AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 1, 2002
REGISTRATION NO. 333-99031
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------
PRE-EFFECTIVE
AMENDMENT NO. 3 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------------------
HARRINGTON WEST FINANCIAL GROUP, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 6035 48-1175170
(State or other jurisdiction of (Primary Standard Industrial Classification Code Number) (I.R.S. Employer
incorporation or organization) Identification No.)
610 ALAMO PINTADO ROAD
SOLVANG, CALIFORNIA 93463
(805) 688-6644
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
--------------------------------
CRAIG J. CERNY
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
HARRINGTON WEST FINANCIAL GROUP, INC.
610 ALAMO PINTADO ROAD
SOLVANG, CALIFORNIA 93463
(805) 688-6644
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
--------------------------------
WITH A COPY TO:
NORMAN B. ANTIN, ESQ.
JEFFREY D. HAAS, ESQ. DAVE M. MUCHNIKOFF, P.C.
KELLEY DRYE & WARREN LLP SILVER, FREEDMAN & TAFF, L.L.P.
8000 TOWERS CRESCENT DRIVE 1700 WISCONSIN AVENUE, N.W.
SUITE 1200 WASHINGTON, D.C. 20007
VIENNA, VIRGINIA 22182
--------------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box. [ ] _______
If this Form is filed to register additional securities for an
offering pursuant to Rule 462(b) under the Securities Act, please check the
following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. [ ] _______
If this Form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [ ] _______
If this Form is a post-effective amendment filed pursuant to Rule
462(d) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [ ] _______
If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
- --------------------------------- ------------------------------ ------------------------------
Title of Each Class of Proposed Maximum Aggregate Amount of
Securities to be Registered Offering Price (1) Registration Fee
- --------------------------------- ------------------------------ ------------------------------
Common Stock, $0.01 par
value $22,540,000 $0
- --------------------------------- ------------------------------ ------------------------------
(1) Estimated solely for the purpose of calculating the amount of the
registration fee pursuant to Rule 457(o).
* The registration fee of $2,074 was previously paid.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE
OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
================================================================================
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE CANNOT
SELL THESE SECURITIES UNTIL THE SECURITIES AND EXCHANGE COMMISSION DECLARES OUR
REGISTRATION STATEMENT EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE
SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE
WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED NOVEMBER 1, 2002
PROSPECTUS
1,400,000 SHARES
HARRINGTON WEST
FINANCIAL GROUP, INC. [HARRINGTON WEST LOGO]
COMMON STOCK
------------------------------
This is the initial public offering of Harrington West Financial Group, Inc.
common stock. We are selling 1,253,615 shares of common stock in this offering
and certain of our stockholders are selling 146,385 shares of common stock in
this offering. We will not receive any of the proceeds from the sale of shares
by the selling stockholders. We anticipate that the initial public offering
price will be between $12.00 and $14.00 per share. Application has been made to
have our common stock listed on the Nasdaq Market under the symbol "HWFG" upon
completion of this offering.
------------------------------
PRICE $ PER SHARE
------------------------------
<Table>
<Caption>
PER SHARE TOTAL
--------- --------
Public offering price....................................... $ $
Underwriting discounts and commissions(1)................... $ $
Proceeds, before expenses, to us............................ $ $
Proceeds, before expenses, to selling stockholders.......... $ $
</Table>
- ---------------
(1) Before certain adjustments. See "Underwriting."
The underwriter has a 30-day option to purchase up to 210,000 additional shares
of common stock from us to cover over-allotments, if any.
The underwriter expects the shares will be ready for delivery to purchasers in
book entry form only through the Depository Trust Company on November , 2002.
------------------------------
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 14.
------------------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is a
criminal offense.
------------------------------
RBC CAPITAL MARKETS
------------------------------
November , 2002.
[MAP/ARTWORK]
Center heading: Harrington West Financial Group, Inc. Locations
Left Heading: California-Central Coast. Below the heading is a graphic with the
corporate logos of Los Padres Bank and Harrington West Financial Group. Right of
the heading are two graphics. The first is a map of California noting the
location of the Central Coast. The second is a map of the Central Coast showing
the following locations using the appropriate corporate logo to indicate whether
the location is a branch of Los Padres Bank or Harrington West Financial Group:
Atascadero, San Luis Obispo, Pismo Beach, Nipomo, Santa Maria, Buellton,
Solvang, Golota and Ojai.
Right Heading: Kansas -- Kansas City Metro. Below the heading is a graphic with
the corporate logos of Harrington Bank and Harrington West Financial Group.
Right of the heading are two graphics. The first is a map of Kansas noting the
location of the Kansas City metropolitan area. The second is a map of the Kansas
City metropolitan area showing the following locations using the appropriate
corporate logo to indicate whether the location is a branch of Harrington Bank
or Harrington West Financial Group: Mission and Overland Park.
Right Heading: Arizona -- Phoenix Metro. Below the heading is a graphic with
the corporate logos of Los Padres Bank and Los Padres Mortgage. Right of the
heading are two graphics. The first is a map of Arizona noting the location of
the Phoenix metropolitan area. The second is a map of the Phoenix metropolitan
area showing the following locations using the appropriate corporate logo to
indicate whether the location is a branch of Los Padres Bank or Los Padres
Mortgage: Surprise, Scottsdale (Kierland Area), Scottsdale, West Phoenix,
Phoenix and Ahwatukee.
At the bottom of the page, the corporate logos of Harrington West Financial
Group, Inc., Los Padres Bank, Harrington Bank, Harrington Wealth Management and
Los Padres Mortgage are displayed from left to the right.
Below the corporate logos, there is the following language in small print:
Los Padres Mortgage Company is a joint venture with Resource Marketing Group,
Inc., the holding company for RE/MAX Achievers of Phoenix, Arizona.
Harrington Wealth Management has headquarters in Fishers, Indiana, with
investment and trust consultants in Solvang, California and Kansas City, Kansas.
Los Padres Bank -- Arizona and Los Padres Mortgage Company are scheduled to open
October 2002.
Harrington Bank in Overland Park, Kansas is scheduled to open in 2003.
THESE SECURITIES ARE NOT SAVINGS OR DEPOSIT ACCOUNTS AND ARE NOT INSURED BY
THE FEDERAL DEPOSIT INSURANCE CORPORATION, BANK INSURANCE FUND, SAVINGS
ASSOCIATION INSURANCE FUND OR ANY OTHER GOVERNMENTAL AGENCY.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS.
WE HAVE NOT, AND THE UNDERWRITER HAS NOT, AUTHORIZED ANY OTHER PERSON TO PROVIDE
YOU WITH DIFFERENT INFORMATION. IF ANYONE PROVIDES YOU WITH DIFFERENT OR
INCONSISTENT INFORMATION, YOU SHOULD NOT RELY ON IT. WE ARE NOT, AND THE
UNDERWRITER IS NOT, MAKING AN OFFER TO SELL THESE SECURITIES IN ANY JURISDICTION
WHERE THE OFFER OR SALE IS NOT PERMITTED. YOU SHOULD ASSUME THE INFORMATION
APPEARING IN THIS PROSPECTUS IS COMPLETE AND ACCURATE ONLY AS OF THE DATE ON THE
FRONT COVER OF THIS PROSPECTUS. OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF
OPERATIONS AND PROSPECTS MAY HAVE CHANGED SINCE THAT DATE.
INFORMATION CONTAINED ON OUR WEB SITE IS NOT PART OF THIS PROSPECTUS.
UNTIL ___________, 2002 ALL DEALERS THAT EFFECT TRANSACTIONS OF THESE
SECURITIES MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE
DEALER'S OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH
RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
TABLE OF CONTENTS
PAGE
----
Prospectus Summary..................................................................................................4
Recent Developments.................................................................................................9
Selected Consolidated Financial Information........................................................................12
Risk Factors.......................................................................................................14
Cautionary Statement Regarding Forward-Looking Statements..........................................................24
Use of Proceeds....................................................................................................25
Capitalization.....................................................................................................27
Dilution...........................................................................................................28
Trading History and Dividend Policy................................................................................29
Management's Discussion and Analysis of Financial Condition and Results of Operations..............................30
Business...........................................................................................................49
Management.........................................................................................................82
Regulation.........................................................................................................92
Principal and Selling Stockholders................................................................................101
Description of Capital Stock......................................................................................103
Underwriting......................................................................................................107
Shares Eligible for Future Sale...................................................................................109
Experts...........................................................................................................110
Legal Matters.....................................................................................................110
Where You Can Find More Information...............................................................................111
Index to Consolidated Financial Statements........................................................................112
3
PROSPECTUS SUMMARY
This summary provides an overview of selected information contained
elsewhere in this prospectus and does not contain all of the information you
should consider. Because this section is a summary, it may not contain all the
information that may be important to you. Therefore, you should read the entire
prospectus, including the "Risk Factors" section beginning on page 16 and the
consolidated financial statements and the notes to those statements, before
making a decision to invest in our common stock.
Unless otherwise stated, all information in this prospectus assumes:
- the underwriter will not exercise its over-allotment option to
purchase any of the 210,000 shares of our common stock subject to
that option;
- we have filed our amended and restated certificate of
incorporation to increase our authorized capital; and
- immediately preceding this offering, we will have completed a
3-for-1 stock split.
HARRINGTON WEST FINANCIAL GROUP, INC.
General. We are a diversified, community-based, financial institution
holding company headquartered in Solvang, California, and we conduct operations
primarily through Los Padres Bank, FSB a federally chartered savings bank. Los
Padres Bank provides an array of financial products and services for businesses
and retail customers through its nine full-service offices located on the
central coast of California and its Harrington Bank division, which operates
through one office located in the Kansas City metropolitan area. Los Padres Bank
is primarily engaged in attracting deposits from individuals and businesses and
using these deposits, together with borrowed funds, to originate single-family
and multi-family residential, commercial real estate, commercial business and
consumer loans. We also maintain a portfolio of highly liquid mortgage-backed
and related securities as a means of managing our excess liquidity and enhancing
our profitability. We utilize various interest rate contracts as a means of
managing our interest rate risk. We also operate Harrington Wealth Management
Company, which provides trust and investment management services to individuals
and small institutional clients, by employing a customized asset allocation
approach and investing predominantly in low fee, indexed mutual funds.
We are focused on providing our diversified products and personalized
service approach in three distinct markets: (i) the central coast of California,
(ii) the Kansas City metropolitan area and (iii) beginning in the fourth quarter
of 2002, the Phoenix/Scottsdale metropolitan area. We have targeted these
markets because of our senior management's extensive knowledge of these areas as
well as the anticipated continued economic growth and potential for business
development in these markets. In addition, our Chief Executive Officer, Craig J.
Cerny, resides in the Kansas City metropolitan area, where we maintain our
executive office and where our Harrington Bank division of Los Padres Bank
operates. We have one office in Mission, Kansas and we anticipate opening a
second branch in the Kansas City metropolitan area in mid-2003. We are also
opening a de novo office in the Phoenix/Scottsdale, Arizona metropolitan area in
the fourth quarter of 2002. Management estimates that it will take approximately
18 months from commencement of operations for each of our new branches to be
profitable and expects that we will incur average monthly losses of
approximately $35,000 for the Phoenix/Scottsdale, Arizona branch and $14,000 for
the Kansas City metropolitan area branch until each branch achieves
profitability. These estimates are based on our financial model which reflects
various assumptions, and we cannot give assurance that we will achieve
profitability when estimated or that losses will not be greater than
anticipated. Each of our markets has its own local independent management team
operating under the Los Padres or Harrington names. Our loan underwriting,
corporate administration, and treasury functions are centralized to create
operating efficiencies.
Summary Consolidated Financial Information. The following summary
presents our summary consolidated financial information for the six-months ended
June 30, 2002 and 2001 and the five years ended December 31, 2001. The summary
consolidated financial information set forth below should be read in conjunction
with, and is qualified in its entirety by, our historical consolidated financial
4
statements, including the related notes, included elsewhere in this prospectus.
You should also refer to "Selected Consolidated Financial Information."
AT OR FOR THE SIX MONTHS
ENDED JUNE 30, AT OR FOR THE YEAR ENDED DECEMBER 31,
--------------------- ----------------------------------------
2002 2001 2001 2000 1999
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income.......................................... $2,318 $2,002 $3,802 $2,581 $2,360
Diluted earnings per share ......................... 0.67 0.60 1.12 0.77 0.71
Total assets........................................ 683,648 565,990 670,323 484,969 495,191
Loans receivable, net............................... 431,408 371,741 449,709 395,537 384,223
Securities(1)....................................... 214,040 158,348 184,244 50,125 741
Trading account assets.............................. 2,076 3,658 2,751 3,964 86,174
Deposits............................................ 505,439 387,358 520,858 355,705 379,839
Number of branch operations......................... 10 8 10 7 9
Stockholders' equity................................ $ 32,023 $ 28,767 $ 30,144 $ 25,557 $ 23,736
Net charge offs to average loans outstanding........ -- -- -- -- 0.01%
AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997
-------- --------
Net income.......................................... $602 $881
Diluted earnings per share ......................... 0.20 0.33
Total assets........................................ 495,179 425,575
Loans receivable, net............................... 335,269 256,464
Securities(1)....................................... -- --
Trading account assets.............................. 128,730 149,450
Deposits............................................ 327,681 301,602
Number of branch operations......................... 9 7
Stockholders' equity................................ $ 21,376 $ 16,804
Net charge offs to average loans outstanding........ 0.10% 0.01%
- ----------------------
(1) Includes securities classified as available for sale and held to
maturity.
Strategic Expansion. Since our acquisition of Los Padres Bank in
1996, we have grown our assets, deposits and profits internally by opening de
novo branches and by hiring experienced bankers with existing customer
relationships in our markets, as well as through opportunistic branch
acquisitions. Although we intend to expand primarily through internal growth, we
will continue to explore opportunities to expand through acquisitions. In
November 2001, we acquired the Kansas City operations of Harrington Bank, FSB
and successfully retained their experienced commercial bankers. The Kansas
acquisition contributed $69.9 million in loans and $74.4 million in deposits. We
continue to operate in this market under the Harrington Bank name. The Kansas
City metropolitan area is attractive to us because our senior management has
extensive knowledge of and experience in such market and, as a result, we
believe that significant potential exists for commercial and retail business
development. The Kansas City market is also home to a large number of small to
medium sized businesses due to its central location in the U.S. The U. S. Census
Bureau reports that the Kansas City metropolitan area had a population of nearly
1.8 million people, grew by 12% from 1990 to 2000, and is growing at a rate of
approximately 1% annually. We anticipate opening a second branch office in the
Kansas City metropolitan area in mid 2003.
As the next step in our growth plan, we are opening a de novo office
in the Phoenix/Scottsdale metropolitan area in the fourth quarter of 2002. We
have selected the Phoenix/Scottsdale market for expansion because of our
expectations for continued growth in the real estate market in this area, which
corresponds well to our expertise in single-family residential and commercial
real estate secured lending and senior management's knowledge of this market
area. The Phoenix/Scottsdale market has generated over 30,000 housing starts
during the last three years. We also believe that the growth in the
Phoenix/Scottsdale market provides an attractive opportunity for our commercial
loan products and community banking approach, which will be directed by our
local senior management. The U. S. Census Bureau reports that the Phoenix
metropolitan statistical area had a population of over 3.2 million, representing
a 45% increase from 1990 to 2000. According to the U. S. Census Bureau, the
surrounding Maricopa County is the fastest growing county in the nation, and its
population increased by an additional 4% from April 1, 2000 to July 1, 2001.
Management estimates that it will take approximately 18 months from commencement
of operations for each of our new branches to be profitable and expects that we
will incur average monthly losses of approximately $35,000 for the
Phoenix/Scottsdale, Arizona branch and $14,000 for the Kansas City metropolitan
area branch until each branch achieves profitability. These estimates are based
on our financial model which reflects various assumptions, and we cannot give
assurance that we will achieve profitability when estimated or that losses will
not be greater than anticipated.
Los Padres Bank recently established Los Padres Mortgage Company
LLC, or Los Padres Mortgage. Los Padres Mortgage has entered into a
non-exclusive joint venture with Market Resources Inc., the owner of numerous
RE/MAX brokerage agencies in the Phoenix/Scottsdale metropolitan area. Based on
RE/MAX network referrals, Los Padres Mortgage will originate single-family
residential and commercial real estate loans primarily for sale to third party
investors. Los Padres Bank has the ability to engage in similar
5
relationships with other brokerage agencies in the Phoenix/Scottsdale
metropolitan area, subject to a right of first refusal in favor of Los Padres
Mortgage. Los Padres Bank will also have the opportunity to purchase select
single-family and commercial real estate loans from Los Padres Mortgage for its
portfolio.
We also intend to pursue expansion opportunities along California's
central coast in order to expand our presence, market share and geographic
coverage in that region. The three counties comprising California's central
coast are San Luis Obispo, Santa Barbara and Ventura, which according to the U.
S. Census Bureau, had a combined population of 1.4 million and was growing at a
rate of approximately 1.6% per year.
Our approach to expansion is predicated on recruiting key personnel
with strong community ties and relationships. We believe that by focusing on
experienced bankers who are established in their communities, we enhance our
market position and add profitable growth opportunities.
While we periodically engage in discussions with companies concerning
potential acquisition opportunities, we have no present agreements or
understandings with any party and there can be no assurance that we will be
successful in completing any acquisitions in the future.
Our Business Strategy. Our goal is to continue to enhance our
franchise value and earnings through controlled growth in our banking
operations, while maintaining the combination of community-oriented customer
service and sophisticated centralized financial management that have
characterized our success to date. Our strategy for achieving this goal is:
- Hiring Experienced Employees With A Customer Service Focus. We
provide personalized service and relationship banking to our
customers. Our ability to continue to attract and retain banking
professionals with significant experience in and knowledge of our
markets who share our customer service philosophy is key to our
success. By offering quick decision making in the delivery of
banking products and services, offering customized products where
appropriate, and providing customer access to our senior
managers, we distinguish ourselves from larger, regional banks
operating in our market areas, while our larger capital base and
product mix enable us to compete effectively against smaller
community banks.
- Expanding Our Product Offerings. We will diversify our loan
portfolio by continuing to grow our commercial and industrial
business lines, while still providing high quality loan products
for single-family and multi-family residential borrowers. We also
intend to selectively add additional products to provide
diversification of revenue sources and to capture our customer's
full relationship. As part of this strategy, we are focused on
increasing our deposit and loan fees and further developing our
wholesale banking activities that provide single-family loan
originations for other lenders. We intend to continue to expand
the wealth management area of our business by cross selling our
trust and investment products and services to our customers
through Harrington Wealth Management Company. Through Harrington
Wealth Management Company, we offer a wide range of financial
instruments and services, including low fee indexed mutual funds,
personal trusts, investment management, custody, estates,
guardianships, land trusts, and retirement plan services.
- Strategic Expansion. We will continue to expand our branch
network through de novo office openings in all of our markets.
We expect to open an office in the Phoenix/Scottsdale market in
the fourth quarter of 2002 and a second office located in the
Kansas City metropolitan area in mid 2003. These openings are
intended to capitalize on the opportunities these markets
present to us, with a view to continued growth in all of our
markets. We believe that our centralized underwriting,
administration and treasury functions enables us to increase
6
operating efficiencies over time. Acquisitions have played an
integral role in our past growth. We are committed to exploring
opportunistic controlled expansion of our franchise through
strategic acquisitions designed to increase our market share and
branch office locations. We believe that continued development
of the Los Padres and Harrington franchises will provide us with
additional profits over time and enhance our market and
franchise value.
- Using Financial Management Techniques to Manage Our Interest
Rate Risk and Enhance Our Profitability. We deploy our excess
capital in a portfolio of highly liquid mortgage backed and
related securities until we are able to reinvest these assets
into loans or other community banking assets. Our securities
portfolio is funded primarily by deposits and borrowings and is
managed to a short duration with the intention of creating
additional income and improving our return on equity. The
interest rate sensitivity of our investments, loans and funding
sources is reduced using various interest rate contracts,
including interest rate swaps, caps and floors and
exchange-traded futures and options. In selecting
mortgage-backed and related securities for our portfolio and in
pricing our loans, we employ option-adjusted spread pricing
analysis to ascertain the net risk-adjusted spread expected to
be earned on the various investments and loans. This analysis
considers the interest rate, prepayment, credit and liquidity
risks in an investment or loan, and we seek to select securities
and loans with the highest spread over funding costs after
covering the expected costs of the embedded risks. In this
manner, our securities portfolio can enhance our profitability
through interest earned on these securities over our funding
costs and through possible gains as a result of price changes
net of hedging activities.
Offices. Our headquarters are located at 610 Alamo Pintado Road,
Solvang, California 93463, and our telephone number at our headquarters is (805)
688-6644. Our executive offices are located at 10801 Mastin Boulevard, Suite
740, Overland Park, Kansas 66210, and our telephone number at our executive
offices is (913) 663-0180.
7
THE OFFERING
Common Stock offered by us................................. 1,253,615 shares
Common Stock offered by the selling stockholders........... 146,385 shares
Common Stock outstanding after this offering............... 4,607,951 shares
Initial public offering price.............................. Between $12.00 and $14.00 per share. Prior to this offering, there has
been no public market for our common stock. The offering price for our
common stock in this offering will be determined by negotiations
between us and the underwriter. For further information, please refer
to "Risk Factors--There has been no prior market for our common stock
and our stock price may be volatile."
Proposed Nasdaq National Market symbol..................... HWFG
Use of proceeds............................................ Our net proceeds from this offering are estimated to be approximately
$14.7 million based on an assumed offering price of $13.00 per share.
We will not receive any of the proceeds from the sale of shares by the
selling stockholders. We will use the net proceeds from this offering
primarily to support the continued growth of our business operations
and product lines and for general corporate purposes. We expect that
until we are able to utilize the full amount of the proceeds in our
business, we will use a portion of the proceeds to reduce the
outstanding balance on our existing revolving line of credit from
unaffiliated lenders and/or invest the proceeds in interest-bearing
investment grade fixed-income securities and mortgaged-backed
securities managed to a short duration.
Dividends.................................................. We currently pay a cash dividend of $0.033 per share per quarter, or
$0.13 per share per year. After this offering, we intend to continue
to pay cash dividends on a quarterly basis. The dividend rate and the
continued payment of dividends will depend on a number of factors
including our capital requirements, our financial condition and results
of operations, tax considerations, statutory and regulatory
limitations, and general economic conditions. We cannot assure you
that we will not reduce or eliminate dividends in the future.
Risk factors............................................... Investing in our common stock involves certain risks, which are
described under "Risk Factors," beginning on page 16 of this
prospectus.
The number of shares of common stock to be outstanding after this
offering is based upon the number of shares outstanding on September 30, 2002.
If the underwriter exercises its over-allotment option in full, 4,817,951 shares
of common stock will be outstanding after the offering. These amounts do not
include:
- 365,216 shares of common stock issuable upon the exercise of
outstanding stock options at exercise prices ranging between
$5.83 and $9.33 per share; and
- 125,598 shares of common stock reserved for issuance under our
stock option plan.
We have not issued any shares of common stock since June 30, 2002, which is the
date of the most recent financial information contained in this prospectus.
8
RECENT DEVELOPMENTS
(Dollars In Thousands, Except Per Share Data)
The following summary presents our selected consolidated financial information
at or for the three and nine months ended September 30, 2002 and 2001. Financial
information at or for the three and nine month periods ended September 30, 2002
and 2001 are derived from our unaudited consolidated financial statements,
which, in the opinion of management, include all adjustments (consisting only of
normal recurring accruals) necessary for a fair presentation of the results for
such periods. The selected historical consolidated financial and other data set
forth below should be read in conjunction with and is qualified in its entirely
by, our historical consolidated financial statements, including the related
notes, included elsewhere in the prospectus. Results for the three and nine
month periods ended September 30, 2002 are not necessarily indicative of our
expected results for the full year ending December 31, 2002.
<Table>
<Caption>
At September 30, At December 31,
2002 2001
---------------- ---------------
Selected Financial Condition Data:
Total assets $ 781,063 $ 670,323
Loans receivable net 421,349 449,709
Securities available for sale 314,770 181,627
Securities held to maturity 2,464 2,617
Trading account assets 2,008 2,751
Deposits 510,596 520,858
Federal Home Loan Bank Advances 209,000 96,403
Note payable 20,800 18,000
Stockholders' equity 31,444 30,144
</Table>
<Table>
<Caption>
At or For the Nine Months At or For the Three Months
Ended September 30, Ended September 30,
---------------------------------- ----------------------------------
2002 2001 2002 2001
--------------- --------------- --------------- ---------------
Selected Income Statement Data:
Interest income $ 32,552 $ 30,507 $ 11,101 $ 10,601
Interest expense 16,580 19,223 5,410 6,539
--------------- --------------- --------------- ---------------
Net interest income 15,972 11,284 5,691 4,062
Provision for loan losses 325 1 50 --
--------------- --------------- --------------- ---------------
Net interest income after provision
for loan losses 15,647 11,283 5,641 4,062
Other Income:
Income (loss) from trading account
assets (165) 375 (69) (351)
Gain on sale of loans -- 69 -- --
Other income(1) 1,204 627 295 259
Other expenses:
Salaries and employee benefits 5,663 3,868 1,893 1,328
Premises and equipment 1,568 1,170 552 408
Other expenses(2) 3,249 2,392 1,155 749
--------------- --------------- --------------- ---------------
Income before income taxes 6,206 4,924 2,267 1,485
Income taxes 2,550 2,058 929 621
--------------- --------------- --------------- ---------------
Net Income $ 3,656 $ 2,866 $ 1,338 $ 864
=============== =============== =============== ===============
Common Stock Summary:
Diluted earnings per share $ 1.05 $ 0.85 $ 0.38 $ 0.26
=============== =============== =============== ===============
Dividends per share 0.09 0.08 0.03 0.03
Stockholders' equity per share 9.37 8.51 9.37 8.51
Diluted weighted average shares
outstanding 3,484,511 3,382,956 3,484,511 3,378,648
=============== =============== =============== ===============
</Table>
9
<Table>
<Caption>
At or For the Nine Months At or For the Three Months
Ended September 30, Ended September 30,
------------------------- --------------------------
2002 2001 2002 2001
-------- -------- ------ --------
Selected Operating Date(3):
Performance Ratios and Other Data:
Return on average assets 0.67% 0.69% 0.73% 0.58%
Return on average equity 15.83 14.12 16.87 12.06
Equity to assets 4.03 4.63 4.03 4.63
Interest rate spread(4) 3.04 2.63 3.14 2.70
Net interest margin(4) 3.21 2.91 3.30 2.97
Average interest-earning assets to
average interest-bearing
liabilities 105.07 105.78 105.13 105.69
Total noninterest expenses to
average total assets 2.04 1.80 2.11 1.88
Efficiency ratio(5) 62.19 62.38 60.65 57.51
Asset Quality Ratios(6):
Non-performing assets and troubled
debt restructurings to total assets 0.28% 0.10% 0.28% 0.10%
Non-performing loans and troubled debt
restructurings to total loans 0.51 0.17 0.51 0.17
Allowance for loan losses to total loans 0.95 0.83 0.95 0.83
Allowance for loan losses to total
non-performing loans and troubled
debt restructurings 186.81 501.68 186.81 501.68
Net charge-offs to average loans outstanding -- -- -- --
</Table>
(1) Consists of service charges, wholesale mortgage banking income, trust
income, other commissions and fees and other miscellaneous noninterest
income.
(2) Consists of computer services, consulting fees, marketing and other
miscellaneous noninterest expenses.
(3) With the exception of return on average assets and return on average equity
(which are based on average month-end balances), all ratios are based on
average daily balances. All ratios are annualized where appropriate.
(4) Interest rate spread represents, the difference between the weighted
average yield on interest-earning assets and the weighted average
rate on interest-bearing liabilities. Net interest margin represents net
interest income as a percentage of average interest-earning assets.
(5) Efficiency ratio represents noninterest revenues as a percentage of the
aggregate of net interest income after provision for loan losses and
noninterest income excluding gains on sales of securities deposits and
loans.
(6) Non-performing loans generally consist of non-accrual loans and
non-performing assets generally consist of non-performing loans and real
estate acquired by foreclosure or deed-in-lieu thereof.
Results of Operations
We reported net income of $3.7 million for the nine months ended
September 30, 2002, as compared to $2.9 million for the nine months ended
September 30, 2001, an increase of $790,000 or 27.6%. We reported net income of
$1.3 million for the three months ended September 30, 2002, as compared to
$864,000 for the three months ended September 30, 2001, an increase of $474,000
or 54.9%. The increases in our net income during the nine and three month
periods primarily reflected our significant increases in net interest income and
miscellaneous other income, which were partially offset by increases in total
other expenses during such periods. On a diluted earnings per share basis, we
earned $1.05 and $0.38 for the nine and three months ended September 30, 2002,
as compared to $0.85 and $0.26 for the nine and three months ended September 30,
2001.
Our net interest income after provision for loan losses increased by
$4.4 million or 38.7% to $15.6 million during the nine months ended September
30, 2002 and increased by $1.6 million or 38.9% in $5.6 million during the three
months ended September 30, 2002, in each case, over the prior comparable periods
in 2001. The increase in our net interest income during the nine and three month
periods reflected the continued growth in our earning assets and our increased
focus on higher spread-earning loans, primarily commercial and industrial and
commercial real estate and multi-family residential real estate loans. In
addition, we recognized a 41 basis point increase
10
in our interest rate spread during the nine months ended September 30, 2002 and
a 44 basis point increase in our interest rate spread during the three months
ended September 30, 2002, in each case, when compared to the same periods in
2001. The increases in our interest rate spread reflected the change in our
loan mix to higher spread-earning loans and, to a lesser extent, the benefit of
our liabilities repricing faster than our assets as market interest rates
declined.
We increased our provisions for loan losses by $324,000 during the nine
months ended September 30, 2002 and by $50,000 during the three months ended
September 30, 2002, in each case, as compared to the same periods in 2001. These
provisions reflect the required reserves based upon, among other things, our
analysis of the composition, credit quality and growth of our commercial real
estate and commercial and industrial loan portfolios. At September 30, 2002, our
non-performing assets amounted to $2.2 million or 0.51% of total loans, as
compared to $497,000 or 0.11% of total loans as of December 31, 2001.
Our total other income amounted to $1.0 million during both the nine
months ended September 30, 2002 and 2001 and $226,000 during the three months
ended September 30, 2002, as compared to $(92,000) during the three months ended
September 30, 2001. Miscellaneous other income, consisting primarily of fee
income from wholesale banking trust services and deposits and loans, increased
by 92.0% to $1.2 million for the nine months ended September 30, 2002, as
compared to $627,000 for the nine months ended September 30, 2001, due to the
growth of our mortgage banking business and the addition of our trust operation.
Miscellaneous other income increased by 13.9% to $295,000 for the three months
ended September 30, 2002 from $259,000 for the three months ended September 30,
2001 due to the growth in banking fee income. During the nine and three months
ended September 30, 2002, miscellaneous other income included a $160,000 charge
relating to the write-off of computer equipment in connection with an operating
system upgrade. Excluding such charge, miscellaneous other income would have
amounted to $1.4 million for the nine months ended September 30, 2002 and
$455,000 for the three months ended September 30, 2002. Total other income was
also impacted by gains and losses from trading account assets which fluctuate
based upon changes in market spreads.
Our total other expenses increased by $3.1 million or 41.0% during the
nine months ended September 30, 2002, as compared to the same period in 2001 and
by $1.1 million or 44.9% during the three months ended September 30, 2002, as
compared to the same period in 2001. During both the three and nine month
periods ended September 30, 2002, the increase in salaries and employee benefits
over the comparable periods was primarily due to an increase in the number of
employees due to the opening of a new California branch office in Nipomo,
California in July 2001 and the acquisition of the Harrington Bank of Kansas
branch in November 2001, together with our general growth in operations. During
both the three and nine month periods ended September 30, 2002, the increase in
premises and equipment expense over the comparable periods was due to the branch
openings and acquisition of our Kansas banking operation, noted above. During
both the three and nine month periods ended September 30, 2002, the increase in
other expenses over the comparable periods, consisting primarily of computer
services and consulting fees, was due to the general growth over the periods.
Financial Condition
Our total assets increased to $781.1 million at September 30, 2002, an
increase of $110.7 million or 16.5% from December 31, 2001. The increase was
primarily attributable to a $133.1 million or 73.3% increase in securities
classified as available for sale, which consist of mortgage-backed and related
securities. We increase our portfolio of such securities due to favorable market
opportunities during the nine months ended September 30, 2002. The increase in
our available for sale securities portfolio was primarily funded by a $112.6
million of 116.8% increase in advances from the FHLB of San Francisco. Although
our net loans receivable declined from $449.7 million at December 31, 2001 to
$421.3 million at September 30, 2002, our ratio of multi-family residential and
commercial real estate loans and commercial and industrial loans as a percent of
total loans increased from 56.7% at December 31, 2001 to 59.9% at September 30,
2002. Our stockholders' equity increased by $1.3 million to $31.4 million at
September 30, 2002, due primarily to net income recognized during the nine
months ended September 30, 2002. Our stockholders' equity was also affected by
unrealized gains and losses on securities and interest rate contracts and
dividends paid on our common stock.
We declared a $0.04 per share dividend on our outstanding common stock
on October 16, 2002, payable on November 7, 2002 to stockholders of record on
October 24, 2002.
11
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The following summary presents our selected consolidated financial
information at or for the six months ended June 30, 2002 and 2001 and at or for
the five years ended December 31, 2001. Financial information at or for each
of the five years ended December 31, 2001 is derived from our audited
consolidated financial statements. Financial information at or for the six
month periods ended June 30, 2002 and 2001 are derived from our unaudited
consolidated financial statements, which, in the opinion of management,
include all adjustments (consisting only of normal recurring accruals)
necessary for a fair presentation of the results for such periods. The
selected historical consolidated financial and other data set forth below
should be read in conjunction with, and is qualified in its entirety by, our
historical consolidated financial statements, including the related notes,
included elsewhere in this prospectus. Results for the six month period
ended June 30, 2002 are not necessarily indicative of our expected
results for the full year ending December 31, 2002.
AT OR FOR THE SIX MONTHS
ENDED JUNE 30,
------------------------
2002 2001
--------- ---------
SELECTED FINANCIAL CONDITION DATA:
Total assets..................................... $683,648 $565,990
Loans receivable, net............................ 431,408 371,741
Securities available for sale.................... 211,550 155,654
Securities held to maturity...................... 2,490 2,694
Trading account assets........................... 2,076 3,658
Deposits......................................... 505,439 387,358
Federal Home Loan Bank advances.................. 123,403 136,403
Note payable..................................... 16,600 9,300
Stockholders' equity............................. 32,023 28,767
SELECTED INCOME STATEMENT DATA:
Interest income.................................. $21,451 $19,906
Interest expense................................. 11,170 12,684
--------- ---------
Net interest income.............................. 10,281 7,222
Provision (credit) for loan losses............... 275 1
--------- ---------
Net interest income after provision (credit) for
loan losses................................... 10,006 7,221
Other income:
Income (loss) from trading account assets.... (95) 726
Gain on sale of deposits..................... -- --
Gain (loss) on sale of loans................. -- 69
Other income(1).............................. 908 368
Other expenses:
Salaries and employee benefits................ 3,941 2,558
Premises and equipment........................ 1,022 764
Other expenses(2)............................. 1,917 1,623
--------- ---------
Income before income taxes....................... 3,939 3,439
Income taxes..................................... 1,621 1,437
--------- ---------
Net income....................................... $2,318 $2,002
========= =========
COMMON STOCK SUMMARY:
Diluted earnings per share....................... $0.67 $0.60
Dividends per share.............................. 0.05 0.05
Stockholders' equity per share................... 9.55 8.58
Diluted weighted average shares outstanding...... 3,484,518 3,351,093
AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
SELECTED FINANCIAL CONDITION DATA:
Total assets..................................... $670,323 $484,969 $495,191 $495,179 $425,575
Loans receivable, net............................ 449,709 395,537 384,223 335,269 256,464
Securities available for sale.................... 181,627 47,438 -- -- --
Securities held to maturity...................... 2,617 2,687 741 -- --
Trading account assets........................... 2,751 3,964 86,174 128,730 149,450
Deposits......................................... 520,858 355,705 379,839 327,681 301,602
Federal Home Loan Bank advances.................. 96,403 91,000 71,000 134,029 51,170
Note payable..................................... 18,000 9,000 7,665 8,200 9,000
Stockholders' equity............................. 30,144 25,557 23,736 21,376 16,804
SELECTED INCOME STATEMENT DATA:
Interest income.................................. $41,168 $39,143 $36,941 $32,903 $26,671
Interest expense................................. 25,817 27,245 24,546 23,500 19,089
--------- --------- --------- --------- ---------
Net interest income.............................. 15,351 11,898 12,395 9,403 7,582
Provision (credit) for loan losses............... 1 42 155 (32) (117)
--------- --------- --------- --------- ---------
Net interest income after provision (credit) for
loan losses................................... 15,350 11,856 12,240 9,435 7,699
Other income:
Income (loss) from trading account assets.... 436 (2,754) (555) (1,822) (755)
Gain on sale of deposits..................... -- 3,923 -- -- --
Gain (loss) on sale of loans................. 69 (601) -- -- --
Other income(1).............................. 996 554 1,023 685 352
Other expenses:
Salaries and employee benefits................ 5,444 3,942 4,064 3,281 2,724
Premises and equipment........................ 1,631 1,357 1,503 1,105 814
Other expenses(2)............................. 3,242 3,097 3,002 2,874 2,261
--------- --------- --------- --------- ---------
Income before income taxes....................... 6,534 4,582 4,139 1,038 1,497
Income taxes..................................... 2,732 2,001 1,779 436 616
--------- --------- --------- --------- ---------
Net income....................................... $3,802 $2,581 $2,360 $602 $881
========= ========= ========= ========= =========
COMMON STOCK SUMMARY:
Diluted earnings per share....................... $1.12 $0.77 $0.71 $0.20 $0.33
Dividends per share.............................. 0.11 0.30 -- -- --
Stockholders' equity per share................... 8.99 7.87 7.31 6.58 6.26
Diluted weighted average shares outstanding...... 3,396,885 3,331,857 3,313,938 3,027,519 2,684,148
12
AT OR FOR THE SIX MONTHS
ENDED JUNE 30,
------------------------
2002 2001
--------- ---------
SELECTED OPERATING DATA(3):
PERFORMANCE RATIOS AND OTHER DATA:
Return on average assets......................... 0.68% 0.76%
Return on average equity......................... 14.91 14.74
Equity to assets................................. 4.68 5.08
Interest rate spread(4).......................... 3.00 2.61
Net interest margin(4)........................... 3.18 2.91
Average interest-earning assets to average
interest-bearing liabilities.................. 105.04 105.82
Total noninterest expenses to average total
assets........................................ 2.03 1.88
Efficiency ratio(5).............................. 63.04 65.16
ASSET QUALITY RATIOS(6):
Non-performing assets and troubled debt
restructurings to total assets................ 0.27 0.11
Non-performing loans and troubled debt
restructurings to total loans................. 0.43 0.15
Allowance for loan losses to total loans......... 0.92 0.76
Allowance for loan losses to total
non-performing loans and troubled debt 214.95 511.36
restructurings................................
Net charge-offs to average loans outstanding..... -- --
BANK REGULATORY CAPITAL RATIOS(7):
Tier 1 risk-based capital ratio.................. 11.10 11.39
Total risk-based capital ratio................... 12.14 12.38
Tier 1 leverage capital ratio.................... 6.26 6.30
AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
SELECTED OPERATING DATA(3):
PERFORMANCE RATIOS AND OTHER DATA:
Return on average assets......................... 0.66% 0.53% 0.48% 0.13% 0.24%
Return on average equity......................... 13.65 10.47 10.46 3.16 5.38
Equity to assets................................. 4.50 5.27 4.79 4.32 3.95
Interest rate spread(4).......................... 2.55 2.02 2.20 1.89 1.82
Net interest margin(4)........................... 2.81 2.30 2.41 2.06 2.05
Average interest-earning assets to average
interest-bearing liabilities.................. 105.51 105.17 104.53 103.27 104.36
Total noninterest expenses to average total
assets........................................ 1.79 1.54 1.58 1.55 1.53
Efficiency ratio(5).............................. 63.12 67.66 64.61 71.74 72.03
ASSET QUALITY RATIOS(6):
Non-performing assets and troubled debt
restructurings to total assets................ 0.07 0.69 0.30 0.70 2.46
Non-performing loans and troubled debt
restructurings to total loans................. 0.11 0.84 0.38 1.02 4.04
Allowance for loan losses to total loans......... 0.83 0.79 0.80 0.88 1.28
Allowance for loan losses to total
non-performing loans and troubled debt
restructurings................................ 751.71 93.69 209.14 86.38 31.74
Net charge-offs to average loans outstanding..... -- -- 0.01 0.10 0.01
BANK REGULATORY CAPITAL RATIOS(7):
Tier 1 risk-based capital ratio.................. 10.76 10.55 9.48 10.41 11.74
Total risk-based capital ratio................... 11.72 11.56 10.38 11.41 12.99
Tier 1 leverage capital ratio.................... 6.27 6.76 6.09 5.74 5.60
- ------------------------
(1) Consists of service charges, wholesale mortgage banking income, other
commissions and fees and other miscellaneous noninterest income.
(2) Consists of computer services, consulting fees, marketing and other
miscellaneous noninterest expenses.
(3) With the exception of return on average assets and return on average equity,
all ratios calculated subsequent to March 31, 1999 are based on average
daily balances while all ratios calculated prior to March 31, 1999 are based
on average month-end balances. All ratios are annualized where appropriate.
(4) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average rate on
interest-bearing liabilities. Net interest margin represents net interest
income as a percentage of average interest-earning assets.
(5) Efficiency ratio represents noninterest expenses as a percentage of the
aggregate of net interest income after provision for loan losses and
noninterest income, excluding gains on sales of securities, deposits and
loans.
(6) Non-performing loans generally consist of non-accrual loans and
non-performing assets generally consist of non-performing loans and real
estate acquired by foreclosure or deed-in-lieu thereof.
(7) For additional information on Los Padres Bank's regulatory capital
requirements, see "Regulation - Los Padres Bank - Regulatory Capital
Requirements and Prompt Corrective Action."
13
RISK FACTORS
You should carefully read the following risk factors before you
decide to buy any of our common stock. You should also consider the other
information in this prospectus.
RISKS RELATING TO THIS OFFERING
THERE HAS BEEN NO PRIOR MARKET FOR OUR COMMON STOCK AND OUR STOCK PRICE MAY BE
VOLATILE.
Prior to this offering, there has been no public market for our common
stock. The offering price for our common stock in this offering will be
determined by negotiations between us and the underwriter. Among the factors to
be considered in determining the offering price of our common stock, in addition
to prevailing market conditions, will be our historical performance, estimates
regarding our business potential and earnings prospects, an assessment of our
management and the consideration of the above factors in relation to market
valuation of companies in related businesses. We believe that each of these
factors is important, but we are unable to quantify or otherwise indicate the
relative importance of each of these factors. The initial public offering price
of our common stock may bear no relationship to the price at which our common
stock will trade upon completion of this offering. The stock market has
experienced significant price and volume fluctuations recently and you may not
be able to resell your shares at or above the initial public offering price.
YOU WILL EXPERIENCE SUBSTANTIAL DILUTION IN THE VALUE OF YOUR SHARES IMMEDIATELY
FOLLOWING THIS OFFERING.
Investors purchasing shares of our common stock in this offering will
pay more for their shares than the amount paid by existing stockholders who
acquired shares prior to this offering. Accordingly, if you purchase common
stock in this offering, you will incur immediate dilution in pro forma net
tangible book value of approximately $4.02 per share based on an assumed
offering price of $13.00 per share. If the holders of outstanding options
exercise those options, you will incur further dilution. See "Dilution."
WE CANNOT BE SURE THAT A PUBLIC TRADING MARKET FOR OUR COMMON STOCK WILL DEVELOP
OR BE MAINTAINED.
We have applied to list our common stock for quotation on the Nasdaq
National Market under the symbol "HWFG." There can be no assurance, however,
that an established and liquid trading market for our common stock will develop,
that it will continue if it does develop, or that after the completion of the
offering, the common stock will trade at or above the initial public offering
price set forth on the cover of this prospectus. The underwriter has advised us
that it intends to make a market in our common stock and to assist in obtaining
at least two other market makers for our common stock as required by the Nasdaq
National Market. Neither the underwriter nor any other broker-dealer is
obligated, however, to make a market in our common stock, and any market making
may be discontinued at any time in the sole discretion of the party making a
market. In addition, the substantial amount of common stock that is owned by our
directors, executive officers and certain other individuals as described above
under "-Our ownership is concentrated" and "Principal and Selling Stockholders"
may adversely affect the development of an active and liquid trading market.
WE MAY SPEND THE PROCEEDS OF THIS OFFERING IN WAYS WITH WHICH YOU MAY NOT AGREE.
We will have broad discretion as to the use of the net proceeds of
this offering. Accordingly, investors in this offering will be relying on
management's judgment with only limited information about our specific
intentions regarding the use of proceeds. We may spend most of the net proceeds
from this offering in ways with which you may not agree. Our failure to apply
these funds effectively could materially and adversely affect our business,
financial condition, prospects and profitability.
AFTER AN INITIAL PERIOD OF RESTRICTION, THERE WILL BE A SIGNIFICANT NUMBER OF
SHARES OF OUR COMMON STOCK AVAILABLE FOR FUTURE SALE, WHICH MAY DEPRESS OUR
STOCK PRICE.
The market price of our common stock could decline as a result of
sales of substantial amounts of our common stock in the public market after the
closing of this offering, or even the perception that such sales could occur.
We, our directors and executive officers, and certain of our stockholders have
also agreed not to, offer, sell, contract to sell or otherwise dispose of, any
common stock or options to acquire our common stock, for a period of 180 days
after the date of this prospectus without the prior written consent of the
underwriter.
Notwithstanding these arrangements, there will be 4,973,167 shares of
common stock outstanding or subject to currently exercisable options immediately
following this offering, or 5,183,167 shares if the underwriter exercises its
over-allotment option in full. The 1,400,000 shares sold in this offering (or
1,610,000 shares if the underwriter exercises its over-allotment option in full)
will be freely tradable without restriction. In addition, the following will be
available for sale in the public market as follows:
- 678,618 shares will be eligible for sale upon completion of this
offering;
- 21,854 shares will be eligible for sale 90 days after the date of
this prospectus; and
- 2,841,714 shares will be eligible for sale 180 days after the
date of this prospectus upon the expiration of the lock-up
agreements described above.
RISKS RELATING TO OUR BUSINESS
OUR BUSINESS IS SUBJECT TO VARIOUS LENDING RISKS WHICH COULD
ADVERSELY IMPACT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
Our commercial real estate and multi-family residential loans involve
higher principal amounts than other loans, and repayment of these loans may be
dependent on factors outside our control or the control of our borrowers. At
June 30, 2002, commercial real estate loans totaled $152.4 million, or 35.0%, of
our total loan portfolio while multi-family real estate loans totaled $70.5
million, or 16.2%, of our total loan portfolio. Commercial and multi-family real
estate lending typically involves higher loan principal amounts and the
repayment of such loans generally is dependent, in large part, on the successful
operation of the property securing the loan or the business conducted on the
property securing the loan. These loans may be more adversely affected by
conditions in the real estate markets or in the economy generally. For example,
if the cash flow from the borrower's project is reduced due to leases not being
obtained or renewed, the borrower's ability to repay the loan may be impaired.
In addition, many of our commercial real estate and multi-family residential
loans are not fully amortizing and contain large balloon payments upon maturity.
Such balloon payments may require the borrower to either sell or refinance the
underlying property in order to make the payment.
Repayment of our commercial and industrial loans is often dependent
on the cash flows of the borrower, which may be unpredictable, and the
collateral securing these loans may fluctuate in value. At June 30, 2002,
commercial and industrial loans totaled $31.1 million, or 7.1%, of our total
loan portfolio. Our commercial and industrial loans are primarily made based on
the identified cash flow of the borrower and secondarily on the underlying
collateral provided by the borrower. Most often, this collateral consists of
accounts receivable, inventory or equipment. Credit support provided by the
borrower for most of these loans and the probability of repayment is based on
the liquidation of the pledged collateral and enforcement of a personal
guarantee, if any exists. As a result, in the case of loans secured by accounts
receivable, the availability of funds for the repayment of these loans may be
substantially dependent on the ability of the borrower to collect amounts due
from its customers. The collateral securing other loans may depreciate over
time, may be difficult to appraise and may fluctuate in value based on the
success of the business.
Our construction loans are based upon estimates of costs and value
associated with the complete project. These estimates may be inaccurate. At June
30, 2002, construction loans totaled $27.0 million, or 6.2%, of our total loan
portfolio while land acquisition and development loans totaled $6.8 million, or
1.6%, of our total loan portfolio. Construction and acquisition and development
lending involve additional risks because funds are advanced upon the security of
the project, which is of uncertain value prior to its completion. Because of the
uncertainties inherent in estimating construction costs, as well as the market
value of the completed project and the effects of governmental regulation of
real property, it is relatively difficult to evaluate accurately the total funds
required to complete a project and the related loan-to-value ratio. As a result,
construction loans and acquisition and development loans often involve the
disbursement of substantial funds with repayment dependent, in part, on the
success of the ultimate project and the ability of the borrower to sell or lease
the property or obtain permanent take-out financing, rather than the ability of
the borrower or guarantor to repay principal and interest. If our appraisal of
the value of the completed project proves to be overstated, we may have
inadequate security for the repayment of the loan upon completion of
construction of the project and may incur a loss.
14
Our consumer loans generally have a higher risk of default than our
other loans. At June 30, 2002, consumer loans totaled $13.7 million, or 3.2%, of
our total loan portfolio. Consumer loans typically have shorter terms and lower
balances with higher yields as compared to one- to four-family residential
mortgage loans, but generally carry higher risks of default. Consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be affected by adverse personal circumstances.
Furthermore, the application of various federal and state laws, including
bankruptcy and insolvency laws, may limit the amount which can be recovered on
these loans.
OUR ALLOWANCE FOR LOAN LOSSES MAY PROVE TO BE INSUFFICIENT TO ABSORB PROBABLE
LOSSES INHERENT IN OUR LOAN PORTFOLIO.
Like all financial institutions, every loan we make carries a certain
risk that it will not be repaid in accordance with its terms or that any
collateral securing it will not be sufficient to assure repayment. This risk is
affected by, among other things:
- cash flow of the borrower and/or the project being financed;
- in the case of a collateralized loan, the changes and
uncertainties as to the future value of the collateral;
- the credit history of a particular borrower;
- changes in economic and industry conditions; and
- the duration of the loan.
We maintain an allowance for loan losses which we believe is
appropriate to provide for any probable losses inherent in our loan portfolio.
The amount of this allowance is determined by management through a periodic
review and consideration of several factors which are discussed in more detail
under "Business - Asset Quality - Allowance For Loan Losses."
