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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM TO ________________ TO ________________
COMMISSION FILE NO. 0-28938
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COAST BANCORP
(Exact name of registrant as specified in its charter)
CALIFORNIA 77-0401327
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
740 FRONT STREET 95060
(Address of principal executive offices) (Zip Code)
SANTA CRUZ, CALIFORNIA
(City and State of principal executive offices)
(831) 458-4500
Registrant's telephone number, including area code
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Securities to be registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH EACH CLASS IS
TO BE SO REGISTERED TO BE REGISTERED
None None
Securities to be registered pursuant to Section 12(g) of the Act:
COMMON STOCK (NO PAR VALUE) NASDAQ NATIONAL MARKET SYSTEM
(Title of each class) (Name of each exchange on which
registered)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. /X/
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing price of its common stock on March 23, 1999,
on the NASDAQ National Market System was $46,805,976.
At March 23, 1999, 4,778,858 shares of the registrant's common stock (no par
value) were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
PARTS OF FORM 10-K
DOCUMENTS INCORPORATED INTO WHICH INCORPORATED
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Definitive proxy statement for the Company's 1999 Annual Meeting of Shareholders to be
filed within 120 days of the end of the fiscal year ended December 31, 1998............. Part III
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TABLE OF CONTENTS
PAGE
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PART I
ITEM 1. BUSINESS.............................................................................. 1
ITEM 2. PROPERTIES............................................................................ 10
ITEM 3. LEGAL PROCEEDINGS..................................................................... 11
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................... 11
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS............. 11
ITEM 6. SELECTED FINANCIAL DATA............................................................... 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.......................................................................... 13
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................ 29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................................... 31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.......................................................................... 53
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................................... 53
ITEM 11. EXECUTIVE COMPENSATION................................................................ 53
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........................ 53
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................ 53
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K...................... 53
INDEX TO EXHIBITS........................................................................................ 54
SIGNATURES............................................................................................... 55
PART I
ITEM 1. BUSINESS
GENERAL
Coast Bancorp is a commercial bank holding company incorporated in the State
of California in 1995. We were formed to acquire Coast Commercial Bank located
in Santa Cruz, California. Coast Commercial Bank incorporated as a California
state banking corporation on April 27, 1981, and commenced operations on
February 17, 1982. We became the holding company for the Bank on July 25, 1995.
On January 20, 1999 our board of directors approved a 2-for-1 stock split
effective for shareholders of record on February 5, 1999. Accordingly, all
historical financial information has been restated as if the stock split had
been in effect for all periods presented.
GENERAL BANKING SERVICES
We engage in a broad range of financial services activities in our primary
market of Santa Cruz County, and also serve the adjacent areas of San Benito,
Santa Clara and Monterey counties. The City of Santa Cruz, situated 80 miles
south of San Francisco and 35 miles southwest of San Jose, is the largest city
in Santa Cruz County.
We emphasize the needs of local business people and serve individuals,
retailers, professionals and small and medium-sized businesses and operates
through our corporate offices located in Santa Cruz, California and through our
branch offices located in Santa Cruz, Aptos, Capitola, Scotts Valley and
Watsonville, California. Services offered include a full range of commercial
banking services, including the acceptance of demand, savings and time deposits,
overdraft protection for checking accounts, and the making of commercial, real
estate (including residential mortgage), personal, home improvement, automobile
and other installment and term loans. We are one of the largest Small Businesses
Administration ("SBA") lenders in California and have been granted status as a
"preferred lender," allowing us to make SBA loans without first having the SBA
approve the loan, and are also a seller/servicer of Freddie Mac mortgage loans.
We also offers travelers' checks, safe deposit boxes, notary public services,
Visa credit cards, courier service for pick-up of non-cash deposits, debit cards
usable at many ATM's and retailers nationwide and a 24 hour telephone service
for deposit and loan account information. We operate automated teller machines
at our branches and at Seascape Village in Aptos, California. Our Investment
Services Department provides financial planning services, financial consulting,
asset management and the purchase and sale of stocks and bonds through a third
party provider.
The total population base in Santa Cruz County is approximately 249,000
people. Santa Cruz County's economic base has several significant components
including education (e.g., the University of California at Santa Cruz); disk
drive and software companies headquartered in the Northern part of the county
due to its proximity to the high tech base of Silicon Valley in adjacent Santa
Clara County; tourism because of the beaches and Santa Cruz Boardwalk; and
agriculture in the Southern part of the county in and around Watsonville.
We currently have no applications pending to open additional branch offices,
but we may increase the number of our banking facilities in the Bank's trade
areas when expansion is appropriate. Banking facilities that may be considered
in any future expansion include traditional branch offices and mini-branch
offices as in-fill strategies and loan production offices in neighboring
counties. No such facilities are currently under development. Expansion is, of
course, dependent on obtaining the necessary governmental approvals, a continued
earnings pattern and absence of adverse effects from economic conditions,
governmental monetary policies or competition. No assurance can be given that
expansion of our banking operations can be accomplished without being required
to raise additional capital in the future.
1
Coast Commercial Bank is a member of the Federal Deposit Insurance
Corporation ("FDIC") and each depositor's account is insured up to $100,000. We
do not directly offer trust services or international banking services and do
not plan to do so in the near future.
COMPETITION
Our service area consists of Santa Cruz County and extends into the adjacent
areas of San Benito, Santa Clara and Monterey counties. It is estimated that
Santa Cruz County contains 30 competitive banking offices, of which 3 offices
are owned by other independent banks. However, the Bank is the only independent
bank headquartered in Santa Cruz County. It is estimated that the primary
service area also contains 20 offices of savings and loan associations, and 7
offices of credit unions. Based upon total bank deposits as of June 30, 1998
(the last period for which data is available), we are fifth in market share in
Santa Cruz County.
The banking business in California generally, and in our primary service
area specifically is highly competitive with respect to both loans and deposits,
and is dominated by a relatively small number of major banks with many offices
operating over a wide geographic area. Among the advantages such major banks
have over us are their ability to finance wide ranging advertising campaigns and
to allocate their investment assets to regions of highest yield and demand.
These institutions offer certain services such as trust services and
international banking which we do not directly offer (but are offered indirectly
through correspondent institutions), and, by virtue of their greater total
capitalization (legal lending limits to an individual customer are limited to a
percentage of a bank's total capital), they have substantially higher lending
limits than our lending limit. Other entities, both governmental and in private
industry, seeking to raise capital through the issuance and sale of debt or
equity securities also provide competition for us in the acquisition of
deposits. We also compete with money-market funds for deposits.
In order to compete with major financial institutions and other competitors
in our service areas, we build and retain our customer base by drawing upon the
experience of our executive and senior officers in serving business individuals,
and upon our specialized services, local promotional activities and the personal
contacts made by our officers, directors and employees. Our officers and
employees are strongly encouraged to participate in local civic and charitable
organizations and events, which has also serve to promote our business. For
customers whose loan demand exceeds our legal lending limit, we may arrange for
large loans on a participation basis with correspondent banks. Our lending limit
is 15% of our capital and allowance for credit losses for unsecured loans and
25% of our capital and allowance for credit losses for secured loans.
DEPOSITS
Most of our deposits are attracted from individuals, small and medium-sized
businesses and professionals. No single customer relationship accounts for a
significant portion of our deposits.
LENDING ACTIVITIES
We engage in a full complement of lending activities, including commercial,
real estate, SBA and consumer/installment loans.
According to reports from the SBA for the federal fiscal year ended
September 30, 1998, we are one of the largest lenders in Northern California in
the SBA loan program. We make SBA loans from $20,000 to $1,500,000. SBA 7(a)
loans are for working capital, inventory and other purposes, and are government-
guaranteed up to 80% of the loan amount. We also make SBA loans for the purchase
or construction of owner occupied real estate which are also guaranteed up to
80%. The SBA loan program is subject to political and budgetary uncertainty
which in recent years has resulted in a reduction of the guaranteed portion of
SBA loans and lower maximum loan amounts. For example, during the federal fiscal
year ended September 30, 1995, budgetary constraints required the SBA to lower
the maximum loan amount to
2
$500,000. In October 1995, legislation restored the maximum loan amount to
$1,500,000 and imposed additional fees on the program's lenders to raise
additional revenue for the SBA.
We also make commercial real estate loans for other purposes such as the
purchase or refinance of offices, warehouses, professional buildings, and
industrial buildings, including SBA loans. A portion of these loans are SBA
loans which are guaranteed by the U.S. government in an amount up to 90% of the
loan. Commercial real estate loans generally are fully amortized over 15 years
or have a 10 year term with a twenty-five year amortization, and typically have
a maximum loan to value ratio of 70%. SBA loans for this purpose have a term of
up to 25 years and a maximum loan to value ratio of 90%. The Bank had
outstanding real estate term loans of $95,360,000 or 59% of our loan portfolio
at December 31, 1998.
We make commercial loans to small-to-medium sized businesses for working
capital, lines of credit, loans secured by inventory and receivables, and term
loans for equipment and for working capital. Typically, we obtain a security
interest in the collateral being financed or in other available assets of the
customer. Loan to value ratios vary but generally do not exceed 80%. As of
December 31, 1998, we had $38,874,000 in loans for these purposes representing
24% of the our loan portfolio.
We make real estate construction loans for the construction of single and
multi-family residential units, commercial and industrial properties, and SBA
approved owner occupied commercial real estate. These loans typically have
pre-qualified take outs for permanent financing or stand-by commitments and a
maximum loan to value ratio of 70%. We also make loans for lot or land
development with a maximum loan to value ratio of 60%. Construction loans are
secured by a first deed of trust. As of December 31, 1998, we had outstanding
real estate construction loans of $22,206,000 representing 14% of the our loan
portfolio.
Consumer and installment loans are made for household, family and other
personal expenditures on both a secured and unsecured basis. As of December 31,
1998 we had a total of $4,536,000 in consumer and installment loans representing
3% of the our loan portfolio.
We make residential mortgage loans which are typically 30 year loans with
either adjustable or fixed interest rates. These loans are sold to Freddie Mac
on a "servicing retained" basis, i.e., we continue to be paid a fee for
collecting payments on the loan and performing other services, or to other
investors on a "servicing released" basis, i.e. we have no further involvement
in the loan.
We sell the guaranteed portion of SBA loans which we originate into the
secondary market as a source of liquidity and earnings. Additionally, we sell
residential mortgage loans we originate into the secondary market in order to
divest ourselves of the interest rate risk associated with these mostly fixed
interest rate products. No recourse is available to buyers of these loans after
90 days from the sale. Total loans serviced for other investors were
$127,192,000 as of December 31, 1998. For the years ended December 31, 1998,
1997 and 1996, we sold loans totaling $82,869,000, $48,255,000, and $38,497,000,
respectively.
Through 1995, we accounted for these loan sales in accordance with the
Emerging Issues Task Force Issues No. 88-11, "Allocation of Recorded Investment
When a Loan or Part of a Loan is Sold," No. 86-38, "Implications of Mortgage
Prepayments on Amortization of Servicing Rights," and No. 84-21, "Sale of a Loan
with a Partial Participation Retained". Effective January 1, 1996, we adopted
Statement of Financial Accounting Standards ("SFAS") No. 122, "Accounting for
Mortgage Servicing Rights" issued by the Financial Accounting Standards Board
(FASB). This statement eliminated the accounting distinction between rights to
service mortgage loans for others that are acquired through loan origination
activities and those acquired through purchase transactions. Under this
statement, if we sell or securitize loans and retain the mortgage servicing
rights, we allocate the total cost of the mortgage loan to the loan and the
mortgage servicing rights based on their relative fair values. Any cost
allocated to the mortgage servicing rights should be recognized as a separate
asset and amortized over the period of estimated net service income. The
adoption of SFAS No. 122 did not have a significant effect on our financial
position or results of operations.
3
The FASB issued SFAS No. 125, "Accounting for Transfer and Servicing of
Financial Assets and Extinguishments of Liabilities" in June 1996 effective for
transactions occurring after December 31, 1996. SFAS No. 125 supercedes SFAS No.
122 and requires that an asset seller must meet defined conditions to
demonstrate that it has surrendered control over the assets. The failure to meet
these conditions usually results in on-balance-sheet treatment for the assets
and a liability for the sale proceeds received. SFAS No. 125 also requires that
contracts to service are recorded as an asset or a liability based on fair value
or on an allocation of the carrying amount of the financial asset. SFAS 125
covers subsequent accounting, including impairments, and eliminates the
distinction between excess and normal servicing. We adopted SFAS 125 effective
January 1, 1997 and the adoption of SFAS No. 125 did not have a significant
impact on our financial position or results of operations.
Credit risk relates to the ability of a borrower to repay the principal and
interest on their loan and is managed by adherence to credit standards and the
taking of collateral to secure most of our loans. These risks are generally
inherent in commercial lending. Certain risks are specific to particular types
of lending in which we engage such as real estate lending. The major risk
inherent in real estate lending is the potential decline in the value of the
property for market reasons or due to the condition of the property.
OTHER SERVICES
Our Investment Services Department employs 2 investment professionals. The
Investment Services Department offers financial planning services; asset
management services through the use of two unaffiliated investment managers;
retirement plans such as 401(k) plans, IRAs and SEPs; mutual funds; and the
purchase and sale of stocks and bonds on an unsolicited basis.
SUPERVISION AND REGULATION
Coast Commercial Bank is chartered under the banking laws of the State of
California and is subject to the supervision of, and is regularly examined by,
the Commissioner and the FDIC.
Coast Bancorp is a bank holding company within the meaning of The Bank
Holding Act, as amended, (the "BHC Act") is registered as such with and is
subject to the supervision of the Federal Reserve Board ("FRB").
Certain legislation and regulations affecting us are discussed below.
GENERAL
As a bank holding company, Coast Bancorp is subject to the BHC Act. Coast
Bancorp reports to, registers with, and is examined by the FRB. The FRB also has
the authority to examine the our subsidiaries which includes Coast Commercial
Bank.
The FRB requires us to maintain certain levels of capital. See" Capital
Standards" herein. The FRB also has the authority to take enforcement action
against any bank holding company that commits any unsafe or unsound practice, or
violates certain laws, regulations, or conditions imposed in writing by the FRB.
Under the BHC Act, a company generally must obtain the prior approval of the
FRB before it exercises a controlling influence over, or acquires directly or
indirectly, more than 5% of the voting shares or substantially all of the assets
of any bank or bank holding company. Thus, we are required to obtain the prior
approval of the FRB before we acquire, merge or consolidate with any bank, or
bank holding company; any company seeking to acquire, merge or consolidate with
us also would be required to obtain the FRB's approval.
We are generally prohibited under the BHC Act from acquiring ownership or
control of more than 5% of the voting shares of any company that is not a bank
or bank holding company and from engaging
4
directly or indirectly in activities other than banking, managing banks, or
providing services to affiliates of the holding company. A bank holding company,
with the approval of the FRB, may engage, or acquire the voting shares of
companies engaged, in activities that the FRB has determined to be so closely
related to banking or managing or controlling banks as to be a proper incident
thereto. A bank holding company must demonstrate that the benefits to the public
of the proposed activity will outweigh the possible adverse effects associated
with such activity.
The FRB generally prohibits a bank holding company from declaring or paying
a cash dividend which would impose undue pressure on the capital of subsidiary
banks or would be funded only through borrowing or other arrangements that might
adversely affect a bank holding company's financial position. The FRB's policy
is that a bank holding company should not continue its existing rate of cash
dividends on its common stock unless its net income is sufficient to fully fund
each dividend and its prospective rate of earnings retention appears consistent
with its capital needs, asset quality and overall financial condition.
Transactions between Coast Bancorp, Coast Commercial Bank and any future
subsidiaries of Coast Bancorp are subject to a number of other restrictions. FRB
policies forbid the payment by bank subsidiaries of management fees which are
unreasonable in amount or exceed the fair market value of the services rendered
(or, if no market exists, actual costs plus a reasonable profit). Additionally,
a bank holding company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with the extension of credit, sale or
lease of property, or furnishing of services. Subject to certain limitations,
depository institution subsidiaries of bank holding companies may extend credit
to, invest in the securities of, purchase assets from, or issue a guarantee,
acceptance, or letter of credit on behalf of, an affiliate, provided that the
aggregate of such transactions with affiliates may not exceed 10% of the capital
stock and surplus of the institution, and the aggregate of such transactions
with all affiliates may not exceed 20% of the capital stock and surplus of such
institution. Coast Bancorp may only borrow from depository institution
subsidiaries if the loan is secured by marketable obligations with a value of a
designated amount in excess of the loan. Further, Coast Bancorp may not sell a
low-quality asset to a depository institution subsidiary.
CAPITAL STANDARDS
The FRB, FDIC and other federal banking agencies have risk based capital
adequacy guidelines intended to provide a measure of capital adequacy that
reflects the degree of risk associated with a 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 reported as
off-balance-sheet items. Under these guidelines, 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. government securities, to 100% for
assets with relatively higher credit risk, such as business loans.
A banking organization's risk based capital ratios are obtained by dividing
its qualifying capital by its total risk-adjusted assets and off-balance-sheet
items. The regulators measure risk-adjusted assets and off-balance-sheet items
against both total qualifying capital (the sum of Tier 1 capital and limited
amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists of common
stock, retained earnings, noncumulative perpetual preferred stock and minority
interests in certain subsidiaries, less most other intangible assets. Tier 2
capital may consist of a limited amount of the allowance for possible loan and
lease losses and certain other instruments with some characteristics of equity.
The inclusion of elements of Tier 2 capital are subject to certain other
requirements and limitations of the federal banking agencies. Since December 31,
1992, the federal banking agencies have required a minimum ratio of qualifying
total capital to risk-adjusted assets and off-balance-sheet items of 8%, and a
minimum ratio of Tier 1 capital to risk-adjusted assets and off-balance-sheet
items of 4%.
5
In addition to the risk-based guidelines, federal banking regulators require
banking organizations to maintain a minimum amount of Tier 1 capital to total
assets, referred to as the leverage ratio. For a banking organization rated in
the highest of the five categories used by regulators to rate banking
organizations, the minimum leverage ratio of Tier 1 capital to total assets is
3%. It is improbable, however, that an institution with a 3% leverage ratio
would receive the highest rating by the regulators since a strong capital
position is a significant part of the regulators' rating. For all banking
organizations not rated in the highest category, the minimum leverage ratio is
at least 100 to 200 basis points above the 3% minimum. Thus, the effective
minimum leverage ratio, for all practical purposes, is at least 4% or 5%. In
addition to these uniform risk-based capital guidelines and leverage ratios that
apply across the industry, the regulators have the discretion to set individual
minimum capital requirements for specific institutions at rates significantly
above the minimum guidelines and ratios.
