SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
445 Pine Avenue, Goleta, California 93117
(Address of principal executive offices) (Zip code)
(805) 692-5821
(Registrant's telephone number, including area code)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, NO PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 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-B is not contained, and will not be contained, to the best of
the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes[ ] No [X]
As of March 21, 2003, 5,690,224 shares of the registrant's common stock were
outstanding. The aggregate market value of common stock, held by non-affiliates
of the registrant as of March 21, 2003, was $20,846,215 based on a closing price
of $5.00 for the common stock, as reported on the Nasdaq Stock Market. For
purposes of the foregoing computation, all executive officers, Directors and 5
percent beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed to be an admission that such executive
officers, Directors or 5 percent beneficial owners are, in fact, affiliates of
the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A in connection with
the 2003 Annual Meeting are incorporated by reference into Part III of this
Report. The proxy statement will be filed with the Securities and Exchange
Commission not later than 120 days after the registrant's fiscal year ended
December 31, 2002.
COMMUNITY WEST BANCSHARES
FORM 10-K
INDEX
PART I PAGE
ITEM 1. Description of Business 3
ITEM 2. Description of Property 6
ITEM 3. Legal Proceedings 6
ITEM 4. Submission of Matters to a Vote of Security Holders 7
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Shareholder Matters 8
ITEM 6. Selected Financial Data 9
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk 50
ITEM 8. Consolidated Financial Statements and Supplementary Data F-3
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 80
PART III
ITEM 10. Directors and Executive Officers 80
ITEM 11. Executive Compensation 80
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters 80
ITEM 13. Certain Relationships and Related Transactions 80
ITEM 14. Controls and Procedures 81
PART IV
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 81
SIGNATURES 84
CERTIFICATIONS 85
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
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Community West Bancshares ("CWBC") was incorporated in the State of California
on November 26, 1996, for the purpose of forming a bank holding company. On
December 31, 1997, CWBC acquired a 100% interest in Goleta National Bank
("Goleta or Bank"). Effective that date, shareholders of Goleta became
shareholders of CWBC (NASDAQ: CWBC) in a one-for-one exchange. The acquisition
was accounted at historical cost in a manner similar to pooling-of-interests.
CWBC and Goleta are referred to herein as "the Company."
Community West Bancshares is a bank holding company. As of December 31, 2002,
CWBC had one bank subsidiary. CWBC provides management and shareholder services
to the subsidiary bank.
The Bank offers a range of commercial and retail financial services to
professionals, small to mid-sized businesses and individual households. These
services include various commercial, real estate, Small Business Administration
("SBA"), construction and consumer loan options as well as deposit products.
The Bank also offers cash management, remittance processing, electronic banking,
merchant credit card processing, online banking and other financial services.
RELATIONSHIP BANKING - Relationship banking is conducted at the community level
through two full-service branches, one in Goleta, California, and the other in
Ventura, California. The primary customers are individuals and small to
mid-sized businesses in these communities. The primary goal of relationship
banking is to provide the highest quality service and provide the most diverse
products to meet the varying needs of our customers. Products offered through
relationship banking include traditional retail banking deposit accounts, as
well as all types of business loans, real estate, construction, home improvement
and other consumer loans. Customers are also provided an array of ancillary
services, including remittance banking, merchant card processing, courier
service, on-line banking and both debit and credit cards. During 2002, core
deposits (excluding time certificates of deposits) related to relationship
banking grew by $16 million, or 22.9%.
SBA LENDING - Goleta has been an approved lender/servicer of loans guaranteed by
the SBA since late 1990. The Company primarily originates SBA loans for sale
into the secondary market. The Company continues to service these loans after
sale and is required under the SBA programs to retain specified amounts.
Previously, the Company focused on the origination and sale of SBA 7(a) loans.
A 7(a) guaranteed loan is a loan approved and funded by a qualified lender,
guaranteed by the SBA and subject to the regulations and policies applicable to
7(a) loans. The SBA guarantees up to 85% of the loan amount, depending on the
loan size. The maximum SBA loan is $2,000,000 and the maximum dollar guarantee
available is $1,000,000. Purposes of SBA loans include business purchase,
start-up or expansion, equipment purchases and purchase of commercial real
estate. Periodically, the Company may sell up to 20% of the unguaranteed
portion of select loans into the secondary market. The SBA loans are all
variable interest rate loans based upon the Wall Street Journal prime rate. The
servicing spread is a minimum of 1% on all loans. Income recognized by the
Company on the sales of the guaranteed portion of these loans and the ongoing
servicing income received are significant revenue sources for the Company.
In 2001, the Company began offering Business & Industry ("B & I") loans. These
loans are similar to the SBA product, except they are guaranteed by the U.S.
Department of Agriculture and are generally larger loans made to larger
businesses. Similarly to the SBA 7(a) product, they can be sold on the
secondary market. More recently, the Company has been offering 504 loans. The
504 program is an economic development financing program providing long-term,
low down payment loans to healthy and expanding businesses. A 504 financing is
comprised of three parts: the borrower provides at least 10% towards the project
costs; a third party lender (normally a financial institution) provides a
portion of the financing (usually 50% of the project costs) and typically has a
first lien on the project assets being financed; an SBA-guaranteed 504 debenture
finances the rest of the project. The SBA guarantees 100% of the debenture
which is issued by a Certified Development Company ("CDC"). This is the 504
loan and the CDC usually has a second lien on the project being financed.
The Company operates SBA origination and business development offices in Goleta,
California; Atlanta Georgia; Charlotte, North Carolina; Jacksonville, Florida;
Marietta, Georgia; Mill Creek, Washington; Seattle, Washington; and, the
California cities of San Diego, Bakersfield and Sacramento. Beginning in 1995,
the SBA designated the Company as a "Preferred Lender." As a Preferred Lender,
the Company has the ability to move loans through the approval process at the
SBA much more rapidly and with more decision authority than financial
institutions without such a designation. The Company currently has SBA
Preferred Lender status in the California districts of Los Angeles, Fresno,
Sacramento, San Francisco and Santa Ana as well as the states of Georgia, South
3
Carolina, Tennessee, Nevada and Florida. The Company also has Preferred Lender
status in the cities of Seattle, Washington and Portland, Oregon. Subsequent to
year end, the Company was approved as a Preferred Lender in North Carolina and
San Diego, California. Because of Goleta's Preferred Lender status in so many
states and districts, Goleta has achieved competitive advantage in this product
and was able to significantly increase its loan volume in 2002.
In December 2002, the Bank began to build a portfolio of the guaranteed portion
of SBA 7(a) loans. In the future, the decision on whether to sell or hold newly
originated 7(a) loans will be made by management and the Board of Directors on a
quarterly basis and be based on asset/liability considerations as well as
business concentrations.
In January 2003, Goleta acquired a group of seasoned SBA loan production
professionals in Sacramento from a bank that had exited the business, further
expanding the Bank's presence in Northern California.
MORTGAGE LENDING - In 1995, the Company established a Wholesale and Retail
Mortgage Loan Center. The Mortgage Loan Center originates residential real
estate and manufactured housing loans primarily in the California counties of
Ventura, Santa Barbara and San Luis Obispo. Some retail loans not fitting the
Bank's wholesale lending criteria are brokered to other lenders. After
wholesale origination, the real estate loans are sold into the secondary market.
The manufactured housing loans are retained in the Bank's loan portfolio.
From 1996 to July 2002, the Company offered high loan to value second mortgage
loans ("HLTV"). In 1998, the Company accumulated the majority of the HLTV loans
for the purpose of securitization. On December 22, 1998, the Company completed
the securitization of an $81 million pool of loans. On June 18, 1999, the
Company completed the securitization of a $122 million pool of loans. In the
fourth quarter of 1999, the Company decided to cease securitization activities.
From October 1999 to June 2002, the Company originated and sold these loans on a
flow basis with servicing rights released to several investors. As of July
2002, Goleta no longer originates HLTV loans. Goleta retains a small portfolio
(book value of $691,000 as of December 31, 2002) of these loans, which may
experience losses in the future.
SHORT-TERM CONSUMER LENDING - From the second quarter of 2000 until December 31,
2002, the Company originated short-term consumer loans under an agreement with
ACE Cash Express Incorporated ("ACE"), whereby ACE acted as an agent to
originate the loans at its national retail offices. Upon origination, ACE
purchased 90% of the principal and Goleta retained 10% ownership in the
principal of each loan. Loan customers paid a fee for typically a two-week
term, which was renewable. This amount was recorded as interest income. The
annual percentage rate on these loans was approximately 300%. ePacific.com
serviced these loans. In 2002, Goleta's short-term consumer lending program
("STCL") contributed approximately $4.4 million to indirect and corporate
overhead expense after a provision for loan losses of approximately $1.7
million. The Office of the Comptroller of the Currency ("OCC"), Goleta's primary
regulator, expressed strong reservations about Goleta and other national banks
entering into arrangements with third parties to make short-term consumer loans
and believed this program subjected Goleta and the Company to significant
strategic, reputational, compliance and transaction risks. In October 2002,
Goleta entered into a Consent Order with the OCC, agreeing to terminate STCL
effective December 31, 2002.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
Reportable business segments are determined using the "management approach" and
are intended to present reportable segments consistent with how the chief
operating decision maker analyzes segments within the company for making
operating decisions and assessing performance. Information about industry
segments is presented in Note 16 of the Consolidated Financial Statements.
GENERAL DEVELOPMENT OF BUSINESS
On December 14, 1998, CWBC acquired a 100% interest in Palomar Community Bank
("Palomar"). Shareholders of Palomar received 2.11 shares of CWBC for each
share of Palomar. The acquisition was accounted for under the purchase method.
On August 17, 2001, the Company's 100% interest in Palomar was sold to
Centennial First Financial Services. The Company recorded a gain on sale of
$96,000 which was calculated based on the recorded CWBC investment in the
subsidiary of $10,404,000 on the date of sale compared to the $10,500,000
proceeds from the sale.
4
The following table summarizes the assets and liabilities transferred (in
thousands):
Assets: Liabilities:
Cash and due from banks $ 5,193 Deposits $66,863
Federal funds sold 20,773 Other liabilities 1,457
Investments 3,447
Loans 45,284
Other assets 4,044
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Total assets $ 78,741 Total liabilities $68,320
============= =======
Net book value $10,421
=======
On October 16, 1997, the Company purchased a 70% interest in Electronic
Paycheck, LLC, a California limited liability company that is a provider of
customized debit card payment systems and electronic funds transfer services. On
November 9, 1999, Electronic Paycheck LLC merged with ePacific.com Incorporated,
a Delaware Corporation. Subsequent to the merger, ePacific.com purchased
1,800,000 of the Company's 2,100,000 shares and repaid a loan from the Company.
As a result, the Company reflected the remaining 10% investment at the lower of
cost or fair value, which was zero. On October 28, 2002, the Company sold its
remaining 300,000 shares of stock to ACE for $15,000 and recorded a gain of
$15,000 in the Company's Income Statement.
In March 2000, Goleta entered into an agreement ("Formal Agreement") with the
OCC. In October 2002, the Formal Agreement was replaced by the Consent Order
("Consent Order"). The Consent Order requires Goleta to maintain certain
capital levels and to adhere to certain operational and reporting requirements
which could limit Goleta's business activity and increase expense. See -
"Factors That May Affect Future Results of Operations - Consent Order," "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Supervision and Regulation - Consent Order With the OCC," and Note
14 of Notes to Consolidated Financial Statements.
COMPETITION AND SERVICE AREA
The financial services industry is highly competitive with respect to both loans
and deposits. Overall, the industry is dominated by a relatively small number
of major banks with many offices operating over wide geographic areas. Some of
the major commercial banks operating in the Company's service areas offer types
of services that are not offered directly by the Company. Some of these
services include trust and investment services and international banking. To
help offset the numerous branch offices of banks, thrifts and credit unions, as
well as competition from mortgage brokers, insurance companies, credit card
companies and brokerage houses within the Company's service areas, the Company,
through its subsidiary, has established loan production offices in Sacramento,
Santa Maria, Santa Barbara and Ventura, California; Georgia; Florida; North
Carolina: South Carolina and Washington. Part of the Company's strategy is to
establish loan production offices in areas where there is high demand for the
loan products that it originates.
The Company uses the flexibility of its independent status to compete for loans
and deposits within its primary service area. Management has established highly
personalized banking relationships with the Company's customers and is
responsive to their financial requirements. The Company emphasizes its
experienced management and trained staff to handle the specialized banking needs
of its customers. If a customers' loan demand exceeds the Company's lending
limits, the Company works to arrange for the loan on a participation basis with
other financial institutions. The Company also assists those customers who
require specialized services not offered by the Company to obtain the services
through correspondent institutions.
Competition may adversely affect the Company's performance. The financial
services business in the Company's markets is highly competitive and becoming
increasingly more so due to changing regulations, technology and strategic
consolidations amongst other financial service providers. Other banks and
specialty financial services companies may have more capital than the Company,
and can offer lending, leasing and other financial products to the Company's
customer base. In some instances, competitors may offer a financial product
that directly competes with one of the products the Company offers to its
clients. When new competitors seek to enter one of the Company's markets, or
when existing market participants seek to increase their market share, they
sometimes undercut the pricing or credit terms prevalent in that market.
Increasing levels of competition in the banking and financial services
businesses may reduce our market share or cause the prices to fall for which the
Company can charge for products and services.
5
GOVERNMENT POLICIES
The Company's operations are affected by various state and federal legislative
changes and by policies of various regulatory authorities, including those of
the states in which it operates and the United States government. These
policies include, for example, statutory maximum legal lending rates, domestic
monetary policies by the Board of Governors of the Federal Reserve System, U.S.
fiscal policy, U.S. Patriot Act and capital adequacy and liquidity constraints
imposed by bank regulatory agencies. Changes in these laws, regulations and
policies greatly affect our operations. See "Item 7, Management's Discussion
and Analysis of Financial Conditions and Results of Operations - Supervision and
Regulation."
EMPLOYEES
As of December 31, 2002,the Company had 134 full-time and 13 part-time
employees. The Company's employees are not represented by a union or covered by
a collective bargaining agreement. Management of the Company believes that, in
general, its employee relations are good.
ITEM 2. DESCRIPTION OF PROPERTY
- -------- -------------------------
The Company owns the Goleta full-service branch located at 5827 Hollister
Avenue, Goleta, California. It consists of a 4,000 square-foot facility and a
separate 400 square-foot building, which currently is subleased to a third
party.
The Company leases a 21,000 square-foot corporate office located at 445 Pine
Avenue, Goleta. The lease is for a term expiring March 31, 2007, with a current
monthly rent of $32,000. The lease also provides the Company with two renewal
options of five years each. This facility houses the Company's corporate
offices, comprised of various departments, including finance, data processing,
compliance, human resources, electronic business services, special assets,
operations, loan collection and the mortgage loan center.
The Company also leases approximately 3,400 square feet of office space located
at 1463 South Victoria Avenue, Ventura, California. The lease is for a term
expiring August 1, 2007, with an approximate rent payment of $9,000 per month.
This facility houses the Ventura branch office of Goleta, as well as the Ventura
mortgage department.
The Company also leases 15 additional office spaces primarily for the SBA
business development officers which range in size from 190 to 7,600 square feet
with lease terms expiring in one month up to a maximum of 5 years. Monthly
lease expense per premise ranges from $150 to $9,500. The other leases include
approximately 7,600 square feet of space located at 681 South Parker Street
Suite 350, Orange, California. The lease is for a term expiring September 30,
2003, with a current monthly rent of $9,000. This facility is currently vacant
and therefore, the future rent amounts have been fully reserved as of December
31, 2002. The Company also leases two suites in an office building at 5638
Hollister Avenue, Goleta. The leases on these two suites are for terms expiring
May 31, 2003, with a current monthly rent of $9,000 per month for both suites.
The leases also provide the Company with two additional consecutive options of
three years each to extend the leases. The suites consist of approximately
3,300 square feet of office space. The Company sublet these suites to an
independent third party for a term commencing May 1, 2000 and expiring May 31,
2003. The sublease does not provide the sublessee an option to extend the
sublease and the Company has no intention of extending the leases. The
Company's total occupancy expense, including depreciation, for the year ended
December 31, 2002 was $2,888,000. Management believes that its existing
facilities are adequate for its present purposes.
ITEM 3. LEGAL PROCEEDINGS
- -------- ------------------
The following summarizes the Company's significant legal proceedings.
SHORT-TERM CONSUMER LENDING
Throughout 2000, 2001 and 2002, Goleta made short-term consumer loans ("Bank
Loans") using marketing and servicing assistance of ACE at almost all of ACE's
retail locations pursuant to the terms of a Master Loan Agency Agreement between
ACE and Goleta ("Goleta Agreement"). However, in October 2002, Goleta and ACE
entered into separate consent orders with the OCC. In connection with its
Consent Order, Goleta agreed to discontinue making Bank Loans, effective
December 31, 2002, and paid a civil money penalty of $75,000.
A number of lawsuits and state regulatory proceedings have been filed or
initiated against Goleta and/or ACE regarding the Bank Loans. The state
regulatory proceedings have all been settled without Goleta incurring any
liability for settlement payments. However, together with ACE, Goleta remains a
defendant in three class actions, including a nationwide class action brought in
a federal court in Texas and two statewide class actions brought in state courts
in Florida and Maryland. A key issue in the remaining class actions concerning
the Bank Loans is whether Goleta or ACE is properly regarded as the lender.
6
Goleta and ACE maintain that, as provided by the legal documentation and
marketing materials for the Bank Loans, Goleta is the lender and that, because
Goleta is a national bank located in California, the Bank Loans, including the
interest that may legally be charged, should be governed by federal and
California law. The plaintiffs, however, maintain that ACE should be regarded
as the lender, because of the services it renders to Goleta under the Goleta
Agreement and ACE's purchase of participation interests in the Bank Loans, and
that the Bank Loans, including interest that may legally be charged, should be
governed by the laws of the respective states in which the borrowers reside. If
ACE were held to be the lender, then the interest charged for the Bank Loans
would violate most of the applicable states' usury laws, which impose maximum
rates of interest or finance charges that a non-bank lender may charge.
The consequences to ACE of an adverse holding in one or more of the pending
lawsuits would depend on the applicable state's usury and consumer-protection
laws and on the basis for a finding of violation of those laws. Those
consequences could include ACE's obligation to refund interest collected on the
Bank Loans, to refund the principal amount of the Bank Loans, to pay treble or
other multiple damages and/or to pay monetary penalties specified by statute.
Regarding each lawsuit, that amount would depend upon proof of the allegations,
the number or the amount of the loan-related transactions during relevant time
periods and (for certain of the claims) proof of actual damages sustained by the
plaintiffs.
While the Goleta Agreement formerly provided that Goleta would bear between
5% and 10% of the monetary exposure in the Florida, Maryland and Texas,
lawsuits, the Goleta Agreement was amended in October 2002 to provide that ACE
will be liable for 100% of the monetary exposure in all of these cases (and any
additional cases concerning the Bank Loans). However, if the Goleta Agreement
is invalid or unenforceable, or if ACE is unable to pay, Goleta could be liable
for up to the full amount of any and all awards against it in these lawsuits,
which could have a material adverse impact on the Company's financial condition
or results of operations. Under the terms of the Goleta Agreement, Goleta
remains liable for its own willful misconduct, its failure to maintain the
authorizations to conduct the business, regulatory penalties imposed on it, and
any credit losses for the portion of the Bank Loans it retained.
OTHER LITIGATION
The Company is involved in various other litigation of a routine nature which is
being handled and defended in the ordinary course of the Company's business. In
the opinion of management, based in part on consultation with legal counsel, the
resolution of these other litigation matters will not have a material impact on
the Company's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
- ------- ------------------------------------------------------------
None.
7
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
- -------- -------------------------------------------------------------------
MATTERS
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(a) Market Information
The Company's common stock is traded on the Nasdaq Stock Market under the symbol
CWBC. The following table sets forth the high and low closing sales prices on a
per share basis for the Company's common stock as reported by the Nasdaq Stock
Market for the period indicated:
2002 QUARTERS 2001 QUARTERS
-------------------------------- --------------------------------
Fourth Third Second First Fourth Third Second First
------- ------ ------- ------ ------- ------ ------- ------
Stock Price Range:
High $ 4.73 $ 4.44 $ 5.00 $ 6.07 $ 6.50 $ 6.95 $ 6.25 $ 5.50
Low $ 4.16 $ 3.28 $ 4.45 $ 3.95 $ 5.50 $ 6.10 $ 3.95 $ 3.78
As of March 21, 2003, the year to date high and low stock prices were $5.45 and
$4.58, respectively. As of March 21, 2003, the last reported sale price per
share for the Company's common stock was $5.00.
(b) Holders
As of March 21, 2003, the Company had 464 stockholders of record of its common
stock.
(c) Dividends
No cash dividends have been paid to stockholders during the past two years, and
the Company does not expect to declare cash dividends in the foreseeable future.
The payment of dividends requires the approval of the Federal Reserve Bank under
the Company's Memorandum of Understanding ("MOU"). One source of funds for the
payment of dividends would be from dividends paid by Goleta to the Company.
Goleta's ability to pay dividends to the Company is limited by California law,
federal banking law and the terms of Goleta's Consent Order with the OCC. See
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations - Supervision and Regulation - Limitations on Dividend
Payments," "- Consent Order With the OCC" and "-Memorandum of Understanding With
the Federal Reserve Bank."
8
ITEM 6. SELECTED FINANCIAL DATA
- -------- -------------------------
The following selected financial data have been derived from the Company's
consolidated financial condition and results of operations, as of and for the
years ended December 31, 2002, 2001, 2000, 1999 and 1998, should be read in
conjunction with the consolidated financial statements and the related notes
included elsewhere in this report.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT:
Interest income $ 29,976 $ 40,794 $ 51,864 $ 48,495 $ 15,279
Interest expense 13,466 20,338 26,337 25,145 6,317
----------- ----------- ----------- ----------- -----------
Net interest income 16,510 20,456 25,527 23,350 8,962
Provision for loan losses 4,899 11,880 6,794 6,133 1,759
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 11,611 8,576 18,733 17,217 7,203
Other operating income 11,398 22,171 16,481 11,021 11,022
Other operating expense 24,931 32,006 29,978 30,506 17,482
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes (1,922) (1,259) 5,236 (2,268) 743
Provision (benefit) for income taxes (652) (1,281) 2,539 (622) 289
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (1,270) $ 22 $ 2,697 $ (1,646) $ 454
=========== =========== =========== =========== ===========
PER SHARE DATA:
Income (loss) per common share - Basic $ (0.22) $ 0.00 $ 0.44 $ (0.30) $ 0.12
Weighted average shares used in income (loss)
per share calculation - Basic 5,690,224 5,947,658 6,017,216 5,494,217 3,767,607
Income (loss) per common share - Diluted $ (0.22) $ 0.00 $ 0.43 $ (0.30) $ 0.12
Number of shares used in income (loss)
per share calculation - Diluted 5,690,224 5,998,003 6,233,245 5,494,217 3,941,749
Book value per share $ 5.64 $ 5.86 $ 5.90 $ 5.56 $ 4.48
BALANCE SHEET:
Net loans $ 245,856 $ 260,955 $ 329,265 $ 451,664 $ 247,411
Total assets 307,210 323,863 405,255 523,847 327,569
Deposits 219,083 196,166 228,720 313,131 223,853
Total liabilities 275,123 290,506 369,221 489,915 298,448
Total stockholders' equity 32,087 33,357 36,035 33,932 29,121
OPERATING AND CAPITAL RATIOS: YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Return on average equity (3.99)% 0.07% 7.35% (6.68)% 3.50%
Return on average assets (0.42)% 0.01% 0.61% (0.37)% 0.20%
Equity to assets ratio 10.48% 10.30% 8.89% 6.51% 8.77%
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------- -------------------------------------------------------------------
RESULTS OF OPERATIONS
-----------------------
This 2002 Annual Report on Form 10-K contains statements that constitute
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Those forward-looking statements include statements regarding the
intent, belief or current expectations of Community West Bancshares ("Company")
and its management. Any such forward-looking statements are not guarantees of
future performance and involve risks and uncertainties, and actual results may
differ materially from those projected in the forward-looking statements. Such
risks and uncertainties include:
- changes in the interest rate environment reducing interest rate
margins or increasing interest rate risk
- reduction in our earnings by losses on loans
- deterioration in general economic conditions
- the regulation of the banking industry
- compliance with the Consent Order with the OCC and Memorandum of
Understanding with the Federal Reserve Bank
- dependence on real estate
- risks of natural disasters
- increased competitive pressure among financial services companies
- operational risks
- legislative or regulatory changes adversely affecting the business in
which the Company engages
- the availability of sources of liquidity at a reasonable cost
- security risks related to online banking service
- other risks and uncertainties that may be detailed herein
This discussion also provides information on the strategies adopted by the
Company to address these risks and the results (where applicable) of these
strategies.
INTRODUCTION
- ------------
This discussion is designed to provide insight into management's assessment of
significant trends related to the Company's consolidated financial condition,
results of operations, liquidity, capital resources and interest rate
sensitivity. It should be read in conjunction with the consolidated financial
statements and notes thereto and the other financial information appearing
elsewhere in this report.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
- -----------------------------------------------------------
ECONOMIC CONDITIONS
Nationally, the banking industry and the Company have been affected by the
steady growth in the economy and the actions of the Federal Reserve Board to
manage this growth by cutting interest rates to the lowest levels in over 40
years. The changes in interest rates have impacted the Company as market rates
for loans, investments and deposits are near an all time-low.
Goleta serves three primary regions. The Tri-Counties region which consists of
San Luis Obispo, Santa Barbara and Ventura counties in the state of California,
the SBA Western Region where Goleta originates SBA loans (California,
Washington, Nevada and Colorado) and the SBA Southeast Region (Georgia, Florida,
Tennessee, Alabama, North Carolina and South Carolina). The forecast for the
Tri-Counties area is positive for the coming years, but California has its own
unique problems, as budget and energy problems have discouraged business
investment in California and slowed economic growth. Goleta's SBA Western
Region has experienced modest growth. Non-planned retail expenditures should
remain weak. In addition, no significant economic growth is anticipated for some
time. The economy relative to our SBA Southeast region continues to remain
sluggish. Also impacting the Company is the nation's slow recovery in the
tourism and hospitality sectors from the tragedy of September 11, 2001.
REGULATORY CONSIDERATIONS
The financial services industry is heavily regulated. The Company is subject to
federal and state regulation designed to protect the deposits of consumers, not
to benefit shareholders. These regulations include the following:
- the amount of capital the Company must maintain
10
- the types of activities in which it can engage
- the types and amounts of investments it can make
- the locations of its offices
- how much interest Goleta can pay on demand deposits
- insurance of the Company's deposits and the premiums paid for this
insurance
- how much cash the Company must set aside as reserves for deposits
The regulations impose significant limitations on operations and may be changed
at any time, possibly causing future results to vary significantly from past
results. Government policy and regulation, particularly as implemented through
the Federal Reserve System, significantly affects credit conditions. See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations - Supervision and Regulation."
CONSENT ORDER
In March 2000, Goleta entered into the Formal Agreement with its principal
regulator, the Office of the Comptroller of the Currency ("OCC"). In October of
2002, Goleta entered into a stipulation for the entry of a consent order
("Consent Order") with the OCC. As of this date, the Consent Order replaced the
Formal Agreement that Goleta was previously under with the OCC. The Consent
Order requires that Goleta maintain certain capital levels, adhere to certain
operational and reporting requirements, and take certain actions which could
limit Goleta's business activity and increase expense. The failure to fully
comply with the Consent Order requirements could adversely affect the safety or
soundness of Goleta. The OCC possesses broad powers to take corrective and
other supervisory action and bring enforcement actions to resolve unsafe or
unsound practices. The Company believes that it is in substantial compliance
with the Consent Order. See - Supervision and Regulation - Consent Order With
the OCC."
MEMORANDUM OF UNDERSTANDING
In March 2000, CWBC entered into a Memorandum of Understanding ("MOU") with its
principal regulator, the Federal Reserve Bank of San Francisco. The MOU
requires the Company to maintain certain capital levels as well as adhere to
certain operational and regulatory requirements. Compliance with the
requirements of the MOU could limit the Company's business activity and/or
increase costs. The Company believes that it is in substantial compliance with
the MOU. See - Supervision and Regulation - Memorandum of Understanding With
the Federal Reserve Bank."
BANK REGULATIONS COULD DISCOURAGE CHANGES IN THE COMPANY'S OWNERSHIP
Bank regulations could delay or discourage a potential acquirer who might have
been willing to pay a premium price to acquire a large block of common stock.
That possibility could decrease the value of the Company's common stock and the
price that a stockholder will receive if shares are sold in the future. Before
anyone can buy enough voting stock to exercise control over a bank holding
company like CWBC, bank regulators must approve the acquisition. A stockholder
must apply for regulatory approval to own 10 percent or more of the Company's
common stock, unless the stockholder can show that they will not actually exert
control over the Company. Regardless, no stockholder can own more than 25
percent of the Company's common stock without applying for regulatory approval.
THE COMPANY DOES NOT EXPECT TO PAY DIVIDENDS
The Company intends to reinvest earnings into its business rather than pay
dividends on its common stock for the foreseeable future. Additionally, CWBC
would need the approval of the Federal Reserve Bank (under the terms of the
Company's MOU) to pay dividends to its stockholders. One source of funds for
the payment of dividends by CWBC would be from dividends paid by Goleta to CWBC.
Goleta's ability to pay dividends to CWBC is limited by California law, federal
banking law, and the terms of Goleta's Consent Order with the OCC. See
"Supervision and Regulation - Consent Order With the OCC" and "- Memorandum of
Understanding With the Federal Reserve Bank."
