FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [_X_] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended SEPTEMBER 30, 1997 or [___] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Period from _____________ to ___________ Commission File Number: 0-27384 CAPITAL CORP OF THE WEST (Exact name of registrant as specified in its charter) California 77-0405791 (State or otherjurisdiction of IRS Employer ID Number incorporation or organization) 550 West Main, Merced, CA 95340 (Address of principal executive offices) Registrant's telephone number, including area code: (209) 725-2200 Former name, former address and former fiscal year, if changed since last report: 1160 WEST OLIVE, MERCED, CA 95340. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No The number of shares outstanding of the registrant's common stock, no par value, as of September 30, 1997 was $4,356,080. No shares of preferred stock, no par value, were outstanding at September 30, 1997. CAPITAL CORP OF THE WEST Table of Contents PART I. -- FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statements of Cash Flows 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 PART II. -- OTHER INFORMATION Item 1. Legal Proceedings 29 Item 2. Changes in Securities 29 Item 3. Defaults Upon Senior Securities 29 Item 4. Submission of matters to a vote of Security Holders 29 Item 5. Other Information 29 Item 6. Exhibits and Reports on Form 8-K 29 Signatures 31 2 Capital Corp of the West Consolidated Balance Sheets (Unaudited) 09/30/97 12/31/96 09/30/96 -------- -------- -------- (In thousands) ASSETS Cash & noninterest-bearing deposits in other banks $ 15,231 $ 12,982 $ 16,669 Federal funds sold 5,940 3,735 4,395 Investment securities available for sale, at fair value 78,575 43,378 40,846 Investment securities held-to-maturity at amortized cost, market value of $10,512,000 at September 30, 1997 10,545 3,101 - Mortgage loans held for sale - 880 - Loans, net of allowance for loan losses of $2,296,000 at September 30, 1997; $2,792,000 at December 31, 1996; and $2,148,000 at September 30, 1996 206,169 180,455 173,641 Interest receivable 2,409 1,879 1,867 Bank premises and equipment, net 11,095 6,266 4,840 Other assets 13,060 13,313 11,633 -------- -------- -------- Total Assets $343,024 $265,989 $253,891 -------- -------- -------- -------- -------- -------- LIABILITIES Deposits Noninterest-bearing demand $ 42,675 $ 39,157 $ 38,094 Negotiable orders of withdrawal 39,547 34,303 29,734 Savings 118,020 111,285 110,263 Time, under $100,000 53,049 46,990 40,823 Time, $100,000 and over 25,605 6,610 9,825 -------- -------- -------- Total Deposits 278,896 238,345 228,739 Federal funds purchased and securities sold under agreements to repurchase 14,484 - - Short term borrowings 3,046 110 - Long term borrowings 5,105 1,535 106 Accrued interest, taxes and other liabilities 1,644 5,025 5,021 -------- -------- -------- Total Liabilities 303,175 245,015 233,866 SHAREHOLDERS' EQUITY Preferred Stock, no par value; 15,000,000 shares authorized; none outstanding - - - Common stock, no par value, 20,000,000 shares authorized; 4,356,080 issued & outstanding at September 30, 1997; 2,601,711 issued & outstanding at December 31, 1996; and 2,600,211 issued & outstanding at September 30, 1996 33,764 15,321 15,298 Investment securities unrealized (losses) gains, net 37 (69) (400) Retained earnings 6,048 5,722 5,127 -------- -------- -------- Total Shareholders' Equity 39,849 20,974 20,025 -------- -------- -------- Total Liabilities and Shareholders' Equity $343,024 $265,989 $253,891 -------- -------- -------- -------- -------- -------- 3 Capital Corp of The West Consolidated Statements of Income (Unaudited) Three Months Ending Nine Months Ending 9/30/97 9/30/96 9/30/97 9/30/96 ------- ------- ------- ------- (In thousands) (In thousands) Interest income: Interest and fees on loans $ 5,455 $ 4,449 $15,085 $11,515 Interest on investment securities Taxable 982 644 2,709 1,949 Non-taxable 42 63 150 184 Interest on federal funds sold 143 70 235 141 ------- ------ ------- ------- Total interest income 6,622 5,226 18,179 13,789 Interest Expense: Deposits: Negotiable Orders of Withdrawal 87 68 245 195 Savings 1,215 1,132 3,487 3,193 Time, under $100,000 897 548 2,314 1,169 Time, $100,000 and over 157 119 456 304 ------- ------ ------- ------- Total interest on deposits 2,356 1,867 6,502 4,861 Other 217 2 478 49 ------- ------ ------- ------- Total interest expense 2,573 1,869 6,980 4,910 Net interest income 4,049 3,357 11,199 8,879 Provision for loan losses 205 96 3,681 406 ------- ------ ------- ------- Net interest income after provision for loan losses 3,844 3,261 7,518 8,473 Other income (loss): Service charges on deposit accounts 462 343 1,195 944 Income from real estate held for sale or development 89 67 600 143 Other 195 284 897 862 ------- ------ ------- ------- Total Other Income 746 694 2,692 1,949 Other Expenses: Salaries and related benefits 1,612 1,419 4,643 4,059 Premises and occupancy 311 240 887 581 Equipment 335 265 970 749 Professional Fees 153 272 413 604 Supplies 131 90 382 213 Marketing 152 93 463 289 Other 644 607 2,000 1,697 ------- ------ ------- ------- Total other expenses 3,338 2,986 9,758 8,192 Income before income taxes 1,252 969 452 2,230 Provision for income taxes 476 356 106 820 ------- ------ ------- ------- Net income $ 776 $ 613 $ 346 $ 1,410 ------- ------ ------- ------- ------- ------ ------- ------- Net income per share $ 0.23 $ 0.24 $ 0.13 $ 0.60 ------- ------ ------- ------- ------- ------ ------- ------- 4 Capital Corp of The West Statement of Consolidated Cash Flows (Unaudited) 9 months ended 9 months ended 9/30/97 9/30/96 -------------- -------------- (In thousands) OPERATING ACTIVITIES: Net Income $ 346 $ 1,410 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 3,681 406 Depreciation, amortization and accretion, net 1,124 879 Provision (benefit) for deferred income taxes 735 (301) Net (increase) decrease in interest receivable & other assets (2,000) (4,155) Net decrease (increase) in mortgage loans held for sale 880 501 Net increase in deferred loan fees 59 66 Net increase in accrued interest payable & other liabilities (1,130) 3,019 Net (gains) losses on sale of assets (600) (609) --------- -------- Net cash provided by operating activities 3,095 1,216 INVESTING ACTIVITIES: Investment security purchases (60,707) (11,308) Proceeds from maturities of investment securities 10,264 3,836 Proceeds from sales of investment securities 7,718 10,493 Proceeds from sales of commercial and real estate loans 1,415 3,158 Net increase in loans (30,869) (44,801) Purchases of premises and equipment (5,645) (1,279) Purchases of real estate held for sale or development - (795) Proceed from sale of real estate held for sale or development 1,470 436 --------- -------- Net cash (used) by investing activities (76,354) (40,260) FINANCING ACTIVITIES: Net increase in demand, NOW and deposits 15,497 13,809 Net increase in certificates of deposit 25,054 22,329 Net increase in other borrowings 18,738 769 Issuance of common stock for acquisition 17,992 3,969 Issued shares for benefit plan purchases 208 - Fractional shares purchased (10) (82) Exercise of stock options 234 347 --------- -------- Net cash provided by financing activities 77,713 41,141 Net increase in cash and cash equivalents 4,454 2,097 Cash and cash equivalents at beginning of year 16,717 18,967 --------- -------- Cash and cash equivalents at end of quarter $21,171 $21,064 SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Investment securities net unrealized gains 68 (712) 5 Capital Corp of the West Notes to Consolidated Financial Statements September 30, 1997, December 31, 1996, and September 30, 1996 (Unaudited) GENERAL - COMPANY Capital Corp of the West (the "Company" or "Capital Corp") is a bank holding company incorporated under the laws of the state of California on April 26, 1995. On November 1, 1995, the Company became registered as a bank holding company, and is a holder of all of the capital stock of County Bank (the "Bank") and all of the capital stock of Town and Country Finance and Thrift (the "Thrift"). During 1996 the Company formed Capital West Group, a new subsidiary that engages in the financial institution advisory business but is currently inactive. The Company's primary asset is the Bank and the Bank is the Company's primary source of income. The Company's securities consist of 30,000,000 shares of Common Stock, no par value, and 10,000,000 shares of Preferred Stock. As of September 30, 1997 there were 4,356,080 common shares outstanding, held of record by approximately 1,300 shareholders. The weighted average shares outstanding were 2,724,000 and 2,344,000 for the nine months ending September 30, 1997 and 1996 respectively. The weighted average shares outstanding were 3,376,000 and 2,600,000 for the three months ended September 30, 1997 and 1996 respectively. There were no preferred shares outstanding at September 30, 1997. The Bank has two wholly owned subsidiaries, Merced Area Investment & Development, Inc. ("MAID") and County Asset Advisors ("CAA"). CAA is currently inactive. All references herein to the "Company" include the Bank, and the Bank's subsidiaries, Capital West Group and the Thrift, unless context otherwise requires. GENERAL - BANK The Bank was organized on August 1, 1977, as County Bank of Merced, a California state banking corporation. The Bank commenced operations on December 22, 1977. In November 1992, the Bank changed its legal name to County Bank. The Bank's securities consist of one class of Common Stock, no par value and is wholly owned by the Company. The Bank's deposits are insured under the Federal Deposit Insurance Act, by the Federal Deposit Insurance Corporation ("FDIC") up to applicable limits stated therein. The Bank is not a member of the Federal Reserve System. GENERAL - THRIFT The Company acquired the Thrift on June 28, 1996 for a combination of cash and stock with an aggregate value of