SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual report pursuant to Section 13 of the
Securities Exchange Act of 1934, as amended
For the fiscal year ended December 31, 1996
Commission File No.: 0-24802
MONTEREY BAY BANCORP, INC.
(exact name of registrant as specified in its charter)
DELAWARE 77-0381362
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
36 Brennan Street, Watsonville, California 95076
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 722-3885
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of
the Act:
Common Stock, par value $0.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K.
---
The aggregate market value of the voting stock held by non-affiliates
of the registrant, i.e., persons other than the directors and executive officers
of the registrant, was $61,542,969, based upon the last sales price as quoted on
the Nasdaq Stock Market for March 21, 1997.
The number of shares of Common Stock outstanding as of March 21, 1997:
3,593,750
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1997 Annual Meeting of Stockholders are
incorporated by reference into Part III of this Form 10-K.
Portions of the Annual Report to Stockholders for the year ended December 31,
1996 are incorporated by reference into Part II of this Form 10-K.
INDEX
PAGE
PART I
Item 1. Description of Business.................................... 1
Item 2. Properties................................................. 39
Item 3. Legal Proceedings.......................................... 40
Item 4. Submission of Matters to a Vote of Security Holders........ 40
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters........................................ 40
Item 6. Selected Financial Data.................................... 40
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 40
Item 8. Financial Statements and Supplementary Data................ 41
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure..................... 41
PART III
Item 10. Directors and Executive Officers of the Registrant......... 41
Item 11. Executive Compensation..................................... 41
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................. 41
Item 13. Certain Relationships and Related Transactions............. 41
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K................................................ 42
PART I
Item 1. Description of Business.
General
Monterey Bay Bancorp, Inc. (the "Company"), a Delaware corporation, is
a savings and loan holding association incorporated in 1995. The Company's
principal business activities consist of the operation of its wholly owned
subsidiary, Monterey Bay Bank (the "Bank"), formerly Watsonville Federal Savings
and Loan Association. Unless otherwise specified herein, references to the
business and operations of the Bank refer to the business and operations of the
Company. The Bank's principal business is attracting retail deposits from the
general public in the area surrounding its branch offices and investing those
deposits, together with funds generated from operations and borrowings, in one-
to four-family residential mortgage loans and, to a lesser extent, in
multi-family, commercial real estate, construction, land and other mortgage
loans. As part of its ongoing operating strategy, the Bank has been diversifying
its loan portfolio by moderately increasing the amount of multi-family,
construction, and commercial real estate lending in its primary market area. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Management Strategy." Loan sales come from loans which have been
designated as held for sale at origination. The Bank retains virtually all the
servicing rights of loans sold. The Bank's revenues are derived principally from
interest on its mortgage loans, and to a lesser extent, interest and dividends
on its investment securities and mortgage backed securities. The Bank's primary
source of funds are deposits, principal and interest payments on loans, advances
from the Federal Home Loan Bank ("FHLB") and to a lesser extent, proceeds from
the sale of loans. Through its wholly-owned subsidiary, Portola Investment
Corporation ("Portola"), the Bank engages in the sale of noninsured insurance
and investment products on an agency basis and acts as trustee on the Bank's
deeds of trust. See "Subsidiary Activities."
Market Area and Competition
The Bank is a community-oriented financial institution which primarily
originates one- to four-family residential mortgage loans within its market
area. The Bank's deposit gathering and lending markets are concentrated in the
communities surrounding its full service offices in Santa Cruz, Monterey and
portions of Santa Clara counties in Central California. The economy in the
Company's primary market area is predominantly agricultural, with some light
manufacturing and tourism industry in the coastal communities on Monterey Bay.
Despite a moderate weakening in real estate values in its primary market area
since 1991, the economic performance in the Company's primary market area
typically mirrors the national economy and shows seasonal economic fluctuations.
The Company faces significant competition both in making loans and in
attracting deposits. The Company's competitors are the financial institutions
operating in its primary market area, many of which are significantly larger and
have greater financial resources than the Company. The Company's competition for
loans comes principally from commercial banks, savings and loan associations,
mortgage banking companies, credit unions and insurance companies. Its most
direct competition for deposits has historically come from savings and loan
associations and commercial banks. In addition, the Company faces increasing
competition for deposits from nonbank institutions such as brokerage firms and
insurance companies in such areas as short-term money market funds, corporate
and government securities funds, mutual funds and annuities. Competition may
also increase as a result of the lifting of restrictions on the interstate
operations of financial institutions.
The Company serves its market area with a variety of mortgage loan
products and other retail financial services. Management considers the Company's
reputation for financial strength and competitive deposit and loan products as
its major competitive advantage in attracting and retaining customers in its
market area.
1
Lending Activities
Loan Portfolio Composition. The Company's loan portfolio consists
primarily of conventional first mortgage loans secured by one- to four-family
residences. At December 31, 1996, the Company had total gross loans outstanding
of $236.5 million, of which $201.6 million, or 85.2% were one- to four-family,
residential mortgage loans which were primarily owner-occupied. The remainder of
the portfolio consisted of $22.5 million, or 9.5% of multi-family mortgage
loans; $7.5 million, or 3.2% of commercial real estate loans; $4.2 million, or
1.8% of construction and land loans; and nonmortgage loans of $.7 million, or
.3% of total loans. Approximately $9.8 million of the multi-family mortgage
loans were purchased during the period from September 1993 through February 1994
and are secured by apartment buildings located in the greater San Francisco Bay
Area. The Company had $130,000 in loans held for sale at December 31, 1996. At
that same date, 63% of the Company's mortgage loans had adjustable interest
rates. Of the Company's adjustable rate mortgage loans, 47% were indexed to
current market indices and 53% were indexed to the 11th FHLB District Cost of
Funds Index ("11th District Cost of Funds"). At December 31, 1996, 86.7% of the
Company's adjustable rate loans were adjustable within one year. The remainder
had terms to adjustment ranging from one year to five years.
The types of loans that the Company may originate are subject to
federal and state law and regulations. Interest rates charged by the Company on
loans are affected by the demand for such loans and the supply of money
available for lending purposes and the rates offered by competitors. These
factors are, in turn, affected by, among other things, economic conditions,
monetary policies of the federal government, including the Federal Reserve
Board, and legislative tax policies.
2
The following table sets forth the composition of the Company's loan
portfolio in dollar amounts and as a percentage of the portfolio at the dates
indicated.
At December 31,
---------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------------ ------------------ ------------------ ------------------- -----------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
-------- -------- -------- -------- ------ -------- -------- -------- ------- --------
(Dollars in thousands)
Real estate:
Residential:
One- to four-family...... $201,579 85.22% $199,917 86.29% $216,872 88.36% $166,654 85.64% $86,189 88.99%
Multi-family............. 22,455 9.49% 21,503 9.28% 22,231 9.06% 19,052 9.79% 5,267 5.44%
Commercial real estate...... 7,524 3.18% 4,191 1.81% 2,903 1.18% 2,724 1.40% 1,901 1.96%
Construction and land....... 4,226 1.79% 5,476 2.36% 2,947 1.20% 5,701 2.93% 3,237 3.34%
Other(1)...................... 763 .32% 605 .26% 503 .20% 475 .24% 260 .27%
-------- ------- -------- ------- -------- ------- -------- ------- ------- -------
Total loans.............. 236,547 100.00% 231,692 100.00% 245,456 100.00% 194,606 100.00% 96,854 100.00%
======= ======= ======= ======= =======
Plus (Less):
Undisbursed loan funds...... (1,822) (1,895) (1,178) (3,116) (2,089)
Unamortized premium, net.... 452 651 1,006 1,380 -
Deferred loan fees, net..... (528) (607) (971) (905) (1,053)
Allowance for loan losses... (1,311) (1,362) (808) (387) (167)
-------- -------- -------- -------- -------
Total loans, net......... 233,338 228,479 243,505 191,578 93,545
Less:
Loans held for sale:
One- to four-family(2)...... (130) (92) (16,082) (58,875) -
-------- -------- -------- -------- -------
Total loans held for
investment.............. $233,208 $228,387 $227,423 $132,703 $93,545
======== ========= ======== ======== =======
- --------------------------------------
(1) Includes loans secured by savings accounts and unsecured loans.
(2) Loans classified as held for sale at December 31, 1993 were transferred to
loans held for investment in April 1994.
3
Loan Maturity: The following table shows the contractual maturities of the
Company's gross loans at December 31, 1996. The table includes loans held for
sale of $130,000. The table does not include principal repayments. Principal
repayments on total loans totaled $31.2 million for the year ended December 31,
1996.
At December 31, 1996
---------------------------------------------------------------------
One-to Total
Four- Multi- Construction Loans
Family Family Commercial and Land Other(1) Receivable
------ ------ ---------- ------------ -------- ----------
(In thousands)
Amounts due:
One year or less................................. $ 57 $ - $ - $ 4,131 $763 $4,951
-------- ------- ------ ------- ---- ------
After one year:
More than one year to three years............. 765 - 52 78 - 895
More than three years to five years........... 860 - 1,457 - - 2,317
More than five years to 10 years.............. 5,264 260 187 17 - 5,728
More than 10 years to 20 years................ 7,874 1,326 559 - - 9,759
More than 20 years............................ 186,759 20,869 5,269 - - 212,897
------- ------ ----- ------- ---- -------
Total due after December 31, 1997............. 201,522 22,455 7,524 95 - 231,596
------- ------ ----- ------- ---- -------
Total amount due.............................. 201,579 22,455 7,524 4,226 763 236,547
------- ------ ----- ------- ---- -------
Less:
Undisbursed loan funds................. - - - (1,822) - (1,822)
Unamortized (discounts) premiums....... 491 (39) - - - 452
Deferred loan fees, net................ (452) (50) (17) (9) - (528)
Allowance for loan losses.............. (911) (171) (174) (20) (35) (1,311)
----- ----- ----- ------- ---- -------
Total loans, net.............................. 200,707 22,195 7,333 2,375 728 233,338
Loans held for sale........................... (130) - - - - (130)
----- ------- ------ ------- ----- -----
Loans receivable held for investment.......... $200,577 $22,195 $7,333 $ 2,375 $728 $233,208
======== ======= ====== ======= ==== ========
- ------------------------------
(1) Includes loans secured by savings accounts and unsecured loans.
4
The following table sets forth at December 31, 1996, the dollar amount
of gross loans receivable contractually due after December 31, 1997, and whether
such loans have fixed interest rates or adjustable interest rates.
Due After December 31, 1997
Fixed Adjustable Total
----- ---------- -----
(In thousands)
Real estate loans:
One- to four-family................ $85,509 $116,013 $201,522
Multi-family....................... 914 21,514 22,255
Commercial real estate............. 97 7,427 7,524
Construction and land.............. 95 - 95
Other loans...........................
- - -
------- -------- --------
Total loans receivable......... $86,615 $144,981 $231,596
======= ======== ========
Origination, Purchase, Sale and Servicing of Loans. The Company's
mortgage lending activities are conducted primarily through its six branch
offices and approximately 25 wholesale loan brokers who regularly process
applications through the Company. Beginning in 1993, as part of its asset
redeployment and interest rate risk strategy, the Company purchased mortgage
loans originated by other institutions. The determination to purchase specific
loans or pools of loans is based upon criteria substantially similar to the
Company's underwriting policies which consider the financial condition of the
borrower, the location of the underlying property, and the appraised value of
the property, among other factors. As of December 31, 1996, $34.6 million, or
14.9% of the Company's net loans receivable had been purchased from other
financial institutions, primarily consisting of current index, adjustable rate
mortgage loans. Of this amount, 71.9% were one- to four-family residential loans
and 28.1% were multi-family loans. Between November, 1993 and February, 1994 the
Company purchased approximately $10.1 million of multi-family mortgage loans
secured by apartment buildings located in the Greater San Francisco Bay area.