THE PRICE OF THE COMPANY'S COMMON STOCK MAY CHANGE RAPIDLY AND SIGNIFICANTLY
The market price of the Company's common stock could change rapidly and
significantly at any time. The market price of the Company's common stock has
fluctuated in recent years. Between January 1, 2001 and December 31, 2002, the
closing market price of its common stock ranged from a low of $3.28 per share to
a high of $6.07 per share. Fluctuations may occur, among other reasons, in
response to:
- short-term or long-term operating results
- regulatory action or adverse publicity
- perceived value of the Company's loan portfolio
11
- trends in the Company's nonperforming assets or the nonperforming
assets of other financial institutions
- announcements by competitors
- economic changes
- general market conditions
- perceived strength of the banking industry in general
- legislative and regulatory changes
The trading price of the Company's common stock may continue to be subject to
wide fluctuations in response to the factors set forth above and other factors,
many of which are beyond the Company's control. The stock market in recent
years has experienced extreme price and trading volume fluctuations that often
have been unrelated or disproportionate to the operating performance of
individual companies. The Company believes that investors should consider the
likelihood of these market fluctuations before investing in the Company's common
stock.
DEPENDENCE ON REAL ESTATE
Approximately 54% of the loan portfolio of the Company is secured by various
forms of real estate, including residential and commercial real estate. A
decline in current economic conditions or rising interest rates could have an
adverse effect on the demand for new loans, the ability of borrowers to repay
outstanding loans and the value of real estate and other collateral securing
loans. The real estate securing the Company's loan portfolio is concentrated in
California. If real estate values decline significantly, especially in
California, higher vacancies and other factors could harm the financial
condition of the Company's borrowers, the collateral for its loans will provide
less security, and the Company would be more likely to suffer losses on
defaulted loans.
CURTAILMENT OF GOVERNMENT GUARANTEED LOAN PROGRAMS COULD EFFECT AN IMPORTANT
SEGMENT OF THE COMPANY'S BUSINESS
A major segment of the Company's business consists of originating and selling
government guaranteed loans, in particular those guaranteed by the Small
Business Administration. From time to time, the government agencies that
guarantee these loans reach their internal limits and cease to guarantee loans
for a stated time period. In addition, these agencies may change their rules
for loans or Congress may adopt legislation that would have the effect of
discontinuing or changing the programs. Non-governmental programs could replace
government programs for some borrowers, but the terms might not be equally
acceptable. Therefore, if these changes occur, the volume of loans to small
business, industrial and agricultural borrowers of the types that now qualify
for government guaranteed loans could decline. Also, the profitability of these
loans could decline.
ENVIRONMENTAL LAWS COULD FORCE THE COMPANY TO PAY FOR ENVIRONMENTAL PROBLEMS
When a borrower defaults on a loan secured by real property, the Company often
purchases the property in foreclosure or accepts a deed to the property
surrendered by the borrower. The Company may also take over the management of
commercial properties whose owners have defaulted on loans. While Goleta has
guidelines intended to exclude properties with an unreasonable risk of
contamination, hazardous substances may exist on some of the properties that
Goleta owns, manages or occupies. The Company faces the risk that environmental
laws could force it to clean up the properties at the Company's expense. It may
cost much more to clean a property than the property is worth. The Company
could also be liable for pollution generated by a borrower's operations if the
Company took a role in managing those operations after default. Resale of
contaminated properties may also be difficult.
OVERVIEW OF EARNINGS PERFORMANCE
- -----------------------------------
In 2002, the net loss of the Company was $1.3 million, or $(0.22), per basic and
diluted shares. This represents a decrease from the $22,000 net income, or
$0.00 per basic and diluted shares, reported for 2001. Return on average assets
and average equity were (0.42)% and (3.99)% in 2002, compared with returns of
0.01% and 0.07% for 2001. Even though interest rates continued to decline in
2002, the Company's net interest income after provision for loan losses
increased in 2002 by $3 million, or 35.4%. This increase was primarily due to a
reduction in the provision for loan losses of $7 million, or 58.8%, for 2002
which was the result of increased credit quality gained from the Company's exit
from higher risk lending activities as well as the Company's overall tightening
of credit underwriting standards. Despite these increases, the Company's net
income decreased by $1.3 million, primarily due to a 48.6%, or $10.7 million,
decrease in other income. Approximately $7 million of this decline relates to
the legal settlement proceeds received in 2001. The other $3.7 million decline
in other income is primarily due to a $1.8 million decrease in net gains from
loan sales and various small decreases in other loan fees, document processing
fees, net loan servicing and other income. Throughout 2002, the Company made
significant changes in its business lines by exiting both HLTV and STCL and
consolidating its SBA and Mortgage lending operations into the Company's
12
headquarters. These changes, as well as ongoing cost cutting efforts, resulted
in a decrease in non-interest expenses by $7 million, or 28.4 %.
The Company's net income declined $2.7 million, or $0.44 per basic share and
$0.43 per diluted share, from 2000 to 2001. The primary reasons for this
decline were the declines in interest rates during 2001 and the additional loan
loss provision necessary to address the credit quality issues resulting from a
slowdown in the economy. An increase in prepayment speed assumptions of sold
loans also caused the Company to record $2.6 million in amortization and/or
writedowns of its servicing and interest-only assets. These adverse factors
were partially offset by the $4.6 million net proceeds from a legal settlement
with the Company's former auditors.
CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
- -----------------------------------------------------
Net interest income is the difference between the interest and fees earned on
loans and investments and the interest expense paid on deposits and other
liabilities. The amount by which interest income will exceed interest expense
depends on the volume or balance of earning assets compared to the volume or
balance of interest-bearing deposits and liabilities and the interest rate
earned on those interest-earning assets compared to the interest rate paid on
those interest-bearing liabilities.
Net interest margin is net interest income (tax equivalent) expressed as a
percentage of average earning assets. It is used to measure the difference
between the average rate of interest earned on assets and the average rate of
interest that must be paid on liabilities used to fund those assets. To
maintain its net interest margin, the Company must manage the relationship
between interest earned and paid. The following table sets forth, for the
period indicated, the increase or decrease of certain items in the consolidated
income statements of the Company as compared to the prior periods:
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2002 VS 2001 2001 VS 2000 2000 VS 1999
------------------------ ------------------------ ------------------------
AMOUNT OF PERCENT OF AMOUNT OF PERCENT OF AMOUNT OF PERCENT OF
INCREASE INCREASE INCREASE INCREASE INCREASE INCREASE
(DECREASE) (DECREASE) (DECREASE) (DECREASE) (DECREASE) (DECREASE)
----------- ----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
INTEREST INCOME:
Loans, including fees $ (9,952) (25.4)% $ (10,590) (21.2)% $ 2,768 5.9%
Federal funds sold (730) (66.7)% (311) (22.1)% 397 39.4%
Time deposits in other financial institutions (164) (61.0)% 156 137.8% 66 140.3%
Investment securities 30 17.4% (325) (65.4)% 55 12.5%
----------- ----------- -----------
Total interest income (10,818) (26.5)% (11,070) (21.3)% 3,286 6.8%
----------- ----------- -----------
INTEREST EXPENSE
Deposits (3,916) (41.4)% (1,874) (16.5)% $ (3,746) (24.8)%
Bonds payable and other borrowings (2,957) (27.2)% (4,125) (27.5)% 4,661 46.3%
----------- ----------- -----------
Total interest expense (6,873) (33.8)% (5,999) (22.8)% 915 3.6%
----------- ----------- -----------
NET INTEREST INCOME (3,945) (19.3)% (5,071) (19.9)% 2,371 10.1%
PROVISION FOR LOAN LOSSES (6,981) (58.8)% 5,086 74.9% 661 10.8%
----------- ----------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES (3,036) 35.4% (10,157) (54.2)% 1,710 9.9%
----------- ----------- -----------
OTHER INCOME:
Gains from loan sales (1,828) (27.6)% (875) (11.7)% 1,503 25.11%
Other loan origination fees - sold or
brokered loans (44) (1.3)% 1,606 88.0% (884) (32.6)%
Document processing fees (574) (29.0)% 758 62.1% 44 4.1%
Loan servicing fees (622) (36.5)% (1,087) (39.0)% 2,291 458.3%
Service charges (136) (23.6%) 16 2.9% 44 8.6%
Income from sale of interest in subsidiary (96) (100.0% (1,984) (95.4)% 2,080 100.0%
Proceeds from legal settlement (7,000) (100.0)% 7,000 100.0% - -
Other income (473) (61.3)% 256 35.1% 185 99.32%
----------- ----------- -----------
TOTAL OTHER INCOME (10,773) (48.6)% 5,690 34.5% 5,263 47.7%
----------- ----------- -----------
13
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2002 VS 2001 2001 VS 2000 2000 VS 1999
------------------------ ------------------------ ------------------------
AMOUNT OF PERCENT OF AMOUNT OF PERCENT OF AMOUNT OF PERCENT OF
INCREASE INCREASE INCREASE INCREASE INCREASE INCREASE
(DECREASE) (DECREASE) (DECREASE) (DECREASE) (DECREASE) (DECREASE)
----------- ----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
OTHER EXPENSES:
Salaries and employee benefits (4,108) (23.2)% 2,463 16.2% (987) (6.1)%
Occupancy expenses (192) (8.3)% (91) (3.8)% (15) (0.6)%
Impairment-SBA I/O service asset 1,788 - - - - -
Professional services (663) (29.6)% 1,289 135.7% (1,630) (63.2)%
Lower of cost or market provision 1,381 - - - (1,277) (100.0)%
Loan servicing and collection expense (466) (34.8)% (1,351) (50.2)% 137 6.3%
Depreciation expense (648) (45.6)% (98) (6.5)% 89 6.3%
Advertising expense (183) (27.7)% (45) (6.4)% (446) (38.7)%
Postage and freight (44) (10.9)% 107 36.4% (57) (16.2)%
Office supply expense (208) (48.9)% (12) (2.7%) 5 1.4%
Data processing (144) (51.4)% (66) (19.1)% (166) (32.6)%
Amortization of intangible assets (178) (100.0)% (226) (56.0)% 41 11.2%
Impairment of goodwill - - (2,110) (100.0%) 2,110 100.0%
Professional expenses associated with
legal settlement (2,392) (100.0)% 2,392 100.0% - -
Other operating expenses (1,018) (38.3%) (224) (7.8)% 1,665 102.5%
----------- ----------- -----------
TOTAL OTHER EXPENSES (7,075) (21.1)% 2,028 6.8% (531) (1.7)%
----------- ----------- -----------
INCOME (LOSS) BEFOREPROVISION
(BENEFIT) FOR INCOME TAXES (663) (52.7)% (6,495) (124.1)% 7,504 330.8%
PROVISION (BENEFIT) FOR INCOME
TAXES 629 49.1% (3,820) (150.5)% 3,160 508.2%
----------- ----------- -----------
NET INCOME (LOSS) $ (1,292) (5,872.7)% $ (2,675) (99.2)% $ 4,344 263.8%
----------- ----------- -----------
Total interest income decreased 26.5% from $40.8 million in 2001 to $30 million
in 2002. Total interest expense decreased 33.8% from $20.3 in 2001 to $13.5 in
2002. The decrease in both interest income and interest expense was primarily
due to a decline in interest rates; the sale of Palomar which is included in the
income statement for 2001 for seven and one-half months only; and, a prepayment
rate of approximately 39% experienced in Goleta's securitized loan portfolio.
In addition, the Company was somewhat asset sensitive during this period of
declining interest rates. As a result, net interest income decreased 19.3% from
$20.5 million in 2001 to $16.5 in 2002.
Total interest income decreased 21.2% from $51.8 million in 2000 to $40.8
million 2001. Total interest expense decreased 23.4% from $26 million in 2000
to $20 million in 2001. The decrease in both interest income and interest
expense was primarily due to a decline in interest rates; the sale of Palomar
which is included in the income statement for 2001 for seven and one-half months
only and prepayments experienced in the Company's securitized loan portfolio
off-set by increases in the level and yield of Goleta's short-term consumer
loans. As a result, net interest income decreased 19% from $25.7 million in
2000 to $20.8 million in 2001.
14
The following table sets forth the changes in interest income and expense
attributable to changes in rates and volumes:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
2002 VERSUS 2001 2001 VERSUS 2000 2000 VERSUS 1999
----------------------------- ----------------------------- ----------------------------
CHANGE CHANGE CHANGE CHANGE CHANGE CHANGE
TOTAL DUE TO DUE TO TOTAL DUE TO DUE TO TOTAL DUE TO DUE TO
CHANGE RATE VOLUME CHANGE RATE VOLUME CHANGE RATE VOLUME
--------- -------- -------- --------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Time deposits in other
Financial institutions $ (68) $ (58) $ (10) $ 59 $ (32) $ 91 $ 66 $ 1 $ 65
Federal funds sold (730) (747) 17 (311) (417) 106 397 195 202
Investment securities (67) (101) 34 (229) 148 (377) 56 102 (46)
Loans, net (3,190) (1,057) (2,133) 252 2,436 (2,184) (7,159) (2,039) (5,120)
Securitized loans (6,763) (1,019) (5,744) (10,841) (6,295) (4,546) 10,009 7,907 2,102
--------- -------- -------- --------- -------- -------- -------- -------- --------
Total interest-earning
assets (10,818) (2,982) (7,836) (11,070) (4,514) (6,556) 3,369 6,165 (2,796)
--------- -------- -------- --------- -------- -------- -------- -------- --------
Interest-bearing demand (225) (286) 61 35 72 (37) 214 29 185
Savings (159) (79) (80) (249) (87) (162) (172) (159) (13)
Time certificates of
deposit (3,531) (3,196) (335) (1,660) (531) (1,129) (3,788) (1,875) (1,913)
Federal funds purchased - - - (19) (29) 10 (25) 10 (35)
Bonds payable (2,490) 1,997 (4,487) (4,027) (311) (3,716) 4,500 4,011 489
Other borrowings (467) - (467) (79) 186 (265) 463 29 434
--------- -------- -------- --------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities (6,872) (1,564) (5,308) (5,999) (1,281) (4,718) 915 1,768 (853)
--------- -------- -------- --------- -------- -------- -------- -------- --------
Net interest income $ (3,946) $(1,417) $(2,529) $ (5,071) $(1,746) $(3,325) $ 1,192 $ 2,044 $ (851)
========= ======== ======== ========= ======== ======== ======== ======== ========
The Company primarily earns income from the management of its financial assets
and liabilities and from charging fees for services it provides. The Company's
income from managing assets consists of the difference between the interest
income received from its loan portfolio and investments and the interest expense
paid on its liabilities, primarily interest paid on deposits. This difference
or spread is net interest income. Net interest income, when expressed as a
percentage of average total interest-earning assets, is referred to as net
interest margin on interest-earning assets. The Company's net interest income
is affected by the change in the level and the mix of interest-earning assets
and interest-bearing liabilities, referred to as volume changes. The Company's
net yield on interest-earning assets is also affected by changes in the yields
earned on assets and rates paid on liabilities, referred to as rate changes.
Interest rates charged on the Company's loans are affected principally by the
demand for such loans, the supply of money available for lending purposes,
competitive factors and general economic conditions such as federal economic
policies, legislative tax policies and governmental budgetary matters.
The following table presents the net interest income and net interest margin:
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
-------- -------- --------
(DOLLARS IN THOUSANDS)
Interest income $29,976 $40,794 $51,864
Interest expense 13,466 20,338 26,337
-------- -------- --------
Net interest income $16,510 $20,456 $25,527
======== ======== ========
Net interest margin 5.6% 5.6% 6.3%
15
NON-INTEREST INCOME
The following table summarizes the Company's non-interest income for the three
years indicated:
YEAR ENDED DECEMBER 31,
-------------------------
NON-INTEREST INCOME 2002 2001 2000
------- ------- -------
(IN THOUSANDS)
Gains from sale of loans $ 4,788 $ 6,616 $ 7,491
Loan origination fees 3,388 3,432 1,826
Document processing fees 1,404 1,978 1,220
Loan servicing 1,081 1,703 2,790
Service charges 440 575 559
Income from sale of interest in subsidiary - 96 2,080
Proceeds from legal settlement - 7,000 -
Other income 297 771 515
------- ------- -------
TOTAL NON-INTEREST INCOME $11,398 $22,171 $16,481
======= ======= =======
The Company's non-interest income decreased by $10.8 million, or 48.6%, from
2001 to 2002. The primary factors contributing to this decrease in other income
were the $7 million proceeds from the legal settlement against the Company's
former auditors received in 2001 and the decrease of $1.8 million or 27.3% in
gain on loan sales primarily due to Goleta's exit from the HLTV loan origination
and sales business in the second quarter of 2002 and management's strategic
decision not to sell any SBA loans in the fourth quarter of 2002. The other
$2.0 million decline in other income is attributable to small declines in loan
origination and document processing fees, loan servicing income, service charges
and other income.
Non-interest income increased by $5.9 million from 2000 to 2001. The primary
factors contributing to the increase in non-interest income in 2001 were $7
million in proceeds from a legal settlement against the Company's former
auditors; an $862,000 increase in document processing fees, principally in the
Company's mortgage origination business; and a $1.6 million increase in loan
origination fees, also principally in the Company's mortgage origination
business. Factors adversely affecting 2001 non-interest income included an
$875,000 reduction in the gain on sale of loans, principally in the Company's
SBA business and a $1 million reduction in loan servicing fees. The reduction
in 2001 loan servicing fees was principally due to an increase in the
amortization and valuation adjustment of the Company's SBA related servicing and
interest-only strip assets to $2.3 million in 2001.
NON-INTEREST EXPENSES
The following table summarizes the Company's non-interest expenses for the three
years indicated:
YEAR ENDED DECEMBER 31,
-------------------------
NON-INTEREST EXPENSES 2002 2001 2000
------- ------- -------
(IN THOUSANDS)
Salaries and employee benefits $13,596 $17,704 $15,241
Occupancy and depreciation 2,119 2,311 2,402
Impairment of SBA I/0 and Servicing Assets 1,788 - -
Professional services 1,575 2,238 949
Lower of cost or market provision 1,381 - -
Loan servicing and collection 872 1,338 2,689
Depreciation 771 1,419 1,517
Advertising 478 661 706
Postage and freight 359 402 295
Office supplies 217 425 437
Data and ATM processing 136 279 345
Amortization of intangible assets - 178 404
Impairment of goodwill - - 2,110
Professional expenses associated with legal settlement - 2,392 -
Other operating expense 1,639 2,657 2,883
------- ------- -------
TOTAL NON-INTEREST EXPENSES $24,931 $32,006 $29,978
======= ======= =======
16
Non-interest expenses decreased by $7.1 million, or 22.1%, from 2001 to 2002 and
increased by $2.4 million or 6.3% from 2000 to 2001. The decrease in 2002 was
primarily due to the Company's reorganization and cost cutting efforts.
Salaries and employee benefits decreased by $4.1 million, or 23.2%, due
primarily to the Company's exit from HLTV and STCL lending as well as
consolidation of its SBA support departments. Other declines in expenses
include professional services by $700,000, depreciation by $600,000, loan
collection by $500,000, other operating expenses by $1 million and the $2.4
million in expenses related to the legal settlement in 2001. Some of this
decline is attributable to Palomar's $2.2 million in non-interest expenses
included in 2001. The decreases in these expense categories were partially
offset by the Company's recognition of $1.7 million of impairment on SBA
servicing and I/O strip assets and a $1.4 million increase in lower of cost or
fair value adjustments made on the HLTV loan portfolio transferred to held for
sale in the third quarter of 2002.
The primary factors contributing to the $2.4 million increase in non-interest
expenses from 2000 to 2001 were $2.4 million of professional expenses incurred
in 2001 in connection with a legal settlement with the Company's former auditors
and a $2.5 million increase in salaries and employee benefits, principally
commission paid on SBA and mortgage loans originated or brokered. These
increases were offset by the reduction in 2001 of the impairment of goodwill
charge from the sale of the Company's subsidiary, Palomar and a reduction of
$1.1 million in loan servicing and collection expense, principally due to the
paydown of Goleta's securitized loan portfolios which are serviced by a third
party.
The following table compares the various elements of non-interest expenses as a
percentage of average assets:
TOTAL SALARIES AND OCCUPANCY AND
AVERAGE NON-INTEREST EMPLOYEE DEPRECIATION
YEAR ENDED DECEMBER 31, ASSETS EXPENSES BENEFITS EXPENSES
- ------------------------ -------- ------------- -------------- -------------
(DOLLARS IN THOUSANDS)
2002 $301,962 8.25% 4.50% 0.95%
2001 $371,923 8.71% 4.76% 0.97%
2000 $439,945 6.81% 3.46% 0.89%
INCOME TAXES
Income taxes (benefit) provision was $(652,000) in 2002, $(1,281,000) in 2001
and $2,539,000 in 2000. The effective income (benefit) tax rate was (33.9%),
(101.8%) and 48.5% for 2002, 2001 and 2000, respectively. The change in
effective tax rates from 2001 to 2002 is principally due to the taxable gain on
sale of Palomar increasing the effective tax rate and the proceeds from capital
recovery, treated as a non-taxable item for income tax purposes, recognized in
2001 and decreasing the effective tax rate. The State of California does not
allow a net operating loss ("NOL") carryback for tax purposes. Since the
realization of this benefit in the future is not assured, the Company has
established a 100% valuation allowance against the California NOL tax benefit
carryforward, which reduced the 2002 effective tax rate. See footnote 9,
"Income Taxes", in the notes to the Consolidated Financial Statements.
CAPITAL RESOURCES
- ------------------
The Federal Deposit Insurance Corporation Improvement Act, herein referred to as
the "FDICIA," was signed into law on December 19, 1991. FDICIA included
significant changes to the legal and regulatory environment for insured
depository institutions, including reductions in insurance coverage for certain
kinds of deposits, increased supervision by the federal regulatory agencies,
increased reporting requirements for insured institutions, and new regulations
concerning internal controls, accounting and operations.
The prompt corrective action regulations of FDICIA define specific capital
categories based on the institutions' capital ratios. The capital categories,
in declining order, are "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized." To be considered "well capitalized," an institution must
have a core capital ratio of at least 5% and a total risk-based capital ratio of
at least 10%. Additionally, FDICIA imposed in 1994 a new Tier I risk-based
capital ratio of at least 6% to be considered "well capitalized." Tier I
risk-based capital is, primarily, common stock and retained earnings net of
goodwill and other intangible assets.
17
To be categorized as "adequately capitalized" or "well capitalized," Goleta must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
and values as set forth in the tables below:
TO BE WELL
CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE
ADEQUACY ACTION
ACTUAL PURPOSES PROVISIONS
--------------- --------------- ---------------
YEAR ENDED DECEMBER 31, 2002: AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ------ ------- ------ ------- ------
(DOLLARS IN THOUSANDS)
Total Risk-Based Capital (to Risk Weighted Assets)
Consolidated $35,080 13.92% $20,162 8.00% N/A N/A
Goleta National Bank $32,492 13.31% $19,537 8.00% $24,421 10.00%
Tier I Capital (to Risk Weighted Assets)
Consolidated $31,897 12.66% $10,081 4.00% N/A N/A
Goleta National Bank $29,405 12.04% $ 9,768 4.00% $14,652 6.00%
Tier I Capital (to Average Assets)
Consolidated $31,897 10.48% $12,170 4.00% N/A N/A
Goleta National Bank $29,405 9.80% $12,004 4.00% $15,005 5.00%
YEAR ENDED DECEMBER 31, 2001:
Total Risk-Based Capital (to Risk Weighted Assets)
Consolidated $36,689 13.02% $22,546 8.00% N/A N/A
Goleta National Bank $32,623 11.84% $22,050 8.00% $27,562 10.00%
Tier I Capital (to Risk Weighted Assets)
Consolidated $33,108 11.75% $11,273 4.00% N/A N/A
Goleta National Bank $29,122 10.40% $11,025 4.00% $16,537 6.00%
Tier I Capital (to Average Assets)
Consolidated $33,108 9.07% $14,602 4.00% N/A N/A
Goleta National Bank $29,122 9.05% $12,874 4.00% $16,093 5.00%
A bank may not be considered "well capitalized" if it is operating under a
regulatory agreement, as is the case of Goleta. See " - Supervision and
Regulation - Consent Order with the OCC."
On March 23, 2000, Goleta signed a Formal Agreement with the OCC. On October
25, 2002, the Formal Agreement was replaced by the Consent Order with the OCC.
Under the terms of both the Formal Agreement and the Consent Order, Goleta was
required to achieve and maintain total capital at least equal to 12% of total
risk-weighted assets, and Tier I capital at least equal to 7% of adjusted total
assets. Goleta has maintained a total risk weight assets ratio of over 12% and
Tier 1 capital of above 7% during 2002 and ended the year with a total risk
based ratio of 13.31%. The Company does not anticipate any material changes in
its capital resources. CWBC has common equity only and does not have any
off-balance sheet financing arrangements. In 1998, the Board of Directors
authorized a stock buy-back plan. Under this plan, the Company is authorized to
repurchase up to $2 million of the outstanding shares of the Company's common
stock on the open market. During 2001, the Company repurchased 138,937 shares
for $1.2 million under this plan. Additionally, in a privately negotiated
transaction, the Company repurchased 449,592 shares for $2.8 million in 2001.
The Company has not reissued any treasury stock nor does it have any immediate
plans or programs to do so. In addition, under the terms of CWBC's MOU with the
Federal Reserve, the Company would need approval for any additional stock
repurchases. For additional information, see "- Supervision and Regulation -
Consent Order With the OCC and Memorandum of Understanding with the Federal
Reserve."
Goleta maintained both of the aforementioned required 12% and 7% capital ratios
from September 30, 2000 to the end of 2001. As the result of fourth quarter
2001 losses, Goleta's risk-based capital ratio declined to 11.84% at December
31, 2001. On March 8, 2002, the Company made a $750,000 capital contribution to
Goleta, which would have increased Goleta's risk-based capital ratio to 12.11%
at December 31, 2001, had the contribution been made on that date.
18
SCHEDULE OF AVERAGE ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY
As of the dates indicated below, the following schedule shows the average
balances of the Company's assets, liabilities and stockholders' equity accounts
as a percentage of average total assets:
DECEMBER 31,
-----------------------------------------------------
2002 2001 2000
---------------- ---------------- -----------------
AMOUNT % AMOUNT % AMOUNT %
-------- ------ -------- ------ --------- ------
ASSETS (DOLLARS IN THOUSANDS)
- ------
Cash and due from banks $ 6,684 2.2% $ 8,327 2.2% $ 9,550 2.2%
Federal funds sold 22,903 7.6% 26,696 7.1% 22,833 5.2%
Time deposits in other financial institutions 3,929 1.3% 4,498 1.2% 1,654 0.4%
FRB/FHLB Stock 780 .3% 1,141 0.3% 926 0.2%
Investment securities 4,264 1.4% 2,861 0.8% 6,445 1.5%
Interest only strips 6,104 2.0% 8,560 2.3% 6,438 1.5%
Loans held for investment, net 132,061 43.7% 159,237 42.8% 116,560 26.4%
Securitized loans, net 83,876 27.8% 132,973 35.8% 174,245 39.6%
Loans held for sale 27,699 9.2% 18,344 4.9% 79,222 18.0%
Servicing assets 2,213 0.7% 2,654 0.7% 2,051 0.5%
Other real estate owned 554 0.2% 207 0.1% 147 0.0%
Premises and equipment, net 2,338 0.8% 3,533 1.0% 4,302 1.0%
Other assets 8,557 2.8% 2,892 0.8% 15,572 3.5%
-------- ------ -------- ------ --------- ------
TOTAL ASSETS $301,962 100.0% $371,923 100.0% $439,945 100.0%
======== ====== ======== ====== ========= ======
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Deposits:
Noninterest-bearing demand $ 31,388 10.4% $ 39,708 10.7% $ 30,381 6.9%
Interest-bearing demand 27,439 9.1% 22,476 6.0% 23,548 5.3%
Savings 13,270 4.4% 17,056 4.6% 23,254 5.3%
Time certificates of $100,000 or more 42,970 14.2% 79,195 21.3% 78,342 17.8%
Other time certificates 85,137 28.2% 65,102 17.5% 86,227 19.6%
-------- ------ -------- ------ --------- ------
Total deposits 200,204 66.3% 223,537 60.1% 241,752 54.9%
Bonds payable 69,251 22.9% 111,327 29.9% 151,126 34.4%
Other borrowings - - 3,463 0.9% 5,795 1.3%
Federal funds purchased 22 0.0% - 0.0% 287 0.1%
Other liabilities 667 0.2% 395 0.1% 4,297 1.0%
-------- ------ -------- ------ --------- ------
Total liabilities 270,144 89.4% 338,722 91.0% 403,257 91.7%
Stockholders' equity
Common stock 29,797 9.9% 26,297 7.1% 26,571 6.0%
Retained earnings 2,021 .7% 6,901 1.9% 10,163 2.3%
Unrealized loss on AFS securities - - 3 0.0% (46) 0.0%
-------- ------ -------- ------ --------- ------
Total stockholders' equity 31,818 10.6% 33,201 9.0% 36,688 8.3%
-------- ------ -------- ------ --------- ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $301,962 100.0% $371,923 100.0% $439,945 100.0%
======== ====== ======== ====== ========= ======
INTEREST RATES AND DIFFERENTIALS
- -----------------------------------
The following table illustrates average yields on our interest-earning assets
and average rates on our interest-bearing liabilities for the years indicated.
These average yields and rates are derived by dividing interest income by the
average balances of interest-earning assets and by dividing interest expense by
the average balances of interest-bearing liabilities for the years indicated.
Amounts outstanding are averages of daily balances during the period.