approximately $5.8 million. The Thrift is an industrial loan company with four offices. It specializes in direct loans to the public and the purchase of financing contracts. It was originally incorporated in 1957. Its deposits (technically known as investment certificates or certificates of deposit rather than deposits) are insured by the FDIC up to applicable limits. BANK'S INDUSTRY AND MARKET AREA The Bank engages in general commercial banking business primarily in Merced, Tuolumne and Stanislaus Counties. The Bank has nine branch offices: two in Merced with the branch located in north Merced currently designated as the head office, and offices in Atwater, Turlock, Hilmar, Sonora, Los Banos, and two offices in Modesto opened in late 1996. The Bank relocated its existing administrative office and existing branch in downtown Merced to a new facility constructed in downtown Merced in September, 1997. In conjunction with the construction of the facility, the Merced Redevelopment Agency has provided the Bank with an interest free loan in the amount of $3.0 million. The loan, originally scheduled to mature on July 8, 1997, was extended until October 8, 1997. For the interim period of extension, an interest rate of 6% was charged on the loan. The loan was paid in full on October 8, 1997 and it is anticipated that during the fourth quarter of 1997 a permanent mortgage loan will be obtained from an unaffiliated lender. The Thrift engages in the general consumer lending business primarily in Stanislaus, Fresno, and Tulare counties from its main office in Turlock; and branch offices located in Modesto, Visalia, and Fresno. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 6 THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS. These factors include risks inherent to commercial lending, dependence upon key personnel, present and future regulation and legislation, and risks related to asset quality. The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to the Company and its subsidiaries' financial condition, operating results, asset and liability management, liquidity and capital resources and should be read in conjunction with the Consolidated Financial Statements of the Company and the Notes thereto. RESULTS OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED WITH NINE MONTHS ENDED SEPTEMBER 30, 1996 OVERVIEW. For the nine months ended September 30, 1997, the Company reported net income of $346,000 compared with net income of $1,410,000 for the nine months ended September 30, 1996. Earnings per share were $.13 and $.60, respectively. The annualized return on average assets was .16% and .87% for the first nine months of 1997 and 1996, respectively. The Company's annualized return on average equity was 1.91% and 11.74% for the nine months ended September 30, 1997 and 1996, respectively. The decreases in earnings per share, return on average assets and return on average equity were primarily attributable to the significant increase in the loan loss provision taken in the first six months of 1997. NET INTEREST INCOME. The Company's primary source of income is the difference between interest income and fees derived from earning assets and interest paid on liabilities. The difference between the two is net interest income. Net interest income for the nine months ended September 30, 1997 totaled $11,199,000 compared with $8,879,000 for the same period in 1996, an increase of $2,320,000 or 26%. Total interest and fees on earning assets were $18,179,000 for the first nine months of 1997, an increase of $4,390,000 or 32% from $13,789,000 for the same nine months in 1996. The level of interest income is affected by changes in volume of and rates earned on interest-earning assets. Interest-earning assets consist primarily of loans, investment securities and federal funds sold. The increase in interest income in the first nine months of 1997 was primarily the result of an increase in the volume of interest-earning assets. Average interest-earning assets for the first nine months of 1997 were $246,254,000 compared with $194,006,000 for the first nine months of 1996, an increase of $52,248,000 or 27%. Interest expense is a function of the volume of and the rates paid on interest-bearing liabilities. Interest-bearing liabilities consist primarily of certain deposits and borrowed funds. Total interest expense was $6,980,000 for the nine months ended September 30, 1997, compared with $4,910,000 for the nine months ended September 30, 1996, an increase of $2,070,000 or 42%. This increase was primarily the result of an increase in the volume of interest-bearing liabilities. Average interest-bearing liabilities were $229,029,000 for the first nine months of 1997 compared with $169,088,000 for the same nine months in 1996, an increase of $59,941,000 or 35%. The Company's net interest margin, the ratio of net interest income to average interest-earning assets, was 5.84% for the nine months ended September 30, 1997 compared with 6.12% for the same period in 1996. Net interest margin provides a measurement of the Company's ability to employ funds profitably during the period being measured. The Company's decrease in net interest margin was primarily attributable to a moderate change in the mix of interest-bearing liabilities. Certificate of deposits as a percentage of average interest-bearing liabilities increased from 22% for the nine months ended June 30, 1996 to 29% for the nine months ended September 30, 1997. AVERAGE BALANCES AND RATES EARNED AND PAID. The following table presents condensed average balance sheet information for the Company, together with interest rates earned and paid on the various sources and uses of 7 its funds for each of the periods indicated. Nonaccruing loans are included in the calculation of the average balances of loans, but the nonaccrued interest on such loans is excluded. FOR THE NINE MONTHS ENDED ------------------------------------------------------------------------------- SEPTEMBER 30, 1997 SEPTEMBER 30, 1996 ------------------------------------- -------------------------------------- INTEREST RATES INTEREST RATES AVERAGE INCOME/ EARNED/ AVERAGE INCOME/ EARNED/ BALANCE EXPENSE PAID BALANCE EXPENSE PAID ------------ ------------ ------- ------------- ----------- -------- (DOLLARS IN THOUSANDS) Assets Federal funds sold $ 5 ,770 $ 235 5.45% $ 3,608 $ 141 5.22% Taxable investment securities: (1) 53,112 2,709 6.82% 37,246 1,949 7.00% Nontaxable investment securities 3,727 150 5.38% 4,545 184 5.41% Loans, gross: (2) 193,645 15,085 10.42% 148,607 11,515 10.36% ------------ ------------ ------- ------------- ----------- -------- Total Earning Assets 256,254 $ 8,179 9.48% 194,006 $ 13,789 9.50% ------------ ----------- Allowance for loan losses (2,730) (1,897) Cash and due from banks 13,528 10,201 Premises and equipment 8,909 4,512 Interest receivable and other assets 15,056 10,152 ------------ ------------- Total Assets $ 291,017 $ 216,974 ------------ ------------- ------------ ------------- Liabilities and Shareholders' Equity Interest-bearing demand deposits $ 36,196 $ 245 0.90% $ 28,512 $ 195 0.91% Savings deposits 114,256 3,487 4.08% 102,170 3,193 4.18% Time deposits 67,271 2,770 5.51% 37,257 1,473 5.29% Other borrowed funds 11,306 478 5.65% 1,149 49 5.70% ------------ ------------ ------- ------------- ----------- -------- Total interest-bearing liabilities 229,029 $ 6,980 4.07% 169,088 $4,910 3.88% ------------ Noninterest-bearing demand deposits 35,096 29,590 Accrued interest, taxes and other liabilities 2,762 2,236 ------------ ------------- Total liabilities 266,887 200,914 Shareholders' equity 24,130 16,060 ------------ ------------- Total Liabilities and Shareholders' Equity $ 291,017 $216,974 ------------ ------------- ------------ ------------- Net interest income $ 11,199 $ 8,879 ------------ ----------- ------------ ----------- Net interest margin (3) 5.84% 6.12% ------- -------- ------- -------- ___________ (1) Interest on municipal securities is not computed on a tax-equivalent basis. (2) Amounts of interest earned includes loan fees of $1,043,000 and $713,000 for the periods included. (3) Net interest margin is computed by dividing net interest income by total average interest-earning assets. 8 NET INTEREST INCOME CHANGES DUE TO VOLUME AND RATE. The following table sets forth, for the periods indicated, a summary of the changes in average asset and liability balances and interest earned and interest paid resulting from changes in average asset and liability balances (volume) and changes in average interest rates and the total net change in interest income and expenses. The changes in interest due to both rate and volume have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each. NINE MONTHS ENDED SEPTEMBER 30 1997 OVER NINE MONTHS ENDED SEPTEMBER 30 1996 ---------------------------------- INCREASE (DECREASE) DUE TO CHANGE IN ---------------------------------- AVERAGE AVERAGE VOLUME RATE TOTAL ---------- ------- -------- (IN THOUSANDS) INCREASE (DECREASE) IN INTEREST AND FEE INCOME: Federal funds sold $ 88 $ 6 $ 94 Taxable investment securities 808 (48) 760 Nontaxable investment securities(1) (33) (1) (34) Loans, gross 3,508 62 3,570 ---------- ------- -------- Total 4,371 19 4,390 ---------- ------- -------- ---------- ------- -------- INCREASE (DECREASE) IN INTEREST EXPENSE: Interest-bearing demand deposits 52 (2) 50 Savings deposits 367 (73) 294 Time deposits 1,233 64 1,297 Other borrowed funds 429 0 429 ---------- ------- -------- Total 2,081 (11) 2,070 ---------- ------- -------- ---------- ------- -------- Total change in net interest income $ 2,290 $ 30 $2,320 ---------- ------- -------- ---------- ------- -------- ___________ (1) Interest on nontaxable securities is not computed on a tax-equivalent basis. PROVISION FOR LOAN LOSSES. The provision for loan losses for the first nine months of 1997 was $3,681,000 compared with $406,000 in the nine months ended September 30, 1996. During the three months ended June 30, 