At June 30, 2002, our allowance for loan losses as a percentage of
total loans was 0.92%. Federal regulatory agencies, as an integral part of their
examination process, review our loans and allowance for loan losses. Although we
believe our loan loss allowance is adequate to absorb probable losses in our
loan portfolio, we cannot predict these losses or whether our allowance will be
adequate or that regulators will not require us to increase this allowance. Any
of these occurrences could materially and adversely affect our business,
financial condition, prospects and profitability.
OUR BUSINESS IS SUBJECT TO ECONOMIC AND OTHER GENERAL RISKS WHICH MAY ADVERSELY
IMPACT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
Changes in economic conditions, in particular an economic slowdown in
the markets in which we operate, could hurt our business. Our business is
directly affected by factors such as economic, political and market conditions,
broad trends in industry and finance, legislative and regulatory changes,
changes in government monetary and fiscal policies and inflation, all of which
are beyond our control. A deterioration in economic conditions, in particular an
economic slowdown in the markets in which we operate in California, Kansas or
Arizona, after we open our Phoenix/Scottsdale, Arizona office, could result in
the following consequences, any of which could materially and adversely affect
our business, financial condition, prospects and profitability:
- loan delinquencies may increase;
15
- problem assets and foreclosures may increase;
- demand for our products and services may decline;
- low cost or noninterest bearing deposits may decrease; and
- collateral for loans made by us, especially real estate, may
decline in value, in turn reducing customers' borrowing power.
A downturn in the real estate market may adversely affect our
business. A majority of the loans in our portfolio are secured by real estate.
Negative conditions in the real estate markets where collateral for a mortgage
loan is located could adversely affect the borrower's ability to repay the loan
and the value of the collateral securing the loan. Our ability to recover on
defaulted loans by selling the real estate collateral would then be diminished,
and we would be more likely to suffer losses on defaulted loans. As of June 30,
2002, approximately 90.0% of the book value of our loan portfolio consisted of
loans secured by various types of real estate. Approximately 86.1% of our real
property collateral is located in California and approximately 13.9% is located
in the Kansas City metropolitan area. If there is a significant decline in real
estate values, the collateral for our loans will provide less security. Real
estate values are affected by various other factors, including changes in
general or regional economic conditions, governmental rules or policies and
among other things, earthquakes and other national disasters particular to
California.
We are exposed to risk of environmental liabilities with respect to
properties to which we take title. In the course of our business, we may
foreclose and take title to real estate, and we could be subject to
environmental liabilities with respect to these properties. We may be held
liable to a governmental entity or to third parties for property damage,
personal injury, investigation and clean-up costs incurred by these parties in
connection with environmental contamination, or we may be required to
investigate or clean up hazardous or toxic substances or chemical releases at a
property. The costs associated with investigation or remediation activities
could be substantial. In addition, as the owner or former owner of a
contaminated site, we may be subject to common law claims by third parties based
on damages and costs resulting from environmental contamination emanating from
the property. If we ever become subject to significant environmental
liabilities, we could suffer a material and adverse effect on our business,
financial condition, prospects and profitability.
We may suffer losses in our loan portfolio despite our underwriting
practices. We seek to mitigate the risks inherent in our loan portfolio by
adhering to certain underwriting practices. These practices include analysis of
prior credit histories, financial statements, tax returns and cash flow
projections, valuation of collateral based on reports of independent appraisers
and verification of liquid assets. Although we believe that our underwriting
criteria are appropriate for the various kinds of loans we make, we may incur
losses on loans that meet our underwriting criteria, and these losses may exceed
the amounts set aside as reserves for losses in the allowance for loan losses.
OUR BUSINESS IS SUBJECT TO INTEREST RATE RISK AND VARIATIONS IN INTEREST RATES
MAY NEGATIVELY AFFECT OUR FINANCIAL PERFORMANCE.
Like other financial institutions, our operating results are largely
dependent on our net interest income. Net interest income is the difference
between interest earned on loans and securities and interest expense incurred on
deposits and borrowings. Our net interest income is impacted by changes in
market rates of interest, the interest rate sensitivity of our assets and
liabilities, prepayments on our loans and securities and limits on increases in
the rates of interest charged on our loans. We expect that we will continue to
realize income from the differential or "spread" between the interest earned on
loans,
16
securities and other interest-earning assets, and interest paid on deposits,
borrowings and other interest-bearing liabilities. Net interest spreads are
affected by the difference between the maturities and repricing characteristics
of interest-earning assets and interest-bearing liabilities.
We cannot control or accurately predict changes in market rates of
interest. The following are some factors that may affect market interest rates,
all of which are beyond our control:
- inflation;
- slow or stagnant economic growth or recession;
- unemployment;
- money supply and the monetary policies of the Federal Reserve
Board;
- international disorders; and
- instability in domestic and foreign financial markets.
We are vulnerable to an increase in interest rates because our
interest-earning assets generally have longer maturities than our
interest-bearing liabilities. Under such circumstances, material and prolonged
increases in interest rates will negatively affect our net interest income. In
addition, loan volume and yields are affected by market interest rates on loans,
and rising interest rates generally are associated with a lower volume of loan
originations. In addition, an increase in the general level of interest rates
may adversely affect the ability of certain borrowers to pay the interest on and
principal of their obligations. Accordingly, changes in levels of market
interest rates could materially and adversely affect our net interest spread,
asset quality, loan origination volume, securities portfolio, and overall
profitability. Although we attempt to manage our interest rate risk, we cannot
assure you that we can minimize our interest rate risk.
OUR INVESTMENT PORTFOLIO INCLUDES SECURITIES WHICH ARE SENSITIVE TO INTEREST
RATES AND WHICH WE MAY BE REQUIRED TO SELL AT A LOSS TO MEET OUR LIQUIDITY
NEEDS.
At June 30, 2002, our investment portfolio included $214.0 million of
securities, which are sensitive in value to interest rate fluctuations. Our
available for sale portfolio totaled $211.6 million at June 30, 2002. The
unrealized gains or losses in our available for sale portfolio are reported as a
separate component of stockholders' equity until realized upon sale. As a
result, future interest rate fluctuations may impact stockholders' equity,
causing material fluctuations from quarter to quarter. The risk of us realizing
a loss upon a sale in our available for sale portfolio is a function of our
liquidity needs and market conditions at the time of sale. Failure to hold our
securities until maturity or until market conditions are favorable for a sale
could materially and adversely affect our business, financial condition,
profitability and prospects.
WE INVEST IN INTEREST RATE CONTRACTS WHICH CAN CAUSE LOSSES TO US IN EXCESS OF
THE VALUE AT WHICH WE CARRY THESE INVESTMENTS.
We invest in interest rate contracts for the purpose of reducing
interest rate risk and, to a much more limited extent, to enhance spread income
through asset based interest rate swaps. These interest rate contracts may
include interest rate swaps, caps and floors and exchange traded futures and
options. At June 30, 2002, we had invested in interest rate swaps with an
aggregate notional amount of $73.9 million. Although, we have utilized caps,
floors and exchange traded futures and options in prior periods, as of June 30,
2002, we did not have any investments in such interest rate contracts. Interest
rate contracts can cause losses to us which will be reflected in our statements
of earnings, and the
17
maximum potential loss reflected in our statements of earnings may exceed the
value at which we carry these instruments. These losses result from changes in
the market values of such interest rate contracts. At June 30, 2002, the
approximate net market value of our interest rate contracts was $(2.2)
million. For additional information see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Asset and Liability Management."
Our interest rate contracts expose us to:
- basis or spread risk, which is the risk of loss associated with
variations in the spread between the interest rate contract and
the hedged item;
- credit risk, which is the risk of the insolvency or other
inability of another party to the transaction to perform its
obligations;
- interest rate risk;
- volatility risk, which is the risk that the expected uncertainty
relating to the price of the underlying asset differs from what
is anticipated; and
- liquidity risk.
If we suffer losses on our interest rate contracts, our business,
financial condition and prospects may be negatively affected, and our net income
will decline.
WE ARE SUBJECT TO EXTENSIVE REGULATION WHICH COULD ADVERSELY AFFECT OUR
BUSINESS.
Our operations are subject to extensive regulation by federal, state
and local governmental authorities and are subject to various laws and judicial
and administrative decisions imposing requirements and restrictions on part or
all of our operations. We believe that we are in substantial compliance in all
material respects with applicable federal, state and local laws, rules and
regulations. Because our business is highly regulated, the laws, rules and
regulations applicable to us are subject to regular modification and change.
There are currently proposed various laws, rules and regulations that, if
adopted, would impact our operations. In addition, the Financial Accounting
Standards Board, or FASB, is considering changes to applicable accounting
standards which may require, among other things, the expensing of the costs
related to the issuance of stock options. If these or any other laws, rules or
regulations are adopted in the future, they could make compliance much more
difficult or expensive, restrict our ability to originate, broker or sell loans,
further limit or restrict the amount of commissions, interest or other charges
earned on loans originated or sold by us or otherwise materially and adversely
affect our business, financial condition, prospects or profitability.
OUR CONTINUED PACE OF GROWTH MAY REQUIRE US TO RAISE ADDITIONAL CAPITAL IN THE
FUTURE, BUT THAT CAPITAL MAY NOT BE AVAILABLE WHEN IT IS NEEDED.
We are required by federal regulatory authorities to maintain adequate
levels of capital to support our operations. In addition, due to our business
strategy which has concentrated on growth and a shift in our lending focus to
more commercial lending and the size and character of our available for sale and
trading securities portfolio, we have agreed with our federal banking regulator,
the Office of Thrift Supervision, or OTS, that we will maintain a total
risk-based capital ratio and a leverage capital ratio of at least 11% and 6%,
respectively, which is in excess of the OTS' minimum requirements. Management
does not believe that Los Padres Bank's agreement with the OTS to maintain
increased ratios of total risk-based and leverage capital will limit or restrict
our operations. However, to the extent that Los Padres Bank fails to comply with
these additional increased capital ratios, the OTS could take such failure to
comply into consideration in connection with further requests to have Los Padres
Bank pay dividends to us and in additional future branch applications. Los
Padres Bank's failure to comply could also impact its overall assessment by the
OTS in future regulatory examinations, which, if adverse could also impact its
FDIC insurance assessment. See "Capitalization," "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources - Capital Resources," and "Regulation - Los Padres Bank -
Regulatory Capital Requirements and Prompt Corrective Action."
18
We anticipate that our existing capital resources will satisfy our
capital requirements for the foreseeable future. However, we may at some point
need to raise additional capital to support continued growth, both internally
and through acquisitions. Our ability to raise additional capital, if needed,
will depend on conditions in the capital markets at that time, which are outside
our control, and on our financial performance. Accordingly, we cannot assure you
of our ability to raise additional capital if needed or on terms acceptable to
us. If we cannot raise additional capital when needed, our ability to further
expand our operations through internal growth and acquisitions could be
materially impaired.
OUR PLAN TO ADD AN ADDITIONAL BRANCH IN KANSAS AND START A DE NOVO BRANCH IN
ARIZONA MAY NOT BE SUCCESSFUL, WHICH WOULD NEGATIVELY AFFECT OUR GROWTH STRATEGY
AND PROSPECTS.
We intend to open a new branch located in the Phoenix/Scottsdale,
Arizona metropolitan area in the last quarter of 2002 and a second branch in the
Kansas City metropolitan area in mid 2003. Management estimates that it will
take approximately 18 months for each of the new branches to be profitable and
expects that we will incur average monthly losses of approximately $35,000 for
the Phoenix/Scottsdale, Arizona branch and $14,000 for the Kansas City
metropolitan area branch until each branch achieves profitability. These
estimates are based on our financial model which reflects various assumptions,
and we cannot give assurance that we will achieve profitability when estimated
or that losses will not be greater than anticipated. While our management has
significant experience in the Kansas market, we cannot be sure that our
expansion in that market will meet our expectations. In addition, although we
have hired experienced personnel who are familiar with the market and although
our senior management has extensive knowledge of the area, we are new to the
Arizona market and have never conducted any banking business in Arizona before.
Accordingly, we may not be successful in these operations and we may not be able
to compete in either location successfully. If we are unsuccessful in expanding
our business in Kansas and starting our business in Arizona, our growth
strategy, financial condition, prospects and profitability may be adversely
affected.
WE ARE DEPENDENT ON KEY INDIVIDUALS AND OUR ABILITY TO ATTRACT AND RETAIN
BANKING PROFESSIONALS WITH SIGNIFICANT EXPERIENCE IN OUR LOCAL MARKETS.
We currently depend heavily on Craig J. Cerny, our chief executive
officer, and William W. Phillips, Jr., our president. We believe that the
prolonged unavailability or the unexpected loss of the services of Messrs. Cerny
or Phillips could have a material adverse effect upon us because attracting
suitable replacements may involve significant time and/or expense. We do not
have employment agreements with Mr. Cerny, Mr. Phillips or any of our other
executive officers. We do not currently maintain key man life insurance policies
on our executive officers.
In order to continue our expansion, we must attract and retain
experienced banking professionals. The competition to hire experienced banking
professionals is intense. If we are unable to attract qualified banking
professionals, our expansion plans could be delayed or curtailed. If we are
unable to retain our current banking professionals, our business, financial
condition, prospects and profitability may be adversely affected.
WE RELY ON THE INVESTMENT ADVICE AND RESEARCH OF AN INDEPENDENT ADVISOR, AND THE
LOSS OF SERVICES FROM THAT ADVISOR COULD DISRUPT OUR BUSINESS.
Los Padres Bank has entered into an Investment and Interest Rate
Advisory Agreement with Smith Breeden Associates, Inc., or Smith Breeden. Under
the terms of the agreement, Smith Breeden provides us with investment advice and
research related to Los Padres Bank's portfolio of investments and its asset and
liability management strategies. Los Padres Bank employs 'option-adjusted
pricing analysis' with respect to the purchase and sale of mortgage-backed and
related securities for its investment portfolio and relies on Smith Breeden with
respect to this analysis as well as the execution of Los Padres Bank's asset and
liability management strategies. We believe that there are other investment
advisors that could perform the services currently being provided by Smith
Breeden; however, there can be no assurance that an alternative investment
advisor could be retained on a timely basis if Los Padres Bank's agreement with
Smith Breeden was terminated or Smith Breeden was otherwise unable to perform
its services to Los Padres Bank. In
19
addition, Smith Breeden provides consulting and investment advice for a number
of other financial institutions. Although Smith Breeden has adopted a policy in
order to reduce potential conflicts of interest with respect to its financial
institution consulting practice, no assurance can be made that a conflict of
interest would not arise which conflict could adversely affect Los Padres Bank.
Craig J. Cerny, our chief executive officer, was a principal of Smith Breeden
until 1996, and persons related to Smith Breeden, other than Mr. Cerny, owned
approximately 27% of our common stock outstanding immediately prior to this
offering.
OUR OWNERSHIP IS CONCENTRATED IN THE HANDS OF OUR DIRECTORS, EXECUTIVE OFFICERS
AND PERSONS CONNECTED WITH SMITH BREEDEN, WHO COULD MAKE DECISIONS THAT ARE NOT
IN THE BEST INTERESTS OF ALL STOCKHOLDERS.
Our directors, executive officers and persons connected with Smith
Breeden, our investment advisor, will own approximately 41.5% of our outstanding
common stock on an aggregate basis following this offering (39.7% assuming full
exercise of the underwriter's over-allotment option). See "Principal and Selling
Stockholders." In addition, our directors and executive officers have been
granted options to acquire additional shares of our common stock, as described
under "Management-1996 Stock Option Plan." Assuming the full exercise of such
options, our directors and executive officers would own in the aggregate
approximately 51.0% (48.8)% assuming full exercise of the underwriter's
over-allotment option). As a result, our directors, executive officers and these
other referenced individuals will continue to have the ability to significantly
influence the election and removal of our board of directors and management and
the outcome of most matters to be decided by a vote of stockholders. The
interest of these individuals may not necessarily always be consistent with the
interests of all other stockholders.
WE FACE STRONG COMPETITION FROM OTHER FINANCIAL INSTITUTIONS, FINANCIAL SERVICE
COMPANIES AND OTHER COMPANIES THAT OFFER BANKING SERVICES WHICH CAN HURT OUR
BUSINESS.
We conduct our banking operations primarily along the central coast
of California and, to a lesser extent, in the Kansas City metropolitan area. We
intend to open up an office located in the Phoenix/Scottsdale, Arizona
metropolitan area in the fourth quarter of 2002 and a second branch office
located in the Kansas City metropolitan area in mid 2003. Many competitors offer
the banking services that we offer in our service area, and in the areas we
intend to expand in. These competitors include other savings associations,
national banks, regional banks and other community banks. We also face
competition from many other types of financial institutions, including finance
companies, brokerage firms, insurance companies, credit unions, mortgage banks
and other financial intermediaries. In particular, our competitors include major
financial companies whose greater resources may afford them a marketplace
advantage by enabling them to maintain numerous banking locations and mount
extensive promotional and advertising campaigns. Increased competition in our
market areas may result in reduced loans and deposits. Ultimately, we may not be
able to compete successfully against current and future competitors.
Additionally, banks and other financial institutions with larger
capitalization and financial intermediaries not subject to bank regulatory
restrictions have larger lending limits and are thereby able to serve the credit
needs of larger customers. Areas of competition include interest rates for loans
and deposits, efforts to obtain deposits, and range and quality of products and
services provided, including new technology-driven products and services.
Technological innovation continues to contribute to greater competition in
domestic and international financial services markets as technological advances
enable more companies to provide financial services. We also face competition
from out-of-state financial intermediaries that have opened low-end production
offices or that solicit deposits in our market areas. If we are unable to
attract and retain banking customers, we may be unable to continue our loan
growth and level of deposits and our business, financial condition and prospects
may otherwise be negatively affected.
20
WE CONTINUALLY ENCOUNTER TECHNOLOGICAL CHANGE, AND WE MAY HAVE FEWER RESOURCES
THAN MANY OF OUR COMPETITORS TO CONTINUE TO INVEST IN TECHNOLOGICAL
IMPROVEMENTS.
The financial services industry is undergoing rapid technological
changes, with frequent introductions of new technology-driven products and
services. The effective use of technology increases efficiency and enables
financial institutions to better serve customers and to reduce costs. Our future
success will depend, in part, upon our ability to address the needs of our
clients by using technology to provide products and services that will satisfy
client demands for convenience, as well as to create additional efficiencies in
our operations. Many of our competitors have substantially greater resources to
invest in technological improvements. We may not be able to effectively
implement new technology-driven products and services or be successful in
marketing these products and services to our customers.
THE STOCK OF LOS PADRES BANK IS PLEDGED UNDER A REVOLVING LINE OF CREDIT, AND IF
WE WERE TO DEFAULT ON THE REVOLVING LINE OF CREDIT, THE STOCK COULD BE SOLD AND
WE WOULD NO LONGER HAVE ANY BANKING OPERATIONS.
We currently have a revolving loan facility with two financial
institutions which provide us with a revolving line of credit of up to $25.0
million. At June 30, 2002, we had drawn down $16.6 million under this line of
credit. We have pledged the stock of Los Padres Bank as security under the line
of credit. The line of credit requires us to maintain compliance with a number
of covenants including financial covenants related to our profitability, other
indebtedness, capital requirements and loan-to-value ratios. If we were to
default under the line of credit, the stock could be foreclosed upon and we
could lose all of our banking operations and our common stock would materially
diminish in value. See "Business - Source of Funds - Borrowings."
OUR ABILITY TO SERVICE OUR DEBT, PAY DIVIDENDS, AND OTHERWISE PAY OUR
OBLIGATIONS AS THEY COME DUE IS SUBSTANTIALLY DEPENDENT ON CAPITAL DISTRIBUTIONS
FROM LOS PADRES BANK, AND THESE DISTRIBUTIONS ARE SUBJECT TO REGULATORY LIMITS
AND OTHER RESTRICTIONS.
A substantial source of our income from which we service our debt,
pay our obligations and from which we can pay dividends is the receipt of
dividends from Los Padres Bank. The availability of dividends from Los Padres
Bank is limited by various statutes and regulations. See "Regulation -
Regulation of Los Padres Bank - Capital Distributions." It is possible,
depending upon the financial condition of Los Padres Bank, and other factors,
that the OTS could assert that payment of dividends or other payments is an
unsafe or unsound practice. We are also subject to contractual restrictions on
our ability to pay dividends under our revolving loan facility. See "Trading
History and Dividend Policy." In the event Los Padres Bank is unable to pay
dividends to us, we may not be able to service our debt, pay our obligations or
pay dividends on our common stock. The inability to receive dividends from Los
Padres Bank would adversely affect our business, financial condition, results of
operations and prospects.
21
22
PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND BYLAWS LIMIT THE AUTHORITY OF
OUR STOCKHOLDERS, AND THEREFORE MINORITY STOCKHOLDERS MAY NOT BE ABLE TO
SIGNIFICANTLY INFLUENCE OUR GOVERNANCE OR AFFAIRS.
Our board of directors has the authority to issue shares of preferred
stock and to determine the price, rights, preferences and restrictions,
including the voting rights, of those shares without any further vote or action
by stockholders. The rights of the holders of common stock will be subject to,
and may be adversely affected by, the rights of the holders of any preferred
stock that may be issued in the future.
Our Certificate of Incorporation and Bylaws also provide for
limitations on the ability of stockholders to call special meetings and prohibit
cumulative voting for directors. As a result, minority stockholder
representation on the board of directors may be difficult to establish. These
documents also establish advance notice requirement for nominations for election
to the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
The provisions of our Certificate of Incorporation and Bylaws
described above may, in certain circumstances, have the effect of delaying,
deferring or preventing a change in control of us, may discourage bids for our
common stock at a premium over the current market price of the common stock and
could have an adverse effect on our stock price.
FEDERAL LAW IMPOSES CONDITIONS ON THE ABILITY TO ACQUIRE CONTROL OF CERTAIN
THRESHOLD PERCENTAGES OF OUR COMMON STOCK, WHICH COULD DISCOURAGE BIDS FOR OUR
COMMON STOCK OR A CHANGE IN CONTROL OF OUR STOCK, AND PUT DOWNWARD PRESSURE ON
OUR COMMON STOCK TRADING PRICE.
Acquisition of control of a federal savings bank, such as Los Padres
Bank, requires advance approval by the OTS. Under federal law, the acquisition
of 10% or more of our common stock would result in a rebuttable presumption of
control of Los Padres Bank and the ownership of 25% or more of the voting stock
23
results in conclusive control of Los Padres Bank. These regulations could have
the effect of delaying, deferring or preventing a change in control of us, may
discourage bids for the common stock at a premium over the current market price
of the common stock and could put downward pressure on our stock price.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains and incorporates by reference
forward-looking statements about our financial condition, results of operations
and business. These statements may include statements regarding projected
performance for periods following the completion of this offering. You can find
many of these statements by looking for words such as "believes," "expects,"
"anticipates," "estimates," "intends," "will," "plans" or similar words or
expressions. These forward-looking statements involve substantial risks and
uncertainties. Some of the factors that may cause actual results to differ
materially from those contemplated by such forward-looking statements include,
but are not limited to, those identified under "Risk Factors" above as well as
the following:
- we may experience higher defaults on our loan portfolio than we
expect;
- changes in management's estimate of the adequacy of the
allowance for loan losses;
- changes in management's valuation of our mortgage-backed and
related securities portfolio and interest rate contracts;
- increases in competitive pressure among financial institutions;
- general economic conditions, either nationally or locally in
areas in which we conduct or will conduct our operations, or
conditions in financial markets may be less favorable than we
currently anticipate;
- our net income from operations may be lower than we expect;
- we may lose more business or customers than we expect, or our
operating costs may be higher than we expect;
- changes in the interest rate environment and their impact on
customer behavior and our interest margins;
- the impact of repricing and competitors' pricing initiatives on
loan and deposit products;
- our ability to adapt successfully to technological changes to
meet customers' needs and developments in the market place;
- our ability to access cost-effective funding;
- our ability to successfully complete our strategy to continue to
grow our business in California and in Kansas or to successfully
initiate operations in Arizona;
- our interest income from our securities portfolio may be lower
than we expect; or
- legislative or regulatory changes or changes in accounting
principles, policies or guidelines may adversely affect our
ability to conduct our business.
24
Because these forward-looking statements are subject to risks and
uncertainties, our actual results may differ materially from those expressed or
implied by these statements. You are cautioned not to place undue reliance on
our forward-looking statements, which speak only as of the date of this
prospectus. Forward-looking statements are not guarantees of performance. They
involve risks, uncertainties and assumptions. The future results and stockholder
values of our common stock following this offering may differ materially from
those expressed in these forward-looking statements. Many of the factors that
will determine these results and values are beyond our ability to control or
predict.
All subsequent written and oral forward-looking statements
attributable to us or any person acting on our behalf are expressly qualified in
their entirety by the cautionary statements contained or referred to in this
section. We do not undertake any obligation to release publicly any revisions to
such forward-looking statements to reflect events or circumstances after the
date of this prospectus or to reflect the occurrence of unanticipated events.
USE OF PROCEEDS
Our net proceeds from the sale of our shares of common stock are
expected to be $14.7 million, based on an assumed offering price of $13.00 per
share after deducting the underwriting discounts and commissions and estimated
offering expenses. Our net proceeds are expected to be $17.3 million if the
underwriter's over-allotment option is exercised in full.
We will not receive any of the proceeds from the sale of our shares
of common stock by the selling stockholders. See "Principal and Selling
Stockholders" and "Underwriting."
We will use the net proceeds of this offering primarily to support
the continued growth of our business operations and product lines and for
general corporate purposes. We expect that we will use the net proceeds to:
- support loan growth, including multi-family residential and
commercial mortgage loans, single-family mortgage loans,
commercial and industrial loans and consumer loans;
- expand Los Padres Bank's retail banking franchise, by
establishing or acquiring new offices or by acquiring other
financial institutions, although no acquisition transactions are
specifically being considered at this time;
- develop new products and services; and
- invest in high credit quality, fixed income and mortgage-backed
securities managed to a short duration.
Pending our deployment of the proceeds as discussed above, we intend
to apply a portion of the proceeds to reduce the outstanding balance on our
existing revolving line of credit from unaffiliated lenders and/or invest such
proceeds in interest-bearing investment grade fixed income securities and
mortgage-backed securities managed to a short duration. We have made no specific
determination as to the amount of proceeds we will apply to reducing the
outstanding balance under the line of credit. At June 30, 2002, we had an
outstanding balance of $16.6 million on our revolving line of credit, the
principal amount of which must be repaid on or before September 30, 2007.
25
As of June 30, 2002, the adjustable interest rate we are paying on the
outstanding amount of the line of credit is 4.0% per annum, although the
interest rate is subject to change in certain circumstances. For further
information on our revolving line of credit, see "Business-Sources of
Funds-Borrowings."
26
CAPITALIZATION
The following table sets forth our total deposits, indebtedness and
capitalization at June 30, 2002, and as adjusted to reflect our issuance and
sale of 1,253,615 shares of common stock at an assumed offering price of $13.00
per share and the application of the net proceeds. This information should be
read in conjunction with our consolidated financial statements and the related
notes included elsewhere in this prospectus. The as adjusted Bank regulatory
capital ratios column assumes the contribution of $10.0 million of the net
proceeds of this offering to Los Padres Bank and the deployment of such proceeds
in assets with a 30% risk weighting under applicable regulations.
JUNE 30, 2002
-------------------------------
ACTUAL AS ADJUSTED
-------- -----------
(DOLLARS IN THOUSANDS)
Deposits........................................................................ $505,439 $505,439
======== ========
INDEBTEDNESS:
FHLB advances................................................................ $123,403 $123,403
Note payable................................................................. 16,600 16,600(1)
-------- --------
Total indebtedness................................................... $140,003 $140,003
======== ========
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued and
outstanding or as adjusted.............................................. -- --
Common Stock, $0.01 par value; 9,000,000 shares authorized(2); 3,354,336
shares issued and outstanding and 4,607,951 shares
issued and outstanding and as adjusted.................................. 34 47
Additional paid-in capital.................................................. 20,305 35,022
Retained earnings........................................................... 11,313 11,313
Accumulated other comprehensive income, net of tax.......................... 371 371
-------- --------
Total stockholders' equity........................................... $ 32,023 $ 46,753
======== ========
BANK REGULATORY CAPITAL RATIOS(3):
Tier 1 risk-based capital ratio.............................................. 11.10% 13.66%
Total risk-based capital ratio............................................... 12.14% 14.70%
Tier 1 leverage capital ratio................................................ 6.26% 7.63%
- -------------------
(1) Pending our deployment of the proceeds, as discussed under "Use of
Proceeds," we intend to apply a portion of the proceeds to reduce the
outstanding balance on our revolving line of credit. We have made no
determination as to the amount of proceeds we will apply to reduce
the outstanding balance under the line of credit.
(2) Subsequent to June 30, 2002, our stockholders approved an increase in
our authorized common stock from 3,000,000 to 9,000,000 shares.
(3) See "Regulation-Los Padres Bank-Regulatory Capital Requirements and
Prompt Corrective Action" for a discussion of capital requirements
applicable to Los Padres Bank under federal regulation. In addition,
we have agreed with the OTS that Los Padres Bank would maintain its
total risk-based capital ratio and its leverage capital ratio at 11%
and 6%, respectively, which is in excess of the minimum regulatory
requirements. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital
Resources-Capital Resources" and "Regulation-Los Padres
Bank-Regulatory Capital Requirements and Prompt Corrective Action."
27
DILUTION
If you invest in our common stock, your interest will be diluted to
the extent of the difference between the initial public offering price per share
of our common stock and the pro forma net tangible book value per share of our
common stock after this offering.
The net tangible book value of our common stock at June 30, 2002 was
approximately $26.6 million, or $7.94 per share. Net tangible book value per
share is equal to the amount of our total tangible assets less total
liabilities, divided by the number of shares of common stock outstanding as of
June 30, 2002.
Our pro forma net tangible book value as of June 30, 2002 was $41.4
million, or $8.98 per share after giving effect to our sale of common stock in
the offering at an assumed initial public offering price of $13.00 per share,
and our receipt of the estimated net proceeds from the offering. This represents
an immediate increase in net tangible book value of $1.04 per share to existing
stockholders and an immediate dilution of $4.02 per share to new investors. The
following table illustrates this per share dilution:
Initial public offering price per share ............................................. $ 13.00
Historical net tangible book value per share before the offering..................... $ 7.94
Increase per share attributable to new investors..................................... 1.04
---------
Pro forma net tangible book value per share after the offering....................... 8.98
---------
Dilution per share to new investors.................................................. $ 4.02
---------
If the underwriter exercises its over-allotment in full, there will
be an increase in pro forma net tangible book value to $9.11 per share to
existing stockholders and an immediate dilution in pro forma net tangible book
value of $3.89 to new stockholders. Our existing stockholders would own 72.8%
and our new public investors would own 27.2% of the total number of shares of
our common stock outstanding after this offering.
The following table summarizes, on a pro forma basis as of June 30,
2002, the differences between existing stockholders and the new investors with
respect to the number of shares of common stock purchased from us, the total
consideration paid and the average price per share paid before deducting the
underwriting discounts and commissions and our estimated offering expenses.
SHARES PURCHASED TOTAL CONSIDERATION
---------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------ ------- ------ ------- ---------
Existing stockholders.......................... 3,354,336 72.8 20,311,148 55.5 6.06
New public investors........................... 1,253,615 27.2 16,296,995 44.5 13.00
--------- ------- ---------- ------- ---------
Total.................................... 4,607,951 100.00% 36,608,143 100.00% 9.15
========= ======= ========== ======= =========
The discussion and tables above assume no exercise of stock options
outstanding as of June 30, 2002. As of June 30, 2002, there were options
outstanding under our stock option plan to purchase a total of 268,875 shares of
common stock, with a weighted average exercise price of $7.18 per share. To the
extent that any of these options are exercised, there will be further dilution
to new investors.
28
TRADING HISTORY AND DIVIDEND POLICY
Prior to this offering, there has been no established market for our
common stock. We expect that following the offering, our common stock will be
traded on the Nasdaq National Market. We have applied to list our common stock
for quotation on the Nasdaq National Market under the symbol "HWFG."
The underwriter has advised us that, upon completion of the offering,
it intends to act as a market maker in our common stock and it intends to use
its best efforts to obtain at least two other market makers as required by the
Nasdaq National Market. Neither the underwriter nor any other broker-dealer,
however, is obligated to make a market in our common stock, and any market
making may be discontinued at any time in the sole discretion of the party
making a market. Accordingly, we cannot assure you that an active and liquid
trading market for our common stock will develop or that, if developed, it will
continue. Also, we cannot assure you that persons purchasing shares of our
common stock will be able to sell them at or above the offering price set forth
on the cover page of this prospectus. In addition, the substantial amount of
common stock owned by our directors, executive officers and certain other
individuals with whom we do business may adversely affect the development of an
active and liquid trading market. See "Risk Factors-Our ownership is
concentrated," and "Principal and Selling Stockholders."
We paid a special dividend in the second quarter of 2000 of $0.250
per share. Commencing in the third quarter of 2000 and continuing through the
second quarter of 2002, we paid a quarterly dividend of $0.027. In the third
quarter of 2002, we declared an increase in the quarterly dividend to $0.033.
After this offering, we intend to continue to pay cash dividends on a quarterly
basis. The dividend rate and the continued payment of dividends will be
determined by our board of directors, and in making the decision to declare
dividends, they will take into account our consolidated earnings, financial
condition, liquidity and capital requirements, applicable governmental
regulations and policies, and other factors deemed relevant by our board of
directors.
Our ability to pay dividends may be dependent on our ability to
continue to receive dividends from Los Padres Bank, which is subject to
compliance with federal regulatory requirements. In addition, under the terms of
our revolving line of credit agreement with unaffiliated lenders, we cannot
declare dividends in an amount exceeding the greater of $300,000 or 25% of our
consolidated net income during any fiscal quarter or declare dividends at any
time an event of default has occurred under the revolving line of credit. See
"Business -Sources of Funds-Borrowings," "Regulation-Regulation of Los Padres
Bank-Capital Distributions" and "Description of Capital Stock-Common Stock -
Dividends." We cannot assure you that we will not reduce or eliminate dividends
in the future.
As of June 30, 2002, we had 216 stockholders of record.
29
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion provides information about our results of
operations, financial condition, liquidity and asset quality. This information
is intended to facilitate the understanding and assessment of significant
changes and trends related to our financial condition and the results of
operations. This discussion and analysis should be read in conjunction with our
consolidated financial statements and the accompanying notes presented elsewhere
in this prospectus.
GENERAL
We attempt to enhance our profitability with prudent levels of
credit, interest rate and liquidity risk by managing our interest-earning assets
and funding sources to generate favorable interest rate spreads. We invest in
loans secured by single-family and multi-family residences and commercial
properties, as well as commercial and industrial loans and consumer loans. We
utilize excess capital balances through the management of an investment
portfolio that is primarily comprised of short duration mortgage-backed
securities and other investments. We also attempt to increase our retail banking
fee income from deposit fees, loan origination fees and revenue from Harrington
Wealth Management Company. Our funding strategy focuses on accessing
cost-efficient funding sources, including retail deposits, FHLB advances,
securities sold under agreements to repurchase and a revolving line of credit we
have with three unaffiliated financial institutions. We seek to reduce our
exposure to interest rate risk by hedging either internally through the use of
longer term certificates of deposit, less interest rate sensitive transaction
deposits and Federal Home Loan Bank, or FHLB, advances, or externally through
the use of interest rate contracts.
Our strategy has been to build a community-oriented banking operation
in each of the markets in which we operate in order to sustain loan origination
and deposit growth and generate additional fee income. Our growth is designed to
be achieved internally, although we have pursued, and will continue to pursue,
acquisition opportunities when appropriate. Our overall goal is to increase
stockholders' value from earnings and the growth of our franchise.
CRITICAL ACCOUNTING POLICIES
General. The following discussion and analysis of financial condition
and results of operations is based upon our consolidated financial statements,
and the notes thereto, which have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these consolidated financial statements requires us to make a number of
estimates and assumptions that affect the reported amounts and disclosures in
the consolidated financial statements. On an ongoing basis, we evaluate our
estimates and assumptions based upon historical experience and various other
factors and circumstances. We believe that our estimates and assumptions are
reasonable in the circumstances; however, actual results may differ
significantly from these estimates and assumptions which could have a material
impact on the carrying value of assets and liabilities at the balance sheet
dates and our results of operations for the reporting periods.
The financial information contained in our consolidated financial
statements is, to a significant extent, based on approximate measures of the
financial effects of transactions and events that have already occurred. A
variety of factors could affect the ultimate value that is obtained either when
recognizing income or expense, recovering an asset or relieving a liability. We
use historical loss factors to determine the inherent loss that may be present
in our loan portfolio. Actual losses could differ significantly from the
historical factors that we use. We also calculate the fair value of our interest
rate
30
contracts and securities based on market prices and the expected useful lives of
our depreciable assets. We enter into interest rate contracts that are
classified as trading account assets or to accommodate our own risk management
purposes. The interest rate contracts are generally interest swaps, caps, floors
and futures contracts, although we could enter into other types of interest rate
contracts. We value these contracts at fair value, using readily available,
market quoted prices. We have not historically entered into derivative contracts
which relate to credit, equity, commodity, energy or weather-related indices.
Generally accepted accounting principles themselves may change from one
previously acceptable method to another method. Although the economics of our
transactions would be the same, the timing of events that would impact our
transactions could change. As of June 30, 2002, we have not created any special
purpose entities to securitize assets or to obtain off-balance sheet funding.
Although we have sold loans in the past two years, those loans have been sold to
third parties without recourse, subject to customary representations and
warranties. Please see our disclosure regarding contractual obligations and
commitments in "-Contractual Obligations and Commercial Commitments."
Allowance for loan losses. The allowance for loan losses is an
estimate of the losses that may be sustained in our loan portfolio. The
allowance is based on two principles of accounting: (i) Statement of Financial
Accounting Standards, or SFAS, No. 5, "Accounting for Contingencies," which
requires that losses be accrued when they are probable of occurring and
estimable; and (ii) SFAS No. 114, "Accounting by Creditors for Impairment of a
Loan" and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income
Recognition and Disclosures," which requires that losses be accrued based on the
differences between the value of collateral, present value of future cash flows
or values that are observable in the secondary market and the loan balance. Our
allowance for loan losses has four components: (i) an allocated allowance for
specifically identified problem loans, (ii) a formula allowance for
non-homogenous loans, (iii) an allocated allowance for large groups of smaller
balance homogenous loans and (iv) an unallocated allowance. Each of these
components is determined based upon estimates that can and do change when the
actual events occur. The formula allowance uses a model based on historical
losses as an indicator of future losses and as a result could differ from the
losses incurred in the future; however, since this history is updated with the
most recent loss information, the differences that might otherwise occur may be
mitigated. The specific allowance uses various techniques to arrive at an
estimate of loss. Historical loss information, discounted cash flows, fair
market value of collateral and secondary market information are all used to
estimate those losses. The use of these values is inherently subjective and our
actual losses could be greater or less than the estimates. The unallocated
allowance captures losses that are attributable to various economic events,
industry or geographic sectors whose impact on the portfolio have occurred but
have yet to be recognized in either the formula or specific allowances. For
further information regarding our allowance for credit losses, see "Business -
Asset Quality - Allowance for Loan Losses."
31
RESULTS OF OPERATIONS
Summary of Earnings. We reported net income for the six months ended
June 30, 2002 of $2.3 million, compared to $2.0 million for the six months ended
June 30, 2001, an increase of $316,000 or 15.8%. We reported net income for the
year ended December 31, 2001 of $3.8 million, compared to $2.6 million and $2.4
million for the years ended December 31, 2000 and 1999. Our net income improved
by $1.2 million or 47.3% during 2001 as compared to 2000 and $221,000 or 9.4%
during 2000 as compared to 1999. On a diluted earnings per share basis, we
earned $0.67, $0.60, $1.12, $0.77 and $0.71 for the six months ended June 30,
2002 and 2001 and the years ended December 31, 2001, 2000 and 1999.
Our income is dependent on loan growth, growth in our securities
portfolio, controlling costs and our continued efforts to prevent any unexpected
loan losses that would require additions to our allowance for loan losses.
During the periods presented, our profitability has been primarily attributable
to the growth of our core banking income. We define core banking income as net
interest income after the provision for loan losses plus fee income from banking
services less our operating expenses. We have expanded our franchise during the
periods presented, through internal growth, de novo branching and a branch
acquisition, which has resulted in an increase in our operating expenses.
Notwithstanding increased operating costs, core banking income has increased
over the periods.
The following table presents selected information on our core banking
income over the periods presented as well as a reconciliation of our core
banking income to income before income taxes (computed in accordance with
generally accepted accounting principles):
FOR THE
SIX MONTHS ENDED FOR THE YEAR ENDED
JUNE 30, DECEMBER 31,
------------------------------ ------------------------------------------------
2002 2001 2001 2000 1999
------------- ------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
Net interest income after provision for loan
losses.................................... $10,006 $7,221 $15,350 $11,856 $12,240
Retail banking fees and other income......... 908 368 996 554 1,023
------- ------ ------- ------- -------
Total net revenue...................... 10,914 7,589 16,346 12,410 13,263
Other expenses......................... 6,880 4,945 10,317 8,396 8,569
------- ------ ------- ------- -------
Core banking income............... 4,034 2,644 6,029 4,014 4,694
Other noninterest income (1)................. (95) 795 505 568 (555)
------- ------ ------- ------- -------
Income before income taxes........ $3,939 $3,439 $6,534 $4,582 $4,139
====== ====== ====== ====== ======
Core banking income as a percent of
income before income taxes 102.41% 76.88% 92.27% 87.60% 113.41%
- ------------------
(1) Consists of income (loss) from trading assets, gain on sale of
deposits and gain (loss) on sale of loans.
To a lesser extent during the periods presented, our results of
operations have been impacted by realized and unrealized gains and losses
incurred in trading account assets, and as a result of gains on our sale of
loans and deposits. These results are described more particularly under "-Other
Income" and under "-Asset and Liability Management."
Net Interest Income. Net interest income is determined by our
interest rate spread, which is the difference between the yields earned on our
interest-earning assets and the rates paid on our interest-bearing liabilities,
and the relative amounts of interest-earning assets and interest-bearing
liabilities.
Net interest income increased by $3.1 million or 42.4% to $10.3
million during the six months ended June 30, 2002 over the prior comparable
period in 2001, due to a $150.4 million or 30.3% increase in the average balance
of interest-earning assets. The overall increase in the average balance of
interest-earning assets was enhanced by a 39 basis point increase in the
interest rate spread, attributable to a greater decline in average rates paid on
deposits than on the yields earned on earning assets. The increased interest
rate spread was due to an increase in the percentage of commercial loans we hold
in our loan portfolio, which carry higher interest rates, as well as the fact
that our deposits generally reprice more quickly than our assets.
32
Net interest income after provision for loan losses increased by $3.5
million or 29.5% to $15.4 million during the year ended December 31, 2001, as
compared to the prior year, due to a $27.8 million or 5.4% increase in the
average balance of interest-earning assets. Our interest rate spread increased
by 53 basis points, primarily for the same reason discussed above for the
comparative six month periods. Net interest income decreased by $497,000 or 4.0%
to $11.9 million during the year ended December 31, 2000, from $12.4 million in
the prior year, as a $5.0 million or 1.0% increase in the average balance of
earning assets was not sufficient to offset a 18 basis point decline in our
interest rate spread.
AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID
The following table sets forth, for the periods indicated,
information regarding (i) the total dollar amount of interest income from
interest-earning assets and the resultant average yields; (ii) the total dollar
amount of interest expense on interest-bearing liabilities and the resultant
average rate; (iii) net interest income; (iv) interest rate spread; and (v) net
interest margin. No tax equivalent adjustments were made during the periods
presented. Information is based on average daily balances during the indicated
periods, except information prior to March 31, 1999 is based on average
month-end balances and noninterest-bearing deposits information is based on
average balances for all periods.
SIX MONTHS ENDED JUNE 30,
------------------------------------------------------------------
2002 2001
------------------------------ -------------------------------
AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- --------- ------- -------- ---------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans receivable(1)............. $436,051 $16,138 7.40% $398,299 $16,308 8.19%
Securities and trading account
assets(2).................... 188,886 5,014 5.31 77,707 3,127 8.05
FHLB stock ..................... 6,024 181 6.00 6,244 210 6.72
Cash and cash equivalents(3).... 15,801 118 1.49 14,118 261 3.70
-------- ------- -------- -------
Total interest-earning assets 646,762 21,451 6.63 496,368 19,906 8.02
-------- ------- -------- -------
Noninterest-earning assets......... 30,087 29,112
-------- --------
Total assets.............. $676,849 $525,480
======== ========
Interest-bearing liabilities:
Deposits:
NOW and money market
accounts.................. $78,243 $ 658 1.68 $39,685 $ 488 2.45
Passbook accounts and
certificates of deposit... 415,339 7,108 3.42 317,138 8,985 5.67
-------- ------- -------- -------
Total deposits............ 493,582 7,766 3.15 357,003 9,473 5.31
FHLB advances(4)................ 103,955 3,053 5.87 102,696 2,830 5.51
Reverse repurchase agreements... 1,075 6 1.20 - - -
Other borrowings(5)............. 17,134 345 4.03 9,348 381 8.15
-------- ------- -------- -------
Total interest-bearing liabilities 615,746 11,170 3.63 469,047 12,684 5.41
-------- ------- -------- -------
Noninterest-bearing deposits.... 13,077 6,899
Noninterest-bearing liabilities. 17,079 22,372
-------- --------
Total liabilities............ 645,902 498,318
Stockholders' equity............... 30,947 27,162
-------- --------
Total liabilities and stockholders'
equity....................... $676,849 $525,480
======== ========
Net interest-earning assets
(liabilities)................... $31,016 $27,321
======== ========
Net interest income/interest rate
spread.......................... $10,281 3.00 $7,222 2.61
======= =======
Net interest margin................ 3.18 2.91
Ratio of average interest-earnings
assets to average interest-bearing
liabilities..................... 105.04 105.82
33
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000
------------------------------ -------------------------------
AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- --------- ------- -------- ---------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans receivable(1)............. $396,132 $31,914 8.06% $389,416 $30,365 7.80%
Securities and trading account
assets(2).................... 127,841 8,411 6.58 100,446 7,066 7.03
FHLB stock ..................... 7,037 407 5.78 6,447 453 7.02
Cash and cash equivalents(3).... 15,166 436 2.88 22,107 1,259 5.70
-------- ------- -------- -------
Total interest-earning assets 546,176 41,168 7.54 518,416 39,143 7.55
-------- ------- -------- -------
Noninterest-earning assets......... 31,401 28,344
-------- --------
Total assets.............. $577,577 $546,760
======== ========
Interest-bearing liabilities:
Deposits:
NOW and money market
accounts.................. $45,234 $ 978 2.16 $40,604 $1,199 2.95
Passbook accounts and
certificates of deposit... 354,873 18,204 5.13 295,270 16,388 5.55
-------- ------- -------- -------
Total deposits............ 400,107 19,182 4.79 335,874 17,587 5.24
FHLB advances(4)................ 107,233 5,942 5.54 105,790 6.263 5.92
Reverse repurchase agreements... 108 1 1.24 42,027 2,509 5.97
Other borrowings(5)............. 10,189 692 6.79 9,228 886 9.60
-------- ------- -------- -------
Total interest-bearing liabilities 517,637 25,817 4.99 492,919 27,245 5.53
-------- ------- -------- -------
Noninterest-bearing deposits.... 7,882 5,493
Noninterest-bearing liabilities. 24,276 23,702
-------- --------
Total liabilities............ 549,795 522,114
Stockholders' equity............... 27,782 24,646
-------- --------
Total liabilities and stockholders'
equity....................... $577,577 $546,760
======== ========
Net interest-earning assets
(liabilities)................... $28,539 $25,497
======== ========
Net interest income/interest rate
spread.......................... $15,351 2.55 $11,898 2.02
Net interest margin................ ======= 2.81 ======= 2.30
Ratio of average interest-earnings
assets to average interest-bearing
liabilities..................... 105.51 105.17
YEAR ENDED DECEMBER 31,
------------------------------
1999
------------------------------
AVERAGE
AVERAGE YIELD/
BALANCE INTEREST COST
------- -------- ---------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans receivable(1)............. $355,570 $26,868 7.56%
Securities and trading account
assets(2).................... 136,406 9,142 6.70
FHLB stock ..................... 5,970 351 5.89
Cash and cash equivalents(3).... 15,463 580 3.75
-------- -------
Total interest-earning assets 513,409 36,941 7.20
-------- -------
Noninterest-earning assets......... 29,710
--------
Total assets.............. $543,119
========
Interest-bearing liabilities:
Deposits:
NOW and money market
accounts.................. $48,593 $1,445 2.97
Passbook accounts and
certificates of deposit... 310,060 15,240 4.92
-------- -------
Total deposits............ 358,653 16,685 4.65
FHLB advances(4)................ 81,809 5,028 6.15
Reverse repurchase agreements... 42,742 2,155 5.04
Other borrowings(5)............. 7,972 678 8.51
-------- -------
Total interest-bearing liabilities 491,176 24,546 5.00
-------- -------
Noninterest-bearing deposits.... 3,694
Noninterest-bearing liabilities. 25,693
--------
Total liabilities............ 520,563
Stockholders' equity............... 22,556
--------
Total liabilities and stockholders'
equity....................... $543,119
========
Net interest-earning assets
(liabilities)................... $22,233
========
Net interest income/interest rate
spread.......................... $12,395 2.20
=======
Net interest margin................ 2.41
Ratio of average interest-earnings
assets to average interest-bearing
liabilities..................... 104.53
- --------------------
(1) Includes non-accrual loans. Interest income includes fees earned on loans
originated.
(2) Consists of securities classified as available for sale and held to
maturity and trading account assets.
(3) Consists of cash and due from banks and federal funds sold.
(4) Interest on FHLB advances is net of hedging costs. We use
interest rate swaps to hedge the short-term repricing characteristics of
our floating-rate FHLB advances. See "-Asset and Liability Management."
(5) Consists of a note payable under a revolving line of credit.
34
RATE/VOLUME ANALYSIS
The following table sets forth the effects of changing rates and
volumes on our net interest income. Information is provided with respect to (i)
effects on interest income attributable to changes in rate (changes in rate
multiplied by prior volume); (ii) effects on interest income attributable to
changes in volume (changes in volume multiplied by prior rate); and (iii)
changes in rate/volume (change in rate multiplied by change in volume).
