UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1998
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number: 0-28938
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Coast Bancorp
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
California 77-0401327
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
740 Front Street, Santa Cruz, California 95060
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(Address of principal executive offices) (Zip Code)
(408) 458-4500
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
/X/ Yes / / No
No. of shares of Common Stock outstanding on November 5, 1998: 2,383,679
---------
COAST BANCORP
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
PART I
Page
Item 1. Financial Statements 1
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 5
PART II
Item 1. Legal Proceedings 18
Item 2. Changes in Securities 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
PART I
Item 1. Financial Statements
COAST BANCORP
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- -----------
ASSETS (unaudited)
Cash and due from banks $ 16,287,000 $ 15,853,000
Federal funds sold 37,000,000 15,000,000
------------ ------------
Total cash and equivalents 53,287,000 30,853,000
Securities available-for-sale, at fair value 98,890,000 80,466,000
Loans:
Commercial 39,748,000 42,838,000
Real estate - construction 20,413,000 21,376,000
Real estate - term 87,299,000 76,101,000
Installment and other 4,502,000 6,112,000
------------ ------------
Total loans 151,962,000 146,427,000
Unearned income (3,161,000) (2,349,000)
Allowance for credit losses (3,776,000) (3,609,000)
------------ ------------
Net loans 145,025,000 140,469,000
Bank premises and equipment, net 2,412,000 2,045,000
Other real estate owned 197,000 112,000
Accrued interest receivable and other assets 8,687,000 7,560,000
------------ ------------
TOTAL ASSETS $308,498,000 $261,505,000
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Non-interest bearing demand $ 66,184,000 $ 66,812,000
Interest-bearing demand 96,643,000 76,123,000
Savings 49,003,000 23,942,000
Time 53,548,000 34,320,000
------------ ------------
Total deposits 265,378,000 201,197,000
Other borrowings 10,656,000 30,070,000
Accrued expenses and other liabilities 3,223,000 2,474,000
--------------- --------------
Total liabilities 279,257,000 233,741,000
STOCKHOLDERS' EQUITY:
Preferred stock - no par value;
10,000,000 shares authorized; no shares issued -- --
Common stock - no par value; 20,000,000 shares authorized;
shares outstanding: 2,372,679 in 1998 and 2,203,659 in 1997 20,253,000 11,011,000
Retained earnings 8,044,000 16,060,000
Accumulated other comprehensive income 944,000 693,000
------------ ------------
Total stockholders' equity 29,241,000 27,764,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $308,498,000 $261,505,000
------------ ------------
------------ ------------
See notes to unaudited consolidated financial statements
-1-
COAST BANCORP
CONSOLIDATED INCOME STATEMENTS
(unaudited)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
---------------------------- --------------------------
1998 1997 1998 1997
------------ ----------- ----------- ----------
Interest Income:
Loans, including fees $ 4,125,000 $ 3,718,000 $12,495,000 $10,570,000
Federal funds sold 596,000 304,000 949,000 980,000
Securities:
Taxable 1,306,000 1,201,000 3,757,000 3,397,000
Nontaxable 191,000 82,000 523,000 248,000
----------- ----------- ----------- -----------
Total interest income 6,218,000 5,305,000 17,724,000 15,195,000
Interest expense:
Deposits 1,571,000 1,058,000 4,018,000 3,039,000
Other borrowings 258,000 371,000 990,000 1,041,000
----------- ----------- ----------- -----------
Total interest expense 1,829,000 1,429,000 5,008,000 4,080,000
----------- ----------- ----------- -----------
Net interest income 4,389,000 3,876,000 12,716,000 11,115,000
Provision for credit losses 75,000 75,000 225,000 375,000
----------- ----------- ----------- -----------
Net interest income after provision for credit losses 4,314,000 3,801,000 12,491,000 10,740,000
Noninterest income:
Gain on sale of loans 599,000 252,000 1,895,000 905,000
Customer service fees 460,000 471,000 1,368,000 1,427,000
Loan servicing fees 255,000 270,000 750,000 792,000
Gains (losses) on securities sales 1,000 (10,000) 13,000 (10,000)
Other 172,000 177,000 528,000 489,000
----------- ----------- ----------- -----------
Total noninterest income 1,487,000 1,160,000 4,554,000 3,603,000
Noninterest expenses:
Salaries and benefits 1,672,000 1,381,000 4,773,000 4,168,000
Occupancy 297,000 253,000 859,000 867,000
Equipment 276,000 319,000 828,000 726,000
Stationery and postage 106,000 84,000 299,000 267,000
Insurance 47,000 61,000 163,000 148,000
Legal fees 22,000 23,000 68,000 68,000
Other 693,000 636,000 2,047,000 1,883,000
----------- ----------- ----------- -----------
Total noninterest expenses 3,113,000 2,757,000 9,037,000 8,127,000
----------- ----------- ----------- -----------
Income before income taxes 2,688,000 2,204,000 8,008,000 6,216,000
Provision for income taxes 1,120,000 879,000 3,327,000 2,508,000
----------- ----------- ----------- -----------
Net income $ 1,568,000 $ 1,325,000 $ 4,681,000 $ 3,708,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Earnings per share:
Basic $ .65 $ .55 $ 1.94 $ 1.53
Diluted $ .63 $ .53 $ 1.89 $ 1.50
See notes to unaudited consolidated financial statements
-2-
COAST BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1998 1997
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,681,000 $ 3,708,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for credit losses 225,000 375,000
Depreciation and amortization 88,000 112,000
Gains on securities transactions (13,000) (10,000)
Deferred income taxes 100,000 (306,000)
Proceeds from loan sales 60,028,000 34,710,000
Origination of loans held for sale (63,509,000) (39,369,000)
