U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to __________ to ________
Commission file number 0-10627
NORTH COUNTY BANCORP
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(Exact name of registrant as specified in its charter)
California 95-3669135
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
444 S. Escondido Boulevard, Escondido, California 92025
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (760) 743-2200
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
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(Title of class)
Check whether the registrant (1) 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
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-X contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
As of March 23, 1999, the aggregate market value of the voting stock held
by non-affiliates of the registrant was approximately $31,883,000.
Shares of Common Stock held by each officer and director and each person
owning more than five percent of the outstanding Common Stock have been excluded
in that such persons may be deemed to be affiliates. This determination of the
affiliate status is not necessarily a conclusive determination for other
purposes.
The number of shares of Common Stock of the registrant outstanding as of
March 23, 1999 was 4,882,705.
Part of Form 10-K
Documents Incorporated by Reference: into which incorporated
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Proxy Statement for the Company's Annual Meeting of Shareholders
to be held June 16, 1999 Part III
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
THE COMPANY
North County Bancorp (the "Company") is a California corporation
registered as a bank holding company under the Bank Holding Company Act of 1956,
as amended (the "BHC Act"), and is headquartered in Escondido, California. The
Company was incorporated in October, 1981 and acquired all of the outstanding
shares of North County Bank (the "Bank") in July, 1982. The Company's only
subsidiary and principal asset is the Bank. The Company exists primarily for the
purpose of holding the stock of its subsidiary, the Bank, and of such other
subsidiaries as it may acquire or establish.
The Company's principal sources of income are dividends from the Bank.
The expenditures of the Company, including (but not limited to) the payment of
dividends to stockholders, if and when declared by the Board of Directors, and
the cost of servicing debt will generally be paid from such payments made to the
Company by the Bank. At December 31, 1998, the Company had consolidated assets
of $337.4 million, deposits of $303.1 million and stockholders' equity of $30.0
million.
The Company's Administrative Offices are located at 444 South Escondido
Boulevard, Escondido, California and its telephone number is (760) 743-2200.
References herein to the "Company" include the Company and the Bank, unless the
context indicates otherwise.
THE BANK
North County Bank, a California state-chartered bank that commenced
operations in June, 1974, conducts its business through nine full-service
branches and one loan production office. Five of the branches are located in San
Diego County in the cities of Escondido, Poway, San Marcos and San Diego, with
the remaining in Riverside County in the cities of Temecula, Murrieta, Beaumont
and Banning. The Bank's loan production office is in Renton, Washington. The
Bank provides a wide range of banking services to small and medium-sized
businesses, real estate construction and development companies, professionals
and individuals located in San Diego and Riverside counties, and offers small
business loans through its loan production office in the Seattle, Washington
area.
The Bank holds no material patents, trademarks, licenses (other than
licenses obtained from bank regulatory authorities), franchises or concessions,
and did not spend any amounts on research and development activities in either
of the Company's last three fiscal years. The Bank owns three subsidiaries; NCB
Joint Venture-1, Inc. and GWB Development, which participated in real estate
development, and NCB Mortgage, all of which are inactive corporations.
RETAIL BANKING SERVICES
DEPOSITS ACCOUNTS
The Bank offers a wide variety of deposit products for the retail
banking market including checking, interest-bearing checking, savings,
certificates of deposit and retirement accounts. As of December 31, 1998, the
Bank had approximately 25,995 retail deposit accounts with a balance of $169.6
million as compared to 22,706 accounts with a balance of $115.4 million at
December 31, 1997. The Bank attempts to attract deposits through its product
mix, pricing, convenient locations, extended hours, and efforts to provide the
highest level of customer service. At December 31, 1998 the Bank's retail
deposits consisted of $25.3 million or 15% in noninterest-bearing demand
deposits, $20.6 million or 12% in interest-bearing demand deposits, $54.2
million or 32% in savings and money market deposits, $6.3 million or 4% in
individual retirement accounts and $63.2 million or 37% in time certificates of
deposit. (See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Financial Condition -Deposits.")
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LOANS
The Bank also offers many types of consumer loans to its customers.
These include new and used automobile, home improvement, home equity, personal
lines of credit, overdraft protection, credit cards and other secured and
unsecured installment and consumer loans. The Bank's consumer loans totaled
approximately $34.2 million and $41.0 million at December 31, 1998 and 1997,
respectively. The Bank also makes construction loans for custom built,
owner-occupied homes, but generally does not offer long term home mortgage
loans. Additionally, the Bank offers its customers FHA Title I home improvement
loans and other home equity loan products, as well as purchasing these types of
loans from other lenders. The Bank generally sells these loans in the secondary
market, generating fee income on the sale. (See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Financial
Condition -- Loans.")
OTHER RETAIL PRODUCTS AND SERVICES
The Bank offers other products and services to its retail customers
which complement its deposit and loan products. These include life insurance
products, including annuities, investments, travelers' checks, safe deposit
boxes, escrow, notary, and collection services. The Bank also has drive-through
facilities with extended hours, provides its customers with access to ATMs and
POS terminals throughout the world and offers a telephone voice response service
which gives customers access to account information 24 hours a day.
BUSINESS BANKING SERVICES
DEPOSIT ACCOUNTS
The Bank offers interest-bearing and noninterest-bearing deposit
accounts designed for small to medium-sized business customers. The services
offered in conjunction with these accounts may include providing currency and
coin, armored car pick-up, courier services, payroll services, credit card
merchant services, document collection and wire transfers. The fees charged for
a business account typically vary with the amount of services provided and the
level of balances the customer keeps on deposit. The Bank relies on marketing
and promotional activities and personal contact by its officers, directors and
employees to develop these customer relationships, emphasizing the Bank's local
ownership and decision making, personal service, community ties and financial
strength. At December 31, 1998 the Bank had approximately 7,350 business deposit
accounts totaling $126.5 million as compared to approximately 7,582 accounts
totaling $129.9 million at December 31, 1997. (See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Financial Condition
- -- Deposits.")
LOANS
The Bank provides secured and unsecured loans and lines of credit for
the operating and expansion needs of businesses, ranging from inventory and
accounts receivable financing to equipment financing and letters of credit.
These loans are generally for terms of one year or less. Significant emphasis is
placed on the borrower's earnings history, capitalization, secondary sources of
repayment (such as accounts receivable) or highly liquid collateral (such as
certificates of deposit or publicly traded stocks or bonds). The Bank also makes
loans to local real estate developers for the construction of entry level to
middle income single family residences and fixed and variable rate loans on
commercial real estate with terms of up to ten years. For customers whose loan
demands exceed the Bank's legal lending limits, the Bank attempts to arrange for
such loans on a participation basis with correspondent banks. Commercial loans
(including commercial real estate loans) and construction loans totaled
approximately $179.8 million and $19.9 million, respectively, at December 31,
1998, compared to $154.6 million and $10.3 million at December 31, 1997,
respectively.
The Bank is also one of the largest lenders of loans guaranteed by the
U.S. Small Business Administration ("SBA") in its market area. SBA loans
generally have maturities ranging from seven to 25 years, often are secured by
commercial real estate and are currently guaranteed up to 80% by the SBA. The
Bank sometimes sells these loans for a premium as there is an active secondary
market for these loans. The Bank originated approximately $29.6 million and
$35.0 million in SBA loans in 1998 and 1997, respectively. The Bank's SBA loan
servicing portfolio, consisting of the guaranteed portion of SBA loans
originated and sold, for which the Bank earns servicing fee income, totaled
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approximately $32.0 million and $42.9 million at December 31, 1998 and 1997,
respectively. (See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Financial Condition -- Loans.")
REAL ESTATE INVESTMENTS
The Company has engaged in direct and indirect real estate development
activities on a selective basis. At December 31, 1996, the Company was involved
in one development project that originated in 1989. The project held one
remaining lot for sale at December 31, 1996, which was sold in January of 1997.
The Company has no plans for future involvement in real estate development
projects.
COMPETITION
The banking business in southern California is highly competitive with
respect to virtually all products and services and has become increasingly so in
recent years. The industry continues to consolidate, and strong, unregulated
competitors have entered the banking market with focused products targeted at
highly profitable customer segments. Many largely unregulated competitors are
able to compete across geographic boundaries and provide customers increasing
access to meaningful alternatives to banking services in nearly all significant
products. These competitive trends are likely to continue.
With respect to commercial bank competitors, the business is largely
dominated by a relatively small number of major banks with many offices
operating over a wide geographical area, which banks have, among other
advantages, the ability to finance wide-ranging and effective advertising
campaigns and to allocate their investment resources to regions of highest yield
and demand.
Several mergers of large regional banks and large savings and loan
associations with major banks, acquisitions of independent banks by major banks,
and the failures of several independent banks in the Company's market area have
significantly increased the presence of large regional banks and have reduced
the number of independent banks competing in the Company's market area. Many of
the major banks operating in the area offer certain services which the Bank does
not offer directly (but some of which the Bank offers through correspondent
institutions). By virtue of their greater total capitalization, such banks also
have substantially higher lending limits than does the Bank(1). Although major
banks have some competitive advantages over small independent banks, the Bank
has actively tried to make the loss of local independent banks a competitive
advantage by soliciting customers who prefer the personal service offered by the
Bank. The Company's promotional activities emphasize the advantages of dealing
with a local bank attuned to the particular needs of the community and relies
heavily upon local promotional activities and personal contact by its officers,
directors, and employees.
In addition to other banks, competitors include savings institutions,
credit unions, and numerous non-banking institutions, such as finance companies,
brokerage firms, mortgage companies and insurance companies. In recent years,
increased competition has also developed from specialized finance and
non-finance companies that offer wholesale finance, credit card, and other
consumer finance services, including on-line banking services and personal
finance software. Strong competition for deposit and loan products affects the
rates of those products as well as the terms on which they are offered to
customers. Mergers between financial institutions have placed additional
pressure on banks within the industry to streamline their operations, reduce
expenses, and increase revenues to remain competitive. Competition has also
intensified due to recently enacted federal and state interstate banking laws,
which permit banking organizations to expand geographically, and the California
market has been particularly attractive to out-of-state institutions.
Technological innovation has also resulted in increased competition in
financial services markets. Such innovation has, for example, made it possible
for non-depository institutions to offer customers automated transfer payment
services that previously have been considered traditional banking products. In
addition, many customers now expect a choice of several delivery systems and
channels, including telephone, mail, home computer, ATMs, self-service branches,
and/or in-store branches. In addition to other banks, the sources of competition
for such products include savings associations, credit unions, brokerage
firms, money market and other mutual funds, asset management groups, finance
and insurance companies, and mortgage banking firms.
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(1) Legal lending limits to each customer are restricted to a percentage of the
Bank's total stockholders' equity, the exact percentage depending upon the
nature of the loan transaction.
3
REGULATION AND SUPERVISION
The Company and the Bank are subject to significant regulation by
Federal and state regulatory bodies. The following discussion of statutes and
regulations is only a brief summary and does not purport to be complete. This
discussion is qualified in its entirety by reference to such statutes and
regulations. No assurance can be given that such statutes or regulations will
not change in the future.
THE COMPANY
The Company is subject to the periodic reporting requirements of
Section 13 of the Securities Exchange Act of 1934 (the "Exchange Act") which
requires the Company to file annual, quarterly and other current reports with
the Securities and Exchange Commission (the "Commission"). The Company is also
subject to additional regulations including, but not limited to, the proxy and
tender offer rules promulgated by the Commission under Sections 13 and 14 of the
Exchange Act; the reporting requirements of directors, executive officers and
principal stockholders regarding transactions in the Company's Common Stock and
short-swing profits rules promulgated by the Commission under Section 16 of the
Exchange Act; and certain additional reporting requirements by principal
stockholders of the Company promulgated by the Commission under Section 13 of
the Exchange Act.
The Company is a bank holding company within the meaning of the Bank
Holding Company Act and is registered as such with the Board of Governors of the
Federal Reserve System (the "FRB"). A bank holding company is required to file
with the FRB annual reports and other information regarding its business
operations and those of its subsidiaries. It is also subject to examination by
the FRB and is required to obtain FRB approval before acquiring, directly or
indirectly, ownership or control of any voting shares of any bank if, after such
acquisition, it would directly or indirectly own or control more than 5% of the
voting stock of that bank, unless it already owns a majority of the voting stock
of that bank.
The FRB has by regulation determined certain activities in which the
Company may or may not conduct business. The Company is currently prohibited
from such activities as real estate brokerage and syndication; real estate
development; property management; underwriting of life insurance not related to
credit transactions; and, with certain exceptions, securities underwriting and
equity funding.
THE BANK
The Bank joined the Federal Reserve System as a state-chartered member
in July 1997. As a California state-chartered bank and member of the Federal
Reserve System, the Bank is subject to regulation, supervision and regular
examination by the California Department of Financial Institutions (the
"Department") and by the FRB. The regulations of these agencies govern most
aspects of the Bank's business, including the making of periodic reports by the
Bank, and the Bank's activities relating to dividends, investments, loans,
borrowings, capital requirements, certain check-clearing activities, branching,
mergers and acquisitions, reserves against deposits and numerous other areas.
Supervision, legal action and examination of the Bank by the regulatory agencies
are generally intended to protect depositors and are not intended for the
protection of stockholders.
The earnings and growth of the Bank are largely dependent on its
ability to maintain a favorable differential or "spread" between the yield on
its interest-earning assets and the rate paid on its deposits and other
interest-bearing liabilities. As a result, the Bank's performance is influenced
by general economic conditions, both domestic and foreign, the monetary and
fiscal policies of the federal government, and the policies of the regulatory
agencies, particularly the FRB. The FRB implements national monetary policies
(such as seeking to curb inflation and combat recession) by its open-market
operations in United States Government securities, by adjusting the required
level of reserves for financial institutions subject to its reserve requirements
and by varying the discount rate applicable to borrowings by banks which are
members of the Federal Reserve System. The actions of the FRB in these areas
influence the growth of bank loans, investments and deposits and also affect
interest rates charged on loans and deposits. The nature and impact of any
future changes in monetary policies cannot be predicted.
4
CAPITAL ADEQUACY REQUIREMENTS
Both the Bank and the Company are subject to the regulations of the FRB
governing capital adequacy. These regulations incorporate both risk-based and
leverage capital requirements. Risk-based capital ratios are calculated to
provide a measure of capital that reflects the degree of risk associated with a
banking organization's operations. Under these guidelines, the nominal dollar
amounts of assets and credit-equivalent amounts of off-balance sheet items are
multiplied by one of several risk adjustment percentages, which range from 0%
for assets with low credit risk, such as certain U.S. Treasury securities, to
100% for assets with relatively high credit risk, such as business loans. Total
capital requirements are defined in terms of "core capital elements," or Tier 1
capital and "supplemental capital elements," or Tier 2 capital. The minimum
ratio of qualifying total capital to total risk-weighted assets is 8.0%, at
least one-half of which must be in the form of Tier 1 capital. As of December
31, 1998, the Company's Tier 1 risk-based capital and total risk-based capital
ratios were 11.68% and 12.93%, respectively, and the Bank's Tier 1 risk-based
capital and total risk-based capital ratios were 11.58% and 12.83%,
respectively.
The federal banking agencies have revised the risk-based capital
standards to take adequate account of concentrations of credit (i.e., relatively
large proportions of loans involving one borrower, industry, location,
collateral or loan type) and the risks of "non-traditional" activities (those
that have not customarily been part of the banking business). The regulations
require institutions with high or inordinate levels of risk to operate with
higher minimum capital standards, and authorize the regulators to review an
institution's management of such risks in assessing an institution's capital
adequacy.
The federal banking agencies have also revised the risk-based capital
regulations to include exposure to interest rate risk as a factor that the
regulators will consider in evaluating a bank's capital adequacy. Interest rate
risk is the exposure of a bank's current and future earnings and equity capital
arising from adverse movements in interest rates. While interest risk is
inherent in a bank's role as financial intermediary, it introduces volatility to
bank earnings and to the economic value of the bank.
The FRB also requires the maintenance of a leverage capital ratio
designed to supplement the risk-based capital guidelines. Banks and Bank Holding
Companies that have received the highest regulatory ratings must maintain a Tier
1 leverage capital ratio of at least 3.0%. All other institutions are required
to maintain a leverage ratio of at least 100 to 200 basis points above the 3.0%
minimum, for a minimum of 4.0% to 5.0%. Pursuant to federal regulations, banks
must maintain capital levels commensurate with the level of risk to which they
are exposed, including the volume and severity of problem loans, and federal
regulators may, however, set higher capital requirements when a bank's
particular circumstances warrant. As of December 31, 1998 the Company's and the
Bank's Tier 1 leverage capital ratios were 8.80% and 8.76%, respectively,
exceeding regulatory minimums. (See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Capital Resources").
PROMPT CORRECTIVE ACTION PROVISIONS
Federal law requires each federal banking agency to take prompt
corrective action to resolve the problems of insured financial institutions,
including but not limited to those that fall below one or more prescribed
minimum capital ratios. The federal banking agencies have by regulation defined
the following five capital categories: "well capitalized" (Total Risk-Based
Capital Ratio of 10%; Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Ratio
of 5%); "adequately capitalized" (Total Risk-Based Capital Ratio of 8%; Tier 1
Risk-Based Capital Ratio of 4%; and Leverage Ratio of 4%); "undercapitalized"
(Total Risk-Based Capital Ratio of less than 8%; Tier 1 Risk-Based Capital less
than 4%; or Leverage Ratio of less than 4%) (or 3% if the institution receives
the highest rating from its primary regulator); "significantly undercapitalized"
(Total Risk-Based Capital Ratio of less than 6%; Tier 1 Risk-Based Capital Ratio
of less than 3%; or Leverage Ratio of less than 3%); and "critically
undercapitalized" (tangible equity to total assets less than 2%). A bank may be
treated as though it were in the next lower capital category if after notice and
the opportunity for a hearing, the appropriate federal agency finds an unsafe or
unsound condition or practice so warrants, but no bank may be treated
as"critically undercapitalized" unless its actual capital ratio warrants such
treatment.
At each successively lower capital category, an insured bank is
subject to increased restrictions on its operations. For example, a bank is
generally prohibited from paying management fees to any controlling persons
or from making capital distributions if to do so would make the bank
"undercapitalized". Asset growth and branching restrictions apply to
undercapitalized banks, which are required to submit written capital
restoration plans meeting
5
specified requirements (including a guarantee by the parent holding company,
if any). "Significantly undercapitalized" banks are subject to broad
regulatory authority, including among other things, capital directives,
forced mergers, restrictions on the rates of interest they may pay on
deposits, restrictions on asset growth and activities, and prohibitions on
paying certain bonuses without regulatory approval. Even more severe
restrictions apply to critically undercapitalized banks. Most importantly,
except under limited circumstances, not later than 90 days after an insured
bank becomes critically undercapitalized, the appropriate federal banking
agency is required to appoint a conservator or receiver for the bank.
In addition to measures taken under the prompt corrective action
provisions, insured banks may be subject to potential actions by the federal
regulators for unsafe or unsound practices in conducting their businesses or for
violations of any law, rule, regulation or any condition imposed in writing by
the agency or any written agreement with the agency. Enforcement actions may
include the issuance of cease and desist orders, termination of insurance of
deposits (in the case of a bank), the imposition of civil money penalties, the
issuance of directives to increase capital, formal and informal agreements, or
removal and prohibition orders against "institution-affiliated" parties.