SIX MONTHS ENDED JUNE 30, 2002
COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
-----------------------------------------------------
INCREASE (DECREASE) DUE TO
-------------------------------------- ---------
TOTAL NET
RATE/ INCREASE
RATE VOLUME VOLUME (DECREASE)
------- -------- ------- -------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans receivable .................. $(3,147) $ 3,092 $ (114) $ (169)
Securities and trading account
assets(1) ...................... (2,127) 8,947 (4,933) 1,887
FHLB stock ........................ (45) (15) 31 (29)
Cash and cash equivalents(2) ...... (313) 62 107 (144)
------- -------- ------- -------
Total net change in income on
interest-earning assets ........... (5,632) 12,086 (4,909) 1,545
------- -------- ------- -------
Interest-bearing liabilities:
Deposits
NOW and money market
accounts .................... (306) 940 (464) 170
Passbook accounts and
certificates of deposit ..... (7,115) 5,564 (326) (1,877)
------- -------- ------- -------
Total deposits ............ (7,421) 6,504 (790) (1,707)
FHLB advances(3) .................. 373 69 (219) 223
Reverse repurchase agreements ..... - - 6 6
Other borrowings(4) ............... (386) 635 (285) (36)
------- -------- ------- -------
Total net change in expense on
interest-bearing liabilities ...... (7,434) 7,208 (1,288) (1,514)
------- -------- ------- -------
Change in net interest income ........ $ 1,802 $ 4,878 $(3,621) $ 3,059
======= ======== ======= =======
YEAR ENDED DECEMBER 31, 2001
COMPARED TO YEAR ENDED DECEMBER 31, 2000
-----------------------------------------------------
INCREASE (DECREASE) DUE TO
-------------------------------------- ---------
TOTAL NET
RATE/ INCREASE
RATE VOLUME VOLUME (DECREASE)
------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans receivable .................. $ 1,008 $ 524 $ 17 $ 1,549
Securities and trading account
assets(1) ...................... (457) 1,927 (125) 1,345
FHLB stock ........................ (80) 41 (7) (46)
Cash and cash equivalents(2) ...... (624) (395) 196 (823)
------- ------- ------- -------
Total net change in income on
interest-earning assets ........... (153) 2,097 81 2,025
------- ------- ------- -------
Interest-bearing liabilities:
Deposits
NOW and money market
accounts .................... (321) 137 (37) (221)
Passbook accounts and
certificates of deposit ..... (1,241) 3,308 (251) 1,816
------- ------- ------- -------
Total deposits ............ (1,562) 3,445 (288) 1,595
FHLB advances(3) .................. (401) 93 (5) (321)
Reverse repurchase agreements ..... (1,986) (2,503) 1,981 (2,508)
Other borrowings(4) ............... (260) 85 (27) (194)
------- ------- ------- -------
Total net change in expense on
interest-bearing liabilities ...... (4,209) 1,120 1,661 (1,428)
------- ------- ------- -------
Change in net interest income ........ $ 4,056 $ 977 $(1,580) $ 3,453
======= ======= ======= =======
YEAR ENDED DECEMBER 31, 2000
COMPARED TO YEAR ENDED DECEMBER 31, 1999
-----------------------------------------------------
INCREASE (DECREASE) DUE TO
-------------------------------------- ---------
TOTAL NET
RATE/ INCREASE
RATE VOLUME VOLUME (DECREASE)
------- ------- ----- -------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans receivable .................. $ 858 $ 2,558 $ 81 $ 3,497
Securities and trading account
assets(1) ...................... 454 (2,410) (120) (2,076)
FHLB stock ........................ 67 29 6 102
Cash and cash equivalents(2) ...... 300 249 130 679
------- ------- ----- -------
Total net change in income on
interest-earning assets ........... 1,679 426 97 2,202
------- ------- ----- -------
Interest-bearing liabilities:
Deposits
NOW and money market
accounts .................... (10) (238) 2 (246)
Passbook accounts and
certificates of deposit ..... 1,968 (726) (94) 1,148
------- ------- ----- -------
Total deposits ............ 1,958 (964) (92) 902
FHLB advances(3) .................. (185) 1,474 (54) 1,235
Reverse repurchase agreements ..... 396 (35) (7) 354
Other borrowings(4) ............... 87 107 14 208
------- ------- ----- -------
Total net change in expense on
interest-bearing liabilities ...... 2,256 582 (139) 2,699
------- ------- ----- -------
Change in net interest income ........ $ (577) $ (156) $ 236 $ (497)
======= ======= ===== =======
- ------------
(1) Consists of securities classified as available for sale and held to
maturity and trading account assets.
(2) Consists of cash and due from banks and federal funds sold.
(3) Interest on FHLB advances is net of cash flow hedging costs. We use
interest rate swaps to hedge the short-term repricing characteristics of
our floating-rate FHLB advances. See "-Asset and Liability Management."
(4) Consists of a note payable under a revolving line of credit.
35
Interest Income. Total interest income increased by $1.5 million or 7.8%
during the six months ended June 30, 2002 over the comparable period in 2001,
from $19.9 million to $21.5 million. The primary reason for the increase during
the period was an increase in the average balance of earning assets, due to our
de novo expansion and the Harrington Bank branch acquisition in late 2001.
During the period, we experienced an $111.2 million or 143.1% increase in the
average balance of securities and trading account assets, and a $37.8 million or
9.5% increase in the average balance of loans receivable, net, attributable to
loans acquired in the acquisition of our Kansas banking operation. The increase
in average balance of earning assets more than offset a decline in the average
yield earned on our loan portfolio and securities portfolio (including trading
account assets), which declined by 79 and 274 basis points, respectively, over
the period, to 7.40% and 5.31%, respectively. The Federal Reserve Board lowered
interest rates several times after June 30, 2001, and since a substantial
portion of our earning assets reprice with the general level of interest rates,
our average yield on earning assets declined.
Total interest income increased by $2.0 million or 5.2% from $39.1
million to $41.2 million during the year ended December 31, 2001 over 2000, and
increased by $2.2 million or 6.0% during the year ended December 31, 2000 over
1999, from $36.9 million to $39.1 million. During 2001, we experienced a $27.4
million or 27.3% increase in the average balance of securities and trading
account assets and a $6.7 million or 1.7% increase in the average balance of
loans receivable, net. The acquisition of our Kansas banking operation, which
added $69.9 million of loans, was completed in November 2001, and accordingly
did not significantly affect the averages for the entire year. In addition, the
average yield earned on our loan portfolio increased by 26 basis points to
8.06%, which was partially offset by a decline in the average yield earned on
our securities portfolio (including trading account assets) of 45 basis points
to 6.6%. The increase in the average yield earned on our loan portfolio reflects
the increase in commercial and consumer loans which carry higher yields as
compared to single-family residential loans. During 2000, we sold securities and
increased our investments in higher yielding loans, primarily commercial real
estate loans, which resulted in a $36.0 million or 26.4% decline in the average
balance of securities and trading account assets and a $33.8 million or 9.5%
increase in the average balance of loans receivable, net. In addition, the
average yield earned on our loan portfolio and securities portfolio (including
trading account assets) increased by 24 and 33 basis points to 7.80% and 7.03%,
respectively, as compared to 1999.
Interest Expense. Total interest expense decreased by $1.5 million or
11.9% during the six months ended June 30, 2002 over the comparable period in
2001, from $12.7 million to $11.2 million. During this period, our average
interest-bearing liabilities increased by $146.7 million or 31.3%, due primarily
to deposits generated by our de novo branches and our acquisition of the Kansas
banking operation. Notwithstanding the increase in the average balance of
liabilities, successive interest rate reductions during the period more than
compensated for the increase in average balance, with the average yield on
interest-bearing liabilities declining by 178 basis points over the period, from
5.41% to 3.63%. We funded our asset growth during this period primarily by
growth in deposits, primarily certificates of deposit, but also with transaction
accounts. Average deposits increased by $142.8 million or 39.2%. We also
increased the amount drawn on our note payable during the period, which
increased by $7.8 million or 83.3% to fund our acquisition of the Kansas banking
operation. FHLB advances remained relatively stable during the period,
increasing by $1.3 million or 1.2%.
Total interest expense decreased by $1.4 million or 5.2% during the year
ended December 31, 2001 over 2000, from $27.2 million to $25.8 million, and
increased by $2.7 million or 11.0% during the year ended December 31, 2000 over
1999, from $24.5 million to $27.2 million. During 2001, we funded our growth
primarily with deposits, with average increases of $64.8 million or 18.0%. The
increase in deposits replaced reverse repurchase agreements, the average balance
of which declined from $42.0 million for 2000 to $108,000 for 2001 and $1.1
million for the six months ended June 30, 2002. In addition, the average rate
paid on deposits declined from 5.24% to 4.79% during the year. During 2000, the
increase in interest expense
36
was attributable primarily to a 59 basis point increase in the average rate paid
on deposits, from 4.65% to 5.24%, while the average balance of interest bearing
liabilities increased by $1.7 million or 0.4%. We funded our growth during this
period primarily through an increase in FHLB advances, which increased by $24.0
million or 29.3%, while interest bearing deposits declined by $22.8 million or
6.4%. We chose to fund this growth with short-term FHLB advances due to the
rates that were otherwise available on deposits of a similar term.
Provision for Loan Losses. We established provisions for loan losses of
$275,000 and $1,000 during the six months ended June 30, 2002 and 2001, and
$1,000, $42,000 and $155,000 during the years ended December 31, 2001, 2000 and
1999, respectively. We also acquired $600,000 in additional allowance for loan
losses in connection with our acquisition of our Kansas banking operation in
2001. Provisions for loan losses are charged to income to bring our allowance
for loan losses to a level deemed appropriate by management based on the factors
discussed under "Business-Asset Quality-Allowance for Loan Losses." Our
provision for the six months ended June 30, 2002 was affected by higher levels
of criticized assets, and the increasing levels of nonaccrual loans, from
$497,000 at December 31, 2001 to $1.9 million at June 30, 2002. In addition, we
have increased our allowance for loan losses as we have increased our commercial
real estate and commercial and industrial loan portfolios.
Other Income. Total other income has fluctuated over the periods
presented, due to our management of our securities portfolio, which is intended
to enhance both net interest income as well as other income by capitalizing on
changes in option-adjusted spreads.
The following table sets forth information regarding other income for
the periods shown.
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
------------------- ------------------------------
2002 2001 2001 2000 1999
------- ------- ------- ------- -------
(IN THOUSANDS)
Income (loss) from trading account assets .... $ (95) $ 726 $ 436 $(2,754) $ (555)
Gain on sale of deposits ..................... - - - 3,923 -
Gain (loss) on sale of loans ................. - 69 69 (601) -
Other (1) .................................... 908 368 996 554 1,023
------- ------- ------- ------- -------
Total other income ..................... $ 813 $ 1,163 $ 1,501 $ 1,122 $ 468
======= ======= ======= ======= =======
- ----------------
(1) Consists primarily of banking fee income such as service charges and
fees on deposit accounts, fees from our trust and investment management
services, and other miscellaneous fees.
Our management's goal is to attempt to mitigate any change in the market
value of our securities portfolio by the change in the market value of the
interest rate contracts utilized by us to hedge our interest rate exposure. In
addition, we attempt to report an overall gain with respect to our securities
portfolio through the use of option-adjusted pricing analysis which we utilize
in order to select securities with wider spreads for purchase, as compared to
other similar securities available in the market, and as spreads tighten, to
sell these securities for a gain, net of the gain or loss recognized with
respect to related interest rate contracts.
Total other income amounted to $813,000, a decline of $350,000 or 30.1%
during the six months ended June 30, 2002 over the prior comparable period, due
primarily to a $821,000 or 113.1% decrease in income from trading account
assets, reflecting the reduction in our trading activities and the emphasis on
holding investments in order to generate spread income, as well as no gains
associated with the sale of loans compared to a gain of $69,000 during the 2001
period, which was partially offset by a $540,000 or 146.7% increase in
miscellaneous other income, primarily attributable to fees generated from our
core banking operations.
37
Total other income amounted to $1.5 million, an increase of $379,000 or
33.8% during the year ended December 31, 2001 over 2000. During 2001, we
recognized $436,000 in income from trading account assets, as compared to a $2.8
million loss during 2000. This increase in income from trading account assets
reflected increases in the carrying values of our trading account assets, which
was partially offset by decreases in the carrying values of our interest rate
contracts. In addition, during 2001, other miscellaneous income, consisting
primarily of income from our core banking services, increased by $442,000 or
79.8% over 2000, due principally to fees received in connection with the
brokering of single-family loans to third party investors and increased other
fee income. To a lesser extent, we had a $69,000 gain on sale of loans during
2001, compared to a loss of $601,000 during 2000, which was attributable to the
relative market values on the loans sold. These increases were partially offset
by a $3.9 million decrease in gain on sale of deposits. We recognized a $3.9
million gain on the sale of two branch offices during 2000.
Total other income amounted to $1.1 million, an increase of $654,000 or
139.7% during the year ended December 31, 2000 over 1999. During 2000, a $2.8
million loss on trading assets was more than offset by a $3.9 million gain on
sale of deposits, which related to our sale of branches and related deposits we
had previously acquired in 1997. The loss we recognized from our trading account
assets in 2000 reflected the decreases in the carrying values of our trading
account assets, which were partially offset by increases in the carrying value
of our interest rate contracts. In addition, miscellaneous other income
decreased by $469,000 or 45.8% during 2000, due to a decrease in loan fees, a
decline in loan origination fees, lower deposit related fees and a loss
generated from Los Padres Bank's investment in Harrington Wealth Management
Company. In contrast, during 1999, we incurred a loss on trading account assets
of $555,000, which was more than offset by $1.0 million of miscellaneous other
income attributable to an increase in loan fees from refinancings.
Other Expenses. The following table sets forth certain information
regarding other expenses for the periods shown.
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
------------------ -----------------------------
2002 2001 2001 2000 1999
------- ------- ------- ------- -------
(IN THOUSANDS)
Salaries and employee benefits ..... $ 3,941 $ 2,558 $ 5,444 $ 3,942 $ 4,064
Premises and equipment ............. 1,022 764 1,631 1,357 1,503
Insurance premiums ................. 122 143 250 278 269
Marketing .......................... 126 85 184 256 245
Computer services .................. 256 213 458 362 371
Consulting fees .................... 332 248 523 495 500
Office expenses and supplies ....... 279 185 427 387 407
Other (1) .......................... 802 749 1,400 1,319 1,210
------- ------- ------- ------- -------
Total other expenses ....... $ 6,880 $ 4,945 $10,317 $ 8,396 $ 8,569
======= ======= ======= ======= =======
- ----------------
(1) Consists primarily of professional fees, and other miscellaneous
expenses.
Total other expenses increased by $1.9 million or 39.1% during the six
months ended June 30, 2002 over the prior comparable period in 2001, increased
by $1.9 million or 22.9% during 2001 over 2000 and decreased marginally by
$173,000 or 2.0% during 2000 over 1999. Increased expenses during the periods
presented reflects our growth during the periods, as evidenced in the discussion
of the major components of other expenses discussed below.
The principal category of our other expenses is salaries and employee
benefits, which increased by $1.4 million or 54.1% during the six months ended
June 30, 2002, as compared to the same period in
38
the prior year. Salaries and employee benefits increased by $1.5 million or
38.1% during 2001 and decreased by $122,000 or 3.0% in 2000. The increases
during the six month period ended June 30, 2002 and 2001 over the prior
comparable respective periods were primarily due to the hiring of additional
employees in connection with the opening of new California branch offices in San
Luis Obispo, California in January 2001 and Nipomo, California in July 2001 and
the acquisition of our Kansas banking operation in November 2001, together with
our general growth in operations. The decrease in such expenses during 2000 was
due to the sale of Los Padres Bank's San Diego branch offices, which was
partially offset by increased staffing of our commercial banking group.
Premises and equipment expenses increased by $258,000 or 33.8% during
the six months ended June 30, 2002, as compared to the same period in the prior
year, increased by $274,000 or 20.2% during 2001 and decreased by $146,000 or
9.7% during 2000. The increase in premises and equipment expense during the six
month period ended June 30, 2002 and 2001 over the prior comparable respective
periods was primarily due to the branch openings and acquisition of our Kansas
banking operation, while the decrease in 2000 was due to the sale of the San
Diego branch offices.
We have contracted with Smith Breeden to provide investment advisory
services and interest rate risk analysis. Certain of our directors are also
principals of Smith Breeden. See "Management - Certain Relationships and Related
Transactions." The consulting fees paid by us to Smith Breeden during the six
months ended June 30, 2002 and 2001 and the years ended December 31, 2001, 2000
and 1999, amounted to $159,000, $140,000, $295,000, $286,000 and $284,000.
The increases in miscellaneous other expenses since 1999 reflect our
growth over the periods.
Income Taxes. We incurred income tax expense of $1.6 million, $1.4
million, $2.7 million, $2.0 million and $1.8 million, during the six months
ended June 30, 2002 and 2001 and the years ended December 31, 2001, 2000 and
1999. The amount of our income tax expense is a function of the amount of our
income before income taxes during the periods presented. Our effective tax rate
amounted to 41.1%, 41.8%, 41.8%, 43.7%, and 43.0% during the six months ended
June 30, 2002 and 2001, and the years ended December 31, 2001, 2000 and 1999.
CHANGES IN FINANCIAL CONDITION
General. At June 30, 2002, our total assets amounted to $683.6
million, compared with $670.3 million at December 31, 2001 and $485.0 million at
December 31, 2000. The increase in total assets during the periods was funded by
increases in total liabilities, primarily deposits and borrowings, and increases
in stockholders' equity. At June 30, 2002, our total liabilities amounted to
$651.6 million, compared to $640.2 million at December 31, 2001 and $459.4
million at December 31, 2000.
Cash and Cash Equivalents. Cash and cash equivalents, consisting of
cash and due from banks and federal funds sold, amounted to $15.6 million at
June 30, 2002, $11.1 million at December 31, 2001 and $13.3 million at December
31, 2000. We manage our cash and cash equivalents based upon our operating,
investing and financing activities. We generally attempt to invest our excess
liquidity into higher yielding assets such as loans or securities. See
"-Liquidity and Capital Resources."
39
Securities. In order to limit our credit risk exposure and to earn a
positive interest rate spread, we maintain a significant portion of our assets
in various types of securities, consisting primarily of investment grade
mortgage-backed securities and collateralized mortgage obligations, or CMOs, and
real estate mortgage investment conduits, or REMICs, which we collectively refer
to as "mortgage-backed and related securities." Our securities portfolio also
includes, to a lesser extent, U.S. Government securities. At June 30, 2002, our
securities portfolio, which is comprised of securities classified as available
for sale and held to maturity, amounted to $214.0 million or 31.3% of our total
assets. Mortgage-backed and related securities, which are the principal
components of our securities portfolio, often carry lower yields than
traditional mortgage loans. These types of securities, however, generally
increase the quality of our assets by virtue of the securities' underlying
insurance or guarantees, require less capital under risk-based regulatory
capital requirements than non-insured or non-guaranteed mortgage loans, are more
liquid than individual mortgage loans, which enhances our ability to actively
manage our portfolio, and may be used to collateralize borrowings or other
obligations we incur.
Securities classified as available for sale, which consist of
mortgage-backed and related securities, amounted to $211.5 million at June 30,
2002, $181.6 million at December 31, 2001 and $47.4 million at December 31,
2000. The $29.9 million or 16.5% increase during the six months ended June 30,
2002 and the $134.2 million or 282.9% increase during 2001 were primarily due to
favorable market opportunities for these securities. Securities classified as
held to maturity, consisting of mortgage-backed and U.S. Government and agency
securities, remained relatively stable at the end of the periods presented,
amounting to $2.5 million at June 30, 2002, $2.6 million at December 31, 2001
and $2.7 million at December 31, 2000.
Trading Account Assets. We also classify certain mortgage-backed and
related securities and equity securities as trading securities in accordance
with SFAS No. 115 and enter into interest rate contracts that do not qualify for
hedge accounting treatment. These assets are collectively referred to as trading
account assets. Trading account assets amounted to $2.1 million at June 30,
2002, $2.8 million at December 31, 2001 and $4.0 million at December 31, 2000.
At June 30, 2002, of the $2.1 million of trading account assets, $1.9 million
consisted of mortgage-backed and related securities, $132,000 consisted of
equity securities and $8,000 consisted of interest rate contracts. The decrease
in trading account assets since December 2000 reflects management's decision to
reduce its trading portfolio and to hold substantially all of its securities in
its available for sale portfolio, reflecting management's general intention of
focusing on interest income from its securities portfolio as opposed to the
generation of short-term gains on sale. This decision is evidenced by the
decline in our securities trading since December 2000.
Loans Receivable. At June 30, 2002, loans receivable, net of our
allowance for loan losses, amounted to $431.4 million or 63.1% of total assets,
as compared to $449.7 million or 67.1% of total assets at December 31, 2001 and
$395.5 million or 81.6% of total assets at December 31, 2000. The $18.3 million
or 4.1% decline in the portfolio at June 30, 2002, compared to December 31,
2001, was due to accelerated prepayments of fixed rate commercial real estate
and single-family mortgage loans and Los Padres Bank's strategy to broker for
third parties substantially all new single-family mortgage originations in order
to generate fee income. During 2001, net loans receivable increased
significantly by $54.2 million or 13.7% from December 31, 2000. The increase was
due to the acquisition of $69.9 million of loans in connection with the
acquisition of Harrington Bank FSB's Kansas banking operation.
Allowance for Loan Losses. At June 30, 2002, our allowance for loan
losses totaled $4.0 million, compared to $3.7 million at December 31, 2001 and
$3.2 million at December 31, 2000. At June 30, 2002, our allowance for loan
losses represented approximately 0.92% of the total loan portfolio and 214.95%
of total non-performing and troubled debt restructurings loans, as compared to
0.83% and 751.7% at December 31, 2001 and 0.79% and 93.69% at December 31, 2000.
The increase in our allowance for loan losses during the periods presented
reflects the growing percentage of commercial loans that we hold in our
portfolio which entail a higher degree of risk. The allowance for loan losses is
established through provisions based on our management's evaluation of the risks
inherent in our loan portfolio and the real estate economies in the markets in
which we operate. See "Business-Asset Quality-Allowance for Loan Losses."
Prepaid Expenses and Other Assets. At June 30, 2002, prepaid
expenses and other assets amounted to $1.6 million, as compared to $1.9 million
as of December 31, 2001 and $8.8 million as of December 31, 2000. The decrease
in prepaid expenses and other assets since December 31, 2000 reflected a $6.9
million receivable relating to the sale of a mortgage-backed security that was
paid subsequent to December 31, 2000.
40
Deposits. At June 30, 2002, deposits totaled $505.4 million, as
compared to $520.9 million as of December 31, 2001, and $355.7 million as of
December 31, 2000. The $15.5 million or 3.0% decline in total deposits during
the six months ended June 30, 2002 was due to management's strategy to reduce
our deposit pricing and allow the resulting reductions in higher cost deposits
to be replaced with FHLB advances. During 2001, we acquired $74.4 million of
deposits in connection with our acquisition of the Kansas banking operation. We
attempt to manage our overall funding costs by evaluating all potential sources
of funds, including retail deposits and short and long-term borrowings, and
identifying which particular source will result in an all-in cost to us that
meets our funding benchmark. At the same time, Los Padres Bank has attempted to
price the deposits offered through its branch system in order to promote retail
deposit growth and offer a wide array of deposit products to satisfy its
customers. In addition to providing a cost-efficient funding source, these
retail deposits provide a source of fee income and the ability to cross-sell
other products or services.
Borrowings. Advances from the FHLB of San Francisco amounted to
$123.4 million at June 30, 2002, $96.4 million at December 31, 2001 and $91.0
million as of December 31, 2000. The increase in FHLB advances since 2000 was
due to our increased utilization of such borrowings to fund our growth in
securities and loans. At June 30, 2002, our FHLB advances had a weighted average
interest rate of 4.23%, as compared to 4.82% at December 31, 2001 and 6.28% at
December 31, 2000. Our outstanding FHLB advances have maturities ranging from
2002 to 2010.
We have a loan facility from two banks consisting of a revolving line
of credit. We are currently permitted to borrow up to $25.0 million under the
line of credit, which decreases to 21.875 million from September 2005 through
September 2006 and further decreases to $18.75 million from September 2006
through September 30, 2007, $18.0 million at December 31, 2001 and $9.0 million
at December 31, 2000. Proceeds from the note payable have been contributed to
Los Padres Bank in order to increase Los Padres Bank's capital and working
capital, thereby permitting us to increase Los Padres Bank's originations of
loans and purchases of mortgage-backed and related securities. The loan facility
is secured by Los Padres Bank's common stock. We also have certain restrictive
debt covenants pursuant to this loan facility. See "Business - Sources of Funds
- - Borrowings."
Stockholders' Equity. Our stockholders' equity amounted to $32.0
million at June 30, 2002, an increase of $1.9 million, and increased by $4.6
million to $30.1 million at December 31, 2001, from $25.6 million at December
31, 2000. These increases reflect our increasing profitability and were
primarily due to net income recognized during the periods presented. Our
stockholders' equity was also affected by unrealized gains and losses on
securities and interest rate contracts, dividends paid on our common stock and
the exercise of stock options.
ASSET AND LIABILITY MANAGEMENT
In general, financial institutions are negatively affected by an
increase in interest rates to the extent that interest-bearing liabilities
mature or reprice more rapidly than interest-earning assets. The lending
activities of savings institutions have historically emphasized the origination
of long-term, fixed-rate loans secured by single-family residences, and the
primary source of funds of such institutions has been deposits, which largely
mature or are subject to repricing within a shorter period of time. This factor
has historically caused the income and market value of portfolio equity, or
MVPE, of savings institutions to be more volatile than other financial
institutions.
MVPE is defined as the net present value of the cash flows from an
institution's existing assets, liabilities and off-balance sheet instruments.
The MVPE is estimated by valuing our assets, liabilities and off-balance sheet
instruments under various interest rate scenarios. The extent to which assets
gain or lose value in relation to the gains or losses of liabilities determines
the appreciation or depreciation in equity on a market value basis. MVPE
analysis is intended to evaluate the impact of immediate and sustained interest
rate shifts of the current yield curve upon the market value of the current
balance sheet. While having liabilities that reprice more frequently than assets
is generally beneficial to net interest income and MVPE in times of declining
interest rates, such an asset/liability mismatch is generally detrimental during
periods of rising interest rates.
41
Our management believes that its asset and liability management
strategy, as discussed below, provides us with a competitive advantage over
other financial institutions. We believe that our ability to hedge our interest
rate exposure through the use of various interest rate contracts provides us
with the flexibility to acquire loans structured to meet our customer's
preferences and investments that provide attractive net risk-adjusted spreads,
regardless of whether the customer's loan or our investment is fixed-rate or
adjustable-rate or short-term or long-term. Similarly, we can choose a
cost-effective source of funds and subsequently engage in an interest rate swap
or other hedging transaction so that the interest rate sensitivities of our
interest-earning assets and interest-bearing liabilities are more closely
matched.
Our asset and liability management strategy is formulated and monitored
by the board of directors of Los Padres Bank. The Board's written policies and
procedures are implemented by the Asset and Liability Committee of Los Padres
Bank, or ALCO, which is comprised of Los Padres Bank's chief executive officer,
president, chief financial officer, controller and four non-employee directors
of Los Padres Bank. The ALCO meets at least eight times a year to review the
sensitivity of Los Padres Bank's assets and liabilities to interest rate
changes, investment opportunities, the performance of the investment portfolios,
and prior purchase and sale activity of securities. The ALCO also provides
guidance to management on reducing interest rate risk and on investment strategy
and retail pricing and funding decisions with respect to Los Padres Bank's
overall asset and liability composition. The ALCO reviews Los Padres Bank's
liquidity, cash flow needs, interest rate sensitivity of investments, deposits
and borrowings, core deposit activity, current market conditions and interest
rates on both a local and national level in connection with fulfilling its
responsibilities.
Smith Breeden provides consulting services to us regarding, among other
things, the selection of our investments and borrowings, the pricing of loans
and deposits, and the use of various interest rate contracts to reduce interest
rate risk. Smith Breeden is a consulting firm which renders investment advice
and asset and liability management service to financial institutions, corporate
and government agencies nationally. Certain of our directors are principals of
Smith Breeden. See "Management-Certain Relationships and Related Transactions."
The ALCO regularly reviews interest rate risk by utilizing analyses
prepared by Smith Breeden with respect to the impact of alternative interest
rate scenarios on net interest income and on Los Padres Bank's MVPE. The Asset
and Liability Committee also reviews analyses prepared by Smith Breeden
concerning the impact of changing market volatility, prepayment forecast error,
and changes in option-adjusted spreads and non-parallel yield curve shifts.
In the absence of our hedging activities, our MVPE would decline as a
result of a general increase in market rates of interest. This decline would be
due to the market values of our assets being more sensitive to interest rate
fluctuations than are the market values of our liabilities due to our investment
in and origination of generally longer-term assets which are funded with
shorter-term liabilities. Consequently, the elasticity (i.e., the change in the
market value of an asset or liability as a result of a change in interest rates)
of our assets is greater than the elasticity of our liabilities.
Accordingly, the primary goal of our asset and liability management
policy is to effectively increase the elasticity of our liabilities and/or
effectively contract the elasticity of our assets so that the respective
elasticities are matched as closely as possible. This elasticity adjustment can
be accomplished internally by restructuring our balance sheet or externally by
adjusting the elasticities of our assets and/or liabilities through the use of
interest rate contracts. Our strategy is to hedge either internally through the
use of longer-term certificates of deposit or less sensitive transaction
deposits and FHLB advances or externally through the use of various interest
rate contracts.
External hedging generally involves the use of interest rate swaps,
caps, floors, options and futures. The notional amount of interest rate
contracts represents the underlying amount on which
42
periodic cash flows are calculated and exchanged between counterparties.
However, this notional amount does not necessarily represent the principal
amount of securities which would effectively be hedged by that interest rate
contract.
In selecting the type and amount of interest rate contract to utilize,
we compare the elasticity of a particular contract to that of the securities to
be hedged. An interest rate contract with the appropriate offsetting elasticity
could have a notional amount much greater than the face amount of the securities
being hedged.
We adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, on January 1, 2001. SFAS No. 133 requires that an entity
recognize all interest rate contracts as either assets or liabilities in the
statement of financial condition and measure those instruments at fair value. If
certain conditions are met, an interest rate contract may be specifically
designated as a fair value hedge, a cash flow hedge, or a hedge of foreign
currency exposure. The accounting for changes in the fair value of an interest
rate contract (that is, gains and losses) depends on the intended use of the
interest rate contract and the resulting designation. To qualify for hedge
accounting, we must show that, at the inception of the interest rate contracts
and on an ongoing basis, the changes in the fair value of the interest rate
contracts are expected to be highly effective in offsetting related changes in
the cash flows of the hedged liabilities. We have entered into various interest
rate swaps for the purpose of hedging certain of our short-term liabilities.
These interest rate swaps qualify for hedge accounting. Accordingly, the
effective portion of the accumulated change in the fair value of the cash flow
hedges is recorded in a separate component of stockholders' equity, net of tax,
while the ineffective portion is recognized in earnings immediately. We have
also entered into various interest rate swaps which hedge a portion of our
securities portfolio. These swaps do not qualify for hedge accounting treatment
and are included in the trading account assets and are reported at fair value
with realized and unrealized gains and losses on these instruments recognized in
income (loss) from trading account assets.
An interest rate swap is an agreement where one party agrees to pay a
fixed rate of interest on a notional principal amount to a second party in
exchange for receiving from the second party a variable rate of interest on the
same notional amount for a predetermined period of time. No actual assets are
exchanged in a swap of this type and interest payments are generally netted.
These swaps are generally utilized by us to synthetically convert floating-rate
deposits and borrowings into fixed-rate liabilities or convert fixed-rate assets
into adjustable-rate instruments, in either case without having to sell or
transfer the underlying liabilities or assets.
At June 30, 2002, we held interest rate swaps which are utilized to
hedge liabilities and which qualify for hedge accounting pursuant to SFAS No.
133 and are included in other assets or other liabilities. These swap agreements
had an aggregate notional amount of $40.0 million and maturities from February
2004 to December 2010. With respect to these agreements, we make fixed rate
payments ranging from 5.27% to 6.29% and receive payments based upon three-month
LIBOR. These fixed-pay swaps, in addition to certain cap agreements, are used to
effectively modify the interest rate sensitivity of a portion of Los Padres
Bank's short-term LIBOR correlated borrowings which include short-term deposits,
securities sold under agreements to repurchase and FHLB advances.
The income (expense) relating to these swaps was $713,000, $26,000,
$528,000, $(205,000), and $(77,000) during the six months ended June 30, 2002
and 2001 and the years ended December 31, 2001, 2000, and 1999, respectively.
This income (expense) is netted against interest expense on FHLB advances in our
consolidated statements of earnings. The approximate net market value of these
interest rate swaps was $(2.2) million, $(1.1) and million and $325,000 as of
June 30, 2002 and December 31, 2001 and 2000, respectively. Effective as of
January 1, 2001, these gains and losses are reflected as a separate component in
43
stockholders' equity. Prior to such date, these gains and losses were not
reflected on our statement of financial condition.
At June 30, 2002, we did not hold any interest rate swaps as trading
account assets, except for certain interest rate swaps that we utilize in order
to enhance our returns and not for the purpose of interest rate risk management.
For information regarding these swaps, which we refer to as "total return
swaps," see "Business-Investment Activities-Trading Account Assets and Other
Securities."
An interest rate cap or an interest rate floor consists of a guarantee
given by the issuer (i.e., a broker) to the purchaser (i.e., us), in exchange
for the payment of a premium. This guarantee states that if interest rates rise
above (in the case of a cap) or fall below (in the case of a floor) a specified
rate on a specified interest rate index, the issuer will pay to the purchaser
the difference between the then current market rate and the specified rate on a
notional principal amount. No funds are actually borrowed or repaid.
At June 30, 2002, we did not have any interest rate caps or floors which
qualify for hedge accounting pursuant to SFAS No. 133. Such caps are sometimes
used to effectively modify the interest rate sensitivity of a portion of Los
Padres Bank's short-term LIBOR correlated liabilities, which include short-term
deposits, securities sold under agreements to repurchase and FHLB advances. The
aggregate net interest expense (income) related to such interest rate caps and
floors was $(10,000), $(10,000), $(20,000), $193,000 and $789,000 for the six
months ended June 30, 2002 and 2001 and the years ended December 31, 2001, 2000,
and 1999, respectively. The approximate market value of the caps and floors was
$0, $0, $0 and $2.1 million at June 30, 2002 and December 31, 2001, 2000, and
1999, respectively.
At June 30, 2002, we did not have any caps or floors in our trading
portfolio. The aggregate net expense (income) relating to our interest rate caps
and floors held in the trading portfolio was $0, $0, $0, $57,000 and $(254,000)
during the six months ended June 30, 2002 and 2001 and the years ended December
31, 2001, 2000 and 1999, respectively. The approximate market value of our
interest rate caps and floors which are maintained in the trading portfolio was
$0 as of June 30, 2002 and December 31, 2001, and 2000.
Interest rate futures are commitments to either purchase or sell
designated instruments at a future date for a specified price. Futures contracts
are generally traded on an exchange, are marked-to-market daily and are subject
to initial and maintenance margin requirements. We generally use 91-day
Eurodollar certificates of deposit contracts ("Eurodollar futures contracts")
which are priced off LIBOR as well as Treasury Note and Bond futures contracts.
We will from time to time agree to sell a specified number of contracts at a
specified date. To close out a contract, we will enter into an offsetting
position to the original transaction.
If interest rates rise, the value of our short futures positions
increase. Consequently, sales of futures contracts serve as a hedge against
rising interest rates. At June 30, 2002, we did not have any futures contracts.
We had total gains (losses) on our futures contracts of $(97,000), $(62,000),
$(291,000), $(6.9) million and $9.0 million for the six months ended June 30,
2002 and 2001 and the years ended December 31, 2001, 2000, and 1999,
respectively.
Options are contracts which grant the purchaser the right to buy or sell
the underlying asset by a certain date for a specified price. Generally, we will
purchase options on financial futures to hedge the changing elasticity exhibited
by mortgage loans and mortgage-backed securities. The changing elasticity
results from the ability of a borrower to prepay a mortgage or caps and floors
on the underlying loans. As market interest rates decline, borrowers are more
likely to prepay their mortgages, shortening the
44
elasticity of the mortgages. Consequently, where interest rates are declining,
the value of mortgage loans or mortgage-backed securities will increase at a
slower rate than would be expected if borrowers did not have the ability to
prepay their mortgage.
At June 30, 2002, we did not have any purchased options contracts in our
portfolio, and we did not incur any net expense relating to purchased options
contracts during the six months ended June 30, 2002 or 2001 or the years ended
December 31, 2001 and 2000.
We are subject to the risk that our counterparties with respect to
various interest rate contracts may default at or prior to maturity of a
particular instrument. In such a case, we might be unable to recover any
unrealized gains with respect to a particular contract. To reduce this potential
risk, we generally deal with large, established investment brokerage firms when
entering into these transactions. In addition, we have a policy whereby we limit
our unsecured exposure to any one counterparty to 25% of Los Padres Bank's
equity during any two-month period and 35% of Los Padres Bank's equity during
any one-month period.
The OTS requires each thrift institution to calculate the estimated
change in the institution's MVPE assuming an instantaneous, parallel shift in
the Treasury yield curve of 100 to 300 basis points either up or down in 100
basis point increments. The OTS permits institutions to perform this MVPE
analysis using their own internal model based upon reasonable assumptions. Smith
Breeden assists us in performing the required calculation of the sensitivity of
our market value to changes in interest rates.
In estimating the market value of mortgage loans and mortgage-backed
securities, we utilize various prepayment assumptions which vary, in accordance
with historical experience, based upon the term, interest rate and other factors
with respect to the underlying loans. At June 30, 2002, these prepayment
assumptions varied from 15% to 65% for fixed-rate mortgages and mortgage-backed
securities and varied from 15% to 23% for adjustable-rate mortgages and
mortgage-backed securities.
The following table sets forth at June 30, 2002 the estimated
sensitivity of Los Padres Bank's MVPE to parallel yield curve shifts using our
internal market value calculation. The table demonstrates the sensitivity of our
assets and liabilities both before and after the inclusion of our interest rate
contracts.
CHANGE IN INTEREST RATES (IN BASIS POINTS)(1)
------------------------------------------------------------------------------------
-300 -200 -100 - +100 +200 +300
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Market value gain (loss) in assets ........ $ 20,382 $ 14,663 $ 7,943 -- ($11,308) ($25,692) ($40,813)
Market value gain (loss) of liabilities ... (18,364) (13,344) (6,831) -- 7,087 14,443 22,028
-------- -------- -------- -------- -------- --------
Market value gain (loss) of net assets
before interest rate contracts ........ 2,018 1,319 1,112 -- (4,221) (11,249) (18,785)
Market value gain (loss) of interest
rate contracts ........................ (7,410) (4,742) (2,279) -- 2,120 4,095 5,934
-------- -------- -------- -------- -------- --------
Total change in MVPE(2) ................... ($ 5,392) ($ 3,423) ($ 1,167) -- ($ 2,101) ($ 7,154) ($12,851)
======== ======== ======== ======== ======== ========
Change in MVPE as a percent of:
MVPE(2) ............................... (9.13)% (5.79)% (1.97)% -- (3.56)% (12.11)% (21.75)%
Total assets of Los Padres Bank ....... (0.79)% (0.50)% (0.17)% -- (0.31)% (1.05)% (1.88)%
----------------
(1) Assumes an instantaneous parallel change in interest rates at
all maturities.
(2) Based on our pre-tax MVPE of $59.1 million at June 30, 2002.
45
The table set forth above does not purport to show the impact of
interest rate changes on our equity under generally accepted accounting
principles. Market value changes only impact our income statement or the balance
sheet to the extent the affected instruments are marked to market, and over the
life of the instruments as an impact on recorded yields.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The liquidity of the Los Padres Bank, as measured by the
ratio of cash, cash equivalents (not committed, pledged or required to liquidate
specific liabilities), investments and qualifying mortgage-backed securities to
the sum of total deposits plus borrowings payable within one year, was 6.79% at
June 30, 2002. At June 30, 2002, Los Padres Bank's "liquid" assets totaled
approximately $25.3 million.
Our liquidity, represented by cash and cash equivalents, is a product of
our operating, investing and financing activities. Our primary sources of
internal liquidity consist of deposits, prepayments and maturities of
outstanding loans and mortgage-backed and related securities, maturities of
short-term investments, sales of mortgage-backed and related securities and
funds provided from operations. While scheduled loan and mortgage-backed and
related securities amortization and maturing short-term investments are
relatively predictable sources of funds, deposit flows and loan prepayments are
greatly influenced by general interest rates, economic conditions and
competition. Our external sources of liquidity consist of borrowings, primarily
advances from the FHLB of San Francisco and a revolving line of credit loan
facility which we maintain with two banks. At June 30, 2002, we had $123.4
million in FHLB advances and we had $115.7 million of additional borrowing
capacity with the FHLB of San Francisco. At June 30, 2002, our note payable
under our revolving line of credit amounted to $16.6 million and we had $3.4
million of additional borrowing capacity under this loan facility. On September
17, 2002, we entered into an amendment to this loan facility that increased our
additional borrowing capacity initially by up to $8.4 million, increased our
dividend paying capacity and relaxed certain restrictive covenants applicable to
us, which, among other things, requires us to comply with specified financial
ratios and tests, including a minimum ratio of non-performing assets to initial
stockholders' equity plus loan loss reserves, minimum regulatory capital
requirements that are consistent with current requirements for being classified
as "well capitalized," a minimum loan to value ratio and a minimum core
profitability requirement. The covenant that restricts our ability to invest in
mortgage derivative securities has been revised to allow us to maintain a larger
balance as of the last day of the month. The covenant that restricts payment of
cash dividends has been revised to provide us with greater flexibility to pay
dividends, in an aggregate amount not to exceed the greater of (a) $300,000
during any fiscal quarter, or (b) up to a maximum of 25% of consolidated net
income for the quarter. The minimum core profitability requirements have been
made slightly more restrictive, and the covenant which addresses Los Padres
Bank's non-performing assets is new. Management believes that as of June 30,
2002, it was in compliance with all of such covenants and restrictions and does
not anticipate that such covenants and restrictions will limit our operations.
For additional information, see "Business-Borrowings."
Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally used to pay down short-term
borrowings. On a longer-term basis, we maintain a strategy of investing in
various mortgage-backed and related securities and loans as described in greater
detail under "Business - Investment Activities." We use our sources of funds
primarily to meet our ongoing commitments, to pay maturing savings certificates
and savings withdrawals, fund loan commitments and maintain a portfolio of
mortgage-backed and related securities as well as certain other investments. At
June 30, 2002, the total approved loan commitments outstanding amounted to $38.9
million. Certificates of deposit scheduled to mature in one year or less at June
30, 2002 totaled $298.1 million and borrowings that are scheduled to mature
within the same period amounted to $48.4 million. We believe that we have
adequate resources to fund all of our commitments and that we could either
adjust the rate of certificates of deposit in order to retain deposits in
changing interest rate environments or replace such deposits with advances from
the FHLB of San Francisco if it proved to be cost-effective to do so.
A substantial source of our income from which we service our debt, pay
our obligations and from which we can pay dividends is the receipt of dividends
from Los Padres Bank. The availability of dividends from Los Padres Bank is
limited by various statutes and regulations. See "Regulation - Regulation of Los
Padres Bank. Capital Distributions." At June 30, 2002, Los Padres Bank was
permitted to pay up to $1.8 million of dividends to us. In order to make such
dividend payment, Los Padres Bank is required to provide 30 days advance notice
to the OTS, during which time the OTS may object to such dividend payment. It is
possible, depending upon the financial condition of Los Padres Bank, and other
factors, that the OTS could object to the payment of dividends by Los Padres
Bank on the basis that the payment of such dividends is an unsafe or unsound
practice. In addition, we are also subject to restrictions on our ability to pay
dividends under our revolving loan facility. See "Trading History and Dividend
Policy." In the event Los Padres Bank is unable to pay dividends to us, we may
not be able to service our debt, pay our obligations or pay dividends on our
common stock.
Capital Resources. Federally insured savings institutions such as Los
Padres Bank are required to maintain minimum levels of regulatory capital. In
addition, due to our business strategy which has concentrated on growth, a shift
in our lending focus to more commercial lending and the size of our securities
portfolios, we have informally agreed with the OTS that Los Padres Bank will
maintain a total risk-based capital ratio and a leverage capital ratio of at
least 11% and 6%, respectively, which is in excess of the OTS' minimum
regulatory requirements. Management does not believe that Los Padres Bank's
agreement with the OTS to maintain increased ratios of total risk-based and
leverage capital will limit or restrict our operations. To the extent that Los
Padres Bank fails to comply with these additional increased capital ratios, the
OTS could take such failure to comply into consideration in connection with
further requests to have Los Padres Bank pay dividends to us and in additional
future branch applications. Los Padres Bank's failure to comply could also
impact its overall assessment by the OTS in future regulatory examinations,
which if adverse, could also impact its FDIC insurance assessment. See
"Regulation-Regulation of Los Padres Bank-Regulatory Capital Requirements and
Prompt Corrective Action."
46
The following table as of June 30 2002, reflects Los Padres Bank's
actual levels of regulatory capital and both the applicable regulatory capital
requirements as well as the increased capital requirements that Los Padres has
informally agreed with the OTS that it will maintain.
TANGIBLE CAPITAL(1) TIER 1 LEVERAGE CAPITAL(1) RISK-BASED CAPITAL(1)
-------------------- -------------------------- ---------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- -------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Actual regulatory capital N/A N/A $42,256 6.26% $46,217 12.14%
Minimum required by OTS
agreement (2) N/A N/A 40,504 6.00 41,897 11.00
------- ---- ------- ---- ------- ------
Excess regulatory capital N/A N/A $ 1,752 0.26% $ 4,338 1.14%
======= ==== ======= ==== ======= =====
Actual regulatory capital $42,256 6.26% $42,256 6.26% $46,217 12.14%
Minimum regulatory capital 10,126 1.50 27,003 4.00 30,458 8.00
------- ---- ------- ---- ------- ------
Excess regulatory capital $32,130 4.76% $15,253 0.26% $15,759 4.14%
======= ==== ======= ==== ======= =====
- ----------
(1) The tangible capital ratio is computed as a percentage of tangible
assets and the Tier 1 leverage ratio is computed as a percentage of
adjusted total assets, both of which are $675.1 million at June 30,
2002.
(2) Although applicable OTS regulations require Los Padres Bank to maintain
Tier 1 leverage capital equal to 4.00% of adjusted total assets and
risk-based capital equal to 8.00% of adjusted risk-weighted assets. Los
Padres Bank has informally agreed with the OTS that it will maintain
Tier 1 leverage capital equal to 6.00% of adjusted total assets and
risk-based capital equal to 11.00% of adjusted risk-weighted assets.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following tables present our contractual cash obligations and
commercial commitments as of June 30, 2002.
PAYMENT DUE PERIOD
-------------------------------------------------
LESS THAN TWO TO FOUR TO AFTER
TOTAL ONE YEAR THREE YEARS FIVE YEARS FIVE YEARS
-------- -------- ----------- ---------- ----------
(IN THOUSANDS)
Contractual cash obligations:
Certificates of deposit ..... $353,372 $298,084 $ 42,404 $ 12,743 $ 141
FHLB advances ............... 123,403 48,403 55,000 -- 20,000
Note payable ................ 16,600 -- 16,600 -- --
-------- -------- -------- -------- --------
Total contractual cash
obligations ............ $493,375 $346,487 $114,004 $ 12,743 $ 20,141
======== ======== ======== ======== ========
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
----------------------------------------------
UNFUNDED LESS THAN ONE TO FOUR TO AFTER
COMMITMENTS ONE YEAR THREE YEARS FIVE YEARS FIVE YEARS
----------- -------- ----------- ---------- ----------
(IN THOUSANDS)
Commitments:
Commercial lines of credit .................... $13,278 $10,435 $ 1,201 $ 1,642 $ --
Consumer lines of credit(1) ................... 8,634 1,055 -- -- 7,579
Undisbursed portion of loans in process ....... 16,578 14,931 1,647 -- --
Letters of credit ............................. 381 381 -- -- --
------- ------- ------- ------- -------
Total commitments ........................ $38,871 $26,802 $ 2,848 $ 1,642 $ 7,579
======= ======= ======= ======= =======
- ----------
(1) Lines of credit with no stated maturity date are included in commitments
for less than one year.
INFLATION AND CHANGING PRICES
Our consolidated financial statements and related data presented in this
prospectus have been prepared in accordance with accounting principles generally
accepted in the U.S., which require the measurement of financial position and
operating results in terms of historical dollars (except with respect
47
to securities which are carried at market value), without considering changes in
the relative purchasing power of money over time due to inflation. Unlike most
industrial companies, substantially all of our assets and liabilities are
monetary in nature. As a result, interest rates have a more significant impact
on our performance than the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or in the same magnitude as
the prices of goods and services.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 141, Business Combinations, and
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
completed after June 30, 2001 and also specifies the types of acquired
intangible assets that are required to be recognized and reported separately
from goodwill and those acquired intangible assets that are required to be
recognized and reported separately from goodwill. SFAS No. 142 requires that
goodwill no longer be amortized, but instead be tested for impairment at least
annually. SFAS No. 142 also requires recognized intangible assets to be
amortized over their respective estimated useful lives and reviewed for
impairment in accordance with SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, as replaced by
SFAS No. 144. Any recognized intangible asset determined to have an indefinite
useful life will not be amortized, but instead must be tested for impairment
until its life is determined to no longer be indefinite. We adopted the new
rules on accounting for goodwill and other intangible assets on January 1, 2002.
Furthermore, in connection with the required transitional impairment
evaluation, SFAS No. 142 requires us to perform an assessment of whether there
was an indication that goodwill was impaired as of January 1, 2002. The
transitional assessment consists of the following steps: (1) identify our
reporting units, (2) determine the carrying value of each reporting unit by
assigning the assets and liabilities, including the existing goodwill and
intangible assets to those reporting units, and (3) determine the fair value of
each reporting unit. The transitional goodwill impairment test was completed
during the six months ended June 30, 2002. No transitional impairment loss was
recorded as a result of adopting this standard.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 updates, clarifies and simplifies existing accounting
pronouncements including: rescinding SFAS No. 4, which required all gains and
losses from extinguishment of debt to be aggregated and, if material, classified
as an extraordinary item, net of related income tax effect and amended SFAS No.
13 to require that certain lease modifications that have economic effects
similar to sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. SFAS No. 145 is effective for fiscal years
beginning after May 15, 2002, with early adoption of the provisions related to
the rescission of SFAS No. 4 encouraged. We do not expect the adoption of this
Statement to have a material impact on our financial position or results of
operations.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes Emerging Issues Task Force ("EITF") Issue 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146
requires that a liability for a cost associated with an exit or
48
disposal activity be recognized when the liability is incurred. Under Issue
94-3, a liability for an exit cost is defined in EITF-94-3 was recognized at the
date of an entity's commitment to an exit plan. SFAS No. 146 also establishes
that the liability should initially be measured and recorded at fair value. We
intend to adopt the provisions of SFAS No. 146 for exit or disposal activities
that are initiated after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain
Financial Institutions, which provides guidance on the accounting for the
acquisition of a financial institution. This statement requires that the excess
of the fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired in a business combination represents
goodwill that should be accounted for under SFAS No. 142, Goodwill and Other
Intangible Assets. Thus, the specialized accounting guidance in paragraph 5 of
SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift
Institutions, will not apply after September 30, 2002. If certain criteria in
SFAS No. 147 are met, the amount of the unidentifiable intangible asset will be
reclassified to goodwill upon adoption of the statement. Financial institutions
meeting conditions outlined in SFAS No. 147 will be required to restate
previously issued financial statements. Additionally, the scope of SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, is amended to
include long-term customer-relationship intangible assets such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible assets.