See "Capital Resources" in Management's Discussion and Analysis of Financial
Condition and Results of Operations for our capital ratios at December 31, 1998.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS
The power of the board of directors of an insured depository institution to
declare a cash dividend or other distribution with respect to capital is subject
to statutory and regulatory restrictions which limit the amount available for
such distribution depending upon the earnings, financial condition and cash
needs of the institution, as well as general business conditions. Federal law
prohibits insured depository institutions from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if, after such transaction, the institution
would be undercapitalized.
The FRB has issued a policy statement that a bank holding company should not
declare or pay a cash dividend to its stockholders if the dividend would place
undue pressure on the capital of its subsidiary banks or if the dividend could
be funded only through additional borrowings or other arrangements that might
adversely affect the financial position of the bank holding company.
Specifically, a bank holding company should not continue its existing rate of
cash dividends on its common stock unless its net income is sufficient to fully
fund each divident and its prospective rate of earnings retention appears
consistent with its capital needs, asset quality, and overall financial
condition. Further, the Company is expected to act as a source of financial
strength for each of its subsidiary banks and to commit resources to support
each subsidiary bank in circumstances when it might not do so absent such
policy.
Our ability to pay dividends depends in large part on the ability of Coast
Commercial Bank to pay management fees and dividends to the Company. The ability
of its subsidiary banks to pay dividends will be subject to restrictions set
forth in the California Banking Law and regulations of the FDIC.
The payment of dividends by a state bank is further restricted by additional
provisions of state law. Under Section 642 of the California Financial Code,
funds available for cash dividend payments by a bank are restricted to the
lesser of: (i) retained earnings; or (ii) the bank's net income for its three
fiscal years (less any distributions to stockholders made during such period).
However, under Section 643 of the California Financial Code, with the prior
approval of the Commissioner, a bank may pay cash dividends in an amount not to
exceed the greater of the: (1) retained earnings of the bank; (2) net income of
the bank for its last fiscal year; or (3) net income of the bank for its current
fiscal year. However, if the Commissioner finds that the stockholders' equity of
the bank is not adequate or that the payment of a dividend would be unsafe or
unsound, the Commissioner may order such bank not to pay a dividend to
stockholders. Currently, it is permissible for Coast Commercial Bank to pay cash
dividends without the Commissioner's prior approval.
Additionally, under Federal law, a bank may not make any capital
distribution, including the payment of dividends, if after making such
distribution the bank would be in any of the "under-capitalized" categories
under the FDIC's Prompt Corrective Action regulations.
6
Also, under the Financial Institution's Supervisory Act, the FDIC also has
the authority to prohibit a bank from engaging in business practices which the
FDIC considers to be unsafe or unsound. It is possible, depending upon the
financial condition of a bank and other factors, that the FDIC could assert that
the payment of dividends or other payments in some circumstances might be such
an unsafe or unsound practice and thereby prohibit such payment.
COMMUNITY REINVESTMENT ACT
Banks are subject to the Community Reinvestment Act ("CRA"), which was
enacted in 1977 to promote lending by financial institutions to individuals and
businesses located in low and moderate income areas. New CRA regulations went
into effect as of July 1, 1997. As revised the CRA regulations emphasize an
assessment of actual performance rather than of the procedures followed by a
bank, to evaluate compliance with the CRA. Overall CRA compliance continues to
be rated across a four-point scale from "outstanding" to "substantial
noncompliance," and continues to be a factor in review of applications to merge,
establish new branches or form bank holding companies. In addition, any bank
rated in "substantial noncompliance" with the revised CRA regulations may be
subject to enforcement proceedings.
The regulations provide that "small banks", which are defined to include any
independent bank with total assets of less than $50 million, are to be evaluated
by means of a so-called "streamlined assessment method" unless such a bank
elects to be evaluated by one of the other methods provided in the regulations.
The differences between the evaluation methods may be summarized as follows:
(1) The "streamlined assessment method" applicable to small banks requires
that a bank's CRA compliance be evaluated pursuant to five "assessment
criteria," including its (i) loan-to-deposit ratio (as adjusted for seasonal
variations and other lending-related activities, such as sales to the secondary
market or community development lending); (ii) percentage of loans and other
lending-related activities in the bank's service area(s); (iii) distribution of
loans and other lending-related activities among borrowers of different income
levels, given the demographic characteristics of its service area(s); (iv)
geographic distribution of loans and other lending-related activities within its
service area(s); and (v) record of response to written complaints, if any, about
its CRA performance.
(2) The "lending, investments and service tests method" is applicable to all
banks larger than $250 million which are not wholesale or limited purpose banks
and do not elect to be evaluated by the "strategic plan assessment method."
Central to this method is the requirement that such banks collect and report to
their primary federal banking regulators detailed information regarding home
mortgage, small business and farm and community development loans which is then
used to evaluate CRA compliance. At the bank's option, data regarding consumer
loans and any other loan distribution it may choose to provide also may be
collected and reported.
Using such data, a bank will be evaluated regarding its (i) lending
performance according to the geographic distribution of its loans, the
characteristics of its borrowers, the number and complexity of its community
development loans, the innovativeness or flexibility of its lending practices to
meet low and moderate income credit needs and, at the bank's election, lending
by affiliates or through consortia or third-parties in which the bank has an
investment interest; (ii) investment performance by measure of the bank's
"qualified investments," that is, the extent to which the bank's investments,
deposits, membership shares in a credit union, or grants primarily to benefit
low or moderate income individuals and small businesses and farms, address
affordable housing or other needs not met by the private market, or assist any
minority or women-owned depository institution by donating, selling on favorable
terms or provisioning on a rent-free basis any branch of the bank located in a
predominately minority neighborhood; and (iii) service performance by evaluating
the demographic distribution of the bank's branches and ATMs, its record of
opening and closing them, the availability of alternative retail delivery
systems (such as telephone banking, banking by mail or at work, and mobile
facilities) in low and moderate income geographies and to low and moderate
income individuals, and (given the characteristics of the bank's service area(s)
and its
7
capacity and constraints) the extent to which the bank provides "community
development services" (services which primarily benefit low and moderate income
individuals or small farms and businesses or address affordable housing needs
not met by the private market) and their innovativeness and responsiveness.
(3) Wholesale or limited purpose banks which do not make home mortgage,
small farm or business or consumer loans to retail customers may elect, subject
to agency approval of their status, to be evaluated by the "community
development test method," which assesses the number and amount of the bank's
community development loans, qualified investments and community development
services and their innovativeness and complexity.
(4) Any bank may request to be evaluated by the "strategic plan assessment
method" by submitting a strategic plan for review and approval. Such a plan must
involve public participation in its preparation, and contain measurable goals
for meeting low and moderate income credit needs through lending, investments
and provision of services. Such plans generally will be evaluated by measuring
strategic plan goals against standards similar to those which will be applied in
evaluating a bank according to the "lending, investments and service test
method."
YEAR 2000 DATA PROCESSING ISSUES
The Federal Financial Institution Examination Council ("FFIEC") has issued
an interagency statement and a supplement thereto addressing the business risk
related to the problem of computers which are not programmed to recognize the
Year 2000. Many computer programs are programmed to determine the year based
solely on the last two digits entered and recognize the digits "00" as the year
1900. These programs must be reprogrammed to recognize the year 2000 or they
will not be able to function properly after December 31, 1999.
The FFIEC has established guidelines for all banks to ensure that their
systems recognize the Year 2000. The requirements include establishing,
implementing and monitoring a Year 2000 plan; efforts to monitor the progress of
vendors in changing systems used by banks; requiring bank management to provide
status reports to its board of directors at least quarterly regarding the bank's
internal corrective efforts; and monitoring the ability of the bank's vendors to
provide Year 2000 compliant products and services. Federal banking agencies are
examining banks for Year 2000 compliance.
INTER-COMPANY BORROWINGS
Bank holding companies are also restricted as to the extent to which they
and their subsidiaries can borrow or otherwise obtain credit from one another,
or engage in certain other transactions. The "covered transactions" that an
insured depository institution and its subsidiaries are permitted to engage in
with their nondepository affiliates are limited to the following amounts: (1) in
the case of any one such affiliate, the aggregate amount of covered transactions
of the insured depository institution and its subsidiaries cannot exceed 10% of
the capital stock and the surplus of the insured depository institution; and
(ii) in the case of all affiliates, the aggregate amount of covered transactions
of the insured depository institution and its subsidiaries cannot exceed 20% of
the capital stock and surplus of the insured depository institution. In
addition, extensions of credit that constitute covered transactions must be
collateralized in prescribed amounts.
"Covered transactions" are defined by statute to include a loan or extension
of credit to the affiliate, a purchase of securities issued by an affiliate, a
purchase of assets from the affiliate (unless otherwise exempted by the Federal
Reserve Board), the acceptance of securities issued by the affiliate as
collateral for a loan and the issuance of a guarantee, acceptance, or letter of
credit for the benefit of an affiliate. Further, a bank holding company and its
subsidiaries are prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit, lease or sale of property or furnishing
of services.
8
RECENT AND PROPOSED LEGISLATION
On July 29, 1998, the Homeowners Protection Act of 1998 was enacted which
requires the automatic cancellation and notice of cancellation rights for
private mortgage insurance that is required as a condition for entering into a
residential mortgage transaction. This law will become effective on July 29,
1999.
On December 1, 1998, the FDIC published a final rule revising the FDIC's
rules and regulations governing the activities and investments on insured state
nonmember banks, and consolidating those rules and regulations into a single
section, Part 362 of the FDIC's Rules and Regulations. The FDIC also approved
updating and incorporating into Part 362 portions of the FDIC's rules and
regulations governing securities activities of subsidiaries and affiliates of
insured state nonmember banks. The revised rule provides the framework pursuant
to which certain state chartered banks or their majority owned subsidiaries may
engage in activities that are permissable for national banks or their
subsidiaries. All contemplated activities must, however, be permitted by the
institution's chartering authority. In addition, if an activity or equity
investment is permissable under state law, the revised rule will allow the FDIC
to move more expeditiously on requests. The notice procedure in the final fule
will expedite the processing of requests from banks meeting various eligibility
requirements. The types of activities to which notice processing has been
extended includes securities underwriting and real estate investment activities.
In early January, 1999, United States House of Representatives Banking
Committee Chairman James A. Leach introduced a new Glass-Steagall Bill, the
"Financial Services Act of 1999," which provides, in part, for the merger of
commercial investment banking through the repeal of Section 20 of the Glass-
Steagall Act. Section 20 prohibits banks from affiliating with entities that are
"engaged principally" in the sale and underwriting of corporate equity and
bonds. Section 32 restricts banks and securities firms from sharing officers,
employees or directors.
IMPACT OF MONETARY POLICIES
Banking is a business which depends on interest rate differentials. In
general, the difference between the interest paid by a bank on its deposits and
other borrowings, and the interest rate earned by banks on loans, securities and
other interest-earning assets comprises the major source of banks' earnings.
Thus, the earnings and growth of banks are subject to the influence of economic
conditions generally, both domestic and foreign, and also to the monetary and
fiscal policies of the United States and its agencies, particularly the FRB. The
FRB implements national monetary policy, such as seeking to curb inflation and
combat recession, by its open-market dealings in United States government
securities, by adjusting the required level of reserves for financial
institutions subject to reserve requirements and through adjustments to the
discount rate applicable to borrowings by banks which are members of the FRB.
The actions of the FRB in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates. The nature and timing
of any future changes in such policies and their impact on us cannot be
predicted. In addition, adverse economic conditions could make a higher
provision for loan losses a prudent course and could cause higher loan loss
charge-offs, thus adversely affecting a bank's net earnings.
ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". The Statement
will require us to recognize all derivatives on the balance sheet at fair value.
SFAS No. 133 requires that derivative instruments used to hedge be identified
specifically to assets, liabilities, firm commitments or anticipated
transactions and measured as effective and ineffective when hedging changes in
fair value or cash flows. Derivative instruments that do not qualify as either a
fair value or cash flow hedge will be valued at fair value with the resultant
gain or loss recognized in current earnings. Changes in the effective portion of
fair value hedges will be recognized in current earnings along with the change
in fair value of the hedged item. Changes in the effective portion of cash flow
hedges will be recognized in other comprehensive income until realization of the
cash flows of
9
the hedged item through current earnings. Any ineffective portion of hedges will
be recognized in current earnings. The Company has no derivative instruments
outstanding as of December 31, 1998 and management believes adoption of this
Statement will not have a material impact on our financial position or results
of operations. At the date of adoption, the impact on our financial position and
results of operation will depend upon the accumulated net gain or loss, if any,
of the effective portion of cash flow hedges and the ineffective portion of cash
flow or any other hedges. The Statement is effective for fiscal years beginning
after June 15, 1999, with earlier application encouraged.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Emterprise." This Statement amends SFAS No.
65, "Accounting for Certain Mortgage Banking Activities," which established
accounting and reporting standards for certain activities of mortage banking and
other similar enterprises. After securitization of mortgage loans held for sale,
SFAS No. 134 requires an entity to classify the resulting mortgage-backed
securities or other retained interests based on its ability or intent to sell or
hold those investments. Management believes the adoption of SFAS No. 134 will
have no impact on our financial position or results of operations. This
Statement is effective for fiscal years beginning after December 15, 1998,
earlier application permitted.
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use". Sop 98-1 requires the
capitalization of eligle costs of specified activities related to computer
software developed or obtained for internal use. Management believes that the
adoption of SOP 98-1 will not have a material effect on the our financial
position or results of operations. The statement is effective for fiscal years
beginning after December 15, 1998, with earlier application encouraged. We
expect to adopt SOP 98-1 as of January 1, 1999.
In June 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities". SOP 98-5 requires that entities expense start-up costs and
organization costs as they are incurred. Management believes that the adoption
of SOP 98-5 will not have a material effect on our financial position or results
of operations. The statement is effective for fiscal years beginning after
December 15, 1998, with earlier application encouraged. We expect to adopt SOP
98-5 as of January 1, 1999.
ENVIRONMENTAL MATTERS
We are not involved in any administrative or judicial proceedings pursuant
to federal, state or local laws or regulations regarding the discharge of
materials into the environment or whose purpose is to protect the environment.
EMPLOYEES
At December 31, 1998, we employed one hundred forty (140) persons including
forty-eight (48) part-time employees, four (4) executive officers and thirty
(30) other Vice Presidents and Assistant Vice Presidents. Our employees are not
currently represented by a union or covered under a collective bargaining
agreement. We believe that our employee relations are excellent.
ITEM 2. PROPERTIES
Our administrative offices are leased on a month-to-month basis. Our
branches and operations facilities are occupied under other leases which expire
at various dates through 2002 and in most instances, include options to renew or
extend at market rates and terms.
10
ITEM 3. LEGAL PROCEEDINGS
We are a party to routine litigation which is incidental to our business. As
of December 31, 1998, there are no pending legal proceedings to which we are a
party which may have a materially adverse effect upon our financial position or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the stockholders of our common stock
during the fourth quarter of 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
A. Our Common Stock trades on The NASDAQ Stock Market-SM- under the symbol
CTBP. Our Common Stock began trading on the The NASDAQ Stock MarketSM on
February 19, 1997. Prior to that time, the our Common Stock was listed on the
NASDAQ Bulletin Board and was the subject of limited trading.
The prices indicated below may not necessarily represent actual
transactions.
SALE PRICE OF THE
COMPANY'S COMMON
STOCK
--------------------
QUARTER ENDED 1998 BID ASK
- ----------------------------------------------------------------------------------------------- --------- ---------
December 31.................................................................................... $ 16.25 $ 19.00
September 30................................................................................... 18.00 23.50
June 30........................................................................................ 17.27 22.63
March 31....................................................................................... 16.36 18.64
QUARTER ENDED 1997 BID ASK
- ----------------------------------------------------------------------------------------------- --------- ---------
December 31.................................................................................... $ 13.64 $ 17.05
September 30................................................................................... 10.68 15.45
June 30........................................................................................ 9.66 11.36
March 31....................................................................................... 8.35 11.59
B. As of March 23, 1999, the approximate number of registered holders of
our Common Stock was 384. In addition, the approximate number of beneficial
shareholders was 436.
C. We paid a cash dividend of $0.08 per share in the first quarter of 1999,
a 10% stock dividend in May 1998, and cash dividends of $0.07 per share in each
quarter during 1998; and cash dividends of $0.0523 per share in each quarter of
1997.
There can be no assurances that we will pay either cash or stock dividends
in the future.
We consider the payment of cash dividends in order to return a portion of
our profits to stockholders. In considering the amount of cash dividends to be
paid, if any, we consider the maintenance of a consistent dividend policy as
part of our efforts to make the Company's stock attractive to investors; the
amount and frequency of dividends; the payout ratio; our need to have sufficient
funds available to pay our expenses; and compliance with applicable laws,
regulations and other regulatory requirements.
California law provides that in order to declare dividends: (i) after a
corporation has paid a dividend to its stockholders, it must be likely that the
corporation will be able to meet its liabilities as they mature;
11
and (ii) the amount of the corporation's retained earnings immediately prior to
the payment of the dividend must be equal to or exceed the amount of the
proposed cash dividend.
The holding company's primary source of revenue is dividends from Coast
Commercial Bank. The payment of dividends by the bank is subject to various
legal and regulatory requirements. See Item 1 "Restrictions on Dividends and
Other Distributions."
ITEM 6. SELECTED FINANCIAL DATA
Presented below is selected financial data for the last five years. The data
is calculated from our audited consolidated financial statements.
DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
INCOME STATEMENT SUMMARY:
Net interest income.............................. $ 17,364 $ 15,052 $ 13,435 $ 12,366 $ 9,936
Provision for credit losses...................... 300 450 900 900 600
Noninterest income............................... 5,860 5,060 4,898 3,558 4,044
Noninterest expenses............................. 12,355 11,006 10,539 9,855 9,463
Income before income taxes....................... 10,569 8,656 6,894 5,169 3,917
Provision for income taxes....................... 4,408 3,501 2,766 2,020 1,479
Net income....................................... 6,161 5,155 4,128 3,149 2,438
PERIOD END:
Total loans, gross............................... 160,976 146,427 $ 123,721 $ 106,840 $ 97,648
Assets........................................... 324,748 261,505 236,915 207,668 175,861
Deposits......................................... 280,810 201,197 185,467 164,046 152,130
Stockholders' equity............................. 30,197 27,764 23,193 20,984 17,710
AVERAGES FOR PERIOD:
Total loans, gross............................... 151,374 128,974 $ 115,743 $ 99,842 $ 94,273
Earning assets................................... 269,640 226,650 199,588 167,089 144,093
Assets........................................... 292,227 247,378 217,735 184,977 161,686
Deposits......................................... 238,832 193,260 171,096 151,960 143,195
Stockholders' equity............................. 28,649 25,092 21,466 19,538 17,113
SELECTED RATIOS:
Net interest margin.............................. 6.4% 6.6% 6.7% 7.4% 6.9%
Efficiency ratio................................. 53.2% 54.7% 57.5% 61.9% 67.7%
Allowance for credit losses to total loans....... 2.4% 2.5% 2.6% 2.3% 1.9%
Return on average assets......................... 2.1% 2.1% 1.9% 1.7% 1.5%
Return on beginning stockholders' equity......... 22.2% 22.2% 19.7% 17.8% 15.0%
Dividend payout ratio............................ 21.4% 19.7% 21.5% 26.0% 28.0%
CAPITAL RATIOS:
Average equity to average assets................. 9.8% 10.1% 9.9% 10.6% 10.6%
Total risk-based capital ratio................... 15.4% 16.7% 16.4% 16.9% 15.4%
Tier 1 risk-based capital ratio.................. 14.2% 15.4% 15.2% 15.7% 14.2%
Tier 1 leverage ratio............................ 9.5% 10.3% 9.8% 10.2% 10.9%
PER SHARE DATA:
Diluted net income............................... $ 1.25 $ 1.05 $ 0.84 $ 0.63 $ 0.49
Book value....................................... $ 6.33 $ 5.73 $ 4.77 $ 4.22 $ 3.54
Cash dividends declared.......................... $ .28 $ .21 $ .18 $ 0.16 $ 0.14
Weighted average diluted common shares
outstanding.................................... 4,936,192 4,931,392 4,919,495 5,016,627 5,011,598
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS DOCUMENT MAY CONTAIN FORWARD-LOOKING STATEMENTS THAT ARE SUBJECT TO
RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
FROM THOSE INDICATED. FOR A DISCUSSION OF FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER, PLEAE SEE THE DISCUSSION CONTAINED BELOW AND IN OUR PUBLICLY
AVAILABLE SECURITIES AND EXCHANGE COMMISSION FILINGS AND PRESS RELEASES.
You should read the following discussion and analysis of our financial
condition and the results of our operations for the years ended December 31,
1998, 1997, and 1996 together with our consolidated financial statements and the
notes to consolidated financial statements included in this Form 10-K. This
discussion should be read in conjunction with those financial statements and the
related notes. Averages as presented in the following tables are substantially
all based upon daily average balances.
BUSINESS ORGANIZATION
We are a California corporation organized in 1995 to act as the holding
company for Coast Commercial Bank, a California state chartered bank which
opened in 1982 with headquarters in Santa Cruz and branch offices in Aptos,
Santa Cruz, Scotts Valley and Watsonville. During 1995 we acquired through
merger all of the outstanding common stock of the bank. The merger was accounted
for similar to a pooling of interests in that the historical cost basis of Coast
Commercial Bank has been carried forward. We currently conduct no significant
business activities other than our investment in Coast Commercial Bank.
Consequently, substantially all of the our net income, assets and equity are
derived from our investment in Coast Commercial Bank.
We engage in commercial and consumer banking, offering a range of
traditional banking products and services to individuals, retailers, small and
medium-sized businesses and professionals, primarily within the Santa Cruz
County area.
OVERVIEW
Net income was $6,161,000 for the year ended December 31, 1998, an increase
of 20% from 1997 net income of $5,155,000. Net income reported for 1997
represented an increase of 25% from 1996 net income of $4,128,000. On a diluted
per share basis, net income for 1998 was $1.25 compared with $1.05 and $0.84 for
the preceding two years. The increase in net income in 1998 over 1997 was caused
by the increases in net interest income and noninterest income exceeding the
increase in noninterest expenses and a decrease in the provision for loan
losses. The change in net income in 1997 over 1996 was due the increases in net
interest income and noninterest income exceeding the increase in noninterest
expenses and a decrease in the provision for loan losses.
EARNINGS SUMMARY
NET INTEREST INCOME
Net interest income refers to the difference between interest and fees
earned on loans and investments and the interest paid on deposits and other
borrowed funds. It is the largest component of the net earnings of a financial
institution. The primary factors to consider in analyzing net interest income
are the composition and volume of earning assets and interest-bearing
liabilities, the amount of noninterest bearing liabilities and nonaccrual loans,
and changes in market interest rates.
13
Table I sets forth average balance sheet information, interest income and
expense, average yields and rates, and net interest income and net interest
margin for the years ended December 31, 1998, 1997, and 1996.
TABLE 1 COMPONENTS OF NET INTEREST INCOME
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------------
1998 1997 1996
----------------------------------- ----------------------------------- ---------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE
--------- ----------- ----------- --------- ----------- ----------- ---------
(DOLLARS IN THOUSANDS)
Assets:
Loans(1)(2)........................... $ 151,374 $ 16,891 11.2% $ 128,974 $ 14,383 11.2% $ 115,746
Securities:
Taxable............................. 78,115 5,140 6.6% 68,896 4,721 6.9% 61,929
Nontaxable(3)....................... 13,683 1,073 7.8% 5,920 501 8.5% 6,025
Federal funds sold.................... 26,468 1,388 5.2% 22,860 1,244 5.4% 15,888
--------- ----------- --- --------- ----------- --- ---------
Total earning assets.................. 269,640 24,492 9.1% 226,650 20,849 9.2% 199,588
Cash and due from banks............... 17,688 16,603 13,993
Allowance for credit losses........... (3,716) (3,451) (2,882)
Unearned income....................... (2,771) (1,874) (1,663)
Bank premises and equipment, net...... 2,256 2,046 2,200
Other assets.......................... 9,130 7,404 6,499
--------- --------- ---------
Total assets.......................... $ 292,227 $ 247,378 $ 217,735
--------- --------- ---------
--------- --------- ---------
Interest-bearing liabilities:
Deposits:
Demand.............................. $ 86,809 1,715 2.0% $ 76,638 1,613 2.1% $ 72,035
Savings............................. 36,809 1,471 4.0% 29,652 950 3.2% 27,342
Time................................ 50,531 2,404 4.8% 30,814 1,609 5.2% 23,867
--------- ----------- --- --------- ----------- ---------
Total deposits........................ 174,149 5,590 3.2% 137,104 4,172 3.0% 123,244
Borrowed funds........................ 21,629 1,174 5.4% 26,881 1,455 5.4% 23,528
--------- ----------- --- --------- ----------- ---------
Total interest-bearing liabilities.... 195,778 6,764 3.5% 163,985 5,627 3.4% 146,772
Demand deposits....................... 64,683 56,156 47,852
Other liabilities..................... 3,117 2,145 1,645
Stockholders' equity.................. 28,649 25,092 21,466
--------- --------- ---------
Total liabilities and stockholders'
equity.............................. $ 292,227 $ 247,378 $ 217,735
--------- --------- ---------
--------- --------- ---------
Net interest income and margin........ $ 17,728 6.6% $ 15,222 6.7%
----------- --- ----------- ---
----------- -----------
AVERAGE
INTEREST RATE
----------- -----------
Assets:
Loans(1)(2)........................... $ 12,845 11.1%
Securities:
Taxable............................. 4,235 6.8%
Nontaxable(3)....................... 509 8.4%
Federal funds sold.................... 832 5.2%
----------- ---
Total earning assets.................. 18,421 9.2%
Cash and due from banks...............
Allowance for credit losses...........
Unearned income.......................
Bank premises and equipment, net......
Other assets..........................
Total assets..........................
Interest-bearing liabilities:
Deposits:
Demand.............................. 1,388 1.9%
Savings............................. 819 3.0%
Time................................ 1,228 5.1%
-----------
Total deposits........................ 3,435 2.8%
Borrowed funds........................ 1,378 5.9%
-----------
Total interest-bearing liabilities.... 4,813 3.3%
Demand deposits.......................
Other liabilities.....................
Stockholders' equity..................
Total liabilities and stockholders'
equity..............................
Net interest income and margin........ $ 13,608 6.8%
----------- ---
-----------
- ------------------------------
(1) Loan fees totaling $1,320,000, $1,172,000, and $974,000 are included in loan
interest income for 1998, 1997, and 1996, respectively.
(2) Average nonaccrual loans totaling $458,000, $229,000, and $511,000 are
included in average loans for 1998, 1997 and 1996, respectively.
(3) Tax exempt income includes $365,000, $170,000, and $173,000 in 1998, 1997,
and 1996, respectively, to adjust to a fully taxable equivalent basis using
the Federal statutory rate of 34%.
Net interest income is affected by changes in the amount and mix of
interest-earning assets and interest-bearing liabilities, referred to as "volume
change." Net interest income is also affected by changes in yields earned on
interest-earning assets and rates paid on interest-bearing liabilities, referred
to as "rate change." Table 2 presents changes in interest income and interest
expense for each major category of interest-earning assets and interest-bearing
liabilities. The table also reflects the amount of change attributable to volume
and rate changes for the years indicated on a fully taxable equivalent basis.
14
TABLE 2 RATE/VOLUME ANALYSIS
1998 COMPARED TO 1997 INCREASE 1997 COMPARED TO 1996 INCREASE
(DECREASE) DUE TO CHANGE IN (DECREASE) DUE TO CHANGE IN
--------------------------------- ---------------------------------
VOLUME RATE NET CHANGE VOLUME RATE NET CHANGE
--------- --------- ----------- --------- --------- -----------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans.................................................... $ 2,521 $ (144) $ 2,377 $ 1,458 $ 166 $ 1,624
Securities............................................... 865 126 991 468 9 477
Federal funds sold....................................... 196 (52) 144 365 47 412
--------- --------- ----------- --------- --------- -----------
Total interest income.................................... 3,582 (70) 3,512 2,291 222 2,513
Interest bearing deposits:
Demand................................................... 207 (49) 158 105 120 225
Savings.................................................. 270 82 352 69 62 131
Time..................................................... 921 43 964 356 31 387
--------- --------- ----------- --------- --------- -----------
Interest expense on deposits............................. 1,398 76 1,474 530 213 743
Interest expense on borrowings........................... (295) (42) (337) 199 (121) 78
--------- --------- ----------- --------- --------- -----------
Total interest expense................................... 1,103 34 1,137 729 92 821
--------- --------- ----------- --------- --------- -----------
Increase in net interest income.......................... $ 2,479 $ (104) $ 2,375 $ 1,562 $ 130 $ 1,692
--------- --------- ----------- --------- --------- -----------
--------- --------- ----------- --------- --------- -----------
For 1998, net interest income, on a fully taxable-equivalent basis, was
$17,728,000 or 6.6% of average earning assets, an increase of 16% over
$15,222,000 or 6.7% of average earning assets in the comparable period in 1997.
The increase in 1998 reflects higher levels of earning assets partially offset
by lower yields on earning assets and higher rates paid on interest-bearing
liabilities. Net interest income in 1997, on a fully taxable-equivalent basis,
was $15,222,000 or 6.7% of average earning assets an increase of 12% over
$13,608,000 or 6.8% of average earning assets in the comparable period in 1996.
The increase in 1997 reflects higher levels of earning assets partially offset
by higher rates paid on interest-bearing liabilities.
Interest income, on a fully taxable-equivalent basis, was $24,492,000,
$20,849,000, and $18,421,000 for 1998, 1997 and 1996, respectively. The
increases in 1998 and 1997 resulted from the growth in average earning assets.
Loan yields averaged 11.2% in 1998 and 1997 and 11.1% in 1996. Approximately 84%
of our loans have variable interest rates indexed to the prime rate. Our average
prime rate was 8.36%, 8.44%, and 8.27% in 1998, 1997, and 1996, respectively.
Average earning assets were $269,640,000 for 1998, an increase of 19% over
$226,650,000 in 1997, which increased 14% over $199,588,000 in 1996. The growth
in average earning assets resulted mostly from increased levels of deposits
which were invested primarily in loans and securities.
The increases in interest income during 1998 and 1997, on a fully
taxable-equivalent basis, were partially offset by increases in interest
expense. The increases were primarily due to increases in interest-bearing
deposits and the yields paid on deposits. The average rate paid on interest
bearing deposits was 3.2% in 1998, 3.0% in 1997, and 2.8% in 1996.
15
NONINTEREST INCOME
Table 3 summarizes the sources of noninterest income for the periods
indicated:
TABLE 3 NONINTEREST INCOME
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Gain on sale of loans............................................ $ 2,365 $ 1,404 $ 1,420
Customer service fees............................................ 1,840 1,998 1,808
Loan servicing fees.............................................. 839 1,038 958
Gains (losses) from sale of securities........................... 21 (10) 114
Gain on sale of other real estate owned.......................... 6 -- 39
Other............................................................ 789 630 559
--------- --------- ---------
Total noninterest income..................................... $ 5,860 $ 5,060 $ 4,898
--------- --------- ---------
--------- --------- ---------
Gains on sale of loans increased as a result of increased SBA loan
originations during 1998 and 1997. The 1998 decline in customer service fees
reflects a lower volume of nonsufficient funds items and lower merchant card
processing fees due to competition in attracting and retaining merchants. The
increase in customer service fees in 1997 corresponds with the growth in
deposits and management's focus on enhanced recovery of services provided to
customers. The enhanced recovery program included implementation of demand
deposit account analysis, reductions in waived fees and generally making the fee
structure competitive with other financial institutions.
NONINTEREST EXPENSES
The major components of noninterest expenses stated in dollars and as a
percentage of average earning assets are set forth in Table 4 for the periods
indicated.
TABLE 4 NONINTEREST EXPENSES
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
(DOLLARS IN THOUSANDS)
Salaries and benefits...................................... $ 6,507 2.41% $ 5,692 2.51% $ 5,249 2.63%
Occupancy.................................................. 1,183 .44% 980 .43% 933 .47%
Equipment.................................................. 1,118 .42% 1,120 .50% 1,142 .57%
Customer services.......................................... 698 .26% 462 .20% 443 .22%
Advertising and promotion.................................. 689 .26% 629 .28% 571 .29%
Stationery and postage..................................... 413 .15% 362 .16% 382 .19%
Professional services...................................... 363 .13% 414 .18% 383 .19%
Data processing............................................ 321 .12% 319 .14% 283 .14%
Insurance.................................................. 212 .08% 202 .09% 145 .07%
Other...................................................... 851 .32% 826 .37% 1,008 .51%
--------- --- --------- --- --------- ---
Total noninterest expenses............................. $ 12,355 4.58% $ 11,006 4.86% $ 10,539 5.28%
--------- --- --------- --- --------- ---
--------- --- --------- --- --------- ---
Total noninterest expenses increased $1,349,000 or 12% in 1998 over
$11,006,000 in 1997, which increased $467,000 or 4% from $10,539,000 in 1996.
16
The 1998 increase resulted from higher staff, occupancy, customer services,
stationery and postage, professional service and other costs associated with
opening a sixth branch and other staffing increases to support the growth in
total loans, deposits and assets. The increase in 1997 primarily resulted from
higher staff costs and increased advertising, professional services, data
processing and insurance costs offset partially by a decline in other expenses.
Other expenses decreased in 1997 primarily due to lower costs of OREO, service
charges and operating losses. In 1997 the FDIC levied an additional premium of
approximately 1.3 cents per $100 of deposits against banks for the payment of
certain debt issued by regulatory agencies during the 1980's savings and loan
bailout. The increase in noninterest expenses reflects the growth in total
loans, deposits and assets. The decrease in noninterest expenses as a percentage
of average earning assets is the result of the rate of growth in average earning
assets in 1998 and 1997 exceeding the rate of increase in noninterest expenses.
INCOME TAXES
Our effective tax rate was 41.7% for 1998 compared to 40.4% for 1997 and
40.1% for 1996. Changes in our effective tax rate are primarily due to
fluctuations in the proportion of tax exempt income generated from investment
securities to pre-tax income.
BALANCE SHEET ANALYSIS
Total assets increased to $324.7 million at December 31, 1998, a 24%
increase from the end of 1997. Total assets increased to $261.5 million in 1997,
a 10% increase from the $236.9 million a year earlier. Based on average
balances, 1998 average total assets of $292.2 million represent an increase of
18% over 1997 average total assets of $247.4 million which represent an increase
of 14% over 1996.
EARNING ASSETS
LOANS
Total gross loans at December 31, 1998 were $161.0 million, a 10% increase
from $146.4 million at December 31, 1997 which was a 18% increase from $123.7
million at December 31, 1996.
Table 5 summarizes the composition of the loan portfolio at December 31, for
the past five years.
TABLE 5 LOANS BY TYPE
DECEMBER 31,
---------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ---------
(DOLLARS IN THOUSANDS)
Commercial, financial and agricultural................ $ 38,874 $ 42,838 $ 35,633 $ 34,263 $ 32,294
Real estate mortgage.................................. 95,360 76,101 65,208 50,580 41,200
Real estate construction.............................. 22,206 21,376 15,112 14,008 15,717
Installment and other................................. 4,536 6,112 7,768 7,989 8,437
---------- ---------- ---------- ---------- ---------
Total loans, gross................................ $ 160,976 $ 146,427 $ 123,721 $ 106,840 $ 97,648
---------- ---------- ---------- ---------- ---------
---------- ---------- ---------- ---------- ---------
Average loans in 1998 were $151,374,000 representing an increase of
$22,400,000 or 17% over 1997 and in 1997 were $128,974,000 representing an
increase of $13,231,000, or 11% over 1996. The 1998 and 1997 increases reflect
growth in average real estate loans which in the opinion of management is due to
improved local economic conditions.
Commercial loans were $38,874,000 at the end of 1998 compared to $42,838,000
and $35,633,000 at the end of 1997 and 1996, respecitvely. We make commercial
loans primarily to serve the short- to medium-term credit demands of
small-to-medium sized businesses and professionals located in Santa Cruz
17
County for lines of credit, single payment and term debt obligations. Typically,
loans are collateralized by the working capital, inventory, receivables, or
equipment being financed or other assets available to the borrower. Our
commercial loan portfolio is diversified as to industries and types of
businesses with no material industry concentrations and a profile which we
believe generally reflects the economy of Santa Cruz County. Risks include those
outlined in the Risk Elements section below.
Real estate mortgage loans were $95,360,000 at December 31, 1998 compared to
$76,101,000 and $65,208,000 at the end of 1997 and 1996, respectively. The
increases of $19,259,000 in 1998, $10,893,000 in 1997 and $14,628,000 in 1996
resulted from the retained portion of SBA loans and additional loan demand for
nonresidential real estate financing in our market area. Extensions of credit
are based on an analysis of the borrower's ability to generate debt service,
obtain other financing or sell the property. Advances on nonresidential
properties are limited in general to approximately 70% of the lower of cost or
appraised value.