19
YEAR ENDED DECEMBER 31,
-------------------------------
2002 2001 2000
--------- --------- ---------
INTEREST-EARNING ASSETS: (DOLLARS IN THOUSANDS)
Time deposits in other financial institutions:
Average outstanding $ 3,929 $ 4,498 $ 1,654
Interest income 104 172 113
Average yield 2.6% 3.8% 6.8%
Federal funds sold:
Average outstanding 22,903 26,696 22,833
Interest income 364 1,094 1,405
Average yield 1.6% 4.1% 6.2%
Investment securities:
Average outstanding 5,044 4,002 7,371
Interest income 202 269 498
Average yield 4.0% 6.7% 6.8%
Gross loans excluding securitized:
Average outstanding 164,301 181,122 202,551
Interest income 19,410 22,601 22,348
Average yield 11.8% 12.5% 11.0%
Securitized loans:
Average outstanding 83,876 132,973 174,245
Interest income 9,896 16,658 27,500
Average yield 11.8% 12.5% 15.8%
Total interest-earning assets:
Average outstanding 280,053 349,291 408,654
Interest income 29,976 40,794 51,864
Average yield 10.7% 11.7% 12.7%
20
YEAR ENDED DECEMBER 31,
-------------------------------
2002 2001 2000
--------- --------- ---------
(DOLLARS IN THOUSANDS)
INTEREST-BEARING LIABILITIES:
Interest-bearing demand deposits:
Average outstanding $ 27,438 $ 22,476 $ 23,548
Interest expense 600 825 790
Average effective rate 2.2% 3.7% 3.4%
Savings deposits:
Average outstanding 13,270 17,056 23,254
Interest expense 304 464 712
Average effective rate 2.3% 2.7% 3.1%
Time certificates of deposit:
Average outstanding 128,107 144,297 164,569
Interest expense 4,641 8,171 9,832
Average effective rate 3.6% 5.7% 6.0%
Federal funds purchased:
Average outstanding 22 - 287
Interest expense - - 19
Average effective rate - - 6.6%
Bonds payable:
Average outstanding 83,504 111,327 151,126
Interest expense 7,921 10,411 14,438
Average effective rate 9.5% 9.4% 9.4%
Other borrowings:
Average outstanding - 3,463 5,795
Interest expense - 467 546
Average effective rate - 13.5% 9.4%
Total interest-bearing liabilities:
Average outstanding 252,319 298,619 368,579
Interest expense 13,466 20,338 26,337
Average effective rate 5.3% 6.8% 7.1%
NET INTEREST INCOME 16,510 20,456 25,527
AVERAGE NET YIELD 5.9% 5.9% 6.3%
Nonaccrual loans are included in the average balance of loans outstanding.
LOAN PORTFOLIO
- ---------------
The Company's largest categories of loans held in the portfolio are commercial
loans, real estate loans, unguaranteed portion of SBA loans, installment loans
and second mortgage loans. Loans are carried at face amount, net of payments
collected, the allowance for loan losses, deferred loan fees/costs and discounts
on loans purchased. Interest on all loans is accrued daily, primarily on a
simple interest basis. It is the Company's policy to place a loan on nonaccrual
status when the loan is 90 days past due. Thereafter, previously recorded
interest is reversed and interest income is typically recognized on a cash
basis.
The rates charged on variable rate loans are set at specific increments. These
increments vary in relation to the Company's published prime lending rate or
other appropriate indices. At December 31, 2002, approximately 56% of the
Company's loan portfolio was comprised of variable interest rate loans. At
December 31, 2001 and 2000, variable rate loans comprised approximately 34% and
32%, respectively, of the Company's loan portfolio. Management monitors the
maturity of loans and the sensitivity of loans to changes in interest rates.
21
The following table sets forth, as of the dates indicated, the amount of gross
loans outstanding based on the remaining scheduled repayments of principal,
which could either be repriced or remain fixed until maturity, classified by
years until maturity:
DECEMBER 31,
-------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------------- ------------------- ------------------- ------------------- -------------------
(IN THOUSANDS)
IN YEARS FIXED VARIABLE FIXED VARIABLE FIXED VARIABLE FIXED VARIABLE FIXED VARIABLE
-------- --------- -------- --------- -------- --------- -------- --------- -------- ---------
Less than One $ 2,604 $ 8,188 $ 10,346 $ 26,532 $ 1,058 $ 100,717 $ 789 $ 87,313 $ 5,431 $ 105,173
One to Five 3,615 16,224 3,975 6,195 8,250 5,403 8,342 4,628 10,487 1,272
Over Five (1) 105,491 116,322 164,748 58,761 219,213 642 354,282 536 127,128 -
-------- --------- -------- --------- -------- --------- -------- --------- -------- ---------
Total $111,710 $ 140,734 $179,069 $ 91,488 $228,521 $ 106,762 $363,413 $ 92,477 $143,046 $ 106,445
======== ========= ======== ========= ======== ========= ======== ========= ======== =========
<FN>
(1) Approximately $66 million of these loans at December 31, 2002 are in the Company's securitized loan portfolio which
is funded by approximately $50 million of bonds payable.
DISTRIBUTION OF LOANS
The distribution of the Company's total loans by type of loan, as of the dates
indicated, is shown in the following table:
DECEMBER 31,
-----------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
LOAN LOAN LOAN LOAN LOAN
BALANCE BALANCE BALANCE BALANCE BALANCE
--------- --------- --------- --------- ---------
Commercial $ 19,302 $ 26,411 $ 36,188 $ 12,102 $ 10,612
Real estate 47,456 44,602 55,083 44,139 65,348
SBA unguaranteed loans 40,961 31,889 30,888 25,073 26,687
Installment 35,246 28,223 22,898 6,348 5,638
Participations purchased - - - 25,395 2,287
Securitized 66,195 108,584 153,031 184,559 80,232
Held for sale 43,284 30,848 37,195 158,274 58,687
--------- --------- --------- --------- ---------
Gross Loans 252,444 270,557 335,283 455,890 249,491
Less:
Allowance for loan losses 5,950 8,275 6,746 5,529 3,374
Deferred fees/costs (318) 222 (2,710) (3,079) (1,995)
Discount on SBA loans 956 1,105 1,982 1,776 701
--------- --------- --------- --------- ---------
Net Loans $245,856 $260,955 $329,265 $451,664 $247,411
========= ========= ========= ========= =========
Percentage to Gross Loans:
Commercial 7.6% 9.8% 10.8% 2.7% 4.3%
Real estate 18.8% 16.5% 16.4% 9.7% 26.2%
SBA, unguaranteed loans 16.3% 11.8% 9.2% 5.5% 10.7%
Installment 14.0% 10.4% 6.8% 1.4% 2.3%
Participations purchased - - - 5.6% 0.9%
Securitized 26.2% 40.1% 45.6% 40.5% 32.2%
Held for sale 17.1% 11.4% 11.1% 34.7% 23.5%
--------- --------- --------- --------- ---------
100.0% 100.0% 100.0% 100.0% 100.0%
========= ========= ========= ========= =========
COMMERCIAL LOANS
In addition to traditional term commercial loans made to business customers, the
Company grants revolving business lines of credit. Under the terms of the
revolving lines of credit, the Company grants a maximum loan amount, which
remains available to the business during the loan term. As part of the loan
requirements, the business agrees to maintain its primary banking relationship
with the Company. It is the Company's policy not to extend material loans of
this type in excess of one year.
22
REAL ESTATE LOANS
Real estate loans are primarily made for the purpose of purchasing, improving or
constructing single family residences, commercial or industrial properties. The
majority of the Company's mortgage loans are collateralized by liens on single
family homes. These loans are sold servicing released into the secondary
market.
A large part of the Company's real estate construction loans are first and
second trust deeds on the construction of owner-occupied single family
dwellings. The Company also makes real estate construction loans on commercial
properties. These consist of first and second trust deeds collateralized by the
related real property. Construction loans are generally written with terms of
six to twelve months and usually do not exceed a loan to appraised value of 80%.
Commercial and industrial real estate loans are secured by nonresidential
property. Office buildings or other commercial property primarily secure these
loans. Loan to appraised value ratios on nonresidential real estate loans are
generally restricted to 75% of appraised value of the underlying real property.
UNGUARANTEED PORTION OF SBA LOANS
Under the SBA loan program, the Company is required to retain a minimum of 5% of
the unguaranteed portion of loans it originates and sells into the secondary
market. At December 31, 2002, the Company had $41 million in unguaranteed SBA
loans. This is an increase of $9 million compared to December 31, 2001,
primarily due to the increase in loan origination volume in 2002.
INSTALLMENT LOANS
Installment loans consist of automobile, small equity lines of credit, loans
secured by manufactured housing and general-purpose loans made to individuals.
These loans are primarily fixed rate loans. Included in this category as of
December 31, 2002 and 2001 are approximately $1.6 million and $3.2 million,
respectively of the Company's short-term consumer lending product, which
consists of 14-day loans to individuals. See "Item 1. Business - Lines of
Business - Short-Term Consumer Lending."
The mortgage loan center originates manufactured housing loans secured by mobile
homes located in parks along the Central Coast of California. At December 31,
2002, the Bank had $28.2 million in its portfolio. The loans are serviced
internally and are generally written for terms of 20 years with balloon payments
ranging from 10 to 20 years.
SECOND MORTGAGE LOANS
The Company originated second mortgage loans with loan to value ratios as high
as 125%. In 1998 and 1999, the Company transferred $81 million and $122 million
of these loans, respectively, to special purpose trusts ("Trusts"). The Trusts
then sold bonds to third party investors, which were secured by the transferred
loans. The bonds are held in a trust independent of the Company, the trustee of
which oversees the distribution to the bondholders. The mortgage loans are
serviced by a third party ("Servicer"), who receives a stated servicing fee.
There is an insurance policy on the subordinate bonds that guarantees the
payment of the bonds.
As part of the securitization agreements, the Company received an option to
repurchase the bonds when the aggregate principal balance of the mortgage loans
sold declined to 10% or less of the original balance of mortgage loans
securitized. Because the Company has a call option to reacquire the loans
transferred and did not retain the servicing rights, the Company is deemed to
not have surrendered effective control over the loans transferred. Therefore,
the securitizations are accounted for as secured borrowings with a pledge of
collateral. Accordingly, the Company consolidates the Trusts and the financial
statements of the Company include the loans transferred and the related bonds
issued. The securitized loans are classified as held for investment. At
December 31, 2002 and 2001, the net balance of the securitized loan portfolio
was $63.6 million and $104.4 million, respectively. The related net bond
balances were $50.5 million and $89.4 million at December 31, 2002 and 2001,
respectively.
23
LOAN COMMITMENTS OUTSTANDING
The Company's loan commitments outstanding at the dates indicated are summarized
below:
DECEMBER 31,
-------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
(IN THOUSANDS)
Commercial $11,370 $ 7,450 $ 9,776 $ 6,641 $10,693
Real estate 7,664 6,370 8,323 4,135 12,306
SBA 8,675 4,712 4,545 5,266 4,230
Installment loans 2,402 13,339 2,260 2,205 1,502
Standby letters of credit 380 438 913 713 35
------- ------- ------- ------- -------
Total commitments $30,491 $32,309 $25,817 $18,960 $28,766
======= ======= ======= ======= =======
The Company makes loans to borrowers in a number of different industries. Other
than Manufactured Housing, no single industry comprises 10% or more of the
Company's loan portfolio. Commercial real estate loans and SBA loans comprised
over 10% of the Bank's loan portfolio at December 31, 2002, but consisted of
diverse borrowers. Although the Company does not have significant
concentrations in its loan portfolio, the ability of the Company's customers to
honor their loan agreements is dependent upon, among other things, the general
economy of the Company's market area.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
- --------------------------------------------
The Company maintains a detailed, systematic analysis and procedural discipline
to determine the amount of the allowance for loan losses ("ALL"). The ALL is
based on estimates and is intended to be adequate to provide for probable losses
inherent in the loan portfolio. This process involves deriving probable loss
estimates that are based on individual loan loss estimation, migration
analysis/historical loss rates and management's judgment.
The Company employs several methodologies for estimating probable losses.
Methodologies are determined based on a number of factors, including type of
asset, credit score, concentrations, collateral value and the input of the
Special Assets group, functioning as a workout unit.
The ALL calculation for the different major loan types is as follows:
- SBA - All loans are reviewed and classified loans are assigned a
---
specific allowance. Those not assigned to a "watch list" category are
classified as "pass." A migration analysis is then used to calculate
the required allowance on those pass loans. Due to gradually improving
migration analysis trends by the fourth quarter of 2002, the Company
was able to reduce its pass allocation.
- Relationship Banking - Includes commercial and real estate mortgage
---------------------
loans originated by the branch locations. Classified loans are
assigned a specific allowance. A migration analysis is then used to
calculate the required allowance on the remaining pass loans.
- Short-term Consumer Loans - Classified as a homogeneous portfolio and
--------------------------
the allowance calculated based on past due statistics and past
charge-off history.
- Manufactured Housing - An allowance is prudently calculated based on a
--------------------
review of delinquency statistics.
- Securitized Loans - The Company considers this a homogeneous portfolio
-----------------
and calculates the allowance based on statistical information provided
by the servicer. Charge-off history is calculated based on 3
methodologies; a 3-month and a 12-month historical trend and by
delinquency information. The highest requirement of the 3 methods is
used.
Management reviews the ALL on a monthly basis and records additional provision
to the allowance as required. The review of the adequacy of the allowance takes
into consideration such factors as changes in the growth, size and composition
of the loan portfolio, overall portfolio quality, review of specific problem
loans, collateral, guarantees and economic conditions that may affect the
borrowers' ability to pay and and/or the value of the underlying collateral.
These estimates depend on the outcome of future events and, therefore, contain
inherent uncertainties.
The Company's ALL is maintained at a level believed adequate by management to
absorb known and inherent probable losses on existing loans. A provision for
loan losses is charged to expense. The allowance is charged for losses when
management believes that full recovery on the loan is unlikely. Generally,
Goleta charges off any loan classified as a "loss"; portions of loans which are
deemed to be uncollectible; short-term consumer loans which are past due 60 or
23
more days; overdrafts which have been outstanding for more than 30 days;
consumer finance loans which are past due 120 or more days; and, all other
unsecured loans past due 120 or more days. Subsequent recoveries, if any, are
credited to the allowance for loan losses.
The following table summarizes the Company's loan loss experience for the
periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
(IN THOUSANDS)
Average gross loans, held for investment $218,317 $267,402 $297,574 $260,709 $149,690
Gross loans at end of year, held for investment 208,522 237,989 302,476 297,616 190,804
Allowance for loan losses, beginning of year $ 8,275 $ 6,746 $ 5,529 $ 3,374 $ 1,286
Provision for loan losses 4,899 11,881 6,794 6,133 1,760
Loans charged off :
Commercial (1) (614) (410) - -
Real estate (2,474) (3,129) (1,216) (2,093) (360)
Installment - - (446) - -
Short-term consumer (3,162) (2,478) (2) - -
Securitized (4,012) (4,358) (3,674) (1,943) -
--------- --------- --------- --------- ---------
9,649 10,580 5,748 4,036 360
--------- --------- --------- --------- ---------
Recoveries of loans previously charged off
Commercial 71 40 154 - -
Real estate 396 171 17 32 61
Installment - - - - -
Short-term consumer 1,392 400 - - -
Securitized 566 378 1 26 -
--------- --------- --------- --------- ---------
2,425 990 171 58 61
--------- --------- --------- --------- ---------
Net loans charged off 7,224 9,590 5,577 3,977 299
Adjustments due to Palomar purchase/sale - (762) - - 627
--------- --------- --------- --------- ---------
Allowance for loan losses, end of year $ 5,950 $ 8,275 $ 6,746 $ 5,529 $ 3,374
========= ========= ========= ========= =========
Ratios:
Net loan charge-offs to average loans 3.3% 3.6% 1.9% 1.5% 0.2%
Net loan charge-offs to loans at end of period 3.5% 4.0% 1.8% 1.3% 0.2%
Allowance for loan losses to average loans 2.7% 3.1% 2.3% 2.1% 2.3%
Allowance for loan losses to loans held for
investment at end of period 2.9% 3.5% 2.2% 1.9% 1.8%
Net loan charge-offs to allowance for loan
losses at beginning of period 87.3% 142.2% 100.9% 117.9% 309.3%
Net loan charge-offs to provision for loan
losses 147.5% 80.7% 82.1% 64.8% 17.0%
Total ALL decreased $2.3 million, or 28.1%, from $8.3 million at December 31,
2001 to $6.0 million at December 31, 2002. Of this decrease, $1.6 million, or
69.6 %, relates to decrease in the ALL for the securitized loan portfolio and
$707,000, or 30.4%, relates to all other loan types.
The securitized loan loss allowance changed primarily due to the significant
principal balance pay-downs of $41.3 million, or 38.9%, experienced in both loan
pools during 2002, as well as a 15.5% decrease in net charge-offs from 2001.
As previously discussed, as part of the Consent Order, no short-term consumer
loans were originated subsequent to December 31, 2002. Therefore, this is part
of the ALL decrease as related loan losses are not anticipated to be
substantial.
The decrease in ALL for the other types of loans is primarily due to the
transfer in 2002 of $5.2 million in HLTV loans from held for investment to held
for sale. This transfer resulted in a reduction in 2002 of the ALL for HLTV
loans from $598,000 to zero as the Company recorded a lower of cost or market
adjustment of $1.3 million on these loans at the transfer date. At December 31,
2002, $1.1 million of these loans remain as held for sale with a valuation
24
allowance of $359,000 for a net value of $691,000. The Company held no ALL for
these loans at December 31, 2002. The remaining $107,000 reduction in the
allowance for other loan types is attributable to increased collections and
improved loss/delinquency factors in the most recent migration analysis results.
The migration analysis is based on rolling three-year historical data weighted
more heavily on the four most recent quarters to reflect the most recent
experiences in the performance of the portfolio.
Loans charged off, net of recoveries, were $7.2 million in 2002, $9.6 million in
2001, $5.6 million in 2000, $4.0 million in 1999 and $0.3 million in 1998. The
primary reason for the decline in net charge-offs in 2002 was the significant
paydown in the securitized loan portfolio and the increase in the overall
portfolio credit quality specifically in the SBA loan portfolio. At the end of
2001, the Company tightened its underwriting standards in the SBA program which
management believes has influenced the decline in problem loans in the SBA
portfolio. Despite the increase in short-term consumer loan charge-offs of
27.6%, the net charge-offs for these loans declined by 14.8% due to increased
loan loss recoveries of 348% over 2001. In addition, the securitized loan
portfolio experienced a decline in net charge-offs of 13.4%, which was the
result of a 7.9% decline in charge-offs and a 49.7% increase in loan loss
recoveries. The Company anticipates this trend to continue as the securitized
loans continue to be paid.
In management's opinion, the balance of the allowance for loan losses was
sufficient to absorb known and inherent probable losses in the loan portfolio at
December 31, 2002.
The Company recorded $4.9 million as a provision for loan losses in 2002, $11.9
million in 2001 and $6.8 million in 2000. The primary reason for the decrease
in provision expense is the Company's change in portfolio mix to perceived less
risky loans. The Company exited the HLTV market and the securitized loan
portfolio paid down by approximately 40%.
The following table summarizes the provision:
AS OF
DECEMBER 31,
2002 YEAR ENDED DECEMBER 31, 2002
----------- ------------------------------
Allowance Ending Percent
For Loan Loan of
Provision Losses, net Balance Loans
----------- ------------ -------- ------
Short-term consumer loan portfolio $ 1,706 $ 566 $ 1,624 0.8%
Securitized loan portfolio 1,828 2,571 66,195 31.7%
SBA 1,461 1,874 26,623 12.8%
All other loans (96) 939 114,080 54.7%
----------- ------------ -------- ------
Total provision $ 4,899 $ 5,950 $208,522 100.0%
=========== ============ ======== ======
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest under the contractual terms of the loan agreement.
Factors considered by management in determining impairment include payment
status, collateral value and the probability of collecting scheduled principal
and interest payments. Loans that experience insignificant payment delays or
payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis. When determining the possibility of impairment, management
considers the circumstances surrounding the loan and the borrower, including the
length of the delay, the reasons for the delay, the borrower's prior payment
record and the amount of the shortfall in relation to the principal and interest
owed. For collateral dependent loans, the Company uses the fair value of
collateral method to measure impairment. All other loans, except for
securitized and short-term consumer are measured for impairment based on the
present value of future cash flows. Impairment is measured on a loan by loan
basis for all loans in the portfolio except for the securitized and short-term
consumer loans, which are evaluated for impairment on a collective basis.
26
The recorded investment in loans that are considered to be impaired:
DECEMBER 31,
-----------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- -------
(IN THOUSANDS)
Impaired loans without specific
valuation allowances $ - $ - $ 565 $ 3,251 $4,450
Impaired loans with specific valuation
allowances 8,394 6,587 3,531 1,402 814
Specific valuation allowances allocated
to impaired loans (1,278) (1,669) (1,207) (1,039) (464)
-------- -------- -------- -------- -------
Impaired loans, net $ 7,116 $ 4,918 $ 2,889 $ 3,614 $4,800
======== ======== ======== ======== =======
Average investment in impaired loans $ 7,565 $ 5,047 $ 4,677 $ 5,120 $4,009
======== ======== ======== ======== =======
Interest income that would have been
recognized at original contract terms $ 1,453 $ 2,289 $ 979 $ 1,829 $ 703
Interest income recognized on impaired
loans 190 1,443 387 244 289
-------- -------- -------- -------- -------
Foregone interest income $ 1,263 $ 1,146 $ 592 $ 1,585 $ 414
======== ======== ======== ======== =======
The accrual of interest is discontinued when substantial doubt exists as to
collectibility of the loan; generally at the time the loan is 90 days
delinquent. Any unpaid but accrued interest is reversed at that time.
Thereafter, interest income is no longer recognized on the loan. As such,
interest income may be recognized on impaired loans to the extent they are not
past due by 90 days. Interest on nonaccrual loans is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual.
Loans are returned to accrual status when all of the principal and interest
amounts contractually due are brought current and future payments are reasonably
assured. All of the nonaccrual loans are impaired.
Total impaired loans increased by $1.8 million, or 27.4%, over 2001. Despite
this increase, specific valuation allowance allocated to these loans decreased
by $391,000, or 23.4%. Of the $6.6 million in classified assets at December 31,
2001, $1.3 million were foreclosed and transferred to other real estate owned.
Additionally, the Company downgraded one large loan of $1.4 million to
nonaccrual during 2002 but because this loan is well collateralized, the related
specific allowance for loan loss is less than the average.
Financial difficulties encountered by certain borrowers may cause the Company to
restructure the terms of their loan to facilitate loan repayment. A troubled
loan that is restructured would generally be considered impaired. The balance
of impaired loans disclosed above includes all troubled debt restructured loans
that, as of December 31, 2002, 2001 and 2000, are considered impaired. Total
trouble debt restructured loans decreased by 24.2%, or $264,000, from $1.1
million to $829,000 at December 31, 2001 and 2002, respectively.
The following schedule reflects recorded investment at the dates indicated in
certain types of loans:
DECEMBER 31,
--------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- ------ ------
(IN THOUSANDS)
Nonaccrual loans $13,965 $11,413 $ 4,893 ** **
SBA guaranteed portion of loans included above (8,143) (7,825) (2,748) ** **
-------- -------- -------- ------ ------
Nonaccrual loans, net $ 5,821 $ 3,816 $ 2,235 $3,091 $2,971
======== ======== ======== ====== ======
Troubled debt restructured loans, gross $ 829 $ 1,093 $ 615 $ 656 $1,313
Loans 30 through 89 days past due with interest accruing $ 5,122 $ 2,607 $ 4,277 $2,550 $ 678
**( Gross-up information unavailable for 1998 and 1999 comparisons)
Even though the net nonaccrual loans increased from December 31, 2001 to
December 31, 2002, the total year end allowance for loan losses decreased. The
decrease in the allowance is primarily due to the decrease in the loan
27
portfolio, the migration analysis improvement and that several loans transferred
in 2002 to nonaccrual status had smaller relative specific allowance
allocations.
INVESTMENT PORTFOLIO
- ---------------------
The following table summarizes the year-end carrying values of the Company's
investment securities for the years indicated:
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
------- ------ ------
(IN THOUSANDS)
U.S. Treasury and Agency $ 6,012 $ 118 $7,116
======= ====== ======
At December 31, 2002, a Federal Home Loan Bank security for $205,000 was pledged
as collateral to the U.S. Treasury for the Bank's treasury, tax and loan
account.
The following table summarizes the maturity period and weighted average yields
of the Company's investment securities at December 31, 2002:
One Year or One to Five Five to Ten Over Ten
Less Years Years Years
--------------- --------------- --------------- --------------
Amount Yield Amount Yield Amount Yield Amount Yield
------- ------ ------- ------ ------- ------ ------- -----
(DOLLARS IN THOUSANDS)
U.S. Treasury and
Agency $ 1,854 3.5% $ 2,772 4.5% $ 1,085 4.6% $ 302 4.6%
======= ======= ======= =======
INTEREST-ONLY STRIPS AND SERVICING ASSETS
At December 31, 2002 and 2001, the Company held interest-only strips in the
amount of $4.6 million and $7.7 million, respectively. These interest-only
strips represent the present value of the right to the estimated net cash flows
generated by SBA loans sold. Net cash flows consist of the difference between
(a) interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors and (ii) contractual
servicing fees. The Company also held servicing assets related to SBA loans
sales of $1.9 million and $2.5 million at December 31, 2002 and 2001,
respectively. For loans sold subsequent to March 31, 2002, the initial
servicing assets and resulting gain on sale were calculated based on the
difference between the best actual par and premium bids on an individual loan
basis. The servicing asset balances are subsequently amortized over the
estimated life of the loans using an estimated prepayment rate of 25%. During
the second quarter of 2002, the Company recorded a $1.8 million impairment
charge related to the valuation of the servicing assets and I/O strips. The
interest-only strips are accounted for as investments in debt securities
classified as trading securities. Accordingly, the Company marks them to fair
value with the resulting increase or decrease recorded through operations in the
current period.
At December 31, 2001 and prior to April 1, 2002, the Company utilized a CPR
assumption of 13.44% which is the weighted average actual prepayment speed
experienced by all serviced loans which have been in the portfolio for more than
eight quarters. This prepayment speed assumption is applied to all loans
including those which have been in the portfolio for less than eight quarters.
The Company used discount rates of 9.25% to 10.25% in its calculations.
LIQUIDITY MANAGEMENT
- ---------------------
The Company has established policies as well as analytical tools to manage
liquidity. Proper liquidity management ensures that sufficient funds are
available to meet normal operating demands in addition to unexpected customer
demand for funds, such as high levels of deposit withdrawals or increased loan
demand, in a timely and cost effective manner. The most important factor in the
preservation of liquidity is maintaining public confidence that facilitates the
retention and growth of core deposits. Ultimately, public confidence is gained
through profitable operations, sound credit quality and a strong capital
position. The Company's liquidity management is viewed from both a long-term
and short-term perspective as well as from an asset and liability perspective.
Management monitors liquidity through regular reviews of maturity profiles,
funding sources and loan and deposit forecasts to minimize funding risk. The
Company has asset/liability committees ("ALCO") at the Board and Bank management
level to review asset/liability management and liquidity issues. The Company
maintains strategic liquidity and contingency plans. Previously, the Company
relied heavily on short-term time certificates from other financial institutions
obtained quickly to meet liquidity shortfalls. Recently, the Company has
invested more resources in the purchase of government-guaranteed investment
securities and obtained a financing arrangement, which allows it to pledge these
28
securities, as collateral for short-term borrowing in case of increased
liquidity needs. This arrangement (repurchase agreements) gives the Company
improved flexibility in managing its liquidity resources.
The Company, through the Bank, also has the ability as a member of the Federal
Reserve System, to borrow at the discount window up to 50% of what is pledged at
the Federal Reserve Bank. On January 9, 2003, the Reserve Bank replaced the
existing discount window program with new primary and secondary credit programs.
GNB was notified it qualifies for primary credit as it has been deemed to be in
sound financial condition. The rate on primary credit will be 50 basis points
less than the secondary credit rate and will generally be granted on a "no
questions asked basis" at a rate that initially will be at 100 basis points
above the Federal Open Market Committee's (FOMC) target federal funds rate
(currently at 1.25%). As the rate is currently not attractive, it is unlikely
it will be used as a regular source of funding, but is noted as available as an
alternative funding source.
The exit from STCL has resulted in a decrease in the daily fluctuations of the
Company's cash position. The Company has not experienced disintermediation and
does not believe this is a potentially probable occurrence. The Bank's core
deposits (excluding certificate of deposit) grew by approximately $16 million
during 2002. The liquidity ratio of the Company has steadily increased and was
20%, 21% and 25% at December 31, 2000 and 2001 and 2002, respectively. The
liquidity ratio consists of cash and due from banks, deposits in other financial
institutions, available for sale investments, federal funds sold and loans held
for sale, divided by total assets.
CWBC's routine funding requirements primarily consist of operating expenses.
Normally, CWBC obtains funding to meet its obligations from dividends collected
from its subsidiaries and issuance of debt securities. Federal banking laws
regulate the amount of dividends that may be paid by banking subsidiaries
without prior approval. In addition, because of Goleta's Consent Order with the
OCC, it must obtain approval for any amount of dividends.
INTEREST RATE RISK
The Company is exposed to different types of interest rate risks. These risks
include: lag, repricing, basis and prepayment risk.
LAG RISK- lag risk results from the inherent timing difference between the
repricing of the Company's adjustable rate assets and liabilities. For
instance, certain loans tied to the prime rate index may only reprice on a
quarterly basis. However, at a community bank such as Goleta, when rates
are rising, funding sources tend to reprice more slowly than the loans.
Therefore, for Goleta, the effect of this timing difference is generally
favorable during a period of rising interest rates and unfavorable during a
period of declining interest rates. This lag can produce some short-term
volatility, particularly in times of numerous prime rate changes.
REPRICING RISK - repricing risk is caused by the mismatch in the maturities
/ repricing periods between interest-earning assets and interest-bearing
liabilities. If the Bank were perfectly matched, the net interest margin
would expand during rising rate periods and contract during falling rate
periods. This is so since loans tend to reprice more quickly than funding
sources. Typically, since Goleta is asset sensitive, this would also tend
to expand the net interest margin during times of interest rate increases.
BASIS RISK - item pricing tied to different indices may tend to react
differently; however, all the Bank's variable products are priced off of
the prime rate.
PREPAYMENT RISK - prepayment risk results from borrowers paying down / off
their loans prior to maturity. Prepayments on fixed-rate products increase
in falling interest rate environments and decrease in rising interest rate
environments. Since most of the Bank's loan originations are adjustable
rate and set based on prime, and there is little lag time on the reset, the
Bank does not experience significant prepayments. However, the Bank does
have more prepayment risk on its securitized loans and its mortgage-backed
investment securities. Offsetting the prepayment risk on the securitized
loans are the related bonds payable, which were issued at a fixed rate.
When the bonds payable prepay, given the current interest rate environment
this reduces the Bank's interest rate exposure as a higher, fixed rate is,
in effect, traded for a lower, variable rate funding source.