This statement is effective for Los Padres Bank beginning October 1, 2002. We
have adopted the new standard as of October 1, 2002 and the adoption of this
standard did not have a material impact on our financial position or results of
operation.
BUSINESS
GENERAL
We are the holding company for Los Padres Bank, a federally chartered
savings bank with ten full-service offices, nine of which are located on the
central coast of California and one of which is located in the Kansas City
metropolitan area. We operate our Kansas banking operation as a division of Los
Padres Bank under the name Harrington Bank. We plan to open a banking office in
the Phoenix/Scottsdale metropolitan area and commence operations of a joint
venture with the largest RE/MAX franchise in such metropolitan area in the
fourth quarter of 2002, through a mortgage company we have formed. We also
operate Harrington Wealth Management Company, a subsidiary of Los Padres Bank.
Harrington Wealth Management Company provides trust and investment management
services to individuals and small institutional clients using a customized
investment allocation approach and low fee, indexed mutual funds. At June 30,
2002, we had consolidated total assets of $683.6 million, total deposits of
$506.8 million and stockholders' equity of $32.0 million.
Los Padres Bank was originally organized in 1983 as a
California-licensed savings association under the name "Santa Ynez Valley
Savings and Loan Association" and converted to a federally chartered savings
bank in 1993. In August 1995, we were formed for the purpose of acquiring Los
Padres Bank. We completed our acquisition of the Los Padres Bank in April 1996.
We did not engage in any business prior to our concurrent with our acquisition
of Los Padres Bank. In 1997, we acquired all the assets and liabilities of a
bank in San Diego, California, which contributed two branches, $79 million in
assets and $71 million in deposits. In November 1997, we acquired two branches
in Solvang and Qiai, California with over $49 million in deposits from another
financial institution. In February 2000, we sold the two branches and deposits
associated with the 1997 acquisition. In December 1997, we opened an office in
Buellton, California to further service the Santa Ynez Valley, which had $16.1
million of deposits at June 30, 2002. In February 1999, we opened an office in
Goleta, California, which had $69.8 million of deposits at June 30, 2002 and
acquired a 49% ownership interest in Harrington Wealth Management Company in a
joint venture with Harrington Bank, FSB which, as discussed below, was a related
party. In January and July 2001, Los Padres Bank opened full-serving banking
facilities in San Luis Obispo and Nipomo, California. These new operations
collectively had $26.5 million of deposits at June 30, 2002. Finally in November
2001, we successfully acquired the Kansas banking operation of Harrington Bank,
FSB and the remaining 51% ownership of Harrington Wealth Management Company from
Harrington Bank, FSB. Mr. Cerny, our Chief Executive Officer, was also the Chief
Executive Officer of Harrington Bank, FSB at the time of our acquisition and
thus, our acquisition of Harrington Bank, FSB involved a related party. The
Kansas branch acquisition, contributed $69.9 million in loans and $74.4 million
in deposits. We anticipate opening a second office in Kansas in mid 2003 and a
new office in the Phoenix/Scottsdale metropolitan area in the fourth quarter of
2002.
Our goal is to continue to enhance our franchise value and earnings
through controlled growth in our banking operations, while maintaining the
combination of community-oriented customer service and sophisticated centralized
financial management that have characterized our success to date. Our strategy
for achieving this goal is:
- Hiring Experienced Employees With A Customer Service Focus. We
provide personalized service and relationship banking to our
customers. Our ability to continue to attract and retain banking
professionals with significant experience in and knowledge of our
markets who share our customer service philosophy is key to our
success. By offering quick decision making in the delivery of
banking products and services, offering customized products where
appropriate, and providing customer access to our senior managers,
we distinguish ourselves from larger, regional banks operating in
our market areas, while our larger capital base and product mix
enable us to compete effectively against smaller community banks.
- Expanding Our Product Offerings. We will diversify our loan
portfolio by continuing to grow our commercial and industrial
business lines, while still providing high quality loan products for
single-family and multi-family residential borrowers. We also intend
to selectively add additional products to provide diversification of
revenue sources and to capture our customer's full relationship. As
part of this strategy, we are focused on increasing our deposit and
loan fees and further developing our wholesale banking activities
that provide single-family loan originations for other lenders. We
intend to continue to expand the wealth management area of our
business by cross selling our trust and investment products and
services to our customers through Harrington Wealth Management
Company. We offer a wide range of financial instruments and
services, including low fee indexed mutual funds, personal trusts,
investment management, custody, estates, guardianships, land trusts,
and retirement plan services.
- Strategic Expansion. We will continue to expand our branch network
through de novo office openings in all of our markets. We expect to
open an office in the Phoenix/Scottsdale market
49
in the fourth quarter of 2002 and a second office in the Kansas City
metropolitan area in mid 2003. These openings are intended to
capitalize on the opportunities these markets present to us, with a
view to continued growth in both of these markets. We believe that
our centralized underwriting, administration and treasury functions
should enable us to increase operating efficiencies over time.
Acquisitions have played an integral role in our past growth. We are
committed to exploring opportunistic controlled expansion of our
franchise through strategic acquisitions designed to increase our
market share and branch office locations. We believe that continued
development of the Los Padres and Harrington franchises will provide
us with additional profits over time and enhance our market and
franchise value.
- Using Financial Management Techniques to Manage Our Interest Rate
Risk and Enhance our Profitability. We deploy our excess capital in
a portfolio of highly liquid mortgage backed and related securities
until we are able to reinvest these assets into loans or other
community banking assets. Our securities portfolio is funded
primarily by deposits and borrowings and is managed to a short
duration with the intention of creating additional income and
improving our return on equity. The interest rate sensitivity of our
investments, loans and funding sources is reduced using various
interest rate contracts, including interest rate swaps, caps and
floors and exchange-traded futures and options. In selecting
mortgage-backed and related securities for our portfolio and in
pricing our loans, we employ option-adjusted spread pricing analysis
to ascertain the net risk-adjusted spread expected to be earned on
the various investments and loans. This analysis considers the
interest rate, prepayment, credit and liquidity risks in an
investment or loan, and we seek to select securities and loans with
the highest spread over funding costs after covering the expected
costs of the embedded risks. In this manner, our portfolio can
enhance our profitability through interest earned on these
securities over our funding costs and through possible gains as a
result of price changes net of hedging activities.
LENDING ACTIVITIES
General. At June 30, 2002, Los Padres Bank's net loan portfolio totaled
$431.4 million, representing approximately 63.1% of our $683.6 million of total
assets at the date. Los Padres Bank's primary focus with respect to its lending
operations has historically been the direct origination of single-family
residential, multi-family residential and commercial real estate loans. While we
continue to emphasize single-family residential loans products that meet our
customer's needs, we now generally broker such loans on behalf of third party
investors in order to generate fee income and have been increasing our emphasis
on loans secured by commercial real estate and commercial and industrial loans.
We also offer multi-family residential loans, construction loans secured by both
residential and commercial properties and consumer loans.
The risks associated with mortgage lending are well-defined and
controllable. Credit risk is controlled through the adherence, with few
exceptions, to secondary market underwriting guidelines. We rely on our internal
credit approval and administrative process to originate loans as well as our
internal asset review process which oversees our loan quality in order to ensure
that our underwriting standards are maintained. We believe that the low level of
our non-performing assets is evidence of our adherence to our underwriting
guidelines. See "-Asset Quality-Non-Performing Assets." Market risk is
controlled by our approach to pricing and by regular monitoring and management
of the institution's overall sensitivity to interest rate changes. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Asset and Liability Management."
As a federally chartered savings institution, Los Padres Bank has
general authority to originate and purchase loans secured by real estate located
throughout the United States. Despite this nationwide
50
lending authority, we estimate that at June 30, 2002, substantially all of the
loans in Los Padres Bank's portfolio are secured by properties located or made
to customers residing in each of our primary market areas located in the
California central coast and the Kansas City metropolitan area.
51
The following table sets forth the composition of our loan portfolio by
type of loan at the dates indicated.
DECEMBER 31,
JUNE 30, -----------------------------------------------------
2002 2001 2000
------------------------ ------------------------ ------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
---------- ---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Real estate loans:
Single-family ....................... $ 133,157 30.6% $ 156,150 34.5% $ 200,373 50.2%
Multi-family ........................ 70,531 16.2 69,584 15.4 66,005 16.6
Commercial .......................... 152,358 35.0 156,431 34.5 108,820 27.3
Construction(1) ..................... 26,997 6.2 20,235 4.5 13,079 3.3
Land acquisition and development .... 6,800 1.6 7,889 1.7 2,511 0.6
Commercial and industrial loans ........ 31,078 7.1 30,838 6.8 3,969 1.0
Consumer loans ......................... 13,746 3.2 11,107 2.5 3,265 0.8
Other loans (2) ........................ 511 0.1 539 0.1 753 0.2
---------- ---------- ---------- ---------- ---------- ----------
Total loans receivable ......... 435,178 100.0% 452,773 100.0% 398,775 100.0%
---------- ========== ---------- ========== ---------- ==========
Less:
Allowance for loan losses ........... (4,011) (3,736) (3,150)
Net deferred loan fees .............. (1,066) (1,102) (485)
Net premiums ........................ 1,307 1,774 397
---------- ---------- ----------
(3,770) (3,064) (3,238)
---------- ---------- ----------
Loans receivable, net ............... $ 431,408 $ 449,709 $ 395,537
========== ========== ==========
DECEMBER 31,
--------------------------------------------------------------------------------
1999 1998 1997
------------------------ ------------------------ ------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
---------- ---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Real estate loans:
Single-family ....................... $ 206,572 53.4% $ 199,161 59.1% 126,272 48.8%
Multi-family ........................ 60,746 15.7 51,675 15.3 57,350 22.1
Commercial .......................... 93,803 24.2 71,374 21.2 65,610 25.3
Construction(1) ..................... 20,814 5.4 8,792 2.6 4,918 1.9
Land acquisition and development .... 3,525 0.9 4,477 1.3 3,675 1.4
Commercial and industrial loans ........ - - - - - -
Consumer loans ......................... 1,088 0.3 1,135 0.3 219 0.1
Other loans (2) ........................ 502 0.1 694 0.2 979 0.4
---------- ---------- ---------- ---------- ---------- ----------
Total loans receivable ......... 387,050 100.0% 337,308 100.0% 259,023 100.0%
---------- ========== ---------- ========== ---------- ==========
Less:
Allowance for loan losses ........... (3,112) (2,975) (3,324)
Net deferred loan fees .............. (258) 164 (43)
Net premiums ........................ 543 772 808
---------- ---------- ----------
(2,827) (2,039) (2,559)
---------- ---------- ----------
Loans receivable, net ............... $ 384,223 $ 335,269 $ 256,464
========== ========== ==========
- ----------------
(1) Includes loans secured by residential and commercial properties. At June
30, 2002, we had $15.7 million of construction loans secured by
residential properties and $11.3 million of construction loans secured
by commercial properties.
(2) Includes loans collateralized by deposit accounts and consumer line of
credit loans.
52
The following table sets forth certain information at December 31, 2001
regarding the dollar amount of loans maturing in our total loan portfolio based
on the contractual terms to maturity or scheduled amortization, but does not
include potential prepayments. Loans having no stated schedule of repayments and
no stated maturity are reported as due in one year or less.
DUE 1-5 DUE 5 OR MORE
YEARS AFTER YEARS AFTER
DUE 1 YEAR DECEMBER 31, DECEMBER 31,
OR LESS 2000 2001 TOTAL
---------- ----------- -------------- --------
(IN THOUSANDS)
Real estate loans:
Single-family residential ........... $ 8 $ 2,353 $153,789 $156,150
Multi-family residential ............ 449 3,994 65,141 69,584
Commercial .......................... 5,124 20,163 131,144 156,431
Construction(1) ..................... 8,484 -- 11,751 20,235
Land acquisition and development .... 6,513 1,376 -- 7,889
Commercial and industrial loans .......... 15,493 12,034 3,311 30,838
Consumer loans ........................... 98 2,926 8,083 11,107
Other loans (2) .......................... 539 -- -- 539
-------- -------- -------- --------
Total ............................... $ 36,708 $ 42,846 $373,219 $452,773
======== ======== ======== ========
- ----------------
(1) Includes loans secured by residential and commercial properties.
(2) Includes loans collateralized by deposit accounts and consumer line of
credit loans.
Scheduled contractual amortization of loans does not reflect the
expected term of our loan portfolio. The average life of loans is substantially
less than their contractual terms because of prepayments and due-on-sales
clauses, which gives us the right to declare a conventional loan immediately due
and payable in the event that the borrower sells the real property subject to
the mortgage and the loan is not repaid. The average life of mortgage loans
tends to increase when current mortgage loan rates are higher than rates on
existing mortgage loans and, conversely, decrease when rates on existing
mortgage loans are lower than current mortgage loan rates. Under the latter
circumstance, the weighted average yield on loans decreases as higher-yielding
loans are repaid or refinanced at lower rates.
53
The following table sets forth the dollar amount of total loans due
after one year from December 31, 2001, as shown in the preceding table, which
have fixed interest rates or which have floating or adjustable interest rates.
FLOATING OR
ADJUSTABLE-
FIXED RATE RATE TOTAL
---------- ----------- -------
(IN THOUSANDS)
Real estate loans:
Single-family residential ............ $104,658 $ 51,484 $156,142
Multi-family residential ............. 21,019 48,116 69,135
Commercial ........................... 60,079 91,228 151,307
Construction(1) ...................... 2,102 9,649 11,751
Land acquisition and development ..... 432 944 1,376
Commercial and industrial loans ............ 8,323 7,022 15,345
Consumer loans ............................. 4,840 6,169 11,009
Other loans(2) ............................. - -
-------- -------- --------
Total ................................. $201,453 $214,612 $416,065
======== ======== ========
- ----------------
(1) Includes loans secured by residential and commercial properties.
(2) Includes loans collateralized by deposit accounts and consumer line of
credit loans.
Origination, Purchase and Sale of Loans. The lending activities of Los
Padres Bank are subject to the written, non-discriminatory underwriting
standards and loan origination procedures established by Los Padres Bank's board
of directors and management. Loan originations are obtained by a variety of
sources, including referrals from real estate brokers, builders, existing
customers, walk-in customers and advertising. In its present marketing efforts,
Los Padres Bank emphasizes its community ties, customized personal service,
competitive rates, and its efficient underwriting and approval process. Loan
applications are taken by lending personnel, and the loan department supervises
the obtainment of credit reports, appraisals and other documentation involved
with a loan. Property valuations are performed by independent outside appraisers
approved by Los Padres Bank's board of directors. Los Padres Bank requires
title, hazard and, to the extent applicable, flood insurance on all security
property.
Mortgage loan applications are initially processed by loan officers who
do not have approval authority. All real estate loans which are either at or
below the Federal Home Loan Mortgage Corporation's, or Freddie Mac's, lending
limit and which meet all of the current Freddie Mac underwriting guidelines can
be approved by designated senior management of Los Padres Bank. All consumer
loans up to $25,000 may be approved by designated senior management of Los
Padres Bank. All loans in excess of these amounts up to $1.0 million require the
approval of two members of Los Padres Bank's Executive Loan Committee, which
consists of designated senior management of Los Padres Bank. Loans in excess of
$1.0 million, but not exceeding $3.0 million, require the approval of a majority
of Los Padres Bank's Management Real Estate Loan Committee, consisting of
designated senior management of Los Padres Bank. All loans in excess of $3.0
million, up to Los Padres Bank's legal lending limit, must be approved by either
Los Padres Bank's Loan Oversight Committee, comprised of both designated senior
management and certain members of the board of directors, or the board of
directors of Los Padres Bank. In addition, the board of directors of Los Padres
Bank ratifies all loans originated and purchased by Los Padres Bank.
A savings institution generally may not make loans to any one borrower
and related entities in an amount which exceeds 15% of its unimpaired capital
and surplus, although loans in an amount equal to an
54
additional 10% of unimpaired capital and surplus may be made to a borrower if
the loans are fully secured by readily marketable securities. At June 30, 2002,
Los Padres Bank's regulatory limit on loans-to-one borrower was $6.9 million and
its five largest loans or groups of loans-to-one borrower, including related
entities, aggregated $5.7 million, $5.5 million, $5.0 million, $4.6 million and
$4.4 million. These five largest loans or loan concentrations were secured by
commercial real estate and business assets. All of these loans or loan
concentrations were performing in accordance with their payment terms at June
30, 2002. See "Regulation-Regulation of Los Padres Bank-Loans-to-One Borrower
Limitations."
Single-Family Residential Real Estate Loans. Los Padres Bank has
historically concentrated its lending activities on the origination of loans
secured by first mortgage liens on existing single-family residences. The
single-family residential loans originated by Los Padres Bank are generally made
on terms, conditions and documentation which permit the sale of such loans to
Freddie Mac, the Federal National Mortgage Association, or Fannie Mae, and other
institutional investors in the secondary market. Since January 2001, as a means
of generating additional fee income and in order to reflect management's
decision to emphasize holding higher yielding loans in its portfolio, Los Padres
Bank has been brokering conforming permanent single-family residential loans on
behalf of third parties in order to generate fee income. During the six months
ended June 30, 2002 and the year ended December 31, 2001, Los Padres Bank
brokered $32.9 and $39.8 of such single-family residential loans on behalf of
third parties.
55
Los Padres Bank still holds a portfolio of single-family residential
loans. Los Padres Bank will retain in its portfolio single-family residential
loans that, due to the nature of the collateral, carry higher risk adjusted
spreads. Examples of these types of loans include construction loans that have
converted into permanent loans and non-conforming single-family loans, whether
as a result of a non-owner occupied or rural property, balloon payment or other
exception from agency guidelines. At June 30, 2002, Los Padres Bank had $133.2
million of single-family residential loans in its portfolio, which amounted to
30.6% of total loans receivable as of such date. At June 30, 2002, $93.4 million
or 70.2% of Los Padres Bank's single-family residential loans had fixed interest
rates and $39.7 million or 29.8% had interest rates which adjust in accordance
with a designated index. Single-family residential loans have terms of up to
30 years and generally have loan-to-value ratios of 80% or less, or 90% or less
to the extent the borrower carries private mortgage insurance for the balance in
excess of the 80% loan-to-value ratio.
Multi-Family Residential and Commercial Real Estate Loans. At June 30,
2002, Los Padres Bank had an aggregate of $70.5 million and $152.4 million
invested in multi-family residential and commercial real estate loans,
respectively, or 16.2% and 35.0% of total loans receivable, respectively. Los
Padres Bank has generally targeted smaller commercial real estate loans with
principal balances of up to its legal lending limit.
Los Padres Bank's multi-family residential loans are secured by
multi-family properties of five units or more, while Los Padres Bank's
commercial real estate loans are secured by industrial, warehouse and
self-storage properties, office buildings, office and industrial condominiums,
retail space and strip shopping centers, mixed-use commercial properties, mobile
home parks, nursing homes, hotels and motels. Substantially all of these
properties are located in Los Padres Bank's primary market areas. Los Padres
Bank typically originates commercial real estate loans for terms of up to 10
years based upon a 30-year loan amortization period and multi-family residential
loans for terms of up to 15 years based upon up to a 30-year amortization
schedule. Los Padres Bank will originate these loans on both a fixed-rate or
adjustable-rate basis, with the latter adjusting on a periodic basis of up to
one year based on LIBOR, the one year U.S. Treasury index of constant comparable
maturities, a designated prime rate or the 11th District Cost of Funds Index.
Adjustable-rate loans may have an established ceiling and floor, and the maximum
loan-to-value for these loan products is generally 75%. As part of the criteria
for underwriting commercial real estate loans, Los Padres Bank generally
requires a debt coverage ratio (the ratio of net cash from operations before
payment of debt service to debt service) of 1.3:1 or more. It is also Los Padres
Bank's general policy to seek additional protection to mitigate any weaknesses
identified in the underwriting process. Additional converge may be provided
through secondary collateral and personal guarantees from the principals of the
borrowers.
Commercial real estate lending entails different and significant risks
when compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. In addition, the balloon payment
features of these loans may require the borrower to either sell or refinance the
underlying property in order to make the payment. These risks can also be
significantly affected by supply and demand conditions in the local market for
apartments, offices, warehouses or other commercial space. Los Padres Bank
attempts to minimize its risk exposure by requiring loan-to-value and debt
coverage ratios, and by monitoring the operation and physical condition of the
collateral.
Construction Loans. Los Padres Bank also originates loans to finance
the construction of single-family residences and commercial properties located
in its primary market area. At June 30, 2002, Los Padres Bank's construction
loans amounted to $27.0 million or 6.2% of total loans receivable, $15.7 million
of which were for the construction of residential properties and $11.3 million
of which were for the construction of commercial properties. Los Padres Bank
also originates land acquisition and development loans which are loans
56
for the acquisition of land and the development of residential properties. At
June 30, 2002, Los Padres Bank's land acquisition and development loans amounted
to $6.8 million of 1.6% of total loans receivable.
Los Padres Bank primarily provides construction loans to individuals
building their primary or secondary residence as well as to local developers
with whom Los Padres Bank is familiar and who have a record of successfully
completing projects. Residential construction loans to developers generally are
made with terms not exceeding two years, have interest rates which are fixed or
adjust, with the latter adjusting on a periodic basis of up to one year based
upon a designated prime rate or LIBOR, and are generally made with loan-to-value
ratios of 80% or less. Residential construction loans to individuals are
interest only loans for the term of the construction and then generally convert
to a permanent loan at market rates. Los Padres Bank's construction/permanent
loans have been successful due to its ability to offer borrowers a single
closing and, consequently, reduced costs. Los Padres Bank also offers
adjustable-rate loans based on a designated prime rate or other indices with
terms of up to two years for the construction of commercial properties. Such
loans are generally made at a loan-to-value ratio of 85% of discounted appraised
value or less. Land acquisition and development loans are typically issued with
one year terms, bearing adjustable-rates of interest based on a designated prime
rate or LIBOR and are generally made with loan-to-value ratios of 75% or less.
Construction lending and acquisition and development lending are
generally considered to involve a higher degree of risk of loss than long-term
financing on improved, owner-occupied real estate. Risk of loss on construction
loans and acquisition and development loans is dependent largely upon the
accuracy of the initial appraisal of the property's projected value at
completion of construction as well as the estimated cost, including interest, of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If either estimate proves to be inaccurate and the
borrower is unable to provide additional funds, the lender may be required to
advance funds beyond the amount originally committed to permit completion of the
project and/or be confronted at the maturity of the construction loan with a
project whose value is insufficient to assure full payment. Los Padres Bank
attempts to minimize the foregoing risks primarily by limiting its construction
lending to experienced developers and by limiting the total amount of loans to
builders for speculative construction projects. It is also Los Padres Bank's
general policy to obtain regular financial statements and tax returns from
builders so that it can monitor their financial strength and ability to repay.
Commercial and Industrial Loans. Los Padres Bank is placing increased
emphasis on the origination of commercial business loans. During the six months
ended June 30, 2002 and the year ended December 31, 2001, Los Padres Bank
originated $40.3 million and $24.4 million of commercial and industrial loans,
respectively. At June 30, 2002, Los Padres Bank's commercial and industrial
loans amounted to $31.1 million or 7.1% of total loans receivable. The
commercial loan portfolio increased significantly in 2001 with the acquisition
of the Kansas operations of Harrington Bank, FSB in November 2001.
The commercial and industrial loans that Los Padres Bank is originating
include lines of credit, term loans and letters of credit. These loans are
typically secured by collateral and are used for general business purposes,
including working capital financing, equipment financing, capital investment and
general investment. Depending on the collateral pledged to secure the extension
of credit, maximum loan-to-value ratios are 80% or less. Loan terms vary from
one to seven years. The interest rates on such loans are generally variable and
are indexed to the Wall Street Journal Prime Rate, plus a margin. Commercial and
industrial loans typically have shorter maturity terms and higher interest
spreads than mortgage loans, but generally involve more credit risk than
mortgage loans because of the type and nature of the collateral. Los Padres
Bank's business customers are typically small to medium sized, privately-held
companies with local or regional businesses that operate in Los Padres Bank's
primary markets.
57
Consumer Loans. Los Padres Bank is authorized to make loans for a wide
variety of personal or consumer purposes. Los Padres Bank has been originating
consumer loans in recent years in order to provide a wider range of financial
services to its customers and because such loans generally carry higher interest
rates than mortgage loans. The consumer loans offered by Los Padres Bank include
home equity lines of credit, home improvement loans, automobile loans, secured
and unsecured personal lines of credit and deposit account secured loans. At
June 30, 2002, $14.3 million or 3.3% of Los Padres Bank's total loans receivable
consisted of consumer loans.
Home equity lines of credit are originated by Los Padres Bank for up to
80% of the appraised value, less the amount of any existing prior liens on the
property. Los Padres Bank also offers home improvement loans in amounts up to
80% of the appraised value, less the amount of any existing prior liens on the
property. Home improvement loans have a maximum term of 15 years and carry fixed
or adjustable interest rates. Home equity lines of credit have a maximum
repayment term of 10 years and carry interest rates which adjust monthly in
accordance with a designated prime rate or floating LIBOR rate. Los Padres Bank
will secure each of these types of loans with a mortgage on the property,
generally a second mortgage, and may originate the loan even if another
institution holds the first mortgage. At June 30, 2002, home equity lines of
credit and home improvement loans totaled $12.5 million or 87.9% of Los Padres
Bank's total consumer loan portfolio and an aggregate of $8.6 million was
committed and undrawn under these loans and lines of credit.
Los Padres Bank currently offers loans secured by deposit accounts,
which amounted to $399,000 or 2.8% of Los Padres Bank's total consumer loan
portfolio at June 30, 2002. Such loans are originated for up to 90% of the
deposit account balance, with a hold placed on the account restricting the
withdrawal of the account balance.
At June 30, 2002, automobile and secured and unsecured personal line of
credit loans amounted to $1.3 million or 9.3% of Los Padres Bank's total
consumer loan portfolio.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral. In addition, consumer lending
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness and
personal bankruptcy. Los Padres Bank believes that the generally higher yields
earned on consumer loans compensate for the increased credit risk associated
with such loans and Los Padres Bank intends to continue to offer consumer loans
in order to provide a full range of services to its customers.
ASSET QUALITY
General. Los Padres Bank's Internal Asset Review Committee, consisting
of Los Padres Bank's senior executive officers, monitors the credit quality of
Los Padres Bank's assets, reviews classified and other identified loans and
determines the proper level of reserves to allocate against Los Padres Bank's
loan portfolio, in each case subject to guidelines approved by Los Padres Bank's
board of directors.
Loan Delinquencies. When a borrower fails to make a required payment on
a loan, Los Padres Bank attempts to cure the deficiency by contacting the
borrower and seeking payment. Contacts are generally made following the
sixteenth day after a payment is due, at which time a late payment is assessed.
In most cases, deficiencies are cured promptly. If a delinquency extends beyond
16 days, the loan and payment history is reviewed and efforts are made to
collect the loan. While Los Padres Bank generally prefers to work with borrowers
to resolve such problems, when the account becomes 90 days delinquent, Los
Padres Bank will institute foreclosure or other proceedings, as necessary, to
minimize any potential loss.
58
Non-Performing Assets. Los Padres Bank will place loans on non-accrual
status when, in the judgment of management, the probability of collection of
interest is deemed to be insufficient to warrant further accrual. When such a
loan is placed on non-accrual status, previously accrued but unpaid interest is
deducted from interest income. Los Padres Bank generally does not accrue
interest on loans past due 60 days or more.
Non-performing loans are defined as non-accrual loans. Non-performing
assets are defined as non-performing loans and real estate acquired by
foreclosure or deed-in-lieu thereof. Troubled debt restructurings are defined as
loans which Los Padres Bank has agreed to modify by accepting below market terms
either by granting interest rate concessions or by deferring principal and/or
interest payments. The following table sets forth the amounts and categories of
our non-performing assets and troubled debt restructurings at the dates
indicated.
AT DECEMBER 31,
AT JUNE 30, -------------------------------------------------------
2002 2001 2000 1999 1998 1997
------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Non-accruing loans:
Single-family residential ............................... $ 157 $ 56 $ 767 $ 99 $ 966 $ 438
Multi-family residential ................................ 351 -- 2,592 -- -- 391
Commercial real estate .................................. 654 348 -- -- -- 362
Land acquisition and development ........................ -- -- -- 689 -- --
Commercial and industrial ............................... 704 93 -- -- -- --
Consumer and other ...................................... -- -- 3 -- -- --
------- ------- ------- ------- ------- -------
Total non-accruing loans ............................. 1,866 497 3,362 788 966 1,191
------- ------- ------- ------- ------- -------
Total non-performing loans ........................... 1,866 497 3,362 788 966 1,191
------- ------- ------- ------- ------- -------
Troubled debt restructurings ............................... -- -- -- 700 1,787 8,680
Real estate owned, net of reserves ......................... -- -- -- -- 691 603
------- ------- ------- ------- ------- -------
Total non-performing assets and troubled debt
restructurings .......................................... $ 1,866 $ 497 $ 3,362 $ 1,488 $ 3,444 $10,474
======= ======= ======= ======= ======= =======
Total non-performing loans and troubled debt
restructurings as a percentage of total loans ...... 0.43% 0.11% 0.84% 0.38% 1.02% 4.04%
======= ======= ======= ======= ======= =======
Total non-performing assets and troubled debt
restructurings as a percentage of total assets ..... 0.27% 0.07% 0.69% 0.30% 0.70% 2.46%
======= ======= ======= ======= ======= =======
At June 30, 2002, we had no loans 60-89 days delinquent and a total of
five non-performing loans. Total non-performing loans at such date amounted to
$1.9 million, which is a $1.4 million or 275.5% increase from December 31, 2001.
The increase at June 30, 2002 was primarily attributable to a $611,000 increase
in non-accruing commercial and industrial loans, which related to one commercial
borrowing relationship in the Kansas City metropolitan area that experienced a
slow-down in sales and cash flow in the current economic environment and a
$351,000 increase in non-accruing multi-family loans, attributable to a
delinquency over 90 days that was cured in July 2002. During 2001, 2000 and
1999, we had three, two and four non-performing loans. At June 30, 2002, we had
no real estate owned or troubled debt restructurings. The interest income that
would have been recorded during the six months ended June 30, 2002 and the years
ended December 31, 2001, 2000 and 1999 if Los Padres Bank's non-accruing loans
at the end of such periods had been current in accordance with their terms
during such periods was $57,824, $26,979, $113,403 and $31,791, respectively.
The interest income that was recorded during the six months ended June 30, 2002
and the years ended December 31, 2001, 2000 and 1999 with respect to Los Padres
Bank's non-accruing loans was $0, $0, $0 and $0, respectively.
Classified Assets. Federal regulations require that each insured savings
institution classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. Los Padres Bank has
59
established three classifications for potential problem assets: "substandard,"
"doubtful" and "loss." Substandard assets have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. Doubtful assets
have the weaknesses of substandard assets with the additional characteristic
that the weaknesses make collection or liquidation in full on the basis of
currently existing facts, conditions and values questionable, and there is a
high possibility of loss. An asset classified loss is considered uncollectible
and of such little value that continuance as an asset of the institution is not
warranted. Los Padres Bank has established another category, designated "special
mention," for assets which do not currently expose Los Padres Bank to a
sufficient degree of risk to warrant classification as substandard, doubtful or
loss. Assets classified as substandard or doubtful require Los Padres Bank to
establish allowances for loan losses based on the methodology described below.
If an asset or portion thereof is classified loss, the insured institution must
either establish specific allowances for loan losses in the amount of 100% of
the portion of the asset classified loss, or charge-off such amount. At June 30,
2002, in addition to the non-performing assets described above, Los Padres Bank
had $1.2 million of classified loans, $1.15 million of which was classified as
substandard and $50,000 of which was classified loss (as to which Los Padres
Bank had established a specific reserve). As of June 30, 2002, Los Padres Bank
had $11.4 million of loans that were designated special mention. Our classified
and special mention loans, in addition to the non-performing loans discussed
above, are the extent of the loans in our portfolio which give us some repayment
concern.
Allowance for Loan Losses. The allowance for loan losses reflects
management's judgment of the level of allowance adequate to provide for probable
losses inherent in the loan portfolio as of the balance sheet date. On a
quarterly basis, Los Padres Bank assesses the overall adequacy of the allowance
for loan losses, utilizing a consistent and systematic approach which includes
the application of an allocated allowance for specifically identified problem
loans, a formula allowance for non-homogenous loans, a formula allowance for
large groups of smaller balance homogenous loans and an unallocated allowance.
Allocated allowance for specifically identified problem loans. A
specific reserve is established for impaired loans in accordance with SFAS No.
114, "Accounting by Creditors for Impairment of a Loan." A loan is impaired
when, based on current information and events, it is probable that a creditor
will be unable to collect all amounts due according to the contractual terms of
the loan agreement. The specific reserve is determined based on the present
value of expected future cash flows discounted at the loan's effective interest
rate, except that as a practical expedient, we may measure impairment based on a
loan's observable market price, or the fair value of the collateral if the loan
is collateral dependent.
Formula allowance for non-homogenous loans. Los Padres Bank segments its
non-homogenous loan portfolio into pools with similar characteristics based on
loan type (collateral driven) and risk factor (loan grade). Currently, these
loans are segmented into four categories by collateral, further stratified by
loan grade (pass, special mention and substandard). The general pool categories
are multi-family residential, commercial real estate, land acquisition and
development, and commercial and industrial. These non-homogenous loans are
reviewed individually.
The formula allowance is calculated by applying adjusted loss rates to
these pools. Pool loss rates are established by examining historical charge-off
data for groups of loans and adjusting them for a variety of qualitative factors
deemed appropriate by management. The analysis of historical loss data in
determining the initial loss rates is based on average balances over a ten year
period. Management believes this period is conservative since it includes the
severe economic recession of the early 1990's and the current recession, which
started in the third quarter of 2001. Where Los Padres Bank has no or nominal
actual charge-off data for certain loan types, industry data and management's
judgment is utilized as representative starting loss rates.
60
Formula allowance for large groups of smaller balance homogenous loans.
The allocated loan loss allowance for large groups of smaller balance homogenous
loans is focused on loss experience for the pool rather than on an analysis of
individual loans. Large groups of smaller balance homogenous loans consist of
consumer loans and single-family residential loans. The allowance for groups of
performing loans is based on historical losses over a ten year period.
Unallocated Allowance. The unallocated allowance contains amounts that
are based on management's evaluation of conditions that are not directly
measured in the determination of the formula and specific allowances. The
evaluation of the inherent loss with respect to these conditions is subject to a
higher degree of uncertainty because they are not identified with specific
problem credits or portfolio segments. The conditions evaluated in connection
with the unallocated allowance include the following, which existed at the
balance sheet date:
- trends in criticized and non-accrual assets;
- the levels and trends in charge-offs, recovery history and loan
restructuring;
- changes in volumes and terms of the loan portfolio;
- changes in the effectiveness of the internal asset review process;
- changes in lending policies, procedures and practices;
- changes in the experience, ability and depth of lending management;
- changes in the national and local economic conditions; and
- the trend in local real estate values.
Management and the Internal Asset Review Committee review these
conditions quarterly in discussion with our senior credit officers. To the
extent that any of these conditions is evidenced by a specifically identifiable
problem credit or portfolio segment as of the evaluation date, management's
estimate of the effect of such condition may be reflected as a specific
allowance, applicable to such credit or portfolio segment. Where any of these
conditions is not evidenced by a specifically identifiable problem credit or
portfolio segment as of the evaluation date, management's evaluation of the
probable loss related to such condition is reflected in the unallocated
allowance.
The allowance for loan losses is based upon estimates of probable losses
inherent in the loan portfolio. The actual losses can vary from the estimated
amounts. Our methodology includes several features that are intended to reduce
the differences between estimated and actual losses. The loss migration model
that is used to establish the loan loss factors is designed to be
self-correcting by taking into account our loss experience over prescribed
periods. Similarly, by basing the loan loss factors over a period reflective of
two business cycles, the methodology is designed to take our recent loss
experience for consumer and commercial and industrial loans into account.
Furthermore, based on management's judgment, our methodology permits adjustments
to any loss factor used in the computation of the formula allowance for
significant factors, which affect the collectibility of the portfolio as of the
evaluation date, but are not reflected in the loss factors. By assessing the
probable estimated losses inherent in the loan portfolio on a quarterly basis,
we are able to adjust specific and inherent loss estimates based upon the most
recent information that has become available.
61
Although our management believes it uses the best information available
to establish the level of the allowance, there can be no assurance that
additions to such allowance will not be necessary in future periods.
Furthermore, various regulatory agencies, as an integral part of their
examination process, periodically review our valuation allowance. These agencies
may require us to increase the allowance, based on their judgments of the
information available to them at the time of the examination.
The following table is an allocation of our allowance for loan losses as
of the dates presented:
AT DECEMBER 31,
AT JUNE 30, --------------------------------
2002 2001 2000 1999
------ ------ ------ ------
(IN THOUSANDS)
Specific reserve ............. $ 50 $ 50 $ 50 $ 233
Formula-non homogenous ....... 3,394 2,993 1,617 1,661
Formula-homogenous ........... 491 522 736 759
Unallocated .................. 76 171 747 459
------ ------ ------ ------
$4,011 $3,736 $3,150 $3,112
====== ====== ====== ======
At June 30, 2002, the formula allowance for non-homogeneous loans
increased by $401,000 from December 31, 2001, primarily due to the increase in
reserves related to commercial and industrial loans. A significant portion of
the increase relates to one commercial borrowing relationship in the Kansas City
metropolitan area that experienced a slow-down in sales and cash flow in the
current economic environment that necessitated the migration in loan
classification to doubtful from substandard. At December 31, 2001, the formula
allowance for non-homogeneous loans increased $1.4 million from December 31,
2000 as a result of the commercial and industrial loans acquired in connection
with the branch purchase from Harrington Bank, FSB in November 2001.
The formula allowance for homogeneous loans decreased by $31,000,
$214,000 and $23,000 for the six month period ending June 30, 2001 and the years
ending December 31, 2001 and 2000, respectively, as a result of decreasing
single-family loan balances. Los Padres Bank shifted its strategic focus away
from originating single-family loans for its portfolio and has opted to
originate such loans on a brokered basis due to high competition and the
resulting low risk-adjusted spreads. In addition, Los Padres Bank sold $27.6
million and $10.1 million of such loans in 2001 and 2000, respectively, for the
same reason.
Specific reserves are established for impaired loans in accordance with
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." From December
31, 2000 to June 30, 2002, the balance in specific reserves has remained
constant at $50,000 and relates to one single-family loan.
62
The following table sets forth the activity in our allowance for loan
losses for the periods indicated
AT AND FOR THE SIX
MONTHS ENDED AT AND FOR THE YEAR ENDED
JUNE 30, DECEMBER 31,
------------------- ---------------------------------------------------
2002 2001 2001 2000 1999 1998 1997
-------- -------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Balance at beginning of period ..................... $ 3,736 $ 3,150 $ 3,150 $ 3,112 $ 2,975 $ 3,324 $ 1,350
Charge-offs:
Real estate loans
Single-family residential .................... -- -- -- -- (13) (11) --
Multi-family residential ..................... -- -- -- -- -- (109) --
Commercial ................................... -- -- -- -- -- (185) --
Consumer and other loans ........................ -- (1) (15) (4) (5) (12) (12)
------- ------- ------- ------- ------- ------- -------
Total charge-offs ............................ -- (1) (15) (4) (18) (317) (12)
------- ------- ------- ------- ------- ------- -------
Net charge-offs .................................... -- (1) (15) (4) (18) (317) (12)
------- ------- ------- ------- ------- ------- -------
Allowance for loan losses acquired
in connection with branch
purchase(1) ...................................... -- -- 600 -- -- -- 2,103
------- ------- ------- ------- ------- ------- -------
Provision (credit) for losses on loans ............. 275 1 1 42 155 (32) (117)
------- ------- ------- ------- ------- ------- -------
Balance at end of period ........................... $ 4,011 $ 3,150 $ 3,736 $ 3,150 $ 3,112 $ 2,975 $ 3,324
======= ======= ======= ======= ======= ======= =======
Allowance for loan losses as a percent of total
loans outstanding ............................... 0.92% 0.76% 0.83% 0.79% 0.80% 0.88% 1.28%
======= ======= ======= ======= ======= ======= =======
Ratio of net charge-offs to average loans
outstanding ..................................... --% --% --% --% 0.01% 0.10% 0.01%
======= ======= ======= ======= ======= ======= =======
- ----------------
(1) In November 2001, we acquired from Harrington Bank, FSB the Shawnee
Mission, Kansas branch, along with related loans and deposits. In June
1997, we acquired all of the assets and liabilities of U.S. Community
Savings Bank, FSB.
63
The following table sets forth information concerning the allocation of
our allowance for loan losses by loan category at the dates indicated.
DECEMBER 31,
---------------------------------------------------
JUNE 30, 2002 2001 2000
---------------------- ---------------------- ----------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN LOANS IN LOANS IN
EACH EACH EACH
CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ -----------
(DOLLARS IN THOUSANDS)
Real estate loans:
Single-family residential ........... $ 411 30.6% $ 509 34.5% $ 717 50.2%
Multi-family residential ............ 464 16.2 437 15.4 453 16.6
Commercial .......................... 664 35.0 693 34.4 679 27.3
Construction ........................ 634 6.2 612 4.6 380 3.3
Land acquisition and development .... 82 1.6 79 1.7 25 0.6
Commercial and industrial loans ........ 1,550 7.1 1,172 6.8 80 1.0
Consumer and other loans ............... 130 3.3 63 2.6 69 1.0
Unallocated reserve .................... 76 -- 171 -- 747 --
------ ------ ------ ------ ------ ------
Total .................................. $4,011 100.0% $3,736 100.0% $3,150 100.0%
====== ====== ====== ====== ====== ======
DECEMBER 31,
---------------------------------------------------------------------------------
1999 1998 1997
---------------------- ---------------------- -----------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN LOANS IN LOANS IN
EACH EACH EACH
CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ -----------
(DOLLARS IN THOUSANDS)
Real estate loans:
Single-family residential ........... $ 804 53.4% $ 963 59.1% $ 870 48.8%
Multi-family residential ............ 424 15.7 399 15.3 605 22.1
Commercial .......................... 994 24.2 783 21.2 1,037 25.3
Construction ........................ 331 5.4 309 2.6 140 1.9
Land acquisition and development .... 72 0.9 90 1.3 86 1.4
Commercial and industrial loans ........ -- -- -- -- -- --
Consumer and other loans ............... 28 0.4 29 0.5 10 0.5
Unallocated reserve .................... 459 -- 402 -- 576 --
------ ------ ------ ------ ------ ------
Total .................................. $3,112 100.0% $2,975 100.0% $3,324 100.0%
====== ====== ====== ====== ====== ======
64
INVESTMENT ACTIVITIES
General. Our securities portfolio is managed under the direction of the
Chief Executive Officer in accordance with a comprehensive written investment
policy which addresses strategies, types and levels of allowable investments and
which are reviewed and approved by Los Padres Bank's board of directors. The
management of the securities portfolio is set in accordance with strategies
developed by Los Padres Bank's ALCO. In addition, Los Padres Bank has entered
into an agreement with Smith Breeden whereby Smith Breeden has been appointed as
investment advisor with respect to the management of Los Padres Bank's
securities portfolio. See "Management-Certain Relationships and Related
Transactions." With the assistance of Smith Breeden, Los Padres Bank's Chief
Executive Officer, President and Chief Financial Officer execute various
transactions with respect to the portfolio and are responsible for informing
ALCO of the types of investments available, the status and performance of the
portfolio and current market conditions. Such officers are authorized to:
purchase or sell eligible investments under repurchase or reverse repurchase
agreements; execute hedging strategies approved by the ALCO; pledge securities
owned as collateral for public agency deposits or repurchase accounts or
agreements; and lend securities to approved dealers in government securities or
approved commercial banks. Any of the Chief Executive Officer, the President or
the Chief Financial Officer has the authority to purchase or sell designated
instruments up to $5.0 million in any one transaction and, acting together, any
two members of the ALCO have authority to purchase or sell securities of between
$5.0 million and $30.0 million in any one transaction. For purchases or sales
greater than $30.0 million, the prior approval of a majority of the ALCO is
required. Designated officers are also authorized to invest excess liquidity in
approved liquid investment vehicles. In addition, the board of directors of Los
Padres Bank ratifies all securities purchased and sold by Los Padres Bank.
We invest in a portfolio of mortgage-backed and related securities,
interest rate contracts, U.S. Government agency securities and, to a much lesser
extent, equity securities. In selecting securities for our portfolio, we employ
option-adjusted pricing analysis with the assistance of Smith Breeden in order
to ascertain the net risk-adjusted spread expected to be earned with respect to
the various investment alternatives. The nature of this analysis is to quantify
the costs embedded in the yield of an investment, such as the duration-matched
funding cost, the costs of the options embedded in the investment's cash flow
(such as a borrower's ability to prepay a mortgage) and servicing costs. The
objective of our investment management process is to select investments with the
greatest net spreads and actively manage the underlying risks of these
investments.
We manage our securities portfolio in order to enhance net interest
income and net market value on a risk-adjusted basis and deploy excess capital
until we can reinvest such assets into loans or other community banking assets.
As a result, we monitor the net risk-adjusted spread of our investments and
compare them with the spreads available with respect to other securities in the
market. Accordingly, as market conditions fluctuate (e.g., as risk-adjusted
spreads narrow), we may sell individual securities prior to their maturity and
reinvest the proceeds into new investments which generally carry wider
risk-adjusted spreads. We utilize various interest rate contracts such as
interest rate swaps, caps, floors, options and futures in order to hedge our
interest rate exposure in our securities portfolio, which allows us to respond
to changing prepayment rates on our mortgage-backed and related securities. The
investment portfolio, although hedged for interest rate risk, is still
susceptible to adverse changes in the spreads between the yields on
mortgage-backed and related securities and the related Treasury and LIBOR based
hedges. Substantially all of our securities are classified as available for sale
securities and, pursuant to SFAS No. 115, are reported at fair value with
unrealized gains and losses included in stockholders' equity.
Mortgage-Backed and Related Securities. At June 30, 2002, our
mortgage-backed and related securities classified as available for sale and held
to maturity amounted to $214.0 million or 99.0% of our securities portfolio and
31.3% of our total assets. By investing in mortgage-backed and related
securities, our management seeks to achieve a targeted option-adjusted spread
over applicable funding costs.
65
We invest in mortgage-backed and related securities, including mortgage
participation certificates, which are insured or guaranteed by U.S. Government
agencies and government sponsored enterprises, and investment grade CMOs and
REMICs. Mortgage-backed securities, which also are known as mortgage
participation certificates or pass-through certificates, represent a
participation interest in a pool of single-family mortgages. The principal and
interest payments on these securities are passed from the mortgage originators,
through intermediaries, generally U.S. Government agencies and government
sponsored enterprises, that pool and repackage the participation interests in
the form of securities, to investors such as us. Such U.S. Government agencies
and government sponsored enterprises, which guarantee the payment of principal
and interest to investors, primarily include Freddie Mac, Fannie Mae and Ginnie
Mae.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgages, i.e., fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The term of a mortgage-backed pass-through security thus approximates
the terms of the underlying mortgages.
Our mortgage-backed and related securities, including CMO's, which
include securities issued by entities which have qualified under the Internal
Revenue Code as REMICs. CMOs and REMICs, referred to in this prospectus as CMOs,
were developed in response to investor concerns regarding the uncertainty of
cash flows associated with the prepayment option of the underlying mortgagor and
are typically issued by governmental agencies, government sponsored enterprises
and special purpose entities, such as trusts, corporations or partnerships,
established by financial institutions or other similar institutions. In contrast
to pass-through mortgage-backed securities, in which cash flow is received pro
rata by all security holders, the cash flow from the mortgages underlying a CMO
is segmented and paid in accordance with a predetermined priority to investors
holding various CMO classes. By allocating the principal and interest cash flows
from the underlying collateral among the separate CMO classes, different classes
of bonds are created, each with its own stated maturity, estimated average life,
coupon rate and prepayment characteristics.
Like most fixed-income securities, mortgage-backed and related
securities are subject to interest risk. Unlike most fixed-income securities,
however, the mortgage loans underlying a mortgage-backed or related security
generally may be prepaid at any time without penalty. The ability to prepay a
mortgage loan generally results in significantly increased price and yield
volatility, with respect to mortgage-backed and related securities, than is the
case with non-callable fixed income securities. Furthermore, mortgage-backed
securities often are more sensitive to changes in interest rates and prepayments
than traditional mortgage-backed securities and are, therefore, even more
volatile. Nevertheless, we attempt to hedge against both interest rate and
prepayment risk. No assurance can be made, however, that these hedges will be
effective.
Although mortgage-backed and related securities often carry lower yields
than traditional mortgage loans, these securities generally increase the quality
of our assets by virtue of the securities' underlying insurance or guarantees or
collateral support. These securities also require less capital under risk-based
regulatory capital requirements than non-insured or non-guaranteed mortgage
loans, are more liquid than individual mortgage loans, which enhances our
ability to actively manage our portfolio, and may be used to collateralize
borrowings or other obligations. At June 30, 2002, $196.6 million or 92% of our
mortgage-backed and related securities were pledged to secure various
obligations (such as FHLB advances and interest rate swaps). In addition, as a
result of our maintaining a substantial portion of our assets in mortgage-backed
and related securities, we have been able to maintain a relatively low level of
operating expenses.
66
At June 30, 2002, the contractual maturity of substantially all of our
mortgage-backed or related securities was in excess of 10 years. The actual
maturity of a mortgage-backed or related security may be less than its stated
maturity due to prepayments of the underlying mortgages. Prepayments that are
faster than anticipated may shorten the life of the security and affect its
yield to maturity. The yield to maturity is based upon the interest income and
the amortization of any premium or discount related to the security. In
accordance with generally accepted accounting principles, premiums and discounts
are amortized over the estimated life of the loans, which decrease and increase
interest income, respectively. The prepayment assumptions used to determine the
amortization period of premiums and discounts can significantly affect the yield
of the mortgage-backed or related security, and these assumptions are reviewed
periodically to reflect actual prepayments. Although prepayments of underlying
mortgages depends on many factors, including the type of mortgages, the coupon
rate, the age of mortgages, the geographical location of the underlying real
estate collateralizing the mortgages and general levels of market interest
rates, the difference between the interest rates on the underlying mortgages and
the prevailing mortgage interest rates generally is the most significant
determinant of the rate of prepayments. During periods of falling mortgage
interest rates, if the coupon rate of the underlying mortgages exceeds the
prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgages
and the related security. At June 30, 2002, of the $214.0 million of
mortgage-backed and related securities held by us, an aggregate of $85.7 million
were secured by fixed-rate mortgage loans and an aggregate of $128.3 million
were secured by adjustable-rate mortgage loans.