Our real estate construction loan portfolio was $22,206,000 at December 31,
1998, compared to $21,376,000 and $15,112,000 at the end of 1997 and 1996,
respectively. Construction loans represented 14% of total loans at December 31,
1998 compared to 15% and 12% in 1997 and 1996. We finances the construction of
commercial and residential properties. These loans are at variable rates,
generally have maturities of less than 12 months, and are secured by first deeds
of trust on the underlying properties. Repayment is expected from the borrower's
ability to obtain take-out financing or sell the property. Advances on
residential and commercial projects are limited in general to the lower of
approximately 80% and 70%, respectively, of cost or appraised value of the
collateral.
Real estate mortgage and construction lending entail potential risks which
are not inherent in other types of loans. These potential risks include declines
in market values of underlying real property collateral and, with respect to
construction lending, delays or cost overruns which could expose the us to loss.
In addition, risks in commercial real estate lending include declines in
commercial real estate values, general economic conditions surrounding the
commercial real estate properties, and vacancy rates. A decline in the general
economic conditions or real estate values within the Company's market area could
have a negative impact on the performance of the loan portfolio or value of the
collateral. Because we lend primarily within our market area, the real property
collateral for our loans is similarly concentrated, rather than diversified over
a broader geographic area. We could therefore be adversely affected by a decline
in real estate values in our target market, even if real estate values elsewhere
in California generally remained stable or increased. Risks also include those
outlined in the Risk Elements section below.
Installment loans were $4,536,000 compared to $6,112,000 and $7,768,000 at
the end of 1998, 1997, and 1996, respectively. The installment loan portfolio
finances customers' household, family and other personal expenditures on both a
secured and unsecured basis. Risks include those outlined in the Risk Elements
section below.
RISK ELEMENTS
Lending money involves an inherent risk of nonpayment. Through the
administration of loan policies and monitoring of the portfolio, management
seeks to reduce such risks. The allowance for credit losses is an estimate to
provide a financial buffer for losses, both identified and unidentified, in the
loan portfolio.
Management strives to achieve a low level of credit losses by continuing
emphasis on credit quality in the loan approval process, active credit
administration and regular monitoring. An important tool in achieving a high
level of credit quality is the loan grading system to assess the risk inherent
in each loan. Additionally, management believes our ability to manage portfolio
credit risk is enhanced by lending personnel's knowledge of the our service
area. Our directors, senior managers and lending personnel live in the
communities we serve and are active members of civic, charitable and service
groups in our communities. Further, we have experienced minimal turnover of
senior management since the inception of Coast Commercial Bank in 1982.
18
Ultimately, credit quality may be influenced by underlying trends in the
economic and business cycles. Management believes that our lending policies and
underwriting standards will tend to minimize losses in an economic downturn,
however, there is no assurance that losses will be limited under such
circumstances. Our loan policies and underwriting standards include, but are not
limited to, the following: 1) maintaining a thorough understanding of the our
service area and limiting investments outside of this area, 2) maintaining a
thorough understanding of the borrowers' knowledge and capacity in their field
of expertise, 3) basing real estate construction loan approval not only on
marketability of the project, but also on the borrowers' capacity to support the
project financially in the event it does not sell within the original projected
time period, and 4) maintaining conforming and prudent loan to value and loan to
cost ratios based on independent outside appraisals and ongoing inspection and
analysis by our construction lending officers. In addition, we strive to
diversify the risk inherent in the construction portfolio by avoiding
concentrations to individual borrowers and on any one project.
Management regularly reviews and monitors the loan portfolio to determine
the risk profile of each credit, and to identify credits whose risk profiles
have changed. This review includes, but is not limited to, such factors as
payment status, the financial condition of the borrower, borrower compliance
with loan convenants, underlying collateral values, potential loan
concentrations, and general economic conditions. When potential problem credits
are identified by management, action plans for each credit are developed for our
personnel to mitigate the credit risk through measures such as increased
monitoring, debt reduction goals, addition collateral and possible credit
restructuring opportunities.
NONACCRUAL LOANS, LOANS PAST DUE AND OREO
The accrual of interest is discontinued and any accrued and unpaid interest
is reversed when the payment of principal or interest is 90 days past due unless
the amount is well secured and in the process of collection. Income on such
loans is then recognized only to the extent that cash is received and where the
future collection of principal is probable. At December 31, 1998 nonaccrual
loans totaled $1,108,000 or .7% of total loans compared to $266,000 or .2% at
December 31, 1997 and $159,000 or .1% at December 31, 1996. The 1998 increase in
nonaccrual loans is due primarily to one commercial real estate term loan. If
the nonaccrual loans at December 31, 1998 had not been on nonaccrual, $124,000
of interest income would have been realized in 1998. We realized $74,000 on
these nonaccrual loans in 1998.
At December 31, 1997 and 1996 our nonperforming assets, in particular
nonaccrual loans, reached historically low levels. Management believes the level
of nonperforming assets, including nonaccrual loans, will fluctuate throughout
business and economic cycles, and there is no assurance the 1997 and 1996 levels
of nonperforming assets can be achieved or sustained.
19
Table 6 presents the composition of nonperforming assets at December 31 for
the last 5 years.
TABLE 6 NONPERFORMING ASSETS
DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Nonperforming Assets:
Loans Past Due 90 Days or More................................. $ -- $ -- $ 50 $ 3 $ --
Nonaccrual Loans............................................... 1,108 266 159 824 848
--------- --------- --------- --------- ---------
Total Nonperforming Loans........................................ 1,108 266 209 827 848
OREO............................................................. -- 112 551 830 1,419
--------- --------- --------- --------- ---------
Total Nonperforming Assets....................................... $ 1,108 $ 378 $ 760 $ 1,657 $ 2,267
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Nonperforming Loans as a Percent of Total Loans.................. 0.69% 0.18% 0.17% 0.77% 0.87%
OREO as a Percent of Total Assets................................ -- 0.04% 0.23% 0.40% 0.81%
Nonperforming Assets as a Percent of Total Assets................ 0.34% 0.14% 0.32% 0.80% 1.29%
Allowance for Loan Losses........................................ $ 3,871 $ 3,609 $ 3,158 $ 2,478 $ 1,859
As a Percent of Total Loans.................................... 2.40% 2.46% 2.55% 2.32% 1.90%
As a Percent of Nonaccrual Loans............................... 349% 1357% 1986% 301% 219%
As a Percent of Nonperforming Loans............................ 349% 1357% 1511% 300% 219%
There were no loans at December 31, 1998 where management had serious doubts
about the borrower's ability to comply with loan repayment terms and which may
result in disclosure as a nonaccrual, past due or restructured loan, except as
disclosed in Table 6.
For a discussion of concentrations in the the loan portfolio, see Note 10 of
Notes to Consolidated Financial Statements.
PROVISION AND ALLOWANCE FOR CREDIT LOSSES
Management has established an evaluation process designed to determine the
adequacy of the allowance for credit losses. This process attempts to assess the
risk of loss inherent in the portfolio by segregating the allowance for credit
losses into three components: "historical losses;" "specific;" and "margin for
imprecision." The "historical losses" component is calculated as a function of
the prior four years loss experience for commercial, real estate and consumer
loan types. The four years are assigned weightings of 35%, 30%, 20% and 15%
beginning with the most recent year. The "specific" component is established by
allocating a portion of the allowance to individual classified credits on the
basis of specific circumstances and assessments. The "margin for imprecision"
component is an unallocated portion that supplements the first two components as
a conservative margin to guard against unforeseen factors. The "historical
losses" and "specific" components include management's judgment of the effect of
current and forecasted economic conditions on the ability of our borrowers' to
repay; an evaluation of the allowance for credit losses in relation to the size
of the overall loan portfolio; an evaluation of the composition of, and growth
trends within, the loan portfolio; consideration of the relationship of the
allowance for credit losses to nonperforming loans; net charge-off trends; and
other factors. While this evaluation process utilizes historical and other
objective information, the classification of loans and the establishment of the
allowance for credit losses, relies, to a great extent, on the judgment and
experience of management. We evaluate the adequacy of our allowance for credit
losses quarterly.
There were no impaired loans at December 31, 1998, 1997 and 1996. The
average recorded investment in impaired loans was zero in 1998 and 1997,
respectively, and $273,000 1996. No interest income was recognized on impaired
loans during the period of impairment.
20
The allowance for credit losses totaled $3,871,000 or 2.4% of total loans as
of December 31, 1998 compared to $3,609,000 or 2.5% as of December 31, 1997, and
$3,158,000 or 2.6% as of December 31, 1996. It is the policy of management to
maintain the allowance for possible credit losses at a level adequate for known
and inherent risks in the loan portfolio. Based on information currently
available to analyze loan loss potential, including economic factors, overall
credit quality, historical delinquency and a history of actual charge-offs,
management believes that the loan loss provision and allowance are adequate;
however, no assurance of the ultimate level of credit losses can be given with
any certainty. Loans are charged against the allowance when management believes
that the collectibility of the principal is unlikely. An analysis of activity in
the allowance for credit losses is presented in Table 7.
TABLE 7 ALLOWANCE FOR CREDIT LOSSES
DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Total Loans Outstanding.................... $ 160,976 $ 146,427 $ 123,721 $ 106,840 $ 97,648
Average Total Loans........................ 151,374 128,974 115,743 99,842 94,273
Allowance for credit losses:
Balance, January 1......................... $ 3,609 $ 3,158 $ 2,478 $ 1,859 $ 1,723
Charge-offs by Loan Category:
Commercial............................... 79 108 256 293 304
Installment and other.................... 34 57 96 108 32
Real Estate construction................. -- -- -- -- 120
Real Estate-term......................... -- -- -- -- 30
--------- --------- --------- --------- ---------
Total Charge-Offs.......................... 113 165 352 401 486
Recoveries by Loan Category:
Commercial............................... 45 107 78 79 17
Installment and other.................... 30 53 9 25 3
Real Estate construction................. -- 6 45 16 --
Real Estate-term......................... -- -- -- -- 2
--------- --------- --------- --------- ---------
Total Recoveries....................... 75 166 132 120 22
Net Charge-Offs (recoveries)............... 38 (1) 220 281 464
Provision Charged to Expense............... 300 450 900 900 600
--------- --------- --------- --------- ---------
Balance, December 31....................... $ 3,871 $ 3,609 $ 3,158 $ 2,478 $ 1,859
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Ratios:
Net Charge-offs to Average Loans......... 0.03% 0.00% 0.19% 0.28% 0.49%
Reserve to Total Loans................... 2.40% 2.46% 2.55% 2.32% 1.90%
The allowance for credit losses is allocated based upon management's review
of credit quality and is presented in Table 8. This allocation should not be
interpreted as an indication of expected amounts or categories where losses will
occur.
21
TABLE 8 ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES
DECEMBER 31,
---------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------------- ---------------------- ---------------------- ---------------------- ---------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF 1994
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT
--------- ----------- --------- ----------- --------- ----------- --------- ----------- ---------
(DOLLARS IN THOUSANDS)
Commercial............... $ 1,318 24.2% $ 1,538 29.3% $ 1,658 28.8% $ 1,338 32.1% $ 1,051
Real estate.............. 2,298 73.0% 1,793 66.5% 1,154 64.9% 991 60.4% 705
Installment and other.... 255 2.8% 278 4.2% 346 6.3% 149 7.5% 103
--------- ----- --------- ----- --------- ----- --------- ----- ---------
$ 3,871 100% $ 3,609 100.0% $ 3,158 100.0% $ 2,478 100.0% $ 1,859
--------- ----- --------- ----- --------- ----- --------- ----- ---------
--------- ----- --------- ----- --------- ----- --------- ----- ---------
PERCENT OF
TOTAL LOANS
-----------
Commercial............... 33.1%
Real estate.............. 58.3%
Installment and other.... 8.6%
-----
100.0%
-----
-----
The allocation for real estate includes real estate construction and real
estate term loans. Management has historically not allocated the allowance for
credit losses separately for real estate construction and real estate term
loans.
OTHER INTEREST EARNING ASSETS
The average balance of securities and federal funds sold increased
$20,590,000 to $118,266,000 in 1998. The average balance of securities and
federal funds sold totaled $97,676,000 in 1997, an increase of $13,902,000 from
$83,774,000 in 1996. The 1998 and 1997 increases resulted from deploying
additional liquidity in the securities portfolio. Sources of the additional
liquidity were borrowed funds and the excess of the increase in average deposits
over the increase in average loans. Management uses borrowed funds to increase
earning assets and enhance our interest rate risk profile.
FUNDING
Deposits represent our principal source of funds for investment. Deposits
are primarily core deposits in that they are demand, savings, and time deposits
under $100,000 generated from local businesses and individuals. These sources
represent relatively stable, long term deposit relationships which minimize
fluctuations in overall deposit balances. During 1998, we accepted a $15,000,000
time deposit from the State of California to replace other borrowed funds. The
State of California time deposit is renewable approximately every three months
at a rate similar to the three month U.S. Treasury bill. We have never used
brokered deposits. Table 9 presents the composition of deposits for the five
years ended December 31, 1998.
TABLE 9 COMPOSITION OF DEPOSITS
DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Demand, non-interest................................. $ 75,978 $ 66,812 $ 56,699 $ 49,575 $ 43,112
Demand, interest..................................... 100,707 76,123 69,305 74,944 77,380
Savings.............................................. 51,873 23,942 32,296 17,385 17,254
Time................................................. 52,252 34,320 27,167 22,142 14,384
---------- ---------- ---------- ---------- ----------
Total................................................ $ 280,810 $ 201,197 $ 185,467 $ 164,046 $ 152,130
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Deposits increased $79,613,000 or 40% to $280,810,000 as of December 31,
1998 and $15,730,000 or 8% to $201,197,000 as of December 31, 1997 and
$21,421,000 or 13% to $185,467,000 as of December 31, 1996. Average total
deposits in 1998 of $238,832,000 showed an increase of $45,572,000 or 24% over
the same period in 1997 and in 1997 of $193,260,000 showed an increase of
$22,168,000 or 13% over 1996.
22
During 1998, average interest-bearing deposits increased $37,045,000 and average
non-interest bearing deposits increased $8,527,000 over 1997.
Another source of funding is borrowed funds. Management uses borrowed funds
to increase earning assets, prudently leverage capital and minimize our interest
rate risk. Typically, these funds result from the use of advances from the FHLB
and agreements to sell securities with repurchase at a designated future date,
also known as repurchase agreements. Repurchase agreements are conducted with
major banks and investment brokerage firms. The maturity of these arrangements
for the us is typically 30 to 90 days. Advances from the FHLB may vary in
maturity from 1 to 10 years. During 1998 we obtained $10,000,000 in advances
from the FHLB payable at maturity in 5 years. The advances are callable by the
FHLB beginning in February 1999 and bear interest at 5.0%. The average balance
of borrowed funds was $21,629,000 and $26,881,000 during 1998 and 1997,
respectively. The decrease in average borrowed funds reflects the substitution
of the $15,000,000 in time deposits from the State of California for borrowed
funds. The weighted average interest rate for 1998 and 1997 was 5.4%. The
maximum amount of borrowings at any month-end during 1998 was $32,800,000. The
weighted average interest rate on borrowed funds outstanding at December 31,
1998 and 1997 was 5.0% and 5.7%, respectively.
LIQUIDITY AND INTEREST RATE SENSITIVITY
Liquidity management refers to our ability to provide funds on an ongoing
basis to meet fluctuations in deposit levels as well as the credit needs and
requirements of our clients. Both assets and liabilities contribute to our
liquidity position. Federal funds lines, short-term investments and securities,
and loan repayments contribute to liquidity, along with deposit increases, while
loan funding and deposit withdrawals decrease liquidity. We assess the
likelihood of projected funding requirements by reviewing historical funding
patterns, current and forecasted economic conditions and individual client
funding needs. We maintain informal lines of credit with our correspondent banks
for short-term liquidity needs. These informal lines of credit are not committed
facilities by the correspondent banks and no fees are paid to maintain them.
We manage our liquidity by maintaining a majority of our investment
portfolio in liquid investments in addition to our federal funds sold. Liquidity
is measured by various ratios, including the liquidity ratio of net liquid
assets compared to total assets. As of December 31, 1998, this ratio was 31.4%.
Other key liquidity ratios are the ratios of gross loans to deposits and federal
funds sold to deposits, which were 57.3% and 10.3%, respectively, as of December
31, 1998.
INTEREST RATE SENSITIVITY
Interest rate sensitivity is a measure of the exposure of our the future
earnings due to changes in interest rates. If assets and liabilities do not
reprice simultaneously and in equal volumes, the potential for such exposure
exists. It is management's objective to achieve a modestly asset-sensitive
position, such that our net interest margin increases as market interest rates
rise and decreases when rates decline.
One quantitative measure of the "mismatch" between asset and liability
repricing is the interest rate sensitivity "gap" analysis. All interest-earning
assets and funding sources are classified as to their expected repricing or
maturity date, whichever is sooner. Within each time period, the difference
between asset and liability balances, or "gap," is calculated. Positive
cumulative gaps in early time periods suggest that earnings will increase if
interest rates rise. Negative gaps suggest that earnings will decline when
interest rates rise. Table 10 presents the our gap analyses at December 31,
1998. Mortgage backed securities are reported in the period of their expected
repricing based upon estimated prepayments developed from recent experience.