All of the loans purchased had been recently originated and have interest rates
that adjust monthly to the 11th District Cost of Funds. The 11th District Cost
of Funds at December 31, 1996 was 4.84%. The Company did not purchase any loans
during the year ended December 31, 1996. During 1996, the Company entered into a
participation agreement with another financial institution to originate a land
improvement loan, of which the Company's share was $1.4 million. The Company did
not enter into any other participation agreements during the year ended December
31, 1996.
The Company originates both adjustable rate mortgage loans and fixed
rate mortgage loans. Its ability to originate loans is dependent upon the
relative customer demand for fixed rate or adjustable rate mortgage loans, which
is affected by the current and expected future level of interest rates. From
time to time the Company sells fixed rate conforming loans that it originates.
Such sales are dependent on current market rates and opportunities. During the
year ended December 31, 1996, the Company sold $2.6 million of fixed rate
conforming mortgage loans to FHLMC. During the year ended December 31, 1995, the
Company sold $18.5 million of adjustable rate mortgage loans that it originated
during 1994 and 1995 to another financial institution, pursuant to an agreement
which expired in early 1995. Similarly, the Company may sell adjustable rate
mortgage loans in the future, depending upon market opportunities and prevailing
interest rates at the time such a decision is made.
Effective December 1995, the Company adopted Statement of Financial
Accounting Standards No. 122 ("SFAS 122"), Accounting for Mortgage Servicing
Rights. SFAS 122 allows financial institutions that originate mortgages and sell
them into the secondary market to recognize the retained right to service the
loans. This rule amends SFAS 65, which permitted only purchased mortgage
servicing rights to be recognized as an asset. SFAS 122 makes no distinction
between purchased and originated mortgage servicing rights. During 1996 and
1995, the Company recorded $21,000 and $118,000, respectively, of originated
mortgage servicing rights.
5
The Company recognizes, at the time of sale, the cash gain or loss on
the sale of the loans based on the difference between the net cash proceeds
received and the carrying value of the loans sold. In addition, excess
servicing, which is the present value of any difference between the interest
rate charged to the borrower and the interest rate paid to the purchaser after
deducting a normal servicing fee, is recognizable as an adjustment to the cash
gain or loss. The excess servicing gain or loss is dependent on prepayment
estimates and discount rate assumptions. Historically, such excess servicing
gains or losses have not been material but may become more significant in future
periods. See "- Loan Servicing."
At December 31, 1996 and 1995, the Company was servicing loans for
others with unpaid principal of $61.3 million and $68.8 million, respectively.
Servicing loans for others generally consists of collecting mortgage payments,
maintaining escrow accounts, disbursing payments to investors, and conducting
foreclosure proceedings. Loan servicing income is recorded on the accrual basis
and includes servicing fees from investors and certain charges collected from
borrowers, such as late payment fees.
6
The following tables set forth the Company's loan originations,
purchases, sales and principal repayments information for the periods indicated:
For the Years Ended December 31,
-----------------------------------
1996 1995 1994
--------- -------- --------
(In thousands)
Gross loans(1):
Beginning balance....................... $229,841 $244,313 $191,965
Loans originated:
One- to four-family(2)(3)........ 27,768 38,630 108,423
Multi-family..................... 1,944 2,515 3,787
Commercial real estate........... 3,363 349 384
Construction and land............ 3,790 5,776 3,687
--------- --------- ---------
Total loans originated........ 36,865 47,270 116,281
Loans purchased..................... - - 3,988
--------- --------- ---------
Total......................... 266,706 291,583 312,234
Less:
Transfer to real estate owned....... 369 297 -
Principal repayments(4)............. 27,238 26,017 29,360
Sales of loans...................... 2,628 18,541 37,383
Securitized loans(5)................ - 14,992 -
Loans in process.................... 1,822 1,895 1,178
--------- --------- ---------
Total loans............................. 234,649 229,841 244,313
Less loans held for sale(2)......... 130 92 16,082
--------- --------- ---------
Ending balance held for investment...... $ 234,519 $ 229,749 $ 228,231
========= ========= =========
(1) Gross loans includes loans receivable held for investment and loans held
for sale, net of deferred loan fees, undisbursed loan funds and
unamortized premiums and discounts.
(2) During 1995, the Company transferred, at market value, $7.4 million of
loans held for sale to loans held for investment, and recorded a lower of
cost or market adjustment of $35,000 through earnings. During 1994, the
Company transferred $58.0 million of loans held for sale to loans held for
investment. At the time of transfer, the fair value of the loans equaled
their cost basis.
(3) Originations of one- to four-family loans decreased during the years ended
December 31, 1996 and 1995 compared to 1994 because of the substantial
increase in one- to four-family loan originations during 1994 to fulfill
an agreement to sell adjustable rate mortgage loans to another financial
institution.
(4) Principal repayments include amortization of premiums, net of discounts;
amortization of deferred loan fees; net changes in nonmortgage loans
receivable; and other adjustments.
(5) During 1995, the Company securitized $15.0 million of mortgage loans and
acquired mortgage backed securities in exchange.
7
One- to Four-Family Mortgage Lending. The Company offers both fixed
rate and adjustable rate mortgage loans secured by one- to four-family
residences, primarily owner-occupied, located in the Company's primary market
area, with maturities up to thirty years. Substantially all of such loans are
secured by property located in Central California. Loan originations are
generally obtained from existing or past customers and members of the local
communities. In addition, in 1993 and 1994, as part of its asset redeployment
and interest rate risk strategy, the Company purchased mortgage loans
originated by other institutions. The purchased loans consisted of
approximately $39.0 million loans secured by one- to four-family residences
located in Southern California, approximately $11.0 million in loans secured
by one- to four-family residences located in Central California and
approximately $10.1 million in loans secured by multi-family residences
located in Central California. See "Origination, Purchase, Sale and Servicing
of Loans."
At December 31, 1996, the Company's total loans outstanding were $236.5
million, of which $201.6 million, or 85.2%, were one- to four-family residential
mortgage loans. Of the one- to four-family residential mortgage loans
outstanding at that date, 37% were fixed rate loans and 63% were adjustable rate
mortgage loans. The interest rate for 53% of the Company's adjustable rate
mortgage loans are indexed to the 11th District Cost of Funds. The remaining 47%
of adjustable rate mortgage loans are indexed to current market indices. The
Company currently offers a number of adjustable rate mortgage loan programs with
interest rates which adjust monthly or semi-annually. In 1996, the Company also
offered a 25-year fixed rate affordable housing loan, an "easy qualifier" loan,
and 30-year adjustable rate loans with initial three- and five-year fixed rate
terms. In addition, the Company began originating loans subject to negative
amortization in 1996. Negative amortization involves a greater risk to the
Company because during a period of high interest rates the loan principal may
increase above the amount originally advanced. However, the Company believes
that the risk of default on these loans is mitigated by negative amortization
caps, underwriting criteria, relatively low loan to value ratios, and the
stability provided by payment schedules. At December 31, 1996, the Company's
loan portfolio included $4.9 million of mortgage loans subject to negative
amortization, which represented 2.1% of total loans outstanding.
The Company's policy is to originate one- to four-family residential
mortgage loans in amounts up to 80% of the lower of the appraised value or the
selling price of the property securing the loan and up to 97% of the appraised
value or selling price if private mortgage insurance is obtained. Mortgage loans
originated by the Company generally include due-on-sale clauses which provide
the Company with the contractual right to deem the loan immediately due and
payable in the event the borrower transfers ownership of the property without
the Company's consent. Due-on-sale clauses are an important means of adjusting
the rates on the Company's fixed rate mortgage loan portfolio and the Company
has generally exercised its rights under these clauses.
Multi-Family Lending. The Company originates multi-family mortgage
loans generally secured by six to thirty-six unit apartment buildings located in
the Company's primary market area. As part of its operating strategy, the
Company has moderately increased the amount of multi-family mortgage lending in
its primary market area. In reaching its decision on whether to make a
multi-family loan, the Company considers the qualifications of the borrower as
well as the underlying property. Some of the factors to be considered are the
net operating income of the mortgaged premises before debt service and
depreciation, the debt service ratio (the ratio of net earnings to debt
service), and the ratio of loan amount to appraised value. Pursuant to the
Company's underwriting policies, a multi-family adjustable rate mortgage loan
may only be made in an amount up to 65% of the appraised value of the underlying
property. Subsequent declines in the real estate values in the Company's primary
market area have resulted in some increase in the loan-to-value ratio on some
mortgage loans. In addition, the Company generally requires a debt service ratio
of 1.10x. Properties securing a loan are appraised by an independent appraiser
and title insurance is required on all loans. The Company's multi-family loan
portfolio at December 31, 1996 was approximately $22.5 million, or 9.49% of the
Company's total loans outstanding.
When evaluating the qualifications of the borrower for a multi-family
loan, the Company considers the financial resources and income level of the
borrower, the borrower's experience in owning or managing similar
8
property, and the Company's lending experience with the borrower. The Company's
underwriting policies require that the borrower be able to demonstrate
strong management skills and the ability to maintain the property from current
rental income. The borrower should also present evidence of the ability to
repay the mortgage and a history of making mortgage payments on a timely basis.
In making its assessment of the creditworthiness of the borrower, the Company
generally reviews the financial statements, employment and credit history of
the borrower, as well as other related documentation. The Company's largest
multi-family loan at December 31, 1996 had an outstanding balance of $913,000
and is secured by a 26-unit apartment building located in Sacramento,
California. Included in multi-family loans at December 31, 1996 was $9.8 million
of loans purchased during 1993, which consisted primarily of newly originated
loans secured by apartment buildings in the greater San Francisco Bay Area.
These loans were underwritten to standards substantially similar to those
utilized by the Company in originating loans. See "Origination, Purchase,
Sale and Servicing of Loans."
Loans secured by apartment buildings and other multi-family residential
properties are generally larger and involve a greater degree of risk than one-
to four-family residential mortgage loans. Because payments on loans secured by
multi-family properties are often dependent on successful operation or
management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
The Company seeks to minimize these risks through its underwriting policies,
which require such loans to be qualified at origination on the basis of the
property's income and debt coverage ratio.
Construction and Land Lending. The Company originates loans for the
acquisition and development of property to contractors and individuals in its
primary market area. The Company's construction loans primarily have been made
to finance the construction of one- to four-family, owner-occupied residential
properties. These loans are primarily adjustable rate loans with construction
terms of one year. The Company's policies provide that construction loans may be
made in amounts up to 80% of the appraised value of the property for
construction of one- to four-family residences and multi-family properties,
subject to the limitation on loans to one borrower. The Company requires an
independent appraisal of the property. Loan proceeds are disbursed in increments
as construction progresses and as inspections warrant. Land loans are determined
on an individual basis, but generally they do not exceed 50% of the actual cost
or current appraised value of the property, whichever is less. The largest
construction loan in the Company's portfolio at December 31, 1996 was $1.4
million and is secured by land located in Stockton, California. At December 31,
1996, the Company had $4.2 million (less undisbursed loan funds of $1.8 million)
of construction and land loans which amounted to 1.8% of the Company's total
portfolio.
As part of its operating strategy, the Company intends to moderately
increase the amount of construction and land lending in its primary market area.
Construction and land financing is generally considered to involve a higher
degree of credit risk than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development compared to the estimated cost (including interest)
of construction. If the estimate of value proves to be inaccurate, the Company
may be confronted with a project, when completed, having a value which is
insufficient to assure full repayment.
Commercial Real Estate Lending. The Company originates commercial real
estate loans that are generally secured by properties used for business purposes
such as small office buildings or a combination of residential and retail
facilities located in the Company's primary market area. The Company's
underwriting procedures provide that commercial real estate loans may be made in
amounts up to the lesser of 65% of the appraised value of the property, or at
the Company's current loans-to-one borrower limit. These loans may be made with
terms up to 25 years for adjustable rate loans and are indexed to the one year
treasury or to the 11th District Cost of Funds. The Company's underwriting
standards and procedures are similar to those applicable to its multi-family
loans, whereby the Company considers the net operating income of the property
and the borrower's expertise, credit history and profitability. The Company has
generally required that the properties securing commercial real estate loans
have debt service coverage ratios of at least 1.10x. The largest
9
commercial real estate loan in the Company's portfolio at December 31, 1996 was
$1,971,000 and is secured by a 9-unit retail center located in Watsonville,
California. At December 31, 1996, the Company's commercial real estate loan
portfolio was $7.5 million, or 3.2% of total loans.