SAFETY AND SOUNDNESS STANDARDS
The federal banking agencies have adopted final guidelines establishing
safety and soundness standards for all insured depository institutions. Those
guidelines relate to internal controls, information systems, internal audit
systems, loan underwriting and documentation, compensation and interest rate
exposure. In general, the standards are designed to assist the federal banking
agencies in identifying and addressing problems at insured depository
institutions before capital becomes impaired. If an institution fails to meet
these standards, the appropriate federal banking agency may require the
institution to submit a compliance plan and institute enforcement proceedings if
an acceptable compliance plan is not submitted.
PREMIUMS FOR DEPOSIT INSURANCE
FDIC insured depository institutions are required to pay insurance
premiums depending on their risk classification. Institutions such as the Bank
which are insured by the Bank Insurance Fund ("BIF"), are categorized into one
of three capital categories (well capitalized, adequately capitalized, and
undercapitalized) and one of three supervisory categories based on federal
regulatory evaluations. The three supervisory categories are: financially sound
with only a few minor weaknesses (Group A), demonstrates weaknesses that could
result in significant deterioration (Group B), and poses a substantial
probability of loss (Group C). The capital ratios used by the FDIC to define
well capitalized, adequately capitalized and undercapitalized are the same in
the FDIC's prompt corrective action regulations. The current BIF assessment
rates are summarized as follows:
Assessment Rates Effective January 1, 19982
Group A Group B Group C
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Well Capitalized............. 0 3 17
Adequately Capitalized....... 3 10 24
Undercapitalized............. 10 24 27
In addition, pursuant to recent legislation, BIF member banks (such as the
Bank) began in 1997 to pay an amount which has fluctuated between approximately
1.16 and 1.30 (and is currently 1.22) basis points, or cents per $100 of insured
deposits, towards the retirement of the Financing Corporation bonds (the "FICO
Bonds") issued in the 1980's to assist in the recovery of the savings and loan
industry. Members of the Savings Association Insurance Fund ("SAIF"), in
addition to their normal deposit insurance premium, currently pay approximately
6.1 basis points. The rate paid to retire the FICO Bonds will become equal for
members of the BIF and the SAIF on either January 1, 2000, or the date on which
the BIF and SAIF insurance funds are merged, whichever occurs first.
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(2) Subject to statutory minimum assessment of $1,000 per semi-annual period
(which also applies to all other assessment risk classifications). Assessment
figures are expressed in terms of costs per $100 in deposits.
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COMMUNITY REINVESTMENT ACT
The Bank is subject to certain requirements and reporting obligations
involving Community Reinvestment Act ("CRA") activities. The CRA generally
requires the federal banking agencies to evaluate the record of a financial
institution in meeting the credit needs of its local communities, including low
and moderate income neighborhoods. The CRA further requires the agencies to take
a financial institution's record of meeting its community credit needs into
account when evaluating applications for, among other things, domestic branches,
consummating mergers or acquisitions, or holding company formations. In
measuring a bank's compliance with its CRA obligations, the regulators now
utilize a performance-based evaluation system which bases CRA ratings on the
bank's actual lending service and investment performance, rather than on the
extent to which the institution conducts needs assessments, documents community
outreach activities or complies with other procedural requirements. In
connection with their assessment of CRA performance, the federal regulators
assign a rating of "outstanding," "satisfactory," "needs to improve" or
"substantial noncompliance." The Bank was last examined for CRA compliance in
1998 and received a "satisfactory" CRA Assessment Rating.
OTHER CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are increasingly focusing attention on
compliance with consumer protection laws and regulations. Banks have been
advised by federal regulators to carefully monitor compliance with various
consumer protection laws and their implementing regulations. The federal
Interagency Task Force on Fair Lending issued a policy statement on
discrimination in home mortgage lending describing three methods that federal
agencies will use to prove discrimination: overt evidence of discrimination,
evidence of disparate treatment, and evidence of disparate impact. In addition
to CRA and fair lending requirements, the Bank is subject to numerous other
federal consumer protection statutes and regulations. Due to heightened
regulatory concern related to compliance with consumer protection laws and
regulations generally, the Bank may incur additional compliance costs or be
required to expend additional funds for investments in the local communities it
serves.
INTERSTATE BANKING AND BRANCHING
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Interstate Banking Act") regulates the interstate activities of banks and
bank holding companies and establishes a framework for nationwide interstate
banking and branching. Since June 1, 1997, a bank in one state has generally
been permitted to merge with a bank in another state without the need for
explicit state law authorization. However, states were given the ability to
prohibit interstate mergers with banks in their own state by "opting-out"
(enacting state legislation applying equality to all out-of-state banks
prohibiting such mergers ) prior to June 1, 1997. Limited interstate bank
mergers were permitted prior to June 1, 1997 provided the applicable states'
laws met certain requirements.
Since 1995, adequately capitalized and managed bank holding companies have
been permitted to acquire banks located in any state, subject to two exceptions:
first, any state may still prohibit bank holding companies from acquiring a bank
which is less than five years old; and second, no interstate acquisition can be
consummated by a bank holding company if the acquiror would control more then
10% of the deposits held by insured depository institutions nationwide or 30%
percent or more of the deposits held by insured depository institutions in any
state in which the target bank has branches.
A bank may establish and operate DE NOVO branches in any state in which
the bank does not maintain a branch if that state has enacted legislation to
expressly permit all out-of-state banks to establish branches in that state.
Among other things, the Interstate Banking Act amended the Community
Reinvestment Act to require that in the event a bank has interstate branches,
the appropriate federal banking regulatory agency must prepare for such
institution a written evaluation of (i) the bank's record of performance; and
(ii) the bank's performance in each applicable state. Interstate branches are
now prohibited from being used as deposit production offices, and foreign banks
will be permitted to establish branches in any state other than its home state
to the same extent that a bank chartered by the foreign bank's home state may
establish such branches.
The Caldera, Weggeland, and Killea California Interstate Banking and
Branching Act of 1995 (the "Caldera Weggeland Act") was designed among other
things to implement important provisions of the Interstate Banking Act
7
discussed above and to repeal California's previous interstate banking laws,
which were largely preempted by the Interstate Banking Act. (Prior California
law prohibited, among other things, an out-of-state bank holding company from
establishing a DE NOVO California bank except for the purpose of taking over
the deposits of a closed bank. This restriction has been eliminated.)
As indicated above, the Interstate Banking Act generally permits a bank in
one state to merge with a bank in another state without the need for explicit
state law authorization. However, the Caldera Weggeland Act expressly prohibits
a foreign (other state) bank which does not already have a California branch
office from (i) purchasing a branch office of a California bank (as opposed to
the entire bank) and thereby establishing a California branch office or (ii)
establishing a California branch office on a DE NOVO basis.
The Interstate Banking Act also requires, among other things, approval of
the state bank supervisor of the target bank's home state for interstate
acquisitions of banks by bank holding companies. The Caldera Weggeland Act
authorizes the California Commissioner of Financial Institutions (the
"Commissioner") to approve such an interstate acquisition if the Commissioner
finds that the transaction is consistent with certain criteria specified by law.
The changes effected by Interstate Banking Act and Caldera Weggeland Act
are expected to increase competition in the environment in which the Bank
operates to the extent that out-of-state financial institutions directly or
indirectly enter the Bank's market areas. It appears that the Interstate Banking
Act has contributed to the accelerated consolidation of the banking industry in
that a number of the largest bank holding companies are expanding into different
parts of the country that were previously restricted. While many large
out-of-state banks have already entered the California market as a result of
this legislation, it is not possible to predict the precise impact of this
legislation on the Bank or the Company and the competitive environment in which
it operates.
OTHER PENDING AND PROPOSED LEGISLATION
Other legislative and regulatory initiatives which could affect the Bank
and the banking industry in general are pending, and additional initiatives may
be proposed or introduced, before the United States Congress, the California
legislature and other governmental bodies in the future. For example, consumer
legislation has been proposed in Congress which would require banks to offer
basic, low-cost financial services to meet minimum customer needs. Other
legislation has been proposed which would reform the Glass-Steagall Act and the
Bank Holding Company Act, which restrict banks' and bank holding companies'
ability to engage in certain activities, including the underwriting of and
dealing in various securities. The latter proposal would significantly change
the makeup of the financial services industry, expand the ability of banks and
bank holding companies to offer a broader range of financial products, and
provide the opportunity for additional competitors to be able to enter the
financial services market in ways that are not currently permissible. Such
proposals, if enacted, may further alter the structure, regulation and
competitive relationship among financial institutions, and may subject the Bank
to increased regulation, disclosure and reporting requirements. In addition, the
various banking regulatory agencies often adopt new rules and regulations to
implement and enforce existing legislation. It cannot be predicted whether, or
in what form, any such legislation or regulations may be enacted or the extent
to which the business of the Bank or the Company would be affected thereby.
ACCOUNTING CHANGES
The Financial Accounting Standards Board (the "FASB") issued Statement of
Financial Accounting Standard ("SFAS") No. 131, "Disclosures about Segments of
an Enterprise and Related Information," effective for financial statements for
periods beginning after December 15, 1997. SFAS No. 131 establishes annual and
interim reporting standards for an enterprise's operating segments and related
disclosures about its products and services, geographic areas, and major
customers. Operating segments are components of an enterprise about which
financial information is available and is evaluated regularly in deciding how to
allocate resources and assess performance. The adoption of SFAS 131 had no
material impact on the presentation of the Company's financial condition or
results of operations.
The FASB issued SFAS No. 132 "Employer's Disclosure about Pensions and
Other Postretirement Benefits," effective for fiscal years beginning after
December 15, 1997. SFAS No. 132 standardizes the disclosure requirements
for pensions and other postretirement benefits to the extent practicable.
Adoption of this statement had no impact on the Company's financial position or
results of operations.
8
The FASB issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," effective for all quarters of fiscal years beginning after
June 15, 1999. This statement establishes accounting and reporting standards for
derivative instruments and hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. Management does
not expect this change in accounting principle to have a material impact on the
Company's financial condition or results of operations.
EMPLOYEES
As of December 31, 1998, the Company had 136 full-time employees and 111
part-time employees. The Company's Management believes that its employee
relations are satisfactory.
SELECTED STATISTICAL INFORMATION
Selected statistical information relating to the Company has been included
in Management's Discussion and Analysis of Financial Condition and Results of
Operations.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company's administrative office and main branch location, are located
at 444 South Escondido Boulevard in Escondido, California., where the Company
leases approximately 26,100 square feet of a two-story professional office
building. The terms of the lease provide for two five year extension options
upon its expiration on March 31, 2006.
Other properties either owned or leased by the Company include eight other
branches, a data processing center, and a business loan office located in San
Diego and Riverside counties, a loan production office in the Seattle,
Washington area and land (a future branch site) in Riverside county. In the
opinion of Management, the Company maintains adequate comprehensive general
liability and casualty loss insurance covering its properties and activities
conducted in or about its properties.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company and the Bank are defendants in legal
proceedings arising in the ordinary course of business. Some of these
proceedings which relate to lending, collections, and other activities may seek
substantial sums as damages. It may take a number of years to finally resolve
some of the pending legal proceedings due to their complexity and other reasons.
At December 31, 1998, the Bank was party to certain legal actions, the potential
exposure from which is not possible to determine with any certainty at this
time. However, the Company has reviewed these matters with legal counsel and, in
management's opinion, the ultimate resolution of these actions will not have a
material effect on the Company's financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
9
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) MARKET INFORMATION
North County Bancorp's Common Stock trades on the Nasdaq National Market
System under the symbol "NCBH." Although trading in the Company's Common Stock
has increased since the stock began trading on Nasdaq in July of 1996, such
trades cannot be characterized as constituting an active trading market. Based
on information provided by Nasdaq, Management believes that approximately
640,000 and 804,000 shares were traded in each of 1998 and 1997, respectively.
As reported by the National Daily Quotation Service, bid prices for the Common
Stock ranged from a low of $10.50 to a high of $15.625 during 1998 and from a
low of $7.125 to a high of $13.75 during 1997. These quotes reflect inter-dealer
prices without retail mark-ups, mark-downs or commissions and may not
necessarily have represented actual transactions. There may have been
transactions at other prices during that time. The following table provides
information with respect to the range of high and low bid prices for the
Company's stock for each quarterly period in 1998 and 1997:
1998 1997
------------------- -------------------
High Low High Low
-------- -------- ------- -----
First Quarter $15.625 $13.250 $ 9.875 $ 7.125
Second Quarter 14.875 13.375 9.250 7.500
Third Quarter 13.375 10.500 10.375 8.000
Fourth Quarter 12.500 11.375 13.750 10.375
(b) HOLDERS
On February 1, 1999 there were approximately 1,200 stockholders of record
of the Common Stock.
(c) DIVIDENDS
As a bank holding company without significant assets other than its equity
interest in the Bank, the Company's ability to pay dividends primarily depends
upon the dividends it receives from the Bank. The Bank currently has outstanding
75,000 shares of noncumulative preferred stock with a $2.00 per share annual
dividend and 166,677 shares of noncumulative preferred stock with a $0.72 per
share annual dividend. The Bank resumed the payment of dividends in 1997 on the
Bank's preferred stock. Such dividends had not been paid since 1994, pursuant to
formal and informal agreements with the Bank's regulators and a Board resolution
adopted in May of 1996, the last of which was terminated in March 1997. As with
the Company, any change in the Bank's dividend practices will depend upon the
Bank's earnings, financial position, current and anticipated cash requirements
and other factors deemed relevant by the Bank's Board of Directors at that time.
(See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources").
The Bank's ability to pay dividends to the Company is also subject to
certain legal limitations. Under California law, the Bank may declare a cash
dividend out of the Bank's net profits up to the lesser of the Bank's retained
earnings or the Bank's net income for the last three (3) fiscal years (less any
distributions made to stockholders during such period), or, with the prior
written approval of the Commissioner, in an amount not exceeding the greatest of
(i) the retained earnings of the Bank, (ii) the net income of the Bank for its
last fiscal year, or (iii) the net income of the Bank for its current fiscal
year.
In addition, under federal law, the Bank is prohibited from paying any
dividends if after making such payment the Bank would fail to meet any of its
minimum capital requirements. (See "Item 1 -- Business -- Regulation and
Supervision -- Capital Adequacy Requirements"). The federal regulators also have
the authority to prohibit the Bank from engaging in any business practices which
are considered to be unsafe or unsound, and in some circumstances the regulators
might prohibit the payment of dividends on that basis even though such payments
would otherwise be permissible.
The Company's ability to pay dividends is also limited by state
corporation law. The California General Corporation Law prohibits the Company
from paying dividends on the Common Stock unless: (1) its retained earnings,
10
immediately prior to the dividend payment, equals or exceeds the amount of the
dividend or (2) immediately after giving effect to the dividend the sum of the
Company's assets (exclusive of goodwill and deferred charges) would be at least
equal to 125% of its liabilities (not including deferred taxes, deferred income
and other deferred liabilities) and the current assets of the Company would be
at least equal to its current liabilities, or, if the average of its earnings
before taxes on income and before interest expense for the two preceding fiscal
years was less than the average of its interest expense for the two preceding
fiscal years, at least equal to 125% of the current liabilities.
The Company's practice has been to retain earnings to provide funds for
the operation and expansion of its business. Accordingly, the Company has not
paid any cash dividends on its Common Stock since 1984. Management has no
current plans to pay cash dividends in the foreseeable future. However, the
Board's practice is to review annually the advisability of paying cash dividends
based upon the Company's earnings, financial position, current and anticipated
cash requirements and other factors deemed relevant by the Board of Directors at
that time. In making any such assessment, the Board of Directors of the Company
would have to consider among other things the capital requirements of the Bank
and other factors concerning the Bank, including the dividend guidelines and
maintenance of an adequate allowance for loan losses.
11
ITEM 6. SELECTED FINANCIAL DATA.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The table below sets forth certain selected consolidated financial data
for the Company and is qualified in its entirety by the detailed information and
financial data presented in the Company's Consolidated Financial Statements and
related Notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
As of or for the Years Ended December 31,
----------------------------------------------------------------
1998 1997 1996 1995 1994
----------- --------- ---------- --------- ---------
SUMMARY STATEMENT OF INCOME DATA
Interest income..................................... $25,704 $22,295 $19,840 $19,286 $ 17,647
Interest expense.................................... 6,339 5,941 5,112 5,164 4,525
-------- -------- -------- -------- --------
Net interest income................................. 19,365 16,354 14,728 14,122 13,122
Provision for loan and lease losses................. 1,474 1,122 1,300 3,306 3,135
Noninterest income.................................. 7,066 6,788 6,975 6,612 6,873
Noninterest expense................................. 16,825 16,198 15,567 15,334 16,521
------- ------- ------- ------- -------
Income before provision for income taxes............ 8,132 5,822 4,836 2,094 339
Provision for income taxes.......................... 3,363 2,313 2,092 562 254
-------- -------- -------- --------- --------
Net income.......................................... $ 4,769 $ 3,509 $ 2,744 $ 1,532 $ 85
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
SUMMARY BALANCE SHEET DATA (PERIOD END)
Loans net of unearned income........................ $237,702 $210,991 $180,410 $161,950 $166,609
Allowance for loan and lease losses................. 3,592 3,268 3,129 2,916 2,739
Investment securities............................... 43,821 29,679 34,461 26,172 27,168
Earning assets...................................... 298,523 244,670 217,071 198,622 198,049
Total assets........................................ 337,413 280,734 257,306 237,034 246,840
Interest-bearing deposits........................... 202,594 161,703 145,407 143,108 146,450
Total deposits...................................... 303,059 251,555 229,344 213,839 226,101
Long term obligations............................... 387 415 3,513 3,640 3,669
Total stockholders' equity.......................... 30,000 25,193 20,172 17,227 13,756
PER SHARE DATA (1)
Basic EPS........................................... $0.98 $0.78 $0.63 $0.39 $0.02
Diluted EPS ........................................ 0.94 0.72 0.58 0.37 -- (2)
Book value.......................................... 6.16 5.17 4.57 3.96 3.65
Average common shares............................... 4,868,906 4,513,556 4,366,729 3,973,170 3,767,362
Average common shares assuming dilution............. 5,073,371 5,004,430 4,884,121 4,428,824 --
Common shares outstanding........................... 4,868,906 4,868,906 4,417,041 4,350,975 3,767,362
SELECTED FINANCIAL RATIOS (3)
Return on average stockholders' equity.............. 17.25% 15.72% 14.73% 9.97% 0.60%
Return on average assets............................ 1.54 1.28 1.11 0.66 0.03
Net interest spread (4)............................. 6.04 5.90 6.18 6.47 5.96
Net interest margin (5)............................. 7.13 6.94 7.09 7.30 6.63
Tier 1 leverage capital ratio ...................... 8.80 8.76 7.70 7.17 5.47
Nonperforming loans to total gross loans............ 0.33 1.43 1.96 3.27 3.08
Nonperforming assets to total gross loans and
other real estate owned (6)...................... 0.49 1.89 3.44 4.68 5.13
Net charge-offs to average loans.................... 0.52 0.50 0.63 1.89 1.54
Average stockholders' equity to average assets...... 8.95 8.14 7.54 6.61 5.79
Loans to deposits................................... 78.4 83.9 78.7 75.7 73.7
(1) Restated to reflect stock dividends.
(2) The calculation of Diluted EPS upon conversion of the Company's
subordinated debentures proved to be anti-dilutive at December 31, 1994.
(3) For purposes of calculating the financial ratios, average balances are
the consolidated average balances of the Company and the Bank. Bank
average balances are based upon daily average balances, and Company
average balances are based upon month end balances.
(4) Represents the average rate earned on interest-earning assets less the
average rate paid on interest-bearing liabilities.
(5) Represents net interest income as a percentage of average
interest-earning assets.
(6) Nonperforming assets consist of nonaccrual loans, loans past due 90 days
or more and other real estate owned.