1997, the Company made a provision of $3,236,000 for loan losses and charged off a real estate development loan with a balance of $3,458,000. As of September 30, 1997 the allowance for loan losses was $2,296,000 or 1.10% of total loans. At September 30, 1997, nonperforming assets totaled $2,409,000 or .70% of total assets, nonperforming loans totaled $2,181,000 or 1.05% of total loans and the allowance for loan losses totaled 105.27% of nonperforming loans. No assurance can be given that nonperforming loans will not increase or that the allowance for loan losses will be adequate to cover losses inherent in the loan portfolio. NONINTEREST INCOME. Noninterest income increased by $743,000 or 38% to $2,692,000 for the nine months ended September 30, 1997 compared with $1,949,000 in the same period in 1996. Service charges on deposit accounts increased by $251,000 or 27%, income from the sale of real estate held for sale or development increased by $457,000 or 320% and other income increased by $35,000 or 4%. The increases in service charges are primarily due to general growth of the Company. The increase in income from the sale of real estate held for sale or development was due to increased sales of residential lots. The primary reasons for the increase in other income were increases from loan servicing income and retail investment sales. NONINTEREST EXPENSE. Noninterest expenses increased by $1,566,000 or 19% to $9,758,000 for the nine months ended September 30, 1997 compared with $8,192,000 for the same period in 1996. The primary 9 components of noninterest expenses were salaries and employee benefits, occupancy expenses, furniture and equipment expenses, and other operating expenses. The following table summarizes noninterest expenses for the nine-month periods ended September 30, 1997 and 1996. FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------------- 1997 1996 ----------- ------------ (IN THOUSANDS) Salaries and employee benefits $ 4,643 $ 4,059 Furniture and equipment 970 749 Occupancy expense 887 581 Marketing 463 289 Professional fees 413 604 Supplies 382 213 Other 2,000 1,697 ----------- ------------ Total $ 9,758 $ 8,192 ----------- ------------ ----------- ------------ For the nine months ended September 30, 1997 compared with the nine months ended September 30, 1996, salaries and related benefits increased by $584,000 or 14%, equipment expenses increased $221,000 or 30%, occupancy expenses increased $306,000 or 53%, marketing expenses increased by $174,000 or 60% and other expenses, including professional fees, and supplies increased by $281,000 or 11%. The expense increases were primarily the result of expansion, including expenses associated with acquisition and operation of Town & Country (acquired in June 1996) and the opening of two branch offices in December 1996. PROVISION FOR INCOME TAXES. The Company recorded a $106,000 tax benefit for the nine months ended September 30, 1997 compared with a provision for income taxes of $820,000 for the same nine months in 1996. Tax rates were positively affected by the purchase of limited partnership investments in low-income affordable housing projects providing the investor with affordable housing income tax credits. The Company had investments in these partnerships of $2,700,000 as of September 30, 1997 and $1,700,000 as of September 30, 1996, resulting in tax credits of $97,000 and $55,000, respectively. NET INCOME. The decrease in earnings in the first nine months of 1997 compared with the first nine months of 1996 resulted primarily from the increase in the provision for loan losses and the related charge-off a real estate development loan. The increase in the loan loss provision was partially offset by the increases in net interest income and in the sale of real estate that had been previously written off. 10 ASSET AND LIABILITY MANAGEMENT Asset and liability management is an integral part of managing a banking institution's primary source of income, net interest income. The Company manages the balance between rate-sensitive assets and rate-sensitive liabilities being repriced in any given period with the objective of stabilizing net interest income during periods of fluctuating interest rates. The Company considers its rate-sensitive assets to be those which either contain a provision to adjust the interest rate periodically or mature within one year. These assets include certain loans and investment securities and federal funds sold. Rate-sensitive liabilities are those which allow for periodic interest rate changes within one year and include maturing time certificates, certain savings deposits and interest-bearing demand deposits. The difference between the aggregate amount of assets and liabilities that reprice within various time frames is called the "gap." Generally, if repricing assets exceed repricing liabilities in a time period the Company would be deemed to be asset-sensitive. If repricing liabilities exceed repricing assets in a time period the Company would be deemed to be liability-sensitive. Generally, the Company seeks to maintain a balanced position whereby there is no significant asset or liability sensitivity within a one-year period to ensure net interest margin stability in times of volatile interest rates. This is accomplished through maintaining a significant level of loans, investment securities and deposits available for repricing within one year. The following tables set forth the interest rate sensitivity of the Bank's interest-earning assets and interest-bearing liabilities as of September 30, 1997, using the interest rate sensitivity gap ratio. For purposes of the following table, an asset or liability is considered rate-sensitive within a specified period when it can be repriced or matures within its contractual terms. AT SEPTEMBER 30, 1997 ------------------------------------------------------------------------------------ AFTER 3 AFTER 1 BUT YEAR BUT WITHIN WITHIN WITHIN AFTER NONINTEREST- 3 MONTHS 12 MONTHS 5 YEARS 5 YEARS BEARING TOTAL -------- --------- -------- ------- ------------ --------- (DOLLARS IN THOUSANDS) ASSETS Time deposits at other banks $ 0 $ 99 $ - $ - $ - $ 99 Federal funds sold 5,940 - - - - 5,940 Investment securities 418 6,006 32,476 50,121 - 89,021 Loans 127,733 32,603 37,928 10,201 - 208,465 Total earning assets 134,091 38,708 70,404 60,322 303,525 Noninterest-earning assets and allowances for loan losses - - - - 39,499 39,499 Total assets $134,091 $38,708 $70,404 $60,322 $39,499 $343,024 LIABILITIES AND SHAREHOLDERS' EQUITY Savings, money market and NOW deposits $157,567 $ - $ - $ - $42,675 $200,242 Time deposits 16,696 49,100 12,597 261 - 78,654 Other interest-bearing liabilities 3,046 14,484 5,105 - - 22,635 Other liabilities and shareholders' equity - - - - 41,493 41,493 --------- -------- Total liabilities and shareholders' equity 177,309 63,584 17,702 261 84,168 $343,024 --------- -------- ------ ------- --------- -------- Incremental gap (43,218) (24,876) 52,702 60,061 ($44,669) --------- -------- ------ ------- --------- --------- -------- ------ ------- --------- Cumulative gap $(43,218) $(68,094) $(15,392) $44,669 --------- -------- ------ ------- --------- -------- ------ ------- Cumulative gap as a % of earning assets (14.2)% (22.4)% (5.1)% 14.7% The Company was liability-sensitive with a negative cumulative one-year gap of $ 68,094,000 or 22% of interest-earnings assets at September 30, 1997. In general, based upon the Company's mix of deposits, loans and investments, increases in interest rates would be expected to result in a decrease in the Company's net interest margin. The interest rate gaps reported in the tables arise when assets are funded with liabilities having different repricing intervals. Since these gaps are actively managed and change daily as adjustments are made in interest rate views and market outlook, positions at the end of any period may not be reflective of the Company's interest rate sensitivity in subsequent periods. Active management dictates that longer-term economic views are balanced against prospects for short-term interest rate changes in all repricing intervals. For purposes of the analysis above, repricing of fixed-rate instruments is based upon the contractual maturity of the applicable instruments. Actual payment patterns may differ from contractual payment patterns. The change in net interest income may not always follow the general expectations of an asset-sensitive or liability-sensitive balance sheet during periods of changing interest rates, because interest rates earned or paid may change by differing increments and at different time intervals for each type of interest-sensitive asset and liability. As a result of these factors, at any given time, the Company may be more sensitive or less sensitive to changes in interest rates than indicated in the above tables. Greater sensitivity would have a more adverse effect on net interest margin if market interest rates were to increase, and a more favorable effect if rates were to decrease. An additional measure of interest rate sensitivity that the Company monitors through a detailed model is its expected change in earnings. This model's estimate of interest rate sensitivity takes into account the differing time intervals and differing rate change increments of each type of interest-sensitive asset and liability. It then measures the projected impact of changes in market interest rates on the Company's return on equity. Based upon the September 30, 1997 mix of interest-sensitive assets and liabilities, given an immediate and sustained increase in the federal funds rate of 1%, this model estimates the Company's cumulative return on equity over the next year would decrease by less than 1%. No assurance can be given that the actual return on equity would not decrease by more than 1% in response to a 1% increase in federal funds rate, or that actual return on equity would not decrease substantially if market interest rates increased by more