As part of its operating strategy, the Company has moderately increased
commercial real estate lending in its primary market area. Loans secured by
commercial real estate properties, like multi-family loans, are generally larger
and involve a greater degree of risk than one- to four-family residential
mortgage loans. Because payments on loans secured by commercial real estate
properties are often dependent on successful operation or management of the
properties, repayment of such loans may be subject to a great extent to adverse
conditions in the real estate market or the economy. The Company seeks to
minimize these risks through its underwriting standards, which require such
loans to be qualified on the basis of the property's income and debt service
ratio.
Loan Approval Procedures and Authority. The Board of Directors
authorizes or may limit the lending activity of the Company, establishes the
lending policies of the Company and reviews properties offered as security. The
Board of Directors has authorized the following persons to approve loans up to
the amounts indicated: mortgage loans in amounts of $207,000 and below may be
approved by the Company's staff underwriters; mortgage loans in excess of
$207,000 and up to $250,000 may be approved by the underwriting/processing
manager; mortgage loans in excess of $250,000 and up to $350,000 require the
approval of the Chief Lending Officer; and loans in excess of $350,000 and up to
$500,000 require the approval of the Chief Executive Officer or the President.
Loans in excess of $500,000 and up to $750,000 require the approval of the
Management Loan Committee, which includes the Chief Executive Officer, the
President, and other Senior Officers. Loans in excess of $750,000 and up to $1.0
million require the approval of not less than three of the eight Board members.
A resolution of the Board of Directors is required for mortgage loans in excess
of $1.0 million.
For all loans originated by the Company, upon receipt of a completed
loan application from a prospective borrower, a credit report is ordered and
certain other information is verified by an independent credit agency and, if
necessary, additional financial information is required. An appraisal of the
real estate intended to secure the proposed loan is required which currently is
performed by an independent appraiser designated and approved by the Company.
The Board annually approves the independent appraisers used by the Company and
approves the Company's appraisal policy. The Company's policy is to obtain title
and hazard insurance on all real estate loans. If the original loan amount
exceeds 80% on a sale or refinance of a first trust deed loan or private
mortgage insurance is required, the borrower will be required to make payments
to a mortgage impound account from which the Company makes disbursements for
property taxes and mortgage insurance.
Loan Servicing. The Company also services mortgage loans for others. As
part of its operating strategy, the Company has increased the amount of loan
servicing it performs for others. Loan servicing includes collecting and
remitting loan payments, accounting for principal and interest, making
inspections as required of mortgaged premises, contacting delinquent mortgagors,
supervising foreclosures and property dispositions in the event of unremedied
defaults, making certain insurance and tax payments on behalf of the borrowers
and generally administering the loans. At December 31, 1996, the Company was
servicing $61.3 million of loans for others.
Delinquencies and Classified Assets. Management and the Board of
Directors perform monthly reviews of delinquent loans. The procedures taken by
the Company with respect to delinquencies vary depending on the nature of the
loan and period of delinquency. The Company's policies generally provide that
delinquent mortgage loans be reviewed and that a written late charge notice be
mailed no later than the 15th day of delinquency for mortgage loans. The
Company's policies provide that telephone contact will be attempted to ascertain
the reasons for delinquency and the prospects of repayment. When contact is made
with the borrower at any time prior to foreclosure, the Company will attempt to
obtain full payment or work out a
10
repayment schedule with the borrower to avoid foreclosure. It is the Company's
general policy to continue to accrue interest on all loans up to 90 days past
due, unless it is determined that the collection of interest and/or principal is
not probable under the contractual terms of the agreement. Property acquired
by the Company as a result of foreclosure on a mortgage loan is classified as
real estate owned and is recorded at the lower of the unpaid principal balance
or fair value less costs to sell at the date of acquisition and thereafter.
Federal regulations and the Company's Internal Asset Review Policy
require that the Company utilize an internal asset classification system as a
means of reporting problem and potential problem assets. The Company has
incorporated the Office of Thrift Supervision ("OTS") internal asset
classifications as a part of its credit monitoring system. The Company currently
classifies problem and potential problem assets as "Substandard," "Doubtful" or
"Loss" assets. An asset is considered "Substandard" if it is inadequately
protected by the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. "Substandard" assets include those characterized by
the "distinct possibility" that the insured institution will sustain "some loss"
if the deficiencies are not corrected. Assets classified as "Doubtful" have all
of the weaknesses inherent in those classified "Substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as "Loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. Assets
which do not currently expose the insured institution to sufficient risk to
warrant classification in one of the aforementioned categories but possess
weaknesses are designated as "Special Mention."
When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, it is required to establish an allowance
for loan losses in an amount deemed prudent by management. These allowances
represent loss allowances which have been established to recognize the inherent
risk associated with lending activities, but which, unlike specific allowances,
have not been allocated to particular problem assets. When an insured
institution classifies one or more assets, or portions thereof, as "Loss," it is
required either to establish a specific allowance for losses equal to 100% of
the amount of the asset so classified or to charge off such amount.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies,
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation guidelines. Generally, the policy
statement recommends that institutions have effective systems and controls to
identify, monitor and address asset quality problems; that management has
analyzed all significant factors that affect the collectibility of the portfolio
in a reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
As a result of the declines in local and regional real estate market values and
the significant losses experienced by many financial institutions, there has
been a greater level of scrutiny by regulatory authorities of the loan
portfolios of financial institutions undertaken as part of the examination of
institutions by the OTS and the Federal Deposit Insurance Corporation ("FDIC").
While the Company believes that it has established an adequate allowance for
loan losses, actual losses are dependent upon future events and, as such,
further additions to the level of specific and general loan loss allowances may
become necessary. In addition, there can be no assurance that regulators, in
reviewing the Company's loan portfolio, will not request the Company to
materially increase its allowance for loan losses, thereby negatively affecting
the Company's financial condition and earnings at that time.
The Company's Internal Asset Review Committee reviews and classifies
the Company's assets monthly and reports the results of its review to the Board
of Directors. The Company classifies assets in accordance with the management
guidelines described above. At December 31, 1996, the Company had $.8 million of
11
assets classified as Special Mention. Loans classified as Special Mention are a
result of past delinquencies or other identifiable weaknesses. At December 31,
1996, the largest loan classified as Special Mention had a loan balance of
$124,000. The Company had $4.9 million of assets classified as Substandard,
which included $1.4 million of nonaccrual loans and $3.5 million of loans which
were performing in accordance with their contractual terms but were classified
as Substandard due to identified risk characteristics including delinquent tax
status and a pattern of historical delinquencies. Of the $1.4 million of
nonaccrual loans, all were one- to four-family mortgage loans. At December 31,
1996, the largest loan classified as Substandard had a loan balance of $821,000.
The Company had $1,000 of assets classified as Loss and no assets classified as
Doubtful at December 31, 1996.
The Company generally requires appraisals on an annual basis on
foreclosed properties and, to the extent necessary, properties deemed to be
in-substance foreclosures. The Company generally conducts external inspections
on foreclosed properties and properties deemed in-substance foreclosures on at
least a quarterly basis.
12
The following table sets forth delinquencies in the Company's loan
portfolio as of the dates indicated:
At December 31, 1996 At December 31, 1995
------------------------------------------------ -------------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
----------------------- ----------------------- ----------------------- ----------------------
Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans
---------- ---------- --------- ---------- ------------ ---------- ---------- ---------
(Dollars in thousands)
One- to four-family......... 3 $ 455 11 $ 1,392 4 $297 8 $1,544
Multi-family................ - - - - 1 170 - -
Commercial.................. - - - - - - - -
Construction and land....... - - - - 1 48 - -
Other....................... 3 1 2 1 - - 2 1
-------- --------- -------- -------- ------- ---- ------ ------
Total....................... 6 $ 456 13 $ 1,393 6 $515 10 $1,545
======== ======= ======== ======= ======= ==== ======= ======
Delinquent loans to total
gross loans............ .14% .19% .06% .59% .22% .22% .37% .67%
At December 31, 1994
-----------------------------------------------------------
60-89 Days 90 Days or More
--------------------------- ----------------------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
---------- ---------- -------------- ----------
(Dollars in thousands)
One- to four-family.......... 1 $64 4 $711
Multi-family................. - - - -
Commercial................... - - - -
Construction and land........ 3 - - -
Other........................ - - - -
------- ------ ------- ------
Total........................ 4 $64 4 $711
======= ====== ======= ======
Delinquent loans to total
gross loans............. .15% .03% .08% .29%
13
Nonaccrual and Past Due Loans. Loans are generally placed on nonaccrual
status when the payment of interest is 90 days or more delinquent, or the
collection of interest and/or principal is not probable under the contractual
terms of the loan agreement. Loans on which the Company has ceased the accrual
of interest constitute the primary component of the portfolio of nonperforming
loans. Nonperforming loans consist of all nonaccrual loans and restructured
loans not performing in accordance with their restructured terms. Nonperforming
assets include all nonperforming loans and REO. The following table sets forth
information regarding nonperforming assets. At December 31, 1996, the Company
had $1.4 million of nonaccrual loans. The effect on interest income due to the
nonaccrual status of these loans was approximately $89,000. The Company
recognized $43,000 of interest income on these loans during 1996. For the year
ended December 31, 1996, the gross interest income which would have been earned
had these loans been performing in accordance with contractual terms was
approximately $132,000. At December 31, 1996, the Company had $354,000 of loans
which met the definition of a troubled debt restructuring, all of which were
current and paying according to the terms of their contractually restructured
agreements on December 31, 1996. The Company had no REO at December 31, 1996 or
any of the dates presented below. The Company does not accrue interest on loans
past due 90 days or more, and accordingly, there were no accruing loans past due
90 days or more at any of the dates presented below.
At December 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ------------ ------------ ----------- -----------
Nonaccrual loans 90 days or more past due:
Residential real estate:
One- to four-family...................... $ 1,393 $ 1,544 $ 711 $ - $ 644
Multi-family............................. - 830 - - -
Construction and land...................... - 825 - - -
Non-mortgage............................... - 1 - 1 -
------- ------- ----- ------- -----
Total loans on nonaccrual................ 1,393 3,200 711 1 644
Restructured loans not performing in
accordance with their restructured terms....... - - - - -
Real estate owned.............................. - - - - -
------- ------- ----- ------- -----
Total nonperforming assets(1)............ $ 1,393 $ 3,200 $ 711 $ 1 $ 644
======= ======= ===== ======= =====
Allowance for loan losses as a percent
of gross loans receivable(2)............... .56% .59% .33% .20% .17%
Allowance for loan losses as a percent
of total nonperforming loans(1)............ 94.10% 42.56% 113.64% NM(3) 25.93%
Nonperforming loans as a percent
of gross loans receivable(1)(2)............ .59% 1.39% .29% NM(3) .66%
Nonperforming assets as a percent
of total assets(1)......................... .33% .97% .24% NM(3) .40%
- --------------------------------------
(1) Nonperforming assets consist of nonperforming loans (nonaccrual loans and
restructured loans not performing in accordance with their restructured
terms) and REO. REO consists of real estate acquired through foreclosure
and real estate acquired by acceptance of a deed-in-lieu of foreclosure.
The Company had no REO or nonperforming restructured loans, and
nonperforming loans equaled nonperforming assets, at each of the dates
presented above.
(2) Gross loans receivable includes loans receivable held for investment and
loans held for sale, less undisbursed loan funds, deferred loan origination
fees, and unamortized discounts and premiums.
(3) At December 31, 1993, the Company had $1,000 of nonperforming loans.
Accordingly, ratio data presenting the allowance for loan losses as a
percentage of nonperforming loans for such periods would not be meaningful.