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following analysis of the Company's results of operations and
financial condition as of and for the three years ended December 31, 1998 should
be read in conjunction with the consolidated financial statements and the notes
related thereto, and with reference to the discussion of the operations and
other financial information presented elsewhere in this report. For purposes of
calculating the financial ratios, average balances are comprised of both average
Company and Bank balances. Bank average balances are based upon daily average
balances, and Company average balances are based upon month end balances.
Statements contained in this Report on Form 10K that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectations, intentions,
beliefs or strategies regarding the future. All forward-looking statements
included in this document are based on information available to the Company on
the date thereof, and the Company assumes no obligation to update any such
forward-looking statements. It is important to note that the Company's actual
results could differ materially from those in such forward-looking statements.
Factors that could cause actual results to differ materially from those in such
forward-looking statements include general economic conditions, particularly in
the Company's market areas, changes in prevailing interest rates, competitive
products and pricing, inflation, credit and other risks of lending and
investment activities, fiscal and monetary policies of the U.S. and other
governments, regulations affecting financial institutions, and other risks and
uncertainties affecting the Company's operations and personnel.
RESULTS OF OPERATIONS
SUMMARY
A comparison of the annual results for the two years ended December 31,
1998 (see "Item 6. Selected Financial Data") reflects net income growth of
approximately 36% and 28% in 1998 and 1997, respectively, amounting to $4.8
million in 1998 compared to $3.5 million in 1997 and $2.7 million in 1996. Net
interest income, the primary contributor to the increase in earnings, rose 18%
in 1998 to $19.4 million and 11% in 1997 to $16.4 million. Basic earnings per
share increased 26% to $0.98 in 1998 and 24% to $0.78 in 1997. Diluted earnings
per share increased 31% to $0.94 in 1998 and 24% to $0.72 in 1997. The 1998
results produced returns on average assets and average equity of 1.54% and
17.25%, respectively, compared to 1.28% and 15.72%, respectively, in 1997.
NET INTEREST INCOME
Net interest income, the principal source of income for the Company, is
interest and fees earned on loans and investments less the interest paid on
deposits and borrowings. Primary factors affecting the level of net interest
income include increases or decreases in the average balances (volume) of
interest-earning assets and interest-bearing liabilities, increases or decreases
in the average rates earned and paid on these assets and liabilities, the
Company's ability to manage its earning asset portfolio and the availability of
particular sources of funds. An analysis of the Company's taxable-equivalent net
interest income and average balance sheet levels for the last three years is
presented in Table One. The changes in net interest income from year to year are
analyzed in Table Two. Interest income and yields in the following discussion
are on a tax-equivalent basis.
Net interest income increased 18% or $3.0 million in 1998 to $19.4
million from $16.5 million in 1997. This increase was the result of loan growth
and deposit pricing management efforts. Average loans and loan yields in 1998
increased to $222.2 million at 10.31% from $195.5 million at 10.25% in 1997,
representing a 14% growth in volume and resulting in an increase of 14% or $2.9
million in loan income. Management believes that interest rates on each category
of loans in the Bank's loan portfolio are competitively priced for banks in its
market area. The yield on average loans is also influenced by the mix of loans
in the loan portfolio. Real estate construction loans, commercial real estate
loans and commercial loans are typically offered at higher interest rates and
fees than residential real estate loans, lease financing or automobile and other
consumer loans. (See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Financial Condition -- Loans"). Interest
on Federal funds sold increased by 90% or $394,000 due to growth of $7.8 million
or 96% in average funds sold resulting from significant deposit growth in 1998.
Net interest income in 1997 increased 11% primarily due to an increase in
average interest-earning assets partly offset by a decrease in the net
interest margin. Maturities of fixed rate higher yielding loans combined with
a decrease in total consumer loans outstanding and a declining interest rate
environment decreased the yield on the loan portfolio to 10.25% in 1997
13
from 10.37% in 1996. The average tax equivalent yield on interest-earning
assets was 9.45% in 1997 compared to 9.53% in 1996.
Total interest expense increased approximately 7% or $398,000 in 1998
due to an increase of $585,000 in interest paid on deposits partly offset by
decreases of $30,000 and $157,000, respectively, in interest paid on overnight
funds and on long term borrowings. Average interest-bearing deposits grew
approximately 12% or $20.1 million to $184.2 million from $164.1 million in
1997. The increase in interest expense due to growth was partially offset by a
slight decrease in interest expense due to the average rate paid on
interest-bearing deposits declining to 3.39% in 1998 from 3.44% the prior year.
Time deposits averaged $62.4 million at an average rate paid of 5.02% in 1998
compared to $51.6 million at 5.11% in 1997. The decrease in rates paid on
deposits in 1998 compared to 1997 is attributable to a number of factors
including government easing of short term interest rates, a short term (seven
months) certificate of deposit promotion at an above market rate (6.0%) during
the first part of 1997, and the Company generally lowering interest rates as
deposit growth outpaced loan growth in 1998. The net interest margin (net
interest income as a percentage of average earning assets) increased to 7.13% in
1998 from 6.94% in 1997. This margin, however, had narrowed during the last
quarter of 1998 to 6.84%, a trend that management believes is likely to continue
in 1999 based on current rate trends. The certificate of deposit promotion was
the primary reason that average time deposits increased by 47% or $16.4 million
in 1997 from $35.2 million in 1996, and contributed to the $961,000 increase in
interest expense related to time deposits that year. The Company's net interest
margin decreased to 6.94% in 1997 from 7.09% in 1996. (See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Financial Condition -- Deposits.")
14
TABLE ONE - ANALYSIS OF TAXABLE-EQUIVALENT NET INTEREST INCOME
(DOLLARS IN THOUSANDS)
This table presents an analysis of net interest income and average
balance sheet levels for the last three years. Tax-exempt income is presented on
a tax-equivalent basis assuming a 34% federal tax rate.
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------
1998 1997
---------------------------------------------------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ RATE/ AVERAGE INCOME/ RATE/
BALANCE EXPENSE YIELD BALANCE EXPENSE YIELD
------- ----------- ------- --------- ----------- -------
ASSETS
Interest-earning assets:
Loans (1) .......................... $ 222,193 $ 22,906 10.31% $ 195,536 $ 20,050 10.25
Taxable investment
securities ....................... 29,624 1,753 5.92 30,289 1,713 5.65
Tax-exempt investment
securities ....................... 2,840 183 6.46 2,861 182 6.37
Interest-bearing deposits .......... 2,110 112 5.33 277 16 5.79
Federal funds sold ................. 15,936 833 5.23 8,124 439 5.41
--------- ----------- ----------- --------- ----------- ----------
Total earning assets ............... 272,703 25,787 9.46 237,087 22,400 9.45
--------- ----------- ----------- --------- ----------- ----------
Noninterest-earning assets:
Cash and due from banks ............ 23,293 23,079
Premises and equipment, net ........ 9,385 8,328
Other assets (2) ................... 6,945 9,055
--------- ---------
Total noninterest-earning assets ... 39,623 40,462
---------
Less allowance for loan
and lease losses ................... 3,517 3,264
--------- ---------
Total assets ....................... $ 308,809 $ 274,285
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits:
Interest-bearing demand .......... $ 41,391 546 1.32 $ 36,809 525 1.43
Savings .......................... 80,415 2,563 3.19 75,650 2,489 3.29
Time ............................. 62,359 3,128 5.02 51,621 2,638 5.11
Other short term borrowings ........ 943 44 4.71 1,410 74 5.24
Capital lease ...................... 407 58 14.17 422 61 14.57
Long term debt ..................... -- -- -- 1,624 154 9.47
--------- ----------- ----------- --------- ----------- ----------
Total interest-bearing
liabilities ...................... 185,515 6,339 3.42 167,536 5,941 3.55
----------- ----------- ----------- ----------
Noninterest-bearing liabilities:
Demand deposits .................... 92,885 81,958
Other liabilities .................. 2,763 2,474
--------- ---------
Total liabilities .................. 281,163 251,968
Stockholders' equity .................. 27,646 22,317
--------- ---------
Total liabilities and
stockholders' equity ............. $ 308,809 $ 274,285
--------- ---------
--------- ---------
Net interest income
(tax equivalent basis) ............. 19,448 16,459
Reversal of tax equivalent adjustment.. (83) (105)
----------- ---------
Net interest income ................... $ 19,365 $ 16,354
----------- ---------
----------- ---------
Net interest spread(3) ................ 6.04% 5.90%
----------- ----------
Net interest margin(4) ................ 7.13% 6.94%
----------- ----------
----------- ----------
1996
----------------------------------------
INTEREST AVERAGE
AVERAGE INCOME/ RATE/
BALANCE EXPENSE YIELD
--------- --------- ---------
ASSETS
Interest-earning assets:
Loans (1) .......................... $ 171,906 $ 17,831 10.37%
Taxable investment
securities ....................... 27,570 1,592 5.78
Tax-exempt investment
securities ....................... 2,261 138 6.09
Interest-bearing deposits .......... -- -- --
Federal funds sold ................. 7,573 385 5.08
--------- --------- -----------
Total earning assets ............... 209,310 19,946 9.53
--------- --------- -----------
Noninterest-earning assets:
Cash and due from banks ............ 22,560
Premises and equipment, net ........ 9,184
Other assets (2) ................... 9,028
---------
Total noninterest-earning assets ... 40,772
Less allowance for loan
and lease losses ................... 3,233
---------
Total assets ....................... $ 246,849
---------
---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits:
Interest-bearing demand .......... $ 36,791 528 1.44
Savings .......................... 75,583 2,488 3.29
Time ............................. 35,166 1,677 4.77
Other short term borrowings ........ 1,622 74 4.43
Capital lease ...................... 444 65 14.59
Long term debt ..................... 3,229 280 8.67
--------- --------- -----------
Total interest-bearing
liabilities ...................... 152,835 5,112 3.34
--------- --------- -----------
Noninterest-bearing liabilities:
Demand deposits .................... 73,298
Other liabilities .................. 2,102
---------
Total liabilities .................. 228,235
Stockholders' equity .................. 18,614
---------
Total liabilities and
stockholders' equity ............. $ 246,849
---------
---------
Net interest income
(tax equivalent basis) ............. 14,834
Reversal of tax equivalent adjustment.. (106)
---------
Net interest income ................... $ 14,728
---------
---------
Net interest spread(3) ................ 6.18%
---------
---------
Net interest margin(4) ................ 7.09%
---------
---------
- ---------------------
(1) For purposes of these computations, nonaccrual loans are included in the
daily average loan amounts outstanding.
(2) Includes average balances of real estate owned other than Company and
Bank premises during 1998, 1997, and 1996 of $837,000, $1.0 million, and
$2.8 million, respectively.
(3) Represents the average rate earned on interest-earning assets less the
average rate paid on interest-bearing liabilities.
(4) Represents net interest income as a percentage of average
interest-earning assets.
15
TABLE TWO - CHANGES IN TAXABLE-EQUIVALENT NET INTEREST INCOME
(DOLLARS IN THOUSANDS)
This table sets forth the year-to-year changes in net interest income
on a fully taxable-equivalent basis for the years shown. The changes for each
major category of interest income and interest expense are divided between the
portion of change attributable to the variance in average balances (volume) or
average rates for that category. The amount of change that cannot be separated
is allocated to each variance proportionately.
1998 vs. 1997 1997 vs. 1996
-------------------------------- ----------------------------------
Increase (Decrease) Increase (Decrease)
Due to Changes in Due to Changes in
-------------------------------- ----------------------------------
Volume Rate Total Volume Rate Total
------ ------ ------ ------ ---- -----
Earning assets -- Interest income:
Loans $2,748 $ 108 $2,856 $2,425 $(206) $2,219
Investment securities:
Taxable (38) 78 40 155 (34) 121
Non-taxable (1) 2 1 38 6 44
Federal funds sold 409 (15) 394 29 25 54
Interest-bearing deposits 97 (1) 96 16 -- 16
-------- ------- -------- ------- ------- -------
Total 3,215 172 3,387 2,663 (209) 2,454
------ ------ -------- ------- ------- -------
Deposits and borrowed funds --
Interest expense:
Interest-bearing demand
deposits 62 (41) 21 -- (3) (3)
Savings deposits 152 (78) 74 2 (3) (1)
Time deposits 540 (50) 490 833 128 961
Other short term borrowings (23) (7) (30) (10) 12 2
Long term debt (154) -- (154) (150) 24 (126)
Capital lease (2) (1) (3) (4) -- (4)
------- ------- ------- ------- ------- --------
Total 575 (177) 398 671 158 829
------ ------ ------- ------- ------- --------
Change in net interest income $2,640 $ 349 $2,989 $1,992 $(367) $1,625
------ ------ ------- ------- ------- --------
------ ------ ------- ------- ------- --------
PROVISION FOR LOAN AND LEASE LOSSES
The Company provides for loan and lease losses by a charge to
operations based upon Management's evaluation of the loan portfolio, past loan
loss experience, general economic conditions, and other pertinent factors. The
provision for loan and lease losses increased $352,000 or 31% to $1.5 million in
1998 and decreased $178,000 or 14% to $1.1 million in 1997 as compared to 1996.
The 1998 increase was attributable to an increase of approximately 13% or $26.7
million in outstanding loans at year-end and an increase in net loans charged
off to $1.2 million or 0.52% of average loans from $1.0 million or 0.50%,
respectively, in 1997. The 1997 decrease was due to a decline in net loans
charged off from $1.1 million or 0.63% of average loans outstanding in 1996, as
well as a decreased provision for loan and lease losses that in Management's
opinion reflected the improvement in the Southern California economy and in the
real estate market. During 1998, 1997 and 1996, the Company provided $640,000,
$1.2 million and $400,000, respectively, to the provision for loan and lease
losses to supplement its Title I HUD reserves. As of December 31, 1998, 1997 and
1996, the allowance for loan and lease losses represented 1.51%, 1.55% and
1.73%, respectively, of total loans. (See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Financial Condition --
Allowance for Loan and Lease Losses.")
NONINTEREST INCOME
As presented in Table Three, noninterest income increased 4% or
$278,000 to $7.1 million in 1998, consisting of increases of 19% or $244,000
in gain on loan sales and 28% or $221,000 in other income, partly offset by a
decrease of 26% or $192,000 in loan servicing fees. In 1998, an increase in
SBA loan prepayments as a consequence of declining interest rates prompted
management's decision to sell $3.0 million in SBA loans and recognize gains
on loan sales of $277,000. In addition, $4.5 million in SBA "504" loans, a
relatively new line of business for the Company, were sold for gains of
$216,000. Gains on the sale of Title 1 and other equity loans declined by
$152,000 and $97,000, respectively, due to the lower volume of sales and
premiums paid for these loans. Noninterest income decreased 3% or $187,000 to
$6.8 million in 1997 from $7.0 million in 1996, due primarily to a decrease
of 9% or $124,000 in gains on loan sales. The Company sold no SBA loans in
1997 compared to sales of $8.3 million in 1996 due to Management's decision
to retain these loans in its portfolio to enhance loan yields and to offset
the slow demand for other types of loans in the Company's market area. This
16
resulted in a decrease in the gains on the sale of SBA loans of $687,000
which was partly offset by an increase in gains related to the sale of Title
I and other equity loans of $563,000. During 1997, the Company sold Title I
and other equity loans of $52.7 million as compared to $18.8 million in 1996.
(See "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Loans").
TABLE THREE - NONINTEREST INCOME
(DOLLARS IN THOUSANDS)
This table presents significant categories of noninterest income for
each of the last three years and the percentage change between the years.
% %
CHANGE CHANGE
1998 98/97 1997 97/96 1996
------- ------- ------- -------- -------
Service charges on deposits $3,941 0.1 $3,936 2.9 $3,827
Gain on sale of loans 1,545 18.6 1,301 (8.7) 1,425
Loan servicing fees 561 (25.5) 753 0.8 747
Other income 1,019 27.7 798 (18.2) 976
------- -------- --------
Total noninterest income $7,066 4.1 $6,788 (2.7) $6,975
------- -------- --------
------- -------- --------
NONINTEREST EXPENSE
Noninterest expense increased 4% or $627,000 in 1998 to $16.8 million
compared to a 4% increase of $631,000 in 1997 to $16.2 million from $15.6
million in 1996. A breakdown of significant noninterest expense categories for
the three years ended December 31, 1998 is presented in Table Four. Salaries and
employee benefits increased 8% or $740,000 in 1998 and 12% or $1.0 million in
1997. On December 31, full time equivalent employees totaled 218 in 1998, 210 in
1997 and 196 in 1996. Occupancy expense increased 8% or $245,000 and 4% or
$137,000 in 1998 and 1997, respectively, during which time the Company opened
its ninth full service office and expanded its SBA business into the Seattle,
Washington area. Expenses related to the acquisition, maintenance and sale of
other real estate owned partially offset the increases in the other expense
categories with a decrease of $375,000 to a net gain of $473,000 in 1998, of
which amount $289,000 was related to the sale of one property, compared to a net
gain of $98,000 in 1997 and a net loss of $614,000 in 1996. Collection expenses
incurred to recover or mitigate loan and operating losses decreased by $157,000
in 1998 and $88,000 in 1997. The Company currently plans additional expansion in
1999, including the opening of a full service branch in Vista, California, the
construction of a new facility for its Murrieta branch, and is planning the
possible opening of additional SBA loan production offices.
TABLE FOUR - NONINTEREST EXPENSE
(DOLLARS IN THOUSANDS)
The following table presents significant categories of noninterest
expense for each of the last three years and the percentage change between the
years.
% %
CHANGE CHANGE
1998 98/97 1997 96/97 1996
-------- --------- -------- ---------- --------
Salaries and employee benefits $ 9,888 8.1 $ 9,148 12.4 $ 8,136
Occupancy expense 3,477 7.6 3,232 4.4 3,095
Telephone and postage 895 29.9 689 6.8 645
Advertising and public relations 692 (2.7) 711 35.7 524
Professional services 574 11.7 514 63.2 315
Printing, stationery and supplies 335 (3.2) 346 25.8 275
Collection expense 76 (67.4) 233 (27.4) 321
Other real estate owned (473) (382.7) (98) (116.0) 614
Other expenses 1,361 (4.4) 1,423 (13.3) 1,642
--------- --------- ---------
Total noninterest expense $16,825 3.9 $16,198 4.1 $15,567
--------- --------- ---------
--------- --------- ---------
17
IMPACT OF YEAR 2000 ON COMPUTER SYSTEMS
Noninterest expense includes the cost of projects to ensure accurate
date recognition and data processing with respect to the century date change
(commonly referred to as "Y2K"). The Y2K issue confronting the Company, its
suppliers, customers, customer's suppliers and competitors centers on the
inability of computer systems to recognize the year 2000. Most computer
systems in use today were designed and developed when computer memory was
limited and expensive on early mainframes. As a consequence many programs
used only two digits for the year in the date field to conserve memory. As a
result, many computer applications could fail completely or create erroneous
results by the year 2000 unless corrective measures are taken. To the extent
that the problem is not successfully addressed, consequences, the extent of
which are unknown, could impact the Company's business, operations, customers
and vendors. The Company has identified critical systems and processes and is
in the process of testing and formulating contingency plans for replacing or
repairing any non-compliant systems. The Company expects to substantially
complete the Y2K hardware and software testing, validation and remediation of
its critical systems by the end of the first quarter of 1999. The Company is
also assessing the potential impact of this problem on its customers. The
related costs, which are expensed as incurred, are primarily included in
professional services, equipment repairs (a component of occupancy expense)
and salary expense. Y2K expenses incurred through the end of 1998 amounted to
approximately $175,000 and the total cost of the project is estimated to be
approximately $360,000. The Company does not believe that the costs of
addressing this problem will have a material effect on the results of its
operations.