MANAGEMENT OF INTEREST RATE RISK
To mitigate the impact of changes in market interest rates on the Company's
interest-earning assets and interest-bearing liabilities, the amounts and
maturities are actively managed. Short-term, adjustable-rate assets are
generally retained as they have similar repricing characteristics as our funding
sources. The Company sells mortgage products and a portion of its SBA loan
originations. While the Company has some interest rate exposure in excess of
29
five years, it has internal policy limits designed to minimize risk should
interest rates rise. Currently, the Company does not use derivative instruments
to help manage risk, but will consider such instruments in the future if the
perceived need should arise.
LOAN SALES- The Company's ability to originate, purchase and sell loans is also
significantly impacted by changes in interest rates. Increases in interest
rates may also reduce the amount of loan and commitment fees received by the
Company. A significant decline in interest rates could also decrease the size
of the Company's servicing portfolio and the related servicing income by
increasing the level of prepayments. The Company does not currently utilize any
specific hedging instruments to minimize exposure to fluctuations in the market
price of loans and interest rates with regard to loans held for sale in the
secondary mortgage market. Therefore, in the short time between when the
Company originates and sells the loans, the Company is exposed to decreases in
the market price of such loans due to increases in interest rates.
OPERATIONAL RISK
Operational risk represents the risk of loss resulting from the Company's
operations, including but not limited to, the risk of fraud by employees or
persons outside the Company, the execution of unauthorized transactions by
employees, transaction processing errors and breaches of internal control system
and compliance requirements. This risk of loss also includes the potential
legal actions that could arise as a result of an operational deficiency or as a
result of noncompliance with applicable regulatory standards, adverse business
decisions or their implementation and customer attrition due to potential
negative publicity.
Operational risk is inherent in all business activities and the management of
this risk is important to the achievement of the Company's objectives. In the
event of a breakdown in the internal control system, improper operation of
systems or improper employee actions, the Company could suffer financial loss,
face regulatory action and suffer damage to its reputation. The Company manages
operational risk through a risk management framework and its internal control
processes. The framework involves business units, corporate risk management
personnel and executive management. Under this framework, the business units
have direct and primary responsibility and accountability for identifying,
controlling and monitoring operational risk. Business unit managers maintain a
system of controls with the objective of providing proper transaction
authorization and execution, proper system operations, safeguarding of assets
from misuse or theft and ensuring the reliability of financial and other data.
Business unit managers ensure that the controls are appropriate and are
implemented as designed. Business continuation and disaster recovery planning
is also critical to effectively manage operational risks. The Company's
internal audit function (currently outsourced to a third party) validates the
system of internal controls through risk-based regular and ongoing audit
procedures and reports on the effectiveness of internal controls to executive
management and the Audit Committee of the Board of Directors.
While the Company believes that it has designed effective methods to minimize
operational risks, there is no absolute assurance that business disruption or
operational losses would not occur in the event of disaster.
DEPOSITS
- --------
The following table shows the Company's daily average deposits for each of the
periods indicated below:
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2002 2001 2000
------------------- ------------------- -------------------
AVERAGE PERCENT AVERAGE PERCENT AVERAGE PERCENT
-------- --------- -------- --------- -------- ---------
BALANCE OF TOTAL BALANCE OF TOTAL BALANCE OF TOTAL
-------- --------- -------- --------- -------- ---------
(DOLLARS IN THOUSANDS)
Noninterest-bearing demand $ 31,560 15.6% $ 39,708 17.8% $ 30,381 12.6%
Interest-bearing demand 29,347 14.5% 22,476 10.1% 23,548 9.7%
Savings 13,270 6.6% 17,056 7.6% 23,254 9.6%
TCDs of $100,000 or more 42,970 21.2% 79,195 35.4% 78,342 32.4%
Other TCDs 85,137 42.1% 65,102 29.1% 86,227 35.7%
-------- --------- -------- --------- -------- ---------
Total Deposits $202,284 100.0% $223,537 100.0% $241,752 100.0%
======== ========= ======== ========= ======== =========
30
The maturities of time certificates of deposit ("TCDs") were as follows:
DECEMBER 31,
-------------------------------------------------
2002 2001
------------------------ -----------------------
TCD'S OVER TCD'S OVER
----------- ----------
$100,000 OTHER TCDS $100,000 OTHER TCDS
----------- ----------- ---------- -----------
(IN THOUSANDS)
Less than three months $ 11,403 $ 20,107 $ 34,483 $ 28,114
Over three months through six months 5,981 17,709 12,693 11,991
Over six months through twelve months 5,265 17,050 17,470 12,716
Over twelve months through five years 3,036 52,648 2,751 5,746
----------- ----------- ---------- -----------
Total $ 25,325 $ 107,514 $ 67,397 $ 58,567
=========== =========== ========== ===========
The deposits of the Company may fluctuate up and down with local and national
economic conditions. However, management does not believe that deposit levels
are significantly influenced by seasonal factors.
The Company manages its money desk in accordance with its liquidity and
strategic planning. Such deposits decreased during 2002 as the Company's
general funding needs declined due to loan sales and the exit from certain
lending lines. The Company can obtain funds when necessary, in a short
timeframe, however, it is more expensive as there is substantial competition for
these deposits.
31
SUPERVISION AND REGULATION OF THE COMPANY
The following discussion of statutes and regulations affecting banks and their
holding companies is only a summary, does not purport to be complete, and is
qualified in its entirety by reference to the actual statutes and regulations.
No assurance can be given that the statutes and regulations will not change in
the future. Moreover, any changes may have a material adverse effect on our
business.
GENERAL
The Company, as a bank holding company registered under the Bank Holding Company
Act of 1956, as amended herein referred to the "BHCA," is subject to regulation
by the Board of Governors of the Federal Reserve System ("FRB"). Under FRB
regulation, the Company is expected to act as a source of managerial and
financial strength for its bank subsidiary. It cannot conduct operations in an
unsafe or unsound manner and must commit resources to support its banking
subsidiary in circumstances where the Company might not otherwise do so. Under
the BHCA, the Company and its banking subsidiary are subject to periodic
examination by the FRB. The Company is also required to file periodic reports of
its operations and any additional information regarding its activities and those
of its subsidiaries with the FRB, as may be required.
The Company is also a bank holding company within the meaning of Section 3700 of
the California Financial Code. As such, the Company and its subsidiaries are
subject to examination by, and may be required to file reports with, the
Commissioner of the California Department of Financial Institutions, herein
referred to as the "Commissioner" or the "DFI." Regulations have not yet been
proposed or adopted or steps otherwise taken to implement the Commissioner's
powers under this statute.
The Company has a class of securities registered with the Securities Exchange
Commission ("SEC") under Section 12 of the Securities Exchange Act of 1934
("1934 Act") and has its common stock listed on the National Market System of
the NASDAQ Market System ("NASDAQ"). Consequently, the Company is subject to
supervision and regulation of the SEC and compliance with the listing
requirements of the NASDAQ.
RECENT LEGISLATION
THE SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act of 2002 ("SOX") became effective on July 30, 2002 and
represents the most far reaching corporate and accounting reform legislation
since the enactment of the Securities Act of 1933 and the Securities Exchange
Act of 1934 ("1934 Act"). SOX is designed to protect investors in capital
markets by improving the accuracy and reliability of corporate disclosures of
public companies. It is designed to address weaknesses in the audit process,
financial reporting systems and controls and broker-dealer networks surrounding
companies that have a class of securities registered under Section 12 of the
1934 Act or are otherwise reporting to the SEC pursuant to Section 15(d) of the
1934 Act (collectively, "public companies"). It is intended that by addressing
three weaknesses public companies will be able to avoid the problems encountered
by many notable public companies in 2002.
The provisions of SOX and regulations issued by the SEC and the National
Association of Securities Dealers for companies whose shares are listed on
NASDAQ (on which the Company's shares are listed) will have a direct and
significant impact on banks and bank holding companies that are public
companies, including the Company.
Enhanced Financial Disclosure and Reports
-----------------------------------------
Certification of Financial Statements. Two sections of SOX (Sections 302 and
- ----------------------------------------
906) require that the principal executive officer(s) and the principal financial
officer(s) of an issuer certify that the company's periodic reports (i.e.
quarterly and annual reports) do not contain any untrue statements of material
fact, contain financial statements that fully comply with the applicable
sections of the 1934 Act and fairly present the financial conditions and results
of operations of the company. Under Section 302, the certifying officers are
responsible for designing controls to ensure that all material information is
reported to them, evaluating the effectiveness of the controls at least once
every 90 days and reporting their conclusions and recommended corrective action
to the company's auditors and Audit Committee.
The Section 906 certification imposes significant criminal penalties for knowing
or willful false representations in the public company's financial statements
including fines of up to $5 million and prison sentences of up to 20 years. Of
course, such conduct also exposes the officer to civil liability including
shareholder suits for violations of Section 10(b) of the 1934 Act.
32
These certification provisions became effective August 29, 2002.
Disclosure of Material Information. Under rules adopted by the SEC, reporting
- ------------------------------------
companies with a public float of at least $75 million, that have been reporting
for at least 12 months, have previously filed at least one annual report, and
are not small business issuers will have to accelerate the filing of their
periodic reports over three years beginning with the fiscal year ending on or
after December 15, 2003. The due date for annual reports will be reduced from
90 days to 75 days after the fiscal year end in the second year and then to 60
days after the fiscal year end in the third year and beyond. The quarterly
reports will be due 40 days after quarter end in the second year and then be
further reduced to 35 days for the third year and thereafter. In addition,
accelerated filers will have to make their periodic reports available on their
websites for fiscal years ended on or after December 15, 2002.
Section 409 of SOX requires that public companies report on a "rapid and
current" basis information regarding material changes to its financial condition
and other operations. In response thereto, effective March 28, 2003, the SEC
has adopted rules to improve the timeliness of public disclosure of such
information. Under those rules a Current Report on Form 8-K must be filed with
the SEC within five (5) business days of any public announcement of material non
public information regarding a public company's result of operations or
financial conditions for a prior annual or quarterly fiscal period. While this
regulation does not require the filing of the report upon the occurrence of the
event that effects the company's financial condition, once an announcement has
been made regarding the previously non public information, the report on Form
8-K is required. All further announcements made within 48 hours of the Form 8-K
filing regarding the same information do not trigger an additional Form 8-K
filing.
Section 401 of SOX requires public companies to disclose in their quarterly and
annual reports "all material off-balance sheet transactions, arrangement,
obligations, and other relationships that may have a material current or future
effect" on the company's "financial condition, results of operations,
liquidity," or capital expenditures or resources. Under implementing
regulations adopted by the SEC, these disclosures are to be made part of a
separately captioned section of the company's management discussion and analysis
and in a tabular format. The nature and business purpose of the off balance
sheet arrangement, the financial impact and risk exposure and the actual amounts
of payment due for each category and time period therefore must be disclosed.
Compliance with most amendments is required for all financial statements for
fiscal years ending on or after December 15, 2003.
SOX also requires directors, officers and beneficial owners of more than ten
percent of the public company's securities (i.e. Section 16 reporting persons)
to file a notice of their attaining such status within 10 days following the
occurrence and to file reports of their purchase or sale of the company's
securities not later than the second business day following the day of the
transaction(s).
Section 306 of SOX prohibits directors and officers from being involved,
directly or indirectly, in a purchase or sale of the company's equity securities
during any mandatory blackout period for the company's employee pension plans
during which the plan participants and beneficiaries are prevented from engaging
in transactions regarding the public company's securities held in their pension
plan accounts. Under this Section, the company or its shareholders (in a
derivative suit) may seek to recover any profit realized in violation of this
Section in an action against the director or officer.
Section 408 of SOX requires the SEC to review the financial statements and other
disclosures issued by public companies on a "regular and systematic" basis
which, in any event, shall not be "less frequently than once every three years."
In scheduling the reviews, the SEC will take into account issuers (i) that have
issued material restatements of its financial statements, (ii) that have
experienced significant volatility in their stock price, (iii) whose operations
effect material sectors of the economy, (iv) with the largest market
capitalization, and (v) emerging companies.
Enhanced Accounting Oversight, Board Independence and Conflicts of Interest
---------------------------------------------------------------------------
Public Accounting Oversight Board. SOX establishes the Public Company
- ------------------------------------
Accounting Oversight Board ("Board"). The Board is a non-profit corporation to
be composed of five persons of "integrity and reputation" who have demonstrated
a commitment to the investing public and are understanding of the
responsibilities of financial disclosure under the securities law. The Board
will be appointed by and operate under the supervision of the SEC. Section 103
of SOX authorizes the Board to set standards for the accounting industry
including auditing standards, quality control standards, and independence
standards. All accounting firms that audit public companies must register with
the Board within 180 days of the Board's establishment Under SOX, the Board is
33
to be established by the SEC by April 26, 2003. The Board will have the power
to inspect the firms, conduct investigations and disciplinary proceedings and
oversee compliance by the public accounting firms with the standards established
to restore investor confidence in the periodic reports of public companies.
Auditor Independence. In addition to accounting firms being subject to
- ---------------------
oversight by the Board, SOX prohibits registered public accounting firms from
providing audit and certain non audit services to the same public company. SOX
also prohibits any accounting firm from providing audit services if an executive
officer of the public company was employed by that firm during the one year
preceding initiation of the audit. The law also makes it unlawful for public
accounting firms to audit a public company if the lead partner in the audit has
performed audit services in each of the previous five years. This is to force
accounting firms to rotate their lead partner on audits.
Independent Audit Committees. One of the most critical provisions of SOX is
- ------------------------------
Section 301 which requires the SEC to direct national securities exchanges to
delist all public companies that do not establish audit committees made up of
entirely independent members of the board of directors. If a separate Audit
Committee is not established, the Board of Directors will be deemed to be the
Audit Committee and will have to satisfy the independence standard. To be
"independent" the member must not receive any consulting, advisory or other fees
or compensation from the public company (other than director fees) or be an
affiliated person of the company.
The definition of "affiliated person" for this purpose has not yet been
established by the SEC. As Section 301 amends Section 10A of the 1934 Act, and
since Section 3(a)(19) of the 1934 Act refers to the definition provided in the
Investment Company Act several commentators have suggested that the definition
of an "affiliated person" in that statute should apply. An "affiliate person"
therein is and owner or holder with the power to vote of five percent or more of
outstanding voting securities of the company or any officer, director, or
employee of the company. This definition would require that all directors be
precluded from serving on the Audit Committee. Obviously, further clarification
from the SEC is needed.
The audit committee is responsible for the appointment, compensation and
oversight of the company's auditors. Section 202 requires that the audit
committee pre-approve all audit and non-audit services to be performed by the
outside accountants. The auditors must report directly to the audit committee.
The committee has authority to engage its own legal counsel and advisors to
assist them in carrying out their duties. The public company is obligated to
provide adequate funding for the committee to meet its obligations.
Section 407 of SOX requires public companies to disclose in their periodic
reports whether the audit committee of the company includes at least one member
whose education and experience as a public accountant, auditor or principal
financial or accounting officer renders them capable of understanding generally
accepted accounting principles, gives them experience in the preparation of
financial statements and the application of principles as well as experience in
internal accounting controls and audit committee functions. While this
provision does not require the inclusion of such an "audit committee financial
expert" on the committee, the likely market reaction to the disclosure that the
company has failed to appoint such a person is likely to result in public
companies working diligently to include at least one "audit committee financial
expert" on its audit committee. Public companies must comply with the
disclosure requirements of Section 407 in their annual reports for fiscal years
ending on or after July 15, 2003. Small business issuers have to comply in
their annual reports for fiscal years ending on or after December 15, 2003.
Section 303 of SOX makes it unlawful for any officer or director of a public
company to influence, coerce, manipulate or mislead any auditor of the company's
financial statements. The SEC is empowered to enforce this provision in civil
proceedings.
Code of Ethics. Section 406 of SOX requires the disclosure as to whether a
- ----------------
public company has adopted a code of ethics establishing standards that promote
(i) honest and ethical conduct by the Board of Directors, (ii) the company's
full, fair and accurate disclosures in the company's periodic reports and (iii)
the company's compliance with applicable rules and regulations. Should a
company fail to adopt such a code of ethics its disclosure must also explain why
the company has filed to do so. Regulations promulgated by the SEC require
disclosure of such information in annual reports for fiscal years ending on or
after July 15, 2003.
Independent Board of Directors. In response to SOX, the national securities
- ---------------------------------
exchanges have issued proposed rules to the SEC that increase the independence
of the boards of directors. Under proposed rules NASDAQ listed companies that
are not controlled by an individual or a group that owns or controls more than
50% of the company's stock are required to have a board of directors a majority
of whose members are "independent." To be "independent," the proposed rules
34
state that the directors must have no relationship which, in the company's board
of directors' opinion, would interfere with the exercise of independent
judgments as a director. A director is not independent if that person: (i) has
received more than $60,000 from the company for services (other than board or
committees service), (ii) is or was an employee of the company's auditing firm
that worked on the company audit, (iii) is a partner or controlling shareholder
or executive officer of any entity that receives from or makes payments to the
company in an amount that exceeds 5% of the entity's gross revenues or $200,000
which ever is greater in the current year or in any of the past three years or
(iv) is a part of an interlocking compensation committee. The independent
directors must meet regularly in executive session. Adoption of the final rules
by NASDAQ is awaiting SEC approval.
Independent Nominating Committee and Compensation Committee. Proposed NASDAQ
- --------------------------------------------------------------
rules would also require that any director nominating committee established be
comprised of independent directors, a majority of whom approve all director
nominations. The committee may include one non-independent director who is an
officer and owns more than 20% of the outstanding voting securities of the
company or any other non-independent director under specified exceptional
circumstances. If such a committee is not established, a majority of the
independent directors must act upon nominations.
NASDAQ proposed rules also require that any compensation committee established
be comprised of independent directors with the exception that one
non-independent director may serve for two years under specified exceptional
circumstances. This committee must approve all executive officer compensation.
If no such committee is established, a majority of the independent directors
must approve all executive officer compensation.
Director and Executive Officer Loans. Section 402 of SOX prohibits public
- ----------------------------------------
companies and their subsidiaries from making loans to a director or executive
officer from and after July 30, 2002. This prohibition, however, does not apply
to insured depositary institutions provided the loan is subject to Section 22(h)
of the Federal Reserve Act and Regulation O. Consequently, banks and bank
subsidiaries may continue to make loans to their directors and executive
officers as long as they comply with Regulation O. However, the ban on insider
loans imposed by Section 402 still applies to the bank holding company (or any
nonbank subsidiary) as it is not an insured depositary institution. Section 402
still permits certain loans including, home improvement loans, consumer credit
and charge cards, provided the extension of credit is made in the ordinary cause
of business, is the type of credit generally made to the public by the company
and is made on no more favorable terms than offered to the general public.
Stock Option Plans. While SOX does not address procedures for modification of
- --------------------
stock option plans, NASDAQ proposed rules would require shareholder approval of
newly adopted stock option plans and significant modification of existing plans.
There are certain exceptions including the assumption of outstanding options as
part of a merger and employee stock ownership plans.
Attorney Conduct. Section 307 of SOX grants the SEC the authority to establish
- -----------------
federal standards for attorneys regarding their obligations to report evidence
of a material violation of securities law or a breach of fiduciary duty to the
public company's chief executive officer or chief legal counsel. The statute
indicates that should those persons not "appropriately respond" the attorney
must report the information to the audit committee or other duly designated
independent committee of the board of directors.
Enhanced Enforcement Powers and Penalties
-----------------------------------------
Document Destruction. Sections 802 and 1102 of SOX create new crimes for
- ---------------------
document tampering or destruction. Anyone who "knowing alters, destroys,
mutilates, conceals, covers up, falsifies or makes a false entry" in any
document with the intent of influencing an investigation or administrative
proceeding can be imprisoned for up to 20 years and fined for their conduct. In
addition, Section 1102 provides that "whoever corruptly alters, destroys,
mutilates or conceals a record, document or other object with the intent to
impair the objects integrity or availability for use in an official proceeding"
or attempts to influence or impede any official proceeding can be fined and
imprisoned for up to 20 years.
Forfeiture For Restated Financial Statements. Section 306 of SOX provides that
- ---------------------------------------------
should a company be required to restate its financial statements due to a
material non-compliance with the reporting requirements as a result of
"misconduct" of the principal executive officer(s) or the principal financial
officer(s), the officer must reimburse the company the amount of any bonus or
equity based compensation received during the twelve months preceding the
improper reporting and any profits realized by the officer from the company's
securities during the same period.
No Discharge in Bankruptcy. Section 803 prohibits an officer of a public
- -----------------------------
company who has been adjudicated guilty of securities fraud from discharging the
35
judgment in bankruptcy thereby causing the officer to remain personally liable
until the judgment is satisfied.
Power to Freeze Funds. Under SOX, the SEC enforcement powers have also been
- ------------------------
enhanced allowing the SEC to obtain a temporary or permanent ban against an
individual prohibiting that person from continuing to serve as an officer of a
public company upon a showing in an administrative proceeding that the
individual is "unfit" to serve as an officer. Section 1103 of SOX also
authorizes the SEC to freeze "extraordinary payments" to officers or directors
for up to 90 days during an SEC investigation. The freeze on the funds may
remain in effect beyond the 90-day period should the SEC commence an action
against the officer for securities law violations.
Whistleblower Protection. Section 806 of SOX affirmatively prohibits a public
- -------------------------
company from discharging or discriminating against (i.e. demoting, suspending,
threatening or harassing) any officer, employee, contractor or agent because the
person has provided information or otherwise assisted in an investigation
conducted by federal regulatory or law enforcement agency, Congress or a person
in the public company with supervisory authority over the employee, contractor
or agent. The "whistleblower" may file an action with the Department of Labor
or in federal court if no action is taken within 180 days of the filing.
Securities Fraud Felony. Section 807 of SOX creates a new federal crime
- -------------------------
punishable by a fine and imprisonment for up to 25 years for anyone who
"knowingly executes, or attempts to execute, a scheme or artifice to defraud
any person in connection with any security" of a public company.
Extended Statue of Limitation. Section 804 of SOX has extended the time frame
- -------------------------------
in which claims may be filed under Section 10(b) of the 1934 Act. Claimants now
have until the earlier of two years after discovery of the fraud or five years
after the violation to initiate a lawsuit.
Although no assurances can be given, it is anticipated that this far reaching
legislation and the rules to be issued by the SEC and the national securities
exchanges pursuant to SOX will result in significant additional regulations and
requirements for compliance by banks and their bank holding companies. It is
likely that these additional obligations will result in additional significant
and material expenditures by the public companies in auditors' fees, directors'
fees, attorneys' fees, outside advisor fees, increased errors and omissions
insurance premium costs, increased errors and omissions insurance premium costs
and other costs of compliance for the public companies to satisfy the new
requirements for corporate governance imposed by SOX and the accompanying rules
and regulations.
THE CALIFORNIA CORPORATE DISCLOSURE ACT
On January 1, 2003, the California Corporate Disclosure Act ("CCD") became
effective. The new law requires that all "publicly traded companies" file with
the California Secretary of State a statement on an annual basis that includes
at least the following information:
- The name of the independent auditor for the publicly traded company, a
description of the services rendered by the auditor during the
previous 24 months, the date of the last audit and a copy of the
report
- The annual compensation paid to each director and executive officer
including options or shares granted to them that were not available to
other employees of the company
- A description of any loans made to any director at a preferential loan
rate during the previous 24 months including the amount and terms
- A statement indicating whether any bankruptcy has been filed by the
company's executive officers or directors during the past 10 years
- The statement indicating whether any member of the board of directors
or executive officer was convicted of fraud during the past 10 years
- A statement indicating whether the corporation has bee adjudicated as
guilty of having violated any federal securities laws or any banking
or securities laws of California during the past 10 years which a
judgment of over $10,000 was imposed
For purposes of the CCD, a "publicly traded company" is any company whose
securities are listed on a national or foreign exchange or which is the subject
of a two-way quotation system that is regularly published.
BANK HOLDING COMPANY LIQUIDITY
The Company is a legal entity, separate and distinct from its Bank subsidiary.
Although it has the ability to raise capital on its own behalf or borrow from
35
external sources, the Company may also obtain additional funds through dividends
paid by, and fees for services provided to, the Bank. However, regulatory
constraints may restrict or totally preclude the bank from paying dividends to
the Company. See "- Limitations on Dividend Payments."
The FRB's policy regarding dividends provides that a bank holding company should
not pay cash dividends exceeding its net income or which can only be funded in
ways, such as by borrowing, that weaken the bank holding company's financial
health or its ability to act as a source of financial strength to its subsidiary
banks. The FRB also possesses enforcement powers over bank holding companies and
their non-bank subsidiaries to prevent or remedy actions that represent unsafe
or unsound practices or violations of applicable statutes and regulations. In
March 2000, the Company entered into a MOU with the FRB, which requires the
Company to refrain from declaring any dividends on the Company's stock or
redeeming any of its stock without the approval of the FRB. See "- Memorandum of
Understanding With the Federal Reserve Bank."
TRANSACTIONS WITH AFFILIATES
The Company and any subsidiaries it may purchase or organize are deemed to be
affiliates of the bank subsidiary within the meaning of Sections 23A and 23B of
the Federal Reserve Act, herein referred to as the "FRA," as amended. Pursuant
thereto, loans by Goleta to affiliates, investments by Goleta in affiliates'
stock, and taking affiliates' stock as collateral for loans to any borrower will
be limited to 10% of Goleta's capital, in the case of any one affiliate, and
will be limited to 20% of Goleta's capital in the case of all affiliates. In
addition, such transactions must be on terms and conditions that are consistent
with safe and sound banking practices. Specifically, a bank and its subsidiaries
generally may not purchase from an affiliate a low-quality asset, as defined in
the FRA. Such restrictions also prevent a bank holding company and its other
affiliates from borrowing from a banking subsidiary of the bank holding company
unless the loans are secured by marketable collateral of designated amounts. The
Company and Goleta are also subject to certain restrictions with respect to
engaging in the underwriting, public sale and distribution of securities. See "-
Supervision and Regulation of the Bank Subsidiary - Significant Legislation."
LIMITATIONS ON BUSINESSES AND INVESTMENT ACTIVITIES
Under the BHCA, a bank holding company must obtain the FRB's approval before:
- directly or indirectly acquiring more than 5% ownership or control of
any voting shares of another bank or bank holding company
- acquiring all or substantially all of the assets of another bank
- merging or consolidating with another bank holding company
The FRB may allow a bank holding company to acquire banks located in any state
of the United States without regard to whether the acquisition is prohibited by
the law of the state in which the target bank is located. In approving
interstate acquisitions, however, the FRB must give effect to applicable state
laws limiting the aggregate amount of deposits that may be held by the acquiring
bank holding company and its insured depository institutions in the state in
which the target bank is located, provided that those limits do not discriminate
against out-of-state depository institutions or their holding companies, and
state laws which require that the target bank have been in existence for a
minimum period of time, not to exceed five years, before being acquired by an
out-of-state bank holding company.
In general, the BHCA prohibits a bank holding company from acquiring direct or
indirect ownership or control of more than 5% of the voting securities of a
company that is not a bank or a bank holding company. However, with FRB consent,
a bank holding company may own subsidiaries engaged in certain businesses that
the FRB has determined to be "so closely related to banking as to be a proper
incident thereto. " The Company, therefore, is permitted to engage in a variety
of banking-related businesses, subject to limitations imposed as a result of
regulatory action. See "Memorandum of Understanding With The Federal Reserve
Bank." Some of the activities that the FRB has determined, pursuant to its
Regulation Y, to be related to banking are:
- making or acquiring loans or other extensions of credit for its own
account or for the account of others
- servicing loans and other extensions of credit
- operating a trust company in the manner authorized by federal or state
law under certain circumstances
- leasing personal and real property or acting as agent, broker, or
adviser in leasing such property in accordance with various
restrictions imposed by FRB regulations
37
- acting as investment or financial advisor
- providing management consulting advice under certain circumstances
- providing support services, including courier services and printing
and selling MICR-encoded items
- acting as a principal, agent or broker for insurance under certain
circumstances
- making equity and debt investments in corporations or projects
designed primarily to promote community welfare or jobs for residents
- providing financial, banking or economic data processing and data
transmission services
- owning, controlling or operating a savings association under certain
circumstances
- selling money orders, travelers' checks and U.S. Savings Bonds
- providing securities brokerage services, related securities credit
activities pursuant to Regulation T and other incidental activities
- underwriting and dealing in obligations of the United States, general
obligations of states and their political subdivisions and other
obligations authorized for state member banks under federal law
Generally, the BHCA does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
Federal law prohibits a bank holding company and any subsidiary banks from
engaging in certain tie-in arrangements in connection with the extension of
credit. Thus, for example, Goleta may not extend credit, lease or sell property,
or furnish any services, or fix or vary the consideration for any of the
foregoing on the condition that:
- the customer must obtain or provide some additional credit, property
or services from or to Goleta other than a loan, discount, deposit or
trust service
- the customer must obtain or provide some additional credit, property
or service from or to the Company or Goleta
- the customer may not obtain some other credit, property or services
from competitors, except reasonable requirements to assure soundness
of credit extended
In 1999, the Gramm-Leach-Bliley Act ("GLB Act") was enacted. The GLB Act
significantly changed the regulatory structure and oversight of the financial
services industry. The GLB Act permits banks and bank holding companies to
engage in previously prohibited activities under certain conditions. Also, banks
and bank holding companies may affiliate with other financial service providers
such as insurance companies and securities firms under certain conditions.
Consequently, a qualifying bank holding company, called a financial holding
company ("FHC"), can engage in a full range of financial activities, including
banking, insurance and securities activities, as well as merchant banking and
additional activities that are beyond those traditionally permitted for bank
holding companies. Moreover, various non-bank financial service providers who
were previously prohibited from engaging in banking can now acquire banks while
also offering services such as securities underwriting and underwriting and
brokering insurance products. The GLB Act also expands passive investment
activities by FHCs, permitting them to indirectly invest in any type of company,
financial or non-financial, through merchant banking activities and insurance
company affiliations. See "- Supervision and Regulation of the Bank Subsidiary -
Significant Legislation."