14
Impaired Loans. A loan is designated as impaired when the Company
determines it may be unable to collect all amounts due according to the
contractual terms of the loan agreement, whether or not the loan is 90 days past
due. Excluded from the definition of impairment are smaller balance homogenous
loans that are collectively evaluated for impairment. In addition, any loans
which meet the definition of a troubled debt restructuring, or are partially or
completely classified as Doubtful or Loss, are considered impaired.
The Company has established a monitoring system for its loans in order
to identify impaired loans, potential problem loans, and to permit periodic
evaluation of the adequacy of allowances for losses in a timely manner. In
analyzing its loans, the Company has established specific monitoring policies
and procedures suitable for the relative risk profile and other characteristics
of loans by type. The Company's residential one- to four-family and non-mortgage
loans, where the aggregate loans to one borrower is less than $500,000, are
considered to be relatively homogeneous and no single loan is individually
significant in terms of its size or potential risk of loss. Therefore, the
Company generally reviews its residential one-to four-family and non-mortgage
loans, where the aggregate loans to one borrower is less than $500,000, by
analyzing the performance and composition of collateral for the portfolio as a
whole. For non-homogeneous loans, including loans to one borrower that in
aggregate exceed $500,000, the Company conducts a periodic review of each loan.
The frequency and type of review is dependent upon the inherent risk attributed
to each loan and the adversity of the loan grade. The Company evaluates the risk
of loss and default for each loan subject to individual monitoring.
Factors considered as part of the periodic loan review process to
determine whether a loan is impaired address both the amount the Company
believes is probable that it will collect and the timing of such collection. As
part of the Company's loan review process the Company considers such factors as
the ability of the borrower to continue meeting the debt service requirements,
assessments of other sources of repayment, and the fair value of any collateral.
Insignificant delays or shortfalls in payment amounts, in the absence of other
facts and circumstances, would not alone lead to the conclusion that a loan is
impaired.
When a loan is designated as impaired, the Company measures impairment
based on the fair value of the collateral of the collateral-dependent loan. The
amount by which the recorded investment of the loan exceeds the measure of the
impaired loan is recognized by recording a valuation allowance with a
corresponding charge to earnings. The Company charges off a portion of an
impaired loan against the valuation allowance when it is probable that there is
no possibility of recovering the full amount of the impaired loan.
The following table identifies the Company's total recorded investment
in impaired loans by type at December 31, 1996 and 1995 (dollars in thousands).
December 31,
------------------------
1996 1995
Residential one- to four-family
non-homogenous loans $ 354 $ 1,544
Multi-family loans 821 830
Commercial real estate loans - -
Construction loans - 825
Non-mortgage loans 1 1
-------- --------
Total impaired loans $ 1,176 $ 3,200
======== ========
For the year ended December 31, 1996, the Company recognized interest
on impaired loans of $145,000. No impaired loans were on nonaccrual status at
December 31, 1996, and therefore no interest was uncollected on impaired
loans. During the year ended December 31, 1996, the Company's average
15
investment in impaired loans was $.9 million. Valuation allowances on impaired
loans were $82,900 at December 31, 1996.
Allowance for Estimated Loan Losses. The allowance for loan losses is
established through a provision for loan losses based on management's evaluation
of the risks inherent in its loan portfolio and the general economy. The
allowance for loan losses is maintained at an amount management considers
adequate to cover estimated losses in loans receivable which are deemed
probable and estimable. The allowance is based upon a number of factors,
including asset classifications, economic trends, industry experience and
trends, industry and geographic concentrations, estimated collateral values,
management's assessment of the credit risk inherent in the portfolio, historical
loan loss experience, and the Company's underwriting policies. As of December
31, 1996, the Company's allowance for loan losses was .56% of total loans,
compared to .59% as of December 31, 1995. The Company will continue to monitor
and modify its allowances for loan losses as conditions dictate. Various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's valuation allowance. These agencies may
require the Company to establish additional valuation allowances, based on their
judgments of the information available at the time of the examination.
At December 31, 1996, the Company did not have any REO. If the
Company acquires any REO, it will be initially recorded at the lower of the
recorded investment in the loan or the fair value of the related assets at the
date of foreclosure, less costs to sell. Thereafter, if there is a further
deterioration in value, the Company either writes down the REO directly or
provides a valuation allowance and charges operations for the diminution in
value. It is the policy of the Company to charge off consumer loans when it is
determined that they are no longer collectible. The policy for loans secured
by real estate, which comprise the bulk of the Company's portfolio, is to
establish loss reserves in accordance with the Company's asset classification
process, based on generally accepted accounting principles ("GAAP"). It is
the policy of the Company to obtain an appraisal on all real estate acquired
through foreclosure at the time of foreclosure.
The Company did not have any real estate held for investment at
December 31, 1996. If the Company subsequently has real estate held for
investment it will be carried at the lower of cost or net realizable value. All
costs of anticipated disposition are considered in the determination of net
realizable value.
Activity in the Company's allowance for loan losses for the periods
indicated are set forth in the table below (in thousands).
At or For the Year Ended December 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ----------- ------------ ------------ ----------
Balance at beginning of year............... $1,362 $ 808 $387 $167 $174
Provision (credit) for loan losses......... 28 663 421 220 (2)
Charge-offs, net........................... (79) (109) - - (5)
------ ------ ---- ---- ----
Balance at end of period................... $1,311 $1,362 $808 $387 $167
====== ====== ==== ==== ====
16
The following table sets forth the Company's allowance for loan losses to
total loans, and the percent of loans to total loans in each of the categories
listed at the dates indicated.
At December 31,
- --------------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
--------------------------------- --------------------------------- ---------------------------------
Percent of Percent of Percent of
Percent of Loans in Percent of Loans in Percent of Loans in
Allowance to Each Allowance to Each Allowance to Each
Total Category to Total Category to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans Amount Allowance Total Loans
------ ------------ ----------- ------ ------------ ----------- ------ ------------ -----------
(Dollars in thousands)
One-to
four family..... $ 911 69.49% 85.22% $1,080 79.30% 86.29% $676 83.66% 88.36%
Multi-family...... 171 13.04% 9.49% 143 10.50% 9.28% 91 11.26% 9.06%
Commercial........ 174 13.27% 3.18% 58 4.26% 1.81% 31 3.84% 1.18%
Construction
and land........ 20 1.53% 1.79% 77 5.65% 2.36% 7 .87% 1.20%
Other............. 35 2.67% .32% 4 .29% .26% 3 .37% .20%
------ ------- ------- ------ ------- ------- ---- ------- -------
Total valuation
allowances........ $1,311 100.00% 100.00% $1,362 100.00% 100.00% $808 100.00% 100.00%
====== ======= ======= ====== ======= ======= ==== ======= =======
- --------------------------------------------------------------------------------------------
1993 1992
--------------------------------- ---------------------------------
Percent of Percent of
Percent of Loans in Percent of Loans in
Allowance to Each Allowance to Each
Total Category to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
------ ------------ ----------- ------ ------------ -----------
One-to
four family..... $264 68.22% 85.64% $137 82.04% 88.99%
Multi-family...... 60 15.50% 9.79% 11 6.59% 5.44%
Commercial........ 26 6.72% 1.40% 4 2.40% 1.96%
Construction
and land........ 31 8.01% 2.93% 15 8.97% 3.34%
Other............. 6 1.55% .24% - - .27%
---- ------- ------- ---- ------- -------
Total valuation
allowances........ $387 100.00% 100.00% $167 100.00% 100.00%
==== ======= ======= ==== ======= =======
17
Investment Activities
Federally chartered savings institutions have the authority to invest
in various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, certificates of deposit of insured banks
and savings institutions, bankers' acceptances, repurchase agreements and
federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest their assets in commercial paper, investment-grade
corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. Additionally, the Company must maintain minimum
levels of investments that qualify as liquid assets under OTS regulations. See
"Regulation - Federal Savings Institution Regulation - Liquidity." Historically,
the Company has maintained liquid assets above the minimum OTS requirements and
at a level considered to be adequate to meet its normal daily activities.
The Company's investment activities described herein include
transactions related to short-term investments, investment securities and
mortgage backed securities held by the Company. The investment policies of the
Company as established by the Board of Directors attempt to provide and maintain
liquidity, generate a favorable return on investments without incurring undue
interest rate and credit risk, and complement the Company's lending activities.
Specifically, the Company's policies generally limit investments to government
and federal agency-backed securities and other non-government guaranteed
securities, including corporate debt obligations, that are investment grade. The
Company's policies provide the authority to invest in marketable equity
securities meeting the Company's guidelines and in mortgage backed securities
guaranteed by the U.S. government and agencies thereof and other financial
institutions. At December 31, 1996, the Company had federal funds sold and other
short-term investments, investment securities (including certificates of
deposit) and mortgage backed securities with an aggregate amortized cost of
$168.7 million and a market value of $167.9 million.
At December 31, 1996, the Company had $50.4 million in investment
securities consisting primarily of $14.8 million invested in a short-term
government securities fund and the remainder invested in U.S. government and
agency obligations. The Company's mortgage backed and mortgage related
securities portfolio consists primarily of seasoned fixed rate and adjustable
rate mortgage backed and mortgage related securities. At December 31, 1996, the
Company had approximately $116.8 million in mortgage backed securities insured
or guaranteed by either the FNMA, GNMA, or FHLMC, including $116.6 million in
mortgage backed securities available for sale. Investments in mortgage backed
securities involve a risk that actual prepayments will exceed prepayments
estimated over the life of the security which may result in a loss of any
premium paid for such instruments thereby reducing the net yield on such
securities. In addition, if interest rates increase, the market value of such
securities may be adversely affected.
18
The Bank had an amount of mortgage backed and investment securities
issued by the following entities which had a total amortized cost in excess of
10% of the Bank's equity at December 31, 1996. These amounts do not include
investment securities and mortgage backed securities held by the Company
(dollars in thousands).
Issuer Amortized Cost Market Value
------ -------------- ------------
Smith Breeden Short-Term Government
Securities Mutual Fund.................... $15,000 $14,799
Federal Home Loan Mortgage Corporation...... 50,429 50,245
Federal National Mortgage Company........... 60,358 60,100
Federal Home Loan Bank...................... 22,000 21,907
Government National Mortgage Association.... 15,786 15,696
19
The following table sets forth the composition of the Company's
mortgage backed securities portfolio in dollar amounts and in percentages of the
respective portfolios at the dates indicated (dollars in thousands). Available
for sale securities are reflected at fair market value and held to maturity
securities are reflected at amortized cost pursuant to Statement of Financial
Accounting Standards No. 115, Accounting for Certain Investments in Debt an
Equity Securities ("SFAS No. 115").
At December 31,
---------------------------------------------------------------------------------
1996 1995 1994
-------------------------- -------------------------- --------------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------------- ------------ ------------ ------------- ------------ ------------
Mortgage backed securities:
FNMA........................................ $ 45,243 39.62% $ 23,485 45.57% $ 155 1.07%
FHLMC....................................... 38,206 33.46% 28,046 54.43% - -
GNMA........................................ 15,158 13.27% - - - -
CMOs(1)..................................... 15,590 13.65% - - 14,282 98.93%
-------- ------- -------- ------- --------- -------
Total mortgage backed securities......... 114,197 100.00% 51,531 100.00% 14,437 100.00%
======= ======= =======
Plus (Less):
Unamortized premium (discount), net......... 2,586 1,091 (754)
-------- -------- ---------
Total mortgage backed
securities, net....................... 116,783 52,622 13,683
Less:
Mortgage backed securities available
for sale......................... 116,610 52,417 13,523
-------- -------- ---------
Total mortgage backed securities
held to maturity...................... $ 173 $ 205 $ 160
========= ======== ========
- ---------------------------------
(1) The CMOs primarily consisted of mortgage backed securities tied to single
current index securities.
20
The following tables set forth the Company's mortgage backed securities
activities for the periods indicated (dollars in thousands).