Accrued interest receivable and other assets (1,228,000) 616,000
Accrued expenses and other liabilities 749,000 411,000
Increase in unearned income 1,582,000 998,000
Other - net (252,000) 30,000
------------- -------------
Net cash provided by operating activities 2,451,000 1,275,000
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available-for-sale 25,418,000 5,552,000
Proceeds from maturities of securities 15,787,000 12,027,000
Purchases of securities available-for-sale (59,498,000) (27,064,000)
Net increase in loans (2,111,000) (3,656,000)
Purchases of bank premises and equipment (925,000) (382,000)
------------- -------------
Net cash (used in) investing activities (21,329,000) (13,523,000)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from securities sold under
agreements to repurchase (19,414,000) 4,242,000
Net increase in deposits 64,181,000 12,710,000
Payment of cash dividends (983,000) (764,000)
Repurchase of common stock (2,651,000) (130,000)
Exercise of stock options 186,000 --
Payment of fractional shares resulting from stock dividend (7,000) --
------------- -------------
Net cash provided by financing activities 41,312,000 16,058,000
------------- -------------
Net increase in cash and equivalents 22,434,000 3,810,000
------------- -------------
Cash and equivalents, beginning of period 30,853,000 37,992,000
------------- -------------
Cash and equivalents, end of period $ 53,287,000 $ 41,802,000
------------- -------------
------------- -------------
OTHER CASH FLOW INFORMATION - CASH PAID DURING THE PERIOD FOR:
Interest $ 4,907,000 $ 3,945,000
Income taxes 3,146,000 1,586,000
NON-CASH INVESTING AND FINANCING TRANSACTIONS:
Additions to other real estate owned $ 85,000 $ --
See notes to unaudited consolidated financial statements
-3-
COAST BANCORP
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED SEPTEMBER 30, 1998 and 1997
- -------------------------------------------------------------------------------
1. BASIS OF PRESENTATION - These financial statements reflect, in
management's opinion, all adjustments, consisting of adjustments of a
normal recurring nature, which are necessary for a fair presentation of
Coast Bancorp's financial position and results of operations and cash
flows for the periods presented. The results of interim periods are not
necessarily indicative of results of operations expected for the full
year. These financial statements should be read in conjunction with the
audited financial statements for 1997 included in the Company's Form 10-K.
2. NET EARNINGS PER SHARE AND STOCK DIVIDEND- Basic earnings per share is
computed by dividing net income by the number of weighted average common
shares outstanding. Diluted earnings per share reflects potential dilution
from outstanding stock options, using the treasury stock method. The number
of weighted average shares used in computing basic and diluted net income
per share are as follows:
Three months ended September 30,
-----------------------------------
1998 1997
---- ----
Basic shares 2,398,079 2,424,025
Dilutive effect of stock options 75,778 54,100
-----------------------------------
Diluted shares 2,473,857 2,478,125
-----------------------------------
Nine months ended September 30,
-----------------------------------
1998 1997
---- ----
Basic shares 2,407,767 2,427,172
Dilutive effect of stock options 70,502 51,146
-----------------------------------
Diluted shares 2,478,269 2,478,318
-----------------------------------
On April 15, 1998, the Board of Directors declared a 10% stock dividend paid
on May 27, 1998.
3. NEW ACCOUNTING PRONOUNCEMENTS - Effective January 1, 1998, the Company
adopted Statement of Financial Accounting Standards No. 130 "Reporting
Comprehensive Income," (SFAS No. 130). This Statement requires that all
items recognized under accounting standards as components of comprehensive
income be reported in an annual financial statement that is displayed with
the same prominence as other financial statements. Annual financial
statements for prior periods will be reclassified, as required. The
Company's source of other comprehensive income is unrealized gains and
losses on securities available-for-sale. Total comprehensive income was as
follows:
Three Months Ended
September 30,
-----------------------------------
1998 1997
-----------------------------------
Net income $1,568,000 $1,325,000
Other comprehensive income 341,000 199,000
-----------------------------------
Total comprehensive income $1,909,000 $1,524,000
-----------------------------------
Nine Months Ended
September 30,
-----------------------------------
1998 1997
-----------------------------------
Net income $4,681,000 $3,708,000
Other comprehensive income 251,000 264,000
Total comprehensive income $4,932,000 $3,972,000
-----------------------------------
-4-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Net income for the three months ended September 30, 1998 was $1,568,000
compared to $1,325,000 during the same period in 1997, representing an
increase of 18%. Net income for the nine months ended September 30, 1998 was
$4,681,000 compared to $3,708,000 for the prior year period. The increase
in net income during 1998 was primarily due to increases in net interest
income and noninterest income partially offset by an increase in
noninterest expenses and a related increase in income tax expense.
EARNINGS SUMMARY
NET INTEREST INCOME
Net interest income refers to the difference between interest and fees earned
on loans and investments and the interest paid on deposits and other borrowed
funds. It is the largest component of the net earnings of a financial
institution. The primary factors to consider in analyzing net interest
income are the composition and volume of earning assets and interest-bearing
liabilities, the amount of noninterest bearing liabilities and nonaccrual
loans, and changes in market interest rates.