Trading Account Assets and Other Securities. At June 30, 2002, we held a
variety of assets classified as trading securities pursuant to SFAS No. 115,
including mortgage-backed securities, which had a carrying value of $1.9 million
as of June 30, 2002, and equity securities (consisting of mutual funds invested
in a variety of corporate fixed income and equity securities), which had a
carrying value of $132,000 as of June 30, 2002. We also have asset-based (i.e.,
total return) interest rate swaps which we use to enhance our returns, and
certain other interest rate contracts which do not receive hedge accounting
treatment pursuant to SFAS No. 133. For information concerning our interest rate
contracts which do not receive hedge accounting treatment pursuant to SFAS No.
133 and which are held as trading account assets and used for asset and
liability management purposes, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Asset and Liability Management."
Other securities owned by us at June 30, 2002 and held in our held to maturity
portfolio consisted of U.S. Government and agency securities, which had a
carrying value of $2.0 million as of June 30, 2002.
At June 30, 2002, we were a party to various interest rate swap
agreements which we hold as trading account assets and which we refer to as
"total return swaps." Pursuant to such total return swaps, we receive a total
return (i.e., interest income and price changes) as a percentage of a notional
amount of a designated mortgage backed securities index, and we pay 3-month
London Interbank Offered Rate, or LIBOR, less a spread. We, in turn, hedge the
interest rate risk of the total return swaps, with separate interest rate swaps
with the same notional amounts and similar terms. The purpose of these hedged
total return swaps is to create incremental income for Los Padres Bank. At June
30, 2002, we had total return swaps with an aggregate notional amount of $18.9
million, a payable rate of 1.84%, a receivable rate of 6.63%, a maturity date of
October 2003 and which utilized a basket of adjustable rate Government National
Mortgage Association, or Ginnie Mae, securities. As of June 30, 2002, we had
total return swaps with an aggregate notional amount of $15.0 million which
matured July 2002 and as to which we received 30 basis points over an investment
grade commercial mortgage-backed securities index.
The net interest expense (income) relating to our total returns swaps
was $108,000, $129,000, $432,000, $(117,000) and $69,000 during the six months
ended June 30, 2002 and 2001 and the years ended December 31, 2001, 2000, and
1999. The approximate net market value of our total returns
67
swaps maintained as trading account assets was $0, $60,000, $(653,000) and $0
as of June 30, 2002 and December 31, 2001, 2000 and 1999, respectively.
68
The following table presents certain information regarding the
composition and period to maturity of our securities classified as available for
sale as of the dates indicated below.
DECEMBER 31,
------------------------------------
JUNE 30, 2002 2001
------------------------------------ ------------------------------------
WEIGHTED WEIGHTED
AMORTIZED FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE YIELD COST VALUE YIELD
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities:
Due from five-ten years .......... $ 7,038 $ 7,242 6.21% $ 8,494 $ 8,693 6.24%
Due over ten years ............... 201,785 204,308 4.94 171,153 172,934 5.80
-------- -------- -------- --------
Total mortgage-backed
securities classified as
available for sale .......... $208,823 $211,550(1) 4.98 $179,647 $181,627 5.82
======== ======== ======== ========
DECEMBER 31,
------------------------------------------------------------------------------
2000 1999
------------------------------------ ------------------------------------
WEIGHTED WEIGHTED
AMORTIZED FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE YIELD COST VALUE YIELD
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities:
Due from five-ten years .......... $ -- $ -- 7.36% $ -- $ -- --%
Due over ten years ............... 47,051 47,438 -- -- -- --
-------- -------- -------- --------
Total mortgage-backed
securities classified as
available for sale .......... $ 47,051 $ 47,438 7.36 $ -- $ -- --
======== ======== ======== ========
- ----------------
(1) At June 30, 2002, consisted of $20.4 million of Fannie Mae participation
certificates, $167.6 million of Ginnie Mae participation certificates
and $23.6 million of CMOs.
69
The following table presents certain information regarding the
composition and period to maturity of our securities classified as held to
maturity as of the dates indicated below.
DECEMBER 31,
-------------------------------
JUNE 30, 2002 2001
-------------------------------- -------------------------------
WEIGHTED WEIGHTED
AMORTIZED FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE YIELD COST VALUE YIELD
------ ------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities:
Due over ten years .................. $ 467 $ 492 6.99% $ 583 $ 604 7.00%
------ ------ ------ ------
Total mortgage-backed
securities ........................ 467 492(1) 6.99 583 604 7.00
------ ------ ------ ------
U.S. Government and agency
securities:
Due within one year ................. -- -- -- -- -- --
Due from one-five years ............. 2,023 2,023 5.30 2,034 2,113 5.30
Due from five-ten years ............. -- --
Due over ten years .................. -- -- -- -- -- --
------ ------ ------ ------
Total U.S. Government
and agency securities ............. 2,023 2,023 5.30 2,034 2,113 5.30
------ ------ ------ ------
Total securities classified as held
to maturity .......................... $2,490 $2,515 5.62 $2,617 $2,717 5.68
====== ====== ====== ======
DECEMBER 31,
--------------------------------------------------------------------
2000 1999
-------------------------------- -------------------------------
WEIGHTED WEIGHTED
AMORTIZED FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE YIELD COST VALUE YIELD
------ ------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities:
Due over ten years .................. $ 687 $ 695 7.00% $ 741 $ 733 7.01%
------ ------ ------ ------
Total mortgage-backed
securities ........................ 687 695 7.00 741 733 7.01
------ ------ ------ ------
U.S. Government and agency
securities:
Due within one year ................. 2,000 2,000 6.77 -- -- --
Due from one-five years ............. -- -- -- -- -- --
Due from five-ten years ............. -- -- -- -- -- --
Due over ten years .................. -- -- -- -- -- --
------ ------ ------ ------
Total U.S. Government
and agency securities ............. 2,000 2,000 6.77 -- --
------ ------ ------ ------
Total securities classified as held
to maturity .......................... $2,687 $2,695 6.83 $ 741 $ 733 7.01
====== ====== ====== ======
- ----------------
(1) At June 30, 2002, consisted of $492,000 of Fannie Mae participation
certificates.
70
The following table presents certain information regarding the
composition of our trading account assets as of the dates indicated below.
DECEMBER 31,
----------------------------------
JUNE 30, 2002 2001
--------------------------------- ----------------------------------
WEIGHTED WEIGHTED
AMORTIZED FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE YIELD COST VALUE YIELD
------ ------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities ............... $ 1,860 $ 1,936(1) 6.40% $ 2,258 $ 2,333 6.49%
------- ------- ------- -------
U.S. Government and agency securities .... -- -- -- -- -- --
------- ------- ------- -------
Equity securities(2) ..................... 150 132 -- 150 140 --
------- ------- ------- -------
Other securities(3) ...................... -- 8 -- -- 278 --
------- ------- ------- -------
Total trading account assets ............. $ 2,010 $ 2,076 5.92 $ 2,408 $ 2,751 6.08
======= ======= ======= =======
DECEMBER 31,
-------------------------------------------------------------------------
2000 1999
--------------------------------- ---------------------------------
WEIGHTED WEIGHTED
AMORTIZED FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE YIELD COST VALUE YIELD
------ ------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities ............... $ 3,345 $ 3,372 6.66% $85,957 $83,706 6.82%
------- ------- ------- -------
U.S. Government and agency securities .... -- -- -- 2,000 2,000 5.55
------- ------- ------- -------
Equity securities(2) ..................... 481 393 -- -- -- --
------- ------- ------- -------
Other securities(3) ...................... -- 199 -- 1,837 468 --
------- ------- ------- -------
Total trading account assets ............. $ 3,826 $ 3,964 5.82 $89,794 $86,174 6.65
======= ======= ======= =======
- ----------------
(1) At June 30, 2002, consisted of $5,000 of Freddie Mac participation
certificates, $1.012 million of Fannie Mae participation certificates
and $919,000 of Ginnie Mae participation certificates.
(2) At June 30, 2002, equity securities consisted of mutual funds invested
in a variety of fixed income and equity securities.
(3) At June 30, 2002, consisted of total return swaps which we use to
enhance our returns, and interest rate contracts which do not qualify
for hedge accounting treatment pursuant to SFAS No. 133.
71
The following table sets forth the fair value of our securities
activities with respect to our securities classified as available for sale and
held to maturity for the periods indicated.
AT OR FOR SIX MONTHS AT OR FOR THE YEARS
ENDED JUNE 30, ENDED DECEMBER 31,
------------------------ ---------------------------------------
2002 2001 2001 2000 1999
--------- --------- --------- --------- ---------
(IN THOUSANDS)
Beginning balance ..................................... $ 184,344 $ 50,133 $ 50,133 $ 733 $ --
--------- --------- --------- --------- ---------
Mortgage-backed securities purchased-
available for sale .................................. 72,801 119,027 189,437 100,757 --
Mortgage-backed securities purchased-
held to maturity .................................... -- -- -- -- 751
U.S. Government and agency securities purchased - held
to maturity ......................................... -- 2,055 2,055 2,000 --
--------- --------- --------- --------- ---------
Total securities purchased ................. 72,801 121,082 191,492 102,757 751
--------- --------- --------- --------- ---------
Less:
Sale of mortgage-backed securities-
available for sale ............................. (41,766) (11,257) (54,750) (53,682) --
--------- --------- --------- --------- ---------
Total Securities sold ............................ (41,766) (11,257) (54,750) (53,682) --
--------- --------- --------- --------- ---------
Proceeds from maturities of securities ........... -- (2,000) (2,000) -- --
Change in net unrealized gain (loss) on
securities available for sale and held to
maturity ......................................... 671 764 1,685 403 (8)
Amortization of (premium)/discount ............... (1,985) (362) (2,216) (78) (10)
--------- --------- --------- --------- ---------
Ending balance ........................................ $ 214,065 $ 158,360 $ 184,344 $ 50,133 $ 733
========= ========= ========= ========= =========
72
SOURCES OF FUNDS
General. We consider various sources of funds to fund our investing and
lending activities and we evaluate the available sources of funds in order to
reduce our overall funding costs. Deposits, reverse repurchase agreements,
advances from the FHLB of San Francisco, notes payable, and sales, maturities
and principal repayments on loans and securities have been the major sources of
funds for use in our lending and investing activities, and for other general
business purposes. We closely monitor rates and terms of competing sources of
funds on a daily basis and utilize the source which we believe to be cost
effective.
Deposits. Los Padres Bank attempts to price its deposits in order to
promote deposit growth and offers a wide array of deposit products in order to
satisfy our business and retail customers' needs. Los Padres Bank's current
deposit products include passbook accounts, negotiable order of withdrawal
("NOW") and demand deposit accounts, money market deposit accounts, fixed-rate,
fixed-maturity retail certificates of deposit ranging in terms from one month to
five years and individual retirement accounts.
Los Padres Bank's retail deposits are generally obtained from residents
in each of its primary market areas. Los Padres Bank also intends to open a new
branch in the Phoenix/Scottsdale, Arizona metropolitan area during the fourth
quarter of 2002 and another branch in the Kansas City metropolitan area in mid
2003. The principal methods currently used by Los Padres Bank to attract deposit
accounts include offering a variety of products and services and competitive
interest rates. Los Padres Bank utilizes traditional marketing methods to
attract new customers and savings deposits, including various forms of
advertising.
73
The following table presents the average balance of each deposit type
and the average rate paid on each deposit type of Los Padres Bank for the
periods indicated.
DECEMBER 31,
---------------------------------------------------------------------
JUNE 30, 2002 2001 2000 1999
-------------------- -------------------- --------------------- ---------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE PAID BALANCE RATE PAID BALANCE RATE PAID BALANCE RATE PAID
------- --------- ------- --------- ------- --------- ------- ---------
(DOLLARS IN THOUSANDS)
Passbook accounts.................. $19,371 1.35% $13,429 1.93% $11,688 2.59% $13,293 2.65%
Money market accounts.............. 47,647 2.39 25,409 3.11 22,609 4.24 30,908 4.13
NOW accounts ...................... 30,596 0.59 19,825 0.95 17,995 1.34 17,685 0.96
Certificates of deposit ........... 395,968 3.52 341,444 5.26 283,582 5.67 296,767 5.02
--------- --------- --------- ---------
Total deposits............ $493,582 3.15 $400,107 4.79 $335,874 5.24 $358,653 4.65
========= ========= ========= =========
The following table sets forth the maturities of Los Padres Bank's
certificates of deposit having principal amounts of $100,000 or more at June 30,
2002.
AMOUNT
-----------------
(IN THOUSANDS)
Certificates of deposit maturing:
Three months or less........................................ $48,741
Over three through six months................................ 36,584
Over six through twelve months............................... 62,996
Over twelve months........................................... 20,810
----------
Total..................................................... $169,131
==========
74
The following table sets forth the activity in Los Padres Bank's
deposits during the period indicated.
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
--------------------------- ------------------------------------------
2002 2001 2001 2000 1999
----------- ----------- ------------ ---------- -----------
(IN THOUSANDS)
Beginning balance........................... $520,858 $355,705 $355,705 $379,839 $327,681
Net increase (decrease) before interest
credited.................................. (22,283) 23,424 71,633 30,483 37,820
Interest credited........................... 7,328 8,238 16,895 14,713 14,338
Deposit acquisitions (dispositions)......... -- -- 75,410(1) (65,407)(2) --
Gain on sale of Deposits.................. -- -- -- (3,923) --
Purchase accounting premium............... -- -- 1,365 -- --
Amortization of purchase accounting
premium.................................. (464) (9) (150) -- --
---------- --------- --------- --------- --------
Net increase (decrease) in deposits......... (15,419) 31,653 165,153 (24,134) 52,158
---------- --------- --------- --------- --------
Ending balance.............................. $505,439 $387,358 $520,858 $355,705 $379,839
========== ========= ========= ========= ========
- --------------
(1) In November 2001, we acquired from Harrington Bank, FSB its Shawnee
Mission, Kansas branch along related with deposits and loans.
(2) In February 2000, we sold two branches and the related deposits that we
had acquired in 1997.
The following table sets forth by various interest rate categories the
certificates of deposit with Los Padres Bank at the dates indicated.
AT AT DECEMBER 31,
JUNE 30 ---------------------------------------
2002 2001 2000 1999
-------- ---------- --------- -----------
(IN THOUSANDS)
0.00% to 2.99%.............................. $209,671 $59,511 $37 $322
3.00 to 3.99................................ 71,080 61,181 -- 604
4.00 to 4.99................................ 36,232 203,718 4,582 73,927
5.00 to 5.99................................ 23,996 61,108 136,624 229,739
6.00 to 6.99................................ 11,186 39,866 155,378 7,008
7.00 and higher............................. 1,207 1,183 216 204
-------- ---------- --------- ---------
Total..................................... $353,372 $426,567 $296,837 $311,804
======== ========== ========= =========
75
The following table sets forth the amount and remaining maturities of
Los Padres Bank's certificates of deposit at June 30, 2002.
OVER SIX
MONTHS OVER ONE OVER TWO
SIX MONTHS THROUGH ONE YEAR THROUGH YEARS THROUGH OVER THREE
AND LESS YEAR TWO YEARS THREE YEARS YEARS TOTAL
------------- ------------- ------------ ------------- ----------- ----------
(IN THOUSANDS)
0.00% to 2.99%............ $108,577 $ 98,630 $ 2,450 $ - $ 15 $ 209,672
3.00 to 3.99 54,749 9,893 4,853 779 805 71,079
4.00 to 4.99.............. 9,107 2,443 1,527 17,595 5,561 36,233
5.00 to 5.99.............. 6,246 1,791 4,622 4,836 6,501 23,996
6.00 to 6.99.............. 4,305 2,212 1,298 3,368 2 11,185
7.00 and higher........... 113 18 - 1,076 - 1,207
---------- ---------- ---------- ----------- ---------- ----------
Total................... $183,097 $114,987 $14,750 $27,654 $12,884 $ 353,372
========== ========== ========== =========== ========== ==========
Borrowings. We obtain both long-term fixed-rate and short-term
variable-rate advances from the FHLB of San Francisco upon the security of
certain of our residential first mortgage loans and other assets, provided
certain standards related to creditworthiness of Los Padres Bank have been met.
FHLB of San Francisco advances are available for general business purposes to
expand lending and investing activities. Borrowings have generally been used to
fund the purchase of mortgage-backed and related securities and lending
activities and have been collateralized with a pledge of loans, securities in
our portfolio or any mortgage-backed or related securities purchased. Advances
from the FHLB of San Francisco are made pursuant to several different credit
programs, each of which has its own interest rate and range of maturities. At
June 30, 2002, we had seven advances from the FHLB of San Francisco which mature
between July 2002 and June 2010. At June 30, 2002, we had total FHLB of San
Francisco advances of $123.4 million at a weighted average coupon of 4.23%. Our
borrowings from the FHLB of San Francisco are limited to 35% of Los Padres
Bank's total assets, or $239.1 million at June 30, 2002, $234.4 million at
December 31, 2001, and $169.5 million at December 31, 2000.
While not presently utilizing this funding source, we also have in the
past obtained funds from the sales of securities to investment dealers under
agreements to repurchase, known as reverse repurchase agreements. In a reverse
repurchase agreement transaction, we will generally sell a mortgage-backed
security agreeing to repurchase either the same or a substantially identical
security on a specific later date, generally not more than 90 days, at a price
less than the original sales price. The difference in the sale price and
purchase price is the cost of the use of the proceeds. The mortgage-backed
securities underlying the agreements are delivered to the dealers who arrange
the transaction. For agreements in which we have agreed to repurchase
substantially identical securities, the dealers may sell, loan or otherwise
dispose of our securities in the normal course of their operations; however,
such dealers or third party custodians safe-keep the securities which are to be
specifically repurchased by us. In this type of transaction, we are subject to
the risk that the lender may default at maturity and not return the collateral.
The amount at risk is the value of the collateral which exceeds the balance of
the borrowing. In order to minimize this potential risk, we only deal with
large, established dealers when entering into these transactions. Reverse
repurchase transactions are accounted for as financing arrangements rather than
as sales of such securities, and the obligation to repurchase such securities is
reflected in a liability in our consolidated financial statements.
We are parties to a credit agreement with Harris Trust and Savings Bank
and US Bank, N.A. Under the credit agreement, we have a revolving credit
facility that enables us to borrow up to $25 million for general corporate
purposes from time to time prior to September 17, 2005, up to $21.875 million
from September 17, 2005 through September 17, 2006, and up to $18.75 million
from September 17, 2006 through September 30, 2007, in each case subject to
customary borrowing conditions. As of June 30, 2002, we had outstanding
borrowings of $16.6 million under the
76
credit agreement. Our payment obligations under the credit agreement are secured
by a first priority security interest in the capital stock of Los Padres Bank.
We pay interest on the outstanding amount of our borrowings from time
to time under the credit agreement at an interest rate that adjusts based upon
our compliance with certain financial criteria and our selection of an interest
rate formula. At our option, the interest rates per annum applicable to any
particular borrowing under the credit agreement is either (1) adjusted LIBOR
plus a margin ranging from 2.0% to 3.0% or (2) the prime rate announced from
time to time by Harris Trust and Savings Bank minus a margin ranging from 0.5%
to 0.0%. The factors that determine the amount of the margin include our core
profitability and our non-performing asset ratio. We are currently at the most
favorable pricing level under the credit agreement. In each year, we also pay a
commitment fee to the lenders equal to 0.25% of the average daily undrawn
portion of the borrowings available to us under the credit agreement for that
year.
The credit agreement contains a number of significant covenants that
restrict our ability to dispose of assets, incur additional indebtedness, invest
in mortgage derivative securities above certain thresholds, create liens on
assets, engage in mergers or consolidations or a change-of control, engage in
certain transactions with affiliates, pay cash dividends or repurchase common
stock. The credit agreement also requires us to comply with specified financial
ratios and tests, including causing Los Padres Bank to maintain a ratio of
non-performing assets to the sum of Tier 1 risk-based capital plus loan loss
reserves of not more than 0.20 to 1, maintaining a ratio of outstanding loans
under the credit agreement to the stockholders' equity of Los Padres Bank of
less than 0.50 to 1, maintaining Los Padres Bank's status as a "well
capitalized" institution and complying with minimum core profitability
requirements. Management believes that as of June 30, 2002, it was in compliance
with all of such covenants and restrictions and does not anticipate that such
covenants and restrictions will limit its operations.
77
The following table sets forth certain information regarding our
short-term borrowings at or for the dates indicated.
AT OR FOR THE SIX MONTHS ENDED
JUNE 30,
------------------------------
2002 2001
----------- -----------
(DOLLARS IN THOUSANDS)
Securities sold under agreements to repurchase:
Average balance outstanding......................................... $ 1,075 $ --
Maximum amount outstanding at any month-end during the period....... 1,427 --
Balance outstanding at end of period................................ 1,322 --
Average interest rate during the period............................. 1.20% --%
Average interest rate at end of period.............................. 1.28% --%
Short-term FHLB advances:
Average balance outstanding......................................... $28,956 $47,696
Maximum amount outstanding at any month-end during the period....... 48,403 81,403
Balance outstanding at end of period................................ 48,403 81,403
Average interest rate during the period............................. 2.28% 4.90%
Average interest rate at end of period.............................. 2.18% 4.31%
AT OR FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------------------------
2001 2000 1999
------------- ------------- ------------
(DOLLARS IN THOUSANDS)
Securities sold under agreements to repurchase:
Average balance outstanding......................................... $108 $42,027 $42,742
Maximum amount outstanding at any month-end during the period....... 613 104,278 96,938
Balance outstanding at end of period................................ 365 -- 9,982
Average interest rate during the period............................. 1.24% 5.97% 5.04%
Average interest rate at end of period.............................. 1.00% --% 5.55%
Short-term FHLB advances:
Average balance outstanding......................................... $47.959 $38,461 $8,581
Maximum amount outstanding at any month-end during the period....... 85,403 63,000 58,000
Balance outstanding at end of period................................ 21,403 36,000 6,000
Average interest rate during the period............................. 4.05% 6.36% 5.19%
Average interest rate at end of period.............................. 4.07% 6.58% 5.49%
78
SUBSIDIARIES
Our primary subsidiary is Los Padres Bank. We were formed for the
purpose of acquiring Los Padres Bank, and we completed the acquisition in 1996.
Los Padres Bank is a wholly-owned subsidiary.
In February 1999, we purchased a 49% interest in Harrington Wealth
Management Company, which provides trust and investment management services to
individuals and small institutional clients. In November 2001, we purchased the
remaining 51% interest in Harrington Wealth Management Company. Harrington
Wealth Management Company emphasizes the management of expected risk and return
through personal knowledge and analysis of each customer's investment needs,
risk tolerance, tax situation and investment horizon. At June 30, 2002,
Harrington Wealth Management Company administered approximately 374 accounts and
had $96.7 million of assets under management which are not included on our
balance sheet. For the six months ended June 30, 2002 and 2001 and the years
ended December 31, 2001, 2000 and 1999, Harrington Wealth Management Company
generated revenues of $201,000, $164,000, $348,000, $261,000 and $152,000,
respectively. Harrington Wealth Management Company is a wholly-owned subsidiary
of Los Padres Bank.
In August 2002, we established Los Padres Mortgage as a 51%-owned
mortgage banking subsidiary of Los Padres Bank. Los Padres Mortgage has not yet
engaged in business. Los Padres Mortgage has entered into a non-exclusive joint
venture with Market Resources Inc., the owner of numerous RE/MAX brokerage
agencies in the Phoenix/Scottsdale metropolitan area, which owns 49% of Los
Padres Mortgage. Based on RE/MAX network referrals, Los Padres Mortgage will
originate single-family residential and commercial real estate loans primarily
for sale to third party investors. Los Padres Bank has the ability to engage in
similar relationships with other brokerage agencies in the Phoenix/Scottsdale
metropolitan area, subject to a right of first refusal in favor of Los Padres
Mortgage. Los Padres Bank will also have the opportunity to purchase select
single-family and commercial real estate loans from Los Padres Mortgage for its
portfolio.
Valley Oaks Financial Corporation was formed as a wholly owned service
corporation of Los Padres Bank in 1983 and serves as the title holder with
respect to the mortgages we originate.
LEGAL PROCEEDINGS
We are involved in a variety of litigation matters in the ordinary
course of our business and anticipate that we will become involved in new
litigation matters from time to time in the future. Based on the current
assessment of the other matters, we do not presently believe that any one of
these existing other matters or all such matters taken as a whole is likely to
have a material adverse impact on our financial condition, results of
operations, cash flows or prospects. However, we will incur legal and related
costs concerning litigation and may from time to time determine to settle some
or all of the cases, regardless of our assessment of our legal position. The
amount of legal defense costs and settlements in any period will depend on many
factors, including the status of cases, the number of cases that are in trial or
about to be brought to trial, and the opposing parties' aggressiveness in
pursuing their cases and their perception of their legal position.
79
OFFICE LOCATIONS
The following table sets forth certain information with respect to our
offices at June 30, 2002.
LEASED/OWNED DATE OFFICE
AND OPENED OR PURCHASE TOTAL DEPOSITS AT
OFFICE LOCATION LEASE EXPIRATION DATE DATE JUNE 30, 2002
- ----------------------------------------- ------------------------ ------------------ -----------------
Solvang Branch and Administrative Offices Lease expires on 1/31/05 June 1983 $98,182
610 Alamo Pintado Road with two options for
Solvang, CA 93463 five years each
Loan Center Lease expires on 1/31/05 March 1998 --
1992 Mission Drive with two options for
Solvang, CA 93463 five years each
Pismo Branch Lease expires on 2/9/08 May 1988 80,636
831 Oak Park Boulevard with two options for
Pismo Beach, CA 93449 five years each
Atascadero Branch Lease expires on 4/30/06 May 1991 48,221
7315 El Camino Real with two options for
Atascadero, CA 93422 five years each
Santa Maria Branch Lease expires on 6/30/07 July 1992 58,942
402 E. Main Street with three options for
Santa Maria, CA 93454 five years each
Buellton Branch Lease expires on 11/2/07 December 1997 16,149
234 E. Highway 246, Suite 109 with one option for five
Buellton, CA 93427 years
Goleta Branch Lease expires on February 1999 69,838
197 North Fairview 12/31/03 with four
Goleta, CA 93117 options for five years
each
San Luis Branch Lease expires on January 2001 15,797
1322 Madonna Road 12/31/05 with two
San Luis Obispo, CA 93405 options for five years
each
Nipomo Branch Lease expires on July 2001 10,691
542 W. Teft Road 11/30/05 with three
Nipomo, CA 93444 options for five years
each
Storage Area Month-to-month Lease June 1992 --
1120 Mission Drive with no expiration date
Solvang, CA 93463
80
LEASED/OWNED DATE OFFICE
AND OPENED OR PURCHASE TOTAL DEPOSITS AT
OFFICE LOCATION LEASE EXPIRATION DATE DATE JUNE 30, 2002
- ----------------------------------------- ------------------------ ------------------ -----------------
Human Resources and Compliance Lease expires on 1/31/05 March 2000 --
Training Room with two options for
Suite A-4 and A-5 five years each
1984 Old Mission Drive
Solvang, CA 93463
Loan Origination Center Lease expires on 1/31/05 April 2002 --
Suite B-12 with two options for
1988 Old Mission Drive five years each
Solvang, CA 93463
Harrington Bank Lease expires on November 2001 70,218
6300 Nall Avenue 12/31/10 with four
Kansas City, KS 66208 options for five years
each
Harrington West Financial Group, Inc. Lease expires on 3/31/04 January 2002 --
10801 Mastin Boulevard, Suite 740
Overland Park, KS 66210
Harrington Wealth Management Company Lease expires on 10/31/06 November 2001 --
10150 Lantern Road, Suite 150
Fishers, IN 46038
Proposed Scottsdale Branch Lease expires on 9/30/12 Fourth quarter 2002 --
10555 North 114th Street, Suite 100 with two options for (proposed)
Scottsdale, AZ 85295 five years each
Ojai Branch Owned November 1997 38,087
110 South Ventura Street
Ojai, CA 93023
Hanalei Bay Condo Owned July 1994 --
5380 Honiki Road
Princeville, Kauai
Proposed Kansas Branch -- Mid 2003 --
143rd and Metcalf (Proposed)
Overland Park, KS 66223 (1)
- ----------------
(1) Represents a lot that we are currently in the process of purchasing.
81
EMPLOYEES
As of June 30, 2002, we had 130 full-time equivalent employees. Our
employees are not subject to any collective bargaining agreements and we believe
that our relationship with our employees is satisfactory.
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table lists our directors and executive officers and also
presents those of Los Padres Bank as of June 30, 2002.
NAME AGE POSITION
---- --- --------
Craig J. Cerny 47 Chairman of the Board and Chief Executive Officer
For Los Padres Bank, Chairman of the Board, Chief
Executive Officer and Chief Investment Officer
William W. Phillips, Jr. 49 President and a Director
For Los Padres Bank, Chief Operating Officer, President
and a Director
Susan C. Weber 55 Senior Vice President and Secretary
For Los Padres Bank, Executive Vice President and Chief
Lending Officer and a Director
Mark R. Larrabee 44 For Los Padres Bank, President, Kansas Region, Chief
Commercial Lending Officer and a Director
Sean Callow 37 Senior Vice President and Chief Financial Officer
For Los Padres Bank, Senior Vice President and Chief
Financial Officer
Vernon H. Hansen 49 For Los Padres Bank, President, Arizona Region
Michele K. Morrison 43 For Los Padres Bank, Senior Vice President and
Chief Savings Officer
Steven J. Berg 52 For Los Padres Bank, Senior Vice President -Compliance and
Corporate Counsel
Louise J. Thurman 60 For Los Padres Bank, Senior Vice President - Human Resources,
Manager and Security Officer
Paul O. Halme 61 Director
For Los Padres Bank, Director
Stanley J. Kon 53 Director
For Los Padres Bank, Director
John J. McConnell 56 Director
For Los Padres Bank, Director
William D. Ross 73 Director
For Los Padres Bank, Director
Dean A. Anders 68 For Los Padres Bank, Director
George G. Jones 66 For Los Padres Bank, Director
82
We do not have employment agreements, severance agreements or change of
control agreements with any of our executive officers, and all of them are
subject to termination at will. Our board of directors is elected annually by
our stockholders, and each member of the board of directors serves until the
next annual meeting of stockholders and until his or her successor is elected
and qualified. The last annual meeting of stockholders was held in May 2002.
Craig J. Cerny has served as our Chairman of the Board and Chief
Executive Officer since August 1995, when he formed Harrington West Financial
Group, Inc. to acquire Los Padres Bank. Mr. Cerny has been the Chief Executive
Officer of Los Padres Bank since October 2001 and the Chairman of the Board of
Los Padres Bank since May 2002. Mr. Cerny has also served as a director and the
Chief Investment Officer of Los Padres Bank since April 1996. Until January
2002, Mr. Cerny was the Chief Executive Officer, President and a director of
Harrington Financial Group, Inc., Richmond, Indiana or HFGI, and Chairman of the
Board and Chief Executive Officer and President of HFGI's subsidiary, Harrington
Bank, FSB, positions he held since February 1992. Thus, Mr. Cerny served in the
capacities noted above with us and Los Padres Bank at the same time that he
served as Chief Executive Officer of HFGI. However, we and HFGI have always
operated as separate companies, with, except in the case of Mr. Cerny, Mr. Kon
and Mr. McConnell, separate boards of directors and, except in the case of Mr.
Cerny, separate management. In addition, we also had some common stockholders.
In January 2002, HFGI and Harrington Bank merged with an unaffiliated financial
institution after the sale, among other things, of the assets of HFGI's Shawnee
Mission, Kansas operations to Los Padres Bank. Prior to holding these positions,
Mr. Cerny served as a principal and member of the board of directors of Smith
Breeden which renders consulting and advisory services to us. Mr. Cerny was
employed at Smith Breeden from April 1985 to December 1996, where he was active
in their bank consulting and investment advisory practice. Mr. Cerny remains a
stockholder in Smith Breeden. Prior to joining Smith Breeden, Mr. Cerny held a
number of financial management related positions with Hallmark Cards, Inc. and
Pizza Hut Restaurants, Inc. He holds a Master of Business Administration in
Finance and a Bachelor of Science in Finance from Arizona State University. Mr.
Cerny resides in the Kansas City Metropolitan area, where we maintain an
executive office and the Harrington Bank division of Los Padres Bank operates.
William W. Phillips, Jr. is our President and a director and he is the
President, Chief Operating Officer and a director of Los Padres Bank. Mr.
Phillips has been our President since 1998 and a director since May 2002. Mr.
Phillips became a director of Los Padres Bank in 2001. Mr. Phillips had served
as the President and Chief Operating Officer of Los Padres Bank since 1997.
Prior to being named as our President, Mr. Phillips held positions as our Chief
Financial Officer and as our Chief Operating Officer. Prior to being the
President and Chief Operating Officer of Los Padres Bank, he served as its
Senior Vice President and Treasurer. He has more than 23 years experience in the
banking industry and has served Los Padres Bank in progressively responsible
capacities since its inception in 1983.
Susan C. Weber has been with Los Padres Bank since 1983. She has served
as our Senior Vice President and Secretary since 1999. Ms. Weber has served as
Executive Vice President and Chief Lending Officer of Los Padres Bank since
1999, and she has been a director of Los Padres Bank since 2001. When Ms. Weber
joined Los Padres Bank in 1983 as Vice President and Loan Manager, she was
instrumental in establishing its loan department. Shortly thereafter she was
promoted to Vice President and Chief Loan Officer and, in June 1997, she was
promoted to Senior Vice President and Chief Loan Officer. She has more than 30
years experience in the banking industry, including 19 years at Los Padres Bank.
Mark R. Larrabee. Mr. Larrabee has been President of the Kansas Region
and Chief Commercial Lending Officer of Los Padres Bank since November 2001,
when Los Padres Bank acquired the Kansas operations of Harrington Bank, FSB. In
December 2001, he was also named a director of Los Padres Bank. Mr. Larrabee
held similar positions at Harrington Bank, FSB since February 1998. From January
1996 to February 1998, Mr. Larrabee served as Executive Vice President for
Country Club Bank, Kansas City, Missouri. Prior to joining Country Club Bank,
Mr. Larrabee was Senior Vice President for Bank IV Kansas, National Association,
Overland Park, Kansas, from March 1984 to January 1996. His previous experience
includes an extensive commercial lending background, senior management positions
with various responsibilities including strategic planning and corporate
development, and the start up of a de novo
83
national bank. Mr. Larrabee holds a Bachelor of Science in Business
Administration from the University of Kansas and a Master of Business
Administration from the University of Missouri, graduating with Highest
Distinction.
Sean M. Callow has served as Senior Vice President and Chief Financial
Officer for us and Los Padres Bank since April 1999. Prior to being named as our
Chief Financial Officer, Mr. Callow held the position of controller. Prior to
joining us in 1991 he was a senior accountant with Deloitte & Touche, auditing
companies in the real estate and savings and loan industry. Prior to that Mr.
Callow served as the controller at Danvik Engineering Consulting. Mr. Callow has
a Bachelor of Arts with emphasis in Accounting from the University of
California, Santa Barbara and is a certified public accountant.
Vernon H. Hansen joined Los Padres Bank in July 2002 as President of
our newly formed Arizona Region. He has several years of experience in the
Phoenix, Arizona metropolitan market, and a 30-year background in commercial and
community banking, including duties as President, Branch Manager, Chief Credit
Officer and Lending Officer. Prior to joining Los Padres Bank, Mr. Hansen was
Executive Vice President - Chief Lending Officer for Bank of the Southwest in
Tempe, Arizona from May 2001 to July 2002, and Vice President - Chief Credit
Officer for Matrix Capital Bank in Phoenix and Denver from January 1997 to May
2001. He was also employed by the FDIC as a bank examiner earlier in his career.
Mr. Hansen graduated from the University of Iowa, with a BBA in Finance.
Michelle K. Morrison has been with Los Padres Bank since its inception
in 1983. She has served as Senior Vice President and Chief Savings Officer of
Los Padres Bank since 1999. Prior to 1999, she has held several positions within
Savings Administration for Los Padres Bank. Ms. Morrison has more than 20 years
experience in the banking industry.
Steven J. Berg has served as our Corporate Counsel and as Senior Vice
President and Compliance Officer of Los Padres Bank since October 1996. At the
time Mr. Berg joined Los Padres Bank, Mr. Berg was in private law practice in
Santa Barbara and Goleta, California, where he focused on banking and creditors
rights law. Prior to that, Mr. Berg served in various legal positions, including
general counsel with Santa Barbara Federal Savings & Loan Association. Mr. Berg
entered private law practice in 1976. He received a Juris Doctor from the
University of South Dakota School of Law in 1976 and received a Bachelor of
Science degree with Honors in Business Administration, University of South
Dakota, 1972.
Louise J. Thurman has served as Senior Vice President, Manager of Human
Resources and Security Offices of Los Padres Bank since 1996. Prior to that she
was at First Banks, Inc. (formerly La Cumbre Savings Bank, FSB) for five years
where she was Vice President, Human Resources Manager. Ms. Thurman's previous
human resources experience includes seven years with First Federal Bank of
California, Santa Monica, California, where she served in progressively
increasing levels of responsibilities culminating as Vice President, Human
Resources Director, and nine years with the Power Systems Division of Gould,
Inc., Downey, California, where she also served as a member of the management
negotiating team during contract negotiations with two bargaining units under
the I.B.E.W.
Paul O. Halme has served as a director since May 2002 and as a Director
of Los Padres Bank since 2000. Mr. Halme is an attorney and a partner in the law
firm of Halme and Clark in Solvang, California. Mr. Halme received his
bachelor's degree from the University of California at Los Angeles and his law
degree from the University of California, Hastings College of Law.
Stanley J. Kon has served as a director and as a Director of Los Padres
Bank since 1996. Dr. Kon also served as a director of HFGI until January 2002.
Dr. Kon is a Senior Vice President, a director and co-head of Smith Breeden's
Investment Management Group. Dr. Kon also serves as the firm's Director of
Research. Prior to joining Smith Breeden in 1997, Dr. Kon was a Professor of
Finance at the University
84
of Michigan since 1982. Dr. Kon has also served as a consultant to government,
business and financial institutions, including the U.S. Department of Labor,
Resolution Trust Corporation, U.S. Securities and Exchange Commission, Catalyst
Group, The Commodity Exchange and Chase Econometric Associates. Dr. Kon is the
editor of the Journal of Fixed Income. Dr. Kon holds a Ph.D. in Finance from the
State University of New York at Buffalo, a Master of Business Administration in
Finance and Economics from St. John's University and a Bachelor of Science in
Chemical Engineering from the Lowell Technological Institute.
John J. McConnell has served as a director and as a Director of Los
Padres Bank since 1996. Dr. McConnell also served as a director of HFGI until
January 2002. Dr. McConnell is the Emanuel T. Weiler Distinguished Professor of
Management at the Krannert School of Management, Purdue University, where he has
been a faculty member since 1976. He served on the Board of Directors of the
FHLB of Indianapolis from 1983 to 1986 and has been a consultant for various
government agencies, trade associations, law firms, and corporations. Dr.
McConnell holds a Ph.D. in Finance from Purdue University and a Master of
Business Administration in Finance and Accounting from the University of
Pittsburgh. He received his undergraduate degree in Economics from Denison
University.
William D. Ross has served as a director since our inception. Mr. Ross
served as our President and as the Chief Executive Officer of Los Padres Bank
from 1983 to 1998 and was Chairman of Los Padres Bank from 1997 to May 2002. Mr.
Ross has spent more than forty-five years in the banking business. He is a
graduate in Business Administration from the University of Southern California.
Dean A. Anders has served as a Director of Los Padres Bank since 1999.
He is a retired superintendent of the Santa Ynez Valley Union High School
District.
George G. Jones has served as a Director of Los Padres Bank since its
inception. Mr. Jones is the Chairman, CEO and owner of The Jones Organization
Insurance Services in Solvang, California.
COMMITTEES OF THE BOARD OF DIRECTORS
General. Our board of directors has an audit committee and a
compensation committee, each of which is described below. Our audit and
compensation committees will be comprised entirely of independent directors. The
members of our audit committee are Messrs. Ross, Halme and McConnell. Our
compensation committee is also comprised of Messrs. Ross, Halme and McConnell.
Audit Committee. Our audit committee reviews our auditing, accounting,
financial reporting and internal control functions and make recommendations to
the board of directors for the selection of independent accountants. In
addition, the committee monitors the quality of our accounting principles and
financial reporting, as well as the independence of and the non-audit services
provided by our independent accountants. In discharging its duties, the audit
committee:
- - reviews and approves the scope of the annual audit and the independent
accountants' fees;
- - meets independently with our compliance staff, contracted internal
auditors, our independent accountants and our senior management; and
- - reviews the general scope of our accounting, financial reporting,
annual audit and internal audit program, matters relating to internal
control systems as well as the results of the annual audit.
85
Compensation Committee. Our compensation committee determines, approves
and reports to the board of directors on all elements of compensation for our
elected officers including targeted total cash compensation and long-term equity
based incentives.
Bank Committees. In addition, Los Padres Bank has the following
committees: an asset/liability management committee, an audit committee, a
compensation committee, a CRA committee, an executive committee, an internal
asset review oversight committee and a loan oversight committee.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Our board of directors' compensation committee currently consists of
the following non-employee directors: Messrs. Ross, Halme and McConnell. Mr.
Halme became a member of the committee in July of 2002, replacing Mr. Kon. Until
the compensation committee was formed in December of 1999, the full board of
directors made all decisions regarding executive compensation. During the year
ended December 31, 2001, no member of our board of directors or of its
compensation committee served as a member of the board of directors or
compensation committee of an entity that had one or more executive officers
serving as members of our board of directors or its compensation committee.
None of the members of the compensation committee during fiscal year
ended December 31, 2001, served as an officer or employee of ours or Los Padres
Bank, and except for the following two disclosures, none of the members of the
compensation committee has served as one of our officers, or as an officer of
Los Padres Bank, or had a relationship with us or Los Padres Bank requiring
disclosure under the securities laws. William D. Ross was one of our senior
executive officers and a senior executive officer of Los Padres Bank until 1998.
Stanley Kon, one of our directors, and a member of the compensation committee
during 2001 and until July 2002, is a principal and director at Smith Breeden.
Los Padres Bank entered into an Investment and Interest Rate Advisory Agreement
with Smith Breeden in February 1997, which was amended in January 2002. Smith
Breeden received fees of $159,000, $140,000, $295,000, $286,000, and $284,000
during the six months ended June 30, 2002 and 2001 and during 2001, 2000, and
1999 under this agreement. See - Certain Relationships and Related
Transactions."
DIRECTOR COMPENSATION
Our non-employee directors receive an annual fee of $10,000 for
attending board of directors and committee meetings. Non-employee directors of
Los Padres Bank receive an annual fee of $27,500 for attending board of director
and committee meetings of Los Padres Bank.
In addition, each of our directors is eligible to receive option grants
under the terms of the 1996 Stock Option Plan. Our non-employee directors and
non-employee directors of Los Padres Bank may not receive an option to purchase
more than 4,500 shares of our common stock in any calendar year, provided the
maximum grant may not be more than 6,000 shares in any calendar year if such
individual is serving as a director of both us and Los Padres Bank. See "-1996
Stock Option Plan."
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EXECUTIVE COMPENSATION
The following table sets forth salaries and bonuses paid during the
last three years to our Chief Executive Officer and our next most highly
compensated executive officers whose total annual salary and bonus exceeds
$100,000. The individuals included in this table are referred to as the "named
executive officers."
ANNUAL COMPENSATION
---------------------------------------------------
OTHER ANNUAL
NAME AND PRINCIPAL POSITION YEAR SALARY(1)(2) BONUS COMPENSATION(3)
- ------------------------------------------------ ----------- -------------- ------------- ---------------------
Craig J. Cerny 2001 $236,000 $140,000 $5,250
Chairman and Chief Executive Officer of the 2000 234,300 100,000 5,250
Company 1999 230,800 75,000 5,000
William W. Phillips, Jr. 2001 158,500 75,000 $5,250
President of the Company and Los Padres Bank 2000 150,800 50,000 5,250
1999 141,400 47,500 5,000
Sean M. Callow 2001 103,625 37,500 $3,150
Chief Financial Officer of the Company and 2000 90,240 25,000 3,150
Bank and Senior Vice President of Los Padres Bank 1999 83,900 20,000 2,925
Susan C. Weber 2001 111,250 40,000 $3,150
Senior Vice President of the Company and 2000 104,000 20,000 3,000
Executive Vice President of Los Padres Bank 1999 95,540 22,500 3,000
LONG-TERM
COMPENSATION
--------------
AWARDS
--------------
ALL OTHER
NAME AND PRINCIPAL POSITION OPTIONS COMPENSATION
- ------------------------------------------------ -------------- ------------------
Craig J. Cerny - $ -
Chairman and Chief Executive Officer of the - -
Company 22,500 -
William W. Phillips, Jr. 6,000 -
President of the Company and Los Padres Bank - -
16,500 -
Sean M. Callow 3,750 -
Chief Financial Officer of the Company and - -
Bank and Senior Vice President of Los Padres Bank 7,500 -
Susan C. Weber 4,500 -
Senior Vice President of the Company and - -
Executive Vice President of Los Padres Bank 9,000 -
---------------------
(1) Mr. Cerny's salary includes fees paid to him as a director of Los
Padres Bank.
(2) Includes discretionary contributions to the 401(k) plan for all named
officers.
(3) Includes matching contributions to the 401(k) plan for all named
officers.
87
The following tables presents information on our equity compensation
plans generally at December 31, 2001.
NUMBER OF SECURITIES
NUMBER OF REMAINING AVAILABLE
SECURITIES TO BE FOR FUTURE ISSUANCE
ISSUED UPON UNDER EQUITY
EXERCISE OF WEIGHTED-AVERAGE COMPENSATION PLANS
OUTSTANDING EXERCISE PRICE OF (EXCLUDING SECURITIES
OPTIONS, WARRANTS OUTSTANDING OPTIONS, REFLECTED IN COLUMN
AND RIGHTS WARRANTS AND RIGHTS (a))
PLAN CATEGORY (a) (b) (c)
- --------------------------------------------- ------------------- --------------------- ----------------------
Equity compensation plans approved by
security holders......................... 373,050 $7.50 125,598
Equity compensation plans not approved by
security holders......................... -- -- --
-------------- --------------- ---------------
Total................................ 373,050 $7.50 125,598
============== =============== ===============
Our 1996 Stock Option Plan authorized the issuance of options for
common stock in the aggregate amount of the lesser of 900,000 shares or 15% of
our outstanding common stock. Currently the lesser of these amounts is the 15%
figure which is approximately 503,150 shares and upon completion of this
offering the lesser of these amounts will be 722,150 shares.
The following table provides information with respect to the exercise
of stock options during 2001 by our named executive officers and the value of
unexercised options at December 31, 2001.
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS AT 12/31/01 12/31/01 (1)
---------------------------- -------------------------------
SHARES ACQUIRED VALUE
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- -------------------------------- ----------------- ---------------- ------------- -------------- --------------- ---------------
Craig J. Cerny............... -- $-- 103,953 16,500 $268,173 $15,125
William W. Phillips, Jr...... -- -- 43,500 18,000 86,375 16,500
Sean M. Callow............... -- -- 26,250 11,250 54,063 10,313
Susan C. Weber............... -- -- 17,250 9,000 33,813 8,250
- ---------------------------
(1) Value of unexercised "in-the-money" options is the difference between
the fair market value of the securities underlying the options and the
exercise or base price of the options as of December 31, 2001.
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The following table provides information with respect to the named
executive officers concerning the grant of stock options during the year 2001.
INDIVIDUAL GRANTS
(OPTIONS GRANTED IN 2001) (1)
--------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF PERCENT OF ANNUAL RATES OF
SECURITIES TOTAL OPTIONS STOCK PRICE
UNDERLYING GRANTED EXERCISE APPRECIATION
OPTIONS TO EMPLOYEES OR BASE EXPIRATION FOR OPTION TERM
NAME GRANTED IN 2001 PRICE DATE (2) 5% 10%
-------------------------- --------------- ---------------- --------- ---------- -------------------
Craig J. Cerny (3)...... 42,453 -- $8.33 6/30/2003 $41,121 $ 84,960
William W. Phillips, Jr. 6,000 18.4 8.33 1/11/2011 31,432 79,655
Sean M. Callow.......... 3,750 11.5 8.33 1/11/2011 19,645 49,784
Susan C. Weber.......... 4,500 13.8 8.33 1/11/2011 23,574 59,741
- ---------------------------
(1) Additional options were granted on January 11, 2002 at an exercise
price of $9.33 to the following individuals: Craig J. Cerny, 7,500
shares; William W. Phillips, Jr., 6,000 shares; Susan C. Weber, 4,500
shares; and Sean M. Callow, 3,750 shares.
(2) All stock options granted under the 1996 Plan vest in four equal annual
installments commencing on the first anniversary of the grant date.
(3) In connection with the acquisition of Los Padres Bank in 1996, Mr.
Cerny acquired or had assigned to him options for 42,453 shares. We
extended the expiration of 42,453 options held by Mr. Cerny to June 30,
2003 in lieu of additional option grants in year 2001 from the
qualified option plan. The incremental value of extending these 42,453
options to June 30, 2003 equals the value of 7,500 new at-the-money
10-year options of the qualified plan based on a Black-Scholes pricing
analysis. In 2001, we recorded a one-time pre-tax charge of $106,000 to
reflect the cost associated with the extension of the options.
1996 STOCK OPTION PLAN
Our 1996 Stock Option Plan was adopted by our board of directors and
was subsequently approved by our stockholders in April 1997. In April 2000, our
shareholders approved an amendment to the 1996 Plan that increased the number of
shares available for grant of stock options to 900,000, provided, however, that
the committee administering the 1996 Plan may not grant any stock options if as
a result the number of shares subject to stock options would exceed 15% of the
total issued and outstanding shares of our common stock. In addition, the
amendment sets annual ceilings for option grants to non-employee directors. We
established this plan to provide our employees and our non-employee directors,
and those of our subsidiaries, the ability to acquire an ownership interest in
our company. Under the terms of the 1996 Plan, we are permitted to make grants
of incentive stock options and nonqualified stock options.
The 1996 Plan provides for administration by a committee of two or more
non-employee directors. The committee has full power to select, from among the
individuals eligible for option grants, the participants to whom the options
will be granted, and to determine the specific terms and conditions of each
option, subject to the provisions of the plan. Non-employee directors who are
serving solely as our directors may not receive an option to purchase more than
4,500 shares of our common stock in any
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calendar year, while the number of shares is limited to not more than 6,000
shares in any calendar year if such individual is serving as both our director
and a director of Los Padres Bank.