For the Year Ended December 31,
-------------------------------
1996 1995 1994
---- ---- ----
Beginning balance ............................................ $52,622 $13,683 $32,395
Mortgage backed securities purchased - held to maturity... - 69 -
Mortgage backed securities purchased - available for sale. 85,467 43,022 15,216
Mortgage backed securities acquired in exchange for
securitized loans....................................... - 14,992 -
Sales of mortgage backed securities available for sale,
proceeds from sale..................................... (8,427) (13,746) (29,192)
Principal repayments ..................................... (11,776) (6,240) (3,742)
Realized gain (loss) received on sale of
mortgage backed securities............................ 70 (258) 176
Amortization of (premium)/discount........................ (276) (277) (206)
Unrealized gain (loss) on available for sale.............. (897) 1,377 (964)
-------- ------- -------
Ending balance................................................ $116,783 $52,622 $13,683
======== ======= =======
The following table sets forth certain information regarding the
amortized cost and market values of the Company's mortgage backed securities at
the dates indicated (dollars in thousands):
At December 31,
---------------
1996 1995 1994
-------------------------- ------------------------- --------------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
------------- ------------ ------------------------- ------------ ------------
Mortgage backed securities:
Available for sale:
GNMA.............................. $ 15,786 $ 15,696
FHLMC............................. 39,110 38,988 $27,984 $28,187
FNMA.............................. 46,410 46,221 24,020 24,230
CMO(1)............................ 15,788 15,705 - - $14,487 $13,523
-------- -------- ------- ------- ------- -------
Total available for sale........ 117,094 116,610 52,004 52,417 14,487 13,523
-------- -------- ------- ------- ------- -------
Held to maturity:
FNMA.............................. 173 169 205 199 160 144
-------- -------- ------- ------- ------- -------
Total held to maturity.......... 173 169 205 199 160 144
-------- -------- ------- ------- ------- -------
Total mortgage backed
securities................... $117,267 $116,779 $52,209 $52,616 $14,647 $13,667
======== ======== ======== ======= ======= =======
- ----------------------------
(1) The CMOs primarily consisted of mortgage backed securities tied to single
current index securities.
21
The following table sets forth certain information regarding the
amortized cost and market values of the Company's federal funds sold and other
short-term investments and investment securities at the dates indicated (dollars
in thousands):
At December 31,
------------------------------------------------------------------------
1996 1995 1994
-------------------------------------------------------------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
-------------------------------------------------------------------------
Federal funds sold and other
short-term investments............ $ 531 $ 531 $ - $ - $ 4,100 $ 4,100
======== ======= ======= ======= ======= =======
Investment securities:
Certificates of deposit(1)........ 199 199 782 782 1,469 1,469
-------- ------- ------- ------- ------- -------
Held to maturity:
U.S. Treasury notes............. 153 152 355 359 395 395
Tennessee Valley bond........... 144 144 145 144
FICO zero coupon bond........... 107 107 290 294 - -
-------- ------- ------- ------- ------- -------
Total held to maturity........ 404 403 790 797 395 395
-------- ------- ------- ------- ------- -------
Available for sale:
U.S. government and federal
agency obligations.............. 35,322 35,156 16,025 16,161 3,001 2,907
Short-term government
securities mutual fund.......... 15,000 14,799 15,000 14,723 15,000 14,848
Common stock.................... 85 106 - -
Tennessee Valley bond........... - - - - 2,000 1,948
-------- ------- ------- ------- ------- -------
Total available for sale...... 50,322 49,955 31,110 30,990 20,001 19,703
-------- ------- ------- ------- ------- -------
Total investment securities......... $ 51,456 $51,088 $32,682 $32,569 $21,865 $21,567
======== ======= ======= ======= ======= =======
- -----------------------------
(1) Includes certificates of deposit with original maturities of greater than 90
days.
22
The table below sets forth certain information regarding the amortized
cost, weighted average yields and contractual maturities of the Company's
federal funds sold and other short-term investments, investment securities and
mortgage backed securities as of December 31, 1996.
At December 31, 1996
-----------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years
------------------------ ------------------------ --------------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
------------ ----------- ------------ ----------- ------------- ------------
(Dollars in thousands)
Investment securities:
Certificates of Deposit(1)......... $ 100 7.13% $ 99 7.07% $ - -
-------- ------- ----------
Held to Maturity:
U.S. government and
federal agency obligations.... 260 5.11% 144 5.29% - -
-------- ------- ----------
Available for sale:
U.S. government and
federal agency obligations..... 3,004 5.71% 20,208 6.72% 12,110 7.12%
Short-term government securities
mutual fund.................... 15,000 5.19% - - - -
-------- ------- ----------
Total available for sale....... 18,004 5.28% 20,208 6.72% 12,110 7.12%
-------- ------- ----------
Total investment securities.... $18,364 5.28% $20,451 6.71% $12,110 7.12%
======= ======= -------
Mortgage backed securities:
Held to maturity:
FNMA............................. - - 173 5.12% - -
-------- ------- ----------
Total held for investment...... - - $ 173 5.12% - -
-------- ------- ----------
Available for sale:
FHLMC............................ - - $ 1,909 7.34% - -
GNMA............................. - - - - - -
FNMA............................. - - - - - -
CMO'S............................ - - - - - -
-------- ------- ----------
Total available for sale....... - - 1,909 7.34% - -
-------- ------- ----------
Total mortgage backed
securities.................. - - $ 2,082 7.16% $ - -
======== ======= ==========
----------------------------------------------------
More than Ten Years Total
------------------------ ---------------------------
Weighted Weighted
Amortized Average Amortized Average
Cost Yield Cost Yield
------------ ----------- ------------ --------------
Investment securities:
Certificates of Deposit(1)......... $ - - $ 199 7.10%
-------- ---------
Held to Maturity:
U.S. government and
federal agency obligations.... - - 404 5.17%
-------- ---------
Available for sale:
U.S. government and
federal agency obligations..... - - 35,322 6.77%
Short-term government securities
mutual fund.................... - - 15,000 5.19%
-------- -------
Total available for sale....... - - 50,322 6.30%
-------- -------
Total investment securities.... $ - - $50,925 6.29%
======== =======
Mortgage backed securities:
Held to maturity:
FNMA............................. - - 173 5.12%
-------- --------
Total held for investment...... - - $ 173 5.12%
-------- --------
Available for sale:
FHLMC............................ $ 37,201 7.42% $ 39,109 7.41%
GNMA............................. 15,786 7.62% 15,786 7.62%
FNMA............................. 46,410 7.68% 46,410 7.68%
CMO'S............................ 15,788 6.74% 15,788 6.74%
-------- --------
Total available for sale....... 115,185 7.46% 117,094 7.46%
-------- --------
Total mortgage backed $115,185 7.46% $117,266 7.45%
securities................... ======== ========
- ---------------------------------
(1) Includes certificates of deposit with original maturities of greater than
90 days.
23
Sources of Funds
General. Deposits, repayments and prepayments on loans and mortgage
backed securities, proceeds from sales of loans and investments, cash flows
generated from operations and FHLB borrowings are the primary sources of the
Company's funds for use in lending, investing and for other general purposes.
Deposits. The Company offers a variety of deposit accounts with a range
of interest rates and terms. The Company's deposits consist of passbook savings,
checking accounts, money market accounts and certificates of deposit. For the
year ended December 31, 1996, certificates of deposit constituted 79.4% of total
average deposits. The flow of deposits is influenced significantly by general
economic conditions, changes in money market rates, prevailing interest rates
and competition. The Company's deposits are obtained predominantly from the
areas in which its branch offices are located. The Company relies primarily on
customer service and long-standing relationships with customers to attract and
retain these deposits; however, market interest rates and rates offered by
competing financial institutions significantly affect the Company's ability to
attract and retain deposits. Certificate accounts in excess of $100,000 are not
actively solicited by the Company nor has the Company since 1992 used brokers to
obtain deposits.
In 1996 the Company assumed $102.1 million of deposit liabilities in
exchange for cash. In 1993, the Company acquired three branch offices which
resulted in the Company assuming total deposit liabilities of $95.3 million.
In response to the rising interest rate environment, the Company offers
two certificate accounts whose interest rate may be adjusted to prevailing
market rates according to the terms of the account. The "multi-flex" certificate
account may have either a seven or seventeen month term. The depositor has the
option to increase the interest rate once during the term to the current quoted
rate, and may withdraw all or a portion of the deposited funds once during the
term of the account without penalty. The seven-month "multi-flex" certificate
account allows the depositor to increase the deposit amount in the account.
Management continually monitors the Company's certificate accounts and, based on
historical experience, management believes it will retain a large portion of
such accounts upon maturity. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
The following table presents the deposit activity of the Company for
the periods indicated (dollars in thousands).
For the year ended December 31,
-----------------------------------
1996 1995 1994
---- ---- ----
Deposits............................ $ 509,649 $ 474,839 $ 299,767
Purchased deposits(1)............... 102,063 - -
Withdrawals......................... (519,685) (484,457) (311,800)
--------- ---------- -----------
Net deposits (withdrawals).......... 92,027 (9,618) (12,033)
Interest credited on deposits....... 10,834 10,592 8,001
--------- ---------- -----------
Total increase (decrease)
in deposits..................... $ 102,861 $ 974 $ (4,032)
========= ========== ===========
- ------------------------------
(1) In December 1996, the Company assumed $ 102. 1 million of deposits from
Fremont Investment and Loan.
24
At December 31, 1996, the Company had $49.2 million in certificate
accounts in amounts of $100,000 or more maturing as indicated in the following
table. At December 31, 1995, the Company had $42.0 million of certificate
accounts in amounts of $100,000 or more, with a weighted average rate of 5.89%
at year end. The Company does not offer premium rates on jumbo certificate
accounts.
Weighted
Maturity Period Amount Average Rate
- ------------------------------------------ ------------ --------------
(Dollars in thousands)
Three months or less...................... $ 7,218 5.82%
Over three through six months............. 8,868 5.40%
Over six through 12 months................ 16,557 5.41%
Over 12 months............................ 16,573 5.52%
--------
Total............................ $ 49,217 5.51%
========
25
The following table sets forth the distribution of the Company's
average deposit accounts for the periods indicated and the weighted average
interest rates on each category of deposits presented.
For the Year Ended December 31,
---------------------------------------------------------------------------------------------
1996 1995 1994
----------------------------- --------------------------------- ----------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Yield Balance Deposits Yield
--------- --------- --------- ----------- ----------- --------- --------- -------- --------
(Dollars in thousands)
Money market deposits............. $ 19,387 8.65% 3.58% $14,619 6.75% 2.70% $19,773 9.27% 2.32%
Passbook deposits................. 13,381 5.97% 1.90% 15,048 6.95% 2.04% 18,341 8.60% 2.23%
Checking accounts................. 13,485 6.01% .58% 15,012 6.93% .80% 13,851 6.48% .89%
-------- ------- -------- ------- -------- -------
Total.......................... 46,253 20.63% 44,679 20.63% 51,965 24.35%
-------- ------- -------- ------- -------- -------
Certificate accounts:
Three months or less............ 35,720 20.07% 5.57% 29,772 13.75% 5.52% 39,231 18.39% 4.46%
Over three through six months... 37,366 21.00% 5.61% 42,264 19.52% 5.95% 31,725 14.87% 5.32%
Over six through 12 months...... 58,924 33.11% 5.61% 66,272 30.60% 5.31% 27,134 12.72% 5.37%
Over one to three years......... 44,585 25.05% 5.71% 32,492 15.00% 6.22% 59,428 27.85% 3.25%
Over three to five years........ 1,166 .66% 6.65% 735 .34% 7.29% 3,401 1.59% 9.01%
Over five to ten years.......... 204 .11% 7.23% 343 .16% 7.28% 484 .23% 7.36%
-------- ------- -------- ------- -------- -------
Total certificates............. 177,964 79.37% 5.58% 171,878 79.37% 5.69% 161,403 75.65% 4.40%
-------- ------- -------- ------- -------- -------
Total average deposits......... $224,217 100.00% $216,557 100.00% $213,368 100.00%
======== ======= ======= ======= ======== =======
26
The following table presents, by various rate categories, the
amount of certificate accounts outstanding at the dates indicated and the
periods to maturity of the certificate accounts outstanding at December 31, 1996
(in thousands).