23
TABLE 10 INTEREST RATE SENSITIVITY
NEXT DAY OVER THREE
AND WITHIN MONTHS AND OVER ONE
THREE WITHIN ONE AND WITHIN OVER FIVE
IMMEDIATELY MONTHS YEAR FIVE YEARS YEARS TOTAL
----------- ----------- ----------- ----------- --------- ---------
(DOLLARS IN THOUSANDS)
As of December 31, 1997
Rate Sensitive Assets:
Federal Funds Sold................ $ 29,000 $ -- $ -- $ -- $ -- $ 29,000
Investment Securities:
Treasury and Agency Obligations... -- 11,900 4,500 1,692 -- 18,092
Mortgage-Backed Securities........ -- 2,505 7,389 27,888 19,999 57,781
Municipal Securities.............. -- 611 225 2,952 10,668 14,457
Corporate Securities.............. -- -- -- 3,591 11,014 14,605
Other............................. -- -- -- -- 1,503 1,503
----------- ----------- ----------- ----------- --------- ---------
Total Investment Securities......... -- 15,016 12,114 36,124 43,184 106,438
Loans Excluding Nonaccrual Loans.... 134,990 1,255 3,068 6,360 14,195 159,868
----------- ----------- ----------- ----------- --------- ---------
Total Rate Sensitive Assets......... $ 163,990 $ 16,271 $ 15,182 $ 42,484 $ 57,379 $ 295,306
----------- ----------- ----------- ----------- --------- ---------
Rate Sensitive Liabilities:
Deposits:
Demand and Savings.............. $ 152,580 $ -- $ -- $ -- $ -- $ 152,580
Time............................ -- 37,969 11,494 2,789 -- 52,252
----------- ----------- ----------- ----------- --------- ---------
Total Interest-bearing Deposits..... 152,580 37,969 11,494 2,789 -- 204,832
Other Borrowings.................... -- 416 -- 10,000 -- 10,416
----------- ----------- ----------- ----------- --------- ---------
Total Rate Sensitive
Liabilities..................... $ 152,580 $ 38,385 $ 11,494 $ 12,789 $ -- $ 215,248
----------- ----------- ----------- ----------- --------- ---------
Gap............................. $ 11,410 $ (22,114) $ 3,688 $ 29,695 $ 57,379 $ 80,058
Cumulative Gap...................... $ 11,410 $ (10,704) $ (7,016) $ 22,679 $ 80,058
Our positive cumulative total gap results from the exclusion from the above
table of noninterest-bearing demand deposits, which represent a significant
portion of our funding sources. We maintain a positive cumulative gap in all
time periods except next day and less than 3 months and the over 3 months and
less than one year periods. Our experience indicates money market deposit rates
tend to lag changes in the prime rate which immediately impact the prime-based
loan portfolio. Even in the our negative gap time periods, rising rates tend to
result in an increase in net interest income. Should interest rates stabilize or
decline in future periods, it is reasonable to assume that our net interest
margin, as well as net interest income, may decline correspondingly.
Table 11 presents the contractual maturity distribution of investment
securities and the weighted average yields for each range of maturities. Yields
are presented on an actual basis.
24
TABLE 11 INVESTMENT MATURITY DISTRIBUTION
DECEMBER 31, 1998
WEIGHTED WEIGHTED WEIGHTED
CARRYING 1 YEAR OR AVERAGE 1 YEAR TO 5 AVERAGE 5 YEARS TO AVERAGE MORE THAN
VALUE LESS YIELD YEARS YIELD 10 YEARS YIELD 10 YEARS
---------- --------- ----------- ----------- --------- ----------- ----------- -----------
U.S. Treasury and Agency
Obligations............ $ 18,092 $ 11,385 5.20% $ 6,707 5.94%
Mortgage Backed
Securities............. 58,427 415 6.55% $ 1,752 7.57% $ 56,260
Obligations of State and
Municipal
Obligations............ 14,799 781 6.31% 3,630 5.02% 10,388
Corporate securities..... 14,139 14,139
Federal Home Loan Bank
Stock.................. 1,503 1,503
---------- --------- ----------- ----------- --------- ----------- --- -----------
$ 106,960 $ 11,800 $ 7,488 $ 5,382 $ 82,290
---------- --------- ----------- ----------- --------- ----------- --- -----------
---------- --------- ----------- ----------- --------- ----------- --- -----------
WEIGHTED
AVERAGE
YIELD
-----------
U.S. Treasury and Agency
Obligations............
Mortgage Backed
Securities............. 6.72%
Obligations of State and
Municipal
Obligations............ 5.06%
Corporate securities..... 7.10
Federal Home Loan Bank
Stock..................
---
---
---
Table 12 presents the time remaining until maturity for certificates of
deposits in denominations of $100,000 or more as of December 31, 1998.
TABLE 12 CERTIFICATES OF DEPOSIT
DENOMINATIONS OF $100,000 OR MORE
(IN THOUSANDS)
DECEMBER 31,
1998
------------
Time remaining until maturity:
Less than 3 months.............................................................. $ 38,106
3 months to 6 months............................................................ 7,074
6 months to 12 months........................................................... 5,692
More than 12 months............................................................. 1,380
------------
Total........................................................................... $ 52,252
------------
------------
Loan maturities for commercial and real estate construction loans at
December 31, 1998, are presented in Table 13.
TABLE 13 LOAN MATURITIES
AFTER ONE AFTER
WITHIN ONE BUT WITHIN FIVE
YEAR FIVE YEARS YEARS TOTAL
----------- ----------- --------- ---------
(DOLLARS IN THOUSANDS)
Commercial...................................... $ 21,388 $ 11,731 $ 5,755 $ 38,874
Real estate construction........................ 18,609 3,597 -- 22,206
----------- ----------- --------- ---------
Total....................................... $ 39,997 $ 15,328 $ 5,755 $ 61,080
----------- ----------- --------- ---------
----------- ----------- --------- ---------
25
Commercial loans at December 31, 1998 maturing after one year are comprised
of fixed rate and variable rate loans as shown below:
AFTER ONE AFTER
BUT WITHIN FIVE
FIVE YEARS YEARS TOTAL
----------- --------- ---------
(DOLLARS IN THOUSANDS)
Fixed rate................................................... $ 514 $ 427 $ 941
Variable rate................................................ 11,217 5,328 16,545
----------- --------- ---------
$ 11,731 $ 5,755 $ 17,486
----------- --------- ---------
----------- --------- ---------
CAPITAL RESOURCES
Management seeks to maintain adequate capital to support anticipated asset
growth and credit risks, and to ensure that we are in compliance with all
regulatory capital guidelines. Our primary source of new capital has been the
retention of earnings. Stockholders' equity was $30,197,000 at December 31, 1998
an increase of $2,433,000, or 8.8% from $27,764,000 at December 31, 1997. This
increase was due to 1998 earnings of $6,161,000 and proceeds related to stock
option exercises of $623,000, offset by cash distributions of $1,324,000, a
decrease in the net after-tax unrealized gain on securities available-for-sale
of $376,000, and the repurchase of common stock of $2,651,000. We do not have
any material commitments for capital expenditures as of December 31, 1998.
We pay a quarterly cash dividend on our common stock as part of efforts to
enhance stockholder value. Our goal is to maintain a strong capital position
that will permit payment of a consistent cash dividend which grows commensurate
with earnings growth.
During 1995, the Board of Directors approved a stock repurchase program
authorizing open market purchases of up to 150,348 of the outstanding shares, or
approximately 3%, in order to enhance long term stockholder value. The 1995
repurchase program was completed during 1996 with 150,348 shares purchased for a
total purchase price of $952,000. In January 1997, the directors approved a plan
to repurchase up to 3% of outstanding shares, or 145,837 shares, from time to
time in open market transactions. As of December 31, 1998, 145,500 shares had
been acquired for a total purchase price of $2,781,000.
We are subject to capital adequacy guidelines issued by the federal bank
regulatory authorities. Under these guidelines, the minimum total risk-based
capital requirement is 10.0% of risk-weighted assets and certain off-balance
sheet items for a "well capitalized" depository institution. At least 6.0% of
the 10.0% total risk-based capital ratio must consist of Tier 1 capital, defined
as tangible common equity, and the remainder may consist of subordinated debt,
cumulative preferred stock and a limited amount of the allowance for loan
losses.
The federal regulatory authorities have established minimum capital leverage
ratio guidelines for state member banks. The ratio is determined using Tier 1
capital divided by quarterly average total assets. The guidelines require a
minimum of 5.0% for a "well capitalized" depository institution.
Our risk-based capital ratios were in excess of regulatory guidelines for a
"well capitalized" depository institution as of December 31, 1998, 1997 and
1996. Table 14 summarizes our capital ratios:
26
TABLE 14 CAPITAL RATIOS
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Consolidated:
Total risk-based capital ratio............................ 15.4% 16.7% 16.4%
Tier 1 risk-based capital ratio........................... 14.2% 15.4% 15.2%
Tier 1 leverage ratio..................................... 9.5% 10.3% 9.8%
Coast Commercial Bank:
Total risk-based capital ratio............................ 14.8% 15.1% 15.0%
Tier 1 risk-based capital ratio........................... 13.6% 13.9% 13.8%
Tier 1 leverage ratio..................................... 9.3% 9.3% 8.7%
EFFECTS OF INFLATION
The impact of inflation on a financial institution differs significantly
from that exerted on manufacturing, or other commercial concerns, primarily
because its assets and liabilities are largely monetary. In general, inflation
primarily affects us indirectly through its effect of increasing market rates of
interest. However, our earnings are affected by the spread between the yield on
earning assets and rates paid on interest-bearing liabilities rather than the
absolute level of interest rates. Additionally, there may be some upward
pressure on our operating expenses, such as adjustments in salaries and benefits
and occupancy expense, based upon consumer price indices. In the opinion of
management, inflation has not had a material effect on the consolidated
financial statements for the years ended December 31, 1998, 1997 and 1996.
Changes in interest rates are highly sensitive to many factors which are beyond
the control of management. Changes in interest rates will influence the growth
of loans, investments and deposits, as well as the rates charged on loans and
paid on deposits. The nature, timing and impact of future changes in interest
rates or monetary and fiscal policies are not predictable.
YEAR 2000
The year 2000 problem exists because many computer systems use only the last
two digits to refer to a year. This convention could affect date-sensitive
calculations that treat "00" as the year 1900 rather than 2000. Another issue is
that the year 2000 is a leap year and some programs may not properly provide for
February 29, 2000.
This discussion of the implications of the year 2000 problem for us contains
numerous forward-looking statements on inherently uncertain information. The
cost of the project and the date on which we plan to complete the internal year
2000 modifications are based on management's best estimates, which were derived
utilizing a number of assumptions of future events including the continued
availability of internal and external resources, third party modifications and
other factors. We cannot guarantee, however, these estimates, and actual results
could differ. Moreover, although management believes it will be able to make the
necessary modifications in advance, there can be no guarantee that the failure
to modify the systems would not have a material adverse impact on us.
READINESS PREPARATION
Our plan to address the year 2000 issues includes a process of inventory,
analysis, modification, testing and certification, and implementation. In 1997
we alerted our business customers of the year 2000 problem and are now assessing
the readiness preparations of our major customers and suppliers. Reviews of our
information systems and information provided by our primary vendors, large
customers and suppliers have not identified any year 2000 readiness issues which
appear to be unresolvable by December 31, 1999.
27
Our major critical information system is our core transaction processing
software which provides transaction processing for loans, deposits and general
ledger. The vendor supplying our core transaction processing software has
provided evidence of year 2000 readiness. Efforts continue to ascertain the year
2000 readiness of various systems that integrate information into the core
processing software. To date, no significant information systems have been found
not ready for year 2000. Among the major actions remaining is the testing of the
core processing software and other systems which integrate into the core
processing software. Other purchased software and systems supported by external
parties are also being tested as part of the year 2000 program. In addition,
contingency plans are being developed to reduce the impact of potential events
that may occur. We cannot guarantee, however, the systems of vendors or
customers with which we conduct business will be completed on a timely basis, or
that contingency plans will shield operations from failures that may occur.
We do not significantly rely on embedded technology in our critical
processes. Embedded technology typically controls operations such as power
management and related facilities functions. Year 2000 risks associated with
embedded technology in our facilities appear low.
We rely on suppliers and customers, and we are addressing year 2000 issues
with both groups. We have identified vendors upon whom there is significant
reliance and made inquiries regarding year 2000 readiness plans and status.
Appropriate measures to minimize risk will be undertaken with those that appear
to pose a significant risk. Replacements may be effected where necessary. We
have, however, no viable alternative for some suppliers, such as power
distribution and local telephone companies. We are still evaluating these
companies, we will use the results as information for contingency planning. As
with all financial institutions, we place a high degree of reliance on the
systems of other institutions, including government agencies, to settle
transactions. Principal settlement methods associated with major payment systems
will be tested as part of their integration with the core processing system.
We also rely on our customers to make necessary preparations for year 2000
so that their business operations will not be interrupted, thus threatening
their ability to honor their financial commitments. Borrowers, funding sources
and large depositors are being reviewed to determine those with financial
volumes sufficiently large to warrant inquiry and assessment of the year 2000
readiness preparation. Financial volumes include loans and unused commitments,
collected deposit balances, ACH, foreign exchange, etc.
The population of customers with loans and unused commitments outstanding
("borrowers") pose the highest risk level of concern for any lender. Business
purpose borrowings exceeding $50,000 were assigned one of three year 2000 risk
levels: low, medium or high. Borrowers representing 3% and 28% of outstanding
loans were assigned high and medium year 2000 risk levels, respectively.
Ongoing reassessments with risk mitigation plans will be made for all levels
of risk. Customers with low and medium risk will be reassessed annually, while
customers with high risk will be reassessed at least quarterly. The risk
mitigation plan will evaluate whether year 2000 issues will materially affect
the customer's cash flows, asset account values related to its balance sheet,
and/or collateral pledged to us. The risk mitigation plan is incorporated into
the normal credit review process.
COST
Amounts expensed in the first nine months of 1998 were not significant to
our financial position or results of operations. Although the remaining costs
associated with achieving year 2000 compliance have not yet been determined,
management believes the amounts expensed during 1998 and 1999 will not have a
material effect on the our financial position, results of operations or cash
flows. In addition, we may also replace certain equipment and software to ensure
year 2000 readiness. The cost of the replacement items will be expensed over the
useful lives of those assets. During the third quarter of 1998 six existing
automated teller machines were replaced with new machines at a cost of
approximately $300,000 due in part to year 2000 issues with the existing
equipment. The cost of other identified replacement items and
28
contingency equipment is estimated at less than $100,000. Estimated total costs
could change as analysis continues.
RISKS
The principal risks associated with the year 2000 problem can be grouped
into three categories:
- we do not successfully ready our operations for the next century,
- disruption of our operations due to operational failures of third parties,
and
- business interruption among fund providers and obligors such that expected
funding and repayment does not take place.
The only risk largely under our control is preparing our internal operations
for the year 2000. We, like other financial institutions, are heavily dependent
on our computer systems. The complexity of these systems and their
interdependence make it impracticable to switch to alternative systems without
interruptions if necessary modifications are not completed on schedule.
Management believes it will be able to make the necessary modifications on
schedule.
Failure of third parties may jeopardize our operations, but the seriousness
of this risk depends on the nature and duration of the failures. The most
serious impact on our operations from suppliers would result if basic services
such as telecommunications, electric power suppliers and services provided by
other financial institutions and governmental agencies were disrupted. Some
public disclosure about readiness preparation among basic infrastructure and
other suppliers is now available. We are unable, however, to estimate the
likelihood of significant disruptions among our basic infrastructure suppliers.
In view of the unknown probability of occurrence and impact on operations, we
consider the loss of basic infrastructure services to be the most reasonably
likely worst case year 2000 scenario.
Operational failures among our customers could affect their ability to
continue to provide funding or meet obligations when due. The information we
develop in the customer assessments described earlier allows us to identify
those customers that exhibit a risk of not making the adequate preparations for
the century change. We are taking appropriate actions to manage these risks.
PROGRAM ASSESSMENT
Senior management and banking regulators regularly assess our year 2000
preparations. Additionally, a consulting and services firm has been retained to
review and advise senior management on internally developed testing plans for
critical systems.
CONTINGENCY PLANS
We are developing remediation contingency plans and business resumption
contingency plans specific to the year 2000. Remediation contingency plans
address the actions to be taken if the current approach to remediating a system
is falling behind schedule or otherwise appears in jeopardy of failing to
deliver a year 2000 ready system when needed. Business resumption contingency
plans address the actions that would be taken if critical business functions can
not be carried out in the normal manner upon entering the next century due to
system or supplier failure. Most contingent action plans prepared at this time
involve manual processing of transactions. Given the size, scope and complexity
of our operations, manual processing appears a viable alternative for most
information systems other than the core processing system.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under Item 7 of this Report under the Caption "Interest Rate
Sensitivity" is incorporated herein by reference.
29
Our profitability is dependent to a large extent upon our net interest
income, which is the difference between our interest income on earning assets,
such as loans and securities, and our interest expense on interest-bearing
liabilities, such as deposits and borrowings. We , like other financial
institutions, are subject to interest rate risk to the degree that our
interest-earning assets reprice differently than our interest-bearing
liabilities. We manage our mix of assets and liabilities with the goals of
limiting our exposure to interest rate risk, ensuring adequate liquidity, and
coordinating our sources and uses of funds. Specific strategies have included
increasing the volume of fixed rate securities funded in part by borrowings such
as repurchase agreements.
We seek to control our interest rate risk exposure in a manner that will
allow for adequate levels of earnings and capital over a range of possible
interest rate environments. We have adopted formal policies and practices
monitor and manage interest rate risk exposure. As part of this effort, we use
the market value of portfolio equity (MVPE) methodology to gauge interest rate
risk exposure.
Generally, MVPE is the discounted present value of the difference between
incoming cash flows on interest-earning assets and other assets and outgoing
cash flows on interest-bearing liabilities and other liabilities. The
application of the methodology attempts to quantify interest rate risk as the
change in MVPE which would result from a theoretical 200 basis point (1 basis
point equals .01%) change in market interest rates. Both 200 basis point
increases and decreases in market rates are considered.
The following table, as of December 31, 1998 and 1997, is an analysis of our
interest rate risk as measured by changes in MVPE for instantaneous and
sustained parallel shifts of 200 basis points in market interest rates.
ESTIMATED CHANGE IN MVPE
------------------------------------------------------
1998 1997
-------------------------- --------------------------
BASIS POINT (BP) CHANGE IN RATES AMOUNT % AMOUNT %
- -------------------------------------------- ------------- ----------- ------------- -----------
+ 200....................................... $ 2,453,000 6.1 $ 1,972,000 5.4
0........................................... -- 0 -- 00
- - 200....................................... $ (7,208,000) (17.8) $ (5,306,000) (14.6)
The above table illustrates, for example, that an instantaneous 200 basis
point decrease in market interest rates at December 31, 1998 would reduce our
MVPE by approximately $7.2 million at that date.
Management believes the MVPE methodology overcomes three shortcomings of the
typical maturity gap methodology. First, it does not use arbitrary repricing
intervals and accounts for all expected future cash flows; weighting each by its
appropriate discount factor. Second, because the MVPE method projects cash flows
of each financial instrument under different interest-rate environments, it can
incorporate the effect of embedded options on an institution's interest rate
risk exposure. Third, it allows interest rates on different instruments to
change by varying amounts in response to a change in market interest rates,
resulting in more accurate estimates of cash flows.