Table I sets forth average balance sheet information, interest income and
expense, average yields and rates, and net interest income and net interest
margin for the three and nine months ended September 30, 1998 and 1997.
-5-
Table I Components of Net Interest Income
Three months ended September 30, 1998 1997
-------------------------------- -------------------------------
Average Average Average Average
(Dollars in thousands) Balance Interest Rate(4) Balance Interest Rate(4)
---------- -------- ------- ---------- -------- -------
Assets:
Loans (2) (3) $ 148,602 $ 4,126 11.1% $ 131,364 $ 3,718 11.3%
Investment securities:
Taxable 78,113 1,306 6.7% 71,025 1,201 6.8%
Nontaxable (1) 14,192 290 7.8% 5,905 124 8.4%
Federal funds sold 42,560 596 5.6% 22,123 304 5.5%
--------- ------- --------- --------
Total earning assets 284,187 6,318 8.9% 222,901 15,323 9.3%
Cash and due from banks 18,177 17,575
Allowance for credit losses (3,723) (3,522)
Unearned income (2,899) (1,853)
Bank premises and equipment, net 2,376 2,003
Other assets 9,049 7,340
--------- ---------
Total assets $ 307,167 $ 251,960
--------- ---------
--------- ---------
Interest-bearing liabilities:
Deposits:
Demand $ 91,787 476 2.1% $ 77,794 408 2.1%
Savings 42,090 435 4.1% 27,709 261 3.8%
Time 53,938 660 4.9% 32,393 389 4.8%
--------- ------- --------- --------
Total deposits 187,815 1,571 3.4% 137,896 1,058 3.1%
Borrowed funds 20,079 258 5.1% 26,763 371 5.5%
--------- ------- --------- --------
Total interest-bearing liabilities 207,894 1,829 3.5% 164,659 1,429 3.5%
Demand deposits 68,317 59,261
Other liabilities 3,174 2,223
Stockholders' equity 27,782 25,817
--------- ---------
Total liabilities and stockholders' equity $ 307,167 $ 251,960
--------- ---------
--------- ---------
Net interest income and margin $ 4,489 6.3% $ 3,918 6.8%
-------- ----- -------- -------
-------- ----- -------- -------
(1) Tax exempt income includes $99,000 and $42,000 in 1998 and 1997,
respectively, to adjust to a fully taxable equivalent basis using the federal
statutory rate of 34%.
(2) Loan fees totaling $281,000 and $294,000 are included in loan interest
income for the three months ended September 30, 1998 and 1997, respectively.
(3) Average nonaccrual loans totaling $58,000 and $280,000 are included in
average loans for the three months ended September 30, 1998 and 1997,
respectively.
(4) Annualized
-6-
Table I Components of Net Interest Income
Nine months ended September 30, 1998 1997
-------------------------------- --------------------------------
Average Average Average Average
(Dollars in thousands) Balance Interest Rate(4) Balance Interest Rate(4)
---------- -------- ------- ---------- -------- -------
Assets:
Loans (2) (3) $ 149,662 $12,496 11.1% $ 125,665 $10,570 11.2%
Investment securities:
Taxable 75,573 3,757 6.6% 67,043 3,397 6.8%
Nontaxable (1) 13,423 792 7.9% 5,912 376 8.5%
Federal funds sold 23,376 949 5.4% 24,281 980 5.4%
--------- ------- --------- --------
Total earning assets 262,034 17,994 9.2% 222,901 15,323 9.2%
Cash and due from banks 17,901 16,260
Allowance for credit losses (3,682) (3,404)
Unearned income (2,666) (1,799)
Bank premises and equipment, net 2,202 2,089
Other assets 8,983 7,437
--------- ---------
Total assets $ 284,772 $ 243,484
--------- ---------
--------- ---------
Interest-bearing liabilities:
Deposits:
Demand $ 83,348 1,265 2.0% $ 75,737 1,145 2.0%
Savings 32,318 957 3.9% 30,856 872 3.8%
Time 49,796 1,796 4.8% 29,692 1,021 4.6%
--------- ------- --------- --------
Total deposits 165,462 4,018 3.2% 136,285 3,038 3.0%
Borrowed funds 25,201 990 5.2% 25,906 1,041 5.4%
--------- ------- --------- --------
Total interest-bearing liabilities 190,663 5,008 3.5% 162,191 4,079 3.4%
Demand deposits 63,064 54,764
Other liabilities 2,865 1,995
Stockholders' equity 28,180 24,484
--------- ---------
Total liabilities and stockholders' equity $ 284,772 $ 243,484
--------- ---------
--------- ---------
Net interest income and margin $12,986 6.6% $11,244 6.7%
-------- ----- -------- -------
-------- ----- -------- -------
(1) Tax exempt income includes $269,000 and $128,000 in 1998 and 1997,
respectively, to adjust to a fully taxable equivalent basis using
the federal statutory rate of 34%.
(2) Loan fees totaling $950,000 and $808,000 are included in loan interest
income for the nine months ended September 30, 1998 and 1997, respectively.
(3) Average nonaccrual loans totaling $243,000 and $220,000 are included in
average loans for the nine months ended September 30, 1998 and 1997,
respectively.