Period to Maturity from December 31, 1996 At December 31,
-------------------------------------------------------------------- -------------------------------------
Less than One to Two to Three to Four to Over five
One Year Two years Three years Four years Five years years 1996 1995 1994
-------------------------------------------------------------------- -------------------------------------
Certificate accounts:
0 to 4.00%............. $ 1,347 $ 30 $ 54 $ - $ - $ - $ 1,431 $ 1,747 $ 34,547
4.01 to 5.00%.......... 30,752 361 344 - - - 31,457 12,129 34,728
5.01 to 6.00%.......... 136,600 53,591 3,585 369 360 - 194,505 83,449 64,888
6.01 to 7.00%.......... 16,935 2,394 1,578 323 246 277 21,753 72,200 28,410
7.01 to 8.00%.......... 2,105 448 481 122 155 - 3,311 2,400 1,284
8.01 to 9.00%.......... 5 43 416 47 - - 511 468 533
Over 9.01%............. 106 18 101 37 - 14 276 377 738
-------- ------- ------- ------- ------ ------- -------- -------- --------
Total............... $187,850 $56,885 $ 6,559 $ 898 $ 761 $ 291 $253,244 $172,770 $165,128
======== ======= ======= ======= ====== ======= ======== ======== ========
27
Borrowings
From time to time the Company has obtained FHLB advances and entered
into reverse repurchase agreements with the FHLB as an alternative to retail
deposit funds and may do so in the future as part of its operating strategy.
FHLB borrowings may also be used to acquire certain other assets as may be
deemed appropriate for investment purposes. These borrowings are collateralized
primarily by certain of the Company's mortgage loans and mortgage backed
securities and secondarily by the Company's investment in capital stock of the
FHLB. See "Regulation - Federal Home Loan Bank System." Such borrowings are made
pursuant to several different credit programs, each of which has its own
interest rate and range of maturities. The maximum amount that the FHLB will
advance to member institutions, including the Company, fluctuates from time to
time in accordance with the policies of the OTS and the FHLB. At December 31,
1996, the Company had $59.8 million in outstanding borrowings from the FHLB
consisting of $46.8 million of advances and $13.0 million of reverse repurchase
agreements.
The following table sets forth certain information regarding the
Company's borrowed funds at or for the periods indicated (in thousands):
At or For the Years Ended December 31,
--------------------------------------
1996 1995 1994
----------- --------- -----------
FHLB advances:
Average balance outstanding................. $43,619 $45,744 $38,532
Maximum amount outstanding at any
month-end during the period............. 99,607 68,032 61,000
Balance outstanding at end of period........
46,807 46,520 59,782
Weighted average interest rate during
the period.............................. 5.75% 6.00% 4.58%
Weighted average interest rate at end
of period............................... 5.72% 5.84% 5.82%
<CAPTION
At or For the Years Ended December 31,
--------------------------------------
1996 1995 1994
----------- ---------- ----------
Securities sold under agreements to repurchase:
Average balance outstanding................. $14,644 $14,487 -
Maximum amount outstanding at any
month-end during the period............. 16,648 26,124 -
Balance outstanding at end of period........ 13,000 17,361 -
Weighted average interest rate during
the period.............................. 5.98% 6.06% -
Weighted average interest rate at end
of period............................... 5.94% 5.91% -
28
Subsidiary Activities
Portola, a California corporation, is currently engaged on an agency
basis in the sale of insurance, mutual funds and annuity products primarily to
the Company's customers and members of the local community. The Company has
recently expanded Portola's activities to include the sale of credit life
insurance. As of December 31, 1996, Portola had $441,000 in total assets and a
net loss for the year ended December 31, 1996 of $62,000.
Personnel
As of December 31, 1996, the Company had 81 full-time employees and 3
part-time employees. The employees are not represented by a collective
bargaining unit and the Company considers its relationship with its employees to
be good.
REGULATION AND SUPERVISION
General
The Company, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the
activities of savings institutions, such as the Bank, are governed by the HOLA
and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and
supervision by the OTS, as its primary federal regulator, and the FDIC, as the
deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB")
System and its deposit accounts are insured up to applicable limits by the
Savings Company Insurance Fund ("SAIF") managed by the FDIC. The Bank must file
reports with the OTS and the FDIC concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other savings
institutions. The OTS and/or the FDIC conduct periodic examinations to test the
Bank's safety and soundness compliance with various regulatory requirements.
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 insurance fund 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
regulatory requirements and policies, whether by the OTS, the FDIC or the
Congress could have a material adverse impact on the Company, the Bank and their
operations. Certain of the regulatory requirements applicable to the Bank and to
the Company are referred to below or elsewhere herein. The description of
statutory provisions and regulations applicable to savings institutions and
their holding companies set forth in this Form 10-K does not purport to be a
complete description of such statutes and regulations and their effects on the
Bank and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding
company within the meaning of the HOLA. As a unitary savings and loan holding
company, the Company generally will not be restricted under existing laws as to
the types of business activities in which it may engage, provided that the Bank
continues to be a qualified thrift lender ("QTL"). See "Federal Savings
Institution Regulation - QTL Test." Upon any non-supervisory acquisition by the
Company of another savings institution or savings bank that meets the QTL test
and is deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive
29
limitations on the types of business activities in which it could engage. The
HOLA limits the activities of a multiple savings and loan holding company and
its non-insured institution subsidiaries primarily to activities permissible
for bank holding companies under Section 4(c)(8) of the Bank Holding Company
Act ("BHC Act"), subject to the prior approval of the OTS, and activities
authorized by OTS regulation.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5% of a nonsubsidiary company engaged in activities other
than those permitted by the HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result
in a multiple savings and loan holding company controlling savings institutions
in more than one state, subject to two exceptions: (i) the approval of
interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions, as described below. The Bank must notify the OTS 30 days
before declaring any dividend to the Company. In addition, the financial impact
of a holding company on its subsidiary institution is a matter that is evaluated
by the OTS and the agency has authority to order cessation of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio. In
addition, the prompt corrective action standards discussed below also establish,
in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital
ratio (3% for institutions receiving the highest rating on the CAMEL financial
institution rating system), and, together with the risk-based capital standard
itself, a 4% Tier I risk-based capital standard. Core capital is defined as
common stockholder's equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus, and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
purchased mortgage servicing rights and credit card relationships. The OTS
regulations also require that, in meeting the tangible leverage (core) and
risk-based capital standards, institutions must generally deduct investments in
and loans to subsidiaries engaged in activities not permissible for a national
bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of 4% and 8%, respectively.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, as
assigned by the OTS capital regulation based on the risks OTS believes are
inherent in the type of asset. The components of Tier I (core) capital are
equivalent to those discussed earlier. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock and the allowance for loan and lease losses limited to a maximum
of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
30
The OTS regulatory capital requirements also incorporate an interest
rate risk component. Savings institutions with "above normal" interest rate risk
exposure are subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. A savings institution's
interest rate risk is measured by the decline in the net portfolio value of its
assets (i.e., the difference between incoming and outgoing discounted cash flows
from assets, liabilities and off-balance sheet contracts) that would result from
a hypothetical 200 basis point increase or decrease in market interest rates
divided by the estimated economic value of the institution's assets. In
calculating its total capital under the risk-based capital rule, a savings
institution whose measured interest rate risk exposure exceeds 2% must deduct an
amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
institution's assets. The Director of the OTS may waive or defer a savings
institution's interest rate risk component on a case-by-case basis. A savings
institution with assets of less than $300 million and risk-based capital ratios
in excess of 12% is not subject to the interest rate risk component, unless the
OTS determines otherwise. For the present time, the OTS has deferred
implementation of the interest rate risk component. At December 31, 1996, the
Bank met each of its capital requirements, in each case on a fully phased-in
basis.
The following table presents the Bank's capital position at December
31, 1996 relative to fully phased - in regulatory requirements:
Excess Capital
----------------------------------
Actual Required (Deficiency) Actual Required
Capital Capital Amount Percent Percent
--------------- -------------- ----------------- --------------- -----------------
(Dollars in thousands)
Tangible................... $34,440 $6,239 $28,201 8.28% 1.50%
Core (leverage)............ 34,787 12,488 22,299 8.36% 3.00%
Risk-based................. 36,097 15,026 21,071 19.22% 8.00%
Prompt Corrective Regulatory Action. Under the OTS prompt corrective
action regulations, the OTS is required to take certain supervisory actions
against undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a savings institution is
considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6%, its ratio of core capital to total assets is at least 5%,
and it is not subject to any order or directive by the OTS to meet a specific
capital level. A savings institution generally is considered "adequately
capitalized" if its ratio of total capital to risk-weighted assets is at least
8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%,
and its ratio of core capital to total assets is at least 4% (3% if the
institution receives the highest CAMEL rating). A savings institution that has a
ratio of total capital to weighted assets of less of than 8%, a ratio of Tier I
(core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be "undercapitalized." A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
risk-based capital ratio of less than 3% or a leverage ratio that is less than
3% is considered to be "significantly undercapitalized" and a savings
institution that has a tangible capital to assets ratio equal to or less than 2%
is deemed to be "critically undercapitalized." Subject to a narrow exception,
the banking regulator is required to appoint a receiver or conservator for an
institution that is "critically undercapitalized." The regulation also provides
that a capital restoration plan must be filed with the OTS within 45 days of the
date a savings institution receives notice that it is "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Compliance
with the plan must be guaranteed by any parent holding company. In addition,
numerous mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on
31
growth, capital distributions and expansion. The OTS could also take any one
of a number of discretionary supervisory actions, including the issuance of
a capital directive and the replacement of senior executive officers and
directors.
Insurance of Deposit Accounts. Deposits of the Bank are presently
insured by the SAIF. Both the SAIF and the Bank Insurance Fund ("BIF") (the
deposit insurance fund that covers most commercial bank deposits) are
statutorily required to be recapitalized to a 1.25% of insured reserve
deposits ratio. Until recently, members of the SAIF and BIF were paying average
deposit insurance premiums of between 24 and 25 basis points. The BIF met the
required reserve in 1995, whereas the SAIF is not expected to meet or exceed
the required level until 2002 at the earliest. This situation is primarily due
to the statutory requirement that SAIF members make payments on bonds issued
in the late 1980s by the Financing Corporation ("FICO") to recapitalize the
predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC adopted a new
assessment rate schedule of 0 to 27 basis points under which 92% of BIF members
paid an annual premium of only $2,000. With respect to SAIF member institutions,
the FDIC adopted a final rule retaining the existing assessment rate schedule
applicable to SAIF member institutions of 23 to 31 basis points. As long as the
premium differential continued, it may have adverse consequences for SAIF
members, including reduced earnings and an impaired ability to raise funds in
the capital markets. In addition, SAIF members such as the Bank were placed at a
substantial competitive disadvantage to BIF members with respect to pricing of
loans and deposits and the ability to achieve lower operating costs.
On September 30, 1996, the President signed into law the Deposit
Insurance Funds Act of 1996 (the "Funds Act") which, among other things, imposed
a special one-time assessment on SAIF member institutions, including the Bank,
to recapitalize the SAIF. As required by the Funds Act, the FDIC imposed a
special assessment of 65.7 basis points on SAIF assessable deposits held as of
March 31, 1995, payable November 27, 1996 (the "SAIF Special Assessment"). The
SAIF Special Assessment was recognized by the Bank as an expense in the quarter
ended September 30, 1996 and is generally tax deductible. The SAIF Special
Assessment recorded by the Bank amounted to $1.4 million on a pre-tax basis and
$.8 million on an after-tax basis.
The Funds Act also spreads the obligations for payment of the FICO
bonds across all SAIF and BIF members. Beginning on January 1, 1997, BIF
deposits will be assessed for FICO payment of 1.3 basis points, while SAIF
deposits will pay 6.48 basis points. Full prorata sharing of the FICO
payments between BIF and SAIF members will occur on the earlier of January
1, 2000 or the date the BIF and SAIF are merged. The Funds Act specifies
that the BIF and SAIF will be merged on January 1, 1999, provided no savings
associations remain as of that time.
