Independent Auditors' Report
To the Board of Directors and Shareholders of Capital Corp of the West:
We have audited the accompanying consolidated balance sheets of Capital
Corp of the West and subsidiaries ("the Company") as of December 31, 1998 and
1997 and the related consolidated statements of income, and comprehensive
income, cash flows, and shareholders' equity for each of the years in the three
year period ended December 31, 1998. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated 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, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Capital Corp
of the West and subsidiaries as of December 31, 1998 and 1997 and the results of
their operations and their cash flows for each of the years in the three year
period ended December 31, 1998 in conformity with generally accepted accounting
principles.
Sacramento, California
February 5, 1999
1
CAPITAL CORP OF THE WEST
(Amounts in thousands)
1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
SUMMARY INCOME DATA:
Interest income $ 34,614 $ 25,912 $ 19,351 $ 15,873 $ 12,807
Interest expense 13,634 10,190 6,865 5,717 3,850
Net interest income 20,980 15,722 12,486 10,156 8,957
Provision for loan losses 3,903 5,825 1,513 228 -
Noninterest income (loss) 4,838 3,852 2,935 (1,224) 805
Noninterest expense 18,244 13,372 10,736 8,146 6,923
Provision (benefit) for income taxes 930 (26) 1,163 223 1,103
Net income $ 2,741 $ 403 $ 2,009 $ 335 $ 1,736
SHARE DATA:
Average common shares outstanding 4,602 3,467 2,485 2,207 2,100
Basic earnings per share .60 .12 .81 .15 .83
Diluted earnings per share .58 .11 .77 .15 .83
Cash dividends per share - - .03 - -
Book value per share 9.29 8.74 7.66 6.80 6.36
Tangible book value per share $ 8.02 $ 7.30 $ 6.78 $ 6.80 $ 6.36
BALANCE SHEET DATA:
Total assets $499,859 $421,394 $265,989 $209,033 $178,121
Total securities 154,867 148,032 43,378 45,302 35,826
Total loans 268,933 217,977 183,247 133,734 113,600
Total deposits 444,210 356,395 283,345 192,601 163,199
Stockholders' equity $ 42,804 $ 40,248 $ 20,974 $ 15,093 $ 14,082
OPERATING RATIOS:
Return on average equity 6.48% 1.46% 10.24% 11.05% 2.16%
Return on average assets .60 .13 .88 .18 1.05
Net interest margin 5.17 5.64 6.12 6.09 6.03
CREDIT QUALITY RATIOS:
Nonperforming loans to total loans (1) .54% 1.26% 3.71% 3.04% 3.63%
Allowance for loan losses to total loans 1.78 1.76 1.52 1.27 1.43
Allowance for loan losses to nonperforming loans 310.87 139.79 50.14 35.07 231.90
CAPITAL RATIOS:
Risk-based tier 1 capital 10.69% 11.60% 9.04% 9.22% 10.50%
Total risk-based capital 11.94 12.78 10.20 10.27 11.70
Leverage ratio 7.58 8.58 7.37 7.43 8.38
(1) NONPERFORMING LOANS CONSIST OF LOANS ON NONACCRUAL, LOANS PAST DUE 90
DAYS OR MORE AND RESTRUCTURED LOANS.
2
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion and analysis is designed to provide a better
understanding of the significant changes and trends related to Capital Corp of
the West (the "Company"). The following discussion should be read in conjunction
with the Consolidated Financial Statements of the Company and the Notes thereto.
The Consolidated Financial Statements of the Company include its subsidiaries,
County Bank (the "Bank"), and Town & Country Finance and Thrift (the "Thrift").
It also includes the Bank's subsidiary, Merced Area Investment Development, Inc.
("MAID").
In addition to historical information, this discussion includes certain
forward-looking statements regarding events and trends which may affect the
Company's future results. Such statements are subject to risks and uncertainties
that could cause the Company's actual results to differ materially. These
factors include general risks inherent to commercial lending; risks related to
asset quality; risks related to the Company's dependence on key personnel and
its ability to manage existing and future growth; risks related to competition;
risks posed by present and future government regulation and legislation; and
risks resulting from federal monetary policy.