INCOME TAXES
The Company's income tax expense for 1998, 1997 and 1996 was $3.4
million, $2.3 million and $2.1 million, respectively, reflecting an effective
tax rate of 41.4%, 39.7% and 43.3%, respectively. Note Eleven to the
consolidated financial statements includes a reconciliation of federal income
tax expense computed using the federal statutory rate of 34% to actual income
tax expense.
FINANCIAL CONDITION
SUMMARY
An analysis of the summary year-end balance sheet data for 1994 through
1998 as presented in Selected Financial Data (Item 6) illustrates an increasing
rate of growth over the last four years. From 1995 to 1998, the Company's total
assets have grown an average of over 12% per year. During the same period, loan
growth averaged 13%, deposit growth averaged 12% and stockholders' equity grew
at an average rate of 20% per year.
A review of the Company's rate of growth for year-end 1998 over 1997
reflects a 20% increase in total assets, a 13% increase in total loans, and a
21% increase in deposits. A number of factors supported the growth of assets,
loans and deposits in 1998. The Company focused on opportunities to attract new
clients which were presented by bank merger and acquisition activity in its
market areas. Loan growth, primarily in commercial, commercial real estate and
construction lending, was encouraged by the expansion of the local real estate
markets. The volatile stock market helped to promote bank deposits, primarily
certificates of deposit, as a safe short term investment. The following
discussion of the Company's financial condition is segmented into loans,
investments, deposits and capital resources.
LOANS
Gross loans and leases, the Company's primary use of funds, represented
70% of total assets at December 31, 1998 compared to 75% at year-end 1997. Gross
loans increased 13% to $237.7 million at year-end 1998 and 17% to $211.0 million
in 1997 from $180.4 million in 1996. Average gross loans for 1998 increased 14%
or $26.7 million to $222.2 million from $195.5 million in 1997 which represented
an increase of 14% from average loans of $171.9 million in 1996. Average gross
loans represented 80% and 79% of total average deposits in 1998 and 1997,
respectively.
As presented in Table Five, real estate construction loans at
year-end 1998 had increased 92% to $19.9 million and 197% to $10.3 million in
1997 following declines in the previous two years due to a decline in real
estate values and a generally poor economy in Southern California. During
1996 the demand for real estate in Southern California, and therefore, real
estate values, began improving and have continued to improve through
18
the end of 1998, largely accounting for the increase in real estate
construction loans outstanding and undisbursed real estate construction loan
commitments. Real estate construction loans represented 8.4% and 4.9% of
total loans at December 31, 1998 and 1997, respectively. Total undisbursed
commitments for these loans were $10.9 million at year-end 1998 compared to
$18.9 million the end of 1997. The Company's real estate construction loans
are primarily for single family residences located within San Diego and
Riverside counties in the $100,000 to $400,000 range. Based upon the current
housing market in its market area, management believes real estate demand
will likely continue at its current strong levels and believes that its level
of real estate construction activities will expand over that of 1998.
Commercial real estate loans (commercial loans secured by first trust
deeds on commercial real estate) increased 20% to $51.5 million at year-end 1998
from $42.9 million in 1997, which represented a 23% increase over $35.0 million
in 1996. These increases were the result of the Company's promotional efforts in
the commercial real estate market as well as stabilization of commercial real
estate values in Southern California.
Residential mortgages decreased 25% to $2.2 million in 1998 from $2.9
million in 1997, a decrease of 13% from $3.3 million at year-end 1996. The
Company closed its residential mortgage banking operations in early 1995, unable
to generate a sufficient volume of residential mortgage loans to support a
profitable operation. At December 31, 1998, 1997 and 1996, the amount of
mortgage loans which the Company continued to service was $35.3 million, $45.7
million and $51.6 million, respectively, with related servicing income of
$104,000, $145,000 and $149,000, respectively. Declining home mortgage rates
have increased mortgage refinancing activity, which, if continued, will continue
to reduce servicing income on these loans.
TABLE FIVE - LOAN DISTRIBUTION
(DOLLARS IN THOUSANDS)
The following table sets forth the amount of total loans outstanding in
each category and the percentage of total loans of each category at the dates
indicated.
DECEMBER 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- --------- ---------
Commercial loans ..................... $128,298 $111,726 $ 81,692 $ 74,755 $ 75,700
Commercial real estate loans ......... 51,520 42,891 35,012 23,075 19,287
Installment and consumer loans ....... 34,171 41,024 53,815 46,748 45,022
Real estate construction loans ....... 19,881 10,334 3,481 9,212 14,211
Residential real estate loans ........ 2,192 2,912 3,340 3,795 7,454
Lease financing ...................... 617 1,270 2,329 3,586 4,148
All other loans (including overdrafts) 1,023 834 741 779 787
-------- -------- -------- -------- --------
Total gross loans ................ 237,702 210,991 180,410 161,950 166,609
Less: Allowance for loan
and lease losses .................. 3,592 3,268 3,129 2,916 2,739
-------- -------- -------- -------- --------
Total net loans (1) .............. $234,110 $207,723 $177,281 $159,034 $163,870
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
PERCENTAGE OF TOTAL LOANS:
Commercial loans ..................... 54.0% 53.0% 45.3% 46.2% 45.4%
Commercial real estate loans ......... 21.6 20.3 19.4 14.2 11.6
Installment and consumer loans ....... 14.4 19.4 29.8 28.9 27.0
Real estate construction loans ....... 8.4 4.9 1.9 5.7 8.5
Residential real estate loans ........ 0.9 1.4 1.9 2.3 4.5
Lease financing ...................... 0.3 0.6 1.3 2.2 2.5
All other loans (including overdrafts) 0.4 0.4 0.4 0.5 0.5
-------- -------- -------- -------- --------
Total gross loans ................ 100.0 100.0 100.0 100.0 100.0
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
(1) Net of participations sold of $1.5 million, $2.2 million, $2.2 million,
$2.9 million, and $4.2 million in 1998, 1997, 1996, 1995, and 1994,
respectively. Participations are sold without recourse.
19
Commercial loans, as illustrated in Table Five, have grown at annual
rates of 15%, 37% and 9% in 1998, 1997 and 1996, respectively, representing 54%,
53% and 45% of year-end gross loans in 1998, 1997, and 1996, respectively.
Commercial lending is primarily to professionals and companies with sales from
$1 million to $15 million. The Company also originates loans partially
guaranteed by the SBA which are included in the commercial loan category and
were largely responsible for the growth in 1998 and 1997. SBA loans have
maturities ranging from seven to 25 years and are currently guaranteed up to 80%
by the SBA. These loans increased 19% to $65.8 million in 1998 from $55.1
million in 1997, representing an increase of 87% over $29.5 million at year-end
1996. The increases were largely due to expansion of the Company's market area
in 1997 and to Management's decision during 1996 to retain these loans rather
than sell the guaranteed portions for a premium. The Company's SBA loan
originations totaled approximately $29.6 million, $35.0 million and $15.4
million in 1998, 1997 and 1996, respectively. In 1997, the Company opened two
new offices for the production of SBA lending, located in the Seattle,
Washington area and Orange County, California. The Orange County office proved
unprofitable due to strong competition in that market and was closed in January
1999. The Company intends to continue expanding its SBA lending activities
possibly entering new geographic markets in 1999. In 1996, Management's decision
to reduce the volume of SBA loan sales and retain these loans in the portfolio
was due to the low level of demand for other types of loans. Management does not
currently intend to sell a significant amount of these loans, however, some
sales are likely depending on loan demand, premium levels, prepayment risk and
the characteristics of these loans. SBA loan sales totaled $7.5 million in 1998,
$0 in 1997 and $8.3 million in 1996.
Installment and consumer loans have shown a steady rate of decline in
total and as a percentage of gross loans since 1996. These loans decreased 17%
and 24% in 1998 and 1997, respectively, and represented 14% and 19% of total
gross loans, respectively. As of year-end 1996, this category had increased 15%
over the prior year and constituted 30% of gross loans. The four largest
sub-categories of installment and consumer loans are automobile loans, Title I
home improvement loans, home equity lines of credit and other home equity loans.
The decreases in installment and consumer loans in 1998 and 1997 and the
increase in 1996 were due primarily to the Company's Title I loan activities.
Title I loans decreased 31% to $7.2 million in 1998 and decreased 55% to
$10.4 million in 1997 from $23.0 million in 1996, an increase of 92% from $12.0
million at year-end 1995.
Title I loans are secured by junior liens on residential properties and
insured up to 90% by an agency of the U.S. Government. The proceeds of Title I
loans must be used for home improvements. In addition to offering these loans to
its customers, the Company also purchases Title I loans from other Title I
lenders. The amount of Title I loans that the Company originated or purchased
declined to approximately $2.5 million in 1998 and $6.8 million in 1997 from
$18.0 million in 1996, due to increased competition in the Title I market and
the the rising popularity of other home equity loans. Prior to 1997, the
Company's policy was to hold certain Title I loans in its portfolio and sell the
remaining loans often retaining the servicing rights. A higher than acceptable
loss ratio, however, prompted the Company to change its policy and currently the
Company sells all Title I loan originations immediately resulting in a large
volume of sales in 1997. The Company continues to hold $7.2 million of Title I
loans as of December 31, 1998 compared to $10.4 million in 1997. During 1998,
1997 and 1996, the Company sold a total of $2.1 million, $18.5 million and $5.3
million, respectively, in Title I loans. The Company serviced a total of $2.3
million, $3.6 million and $9.3 million in Title I loans at December 31, 1998,
1997 and 1996, respectively.
Other home equity loans are secured by junior trust deeds on
residential properties and may be made to homeowners with little or no equity in
the property. Unlike Title I loans, the proceeds can be used for a variety of
purposes the most common of which are home improvement and debt consolidation.
The Company purchases and originates equity loans for immediate sale into the
secondary market. As a result of increased demand for other types of equity
loans, and to mitigate the impact of decreased premiums from the sale of Title I
loans to current income, the Bank increased its volume in other equity loans
during 1997 and 1996. The secondary market demand for these loans decelerated in
1998 and consequently the Company's volume declined. During 1998, 1997 and 1996,
the Bank originated or purchased approximately $30.4 million, $37.1 million and
$13.5 million, respectively, in equity loans which were sold in the secondary
market. These loans totaled $ 3.2 million, $4.5 million, and $1.2 million at
year-end 1998, 1997 and 1996, respectively. Despite the recent decline in demand
for Title I and other home equity loans, the Company currently intends to remain
active in this line of business.
Home equity lines of credit, secured primarily by second trust deeds on
single family residences, declined 7% to $6.0 million in 1998 from $6.5 million
in 1997, a decrease of 12% from $7.4 million the prior
20
year. The Company requires a debt-to-value ratio of not higher than 80% for
home equity lines. Automobile loans increased only 1% in 1998 to $9.5 million
after decreasing 2% to $9.4 million in 1997 from $9.6 million at year-end
1996. The decline in the volume of automobile loans since 1996 is due to the
intense competition from other bank and non-bank lenders in this market.
The Company provides lease financing to municipalities and school
districts in its market area subject to the same underwriting considerations and
criteria as commercial loans. These leases are qualified tax-exempt lease
obligations for federal income tax purposes. Low taxable-equivalent yields as
compared to commercial, commercial real estate and SBA loans has significantly
reduced the Company's level of activity in these leases (see Table Five).
In the usual course of business, the Company makes commitments to extend
credit provided there is no violation of any conditions established in the loan
contract. Total unfunded commitments to extend credit were $68.5 million, $68.4
million and $45.1 million at December 31, 1998, 1997 and 1996, respectively, and
included standby letters of credit of $1.3 million, $1.7 million, and $1.9
million, respectively.
Loan repayments and maturities represent a significant source of
liquidity for the Company. Table Six shows selected loan maturity data as of
December 31, 1998 and indicates that 34% of the selected loans had contractual
maturities of one year or less.
TABLE SIX - SELECTED LOAN MATURITY DATA
(DOLLARS IN THOUSANDS)
This table presents maturity distribution and interest sensitivity of
selected loan categories (excluding nonaccrual commercial loans of $387,000).
Maturities are presented on a contractual basis.
MATURING
----------------------------------------------
AFTER ONE
WITHIN BUT WITHIN MORE THAN
ONE YEAR FIVE YEARS FIVE YEARS TOTAL
-------- ---------- ---------- --------
Real estate construction loans ......... $19,320 $ 561 $ -- $ 19,881
Commercial loans ....................... 30,345 28,397 69,169 127,911
------- -------- -------- --------
Total ......................... $49,665 $ 28,958 $ 69,169 $147,405
------- -------- -------- --------
------- -------- -------- --------
Sensitivity of loans due after one year
to changes in interest rates:
Fixed interest rate ................ $ 16,320 $ 7,531 $ 23,851
Floating or adjustable interest rate 12,638 61,638 74,276
-------- -------- --------
Total ......................... $ 28,958 $ 69,169 $ 98,127
-------- -------- --------
-------- -------- --------
NONPERFORMING ASSETS AND RESTRUCTURED LOANS
Nonperforming assets consist of nonperforming loans and other real
estate owned ("OREO"). The Company considers a loan to be nonperforming when any
one of the following events occurs: (i) any installment of principal or interest
is 90 days past due; (ii) the full timely collection of interest or principal
becomes uncertain; (iii) the loan is classified as "doubtful" by bank examiners;
or (iv) a portion of its principal balance has been charged-off. OREO, which is
any real estate owned other than banking premises, typically consists of
foreclosed properties.
Total nonperforming assets declined 71% to $1.2 million at December 31,
1998 from $4.0 million at year-end 1997, a decline of 36% from $6.3 million the
prior year-end. This progress was the result of the Company's continued efforts
to improve asset quality, as well as improvement in the Southern California
economy. As presented in Table Seven, nonaccrual loans decreased 74% to $788,000
at December 31, 1998 from $3.0 million at year-end 1997, a 15% decrease from
$3.5 million at December 31, 1996. OREO at December 31, 1998 totaled $374,000, a
decrease of 62% from $986,000 at the end of 1997, which represented a decrease
of 64% as compared to $2.8 million at December 31, 1996.
OREO is recorded at its net realizable value at the time the asset is
transferred to OREO. Additional writedowns in the value of the properties may
occur depending upon changes in the market, annual appraisals
21
of the property and the estimated length of time needed to dispose of the
property. The Company has experienced some improvement in its ability to
dispose of its OREO over the last several years, selling nine properties that
totaled $1.2 million in 1998, thirteen properties that totaled $3.3 million
in 1997 and 22 properties that totaled $2.8 million in 1996. At December 31,
1998, OREO consisted of one single family residence totaling $306,000, five
parcels of vacant land zoned for residential use carried at $68,000 and one
parcel of vacant land zoned for commercial use carried at $0.
Interest income included in net interest income relating to nonaccrual
loans was $38,000 and $123,000 for the years ended December 31, 1998 and 1997,
respectively. Additional interest income of $62,000 and $212,000 would have been
recorded during 1998 and 1997, respectively, if the loans had been paid in
accordance with their original terms.
TABLE SEVEN - NONPERFORMING ASSETS
(DOLLARS IN THOUSANDS)
DECEMBER 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
------- ------ ------ ------ ------
Loans 90 days or more past due
and still accruing (as to principal or interest):
Installment and consumer loans ................ $ -- $ -- $ -- $ -- $ 14
------ ------ ------ ------ ------
Nonaccrual loans:
Residential real estate ....................... 130 -- 150 317 622
Commercial real estate ........................ -- -- -- 778 565
Real estate construction ...................... -- -- 581 1,506 1,389
Commercial .................................... 387 2,163 1,540 1,560 1,775
Installment and consumer loans ................ 271 858 1,270 1,129 767
------ ------ ------ ------ ------
Total ....................................... 788 3,021 3,541 5,290 5,118
------ ------ ------ ------ ------
Total nonperforming loans ................... 788 3,021 3,541 5,290 5,132
Other real estate owned ......................... 374 986 2,756 2,402 3,607
------ ------ ------ ------ ------
Total nonperforming assets .................. $1,162 $4,007 $6,297 $7,692 $8,739
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Nonperforming loans to
total gross loans ............................. 0.33% 1.43% 1.96% 3.27% 3.08%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Nonperforming assets to
total gross loans plus
other real estate owned ....................... 0.49% 1.89% 3.44% 4.68% 5.13%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Other past due loans at December 31, 1998 included $877,000 of loans past
due more than 30 days but less than 90 days.
TABLE EIGHT - RESTRUCTURED LOANS
(DOLLARS IN THOUSANDS)
The following table provides information with respect to the components
of the Company's restructured loans at the dates indicated.
DECEMBER 31,
--------------------------------------------------
1998 1997 1996 1995 1994
------ ----- ------ ------ ------
Residential real estate .. $ 151 $ 171 $ 240 $ 548 $ 646
Commercial real estate ... 4,759 3,207 3,853 4,405 2,960
Real estate construction . -- -- 581 1,506 1,171
Commercial ............... 166 484 731 479 1,354
------ ------ ------ ------ ------
Total restructured loans $5,076 $3,862 $5,405 $6,938 $6,131
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Restructured loans consist of loans whose terms have been modified to
provide some relief from the scheduled interest and principal payments in light
of the customer's financial difficulties, the objective of which is to maximize
the Bank's possibility of collection. Restructured loans totaled $5.1 million
and $3.9 million at
22
December 31, 1998 and 1997, respectively. There were no restructured loans
accounted for as nonaccrual loans at December 31, 1998. Restructured loans
includes $115,000 and $45,000 in residential real estate loans and commercial
loans, respectively, which were accounted for as nonaccrual loans at December
31, 1997.
A loan is deemed to be impaired when it is probable that a creditor
may not collect amounts due according to the original contractual terms of the
original loan agreement. Impaired loans are measured using one of the following
methods: (i) the present value of expected cash flows discounted at the loan's
effective interest rate; (ii) the observable value of the loan's market price;
or (iii) the fair value of the collateral if the loan is collateral dependent.
All impaired loans at December 31, 1998 were measured based on the fair value of
the loan collateral. Interest income on impaired loans is recognized on a cash
basis.
The Bank's recorded investments in impaired loans at December 31,
1998 and 1997, were $954,000 and $2,163,000, respectively. Reserves for loan
losses of $48,000 and $151,000 were established for impaired loans at December
31, 1998 and 1997, respectively. The average recorded investments in impaired
loans during 1998 and 1997 were $1,654,000 and $2,528,000, respectively.
Interest income on impaired loans of $16,000 and $120,000 was recognized for
cash payments received in 1998 and 1997. The Company is not committed to lend
additional funds to debtors whose loans have been modified.
ALLOWANCE FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses at December 31, 1998 totaled
$3.6 million or 1.51% of total gross loans as compared to $3.3 million or 1.55%
of total gross loans at December 31, 1997 and $3.1 million or 1.73% of total
gross loans at December 31, 1996.
It is the Company's practice to maintain the allowance for loan and
lease losses at a level considered by Management to be adequate. Each month
Management calculates a minimum acceptable allowance for loan and lease losses
using an internal rating system based upon the risk associated with various
categories of loans. In determining the actual allowance for loan and lease
losses to be maintained, Management augments this calculation with an analysis
of the present and prospective financial condition of certain borrowers,
industry concentrations within the portfolio, trends in delinquent and
nonaccrual loans and general economic conditions. A portion of the calculation
is based upon the historical loss experience of the preceding five years and in
some risk categories the degree of collateralization. The risk assigned to each
loan is first determined when the loan is originated. It is then reviewed
quarterly and revised as appropriate. In addition, the Company maintains a
monitoring system for all credits that have been identified either internally or
externally as warranting additional Management attention. These credits are
formally reported to Management by the lending officers on a quarterly basis and
are subsequently reviewed by the Loan Committee of the Board of Directors.