than 1%. FINANCIAL CONDITION Total assets at September 30, 1997 were $343,024,000, an increase of $77,035,000 or 29% compared with total assets of $265,989,000 at December 31, 1996, and an increase of $89,133,000 or 35% compared with total assets of $253,891,000 at September 30, 1996. Net loans were $206,169,000 at September 30, 1997, an increase of $25,714,000 or 14.0% compared with net loans of $180,455,000 on December 31, 1996, and an increase of $32,528,000 or 19% compared with net loans of $173,641,000 at September 30, 1996. The growth of the Company from September 30, 1996 to September 30, 1997 was primarily the result of the opening of new branch offices of County Bank within that period and an increased utilization of purchasing investments using funds obtained from short term borrowings. The allowance for loan losses was $2,296,000 at September 30, 1997, representing a decrease of 18% of the allowance at December 31, 1996 but an increase of 7% of the allowance at September 30, 1996. The allowance at September 30, 1997 represented 1.1% of total loans, compared with 1.5% of total loans at December 31, 1996. Nonperforming loans at September 30, 1997 decreased by $3,387,000 from December 31, 1996, moving from 3.04% of total loans to 1.05% of total loans. In addition, the allowance for loan losses as a percentage of nonperforming loans increased from 50.14% at December 31, 1996 to 105.27% at September 30, 1997. Deposits were $278,896,000 at September 30, 1997, an increase of $40,551,000 or 17% compared with deposits of $238,345,000 at December 31, 1996, and an increase of $50,157,000 or 22% compared with deposits of $228,739,000 at September 30, 1996. Total shareholders' equity was $39,849,000 at September 30, 1997, an increase of $18,875,000 or 90% from $20,974,000 at December 31, 1996, and a 94% increase from $20,025,000 at September 30, 1996. The growth in shareholders' equity was primarily due to the issuance of 1,725,000 additional shares of no par common stock which generated a net addition of $17,992,000 to stockholders' equity. The additional shares were the result of an equity offering that was completed on August 22, 1997. INVESTMENT PORTFOLIO. The following table sets forth the fair value of securities available for sale and the book and market values of securities held for maturity at the dates indicated. AT DECEMBER 31, ------------------------------------------------------------------------- AT SEPTEMBER 30, 1996 1995 1994 ---------------- ------------------- ------------------- --------------------- 1997 ---------------- BOOK MARKET BOOK MARKET BOOK MARKET BOOK MARKET ------- -------- -------- -------- -------- -------- ------- ---------- (DOLLARS IN THOUSANDS) AVAILABLE FOR SALE U.S. Treasury and U.S. $ 10,839 $17,711 $22,521 $20,593 Government agency State and political 3,283 4,271 4,297 subdivisions Mortgage-backed securities 63,223 20,751 17,932 & CMOs Other securities 1,230 645 552 487 -------- ------- ------- ------- Total $ 78,575 $43,378 $45,302 $21,080 -------- ------- ------- ------- -------- ------- ------- ------- HELD TO MATURITY U.S. Treasury and U.S. Government agency $10,545 $10,512 - - $8,175 $7,989 State and political subdivisions _ _ _ _ 6,571 6,567 ------- ------- Total $10,545 $10,512 _ _ $14,746 $14,556 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- The following table sets forth the maturities of the Company's investment securities at September 30, 1997 and the weighted average yields of such securities calculated on the basis of the cost and effective yields based on the scheduled maturity of each security. Maturities of mortgage-backed securities are stipulated in their respective contracts. However, actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call prepayment penalties. Yields on municipal securities have not been calculated on a tax-equivalent basis. AT SEPTEMBER 30, 1997 --------------------------------------------------------------------------------------------------- AFTER ONE BUT AFTER FIVE BUT WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN 10 YEARS AFTER 10 YEARS TOTAL --------------- ------------------ ------------------- ------------------- --------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT ------ ------ ------- -------- -------- -------- --------- ------- --------------- (DOLLARS IN THOUSANDS) AVAILABLE FOR SALE U.S. Treasury and U.S. $ - - $5,552 6.16% $1,896 7.07% $ 3,391 7.24% $10,839 Government agency State and political 452 5.01% 2,524 5.38% 307 4.22% - - 3,283 subdivisions Mortgage-backed securities & CMOs 10,190 6.45% 14,440 7.22% 7,222 7.12% 31,371 7.27% 63,223 Equity securities 1,230 - - - 1,230 ------- ------- Total $11,872 $22,516 $9,425 $34,762 $78,575 ------- ------- ------ ------- ------- ------- ------- ------ ------- ------- HELD TO MATURITY U.S. Treasury and U.S. 99 5.85% - - $7,047 6.93% $ 3,399 7.24% $10,545 Government agency ------- ---- ------- ------- ------ ---- ------- ---- ------- ------- ---- ------- ------- ------ ---- ------- ---- ------- In the above table, mortgage-backed securities and Collateralized Mortgage Obligations (CMO) are shown repricing at the time of maturity rather than in accordance with their principal amortization schedules. The Company does not own securities of a single issuer whose aggregate book value is in excess of 10% of its total equity. LOAN PORTFOLIO. The following table shows the composition of the Company's loan portfolio at the dates indicated. AT SEPTEMBER 30, AT DECEMBER 31, ---------------------------------------------------------------------- 1997 1996 1995 1994 1993 1992 ----------------- ------------- ------------ ----------- ----------- --------------- (IN THOUSANDS) Commercial $34,235 $27,857 $20,374 $15,229 $16,896 $24,094 Agricultural 43,682 43,929 45,187 40,598 38,029 32,997 Real estate-construction 11,934 13,923 12,006 11,726 9,143 7,131 Real estate-mortgage 67,486 57,098 42,128 34,743 32,984 21,338 Consumer 51,128 40,440 14,039 11,304 10,072 11,775 -------- -------- -------- -------- -------- ------- Total $208,465 $183,247 $133,734 $113,600 $107,124 $97,335 -------- -------- -------- -------- -------- ------- -------- -------- -------- -------- -------- ------- The following tables show the maturity distribution of the loan portfolio at September 30, 1997, and December 31, 1996, and the loan portfolio's sensitivity to changes in interest rates. AT SEPTEMBER 30, 1997 ------------------------------------------------------------------------------ AFTER 1 BUT WITHIN 1 YEAR WITHIN 5 YEARS AFTER 5 YEARS TOTAL ------------------------------------------------------------------------------ (IN THOUSANDS) Commercial and agricultural Loans with floating interest rates $49,438 $15,153 $3,133 $67,724 Loans with fixed interest rates 4,320 4,963 910 10,193 -------- ------- ------- -------- Subtotal 53,758 20,116 4,043 77,917 -------- ------- ------- -------- Real estate-construction Loans with floating interest rates 5,327 3,263 1,260 9,850 Loans with fixed interest rates 947 997 140 2,084 -------- ------- ------- -------- Subtotal 6,274 4,260 1,400 11,934 -------- ------- ------- -------- Real estate-mortgage 7,644 38,108 21,734 67,486 Consumer 33,577 16,595 956 51,128 -------- ------- ------- -------- Total $101,253 $79,079 $28,133 $208,465 -------- ------- ------- -------- -------- ------- ------- -------- 15 AT DECEMBER 31, 1996 -------------------- AFTER 1 BUT WITHIN 1 YEAR WITHIN 5 YEARS AFTER 5 YEARS TOTAL ------------- -------------- ------------- ----- (IN THOUSANDS) Commercial and agricultural Loans with floating interest rates $39,515 $20,150 $4,337 $64,002 Loans with fixed interest rates 630 6,116 1,038 7,784 ------- ------- ------ ------- Subtotal 40,145 26,266 5,375 71,786 ------- ------- ------ ------- Real estate-construction Loans with floating interest rates 5,419 4,528 2,542 12,489 Loans with fixed interest rates 674 32 728 1,434 ------- ------- ------ ------- Subtotal 6,093 4,560 3,270 13,923 Real estate-mortgage 4,384 39,845 12,809 57,098 Consumer 3,909 33,192 3,339 40,440 ------- ------- ------ ------- Total $54,531 $103,863 $24,793 $183,247 ------- ------- ------ ------- ------- ------- ------ ------- OFF-BALANCE SHEET COMMITMENTS. The following table shows the distribution of the Company's undisbursed loan commitments at the dates indicated. AT SEPTEMBER 30, AT DECEMBER 31, ---------------- --------------- 1997 1996 1995 ------ ------ ------ (IN THOUSANDS) Real estate-construction $11,050 $6,305 $4,232 Standby letters of credit 2,265 3,231 2,465 Other 43,770 36,623 21,624 ------- ------ ------ Total $57,085 $46,159 $28,321 ------- ------ ------ ------- ------ ------ OTHER INTEREST-EARNING ASSETS. The following table relates to other interest-earning assets not disclosed previously for the dates indicated. This item consists of a salary continuation plan for the Company's executive management and deferred retirement benefits for participating board members. The plan is informally linked with universal life insurance policies for the salary continuation plan. Income from these policies is reflected in noninterest income. AT SEPTEMBER 30, AT DECEMBER 31, ---------------- ---------------------------------- 1997 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- ---- (IN THOUSANDS) Cash surrender value of life insurance $3,349 $3,134 $1,290 $288 -- -- ------ ------ ------ ---- --- --- ------ ------ ------ ---- --- --- 16 NONPERFORMING ASSETS. Nonperforming assets include nonaccrual loans, loans 90 days or more past due, restructured loans and other real estate owned. Nonperforming loans are those which the borrower fails to perform in accordance with the original terms of the obligation and include loans on nonaccrual status, loans past due 90 days or more and restructured loans. The Company generally places loans on nonaccrual status and accrued but unpaid interest is reversed against the current year's income when interest or principal payments become 90 days or more past due unless