OVERVIEW
Total net income for 1998 was $2,741,000 compared to $403,000 in 1997 and
$2,009,000 in 1996. Basic earnings per share were $.60 in 1998 compared to $.12
in 1997 and $.81 in 1996. The Company's return on average total assets was .60%
in 1998 as compared with .13% in 1997 and .88% in 1996. Earnings improved in
1998 as a result of strong growth in interest-earning assets, improvements in
noninterest income and a lower level provision for loan losses as compared to
the prior year. Included in 1997 earnings is a significant increase in the
provision for loan losses. This was primarily attributable to the charge-off of
one commercial real estate loan, which had previously been considered a
nonperforming asset. The charge-off related to this loan totaled $3,458,000 in
1997. The provision was also increased due to a change in the methodology for
determining the appropriate levels maintained as an allowance for loan losses.
In 1998, the provision for loan losses was also at a higher level than expected,
due in large part to a provision for loan losses and the charge-off of a single
commercial relationship totaling $1,325,000.
The Company achieved strong growth in 1998, reaching total assets at
December 31, 1998 of $499,859,000, up $78,465,000 or 19% from $421,394,000 at
December 31, 1997. Net loans grew to $264,158,000 at year end 1998, a 23%
increase and deposits grew to $444,210,000, a 25% increase over 1997. Total
equity capital grew to $42,804,000, a 6% increase over year end 1997 and the
Company continues to be well capitalized by regulatory definitions.
RESULTS OF OPERATIONS
Net income in 1998 was $2,741,000 with basic earnings per share of $.60 as
compared to $403,000 or $.12 in 1997. The Company's net interest income
increased by $5,258,000, or 33%, to $20,980,000 as compared to $15,722,000 in
1997, primarily related to growth in average interest-earning assets. In late
1997 the Company purchased three branches from Bank of America and increased
deposits by $60,849,000 (there were no loans purchased). The Company also had a
stock offering in 1997, increasing capital by $17,951,000. These improved
earnings were primarily a result of the ability of the Company to absorb these
new branches and redeploy the newly acquired funds into interest earning assets.
The Company reported net income in 1997 of $403,000 compared to $2,009,000
in 1996. Basic earnings per share in 1997 were $.12 compared to $.81 in 1996.
The decrease in earnings in 1997 as compared to 1996 is primarily due to the
write-off of a commercial real estate loan in 1997 and a change in the
methodology in calculating the adequacy of the allowance of the loan losses.
The following table presents, for the periods indicated, the distribution
of average assets, liabilities and stockholders' equity as well as the total
dollar amount of interest income from average interest-earning assets and
resultant yields and the dollar amounts of interest expense and average
interest-bearing liabilities, expressed both in dollars and in rates.
3
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
-------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
(Dollars in thousands) BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- -------------------------------------------------------------------------------------------------------------------------
ASSETS
Federal funds sold $ 23,469 $ 1,253 5.34% $ 6,288 $ 344 5.47% $ 3,920 $ 207 5.28%
Time deposits at other financial 1,040 57 5.48 1,124 53 4.21 3,175 127 4.00
institutions
Nontaxable investment securities(1) 16,320 797 4.88 4,358 231 5.30 4,531 246 5.43
Taxable investment securities 121,728 7,348 6.66 68,900 4,638 6.73 35,156 2,469 7.02
Loans, gross (2) 242,989 25,159 10.35 198,140 20,646 10.42 157,098 16,302 10.38
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest-earning assets 405,546 34,614 8.54 278,810 25,912 9.29 203,880 19,351 9.49
Allowance for loan losses (4,158) (2,615) (1,913)
Cash and noninterest-bearing deposits
at other banks 19,610 14,384 10,436
Premises and equipment, net 13,390 9,596 4,775
Interest receivable and other assets 22,084 14,016 10,946
-------- -------- --------
Total assets $456,742 $314,191 $228,124
-------- -------- --------
-------- -------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Negotiable orders of withdrawal 57,602 503 .87% 38,164 345 .90% $29,376 268 .91%
Savings deposits 156,956 5,696 3.63 117,357 4,770 4.06 104,938 4,350 4.15
Time deposits 112,555 6,143 5.46 71,808 3,983 5.55 40,994 2,167 5.29
Other borrowings 20,862 1,292 6.19 18,721 1,092 5.83 1,020 80 7.84
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest-bearing liabilities 347,975 13,634 3.92 246,050 10,190 4.16 176,328 6,865 3.89
Noninterest-bearing deposits 63,243 38,023 30,549
Accrued interest, taxes and other
liabilities 2,976 2,583 3,067
-------- -------- --------
Total Liabilities 414,194 286,656 209,944
Total shareholders' equity 42,278 27,535 18,180
-------- -------- --------
Total liabilities and shareholders' $456,472 $314,191 $228,124
equity
NET INTEREST INCOME AND MARGIN (3) $20,980 5.17% $15,722 5.64% $12,486 6.12%
(1) INTEREST ON MUNICIPAL SECURITIES IS NOT COMPUTED ON TAX-EQUIVALENT BASIS.