As a result of the Funds Act, the FDIC recently voted to effectively
lower SAIF assessments to 0 to 27 basis points as of January 1, 1997, a range
comparable to that of BIF members. SAIF members will also continue to make the
FICO payments described above. The FDIC also lowered the SAIF assessment
schedule for the fourth quarter of 1996 to 18 to 27 basis points. Management
cannot predict the level of FDIC insurance assessments on an on-going basis,
whether the savings association charter will be eliminated or whether the
BIF and SAIF will eventually be merged.
The Company's assessment rate for fiscal 1996 was 26 basis points
and the premium paid for this period was $516,000. A significant increase
in SAIF insurance premiums would likely have an adverse effect on the operating
expenses and results of operations of the Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC
upon a finding that the institution 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
32
OTS. The management of the Bank does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
Thrift Chartering Legislation. The Funds Act provides that the BIF
and SAIF will merge on January 1, 1999 if there are no more savings
associations as of that date. That legislation also requires that the
Department of Treasury submit a report to Congress by March 31, 1997 that makes
recommendations regarding a common financial institutions charter, including
whether the separate charters for thrifts and banks should be abolished.
Various proposals to eliminate the federal thrift charter, create a uniform
financial institutions charter and abolish the OTS have been introduced in
Congress. The bills would require federal savings institutions to convert to
a national bank or some type of state charter by a specified date (January 1,
1998 in one bill, June 30, 1998 in the other) or they would automatically
become national banks. Converted federal thrifts would generally be required
to conform their activities to those permitted for the charter selected and
divestiture of nonconforming assets would be required over a two year period,
subject to two possible one year extensions. State chartered thrifts would
become subject to the same federal regulation as applies to state commercial
banks. Holding companies for savings institutions would become subject to the
same regulation as holding companies that control commercial banks, with a
limited grandfather provision for unitary savings and loan holding company
activities. The Bank is unable to predict whether such legislation would be
enacted, the extent to which the legislation would restrict or disrupt its
operations or whether the BIF and SAIF funds will eventually merge.
Loans to One Borrower. Under the HOLA, savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. Generally, savings institutions may not make a loan or extend credit
to a single or related group of borrowers in excess of 15% of its unimpaired
capital and surplus. An additional amount may be lent, equal to 10% of
unimpaired capital and surplus, if such loan is secured by readily-marketable
collateral, which is defined to include certain financial instruments and
bullion. At December 31, 1996, the Bank's limit on loans to one borrower was
$5.4 million. At December 31, 1996, the Bank's largest aggregate outstanding
balance of loans to one borrower totaled $2.0 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test.
Under the QTL test, a savings and loan association is required to maintain at
least 65% of its "portfolio assets" (total assets less (i) specified liquid
assets up to 20% of total assets; (ii) intangibles, including goodwill; and
(iii) the value of property used to conduct business) in certain "qualified
thrift investments" (primarily residential mortgages and related investments,
including certain mortgage backed securities) in at least 9 months out of each
12 month period.
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. As of
December 31, 1996, the Bank maintained 85.04% of its portfolio assets in
qualified thrift investments and, therefore, met the QTL test.
Limitation on Capital Distributions. OTS regulations impose
limitations upon all capital distributions by savings institutions, such as
cash dividends, payments to repurchase or otherwise acquire its shares,
payments to shareholders of another institution in a cash-out merger and other
distributions charged against capital. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level.
An institution that exceeds all fully phased-in capital requirements before
and after a proposed capital distribution ("Tier 1 Company") and has not been
advised by the OTS that it is in need of more than normal supervision, could,
after prior notice but without obtaining approval of the OTS, make capital
distributions during a calendar year equal to the greater of (i) 100% of its
net earnings to date during the calendar year plus the amount that would reduce
by one-half its "surplus capital ratio" (the excess capital over its fully
phased-in capital requirements) at the beginning of the calendar year or (ii)
75% of its net income for the previous four quarters. Any additional capital
distributions would require prior regulatory approval. In the event the
Bank's capital fell below its regulatory requirements or the OTS notified it
that it was in need of more than normal supervision, the Bank's ability to
make capital distributions could be restricted. In addition, the OTS could
prohibit a proposed capital distribution by any institution, which would
otherwise be permitted by the
33
regulation, if the OTS determines that such distribution would constitute an
unsafe or unsound practice. In December 1994, the OTS proposed amendments
to its capital distribution regulation that would generally authorize the
payment of capital distributions without OTS approval provided the payment
does not cause the institution to be undercapitalized within the meaning of
the prompt corrective action regulation. However, institutions in a holding
company structure would still have a prior notice requirement. At December 31,
1996, the Bank was a Tier 1 Bank.
Liquidity. The Company is required to maintain an average daily
balance of specified liquid assets equal to a monthly average of not less than
a specified percentage of its net withdrawable deposit accounts plus
short-term borrowings. This liquidity requirement is currently 5% but may be
changed from time to time by the OTS to any amount within the range of 4% to 10%
depending upon economic conditions and the savings flows of member institutions.
OTS regulations also require each member savings institution to maintain an
average daily balance of short-term liquid assets at a specified percentage
(currently 1%) of the total of its net withdrawable deposit accounts and
borrowings payable in one year or less. Monetary penalties may be imposed for
failure to meet these liquidity requirements. The Bank's average liquidity and
short-term liquidity ratios for December 31, 1996 were 7.74% and 4.79%
respectively, which exceeded the then applicable requirements. The Bank has
never been subject to monetary penalties for failure to meet its liquidity
requirements.
Assessments. Savings institutions are required to pay assessments to
the OTS to fund the agency's operations. The general assessment, paid on a
semi-annual basis, is computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest
quarterly thrift financial report. The assessments paid by the Bank for the
fiscal year ended December 31, 1996 totaled $81,000.
Branching. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and
to geographically diversify their loan portfolios and lines of business.
The OTS authority preempts any state law purporting to regulate branching by
federal savings institutions.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (e.g.., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by Sections 23A and
23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount
of covered transactions with any individual affiliate to 10% of the capital
and surplus of the savings institution. The aggregate amount of covered
transactions with all affiliates is limited to 20% of the savings institution's
capital and surplus. Certain transactions with affiliates are required to
be secured by collateral in an amount and of a type described in Section 23A
and the purchase of low quality assets from affiliates is generally prohibited.
Section 23B generally provides that certain transactions with affiliates,
including loans and asset purchases, must be on terms and under circumstances,
including credit standards, that are substantially the same or at least as
favorable to the institution as those prevailing at the time for comparable
transactions with non-affiliated companies. In addition, savings institutions
are prohibited from lending to any affiliate that is engaged in activities that
are not permissible for bank holding companies and no savings institution may
purchase the securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors
and 10% shareholders, ("insiders"), as well as entities such persons control, is
governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. Recent legislation created an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees. Regulation O also places individual and aggregate
limits on the amount of loans the Bank may
34
make to insiders based, in part, on the Bank's capital position and requires
certain board approval procedures to be followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on
an insured institution. Formal enforcement action may range from the issuance
of a capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and an
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to be taken with respect to a particular
savings institution. If action is not taken by the Director, the FDIC has
authority to take such action under certain circumstances. Federal law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset growth; and compensation, fees and benefits.
If the appropriate federal banking agency determines that an institution fails
to meet any standard prescribed by the Guidelines, the agency may require the
institution to submit to the agency an acceptable plan to achieve compliance
with the standard, as required by the FDI Act. The final rule establishes
deadlines for the submission and review of such safety and soundness compliance
plans when such plans are required.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily checking accounts). During fiscal year 1996, the Federal Reserve
Board regulations generally require that reserves be maintained against
aggregate transaction accounts as follows: for accounts aggregating $52.0
million or less (subject to adjustment by the Federal Reserve Board) the
reserve requirement is 3%; and for accounts greater than $52.0 million, the
reserve requirement is $1.6 million plus 10% (subject to adjustment by the
Federal Reserve Board between 8% and 14%) against that portion of total
transaction accounts in excess of $52.0 million. The first $4.3 million of
otherwise reservable balances (subject to adjustments by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with the foregoing requirements. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements imposed by the OTS.
35
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Bank and the Company report their income on a consolidated
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS during the last
five years. For its 1996 taxable year, the Bank is subject to a maximum federal
income tax rate of 34%.
Bad Debt Reserve. For fiscal years beginning prior to December 31,
1995, thrift institutions which qualified under certain definitional tests and
other conditions of the Internal Revenue Code of 1986 (the "Code") were
permitted to use certain favorable provisions to calculate their deductions from
taxable income for annual additions to their bad debt reserve. A reserve could
be established for bad debts on qualifying real property loans (generally
secured by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which
was enacted on August 20, 1996, requires savings institutions to recapture
(i.e., take into income) certain portions of their accumulated bad debt
reserves. The 1996 Act repeals the reserve method of accounting for bad debts
effective for tax years beginning after 1995. Thrift institutions that would be
treated as small banks are allowed to utilize the Experience Method applicable
to such institutions, while thrift institutions that are treated as large banks
(those generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of computing
reserves for bad debts will treat such change as a change in method of
accounting, initiated by the taxpayer, and having been made with the consent of
the IRS. Any Section 481 (a) adjustment required to be taken into income with
respect to such change generally will be taken into income ratably over a
six-taxable year period, beginning with the first taxable year beginning after
1995, subject to the residential loan requirement.
Under the residential loan requirement provision, the recapture
required by the 1996 Act will be suspended for each of two successive taxable
years, beginning with the Bank's current taxable year, in which the Bank
originates a minimum of certain residential loans based upon the average of the
principal amounts of such loans made by the Bank during its six taxable years
preceding its current taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank
is permitted to make additions to its tax bad debt reserves. In addition, the
Bank is required to recapture (i. e., take into income) over a six year period
the excess of the balance of its tax bad debt reserves as of December 31, 1995
over the balance of such reserves as of December 31, 1987.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
36
The amount of additional taxable income triggered by an non-dividend is
an amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Thus, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion its bad debt reserves.
SAIF Recapitalization Assessment. The Funds Act levied a 65.7-cent fee
on every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that the
amount of any special assessment paid to capitalize SAIF under this legislation
is deductible under Section 162 of the Code in the year of payment.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986,
as amended (the "Code") imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using
the percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current earnings
exceeds its AMTI (determined without regard to this preference and prior to
reduction for net operating losses). In addition, for taxable years beginning
after December 31, 1986 and before January 1, 1996, an environmental tax of .12%
of the excess of AMTI (with certain modifications) over $2.0 million is imposed
on corporations, including the Company, whether or not an Alternative Minimum
Tax ("AMT") is paid. The Bank does not expect to be subject to the AMT, but may
be subject to the environmental tax liability.
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank own more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
37
State and Local Taxation
State of California. The California franchise tax rate applicable to
the Bank equals the franchise tax rate applicable to corporations generally,
plus an "in lieu" rate approximately equal to personal property taxes and
business license taxes paid by such corporations (but not generally paid by
banks or financial corporations such as the Bank); however, the total tax rate
cannot exceed 11.7%. Under California regulations, bad debt deductions are
available in computing California franchise taxes using a three or six year
weighted average loss experience method. The Bank and its California subsidiary
file California state franchise tax returns on a combined basis. The Company, as
a savings and loan holding company commercially domiciled in California, is
treated as a financial corporation and subject to the general corporate tax rate
plus the "in lieu" rate as discussed previously for the Bank.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
Additional Item. Executive Officers of the Registrant
The following table sets forth certain information regarding the
executive officers of the Company who are not also directors:
Name Age (1) Position Held With Company
------------------------------ -------- -------------------------------
Marshall G. Delk 42 President and Chief
Operating Officer
Deborah R. Chandler 42 Senior Vice President,
Chief Financial Officer
and Treasurer
Carlene F. Anderson 44 Corporate Secretary
(1) At December 31, 1996
38
Item 2. Properties.
