal with the uncertainty
associated with the Year 2000 problem, the Company has developed a contingency
plan to address the possibility that efforts to mitigate the Year 2000 risk are
not successful either in whole or part. These plans include manual processing of
information for critical information technology systems and increased cash on
hand. The contingency plans, including employee training, will be tested by June
3, 1999.
As of March 31, 1999, the Company had incurred approximately $220,000
in Year 2000 costs, which have been expensed as incurred. Year 2000-related
costs have been funded from the continuing operations of the Company and, as of
March 31, 1999, have constituted approximately 2% of the Company's information
systems expenses for 1999. The Company estimates that additional costs to
complete Year 2000 compliance will be approximately $100,000. This estimate
includes the cost of purchasing hardware and licenses for software programming
tools, the cost of the time of internal staff and the cost of consultants. The
estimate does not include the time that internal staff is devoting to testing
programming changes. Testing is not expected to add significant incremental
costs. Certain information system projects at the Company have been deferred as
a result of the Company's Year 2000 compliance efforts. However, these deferrals
are not expected to have a material effect on the Company's business.
Item 3. Quantitative and Qualitative Disclosure of Market Risk
For the above-captioned information, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Interest Rate
Sensitivity and Market Risk Analysis."
17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is involved as plaintiff or defendant in various legal
actions incident to its business, none of which is believed by management to be
material to the financial condition of the Company.
Item 2. Changes in Securities.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
On April 29, 1999, the Company entered into an agreement with Josiah T.
Austin, the beneficial owner of 339,205 shares, or approximately 9.7%
of the Company's outstanding common stock. Pursuant to the agreement,
Mr. Austin has been appointed a director of the Company for a term
expiring at the Company's 2000 annual meeting and has agreed to not
participate in a solicitation of proxies in opposition to any
recommendation of the Board of Directors during the term of the
agreement and to vote all shares of Company common stock beneficially
owned by him for the Board's nominees at the 1999 annual meting. The
Company has agreed to retain an investment-banking firm to advise the
Company concerning various means of enhancing shareholder value.
Item 6. Exhibits and Reports on Form 8-K.
Exhibit 3(i) - Certificate of Incorporation of Monterey Bay Bancorp,
Inc., incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1995.
Exhibit 3(ii) - Bylaws of Monterey Bay Bancorp, Inc., Incorporated by
reference to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.
Exhibit 10(i) - Settlement Agreement dated April 29, 1999 between
Monterey Bay Bancorp, Inc. and Josiah T. Austin.
Exhibit 10(ii) - Monterey Bay Bancorp, Inc. Stock Award Plan for
Outside Directors.
Exhibit 11.0 - Computation of per share earnings (filed herewith).
Exhibit 27.0 - Financial Data Schedule (filed herewith).
18
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.
MONTEREY BAY BANCORP, INC.
Date: May 12, 1999 By /s/ Marshall G. Delk
------------------------ --------------------------------------
Marshall G. Delk
President, Chief Operating Officer
and Chief Financial Officer
Date: May 12, 1999 By /s/ Philip Safran
------------------------ --------------------------------------
Philip Safran
Vice President
and Controller
19