Each option must be granted at no less than 100% of the fair market
value of a share of common stock at the time such option is granted. Incentive
stock options are also subject to limitations prescribed by the Internal Revenue
Code, including the requirement that such options may not be granted to
employees who own more than 10% of the combined voting power of all classes of
our voting stock, unless the option price is at least 110% of the fair market
value of the common stock subject to the option, and may be exercised for no
more than five years from the grant date.
Our board of directors may at any time amend or terminate the 1996 Plan
with respect to any shares of common stock as to which option have not been
granted, subject to any applicable regulatory requirements and any required
stockholder approval. Our board of directors may not, without the consent of the
option holder, alter or impair any option previously granted or awarded under
the plan.
All stock options granted under the 1996 Plan vest in four equal annual
installments commencing on the first anniversary of the grant date. Unless the
committee administering the plan states otherwise, all options granted under the
1996 Plan vest and become exercisable upon the death, disability or retirement
after reaching retirement age of the optionee or upon termination of the
optionee's employment after a change of control. Except in the cases of death,
disability, retirement or a change in control, all options shall terminate three
months after the date on which the optionee ceases to be employed (or serve on
the board of directors, in the case of non-employee directors) with us or our
subsidiaries, unless the committee, only in the case of non-qualified options,
decides to extend such period of exercise upon termination of employment or
service from three months to a period not more than one year. Stock options are
not transferable except by will or the laws of descent.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Except as described below, since January 1, 1999, we have not been a
party to any transaction or series of transactions in which the amount involved
exceeds $60,000 and in which any director, executive officer, or holder of more
than 5% of our common stock had or will have a direct or indirect material
interest.
Under applicable federal law, Los Padres Bank can make loans or
extensions of credit to our and its executive officers and directors only if
there are loans and extensions of credit made on substantially the same terms,
including interest rates and collateral, as Los Padres Bank then makes available
for comparable transactions with the general public, unless the loans are made
pursuant to a benefit or compensation program that (i) we make widely available
to our employees and (ii) does not give preference over other employees to any
director, executive officer or principal stockholder or certain affiliates.
Also, if Los Padres Bank makes a loan or extends credit to any of our or its
executive officers or directors, the transaction must not involve more than the
normal risk of repayment or present other unfavorable features. In early 2002,
we adopted a mortgage loan program for the benefit of all of our employees.
Under this program, we offer our employees mortgage loans on our customary
terms, provided that during the period they are employed by Los Padres Bank the
interest rate on the mortgage loan will be equal to the cost-of-funds index plus
one percent. This results in below market interest rates for our employees. The
only executive officers who have participated in this program are Susan C.
Weber, who had a $349,000 loan outstanding at June 30, 2002, and Mark R.
Larrabee, who had a $180,000 loan outstanding at June 30, 2002. In addition,
William W. Phillips, Jr. had an outstanding loan balance of $218,000 as of such
date pursuant to a program which was offered by Los Padres Bank in the late
1980's which offered employees a below market rate.
90
As of June 30, 2002, mortgage and consumer loans to directors and
officers in excess of $60,000 aggregated $2.9 million or 9.1% of our
consolidated stockholders' equity as of such date, including the loans to Ms.
Webber and Mr. Larrabee described above. All such loans were made by Los Padres
Bank in accordance with the policy and program described in the preceding
paragraphs.
Los Padres Bank entered into an Investment and Interest Rate Advisory
Agreement with Smith Breeden in February 1997, which was amended in January
2002. Under the terms of the agreement, Los Padres Bank appointed Smith Breeden
as investment advisor with respect to the management of Los Padres Bank's
portfolio of investments and its asset and liability management strategies.
Specifically, Smith Breeden advises and consults with Los Padres Bank with
respect to its investment activities, including the acquisition of
mortgage-backed securities, the use of repurchase agreement transactions in
funding and the acquisition of certain hedging instruments to reduce the
interest rate risk of Los Padres Bank's investments. Under the Agreement, Smith
Breeden, as agent, may (1) buy, sell, exchange and otherwise trade in
mortgage-backed securities or other investments, and (2) arrange for necessary
placement of orders, execution of transactions, purchases, sales and conveyances
with or through such brokers, dealers, issuers or other persons as Smith Breeden
may select, subject to the approval of Los Padres Bank, and establish the price
and trade conditions, including brokerage commissions. For its services, Smith
Breeden receives a monthly fee, based on its standard fee schedule for such
services, which is based on Los Padres Bank's total consolidated assets plus
unsettled purchase of securities and minus unsettled sales of securities. Smith
Breeden received fees of $159,000, $140,000, $295,000, $286,000, and $284,000
during the six months ended June 30, 2002 and 2001 and during 2001, 2000, and
1999 under this agreement. Doug Breeden, a 12.8% stockholder of Harrington West
Financial Group at June 30, 2002, is the Chairman of Smith Breeden. Also Stanley
Kon, one of our directors, is a principal and director at Smith Breeden. As of
June 30, 2002, all persons affiliated with Smith Breeden owned 26.7% of our
shares. Additionally, Mr. Cerny, our Chairman of the Board and Chief Executive
Officer, was previously a principal and director at Smith Breeden and was
employed by them from April 1985 to December 1996 and is still a minority
shareholder in Smith Breeden.
In March 2000, Los Padres Bank granted a loan totaling $600,000 to
Smith Breeden at an interest rate of 10% with a maturity of April 2001. The
purpose of the loan was to provide funds to pay off a loan Smith Breeden had
outstanding with Harrington Bank, FSB. The loan was paid off in September 2000.
In November 2001, Los Padres Bank acquired certain assets and deposits
of Harrington Bank, FSB. See Note 17 of the notes to consolidated financial
statements. Harrington Bank, FSB was a subsidiary of Harrington Financial Group,
Inc., which was controlled by Douglas T. Breeden. At the time of the
acquisition, Mr. Breeden and Mr Cerny owned respectively 10.94% and 12.14% of us
and 49.52% and 7.06% of HFGI. Mr. Cerny, our Chairman of the Board and Chief
Executive Officer, was also a director and President of HFGI and the Chairman of
the Board and Chief Executive Officer of the Harrington Bank, FSB prior to its
acquisition by us, and thus, the acquisition was with a related party. Mr. Kon
and Mr. McConnell, our directors, were also directors of HFGI. Both parties to
the transaction obtained fairness opinions from investment bankers.
In February 1999, we acquired a 49% ownership interest in Harrington
Wealth Management Company in a joint venture with Harrington Bank, FSB, a
related party. In November 2001, we acquired the remaining 51% ownership of
Harrington Wealth Management Company from Harrington Bank, FSB.
We have adopted policies and procedures which address, among other
things, loans to insiders, transactions with affiliates, and authority for
corporate decision-making. Our policy "Directors' Responsibility -- Loyalty and
Care," addresses, among other things, the duty of care and the duty of loyalty
of our directors and compliance with applicable regulations. Our policy,
"Transactions with Affiliates and Loans to Insiders Policy and Procedures," is
intended to implement restrictions imposed on us and Los Padres Bank as
regulated financial entities. We have a "Code of Conduct and Conflicts of
Interest Policy and Procedure," which sets forth requirements with regard to
business conduct and ethics and conflicts of interest. Finally, we have an
"Insider Trading Policy" which is intended to ensure compliance with federal
securities laws. These policies and procedures are designed to minimize the
possibility of conflicts of interest arising among our directors and officers
as well as undue influence by controlling stockholders.
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REGULATION
GENERAL
Savings and loan holding companies and savings associations are
extensively regulated under both federal and state law. This regulation is
intended primarily for the protection of depositors and the Savings Association
Insurance Fund, or SAIF, and not for the benefit of our stockholders. The
following information describes certain aspects of that regulation applicable to
us, Los Padres Bank and Harrington Wealth Management Company, and does not
purport to be complete. The discussion is qualified in its entirety by reference
to all particular statutory or regulatory provisions.
REGULATION OF HARRINGTON WEST FINANCIAL GROUP, INC.
General. We are a unitary savings and loan holding company subject to
regulatory oversight by the OTS. As such, we are required to register and file
reports with the OTS and are subject to regulation and examination by the OTS.
In addition, the OTS has enforcement authority over us and our subsidiaries,
which also permits the OTS to restrict or prohibit activities that are
determined to be a serious risk to Los Padres Bank.
Activities Restriction Test. As a unitary savings and loan holding
company, we are generally not subject to activity restrictions, provided Los
Padres Bank satisfies the Qualified Thrift Lender, or QTL, test or meets the
definition of a domestic building and loan association pursuant to the Internal
Revenue Code of 1986, as amended, or the Code. We presently intend to continue
to operate as a unitary savings and loan holding company. Recent legislation
terminated the "unitary thrift holding company exemption" for all companies that
apply to acquire savings associations after May 4, 1999. However, since we are
grandfathered, our unitary holding company powers and authorities were not
affected. Despite our grandfathered status, if we acquire control of another
savings association as a separate subsidiary, we would become a multiple savings
and loan holding company, and our activities and any of our subsidiaries (other
than Los Padres Bank or any savings association) would be restricted generally
to activities permissible for financial holding companies and other activities
permitted for multiple savings and loan holding companies under OTS regulations,
unless such other associations each also qualify as a QTL or a domestic building
and loan association and were acquired in a supervisory acquisition.
Furthermore, if we were in the future to sell control of Los Padres Bank to any
other company, such company would not succeed to our grandfathered status and
would be subject to the same business activity restrictions. See "- Regulation
of Los Padres Bank - Qualified Thrift Lender Test."
Restrictions on Acquisitions. We must obtain approval from the OTS
before acquiring control of any other savings association. Such acquisitions are
generally prohibited if they result in a multiple savings and loan holding
company controlling savings associations in more than one state. However, such
interstate acquisitions are permitted based on specific state authorization or
in a supervisory acquisition of a failing savings association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may acquire
"control," as that term is defined in OTS regulations, of a federally insured
savings association without giving at least 60 days written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition. In
addition, no company may acquire control of such an institution without prior
OTS approval. These provisions also prohibit, among other things, any director
or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of a savings and loan holding
company, from acquiring control of any savings association not a subsidiary of
the savings and loan holding company, unless the acquisition is approved by the
OTS.
92
REGULATION OF LOS PADRES BANK
General. As a federally chartered, SAIF-insured savings association,
Los Padres Bank is subject to extensive regulation by the OTS and the Federal
Deposit Insurance Corporation, or FDIC. Lending activities and other investments
of Los Padres Bank must comply with various statutory and regulatory
requirements. Los Padres Bank is also subject to certain reserve requirements
promulgated by the Federal Reserve Board.
The OTS, in conjunction with the FDIC, regularly examines Los Padres
Bank and prepares reports for the consideration of Los Padres Bank's Board of
Directors on any deficiencies found in the operations of Los Padres Bank. The
relationship between Los Padres Bank and depositors and borrowers is also
regulated by federal and state laws, especially in such matters as the deposit
insurance of savings accounts and the form and content of mortgage documents
utilized by Los Padres Bank.
Los Padres Bank must file reports with the OTS and the FDIC concerning
its activities and financial condition, in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with or
acquisitions of other financial institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the SAIF and depositors.
The regulatory structure also gives the regulatory authorities extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such regulations, whether by the OTS, the FDIC, or the
Congress could have a material adverse impact on us, Los Padres Bank, and our
operations.
Insurance of Deposit Accounts. The SAIF, as administered by the FDIC,
insures Los Padres Bank's deposit accounts up to the maximum amount permitted by
law. The FDIC may terminate insurance of deposits upon a finding that Los Padres
Bank:
- has engaged in unsafe or unsound practices;
- is in an unsafe or unsound condition to continue operations;
or
- has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC or the OTS.
The FDIC charges an annual assessment for the insurance of deposits
based on the risk a particular institution poses to its deposit insurance fund.
Under this system as of December 31, 2001, SAIF members pay within a range of 0
cents to 27 cents per $100 of domestic deposits, depending upon the
institution's risk classification. This risk classification is based on an
institution's capital group and supervisory subgroup assignment. In addition,
all FDIC-insured institutions are required to pay assessments to the FDIC at an
annual rate for the third quarter of 2002 at approximately $0.0172 per $100 of
assessable deposits to fund interest payments on bonds issued by the Financing
Corporation, or FICO, an agency of the Federal government established to
recapitalize the predecessor to the SAIF. These assessments will continue until
the FICO bonds mature in 2017.
Proposed Legislation. From time to time, new laws are proposed that, if
enacted, could have an effect on the financial institutions industry. For
example, deposit insurance reform legislation has recently been introduced in
Congress that would:
- merge the Bank Insurance Fund and the SAIF.
93
- increase the current deposit insurance coverage limit for
insured deposits to $130,000 and index future coverage limits
to inflation.
- increase deposit insurance coverage limits for municipal
deposits.
- double deposit insurance coverage limits for individual
retirement accounts.
- replace the current fixed 1.25 designated reserve ratio with a
reserve range of 1-1.5%, giving the FDIC discretion in
determining a level adequate within this range.
While we cannot predict whether such proposals will eventually become
law, they could have an effect on our operations and the way we conduct
business.
Regulatory Capital Requirements and Prompt Corrective Action. The
prompt corrective action regulation of the OTS, requires certain mandatory
actions and authorizes certain other discretionary actions to be taken by the
OTS against a savings association that falls within certain undercapitalized
capital categories specified in the regulation.
Under the regulation, an institution is well capitalized if it has a
total risk-based capital ratio of at least 10.0%, a Tier 1 risk-based capital
ratio of at least 6.0% and a leverage ratio of at least 5.0%, with no written
agreement, order, capital directive, prompt corrective action directive or other
individual requirement by the OTS to maintain a specific capital measure. An
institution is adequately capitalized if it has a total risk-based capital ratio
of at least 8.0% and a Tier 1 risk-based capital ratio of at least 4.0% and a
leverage ratio of at least 4.0% (or 3.0% if it has a composite rating of "1").
The regulation also establishes three categories for institutions with lower
ratios: undercapitalized, significantly undercapitalized and critically
undercapitalized. At June 30, 2002, Los Padres Bank met the capital
requirements of a "well capitalized" institution under applicable OTS
regulations.
In general, the prompt corrective action regulation prohibits an
insured depository institution from declaring any dividends, making any other
capital distribution, or paying a management fee to a controlling person if,
following the distribution or payment, the institution would be within any of
the three undercapitalized categories. In addition, adequately capitalized
institutions may accept brokered deposits only with a waiver from the FDIC and
are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew, or roll over
brokered deposits.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions. Finally, pursuant to an interagency
agreement, the FDIC can examine any institution that has a substandard
regulatory examination score or is considered undercapitalized without the
express permission of the institution's primary regulator.
OTS capital regulations also require savings associations to meet three
capital standards:
- tangible capital equal to at least 1.5% of total adjusted
assets,
- leverage capital (core capital) equal to 4% of total adjusted
assets, and
94
- risk-based capital equal to 8.0% of total risk-weighted
assets.
These capital requirements are viewed as minimum standards by the OTS,
and most institutions are expected to maintain capital levels well above the
minimum. Minimum capital levels higher than those provided in the regulations
may be established by the OTS for individual savings associations, upon a
determination that the savings association's capital is or may become inadequate
in view of its circumstances.
In addition to minimum capital requirements and the prompt corrective
action requirements set forth above, due to our business strategy which has
concentrated on growth, a shift in our lending focus to more commercial lending
and the size and character of our available for sale securities and trading
account assets, we have informally agreed with the OTS that Los Padres Bank will
maintain a total risk-based capital ratio and a leverage capital ratio of at
least 11% and 6%, respectively, which is in excess of both the OTS' minimum
regulatory requirement as well as the OTS' prompt corrective action
requirements. Management does not believe that Los Padres Bank's agreement with
the OTS to maintain increased ratios of total risk-based and leverage capital
will limit or restrict our operations. However, to the extent that Los Padres
Bank fails to comply with these additional increased capital ratios, the OTS
could take such failure to comply into consideration in connection with further
requests to have Los Padres Bank pay dividends to us and in additional future
branch applications. Los Padres Bank's failure to comply could also impact its
overall assessment by the OTS in future regulatory examinations, which, if
adverse, could also impact its FDIC insurance assessment.
The following table reflects as of June 30, 2002, Los Padres Bank's
actual levels of regulatory capital and both the applicable regulatory capital
requirements as well as the increased capital requirements that Los Padres Bank
has informally agreed with the OTS that it will maintain.
<Table>
<Caption>
TANGIBLE CAPITAL(1) TIER 1 LEVERAGE CAPITAL(1) RISK-BASED CAPITAL(1)
------------------------ -------------------------- ------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- -------- ------- -------- ------- --------
(DOLLARS IN THOUSANDS)
Actual regulatory capital ........ N/A N/A $42,256 6.26% $46,217 12.14%
Minimum required by OTS agreement
capital(2) ..................... N/A N/A 40,504 6.00 41,879 11.00
------- ---- ------- ---- ------- -----
Excess regulatory capital ........ N/A N/A $ 1,752 0.26 4,338 1.14%
------- ---- ------- ---- ------- -----
Actual regulatory capital ........ $42,256 6.26% $42,256 6.26% $46,217 12.14%
Minimum regulatory capital ....... 10,126 1.50 27,003 4.00 30,458 8.00
------- ---- ------- ---- ------- -----
Excess regulatory capital ........ $32,130 4.76% $15,253 2.26 15,759 4.14%
------- ---- ------- ---- ------- -----
</Table>
- ----------
(1) The tangible capital ratio is computed as a percentage of tangible assets
and the Tier 1 leverage ratio is computed as a percentage of adjusted
total assets, both of which are $675.1 million at June 30, 2002.
(2) Although applicable OTS regulations require Los Padres Bank to maintain
Tier 1 leverage capital equal to 4.00% of adjusted total assets and
risk-based capital equal to 8.00% of adjusted risk-weighted assets, Los
Padres Bank has informally agreed with the OTS that it will maintain Tier
1 leverage capital equal to 6.00% of adjusted total assets and risk-based
capital equal to 11.00% of adjusted risk-weighted assets.
The Home Owners' Loan Act, or HOLA, permits savings associations not in
compliance with the OTS capital standards to seek an exemption from certain
penalties or sanctions for noncompliance. Such an exemption will be granted only
if certain strict requirements are met, and must be denied under certain
circumstances. If an exemption is granted by the OTS, the savings association
still may be subject to enforcement actions for other violations of law or
unsafe or unsound practices or conditions.
Loans-to-One Borrower Limitations. Savings associations generally are
subject to the lending limits applicable to national banks. With certain limited
exceptions, the maximum amount that a savings association or a national bank may
lend to any borrower (including certain related entities of the borrower) at one
time may not exceed 15% of the unimpaired capital and surplus of the
institution, plus an additional 10% of unimpaired capital and surplus for loans
fully secured by readily marketable collateral. Savings associations are
additionally authorized to make loans to one borrower, for any purpose, in an
amount not to exceed $500,000 or, by order of the Director of OTS, in an amount
not to exceed the lesser of $30.0 million or 30% of unimpaired capital and
surplus to develop residential housing, provided:
- the purchase price of each single-family dwelling in the
development does not exceed $500,000;
- the savings association is in compliance with its capital
requirements;
- the loans comply with applicable loan-to-value requirements;
and
- the aggregate amount of loans made under this authority does
not exceed 150% of unimpaired capital and surplus.
At June 30, 2002, Los Padres Bank's loans-to-one-borrower limit was
$6.9 million based upon the 15% of unimpaired capital and surplus measurement.
At June 30, 2002, Los Padres Bank's largest single lending relationship had an
outstanding aggregate balance of $5.7 million, and consisted of three loans
secured by commercial real estate and equipment, each of which was performing in
accordance with its terms.
Qualified Thrift Lender Test. Savings associations must meet a QTL
test, which test may be met either by maintaining a specified level of assets in
qualified thrift investments as specified in HOLA or by
95
meeting the definition of a "domestic building and loan association" under the
Internal Revenue Code of 1986, as amended, or Code. Qualified thrift investments
are primarily residential mortgages and related investments, including certain
mortgage related securities. The required percentage of investments under HOLA
is 65% of assets while the Code requires investments of 60% of assets. An
association must be in compliance with the QTL test or the definition of
domestic building and loan association on a monthly basis in nine out of every
12 months. Associations that fail to meet the QTL test will generally be
prohibited from engaging in any activity not permitted for both a national bank
and a savings association. As of June 30, 2002, Los Padres Bank was in
compliance with its QTL requirement and met the definition of a domestic
building and loan association.
Affiliate Transactions. Transactions between a savings association and
its "affiliates" are quantitatively and qualitatively restricted under the
Federal Reserve Act. Affiliates of a savings association include, among other
entities, the savings association's holding company and companies that are under
common control with the savings association. We and Harrington Wealth Management
Company are both considered to be affiliates of Los Padres Bank. In general, a
savings association or its subsidiaries are limited in their ability to engage
in "covered transactions" with affiliates:
- to an amount equal to 10% of the association's capital and
surplus, in the case of covered transactions with any one
affiliate; and
- to an amount equal to 20% of the association's capital and
surplus, in the case of covered transactions with all
affiliates.
In addition, a savings association and its subsidiaries may engage in
covered transactions and other specified transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction"
includes:
- a loan or extension of credit to an affiliate;
- a purchase of assets from an affiliate, with some exceptions;
- the acceptance of securities issued by an affiliate as
collateral for a loan or extension of credit to any party; or
- the issuance of a guarantee, acceptance or letter of credit on
behalf of an affiliate.
In addition, under the OTS regulations:
- a savings association may not make a loan or extension of
credit to an affiliate unless the affiliate is engaged only in
activities permissible for bank holding companies;
- a savings association may not purchase or invest in securities
of an affiliate other than shares of a subsidiary;
- a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate;
- covered transactions and other specified transactions between
a savings association or its subsidiaries and an affiliate
must be on terms and conditions that are consistent with safe
and sound banking practices; and
96
- with some exceptions, each loan or extension of credit by a
savings association to an affiliate must be secured by
collateral with a market value ranging from 100% to 130%,
depending on the type of collateral, of the amount of the loan
or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
these subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail and provides that specified classes of savings associations
may be required to give the OTS prior notice of affiliate transactions.
Capital Distribution Limitations. OTS regulations impose limitations
upon all capital distributions by savings associations, like cash dividends,
payments to repurchase or otherwise acquire its shares, payments to stockholders
of another institution in a cash-out merger and other distributions charged
against capital. Under the rule, a savings association in some circumstances
may:
- be required to file an application and await approval from the
OTS before it makes a capital distribution;
- be required to file a notice 30 days before the capital
distribution; or
- be permitted to make the capital distribution without notice
or application to the OTS.
The OTS regulations require a savings association to file an
application if:
- it is not eligible for expedited treatment of its other
applications under OTS regulations;
- the total amount of all of capital distributions, including
the proposed capital distribution, for the applicable calendar
year exceeds its net income for that year to date plus
retained net income for the preceding two years;
- it would not be at least adequately capitalized, under the
prompt corrective action regulations of the OTS following the
distribution; or
- the association's proposed capital distribution would violate
a prohibition contained in any applicable statute, regulation,
or agreement between the savings association and the OTS, or
the FDIC, or violate a condition imposed on the savings
association in an OTS-approved application or notice.
In addition, a savings association must give the OTS notice of a
capital distribution if the savings association is not required to file an
application, but:
- would not be well capitalized under the prompt corrective
action regulations of the OTS following the distribution;
- the proposed capital distribution would reduce the amount of
or retire any part of the savings association's common or
preferred stock or retire any part of debt instruments like
notes or debentures included in capital, other than regular
payments required under a debt instrument approved by the OTS;
or
- the savings association is a subsidiary of a savings and loan
holding company.
97
If neither the savings association nor the proposed capital
distribution meet any of the above listed criteria, the OTS does not require the
savings association to submit an application or give notice when making the
proposed capital distribution. The OTS may prohibit a proposed capital
distribution that would otherwise be permitted if the OTS determines that the
distribution would constitute an unsafe or unsound practice.
Community Reinvestment Act and the Fair Lending Laws. Savings
associations have a responsibility under the Community Reinvestment Act and
related regulations of the OTS to help meet the credit needs of their
communities, including low- and moderate-income neighborhoods. In addition, the
Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from
discriminating in their lending practices on the basis of characteristics
specified in those statutes. An institution's failure to comply with the
provisions of the Community Reinvestment Act could, at a minimum, result in
regulatory restrictions on its activities and the denial of applications. In
addition, an institution's failure to comply with the Equal Credit Opportunity
Act and the Fair Housing Act could result in the OTS, other federal regulatory
agencies as well as the Department of Justice taking enforcement actions. Based
on an examination conducted in July 2001, Los Padres Bank received a
satisfactory rating with respect to its performance pursuant to the Community
Reinvestment Act.
Federal Home Loan Bank System. Los Padres Bank is a member of the FHLB
system. Among other benefits, each FHLB serves as a reserve or central bank for
its members within its assigned region. Each FHLB is financed primarily from the
sale of consolidated obligations of the FHLB system. Each FHLB makes available
loans or advances to its members in compliance with the policies and procedures
established by the Board of Directors of the individual FHLB. As an FHLB member,
Los Padres Bank is required to own capital stock in an FHLB in an amount equal
to the greater of:
- 1% of its aggregate outstanding principal amount of its
residential mortgage loans, home purchase contracts and
similar obligations at the beginning of each calendar year; or
- 5% of its FHLB advances or borrowings.
Los Padres Bank's required investment in FHLB stock, based on June 30,
2002 financial data, was $5.9 million. At June 30, 2002, Los Padres Bank had
$6.0 million of FHLB stock.
Federal Reserve System. The Federal Reserve Board requires all
depository institutions to maintain non interest bearing reserves at specified
levels against their transaction accounts (primarily checking, NOW, and Super
NOW checking accounts) and non personal time deposits. At June 30, 2002, Los
Padres Bank was in compliance with these requirements.
Activities of Subsidiaries. A savings association seeking to establish
a new subsidiary, acquire control of an existing company or conduct a new
activity through a subsidiary must provide 30 days prior notice to the FDIC and
the OTS and conduct any activities of the subsidiary in compliance with
regulations and orders of the OTS. The OTS has the power to require a savings
association to divest any subsidiary or terminate any activity conducted by a
subsidiary that the OTS determines to pose a serious threat to the financial
safety, soundness or stability of the savings association or to be otherwise
inconsistent with sound banking practices.
RECENT LEGISLATION
USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001
was enacted in response to the terrorist attacks in New York, Pennsylvania and
Washington, D.C. which occurred on September 11, 2001. The Patriot Act is
intended is to strengthen U.S. law enforcement's and the
98
intelligence communities' abilities to work cohesively to combat terrorism on a
variety of fronts. The potential impact of the Patriot Act on financial
institutions of all kinds is significant and wide ranging. The Patriot Act
contains sweeping anti-money laundering and financial transparency laws and
requires various regulations, including standards for verifying customer
identification at account opening, and rules to promote cooperation among
financial institutions, regulators, and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.
Financial Services Modernization Legislation. In November 1999, the
Gramm-Leach-Bliley Act of 1999, or the GLB, was enacted. The GLB repeals
provisions of the Glass-Steagall Act which restricted the affiliation of Federal
Reserve member banks with firms "engaged principally" in specified securities
activities, and which restricted officer, director, or employee interlocks
between a member bank and any company or person "primarily engaged" in specified
securities activities.
In addition, the GLB also contains provisions that expressly preempt
any state law restricting the establishment of financial affiliations, primarily
related to insurance. The general effect of the law is to establish a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial service providers by revising
and expanding the Bank Holding Company Act framework to permit a holding company
to engage in a full range of financial activities through a new entity known as
a "financial holding company." "Financial activities" is broadly defined to
include not only banking, insurance and securities activities, but also merchant
banking and additional activities that the Federal Reserve Board, in
consultation with the Secretary of the Treasury, determines to be financial in
nature, incidental to such financial activities, or complementary activities
that do not pose a substantial risk to the safety and soundness of depository
institutions or the financial system generally.
The GLB provides that no company may acquire control of an insured
savings association unless that company engages, and continues to engage, only
in the financial activities permissible for a financial holding company, unless
the company is grandfathered as a unitary savings and loan holding company. The
Financial Institution Modernization Act grandfathers any company that was a
unitary savings and loan holding company on May 4, 1999 or became a unitary
savings and loan holding company pursuant to an application pending on that
date.
The GLB also permits national banks to engage in expanded activities
through the formation of financial subsidiaries. A national bank may have a
subsidiary engaged in any activity authorized for national banks directly or any
financial activity, except for insurance underwriting, insurance investments,
real estate investment or development, or merchant banking, which may only be
conducted through a subsidiary of a financial holding company. Financial
activities include all activities permitted under new sections of the Bank
Holding Company Act or permitted by regulation.
To the extent that the GLB permits banks, securities firms, and
insurance companies to affiliate, the financial services industry may experience
further consolidation. The GLB is intended to grant to community banks certain
powers as a matter of right that larger institutions have accumulated on an ad
hoc basis and which unitary savings and loan holding companies already possess.
Nevertheless, the GLB may have the result of increasing the amount of
competition that we face from larger institutions and other types of companies
offering financial products, many of which may have substantially more financial
resources than we have.
Sarbanes-Oxley Act. On July 30, 2002, President Bush signed into law
the Sarbanes-Oxley Act of 2002, or the SOA. The stated goals of the SOA are to
increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies and to
protect
99
investors by improving the accuracy and reliability of corporate disclosures
pursuant to the securities laws.
The SOA is the most far-reaching U.S. securities legislation enacted in
some time. The SOA generally applies to all companies, both U.S. and non-U.S.,
that file or are required to file periodic reports with the Securities and
Exchange Commission, or the SEC, under the Securities Exchange Act of 1934, or
the Exchange Act. Given the extensive SEC role in implementing rules relating to
many of the SOA's new requirements, the final scope of these requirements
remains to be determined.
The SOA includes very specific additional disclosure requirements and
new corporate governance rules, requires the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules and mandates further studies of certain issues by the SEC and the
Comptroller General. The SOA represents significant federal involvement in
matters traditionally left to state regulatory systems, such as the regulation
of the accounting profession, and to state corporate law, such as the
relationship between a board of directors and management and between a board of
directors and its committees.
The SOA addresses, among other matters:
- audit committees;
- certification of financial statements by the chief executive
officer and the chief financial officer;
- the forfeiture of bonuses or other incentive-based
compensation and profits from the sale of an issuer's
securities by directors and senior officers in the twelve
month period following initial publication of any financial
statements that later require restatement;
- a prohibition on insider trading during pension plan black out
periods;
- disclosure of off-balance sheet transactions;
- a prohibition on personal loans to directors and officers;
expedited filing requirements for Forms 4s;
- disclosure of a code of ethics and filing a Form 8-K for a
change or waiver of such code;
- "real time" filing of periodic reports;
- the formation of a public accounting oversight board;
- auditor independence; and
- various increased criminal penalties for violations of
securities laws.
The SOA contains provisions which became effective upon enactment on
July 30, 2002 and provisions which will become effective from within 30 days to
one year from enactment. The SEC has been delegated the task of enacting rules
to implement various of the provisions with respect to, among other matters,
disclosure in periodic filings pursuant to the Exchange Act.
100
REGULATION OF NON-BANKING AFFILIATES
Harrington Wealth Management Company is registered with the Securities
and Exchange Commission as an investment advisor. Harrington Wealth Management
Company is subject to various regulations and restrictions imposed by those
entities, as well as by various state authorities.
PRINCIPAL AND SELLING STOCKHOLDERS
The following table provides information regarding the actual
beneficial ownership of our common stock as of June 30, 2002, and as adjusted to
reflect the sale of common stock offered by this prospectus, for:
- each person or group that we know beneficially owns more than
5% of our common stock;
- each of our directors;
- our chief executive officer;
- the other named executive officers;
- all of our directors and executive officers as a group; and
- our selling stockholders.
Percentage of beneficial ownership is based on 3,354,336 shares of
common stock outstanding as of June 30, 2002, together with options that are
exercisable within 60 days of June 30, 2002 for each shareholder. Percentage of
beneficial ownership after the offering is based on 4,607,951 shares of common
stock outstanding, assuming the issuance of 1,253,615 new shares of our common
stock. Under the rules of the Securities and Exchange Commission, beneficial
ownership includes shares over which the indicated beneficial owner exercises
voting and/or investment power. Shares of common stock subject to options that
are currently exercisable or will become exercisable within 60 days are deemed
outstanding for purposes of computing the percentage ownership of any person.
Unless otherwise indicated in the footnotes below, we believe that the persons
and entities named in the table have sole voting and investment power with
respect to all shares beneficially owned, subject to applicable community
property laws. Unless otherwise indicated, the following beneficial owners can
be reached at our principal offices.
101
BENEFICIAL OWNERSHIP AS OF NUMBER OF SHARES BENEFICIAL OWNERSHIP
JUNE 30, 2002 BEING OFFERED AFTER THE OFFERING
----------------------------- ----------------- -------------------------
NAME NUMBER PERCENTAGE NUMBER PERCENTAGE
- ----------------------------------------- ------------- ------------ ---------- -------------
Directors and executive officers:
Craig J. Cerny......................... 564,828 (1) 16.28% -- 564,828 11.96%
William W. Phillips, Jr................ 105,402 (2) 3.09 -- 105,402 2.26
Sean M. Callow......................... 34,374 (3) 1.02 -- 34,374 --
Susan C. Weber......................... 55,320 (4) 1.63 -- 55,320 1.19
Stanley J. Kon......................... 58,278 (5) 1.73 -- 58,278 1.26
John J. McConnell...................... 65,340 (6) 1.94 -- 65,340 1.41
Paul O. Halme.......................... 16,875 (7) .50 -- 16,875 --
William D. Ross........................ 129,699 (8) 3.82 -- 129,699 2.79
Dean A. Anders......................... 10,875 (9) .32 -- 10,875 --
George G. Jones....................... 38,523(10) 1.14 -- 38,523 --
All directors and executive officers as a
group (15 persons).................. 1,125,567 30.44 -- 1,125,567 22.73
5% or greater stockholders:
Douglas T. Breeden................. 429,726(11) 12.81 429,726 9.33
Selling stockholders:
F. Jan Blaustein Scholes .............. 20,703(12) * 6,273 14,430 *
Daniel C. Dektar....................... 41,355 1.23 7,812 33,543 *
Brandon Dunn........................... 17,145 * 8,572 8,573 *
Kevin Patrick Gould ................... 6,000(13) * 6,000 -- *
Paul W. Lingle......................... 36,228 1.08 13,828 22,400 *
Andrew W. Lo........................... 9,000 * 9,000 -- --
Gerald J. Madigan ..................... 45,285(14) 1.35 11,800 33,485 *
James and Diane McCroy................ 57,000 1.69 23,500 33,500 *
Robert and Armina Mead ................ 13,200(15) * 13,200 -- --
Betty L. Mills......................... 85,500 2.55 25,000 60,500 1.31
Reeveston Partners..................... 5,250 * 3,000 2,250 *
John B. Sprow.......................... 37,524 1.11 4,000 33,524 *
Richard T. Vigran...................... 7,500 * 3,000 4,500 *
Michael Ziegelbaum..................... 17,100 * 11,400 5,700 *
- ---------------------------
*Less than 1%
(1) Includes 105,900 shares held by Rhonda Cerny, Mr. Cerny's
wife, 11,715 shares held by Harrington Wealth Management as
agent for the Cerny family, and 114,828 shares underlying
stock options exercisable within 60 days.
(2) Includes 29,802 shares held by the Phillips Family Trust and
52,875 shares underlying stock options exercisable within 60
days.
(3) Includes 1,029 shares held by the Traci Callow IRA and 21,564
shares underlying stock options exercisable within 60 days.
(4) Includes 6,756 shares held by the Weber Family Trust and
31,875 shares underlying stock options exercisable within 60
days.
(5) Includes an aggregate of 17,772 shares held by Mr. Kon's
children and 18,489 shares underlying stock options
exercisable within 60 days.
(6) Includes 18,489 shares underlying stock options exercisable
within 60 days.
(7) Includes 16,500 shares jointly owned by Halme & Clark, a law
firm in which Mr. Halme is a partner, and 375 shares
underlying stock options exercisable within 60 days.
(8) Includes 8,160 shares in the aggregate held as custodian for
various of Mr. Ross' children and grandchildren and 39,489
shares underlying stock options exercisable within 60 days.
(9) Includes 375 shares underlying stock options exercisable
within 60 days.
(10) Includes 17,250 shares underlying stock options exercisable
within 60 days.
(11) Includes 136,500 shares held though the Smith Breeden Profit
Sharing and 401(k) plan.
(12) Jan Blaustein Scholes is selling 6,273 shares held for her
benefit by Morgan Stanley Dean Witter as custodian of her IRA.
(13) Mr. Gould is selling 3,000 shares which are held for his
benefit by Emergency Medicine Care, LLC Money Purchase Pension
Plan and 3,000 shares which are held for his benefit by
Emergency Medicine Care LLC Profit Sharing Plan.
(14) Mr. Madigan is selling 11,800 shares held for his benefit by
the M S Mewkill Trust UA dated December 29, 1983.
(15) Robert and Armina Mead are selling 900 shares that they hold
as joint tenants, Robert Mead is selling 7,500 shares held for
his benefit by Wesbanco Trust and Investment Services as
custodian, and Armina Mead is selling 4,800 shares held for
her benefit by Wesbanco Trust and Investment Services as
custodian.
102
DESCRIPTION OF CAPITAL STOCK
GENERAL
We are authorized to issue 10,000,000 shares of capital stock, of which
9,000,000 are shares of common stock, par value $.01 per share, and 1,000,000
are shares of preferred stock, par value $.01 per share. An aggregate of
3,354,336 shares of our common stock was outstanding at June 30, 2002 and we had
no preferred stock outstanding. See "Capitalization." Each share of common stock
has the same relative rights as, and is identical in all respects with, each
other share of common stock. The common stock is not subject to call for
redemption.
OUR CAPITAL STOCK DOES NOT REPRESENT NONWITHDRAWABLE CAPITAL, IS NOT AN
ACCOUNT OF AN INSURABLE TYPE, AND IS NOT INSURED BY THE FDIC.
COMMON STOCK
Dividends. We can pay dividends if, as and when declared by our board
of directors, subject to compliance with limitations which are imposed by law.
Delaware law provides that a corporation may make a dividend to its stockholders
out of the corporation's capital surplus or, in case there shall be no surplus,
out of its net profits for the fiscal year in which the dividend is declared
and/or the preceding fiscal year. The holders of our common stock are entitled
to receive and share equally in such dividends as may be declared by our board
of directors out of funds legally available therefor. If we issue preferred
stock in the future, those holders may have a priority over the holders of our
common stock with respect to dividends. See "Trading History and Dividend
Policy" and "Regulation-Regulation of Los Padres Bank-Capital Distribution
Limitations."
Voting Rights. The holders of our common stock presently possess
exclusive voting rights. They elect our board of directors and act on such other
matters as are required to be presented to them under Delaware law or our
Certificate of Incorporation or as are otherwise presented to them by our board
of directors. As of the consummation of the offering, each holder of our common
stock will be entitled to one vote per share and each holder of our common stock
does not have any right to cumulate votes in the election of directors. Although
there are no present plans to do so, if we issue preferred stock in the future,
holders of the preferred stock may also possess voting rights.
Liquidation. In the event of any liquidation, dissolution or winding up
of our company, the holders of our common stock would be entitled to receive,
after payment or provision for payment of all its debts and liabilities, all of
our assets available for distribution. If preferred stock is issued, those
holders may have a priority over the holders of our common stock in the event of
liquidation or dissolution. In the event of any liquidation, dissolution or
winding up of Los Padres Bank, we, as the sole holder of Los Padres Bank's
capital stock, would be entitled to receive, after payment or provision for
payment of all debts and liabilities of Los Padres Bank (including all deposit
accounts and accrued interest thereon), all assets of Los Padres Bank available
for distribution.
Preemptive Rights. Holders of our common stock generally are not
entitled to preemptive rights with respect to any of our shares which may be
issued in the future.
PREFERRED STOCK
Our board of directors is authorized to issue preferred stock and to
fix and state voting powers, designations, preferences or other special rights
of such shares and the qualifications, limitations and restrictions that apply
to such preferred stock. Any preferred stock we issue may be issued in
distinctly
103
designated series, may be convertible into common stock and may rank prior to
the common stock as to dividend rights, liquidation preferences, or both.
Our authorized but unissued shares of preferred stock (as well as our
authorized but unissued and unreserved shares of common stock) are available for
issuance in future mergers or acquisitions, in a future public offering or
private placement or for other general corporate purposes. Except as otherwise
may be required to approve a transaction in which the additional authorized
shares of preferred stock would be issued, stockholder approval generally would
not be required for the issuance of these shares. Depending on the
circumstances, however, stockholder approval may be required pursuant to the
requirements for listing the common stock on the Nasdaq Stock Market or any
exchange on which the common stock may then be listed, if any.
RESTRICTIONS ON THE ABILITY TO ACQUIRE US
Restrictions in Our Certificate of Incorporation and Bylaws. A number
of provisions of our Certificate of Incorporation and our Bylaws deal with
matters of corporate governance and certain rights of stockholders. The
following discussion is a summary of the material provisions of our Certificate
of Incorporation and Bylaws which might be deemed to have a potential
"anti-takeover" effect. Reference should be made in each case to our Certificate
of Incorporation and Bylaws. See "Where You Can Find More Information."
Notwithstanding the foregoing, under certain circumstances, we may be subject to
Section 2115 of the California Corporation Code (as a foreign corporation) which
may have the effect of superseding certain provisions of our Certificate of
Incorporation and Bylaws as interpreted by Delaware law, particularly those
provisions providing for the elimination of cumulative voting. However,
management believes that we will be exempt from such provisions of the
California Corporation Code because our securities will be listed on the Nasdaq
National Market.
Board Of Directors. Our Certificate of Incorporation and Bylaws contain
provisions relating to the board of directors and provides, among other things,
that the directors shall be elected annually. We have amended our Certificate of
Incorporation and Bylaws, effective upon the consummation of this offering, to
provide that the board of directors will be divided into three classes as nearly
as equal in number as possible, with one class elected annually, which will make
it more difficult to change a majority of our board of directors. Cumulative
voting in the election of directors is prohibited, which may tend to make it
less likely for holders of a minority position in our common stock to have
representation on our board of directors. Directors may be removed pursuant to a
vote of at least a majority of our stockholders. Any vacancy occurring in the
board of directors for any reason (including an increase in the number of
authorized directors) may be filled by the concurring vote of a majority of the
directors then in office, regardless of whether there is a quorum of the board
of directors, and a director appointed to fill a vacancy serves for the
remainder of the term to which the director has been elected, and until his or
her successor has been elected and qualified. No decrease in the authorized
number of directors may shorten the term of any incumbent director.
Our Bylaws govern nominations for election to the board of directors,
and provide that nominations for election to the board of directors may be made
at a meeting of stockholders by or at the direction of the board of directors or
by any stockholder eligible to vote at an annual meeting of stockholders who has
complied with specified notice requirements. Written notice of a stockholder
nomination must be delivered or mailed to our principal executive offices not
later than ninety (90) days before the anniversary date of the mailing of our
proxy materials in connection with the immediately preceding annual meeting of
stockholders. Nominations not made in accordance with our Bylaws may be
disregarded.
Limitation Of Liability. Our Certificate of Incorporation provides that
the personal liability of our officers for monetary damages shall be eliminated
to the fullest extent permitted by the General Corporation Law of the State of
Delaware.
Indemnification Of Directors, Officers, Employees And Agents. Pursuant
to our Bylaws, we have agreed to indemnify our directors, officers, employees
and agents, to the fullest extent permitted by the
104
General Corporation Law of the State of Delaware, from and against any and all
expenses and liabilities permitted by Delaware law. The indemnification provided
for in our Bylaws is not exclusive of any other rights to which those
indemnified may be entitled under our Certification of Incorporation, or by
agreement, vote of stockholders or disinterested directors or otherwise, and
applies to such party both as to action in his or her official capacity and as
to action in another capacity while holding such office. Moreover, the
indemnification we provide continues as to a person who has ceased to be a
director, officer, employee or agent and inures to the benefit of the heirs,
executors and administrators of such a person.
Our Bylaws also provide that our board of directors may authorize that
we pay, in advance, for expenses incurred in defending any civil or criminal
action of proceeding for which we must or could pay for indemnification,
provided that any party seeking such indemnification provides to us an
undertaking that such person will repay any such amount to us in the event that
it is ultimately determined that such party is not entitled to indemnification.
Special Meetings Of Stockholders And Stockholder Proposals. Our Bylaws
currently provide that special meetings of our stockholders may be called at any
time by the Chairman of the board of directors or the President, or by the board
of directors, or by one or more stockholders holding not less than ten percent
(10%) of the votes at the meeting. We have amended our Bylaws, effective upon
the consummation of this offering, to provide that special meetings of our
stockholders may only be called by the board of directors pursuant to a
resolution approved by the affirmative vote of a majority of the directors then
in office. Special meetings of stockholders may be called for the purpose of
taking any action permitted by stockholders under Delaware law. A special
meeting must be held not less than ten (10) nor more than sixty (60) days after
a notice of the special meeting has been delivered to our stockholders.
At an annual meeting of our stockholders only such business as is
properly brought before the meeting may be conducted. To be properly brought,
business must be specified in the notice of meeting given by our board of
directors or otherwise properly brought by a stockholder. A stockholder may
properly bring notice to our attention by mailing a notice to our principal
offices not later than 90 days prior to the anniversary date of the mailing of
the proxy materials by us with respect to our preceding annual meeting. The
stockholder's notice must set forth the stockholder's business proposal and
pertinent information with respect to the stockholder and their shareholdings in
our stock.
Amendment Of Certificate Of Incorporation And Bylaws. Our Certificate
of Incorporation provides that we reserve the right to repeal, alter, amend or
rescind any provision contained in our Certificate of Incorporation in any
lawful manner, and all rights conferred by our stockholders are granted subject
to this reservation. Notwithstanding the foregoing, no amendment shall be made
to our Certificate of Incorporation unless first approved by resolution of a
majority of our board of directors and thereafter approved by a majority of our
stockholders.
Our Bylaws may be amended by either our board of directors or
stockholders. Our directors may amend the Bylaws by vote of a majority of
directors than in office at any regular or special meeting of the board of
directors. Our stockholders may amend the Bylaws by a majority vote of the
stockholders cast at a meeting expressly called for such purpose.
Other Restrictions on the Ability of Others to Acquire Us. Several
provisions of the Delaware General Corporation Law and federal law affect the
acquisition of our common stock or control of our company. As a Delaware
corporation, we are subject to a provision of the Delaware General Corporation
Law which, subject to specified exceptions, prohibits a Delaware corporation
from engaging in any business combination with any interested stockholders,
defined as any person or entity that is the beneficial owner of at least 15% of
a corporation's voting stock, for a period of three years following the time
that such stockholder became an interested stockholder unless:
105
- Prior to that time, the corporation's board of directors
approved either the business combination or the transaction
that resulted in the stockholder becoming an interested
stockholder;
- Upon consummation of the transaction that resulted in the
stockholder becoming an interested stockholder, the interested
stockholder owned at least 85% of the corporation's voting
stock outstanding at the time the transaction commenced,
excluding, for purposes of determining the number of shares
outstanding, those shares owned by persons who are directors
and also officers and by employee stock plans in which
employee participants do not have the right to determine
confidentially whether shares held subject to the plan will be
tendered in a tender or exchange offer; or
- At or subsequent to such time, the business combination is
approved by the corporation's board of directors and
authorized at any annual or special meeting of stockholders,
and not by written consent, by the affirmative vote of at
least two-thirds of the outstanding voting stock that is not
owned by the interested stockholder.
For purposes of this statute, a "business combination" includes:
- Any merger or consolidation involving the corporation and the
interested stockholder;
- Any sale, lease, exchange, mortgage, transfer, pledge or other
disposition involving the interested stockholder and 10% or
more of the assets of the corporation;
- Subject to specified exceptions, any transaction which results
in the issuance or transfer by the corporation of any stock of
the corporation to the interested stockholder;
- Any transaction involving the corporation that has the effect
of increasing the proportionate share of the stock of any
class or series of the corporation beneficially owned by the
interested stockholder; or
- The receipt by the interested stockholder of the benefit of
any loans, advance, guarantees, pledges or other financial
benefits provided by or through the corporation.
The Change in Bank Control Act provides that no person, acting directly
or indirectly or through or in concert with one or more other persons, may
acquire control of a savings association unless the OTS has been given 60 days'
prior written notice. The HOLA provides that no company may acquire "control" of
a savings association without the prior approval of the OTS. Any company that
acquires such control becomes a savings and loan holding company subject to
registration, examination and regulation by the OTS. See "Regulation -
Regulation of Harrington West Financial Group, Inc. - Restrictions on
Acquisitions."
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock will be Mellon
Investor Services LLC.
106
UNDERWRITING
Subject to the terms and conditions set forth in the underwriting
agreement between us, the selling stockholders and the underwriters named below,
the underwriters named below have severally agreed to purchase from us and the
selling stockholders an aggregate of _____ shares of common stock in the amount
set forth opposite their respective names in the table below.
<Table>
<Caption>
Underwriters Number of Shares
------------ ----------------
RBC Dain Rauscher Inc. ..........
-------
Total .......................
=======
</Table>
The underwriting agreement provides that the underwriters' obligations
are subject to specified conditions precedent and that the underwriters are
committed to purchase all of the shares of our common stock offered by this
prospectus if the underwriters purchase any of the shares of common stock. If an
underwriter defaults, the underwriting agreement provides that the purchase
commitments of the non-defaulting underwriters may be increased or, in certain
cases, the underwriting agreement may be terminated. In the underwriting
agreement, the obligations of the underwriters are subject to approval of
certain legal matters by their counsel, including the authorization and the
validity of the common stock offered by this prospectus, and to other conditions
contained in the underwriting agreement, such as receipt by the underwriters of
the officers' certificates and legal opinions.
The underwriters have advised us that they propose to offer the shares
of common stock to the public at the public offering price, less the
underwriting discount, set forth on the cover page of this prospectus and to
selected dealers at such price less a concession not in excess of $_____ per
share. The underwriters may allow, and such dealers may allow, a discount not in
excess of $_____ per share to certain other brokers and dealers. After the
offering, the public offering price, concession, discount and other selling
terms may be changed by the underwriters. The underwriters have also agreed to
reserve up to 125,000 shares of common stock offered by this prospectus for
purchase by certain investors, these shares being referred to in this document
as the affiliate shares, at an underwriting discount of $_____ per share.
We have granted to the underwriters an option, exercisable for 30 days
after the date of this prospectus, to purchase up to 210,000 additional shares
of our common stock, solely to cover over-allotments, if any, made in connection
with the distribution of the common stock being offered, at the same price per
share to be paid by the underwriters for the other shares of common stock
offered hereby. If the underwriters purchase any of the additional common stock
under this option, each underwriter will be committed to purchase the additional
shares in approximately the same proportion allocated to them in the table
above.
Prior to the offering, there has been no public market for our common
stock. The public offering price was determined by negotiations between us and
the underwriters. Among the factors considered in determining the public
offering price of our common stock, in addition to prevailing market conditions,
were the estimate of our business potential and earnings prospects, an
assessment of our management and the consideration of the above factors in
relations to market valuation of companies in related businesses and other
factors deemed to be relevant.