The Company neither owns or leases any real property. The Company
reimburses the Bank for property and equipment it utilizes per an expense
sharing agreement.
The Company conducts its business through an administrative office
located in Watsonville and seven branch offices, one of which includes a real
estate loan center. The Company believes that its current facilities are
adequate to meet the present and immediately foreseeable needs of the Company.
Original Net Book Value
Year of Property or
Leased Leased Date of Leasehold
or or Lease Improvements at
Location Owned Acquired Expiration December 31, 1996
- ----------------------------------------- ------------- ----------- ----------------- -------------------
Administrative/Branch Office:
15 Brennan Street Owned 12-31-65 N/A $ 22,252
Watsonville, California 95076
36 Brennan Street Owned 03-02-94 N/A 395,959
Watsonville, California 95076
Branch Offices:
35 East Lake Avenue Owned 12-31-65 N/A 340,280
Watsonville, California 95076
805 First Street Owned 12-01-76 N/A 251,962
Gilroy, California 95020
1400 Munras Avenue Owned(1) 07-07-93 10-30-97 943,590
Monterey, California 93940
1890 North Main Street Owned 07-07-93 N/A 1,172,005
Salinas, California 93906
(Real Estate Loan Center)(2)
1127 South Main Street Leased 08-08-93 07-31-98(3) 40,405
Salinas, California 93901
8071 San Miguel Canyon Road Leased 12-24-93 12-24-03(4) 83,742
Prunedale, California 93907
60 Bay Avenue Owned 12-10-96 N/A 1,101,417
Capitola, California 95020
- ---------------------------
(1) Majority owned, portion of property leased, with an option to purchase.
(2) The Company's real estate loan center is located in the facilities of the
branch.
(3) The Company has options to extend the lease term for three consecutive
ten-year periods.
(4) The Company has options to extend the lease term for two consecutive
five-year periods.
39
Item 3. Legal Proceedings.
The Company is not involved in any pending legal proceeding other than
routine legal proceedings occurring in the ordinary course of business. Such
other routine legal proceedings in the aggregate are believed by management to
be immaterial to the Company's financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Common Stock of Monterey Bay Bancorp, Inc. is traded
over-the-counter on the Nasdaq Stock Market under the symbol "MBBC." The stock
began trading on February 15, 1995. As of March 27, 1997, there were 3,593,750
shares outstanding of the Company's common stock. As of December 31, 1996 there
were 337 stockholders of record. This number does not include persons or
entities who hold their stock in nominee or "street" name.
Information regarding quarterly prices for the Company's stock is as
follows:
Quarter Ended Low Bid High Bid
------------- ------- --------
December 31, 1996 $13 3/8 $15 7/8
September 30, 1996 $11 3/8 $13 5/8
June 30, 1996 $11 3/4 $12 3/4
March 31, 1996 $11 $12 3/4
December 31, 1995 $11 1/2 $13
September 30, 1995 $ 9 7/8 $13 1/8
June 30, 1995 $ 9 $10 3/4
March 31, 1995 $ 8 3/4 $ 9 1/2
In the future, the Board of Directors may consider a policy of paying
dividends on the Common Stock. Declarations of dividends by the Board of
Directors, if any, will depend upon a number of factors, including investment
opportunities available to the Company, capital requirements, regulatory
limitations, the Company's financial condition, results of operations, tax
considerations, and general economic conditions. No assurances can be given,
however, that any dividends will be paid or, if commenced, will continue to be
paid.
Item 6. Selected Financial Data.
Selected consolidated financial data for the five years ended December
31, 1996, consisting of data captioned "Selected Consolidated Financial and
Other Data" on page two of the Company's 1996 Annual Report to Stockholders
filed as an exhibit hereto is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
"Management's Discussion and Analysis of Financial Condition and
Results Operations" on pages 4 to 17 of the Company's 1996 Annual Report to
Stockholders filed as an exhibit hereto is incorporated herein by reference.
40
Item 8. Financial Statements and Supplementary Data.
The Consolidated Statements of Condition of Monterey Bay Bancorp, Inc.
and Subsidiary as of December 31, 1996 and 1995 and the related Consolidated
Statements of Income, Stockholders' Equity and Cash Flows for each of the years
in the three-year period ended December 31, 1996, together with the related
notes and the report of Deloitte and Touche LLP, independent auditors, on pages
18 to 58 of the Company's 1996 Annual Report to Stockholders filed as an exhibit
hereto, are incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 2, 1997,
which will be filed no later than 120 days following the Registrant's Fiscal
Year end. Information concerning executive officers who are not directors is
contained in Part I of this report in reliance on Instruction G of Form 10-K.
Item 11. Executive Compensation.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 2, 1997, excluding the
Compensation Committee Report on Executive Compensation and the Stock
Performance Graph , which will be filed no later than 120 days following the
Registrant's Fiscal Year end.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 2, 1997, which will be filed no
later than 120 days following the Registrant's Fiscal Year end.
Item 13. Certain Relationships and Related Transactions.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 2, 1997, which will be filed no
later than 120 days following the Registrant's Fiscal Year end.
41
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a)(1) Financial Statements
The following consolidated financial statements of the registrants and
its subsidiaries are filed as a part of this document under Item 8. Financial
Statements and Supplementary Data.
Consolidated Statements of Financial Condition at December 31,
1996 and 1995.
Consolidated Statements of Operations for each of the years in
the three-year period ended December 31, 1996.
Consolidated Statements of Changes in Stockholders' Equity for
each of the years in the three-year period ended December
31, 1996.
Consolidated Statements of Cash Flows for each of the years in
the three-year period ended December 31, 1996.
Notes to Consolidated Financial Statements.
Independent Auditors' Report.
(a)(2) Financial Statement Schedules
All schedules are omitted because they are not required or are not
applicable or the required information is shown in the consolidated financial
statements or notes thereto.
(a)(3) Exhibits
(a) The following exhibits are filed as part of this report:
3.1 Certificates of Incorporation of Monterey Bay Bancorp, Inc.*
3.2 Bylaws of Monterey Bay Bancorp, Inc.*
4.0 Stock Certificate of Monterey Bay Bancorp, Inc.*
10.1 Form of Employment Agreement between Watsonville Federal
Savings and Loan Association and certain executive officers*
10.2 Form of Employment Agreement between Monterey Bay Bancorp,
Inc. and certain executive officers*
10.3 Form of Change in Control Agreement between Watsonville
Federal Savings and Loan Association and certain executive
officers*
10.4 Form of Change in Control Agreement between Monterey Bay
Bancorp, Inc. and certain executive officers*
10.5 Form of Watsonville Federal Savings and Loan Association of
Employee Severance Compensation Plan*
10.6 Watsonville Federal Savings 401(k) Plan*
10.7 Watsonville Federal Savings and Loan Association 1995
Retirement Plan for Executive Officers and Directors*
10.8 Form of Watsonville Federal Savings and Loan Association
Performance Equity Program for Executives**
10.9 Form of Watsonville Federal Savings and Loan Association
Recognition and Retention Plan for Outside Directors**
10.10 Form of Monterey Bay Bancorp, Inc. 1995 Incentive
Stock Option Plan**
10.11 Form of Monterey Bay Bancorp, Inc. 1995 Stock Option Plan for
Outside Directors**
11 Computation of Per Share Earnings
21 Subsidiary information is incorporated herein by reference
to "Part I - Subsidiaries."
42
23 Consent of Deloitte & Touche LLP
27 Financial Data Schedule
(b) Report on Form 8-K
The Registrant did not file any reports on Form 8-K during
the last quarter of the fiscal year ended December 31, 1996.
* Incorporated herein by reference from the Exhibits to the Registration
Statement on Form S-1, as amended, filed on September 21, 1994, Registration
No. 33-84272.
** Incorporated herein by reference from the Proxy Statement for the Annual
Meeting of Stockholders' filed on July 26, 1995.
43
Exhibit No. 11. Statement re: Computation of Per Share Earnings for the years
ended December 31, 1996 and 1995.(1)
1996 1995
--------- ---------
Net income $ 852,000 $ 673,000
========== ==========
Weighted average shares outstanding 3,331,870 3,565,197
Common stock equivalents due to dilutive
effect on stock options (208,389) (274,432)
---------- ----------
Total weighted average common shares
and equivalents outstanding 3,123,481 3,290,765
========== ==========
Primary earnings per share $ 0.27 $ 0.17
========== ==========
Total weighted average common shares
and equivalents outstanding 3,123,481 3,290,765
Additional dilutive shares using the end
of period market value versus the
average market value when applying
the treasury stock method(2) N/A N/A
Total weighted average common shares
and equivalents outstanding for fully
diluted computation 3,123,481 3,290,765
========== ==========
Fully diluted earnings per share $ 0.27 $ 0.17
========== ==========
(1) Net income per share is meaningful only for the years ended December 31,
1996 and 1995, since the Company's common stock was issued February 14,
1995 in connection with the Conversion of Monterey Bay Bank (formerly
Watsonville Federal Savings and Loan Association) from mutual to stock form.
Net income and common shares outstanding for the period from February 15,
1995 to December 31, 1995 were used to compute net income per share for the
twelve months ended December 31, 1995.
(2) Fully dilutive earnings per share do not result in dilution of three
percent or more or are anti-dilutive and are, therefore, not separately
presented in the consolidated statements of operations.
44
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MONTEREY BAY BANCORP, INC.
Date:___________________ By:_______________________________
Marshall G. Delk, President and
Chief Operating Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities
and on the dates indicated.
Name Title Date
- ---- ----- ----
President and Chief Operating Officer ____________,1997
- ------------------------ (principal executive officer)
Marshall G. Delk
Senior Vice President, ____________,1997
- ------------------------ Chief Financial Officer and Treasurer
Deborah R. Chandler (principal accounting officer)
Chairman of the Board of Directors and ____________,1997
- ------------------------ Chief Executive Officer
Eugene R. Friend
Director ____________,1997
- ------------------------
P. W. Bachan
Director ____________,1997
- ------------------------
Edward K. Banks
Director ____________,1997
- ------------------------
Steven Franich
Director ____________,1997
- ------------------------
Donald K. Henrichsen
45
Director ____________,1997
- ------------------------
Gary L. Manfre
Director ____________,1997
- ------------------------
William S. Meidl
Director ____________,1997
- ------------------------
Louis Resetar, Jr.
Director ____________,1997
- ------------------------
McKenzie Moss
47
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MONTEREY BAY BANCORP, INC.
By: /s/ Marshall G. Delk
_________________________
Marshall G. Delk
DATED: President and Chief Operating Officer
_______________________
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities
and on the dates indicated.
Name Title Date
---- ----- ----
/s/ Marshall G. Delk President and Chief Operating , 1997
- ------------------------------------ Officer ---------------------------------
Marshall G. Delk (principal executive officer)
/s/ Deborah R. Chandler Senior Vice President, Chief , 1997
- --------------------------------- Financial Officer and Treasurer ---------------------
Deborah R. Chandler (principal accounting officer)
/s/ Eugene R. Friend Chairman of the Board , 1997
- --------------------------------- of Directors and Chief
Eugene R. Friend Executive Officer
/s/ P.W. Bachan Director , 1997
- ---------------------------------
P.W. Bachan
/s/ Edward K. Banks Director , 1997
- ---------------------------------
Edward K. Banks
/s/ Steven Franich Director , 1997
- ---------------------------------
Steven Franich
/s/ Donald K. Henrichsen Director , 1997
- ---------------------------------
Donald K. Henrichsen
/s/ Gary L. Manfre Director , 1997
- ---------------------------------
Gary L. Manfre
/s/ William S. Meidl Director , 1997
- ---------------------------------
William S. Meidl
/s/ Louis Resetar, Jr. Director , 1997
- ---------------------------------
Louis Resetar, Jr.
/s/ McKenzie Moss Director , 1997
- ---------------------------------
McKenzie Moss