Reserves against these loans are based on the credit risk assigned to the loans
as described above utilizing a schedule of percentages developed by Management
in accordance with historical loss experience, ranging from 0.5% to 50% of the
present loan balances. These percentages may be modified, based upon current or
prospective local economic conditions. The comments of bank examiners, the
Company's independent auditors and a third party loan review consultant hired by
the Company on a periodic basis are also considered in revising risk category
assignments.
The allowance for loan and lease losses is based upon estimates and
ultimate losses may vary from current estimates. The continuing evaluation of
the loan portfolio and assessment of current economic conditions will dictate
future funding levels. Management believes that the allowance for loan and lease
losses at December 31, 1998 was adequate to absorb the known and inherent risks
in the loan portfolio. However, no assurance can be given that changes in the
current economic environment in the Company's principal market area or other
circumstances will not result in increased losses in the Company's loan
portfolio in the future. Net charged-off loans as a percentage of the beginning
of the period allowance for loan and lease losses were 35.2%, 31.4% and 37.3% in
1998, 1997 and 1996, respectively.
Table Nine summarizes, for the periods indicated, loan balances at
the end of each period and daily averages during the period, changes in the
allowance for loan and lease losses arising from loans charged off,
recoveries on loans previously charged off, and additions to the allowance
which have been charged to operating expense; and certain ratios relating to
the allowance for loan losses.
23
TABLE NINE - ALLOWANCE FOR LOAN AND LEASE LOSSES
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1998 1997 1996 1995 1994
--------- -------- -------- -------- --------
BALANCES:
Average loans during period ............... $222,193 $195,536 $171,906 $165,374 $168,076
Loans at end of period .................... 237,702 210,991 180,410 161,950 166,609
ALLOWANCE FOR LOAN AND LEASE LOSSES:
Balance at beginning of period ............ 3,268 3,129 2,916 2,739 2,195
Actual charge-offs:
Residential real estate loans ........... -- 13 10 137 380
Commercial real estate loans ............ -- -- 88 46 --
Real estate construction loans .......... -- -- 263 525 71
Commercial loans ........................ 291 502 450 1,514 1,595
Installment and consumer loans .......... 1,110 1,054 609 1,022 804
--------- -------- -------- -------- --------
Total ............................... 1,401 1,569 1,420 3,244 2,850
Recoveries on loans previously charged off:
Residential real estate loans ........... -- -- -- -- --
Commercial real estate loans ............ 35 -- -- -- --
Real estate construction loans .......... -- 489 -- -- --
Commercial loans ........................ 98 33 274 47 184
Installment and consumer loans .......... 118 64 59 68 75
--------- -------- -------- -------- --------
Total ............................... 251 586 333 115 259
Net loan charge-offs ...................... 1,150 983 1,087 3,129 2,591
Provision for loan and lease losses ....... 1,474 1,122 1,300 3,306 3,135
--------- -------- -------- -------- --------
Balance at end of period .................. $ 3,592 $ 3,268 $ 3,129 $ 2,916 $2,739
--------- -------- -------- -------- --------
--------- -------- -------- -------- --------
RATIOS:
Net loan charge-offs to average loans ..... 0.52% 0.50% 0.63% 1.89% 1.54%
Allowance for loan and lease losses
to loans at end of period ............... 1.51 1.55 1.73 1.80 1.64
Net loan charge-offs to beginning of the
period allowance for loan and lease
losses .................................. 35.2 31.4 37.3 114.2 118.0
Net loan charge-offs to provision
for loan and lease losses ............... 78.0 87.6 83.6 94.7 82.7
Each type of loan made by the Company presents various types of risk
of loss to the Company. The primary risk element considered by Management
with respect to each installment, commercial real estate and residential real
estate loan is lack of timely payment and the value of the collateral. The
primary risk elements with respect to real estate construction loans are
fluctuations in real estate values in the Company's market areas, inaccurate
estimates of construction costs, fluctuations in interest rates, the
availability of conventional financing, the demand for housing in the
Company's market area and general economic conditions. The primary risk
elements with respect to commercial loans are the financial condition of the
borrower, general economic conditions in the Company's market area, the
sufficiency of collateral, the timeliness of payment and with respect to
adjustable rate loans and interest rate fluctuations. Management has a policy
of requesting and reviewing annual financial statements from its commercial
loan customers and periodically reviews the existence and value of its
collateral. Management also has a reporting system that monitors all past due
loans and has adopted policies to pursue its creditor's rights in order to
preserve the Company's position.
Loans are charged against the allowance when, in Management's
opinion, they are deemed uncollectible, although the Company continues to
aggressively pursue collection. Although Management believes that the
allowance for loan and lease losses is adequate to absorb losses as they
arise, there can be no assurance that (i) the Company will not sustain losses
in any given period which could be substantial in relation to the size of the
allowance for loan and lease losses, (ii) the Company's level of
nonperforming loans will not increase, (iii) the Company will not be required
to make significant additional provisions to its allowance for loan and lease
losses, or (iv) the level of net charge-offs will not increase and possibly
exceed applicable reserves.
24
INVESTMENT PORTFOLIO
The Company's investment strategy is to maximize portfolio yields
commensurate with risk and liquidity considerations. The primary objectives
of the investment strategy are to provide adequate levels of investment
income and secondarily to maintain an appropriate level of liquidity. The
decision to purchase or sell securities is based upon the current assessment
of economic and financial conditions, including the interest rate environment
and liquidity requirements. Among other things, the Company's investment
policy prohibits investments in derivative securities.
At December 31, 1998, investment securities totaled $43.8 million or
13% of total assets, an increase of 48% compared to $29.7 million or 11% of
total assets at December 31, 1997. The 1998 increase was funded by deposit
growth which outpaced growth in the loan portfolio, the Company's primary use
of funds. Average investment securities in 1998 actually decreased slightly
by 2% to $32.5 million from $33.2 million in 1997. Investment purchases in
1998 totaled $29.5 million, of which $21.2 million were in Federal agency
securities. The Company utilizes the services of a professional investment
advisor on a portion of its investment portfolio for which it pays a fee.
The Company's investment securities are classified into two
portfolios: available for sale and held to maturity. The Company does not
maintain a trading portfolio. Investments classified as available for sale
are carried at market value, with the unrealized gain or loss net of tax
effect accumulated as other comprehensive income, a separate component of
stockholders' equity. Unrealized gains of $71,000 in 1998 and unrealized
losses of $3,000 and $156,000 for 1997 and 1996, respectively, were
recognized in the available for sale portfolio. Held to maturity investments
are carried at amortized cost. Table Ten presents the year-end carrying value
for the total portfolio for each of the investment categories for the past
three years.
TABLE TEN - INVESTMENT SECURITIES
(DOLLARS IN THOUSANDS)
AVAILABLE FOR SALE: 1998 1997 1996
------- ------- -------
U.S. Treasury securities .......... $ -- $ -- $ 501
Obligations of other U.S.
government agencies ............. -- 1,002 9,022
Obligations of states and political
sub-divisions ................... 2,085 2,116 2,142
Mortgage-backed securities ........ 13,306 12,896 7,362
Equity securities (1) ............. 1,802 1,530 4,090
------- ------- -------
Total ........................... $17,193 $17,544 $23,117
------- ------- -------
------- ------- -------
HELD TO MATURITY:
U.S. Treasury securities .......... $ 301 $ 301 $747
Obligations of other U.S.
government agencies ............. 21,854 7,478 5,674
Obligations of states and
political sub-divisions ......... 1,849 1,748 1,751
Mortgage-backed securities ........ 2,041 2,608 3,172
Asset-backed securities ........... 583 -- --
------- ------- -------
Total .......................... $26,628 $12,135 $11,344
------- ------- -------
------- ------- -------
- ------------------------
(1) Equity securities in 1998, 1997 and 1996, included $687,000, $498,000
and $3.4 million, respectively, in government securities bond and money market
funds which invest in securities guaranteed by the U.S. Government, $877,000,
$794,000 and $733,000 in Federal Home Loan Bank stock in 1998, 1997 and 1996,
respectively, and $238,000 in Federal Reserve Bank stock in 1998 and 1997.
Equity securities, part of the available for sale portfolio, are carried on
the books of the Company at the lower of aggregate cost or market. In 1998,
1997 and 1996 stockholders' equity was reduced by $39,000, $36,000 and
$68,000, respectively to reflect a decline in the market value of these
securities.
The Company's available for sale portfolio consists primarily of
mortgage-backed securities, which constituted 77% and 74%, respectively, of
this portfolio at the end of 1998 and 1997. Most of these securities are
comprised of adjustable rate mortgages most commonly tied to the one, three
or five year U.S. Treasuries or the Federal Home Loan Bank Eleventh District
cost of funds index. Although market value may fluctuate, the interest rates
of the individual mortgages in these pools are periodically adjusting to
current rates, resulting in
25
an asset with a market value that is relatively stable compared to a fixed
rate security with similar characteristics, reducing the Company's interest
rate risk. Also, due to an active secondary market, mortgage-backed
securities can offer liquidity similar to U.S. Treasury securities at yields
that are typically higher than comparable Treasury securities.
The held to maturity portfolio consists primarily of U.S. Government
and Federal agency securities, which comprised 82% and 62%, respectively, of
this portfolio at the end of 1998 and 1997. This security category contained
$5.0 million, or 19% of the portfolio total, in agency discount notes at the
end of 1998, which matured within one month and offered a higher yielding
alternative for investing excess liquidity as compared to Federal funds sold.
TABLE ELEVEN - INVESTMENT PORTFOLIO MATURITIES AND YIELDS
(DOLLARS IN THOUSANDS)
This table summarizes the maturity of the Company's investment
securities and their weighted average yields at December 31, 1998. Tax-exempt
income from investment securities is presented on a tax-equivalent basis
assuming a 34% federal income tax rate for 1998. Mortgage-backed securities
are categorized based on final maturity dates.
AFTER ONE BUT AFTER FIVE BUT
WITHIN WITHIN FIVE WITHIN TEN AFTER TEN
ONE YEAR YEARS YEARS YEARS TOTAL
----------------- --------------- --------------- ---------------- ---------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------- ----- ------- ----- ------ ----- ------ ----- ------- -----
U.S. Treasury securities .... $ 301 5.15% $ -- -- % $ -- -- % $ -- -- % $ 301 5.15%
Obligations of other U.S.
government agencies ....... 6,499 5.27 10,147 6.01 5,208 6.13 -- -- 21,854 5.82
Obligations of states and
political subdivisions .... 2,716 6.26 619 6.43 -- -- 599 6.32 3,934 6.30
Mortgage-backed securities .. -- -- 210 8.20 1,192 7.06 13,945 6.53 15,347 6.59
Asset-backed securities ..... 583 5.25 -- -- -- -- -- -- 583 5.25
Equity securities ........... 1,802 5.50 -- -- -- -- -- -- 1,802 5.50
------- ------- ------ ------- -------
Total investment securities $11,901 5.52% $10,976 6.08% $6,400 6.31% $14,544 6.52% $43,821 6.11%
------- ------- ------ ------- -------
------- ------- ------ ------- -------
DEPOSITS
Total average deposits during 1998 increased 13% to $277.1 million
compared to $246.0 million in 1997, an increase of 11% from $220.8 million in
1996. The following discussion addresses changes in average balances in 1998
and 1997 compared to the prior years. Average deposit balances and yields are
presented in Table Twelve. The largest percentage increases in 1998 were in
noninterest-bearing demand accounts which increased by 13% to $92.9 million
and time deposits which increased by 21% to $62.4 million. There were no
significant shifts in average deposit mix in 1998. As a percentage of total
deposits, noninterest-bearing demand deposits were at 34%, interest-bearing
demand accounts at 15%, savings and money market accounts at 29% and time
deposits at 23%. Time deposits as a percentage of total deposits increased to
21% in 1997 from 16% the prior year due to a local deposit promotion during
the first part of 1997 that raised approximately $17.0 million in seven month
certificates of deposit. Noninterest-bearing demand deposits increased 12% or
$8.7 million during 1997 and represented 33% of total deposits at both
December 31, 1997 and 1996, respectively.
The levels of noninterest-bearing demand deposits (including retail
accounts) are influenced by such factors as customer service, service charges
and the availability of banking services (i.e., extended hours, convenience
of location, availability of ATMs). No assurance can be given that the
Company will be able to maintain its current level of noninterest-bearing
deposits. The Company's percentage of noninterest-bearing deposits remains
high compared to similar sized institutions. Competition from other banks and
thrift institutions as well as money market funds, some of which offer
interest rates substantially higher than the Company, makes it difficult for
the Company to maintain the current level of noninterest-bearing deposits.
Management continually works to implement pricing and marketing strategies
designed to lower the average rate paid on interest-bearing deposits and to
maintain a stable deposit mix. The rapid rise in time deposits during 1998
precipitated Management's efforts to reduce interest expense by lowering the
rates paid on time deposits which is expected to continue into 1999.
26
TABLE TWELVE - AVERAGE DEPOSITS
(DOLLARS IN THOUSANDS)
This table summarizes the distribution of average deposits and the
average rates paid for the periods indicated.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------
1998 1997 1996
-------------------- ------------------- ----------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
Noninterest-bearing
demand deposits .... $ 92,885 -- $ 81,958 -- $ 73,298 --
Interest-bearing
demand deposits .... 41,391 1.32% 36,809 1.43% 36,791 1.44%
Savings deposits ..... 80,415 3.19 75,650 3.29 75,583 3.29
Time deposits ........ 62,359 5.02 51,621 5.11 35,166 4.77
-------- -------- --------
Total deposits... $277,050 2.25% $246,038 2.30% $220,838 2.13%
-------- -------- --------
-------- -------- --------
As part of its asset/liability management policy, the Company
generally limits the issuance of time deposits of $100,000 or greater
primarily to customers who have other business relationships with the Company
and who reside within the Company's market area, although the Company may
offer such deposits to others to help it meet its liquidity needs. The
Company generally limits the terms of these deposits to less than one year in
order to allow it to react quickly to changing interest rates. Table Thirteen
depicts the maturity distribution of these deposits at year-end 1998. At
December 31, 1998 and 1997, time deposits of $100,000 or more totaled $20.9
million and $9.2 million, respectively, representing 7% and 4% of total
period-end deposits, respectively.
TABLE THIRTEEN - MATURITY OF TIME DEPOSIT OF $100,000 OR MORE
(DOLLARS IN THOUSANDS)
TIME DEPOSITS MATURING IN DECEMBER 31, 1998
------------------------- -----------------
Three months or less........................................ $11,062
Over three months through six months........................ 2,117
Over six months through twelve months....................... 5,537
Over twelve months.......................................... 2,152
-------
Total................................................... $20,868
-------
-------
CAPITAL RESOURCES
Stockholders' equity increased $4.8 million or 19% to $30.0 million
at December 31, 1998, from $25.2 million at December 31, 1997. This increase
was due to net income of $4.8 million and an increase of $41,000 in
unrealized gains on available for sale securities, net of $33,000 in income
taxes. Stockholders' equity increased $5.0 million or 25% to $25.2 million at
year-end 1997 from $20.2 million the prior year-end. This increase was due to
net income of $3.5 million, the conversion of subordinated debentures, net of
deferred offering costs, of $1.4 million, and a decrease of $84,000 in
unrealized losses on available for sale securities, net of $69,000 in taxes.
(See "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Results of Operations.")
Under the risk-based capital guidelines for banks and bank holding
companies adopted by the federal banking regulators in 1988 the Company and
the Bank are required to maintain a minimum ratio of total capital to total
risk-weighted assets of 8.00% (at least one-half of which must consist of
Tier 1 capital). Risk-based capital ratios are calculated to provide a
measure of capital that reflects the degree of risk associated with banking
organization's operations for both transactions reported on the balance sheet
as assets, and transactions, such as letters of credit and recourse
arrangements, which are recorded as off-balance sheet items.
Additionally, the federal banking regulators adopted minimum Tier 1
leverage capital ratio requirements in 1990 supplementing the risked-based
capital regulations and replacing minimum leverage ratios used prior to 1990.
The rules require a minimum ratio of Tier 1 capital to total assets of 3.00%
for institutions receiving the highest regulatory rating. All other
institutions are required to meet a minimum ratio of 4.00% to 5.00%. Tier 1
capital consists of common equity, minority interest in equity of
consolidated subsidiaries, and qualifying
27
perpetual preferred stock. Table Fourteen presents the risk-based and Tier 1
leverage capital ratios for the Company and the Bank at year-end 1998 and
1997. (See "Description of Business - Regulation and Supervision - Capital
Adequacy Requirements").
TABLE FOURTEEN - CAPITAL RATIOS
North County Bancorp North County Bank
-------------------- -------------------
1998 1997 1998 1997
------ ------- ------ -------
Risk-based Capital:
Tier 1 11.68% 10.88% 11.58% 10.85%
Total 12.93% 12.14% 12.83% 12.10%
Tier 1 leverage capital 8.80% 8.76% 8.72% 8.73%
In May 1990, the Company issued $1.7 million in 9 1/4% convertible
subordinated debentures (the "Debentures"). In September 1997, at which time
$1.5 million in Debentures remained outstanding, the Company announced that
it was exercising its option to redeem the Debentures at a price of 102.25%
effective October 31, 1997. Most holders of the Debentures elected to convert
to common stock, receiving 267 shares per $1,000 face value of Debentures,
representing a conversion price of $3.74. The conversion of Debentures during
1997 resulted in an increase in common stock, a component of Tier 1 capital,
of $1.4 million, net of deferred offering costs of $101,000.
As a bank holding company without significant assets other than its
equity interest in the Bank, the Company's ability to meet its obligations
depends upon the dividends it receives from the Bank. The Bank resumed the
payment of dividends in 1997 on the Bank's preferred stock. Such dividends
had not been paid since 1994, pursuant to formal and informal agreements with
the Bank's regulators and a Board resolution adopted in May of 1996, the last
of which was terminated in March 1997.
As of December 31, 1995, the Bank, operating under the terms of a
regulatory order (the "Order") entered into with the FDIC in May 1995 and an
informal agreement entered into with the California Superintendent of Banks
in April 1994, had agreed, among other things, not to pay cash dividends to
the Company without the prior consent of the FDIC. The Order was terminated
in May of 1996, when, at the request of the FDIC, the Board passed a
resolution stating that the Bank would: (i) maintain an adequate level of
capital, (ii) continue to reduce its overall level of classified assets,
(iii) strengthen certain credit review procedures, (iv) increase and
stabilize its earnings, and (v) correct certain deficiencies in its internal
audit and regulatory compliance programs. The FDIC lifted this restriction in
March 1997.
During 1999, Management anticipates capital expenditures of
approximately $2.4 million primarily related to construction of a new office
facility for its existing Murrieta branch scheduled to open in the third
quarter of 1999, and the opening of a full service branch office located at
Palomar Airport Road and Business Park Drive in the City of Vista,
California. This office, which will be a leased facility, is scheduled to
open in mid 1999.