However, as with any method of gauging interest rate risk, there are certain
shortcomings inherent to the MVPE methodology. The model assumes interest rate
changes are instantaneous parallel shifts in the yield curve. In reality, rate
changes are rarely instantaneous. The use of the simplifying assumption that
short-term and long-term rates change by the same degree may also misstate
historic rate patterns, which rarely show parallel yield curve shifts. Further,
the model assumes that certain assets and liabilities of similar maturity or
period to repricing will react the same to changes in rates. In reality, certain
types of financial instruments may react in advance of changes in market rates,
while the reaction of other types of financial instruments may lag behind the
change in general market rates. Additionally, the MVPE methodology may not
reflect the full impact of annual and life time restrictions on changes in rates
for certain assets, such as adjustable-rate mortgages. When interests rates
change, actual loan prepayments and actual early withdrawals from certificates
of deposit may deviate significantly from assumptions used in the model.
Finally, this methodology does not measure or reflect the impact that higher
rates may have on variable or adjustable-rate loan customers' ability to service
their debt. All of these factors are to be considered in monitoring the our
exposure to interest rate risk.
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our audited consolidated financial statements as of December 31, 1998 and
1997 and for the years then ended appear on pages 31 thru 51.
COAST BANCORP
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------------
1998 1997
-------------- --------------
ASSETS
Cash and due from banks.......................................................... $ 23,084,000 $ 15,853,000
Federal funds sold............................................................... 29,000,000 15,000,000
-------------- --------------
Total cash and equivalents................................................... 52,084,000 30,853,000
Securities:
Available-for-sale, at fair value.............................................. 106,960,000 80,466,000
Loans:
Commercial..................................................................... 38,874,000 42,838,000
Real estate-term............................................................... 95,360,000 76,101,000
Real estate-construction....................................................... 22,206,000 21,376,000
Installment and other.......................................................... 4,536,000 6,112,000
-------------- --------------
Total loans.................................................................. 160,976,000 146,427,000
Unearned income................................................................ (3,272,000) (2,349,000)
Allowance for credit losses.................................................... (3,871,000) (3,609,000)
-------------- --------------
Net loans........................................................................ 153,833,000 140,469,000
Bank premises and equipment-net.................................................. 2,408,000 2,045,000
Other real estate owned.......................................................... -- 112,000
Accrued interest receivable and other assets..................................... 9,463,000 7,560,000
-------------- --------------
TOTAL ASSETS................................................................. $ 324,748,000 $ 261,505,000
-------------- --------------
-------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand..................................................... $ 75,978,000 $ 66,812,000
Interest-bearing demand........................................................ 100,707,000 76,123,000
Savings........................................................................ 51,873,000 23,942,000
Time........................................................................... 52,252,000 34,320,000
-------------- --------------
Total deposits............................................................... 280,810,000 201,197,000
Other borrowings................................................................. 10,416,000 30,070,000
Accrued expenses and other liabilities........................................... 3,325,000 2,474,000
-------------- --------------
Total liabilities............................................................ 294,551,000 233,741,000
Commitments and contingencies
STOCKHOLDERS' EQUITY:
Preferred stock--no par value; 10,000,000 shares authorized; no shares issued.... -- --
Common stock--no par value; 20,000,000 shares authorized; shares outstanding:
4,768,678 in 1998 and 4,848,050 in 1997........................................ 20,689,000 11,011,000
Accumulated other comprehensive income........................................... 317,000 693,000
Retained earnings................................................................ 9,191,000 16,060,000
-------------- --------------
Total stockholders' equity..................................................... 30,197,000 27,764,000
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................... $ 324,748,000 $ 261,505,000
-------------- --------------
-------------- --------------
See notes to consolidated financial statements
31
COAST BANCORP
CONSOLIDATED INCOME STATEMENTS
YEARS ENDED DECEMBER 31,
-------------------------------------------
1998 1997 1996
------------- ------------- -------------
Interest income:
Loans, including fees............................................. $ 16,891,000 $ 14,383,000 $ 12,845,000
Securities:
Taxable......................................................... 5,140,000 4,721,000 4,235,000
Nontaxable...................................................... 708,000 331,000 336,000
Federal funds sold................................................ 1,388,000 1,244,000 832,000
------------- ------------- -------------
Total interest income............................................... 24,127,000 20,679,000 18,248,000
Interest expense:
Deposits.......................................................... 5,589,000 4,172,000 3,435,000
Other borrowings.................................................. 1,174,000 1,455,000 1,378,000
------------- ------------- -------------
Total interest expense.............................................. 6,763,000 5,627,000 4,813,000
------------- ------------- -------------
Net interest income................................................. 17,364,000 15,052,000 13,435,000
Provision for credit losses......................................... 300,000 450,000 900,000
------------- ------------- -------------
Net interest income after provision for credit losses............... 17,064,000 14,602,000 12,535,000
Noninterest income:
Customer service fees............................................. 1,840,000 1,998,000 1,808,000
Gain from sale of loans........................................... 2,365,000 1,404,000 1,420,000
Loan servicing fees............................................... 839,000 1,038,000 958,000
Gains (losses) from sale of securities............................ 21,000 (10,000) 114,000
Gain on sale of other real estate owned........................... 6,000 -- 39,000
Other............................................................. 789,000 630,000 559,000
------------- ------------- -------------
Total noninterest income............................................ 5,860,000 5,060,000 4,898,000
Noninterest expenses:
Salaries and benefits............................................. 6,507,000 5,692,000 5,249,000
Occupancy......................................................... 1,183,000 980,000 929,000
Equipment......................................................... 1,118,000 1,120,000 1,146,000
Customer services................................................. 698,000 462,000 443,000
Advertising and promotion......................................... 689,000 629,000 571,000
Stationery and postage............................................ 413,000 362,000 382,000
Professional services............................................. 363,000 414,000 383,000
Data processing................................................... 321,000 319,000 283,000
Insurance......................................................... 212,000 202,000 145,000
Other............................................................. 851,000 826,000 1,008,000
------------- ------------- -------------
Total noninterest expenses.......................................... 12,355,000 11,006,000 10,539,000
------------- ------------- -------------
Income before income taxes.......................................... 10,569,000 8,656,000 6,894,000
Provision for income taxes.......................................... 4,408,000 3,501,000 2,766,000
------------- ------------- -------------
Net income.......................................................... $ 6,161,000 $ 5,155,000 $ 4,128,000
------------- ------------- -------------
------------- ------------- -------------
Earnings per share:
Basic............................................................... $ 1.28 $ 1.06 $ 0.85
------------- ------------- -------------
------------- ------------- -------------
Diluted............................................................. $ 1.25 $ 1.05 $ 0.84
------------- ------------- -------------
------------- ------------- -------------
See notes to consolidated financial statements
32
COAST BANCORP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
ACCUMULATED
COMMON STOCK OTHER TOTAL
--------------------- COMPREHENSIVE COMPREHENSIVE RETAINED STOCKHOLDERS'
SHARES AMOUNT INCOME INCOME EARNINGS EQUITY
--------- ---------- -------------- -------------- ---------- ------------
Balances, January 1, 1996.............. 4,515,798 $11,282,000 -- $ 472,000 $9,230,000 $20,984,000
Cash dividends paid.................... (887,000) (887,000)
Net decrease in value of
available-for-sale securities, net of
tax of $243,000...................... $ (342,000) (342,000) (342,000)
Repurchase of common stock............. (96,480) (241,000) (449,000) (690,000)
Net income............................. 4,128,000 4,128,000 4,128,000
--------- ---------- -------------- -------------- ---------- ------------
Balances, December 31, 1996............ 4,419,318 11,041,000 $3,786,000 130,000 12,022,000 23,193,000
--------- ---------- -------------- -------------- ---------- ------------
Cash dividends paid.................... (1,017,000) (1,017,000)
Net increase in value of
available-for-sale securites, net of
tax of $400,000...................... $ 563,000 563,000 563,000
Repurchase of common stock............. (12,000) (30,000) (100,000) (130,000)
Net income............................. 5,155,000 5,155,000 5,155,000
--------- ---------- -------------- -------------- ---------- ------------
Balances, December 31, 1997............ 4,407,318 11,011,000 $5,718,000 693,000 16,060,000 27,764,000
10% stock dividend..................... 437,540 9,516,000 (9,516,000) --
Cash paid in-lieu of fractional
shares............................... (7,000) (7,000)
Cash dividends paid.................... (1,317,000) (1,317,00)
Net decrease in value of
available-for-sale securities, net of
tax of $272,000...................... $ (376,000) (376,000) (376,000)
Exercise of stock options.............. 52,520 338,000 338,000
Income tax effect from stock options
exercised............................ 285,000 285,000
Repurchase of common stock............. (128,700) (461,000) (2,190,000) (2,651,000)
Net income............................. 6,161,000 6,161,000 6,161,000
--------- ---------- -------------- -------------- ---------- ------------
Balances December 31, 1998............. 4,768,678 $20,689,000 $5,785,000 $ 317,000 $9,191,000 $30,197,000
--------- ---------- -------------- -------------- ---------- ------------
--------- ---------- -------------- -------------- ---------- ------------
See notes to consolidated financial statements
33
COAST BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
----------------------------------------------
1998 1997 1996
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income....................................................... $ 6,161,000 $ 5,155,000 $ 4,128,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for credit losses.................................... 300,000 450,000 900,000
Depreciation and amortization.................................. (179,000) (39,000) (83,000)
Gain on sale of bank premises and equipment.................... -- -- (53,000)
(Gains) losses on securities transactions...................... (21,000) 10,000 (114,000)
Deferred income taxes.......................................... 43,000 (257,000) (785,000)
Proceeds from loan sales....................................... 82,869,000 48,255,000 38,497,000
Origination of loans held for sale............................. (84,432,000) (52,827,000) (41,925,000)
Accrued interest receivable and other assets................... (1,946,000) (1,040,000) (236,000)
Accrued expenses and other liabilities......................... 851,000 (1,173,000) 1,009,000
Increase in unearned income.................................... 2,025,000 1,783,000 1,131,000
Other operating activities..................................... 158,000 (225,000) --
-------------- -------------- --------------
Net cash provided by operating activities........................ 5,829,000 92,000 2,469,000
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available-for-sale............. 27,927,000 5,552,000 13,572,000
Proceeds from maturities of securities........................... 21,574,000 15,291,000 17,047,000
Purchases of securities available-for-sale....................... (77,006,000) (29,236,000) (31,733,000)
Net increase in loans............................................ (13,293,000) (18,133,000) (14,259,000)
Purchases of bank premises and equipment......................... (921,000) (750,000) (430,000)
Proceeds from disposal of bank premises and equipment............ -- -- 14,000
Proceeds from sale of other real estate owned.................... 514,000 -- 904,000
-------------- -------------- --------------
Net cash used in investing activities............................ (41,205,000) (27,276,000) (14,885,000)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits......................................... 79,613,000 15,730,000 21,421,000
Net proceeds from other borrowings............................... (19,654,000) 5,462,000 4,608,000
Payment of cash dividends........................................ (1,317,000) (1,017,000) (887,000)
Payment of cash in-lieu of fractional shares..................... (7,000) -- --
Exercise of stock options........................................ 623,000 -- --
Repurchase of common stock (2,651,000) (130,000) (690,000)
-------------- -------------- --------------
Net cash provided by financing activities........................ 56,607,000 20,045,000 24,452,000
-------------- -------------- --------------
Net increase (decrease) in cash and equivalents.................. 21,231,000 (7,139,000) 12,036,000
Cash and equivalents, beginning of year.......................... 30,853,000 37,992,000 25,956,000
-------------- -------------- --------------
Cash and equivalents, end of year................................ $ 52,084,000 $ 30,853,000 $ 37,992,000
-------------- -------------- --------------
-------------- -------------- --------------
SUPPLEMENTAL CASH FLOW INFORMATION CASH PAID DURING THE YEAR FOR:
Interest......................................................... $ 6,593,000 $ 5,362,000 $ 5,683,000
Income taxes..................................................... $ 4,334,000 3,675,000 3,867,000
NON-CASH INVESTING AND FINANCING TRANSACTIONS:
Additions to other real estate owned............................. $ -- $ -- $ 586,000
See notes to consolidated financial statements
34
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION--In May 1995, the stockholders of Coast Commercial Bank (the
Bank) approved a plan which provided for the formation of Coast Bancorp (a bank
holding company) (the Company) and the conversion of each share of outstanding
Bank common stock into one share of Company common stock. Effective July 25,
1995 the Company issued 4,555,998 shares of its common stock for all the
outstanding shares of the Bank through a merger which has been accounted for
similar to a pooling of interests in that the historical cost basis of the Bank
has been carried forward. As a result of the merger, the Bank became a
wholly-owned subsidiary of the Company.
On January 20, 1999, the Company's board of directors approved the
declaration of a 2-for-1 stock split effective for shareholders of record
February 5, 1999. Accordingly, all historical financial information has been
restated as if the stock split had been in effect for all periods presented.
NATURE OF OPERATIONS--The Company and its subsidiary, Coast Commercial Bank,
operate 6 branches in Santa Cruz County, California. The Company's primary
source of revenue is loans to customers, who are predominately small and
middle-market businesses, professionals and middle-income individuals in Santa
Cruz County. Banking products and services offered include commercial and
consumer banking services such as commercial, construction, real estate, SBA
guaranteed, personal, home equity and other consumer loans as well as checking
and savings accounts, time deposits, overdraft protection, credit and debit
cards, merchant credit card processing, safe deposit boxes and related services.
BASIS OF PRESENTATION--The accounting and reporting policies of the Company
and the Bank conform to generally accepted accounting principles and to
prevailing practices within the banking industry. The methods of applying those
principles which materially affect the consolidated financial statements are
summarized below. In preparing financial statements in conformity with generally
accepted accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities, as of the dates of the balance
sheets, and revenues and expenses for the periods indicated. The allowance for
credit losses is a material estimate. Actual results could differ from those
estimates.
CONSOLIDATION--The consolidated financial statements include the accounts of
the Company and the Bank. All material intercompany accounts and transactions
have been eliminated.
CASH AND EQUIVALENTS--For purposes of reporting cash flows, cash and
equivalents include cash on hand, amounts due from banks and federal funds sold.
Generally, federal funds are sold for one-day periods.
SECURITIES--At the time of purchase, investments in debt and equity
securities are classified as held-to-maturity and measured at amortized cost
only if the Company has the positive intent and ability to hold such securities
to maturity. All other investments in debt and equity securities are classified
as available-for-sale, which are carried at market value with a corresponding
recognition of the unrealized holding gain or loss, net of income taxes, as a
net amount within accumulated other comprehensive income, which is a separate
component of stockholders' equity, until realized.
Amortization of premiums and accretion of discounts arising at acquisition
of securities are included in income using methods that approximate the interest
method. Market values are based on quoted market
35
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
prices or dealer quotes. Gains or losses on the sale of securities are computed
using the specific identification method.
LOANS--Loans are stated at principal amount outstanding. Loans held for sale
are carried at the lower of cost or market. Interest on loans is credited to
income as earned.
The accrual of interest is discontinued and any accrued and unpaid interest
is reversed when the payment of principal or interest is 90 days past due unless
the amount is well secured and in the process of collection. Income on
nonaccrual loans is then recognized only to the extent that cash is received and
where the future collection of principal is probable.
The Bank measures impaired loans based upon the present value of expected
future cash flows discounted at the loan's effective interest rate, except that
as a practical expedient, an impairment may be measured based on a loan's
observable market price or the fair value of the collateral if the loan is
collateral dependent. A loan is impaired when, based upon current information
and events, it is probable that the Bank will be unable to collect all amounts
due according to the contractual terms of the loan agreement.
Loan origination fees and costs are deferred and amortized to income by a
method approximating the effective interest method over the estimated lives of
the underlying loans. Fees received by the Company relating to mortgage loans
held for sale are recognized when the loans are sold.
The Company originates loans that are guaranteed in part by the Small
Business Administration (SBA). The guaranteed portion of such loans can be sold
without recourse. The Company retains the servicing for the portion sold and has
credit risk for the remaining unguaranteed portion. Gains or losses realized on
loans sold are determined by allocating the recorded investment between the
portion of the loan sold and the portion retained based on an estimate of the
relative fair values of those portions as of the date the loan is sold.
The Company also originates and sells residential mortgage loans to the
Federal Home Loan Mortgage Corporation (FHLMC) and other participants in the
mortgage markets.
ALLOWANCE FOR CREDIT LOSSES--The Company maintains an allowance for credit
losses to absorb losses inherent in existing loans and commitments to extend
credit. The allowance is based on quarterly evaluations of collectibility and
prior loan loss experience. The evaluations take into consideration factors such
as specific problem graded loans, impaired loans, and current and anticipated
local economic conditions that may affect the borrowers' ability to pay. The
allowance is increased by a provision for credit losses, which is charged to
current period operating results, and decreased by the amount of chargeoffs, net
of recoveries. Loans are charged against the allowance when management believes
that the collectibility of the principal is unlikely
The allowance also incorporates the results of measuring impaired loans. A
loan is considered impaired when management determines that it is probable the
borrower will not be able to pay all amounts due according to the original
contractual terms of the loan agreement. Impairment is measured by the
difference between the recorded investment in the loan (including accrued
interest, net deferred loan fees or costs and unamortized premium or discount)
and the estimated present value of total expected future cash flows, discounted
at the loan's effective rate, or the fair value of the collateral, if the loan
is collateral
36
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
dependent. Impairment is recognized by adjusting an allocation of the the
existing allowance for credit losses.
In evaluating the probability of collection, management is required to make
estimates and assumptions that affect the reported amounts of loans, allowance
for credit losses and the provision for credit losses charged to operations.
Actual results could differ significantly from those estimates.
BANK PREMISES AND EQUIPMENT--Bank premises and equipment are stated at cost
less accumulated depreciation and amortization. Depreciation and amortization
are computed on a straight-line basis over the estimated useful lives of three
to twenty years. The Company evaluates the recoverability of long-lived assets
on an ongoing basis.
OTHER REAL ESTATE OWNED--Other real estate owned consists of property
acquired as a result of a foreclosure proceeding or through receipt of a
deed-in-lieu of foreclosure. Other real estate owned is carried at the lower of
cost or fair value less estimated costs to sell. Any excess of the loan balance
over the fair value when the property is acquired is charged to the allowance
for credit losses. Subsequent declines in fair value, if any, and disposition
gains and losses are included in noninterest income and noninterest expenses.
ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS--Accrued interest receivable
and other assets includes the cash surrender value of single premium insurance
policies of $1,852,000 and $2,459,000 at December 31, 1998 and 1997,
respectively.
ACCOUNTING FOR FINANCIAL ASSETS AND LIABILITIES--In June, 1996, the
Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities" which is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996. In December 1996, the FASB issued SFAS No.
127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No.