We have applied to list our common stock for quotation on the Nasdaq
National Market. The underwriters have advised us that they intend to make a
market in our common stock but they are not obligated to do so and the
underwriters and any other broker-dealer making a market in our stock may
discontinue any such market making at any time without notice.
The underwriters' commissions are shown in the following table. These
amounts are shown assuming both no exercise and full exercise of the
underwriters' option to purchase additional shares of common stock.
<Table>
<Caption>
No Exercise Full Exercise
----------- -------------
Per share underwriting commission paid by us(1)(2)...
Per share underwriting commission paid by selling
stockholders.......................................
Total(2)........................................
</Table>
- ----------
(1) Reflects a weighted average of the per share underwriting commission paid
by us of $___ for non-affiliate shares and $___ for affiliate shares.
(2) Assumes the sale of 125,000 affiliate shares.
107
In connection with the offering of the shares of our common stock, the
underwriters and any selling group members and their respective affiliates may
engage in transactions effected in accordance with Rule 104 of the SEC's
Regulation M that are intended to stabilize, maintain or otherwise affect the
market price of the shares of our common stock. Such transactions may include
over-allotment transactions in which an underwriter creates a short position for
its own account by selling more shares of our common stock than it is committed
to purchase from us. In such a case, to cover all or part of the short position,
the underwriters may purchase shares of our common stock in the open market
following completion of the initial offering of the shares of our common stock.
The underwriters also may engage in stabilizing transactions in which they bid
for, and purchase, shares of our common stock at a level above that which might
otherwise prevail in the open market for the purpose of preventing or retarding
a decline in the market price of the shares of our common stock. The
underwriters may also reclaim any selling concession allowed to a dealer if the
underwriters repurchase shares distributed by that dealer. Any of the foregoing
transactions may result in the maintenance of a price for the shares of our
common stock at a level above that which might otherwise prevail in the open
market. Neither we nor the underwriters make any representation or prediction as
to the direction or magnitude of any effect that the transactions described
above may have on the price of the shares of our common stock. The underwriters
are not required to engage in any of the foregoing transactions and, if
commenced, such transactions may be discontinued at any time without notice.
These transactions may be effected on the Nasdaq National Market, in the
over-the-counter market or otherwise.
In connection with this offering, some underwriters and any selling
group members and their respective affiliates may also engage in passive market
making transactions in our common stock on the Nasdaq National Market. Passive
market making consists of displaying bids on the Nasdaq National Market limited
by the prices of independent market makers and effecting purchases limited by
those prices in response to order flow. Rule 103 of Regulation M promulgated by
the SEC limits the amount of net purchases that each passive market maker may
make and the displayed size of each bid. Passive market making may stabilize the
market price of our common stock at a level above that which might otherwise
prevail in the open market and, if commenced, may be discontinued at any time.
We and the selling stockholders agreed to indemnify the underwriters
and their controlling persons against specified liabilities, including
liabilities under the Securities Act of 1933, or to contribute to payments the
underwriters may be required to make in respect thereof.
We and each of our directors, executive officers and certain of our 1%
or greater stockholders (which in the aggregate hold 2,330,584 shares of common
stock and options to purchase an additional 432,678 shares of common stock),
have agreed for a period of 180 days after the date of this prospectus, that we
and they will not, without the prior written consent of RBC Dain Rauscher Inc.
on behalf of the underwriters, directly or indirectly, (1) offer, pledge (except
for pledges granted prior to the date of this prospectus), sell, contract to
sell, sell any option or contract to purchase, purchase any option or contract
to sell, grant any option, right or warrant to purchase, lend or otherwise
transfer or dispose of (subject to some exceptions) any shares of our common
stock, or any securities convertible into, or exercisable or exchangeable for,
our common stock or (2) enter into any swap or other agreement that transfers,
in whole or in part, any economic equivalent of ownership of shares of our
common stock.
We have agreed that we will not for a period of 180 days after the date
of this prospectus, without the prior written consent of RBC Dain Rauscher Inc.
on behalf of the underwriters, purchase, redeem or call for redemption, or
prepay or give notice of prepayment, or announce any redemption or call for
redemption, or any prepayment or notice of prepayment of, any of our securities.
The underwriters have informed us that they do not intend to confirm
sales to any discretionary account without the prior written approval of the
customer.
108
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock. No prediction can be made as to the effect, if any, that sales of common
stock or the availability of common stock for sale will have on the market price
of our common stock. The market price of our common stock could drop because of
the sale of a large number of shares of our common stock or the perception that
such sales could occur. These factors could also make it more difficult to raise
funds through future offerings of common stock.
After this offering, 4,973,167 shares of common stock will be
outstanding or subject to currently exercisable options, or 5,183,167 shares if
the underwriter's over-allotment option is exercised in full. Of these shares,
the 1,400,000 shares sold in this offering, or 1,610,000 shares if the
underwriter's over-allotment is exercised in full, will be freely tradable
without restriction under the Securities Act, except that any shares held by our
"affiliates" as defined in Rule 144 under the Securities Act may be sold only in
compliance with the limitations described below. The remaining 3,573,167 shares
of common stock are "restricted securities" or owned by affiliates within the
meaning of Rule 144 under the Securities Act. These securities generally may not
be sold unless they are registered under the Securities Act or are sold pursuant
to an exemption from registration, such as the exemption provided by Rule 144
under the Securities Act.
In connection with this offering, the holders of approximately
2,330,584 shares of our common stock and options to purchase an additional
432,678 shares of our common stock including each of our executive officers,
directors and certain of our 1.0% or greater stockholders, have entered into
lock-up agreements pursuant to which they have agreed not to offer or sell any
shares of common stock that are not included in this offering for a period of
180 days after the date of this prospectus without the prior written consent of
the underwriter, which may, in its sole discretion, at any time and without
notice, waive any of the terms of these lock-up agreements. The underwriter
presently has no intention to allow any shares of common stock to be sold or
otherwise offered by us prior to the expiration of the 180 day lock-up period.
In general, under Rule 144, as currently in effect, any person or
persons whose shares are required to be aggregated, including an affiliate of
ours, who has beneficially owned shares for a period of at least one year is
entitled to sell, within any three month period, commencing 90 days after the
date of this prospectus, a number of shares that does not exceed the greater of:
- 1% of the then outstanding shares of common stock, or
- the average weekly trading volume in the common stock during
the four calendar weeks immediately preceding the date on
which the notice of such sale on Form 144 is filed with the
Securities and Exchange Commission.
Sales under Rule 144 are also subject to certain provisions relating to
notice and manner of sale and the availability of current public information
about us during the 90 days immediately preceding a sale. In addition, a person
who is not an affiliate of ours during the 90 days preceding a sale and who has
beneficially owned the shares proposed to be sold for at least two years would
be entitled to sell such shares under Rule 144(k) without regard to the volume
limitation and other conditions described above.
Our directors or officers who purchased or were awarded our shares in
connection with a written compensatory plan or contract may be entitled to rely
on the resale provisions of Rule 701 of the Securities Act. Rule 701 permits
non-affiliates to sell their Rule 701 shares without having to comply with the
public information, holding period, volume limitation or notice provisions of
Rule 144. Affiliates may sell their Rule 701 shares without having to comply
with Rule 144's holding period
109
restrictions. In each of these cases, Rule 701 allows the stockholders to sell
90 days after the date of this prospectus.
As a result of contractual restrictions and the provisions of Rules 144
and 701, additional shares will be available for sale in the public market as
follows:
- 709,599 restricted securities will be eligible for immediate
sale on the date of this prospectus;
- approximately 21,854 restricted securities will be eligible
for sale beginning 90 days after the date of this prospectus;
and
- approximately 2,841,717 additional restricted securities will
be eligible for sale beginning 180 days after the effective
date of this offering upon expiration of lock-up agreements,
subject in some cases to compliance with Rule 144.
Prior to the expiration of the lock-up agreement, we intend to register
on a registration statement on Form S-8 a total of 498,648 shares of common
stock issuable upon the exercise of options issued or reserved for future
issuance under the 1996 Stock Option Plan. The Form S-8 will permit the resale
in the public market of shares so registered by non-affiliates without
restriction under the Securities Act.
EXPERTS
The consolidated financial statements as of December 31, 2001 and 2000,
and for each of the three years in the period ended December 31, 2001 included
in this prospectus have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their report appearing herein and elsewhere in the
registration statement, and have been so included in reliance upon the report of
such firm given upon their authority as experts in accounting and auditing.
LEGAL MATTERS
The validity of our common stock offered by this prospectus will be
passed upon for us and the selling stockholders by Kelley Drye & Warren LLP.
Certain legal matters relating to this offering will be passed upon for the
underwriter by Silver, Freedman & Taff, L.L.P.
110
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the Securities
and Exchange Commission hereinafter referred to as the SEC. This prospectus,
which is part of the registration statement, does not contain all the
information included in the registration statement. Because some information is
omitted, you should refer to the registration statement and its exhibits. For
example, the descriptions in the prospectus regarding the contents of any
contract or other document are not necessarily complete, and, in each instance,
reference is made to the copy of such contract or other document filed as an
exhibit to the registration statement. Each of these statements is qualified in
all respects by this reference. For copies of actual contracts of documents
referred to in this prospectus, you should refer to the exhibits attached to the
registration statement. You may review a copy of the registration statement,
including the attached exhibits and schedule, at the SEC's public reference
facilities in Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549. You may obtain information on the operation of the Public Reference
Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet
site that contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC. The address
of the SEC's website is www.sec.gov.
111
HARRINGTON WEST FINANCIAL GROUP, INC.
INDEX TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
PAGE
INDEPENDENT AUDITORS' REPORT F-1
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Statements of Financial Condition - June 30, 2002 (Unaudited)
December 31, 2001 and 2000 F-2
Consolidated Statements of Earnings for the Six Months Ended June 30, 2002 and
2001 (unaudited) and Years Ended December 31, 2001, 2000 and 1999 F-3
Consolidated Statements of Stockholders' Equity for the Six Months Ended
June 30, 2002 (unaudited) and Years Ended December 31, 2001, 2000 and 1999 F-4-5
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and
2001 (unaudited) and Years Ended December 31, 2001, 2000 and 1999 F-6-7
Notes to Consolidated Financial Statements F-8-39
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Harrington West Financial Group, Inc.
Solvang, California:
We have audited the accompanying consolidated statements of financial condition
of Harrington West Financial Group, Inc. (the "Company") as of December 31, 2001
and 2000, and the related consolidated statements of earnings, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of the Company as of
December 31, 2001 and 2000, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2001 in conformity
with accounting principles generally accepted in the United States of America.
/s/ DELOITTE & TOUCHE LLP
Los Angeles, California
February 7, 2002 (October 18, 2002 as to the first two paragraphs of Note 20 and
October 31, 2002 as to the third paragraph of Note 20)
F-1
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
- ------------------------------------------------------------------------------------------------------------------------------
JUNE 30 DECEMBER 31,
2002 -------------------------
ASSETS (UNAUDITED) 2001 2000
Cash and cash equivalents $ 15,627 $ 11,107 $ 13,304
Trading account assets 2,076 2,751 3,964
Securities available for sale 211,550 181,627 47,438
Securities held to maturity 2,490 2,617 2,687
Loans receivable, net 431,408 449,709 395,537
Accrued interest receivable 3,467 3,567 2,715
Premises and equipment, net 4,029 3,688 3,013
Prepaid expenses and other assets 1,562 1,937 8,751
Investment in FHLB stock, at cost 6,050 7,834 5,875
Investment in Harrington Wealth Management 800
Goodwill 3,981 3,981 201
Core deposit intangible, net 1,408 1,505 684
-------- -------- --------
TOTAL $683,648 $670,323 $484,969
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Interest bearing $490,595 $508,476 $349,724
Noninterest bearing 14,844 12,382 5,981
-------- -------- --------
Total deposits 505,439 520,858 355,705
FHLB advances 123,403 96,403 91,000
Securities sold under repurchase agreements 1,322 365
Note payable 16,600 18,000 9,000
Accounts payable and accrued expenses 4,292 3,566 2,287
Income taxes payable 100 339 349
Deferred income taxes 469 648 1,071
-------- -------- --------
Total liabilities 651,625 640,179 459,412
-------- -------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 1,000,000 shares authorized; none issued
and outstanding
Common stock, $.01 par value; 9,000,000 shares authorized; 3,354,336 shares
issued and outstanding as of June 30, 2002 (unaudited) and December 31, 2001
and 3,246,789 as of December 31, 2000 34 34 33
Additional paid-in capital 20,305 20,305 19,573
Retained earnings 11,313 9,175 5,726
Accumulated other comprehensive income, net of tax of $178 (unaudited), $358
and $162 at June 30, 2002, December 31, 2001 and 2000, respectively 371 630 225
-------- -------- --------
Total stockholders' equity 32,023 30,144 25,557
-------- -------- --------
TOTAL $683,648 $670,323 $484,969
======== ======== ========
See notes to consolidated financial statements.
F-2
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
- -------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
----------------------------- -----------------------------------------
2002 2001 2001 2000 1999
(UNAUDITED)
INTEREST INCOME:
Interest on loans $ 16,138 $ 16,308 $ 31,914 $ 30,365 $ 26,868
Interest and dividends on securities 5,313 3,598 9,254 8,778 10,073
----------- ----------- ----------- ----------- -----------
Total interest income 21,451 19,906 41,168 39,143 36,941
----------- ----------- ----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 7,772 9,473 19,183 17,587 16,685
Interest on FHLB advances and other borrowings 3,398 3,211 6,634 9,658 7,861
----------- ----------- ----------- ----------- -----------
Total interest expense 11,170 12,684 25,817 27,245 24,546
----------- ----------- ----------- ----------- -----------
NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES 10,281 7,222 15,351 11,898 12,395
PROVISION FOR LOAN LOSSES 275 1 1 42 155
----------- ----------- ----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,006 7,221 15,350 11,856 12,240
----------- ----------- ----------- ----------- -----------
OTHER INCOME (LOSS):
(Loss) income from trading assets (95) 726 436 (2,754) (555)
Gain on sale of deposits 3,923
Gain (loss) on sale of loans 69 69 (601)
Other income 908 368 996 554 1,023
----------- ----------- ----------- ----------- -----------
Total other income 813 1,163 1,501 1,122 468
----------- ----------- ----------- ----------- -----------
OTHER EXPENSES:
Salaries and employee benefits 3,941 2,558 5,444 3,942 4,064
Premises and equipment 1,022 764 1,631 1,357 1,503
Insurance premiums 122 143 250 278 269
Marketing 126 85 184 256 245
Computer services 256 213 458 362 371
Consulting fees 332 248 523 495 500
Office expenses and supplies 279 185 427 387 407
Other 802 749 1,400 1,319 1,210
----------- ----------- ----------- ----------- -----------
Total other expenses 6,880 4,945 10,317 8,396 8,569
----------- ----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 3,939 3,439 6,534 4,582 4,139
INCOME TAXES 1,621 1,437 2,732 2,001 1,779
----------- ----------- -----------
NET INCOME $ 2,318 $ 2,002 $ 3,802 $ 2,581 $ 2,360
=========== =========== =========== =========== ===========
BASIC EARNINGS PER SHARE $ 0.69 $ 0.61 $ 1.14 $ 0.79 $ 0.73
=========== =========== =========== =========== ===========
DILUTED EARNINGS PER SHARE $ 0.67 $ 0.60 $ 1.12 $ 0.77 $ 0.71
=========== =========== =========== =========== ===========
BASIC WEIGHTED-AVERAGE SHARES OUTSTANDING 3,354,336 3,287,496 3,321,189 3,246,789 3,246,789
=========== =========== =========== =========== ===========
DILUTED WEIGHTED-AVERAGE SHARES OUTSTANDING 3,484,518 3,351,093 3,396,885 3,331,857 3,313,938
=========== =========== =========== =========== ===========
See notes to consolidated financial statements.
F-3
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
- -------------------------------------------------------------------------------------------------------------------
COMMON STOCK ADDITIONAL
-------------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS
BALANCE, DECEMBER 31, 1998 3,246,789 $ 33 $ 19,573 $ 1,770
Net income 2,360
---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1999 3,246,789 33 19,573 4,130
Comprehensive income:
Net income 2,581
Other comprehensive income,
net of tax
Unrealized gains on securities
Total comprehensive income
Dividends on common stock (985)
---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 2000 3,246,789 33 19,573 5,726
Comprehensive income
Net income 3,802
Other comprehensive income,
net of tax
Unrealized gains on securities
Effective portion of change in fair
value of cash flow hedges
Total comprehensive income
Dividends on common stock (353)
Stock options 107,547 1 732
---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 2001 3,354,336 34 20,305 9,175
Comprehensive income
Net income (unaudited) 2,318
Other comprehensive income,
net of tax (unaudited)
Unrealized gains on securities
(unaudited)
Effective portion of change in fair
value of cash flow hedges
(unaudited)
Total comprehensive income
Dividends on common stock
(unaudited) (180)
---------- ---------- ---------- ----------
BALANCE, JUNE 30, 2002
(UNAUDITED) $3,354,336 $ 34 $ 20,305 $ 11,313
========== ========== ========== ==========
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE COMPREHENSIVE STOCKHOLDERS'
INCOME INCOME EQUITY
BALANCE, DECEMBER 31, 1998 $ 21,376
Net income $ 2,360 2,360
========== ----------
BALANCE, DECEMBER 31, 1999 23,736
Comprehensive income:
Net income $ 2,581 2,581
Other comprehensive income,
net of tax
Unrealized gains on securities 225 $ 225 225
==========
Total comprehensive income $ 2,806
==========
Dividends on common stock (985)
---------- ----------
BALANCE, DECEMBER 31, 2000 225 25,557
Comprehensive income
Net income $ 3,802 3,802
Other comprehensive income,
net of tax
Unrealized gains on securities 912 912 912
Effective portion of change in fair
value of cash flow hedges (507) (507) (507)
----------
Total comprehensive income $ 4,207
==========
Dividends on common stock (353)
Stock options 733
---------- ----------
BALANCE, DECEMBER 31, 2001 630 30,144
Comprehensive income
Net income (unaudited) 2,318 2,318
Other comprehensive income,
net of tax (unaudited)
Unrealized gains on securities 433 433 433
(unaudited)
Effective portion of change in fair
value of cash flow hedges
(unaudited) (692) (692) (692)
----------
Total comprehensive income $ 2,059
==========
Dividends on common stock
(unaudited) (180)
---------- ----------
BALANCE, JUNE 30, 2002
(UNAUDITED) $ 371 $ 32,023
========== ==========
(Continued)
F-4
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
- ----------------------------------------------------------------------------------------------
YEAR ENDED
DECEMBER 31,
-------------------------------
2001 2000
DISCLOSURE OF RECLASSIFICATION AMOUNT:
Unrealized holding gains arising during the period,
net of tax expense of $715 and $198 for 2001 and $ 988 $ 275
2000, respectively
Less: Reclassification adjustment for gains included in
net income, net of tax expense of $55 and $36 for
2001 and 2000, respectively (76) (50)
----- -----
Net unrealized gain on securities, net of tax expense of
$660 and $162 for 2001 and 2000, respectively $ 912 $ 225
===== =====
Cumulative effect of accounting change (SFAS No. 133),
net of tax expense of $136 $ 188
Unrealized net gains on cash flow hedges, net of tax
benefit of $(500) for 2001 (690)
Less: reclassification adjustment for net gains on
cash flow hedges included in net income, net of
tax benefit of $(4) for 2001 (5)
-----
Net unrealized loss on cash flow hedges $(507)
=====
See notes to consolidated financial statements. (Concluded)
F-5
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
- ----------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED
JUNE 30,
---------------------------
2002 2001
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,318 $ 2,002
Adjustments to reconcile net income to net cash provided by
operating activities:
Accretion of deferred loan fees and costs (445) (445)
Depreciation and amortization 447 345
Amortization of premiums and discounts 1,972 413
Amortization of hedging costs
Provision for loan losses 275 1
Activity in securities held for trading 672 300
Loss (gain) on sale of real estate 35 1
Gain on sale of deposits
Stock-based compensation 106
(Gain) loss on sale of loans (69)
FHLB stock dividend (109) (210)
Increase in accrued interest receivable 100 (560)
Decrease in income taxes (payable) receivable (238)
Deferred income taxes (179) 771
Increase in prepaid expenses 340 37
Increase in accounts payable 34 (107)
--------- ---------
Net cash provided by operating activities 5,222 2,585
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash acquired
Net increase in loans receivable 18,022 (3,216)
Proceeds from sale of loans 27,471
Proceeds from matured and called securities held to maturity 2,000
Proceeds from sales of securities available for sale 6,868
Purchase of securities held to maturity (2,055)
Purchases of securities available for sale (72,801) (119,027)
Principal paydowns on securities available for sale 41,336 10,900
Principal paydowns on securities held to maturity 116 38
Proceeds from sale of real estate acquired through foreclosure
Proceeds from sale of hedges of short-term liabilities
Purchase of premises and equipment (690) (577)
Purchase (redemption) of FHLB stock 1,892 (1,966)
--------- ---------
Net cash used in investing activities (12,125) (79,564)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits (14,955) 31,662
Sale of deposits
Increase (decrease) in securities sold under agreements to repurchase 957
Increase (decrease) in FHLB advances 27,000 45,403
Advances (repayments) on note payable (1,400) 300
Exercise of stock options on common stock 627
Dividends paid on common stock (179) (174)
--------- ---------
Net cash provided by (used in) financing activities 11,423 77,818
--------- ---------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 4,520 839
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 11,107 13,304
--------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 15,627 $ 14,143
========= =========
YEAR ENDED
DECEMBER 31,
-------------------------------------------
2001 2000 1999
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,802 $ 2,581 $ 2,360
Adjustments to reconcile net income to net cash provided by
operating activities:
Accretion of deferred loan fees and costs (969) (834) (905)
Depreciation and amortization 771 679 556
Amortization of premiums and discounts 2,399 235 558
Amortization of hedging costs 520 1,846
Provision for loan losses 1 42 155
Activity in securities held for trading 1,065 81,326 41,308
Loss (gain) on sale of real estate 139 28 (308)
Gain on sale of deposits (3,923)
Stock-based compensation 106
(Gain) loss on sale of loans (69) 601
FHLB stock dividend (408) (421) (362)
Increase in accrued interest receivable (533) (322) 80
Decrease in income taxes (payable) receivable (10) (92) 574
Deferred income taxes (375) (266) (695)
Increase in prepaid expenses (66) (804) (1,123)
Increase in accounts payable 772 1,096 (615)
--------- --------- ---------
Net cash provided by operating activities 6,625 80,446 43,429
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash acquired (375)
Net increase in loans receivable (9,403) (20,659) (48,431)
Proceeds from sale of loans 27,471 9,387
Proceeds from matured and called securities held to maturity 2,000
Proceeds from sales of securities available for sale 12,975 40,652
Purchase of securities held to maturity (2,055) (2,000) (751)
Purchases of securities available for sale (189,437) (100,757)
Principal paydowns on securities available for sale 48,866 6,420
Principal paydowns on securities held to maturity 105 53
Proceeds from sale of real estate acquired through foreclosure 1,036
Proceeds from sale of hedges of short-term liabilities 942
Purchase of premises and equipment (988) (607) (1,642)
Purchase (redemption) of FHLB stock (1,551) (354) 4,062
--------- --------- ---------
Net cash used in investing activities (112,392) (66,923) (45,726)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits 88,528 45,196 52,158
Sale of deposits (65,407)
Increase (decrease) in securities sold under agreements to repurchase 365 (9,982) 9,982
Increase (decrease) in FHLB advances 5,403 20,000 (63,000)
Advances (repayments) on note payable 9,000 1,335 (535)
Exercise of stock options on common stock 627
Dividends paid on common stock (353) (985)
--------- --------- ---------
Net cash provided by (used in) financing activities 103,570 (9,843) (1,395)
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (2,197) 3,680 (3,692)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 13,304 9,624 13,316
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 11,107 $ 13,304 $ 9,624
========= ========= =========
(Continued)
F-6
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
--------------------- ----------------------------
2002 2001 2001 2000 1999
(UNAUDITED)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION -
Cash paid during the year for:
Interest $10,633 $12,714 $25,737 $26,489 $25,242
Income taxes $ 1,850 $ 1,137 $ 3,052 $ 2,423 $ 1,900
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES -
Net unrealized gain on available for sale securities $ 433 $ 912 $ 225
See notes to consolidated financial statements (Concluded)
F-7
HARRINGTON WEST FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS OF THE COMPANY - Harrington West Financial Group, Inc. (the
"Company") is a savings and loan holding company incorporated on August
29, 1995 to acquire and hold all of the outstanding common stock of Los
Padres Bank (the "Bank"), a federally chartered savings bank which
operates 10 branches serving individuals and small to medium-sized
businesses. Nine banking facilities are operated on the California Central
Coast, and one banking facility is located in Shawnee Mission, Kansas, and
operated as a division under the Harrington Bank brand.
On November 3, 2001, the Bank purchased from Harrington Bank, FSB, its $75
million bank located in Shawnee Mission, Kansas, in the heart of the
Kansas City metropolis. For a discussion of the Bank's acquisitions, see
Note 17.
BASIS OF PRESENTATION - The consolidated financial statements include the
accounts of the Company, the Bank and its subsidiaries since their
acquisition dates. All significant intercompany accounts and transactions
have been eliminated.
On February 1, 1999, Los Padres Bank purchased a 49% interest in
Harrington Wealth Management Company ("HWMC"). HWMC offers trust and
investment management services to the customers of Los Padres Bank. On
October 31, 2001, Los Padres Bank purchased the remaining 51% interest in
HWMC. Prior to October 31, 2001, this investment was accounted for using
the equity method. Beginning in November 2001, HWMC became a wholly owned
subsidiary of Los Padres Bank and is consolidated into Los Padres Bank.
USE OF ESTIMATES - The consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in
the United States of America and with prevailing practices in the banking
industry. In preparing such financial statements, management is required
to make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ
from those estimates. Material estimates that are particularly susceptible
to significant change relate to the determination of the allowance for
loan losses.
UNAUDITED INTERIM INFORMATION - The unaudited interim financial
information has been prepared using accounting principles generally
accepted in the United States of America for interim financial information
and in accordance with Regulation S-X of the Securities and Exchange
Commission ("SEC"). In the opinion of management, all adjustments,
consisting of normal recurring accruals considered necessary for a fair
presentation, have been included for the unaudited periods presented.
SEGMENTS - The Company has a single operating segment, banking operations.
The Company has no organizational structure detailed by product lines,
geography or customer types.
CASH AND CASH EQUIVALENTS - For purposes of reporting cash flows, cash and
cash equivalents include cash on hand, amounts due from banks and federal
funds sold. Generally, federal funds are purchased and sold for one-day
periods.
F-8
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - Transactions involving
sales of securities under agreements to repurchase are accounted for as
collateralized financings except where the Bank does not have an
arrangement to purchase the same or substantially the same securities
before maturity at a fixed or determinable price.
TRADING SECURITIES - Trading securities are debt and equity securities
that are bought and held principally for the purpose of active management.
These securities are reported at fair value and included in trading
account assets on the balance sheet. Realized and unrealized gains and
losses are included in income from trading account assets.
AVAILABLE FOR SALE SECURITIES - Debt and equity securities not classified
as either held to maturity or trading securities are classified as
securities available for sale and recorded at fair value, with unrealized
gains and losses, after applicable taxes, excluded from earnings and
reported as a separate component of stockholders' equity. Declines in the
value of debt securities and marketable equity securities that are
considered to be other than temporary are recorded as a permanent
impairment of securities available for sale in the statement of earnings.
Gains and losses on the sale of securities are recorded on the trade date
and are determined using the specific identification method.
HELD TO MATURITY SECURITIES - Held to maturity securities represent
investments that the Bank has the positive intent and ability to hold to
maturity and are reported at amortized cost.
LOANS RECEIVABLE - Loans receivable are carried at the principal amount
outstanding, net of deferred loan fees and costs.
LOAN INTEREST INCOME AND FEES - Interest on loans is accrued as earned,
except non-accrual loans on which interest is normally discontinued
whenever the payment of principal or interest is considered to be in
doubt. When a loan is placed on non-accrual, all previously accrued but
uncollected interest is reversed against current period income. Interest
income is subsequently recognized only to the extent cash payments are
received.
Loan origination fees and certain direct loan origination costs are
deferred and recognized over the lives of the related loans as an
adjustment to yield using a method that approximates the level-yield
method. Calculation of the yield is done on a loan-by-loan basis.
Unamortized fees are recognized in income in the year the related loans
are sold or paid off. Other loan fees and charges representing service
costs for the repayment of loans, delinquent payments or miscellaneous
loan services are recorded as income when collected.
Discounts and premiums on loans are amortized into interest income, using
a method that approximates the level-yield method over the estimated life
of the related loans.
ALLOWANCE FOR LOAN LOSSES - Allowance for loan losses is increased by
charges to income and decreased by charge-offs (net of recoveries).
The allowance is maintained at a level believed by management to be
sufficient to absorb estimated probable credit losses. Management's
determination of the adequacy of the allowance is based on periodic
evaluations of the credit portfolio and other relevant factors. This
evaluation is inherently subjective, as it requires material estimates,
including, among others, the amounts and timing of expected future cash
flows on impaired loans, estimated losses on consumer loans and
residential mortgages, and general amounts for historical loss experience,
economic conditions, uncertainties in estimating losses and inherent risks
in the various credit portfolios, all of which may be susceptible to
significant change.
F-9
In determining the adequacy of the allowance for loan losses, the Company
makes specific allocations to impaired loans in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 114, Accounting by
Creditors for Impairment of a Loan. Loans are identified as impaired when
it is deemed probable that the borrower will be unable to meet the
scheduled principal and interest payments under the terms of the loan
agreement. Impairment is based on the present value of expected future
cash flows discounted at the loan's effective interest rate, except that
as a practical expedient, a creditor may measure impairment based on a
loan's observable market price or the fair value of the collateral if the
loan is collateral dependent.
Allocations to non-homogenous loan pools are developed by loan type and
risk factor and are based on historical loss trends and management's
judgment concerning those trends and other relevant factors. These factors
may include, among others, trends in criticized assets, regional and
national economic conditions, changes in lending policies and procedures,
trends in local real estate values and changes in volumes and terms of the
loan portfolio.
Homogenous (consumer and residential mortgage) loan allocations are made
at a total portfolio level based on historical loss experience adjusted
for portfolio activity and economic conditions.
Management believes the level of the allowance as of December 31, 2001 is
adequate to absorb losses inherent in the loan portfolio.
SERVICING - Servicing assets are recognized as separate assets when rights
are acquired through purchase or through sale of financial assets.
Capitalized servicing rights are reported in prepaid expenses and other
assets and are amortized into other income in proportion to, and over the
period of, the estimated future net servicing income of the underlying
financial assets. Servicing assets are evaluated for impairment based upon
the fair value of the rights as compared to amortized cost. Impairment is
determined by stratifying rights by predominant characteristics, such as
interest rates and terms. Fair value is determined using prices for
similar assets with similar characteristics, when available, or based upon
discounted cash flows using market-based assumptions. Impairment is
recognized through a valuation allowance for an individual stratum, to the
extent that fair value is less than the capitalized amount for the
stratum.
Loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage and
other loans serviced for others were $37,508 and $14,242 at December 31,
2001 and 2000, respectively.
The balance of capitalized servicing rights, net of valuation allowances,
included in other assets at December 31, 2001 and 2000, was $380 and $117,
respectively. The fair values of these rights were $385 and $120,
respectively. The fair value of servicing rights was determined using
discount rates ranging from 15% to 17% and prepayment speeds ranging from
5% to 15%, depending upon the stratification of the specific right.
F-10
The following summarizes mortgage servicing rights capitalized and
amortized, along with the aggregate activity in related valuation
allowances for the years ended December 31:
2001 2000
Beginning balance of capitalized mortgage servicing rights $138
Mortgage servicing rights capitalized 348 $154
Mortgage servicing rights amortized 50 16
---- ----
Ending balance of capitalized mortgage servicing rights $436 $138
==== ====
Valuation allowances:
Balance, beginning of year $ 21
Additions 35 $ 21
---- ----
Balance, end of year $ 56 $ 21
==== ====
REAL ESTATE ACQUIRED THROUGH FORECLOSURE - Real estate acquired through
foreclosure is carried at estimated fair value at the time of
foreclosure. Any subsequent operating expense or income, reduction in
estimated values, and gains or losses on disposition of such properties
are included in current operations.
INCOME TAXES - Deferred tax assets or liabilities shown on the balance
sheet are adjusted to reflect differences between the tax bases of
assets and liabilities and their reported amounts in the financial
statements.
PREMISES AND EQUIPMENT - Premises and equipment are stated at cost less
accumulated depreciation. Depreciation and amortization are computed on
the straight-line method over the estimated useful lives of the assets.
The depreciable lives range from 3 to 20 years for leasehold
improvements, 5 to 20 years for furniture, fixtures and equipment and 27
years for the office building.
IMPAIRMENT OF LONG LIVED ASSETS - The Bank reviews its long-lived assets
for impairment annually or when events or circumstances indicate that
the carrying amount of these assets may not be recoverable. An asset is
considered impaired when the expected undiscounted cash flows over the
remaining useful life is less than the net book value. When impairment
is indicated for an asset, the amount of impairment loss is the excess
of the net book value over its fair value.
CORE DEPOSIT INTANGIBLES - Core deposit intangibles are established in
connection with purchase business combinations of banking or thrift
institutions. The intangible asset represents the fair market value of
acquiring the long-term depositor relationship. Core deposit intangibles
have a finite useful life and it is the Company's policy to amortize the
intangible on a straight-line basis over the estimated useful life of
the deposit base acquired, currently 10 years. At December 31, 2001 and
2000, the gross balance of core deposit intangibles was $1,937 and
$1,000, respectively, and the accumulated amortization was $432 and
$317, respectively. The amortization expense was $116 and $100 for the
years ended December 31, 2001 and 2000, respectively. There were no core
deposit intangibles in 1999.
DERIVATIVES HELD FOR ASSET AND LIABILITY MANAGEMENT PURPOSES - The
Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended by SFAS No. 137, Accounting for
Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of SFAS No. 133, and SFAS No. 138, Accounting for Certain
Derivative Instruments and Certain Hedging Activities - an amendment of
FASB Statement No. 133, on January 1, 2001. These statements establish
F-11
accounting and reporting standards for derivative instruments and for
hedging activities. They require that an entity recognize all
derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated
as a fair value hedge, a cash flow hedge or a hedge of foreign currency
exposure. The accounting for changes in the fair value of a derivative
(that is, gains and losses) depends on the intended use of the
derivative and the resulting designation.
In accordance with these accounting standards, the Company has
identified certain types of short-term interest-bearing liabilities as a
source of interest rate risk to be hedged in connection with the
Company's overall asset-liability management process. Although these
liabilities have contractually fixed rates of interest, their short-term
maturities, together with the expectation that they will be continually
refinanced or replaced with similar products, give rise to the risk of
fluctuations in interest expense as interest rates rise and fall in
future periods. In response to this identified risk, the Company uses
interest rate swaps as cash flow hedges to hedge the interest rate risk
associated with the cash flows of the specifically identified short-term
liabilities.
To qualify for hedge accounting, the Company must show that, at the
inception of the hedges and on an ongoing basis, the changes in the fair
value of the hedging instruments are expected to be highly effective in
offsetting related changes in the cash flows of the hedged liabilities.
These interest rate swaps have been shown to be effective in hedging the
exposure to the short-term liability variability in cash flows and,
therefore, qualify for hedge accounting. Accordingly, the effective
portion of the accumulated change in the fair value of the cash flow
hedges is recorded in a separate component of stockholders' equity, net
of tax, while the ineffective portion is recognized in earnings
immediately. During the next twelve months, the Company expects to
expense $809, net of tax, from the amount recorded in the separate
component of stockholders' equity.
DERIVATIVES NOT QUALIFYING FOR HEDGE ACCOUNTING - The Bank is a party to
a variety of interest rate contracts consisting of interest rate
futures, caps, swaps, floors and options in the management of interest
rate exposure in the investment and loan portfolio. These financial
instruments are included in trading account assets and are reported at
fair value with realized and unrealized gains and losses on these
instruments recognized immediately in income.
In accordance with the transition provisions of SFAS No. 133, the
Company recorded a cumulative-effect type adjustment of $188, net of
tax, in accumulated other comprehensive income and a $43 loss, before
tax, as of January 1, 2001.
RECENT ACCOUNTING PRONOUNCEMENTS - In August 2001, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. This statement
addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. This statement supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and the accounting and reporting provisions of
Accounting Principles Board ("APB") Opinion No. 30, Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, for the disposal of a segment of a business (as
previously defined in that opinion). The provisions of this statement
are effective for financial statements issued for fiscal years beginning
after December 15, 2001 and are not expected to have a material impact
on the financial statements of the Company.
F-12
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections. This statement eliminates the automatic
classification of gain or loss on extinguishment of debt as an
extraordinary item of income and requires that such gain or loss be
evaluated for extraordinary classification under the criteria of APB No.
30, Reporting Results of Operations. This statement also requires
sales-leaseback accounting for certain lease modifications that have
economic effects that are similar to sales-leaseback transactions, and
makes various other technical corrections to existing pronouncements.
This statement will be effective for the Bank for the year ending
December 31, 2003. The adoption of this statement is not expected to
have a material effect on our results of operations or financial
position.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which addresses financial
accounting and reporting for costs associated with exit or disposal
activities and supersedes Emerging Issues Task Force ("EITF") Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in
a Restructuring). SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF Issue No. 94-3, a liability for an
exit cost as defined in EITF Issue No. 94-3 was recognized at the date
of an entity's commitment to an exit plan. SFAS No. 146 also establishes
that the liability should initially be measured and recorded at fair
value. The Company will adopt the provisions of SFAS No. 146 for exit or
disposal activities that are initiated after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain
Financial Institutions, which provides guidance on the accounting for the
acquisition of a financial institution. This statement requires that the
excess of the fair value of liabilities assumed over the fair value of
tangible and identifiable intangible assets acquired in a business
combination represents goodwill that should be accounted for under SFAS
No. 142, Goodwill and Other Intangible Assets. Thus, the specialized
accounting guidance in paragraph 5 of SFAS No. 72, Accounting for Certain
Acquisitions of Banking or Thrift Institutions, will not apply after
September 30, 2002. If certain criteria in SFAS No. 147 are met, the
amount of the unidentifiable intangible asset will be reclassified to
goodwill upon adoption of the statement. Financial institutions meeting
conditions outlined in SFAS No. 147 will be required to restate previously
issued financial statements. Additionally, the scope of SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, is amended
to include long-term customer-relationship intangible assets such as
depositor- and borrower-relationship intangible assets and credit
cardholder intangible assets. This statement is effective for the Bank
beginning October 1, 2002. The Company has adopted the new standard as of
October 1, 2002 and the adoption of this standard did not have a material
impact on the Company's financial position or results of operation.
RECLASSIFICATIONS - Certain reclassifications have been made to the
prior financial statements to conform to the current year presentation.
F-13
2. LOANS RECEIVABLE
The Bank's loan portfolio as of December 31 is summarized as follows:
2001 2000
Real estate loans:
Residential property - one to four units $156,150 $200,373
Residential property - more than four units 69,584 66,005
Residential property - construction 14,607 7,042
Nonresidential property - construction 5,628 6,037
Commercial and other income - producing properties 156,431 108,820
Loans for the acquisition and development of land 7,889 2,511
-------- --------
Total real estate loans 410,289 390,788
Commercial and industrial loans 30,838 3,969
Consumer loans 11,107 3,265
Loans collateralized by deposit accounts 397 599
Consumer line-of-credit loans 142 154
-------- --------
452,773 398,775
Net deferred loan fees (1,102) (485)
Net premiums 1,774 397
Allowance for loan losses (3,736) (3,150)
-------- --------
Loans receivable, net $449,709 $395,537
======== ========
The Bank's lending is concentrated in California's Central Coast and the
Kansas City metropolitan area. A deterioration in the economic
conditions of these markets could adversely affect our business,
financial condition and profitability. Such a deterioration could give
rise to increased loan delinquencies, increased problem asset and
foreclosures, decreased loan demand and a decline in real estate values.
Activity in the allowance for loan losses is summarized as follows for
the years ended December 31:
2001 2000 1999
Balance, beginning of year $3,150 $3,112 $2,975
Allowance acquired in connection with branch purchase 600
Charge-offs (15) (4) (18)
Provision for loan losses 1 42 155
------ ------ ------
Balance, end of year $3,736 $3,150 $3,112
====== ====== ======
F-14
Loans for which impairment has been recognized are as follows at
December 31:
2001 2000
Impaired loans with a valuation allowance $389 $4,411
Impaired loans without a valuation allowance
Total impaired loans 389 4,411
==== ======
Valuation Allowance related to impaired loans $ 50 $ 50
==== ======
2001 2000 1999
Average recorded investment in impaired loans $2,400 $5,180 $6,026
Interest income recognized on impaired loans 26 159 440
At December 31, the Bank had outstanding commitments for loan
originations totaling $6,888 for 2001 and $1,970 for 2000, of which $950
for 2001 and $1,750 for 2000 were for adjustable rate loans and $5,938
for 2001 and $220 for 2000 were for fixed rate loans. Undisbursed loan
funds for the Bank's construction lending program amounted to $18,183
for 2001 and $15,128 for 2000.
3. SECURITIES
The amortized cost and estimated fair values of securities available for
sale are summarized as follows:
Securities Available for Sale: GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2001 COST GAINS LOSSES VALUE
Mortgage-backed securities $ 179,647 $ 2,015 $ (35) $ 181,627
========= ======= ======= =========
Securities Available for Sale: GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2000 COST GAINS LOSSES VALUE
Mortgage-backed securities $ 47,051 $ 387 $ - $ 47,438
========= ======= ======= =========
The amortized cost and fair value of the available for sale debt
securities by contractual maturity at December 31, 2001 are as follows:
AMORTIZED FAIR
COST VALUE
Mortgage-backed Securities:
Due from five to ten years $ 8,494 $ 8,693
Due over ten years 171,153 172,934
-------- --------
Total $179,647 $181,627
======== ========
F-15
Proceeds from sales of available for sale securities were $12,975 in
2001 and $40,652 in 2000, with related gross realized gains of $131 in
2001 and $112 in 2000 and gross realized losses of $26 in 2000. The
Company had no securities available for sale during 1999.
Securities Held to Maturity: GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2001 COST GAINS LOSSES VALUE
Agency securities $2,034 $ 79 $ - $2,113
Mortgage-backed securities 583 21 604
------ ---- ---- ------
Total $2,617 $100 $ - $2,717
====== ==== ==== ======
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2000 COST GAINS LOSSES VALUE
Agency securities $2,000 $ - $2,000
Mortgage-backed securities 687 $ 8 695
------ ---- ---- ------
Total $2,687 $ 8 $ - $2,695
====== ==== ==== ======
The amortized cost and fair value of held to maturity debt securities by
contractual maturity at December 31, 2001 are as follows:
AMORTIZED FAIR
COST VALUE
Mortgage-backed securities -
Due over 10 years $ 583 $ 604
------ ------
Total mortgage-backed securities 583 604
------ ------
Agency bonds -
Due from one to five years 2,034 2,113
------ ------
Total agency bonds 2,034 2,113
------ ------
Total $2,617 $2,717
====== ======
F-16
4. PREMISES AND EQUIPMENT
Premises and equipment consist of the following at December 31:
DEPRECIABLE
LIVES (YEARS) 2001 2000
Land $ 190 $ 190
Office building 27 204 204
Leasehold improvements 3 to 20 2,211 1,668
Furniture, fixtures and equipment 5 to 20 4,046 3,187
------ ------
Total 6,651 5,249
Less accumulated depreciation and amortization 2,963 2,236
------ ------
Premises and equipment, net $3,688 $3,013
====== ======
5. DEPOSITS
A summary of deposits by type of account as of December 31 is as
follows:
2001 2000
-------------------------------- ------------------------------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
Amount Interest Rate Amount Interest Rate
Noninterest bearing $ 12,382 - $ 5,981 -
Passbook 14,507 1.33 % 12,680 2.52 %
NOW accounts 23,109 0.64 % 17,012 1.23 %
Commercial DDA accounts 2,574 1.02 % 944 0.75 %
Money market deposits 41,719 1.98 % 22,251 4.24 %
-------- --------
Total 94,291 1.26 % 58,868 2.51 %
-------- --------
Certificates of deposits:
Over $100 210,584 4.33 % 105,980 6.03 %
Other 215,983 4.43 % 190,857 6.01 %
-------- --------
Total certificates of deposits 426,567 296,837
-------- --------
Total deposits $520,858 $355,705
======== ========
Weighted-average interest rate,
end of period 3.80 % 5.42 %
F-17
As of December 31, 2001, certificates of deposits over $100 are
scheduled to mature as follows:
YEAR ENDING
DECEMBER 31
2002 $200,341
2003 5,804
2004 2,870
2005 1,159
2006 and beyond 410
--------
$210,584
========
In February 2000, the Bank sold its two branches and related deposits in
the market of San Diego, originally acquired through the acquisition of
U.S. Community Bank in 1997. The Bank determined that these branches did
not fit strategically with its core banking operations in the California
central coast. The Bank recognized a gain of $3,923 on the sale of these
deposits.
6. FEDERAL HOME LOAN BANK ADVANCES
We obtain both long-term fixed-rate and short-term variable-rate
advances from the FHLB of San Francisco upon the security of certain of
our residential first mortgage loans, mortgage-backed securities or FHLB
stock. FHLB of San Francisco advances are available for general business
purposes to expand lending and investing activities. Advances from the
FHLB of San Francisco are made pursuant to several different credit
programs, each of which has its own interest rate and range of
maturities. Our advances are limited to 35% of our total Bank assets, or
$239,100 at June 30, 2002 (unaudited), $234,400 and $169,500 at December
31, 2001 and 2000, respectively.
FHLB advances are collateralized by the investment in the stock of the
FHLB and certain mortgage loans aggregating $109,589 and $173,449 at
December 31, 2001 and 2000, respectively, and mortgage-backed securities
aggregating $152,150 and $42,685, current par value, at December 31,
2001 and 2000, respectively. The weighted-average interest rate on these
advances was 4.82% and 6.28% at December 31, 2001 and 2000,
respectively.
The maturities of FHLB advances at December 31 are as follows:
2001 2000
2001 $36,000
2002 $21,403 55,000
2003 and thereafter 75,000
------- -------
$96,403 $91,000
======= =======
F-18
7. NOTE PAYABLE
At December 31, 2001 and 2000, the Company has a loan facility from
three banks consisting of a revolving line of credit on which $18,000
and $9,000 have been drawn at each date, respectively.
On September 28, 1999, the terms of the loan facility were renegotiated
to expand the revolving line of credit commitment from $7,885 to
$15,000. Interest was payable quarterly at the prime rate published in
The Wall Street Journal plus a .25% revolving credit commitment fee on
the unused portion of the line. The note rate was 9.50% at December 31,
2000.
On October 31, 2001, the terms of the loan facility were renegotiated to
expand the revolving line of credit commitment from $15,000 to $20,000.
Under the new terms, interest is payable quarterly and the rate is based
on three defined performance-based levels determined from quarterly
operating results related to core profitability and nonperforming asset
ratios: Level 1 allows for the choice of London Interbank Offered Rate
("LIBOR") plus 200 basis points (in maturities of 30, 60 or 90 days) or
prime rate less 50 basis points; Level 2 allows for the choice of LIBOR
plus 250 basis points or prime rate less 50 basis points; Level 3 allows
for the choice of LIBOR plus 300 basis points or prime rate. At December
31, 2001, the Company qualified for Level 1 loan pricing. A .25%
commitment fee on the unused portion of the line is payable quarterly.
The note rate was 4.19% at December 31, 2001. The committed availability
of the revolving loan is $20 million until October 31, 2002, at which
time the availability will reduce annually based on an eight-year
amortization schedule. The balance of the note will mature on September
30, 2004.
At December 31, 2001 and 2000 the line of credit was secured by the
Bank's common stock. Under the terms of the loan facility, the Company
is bound by a number of significant covenants that restrict our ability
to dispose of assets, incur additional indebtedness, invest in mortgage
derivative securities above certain thresholds, create liens on assets,
engage in mergers or consolidations or a change of control, engage in
certain transactions with affiliates, pay cash dividends or repurchase
common stock. The credit agreement also requires us to comply with
specified financial ratios and tests, including causing Los Padres Bank
to maintain the ratio of non-performing assets to the sum of tier 1
risk-based capital plus loan loss reserves of not more than 0.20 to 1,
maintaining the ratio of outstanding loans under the credit agreement to
the stockholders' equity of Los Padres Bank of less than 0.50 to 1,
maintaining Los Padres Bank's status as a "well capitalized" institution
and complying with minimum core profitability requirements. Management
believes that as of June 30, 2002 (unaudited) and December 31, 2001 and
2000, it was in compliance with all of such covenants and restrictions
and does not anticipate that such covenants and restrictions will limit
its operations.
F-19
8. INCOME TAXES
The provision for taxes on income consists of the following components
for the years ended December 31:
2001 2000 1999
Current tax expense:
Federal $2,334 $1,702 $1,930
State 773 565 544
------ ------ ------
3,107 2,267 2,474
------ ------ ------
Deferred tax benefit:
Federal (314) (216) (609)
State (61) (50) (86)
------ ------ ------
(375) (266) (695)
------ ------ ------
$2,732 $2,001 $1,779
====== ====== ======
The actual tax rates differed from the statutory rates as follows for
the years ended December 31:
2001 2000 1999
Federal income taxes at statutory rates 35.0 % 35.0 % 35.0 %
Increase resulting from:
California franchise tax, net of federal benefit 7.2 7.4 7.2
Other, net (0.4) 1.3 0.8
---- ---- ----
41.8 % 43.7 % 43.0 %
==== ==== ====
F-20
The following is a summary of the income tax liability at December 31:
2001 2000
Current taxes $ 339 $ 349
Deferred taxes 648 1,071
------- -------
$ 987 $ 1,420
======= =======
Deferred tax liabilities:
Net loan fees/costs $ 1,757 $ 2,028
FHLB stock dividends 596 413
Mark to market on securities 6 143
Unrealized gain on available for sale securities 824 162
Purchase accounting adjustments 12 156
------- -------
Gross deferred tax liability 3,195 2,902
------- -------
Deferred tax asset:
Unrealized hedging loss on cash flow hedges (466)
Allowance for loan losses (1,188) (1,185)
California franchise tax (358) (307)
Other (73) (145)
Depreciation (219) (194)
Net operating loss carryforwards (243)
-------
Gross deferred tax asset (2,547) (1,831)
------- -------
Net deferred tax liability $ 648 $ 1,071
======= =======
As a result of acquiring the remaining 51% interest in Harrington Wealth
Management Company in 2001, the Company has federal and state net
operating loss carryforwards of approximately $700, which expire
primarily in 2018 and 2019. Due to the restrictions imposed by Internal
Revenue Code Section 382 for change of control, the annual amount of net
operating loss deductions that can be utilized to offset future income
may be limited.