LIQUIDITY AND ASSET/LIABILITY MANAGEMENT
The liquidity of a banking institution reflects its ability to
provide funds to meet customer credit needs, to accommodate possible outflows
in deposits, to provide funds for day-to-day operations, and to take
advantage of interest rate market opportunities. Funding of loan requests,
providing for liability outflows, and management of interest rate risk
requires continuous analysis in order to match the maturities of categories
of loans and investments with the maturities of deposits and bank-related
borrowings. A bank's liquidity is normally considered in terms of the nature
and mix of its sources and uses of funds. Asset liquidity is provided by
cash, certificates of deposit with other financial institutions, Federal
funds sold, maturing investments, and loan maturities and repayments. Liquid
assets (consisting of cash, Federal funds sold and investment securities)
comprised 26.0% and 20.6% of the Company's total assets at December 31, 1998
and 1997, respectively. Liquidity management also includes the management of
unfunded commitments to make loans and undisbursed amounts under lines of
credit. At December 31, 1998 these commitments totaled $45.3 million in
commercial loans, $1.3 million in letters of credit, $10.9 million in real
estate construction loans, and $11.1 million in installment and consumer
loans. At December 31, 1997 these commitments totaled $37.5 million in
commercial loans, $1.7 million in letters of credit, $18.9 million in real
estate construction loans, and $10.4 million in
28
installment and consumer loans. Average Federal funds sold were $15.9 million
in 1998 and $8.1 million in 1997.
The Bank also has several secondary sources of liquidity. Many of the
Bank's real estate construction, commercial real estate and SBA loans are
originated pursuant to underwriting standards which make them readily
marketable to other financial institutions or investors in the secondary
market. In addition, in order to meet liquidity needs on a temporary basis,
the Bank has unsecured lines of credit in the amount of $15.0 million for the
purchase of Federal funds with other financial institutions and may borrow
funds from the Federal Home Loan Bank and at the Federal Reserve discount
window subject to the Bank's ability to supply collateral. Average Federal
funds purchased were $291,000 and $272,000 in 1998 and 1997, respectively.
The Company regularly monitors the interest rate sensitivity of its
assets and liabilities and has established guidelines for each asset and
liability category and for its interest rate sensitivity position overall.
From time to time Management may emphasize or de-emphasize certain products,
change its product mix, product pricing, funding policies or take other
actions to maintain an acceptable level of interest rate risk. The Company
attempts to minimize the impact of interest rate changes on the Company's
earnings through the management of the amount, composition and repricing
periods of rate-sensitive assets and rate-sensitive liabilities. Emphasis is
placed on maintaining a rate-sensitivity position within the Company's policy
guidelines to avoid wide swings in spreads and to minimize risk due to
changes in interest rates. At December 31, 1998 and 1997, approximately 62.6%
and 59.8%, respectively, of the Company's total loans and 62.2% and 54.8%,
respectively, of the Company's total interest-earning assets were tied to the
Company's base lending rate, national prime rate, or mature within one year.
Most of the Company's interest-bearing liabilities are immediately
repriceable or mature in one year or less (93.9% in 1998 and 97.6% in 1997).
In order to match the rate-sensitivity of its assets, the Company's policy is
to offer a significant number of variable rate deposit products and limit the
level of large dollar time deposits with maturities greater than one year.
29
TABLE FIFTEEN - INTEREST RATE SENSITIVITY GAP
(DOLLARS IN THOUSANDS)
This table sets forth the rate-sensitivity of the Company's
interest-earning assets and interest-bearing liabilities as of December 31,
1998, the interest rate-sensitivity gap (interest rate-sensitive assets less
interest rate-sensitive liabilities), cumulative interest rate-sensitivity
gap, the Company's interest rate-sensitivity gap ratio (interest
rate-sensitive assets divided by interest rate-sensitive liabilities) and the
Company's cumulative interest rate-sensitivity gap ratio. For the purposes of
the following table, an asset or liability is considered rate-sensitive
within a specified period when it matures or could be repriced within such
period in accordance with its contractual terms. Nonaccrual loans of $788,000
are excluded from the presentation.
AFTER THREE AFTER SIX AFTER ONE
WITHIN MONTHS BUT MONTHS BUT YEAR BUT AFTER
THREE WITHIN SIX WITHIN ONE WITHIN FIVE
MONTHS MONTHS YEAR FIVE YEARS YEARS TOTAL
--------- ---------- ---------- ---------- --------- ---------
INTEREST-EARNINGS ASSETS:
Loans ..................... $ 134,072 $ 5,800 $ 8,844 $ 60,630 $ 27,568 $236,914
Investment securities ..... 6,802 2,903 10,149 15,502 8,465 43,821
Federal funds sold ........ 17,000 -- -- -- -- 17,000
--------- ---------- ---------- ---------- --------- ---------
Total ................... 157,874 8,703 18,993 76,132 36,033 297,735
INTEREST-BEARING LIABILITIES:
Interest-bearing demand
deposits ................ 42,825 -- -- -- -- 42,825
Savings deposits .......... 79,682 -- -- -- -- 79,682
Time deposits ............. 34,139 11,341 22,534 12,064 9 80,087
Borrowed funds ............ 1,551 -- -- -- 387 1,938
--------- --------- -------- --------- --------- ---------
Total ................... 158,197 11,341 22,534 12,064 396 204,532
Interest rate-sensitivity gap (323) (2,638) (3,541) 64,068 35,637 $ 93,203
Cumulative interest rate
sensitivity gap ........... $ (323) $ (2,961) $ (6,502) $ 57,566 $ 93,203
Interest rate-sensitivity
gap ratio ................. 1.00x .77x .84x 6.31x 90.99x 1.46x
Cumulative interest rate
sensitivity gap ratio ..... 1.00x .98x .97x 1.28x 1.46x
As of December 31, 1998, the Company was liability-sensitive within
one year and asset-sensitive beyond one year. Liability sensitive means that
rate-sensitive liabilities exceed rate-sensitive assets. This position will
generally result in enhanced earnings in a falling interest rate environment
and declining earnings in a rising interest rate environment. Asset sensitive
means that rate-sensitive assets exceed rate-sensitive liabilities. This
position will generally result in enhanced earnings in a rising interest rate
environment and declining earnings in a falling interest rate environment
because a larger volume of assets than liabilities will reprice. However, the
foregoing table does not necessarily indicate the impact of general interest
rate movements on the Company's net interest yield, because the repricing of
various categories of assets and liabilities is discretionary and is subject
to competition and other pressures. As a result, various assets and
liabilities indicated as repricing within the same period may in fact price
at different times and at different rate levels. Management attempts to
mitigate the impact of changing interest rates in several ways, one of which
is to manage its interest rate-sensitivity gap. The use of a base lending
rate by the Company for the majority of its floating rate loans also allows
the Company more flexibility than the use of a national prime rate in
matching changes to the yield on floating rate loans to changes in its
funding costs. In addition to managing its assets/liability position, the
Company has taken steps to mitigate the impact of changing interest rates by
generating noninterest income through service charges, offering products
which are not interest rate-sensitive, such as escrow services and insurance
products, and through the sale and servicing of loans. (See "Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.")
IMPACT OF INFLATION
The impact of inflation on banks differs from its impact on
non-financial institutions. Banks, as financial intermediaries, have assets
which are primarily monetary in nature and which tend to fluctuate with
inflation. This is especially true for banks with a high percentage of
rate-sensitive interest-earning assets and
30
interest-bearing liabilities. A bank can further reduce the impact of
inflation if it can manage its rate-sensitivity gap (the difference between
variable rate assets and variable rate liabilities). The Company attempts to
structure its assets and liabilities and manage its gap accordingly, thus
seeking to minimize the potential effects of inflation. (See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Asset/Liability Management").
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The composition of the Company's balance sheet consists of
investments in interest-earning assets (primarily loans and investment
securities) which are primarily funded by interest-bearing liabilities
(primarily deposits and borrowings). These financial instruments have varying
levels of sensitivity to changes in market interest rates resulting in market
risk. In evaluating the Company's exposure to market risk, management relies
primarily upon interest-rate sensitivity gap analysis (See "Management's
Discussion and Analysis of Financial Condition and Results of Operations ---
Liquidity and Asset/Liability Management") and interest rate shock analysis.
These methods of analysis provide information as to the maturities and timing
in repricing characteristics of interest rate sensitive instruments as well
as the impact of interest rate changes upon the fair market value of these
instruments. There are certain shortcomings inherent in these methods and the
following presentation that must be considered in evaluating market risk.
Although certain assets and liabilities may have similar maturities or
periods to reprice, they may react in different degrees to changes in market
interest rates or they may anticipate or lag behind changes in market
interest rates. In addition, certain interest rate sensitive assets may have
contractual limitations to changes in interest rates on a short-term basis
and over the life of the asset. Management considers these various factors
and their anticipated effects in managing the Company's exposure to interest
rate risk.
Table Sixteen presents additional information about the Company's
financial instruments that are sensitive to changes in interest rates. Cash
flows in this presentation are grouped by maturity dates rather than
repricing dates with consideration given to prepayment assumptions for
mortgage-backed securities and maturity estimations for instruments without
contractual maturity dates. Loans are distinguished by variable or fixed
rates and contractual principal payments are represented in the cash flows.
Loan fair values are estimated using discounted cash flows or based on quoted
market prices for Title I and SBA loans (See "Note 9-Fair Values of Financial
Instruments" in the accompanying financial statements). Investment securities
are divided into mortgage-backed securities and other securities. The cash
flows from mortgage-backed securities are influenced by principal
prepayments, which are dependent on a number of factors, including, the
current interest rate and interest rate index on the security, the
availability of refinancing of the underlying mortgages at attractive terms,
as well as other factors in specific geographic areas which affect the sales
and price levels of residential property. Management utilizes average
prepayment speeds provided by dealers to calculate principal repayments and
the estimated maturity date for mortgage-backed securities. The cash flows
for other securities are based on the actual maturity dates of the
instruments, except for equity securities which are included in the third
year, 2001. Fair values of investment securities are based on quoted market
prices or dealer quotes. Non-maturing deposits consist of interest-bearing
demand, savings and money market accounts and have no maturity dates. Cash
flow amortizations for these deposits are based on the maximum terms
allowable under regulatory guidelines. The fair value of non-maturing
deposits is estimated to be the carrying or face value, which is the amount
payable on demand. Time deposits are grouped according to their contractual
maturity dates. The fair value of time deposits is estimated using a
discounted cash flow calculation (See "Note 9-Fair Values of Financial
Instruments" in the accompanying financial statements). Average interest
rates represent the weighted average yield in each category.
31
TABLE SIXTEEN - INTEREST-SENSITIVE FINANCIAL INSTRUMENTS
(DOLLARS IN THOUSANDS)
EXPECTED MATURITY DATE
-----------------------------------------------------------------
1999 2000 2001 2002 2003 THEREAFTER TOTAL FAIR VALUE
------- ------- ------- ------- ------- ---------- -------- ----------
FINANCIAL ASSETS:
Loans:
Variable rate ............. $51,028 $10,587 $ 4,901 $ 4,623 $ 4,044 $55,091 $130,274 $132,038
Average interest rate .... 10.64% 10.47% 10.66% 10.47% 10.28% 10.53% 10.56%
Fixed rate ................ $30,348 $19,677 $15,614 $13,401 $ 8,384 $20,004 $107,428 $107,130
Average interest rate .... 9.53% 9.72% 9.63% 9.48% 9.63% 8.87% 9.46%
Investment securities:
Mortgage-backed securities. $ 8,254 $ 756 $ 2,617 $ 748 $ 314 $ 2,658 $ 15,347 $ 15,383
Average interest rate .... 6.29% 6.27% 7.22% 6.60% 7.46% 6.91% 6.59%
Other investment securities $11,600 $ 1,187 $ 1,197 $ 1,684 $ 6,999 $ 5,807 $ 28,474 $ 28,446
Average interest rate .... 5.52% 5.91% 6.23% 6.37% 5.91% 6.15% 5.84%
Federal funds sold .......... $17,000 -- -- -- -- -- $ 17,000 $ 17,000
Average interest rate .... 4.47% -- -- -- -- -- 4.47%
FINANCIAL LIABILITIES:
Interest-bearing deposits:
Non-maturing deposits ..... $25,782 $34,174 $34,174 $ 7,094 $ 7,094 $14,189 $122,507 $115,264
Average interest rate .... 3.08% 2.22% 2.22% 1.71% 1.71% 1.71% 2.28%
Time deposits ............. $67,993 $ 6,305 $ 1,180 $ 678 $ 3,922 $ 9 $ 80,087 $ 80,578
Average interest rate .... 4.70% 5.54% 5.68% 5.70% 5.88% 3.89% 4.84%
Federal funds purchased and
U..S. Treasury demand note. $ 1,551 -- -- -- -- -- $ 1,551 $ 1,551
Average interest rate .... 4.51% -- -- -- -- -- 4.51%
The fair values of financial instruments may not necessarily be
indicative of the net realizable or liquidation value of these instruments.
Furthermore, management does not intend to dispose of significant portions of
all of its financial instruments and, thus, any aggregate unrealized gain or
loss should not be interpreted as a forecast of future earnings and cash
flows.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
North County Bancorp's financial statements begin on page 39 of this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by these items is contained in the
Company's definitive Proxy Statement for the Company's 1999 Annual Meeting of
Shareholders which the Company intends to file with the Commission within 120
days after the close of the Company's 1998 fiscal year in accordance with the
Commission's Regulation 14A under the Securities Exchange Act of 1934. Such
information is incorporated herein by this reference.
33
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
(1) FINANCIAL STATEMENTS
The following consolidated financial statements and report
of independent accountants of North County Bancorp are
included in this report commencing on page 39.
Report of Independent Accountants
Consolidated Balance Sheet - December 31, 1998 and 1997
Consolidated Statement of Income - Three Years ended
December 31, 1998
Consolidated Statement of Cash Flows - Three Years ended
December 31, 1998
Consolidated Statement of Stockholders' Equity - Three Years
ended December 31, 1998
Notes to Consolidated Financial Statements
(2) FINANCIAL STATEMENT SCHEDULES
Schedules to the consolidated financial statements are
omitted because the required information is inapplicable or
the information is presented in North County Bancorp's
consolidated financial statements or related notes.
(3) EXHIBITS
Exhibits required to be filed hereunder are indexed on
sequentially numbered pages 36 through 38 hereof.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the last quarter of the
Company's fiscal year ended December 31, 1998.
34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: March 17, 1999 NORTH COUNTY BANCORP,
a California corporation
By: /s/ Michael J. Gilligan
----------------------------
Michael J. Gilligan
Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Alan P. Chamberlain Director March 17, 1999
- ------------------------------
Alan P. Chamberlain
/s/ G. Bruce Dunn Director March 17, 1999
- ------------------------------
G. Bruce Dunn
/s/ Michael J. Gilligan Vice President and Chief March 17, 1999
- ------------------------------ Financial Officer
Michael J. Gilligan
/s/ Ronald K. Goode Director March 17, 1999
- ------------------------------
Ronald K. Goode
/s/ James M. Gregg Chairman of the Board and March 17, 1999
- ------------------------------ Chief Executive Officer
James M. Gregg
/s/ Rodney D. Jones President and Director March 17, 1999
- ------------------------------
Rodney D. Jones
/s/ Jack Port Director March 17, 1999
- ------------------------------
Jack Port
/s/ Clarence R. Smith Director March 17, 1999
- ------------------------------
Clarence R. Smith
/s/ Raymond V. Stone Director March 17, 1999
- -----------------------------
Raymond V. Stone
/s/ Burnet F. Wohlford Director March 17, 1999
- ------------------------------
Burnet F. Wohlford
35
INDEX TO EXHIBITS
PAGE NUMBER IN
EXHIBIT TABLE SEQUENTIAL
REFERENCE NUMBERING
NUMBER ITEM SYSTEM
- ------------- ---- --------------
3.1 Articles of Incorporation of North County Bancorp filed October 5, 1981
as amended by Certificate of Amendment of Articles of Incorporation filed
July 28, 1988.(2)
3.2 Amended and Restated Bylaws of North County Bancorp as adopted
February 21, 1990.(2)
4.1 Specimen of Common Stock Certificate.(2)
4.2 Form of Indenture between North County Bancorp and Security Pacific
National Bank, as Trustee, for up to $3,593,000 aggregate principal
amount of 9 1/4% convertible subordinated debentures due May 15, 2002.(3)
4.3 Specimen of Debenture Certificate.(3)
10.1 Lease dated April 23, 1975 by and between Fifth Avenue Financial Group, a
general partnership, and North County Bank, including an Amendment to
Lease, effective May 1, 1980, and Assignment of Lease, effective August
1, 1985, for a portion of the office space at the Fifth Avenue Financial
Center in Escondido, California.(2)
10.2 Lease Agreement dated November 1, 1989, between Ontario Associates, a
general partnership, and North County Bancorp, for a portion of the
office space at the Fifth Avenue Financial Center in Escondido,
California.(2)
10.3 Lease Agreement dated March 1, 1990, between Ontario Associates, a
general partnership, and North County Bancorp, for a portion of the
office space at the Fifth Avenue Financial Center in Escondido,
California.(3)
- ---------------
Footnotes on page 38
36
PAGE NUMBER IN
EXHIBIT TABLE SEQUENTIAL
REFERENCE NUMBERING
NUMBER ITEM SYSTEM
- ------------- ---- --------------
10.4 Lease Agreement dated November 1, 1986, between Ontario Associates, a
general partnership, and North County Bancorp, relating to a portion of
the office space at the Fifth Avenue Financial Center in Escondido,
California.(2)
10.5 Assignment of Lease dated July 1, 1989, between First National Bank and
North County Bancorp, for the premises located at 8085 Clairemont Mesa
Boulevard, San Diego, California.(2)
10.6 North County Bancorp Incentive Stock Option Plan and Form of Stock Option
Agreement.(1)
10.7 North County Bank Employee Stock Ownership Plan Restated as of January 1,
1989.(2)
10.8 Employment Contract between James M. Gregg and North County Bank, dated
April 14, 1983.(2)
10.9 Deferred Compensation and Stock Purchase Agreement between James M. Gregg
and North County Bank, dated February 1, 1986.(2)
10.10 Lease Agreement dated March 1, 1990, between Ontario Associates, a
general partnership, and North County Bancorp, for a portion of the
office space at the Fifth Avenue Financial Center in Escondido,
California.(3)
10.11 Lease Agreement dated July 15, 1991 between Ontario Associates, a general
partnership, and North County Bancorp, for a portion of the office space
at the Fifth Avenue Financial Center in Escondido, California.(4)
10.12 Adoption agreement between North County Bank and The Prudential Bank
dated August 29, 1991 for the North County Bancorp and Subsidiaries
401(k) Plan.(4)
- -------------------
Footnotes on following page
37
PAGE NUMBER IN
EXHIBIT TABLE SEQUENTIAL
REFERENCE NUMBERING
NUMBER ITEM SYSTEM
- ------------- ---- --------------
10.13 Lease Agreement dated August 27, 1993 between Ontario Associates, a
general partnership, and North County Bancorp, for a portion of the
office space at the Fifth Avenue Financial Center in Escondido,
California.(5)
10.14 Deferred Compensation and Stock Purchase Agreement between Rodney D.
Jones and North County Bank, dated December 31, 1996.(6)
10.15 North County Bancorp 1997 Stock Option Plan.(7)
22 Subsidiaries of North County Bancorp
24 Consent of Price Waterhouse
- --------------
(1) Incorporated by reference to the Exhibits to the North County Bancorp S-8
Registration Statement, Registration No. 2-84173, as filed with the
Commission on May 25, 1983.
(2) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31, 1989
File No. 0-10627, as filed with the Commission on March 1, 1990, and
amended on April 30, 1990.
(3) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31, 1990
File No. 0-10627, as filed with the Commission on March 31, 1991.
(4) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31, 1991
File No. 0-10627, as filed with the Commission on March 30, 1992.