(2) AMOUNTS OF INTEREST EARNED INCLUDES LOAN FEES OF $1,268,000, $1,366,000
AND $1,106,000 FOR 1998,1997, AND 1996, RESPECTIVELY.
(3) NET INTEREST MARGIN IS COMPUTED BY DIVIDING NET INTEREST INCOME BY TOTAL
AVERAGE INTEREST-EARNING ASSETS.
The Company's primary source of revenue is net interest income, which is
the difference between interest income and fees derived from earning assets and
interest paid on liabilities obtained to fund those assets. Total interest and
fee income on earning assets increased by $8,702,000 or 34% to $34,614,000 in
1998. This compares with an increase from $19,351,000 to $25,912,000, a
$6,561,000 or 34% increase in 1997 and an increase from $15,873,000 to
19,351,000, a $3,478,000 or 22% increase in 1996. The level of interest income
is affected by changes in the volume and the rates earned on interest-earning
assets. Interest-earning assets consist primarily of loans, investment
securities and federal funds sold. Average interest-earning assets in 1998 were
$405,546,000 as compared with $278,810,000 in 1997, a $126,736,000 or 45%
increase.
Interest expense is a function of the volume and rates paid for
interest-bearing liabilities. Interest-bearing liabilities consist primarily of
certain deposits and borrowed funds. Total average interest-bearing liabilities
in 1998 were $347,975,000 as compared with $246,050,000 in 1997 and $176,328 in
1996. The increase in average interest-bearing liabilities in 1998 of
$101,925,000 or 41% compares with an increase during 1997 of $69,722,000 or 40%.
Total interest expense increased $3,444,000 or 34% in 1998.
Interest expense increased $3,325,000 or 48% during 1997.
The Company's net interest margin, the ratio of net interest income
interest-earning assets for 1998 was 5.17%. This is a decrease of 47 basis
points compared to the 1997 margin of 5.64%. The net interest margin decline
during 1998 was primarily due to a change in the asset mix compared with the
previous year. In 1998, loans comprised 60% of interest-earning assets as
compared with 71% in 1997. Securities comprised 34% of interest-earning assets
in 1998 compared with 27% in 1997. The net interest margin in 1997 of 5.64% was
a 48 basis point decrease compared to the 1996 margin of 6.12%. The decrease in
the
4
net interest margin in 1997 is primarily due to a change in the asset mix
compared to the prior year. In 1997, loans comprised 71% of interest-earning
assets as compared to 77% in 1996. In addition in 1997 borrowed funds
comprised 8% of interest bearing liabilities as compared with 1% in 1996. In
the future, the Company plans to redeploy these funds into higher earning
loans, however, no assurance can be given that this movement in the balance
sheet mix will take place. This movement will depend on the economy in the
Company's market area, the Company's ability to extend quality loans on a
diversified basis while controlling risk, and the Company's ability to
attract borrowers that will meet the lending standards adhered to by the
Company.
The Company's net interest income is affected by changes in the amount and
mix of interest-earning assets and interest-bearing liabilities. It is also
affected by changes in yields earned on interest-earning assets and rates paid
on interest-bearing deposits and other borrowed funds. The following table sets
forth changes in interest income and interest expense for each major category of
interest-earning assets and interest-bearing liabilities and the amount of
change attributable to volume and rate changes for the years indicated. The
changes due to both rate and volume have been allocated to rate and volume in
proportion to the relationship of the absolute dollar amount of the change in
each. The effects of tax-equivalent yields have not been considered because they
are not significant.