the outstanding principal and interest is adequately secured and, in the opinion of management, is deemed in the process of collection. Interest income on nonaccrual loans is recorded on a cash basis. Payments may be treated as interest income or return of principal depending upon management's opinion of the ultimate risk of loss on the individual loan. Cash payments are treated as interest income where management believes the remaining principal balance is fully collectible. Additional loans not 90 days past due may also be placed on nonaccrual status if management reasonably believes the borrower will not be able to comply with the contractual loan repayment terms and collection of principal or interest is in question. A "restructured loan" is a loan on which interest accrues at a below market rate or upon which certain principal has been forgiven so as to aid the borrower in the final repayment of the loan, with any interest previously accrued, but not yet collected, being reversed against current income. Interest is reported on a cash basis until the borrower's ability to service the restructured loan in accordance with its terms is established. The Company had no restructured loans as of the dates indicated in the table below. The following table summarizes the Company's nonperforming assets at the dates indicated. AT DECEMBER 31, AT SEPTEMBER 30, -------------------------------------------------------- 1997 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- ---- (IN THOUSANDS) Nonaccrual loans $2,003 $4,968 $4,626 $653 $1,019 $1,064 Accruing loans past due 90 days or more 178 600 224 46 64 145 ------ ------ ------ ---- ------ ------ Total nonperforming loans 2,181 5,568 4,850 699 1,083 1,209 Repossessed Automobiles 147 - - - - - Other real estate owned 81 1,466 47 - - 676 ------ ------ ------ ---- ------ ------ Total nonperforming assets $2,409 $7,034 $4,897 $699 $1,083 $1,885 ------ ------ ------ ---- ------ ------ ------ ------ ------ ---- ------ ------ Interest income on loans on nonaccrual status during the nine months ended September 30, 1997, and the year ended December 31, 1996, that would have been recognized if the loans had been current in accordance with their original terms was approximately $231,000 and $497,000, respectively. In 1995, 1994, 1993 and 1992, the amounts of such interest income were not material. At September 30, 1997, nonperforming assets represented .70% of total assets, and nonperforming loans represented 1.05% of total loans. Nonperforming loans that were secured by first deeds of trust on real property were $416,000 at September 30, 1997, $3,626,000 at December 31, 1996, $3,286,000 at December 31, 1995 and $422,000 at December 31, 1994. Other forms of collateral such as inventory and equipment secured the remaining nonperforming loans as of each date. No assurance can 17 be given that the collateral securing nonperforming loans will be sufficient to prevent losses on such loans. The decrease in nonperforming loans and nonperforming assets as of September 30, 1997 compared with their levels as of December 31, 1996, was due primarily to the write-off of a commercial real estate development loan with a balance of $3,458,000 (mentioned below) and the sale of one agricultural parcel previously acquired through foreclosure. The increase in nonperforming assets at December 31, 1996 from the level at December 31, 1995 was attributable primarily to a commercial real estate loan a purchased portfolio of lease receivables being placed on nonaccrual status and two agricultural real estate properties acquired through foreclosure. In late 1995, a commercial real estate development loan was placed on nonaccrual status. This loan is secured by a second lien (subject to the first lien of project-related municipal development bonds and taxes and assessments) on 10 improved commercial lots and one commercial building and by a second lien on two fully occupied commercial buildings in Sonora, California, and is guaranteed by the principals of the borrowing entity. The owner is developing the property as an office park. The Company had specifically allocated $1,725,000 of its allowance for loan losses as of March 31, 1997 to this loan. See "--Allowance and Provisions for Loan Losses." In the second quarter of 1997, the project funded by the loan become involved in litigation among other parties, and development was suspended for an undetermined period. Without the imminent prospect for completion of the project, the Company made the judgment that its collateral position, subordinate in large part to bonds used to finance the project, should conservatively not be accorded any value and accordingly charged off the entire balance of the loan of $3,458,000. The Company will nonetheless vigorously pursue efforts to realize a potential recovery on the loan. County Bank purchased a portfolio of lease receivables in 1994. The company that packages and sells these leases to financial institutions filed a Chapter 11 reorganization in April 1996 and its chief financial officer has been charged by the Commission with participating in securities fraud. More than 360 banks nationwide had acquired similar lease receivable contracts. The Bank had $1,281,000 of these leases on nonaccrual status as of December 31, 1996. On February 12, 1997, County Bank signed a settlement agreement in regards to this portfolio of leases that established a projected recovery rate at 78.5% or approximately $1,006,000. On March 31, 1997, the Bank charged off $275,000 against its allowance for loan losses and the remaining balance of $1,006,000 remains on nonaccrual. The projected recovery may not be achieved and is subject to uncertainties, including the risk that the delinquency rate in the portfolio might increase, that information that has been provided to the Company by third parties about the likelihood of repayment may prove to be incorrect, that additional fraudulent leases may be discovered in the portfolio or that administrative expenses of the bankruptcy with priority over the Company may exceed estimates on which the recovery projections are based. Any of these uncertainties could reduce, in part or entirely, the amount that the Company recovers on this portfolio. At September 30, 1997, the Company had $81,000 in one condominium property acquired through foreclosure during September, 1997. This property is carried at the lower of its estimated market value, as evidenced by an independent appraisal, or the recorded investment in the related loan, less estimated selling expenses. At foreclosure, if the fair value of the real estate is less than the Company's recorded investment in the related loan, a charge is made to the allowance for loan losses. The Company does not expect to sell this property during 1997. No assurance can be given that the Company will sell such property at any time or the amount for which such property might be sold. 18 In addition to property acquired through foreclosure, the Company has investments in residential real estate lots in various stages of development in Merced County through MAID. MAID held two separate properties for sale or development at September 30, 1997. These investments were completely written off in 1995, although County Bank still retains title to these properties. In the second quarter of 1997, two parcels and four lots were sold for a pre-tax gain of $511,000. The Bank closely monitors its loans classified "Substandard" or "Doubtful" by the regulatory agencies. In March 1997, in response to a 1996 regulatory examination, the Bank committed to reduce loans in the amount of $11,848,000 classified "Substandard" and "Doubtful" at December 2, 1996 to no more than $8,550,000 by June 30, 1997 and to no more than $7,800,000 by December 31, 1997. Such loans totaled $10,362,000 at March 31, 1997 and $11,185,000 at December 31, 1996. At September 30, 1997, such loans totaled $3,804,000. Management defines impaired loans, regardless of past due status on loans, as those on which principal and interest are not expected to be collected under the original contractual loan repayment terms. An impaired loan is charged off at the time management believes the collection process has been exhausted. At September 30, 1997 and December 31, 1996, impaired loans were measured based on the present value of future cash flows discounted at the loan's effective rate, the loan's observable market price or the fair value of collateral if the loan is collateral-dependent. Impaired loans at September 30, 1997 were 1,391,000 (all of which were also nonaccrual loans), on account of which the Company had made provisions to the allowance for loan losses of $536,000. Except for loans that are disclosed above, there were no assets as of September 30, 1997, where known information about possible credit problems of borrower causes management to have serious doubts as to the ability of the borrower to comply with the present loan repayment terms and which may become nonperforming assets. Given the magnitude of the Company's loan portfolio, however, it is always possible that current credit problems may exist that may not have been discovered by management. 