(5) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31, 1993
File No. 0-10627, as filed with the Commission on March 30, 1994.
(6) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996
File No. 0-10627, as filed with the Commission on March 28, 1997.
(7) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K405 for the fiscal year ended December 31, 1997
File No. 0-10627, as filed with the Commission on March 26, 1998.
38
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of North County Bancorp
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of North County
Bancorp and its subsidiary at December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PRICEWATERHOUSECOOPERS LLP
San Diego, California
February 9, 1999
39
NORTH COUNTY BANCORP
CONSOLIDATED BALANCE SHEET
(Dollars in Thousands)
December 31,
------------------------------
1998 1997
--------- --------
ASSETS
Cash and cash equivalents:
Cash and due from banks $ 26,885 $ 24,262
Federal funds sold 17,000 4,000
--------- --------
43,885 28,262
Investment securities:
Available for sale 17,193 17,544
Held to maturity 26,628 12,135
Loans 237,702 210,991
Less: Allowance for loan and lease losses 3,592 3,268
--------- --------
234,110 207,723
Other real estate owned 374 986
Premises and equipment, net 10,013 8,582
Accrued interest receivable and other assets 5,210 5,502
--------- --------
$337,413 $280,734
--------- --------
--------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing $100,465 $ 89,852
Interest-bearing 202,594 161,703
--------- --------
303,059 251,555
Accrued expenses and other liabilities 2,416 2,377
Federal funds purchased and U.S. Treasury demand note 1,551 1,194
Capital lease obligation 387 415
--------- --------
Total liabilities 307,413 255,541
--------- --------
Stockholders' equity:
Common stock, no par value; authorized
10,000,000 shares; outstanding shares
4,868,906 in 1998 and 1997 19,127 16,058
Retained earnings 10,834 9,137
Accumulated other comprehensive income 39 (2)
--------- --------
Total stockholders' equity 30,000 25,193
--------- --------
Commitments and contingencies (Notes 8 and 16)
$337,413 $280,734
--------- --------
--------- --------
See accompanying notes to consolidated financial statements.
40
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF INCOME
(Dollars in Thousands, Except Per Share Data)
Year ended December 31,
----------------------------------------------------
1998 1997 1996
--------- ---------- ----------
Interest income:
Interest and fees on loans $22,885 $20,007 $17,764
Investment securities:
Taxable 1,669 1,648 1,510
Exempt from Federal income taxes 121 120 98
Dividends 84 65 83
Federal funds sold 833 439 385
Deposits with other financial institutions 112 16 --
------- ------- -------
Total interest income 25,704 22,295 19,840
------- ------- -------
Interest expense:
Deposits 6,237 5,652 4,695
Federal funds purchased and
U. S. Treasury demand note 44 74 72
Other borrowings 58 215 345
------- ------- -------
Total interest expense 6,339 5,941 5,112
------- ------- -------
Net interest income 19,365 16,354 14,728
Provision for loan and lease losses 1,474 1,122 1,300
------- ------- -------
Net interest income after
provision for loan and lease losses 17,891 15,232 13,428
Noninterest income 7,066 6,788 6,975
Noninterest expense 16,825 16,198 15,567
------- ------- -------
Income before income taxes 8,132 5,822 4,836
Provision for income taxes 3,363 2,313 2,092
------ -------- --------
Net income $4,769 $ 3,509 $ 2,744
------- ------- -------
------- ------- -------
Earnings per share:
Basic $ 0.98 $ 0.78 $ 0.63
------- ------- -------
------- ------- -------
Diluted $ 0.94 $ 0.72 $ 0.58
------- ------- -------
------- ------- -------
See accompanying notes to consolidated financial statements.
41
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in Thousands)
December 31,
------------------------------------
1998 1997 1996
-------- -------- --------
Cash flows from operating activities:
Net income $ 4,769 $ 3,509 $ 2,744
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization of:
Premises and equipment 1,185 1,229 1,348
Deferred loan fees and costs, net (802) (464) (418)
Investment premiums and discounts, net 206 147 103
Other 34 140 264
(Gain) loss on sale of other real estate owned (471) (416) (285)
Provision for loan and lease losses 1,474 1,122 1,300
(Increase) decrease in interest receivable (197) 90 (204)
Increase (decrease) in taxes payable 273 233 (41)
Increase in accrued expenses 2 492 361
Increase (decrease) in interest payable 41 (18) (114)
Other, net (17) 257 (1,029)
-------- -------- --------
Net cash provided by operating activities 6,497 6,321 4,029
-------- -------- --------
Cash flows from investing activities:
Proceeds from maturities of investment securities 15,153 9,457 11,070
Proceeds from sale of available for sale securities -- 14,602 2,535
Purchase of investment securities (29,502) (19,372) (22,020)
Net increase in loans (27,374) (32,970) (22,217)
Purchase of premises and equipment (2,616) (1,101) (532)
Proceeds from sale of other real estate owned 1,633 3,723 3,111
-------- -------- --------
Net cash used in investing activities (42,706) (25,661) (28,053)
-------- -------- --------
Cash flows from financing activities:
Cash payments on capital lease obligations (29) (14) (32)
Net increase in deposits 51,504 21,204 15,508
Net increase (decrease) in Federal funds purchased and
U.S. Treasury demand note 357 (174) 1,833
Net (decrease) increase in other borrowings -- (1,550) 50
Cash proceeds from sale of common stock -- -- 68
-------- -------- --------
Net cash provided by financing activities 51,832 19,466 17,427
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 15,623 126 (6,597)
Cash and cash equivalents at beginning of year 28,262 28,136 34,733
-------- -------- --------
Cash and cash equivalents at end of year $ 43,885 $ 28,262 $ 28,136
======== ======== ========
Supplemental disclosure of cash flow information:
Total interest paid $ 6,299 $ 5,958 $ 5,226
Total income taxes paid $ 3,385 $ 2,212 $ 2,374
Real estate acquired through foreclosure $ 316 $ 1,871 $ 3,088
Conversion of subordinated debentures into
common stock $ -- $ 1,433 $ 133
See accompanying notes to consolidated financial statements.
42
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Dollars in Thousands, Except Share Data)
Common Stock Accumulated Other
------------------------- Retained Comprehensive Total
Shares Amount Earnings Income Stockholders' Equity
--------- ------- -------- ------ --------------------
Balance at December 31, 1995 1,789,779 $ 9,156 $ 8,164 $(93) $17,227
Five percent stock dividend including cash
for fractional shares 89,288 759 (761) (2)
Five percent stock dividend including cash
for fractional shares 95,140 1,642 (1,647) (5)
Exercise of stock options 10,628 68 68
Conversion of subordinated debentures 18,358 133 133
Comprehensive income:
Unrealized holding gain on available
for sale securities, net of tax of $5 7 7
Net income 2,744 2,744
-------
Total comprehensive income 2,751
--------- ------- ------- ---- -------
Balance at December 31, 1996 2,003,193 11,758 8,500 (86) 20,172
Two for one stock split 2,005,956 -- --
Five percent stock dividend including cash
for fractional shares 220,608 2,867 (2,872) (5)
Exercise of stock options 788 -- --
Conversion of subordinated debentures 406,745 1,433 1,433
Comprehensive income:
Unrealized holding gain on available
for sale securities, net of tax of $69 84 84
Net income 3,509 3,509
-------
Total comprehensive income 3,593
--------- ------- ------- ---- -------
Balance at December 31, 1997 4,637,290 16,058 9,137 (2) 25,193
Five percent stock dividend including cash
for fractional shares declared January 20,
1999, payable on March 10, 1999 to
stockholders of record on February 10, 1999 231,616 3,069 (3,072) (3)
Comprehensive income:
Unrealized holding gain on available for
sale securities, net of tax of $33 41 41
Net income 4,769 4,769
-------
Total comprehensive income 4,810
--------- ------- ------- ---- -------
Balance at December 31, 1998 4,868,906 $19,127 $10,834 $ 39 $30,000
========= ======= ======= ==== =======
See accompanying notes to consolidated financial statements.
43
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION The consolidated financial statements include the
accounts of North County Bancorp (the Company) and its wholly owned
subsidiary, North County Bank (the Bank). All significant intercompany
accounts and transactions have been eliminated. The preparation of financial
statements in accordance with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
reported amounts and disclosures in the financial statements. Actual results
could differ from those estimates.
In the normal course of its business, the Company encounters two significant
types of risk: economic and regulatory. Economic risk is comprised of three
components - interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature and reprice at different speeds, or on a different basis,
than its interest-earning assets. Credit risk is the risk of default on the
Company's loan portfolio that results from the borrower's inability or
unwillingness to make contractually required payments. Market risk results
from changes in the value of assets and liabilities which may impact,
favorably or unfavorably, the realizability of those assets and liabilities.
The Company is subject to regulations of various governmental agencies. These
regulations can and do change significantly from period to period. The
Company also undergoes periodic examinations by the regulatory agencies,
which may subject it to further changes with respect to asset valuations,
amounts of required loss allowances and operating restrictions resulting from
the regulators' judgments based on information available to them at the time
of their examination.
CASH AND CASH EQUIVALENTS Cash on hand, cash items in the process of
collection, amounts due from correspondent banks and the Federal Reserve Bank
and Federal funds sold to other financial institutions are included in cash
and cash equivalents.
INVESTMENT SECURITIES Securities held for investment purposes consist of
debt obligations, marketable equity securities and stock in the Federal
Reserve Bank and Federal Home Loan Bank. Investments are classified into the
following two categories: held to maturity or available for sale. Held to
maturity securities are carried at amortized cost while available for sale
securities are carried at market value. Unrealized gains and losses on
available for sale securities are recorded as other comprehensive income, a
component of stockholders' equity. Gains or losses on sales are based upon
specific identification of securities sold.
LOANS Interest on loans is accrued based upon the principal amount
outstanding. The accrual of interest on loans is discontinued when, in
management's judgment, the interest will not be paid in accordance with its
terms. At that time interest previously recorded but not collected is
reversed and charged against current income. Loan origination fees, certain
direct loan origination costs and purchase premiums and discounts on loans
are deferred and amortized over the related life of the loan as an adjustment
to the loan's yield.
The Company may sell the guaranteed portions of Small Business Administration
(SBA) loans to a variety of secondary market investors. The Bank retains the
unguaranteed portions as well as the rights and obligations to service the
loans. The Company receives an interest rate differential from payments made
by the borrowers which is at least sufficient to provide for the future
servicing costs and an allowance for a reasonable profit. Gains are recorded
upon the sale of the loans based upon premiums paid by the purchasers and
upon the fair value of any retained interests.
The Company also sells home equity loans and Federal Home Administration
Title I loans to secondary market investors. Gains or losses on the sale of
these loans are recognized upon sale as the difference between the net sales
price and the carrying value at the time of sale. Deferred origination fees
and expenses are recognized at the time of sale.
Impaired loans are measured at the present value of expected future cash
flows discounted at the loan's effective rate, or as a practical expedient,
at the loan's observable market price or the fair value of the collateral if
the loan is collateral
44
dependent. A loan is impaired when, based on current information and events,
it is probable that the Company will be unable to collect all amounts due
(principal and interest) according to the contractual terms.
ALLOWANCE FOR LOAN AND LEASE LOSSES The Company provides an allowance
for loan and lease losses by a charge to current operations based on
Management's evaluation of the risks in the loan portfolio, prospective
economic conditions, past loss experience, and other pertinent factors which
form a basis for determining the adequacy of the allowance for loan and lease
losses.
OTHER REAL ESTATE OWNED Real estate acquired in satisfaction of loans is
reported as other real estate owned. Other real estate owned is recorded at
the lower of the loan carrying value at the date of acquisition or the fair
value less expected selling costs. Subsequent operating expenses or income,
reductions in estimated value, and gains or losses upon sale are charged to
current operations.
PREMISES AND EQUIPMENT Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization are
determined by use of the straight-line method over the estimated useful lives
of the assets, 3 to 45 years. Maintenance and repair costs are expensed as
they are incurred, while renewals and betterments are capitalized.
INCOME TAXES The Company files consolidated Federal and combined
California state income tax returns. The Company provides for income taxes
under the liability method. A deferred tax asset and/or liability is computed
for both the expected future impact of differences between the financial
statement and tax basis of assets and liabilities, and for the expected
future tax benefit to be derived from tax loss and tax credit carryforwards.
A valuation allowance may be established to reflect the likelihood of
realization of deferred tax assets. The effect of tax rate changes is
reflected in income in the period in which such changes are enacted.
EARNINGS PER SHARE Basic earnings per share (EPS) represents net income
divided by the weighted average common shares outstanding during the period
excluding any potential dilutive effects. Diluted EPS gives effect to all
potential issuances of common stock that would have caused basic EPS to be
lower as if the issuance had already occurred. A reconciliation of the income
and shares used in the basic and diluted EPS computations, giving retroactive
effect for the stock dividends and stock split, for the three years ended
December 31, 1998 is as follows (dollars in thousands, except share data):
1998
-------------------------------------------
Income Shares Per-Share
------ --------- ----------
Basic EPS $4,769 4,868,906 $0.98
=====
Effect of Dilutive Shares:
Stock options 204,465
---------
Diluted EPS $4,769 5,073,371 $0.94
====== ========= =====
1997
-------------------------------------------
Income Shares Per-Share
------ --------- ----------
Basic EPS $3,509 4,513,556 $0.78
=====
Effect of Dilutive Shares:
Stock options 167,722
Convertible debentures 70 323,152
------- ---------
Diluted EPS $3,579 5,004,430 $0.72
====== ========= =====
1996
-------------------------------------------
Income Shares Per-Share
------ --------- ----------
Basic EPS $2,744 4,366,729 $0.63
=====
Effect of Dilutive Shares:
Stock options 72,520
Convertible debentures 99 444,872
------- ---------
Diluted EPS $2,843 4,884,121 $0.58
====== ========= =====
45
NOTE 2 - REGULATORY CAPITAL:
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain actions by regulators that,
if undertaken, could have a direct material effect on the Company's financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Company and the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items. The capital amounts and
classification of the Company and the Bank are also subject to qualitative
judgments by the regulators regarding components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the following table) of Tier 1 and total capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital to
average assets (as defined). Management believes that the Company and the
Bank meet all capital adequacy requirements to which they are subject at
December 31, 1998.
As of December 31, 1998, the most recent notification from the appropriate
regulatory agency categorized the Bank as "well capitalized" under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum Tier 1 risk-based, total
risk-based and Tier 1 leverage capital ratios as set forth in the following
table. There are no conditions or events since that notification that
management believes have changed the Bank's category.
The actual capital amounts and ratios of the Company and the Bank at December
31, 1998 are presented in the following table (dollars in thousands).
Well Capitalized
Actual Requirement Minimum Required
------------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------- ------ ------ ------ ------- -----
North County Bancorp:
Risk-based capital
Tier 1 $29,700 11.68% -- -- $10,173 4.00%
Total 32,884 12.93% -- -- 20,345 8.00%
Tier 1 leverage capital 29,700 8.80% -- -- 13,502 4.00%
North County Bank:
Risk-based capital
Tier 1 29,392 11.58% $15,236 6.00% 10,157 4.00%
Total 32,571 12.83% 25,393 10.00% 20,314 8.00%
Tier 1 leverage capital 29,392 8.72% 16,848 5.00% 13,479 4.00%
NOTE 3 - INVESTMENT SECURITIES:
The amortized cost and market value of investment securities as of December
31, 1998 and 1997 are as follows (dollars in thousands):
Available for sale at December 31, 1998:
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- -------
U. S. Government and
Federal agencies $ -- $ -- $ -- $ --
States and municipalities 2,073 13 (1) 2,085
Mortgage-backed 13,177 137 (8) 13,306
Equity securities 1,872 -- (70) 1,802
------- ---- ---- -------
$17,122 $150 $(79) $17,193
======= ==== ==== =======
46
Held to maturity at December 31, 1998:
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- -------
U. S. Government and
Federal agencies $22,155 $27 $(71) $22,111
States and municipalities 1,849 17 -- 1,866
Mortgage-backed 2,041 36 -- 2,077
Asset-backed 583 -- (1) 582
------- --- ---- -------
$26,628 $80 $(72) $26,636
======= === ==== =======
Available for sale at December 31, 1997:
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- -------
U. S. Government and
Federal agencies $ 1,000 $ 2 $ -- $ 1,002
States and municipalities 2,104 13 (1) 2,116
Mortgage-backed 12,847 69 (20) 12,896
Equity securities 1,596 -- (66) 1,530
-------- ----- ----- --------
$17,547 $84 $(87) $17,544
======= === ==== =======
Held to maturity at December 31, 1997:
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- -------
U. S. Government and
Federal agencies $ 7,779 $22 $(18) $ 7,783
States and municipalities 1,748 12 --- 1,760
Mortgage-backed 2,608 31 --- 2,639
-------- ---- -------- --------
$12,135 $65 $(18) $12,182
======= === ==== =======
Investment securities with a carrying value of $7,948,000 and $7,538,000 at
December 31, 1998 and 1997, respectively, were pledged to secure public
deposits as well as for other purposes required by law. The Company did not
sell any securities in 1998. Sales of available for sale securities during
1997 resulted in gross gains and losses of $95,000 and $42,000, respectively,
and resulted in net taxes of $21,000.
The maturity distribution of debt securities is presented in the tables below
(dollars in thousands). No maturity breakdown is presented for
mortgage-backed securities because of the unpredictability as to the timing
and amount of principal repayments on these securities.
Available for Sale Held to Maturity
------------------------------- -----------------------------
December 31, 1998: Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
--------- ------------ --------- ------------
Within one year $ 1,969 $ 1,977 $ 7,821 $ 7,824
After one but within five years 105 108 10,959 10,957
After five but within ten years -- -- 5,208 5,180
After ten years -- -- 599 599
Mortgage-backed securities 13,176 13,306 2,041 2,076
------- ------- ------- -------
$15,250 $15,391 $26,628 $26,636
======= ======= ======= =======
47
Available for Sale Held to Maturity
------------------------------- -----------------------------
December 31, 1998: Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
--------- ------------ --------- ------------
Within one year $ -- $ -- $ 2,052 $ 2,048
After one but within five years 2,042 2,048 7,475 7,495
After five but within ten years -- -- -- --
After ten years 1,062 1,070 -- --
Mortgage-backed securities 12,847 12,896 2,608 2,639
------- ------- ------- -------
$15,951 $16,014 $12,135 $12,182
======= ======= ======= =======
NOTE 4 - LOANS:
Loans at December 31 are summarized as follows (dollars in thousands):
1998 1997
-------- --------
Commercial $128,298 $111,726
Installment and consumer 34,171 41,024
Real estate mortgage 53,712 45,803
Real estate construction 19,881 10,334
Lease financing receivables 617 1,270
Other 1,023 834
-------- --------
$237,702 $210,991
======== ========
A summary of the changes in the allowance for loan and lease losses is as
follows (dollars in thousands):
1998 1997 1996
------- ------- -------
Balance at beginning of year $ 3,268 $ 3,129 $ 2,916
Provision charged to operating expense 1,474 1,122 1,300
Recoveries on loans previously charged off 251 586 333
Loans charged off (1,401) (1,569) (1,420)
------- -------- -------
Balance at end of year $ 3,592 $ 3,268 $ 3,129
======= ======= =======
At December 31, 1998 and 1997, loans on a nonaccrual basis were $788,000 and
$3,021,000, respectively. Interest income collected relating to nonaccrual
loans was $38,000 and $123,000 for the years ended December 31, 1998 and
1997. Additional interest income of $62,000 and $212,000 would have been
recorded during 1998 and 1997, respectively, if the loans had been paid in
accordance with their original terms.