125" to defer for one year the effective date of implementation for transactions
related to repurchase agreements, dollar-roll repurchase agreements, securities
lending and other similar transactions. The Company adopted the applicable
provisions of SFAS No. 125 effective January 1, 1997 and SFAS No. 127 on January
1, 1998. The adoption of SFAS No. 125 and SFAS No. 127 did not have a
significant impact on the financial condition and results of operations of the
Company.
INCOME TAXES--Income taxes are provided at current rates. Deferred income
taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and amounts
used for income tax purposes.
STOCK-BASED COMPENSATION--The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to
Employees." Under the intrinsic value method, compensation cost is measured as
the amount by which the quoted market value of the Company's stock at the date
of grant exceeds the stock option exercise price.
NET INCOME PER SHARE--Basic net income per share is computed by dividing net
income by the number of weighted average common shares outstanding. Diluted net
income per share reflects potential dilution
37
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
from outstanding stock options, using the treasury stock method. The number of
weighted average shares used in computing basic and diluted net income per share
are as follows:
YEARS ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
Basic.................................................. 4,803,016 4,852,758 4,880,562
Dilutive effect of stock options, using the treasury
stock method......................................... 133,176 78,634 38,933
---------- ---------- ----------
Diluted................................................ 4,936,192 4,931,392 4,919,495
---------- ---------- ----------
---------- ---------- ----------
COMPREHENSIVE INCOME--The Company has retroactively adopted SFAS No. 130,
"Reporting Comprehensive Income", which requires that an enterprise report and
display, by major components and as a single total, the change in its net assets
during the period fron non-owner sources. The adoption of this statement
resulted in a change in the financial statement presentation, but did not have
an impact on the Company's consolidated financial position, results of
operations or cash flows.
SEGMENT REPORTING--In 1998, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." Adoption of this
statement did not have an impact our consolidated financial position, results of
operations or cash flows, and any effect was limited to the form and content of
our disclosures. See Note 16.
EMPLOYEE BENEFIT AND INCENTIVE PLANS--The Company provides a variety of
benefit and incentive compensation plans for eligible employees. Provisions for
the costs of these employee benefit and incentive plans are accrued and charged
to expense when the benefit is earned. During 1998 the Company adopted SFAS No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits".
Adoption of SFAS No. 132 does not impact the consolidated financial position,
results of operations, or cash flows, and any effect is limited to the form and
content of its disclosures.
RECLASSIFICATIONS--Certain amounts in the 1997 and 1996 financial statements
have been reclassified to conform to the 1998 presentation. These
reclassifications had no impact on stockholders' equity or net income.
NEW ACCOUNTING PRONOUNCEMENTS--In June 1998, the FASB issued No. 133,
"Accounting for Derivative Instruments and Hedging Activities". The Statement
will require the Company to recognize all derivatives on the balance sheet at
fair value. SFAS No. 133 requires that derivative instruments used to hedge be
identified specifically to assets, liabilities, firm commitments or anticipated
transactions and measured as effective and ineffective when hedging changes in
fair value or cash flows. Derivative instruments that do not qualify as either a
fair value or cash flow hedge will be valued at fair value with the resultant
gain or loss recognized in current earnings. Changes in the effective portion of
fair value hedges will be recognized in current earnings along with the change
in fair value of the hedged item. Changes in the effective portion of cash flow
hedges will be recognized in other comprehensive income until realization of the
cash flows of the hedged item through current earnings. Any ineffective portion
of hedges will be recognized in current earnings. The Company has no derivative
instruments outstanding as of December 31, 1998 and management believes adoption
of this Statement will not have a material impact on the Company's financial
38
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
position or results of operations. At the date of adoption, the impact on the
Company's financial position and results of operation will depend upon the
accumulated net gain or loss, if any, of the effective portion of cash flow
hedges and the ineffective portion of cash flow or any other hedges. The
statement is effective for fiscal years beginning after June 15, 1999, with
earlier application encouraged.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise." This Statement amends SFAS No.
65, "Accounting for Certain Mortgage Banking Activities," which established
accounting and reporting standards for certain activities of mortage banking and
other similar enterprises. After securitization of mortgage loans held for sale,
SFAS No. 134 requires an entity to classify the resulting mortgage-backed
securities or other retained interests based on its ability or intent to sell or
hold those investments. Management believes the adoption of SFAS No. 134 will
have no impact on our financial position or results of operations. This
Statement is effective for fiscal years beginning after December 15, 1998,
earlier application permitted.
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use". Sop 98-1 requires the
capitalization of eligle costs of specified activities related to computer
software developed or obtained for internal use. Management believes that the
adoption of SOP 98-1 will not have a material effect on the Company's financial
position or results of operations. The statement is effective for fiscal years
beginning after December 15, 1998, with earlier application encouraged. The
Company will adopt SOP 98-1 as of January 1, 1999.
In June 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities". SOP 98-5 requires that entities expense start-up costs and
organization costs as they are incurred. Management believes that the adoption
of SOP 98-5 will not have a material effect on the Company's financial position
or results of operations. The statement is effective for fiscal years beginning
after December 15, 1998, with earlier application encouraged. The Company will
adopt SOP 98-5 as of January 1, 1999.
2. RESTRICTED CASH BALANCES
The Company, through its bank subsidiary, is required to maintain reserves
with the Federal Reserve Bank of San Francisco. Reserve requirements are based
on a percentage of certain deposits. At December 31, 1998 the Company maintained
reserves of $1,676,000 in the form of vault cash and balances at the Federal
Reserve which satisfied the regulatory requirements.
39
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
3. SECURITIES
The amortized cost and estimated fair values of securities at December 31,
are as follows:
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAIN LOSS VALUE
-------------- ------------ -------------- --------------
DECEMBER 31, 1998
Available-for-sale:
U.S. Treasury and agency securities... $ 18,092,000 27,000 (27,000) 18,092,000
Mortgage-backed securities............ 57,781,000 712,000 (66,000) 58,427,000
State and municipal obligations....... 14,457,000 342,000 -- 14,799,000
Corporate debt securities............. 14,606,000 50,000 (517,000) 14,139,000
Federal Home Loan Bank capital stock.... 1,503,000 -- -- 1,503,000
-------------- ------------ -------------- --------------
Total................................... $ 106,439,000 $ 1,131,000 $ (610,000) $ 106,960,000
-------------- ------------ -------------- --------------
-------------- ------------ -------------- --------------
DECEMBER 31, 1997
Available-for-sale:
U.S. Treasury and agency securities... $ 8,098,000 $ 38,000 $ -- $ 8,136,000
Mortgage-backed securities............ 62,918,000 1,026,000 (44,000) 63,900,000
State and municipal obligations....... 6,916,000 166,000 -- $ 7,082,000
Federal Home Loan Bank capital stock.... 1,348,000 -- -- 1,348,000
-------------- ------------ -------------- --------------
Total................................... $ 79,280,000 $ 1,230,000 $ (44,000) $ 80,466,000
-------------- ------------ -------------- --------------
-------------- ------------ -------------- --------------
The amortized cost and estimated fair value of debt securities at December
31, 1998, by contractual maturity, are presented below. Mortgate-backed
securities generally have stated maturities from 5 to 30 years, but are subject
to substantial prepayments which effectively accelerate maturities.
AVAILABLE-FOR-SALE
------------------------------
AMORTIZED ESTIMATED
COST MARKET VALUE
-------------- --------------
DECEMBER 31, 1998
U.S. Treasury and agency, state and municipal and corporate securities:
Due within one year.................................................... $ 11,392,000 $ 11,385,000
Due after 1 year through 5 years....................................... 7,445,000 7,488,000
Due after 5 years through 10 years..................................... 3,502,000 3,630,000
Due after 10 years..................................................... 24,815,000 24,527,000
-------------- --------------
47,154,000 47,030,000
Mortgage-backed securities............................................. 57,781,000 58,427,000
-------------- --------------
Total.................................................................. $ 104,935,000 $ 105,457,000
-------------- --------------
-------------- --------------
40
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
3. SECURITIES (CONTINUED)
Gross realized gains and gross realized losses from sales of securities
available-for-sale were $73,000 and $52,000 in 1998, respectively, $43,000 and
$53,000 in 1997, respectively, $283,000 and $169,000 in 1996, respectively.
Effective December 31, 1997, state and municipal obligations with an
amortized cost of $5,744,000 and an unrealized gain of $166,000 were
reclassified from held-to-maturity to available-for-sale consistent with the
Company's decision to include all state and municipal obligations in its
interest rate risk management activities.
At December 31, 1998, investment securities with a carrying value of
$52,826,000 were pledged to collateralize public deposits and for other purposes
as required by law or contract.
4. LOANS AND ALLOWANCE FOR CREDIT LOSSES
Sales of SBA loans totaled $25,601,000 $13,431,000, and $15,472,000 in 1998,
1997, and 1996, respectively. SBA loans serviced for other investors were
$89,114,000 and $82,169,000 at December 31, 1998 and 1997, respectively. Sales
of residential mortgage loans totaled $57,268,000, $34,824,000, and $23,025,000
in 1998, 1997, and 1996, respectively. Residential mortgage loans serviced for
other investors were $38,078,000 and $45,912,000 at December 31, 1998 and 1997,
respectively.
At December 31, 1998, SBA loans held for sale were $6,349,000 (1997,
$9,895,000). Mortgage loans held by the Company pending completion of their sale
to the FHLMC or other investors were $9,242,000 and $2,470,000 at December 31,
1998 and 1997, respectively. The Company does not anticipate any loss on the
sale of these loans. Loans held for or pending completion of sale are included
in loans in the consolidated balance sheets and are carried at cost, which is
lower than market value.
Changes in the allowance for credit losses are as follows:
YEARS ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
Balance, beginning of year.......................... $ 3,609,000 $ 3,158,000 $ 2,478,000
Provision charged to expense........................ 300,000 450,000 900,000
Loans charged off................................... (113,000) (165,000) (352,000)
Recoveries.......................................... 75,000 166,000 132,000
------------ ------------ ------------
Balance, end of year................................ $ 3,871,000 $ 3,609,000 $ 3,158,000
------------ ------------ ------------
------------ ------------ ------------
Nonaccrual loans were $1,108,000, $266,000, and $159,000 at December 31,
1998, 1997, and 1996, respectively.
There were no impaired loans at December 31, 1998, 1997 and 1996. The
average recorded investment in impaired loans was $273,000 and $369,000 for 1996
and 1995, respectively. No interest income was recognized during the period of
impairment.
41
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
5. BANK PREMISES AND EQUIPMENT
Bank premises and equipment at December 31 are comprised of the following:
1998 1997
----------- ------------
Buildings and leasehold improvements.............................. 2,485,000 $ 2,328,000
Furniture and equipment........................................... 6,072,000 5,445,000
----------- ------------
Total............................................................. 8,557,000 7,773,000
Accumulated depreciation and amortization......................... (6,149,000) (5,728,000)
----------- ------------
Bank premises and equipment-net................................... 2,408,000 $ 2,045,000
----------- ------------
----------- ------------
Certain of the Company's premises are leased under various noncancelable
operating leases expiring in 2002 which have, in certain instances, renewal
options. Future minimum lease payments are as follows:
1999............................................................ $ 672,000
2000............................................................ 567,000
2001............................................................ 342,000
2002............................................................ 98,000
2003............................................................ 19,000
---------
Total........................................................... $1,698,000
---------
---------
Rent expense under operating leases was $787,000, $652,000 and $637,000 in
1998, 1997 and 1996, respectively.
6. INCOME TAXES
The provision for income taxes consists of the following:
YEARS ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
Current:
Federal........................................... $ 3,271,000 $ 2,832,000 $ 2,609,000
State............................................. 1,094,000 926,000 942,000
------------ ------------ ------------
Total current................................... 4,365,000 3,758,000 3,551,000
------------ ------------ ------------
Deferred:
Federal........................................... 41,000 (228,000) (601,000)
State............................................. 2,000 (29,000) (184,000)
------------ ------------ ------------
Total deferred.................................. 43,000 (257,000) (785,000)
------------ ------------ ------------
Total........................................... $ 4,408,000 $ 3,501,000 $ 2,766,000
------------ ------------ ------------
------------ ------------ ------------
42
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
6. INCOME TAXES (CONTINUED)
The effective tax rate differs from the federal statutory rate as follows:
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Statutory federal income tax rate....... 35.0% 35.0% 35.0%
State income taxes, net of federal tax
effect................................ 6.8 6.8 7.2
Tax exempt income....................... (2.0) (1.2) (1.5)
Other-net............................... 1.9 (0.2) (0.6)
--------- --------- ---------
Total............................... 41.7% 40.4% 40.1%
--------- --------- ---------
--------- --------- ---------
The Company's net deferred tax assets at December 31, are comprised of the
following:
1998 1997
------------ ------------
Deferred tax assets:
Provision for credit losses..................................... $ 1,538,000 $ 1,405,000
Deferred compensation........................................... 529,000 398,000
Accelerated depreciation........................................ 402,000 427,000
State income tax................................................ 191,000 183,000
Mark-to-market adjustment....................................... 90,000 197,000
Provision for other real estate owned........................... -- 29,000
Other........................................................... 8,000 34,000
------------ ------------
Total deferred tax assets..................................... 2,758,000 2,673,000
Deferred tax liabilities:
Real estate investment.......................................... (269,000) (228,000)
Unrealized gains on securities available-for sale............... (222,000) (493,000)
FHLB dividends.................................................. (87,000) --
------------ ------------
Total deferred tax liabilities................................ (578,000) (721,000)
------------ ------------
Net deferred tax assets....................................... $ 2,180,000 $ 1,952,000
------------ ------------
------------ ------------
There was no valuation allowance at December 31, 1998 and 1997.
7. DEPOSITS
The aggregate amount of time deposits each with a minimum denomination of
$100,000 or more was $36,199,000 and $18,172,000 at December 31, 1998 and 1997,
respectively. Included in time deposits at December 31, 1998 is a $15,000,000
deposit of public funds due within three months. Securities were delivered to a
safekeeping agent to collateralize the deposit (See Note 3).
43
COAST BANCOROP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
7. DEPOSITS (CONTINUED)
At December 31, 1998, the scheduled maturities of time deposits are as
follows:
1999........................................................... $50,872,000
2000........................................................... 1,129,000
2001........................................................... 251,000
----------
$52,252,000
----------
----------
8. OTHER BORROWINGS
Other borrowings consist of the following:
1998 1997
------------- -------------
Advances from the Federal Home Loan Bank of San Francisco...... $ 10,000,000 $ --
Securities sold under agreements to repurchase................. -- 28,570,000
Treasury, tax and loan note.................................... 416,000 1,500,000
------------- -------------
$ 10,416,000 $ 30,070,000
------------- -------------
------------- -------------
Information concerning securities sold under agreements to repurchase is
summarized as follows:
1998 1997
------------- -------------
Average balance during the year................................ $ 11,975,000 $ 25,716,000
Average interest rate during the year.......................... 5.7% 5.4%
Maximum month-end balance during the year...................... $ 22,800,000 $ 28,879,000
Average rate at December 31.................................... -- 5.7%
During 1998 the Bank obtained $10,000,000 in advances from the FHLB payable
at maturity in 5 years. The advances are callable by the FHLB beginning in
February 1999 and bear interest at 4.99%. The securities sold under agreements
to repurchase at December 31, 1997 matured within three months.
Mortgage-backed securities were delivered to the broker-dealers who arranged
the transactions to secure the acvances and securities sold under agreements to
repurchase (See Note 3).
In order to receive advances and sell securities under agreements to
repurchase from the FHLB, the Bank is required to own capital stock of the FHLB
(See Note 3).
9. COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, there are outstanding various commitments
and contingent liabilities which are not reflected in the consolidated financial
statements. The Company does not anticipate losses as a result of these
commitments. Undisbursed loan commitments totaled $73,724,000 and standby
letters of credit were $4,652,000 at December 31, 1998. The Company's exposure
to credit loss is limited to amounts funded or drawn.
44
COAST BANCOROP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
9. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Loan commitments are typically contingent upon the borrower meeting certain
financial and other covenants and such commitments typically have fixed
expiration dates and require payment of a fee. As many of these commitments are
expected to expire without being drawn upon, the total commitments do not
necessarily represent future cash requirements. The Company evaluates each
potential borrower and the necessary collateral on an individual basis.
Collateral varies, but may include real property, bank deposits or business or
personal assets.
Standby letters of credit are conditional commitments written by the Company
to guarantee the performance of a customer to a third party. These guarantees
are issued primarily relating to inventory purchases by the Company's commercial
customers and such guarantees are typically short-term. Credit risk is similar
to that involved in extending loan commitments to customers and the Company,
accordingly, uses evaluation and collateral requirements similar to those for
loan commitments. Virtually all of such commitments are collateralized.
10. LOAN CONCENTRATIONS
The Bank's customers are primarily located in Santa Cruz, Monterey and San
Benito counties, an area on the California coast south of San Francisco.
Commercial loans represent 24% of total loans at December 31, 1998, with no
particular industry representing a significant portion. Approximately 14% of the
Company's loans at December 31, 1998 are for real estate construction including
single family residential and commercial properties. Other real estate secured
loans, primarily for commercial properties, represent another 59% of loans at
December 31, 1998. Installment and other loans, primarily automobile and mobile
home loans, represent the remainder of loans. Many of the Company's customers
are employed by or are otherwise dependent on the tourism, high technology,
agriculture and real estate development industries and, accordingly, the ability
of any of the Company's borrowers to repay loans may be affected by the
performance of these sectors of the economy. Virtually all loans are
collateralized. Generally, real estate loans are secured by real property and
commercial and other loans are secured by bank deposits or business or personal
assets. Repayment is generally expected from refinancing or sale of the related
property for real estate construction loans and from cash flows of the borrower
for other loans.
11. RELATED PARTY LOANS
The Bank may make loans to directors and their associates subject to
approval by the Board of Directors. These transactions are at terms and rates
comparable to those granted to other customers of the Company. Loans to related
party loans were $223,000 and $95,000 at December 31, 1998 and 1997,
respectively. During 1998, new loans to these related parties were $185,000 and
repayments were $57,000.
12. REGULATORY MATTERS
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 mandatory and possibly
additional discretionary 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 assets, liabilities, and certain off-balance sheet
items as
45
COAST BANCOROP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
12. REGULATORY MATTERS (CONTINUED)
calculated under regulatory accounting practices. The Company's and Bank's
capital amounts and classification are also subject to qualitative judgments by
the regulators about 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 table below) of total and Tier I capital (as defined in the
regulations) to risk weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December 31,
1998, that the Company and Bank meet all capital adequacy requirements to which
they are subject.