19 ALLOWANCE AND PROVISIONS FOR LOAN LOSSES. The following table sets forth an analysis of the allowance for loan losses and provisions for loan losses for the periods indicated. FOR THE NINE MONTHS ENDING FOR THE YEAR ENDING SEPTEMBER 30, DECEMBER 31, --------------------- --------------------------------------------------------- 1997 1996 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- ---- ---- (DOLLARS IN THOUSANDS) Balance at beginning of period $2,792 $1,701 $1,701 $1,621 $1,747 $1,616 $1,699 -------- -------- -------- -------- -------- -------- Due to acquisition - 160 148 - - - - Provision for possible loan losses 3,681 406 1,513 228 - 254 162 Loans charged off Commercial and agricultural 500 116 518 160 206 217 250 Real estate-construction 3,458 - - - - - - Real estate-mortgage - - - - - - - Consumer 406 39 140 63 42 83 109 -------- -------- -------- -------- -------- -------- ------- Total charge-offs 4,364 155 658 223 248 300 359 -------- -------- -------- -------- -------- -------- ------- Recoveries Commercial and agricultural 123 26 27 66 99 145 87 Real estate-construction 1 - - - 8 - - Real estate-mortgage - - - - - - - Consumer 63 10 61 9 15 32 27 -------- -------- -------- -------- -------- -------- ------- Total recoveries 187 36 88 75 122 177 114 -------- -------- -------- -------- -------- -------- ------- Net charge-offs 4,177 119 570 148 126 123 245 -------- -------- -------- -------- -------- -------- ------- Balance at end of period $2,296 $2,148 $2,792 $1,701 $1,621 $1,747 $1,616 -------- -------- -------- -------- -------- -------- ------- -------- -------- -------- -------- -------- -------- ------- Average loans outstanding, gross $193,645 $151,522 $157,098 $120,620 $110,690 $102,236 $91,458 -------- -------- -------- -------- -------- -------- ------- -------- -------- -------- -------- -------- -------- ------- Total loans at end of period, gross $208,465 $175,789 $183,247 $133,736 $113,600 $107,124 $97,335 -------- -------- -------- -------- -------- -------- ------- -------- -------- -------- -------- -------- -------- ------- Net charge-offs/average loans 2.16% .08% 0.36% 0.11% 0.12% 0.12% 0.27% outstanding Allowance at end of period/loans 1.08 1.22 1.52 1.27 1.43 1.63 1.66 outstanding Allowance/nonperforming loans 105.27 34.67 50.14 35.07 231.90 161.31 133.66 The Company maintains an allowance for loan losses at a level considered by management to be adequate to cover the inherent risks of loss associated with its loan portfolio under prevailing and anticipated economic conditions. In determining the adequacy of the allowance for loan losses, management takes into consideration growth trends in the portfolio, examination of financial institution supervisory authorities, prior loan loss experience for the Company, concentrations of credit risk, delinquency trends, general economic conditions, the interest rate environment and internal and external credit reviews. In addition, the risks management considers vary depending on the nature of the loan. The normal risks considered by management with respect to agricultural loans include the fluctuating value of the collateral, changes in weather conditions and the availability adequate water resources in the Company's local market area. The normal risks considered by management with respect to real estate construction loans include fluctuation in real estate values, the demand for improved commercial and industrial properties and housing, the availability of permanent financing in the Company's market area and borrowers' ability to obtain permanent financing. The normal risks considered by management with respect to real estate mortgage loans include fluctuations in the value of real estate. Additionally, the Company relies on data obtained through independent appraisal for significant properties to determine loss exposure on nonperforming loans. 20 The balance in the allowance is affected by the amounts provided from operations, amounts charged off and recoveries of loans previously charged off. The Company recorded provisions for loan losses in the first nine months of 1997 of $3,681,000 compared with $406,000 in the same period of 1996. The increase was due to the implementation of a new methodology for determining its allowance for loan losses (mentioned below) and the need to replenish the allowance following the charge-off of the real estate development loan previously mentioned with a balance of $3,458,000. See "--Nonperforming Assets." The Company made provisions to the allowance of $1,513,000 in the year ended December 31, 1996 compared with $228,000 in 1995 and none in 1994. The increase in loan loss provisions in 1996 was primarily due to increased reserves established for the same commercial real estate development loan, reserves required for a portfolio of lease receivables purchased in 1994 and, to a lesser extent, reserves to support the general loan growth of the Company. The Company's charge-offs, net of recoveries, were $4,177,000 for the nine months ended September 30, 1997 compared with $119,000 for the same nine months in 1996. The increase in charge-offs was primarily due to the charge-off of $3,458,000 for the real estate development loan previously mentioned and a $275,000 charge-off taken on the portfolio of lease receivables previously mentioned. The Company's charge- offs, net of recoveries, were $570,000 in the year ended December 31, 1996 compared with $148,000 in 1995 and $126,000 in 1994. The increase in net charge-offs for the year ended December 31, 1996 was primarily due to the loss recognized on the foreclosure of a real estate secured agricultural loan, the foreclosed real estate was sold in the second quarter of 1997. As of September 30, 1997, the allowance for loan losses was $2,296,000 or 1.08% of total loans outstanding, compared with $2,792,000 or 1.52% of total loans outstanding as of December 31, 1996 and $1,701,000 or 1.27% of total loans outstanding as of December 31, 1995. From 1992 to 1995, loan losses were relatively low and stable. In 1995 and 1996, the Company experienced loan problems and made provisions at levels not previously experienced. In response to regulatory concerns over the Bank's level of nonperforming assets, in March 1997, the Board of Directors of County Bank adopted resolutions under which the Bank committed, among other things, to maintain an adequate allowance for loan losses, to conduct a review prior to and at each quarter of the adequacy of the allowance and to document the basis for changes in the allowance. As a result, the Company concluded that its historical method of determining the appropriate levels for its allowance and provisions for loan losses should be revised. The Company therefore adopted a new methodology of determining the appropriate level of its allowance for loan losses. This method, sometimes known as a migration analysis, applies relevant risk factors to the entire loan portfolio, including nonperforming loans. The methodology is based, in part, on the Bank's loan grading and classification system. The Bank grades its loans through internal reviews and periodically subjects loans to external reviews which then are assessed by the Bank's audit committee. Credit reviews are performed on a monthly basis and the quality grading process occurs on a quarterly basis. The "migration" of loans from grade to grade is then tracked to help predict future losses and thus more accurately set allowance levels. Risk factors applied to the performing loan portfolio are based on the Company's past loss history considering the current portfolio's characteristics, current economic conditions and other relevant factors. General reserves are applied to various categories of loans at percentages ranging up to 1.5% based on the Bank's assessment of credit risks for each category. Risk factors are applied to the carrying value of each classified loan: (i) loans internally graded "Watch" or "Special Mention" carry a risk factor from 1.0% to 2.0%; (ii) "Substandard" loans carry a risk factor from 3% to 40% depending on collateral securing the loan, if any; (iii) "Doubtful" loans carry a 50% risk factor; and (iv) "Loss" loans are charged off 100%. In addition, a portion of the allowance is specially allocated to identified problem credits. The analysis also includes reference to factors such as the delinquency status of the loan portfolio, inherent risk by type of loans, industry statistical data, recommendations made by the Company's regulatory authorities and outside loan reviewers, and current economic environment. Important components of the overall credit rating process are the asset quality rating process and the internal loan review process. 21 The allowance is based on estimates and ultimate future losses may vary from current estimates. It is always possible that future economic or other factors may adversely affect the Company's borrowers, and thereby cause loan losses to exceed the current allowance. In addition, there can be no assurance that future economic or other factors will not adversely affect the Company's borrowers, or that the Company's asset quality may deteriorate through rapid growth, failure to enforce underwriting standards, failure to maintain appropriate underwriting standards, failure to maintain an adequate number of qualified loan personnel, failure to identify and monitor potential problem loans or for other reasons, and thereby cause loan losses to exceed the current allowance. The following table summarizes a breakdown of the allowance for loan losses by loan category and the allocation in each category as a percentage of total loans in each category at the dates indicated: DECEMBER 31, -------------------------------------------- September 30, 1996 1995 ------------- ---- ---- 1997 ---- Amount Amount Amount to total to total to total loans in loans in loans in Amount category Amount category Amount category ------ -------- ------ -------- ------ -------- (DOLLARS IN THOUSANDS) Commercial and agricultural $1,121 1.20% $840 1.17% $944 1.44% Real estate- construction 265 2.21 1,421 10.21 708 5.90 Real estate- mortgage 558 .87 219 .38 -- -- Consumer 352 .90 312 .77 49 .35 ------ ----- ------ ----- ------ ----- Total $2,296 1.09% $2,792 $1,701 ------ ----- ------ ------ ------ ----- ------ ------ DECEMBER 31, ------------------------------------------------------------ 1994 1993 1992 ---- ---- ---- Amount Amount Amount to total to total to total loans in loans in loans in Amount category Amount category Amount category ------ -------- ------ -------- ------ ------- (Dollars in thousands) Commercial and agricultural $898 1.61% $974 1.77% $835 1.46 Real estate- construction 218 1.86 317 3.47 305 4.28 Real estate- mortgage 376 1.08 296 .90 275 1.29 Consumer 129 1.14 160 1.59 201 1.71 ------ ---- ------ ---- ------ ---- Total $1,621 $1,747 $1,616 ------ ------ ------ ------ ------ ------ The allocation of the allowance to loan categories is an estimate by management of the relative risk characteristics of loans in those categories. No assurance can be given that losses in one or more loan categories will not exceed the portion of the allowance allocated to that category or even exceed the entire allowance. 