(4) Annualized
-7-
For the three months ended September 30, 1998, net interest income, on a
fully taxable-equivalent basis, was $4,489,000 or 6.3% of average
earning assets, an increase of 15% over $3,918,000 or 6.8% of average
earning assets in the comparable period in 1997. For the nine months ended
September 30, 1998, net interest income, on a fully taxable-equivalent
basis, was $12,986,000 or 6.6% of average earning assets, an increase of
15% over $11,244,000 or 6.7% of average earning assets in the comparable
period in 1997. The increase in 1998 reflects higher levels of earning
assets.
Interest income, on a fully taxable-equivalent basis, was $6,318,000 and
$5,347,000 for the three months and $17,994,000 and $15,323,000 for the nine
months ended September 30, 1998 and 1997, respectively. The increase in
1998 resulted from the growth in average earning assets. Loan yields
averaged 11.1% and 11.3% for the three months ended September 30, 1998 and
1997, respectively, and 11.1% and 11.2% for the nine months of 1998 and
1997. Approximately 89% of the Bank's loans have variable interest rates
indexed to the prime rate. The Bank's average prime rate was 8.50% for each
of the three month periods ended September 30, 1998 and 1997, and 8.50% and
8.42% for the nine months ended September 30, 1998 and 1997, respectively.
Average earning assets were $284,187,000 and $262,034,000 for the three and
nine months of 1998 compared to $230,417,000 and $222,901,000 for the same
periods in 1997. The growth in average earning assets resulted from
increased levels of deposits which were invested in loans, securities and
federal funds sold.
The increase in interest income during 1998 on a fully taxable-equivalent
basis, was partially offset by an increase in interest expense. The average
rate paid on interest bearing deposits was 3.5% in each of the three month
periods ended September 30, 1998 and 1997, and 3.5% and 3.4% for the nine
months ended September 30, 1998 and 1997, respectively.
-8-
NONINTEREST INCOME
Table 2 summarizes the sources of noninterest income for the periods indicated:
Table 2 - Noninterest Income
(Dollars in thousands)
Three months ended September 30,
-------------------------------
1998 1997
---------- ----------
Gain on sale of loans $ 599 $ 252
Customer service fees 460 471
Loan servicing fees 255 270
Gains (losses)on securities transactions 1 (10)
Other 172 177
---------- ----------
Total noninterest income $1,487 $1,160
---------- ----------
---------- ----------
Nine months ended September 30,
-------------------------------
1998 1997
---------- ----------
Gain on sale of loans $1,895 $ 905
Customer service fees 1,368 1,427
Loan servicing fees 750 792
Gains (losses) on securities transactions 13 (10)
Other 528 489
---------- ----------
Total noninterest income $4,554 $3,603
---------- ----------
---------- ----------
Gains on sale of loans increased as a result of a higher volume of Small
Business Administration (SBA) loans sold during 1998. The Company sells SBA
loans and FHLMC conforming mortgage loans with SBA loan sales providing the
primary source of gains on sale. The decrease in customer service fees in 1998
relates primarily to lower levels of fees from returned items. Loan servicing
fees declined due to the amortization of increased servicing assets resulting
from the loan sales. Other noninterest income increased consistent with the
growth of deposits.
-9-
NONINTEREST EXPENSES
The major components of noninterest expenses stated in dollars and as a
percentage of average earning assets are set forth in Table 3 for the periods
indicated.
Table 3 - Noninterest Expenses
(Dollars in thousands)
Three months ended September 30,
-------------------------------------
1998 1997
----------------- ------------------
Salaries and benefits $1,672 2.35% $1,381 2.40%
Occupancy 297 0.42% 253 0.44%
Equipment 276 0.39% 319 0.55%
Stationery and postage 106 0.15% 84 0.15%
Insurance 47 0.07% 61 0.11%
Legal fees 22 0.03 23 0.04%
Other 693 0.98% 636 1.10%
----------------- -----------------
Total noninterest expenses $3,113 4.38% $2,757 4.79%
----------------- -----------------
----------------- -----------------
Nine months ended September 30,
-------------------------------------
1998 1997
----------------- ------------------
Salaries and benefits $4,773 2.43% $4,168 2.49%
Occupancy 859 0.44% 726 0.43%
Equipment 828 0.42% 867 0.52%
Stationery and postage 299 0.15% 267 0.16%
Insurance 163 0.08% 148 0.09%
Legal fees 68 0.03 68 0.04%
Other 2,047 1.04% 1,883 1.13%
----------------- -----------------
Total noninterest expenses $9,037 4.60% $8,127 4.86%
----------------- -----------------
----------------- -----------------
The increases in 1998 were primarily related to higher staff costs and
increases in other noninterest expenses. The increase in noninterest
expenses reflects the additional leased space for the customer service/data
processing center and new branch as well as the growth in total loans,
deposits and assets. The decrease in noninterest expense as a percentage of
average earning assets is the result of the rate of growth in average earning
assets in 1998 exceeding the rate of increase in noninterest expenses.
INCOME TAXES
The Company's effective tax rate was 41.7% and 41.5% for the three and nine
months ended September 30, 1998 compared to 39.9% and 40.3% for the
comparable periods in 1997. Changes in the effective tax rate for the
Company are primarily due to fluctuations in the proportion of tax exempt
income generated from investment securities to pre-tax income.
BALANCE SHEET ANALYSIS
Total assets increased to $308.5 million at September 30, 1998, a 18%
increase from the end of 1997. Based on average balances, third quarter 1998
average total assets of $307.2 million represent an increase of 22% over the
third quarter 1997 while nine month 1998 average total assets of $284.8
million represent an increase of 17% over nine months 1997.