As of December 31, 1998 and 1997, the most recent notification from the
Federal Deposit Insurance Corporation categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To be categorized
as adequately capitalized the Bank must maintain minimum total risk-based, Tier
I risk-based, and Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
Actual capital amounts and ratios are as follows:
O BE CATEGORIZED AS WELL
MINIMUM FOR CAPITAL CAPITALIZED UNDER PROMPT
CORRECTIVE ACTION
ACTUAL ADEQUACY PURPOSES: PROVISIONS:
-------------------------- -------------------------- ------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------- ----- ------------- ----- ------------- ---------
THE COMPANY:
As of December 31, 1998:
Total Capital (to Risk Weighted Assets)....... $ 32,529,000 15.4% $ 16,856,000 8.0% N/A N/A
Tier I Capital (to Risk Weighted Assets)...... $ 29,880,000 14.2% $ 8,428,000 4.0% N/A N/A
Tier I Capital (to Average Assets)............ $ 29,880,000 9.5% $ 12,574,000 4.0% N/A N/A
As of December 31, 1997:
Total Capital (to Risk Weighted Assets)....... $ 28,883,000 16.7% $ 13,859,000 8.0% N/A N/A
Tier I Capital (to Risk Weighted Assets)...... $ 26,700,000 15.4% $ 6,929,000 4.0% N/A N/A
Tier I Capital (to Average Assets)............ $ 26,700,000 10.3% $ 10,357,000 4.0% N/A N/A
THE BANK:
As of December 31, 1998:
Total Capital (to Risk Weighted Assets)....... $ 31,198,000 14.8% $ 16,856,000 8.0% $ 21,069,000 10.0%
Tier I Capital (to Risk Weighted Assets)...... $ 28,549,000 13.6% $ 8,428,000 4.0% $ 12,642,000 6.0%
Tier I Capital (to Average Assets)............ $ 28,549,000 9.1% $ 12,574,000 4.0% $ 15,717,000 5.0%
As of December 31, 1997:
Total Capital (to Risk Weighted Assets)....... $ 26,217,000 15.1% $ 13,858,000 8.0% $ 17,323,000 10.0%
Tier I Capital (to Risk Weighted Assets)...... $ 24,034,000 13.9% $ 6,929,000 4.0% $ 10,394,000 6.0%
Tier I Capital (to Average Assets)............ $ 24,034,000 9.3% $ 10,357,000 4.0% $ 12,946,000 5.0%
13. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) tax-deferred savings plan under which eligible
employees may elect to have a portion of their salary deferred and contributed
to the plan. The Company is not obligated to, but
46
COAST BANCOROP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
13. EMPLOYEE BENEFIT PLANS (CONTINUED)
may contribute to the plan. In 1998, the Company matched each employee's
contribution up to $1,000, an increase from $500 in previous years, aggregating
$90,000 ($42,000 in 1997 and 1996). Participants may elect several investment
options.
Substantially all employees with at least 1,000 hours of service are covered
by a discretionary employee stock ownership plan (ESOP). The Company's
contribution to the ESOP was $120,000 in 1997 and 1996. No contribution was made
during 1998 in order to fund the 1998 profit sharing plan.
The Bank established a profit sharing plan for eligible employees during
1998. Distributions under the profit sharing plan are tied to the Bank's net
income. The Bank accrued $180,000 for distributions for 1998.
The Bank has an unfunded salary continuation plan for two officers which
provides for retirement benefits upon reaching age 65. The Bank accrues such
post-retirement benefits over the vesting period of ten years. In the event of a
change in control of the Company, the officers' benefits will fully vest. The
Bank accrued $61,000, $72,000, and $120,000 in 1998, 1997, and 1996,
respectively. The liability under the salary continuation plan was $474,000 and
$414,000 at December 31, 1998 and 1997, respectively. The discount rate used to
measure the liability was 7.05% and 6.95% at December 31, 1998 and 1997,
respectively.
The Bank has a deferred compensation plan whereby certain directors defer
their fees until age 65 or 70. Amounts deferred accrue interest at a rate
determined annually by the Board of Directors (6.7% and 7.7% for 1998 and 1997,
respectively). Accumulated benefits are paid over 8 to 13 years. Total deferred
director fees at December 31, 1998 and 1997 were $705,000 and $448,000,
respectively.
Under the 1995 stock option plan (Plan) the Company may grant options to
purchase up to 880,000 shares of common stock to employees, directors and
consultants at prices not less than the fair market value at date of grant.
Employee options generally expire 5 to 10 years from the date of grant and vest
over a 5-year period. Under the Plan non-employee directors of the Company are
automatically granted options to purchase 2,000 shares of common stock at the
fair market value at the date of grant each year that such person remains a
director of the Company. Options granted under the Plan to non-employee
directors are exercisable after 6 months and expire from 5 years from the date
of grant. The maximum number of shares which may be issued to an individual
non-employee director under the Plan is 10,000.
Option activity under the plan is as follows:
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------
1998 1997
-------------------------- -------------------------- 1996
WEIGHTED- WEIGHTED- ----------------------------
AVERAGE AVERAGE WEIGHTED-
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF AVERAGE
SHARES PRICE SHARES PRICE SHARES EXERCISE PRICE
----------- ------------- ----------- ------------- ----------- ---------------
Options outstanding, beginning of
year.................................. 268,400 $ 7.84 171,600 $ 6.15 30,800 $ 4.66
Granted................................. 96,800 17.12 96,800 10.83 140,800 6.48
Exercised............................... (53,240) 6.34 -- --
Options outstanding, end of year........ 311,960 10.98 268,400 7.84 171,600 6.15
Options exercisable, end of year........ 127,160 10.05 114,400 6.98 61,600 5.54
47
COAST BANCOROP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
13. EMPLOYEE BENEFIT PLANS (CONTINUED)
The weighted-average fair value of options granted was $8.47 during 1998,
$6.79 during 1997 and $2.40 during 1996.
Additional information regarding options outstanding as of December 31, 1998
is as follows:
OPTIONS OUTSTANDING
----------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED AVERAGE ------------------------------
RANGE OF EXERCISE NUMBER REMAINING CONTRACTUAL WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
PRICES OUTSTANDING LIFE (YRS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ----------------- ----------- --------------------- ----------------- ----------- -----------------
$4.66 8,800 1.1 $ 4.66 8,800 $ 4.66
$6.48 118,360 6.6 6.48 52,360 $ 6.48
$10.17--$11.14 88,000 7.0 10.90 35,200 $ 10.53
$17.10--$17.13 96,800 7.6 17.12 30,800 $ 17.10
----------- -----------
311,960 $ 10.98 127,160 $ 10.05
----------- -----------
----------- -----------
At December 31, 1998, 514,800 shares were available for future grants under
the option plan.
As discussed in Note 1, the Company continues to account for its stock-based
awards using the intrinsic value method in accordance with APB Opinion No. 25,
"Accounting for Stock Issued to Employees" and its related interpretations.
Accordingly, no compensation expense has been recognized in the financial
statements for employee stock arrangements.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
disclosure of pro forma net income and earnings per share had the Company
adopted the fair value method as of the beginning of fiscal 1995. Under SFAS
123, the fair value of stock-based awards to employees is calculated through the
use of option pricing models, even though such models were developed to estimate
the fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the calculated
values. The Company's calculations were made using the Black-Scholes option
pricing model with the following weighted average assumptions: expected life,
100 months in 1998, 101 months in 1997, and 102 months in 1996 following grant;
stock volatility, 50% in 1998, 1997 and 1996; risk free interest rates, 5.54% in
1998, 6.55% in 1997, and 6.25% in 1996; and 24% dividends during the expected
term. The Company's calculations are based on a single option valuation approach
and forfeitures are recognized as they occur. If the computed fair values of the
stock option awards had been amortized to expense over the vesting period of the
awards, pro forma net income would have been as follows:
YEARS ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
Proforma net income................................. $ 5,872,000 $ 4,978,000 $ 4,026,000
Proforma net income per share:
Basic............................................. $1.22 $1.13 $0.89
Diluted........................................... $1.19 $1.11 $0.89
48
COAST BANCOROP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
14. DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by using available
market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented are not
necessarily indicative of the amounts that could be realized in a current market
exchange. The use of different market assumptions and/or estimation techniques
may have a material effect on the estimated fair value amounts.
The following table presents the carrying amount and estimated fair value of
certain assets and liabilities held by the Company at December 31, 1998 and
1997. The carrying amounts reported in the consolidated balance sheets
approximate fair value for the following financial instruments: cash and due
from banks, federal funds sold, and demand and savings deposits. See Note 3 for
a summary of the estimated fair value of securities.
1998 1997
------------------------------ ------------------------------
CARRYING ESTIMATED FAIR CARRYING ESTIMATED FAIR
AMOUNT VALUE AMOUNT VALUE
-------------- -------------- -------------- --------------
Loans, net................. $ 153,833,000 $ 152,382,000 $ 140,469,000 $ 140,038,000
Time deposits.............. $ 52,252,000 $ 52,261,000 $ 34,320,000 $ 34,319,000
Other borrowings........... $ 10,416,000 $ 10,475,000 $ 30,070,000 $ 30,070,000
The following methods and assumptions were used by the Company in computing
the estimated fair values in the above table:
LOANS, NET--The fair of variable rate loans is the carrying value as these
loans are regularly adjusted to market rates. The fair value of fixed rate loans
is estimated by discounting the future cash flows using current rates at which
similar loans would be made to borrowers with similar credit ratings for the
same remaining maturities. The fair value calculations are adjusted by the
allowance for loan losses.
TIME DEPOSITS--The fair value of fixed rate time deposits was estimated by
discounting the cash flows using rates currently offered for deposits of similar
remaining maturities.
OTHER BORROWINGS--The fair value of fixed rate other borrowings was
estimated by discounting the cash flows using rates currently offered for these
types of borrowings of similar remaining maturities.
UNUSED COMMITMENTS TO EXTEND CREDIT--The fair value of letters of credit and
standby letters of credit is not significant.
49
COAST BANCOROP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
15. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
As described in Note 1 to the consolidated financial statements, the merger
of Coast Commercial Bank with the Company became effective July, 25, 1995. The
condensed financial statements of Coast Bancorp (parent company only) follow:
DECEMBER 31,
----------------------------
1998 1997
------------- -------------
CONDENSED BALANCE SHEET
Cash............................................................................... $ 1,295,000 $ 2,643,000
Investment in Coast Commercial Bank................................................ 28,866,000 25,103,000
Other assets....................................................................... 61,000 42,000
------------- -------------
Total.......................................................................... $ 30,222,000 $ 27,788,000
------------- -------------
------------- -------------
Liabilities........................................................................ $ 25,000 $ 24,000
Stockholders' equity............................................................... 30,197,000 27,764,000
------------- -------------
Total.......................................................................... $ 30,222,000 $ 27,788,000
------------- -------------
------------- -------------
YEARS ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
CONDENSED INCOME STATEMENT
Interest income......................................................... $ 52,000 $ 85,000 $ 88,000
General and administrative expenses..................................... (105,000) (154,000) (150,000)
------------ ------------ ------------
Loss before equity in net income of Coast Commercial Bank............... (53,000) (69,000) (62,000)
Equity in net income of Coast Commercial Bank:
Dividends received.................................................... 2,340,000 1,048,000 1,116,000
Undistributed equity in net income.................................... 3,858,000 4,155,000 3,058,000
Income tax benefit...................................................... 16,000 21,000 16,000
------------ ------------ ------------
Net income.............................................................. 6,161,000 5,155,000 4,128,000
Net change in accumulated other comprehensive income.................... (376,000) 563,000 (342,000)
------------ ------------ ------------
Comprehensive income.................................................... $ 5,785,000 $ 5,718,000 $ 3,786,000
------------ ------------ ------------
------------ ------------ ------------
50
COAST BANCOROP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
15. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (CONTINUED)
YEARS ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
STATEMENT OF CASH FLOWS
Cash flows from operating activities:
Net income.................................................................. $ 6,161,000 $ 5,155,000 $ 4,128,000
Reconciliation of net income to net cash provided by operations:
Undistributed equity in net income.......................................... (3,858,000) (4,155,000) (3,058,000)
Other assets and liabilities................................................ (14,000) (40,000) 30,000
------------ ------------ ------------
Net cash provided by operating activities................................... 2,289,000 960,000 1,100,000
Cash flows from financing activities:
Cash dividends paid......................................................... (1,317,000) (1,017,000) (887,000)
Cash paid in-lieu of fractional shares...................................... (7,000) -- --
Exercise of stock options................................................... 338,000 -- --
Repurchase of common stock (2,651,000) (130,000) (690,000)
------------ ------------ ------------
Net cash used in financing activities....................................... (3,637,000) (1,147,000) (1,577,000)
------------ ------------ ------------
Net decrease in cash........................................................ (1,348,000) (187,000) (477,000)
Cash, beginning of period................................................... 2,643,000 2,830,000 3,307,000
------------ ------------ ------------
Cash, end of period......................................................... $ 1,295,000 $ 2,643,000 $ 2,830,000
------------ ------------ ------------
------------ ------------ ------------
A principal source of cash for the Company is dividends from its subsidiary
bank. Banking regulations limit the amount of dividends that may be paid without
prior approval of the Company's regulatory agencies to the lesser of retained
earnings or the net income of the Company for its last three fiscal years, less
any distributions during such period, subject to capital adequacy requirements.
At December 31, 1998, the Company has approximately $12,276,000 available for
payment of dividends which would not require the prior approval of the banking
regulators under this limitation.
16. BUSINESS SEGMENTS
Coast Bancorp's only operating unit is Coast Commercial Bank, a commercial
bank, which primarily offers similar products to customers located in Santa Cruz
and surrounding counties of Northern California. Accordingly, the Company
operates as one business segment.
51
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Coast Bancorp:
We have audited the accompanying consolidated balance sheets of Coast
Bancorp and its subsidiary as of December 31, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Coast Bancorp and its
subsidiary as of 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.
DELOITTE & TOUCHE LLP
San Jose, California
January 22, 1999 (February 5, 1999 as to stock split
information in Note 1, paragraph 2)
52
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning our directors and executive officers is included
under the headings "Election of Directors" and "Compliance with Section 16(a) of
the Exchange Act" in the definitive proxy statement for the Company's 1999
Annual Meeting of Shareholders to be filed pursuant to Regulation 14A (Proxy
Statement), which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is included under the heading
"Executive Compensation" in the Proxy Statement, which is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management is included under the heading "Security Ownership of Certain
Beneficial Owners" and "Election of Directors" in the Proxy Statement, which is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Iinformation concerning certain relationships and related transactions is
included under the heading "Indebtedness of Management and Other Transactions"
in the Proxy Statement, which is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. and 2.
The financial statements and supplementary data contained in Item 8 of this
report are filed as part of this report.
All schedules are omitted because of the absence of the conditions under
which they are required or because the required information is included in the
financial statements or related notes.
(a) 3.
Exhibits are listed in the Index to Exhibits beginning on page 54 of this
report.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the quarter ended
December 31, 1998.
53
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
* Plan of Reorganization and Merger Agreement dated March 7, 1995 by and between Coast Commercial, Coast
Merger Corporation and Coast Bancorp.
* Articles of Incorporation of Coast Bancorp.
* Bylaws of Coast Bancorp.
* Salary Continuation Agreement dated September 19, 1992 by and between Coast Commercial Bank and Harvey J.
Nickelson.
* Salary Continuation Agreement dated September 19, 1992 by and between Coast Commercial Bank and David V.
Heald.
* Lease by and between Friend, Friend and Friend and Coast Commercial Bank dated November, 1986, for 720
Front Street, Santa Cruz, California.
* Lease by and between Green Valley Corporation and Coast Commercial Bank dated July 12, 1988, for 740
Front Street, Santa Cruz, California.
* Lease by and between Heffernan Family Trust and Coast Commercial Bank dated June 21, 1989, for 1975
Soquel Drive, Santa Cruz, California.
* Lease by and between Martin N. Boone and Robin Sherman and Coast Commercial Bank dated July 16, 1986, for
7775 Soquel Drive, Aptos, California.
* Lease by and between Scott Valley Partners and Coast Commercial Bank dated November 6, 1991, for 203A Mt.
Hermon Road, Scotts Valley.
* Lease by and between Jay Paul and Coast Commercial Bank dated December 1, 1989, for 1055 S. Green Valley
Road, Watsonville.
* Lease by and between Dubois Office Plaza and Coast Commercial Bank dated January 23, 1993, for 140 Dubois
Street, Santa Cruz.
* Coast Commercial Bank Employee Stock Ownership Plan.
* Coast Bancorp 1995 Amended and Restated Stock Option Plan.
* Deferred Compensation Agreement with Richard E. Alderson dated November 2, 1992.
* Deferred Compensation Agreement with Douglas D. Austin Dated November 2, 1992.
* Deferred Compensation Agreement with Bud W. Cummings Dated November 2, 1992.
* Deferred Compensation Agreement with Ronald M. Israel Dated November 2, 1992.
* Deferred Compensation Agreement with Malcolm D. Moore Dated November 2, 1992.
* Deferred Compensation Agreement with Gus J.F. Norton Dated November 2, 1992.
* Deferred Compensation Agreement with James C. Thompson Dated November 2, 1992.
23.2 Consent of Deloitte & Touche L.L.P.
27 Financial Data Schedule
- ------------------------
* Previously filed.
54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly issued this registration statement
to be signed on its behalf by the undersigned, thereunto duly authorized.
COAST BANCORP
DATE: MARCH 17, 1999
By: /s/ HARVEY J. NICKELSON
-----------------------------------------
Harvey J. Nickelson,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Act of 1934, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ RICHARD ALDERSON
- ------------------------------ Director March 17, 1999
Richard Alderson
/s/ DOUGLAS D. AUSTIN
- ------------------------------ Director March 17, 1999
Douglas D. Austin
/s/ JOHN C. BURROUGHS
- ------------------------------ Director March 17, 1999
John C. Burroughs
/s/ BUD W. CUMMINGS
- ------------------------------ Director March 17, 1999
Bud W. Cummings
/s/ RONALD M. ISRAEL
- ------------------------------ Director March 17, 1999
Ronald M. Israel
Senior Vice President and
/s/ BRUCE H. KENDALL Chief Financial Officer
- ------------------------------ (Principal Financial and March 17, 1999
Bruce H. Kendall Accounting Officer)
55
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ HARVEY J. NICKELSON
- ------------------------------ President, Chief Executive March 17, 1999
Harvey J. Nickelson Officer and Director
/s/ GUS J.F. NORTON
- ------------------------------ Director March 17, 1999
Gus J.F. Norton
/s/ JAMES C. THOMPSON
- ------------------------------ Chairman of the Board of March 17, 1999
James C. Thompson Directors
56