9. STOCKHOLDERS' EQUITY
Retained earnings are restricted to the extent that earnings deducted
for tax purposes as bad debt deductions are not available for payment of
cash dividends or other distributions to stockholders without payment of
federal income taxes by the Bank at the then-prevailing corporate tax
rates. At December 31, 2001, this restricted amount was $671.
QUALIFIED STOCK OPTION PLAN - The Company has a qualified stock option
plan that provides for the granting of stock options to key employees of
the Bank. Options granted under the plan are vested ratably over a
four-year period. The option price is based on a determination of a
price that is not less than the fair value of the shares at the date of
grant by the Compensation Committee and ratified by the Board of
Directors.
F-21
During 1996, the Company granted 150,000 options with a stock price of
$5.83 per share and an expiration date of April 14, 2001. Such options were
granted to Smith Breeden Associates ("SBA") for financial advisory services
provided in connection with the Company's acquisition of the Bank. The
estimated value of such options as of the date granted was considered as
part of the purchase price of the Bank. During 2001, 107,547 of the options
were exercised and the balance of 42,453 options was extended to expire on
June 30, 2003. In accordance with requirements of FASB Interpretation No.
44, Accounting for Certain Transactions Involving Stock Compensation (an
interpretation of APB Opinion No. 25), a one-time $106 pre-tax charge to
earnings was recorded, which was equal to the intrinsic value at the time
of the extension, applied to the number of options extended. The intrinsic
value is the difference between the fair value of the underlying stock at
the extension date (i.e., $8.33) and the strike price of the options (i.e.,
$5.83). The offsetting entry was recorded to paid-in capital in the
stockholders' equity section. The Company recorded a deferred tax asset of
$43.
A summary of the status of the Company's stock options as of December 31
and changes during those years are presented below:
2001 2000 1999
------------------- -------------------- --------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
Incentive stock options:
Outstanding, beginning of year 369,000 $ 7.39 369,000 $ 7.39 259,500 $ 6.99
Granted 32,550 $ 8.33 109,500 $ 8.33
Expired unexercised (28,500) $ 7.07
-------- -------- --------
Outstanding, end of year 373,050 $ 7.50 369,000 $ 7.39 369,000 $ 7.39
Stock options granted to SBA 42,453 $ 5.83 150,000 $ 5.83 150,000 $ 5.83
-------- -------- --------
Outstanding, end of year 415,503 $ 7.33 519,000 $ 6.94 519,000 $ 6.94
======== ======== ========
Exercisable, end of year 268,875 $ 7.18 202,500 $ 6.95 129,750 $ 6.59
The outstanding options have prices ranging from $5.83 to $8.33. Remaining
available options to be issued under the stock option plan were 125,598 and
113,517 for December 31, 2001 and 2000, respectively.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- ------------------------
RANGE OF REMAINING
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OPTIONS LIFE (YEARS) PRICE OPTIONS PRICE
$5.83 117,453 4.5 $ 5.83 75,000 $ 5.83
$6.83 82,500 5.5 $ 6.83 82,500 $ 6.83
$8.33 215,550 6.9 $ 8.33 111,375 $ 8.33
-------- --------
Total 415,503 6.0 $ 7.41 268,875 $ 7.33
======== ========
FAIR VALUE OF OPTIONS - The Company applies APB Opinion No. 25 and related
interpretations in accounting for its stock option plan. Accordingly, no
compensation cost has been recognized for its stock option plan.
F-22
Had compensation cost for the Company's stock option plan been determined
based on the fair value at the grant dates for awards under the plan
consistent with the method of SFAS No. 123, Accounting for Stock-Based
Compensation, the Company's net income and earnings per share for the years
ended December 31 would have been changed to the pro forma amounts
indicated below:
PRO FORMA RESULTS 2001 2000 1999
Net income:
As reported $ 3,802 $ 2,581 $ 2,360
Pro forma $ 3,696 $ 2,448 $ 2,226
Earnings per share - basic:
As reported $ 1.14 $ 0.79 $ 0.73
Pro forma $ 1.11 $ 0.75 $ 0.69
Earnings per share - diluted:
As reported $ 1.12 $ 0.77 $ 0.71
Pro forma $ 1.09 $ 0.73 $ 0.67
The fair values of options granted under the Company's fixed stock option
plan were estimated on the date of grant using the Black-Scholes
option-pricing model, with the following weighted-average assumptions used:
expected volatility of 7.90% for 2001 and 11.30% for 1999; risk-free
interest rate of 4.90% for 2001 and 5.65% for 1999; and expected lives of 9
years for 2001 and 10 years for 1999. The fair value of 32,550 options
granted in 2001 was $2.40. No options were granted in 2000. The fair value
of 103,500 options granted in 1999 was $3.31.
10. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Bank's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures that have been established by regulation to ensure
capital adequacy require the Bank to maintain minimum capital amounts and
ratios (set forth in the table below). The Bank's primary regulatory
agency, the Office of Thrift Supervision ("OTS"), currently requires that
the Bank maintain minimum ratios of tangible capital (as defined in the
regulations) to tangible assets of 1.5%, core capital (as defined) to
adjusted tangible assets of 4%, and total capital (as defined) to
risk-weighted assets of 8%. These capital requirements are viewed as
minimum standards by the OTS, and most institutions are expected to
maintain capital levels well above the minimum. Minimum capital levels
higher than those provided in the regulations may be established by the OTS
for individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its
circumstances.
F-23
Due to our business strategy which has concentrated on growth, a shift in
our lending focus to more commercial lending and the size of our securities
portfolios, we have agreed with the OTS that we will maintain a total
risk-based capital ratio and a leverage capital ratio of at least 11% and
6%, respectively, which is in excess of the OTS' minimum requirements.
As of December 31, 2001 and 2000, the most recent notification from the OTS
categorized the Bank as "well capitalized" under the regulatory framework
for prompt corrective action. To be categorized as well capitalized, the
Bank must maintain minimum total risk-based, Tier I risk-based and Tier I
leverage ratios as set forth in the table. There are no conditions or
events since that notification which management believes have changed the
institution's category.
Federal and state banking regulations place certain restrictions on
dividends paid by the Bank to the Company. The total amount of dividends
that may be paid at any date is generally limited to the retained earnings
of the Bank. At December 31, 2001, the Bank's retained earnings available
for the payment of dividends were $1,752. Accordingly, $28,344 of the
Company's equity in the net assets of the Bank was restricted at December
31, 2001. In addition, dividends paid by the Bank to the Company would be
prohibited if the effect thereof would cause the Bank's capital to be
reduced below applicable minimum capital requirements.
TO BE WELL
CAPITALIZED
UNDER PROMPT
FOR CAPITAL MINIMUM REQUIRED CORRECTIVE ACTION
ACTUAL ADEQUACY PURPOSES BY OTS AGREEMENT PROVISIONS
------------------- ------------------- ------------------- --------------------
(DOLLARS IN THOUSANDS) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
As of December 31, 2001:
Total capital
(to risk-weighted
assets) $ 45,208 11.72 % $ 30,860 > 8.00 % $ 42,432 > 11.00 % $ 38,575 > 10.00 %
- - -
Core capital
(to adjusted tangible
assets) 41,522 6.27 % 26,494 > 4.00 % 39,741 > 6.00 % 33,118 > 5.00 %
- - -
Tangible capital
(to tangible assets) 41,522 6.27 % 9,935 > 1.50 % N/A N/A N/A N/A
-
Tier 1 capital
(to risk-weighted assets) 41,522 10.76 % N/A N/A N/A N/A 23,145 > 6.00 %
-
As of December 31, 2000:
Total capital
(to risk-weighted
assets) $ 35,745 11.56 % $ 24,746 > 8.00 % $ 34,026 > 11.00 % $ 30,392 > 10.00 %
- - -
Core capital
(to adjusted tangible
assets) 32,645 6.76 % 19,325 > 4.00 % 28,988 > 6.00 % 24,157 > 5.00 %
- - -
Tangible capital
(to tangible assets) 32,645 6.76 % 7,247 > 1.50 % N/A N/A N/A N/A
-
Tier 1 capital
(to risk-weighted assets) 32,645 10.55 % N/A N/A N/A N/A 18,559 > 6.00 %
-
F-24
11. EARNINGS PER SHARE
The following tables represent the calculations of earnings per share
("EPS") for the periods presented.
SIX MONTHS ENDED JUNE 30, 2002 YEAR ENDED DECEMBER 31, 2001
------------------------------------- -------------------------------------
INCOME SHARES PER-SHARE INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
(UNAUDITED)
Basic EPS $ 2,318 3,354,336 $ 0.69 $ 3,802 3,321,189 $ 1.14
Effect of dilutive stock options 130,182 (0.02) 75,696 (0.02)
-------- ---------- ------- -------- ---------- ------
Diluted EPS $ 2,318 3,484,518 $ 0.67 $ 3,802 3,396,885 $ 1.12
======== ========== ======= ======== ========== ======
SIX MONTHS ENDED JUNE 30, 2001 YEAR ENDED DECEMBER 31, 2000
------------------------------------- -------------------------------------
INCOME SHARES PER-SHARE INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
(UNAUDITED)
Basic EPS $ 2,002 3,287,496 $ 0.61 $ 2,581 3,246,789 $ 0.79
Effect of dilutive stock options 63,597 (0.01) 85,068 (0.02)
------- ---------- ------- -------- ---------- ------
Diluted EPS $ 2,002 3,351,093 $ 0.60 $ 2,581 3,331,857 $ 0.77
======== ========== ======= ======== ========== ======
YEAR ENDED DECEMBER 31, 1999
-------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
Basic EPS $ 2,360 3,246,789 $ 0.73
Effect of dilutive stock options 67,149 (0.02)
------- ---------- ------
Diluted EPS $ 2,360 3,313,938 $ 0.71
======== ========= ======
12. COMMITMENTS AND CONTINGENCIES
Aggregate minimum lease commitments under long-term operating leases as of
December 31, 2001 are as follows:
2002 $ 952
2003 855
2004 819
2005 807
2006 808
2007 and thereafter 5,848
--------
$ 10,089
========
Minimum lease payments for the Bank's premises are adjusted annually based
upon the Consumer Price Index. The leases also provide for option renewal
periods. Rental expense was $559, $471 and $657 for the years ended
December 31, 2001, 2000 and 1999, respectively.
F-25
13. TRADING ACCOUNT ASSETS
DERIVATIVE INSTRUMENTS NOT RECEIVING HEDGE TREATMENT - The Bank is a party
to a variety of interest rate contracts such as interest rate swaps, caps,
floors, futures, options and total return swaps ("Interest Rate
Agreements"), which are recorded in the financial statements at fair value
with changes in fair value and periodic payments recorded in earnings.
Interest rate swaps are contracts in which the parties agree to exchange
fixed and floating rate payments for a specified period of time on a
specified ("notional") amount. The notional amount is only used to
calculate the amount of the periodic interest payments to be exchanged
and does not represent the amount at risk. As of December 31, 2001, the
Bank has a $25,000 notional amount of Commercial Mortgage Backed
Securities ("CMBS") swaps whereby the Bank receives the total return
(i.e., interest income and price changes) of an investment grade CMBS
index and pays three-month LIBOR less a spread. The Bank, in turn,
hedges the interest rate risk of the CMBS swap with a separate pay
fixed, receive three-month LIBOR swap with the same notional amount,
effectively canceling the effect of the floating LIBOR exposure. The
Bank also has a $23,200 notional amount of Ginnie Mae ("GN")
mortgage-backed security total return swaps whereby the Bank receives
the total return of a basket of GN mortgage-backed securities and pays
three-month LIBOR less a spread.
Interest rate caps and floors are instruments in which the writer
(seller) agrees to pay the holder (purchaser) the amount that an
agreed-upon index is above or below the specified cap or floor rate,
respectively, times the notional amount. The notional amount is never
exchanged between the two parties and does not represent the amount at
risk. The Bank purchases interest rate caps and floors to reduce the
impact of rising or falling interest rates on the fair value of its
trading portfolio and short-term liability repricing. The Company did
not have any caps or floors outstanding at December 31, 2001 and 2000.
Interest rate futures contracts are commitments to either purchase or
sell designated instruments at a future date for a specified price.
Initial margin requirements are met in cash or other instruments, and
changes in the contract values are settled in cash daily. The Bank
maintained $2,034 and $2,000 at December 31, 2001 and 2000,
respectively, in agency securities as a deposit with a broker for its
futures activities.
Financial options are contracts that grant the purchaser, for a premium
payment, the right to either purchase from or sell to the writer a
specified financial instrument under agreed-upon terms. Financial
options to buy or sell securities are typically traded in standardized
contracts on organized exchanges. The Bank purchases financial options
to reduce the risk of the written financial options embedded in
mortgage-related assets.
F-26
The following is a summary of the Interest Rate Agreements as of December
31:
CONTRACT OR ESTIMATED WEIGHTED AVERAGE
NOTIONAL FAIR VALUE INTEREST RATE
----------------- -------------------
2001 AMOUNT ASSET LIABILITY PAYABLE RECEIVABLE
Total return swaps - receive total return
CMBS investment grade total return,
pay LIBOR $ 25,000 $ 41 $ 216 2.94 % 6.22 %
Interest rate swaps - pay fixed, receive
LIBOR 25,000 237 177 5.14 % 2.40 %
Total return swaps - receive total return
GN MBS adjustable rate, pay LIBOR 23,200 3.83 % 6.73 %
Futures 1,900 22 13
2000
Total return swaps - receive total return
CMBS investment grade total return,
pay LIBOR $ 15,000 $ 528 6.07 % 6.74 %
Interest rate swaps - pay fixed, receive
LIBOR 15,000 $ 653 6.83 % 6.76 %
Total return swaps - receive total return
GN MBS adjustable rate, pay LIBOR 75,870 6.69 % 7.13 %
Futures 136,900 2 517
The Interest Rate Agreements used have an active secondary market and are
included in trading account assets at fair value with realized and
unrealized gains and losses on these instruments recognized immediately in
other income. The intent of these Interest Rate Agreements is to
economically hedge the exposures created by the trading securities and
certain interest rate agreements. However, because the exposures being
hedged do not qualify for hedge accounting under SFAS No. 133, changes in
fair value of these instruments are immediately recognized in income.
The Bank's exposure to credit risk from derivative financial instruments is
represented by the fair value of the instruments. Credit risk amounts
represent the replacement cost the Bank could incur should counterparties
with contracts in a gain position completely fail to perform under the
terms of those contracts. Counterparties are subject to the credit approval
and credit monitoring policies and procedures of the Bank. The Bank limits
its credit exposure by entering into International Swap Dealer Association
("ISDA") Master Agreements with each counterparty. ISDA Master Agreements
set the legal framework for transactions with counterparties in over the
counter derivative markets. The Bank only deals with counterparties that
are investment grade.
F-27
The following table shows the various components of the Company's recorded
net gain (loss) on its trading assets for the years ended December 31.
INCOME
REALIZED UNREALIZED FROM
GAINS GAINS TRADING
DECEMBER 31, 2001 (LOSSES) (LOSSES) ASSETS
Interest rate contracts:
Swaps $ 58 $ 9 $ 67
Caps (43) (43)
Futures (291) (291)
------- -------- ------
Total (233) (34) (267)
MBS and other trading assets 902 (199) 703
------- -------- ------
Total trading portfolio $ 669 $ (233) $ 436
======= ======== ======
DECEMBER 31, 2000
Interest rate contracts:
Swaps $ 502 $ 66 $ 568
Floors (1,063) 808 (255)
Futures (6,899) (6,899)
Options 18 (13) 5
------- -------- ------
Total (7,442) 861 (6,581)
MBS and other trading assets 931 2,896 3,827
------- -------- ------
Total trading portfolio $ (6,511) $ 3,757 $ (2,754)
======= ======== ======
DECEMBER 31, 1999
Interest rate contracts:
Swaps $ (190) $ (190)
Caps $ (240) 424 184
Floors (2,888) (2,888)
Futures 9,014 9,014
Options 330 21 351
------- -------- ------
Total 9,104 (2,633) 6,471
MBS and other trading assets (3,133) (3,893) (7,026)
------- -------- ------
Total trading portfolio $ 5,971 $ (6,526) $ (555)
======= ======== ======
F-28
The following table shows the Company's trading securities included in
trading account assets as of December 31:
Securities Held for Trading: GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2001 COST GAINS LOSSES VALUE
Mortgage-backed securities and other -
Trading assets $2,408 $353 $ (10) $2,751
====== ==== ===== ======
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2000 COST GAINS LOSSES VALUE
Mortgage-backed securities and other -
Trading assets $3,826 $879 $(741) $3,964
====== ==== ===== ======
14. DERIVATIVES HELD FOR ASSET AND LIABILITY MANAGEMENT
At December 31, 2001, the swaps listed below are hedging the interest rate
risk of cash flows associated with short-term FHLB advances and
certificates of deposit with terms between six and twelve months. These
swaps qualify as cash flow hedges. During 2001, the ineffective portion of
the change in fair value of the cash flow hedges was immaterial.
CONTRACT OR
NOTIONAL ESTIMATED WEIGHTED-AVERAGE
AMOUNT FAIR VALUE INTEREST RATE
---------------------
RECEIVABLE PAYABLE
DECEMBER 31, 2001 -
Interest rate swaps - pay fixed $ 40,000 $(1,101) 1.99 % 5.84 %
DECEMBER 31, 2000 -
Interest rate swaps - pay fixed $ 35,000 $ 325 6.62 % 5.92 %
Interest rate caps $ 15,000 $ - 7.33 %
The following table sets forth the maturity distribution and
weighted-average interest rates of the interest rate swaps used to limit
the repricing risk of deposits and short-term borrowings as of December 31,
2001:
MATURITIES 2002 2003 2004 2005 2006 THEREAFTER
Interest rate swaps:
Notional amount $ 40,000
Weighted-average
payable rate 5.84 %
Weighted-average
receivable rate 1.99 %
F-29
The Bank is dedicated to managing credit risks associated with investment
and interest rate risk management activities. The Bank maintains positions
with a variety of counterparties or obligors ("counterparties"). To limit
credit exposure arising from such transactions, the Bank evaluates the
credit standing of counterparties, establishes limits for the total
exposure to any one counterparty, monitors exposure against the established
limits, and monitors investment portfolio composition to manage
concentrations.
15. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires that the Bank disclose estimated fair values for its financial
instruments. The estimated fair value amounts have been determined by the
Bank using available market information and appropriate valuation
methodologies; however, considerable judgment is required to interpret
market data to develop estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative
of the amounts the Bank could realize in a current market exchange. The use
of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts at December 31:
2001 2000
--------------------------- ---------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
Assets:
Cash and cash equivalents $ 11,107 $ 11,107 $ 13,304 $ 13,304
Trading account assets 2,751 2,751 3,964 3,964
Securities, available for sale 181,627 181,627 47,438 47,438
Securities, held to maturity 2,617 2,717 2,687 2,695
Loans receivable, net 449,709 458,861 395,537 398,030
FHLB stock 7,834 7,834 5,875 5,875
Accrued interest receivable 3,567 3,567 2,715 2,715
Liabilities:
Demand deposits 94,291 94,291 58,868 58,868
Certificates of deposits 426,567 429,286 296,837 296,869
FHLB advances 96,403 99,721 91,000 92,094
Securities sold under
repurchase agreements 365 365
Note payable 18,000 18,000 9,000 9,000
Accrued interest payable 297 297 436 436
Hedging Instruments -
Interest rate swaps (1,101) (1,101) 325
The methods and assumptions used to estimate the fair value of each class
of financial statements for which it is practicable to estimate that value
are explained below:
Cash and Cash Equivalents - The carrying amounts approximate fair values
due to the short-term nature of these instruments.
Securities - The fair values of securities are generally obtained from
market bids for similar or identical securities or are obtained from
independent security brokers or dealers.
F-30
Securities Sold under Repurchase Agreements - The carrying amounts
approximate fair values due to the short-term nature of these
instruments.
Trading Account Assets - The fair values of trading securities included
in trading account assets are obtained from market bids or from
independent securities brokers or dealers. Fair values of interest rate
contracts are based on quoted market price or dealer quotes.
Loans - Fair values are estimated for portfolios of loans with similar
financial characteristics, primarily fixed and adjustable rate interest
terms. The fair values of mortgage loans are based upon discounted cash
flows utilizing applicable risk-adjusted discount rates relative to
available mortgage-backed securities having similar rate and repricing
characteristics, as well as anticipated prepayment schedules. No
adjustments have been made for changes in credit within the loan
portfolio. It is management's opinion that the allowance for estimated
loan losses pertaining to performing and nonperforming loans results in
a fair valuation of such loans.
FHLB Stock - The carrying amounts approximate fair values, as the stock
may be sold back to the FHLB at cost.
Deposits - The fair values of deposits are estimated based upon the type
of deposit product. Demand accounts, which include passbooks and
transaction accounts, are presumed to have equal book and fair values,
since the interest rates paid on these accounts are based on prevailing
market rates and the amounts are payable upon demand. The estimated fair
values of time deposits are determined by discounting the cash flows of
settlements of deposits having similar maturities and current rates,
utilizing a LIBOR swap curve adjusted for Federal Deposit Insurance
Corporation ("FDIC") insurance that approximates the prevailing rates
offered on the Company's term borrowings less the cost of FDIC insurance
as of the reporting date.
FHLB Advances - The fair values of FHLB advances are based upon
discounted cash flows utilizing applicable risk-adjusted spreads
relative to the current pricing for similar advances.
Notes Payable - The carrying amount approximates fair value, as the rate
is based on current market rates.
Hedging instruments consist of interest rate swaps used to modify the
interest rate sensitivity of certain short-term certificates of deposit,
a portion of the Bank's securities sold under agreements to repurchase
and the short-term FHLB advances. Fair values are based on quoted market
prices or dealer quotes. Where such quotes are not available, fair value
is estimated by using quoted market prices for similar securities or by
discounting future cash flows at a risk-adjusted spread to the
LIBOR-based swap curve.
Commitments to Extend Credit, and Standby and Commercial Letters of
Credit - The fair values of commitments to extend credit and standby
letters of credit were not significant at either December 31, 2001 or
2000, as these instruments predominantly have adjustable terms and are
of a short-term nature.
F-31
The fair value estimates presented herein are based on pertinent
information available to management as of each reporting date. Although
management is not aware of any factors that would significantly affect
the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements
since that date, and therefore, current estimates of fair value may
differ significantly from the amounts presented herein.
16. RELATED-PARTY TRANSACTIONS
The Bank has contracted with SBA to provide investment advisory services
and interest rate risk analysis. Certain stockholders of the Company are
also principals and employees of SBA. The amount of consulting expense
relating to SBA for the years ended December 31, 2001, 2000 and 1999 was
approximately $295, $286 and $284, respectively.
In the ordinary course of business, the Bank has granted loans to principal
officers and directors and their affiliates amounting to $1,976 and $2,236
at December 31, 2001 and 2000, respectively. The following table is a
rollforward of the related party loan activity.
2001 2000
Beginning balance $ 2,236 $ 1,311
Additions 20 1,846
Repayments 280 921
------- -------
Ending balance $ 1,976 $ 2,236
======= =======
Included in the 2000 additions and repayments is a loan for $600 granted in
March 2000 by the Bank to Smith Breeden at an interest rate of 10% with a
maturity of April 2001. The loan was paid off in September 2000.
17. ACQUISITIONS
On November 3, 2001, Los Padres Bank purchased Harrington Bank of Kansas, a
bank located in Shawnee Mission, Kansas. Harrington Bank, FSB was a wholly
owned subsidiary of Harrington Financial Group, a related party. The
largest common shareholders of the former Harrington Financial Group, Inc.,
which include the Chairman and Chief Executive Officer, are also the
largest common shareholders of Harrington West Financial Group. The
acquisition was considered arms-length since both the Company and
Harrington Bank, FSB obtained fairness opinions on the transaction from
investment bankers, and independent committees of Los Padres Bank and
Harrington Bank, FSB, which did not include the Chairman and Chief
Executive Officer, negotiated these transactions. The bank was purchased
based on Los Padres Bank's knowledge of Harrington Bank of Kansas's
management, markets and its loan portfolio to efficiently utilize Los
Padres Bank's interstate banking powers, and for its high financial return
potential. The acquisition was accounted for under the purchase method of
accounting, and the income statement of the combined entity includes the
results of operations of the acquired entity since the acquisition date.
F-32
The following table summarizes the fair values of assets and liabilities
and their related premiums at the date of acquisition:
BOOK VALUES OF FAIR VALUES OF
ASSETS ACQUIRED ASSETS ACQUIRED PREMIUMS AT
AND LIABILITIES AND LIABILITIES DATE OF
ASSUMED ASSUMED ACQUISITION
Loans receivable, net $69,870 $71,569 $ 1,699
Intangible assets subject to amortization 937 937
Intangible assets not subject to amortization 100 100
Other assets 5,894 5,894
------- ------- -------
Total assets 75,764 78,500 2,736
------- ------- -------
Deposits 74,431 75,796 1,365
Other liabilities 1,333 1,333
------- ------- -------
Total liabilities 75,764 77,129 1,365
------- ------- -------
Net asset value 1,371
Purchase price:
Cash consideration 5,000
Direct costs 188
-------
Total purchase price 5,188
-------
Goodwill $ 3,817
=======
The $937 of core deposit intangible assets subject to amortization noted
above relates to the fair value of non-maturing deposits related to their
below market rate attributes which will be amortized over a 10-year period
and subject to periodic impairment tests. The $100 in intangible assets
not subject to amortization is related to the trade name of Harrington
Bank of Kansas, which will be subject to periodic impairment tests. As the
Harrington Bank of Kansas acquisition was considered a taxable
transaction, the entire $3,817 of goodwill is tax deductible.
On February 1, 1999, Los Padres Bank purchased, for $980,000, a 49%
interest in Harrington Wealth Management Company ("HWMC"). HWMC was
established as a joint venture to offer trust and investment management
services to the customers of Los Padres Bank and Harrington Bank, FSB.
Harrington Bank, FSB, which was the wholly owned subsidiary of Harrington
Financial Group, owned the other 51% interest. The largest common
shareholders of the Company, which include the Chairman and Chief
Executive Officer of the Company and formerly the Chief Executive Officer
of Harrington Financial Group, were also the largest common shareholders
of Harrington Financial Group. On October 31, 2001, Los Padres Bank
purchased the remaining 51% interest in HWMC for $776,000. Both Los Padres
Bank and Harrington Bank, FSB engaged separate, unrelated counsel to
assist the transaction. Additionally, both entities formed independent
committees, which excluded the Chief Executive Officer of the Company and
Harrington Financial Group, to review the fairness of the transaction. No
goodwill was recorded in this transaction since the fair value of the
consideration paid was equal to the book value of the net assets acquired.
Prior to the purchase of the 51% interest on October 31, 2001, the income
or loss recognized on the Company's joint venture investment was
immaterial.
F-33
During 1997, the Company acquired all the assets and liabilities of U.S.
Community Savings Bank. This acquisition was accounted for under the
purchase method of accounting, and accordingly, all assets and liabilities
were adjusted to and recorded at their estimated fair values as of the
acquisition date. On February 8, 2000, the Bank sold the two branches and
deposits associated with the 1997 acquisition of U.S. Community Savings
Bank. The Bank sold the deposits at a 5.76% premium, recognizing a $3,923
gain on sale, which included approximately $406 of remaining unamortized
negative goodwill that was written off as a result of the transaction.
In November 1997, the Company purchased the deposits of two branches from
another financial institution that included deposits of approximately
$48,956 for which the Bank paid a premium of $1,000. The unamortized core
deposit premium related to this acquisition is $583 and $683 as of
December 31, 2001 and 2000, respectively.
The carrying values for all other purchased assets and liabilities
approximated their fair values at the acquisition dates.
The premiums on loans are amortized on a loan-by-loan basis using the
straight-line method over the remaining lives of the loans. Premiums on
deposits are amortized using the straight-line method over the
weighted-average maturity of such deposits. Premiums on FHLB advances are
amortized using the level-yield method over the life of each advance.
In July 2001, the FASB issued two new pronouncements: SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 requires that the purchase method of accounting be
used for all business combinations completed after June 30, 2001 and also
specifies the types of acquired intangible assets that are required to be
recognized and reported separately from goodwill and those acquired
intangible assets that are required to be included in goodwill. SFAS No.
142 requires that goodwill no longer be amortized, but instead be tested
for impairment at least annually. Additionally, SFAS No. 142 requires
recognized intangible assets to be amortized over their respective
estimated useful lives and reviewed for impairment in accordance with SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, as superseded by SFAS No. 144. Any
recognized intangible asset determined to have an indefinite useful life
will not be amortized, but instead must be tested for impairment until its
life is determined to no longer be indefinite. We adopted the new rules on
accounting for goodwill and other intangible assets on January 1, 2002.
At adoption and at June 30, 2002, we have a $100 intangible asset related
to the trade name associated with the purchase of Harrington Bank of
Kansas that will no longer be amortized and is subject to annual
impairment testing. During the six months ended June 30, 2002, we
evaluated our existing intangible assets to make any necessary
reclassifications in order to conform to the new requirements. We
reassessed the useful life and the residual value of our intangible assets
and concluded that the useful life will remain the same and no
amortization adjustment was necessary. As of June 30, 2002, intangible
assets that continue to be subject to amortization include core deposits
of $1,408 (net of $529 of accumulated amortization). Estimated
amortization expenses for the remainder of 2002 and the five succeeding
fiscal years follows:
F-34
2002 (remaining six months) $ 97
2003 194
2004 194
2005 194
2006 194
2007 177
Furthermore, in connection with the transitional impairment evaluation,
SFAS No. 142 requires us to perform an assessment of whether there was an
indication that goodwill was impaired as of January 1, 2002. The
transitional assessment consisted of the following steps: (1) identifying
reporting units, (2) determining the carrying value of each reporting unit
to be assigned the assets and liabilities, including the existing goodwill
and intangible assets to those reporting units, and (3) determining the
fair value of each reporting unit. The transitional goodwill impairment
test was completed during the six months ended June 30, 2002. No
transitional impairment loss was recorded by the Company resulting from
the adoption of this standard.
The following table sets forth a reconciliation of net income and earnings
per share information, for the six months ended June 30, 2002 and 2001 and
the years ended December 31, 2001, 2000 and 1999:
PRO FORMA RESULTS SIX MONTHS ENDED
JUNE 30
(UNAUDITED) DECEMBER 31
--------------------------- ---------------------------------------------
2002 2001 2001 2000 1999
Reported net income $ 2,318 $ 2,002 $ 3,802 $ 2,581 $ 2,360
Add back: Goodwill amortization 11 22 20 (10)
--------- --------- --------- --------- ---------
Adjusted net income $ 2,318 $ 2,013 $ 3,824 $ 2,601 $ 2,350
========= ========= ========= ========= =========
Basic earnings per share:
Reported net income $ 0.69 $ 0.61 $ 1.14 $ 0.79 $ 0.73
Goodwill amortization 0.01 0.01 (0.01)
--------- --------- --------- --------- ---------
Adjusted net income $ 0.69 $ 0.61 $ 1.15 $ 0.80 $ 0.72
========= ========= ========= ========= =========
Diluted earnings per share:
Reported net income $ 0.67 $ 0.60 $ 1.12 $ 0.77 $ 0.71
Goodwill amortization 0.01 0.01
--------- --------- --------- --------- ---------
Adjusted net income $ 0.67 $ 0.60 $ 1.13 $ 0.78 $ 0.71
========= ========= ========= ========= =========
18. EMPLOYEE BENEFIT PLAN
The Company sponsors a defined contribution plan for the benefit of its
employees. The Company's contributions to the plan are determined annually
by the Board of Directors in accordance with plan requirements. For tax
purposes, eligible participants may contribute up to a maximum of 15% of
their compensation, not to exceed the dollar limit imposed by the Internal
Revenue Service. For the plan years ended December 31, 2001 and 2000, the
Company contributed $273 and $191, respectively.
F-35
19. PARENT COMPANY ONLY FINANCIAL INFORMATION
CONDENSED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
-----------------------
2001 2000
ASSETS
Cash and cash equivalents $ 473 $ 566
Trading account assets 140 392
Investment in subsidiaries 47,460 33,585
Other assets 314 312
------- -------
TOTAL $48,387 $34,855
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Note payable $18,000 $ 9,000
Accounts payable and other liabilities 243 298
------- -------
Total liabilities 18,243 9,298
------- -------
Stockholders' Equity:
Preferred stock, $.01 par value; 1,000,000 shares authorized;
none issued and outstanding
Common stock, $.01 par value; 9,000,000 shares authorized; 3,354,336 shares
issued and outstanding as of December 31,
2001 and 3,246,789 shares as of December 31, 2000 34 33
Additional paid-in capital 20,305 19,573
Retained earnings 9,175 5,726
Accumulated other comprehensive income, net of tax 630 225
------- -------
Total stockholders' equity 30,144 25,557
------- -------
TOTAL $48,387 $34,855
======= =======
F-36
CONDENSED STATEMENTS OF EARNINGS
YEAR ENDED DECEMBER 31,
-------------------------------------------
2001 2000 1999
Interest income $ 1 $ 1 $ 4
Interest expense (692) (884) (679)
------- ------- -------
Net interest income (691) (883) (675)
Other income 281 (67) 17
Other expense (594) (440) (426)
------- ------- -------
Loss before income taxes and equity in subsidiaries (1,004) (1,390) (1,084)
Income tax benefit 413 572 455
------- ------- -------
Loss before equity in subsidiary (591) (818) (629)
Equity in net earnings of subsidiary 4,393 3,399 2,989
------- ------- -------
Net income $ 3,802 $ 2,581 $ 2,360
======= ======= =======
F-37
CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
----------------------------------------
2001 2000 1999
Cash Flows from Operating Activities:
Net income $ 3,802 $ 2,581 $ 2,360
Adjustments:
Equity in net undistributed earnings of subsidiary (4,393) (3,399) (2,989)
Sale of trading assets 330
Purchase of trading assets (480)
(Increase) decrease in unrealized gain in trading assets (78) 88
Amortization and depreciation 20 5
(Increase) decrease in other assets (22) 52 (211)
(Decrease) increase in accounts payable and
other liabilities (55) 479 (108)
Other 106
------- ------- -------
Net cash used in operating activities (290) (674) (948)
------- ------- -------
Cash Flows from Investing Activities:
Net increase in investment securities
Purchase of furniture, fixtures and equipment (37)
------- ------- -------
Net cash used in investing activities (37)
------- ------- -------
Cash Flows from Financing Activities:
Net proceeds from exercise of stock options 628
Cash contribution to subsidiary (9,578) (1,000)
Cash dividends received from Bank 500 1,500 1,500
Cash dividends paid (353) (985)
Increase (decrease) in notes payable 9,000 1,335 (535)
------- ------- -------
Net cash provided by financing activities 197 850 965
------- ------- -------
Net (decrease) increase in cash and cash equivalents (93) 139 17
Cash and cash equivalents, beginning of year 566 427 410
------- ------- -------
Cash and cash equivalents, end of year $ 473 $ 566 $ 427
======= ======= =======
20. SUBSEQUENT EVENTS
STOCK SPLIT - The accompanying consolidated financial statements reflect a
3-for-1 split of the Company's common stock, distributed in the form of a
stock dividend on September 25, 2002 to shareholders of record on
September 11, 2002. All share and per share information herein has been
retroactively restated to reflect this split. The accompanying
consolidated financial statements also reflect an increase in its
authorized capital shares from 3,000,000 to 10,000,000,which occurred
contemporaneously with the stock split. Of the 10,000,000 shares
authorized, 1,000,000 shares is reserved for preferred stock.
F-38
JOINT VENTURE AGREEMENT - In August 2002, the Bank entered into a joint
venture agreement with Market Resources, Inc., the owner of numerous REMAX
brokerage agencies in the Phoenix and Scottsdale, Arizona, metropolitan
areas. Under the agreement, the Bank established Los Padres Mortgage
L.L.C. as a 51%-owned mortgage banking subsidiary. Los Padres Mortgage
L.L.C. will originate single-family residential and commercial real estate
loans primarily for sale to third party investors. The Bank will also have
the opportunity to purchase select single-family and commercial real
estate loans from Los Padres Mortgage L.L.C. for its portfolio. Los Padres
Mortgage L.L.C. has not engaged in business to date.
On September 17, 2002, the terms of the Company's line of credit under its
loan facility were renegotiated to expand the revolving line of credit
commitment from $20,000 to $25,000, and modify certain covenants.
Specifically, the covenant that restricts our ability to invest in
mortgage derivative securities has been revised to allow us to maintain a
larger balance as of the last day of the month. The covenant that
restricts payment of cash dividends has been revised to allow us to pay
dividends in an aggregate amount not to exceed the greater of (a) $300
during any fiscal quarter, or (b) up to a maximum of 25% of consolidated
net income for the quarter. Additionally, the minimum core profitability
requirements have been slightly increased, and a new covenant requiring a
ratio of non-performing assets to stockholders' equity plus loan loss
reserves to not exceed .3 to 1 has been added.
******
F-39
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
1,400,000 SHARES
HARRINGTON WEST
FINANCIAL GROUP, INC. [HARRINGTON WEST LOGO]
COMMON STOCK
------------------------------
PRICE $ PER SHARE
------------------------------
RBC CAPITAL MARKETS
------------------------------
, 2002
------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
SEC registration fee........................................................ $ 1,932
Nasdaq listing fee.......................................................... 105,000
NASD filing fee............................................................. 2,600
Legal fees and expenses..................................................... 150,000*
Accounting fees and expenses................................................ 150,000*
Printing.................................................................... 35,000*
Miscellaneous expenses...................................................... 50,468*
---------
Total.................................................................... $ 495,000*
==========
* Estimated.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Our certificate of incorporation contains a provision permitted by
Delaware law that generally eliminates the personal liability of directors for
monetary damages for breaches of their fiduciary duties, unless the director has
breached his or her duty of loyalty, failed to act in good faith, engaged in
intentional misconduct or a knowing violation of law, paid a dividend or
approved a stock repurchase in violation of the Delaware General Corporation Law
or obtained an improper personal benefit.
Our bylaws provide that we shall indemnify our directors, officers,
employees or agents to the fullest extent permitted by Delaware law, provided,
however, the we are not liable for any amounts which may be due any person in
connection with a settlement of any action, suit or proceeding effected without
our prior written consent or any action, suit or proceeding initiated by any
person seeking indemnification hereunder without our prior written consent. Our
bylaws also provide for the advancement of expenses to our directors, officers
and employees in defending any civil, criminal, administrative or investigative
action, as authorized by our board of directors.
In addition, our bylaws provide that the right of directors, officers
and employees to indemnification shall be a contract right and shall not be
exclusive of any other rights now possessed or hereafter acquired under our
certificate of incorporation, any agreement, vote of stockholders or
disinterested directors or otherwise. We also have directors' and officers'
insurance against certain liabilities.
Section 145 of the General Corporation Law of Delaware, which governs
indemnification of officers, directors, employees and agents, and insurance is
set forth below.
SECTION 145 INDEMNIFICATION OF OFFICERS, DIRECTORS, EMPLOYEES AND
AGENTS; INSURANCE
(a) A corporation shall have power to indemnify any person who
was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding, whether
civil, criminal, administrative or investigative (other than an action
by or in the right of the corporation) by reason of the fact that the
person is or was a director, officer, employee or agent of the
corporation, or is or was serving at the request of the corporation as
a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, against expenses
(including attorneys'
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fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by the person in connection with such action, suit
or proceeding if the person acted in good faith and in a manner the
person reasonably believed to be in or not opposed to the best
interests of the corporation, and, with respect to any criminal action
or proceeding, had no reasonable cause to believe the person's conduct
was unlawful. The termination of any action, suit or proceeding by
judgment, order, settlement, conviction, or upon a plea of nolo
contendere or its equivalent, shall not, of itself, create a
presumption that the person did not act in good faith and in a manner
which the person reasonably believed to be in or not opposed to the
best interests of the corporation, and, with respect to any criminal
action or proceeding, had reasonable cause to believe that the person's
conduct was unlawful.
(b) A corporation shall have power to indemnify any person who
was or is a party or is threatened to be made a party to any
threatened, pending or completed action or suit by or in the right of
the corporation to procure a judgment in its favor by reason of the
fact that the person is or was a director, officer, employee or agent
of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise
against expenses (including attorneys' fees) actually and reasonably
incurred by the person in connection with the defense or settlement of
such action or suit if the person acted in good faith and in a manner
the person reasonably believed to be in or not opposed to the best
interests of the corporation and except that no indemnification shall
be made in respect of any claim, issue or matter as to which such
person shall have been adjudged to be liable to the corporation unless
and only to the extent that the Court of Chancery or the court in which
such action or suit was brought shall determine upon application that,
despite the adjudication of liability but in view of all the
circumstances of the case, such person is fairly and reasonably
entitled to indemnity for such expenses which the Court of Chancery or
such other court shall deem proper.
(c) To the extent that a present or former director or officer
of a corporation has been successful on the merits or otherwise in
defense of any action, suit or proceeding referred to in subsections
(a) and (b) of this section, or in defense of any claim, issue or
matter therein, such person shall be indemnified against expenses
(including attorneys' fees) actually and reasonably incurred by such
person in connection therewith.
(d) Any indemnification under subsections (a) and (b) of this
section (unless ordered by a court) shall be made by the corporation
only as authorized in the specific case upon a determination that
indemnification of the present or former director, officer, employee or
agent is proper in the circumstances because the person has met the
applicable standard of conduct set forth in subsections (a) and (b) of
this section. Such determination shall be made, with respect to a
person who is a director or officer at the time of such determination,
(1) by a majority vote of the directors who are not parties to such
action, suit or proceeding, even though less than a quorum, or (2) by a
committee of such directors designated by majority vote of such
directors, even though less than a quorum, or (3) if there are no such
directors, or if such directors so direct, by independent legal counsel
in a written opinion, or (4) by the stockholders.
(e) Expenses (including attorneys' fees) incurred by an
officer or director in defending any civil, criminal, administrative or
investigative action, suit or proceeding may be paid by the corporation
in advance of the final disposition of such action, suit or proceeding
upon receipt of an undertaking by or on behalf of such director or
officer to
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repay such amount if it shall ultimately be determined that such person
is not entitled to be indemnified by the corporation as authorized in
this section. Such expenses (including attorneys' fees) incurred by
former directors and officers or other employees and agents may be so
paid upon such terms and conditions, if any, as the corporation deems
appropriate.
(f) The indemnification and advancement of expenses provided
by, or granted pursuant to, the other subsections of this section shall
not be deemed exclusive of any other rights to which those seeking
indemnification or advancement of expenses may be entitled under any
bylaw, agreement, vote of stockholders or disinterested directors or
otherwise, both as to action in such person's official capacity and as
to action in another capacity while holding such office.
(g) A corporation shall have power to purchase and maintain
insurance on behalf of any person who is or was a director, officer,
employee or agent of the corporation, or is or was serving at the
request of the corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other
enterprise against any liability asserted against such person and
incurred by such person in any such capacity, or arising out of such
person's status as such, whether or not the corporation would have the
power to indemnify such person against such liability under this
section.
(h) For purposes of this section, references to "the
corporation" shall include, in addition to the resulting corporation,
any constituent corporation (including any constituent of a
constituent) absorbed in a consolidation or merger which, if its
separate existence had continued, would have had power and authority to
indemnify its directors, officers, and employees or agents, so that any
person who is or was a director, officer, employee or agent of such
constituent corporation, or is or was serving at the request of such
constituent corporation as a director, officer, employee or agent of
another corporation, partnership, joint 'venture, trust or other
enterprise, shall stand in the same position under this section with
respect to the resulting or surviving corporation as such person would
have with respect to such constituent corporation if its separate
existence bad continued.
(i) For purposes of this section, references to "other
enterprises" shall include employee benefit plans; references to
"fines" shall include any excise taxes assessed on a person with
respect to any employee benefit plan; and references to "serving at the
request of the corporation" shall include any service as a director,
officer, employee or agent of the corporation which imposes duties on,
or involves services by, such director, officer, employee, or agent
with respect to an employee benefit plane its participants or
beneficiaries; and a person who acted in good faith and in a manner
such person reasonably believed to be in the interest of the
participants and beneficiaries of an employee benefit plan shall be
deemed to have acted in a manner "not opposed to the best interests of
the corporation" as referred to in this section.
(j) The indemnification and advancement of expenses provided
by, or granted pursuant to, this section shall, unless otherwise
provided when authorized or ratified, continue as to a person who has
ceased to be a director, officer, employee or agent and shall inure to
the benefit of the heirs, executors and administrators of such a
person.
(k) The Court of Chancery is hereby vested with exclusive
jurisdiction to hear and determine all actions for advancement of
expenses or indemnification brought under
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this section or under any bylaw, agreement, vote of stockholders or
disinterested directors, or otherwise. The Court of Chancery may
summarily determine a corporation's obligation to advance expenses
(including attorneys' fees). (Last amended by Ch. 120, L. '97, eff.
7-1-97.)
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of ours in which indemnification would be
required or permitted. We believe that our insurance against certain
liabilities, together with the limitation of liability and indemnification of
our certificate of incorporation and bylaws are necessary to attract and retain
qualified persons as directors, officers and employees.
The Securities and Exchange Commission has advised us that, in its
opinion, any indemnification of our directors and officers for liabilities
arising under the Securities Act of 1933, as amended, is against public policy
as expressed in the Act and is therefore unenforceable.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
From time to time we have granted stock options to our directors and
employees in reliance upon an exemption under the Securities Act of 1933
pursuant to Rule 701. The following table sets forth certain information
regarding these grants:
Range of
Number of Exercise
Period Shares Price(1)
- ------------------------------------------------------------------ --------------- ---------------
January 1, 1999 through December 31, 1999........................ 109,500 $8.33
January 1, 2000 through December 31, 2000........................ -- --
January 1, 2001 through December 31, 2001........................ 75,003(2) $5.83-$8.33
January 1, 2002 through June 30, 2002............................ 59,025 $9.33-$10.50
- -----------------
(1) Reflects 3:1 stock split paid immediately prior to this
offering.
(2) This total includes an option to purchase 42,453 shares whose
termination date was extended by the Registrant from April 2001 to June 2003.
Between January 1, 1999 and June 30, 2002, an aggregate of 201,075
shares of common stock were issued to our employees and directors pursuant to
the exercise of options at a weighted average exercise price of $8.66 per share.
These shares were issued in reliance on an exemption under the Securities Act of
1933 pursuant to Rule 701.
Immediately prior to the effective date of this registration statement,
we will effect a split of our common stock. In the stock split, each share of
our common stock will be converted into three shares of common stock. We will
issue the new shares in exchange for shares held by our existing stockholders.
No commissions or remuneration will be paid or given directly or indirectly in
connection with the stock split. Accordingly, this transaction will be exempt
from registration under Section 3(A)(9) of the Securities Act.
No underwriters were involved in connection with the sales of
securities referred to in this Item 15.
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ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
The exhibits and financial statement schedules filed as a part of this
Registration Statement are as follows:
(a) List of Exhibits:
EXHIBIT NO. EXHIBIT
---------- -------
1.0 Form of Underwriting Agreement*
3.1 Certificate of Incorporation of Harrington West Financial Group,
Inc.*
3.1.1 Certificate of Amendment to Certificate of Incorporation*
3.1.2 Second Certificate of Amendment to Certificate of Incorporation*
3.2 Bylaws of Harrington West Financial Group, Inc.*
3.2.1 Amendment to Bylaws*
4.0 Specimen stock certificate of Harrington West Financial Group,
Inc.*
5.0 Opinion of Kelley Drye & Warren LLP*
10.1 Harrington West Financial Group 1996 Stock Option Plan, as
amended.*
10.2 Amended and Restated Credit Agreement dated as of October 30, 1997
among Harrington West Financial Group, Inc., the lenders party thereto
and Harris Trust and Savings Bank, as amended on October 1, 1999,
May 2, 2000 and November 1, 2001.*
10.2.1 Fourth Amendment to Amended and Restated Credit Agreement dated
September 17, 2002.*
10.3 Investment and Interest Rate Advisory Agreement between Los
Padres Savings Bank, FSB and Smith Breeden Associates, Inc.,
dated February 3, 1997.*
10.4 Purchase and Assumption Agreement by and between Los Padres Bank,
FSB and Harrington Bank, FSB dated as of May 30, 2001.*
10.5 Los Padres Mortgage Company, LLC Operating Agreement by and
between Resource Marketing Group, Inc. and Los Padres Bank FSB
dated June 13, 2002*
10.6 Option Agreement, dated as of April 4, 1996 by and between Smith
Breedon Associates, Inc. and Harrington West Financial Group,
Inc. Assignment of Option, dated as of January 19, 2001, by and
between Craig Cerny.*
10.7 Stock Purchase Agreement by and between Harrington Bank, FSB and
Los Padres Bank, FSB dated as of May 30, 2001.*
21.0 Subsidiaries of the registrant
23.1 Consent of Deloitte & Touche, LLP
23.2 Consent of Kelley Drye & Warren LLP (included within Exhibit 5.1)*
24.0 Power of Attorney (included on signature page to Registration
Statement).*
- ---------------
* Previously filed.
(b) Financial Statement Schedules.
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All schedules have been omitted as not applicable or not
required under the rules of Regulation S-X.
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes:
(1) For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as part
of this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act of 1933 shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment shall be deemed to be a
new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the provisions described under Item 15
above, or otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the Registrant will,
unless in the opinion of our counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
(4) The undersigned registrant hereby undertakes to provide to the
underwriter at the closing specified in the underwriting agreements,
certificates in such denominations and registered in such names as required by
the underwriter to permit prompt delivery to each purchaser.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
Registrant has duly caused this Amendment No. 3 to the Registration Statement to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Solvang, State of California on the 1st day of November of 2002.
HARRINGTON WEST FINANCIAL GROUP, INC.
By: /s/ CRAIG J. CERNY
---------------------------------
Craig J. Cerny
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
/s/ CRAIG J. CERNY
-------------------------- November 1, 2002
Craig J. Cerny Chief Executive Officer
(Principal Executive Officer)
/s/ WILLIAM W. PHILLIPS, JR.
-------------------------- November 1, 2002
William W. Phillips, Jr. President and Director
/s/ SEAN CALLOW*
------------------------- November 1, 2002
Sean Callow Senior Vice President and Chief Financial
Officer (Principal Financial Officer and
Principal Accounting Officer)
/s/ STANLEY J. KON*
------------------------- November 1, 2002
Stanley J. Kon Director
/s/ JOHN J. MCCONNELL*
------------------------- November 1, 2002
John J. McConnell Director
/s/ PAUL O. HALME*
------------------------- November 1, 2002
Paul O. Halme Director
/s/ WILLIAM D. ROSS*
------------------------- November 1, 2002
William D. Ross Director
- ----------
* By Craig Cerny pursuant to Power of Attorney
II - 7