CAPITAL ADEQUACY
Bank holding companies must maintain minimum levels of capital under the FRB's
risk based capital adequacy guidelines. If capital falls below minimum guideline
levels, a bank holding company, among other things, may be denied approval to
acquire or establish additional banks or non-bank businesses.
The FRB's risk-based capital adequacy guidelines for bank holding companies and
state member banks, discussed in more detail below (see "- Supervision and
Regulation of the Bank Subsidiary - Risk-Based Capital Guidelines"), assign
various risk percentages to different categories of assets and capital is
measured as a percentage of those risk assets. Under the terms of the
guidelines, bank holding companies are expected to meet capital adequacy
guidelines based both on total risk assets and on total assets, without regard
to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will
be required if warranted by the particular circumstances or risk profiles of
individual organizations. For example, the FRB's capital guidelines contemplate
that additional capital may be required to take adequate account of, among other
things, interest rate risk, the risks posed by concentrations of credit or risks
associated with nontraditional banking activities or securities trading
37
activities. Moreover, any banking organization experiencing or anticipating
significant growth or expansion into new activities, particularly under the
expanded powers of the GLB Act, may be expected to maintain capital ratios,
including tangible capital positions, well above the minimum levels.
LIMITATIONS ON DIVIDEND PAYMENTS
The Company is entitled to receive dividends when and as declared by Goleta's
Board of Directors, out of funds legally available for dividends, as specified
and limited by the OCC's regulations. Pursuant to the OCC's regulations, funds
available for a national bank's dividends are restricted to the lesser of the
bank's: (i) retained earnings; or (ii) net income for the current and past two
fiscal years (less any dividends paid during that period), unless approved by
the OCC. Furthermore, if the OCC determines that a dividend would cause a bank's
capital to be impaired or that payment would cause it to be undercapitalized,
the OCC can prohibit payment of a dividend notwithstanding that funds are
legally available. Moreover, Goleta is subject to a Consent Order with the OCC
that prohibits the payment of dividends unless Goleta is in compliance with the
capital plan and the applicable provisions of the National Bank Act and has
received the approval of the OCC. See "Supervision and Regulation of the Bank
Subsidiary - Consent Order with the OCC."
Since Goleta is an FDIC insured institution, it is also possible, depending upon
its financial condition and other factors, that the FDIC could assert that the
payment of dividends or other payments might, under some circumstances,
constitute an unsafe or unsound practice and, thus, prohibit those payments.
As a California corporation, the Company's ability to pay dividends is subject
to the dividend limitations of the California Corporations Code ("CCC").
Section 500 of the CCC allows the Company to pay a dividend to its shareholders
only to the extent that the Company has retained earnings and, after the
dividend, the Company meets the following criteria:
- its assets (exclusive of goodwill and other intangible assets) would
be 1.25 times its liabilities (exclusive of deferred taxes, deferred
income and other deferred credits); and
- its current assets would be at least equal to its current liabilities.
The Company is currently prohibited form paying dividends without the prior
approval of the FRB. See "Supervision and Regulations of the Bank Subsidiary -
Memorandum of Understanding with the Federal Reserve Bank."
SUPERVISION AND REGULATION OF THE BANK SUBSIDIARY
- -------------------------------------------------------
GENERAL
Banking is a complex, highly regulated industry. The primary goals of the
regulatory scheme are to maintain a safe and sound banking system, protect
depositors and the FDIC's insurance fund and facilitate to conduct of sound
monetary policy. In furtherance of these goals, Congress and the states have
created several largely autonomous regulatory agencies and enacted numerous laws
that govern banks, bank holding companies and financial services industry.
Consequently, Goleta's growth and earnings performance can be affected not only
by management decisions and general economic conditions, but also by the
requirements of applicable state and federal statutes, regulations and the
policies of various governmental regulatory authorities, including:the FRB;the
OCC and the FDIC.
The system of supervision and regulation applicable to Goleta governs most
aspects of Goleta's business, including:
- the scope of permissible business
- investments
- reserves that must be maintained against deposits
- capital levels that must be maintained
- the nature and amount of collateral that may be taken to secure loans
- the establishment of new branches
- mergers and consolidations with other financial institutions
- the payment of dividends
Goleta, as a national banking association member, is also a member of the
Federal Reserve System, is subject to regulation, supervision and regular
examination by the OCC, the FDIC and the FRB. Goleta's deposits are insured by
the FDIC up to the maximum extent provided by law. The regulations of these
agencies govern most aspects of the Goleta's business. California law exempts
all banks from usury limitations on interest rates.
38
The following summarizes the material elements of the regulatory framework that
applies to Goleta. It does not describe all of the statutes, regulations and
regulatory policies that are applicable. Also, it does not restate all of the
requirements of the statutes, regulations and regulatory policies that are
described. Consequently, the following summary is qualified in its entirety by
reference to the applicable statutes, regulations and regulatory policies may
have material effect on Goleta's business.
SIGNIFICANT LEGISLATION
In 1999, the GLB Act was signed into law, significantly changing the regulatory
structure and oversight of the financial services industry. The GLB Act
repealed the provisions of the Glass-Steagall Act that restricted banks and
securities firms from affiliating. It also revised the BHCA to permit an FHC to
engage in a full range of financial activities, including banking, insurance,
securities and merchant banking activities. It also permits FHCs to acquire many
types of financial firms without the FRB's prior approval.
The GLB Act thus provides expanded financial affiliation opportunities for
existing bank holding companies and permits other financial service providers to
acquire banks and become bank holding companies without ceasing any existing
financial activities. Previously, a bank holding company could only engage in
activities that were "closely related to banking." This limitation no longer
applies to bank holding companies that qualify to be treated as FHCs. To qualify
as an FHC, a bank holding company's subsidiary depository institutions must be
"well-capitalized," "well-managed" and have at least a "satisfactory" Community
Reinvestment Act, herein referred to as "CRA," examination rating.
"Non-qualifying" bank holding companies are limited to activities that were
permissible under the BHCA as of November 11, 1999.
The GLB Act changed the powers of national banks and their subsidiaries and made
similar changes in the powers of state-chartered banks and their subsidiaries.
National banks may now underwrite, deal in and purchase state and local revenue
bonds. Subsidiaries of national banks may now engage in financial activities
that the bank cannot itself engage in, except for general insurance underwriting
and real estate development and investment. For a subsidiary of a national bank
to engage in these new financial activities, the national bank and its
depository institution affiliates must be "well capitalized," have at least
"satisfactory" general, managerial and CRA examination ratings, and meet other
qualification requirements relating to total assets, subordinated debt, capital,
risk management and affiliate transactions. Subsidiaries of state-chartered
banks can exercise the same powers as national bank subsidiaries if they satisfy
the same qualifying rules that apply to national banks, except that
state-chartered banks do not have to satisfy the managerial and debt rating
requirements applicable to national banks.
The GLB Act also reformed the overall regulatory framework of the financial
services industry. To implement its underlying purposes, the GLB Act preempted
conflicting state laws that would restrict the types of financial affiliations
that are authorized or permitted under the GLB Act, subject to specified
exceptions for state insurance laws and regulations. With regard to securities
laws, effective May 12, 2001, the GLB Act removed the current blanket exemption
for banks from being considered brokers or dealers under the Securities Exchange
Act of 1934 and replaced it with a number of more limited exemptions. Thus,
previously exempted banks may become subject to the broker-dealer registration
and supervision requirements of the Securities Exchange Act of 1934. The
exemption that prevented bank holding companies and banks that advised mutual
funds from being considered investment advisers under the Investment Advisers
Act of 1940 was also eliminated.
Separately, the GLB Act imposes customer privacy requirements on any company
engaged in financial activities. Under these requirements, a financial company
is required to protect the security and confidentiality of customer nonpublic
personal information. Also, for customers that obtain a financial product such
as a loan for personal, family or household purposes, a financial company is
required to disclose its privacy policy to the customer at the time the
relationship is established and annually thereafter, including its policies
concerning the sharing of the customer's nonpublic personal information with
affiliates and third parties. If an exemption is not available, a financial
company must provide consumers with a notice of its information sharing
practices that allows the consumer to reject the disclosure of its nonpublic
personal information to third parties. Third parties that receive such
information are subject to the same restrictions as the financial company on the
reuse of the information. A financial company is prohibited from disclosing an
account number or similar item to a third party for use in telemarketing, direct
mail marketing or other marketing through electronic mail.
RISK-BASED CAPITAL GUIDELINES
General. The federal banking agencies have established minimum capital
- -------
standards known as risk-based capital guidelines. These guidelines are intended
39
to provide a measure of capital that reflects the degree of risk associated with
a bank's operations. The risk-based capital guidelines include both a new
definition of capital and a framework for calculating the amount of capital that
must be maintained against a bank's assets and off-balance sheet items. The
amount of capital required to be maintained is based upon the credit risks
associated with the various types of a bank's assets and off-balance sheet
items. A bank's assets and off-balance sheet items are classified under several
risk categories, with each category assigned a particular risk weighting from 0%
to 100%. The bank's risk-based capital ratio is calculated by dividing its
qualifying capital, which is the numerator of the ratio, by the combined risk
weights of its assets and off-balance sheet items, which is the denominator of
the ratio. Qualifying Capital. A bank's total qualifying capital consists of two
types of capital components: "core capital elements," known as Tier 1 capital,
and "supplementary capital elements," known as Tier 2 capital. The Tier 1
component of a bank's qualifying capital must represent at least 50% of total
qualifying capital and may consist of the following items that are defined as
core capital elements:
- common stockholders' equity; qualifying non-cumulative perpetual
preferred stock (including related surplus)
- minority interests in the equity accounts of consolidated subsidiaries
The Tier 2 component of a bank's total qualifying capital may consist of the
following items:
- a portion of the allowance for loan and lease losses
- certain types of perpetual preferred stock and related surplus
- certain types of hybrid capital instruments and mandatory convertible
debt securities
- a portion of term subordinated debt and intermediate-term preferred
stock, including related surplus
Risk Weighted Assets and Off-Balance Sheet Items. Assets and credit equivalent
- --------------------------------------------------
amounts of off-balance sheet items are assigned to one of several broad risk
classifications, according to the obligor or, if relevant, the guarantor or the
nature of the collateral. The aggregate dollar value of the amount in each risk
classification is then multiplied by the risk weight associated with that
classification. The resulting weighted values from each of the risk
classifications are added together. This total is the bank's total risk weighted
assets.
A two-step process determines risk weights for off-balance sheet items, such as
unfunded loan commitments, letters of credit and recourse arrangements. First,
the "credit equivalent amount" of the off-balance sheet items is determined, in
most cases by multiplying the off-balance sheet item by a credit conversion
factor. Second, the credit equivalent amount is treated like any balance sheet
asset and is assigned to the appropriate risk category according to the obligor
or, if relevant, the guarantor or the nature of the collateral. This result is
added to the bank's risk-weighted assets and comprises the denominator of the
risk-based capital ratio.
Minimum Capital Standards. The supervisory standards set forth below specify
- ---------------------------
minimum capital ratios based primarily on broad risk considerations. The
risk-based ratios do not take explicit account of the quality of individual
asset portfolios or the range of other types of risks to which banks may be
exposed, such as interest rate, liquidity, market or operational risks. For this
reason, banks are generally expected to operate with capital positions above the
minimum ratios.
All banks are required to meet a minimum ratio of qualifying total capital to
risk weighted assets of 8%. At least 4% must be in the form of Tier 1 capital,
net of goodwill. The maximum amount of supplementary capital elements that
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of
goodwill. In addition, the combined maximum amount of term subordinated debt and
intermediate-term preferred stock that qualifies as Tier 2 capital for
risk-based capital purposes is limited to 50% of Tier 1 capital. The maximum
amount of the allowance for loan and lease losses that qualifies as Tier 2
capital is limited to 1.25% of gross risk weighted assets. The allowance for
loan and lease losses in excess of this limit may, of course, be maintained, but
would not be included in a bank's risk-based capital calculation.
The federal banking agencies also require all banks to maintain a minimum amount
of Tier 1 capital to total assets, referred to as the leverage ratio. For a bank
rated in the highest of the five categories used by regulators to rate banks,
the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all
banks not rated in the highest category, the minimum leverage ratio must be at
least 4% to 5%. These uniform risk-based capital guidelines and leverage ratios
apply across the industry. Regulators, however, have the discretion to set
minimum capital requirements for individual institutions, which may be
significantly above the minimum guidelines and ratios.
In October 2002, Goleta entered into a Consent Order with the OCC that requires
Goleta to maintain a 12% risk based capital and a 7% Tier I capital ratio. See
"- Consent Order With the OCC."
41
OTHER FACTORS AFFECTING MINIMUM CAPITAL STANDARDS
The federal banking agencies have established certain benchmark ratios of loan
loss reserves to be held against classified assets. The benchmark by federal
banking agencies is the sum of:
- 100% of assets classified loss
- 50% of assets classified doubtful
- 15% of assets classified substandard and
- estimated credit losses on other assets over the upcoming 12 months
The federal risk-based capital rules adopted by banking agencies take into
account bank's concentrations of credit and the risks of engaging in
non-traditional activities. Concentrations of credit refers to situations where
a lender has a relatively large proportion of loans involving a single borrower,
industry, geographic location, collateral or loan type. Non-traditional
activities are considered those that have not customarily been part of the
banking business, but are conducted by a bank as a result of developments in,
for example, technology, financial markets or other additional activities
permitted by law or regulation. The regulations require institutions with high
or inordinate levels of risk to operate with higher minimum capital standards.
The federal banking agencies also are authorized to review an institution's
management of concentrations of credit risk for adequacy and consistency with
safety and soundness standards regarding internal controls, credit underwriting
or other operational and managerial areas.
The federal banking agencies also limit the amount of deferred tax assets that
are allowable in computing a bank's regulatory capital. Deferred tax assets that
can be realized for taxes paid in prior carryback years and from future
reversals of existing taxable temporary differences are generally not limited.
However, deferred tax assets that can only be realized through future taxable
earnings are limited for regulatory capital purposes to the lesser of:
- the amount that can be realized within one year of the quarter-end
report date or
- 10% of Tier 1 capital
The amount of any deferred tax in excess of this limit would be excluded from
Tier 1 capital, total assets and regulatory capital calculations.
The federal banking agencies have also adopted a joint agency policy statement
which provides that the adequacy and effectiveness of a bank's interest rate
risk management process and the level of its interest rate exposure is a
critical factor in the evaluation of the bank's capital adequacy. A bank with
material weaknesses in its interest rate risk management process or high levels
of interest rate exposure relative to its capital will be directed by the
federal banking agencies to take corrective actions. Financial institutions
which have significant amounts of their assets concentrated in high risk loans
or nontraditional banking activities, and who fail to adequately manage these
risks, may be required to set aside capital in excess of the regulatory
minimums.
PROMPT CORRECTIVE ACTION
The federal banking agencies possess broad powers to take prompt corrective
action to resolve the problems of insured banks. Each federal banking agency has
issued regulations defining five capital categories: "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized,"
and "critically undercapitalized." Under the regulations, a bank shall be deemed
to be:
- "well capitalized" if it has a total risk-based capital ratio of 10%
or more, has a Tier 1 risk-based capital ratio of 6% or more, has a
leverage capital ratio of 5% or more and is not subject to specified
requirements to meet and maintain a specific capital level for any
capital measure
- "adequately capitalized" if it has a total risk-based capital ratio of
8% or more, a Tier 1 risk-based capital ratio of 4% or more and a
leverage capital ratio of 4% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized"
- "undercapitalized" if it has a total risk-based capital ratio that is
less than 8%, a Tier 1 risk-based capital ratio that is less than 4%,
or a leverage capital ratio that is less than 4% (3% under certain
circumstances)
- "significantly undercapitalized" if it has a total risk-based capital
ratio that is less than 6%, a Tier 1 risk-based capital ratio that is
less than 3% or a leverage capital ratio that is less than 3%; and
- "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2%
42
Banks are prohibited from paying dividends or management fees to controlling
persons or entities if, after making the payment, the bank would be
"undercapitalized," that is, the bank fails to meet the required minimum level
for any relevant capital measure. Asset growth and branching restrictions apply
to "undercapitalized" banks. Banks classified as "undercapitalized" are required
to submit acceptable capital plans guaranteed by its holding company, if any.
Broad regulatory authority was granted with respect to "significantly
undercapitalized" banks, including forced mergers, growth restrictions, ordering
new elections for directors, forcing divestiture by its holding company, if any,
requiring management changes and prohibiting the payment of bonuses to senior
management. Even more severe restrictions are applicable to "critically
undercapitalized" banks, those with capital at or less than 2%. Restrictions for
these banks include the appointment of a receiver or conservator after 90 days,
even if the bank is still solvent. All of the federal banking agencies have
promulgated substantially similar regulations to implement this system of prompt
corrective action.
A bank, based upon its capital levels, that is classified as "well capitalized,"
"adequately capitalized" or "undercapitalized" may be treated as though it were
in the next lower capital category if the appropriate federal banking agency,
after notice and opportunity for hearing, determines that an unsafe or unsound
condition, or an unsafe or unsound practice, warrants such treatment. At each
successive lower capital category, an insured bank is subject to more
restrictions. The federal banking agencies, however, may not treat an
institution as "critically undercapitalized" unless its capital ratios actually
warrant such treatment.
DEPOSIT INSURANCE ASSESSMENTS
The FDIC has implemented a risk-based assessment system in which the deposit
insurance premium relates to the probability that the deposit insurance fund
will incur a loss. The FDIC sets semi-annual assessments in an amount necessary
to maintain or increase the reserve ratio of the insurance fund to at least
1.25% of insured deposits or a higher percentage as determined to be justified
by the FDIC.
Under the risk-based assessment system adopted by the FDIC, banks are
categorized into one of three capital categories, "well capitalized,"
"adequately capitalized," and "undercapitalized." Assignment of a bank into a
particular capital category is based on supervisory evaluations by its primary
federal regulator. After being assigned to a particular capital category, a bank
is classified into one of three supervisory categories. The three supervisory
categories are:
- Group A - financially sound with only a few minor weaknesses
- Group B - demonstrates weaknesses that could result in significant
deterioration
- Group C - poses a substantial probability of loss.
The capital ratios used by the FDIC to define "well-capitalized," "adequately
capitalized" and "undercapitalized" are the same as in the prompt corrective
action regulations.
The assessment rates are summarized below, expressed in terms of cents per $100
in insured deposits:
Assessment Rates Supervisory Group
-------------------------------------
Capital Group Group A Group B Group C
- ------------------------ ----------- ----------- -----------
1-Well Capitalized 0 3 17
2-Adequately Capitalized 3 10 24
3-Undercapitalized 10 24 27
The bank is currently risk rated a 1B, which translates to well-capitalized,
group B and is assessed a rate of 3 basis points.
INTERSTATE BANKING AND BRANCHING
Bank holding companies from any state may generally acquire banks and bank
holding companies located in any other state, subject in some cases to
nationwide and state-imposed deposit concentration limits and limits on the
acquisition of recently established banks. Banks also have the ability, subject
to specific restrictions, to acquire by acquisition or merger branches located
outside their home state. The establishment of new interstate branches is also
possible in those states with laws that expressly permit it. Interstate
branches are subject to many of the laws of the states in which they are
located.
43
California law authorizes out-of-state banks to enter California by the
acquisition of or merger with a California bank that has been in existence for
at least five years, unless the California bank is in danger of failing or in
certain other emergency situations. Interstate branching into California is,
however, limited to the acquisition of an existing bank.
ENFORCEMENT POWERS
In addition to measures taken under the prompt corrective action provisions,
insured banks may be subject to potential enforcement actions by the federal
regulators for unsafe or unsound practices in conducting their businesses, or
for violation of any law, rule, regulation or condition imposed in writing by
the regulatory agency or term of a written agreement with the regulatory agency.
Enforcement actions may include:
- the appointment of a conservator or receiver for the bank
- the issuance of a cease and desist order that can be judicially
enforced
- the termination of the bank's deposit insurance
- the imposition of civil monetary penalties;
- the issuance of directives to increase capital;
- the issuance of formal and informal agreements
- the issuance of removal and prohibition orders against officers,
directors and other institution-affiliated parties
- the enforcement of such actions through injunctions or restraining
orders based upon a judicial determination that the deposit insurance
fund or the bank would be harmed if such equitable relief was not
granted
FDIC RECEIVERSHIP
The FDIC may be appointed as conservator or receiver of any insured bank or
savings association. In addition, the FDIC may appoint itself as sole
conservator or receiver of any insured state bank or savings association for
any, among others, of the following reasons:
- insolvency - substantial dissipation of assets or earnings due to any
violation of law or regulation or any unsafe or unsound practice
- an unsafe or unsound condition to transact business, including
substantially insufficient capital or otherwise
- any willful violation of a cease and desist order which has become
final
- any concealment of books, papers, records or assets of the institution
- the likelihood that the institution will not be able to meet the
demands of its depositors or pay its obligations in the normal course
of business
- the incurrence or likely incurrence of losses by the institution that
will deplete all or substantially all of its capital with no
reasonable prospect for the replenishment of the capital without
federal assistance
- any violation of any law or regulation, or an unsafe or unsound
practice or condition which is likely to cause insolvency or
substantial dissipation of assets or earnings, or is likely to weaken
the condition of the institution or otherwise seriously prejudice the
interests of its depositors.
As a receiver of any insured depository institution, the FDIC may liquidate such
institution in an orderly manner and dispose of any matter concerning such
institution as the FDIC determines is in the best interests of that institution,
its depositors and the FDIC. Further, the FDIC will, as the conservator or
receiver, by operation of law, succeed to all rights, titles, powers and
privileges of the insured institution, and of any shareholder, member, account
holder, depositor, officer or director of that institution with respect to the
institution and the assets of the institution; may take over the assets of and
operate the institution with all the powers of the members or shareholders,
directors and the officers of the institution and conduct all business of the
institution; and, collect all obligations and money due to the institution and
preserve and conserve the assets and property of the institution.
SAFETY AND SOUNDNESS GUIDELINES
The federal banking agencies have adopted guidelines to assist in identifying
and addressing potential safety and soundness concerns before capital becomes
impaired. These guidelines establish operational and managerial standards
relating to:
- internal controls, information systems and internal audit systems
- loan documentation - credit underwriting
- asset growth
- compensation, fees and benefits
44
Additionally, the federal banking agencies have adopted safety and soundness
guidelines for asset quality and for evaluating and monitoring earnings to
ensure that earnings are sufficient for the maintenance of adequate capital and
reserves. If an institution fails to comply with a safety and soundness
standard, the appropriate federal banking agency may require the institution to
submit a compliance plan. Failure to submit a compliance plan or to implement an
accepted plan may result in a formal enforcement action.
The federal banking agencies have issued regulations prescribing uniform
guidelines for real estate lending. The regulations require insured depository
institutions to adopt written policies establishing standards, consistent with
such guidelines, for extensions of credit secured by real estate. The policies
must address loan portfolio management, underwriting standards and loan-to-value
limits that do not exceed the supervisory limits prescribed by the regulations.
CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are focusing greater attention on compliance with
consumer protection laws and their implementing regulations. Examination and
enforcement have become more intense in nature and insured institutions have
been advised to carefully monitor compliance with various consumer protection
laws and their implementing regulations. Banks are subject to many federal
consumer protection laws and their regulations, including:
- the Community Reinvestment Act, or the CRA
- the Truth in Lending Act or the TILA
- the Fair Housing Act, or the FH Act
- the Equal Credit Opportunity Act or the ECOA
- the Home Mortgage Disclosure Act, or the HMDA
- the Real Estate Settlement Procedures Act or the RESPA
- the Gramm-Leach-Bliley Act, or the GLB Act
The CRA is intended to encourage insured depository institutions, while
operating safely and soundly, to help meet the credit needs of their
communities. The CRA specifically directs the federal bank regulatory
agencies, in examining insured depository institutions, to assess their record
of helping to meet the credit needs of their entire community, including low-
and moderate-income neighborhoods, consistent with safe and sound banking
practices. The CRA further requires the agencies to take a financial
institution's record of meeting its community redit needs into account when
evaluating applications for, among other things, domestic branches, consummating
mergers or acquisitions or holding company formations.
The federal banking agencies have adopted regulations which measure a bank's
compliance with its CRA obligations on a performance-based evaluation system.
This system bases CRA ratings on an institution's actual lending service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements. The ratings range from a high of "outstanding" to a low
of "substantial noncompliance."
The ECOA prohibits discrimination in any credit transaction, whether for
consumer or business purposes, on the basis of race, color, religion, national
origin, sex, marital status, age (except in limited circumstances), receipt of
income from public assistance programs or good faith exercise of any rights
under the Consumer Credit Protection Act. The Federal Interagency Task Force on
Fair Lending issued a policy statement on discrimination in lending. The policy
statement describes the three methods that federal agencies will use to prove
discrimination:
- overt evidence of discrimination
- evidence of disparate treatment
- evidence of disparate impact
If a creditor's actions have had the effect of discriminating, the creditor may
be held liable even when there is no intent to discriminate.
The FH Act regulates many practices, including making it unlawful for any lender
to discriminate against any person in its housing-related lending activities
because of race, color, religion, national origin, sex, handicap or familial
status. The FH Act is broadly written and has been broadly interpreted by the
courts. A number of lending practices have been found to be, or may be
considered, illegal under the FH Act, including some that are not specifically
mentioned in the FH Act itself. Among those practices that have been found to
be, or may be considered, illegal under the FH Act are:
45
- declining a loan for the purposes of racial discrimination
- making excessively low appraisals of property based on racial
considerations
- pressuring, discouraging or denying applications for credit on a
prohibited basis
- using excessively burdensome qualifications standards for the purpose
or with the effect of denying housing to minority applicants
- imposing on minority loan applicants more onerous interest rates or
other terms, conditions or requirements
- racial steering or deliberately guiding potential purchasers to or
away from certain areas because of race
The TILA is designed to ensure that credit terms are disclosed in a meaningful
way so that consumers may compare credit terms more readily and knowledgeably.
As a result of the TILA, all creditors must use the same credit terminology and
expressions of rates, the annual percentage rate, the finance charge, the amount
financed, the total payments and the payment schedule. HMDA grew out of public
concern over credit shortages in certain urban neighborhoods. One purpose of
HMDA is to provide public information that will help show whether financial
institutions are serving the housing credit needs of the neighborhoods and
communities in which they are located. HMDA also includes a "fair lending"
aspect that requires the collection and disclosure of data about applicant and
borrower characteristics as a way of identifying possible discriminatory lending
patterns and enforcing anti-discrimination statutes. HMDA requires institutions
to report data regarding applications for one-to-four family real estate loans,
home improvement loans and multifamily loans, as well as information concerning
originations and purchases of those types of loans. Federal bank regulators
rely, in part, upon data provided under HMDA to determine whether depository
institutions engage in discriminatory lending practices.
RESPA requires lenders to provide borrowers with disclosures regarding the
nature and costs of real estate settlements. Also, RESPA prohibits certain
abusive practices, such as kickbacks, and places limitations on the amount of
escrow accounts.
The GLB Act required disclosure of the bank's privacy policy at the time the
customer relationship is established and annually thereafter. Under the
provisions of the GLB Act financial institutions must put systems in place to
safeguard the non-public personal information of its customers.
Violations of these various consumer protection laws and regulations can result
in civil liability to the aggrieved party, regulatory enforcement including
civil money penalties and even punitive damages.
OTHER ASPECTS OF BANKING LAW
Goleta is also subject to federal and state statutory and regulatory provisions
covering, among other things, security procedures, currency and foreign
transactions reporting, insider and affiliated party transactions, management
interlocks, electronic funds transfers, funds availability and truth-in-savings.
There are also a variety of federal statutes which regulate acquisitions of
control and the formation of bank holding companies.
IMPACT OF MONETARY POLICIES
Banking is a business that depends on rate differentials. In general, the
difference between the interest rate paid by a bank on its deposits and its
other borrowings and the interest rate earned on its loans, securities and other
interest-earning assets comprises the major source of Goleta's earnings. These
rates are highly sensitive to many factors which are beyond Goleta's control
and, accordingly, the earnings and growth of Goleta are subject to the influence
of economic conditions generally, both domestic and foreign, including
inflation, recession and unemployment and also to the influence of monetary and
fiscal policies of the United States and its agencies, particularly the FRB. The
FRB implements national monetary policy, such as seeking to curb inflation and
combat recession, by:
- Open-market dealings in United States government securities
- Adjusting the required level of reserves for financial institutions
subject to reserve requirements
- Placing limitations upon savings and time deposit interest rates
- Adjusting the discount rate applicable to borrowings by banks which
are members of the Federal Reserve System
The actions of the FRB in these areas influence the growth of bank loans,
investments, and deposits and also affect interest rates. Since January 2001,
the FRB has decreased interest rates numerous times. The nature and timing of
any future changes in the FRB's policies and their impact on the Company and
Goleta cannot be predicted; however, depending on the degree to which our
interest-earning assets and interest-bearing liabilities are rate sensitive,
increases in rates would have a temporary effect of increasing our net interest
margin, while decreases in interest rates would have the opposite effect. In
addition, adverse economic conditions could make a higher provision for loan
losses a prudent course and could cause higher loan charge-offs, thus adversely
affecting our net income or other operating costs. See Interest Rate Risk page
29.
46
CONSENT ORDER WITH THE OCC
On October 28, 2002, Goleta entered into a Consent Order with its principal
regulator, the OCC. As of this date, the Consent Order replaces the Formal
Agreement with the OCC. The Consent Order requires that Goleta maintain certain
capital levels, adhere to certain operational and reporting requirements and
take certain actions, including the following:
- Goleta will submit monthly progress reports to the OCC.
- On or before December 31, 2002, Goleta will cease all actions related
to the origination, renewal or rollover of short-term consumer loans,
and on or before November 1, 2002, ACE will assume, indemnify and hold
Goleta harmless for 100% of the costs, expenses, legal fees, damages
and related liabilities from third-party claims in certain
circumstances as specified in and in accordance with the terms of
Goleta's agreement with ACE.