-10-
EARNING ASSETS
LOANS
Total gross loans at September 30, 1998 were $152.0 million, a 3.8% increase
from $146.4 million at December 31, 1997. Average loans in the three and
nine months of 1998 were $148,602,000 and $149,662,000 representing an
increases of 13% and 19% over the comparable period in 1997. At September 30,
1998 loans available for sale were $15,846,000 compared to $12,365,000 at
December 31, 1997 and $10,048,000 at September 30, 1997. The 1998 increases
in average total loans and loans available for sale reflected growth in real
estate loans, particularly SBA guaranteed commercial real estate loans and
residential mortgage loans, which in the opinion of the Company is due to
improved local economic conditions and the level of interest rates. The
origination of loans available for sale is significantly affected by the
level of interest rates and general economic conditions. There can be no
assurance the Company will maintain current origination levels in its SBA and
residential mortgage lending operations as interest rates or economic
conditions change.
Risk Elements
Lending money involves an inherent risk of nonpayment. Through the
administration of loan policies and monitoring of the portfolio, management
seeks to reduce such risks. The allowance for credit losses is an estimate
to provide a financial buffer for losses, both identified and unidentified,
in the loan portfolio.
Nonaccrual Loans, Loans Past Due and OREO
The accrual of interest is discontinued and any accrued and unpaid interest
is reversed when the payment of principal or interest is 90 days past due
unless the amount is well secured and in the process of collection. Income
on such loans is then recognized only to the extent that cash is received and
where the future collection of principal is probable. At September 30, 1998
there were no nonaccrual loans compared to $266,000 or .18% of total loans at
December 31, 1997.
Table 4 presents the composition of nonperforming assets at September 30, 1998.
Table 4 Nonperforming Assets
(dollars in thousands)
September 30,
1998
-------------
Nonperforming assets:
Accruing loans past due 90 days or more $ --
Nonaccrual loans --
------
Total nonperforming loans --
OREO 197
------
Total nonperforming assets $ 197
------
------
Nonperforming loans as a percent of total loans 0.00%
OREO as a percent of total assets 0.06%
Nonperforming assets as a percent of total assets 0.06%
Allowance for credit losses $3,776
As a percent of total loans 2.48%
As a percent of nonaccrual loans n/m%
As a percent of nonperforming loans n/m%
-11-
PROVISION AND ALLOWANCE FOR CREDIT LOSSES
Management has established an evaluation process designed to determine the
adequacy of the allowance for credit losses. This process attempts to assess
the risk of loss inherent in the portfolio by segregating the allowance for
credit losses into three components: "historical losses;" "specific;" and
"margin for imprecision." The "historical losses" and "specific" components
include management's judgment of the effect of current and forecasted
economic conditions on the ability of the Company's borrowers' to repay; an
evaluation of the allowance for credit losses in relation to the size of the
overall loan portfolio; an evaluation of the composition of, and growth
trends within, the loan portfolio; consideration of the relationship of the
allowance for credit losses to nonperforming loans; net charge-off trends;
and other factors. While this evaluation process utilizes historical and
other objective information, the classification of loans and the
establishment of the allowance for credit losses, relies, to a great extent,
on the judgment and experience of management. The Company evaluates the
adequacy of its allowance for credit losses quarterly. It is the policy of
management to maintain the allowance for credit losses at a level adequate
for known and future risks inherent in the loan portfolio. Based on
information currently available to analyze loan loss potential, including
economic factors, overall credit quality, historical delinquency and a
history of actual charge-offs, management believes that the loan loss
provision and allowance are adequate; however, no assurance of the ultimate
level of credit losses can be given with any certainty. Loans are charged
against the allowance when management believes that the collectibility of the
principal is unlikely. An analysis of activity in the allowance for credit
losses is presented in Table 5.
TABLE 5 Allowance for Credit Losses
(Dollars in thousands)
Nine months ended
September 30, 1998
-------------
Total loans outstanding $ 151,961
Average total loans 149,662
Balance, January 1 $ 3,609
Charge-offs by loan category:
Commercial 79
Installment and other 31
Real estate construction --
Real estate-other --
---------
Total charge-offs 110
Recoveries by loan category:
Commercial 26
Installment and other 26
Real estate construction --
Real estate-other --
---------
Total recoveries 52
---------
Net chargeoffs 58
Provision charged to expense 225
---------
Balance, September 30 $ 3,776
---------
---------
Ratios:
Net chargeoffs to average loans 0.04%
Reserve to total loans 2.48%
-12-
OTHER INTEREST-EARNING ASSETS
For the three and nine months ended September 30, 1998, the average balance
of investment securities and federal funds sold totaled $135,585,000 and
$112,372,000, up from $99,043,000 and $97,236,000 for the same periods in
1997. The 1998 increases resulted from deploying additional liquidity in
federal funds sold and investment securities. Additional liquidity was
generated by the excess of the increase in average deposits over the increase
in average loans. Management also uses borrowed funds to increase earning
assets and enhance the Company's interest rate risk profile. During the
first quarter of 1998, the Bank accepted a $15 million certificate of deposit
from the State of California, in part to replace borrowed funds and to
increase earning assets.
FUNDING
Deposits represent the Bank's principal source of funds for investment.
Deposits are primarily core deposits in that they are demand, savings, and
time deposits under $100,000 generated from local businesses and individuals.
These sources represent relatively stable, long term deposit relationships
which minimize fluctuations in overall deposit balances. The Bank has never
used brokered deposits.