The Company's recorded investment in impaired loans at December 31, 1998 and
1997, was $954,000 and $2,163,000, respectively. Reserves for loan losses of
$48,000 and $151,000 were established for impaired loans at December 31, 1998
and 1997, respectively. The average recorded investments in impaired loans
during 1998 and 1997 were $1,654,000 and $2,528,000, respectively. Interest
income on impaired loans of $16,000 and $120,000 was recognized for cash
payments received in 1998 and 1997. The Company is not committed to lend
additional funds to debtors whose loans have been modified.
The Company in the normal course of business to meet the financing needs of
its customers is a party to financial instruments with off-balance sheet
risk. The Company's maximum potential exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for commitments
to extend credit and letters of credit is represented by the contractual
amounts of those instruments.
Commitments to extend credit are agreements to lend to a customer provided
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Letters of credit are conditional
commitments issued by the Company to guarantee the performance of a customer
to a third party. The credit risk in issuing letters of credit is essentially
the same as that involved in extending loan facilities to customers. The
amount of collateral obtained if deemed necessary by the Company upon
extension of credit is based on management's credit evaluation of the
borrower. Since certain of the
48
commitments are expected to expire without being drawn upon, they do not
necessarily represent future cash requirements. The Company evaluates each
customer's creditworthiness on a case-by-case basis. The Company's off-balance
sheet credit risk for undisbursed loan commitments and letters of credit at
December 31, was as follows (dollars in thousands):
1998 1997
--------- ---------
Commercial loans $45,308 $37,534
Installment and consumer loans 11,087 10,370
Real estate construction loans 10,874 18,884
Letters of credit 1,280 1,652
--------- ---------
$68,549 $68,440
--------- ---------
--------- ---------
Most of the Company's business activity is with customers located within San
Diego and Riverside counties of Southern California. Accordingly, the Company's
financial performance may be significantly impacted by the economic conditions
of the area.
NOTE 5 - PREMISES AND EQUIPMENT:
Premises and equipment at December 31 are as follows (dollars in thousands):
1998 1997
-------- --------
Land $ 2,601 $ 2,068
Building and improvements 7,730 7,536
Furniture, fixtures and equipment 10,751 9,063
------- -------
21,082 18,667
Less: Accumulated depreciation and amortization 11,069 10,085
------- -------
$10,013 $ 8,582
------- -------
------- -------
Building and improvements include a capitalized lease on the main branch
premises of $580,000, less accumulated amortization of $440,000, as of December
31, 1998 (see Note 8). Amortization on this capital lease was $20,000 in both
1998 and 1997.
NOTE 6 - DEPOSITS:
Deposits at December 31 are summarized as follows (dollars in thousands):
1998 1997
-------- ---------
Noninterest-bearing demand $100,465 $ 89,852
Interest-bearing demand 42,825 36,620
Savings 79,682 78,352
Time deposits of $100,000 or more 20,868 9,184
Time deposits of less than $100,000 59,219 37,547
-------- --------
$303,059 $251,555
-------- --------
-------- --------
The following table summarizes the maturity distribution of time deposits of
$100,000 or more at December 31 (dollars in thousands):
1998 1997
------- -------
Three months or less $11,062 $5,181
Over three months through six months 2,117 1,439
Over six months through one year 5,537 2,364
Over one year through three years 2,152 200
------- ------
$20,868 $9,184
------- ------
------- ------
49
NOTE 7 - CONVERTIBLE SUBORDINATED DEBENTURES:
In May 1990, the Company issued $1,678,000 in 9 1/4% convertible subordinated
debentures (the "Debentures"). In September 1997, at which time $1,492,000 in
Debentures were outstanding, the Company announced that it was exercising its
option to redeem the Debentures at a price of 102.25% effective October 31,
1997. The conversion of Debentures during 1997 resulted in an increase in common
stock, a component of Tier 1 capital, of $1,433,000 which was net of deferred
offering costs of $101,000.
NOTE 8 - LEASE OBLIGATIONS:
The Company leases the main office premises under a long-term capital lease
agreement which will expire in 2006 and other office space and equipment under
various operating leases. The future minimum lease payments for all lease
obligations consisted of the following at December 31, 1998 (dollars in
thousands):
Capital Operating
Lease Leases
-------- ---------
1999 $ 214 $ 751
2000 214 661
2001 214 465
2002 214 437
2003 214 374
Thereafter 484 1,052
-------- ---------
Total minimum lease payments 1,554 $3,740
---------
---------
Amounts representing interest (308)
Cost escalation (860)
-----
Present value of net minimum lease payments $ 386
-----
-----
The amount of future lease payments is contingent upon normal cost escalation
clauses. Rent expense on the operating leases was $704,000, $607,000 and
$489,000 in 1998, 1997 and 1996, respectively.
NOTE 9 - FAIR VALUES OF FINANCIAL INSTRUMENTS:
The carrying amount and estimated fair value of the Company's financial
instruments as of December 31, 1998 are as follows (dollars in thousands):
Carrying Fair
Amount Value
-------- ---------
Financial assets:
Cash and due from banks $ 26,885 $ 26,885
Federal funds sold 17,000 17,000
Investment securities 43,821 43,829
Loans 237,702 239,168
Financial liabilities:
Deposits $303,059 $296,307
Federal funds purchased and U.S. Treasury Demand Note 1,551 1,551
The following methods and assumptions were used to estimate the fair value of
each material class of financial instruments at December 31, 1998:
CASH AND DUE FROM BANKS AND FEDERAL FUNDS SOLD The carrying amount of cash and
due from banks and Federal funds sold approximates the fair value.
INVESTMENT SECURITIES The fair value of securities held as investments is based
on quoted market prices or dealer quotes.
50
LOANS The fair value of loans is estimated using discounted cash flows. The
discount rate used to determine the present value of these loans is equal to
current market rates at which similar loans would be made to borrowers with
similar credit ratings and for similar maturities. Where credit deterioration
has occurred, management has reduced estimated cash flows to give effect to
estimated future losses. Title I and SBA loans were valued based on quoted
market prices.
DEPOSITS The carrying amount of demand and savings deposits is the estimated
fair value, which is the amount payable on demand. The carrying amount for
variable rate, fixed term time deposit accounts approximates fair value. The
fair value of fixed rate time deposits is estimated using a discounted cash flow
calculation. The discount rate on such deposits is based upon rates currently
offered for deposits of similar remaining maturities.
FEDERAL FUNDS PURCHASED AND U.S. TREASURY DEMAND NOTE The fair value of Federal
funds purchased and U.S. Treasury demand note is estimated to approximate
carrying value.
LETTERS OF CREDIT AND UNDISBURSED LOAN FUNDS The fair value of letters of credit
and undisbursed loan funds is estimated to be the cost to terminate or otherwise
settle such obligations with counterparties.
The fair values of financial instruments may not necessarily be indicative of
the net realizable or liquidation value of these instruments. Furthermore,
management does not intend to dispose of significant portions of all of its
financial instruments and, thus, any aggregate unrealized gain or loss should
not be interpreted as a forecast of future earnings and cash flows.
These fair value disclosures do not include certain financial instruments such
as equity investments in consolidated subsidiaries, obligations for pension and
other post retirement benefits and deferred compensation arrangements. In
addition, fair value estimates do not attempt to estimate the value of
anticipated future business which may result from existing customer
relationships, or the value of assets and liabilities that are not considered
financial instruments, such as deferred tax assets, intangible assets or
property, plant and equipment.
NOTE 10 - NONINTEREST INCOME AND EXPENSE:
Noninterest income for each year consists of (dollars in thousands):
1998 1997 1996
------- ------- -------
Service charges on deposits $3,941 $3,936 $3,827
Gain on sale of loans 1,545 1,301 1,425
Loan servicing fees 561 753 747
Other 1,019 798 976
------ ------- -------
$7,066 $6,788 $6,975
------ ------- -------
------ ------- -------
51
Noninterest expense for each year consists of (dollars in thousands):
1998 1997 1996
--------- --------- -------
Salaries and employee benefits $ 9,888 $ 9,148 $ 8,136
Occupancy expense 3,477 3,232 3,095
Telephone and postage 895 689 645
Advertising and public relations 692 711 524
Professional services 574 514 315
Printing, stationery and supplies 335 346 275
Branch losses 190 182 323
Collection expense 76 233 321
Regulatory assessments 58 91 228
Other real estate owned (473) (98) 614
Other 1,113 1,150 1,091
------- ------- -------
$16,825 $16,198 $15,567
------- ------- -------
------- ------- -------
NOTE 11 - INCOME TAXES:
The provision for income taxes for each year consists of the following (dollars
in thousands):
1998 1997 1996
-------- ------- -------
Current taxes:
Federal $2,421 $1,494 $1,393
State 977 648 611
-------- ------- -------
3,398 2,142 2,004
Deferred taxes:
Federal (14) 179 122
State (21) (8) (34)
-------- ------- -------
(35) 171 88
-------- ------- -------
$3,363 $2,313 $2,092
-------- ------- -------
-------- ------- -------
Deferred tax (assets) liabilities at December 31 are comprised of the following
(dollars in thousands):
1998 1997
-------- -------
Provision for loan and lease losses $ (501) $ (471)
Deferred compensation (247) (202)
Loan fees deferred (203) (516)
Writedown of other real estate owned (107) (107)
Capital lease amortization (101) (105)
Securities held for sale (60) (29)
Unrealized loss on securities -- (2)
-------- -------
Gross deferred tax assets (1,219) (1,432)
-------- -------
Depreciation 247 214
Loan origination cost capitalized 102 112
Unrealized gain on securities 32 --
Loan servicing rights 14 16
-------- -------
Gross deferred tax liabilities 395 342
-------- -------
Deferred tax assets valuation allowance 225 225
-------- -------
$ (599) $ (865)
-------- -------
-------- -------
52
A reconciliation between the provision for income taxes at the statutory Federal
rate and the actual effective provision for income taxes for each year is as
follows (dollars in thousands):
1998 1997 1996
-------- -------- --------
Federal tax at statutory rates $2,765 $1,979 $1,644
State tax, net of Federal tax effect 631 422 381
Tax exempt income (49) (63) (83)
Other 16 (25) 150
-------- -------- --------
$3,363 $2,313 $2,092
-------- -------- --------
-------- -------- --------
Tax exempt income consists of income from investment securities and municipal
lease financing.
NOTE 12 - STOCK OPTION PLAN:
The Company has granted incentive stock options and non-qualified options to
purchase up to 543,847 shares of common stock as of December 31, 1998 under
three stock option plans. No compensation cost has been recognized for its
employee stock option grants, which are fixed in nature, as the options have
been granted at a price equal to the market value of the Company's common stock
at the date of grant. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant date
rather than market value during the three years ended December 31, 1998, the
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below (dollars in thousands, except per share data).
1998 1997 1996
-------- -------- --------
Net Income:
As reported $4,769 $3,509 $2,744
Pro forma 4,713 3,489 2,724
Basic earnings per share:
As reported $0.98 $0.78 $0.63
Pro forma $0.97 $0.77 $0.62
Diluted earnings per share:
As reported $0.94 $0.72 $0.58
Pro forma $0.93 $0.71 $0.58
The fair value for each option grant was estimated at the date of grant using
the following assumptions for 1998, 1997, and 1996, respectively: volatility
factors of 0.36, 0.27 and 0.20; expected option lives of five, seven and ten
years; risk-free interest rates of 5.63%, 5.83% and 6.60%; and a dividend yield
of 0.0% for the three years.
53
A summary of transactions for the three years ended December 31, 1998, after
giving retroactive effect for stock dividends declared, is as follows:
1998 1997 1996
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- ------- -------- -------- --------
Outstanding at beginning of year 525,190 $ 4.17 465,353 $ 3.04 418,305 $2.88
Granted 18,297 12.38 68,364 11.79 111,825 3.50
Exercised -- -- (2,450) 2.38 (24,800) 2.76
Expired -- -- (6,077) 3.50 (39,977) 2.83
------- ------- ------- ------ ------- ------
Outstanding at end of year 543,487 $ 4.45 525,190 $ 4.17 465,353 $3.04
------- ------- ------- ------ ------- ------
------- ------- ------- ------ ------- ------
Options exercisable at end of year
and weighted average exercise price 261,255 $ 2.92 225,330 $ 2.91 191,884 $ 2.91
Weighted average fair value per share of
options granted during the year $ 6.56 $ 5.09 $ 2.41
At December 31, 1998, the Company had outstanding options to purchase 543,487
shares of common stock at exercise prices that ranged from $2.38 to $12.38 per
share with a weighted average exercise price of $4.45 per share. The outstanding
options have a weighted average remaining contractual life of 4.45 years. Under
its stock option plan the Company is authorized to grant an additional 508,869
options for the purchase of the Company's common stock.
NOTE 13 - EMPLOYEE RETIREMENT PLANS:
The Company has established an Employee Stock Ownership Plan (ESOP) to provide
an ownership interest in the Company and retirement benefits to substantially
all full-time employees. The amount of annual contributions is at the discretion
of the Board of Directors, subject to a maximum of 15 percent of the total
annual compensation of all eligible participants. The Company contributed
$150,000 in 1998, 1997 and 1996. The ESOP held 257,997 shares of the Company's
stock at December 31, 1998.
Additionally, all permanent employees who have at least six months of service
are eligible to contribute up to 15% annually of their pretax compensation to a
retirement account under the North County Bancorp 401(k) Plan. Employees control
the investment of their funds and may elect to invest in the Company's common
stock. The Company matches 50% of an employee's contribution up to 5% annually
of the employee's covered compensation for those who have at least six months of
service and who elect to contribute under the plan. The Company contributed
$114,000, $100,000 and $94,000 to the plan in 1998, 1997 and 1996, respectively.
54
NOTE 14 - NORTH COUNTY BANCORP (PARENT CORPORATION):
Condensed financial statements presented on a parent company only basis are as
follows:
CONDENSED BALANCE SHEET (dollars in thousands)
December 31,
-------------------------------------
1998 1997
--------- ---------
ASSETS
Cash $ 20 $ 22
Investment securities 338 145
Investment in subsidiary 29,696 25,068
Premises and equipment, net 140 160
Other assets 217 229
--------- ---------
$30,411 $25,624
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses and other liabilities $ 27 $ 16
Capital lease obligation 387 415
--------- ---------
414 431
--------- ---------
Stockholders' equity
Common stock, no par value 19,127 16,058
Retained earnings and other 10,873 9,135
--------- ---------
Total stockholders' equity 30,000 25,193
-------- --------
$30,411 $25,624
--------- ---------
--------- ---------
CONDENSED STATEMENT OF INCOME (dollars in thousands)
Year Ended December 31,
--------------------------------------------------
1998 1997 1996
------- -------- --------
Dividends from subsidiary $ 270 $1,510 $ ---
Interest income 10 3 4
Other income 279 281 261
------- ------- -------
Total income 559 1,794 265
------- ------ -------
Interest expense 58 215 345
Other operating expense 361 356 282
------- ------- -------
Total expenses 419 571 627
------- ------- -------
Income (loss) before income tax 140 1,223 (362)
Income tax benefit 43 107 145
Equity in undistributed income of subsidiary 4,586 2,179 2,961
------- ------- -------
Net income $4,769 $3,509 $2,744
------- ------- -------
------- ------- -------
55
CONDENSED STATEMENT OF CASH FLOWS (dollars in thousands)
Year Ended December 31,
-------------------------------------------
1998 1997 1996
--------- --------- ---------
Cash flows from operating activities:
Net income $ 4,769 $ 3,509 $ 2,744
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization 20 131 42
Equity in undistributed income of subsidiary (4,586) (2,179) (2,961)
Increase (decrease) in accrued expenses 11 (73) (119)
Other, net 5 2 21
-------- ------- -------
Net cash flows provided by (used in) operating activities 219 1,390 (273)
-------- ------- -------
Cash flows used in investing activities:
Purchase of investment securities (193) -- (145)
-------- ------- -------
Net cash used in investing activities (193) -- (145)
-------- ------- -------
Cash flows from financing activities:
Cash payments on capital lease obligations (28) (14) (32)
Net (decrease) increase in notes payable -- (1,550) 50
Net decrease in convertible subordinated debentures -- (1,534) (144)
Issuance of common stock -- 1,429 195
-------- ------- -------
Net cash (used in) provided by financing activities (28) (1,669) 69
-------- ------- -------
Net decrease in cash and cash equivalents (2) (279) (349)
Cash and cash equivalents at beginning of year 22 301 650
-------- ------- -------
Cash and cash equivalents at end of year $ 20 $ 22 $ 301
-------- ------- -------
-------- ------- -------
NOTE 15 - RELATED PARTY TRANSACTIONS:
Certain directors and executive officers of the Company and their associates are
customers of and have other transactions with the Bank in the ordinary course of
business. Loans and commitments included in such transactions are made on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons. Such loans aggregated $802,000 and $695,000 at
December 31, 1998 and 1997, respectively. During 1998 new loans (including
drawdowns on revolving lines of credit and loan renewals) aggregated $3,590,000
and repayments (including payments on revolving lines of credit and loan
renewals) aggregated $3,483,000.
NOTE 16 - COMMITMENTS AND CONTINGENCIES:
At December 31, 1998, the Bank was party to certain legal actions. The Company
has reviewed these matters with legal counsel and, in management's opinion, the
ultimate resolution of these actions will not have a material effect on the
Company's financial position.
At December 31, 1998, the Company had unsecured lines of credit totaling
$15,000,000 for the purchase of Federal funds with other financial institutions.
In addition the Company may borrow from the Federal Home Loan Bank and at the
Federal Reserve discount window, subject to the Company's ability to supply
collateral.
56
NOTE 17 - SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED):
Basic and diluted EPS have been retroactively restated in the following table to
give effect to the stock dividends and stock split (dollars in thousands, except
per share data).
1998 Quarters Ended
--------------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ --------- --------
Interest income........................................ $6,805 $6,654 $6,342 $5,903
Interest expense....................................... 1,733 1,684 1,496 1,426
------ ------ ------ ------
Net interest income.................................... 5,072 4,970 4,846 4,477
Provision for loan and lease losses.................... (160) 594 450 590
Noninterest income..................................... 1,596 1,728 1,755 1,987
Noninterest expense.................................... 4,501 3,905 4,207 4,212
------ ------ ------ ------
Income before income taxes............................. 2,327 2,199 1,944 1,662
Income tax expense..................................... 916 980 805 662
------ ------ ------ ------
Net income............................................. $1,411 $1,219 $1,139 $1,000
------ ------ ------ ------
------ ------ ------ ------
Basic EPS.............................................. $0.29 $0.25 $0.23 $0.21
Diluted EPS............................................ $0.28 $0.24 $0.23 $0.20
1997 Quarters Ended
-------------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ --------- --------
Interest income........................................ $5,994 $5,837 $5,492 $4,972
Interest expense....................................... 1,454 1,580 1,549 1,358
------ ------ ------ ------
Net interest income.................................... 4,540 4,257 3,943 3,614
Provision for loan and lease losses 400 104 283 335
Noninterest income..................................... 1,902 1,748 1,693 1,445
Noninterest expense.................................... 4,240 4,264 4,012 3,682
------ ------ ------ ------
Income before income taxes............................. 1,802 1,637 1,341 1,042
Income tax expense..................................... 698 695 528 392
------ ------ ------ ------
Net income............................................. $1,104 $ 942 $ 813 $ 650
------ ------ ------ ------
------ ------ ------ ------
Basic EPS.............................................. $0.23 $0.21 $0.18 $0.15
Diluted EPS............................................ $0.22 $0.19 $0.17 $0.14
57