- Goleta will provide written notice to 641 short-term consumer loan
applicants whose files are missing from one ACE store. No later than
February 15, 2003, Goleta will begin a loan file audit, first randomly
sampling 5% of the loan files at each ACE store (except those already
reviewed by Goleta's Quality Assurance Department) to verify the
physical presence of applicants' loan files. If sampling reveals more
than one file missing at a store, Goleta will physically verify the
presence of all of the files generated at that store since June 30,
2002. If any applicant files are not located, Goleta will notify the
applicant in writing of the missing documents and provide them with
information regarding steps that they may take to determine whether
identity theft may have occurred.
- Without admitting or denying any wrongdoing, Goleta will pay a civil
money penalty of $75,000 to the OCC within ten days of the Consent
Order.
- Within 90 days of the Consent Order, Goleta will adopt a written
strategic plan covering at least a three-year period.
- Goleta will maintain total capital at least equal to 12% of
risk-weighted assets and Tier 1 capital at least equal to 7% of
adjusted total assets; develop a three-year capital program to
maintain adequate capital; and refrain from paying dividends without
the approval of the OCC.
- Goleta will develop a written profit plan and submit quarterly
performance reports.
- Goleta will develop and implement a written risk management program
and adopt general procedures addressing compliance management,
internal control systems and education of employees regarding laws,
rules and regulations.
- Goleta will document the information it has relied on to value loans
held on its books, servicing rights, deferred tax assets and
liabilities and interest-only assets and submit the documentation to
the OCC on a quarterly basis.
- Goleta will correct each violation of law, rule or regulation cited in
any report of examination where possible and implement corrective
action to avoid the reoccurrence of any such violations.
- Goleta will obtain the approval of the OCC before it initiates any new
product or service or significantly expands any of its existing
products or services.
Compliance with the provisions of the Order could limit Goleta's business
activity and increase expense. Management believes it is in substantive
compliance with the preceding provisions.
On March 8, 2002, the Company made a $750,000 capital contribution to Goleta
and, as a result Goleta achieved and has maintained the required 12% total
capital ratio and 7% Tier 1 capital ratio. The Company made a $500,000 capital
contribution to Goleta on August 27, 2002. Goleta's total risk based capital
ratio was 13.31% as of December 31, 2002. Management believes that it continues
to comply with all material provisions of the Order regarding capital
requirements.
MEMORANDUM OF UNDERSTANDING WITH THE FEDERAL RESERVE BANK
In March 2000, the Company entered into an MOU with the Reserve Bank. The MOU
requires that the Company maintain certain capital levels and adhere to certain
operational and reporting requirements, including the following:
- refrain from declaring any dividends or redeeming any of its stock
without the approval of the Reserve Bank
47
- adopting a written plan to maintain a sufficient capital position for
the consolidated organization
- refrain from increasing its borrowings or incurring or renewing any
debt without the approval of the Reserve Bank
- correcting any violations of applicable laws, rules or regulations and
developing a written program to ensure compliance in the future
- developing written policies and procedures to strengthen the Company's
records, systems and internal controls
- developing a written plan to enhance management information systems
and the Board of Director's supervision of operations; - developing a
written consolidated strategic plan
- developing a written plan to address weaknesses in the Company's audit
program
- complying with applicable laws with respect to the appointment of any
new directors or the hiring of any senior executive officers
- submitting quarterly progress report.
The Company believes that it is in compliance with the provisions of the MOU.
48
SIGNIFICANT ACCOUNTING POLICIES
INTEREST ONLY STRIPS AND SERVICING ASSETS - The Company originates certain loans
for the purpose of selling either a portion of, or the entire loan, into the
secondary market. FHA Title 1 loans and the guaranteed portion of SBA loans are
sold into the secondary market. Servicing assets are recognized as separate
assets when loans are sold with servicing retained. Servicing assets are
amortized in proportion to, and over the period of, estimated future net
servicing income. Also, at the time of the loan sale, it is the Company's
policy to recognize the related gain on the loan sale in accordance with
generally accepted accounting principles. The Company uses industry prepayment
statistics and its own prepayment experience in estimating the expected life of
the loans. Quarterly, management evaluates servicing assets for impairment.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost on a loan by loan basis. Fair value is
determined using discounted future cash flows calculated on a loan by loan basis
and aggregated to the total asset level. Impairment to the asset is recorded if
the aggregate fair value calculation drops below net book value of the asset.
Additionally, on some SBA loan sales, the Company has retained interest only
("I/O") strips, which represent the present value of excess net cash flows
generated by the difference between (a) interest at the stated rate paid by
borrowers and (b) the sum of (i) pass-through interest paid to third-party
investors and (ii) contractual servicing fees. The Company determined the
present value of this estimated cash flow at the time each loan sale transaction
closed, utilizing valuation assumptions as to discount rate, prepayment rate and
default rate appropriate for each particular transaction. Periodically, the
Company verifies the reasonableness of its valuation estimates by comparison to
the results of an independent third party valuation analysis.
The I/O strips are accounted for like investments in debt securities classified
as trading securities. Accordingly, the Company records the I/O's at fair value
with the resulting increase or decrease in fair value being recorded through
operations in the current period. For the years ended December 31, 2002, 2001
and 2000, net decreases in fair value of $3,385,000, $2,694,000 and $858,000,
respectively, are included in results of operations as reductions to loan
servicing income.
SECURITIZED LOANS AND BONDS PAYABLE - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
trusts ("Trusts"). The transfers have been accounted for as secured borrowings
with a pledge of collateral and, accordingly, the mortgage loans and related
bonds issued are included in the Company's balance sheet. Such loans are
accounted for in the same manner as loans held to maturity. Deferred debt
issuance costs and bond discount related to the bonds are amortized on a method
which approximates the level yield basis over the estimated life of the bonds.
NEW ACCOUNTING PRONOUNCEMENTS - The Financial Accounting Standards Board
("FASB") finalized accounting standards covering business combinations, goodwill
and intangible assets. These new rules published in July 2001 consist of SFAS
No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible
Assets." In conjunction with these new accounting standards, the FASB issued
"Transition Provisions for New Business Combination Accounting Rules" that
required companies to cease amortization of goodwill and adopt the new
impairment approach as of January 1, 2002. The adoption of SFAS Nos. 141 and 142
did not have a material effect on the Bank's financial position or results of
operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" which supersedes SFAS No. 121. SFAS No. 144,
which governs accounting for the impairment of long-lived assets, is effective
for financial statements issued for fiscal years beginning after December 15,
2002. The adoption of SFAS No. 144 is not expected to have a significant impact
on the Company's financial position or results of operations.
In June 2002, the FASB issued SFAS No.146, "Accounting for Costs Associated with
Exit or Disposal Activities" which nullifies Emerging Task Force ("EITF") Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)". This statement requires that a liability for a cost associated
with an exit or disposal activity be recognized when the liability is incurred
and is effective for exit and disposal activities after December 31, 2002.
Under Issue 94-3, a liability for exit cost as defined in Issue 94-3 was
recognized at the date of the entity's commitment to an exit plan. The FASB has
concluded that an entity's commitment to a plan, by itself, does not create a
present obligation to others that meet the definition of a liability.
Therefore, this Statement eliminates the definition and requirements for
recognition of exit costs in Issue 94-3. This Statement also establishes that
fair value is the objective for initial measurement of the liability. The
Company did not elect to early adopt SFAS No. 146. The Company recognized
$650,000 of costs related to exit and disposal activities in 2002. At December
31, 2002, the Company had $405,000 in liabilities related to its exit and
disposal activities. Refer to Note 7 for the components of the exit and
disposal related items.
49
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions" which amends statements SFAS No. 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions" and SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets". This
Statement removes acquisitions of financial institutions from the scope of both
Statement 72 and Interpretation 9 and requires those transactions be accounted
for in accordance with SFAS No. 141, "Business Combinations" and SFAS No. 142,
"Goodwill and Other Intangible Assets". In addition, SFAS No. 147 amends SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", to
include in its scope long-term customer relationship intangible assets of
financial institutions such as credit cardholder intangible assets. SFAS
applies to acquisitions completed on or after October 1, 2002. The adoption of
SFAS No. 147 is not expected to have a significant impact on the Company's
financial position or results of operations.
In November 2002, the Financial Accounting Standards Board issued Interpretation
No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others," to clarify
accounting and disclosure requirements relating to a guarantor's issuance of
certain types of guarantees. FIN 45 requires entities to disclose additional
information about certain guarantees, or groups of similar guarantees, even if
the likelihood of the guarantor's having to make any payments under the
guarantee is remote. The disclosure provisions are effective for financial
statements for fiscal years ended after December 15, 2002. For certain
guarantees, the interpretation also requires that guarantors recognize a
liability equal to the fair value of the guarantee upon its issuance. This
initial recognition and measurement provision is to be applied only on a
prospective basis to guarantees issued or modified after December 31, 2002.
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock Based
Compensation -Transition and Disclosure-an amendment of FASB No.123" This
Statement amends SFAS No.123 "Accounting for Stock-Based Compensation" to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, the Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based compensation and the effect of
the method used on reported results. This Statement is effective for fiscal
years beginning after December 15, 2002. The Company plans to continue to
account for stock-based employee compensation under the intrinsic value based
method and to provide disclosure of the impact of the fair value based method on
reported income. Employee stock options have characteristics that are
significantly different from those of traded options, including vesting
provisions and trading limitations that impact their liquidity. Therefore, the
existing option pricing models, such as Black-Scholes, do not necessarily
provide a reliable measure of the fair value of employee stock options. Refer
to Note 10 of the Notes to Consolidated Financial Statements for proforma
disclosure of the impact of stock options utilizing the Black-Scholes valuation
method
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's primary market risk is interest rate risk ("IRR"). To minimize
the volatility of net interest earnings at risk ("NIE") and the impact on
economic value of equity ("EVE"), the Company manages its exposure to changes in
interest rates through asset and liability management activities within
guidelines established by its Asset Liability Committee ("ALCO") and approved by
the Board of Directors. ALCO has the responsibility for approving and ensuring
compliance with asset/liability management policies, including IRR exposure.
To mitigate the impact of changes in interest rates on the Company's
interest-earning assets and interest-bearing liabilities, the Company actively
manages the amounts and maturities. We generally retain short-term,
adjustable-rate assets as they have similar re-pricing characteristics as our
funding sources. The Company sells mortgage products and a portion of its SBA
loan originations. While the Company has some interest rate exposure in excess
of five years, it has internal policy limits designed to minimize risk should
interest rates rise. Currently, the Company does not use derivative instruments
to help manage risk, but will consider such instruments in the future if the
perceived need should arise.
To analyze IRR for NIE and EVE, the Company uses on a quarterly basis, computer
modeling to forecast/simulate the effects of both higher and lower interest
rates. The model develops a 12-month forecast of earnings and the current
economic value of assets, liabilities and equity are determined given an
assumption of flat interest rates. For purposes of an "up" rate shock
simulation, an assumption is made that market interest rates will be higher than
the forecast by 200 basis points for all points on the yield curve. And for
purposes of a "down" rate shock simulation, an assumption is made that the
market interest rates will be lower than forecast by 200 basis points for all
points on the yield curve.
50
DECEMBER 31,
--------------
RATES UP 200 BASIS POINTS 2002 2001
------ ------
Net interest earnings at risk (NIE) 5.5% 5.4%
Equity value at risk (% of EVE) (2.8%) (7.4%)
RATES DOWN 200 BASIS POINTS
Net interest earnings at risk (NIE) (3.4%) (4.7%)
Equity value at risk (% of EVE) 2.2% (1.8%)
The above table illustrates that the Company has effectively managed its IRR
during both years presented. For September 30, 2002, the latest period for
which comparisons are available, the Company's up and down 200 basis points'
scenarios for NIE and EVE are less (meaning less measured interest rate risk)
than the average for peer banks (in the $300 million to $500 million range).
Also see further discussion of interest rate risk in Item 7.
51
Report of Independent Auditors
The Board of Directors and Stockholders
Community West Bancshares:
We have audited the consolidated balance sheet of Community West Bancshares and
subsidiaries as of December 31, 2002, and the related consolidated statements of
income, shareholders' equity, and cash flows for the year then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Community West
Bancshares and subsidiaries at December 31, 2002, and the consolidated results
of their operations and their cash flows for the year then ended in conformity
with accounting principles generally accepted in the United States.
/s/Ernst & Young LLP
Los Angeles, California
February 26, 2003
F-1
THE FOLLOWING REPORT IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN
LLP AND HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Community West Bancshares:
We have audited the accompanying consolidated balance sheets of Community West
Bancshares and subsidiaries (the "Company") as of December 31, 2001 and 2000,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Community West Bancshares and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
Arthur Andersen LLP /s/
Los Angeles, California
March 8, 2002
F-2
COMMUNITY WEST BANCSHARES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------
2002 2001
-------- --------
(DOLLARS IN
THOUSANDS)
ASSETS
Cash and due from banks $ 10,714 $ 9,806
Federal funds sold 20,380 19,600
-------- --------
Cash and cash equivalents 31,094 29,406
Time deposits in other financial institutions 2,277 5,938
Federal Reserve Bank stock, at cost 812 775
Investment securities held-to-maturity, at amortized cost;
fair value of $6,071 in 2002 and $118 in 2001 6,012 118
Interest only strips, at fair value 4,548 7,693
Loans:
Loans held for sale, at lower of cost or fair value 43,284 30,849
Loans held for investment, net of allowance for loan losses
of $3,379 in 2002 and $4,086 in 2001 138,948 125,711
Securitized loans, net of allowance for loan losses of $2,571 in 2002 and
$4,189 in 2001 63,624 104,395
-------- --------
Total loans 245,856 260,955
Servicing assets 1,897 2,490
Other real estate owned, net 571 266
Premises and equipment, net 1,959 2,726
Other assets 12,184 13,496
-------- --------
TOTAL ASSETS $307,210 $323,863
======== ========
LIABILITIES
Deposits:
Noninterest-bearing demand $ 39,698 $ 33,312
Interest-bearing demand 35,169 22,518
Savings 11,377 14,372
Time certificates of $100,000 or more 25,325 67,397
Other time certificates 107,514 58,567
-------- --------
Total deposits 219,083 196,166
Bonds payable in connection with securitized loans 50,473 89,351
Other liabilities 5,567 4,989
-------- --------
Total liabilities 275,123 290,506
-------- --------
Commitments and contingencies-See Note 15
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized;
5,690,224 shares issued and outstanding 29,798 29,798
Retained earnings 2,289 3,559
-------- --------
Total stockholders' equity 32,087 33,357
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $307,210 $323,863
======== ========
See accompanying notes.
F-3
COMMUNITY WEST BANCSHARES
CONSOLIDATED INCOME STATEMENT
YEAR ENDED DECEMBER 31,
---------------------------
2002 2001 2000
-------- -------- -------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
INTEREST INCOME
Loans $29,306 $39,258 $49,848
Federal funds sold 364 1,095 1,405
Time deposits in other financial institutions 104 172 113
Investment securities 202 269 498
-------- -------- -------
Total interest income 29,976 40,794 51,864
-------- -------- -------
INTEREST EXPENSE
Deposits 5,545 9,460 11,334
Bonds payable and other borrowings 7,921 10,878 15,003
-------- -------- -------
Total interest expense 13,466 20,338 26,337
-------- -------- -------
NET INTEREST INCOME 16,510 20,456 25,527
Provision for loan losses 4,899 11,880 6,794
-------- -------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 11,611 8,576 18,733
NON-INTEREST INCOME
Gains from loan sales, net 4,788 6,616 7,491
Other loan fees - sold or brokered loans 3,388 3,432 1,826
Document processing fees 1,404 1,978 1,220
Loan servicing fees, net 1,081 1,703 2,790
Service charges 440 575 559
Income from sale of interest in subsidiary - 96 2,080
Proceeds from legal settlement - 7,000 -
Other income 297 771 515
-------- -------- -------
Total non-interest income 11,398 22,171 16,481
-------- -------- -------
NON-INTEREST EXPENSES
Salaries and employee benefits 13,596 17,704 15,241
Occupancy expenses 2,119 2,311 2,402
Impairment of SBA interest only strips and servicing assets 1,788 - -
Professional services 1,575 2,238 949
Lower of cost or market provision on loans held for sale 1,381 - -
Loan servicing and collection 872 1,338 2,689
Depreciation 771 1,419 1,517
Advertising 478 661 706
Postage and freight 359 402 295
Office supplies 217 425 437
Data processing/ATM processing 136 279 345
Amortization of intangible assets - 178 404
Impairment of goodwill - - 2,110
Professional expenses associated with legal settlement - 2,392 -
Other operating expenses 1,639 2,659 2,883
-------- -------- -------
Total non-interest expenses 24,931 32,006 29,978
-------- -------- -------
Income (loss) before provision (benefit) for income taxes (1,922) (1,259) 5,236
Provision (benefit) for income taxes (652) (1,281) 2,539
-------- -------- -------
NET INCOME (LOSS) $(1,270) $ 22 $ 2,697
======== ======== =======
INCOME (LOSS) PER SHARE - BASIC $ (0.22) $ 0.00 $ 0.44
INCOME (LOSS) PER SHARE - DILUTED $ (0.22) $ 0.00 $ 0.43
See accompanying notes.
F-4
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
ACCUMULATED
OTHER TOTAL
COMMON STOCK RETAINED COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE
SHARES AMOUNT EARNINGS INCOME (LOSS) EQUITY INCOME (LOSS)
------- -------- ---------- --------------- -------------- ---------------
(IN THOUSANDS)
BALANCES AT JANUARY 1, 2000 6,104 $32,492 $ 1,495 $ (55) $ 33,932
Exercise of stock options 3 26 - - 26
Cash dividends paid ($0.04 per share) - - (246) - (246)
Effect of unconsolidation of sold subsidiary - - (409) - (409)
Comprehensive income:
Net income - - 2,697 - 2,697 $ 2,697
Other comprehensive income - - - 34 34 34
-------------------------------------------------------------------------------
BALANCES AT DECEMBER 31, 2000 6,107 32,518 3,537 (21) 36,034 $ 2,732
===============
Exercise of stock options 34 115 - - 115
Stock repurchase (451) (2,835) - - (2,835)
Comprehensive income:
Net income - - 22 - 22 $ 22
Other comprehensive income - - - 21 21 21
-------------------------------------------------------------------------------
BALANCES AT DECEMBER 31, 2001 5,690 29,798 3,559 - 33,357 $ 43
===============
Comprehensive income:
Net loss - - (1,270) - (1,270) $ (1,270)
-------------------------------------------------------------------------------
BALANCES AT DECEMBER 31, 2002 5,690 $29,798 $ 2,289 $ - $ 32,087 $ (1,270)
===============================================================================
See accompanying notes.
F-5
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
--------- --------- ----------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (1,270) $ 22 $ 2,697
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Provision for loan losses 4,899 11,880 6,794
Provision for losses on real estate owned 86 50 85
Losses on sale of premises and equipment 132 - (17)
Deferred income taxes 1,219 605 1,544
Depreciation and amortization 3,031 1,419 1,290
Amortization of goodwill - 178 404
Impairment of goodwill - - 2,110
Gains on:
Sale of other real estate owned (14) (42) (27)
Sale of subsidiary - (96) -
Disposal of servicing asset - - (187)
Sale of available-for-sale securities - (21) -
Sale of loans held for sale (4,788) (6,616) (7,491)
Changes in:
Fair value of interest only strips 3,385 2,694 1,228
Servicing assets, net of amortization and valuation adjustments 593 116 (250)
Other assets 108 1,451 (2,059)
Other liabilities 726 537 2,308
--------- --------- ----------
Net cash provided by operating activities 8,107 12,177 8,429
--------- --------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities (11,904) (118) (1,903)
Purchase of available-for-sale securities - - (1,015)
Purchase of Federal Reserve Bank stock (37) - (474)
Proceeds from sale of servicing asset - - 335
Proceeds from sale of subsidiary - - 775
Principal paydowns and maturities of available-for-sale securities - 4,820 1,114
Principal paydowns and maturites of held-to-maturity securities 6,010 1,901 498
Redemption of FHLB stock - 395 109
FHLB stock dividend - - (30)
Additions to interest only strip assets (240) (2,846) (3,933)
Loan originations and principal collections, net 14,049 62,505 122,645
Proceeds from sale of other real estate owned 399 492 513
Net decrease (increase) in time deposits in other financial institutions 3,661 (4,356) (1,582)
Purchase of premises and equipment, net of sales (136) (76) (1,388)
--------- --------- ----------
Net cash provided by investing activities 11,802 62,717 115,664
--------- --------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand deposits and savings accounts 16,043 (17,172) 15,152
Net increase (decrease) in time certificates of deposit 6,874 (15,382) (99,645)
Repayments of bonds payable in connection with securitized loans (41,138) (41,404) (36,577)
Repayment of other borrowings - (5,293) (2,014)
Repurchase of outstanding shares - (2,835) -
Proceeds from exercise of stock options - 115 26
Effect of unconsolidation of sold subsidiary - - (409)
Cash dividends paid - - (246)
--------- --------- ----------
Net cash (used in) financing activities (18,221) (81,971) (123,713)
--------- --------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,688 (7,078) 381
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 29,406 36,484 36,103
--------- --------- ----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 31,094 $ 29,406 $ 36,484
========= ========= ==========
<FN>
See accompanying notes.
F-6
COMMUNITY WEST BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Community West Bancshares, a California
Corporation ("Company or CWBC"), and its wholly-owned subsidiary, Goleta
National Bank ("Goleta" or "Bank"), are in accordance with accounting principles
generally accepted in the United States of America ("GAAP") and general
practices within the financial services industry. All material intercompany
transactions and accounts have been eliminated. The following are descriptions
of the most significant of those policies:
NATURE OF OPERATIONS - The Company's primary operations are related to
commercial banking and financial services through Goleta which include the
acceptance of deposits and the lending and investing of money. The Company also
engages in electronic banking services. The Company's customers consist of
small to mid-sized businesses, as well as individuals. The Company also
originates and sells U. S. Small Business Administration ("SBA") and first and
second mortgage loans through its normal operations and loan production offices.
BUSINESS COMBINATIONS AND DISPOSITIONS - On December 14, 1998, the Company
acquired Palomar Community Bank (then known as Palomar Savings and Loan)
("Palomar") by issuing 1,367,542 common shares of Company stock. The
acquisition was accounted for under the purchase method of accounting. The
amount paid in excess of the fair value of the net tangible and intangible
assets acquired, approximately $6.2 million, was recorded as goodwill and was
amortized on a straight-line basis over 20 years. In 2000, the Company entered
into a firm commitment with Centennial First Financial Services to sell Palomar.
In connection therewith, the remaining unamortized goodwill was assessed for
impairment resulting in a charge of $2.1 million. On August 17, 2001, the sale
of Palomar Community Bank to Centennial First Financial Services was consummated
for $10.5 million resulting in a gain of $96,000.
On October 16, 1997, the Company purchased a 70% interest in Electronic
Paycheck, LLC, a California limited liability company that is a provider of
customized debit card payment systems and electronic funds transfer services. On
March 30, 2000, ePacific.com redeemed 1,800,000 of the Company's 2,100,000
shares and repaid a loan from the Company with a balance of $3,725,000 for
$4,500,000 in cash. As a result, the Company reversed previously consolidated
losses in 2000 and reflected the remaining investment at cost, which was zero.
On October 28, 2002, the Company sold its remaining 300,000 shares of stock to
ACE Cash Express Incorporated ("ACE") for $15,000.
INVESTMENT SECURITIES - The Company purchases securities with funds not needed
for immediate liquidity or lending purposes. These debt securities are
classified as held-to-maturity as the Company has the positive intent and
ability to hold them to maturity. Securities held to maturity are accounted for
at amortized cost. Those debt securities to be held for indefinite periods of
time, usually not to maturity, are classified as available-for-sale and carried
at fair value with unrealized gains or losses reported as a separate component
of accumulated other comprehensive income (loss), net of any applicable income
taxes. Realized gains or losses on the sale of securities available-for-sale,
if any, are determined on a specific identification basis. Purchase premiums
and discounts are recognized in interest income using the effective interest
method over the terms of the related securities, or to earlier call dates, if
appropriate. Declines in the fair value of available-for-sale or
held-to-maturity securities below their cost that are deemed to be other than
temporary, if any, are reflected in earnings as realized losses. There is no
recognition of unrealized gains or losses for securities classified as
held-to-maturity. The Company held no debt securities as available-for-sale at
December 31, 2002 or 2001.
INTEREST ONLY STRIPS AND SERVICING ASSETS - The Company originates certain loans
for the purpose of selling either a portion of, or the entire loan, into the
secondary market. FHA Title 1 loans and the guaranteed portion of certain SBA
loans are sold into the secondary market. Servicing assets are recognized as
separate assets when loans are sold with servicing retained. Servicing assets
are amortized in proportion to, and over the period of, estimated future net
servicing income. Also, at the time of the loan sale, it is the Company's
policy to recognize the related gain on the loan sale in accordance with
generally accepted accounting principles. The Company uses industry prepayment
statistics and its own prepayment experience in estimating the expected life of
the loans. Management periodically evaluates servicing assets for impairment.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost on a loan by loan basis. Fair value is
determined using discounted future cash flows calculated on a loan by loan basis
and aggregated to the total asset level. Impairment to the asset is recorded if
the aggregate fair value calculation drops below net book value of the asset.
F-7
Additionally, on some SBA loan sales, the Company has retained interest only
("I/O Strips"), which represent the present value of excess net cash flows
generated by the difference between (a) interest at the stated rate paid by
borrowers and (b) the sum of (i) pass-through interest paid to third-party
investors and (ii) contractual servicing fees. Prior to April 1, 2002, the
Company determined the present value of this estimated cash flow at the time
each loan sale transaction closed, utilizing valuation assumptions as to
discount rate, prepayment rate and default rate appropriate for each particular
transaction. For loans sold after March 31, 2002, the initial servicing assets
and resulting gain on sale were calculated based on the difference between the
best actual par and premium bids on an individual loan basis. This same
methodology would apply to the initial valuation of any new I/O strip assets.
As the Company did not sell any loans for par after March 31, 2002 there were no
additions to the I/O strips using the new assumptions. Periodically, the Company
verifies the reasonableness of its valuation estimates by comparison to the
results of an independent third party valuation analysis.
The I/O strips are classified as trading securities. Accordingly, the Company
records the I/O's strips at fair value with the resulting increase or decrease
in fair value being recorded through operations in the current period. For the
years ended December 31, 2002, 2001 and 2000, net decreases in fair value of
$3,385,000, $2,694,000 and $858,000, respectively, are included in the income
statement as reductions to loan servicing income.
LOANS HELD FOR SALE - Loans which are originated and intended for sale in the
secondary market are carried at the lower of cost or estimated fair value
determined on an aggregate basis. Valuation adjustments, if any, are recognized
through a valuation allowance by charges to lower of cost or market provision.
The Company does not utilize any specific hedging instruments to minimize
exposure to fluctuations in the market price of loans and interest rates with
regard to loans held for sale in the secondary mortgage market. Loans held for
sale are primarily comprised of SBA loans, second mortgage loans and residential
mortgage loans. For the year ended December 31, 2002 the Company had a lower of
cost or market provision of $1,381,000. The Company did not incurr a lower of
cost or market provision in the years ended December 31, 2001 and 2000.
LOANS HELD FOR INVESTMENT - Loans are carried at amounts advanced to the
borrowers less the payments collected. Interest on loans is accrued daily on a
simple-interest basis. The accrual of interest is discontinued when substantial
doubt exists as to collectibility of the loan, generally at the time the loan is
90 days delinquent, unless the credit is well secured and in process of
collection. Any unpaid but accrued interest is reversed at that time.
Thereafter, interest income is no longer recognized on the loan. Interest on
non-accrual loans is accounted for on the cash-basis or cost-recovery method,
until qualifying for return to accrual. Loans are returned to accrual status
when all of the principal and interest amounts contractually due are brought
current and future payments are reasonably assured. Impaired loans are
identified as impaired when it is probable that interest and principal will not
be collected according to the contractual terms of the loan agreement. All of
the Company's nonaccrual loans were also classified as impaired at December 31,
2002 and 2001.
SECURITIZED LOANS AND BONDS PAYABLE - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
trusts ("Trusts"). The transfers have been accounted for as secured borrowings
and, accordingly, the mortgage loans and related bonds issued are included in
the Company's Balance Sheet. Such loans are accounted for in the same manner as
loans held to maturity. Deferred debt issuance costs and bond discount related
to the bonds are amortized on a method which approximates the level yield method
over the estimated life of the bonds.
LOAN FEES AND COSTS - Loan origination fees, certain direct origination costs
and purchase premiums and discounts are deferred and recognized as an adjustment
to the loan yield over the life of the loan using the level-yield method.
PROVISION AND ALLOWANCE FOR LOAN LOSSES - The Company maintains a detailed,
systematic analysis and procedural discipline to determine the amount of the
allowance for loan losses ("ALL"). The ALL is based on estimates and is
intended to be adequate to provide for probable losses inherent in the loan
portfolio. This process involves deriving probable loss estimates that are
based on individual loan loss estimation, migration analysis/historical loss
rates and management's judgment.
The Company employs several methodologies for estimating probable losses.
Methodologies are determined based on a number of factors, including type of
asset, credit score, concentrations, collateral value and the input of the
Special Assets group, functioning as a workout unit.
The ALL calculation for the different major loan types is as follows:
- SBA - All loans are reviewed and classified loans are assigned a
---
specific allowance. Those not assigned to a "watch list" category are
classified as "pass". A migration analysis is then used to calculate
the required allowance on those pass loans.
F-8
- Relationship Banking - Includes commercial and real estate mortgage
---------------------
loans originated by the branch locations. Classified loans are
assigned a specific allowance. A migration analysis is then used to
calculate the required allowance on the remaining pass loans.
- Short-term Consumer Loans - Classified as a homogeneous portfolio and
--------------------------
the allowance calculated based on past due statistics and past
charge-off history.
- Manufactured Housing - An allowance is calculated based on a review of
--------------------
delinquency statistics.
- Securitized Loans - The Company considers this a homogeneous
------------------
portfolio, and calculates the allowance based on statistical
information provided by the servicer. Charge-off history is calculated
based on 3 methodologies; a 3-month and a 12-month historical trend
and by delinquency information. The highest requirement of the 3
methods is used.