Deposits increased $64,181,000 from year-end or 32% to $265,378,000 as of
September 30, 1998. Average total deposits in the three and nine months of
1998 of $256,132,000 and $228,526,000 increased from $197,157,000 and
$197,049,000 in the same periods in 1997.
Another source of funding for the Company is borrowed funds. Typically,
these funds result from the use of agreements to sell investment securities
with a repurchase at a designated future date, also known as repurchase
agreements. Repurchase agreements are conducted with major banks and
investment brokerage firms. The maturity of these arrangements for the Bank
is typically 30 to 90 days.
During the first quarter of 1998, the Bank replaced $10,000,000 of short-term
borrowings with $10,000,000 of borrowings issued by the Federal Home Loan
Bank of San Francisco (FHLBSF) maturing in 5 years at an average cost of
4.99%, callable after one year at the option of the FHLBSF. Additionally,
the Bank issued a $15,000,000 certificate of deposit maturing in three months
to the State of California. The Bank believes the overall effect of these
transactions lowered the effective cost of borrowed funds while increasing
earning assets.
LIQUIDITY
Liquidity management refers to the Bank's ability to provide funds
on an ongoing basis to meet fluctuations in deposit levels as well as the
credit needs and requirements of its clients. Both assets and liabilities
contribute to the Bank's liquidity position. Federal funds lines, short-term
investments and securities, and loan repayments contribute to liquidity,
along with deposit increases, while loan funding and deposit withdrawals
decrease liquidity. The Bank assesses the likelihood of projected funding
requirements by reviewing historical funding patterns, current and forecasted
economic conditions and individual client funding needs. The Bank maintains
informal lines of credit with its correspondent banks for short-term
liquidity needs. These informal lines of credit are not committed facilities
by the correspondent banks and no fees are paid by the Bank to maintain them.
The Bank manages its liquidity by maintaining a majority of its investment
portfolio in liquid investments in addition to its federal funds sold.
Liquidity is measured by various ratios, including the liquidity ratio of net
liquid assets compared to total assets. The Bank targets a minimum of 10%
for this ratio. As of September 30, 1998, this ratio was 33.3%. Other key
liquidity ratios are the ratios of loans to deposits and federal funds sold
to deposits, which were 57.3% and 13.9%, respectively, as of September 30,
1998.
-13-
INTEREST RATE SENSITIVITY
Interest rate sensitivity is a measure of the exposure of the Company's
future earnings due to changes in interest rates. If assets and liabilities
do not reprice simultaneously and in equal volumes, the potential for such
exposure exists. It is management's objective to achieve a near-matched to
modestly asset-sensitive cumulative position at one year, such that the net
interest margin of the Company increases as market interest rates rise and
decreases when short-term interest rates decline.
One quantitative measure of the "mismatch" between asset and liability
repricing is the interest rate sensitivity "gap" analysis. All
interest-earning assets and funding sources are classified as to their
expected repricing or maturity date, whichever is sooner. Within each time
period, the difference between asset and liability balances, or "gap," is
calculated. Positive cumulative gaps in early time periods suggest that
earnings will increase if interest rates rise. Negative gaps suggest that
earnings will decline when interest rates rise. Table 6 presents the gap
analysis for the Company at September 30, 1998. Mortgage backed securities
are reported in the period of their expected repricing based upon estimated
prepayments developed from recent experience.
Table 6 Interest Rate Sensitivity
(Dollars in thousands)
Next day Over three Over one
and within months and and within Over
As of September 30, 1998 Immediately three months within one year five years five years Total
- ---------------------------------------------------------------------------------------------------------------------------------
Rate sensitive assets:
Federal funds sold $ 37,000 $ -- $ -- $ -- $ -- $ 37,000
Investment securities:
Treasury and agency obligations -- 2,500 5,600 1,044 -- 9,144
Mortgage-backed securities -- 2,833 7,654 21,575 26,193 58,255
Municipal securities -- 694 148 3,606 10,593 15,041
Corporate debt securities -- -- -- 1,090 13,879 14,969
Other -- -- -- -- 1,481 1,481
- ---------------------------------------------------------------------------------------------------------------------------------
Total investment securities -- 6,027 13,402 27,315 52,146 98,890
Loans excluding nonaccrual loans 135,394 1,794 1,676 3,792 9,305 151,961
- ---------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive assets $ 172,394 $ 7,821 $ 15,078 $ 31,107 $ 61,451 $ 287,851
- ---------------------------------------------------------------------------------------------------------------------------------
Rate sensitive liabilities:
Deposits:
Money market, NOW, and savings $ 145,646 $ -- $ -- $ -- $ -- $ 145,646
Time certificates -- 33,514 17,182 2,852 -- 53,548
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 145,646 33,514 17,182 2,852 -- 199,194
Borrowings -- -- -- 10,000 -- 10,000
- ---------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive liabilities $ 145,646 $ 33,514 $ 17,182 12,852 -- $ 209,194
- ---------------------------------------------------------------------------------------------------------------------------------
Gap $ 26,748 $ (25,693) $ (2,104) $ 18,255 $ 61,451 $ 78,657
Cumulative gap $ 26,748 $ (1,055) $ (1,049) $ 17,206 $ 78,657
-14-
The Company's positive cumulative total gap results from the exclusion from
the above table of noninterest-bearing demand deposits, which represent a
significant portion of the Company's funding sources. The Company maintains
a minor negative cumulative gap in the over three months and within one year
time period and a positive cumulative gap in all other time periods. The
Company's experience indicates money market deposit rates tend to lag changes
in the prime rate which immediately impact the prime-based loan portfolio.