22 LIQUIDITY AND CAPITAL RESOURCES. In order to maintain adequate liquidity, the Company must have sufficient resources available at all times to meet its cash flow requirements. The need for liquidity in a banking institution arises principally to provide for deposit withdrawals, the credit needs of its customers and to take advantage of investment opportunities as they arise. A company may achieve desired liquidity from both assets and liabilities. The Company considers cash and deposits held in other banks, federal funds sold, other short term investments, maturing loans and investments, payments of principal and interest on loans and investments and potential loan sales as sources of asset liquidity. Deposit growth and access to credit lines established with correspondent banks and market sources of funds are considered by the Company as sources of liability liquidity. The Company reviews its liquidity position on a regular basis based upon its current position and expected trends of loans and deposits. These assets include cash and deposits in other banks, available-for-sale securities and federal funds sold. The Company's liquid assets totaled $99,746,000, $63,196,000 and $64,269,000 on September 30, 1997, December 31, 1996, and December 31, 1995, respectively, and constituted 29.1%, 23.8% and 30.7%, respectively, of total assets on those dates. Liquidity is also affected by the collateral requirements of its public deposits and certain borrowings. Total pledged securities were $35,411,000 at September 30, 1997 compared with $16,678,000 at December 31, 1996 and $18,157,000 at December 31, 1995. Although the Company's primary sources of liquidity include liquid assets and a stable deposit base, the Company maintains lines of credit with the Federal Reserve Bank of San Francisco, Federal Home Loan Bank of San Francisco and Pacific Coast Bankers' Bank aggregating $12,822,000, of which $5,000,000 was outstanding as of September 30, 1997 and $105,000 was outstanding as of December 31, 1996. Management believes that the Company maintains adequate amounts of liquid assets to meet its liquidity needs. The Company's liquidity might be insufficient if deposit withdrawals were to exceed anticipated levels. Deposit withdrawals can increase if a company experiences financial difficulties or receives adverse publicity for other reasons, or if its pricing, products or services are not competitive with those offered by other institutions. Capital serves as a source of funds and helps protect depositors against potential losses. The primary source of capital for the Company has been internally generated capital through retained earnings. However, on August 22, 1997 the issuance of an additional 1,725,000 shares of common stock was completed with the Company receiving $17,992,000 in additional capital through a public offering, net of expenses. This additional capital was needed in order to complete the purchase of three Bank of America branches, scheduled to close during the fourth quarter of 1997. The Company's shareholders' equity increased by $18,875,000 or 90% from December 31, 1996 to September 30, 1997. The Company's shareholders' equity increased $5,881,000 in 1996, $1,011,000 in 1995 and $1,449,000 in 1994. The increase in 1996 was the result issuance of $3,969,000 in common stock in the acquisition of Town & Country, net income for the year of $2,009,000, $208,000 in payments upon the exercise of stock options and $162,000 in payments for the issuance of shares pursuant to employee benefit plans. The increases were partially offset by a net reduction in the net unrealized value in the available-for-sale investment portfolio of $381,000 and cash payments of $86,000 paid in lieu of fractional shares on stock dividends and for cash dividends. 23 Federal regulations establish guidelines for calculating risk-adjusted capital ratios. These guidelines establish a systematic approach of assigning risk weights to bank assets and off-balance sheet items making capital requirements more sensitive to differences in risk profiles among banking organizations. Under these regulations, banks and bank holding companies are required to maintain a risk-based capital ratio of 8.0%; that is, "Tier 1" plus "Tier 2" capital must equal at least 8% of risk-weighted assets plus off-balance sheet items, and Tier 1 capital (primarily shareholders' equity) must constitute at least 50% of qualifying capital. Tier 1 capital consists primarily of shareholders' equity excluding good will, and Tier 2 capital includes subordinated debt and, subject to a limit of 1.25% of risk-weighted assets, the allowance for loan losses. It is the Company's intention to maintain risk-based capital ratios at levels characterized as "well capitalized" for banking organizations: Tier 1 risk-based capital of 6% or above and total risk-based capital at 10% or above. As of September 30, 1997 and December 31, 1996 the Company had Tier 1 risk-based capital ratios of 14.54% and 9.04%, respectively, and total risk-based capital ratios of 15.44% and 10.20%, respectively. The increases were due primarily to the additional equity offering that was completed in the third quarter of 1997. In addition, regulators have adopted a minimum leverage capital ratio standard. This standard is designed to ensure that all financial institutions, irrespective of their risk profile, maintain minimum levels of core capital, which by definition excludes the allowance for loan losses. These minimum standards for top-rated institutions may be as low as 3%; however, regulatory agencies have stated that most institutions should maintain ratios at least 1 to 2 percentage points above the 3% minimum. It is the Company's intention to maintain the leverage ratio for County Bank above the 3% minimum for "well capitalized" banks. As of September 30, 1997 and December 31, 1996, the Company's leverage capital ratio equaled 12.07% and 7.39%, respectively. The increase was due primarily to the additional common stock that was issued during the third quarter of 1997. In addition, in March 1997, in response to regulatory concerns about the Bank's level of nonperforming assets, the Bank's Board of Directors adopted a resolution to maintain a ratio of shareholder's equity to total assets of 6.75% upon reducing its loans classified as "Substandard" or "Doubtful" as of December 2, 1996, from $11,800,000 to no more than $8,555,000 by June 30, 1997, and to maintain a ratio of at least 6.50% upon reducing such loans to $7,800,000 by December 31, 1997. 24 The following table sets forth the capital and leverage ratios of Capital Corp and County Bank as the date indicated . At June 30, 1997 -------------------------------------------------------- Tier 1 Risk-Based Total Risk-Based Leverage Ratio Capital Ratio Capital Ratio -------------- ----------------- ---------------- Capital Corp Actual 12.07% 14.54% 15.44% Minimum regulatory requirement for a well-capitalized institution (1) -- 6.00 10.00 Minimum regulatory requirement (2) 4.00-5.00 4.00 8.00 County Bank Actual 10.91% 13.57% 14.49% Minimum regulatory requirement for a well-capitalized institution (1) 5.00 6.00 10.00 Minimum regulatory requirement (2) 4.00-5.00 4.00 8.00 Minimum requirement under resolution of Board of Directors (3) 6.50 -- -- ___________ (1) Minimum capital ratios for well-capitalized bank holding companies and banks established by FRB and FDIC regulations. (2) Minimum capital ratios for bank holding companies and banks under FRB and FDIC regulations. (3) At September 30, 1997, the Bank's total equity to total assets ratio was 11.62% and was above the 6.50% commitment. The ratio differs from the leverage ratio because it is calculated on period-end assets rather than quarterly average assets used above. At September 30, 1997, loans that were classified "Substandard" and "Doubtful" as of December 2, 1996 were reduced to $3.8 million, below both the $8.6 million target level for June 30, 1997 and the $7.8 million target level for December 31, 1997. Accordingly, the Bank's commitment is to maintain a total equity to total assets ratio (based on period-end assets rather than average assets) of no less than 6.50%. Failure to meet minimum capital requirements can trigger mandatory and possibly additional discretionary actions by the regulators that, if undertaken, could have a material effect on the Company's financial statements and operations. EXTERNAL FACTORS AFFECTING ASSET QUALITY. As a result of the Company's loan portfolio mix, the future quality of its assets could be affected by adverse economic trends in its region or in the agricultural community. These trends are beyond the control of the Company. California is an earthquake-prone region. Accordingly, a major earthquake could result in material loss to the Company. At times the Company's service area has experienced other natural disasters such as floods and droughts. As recently as January of 1997, parts of the Company's market area experienced severe flooding. The Company's properties and substantially all of the real and personal property securing loans in the Company's portfolio are located in California. The Company faces the risk that many of its borrowers face uninsured property damage, interruption of their businesses or loss of their jobs from earthquakes, floods or droughts. As a result these borrowers may be unable to repay their loans in accordance with their terms and the collateral for such loans may decline significantly in value. The Company's service areas is a largely agricultural region and