OTHER REAL ESTATE OWNED - Other real estate owned ("OREO") is real estate
acquired through foreclosure on the collateral property and is recorded at fair
value at the time of foreclosure less estimated costs to sell. Any excess of
loan balance over the fair value of the OREO is charged-off against the
allowance for loan losses. Subsequent to foreclosure, management periodically
performs new valuations and assets are carried at the lower of carrying amount
or fair value. Operating expenses or income, and gains or losses on disposition
of such properties, are charged to current operations.
PREMISES AND EQUIPMENT - Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the terms of the leases or the estimated useful
lives of the improvements, whichever is shorter. Generally, the estimated
useful lives of other items of premises and equipment are as follows:
Building and Improvements 31.5 years
Furniture and Equipment 5 - 7 years
Electronic equipment and software 2 - 3 years
INCOME TAXES - Deferred income taxes are recognized for the tax effect of
differences between the tax basis of assets and liabilities and their financial
reporting amounts at each year-end based on enacted tax laws and statutory tax
rates applicable to the periods in which the differences are expected to affect
taxable income. A valuation allowance is established for deferred tax assets
if, based on weight of available evidence, it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
INCOME (LOSS) PER SHARE - Basic income (loss) per share is computed based on the
weighted average number of shares outstanding during each year divided into net
income (loss). Diluted income (loss) per share is computed based on the
weighted average number of shares outstanding during each year plus the dilutive
effect, if any, of outstanding options divided into net income.
STOCK-BASED COMPENSATION- GAAP permits the Company to use either of two
methodologies to account for compensation cost in connection with employee stock
options. The first method requires issuers to record compensation expense over
the period the options are expected to be outstanding prior to exercise,
expiration or cancellation. The amount of compensation expense to be recognized
over this term is the "fair value" of the options at the time of the grant as
determined by the Black-Scholes valuation model. The Black-Scholes model
computes fair value of the options based on the length of their term, the
volatility of the stock price in past periods and other factors. Under this
method, the issuer recognizes compensation expense regardless of whether the
employee eventually exercises the options.
Under the second methodology, if options are granted at an exercise price equal
to the market value of the stock at the time of the grant, no compensation
expense is recognized. The Company believes that this method better reflects
the motivation for its issuance of stock options, as they are intended as
incentives for future performance rather than compensation for past performance.
GAAP requires that issuers electing the second method must present pro forma
disclosure of net income and earnings per share as if the first method had been
elected. The Company presents these disclosures in Note 10.
F-9
STATEMENT OF CASH FLOWS- For purposes of reporting cash flows, cash and cash
equivalents include cash, due from banks and Federal funds sold. Federal funds
sold are one-day transactions with the Company's funds being returned the
following business day.
RESERVE REQUIREMENTS - All depository institutions are required by law to
maintain reserves on transaction accounts and non-personal time deposits in the
form of cash balances at the Federal Reserve Bank. These reserve requirements
can be offset by cash balances held at the Bank. At December 31, 2002 and 2001,
the Bank's cash balance was sufficient to offset the Federal Reserve
requirement.
USE OF ESTIMATES -. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities as well as disclosures of contingent assets and
liabilities at the date of the financial statements. These estimates and
assumptions also affect the reported amounts of revenues and expenses during the
reporting period. Although management believes these estimates to be reasonably
accurate, actual results may differ.
Certain amounts in the accompanying financial statements for 2001 and 2000
statements have been reclassified to be comparable with classifications in the
2002 financial statements.
NEW ACCOUNTING PRONOUNCEMENTS - The Financial Accounting Standards Board
("FASB") finalized accounting standards covering business combinations, goodwill
and intangible assets. These new rules published in July 2001, consist of SFAS
No. 141, "Business Combinations" ("SFAS No. 141") and No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No.142"). In conjunction with these new
accounting standards, the FASB issued "Transition Provisions for New Business
Combination Accounting Rules" that required companies to cease amortization of
goodwill and adopt the new impairment approach as of January 1, 2002. The
adoption of SFAS Nos. 141 and 142 did not have a material effect on the Bank's
financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS No. 144") which supersedes SFAS No. 121.
SFAS No. 144, which governs accounting for the impairment of long-lived assets,
is effective for financial statements issued for fiscal years beginning after
December 15, 2002. The adoption of SFAS No. 144 is not expected to have a
significant impact on the Company's financial position or results of operations.
In June 2002, the FASB issued SFAS No.146, "Accounting for Costs Associated with
Exit or Disposal Activities" ("SFAS No. 146") which nullifies Emerging Task
Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)" (Issue 94-3"). This statement requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred and is effective for exit and disposal
activities after December 31, 2002. Under Issue 94-3, a liability for exit cost
as defined in Issue 94-3 was recognized at the date of the entity's commitment
to an exit plan. The FASB has concluded that an entity's commitment to a plan,
by itself, does not create a present obligation to others that meet the
definition of a liability. Therefore, this Statement eliminates the definition
and requirements for recognition of exit costs in Issue 94-3. This Statement
also establishes that fair value is the objective for initial measurement of the
liability. The Company did not elect to early adopt SFAS No. 146. The Company
recognized $650,000 of costs related to exit and disposal activities in 2002.
At December 31, 2002, the Company had $405,000 in accrued liabilities related to
its exit and disposal activities all of which relate to liabilities that had
been incurred at December 31, 2002. Accordingly, the adoption of SFAS No. 146
is not expected to have a significant impact on the Company's financial position
or results of operations.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions" ("SFAS No. 147") which amends statements SFAS No. 72,
"Accounting for Certain Acquisitions of Banking or Thrift Institutions" and SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
No. 144"). This Statement removes acquisitions of financial institutions from
the scope of both Statement 72 and Interpretation 9 and requires those
transactions be accounted for in accordance with SFAS No. 141, and SFAS No. 142.
In addition, SFAS No. 147 amends SFAS No. 144, to include in its scope long-term
customer relationship intangible assets of financial institutions such as credit
cardholder intangible assets. SFAS applies to acquisitions completed on or
after October 1, 2002. The adoption of SFAS No. 147 is not expected to have a
significant impact on the Company's financial position or results of operations.
In November 2002, the Financial Accounting Standards Board issued Interpretation
No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others," ("FIN 45") to clarify
F-10
accounting and disclosure requirements relating to a guarantor's issuance of
certain types of guarantees. FIN 45 requires entities to disclose additional
information about certain guarantees, or groups of similar guarantees, even if
the likelihood of the guarantor's having to make any payments under the
guarantee is remote. The disclosure provisions are effective for financial
statements for fiscal years ended after December 15, 2002. For certain
guarantees, the interpretation also requires that guarantors recognize a
liability equal to the fair value of the guarantee upon its issuance. This
initial recognition and measurement provision is to be applied only on a
prospective basis to guarantees issued or modified after December 31, 2002. The
adoption of FIN 45 is not expected to have a significant impact on the Company's
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock Based
Compensation -Transition and Disclosure-an amendment of FASB No.123" This
Statement amends SFAS No.123 "Accounting for Stock-Based Compensation" ("SFAS
No. 123") to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, the Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based compensation and the effect of
the method used on reported results. This Statement is effective for fiscal
years beginning after December 15, 2002. The Company plans to continue to
account for stock-based employee compensation under APB 25 to provide disclosure
of the impact of the fair value based method on reported income. Employee stock
options have characteristics that are significantly different from those of
traded options, including vesting provisions and trading limitations that impact
their liquidity. Therefore, the existing option pricing models, such as
Black-Scholes, do not necessarily provide a reliable measure of the fair value
of employee stock options. Refer to Note 10 of the Notes to Consolidated
Financial Statements for proforma disclosure of the impact of stock options
utilizing the Black-Scholes valuation method.
2. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities is as
follows:
DECEMBER 31, 2002
--------------------------------------------
(IN THOUSANDS)
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
Held-to-maturity securities COST GAINS LOSSES VALUE
- ---------------------------- ---------- ----------- ----------- ------
U.S. treasury and agency $ 6,012 $ 59 $ - $6,071
========== =========== =========== ======
DECEMBER 31, 2001
--------------------------------------------
(IN THOUSANDS)
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
Held-to-maturity securities COST GAINS LOSSES VALUE
- ---------------------------- ---------- ----------- ----------- ------
Mortgaged-backed securities $ 118 - - $ 118
---------- ----------- ----------- ------
$ 118 - - $ 118
========== =========== =========== ======
At December 31, 2002, $205,000 of the above securities was pledged as collateral
to the U.S. Treasury for its treasury, tax and loan account.
3. LOAN SALES AND SERVICING
SBA Loan Sales
- ----------------
The Company sells the guaranteed portion of SBA loans into the secondary market,
on a servicing retained basis, in exchange for a combination of a cash premium,
servicing assets and/or I/O strips. The Company retains the non-guaranteed
portion of these loans and services the loans as required under the SBA programs
to retain specified yield amounts. A portion of the yield is recognized as
servicing fee incoume as it occurs and the remainder is capitalized as excess
servicing and is included in the gain on sale calculation. The fair value of
the I/O strips and servicing assets prior to April 1, 2002 was determined using
a 9.25%-10.25% discount rate based on the term of the underlying loan instrument
and a 13.44% prepayment rate. For loans sold after March 31, 2002, the initial
values of the servicing assets and resulting gain on sale were calculated based
on the difference between the best actual par and premium bids received for each
individual loan. The balance of all servicing assets are subsequently amortized
over the estimated life of the loans using an estimated prepayment rate of
22-25%. Quarterly, the servicing asset and I/O strip assets are analyzed for
F-11
impairment. At December 31, 2002 and 2001, the Company had recognized
impairment charges of $1.8 million and $0 respectively. At December 31, 2001
$317,000 of the $2.5 million in servicing assets consisted of servicing assets
related to FHA Title I loans. At December 31, 2002, all of the servicing assets
are related to SBA loan sales. As of December 31, 2002 and 2001, the Company
had $26.2 million and $10.5 million respectively, in SBA loans held for sale.
The following is a summary of activity in I/O Strips:
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
-------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $ 7,693 $ 7,541 $ 4,836
Additions through loan sales 240 2,846 3,933
Valuation adjustment (3,385) (2,694) (1,228)
-------- -------- --------
Balance, end of year $ 4,548 $ 7,693 $ 7,541
======== ======== ========
The following is a summary of activity in Servicing Assets:
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
-------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $ 2,489 $ 2,605 $ 2,503
Additions through loan sales 597 689 854
Reductions, sale of servicing assets - - (148)
Amortization (426) (197) (582)
Valuation adjustment (763) (607) (22)
-------- -------- --------
Balance, end of year $ 1,897 $ 2,490 $ 2,605
======== ======== ========
The principal balance of loans serviced for others at December 31, 2002, 2001
and 2000 totaled $170,966,000, $288,232,000 and $136,420,000, respectively.
4. LOANS HELD FOR INVESTMENT
The composition of the Company's loans held for investment portfolio, excluding
securitized loans:
DECEMBER 31,
-------------------
2002 2001
--------- --------
(IN THOUSANDS)
Installment $ 30,971 $ 28,893
Commercial 26,256 25,775
Real estate 51,666 43,932
Unguaranteed portion of SBA Loans 34,073 32,525
--------- --------
142,966 131,125
Less:
Allowance for loan losses 3,379 4,086
Deferred fees, net of costs (318) 223
Discount on SBA loans 957 1,105
--------- --------
Loans held for investment, net $138,948 $125,711
========= ========
F-12
An analysis of the allowance for loan losses for loans held for investment is as
follows:
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
-------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $ 4,086 $ 2,704 $ 2,013
Provision for loan losses 3,071 7,754 2,595
Loans charged off (5,637) (6,222) (2,074)
Recoveries on loans previously charged off 1,859 612 170
Transfers and reductions due to sale of Palomar, net - (762) -
-------- -------- --------
Balance, end of year $ 3,379 $ 4,086 $ 2,704
======== ======== ========
The recorded investment in loans that are
considered to be impaired:
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
-------- -------- --------
(IN THOUSANDS)
Impaired loans without specific valuation allowances $ - $ - $ 565
Impaired loans with specific valuation allowances 8,394 6,587 3,531
Specific valuation allowance related to impaired loans (1,278) (1,669) (1,207)
-------- -------- --------
Impaired loans, net $ 7,116 $ 4,918 $ 2,889
======== ======== ========
Average investment in impaired loans $ 7,565 $ 5,047 $ 4,677
======== ======== ========
Non-accrual loans (including SBA guaranteed loans) $13,965 $11,413 $ 2,095
======== ======== ========
Troubled debt restructured loans, gross $ 829 $ 1,093 $ 615
======== ======== ========
Loans 30 through 90 days past due with interest accruing $ 5,122 $ 2,607 $ 4,277
======== ======== ========
Interest income recognized on impaired loans $ 190 $ 1,443 $ 387
Interest foregone on non-accrual loans and troubled debt restructured
loans outstanding 1,263 1,146 592
-------- -------- --------
Gross interest income on impaired loans $ 1,453 $ 2,589 $ 979
======== ======== ========
The Company makes loans to borrowers in a number of different industries. Other
than Manufactured Housing, no single industry comprises 10% or more of the
Company's loan portfolio. Commercial Real Estate Loans and SBA loans
individually comprise over 10% of the bank's loan portfolio at December 31,
2002, but consist of diverse borrowers. Although the Company does not have
significant concentrations in its loan portfolio, the ability of the Company's
customers to honor their loan agreements is dependent upon, among other things,
the general economy of the Company's market area.
5. SECURITIZED LOANS
The Company originated and purchased second mortgage loans that allowed
borrowers to borrow up to 125% of their home's appraised value, when combined
with the balance of the first mortgage loan, up to a maximum loan of $100,000.
In 1998 and 1999, the Company transferred $81 million and $122 million,
respectively, of these loans to two special purpose trusts. These loans were
both originated and purchased by the Company. The trusts, then sold bonds to
third party investors which were secured by the transferred loans. The loans and
bonds are held in the trusts independent of the Company, the trustee of which
oversees the distributions to the bondholders. The mortgage loans are serviced
by a third party ("Servicer"), who receives a stated servicing fee. There is an
insurance policy on the bonds that guarantees the payment of the bonds.
The Company did not surrender effective control over the loans transferred at
the time of securitization. Accordingly, the securitizations are accounted for
as secured borrowings and both the loans and bonds in the trusts are
consolidated into the financial statements of the Company.
F-13
At December 31, 2002 and 2001, respectively, securitized loans are net of an
allowance for loan losses as set forth below, and include purchase premiums and
deferred fees/costs of $1,464,000 and $2,177,000.
An analysis of the allowance for loan losses for securitized loans is as
follows:
YEAR END DECEMBER 31,
----------------------------
2002 2001 2000
-------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $ 4,189 $ 4,042 $ 3,516
Provisions for loan losses 1,828 4,126 4,199
Loans charged off (4,012) (4,358) (3,674)
Recoveries on loans previously charged off 566 379 1
-------- -------- --------
Balance, end of year $ 2,571 $ 4,189 $ 4,042
======== ======== ========
6. PREMISES AND EQUIPMENT
DECEMBER 31,
------------------
2002 2001
-------- --------
(IN THOUSANDS)
Furniture, fixtures and equipment $ 6,846 $ 6,894
Building and land 784 782
Leasehold improvements 805 1,734
-------- --------
8,435 9,410
Less: accumulated depreciation and amortization (6,476) (6,684)
-------- --------
Premises and equipment, net $ 1,959 $ 2,726
======== ========
The Company leases office facilities under various operating lease agreements
with terms that expire at various dates between March 2003 and August 2007, plus
options to extend the lease terms for periods of up to ten years. The minimum
lease commitments as of December 31, 2002, under all operating lease agreements
are as follows:
YEAR ENDED DECEMBER 31,
(IN THOUSANDS)
2003 $ 731
2004 611
2005 604
2006 598
2007 569
---------------
Total $ 3,113
===============
Rent expense for the years ended December 31, 2002, 2001 and 2000, included in
occupancy expense was $951,000, $895,000 and $903,000, respectively.
7. EXIT AND DISPOSAL ACTIVITY
The Company recorded business exit related charges of $970,000 in 2002. The
Company determines exit related items and related accruals based in its
integration strategy and formulated plans. During 2002, the Company decided to
exit the High-Loan-To-Value Subprime Mortgage Lending origination and sale
activities, centralize the support functions of the SBA and its Conventional
Mortgage Lending Divisions into the Goleta, California headquarters and close
the related facilities. In addition, as part of the Consent Order with the OCC,
the Company withdrew from its short-term consumer loan program and discontinued
originating these loans as of December 31, 2002.
Severance and employee related charges include the cost of severance and other
employee benefits associated with the termination of employees primarily in the
subprime mortgage lending operations, short-term consumer lending and SBA
lending support functions. These costs recorded in 2002 were $274,000.
F-14
Asset write-downs and lease terminations represent lease termination costs and
impairment of assets for the office space vacated and equipment disposed of as
part of the restructuring plan. These costs are recognized in the accounting
period that the contract terminations occur or the asset became impaired and was
abandoned. The total costs attributable to the 2002 restructuring were
$369,000. Other exit related costs include; other asset write down of $227,000
and miscellaneous travel, postage, data processing, legal and accounting costs
associated with the short-term consumer lending division of $100,000. As of
December 31, 2002, $405,000, primarily relating to lease termination
obligations, remained as an accrued liability for exit and disposal activities.
8. DEPOSITS
At December 31, 2002, the scheduled maturities of time certificates of deposits
are as follows:
(IN THOUSANDS)
2003 $ 77,155
2004 53,905
2005 635
2006 -
2007 and thereafter 1,144
---------------
Total 132,839
===============
9. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
YEAR ENDED DECEMBER 31,
-----------------------------
2002 2001 2000
-------- --------- --------
(IN THOUSANDS)
Current:
Federal $(1,873) $ (1,385) $ 837
State 2 (501) 158
-------- --------- --------
(1,871) (1,886) 995
Deferred:
Federal 1,223 343 1,037
State (4) 262 507
-------- --------- --------
1,219 605 1,544
-------- --------- --------
Total provision (benefit) $ (652) $ (1,281) $ 2,539
======== ========= ========
The federal income tax provision (benefit) differs from the applicable statutory
rate as follows:
YEAR ENDED DECEMBER 31,
-----------------------------
2002 2001 2000
-------- --------- --------
Federal income tax at statutory rate (34.0)% (34.0)% 34.0%
State franchise tax, net of federal benefit (7.1)% (12.9)% 7.1%
Amortization and impairment of goodwill - 3.4% 19.2%
Taxable gain on sale of Palomar - 81.8% -
Capital recovery proceeds - (137.4)% -
Other 3.2% (2.7)% (11.8)%
Valuation allowance 4.0% - -
-------- --------- --------
(33.9)% (101.8)% 48.5%
======== ========= ========
As of December 31, 2002, the Company had available, for federal income tax
purposes, regular net operating loss carryforwards of approximately $541,000,
expiring in 2022. The Company has recognized that it is more likely than not
that future tax benefits related to the Company's state deferred tax assets will
not be realized and has established a valuation allowance in the current year
against these amounts.
F-15
Significant components of the Company's net deferred taxes as of December 31 are
as follows:
2002 2001
--------- --------
(IN THOUSANDS)
Deferred tax assets:
Allowance for loan losses $ 1,171 $ 1,485
Depreciation 471 436
State taxes 50 51
Net operating loss 482 -
Accrued professional fees 26 147
Other 274 530
--------- --------
2,474 2,649
--------- --------
Less: valuation allowance (486) -
--------- --------
1,988 2,649
--------- --------
Deferred tax liabilities:
Deferred loan fees (2,286) (1,226)
Investment in ePacific.com - (242)
Deferred loan costs (214) (278)
Other - (88)
--------- --------
(2,500) (1,834)
--------- --------
Net deferred taxes $( 512) $ 815
========= ========
At December 31, 2002, the net deferred tax liability is included in other
liabilities in the accompanying consolidated balance sheet. At December 31,
2001, the net deferred tax asset is included in other assets in the accompanying
consolidated balance sheet.
10. STOCKHOLDERS' EQUITY
Common Stock
- -------------
On December 28, 1998, the Board of Directors of the Company authorized a stock
buy-back plan. Under this plan, the Company is authorized to repurchase up to
$2,000,000 worth of the outstanding shares of the Company's common stock on the
open-market. As of December 31, 2001 and 2002, pursuant to this plan, the
Company had repurchased 138,937 shares at a cost of $1,240,148.
In addition during 2001, the Company repurchased 449,592 shares in a privately
negotiated transaction at a cost of $2,830,682.
Earnings per share-Calculation of Weighted Average Shares Outstanding
- ----------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
----------------------
2002 2001 2000
------ ------ ------
(IN THOUSANDS)
Basic weighted average shares outstanding 5,690 5,948 6,107
Dilutive effect of stock options - 50 126
------ ------ ------
Diluted weighted average shares outstanding 5,690 5,998 6,233
====== ====== ======
The incremental shares from assumed conversions of stock options on 13,674
shares in 2002 were excluded from the computations of diluted earnings per share
because the Company had a net loss at December 31, 2002, which makes them
anti-dilutive.
Stock Options
- --------------
Under the terms of the Company's stock option plan, full-time salaried employees
may be granted qualified stock options or incentive stock options and directors
may be granted nonqualified stock options. Options may be granted at a price not
less than 100% of the market value of the stock on the date of grant. Options
are generally exercisable in cumulative 20% installments. All options expire no
later than ten years from the date of grant. As of December 31, 2002, options
were outstanding at prices ranging from $3.00 to $14.875 per share with 208,992
options exercisable and 154,551 options available for future grant. As of
December 31, 2001, options were outstanding at prices ranging from $3.00 to
$16.875 per share with 282,824 options exercisable and 214,291 options available
for future grant. As of December 31, 2002, the average life of the outstanding
options was approximately 7.3 years. Stock option activity is as follows:
F-16
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
2002 2001 2000
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
2002 EXERCISE 2001 EXERCISE 2000 EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- --------- --------- --------- -------- ---------
Options outstanding, January 1, 432,624 $ 6.31 392,196 $ 7.35 269,027 $ 8.48
Granted 88,128 4.60 186,228 1.08 167,800 6.13
Canceled (169,900) 5.77 (111,700) 8.03 (41,771) 9.88
Exercised - - (34,100) 3.36 (2,860) 4.56
--------- --------- --------- --------- -------- ---------
Options outstanding, December 31, 350,852 $ 6.30 432,624 $ 6.31 392,196 $ 7.35
========= ========= ========= ========= ======== =========
Options exercisable, December 31, 208,992 $ 6.49 282,824 $ 5.81 158,796 $ 7.15
========= ========= ========= ========= ======== =========
The grant date estimated fair value of options was $2.90 per share in 2002,
$4.67 per share in 2001, and $6.13 per share in 2000. The Company applies
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its stock option plan. Accordingly, no compensation cost has
been recognized for its stock option plan. Had compensation cost for the
Company's stock option plan been determined based on the fair value at the grant
dates for awards under the plan consistent with the method prescribed by SFAS
No. 123 the Company's net income (loss) and income (loss) per share for the
years ended December 31, 2002, 2001 and 2000 would have been adjusted to the pro
forma amounts indicated below:
YEAR ENDED DECEMBER 31,
-------------------------
2002 2001 2000
--------- ------ ------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
Income (loss):
As reported $( 1,270) $ 22 $2,697
Pro forma ( 1,434) (151) 2,492
Income (loss) per common share - basic
As reported ( 0.22) 0.00 0.44
Pro forma ( 0.25) 0.00 0.41
Income (loss) per common share - assuming dilution
As reported ( 0.22) 0.00 0.43
Pro forma ( 0.25) 0.00 0.40
The fair value of options granted under the Company's stock option plan during
2002, 2001 and 2000 was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions:
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
------- ------ ------
Annual dividend yield 0.0% 0.0% 0.0%
Expected volatility 45.1% 37.0% 39.0%
Risk free interest rate 4.0% 5.9% 6.5%
Expected life (in years) 7.3 6 6
F-17
11. BORROWINGS
Bonds Payable
- --------------
The following is a summary of the outstanding bonds payable:
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
RANGES OF
2002 2001 INTEREST RATES STATED MATURITY DATE
------- ------- --------------- --------------------
(DOLLARS IN
THOUSANDS)
Series 1998-1 $14,490 $30,291 7.06%-7.95% November 25, 2024
Series 1999-1 38,662 63,998 6.46%-8.75% May 25, 2025
------- -------
53,152 94,289
Less: Bond issuance 926 1,679
Bond discount 1,753 3,259
------- -------
Bonds payable, net $50,473 $89,351
======= =======
The bonds are collateralized by securitized loans with an outstanding principal
balance of $20,229,000 and $44,503,000 as of December 31, 2002 for Series 1998-1
and Series 1999-1, respectively. There is no cross collateralization between the
bond issues.
Financial data pertaining to bonds payable were as follows:
YEAR ENDED DECEMBER 31,
------------------------------
2002 2001 2000
-------- --------- ---------
(DOLLARS IN THOUSANDS)
Weighted average coupon interest rate, end of year 8.02% 7.64% 7.44%
Annual weighted average interest rate (including discount amortization) 11.44% 9.02% 9.37%
Average balance of bonds payable, net $69,251 $111,327 $151,126
Maximum amount of bonds payable, net outstanding at any month end $84,910 $128,762 $163,761
At December 31, 2002 the annual scheduled bond repayments are as follows:
2007 AND
-----------
2003 2004 2005 2006 THEREAFTER TOTAL
----- ----- ------ ------ ----------- -------
(IN THOUSANDS)
Bond repayments $ 899 $ 973 $1,054 $1,141 $ 49,085 $53,152
12. EMPLOYEE BENEFIT PLAN
The Company has established a 401(k) plan for the benefit of its employees.
Employees are eligible to participate in the plan after 3 months of consecutive
service. Employees may make contributions to the plan and the Company may make
discretionary profit sharing contributions, subject to certain limitations. The
Company's contributions were determined by the Board of Directors and amounted
to $171,000, $177,000 and $164,000, in 2002, 2001 and 2000, respectively.
13. FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required to interpret market
data to develop estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Company could realize
in a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
F-18
The following table represents the estimated fair values:
DECEMBER 31,
----------------------------------------------
2002 2001
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------------------- ----------------------
(IN THOUSANDS)
Assets:
Cash and cash equivalents $ 31,094 $ 31,094 $ 29,406 $ 29,406
Time deposits in other financial institutions 2,277 2,277 5,938 5,938
Investment securities 6,824 6,883 893 893
Interest-only strips 4,548 4,548 7,693 7,693
Servicing assets 1,897 1,897 2,490 2,490
Net loans 245,856 270,425 260,955 283,939
Liabilities:
Deposits (other than time deposits) 86,244 86,244 70,202 70,202
Time deposits 132,839 137,089 125,965 130,515
Bonds payable 50,473 56,830 89,351 100,502
The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below:
Cash and cash equivalents - The carrying amounts approximate fair value because
of the short-term nature of these instruments.
Time deposits in other financial institutions - The carrying amounts approximate
fair value because of the relative short-term nature of these, generally less
than 180 day terms.
Investment securities - The fair value is based on quoted market prices from
security brokers or dealers if available. If a quoted market price is not
available, fair value is estimated using the quoted market price for similar
securities.
Federal Reserve and Federal Home Loan Bank stock carrying value approximates the
fair value because the stock can be sold back to the Federal Reserve and Federal
Home Loan Bank at anytime.
Loans - The fair value of loans is estimated for portfolios of loans with
similar financial characteristics, primarily fixed and adjustable rate interest
terms. The fair value of fixed-rate mortgage loans is based upon discounted cash
flows utilizing the rate that the Company currently offers as well as
anticipated prepayment schedules. The fair value of adjustable rate loans is
also based upon discounted cash flows utilizing discount rates that the Company
currently offers, as well as anticipated prepayment schedules. No adjustments
have been made for changes in credit within the loan portfolio. The fair value
of loans held for sale is determined based on quoted market prices or dealer
quotes.
Interest Only Strip - The fair value of the interest-only strip has been
determined by the discounted cash flow method, using market discount and
prepayment rates.
Servicing Assets - The carrying amounts approximate fair value because
quarterly, management evaluates servicing assets for impairment. Servicing
assets are evaluated for impairment based upon the fair value of the rights as
compared to amortized cost on a loan by loan basis. Fair value is determined
using discounted future cash flows calculated on a loan by loan basis and
aggregated to the total asset level. Impairment to the asset is recorded if the
aggregate fair value calculation drops below net book value of the asset.
Deposits - The fair values of deposits are estimated based upon the type of
deposit products. Demand accounts, which include savings and transaction
accounts, are presumed to have equal book and fair values, since the interest
rates paid on these accounts are based on prevailing market rates. The estimated
fair values of time deposits are determined by discounting the cash flows of
segments of deposits that have similar maturities and rates, utilizing a yield
curve that approximates the prevailing rates offered to depositors as of the
measurement date.
Bonds Payable - The fair value is estimated using discounted cash flow analysis
based on rates for similar types of borrowing arrangements.
Commitments to Extend Credit, Commercial and Standby Letters of Credit - Due to
the proximity of the pricing of these commitments to the period end the fair
values of commitments are immaterial to the financial statements.
F-19
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 2002 and 2001. Although management
is not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since those dates and, therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
14. REGULATORY MATTERS
The Company (on a consolidated basis) and Goleta are subject to various
regulatory capital requirements administered by the Federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory -
and possibly additional discretionary - actions by regulators that, if
undertaken, could have a direct material effect on the Company's and Goleta's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and Goleta must meet
specific capital guidelines that involve quantitative measures of the Company's
and Goleta's assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Company's and Goleta's
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings and other factors. Prompt
corrective action provisions are not applicable to bank holding companies.
The Federal Deposit Insurance Corporation Improvement Act, ("FDICIA"), was
signed into law on December 19, 1991. FDICIA included significant changes to
the legal and regulatory environment for insured depository institutions,
including reductions in insurance coverage for certain kinds of deposits,
increased supervision by the federal regulatory agencies, increased reporting
requirements for insured institutions and new regulations concerning internal
controls, accounting and operations.