Even in the Company's negative gap time periods, rising rates result in an
increase in net interest income. Should interest rates stabilize or decline
in future periods, it is reasonable to assume that the Company's net interest
margin, as well as net interest income, may decline correspondingly.
CAPITAL RESOURCES
Management seeks to maintain adequate capital to support anticipated asset
growth and credit risks, and to ensure that the Company and the Bank are in
compliance with all regulatory capital guidelines. The primary source of new
capital for the Company has been the retention of earnings. The Company does
not have any material commitments for capital expenditures as of
September 30, 1998.
The Company pays a quarterly cash dividend on its common stock as part of
efforts to enhance shareholder value. The Company's goal is to maintain a
strong capital position that will permit payment of a consistent cash
dividend which may grow commensurately with earnings growth.
On April 15, 1998, the Board of Directors declared a 10 percent stock
dividend paid on May 27, 1998 to stockholders of record as of May 7, 1998.
During 1997, the Board of Directors approved a stock repurchase program
authorizing open market purchases of up to 3% of the shares outstanding, or
approximately 70,519 shares on a post stock dividend basis, in order to
enhance long term shareholder value. As of September 30, 1998, 70,350 shares
had been purchased under the program.
The Company and the Bank are subject to capital adequacy guidelines issued by
the federal bank regulatory authorities. Under these guidelines, the minimum
total risk-based capital requirement is 10.0% of risk-weighted assets and
certain off-balance sheet items for a "well capitalized" depository
institution. At least 6.0% of the 10.0% total risk-based capital ratio must
consist of Tier 1 capital, defined as tangible common equity, and the
remainder may consist of subordinated debt, cumulative preferred stock and a
limited amount of the allowance for loan losses.
The federal regulatory authorities have established minimum capital leverage
ratio guidelines for state member banks. The ratio is determined using Tier 1
capital divided by quarterly average total assets. The guidelines require
a minimum of 5.0% for a "well capitalized" depository institution.
The Company's risk-based capital ratios were in excess of regulatory
guidelines for a "well capitalized" depository institution as of
September 30, 1998, and December 31, 1997. Capital ratios for the
Company are set forth in Table 7:
Table 7 Capital Ratios
September 30, December 31,
1998 1997
------------ ------------
The Company:
Total risk-based capital ratio 14.9% 16.4%
Tier 1 risk-based capital ratio 13.7% 15.2%
Tier 1 leverage ratio 9.7% 9.8%
The Bank:
Total risk-based capital ratio 14.4% 15.1%
Tier 1 risk-based capital ratio 13.1% 13.9%
Tier 1 leverage ratio 8.6% 9.3%
-15-
YEAR 2000
The approach of the year 2000 presents significant issues for many financial,
information, and operational systems. Many computer systems use only two
digits to refer to a year. This convention could affect date-sensitive
calculations that treat "00" as the year 1900 rather than 2000. Another
issue is that the year 2000 is a leap year and some programs may not properly
provide for February 29, 2000.
The following discussion of the implications of the year 2000 problem for the
Company contains numerous forward-looking statements on inherently uncertain
information. The cost of the project and the date on which the Company plans
to complete the internal year 2000 modifications are based on management's
best estimates, which were derived utilizing a number of assumptions of
future events including the continued availability of internal and external
resources, third party modifications and other factors. However, there can
be no guarantee that these estimates will be achieved and actual results
could differ. Moreover, although management believes it will be able to make
the necessary modifications in advance, there can be no guarantee that the
failure to modify the systems would not have a material adverse impact on the
Company.
READINESS PREPARATION
The Company's plan to address the year 2000 issues includes a process of
inventory, analysis, modification, testing and certification, and
implementation. In 1997 the Company alerted its business customers of the
year 2000 problem and is now assessing the readiness preparations of its
major customers and suppliers. Reviews of the Company's information systems
and information provided by the Company's primary vendors, large customers
and suppliers has not identified any year 2000 readiness issues which appear
to be unresolvable by December 31, 1999.
The Company's major critical information system is its core transaction
processing software which provides transaction processing for loans, deposits
and general ledger. The vendor supplying the Company's core transaction
processing software has provided evidence of year 2000 readiness. Efforts
continue to ascertain the year 2000 readiness of various systems that
integrate information into the core processing software. To date, no
significant information systems have been found not ready for year 2000.
Among the major actions remaining is the testing of the core processing
software and other systems which integrate into the core processing software.
Other purchased software and systems supported by external parties are also
being tested as part of the year 2000 program. In addition, contingency
plans are being developed to reduce the impact of potential events that may
occur. However, there can be no guarantee that the systems of vendors or
customers with which the Company does business will be completed on a timely
basis, or that contingency plans will shield operations from failures that
may occur.
The Company does not significantly rely on embedded technology in its
critical processes. Embedded technology typically controls operations such
as power management and related facilities functions. Year 2000 risks
associated with embedded technology in the Company's facilities appear low.
The Company is reliant on suppliers and customers, and year 2000 issues with
both groups are being addressed. Inquiries regarding year 2000 readiness
plans will be directed to vendors upon whom there is significant reliance and
those vendors found to pose a significant risk will be asked to demonstrate
how that risk will be addressed. Appropriate measures to minimize risk will
be undertaken with those that appear to pose a significant risk.