therefore is highly dependent on a reliable supply of water for irrigation purposes. The area obtains nearly all of its water from the run-off of melting snow in the mountains of the Sierra Nevada to the east. Although such sources have usually been available in the past, water supply can be adversely affected by light snowfall over one or more winters or by any diversion of water from its present natural courses. Any such natural disaster could impair the ability of many of the Company's borrowers to meet their obligations to the Company. Parts of California experienced significant floods in January 1997. The Company has completed an analysis of its collateral as a result of the recent floods. Current estimates indicate that there were no material adverse effects to the collateral position of the Company as a result of these events. No assurance can be given that future flooding will not have an adverse impact on the Company and its borrowers and depositors. DEPOSITS. Deposits are the Company's primary source of funds. At September 30, 1997, the Company had a deposit mix of 42% in savings deposits, 28% in time deposits, 16% in interest-bearing checking accounts and 14% in noninterest-bearing demand accounts. Noninterest-bearing demand deposits enhance the Company's net interest income by lowering its costs of funds. The Company obtains deposits primarily from the communities it serves. No material portion of its deposits has been obtained from or is dependent on any one person or industry. The Company's business is not seasonal in nature. The Company accepts deposits in excess of $100,000 from customers. These deposits are priced to remain competitive. At September 30, 1997, the Company had no brokered deposits. 26 The following table sets forth the average balances and the average rates paid for the major categories of deposits for the dates indicated: FOR THE YEAR ENDED FOR THE SIX DECEMBER 31, MONTHS ENDED -------------------------------------------------------------------- SEPTEMBER 30, 1997 1996 1995 1994 -------------- ------------ ------------- --------------- AMOUNT % AMOUNT % AMOUNT % AMOUNT % ---------- ----- -------- ----- -------- ----- -------- ----- Noninterest-bearing demand $35,095 - $30,549 - $26,478 - $25,326 _ Interest-bearing demand 36,196 0.91% 29,376 0.91% 26,192 0.91% 25,126 0.94% Savings 114,256 4.08 104,938 4.15 91,509 4.60 66,517 3.45 Time deposits under $100,000 43,285 5.40 34,408 5.26 19,073 4.84 27,259 3.82 Time deposits $100,000 and over 23,986 5.57 6,586 5.43 6,358 5.17 7,160 3.78 -------- ----- -------- ----- -------- ---- -------- ---- Total deposits $252,818 3.44 $205,857 3.87 $169,610 3.98 $151,388 3.05 -------- ----- -------- ----- -------- ---- -------- ---- -------- ----- -------- ----- -------- ---- -------- ---- Maturities of time certificates of deposits of $100,000 or more outstanding at September 30, 1997 and December 31, 1996 are summarized as follows: AT SEPTEMBER 30, 1997 AT DECEMBER 31, 1996 --------------------- -------------------- (IN THOUSANDS) Three months or less $5,158 $2,840 Over three to six months 12,660 2,146 Over six to twelve months 3,754 3,383 Over twelve months 4,033 3,178 ------- ------- Total $25,605 $11,547 ------- ------- ------- ------- The increase in time deposits from December 31, 1996 to September 30, 1997 was attributable to a deposit promotion held in the recently opened Modesto branch offices. IMPACT OF INFLATION The financial statements and related financial information presented in this Prospectus have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance that the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or same magnitude as the price of goods and services. 27 REAL ESTATE DEVELOPMENT ACTIVITIES California law allows state-chartered banks to engage in real estate development activities. The Bank established MAID in 1987 pursuant to this authorization. After changes in federal law effectively required that these activities be divested as prudently as possible but in any event before 1997, MAID reduced its activities and embarked on a plan to liquidate its real estate holdings. In 1995 the uncertainty about the effect of the investment in MAID on the results of future operations caused management to write off its remaining investment of $2,881,000 in real property development. At September 30, 1997, MAID held two real estate projects including improved and unimproved land in various stages of development. MAID continues to develop these projects, and any amounts realized upon sale or other disposition of these assets above their current carrying value of zero will result in noninterest income at the time of such sale or disposition. In the second quarter of 1997, a number of parcels were sold resulting in noninterest income of approximately $511,000. Although the Company expects that sale or disposition of its remaining assets will result in some positive contribution to noninterest income at some time in the future, no assurance can be given as to whether or when such sales or dispositions will be completed or that the amounts, if any, that the Company will ultimately realize on such assets or whether such amounts will exceed the future expenses required to hold and complete development of the projects. The amounts, if any, realized on future disposition of these properties will depend on conditions in the local real estate market and the demand, if any, for new development. The Company's regulatory deadline for completing its divestiture of these assets is December 31, 2000. 28 PART II Item 1. Legal Proceedings. Not Applicable. Item 2. Changes in Securities. Not Applicable. Item 3. Defaults Upon Senior Securities. Not Applicable. Item 4. Submission of Matters to a Vote of Securities Holders. Not Applicable. Item 5. Other Information. Not Applicable. Item 6. Exhibits and Financial Statement Schedules. (a) Exhibits. Exhibits Description of Exhibits - --------- ----------------------- 2.1 Branch Purchase and Assumption Agreement dated June 25, 1997, between County Bank and Bank of America, incorporated by reference from exhibits filed in registration statement on Form S-2, registration no. 333-31193 filed with the Commission July 14, 1997. 3.1 Articles of Incorporation, incorporated by reference from (filed as Exhibit 3.1 of the Company's September 30, 1996 Form 10Q filed with the SEC on or about November 14, 1996). 3.2 Bylaws (filed as Exhibit 3.2 of the Company's September 30, 1996 Form 10Q filed with the SEC on or about November 14, 1996.) 10.1 Lease Agreement for Downtown Merced Branch (filed as exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.2 Lease Agreement for Administrative Offices (filed as exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 29 10.3 Lease Agreement for Los Banos Branch (filed as exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.4 Architectural Agreement for Administrative Office (filed as exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.5 Lease Agreement for Sonora Branch (filed as exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.6 1992 Stock Option Plan (filed as exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.7 Agreement and Plan of Acquisition dated as of March 22, 1996, between the Company and Town & Country Finance and Thrift Company (filed as exhibit 2.1 to the Company's Registration Statement on Form S-4 filed on April 3, 1996 (Registration No. 333-03174) and incorporated herein by reference). 10.8 Employment Agreement between Thomas T. Hawker and County Bank (filed as exhibit 10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference). 11 Statement re computation of earnings per share, included in notes to the consolidated financial statements for the period ending September 30, 1997. (b) Financial Statement Schedules. Not applicable. 30 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CAPITAL CORP OF THE WEST (Registrant) By /S/ THOMAS T. HAWKER --------------------- Thomas T. Hawker President and Chief Executive Officer By /S/ JANEY E. BOYCE --------------------- Janey E. Boyce Principal Financial Officer Dated: November 13, 1997 EXHIBIT INDEX. Exhibits Description of Exhibits -------- ----------------------- 2.1 Branch Purchase and Assumption Agreement dated June 25, 1997, between County Bank and Bank of America, incorporated by reference from exhibits filed in registration statement on Form S-2, registration no. 333-31193 filed with the Commission July 14, 1997. 3.1 Articles of Incorporation, incorporated by reference from (filed as Exhibit 3.1 of the Company's September 30, 1996 Form 10Q filed with the SEC on or about November 14, 1996). 3.2 Bylaws (filed as Exhibit 3.2 of the Company's September 30, 1996 Form 10Q filed with the SEC on or about November 14, 1996.) 10.1 Lease Agreement for Downtown Merced Branch (filed as exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.2 Lease Agreement for Administrative Offices (filed as exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.3 Lease Agreement for Los Banos Branch (filed as exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.4 Architectural Agreement for Administrative Office (filed as exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.5 Lease Agreement for Sonora Branch (filed as exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.6 1992 Stock Option Plan (filed as exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.7 Agreement and Plan of Acquisition dated as of March 22, 1996, between the Company and Town & Country Finance and Thrift Company (filed as exhibit 2.1 to the Company's Registration Statement on Form S-4 filed on April 3, 1996 (Registration No. 333-03174) and incorporated herein by reference). 31 10.8 Employment Agreement between Thomas T. Hawker and County Bank (filed as exhibit 10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference). 11 Statement re computation of earnings per share, included in notes to the consolidated financial statements for the period ending September 30, 1997. 32