The prompt corrective action regulations of FDICIA, define specific capital
categories based on the institutions' capital ratios. The capital categories,
in declining order, are "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized", and "critically
undercapitalized". To be considered "well capitalized" an institution must have
a core capital ratio of at least 5% and a total risk-based capital ratio of at
least 10%. Additionally, FDICIA imposes Tier I risk-based capital ratio of at
least 6% to be considered "well capitalized". Tier I risk-based capital is,
primarily, common stock and retained earnings net of goodwill and other
intangible assets.
F-20
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as
defined) to average assets (as defined). The Company's and the Bank's actual
capital amounts and ratios as of December 31, 2002 and 2001 are also presented
in the table below:
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
AS OF DECEMBER 31, 2002: ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------- ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
--------------- ----------------- -----------------
(DOLLARS IN THOUSANDS)
Total Risk-Based Capital
(to Risk Weighted Assets)
Consolidated $35,080 13.92% $ 20,162 8.00% N/A N/A
Goleta National Bank $32,492 13.31% $ 19,537 8.00% $24,421 10.00%
Tier I Capital (to Risk Weighted Assets)
Consolidated $31,897 12.66% $ 10,081 4.00% N/A N/A
Goleta National Bank $29,405 12.04% $ 9,768 4.00% $14,652 6.00%
Tier I Capital (to Average Assets)
Consolidated $31,897 10.48% $ 12,170 4.00% N/A N/A
Goleta National Bank $29,405 9.80% $ 12,004 4.00% $15,005 5.00%
AS OF DECEMBER 31, 2001:
Total Risk-Based Capital
(to Risk Weighted Assets)
Consolidated $36,689 13.02% $ 22,546 8.00% N/A N/A
Goleta National Bank $32,623 11.84% $ 22,050 8.00% $27,562 10.00%
Tier I Capital (to Risk Weighted Assets)
Consolidated $33,108 11.75% $ 11,273 4.00% N/A N/A
Goleta National Bank $29,122 10.40% $ 11,025 4.00% $16,537 6.00%
Tier I Capital (to Average Assets)
Consolidated $33,108 9.07% $ 14,602 4.00% N/A N/A
Goleta National Bank $29,122 9.05% $ 12,874 4.00% $16,093 5.00%
A bank may not be considered "well capitalized" if it is operating under a
regulatory agreement, as is the case for Goleta. Under the regulatory
framework, until the regulatory agencies agreement is lifted and the regulatory
agencies notify Goleta that it is deemed "well capitalized", Goleta may not
accept brokered deposits without prior approval from the regulators. Goleta had
no brokered deposits at December 31, 2002 or 2001.
In October 2002, Goleta entered into a stipulation for the entry of a consent
order ("Consent Order") with its principal regulator, the OCC. As of this date,
the Consent Order replaced the Formal Agreement that Goleta was previously
operating under with the OCC. The Consent Order requires that Goleta maintain
certain capital levels, adhere to certain operational and reporting
requirements, and take certain actions, including the following:
- submit monthly progress reports
- on or before December 31, 2002, cease all origination, renewal, or
rollover of short-term consumer loans and receive 100% indemnification
from ACE for costs, expenses, legal fees, damages and related
liabilities from third-party claims in certain circumstances as
specified in and in accordance with the terms of the agreement with
ACE
- maintain total capital at least equal to 12% of risk-weighted assets
and Tier 1 capital at least equal to 7% of adjusted total assets;
develop a three year capital program to maintain adequate capital and
refrain from paying dividends without the approval of the OCC
- develop a written profit plan and submit quarterly performance
reports, develop and implement a written risk management program and
adopt general procedures addressing compliance management, internal
control systems and education of employees regarding laws, rules and
regulations
F-21
- document the information it has relied on to value loans held on its
books, servicing rights, deferred tax assets and liabilities and
interest-only assets, and submit the documentation to the OCC on a
quarterly basis
- correct each violation of law, rule or regulation cited in any report
of examination where possible and implement corrective action to avoid
the reoccurrence of any such violations
- obtain approval from the OCC before it initiates any new product or
service or significantly expands any of its existing products or
services
Compliance with the provisions of the Consent Order could limit Goleta's
business activity and increase expense.
In March 2000, the Company entered into the Memorandum of Understanding ("MOU")
with its principal regulator, the Federal Reserve Bank of San Francisco
("Reserve Bank"). The MOU requires that the Company maintain certain capital
levels and adhere to certain operational and reporting requirements, including
the following:
- refrain from declaring any dividends or redeeming any of the Company's
stock without the approval of the Reserve Bank
- adopting a written plan to maintain a sufficient capital position for
the consolidated organization;
- refrain from increasing the Company's borrowings or incurring or
renewing any debt without the approval of the Reserve Bank
- correcting any violations of applicable laws, rules or regulations and
developing a written program to ensure compliance in the future
- developing written policies and procedures to strengthen the Company's
records, systems and internal controls
- developing a written plan to enhance management information systems
and the Board of Director's supervision of operations;
- developing a written consolidated strategic plan
- developing a written plan to address weaknesses in the Company's audit
program
- complying with applicable laws with respect to the appointment of any
new directors or the hiring of any senior executive officers
- submitting quarterly progress reports
Under the terms of both the Formal Agreement and the Consent Order, Goleta is
required to achieve and maintain total capital at least equal to 12% of total
risk-weighted assets, and Tier I capital at least equal to 7% of adjusted total
assets. Goleta has maintained a total risk weight assets ratio of over 12% and
Tier 1 capital of above 7% during 2002 and ended the year with a total risk
based ratio of 13.31%.
The Company believes that it is in full compliance with all of the provisions of
the Consent Order and the MOU.
15. COMMITMENTS AND CONTINGENCIES
Commitments
- -----------
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet. The Company's exposure to credit loss in the event of nonperformance by
the other party to commitments to extend credit and standby letters of credit is
represented by the contractual notional amount of those instruments. At December
31, 2002 and 2001, the Company had commitments to extend credit of approximately
$30,500,000 and $20,300,000, respectively, including obligations to extend
standby letters of credit of approximately $380,000 and $438,000, respectively.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support private borrowing arrangements. All guarantees are
short term and expire within one year.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for extending loan facilities to customers. The Company
evaluates each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company upon extension of
F-22
credit, is based on management's credit evaluation of the counterparty.
Collateral held varies but may include accounts receivable, inventory, property,
plant and equipment and income-producing commercial properties.
Loans Sold
- -----------
The Company has sold loans that are guaranteed or insured by government agencies
for which the Company retains all servicing rights and responsibilities. The
Company is required to perform certain monitoring functions in connection with
these loans to preserve the guarantee by the government agency and prevent loss
to the Company in the event of nonperformance by the borrower. Management
believes that the Company is in compliance with these requirements. The
outstanding balance of the sold portion of such loans was approximately
$150,200,000 and $146,794,000 at December 31, 2002 and 2001, respectively.
Although the Company sells without recourse substantially all of the mortgage
loans it originates or purchases, the Company retains a substantial degree of
risk relating to the servicing activities and retained interest in sold SBA
loans. In addition, during the period of time that the loans are held for sale,
the Company is subject to various business risks associated with the lending
business, including borrower default, foreclosure and the risk that a rapid
increase in interest rates would result in a decline of the value of loans held
for sale to potential purchasers. In connection with its loan sales, the
Company enters agreements which generally require the Company to repurchase or
substitute loans in the event of a breach of a representation or warranty made
by the Company to the loan purchaser, any misrepresentation during the mortgage
loan origination process or, in some cases, upon any fraud or early default on
such mortgage loans.
Salary Continuation
- --------------------
The Company has a salary continuation agreement with a former officer and
director. The agreement provides monthly cash payments to the officer or
beneficiaries in the event of death, disability or retirement, beginning in the
month after the retirement date or death and extending for a period of fifteen
years. The Company purchased a life insurance policy as an investment. The
income from the policy investment will help offset this liability. The cash
surrender value of the policy was $668,000 and $640,000 at December 31, 2002
and 2001, respectively, and is included in other assets. The present value of
the Company's liability under the agreement is included in accrued interest
payable and other liabilities in the accompanying consolidated balance sheets.
The accrued salary continuation liability was $449,000 and $358,000 at December
31, 2002 and 2001, respectively.
The Company also has two Key Man life insurance policies. The combined cash
surrender value of the policies are $ 171,000 and $165,000 at December 31, 2002
and 2001, respectively.
LITIGATION
- ----------
The following sections summarize the Company's significant legal proceedings.
Short-Term Consumer Lending
- ---------------------------
Throughout 2000, 2001 and 2002, Goleta made short-term consumer loans ("Bank
Loans") using certain marketing and servicing assistance of ACE at almost all of
ACE's retail locations pursuant to the terms of a Master Loan Agency Agreement
between ACE and Goleta ("Goleta Agreement"). However, in October 2002 Goleta
and ACE entered into separate consent orders with the OCC. In connection with
its consent order, Goleta agreed to discontinue making Bank Loans, effective
December 31, 2002, and paid a civil money penalty of $75,000.
A number of lawsuits and state regulatory proceedings have been filed or
initiated against Goleta and/or ACE regarding the Bank Loans. The state
regulatory proceedings have all been settled without Goleta incurring any
liability for settlement payments. However, together with ACE, Goleta remains a
defendant in three class actions, including a nationwide class action brought in
a federal court in Texas and two statewide class actions brought in state courts
in Florida and Maryland. A key issue in the remaining class actions concerning
the Bank Loans is whether Goleta or ACE is properly regarded as the lender.
Goleta and ACE maintain that, as provided by the legal documentation and
marketing materials for the Bank Loans, Goleta is the lender and that, because
Goleta is a national bank located in California, the Bank Loans, including the
interest that may legally be charged, should be governed by federal and
California law. The plaintiffs, however, maintain that ACE should be regarded
as the lender, because of the services it renders to Goleta under the Goleta
Agreement and ACE's purchase of participation interests in the Bank Loans, and
that the Bank Loans, including interest that may legally be charged, should be
governed by the laws of the respective states in which the borrowers reside. If
ACE were held to be the lender, then the interest charged for the Bank Loans
would violate most of the applicable states' usury laws, which impose maximum
rates of interest or finance charges that a non-bank lender may charge.
F-23
The consequences to ACE of an adverse holding in one or more of the pending
lawsuits would depend on the applicable state's usury and consumer-protection
laws and on the basis for a finding of violation of those laws. Those
consequences could include ACE's obligation to refund interest collected on the
Bank Loans, to refund the principal amount of the Bank Loans, to pay treble or
other multiple damages and/or to pay monetary penalties specified by statute.
Regarding each lawsuit, that amount would depend upon proof of the allegations,
the number or the amount of the loan-related transactions during relevant time
periods and (for certain of the claims) proof of actual damages sustained by the
plaintiffs.
While the Goleta Agreement formerly provided that Goleta would bear between 5%
and 10% of the monetary exposure in the Florida, Maryland and Texas lawsuits,
the Goleta Agreement was amended in October 2002 to provide that ACE will be
liable for 100% of the monetary exposure in all of these cases (and any
additional cases concerning the Bank Loans). However, if the Goleta Agreement
is invalid or unenforceable, or if ACE is unable to pay, Goleta could be liable
for up to the full amount of any and all awards against it in these lawsuits,
which could have a material adverse impact on the Company's financial condition
or results of operations. Under the terms of the Goleta Agreement, Goleta
remains liable for its own willful misconduct, its failure to maintain the
authorizations to conduct business, regulatory penalties imposed on it, and any
credit losses for the portion of the Bank Loans it retained.
Other Litigation
- ----------------
The Company is involved in various other litigation of a routine nature which is
being handled and defended in the ordinary course of the Company's business. In
the opinion of management, based in part on consultation with legal counsel, the
resolution of these other litigation matters will not have a material impact on
the Company's financial position or results of operations.
16. SEGMENT INFORMATION
Reportable business segments are determined using the "management approach" and
are intended to present reportable segments consistent with how the chief
operating decision maker organizes segments within the company for making
operating decisions and assessing performance. The Company had three reportable
business segments, Goleta National Bank, Palomar Community Bank (until it was
sold on August 17, 2001) and "Other" which includes holding company
administration areas.
Below is a summary statement of income and certain selected financial data. The
accounting policies used in the disclosure of business segments is the same as
those described in the summary of significant accounting policies. Certain
assumptions are made concerning the allocations of costs between segments which
may influence relative results, most notably, allocations of various types of
overhead and administrative costs and tax expense. Management believes that the
allocations utilized below are reasonable and consistent with the way it manages
the business.
DECEMBER 31, 2002
CONSOLIDATED
GOLETA OTHER ELIMINATION TOTALS
--------------- --------- ------------- --------------
(IN THOUSANDS)
Interest income $ 29,922 $ 54 $ - $ 29,976
--------------- --------- ------------- --------------
Interest expense 13,466 - - 13,466
--------------- --------- ------------- --------------
Net interest income 16,456 54 - 16,510
Provision for loan losses 4,874 25 - 4,899
Non-interest income 11,348 50 - 11,398
Non-interest expense 24,484 447 - 24,931
--------------- --------- ------------- --------------
Income (loss) before taxes $ (1,554) $ (368) $ - $ (1,922)
=============== ========= ============= ==============
Total assets $ 305,499 $ 33,271 $ (31,560) $ 307,210
=============== ========= ============= ==============
F-24
CONSOLIDATED
DECEMBER 31, 2001 GOLETA PALOMAR OTHER ELIMINATIONS TOTALS
--------------- --------- ------------- -------------- --------------
(IN THOUSANDS)
Interest income $ 37,050 $ 3,730 $ 79 $ (65) $ 40,794
Interest expense 18,518 1,418 467 (65) 20,338
--------------- --------- ------------- -------------- --------------
Net interest income 18,532 2,312 (388) - 20,456
Provision for loan losses 11,472 408 - - 11,880
Non-interest income 14,834 173 9,647 (2,483) 22,171
Non-interest expense 26,786 2,185 3,035 - 32,006
--------------- --------- ------------- -------------- --------------
Income (loss) before taxes $ (4,892) $ (108) $ 6,224 $ (2,483) $ (1,259)
=============== ========= ============= ============== ==============
Total assets $ 320,474 $ - $ 36,369 $ (32,980) $ 323,863
=============== ========= ============= ============== ==============
CONSOLIDATED
DECEMBER 31, 2000 GOLETA PALOMAR OTHER ELIMINATIONS TOTALS
--------------- --------- ------------- -------------- --------------
(IN THOUSANDS)
Interest income $ 45,991 $ 5,873 $ - $ - $ 51,864
Interest expense 23,529 2,531 277 - 26,337
--------------- --------- ------------- -------------- --------------
Net interest income 22,462 3,342 (277) - 25,527
Provision for loan losses 6,584 210 - - 6,794
Non interest income 15,933 538 10 16,481
Non interest expense 25,475 5,043 (540) - 29,978
--------------- --------- ------------- -------------- --------------
Income (loss) before taxes $ 6,336 $ (1,373) $ 273 $ - $ 5,236
=============== ========= ============= ============== ==============
Total assets $ 316,570 $ 78,274 $ 53,025 $ (42,614) $ 405,255
=============== ========= ============= ============== ==============
17. COMMUNITY WEST BANCSHARES (PARENT COMPANY ONLY)
DECEMBER 31,
----------------
BALANCE SHEETS 2002 2001
- -------------- ------- -------
(IN THOUSANDS)
Assets
Cash and equivalents $ 1,965 $ 2,001
Time deposits in financial institutions 1,188 4,487
Investment in subsidiaries 29,595 29,371
Loan participation purchased, net of allowance for loan losses
of $140,000 in 2002 and $280,000 in 2001 295 356
Other assets 228 154
------- -------
Total assets $33,271 $36,369
======= =======
Liabilities and stockholders' equity
Other liabilities $ 1,184 $ 3,012
Common stock 29,798 29,798
Retained earnings 2,289 3,559
Total Stockholders equity 32,087 33,359
------- -------
Total liabilities and stockholders' equity $33,271 $36,369
======= =======
F-25
YEAR ENDED DECEMBER 31,
-----------------------------
INCOME STATEMENT 2002 2001 2000
-------- -------- ---------
(IN THOUSANDS)
Total income $ 105 $ 5,263 $ -
Total expense 474 1,522 (1,137)
Equity in undistributed subsidiaries
Net income (loss) from subsidiaries
Subsidiaries (1,026) (2,483) 3,949
-------- -------- ---------
Income (loss) before income tax provision (benefit) (1,395) 1,258 2,812
Income tax provision (benefit) (125) 1,236 115
-------- -------- ---------
Net income (loss) $(1,270) $ 22 $ 2,697
======== ======== =========
COMMUNITY WEST BANCSHARES (PARENT COMPANY ONLY)
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
-------- -------- --------
(IN THOUSANDS)
Cash flows from operating activities:
Net (loss) income $(1,270) $ 22 $ 2,697
Adjustments to reconcile net income (loss) to cash provided by
(used in) operating activities:
Equity in undistributed (income) loss from subsidiaries 1,026 2,483 (3,949)
Net change in other liabilities (1,828) 1,505 1,411
Net change in other assets (13) (419) (32)
-------- -------- --------
Net cash provided by (used in) operating activities (815) 3,591 127
Cash flows from investing activities:
Net decrease (increase) in time deposits in other financial institutions 3,299 (4,405) -
Net payments and investments in subsidiaries (2,520) 10,726 2,167
-------- -------- --------
Net cash provided by investing activities 779 6,321 2,167
Cash flows from financing activities:
Proceeds from issuance of common stock - 112 26
Principal payments on borrowings - (5,270) (2,016)
Dividends - - (222)
Payments to repurchase common stock - (2,835) -
-------- -------- --------
Net cash (used in) financing activities - (7,993) (2,212)
Net increase (decrease) in cash and cash equivalents (36) 1,919 82
Cash and cash equivalents at beginning of year 2,001 82 -
-------- -------- --------
Cash and cash equivalents, at end of year $ 1,965 $ 2,001 $ 82
======== ======== ========
18. SUPPLEMENTAL DISCLOSURE TO THE CONSOLDIATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENT OF CASH FLOWS
Listed below are the supplemental disclosures to the Consolidated Statement of
Cash Flows:
YEAR ENDED DECEMBER 31,
-------------------------
2002 2001 2000
------- ------- -------
(IN THOUSANDS)
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $10,864 $18,950 $25,941
Cash paid for income taxes 3 2 1,312
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real estate owned 939 - 452
Transfers from loans held for sale to loans held for investment 1,587 $ 5,023 3,339
F-26
19. QUARTERLY FINANCIAL DATA (UNAUDITED)
Results of operations on a quarterly basis were as follows:
YEAR ENDED DECEMBER 31, 2002
---------------------------------------------------------------
Q4 Q3 Q2 Q1 TOTALS
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXPECT SHARE DATA)
Interest income $ 7,098 $ 7,677 $ 7,663 $ 7,538 $ 29,976
Interest expense 2,989 3,171 3,442 3,864 13,466
----------- ----------- ----------- ----------- -----------
Net interest income 4,109 4,506 4,221 3,674 16,510
Provision for loan losses 168 1,180 1,275 2,276 4,899
----------- ----------- ----------- ----------- -----------
Net interest income after provsion for loan losses 3,941 3,326 2,946 1,398 11,611
Non-interest income 2,561 2,752 2,710 3,375 11,398
Non-interest expenses 4,547 4,919 9,056 6,409 24,931
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 1,955 1,159 (3,400) (1,636) (1,922)
Provision (benefit) for income taxes 976 487 (1,428) (687) (652)
----------- ----------- ----------- ----------- -----------
NET INCOME (LOSS) $ 979 $ 672 $ (1,972) $ (949) $ (1,270)
=========== =========== =========== =========== ===========
Earnings (loss) per share - basic $ 0.17 $ 0.12 $ (0.35) $ (0.17) $ (0.22)
Earnings (loss) per share - diluted 0.17 0.12 (0.35) (0.17) (0.22)
Weighted average shares:
Basic 5,690,224 5,690,224 5,690,224 5,690,224 5,690,224
Diluted 5,703,459 5,695,301 5,690,224 5,690,224 5,690,224
YEAR ENDED DECEMBER 31, 2001
---------------------------------------------------------------
Q4 Q3 Q2 Q1 TOTALS
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXPECT SHARE DATA)
Interest income $ 8,635 $ 10,526 $ 10,723 $ 10,910 $ 40,794
Interest expense 4,561 4,732 5,342 5,703 20,338
----------- ----------- ----------- ----------- -----------
Net interest income 4,074 5,794 5,381 5,207 20,456
Provision for loan losses 3,251 3,626 2,017 2,986 11,880
----------- ----------- ----------- ----------- -----------
Net interest income after provsion for loan losses 823 2,168 3,364 2,221 8,576
Non-interest income 2,115 4,204 11,458 4,394 22,171
Non-interest expenses 8,129 7,351 9,703 6,823 32,006
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes (5,191) (979) 5,119 (208) (1,259)
Provision (benefit) for income taxes (1,276) 142 563 (710) (1,281)
----------- ----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (3,915) $ (1,121) $ 4,556 $ 502 $ 22
=========== =========== =========== =========== ===========
Earnings (loss) per share - basic $ (0.69) $ (0.19) $ 0.75 $ 0.08 $ 0.00
Earnings (loss) per share - diluted (0.69) (0.19) 0.74 0.08 0.00
Weighted average shares:
Basic 5,675,849 5,917,800 6,094,710 6,107,216 5,947,658
Diluted 5,675,849 5,917,800 6,158,941 6,128,422 5,998,003
F-27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
- -------- ----------------------------------------------
The Company's consolidated financial statements begin on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- -------- -------------------------------------------------------------------
FINANCIAL DISCLOSURE
---------------------
Effective June 27, 2002, as a result of the dissolution of Arthur Andersen LLP,
the Registrant's Audit Committee of the Board of Directors approved the
dismissal of the Registrant's former independent accountants. During the last
two years, reports issued by the former accountants did not contain any adverse
opinion or a disclaimer of opinion, and were not qualified or modified as to
uncertainty, audit scope or accounting principles. During the two most recent
fiscal years preceding the dismissal, there were no disagreements with the
former independent accountants on any matter of accounting principles or
practices, financial statement disclosures, or auditing scope or procedures
which disagreements, if not resolved to the satisfaction of the former
independent accountants, would have caused them to make reference to the subject
matter of the disagreements in connection with its reports on the financial
statements for such years. Community West Bancshares believes that during the
most recent fiscal years, there were no "reportable events" as defined in Item
304 (a)(1)(v) of Regulation S-K of the Securities and Exchange Commission.
Prior to the dismissal of Arthur Andersen LLP, the Company did not consult with
Ernst & Young, LLP on any items regarding the application of accounting
principles, the type of audit opinion that might be rendered on the Company's
financial statements, or the subject matter of a disagreement or reportable
event (as described in Regulation S-K Item 304(a)(2).
Community West Bancshares reported the change in accountants on Form 8-K on July
2, 2002. The Form 8-K contained a letter from Arthur Andersen LLP, addressed to
the Securities and Exchange Commission, stating it agreed with the statements
concerning Arthur Andersen LLP in such Form 8-K.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- --------- ------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
--------------------------------------------------------
The information concerning the directors and executive officers of the Company
is incorporated herein by reference from the section entitled "Proposal 1 -
Election of Directors" contained in the definitive proxy statement of the
Company to be filed pursuant to Regulation 14A within 120 days after the end of
the Company's last fiscal year ("Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
- --------- -----------------------
Information concerning executive compensation is incorporated herein by
reference from the section entitled "Proposal 1 - Election of Directors"
contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
- --------- ------------------------------------------------------------------
RELATED SHAREHOLDER MATTERS
-----------------------------
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the section entitled
"Proposal 1 - Election of Directors" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------- --------------------------------------------------
Information concerning certain relationships and related transactions is
incorporated herein by reference from the section entitled "Proposal 1 -
Election of Directors" contained in the Proxy Statement.
80
ITEM 14. CONTROLS AND PROCEDURES
- --------- -------------------------
Within the 90 days prior to the filing date of this report, the Chief Executive
Officer and the Chief Financial Officer of the Company, with the participation
of the Company's management, carried out an evaluation of the effectiveness of
the Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based on that evaluation, the Chief Executive Officer and the Chief
Financial Officer believe that, as of the date of the evaluation, the Company's
disclosure controls and procedures are effective in making known to them
material information relating to the Company (including its consolidated
subsidiaries) required to be included in this report.
Disclosure controls and procedures, no matter how well designed and implemented,
can provide only reasonable assurance of achieving an entity's disclosure
objectives. The likelihood of achieving such objectives is affected by
limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls, known to the Chief
Executive Officer or the Chief Financial Officer, subsequent to the date of the
evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- --------- ------------------------------------------------------------------
(a)(1) The following consolidated financial statements of Community West
Bancshares are filed as part of this Annual Report.
Report of Independent Public Accountants F-1
Consolidated Balance Sheets as of December 31, 2002 and 2001 F-3
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2001 F-4
Consolidated Statements of Stockholders' Equity for each
of the three years ended in the period ended December 31, 2002 F-5
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2002 F-6
Notes to Consolidated Financial Statements F-7
(a)(2) Financial Statement Schedules
Financial statement schedules other than those listed above have been omitted
because they are either not applicable or the information is otherwise included.
(b) A report on Form 8-K was filed as follows:
July 2, 2002: Item 4 - Change in Registrant's Certifying Accountant
October 28, 2002: Item 5 - Other Events and regulation FD Disclosure
81
(c) Exhibits. The following is a list of exhibits filed as a part of this
report.
2.1 Plan of reorganization (1)
3.1 Articles of Incorporation (3)
3.2 Bylaws (3)
4.1 Common Stock Certificate (2)
10.1 1997 Stock Option Plan and Form of Stock Option Agreement (1)
10.4 Master Loan Agency Agreement between the Company's subsidiary, Goleta
National Bank, and Ace Cash Express, Inc., dated August 11, 1999;
Amendment No. 1 thereto dated March 29, 2001; Amendment No. 2 thereto
dated June 30, 2001. (4)
10.6 Memorandum of Understanding between the Company and the Federal
Reserve Bank of San Francisco, dated February 22, 2001. (5)
10.7 Consulting Agreement between the Goleta National Bank and Llewellyn
Stone. (5)
10.8 Indemnification Agreement between the Company and Stephen W. Haley,
dated December 20, 2001. (5)
10.9 Indemnification Agreement between the Company and Lynda Nahra, dated
December 20, 2001. (5)
10.10 Indemnification Agreement between the Company and Phillip E.
Guldeman, dated April 1, 2002. (5)
10.11 At-will agreement between the Company and Stephen W. Haley, dated
March 29, 2001. (4)
10.12 At-will agreement between the Company and Phillip E. Guldeman, dated
March 14, 2002. (5)
10.13 Consent Order issued by the Office of the Comptroller of the
Currency, dated October 28, 2002. (6)
10.14 Stipulation and Consent to the Issuance of a Consent Order by the
Office of the Comptroller of the Currency, dated October 28, 2002. (6)
10.15 Amendment Number 3 to Master Loan Agency Agreement between Goleta
National Bank and Ace Cash Express, Inc., dated as of November 1,
2002. (6)
10.16 Amendment Number 1 to Collection Servicing Agreement between Goleta
National Bank and Ace Cash Express, Inc., dated as of November 1,
2002. (6)
10.17 Indemnification Agreement between the Company and Charles G.
Baltuskonis, dated March 18, 2003.
21 Subsidiaries of the Registrant
23.1 Consent of Ernst and Young LLP
23.2 Notice of Inability to Obtain Consent of Arthur Andersen LLP
82
99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
_______________________________________________
(1) Filed as and exhibit to the Registrant's Registration Statement
on Form S-8 filed with the Commission on December 31, 1997 and
incorporated herein by this reference.
(2) Filed as an exhibit to the Registrant's Amendment to Registration
Statement on Form 8-A filed with the Commission on March 12, 1998
and incorporated herein by this reference.
(3) Filed as an exhibit to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1997 filed with the
Commission on March 26, 1998 and incorporated herein by this
reference.
(4) Filed as an exhibit to the Registrant's Current Report on Form
8-K filed with the Commission on December 5, 2000 and
incorporated herein by this reference.
(5) Filed as an exhibit to Amendment No. 1 to Registrant's Annual
Report on Form 10-K for the year ended December 31, 2001, filed
with the Commission on April 30, 2002 and incorporated herein by
this reference.
(6) Filed as an exhibit to the Registrant's Current Report on Form
8-K filed with the Commission on November 4, 2002 and
incorporated herein by this reference
83
SIGNATURES
----------
Pursuant to the requirements of Section 13 of 15(d) of the Securities and
Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, on the 27th day of
March, 2003.
COMMUNITY WEST BANCSHARES
(Registrant)
By
/s/Michael A. Alexander
-------------------------
Michael A. Alexander
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated
Signature Title Date
/s/ Michael A. Alexander Director and Chairman of the March 27, 2003
- --------------------------- Board
Michael A. Alexander
/s/ Robert H. Bartlein Director and Secretary March 27, 2003
- -----------------------
Robert H. Bartlein
/s/ Charles G. Baltuskonis Chief Financial Officer March 27, 2003
- -----------------------------
Charles G. Baltuskonis
/s/ Jean W. Blois Director March 27, 2003
- ------------------
Jean W. Blois
/s/ John D. Illgen Director March 27, 2003
- ------------------
John D. Illgen
/s/ Lynda J. Nahra Director March 27, 2003
- ------------------
Lynda J. Nahra
/s/ William R. Peeples Director and Vice Chairman March 27, 2003
- ------------------------- of the Board
William R. Peeples
/s/ James R. Sims Jr. Director March 27, 2003
- -----------------------
James R. Sims Jr.
84
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Michael A. Alexander, Chief Executive Officer of Community West Bancshares, a
California corporation, certify that:
1. I have reviewed the annual report on Form 10-K of Community West
Bancshares;
2. Based on my knowledge, this Form 10-K does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
March 27, 2003
/s/ Michael A. Alexander
---------------------------
Michael A. Alexander
Chief Executive Officer
85
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Charles G. Baltuskonis, Chief Financial Officer of Community West Bancshares,
a California corporation, certify that:
1. I have reviewed the annual report on Form 10-K of Community West
Bancshares;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
i. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
ii. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
March 27, 2003
/s/ Charles G. Baltuskonis
-----------------------------
Charles G. Baltuskonis
Chief Financial Officer
86