Replacements may be effected where necessary. The Company, however, has no
viable alternative for some suppliers, such as power distribution and local
telephone companies. These companies are still being monitored and the
results will be used as information for contingency planning. As with all
financial institutions, the Company places a high degree of reliance on the
systems of other institutions, including government agencies, to settle
transactions. Principal settlement methods associated with major payment
systems will be tested as part of their integration with the core processing
system.
The Company is also reliant on its customers to make necessary preparations
for year 2000 so that their business operations will not be interrupted, thus
threatening their ability to honor their financial commitments. Borrowers,
funding sources and large depositors are being reviewed to determine those
with financial volumes sufficiently large to warrant inquiry and assessment
of the year 2000 readiness preparation. Financial volumes include loans and
unused commitments, collected deposit balances, ACH, foreign exchange, etc.
-16-
The population of customers with loans and unused commitments outstanding
("borrowers") pose the highest risk level of concern for any lender. Business
purpose borrowings exceeding $50,000 are being assigned one of three year
2000 risk levels: low, medium or high. Completion of the assignment of risk
is expected in the fourth quarter of 1998.
Ongoing reassessments with risk mitigation plans will be made for all levels
of risk. Customers with low and medium risk will be reassessed annually,
while customers with high risk will be reassessed at least quarterly. The
risk mitigation plan will evaluate whether year 2000 issues will materially
affect the customer's cash flows, asset account values related to its balance
sheet, and/or collateral pledged to the Bank. The risk mitigation plan is
incorporated into the normal credit review process.
COST
Amounts expensed in the first nine months of 1998 were not significant to the
Company's financial position or results of operations. Although the remaining
costs associated with achieving year 2000 compliance have not yet been
determined, management does not believe the amounts expensed during 1998 and
1999 will have a material effect on the Company's financial position, results
of operations or cash flows. In addition, the Company may also replace
certain equipment and software to ensure year 2000 readiness. The cost of the
replacement items will be expensed over the useful lives of those assets.
During the third quarter of 1998 six existing automated teller machines were
replaced with new machines at a cost of approximately $300,000 due in part to
year 2000 issues with the existing equipment. The cost of other identified
replacement items and contingency equipment is estimated at less than
$100,000. Estimated total costs could change as analysis continues.
RISKS
The principal risks associated with the year 2000 problem can be grouped into
three categories. The first is the risk that the Company does not successfully
ready its operations for the next century. The second is the risk of
disruption of the Company's operations due to operational failures of third
parties. The third is the risk of business interruption among fund providers
and obligors such that expected funding and repayment does not take place.
The only risk largely under the Company's control is preparing its internal
operations for the year 2000. The Company, like other financial
institutions, is heavily dependent on its computer systems. The complexity
of these systems and their dependence on one another makes it impossible to
switch to other systems almost immediately as would be necessary if necessary
corrections were not made in advance. Management believes it will be able to
make the necessary corrections in advance.
Failure of third parties may jeopardize Company operations, but how seriously
depends on the nature and duration of such failures. The most serious impact
on the Company operations from suppliers would result if basic services such
as telecommunications, electric power suppliers and services provided by
other financial institutions and governmental agencies were disrupted.
Significant public disclosure of the state of readiness among basic
infrastructure and other suppliers has not generally been available.
Although the Company's inquiries are underway, the Company does not yet have
the information to estimate the likelihood of significant disruptions among
its suppliers.
Operational failures among the Company's sources of major funding, larger
borrowers and capital market counterparties could affect their ability to
continue to provide funding or meet obligations when due. Similar to the
situation outlined above with suppliers, public information has been scant.
Although the Company's inquiries are underway, the Company does not yet have
the information to estimate the likelihood of significant disruptions among
its funding sources and obligors.
PROGRAM ASSESSMENT
Senior management and banking regulators regularly assess the Company's year
2000 preparations. Additionally, a consulting and services firm has been
retained to review and advise senior management on internally developed
testing plans for critical systems.
-17-
CONTINGENCY PLANS
The Company is developing remediation contingency plans and business
resumption contingency plans specific to the year 2000. Remediation
contingency plans address the actions to be taken if the current approach to
remediating a system is falling behind schedule or otherwise appears in
jeopardy of failing to deliver a year 2000 ready system when needed. Business
resumption contingency plans address the actions that would be taken if
critical business functions can not be carried out in the normal manner upon
entering the next century due to system or supplier failure. Most contingent
action plans prepared at this time involve manual processing of transactions.
Given the size, scope and complexity of the Company's operations, manual
processing appears a viable alternative for most information systems other
than the core processing system.
PART II. OTHER INFORMATION
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 Security Holders
Not applicable
Item 5. Other Information
On October 21, 1998, the Coast Bancorp Board of Directors declared
a cash dividend of fourteen cents ($0.14) per share, payable November 25,
1998, to shareholders of record on November 5, 1998.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
Exhibit Number
27 Financial Data Schedule
b. Reports on Form 8-K
Not applicable
-18-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
COAST BANCORP
---------------------------------------
(REGISTRANT)
Date: November 12, 1998
/s/ HARVEY J. NICKELSON
---------------------------------------
Harvey J. Nickelson
President and Chief Executive Officer
/s/ BRUCE H. KENDALL
---------------------------------------
Bruce H. Kendall
Senior Vice President
and Chief Financial Officer
(Principal Financial and Accounting Officer)
-19-