1998 COMPARED TO 1997 1997 COMPARED TO 1996
--------------------------------------------------------------------
(Dollars in thousands)
--------------------------------------------------------------------
NET INTEREST INCOME VARIANCE ANALYSIS VOLUME RATE TOTAL VOLUME RATE TOTAL
--------------------------------------------------------------------
INCREASE (DECREASE) IN INTEREST INCOME:
Loans $ 4,644 $ (131) $ 4,513 $ 4,276 $ 68 $ 4,344
Taxable investment securities 3,233 (523) 2,710 2,276 (107) 2,169
Nontaxable investment securities 586 (20) 566 (9) (6) (15)
Federal funds sold 917 (8) 909 129 8 137
Time deposit at other institutions (4) (8) 4 (94) 8 (74)
------- ------ ------- ------- ------ -------
Total 9,376 (674) 8,702 6,578 (17) 6,561
INCREASE (DECREASE) IN INTEREST EXPENSE:
Interest-bearing demand deposits 159 (1) 158 77 - 77
Savings deposits 1,088 (162) 926 433 (13) 420
Time deposits 2,162 (2) 2,160 1,704 112 1,816
Other borrowings 130 70 200 1,704 (5) 1,012
------- ------ ------- ------- ------ -------
Total 3,539 (95) 3,444 3,321 94 3,325
------- ------ ------- ------- ------ -------
INCREASE (DECREASE) IN NET INTEREST INCOME $ 5,837 $ (579) $ 5,258 $ 3,347 $ (111) $ 3,236
------- ------ ------- ------- ------ -------
------- ------ ------- ------- ------ -------
The increase in total interest income of $8,702,000 in 1998 is comprised of
a $9,376,,000 volume increase associated with an increase of average
interest-earning assets of $126,298,000 or 45% between 1998 and 1997 partially
offset by a $674,000 rate decrease. The increase in total interest expense of
$3,231,000 in 1998 related to a $101,925,000 or 41% increase in average
interest-bearing liabilities between 1998 and 1997 partially offset by a
$579,000 rate decrease.
The increase in total interest income of $6,561,000 in 1997 is comprised of
a $6,578,000 volume increase associated with the $74,930,000 increase in average
interest-earning assets between 1996 and 1997, and a $17,000 rate decrease. The
increase in total interest expense of $3,325,000 in 1997 is comprised of a
volume increase of $3,231,000 related to the $69,722,000 increase in average
interest-bearing liabilities between 1996 and 1997 and a $94,000 rate increase.
PROVISION FOR LOAN LOSSES
The Company maintains an allowance for loan losses at a level considered by
management to be adequate to cover the inherent risks of loss associated with
its loan portfolio under prevailing and anticipated economic conditions. The
provision for loan losses is charged against income and increases the allowance
for loan losses. The provision for loan losses for the year ended December 31,
1998 was $3,903,000 compared to $5,825,000 in 1997 and $1,513,000 in 1996. The
level of the provision in 1998 is partially attributable to replenishing the
allowance for loan losses following the charge-off of one commercial
relationship totaling $1,325,000. The increase in 1997 is due to the
implementation of a new
5
methodology for determining its allowance for loan losses and replenishing
the allowance for loan lossees following the charge-off of one real estate
loan that was determined to be uncollectible in 1997. The new method applies
relevant risk factors to the entire loan portfolio, including nonperforming
loans. The methodology is based, in part, on the Bank's loan grading and
classification system. The Bank grades its loans through internal reviews and
periodically subjects loans to external reviews which then are assessed by
the Bank's audit committee. Credit reviews are performed on a monthly basis
and the quality grading process occurs on a quarterly basis. The increase in
provision for loan losses in 1998 and 1997 was also required due to support
the general loan growth of the Company, as gross loans increased 24% in 1998
and 27% in 1997.
OTHER INCOME
The following table summarizes other income for the years ended December 31,
(Dollars in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------
OTHER INCOME:
Deposit service charges $ 2,807 $ 1,709 $ 1,274
Income from real estate held for sale or development 540 879 508
Loan service fees 172 195 214
Gain on sale of loans 173 153 210
Retail investment commissions 156 218 229
Earnings on director and officer life insurance 201 181 112
789 517 388
-------- -------- --------
Total other income $ 4,838 $ 3,852 $ 2,935
-------- -------- --------
-------- -------- --------
Total noninterest income increased to $4,838,000 in 1998, compared to
$3,852,000 in 1997 a $986,000 or 26% increase. Deposit service charges increased
by $1,098,000 or 64%. This in a large part was attributable to the purchase of
the three branches of Bank of America and the Bank's growth. Other income
increased by $272,000. This is primarily due to increased fees collected for the
brokering of mortgage loans. The increase in 1997 of $917,000 or 31% is due to
an increase in service charge income due primarily to growth of the Company's
deposit base and to increased service charges. The increase in income from the
sale of real estate held for sale or development in 1997 was due to increased
sales.
The Bank has investments in residential real estate in Merced County
through its wholly owned subsidiary, MAID,which is now inactive. This investment
was completely written-off in 1995. As of December 31, 1998, the Bank has 117
unimproved and 1 improved lots in a residential subdivision. As these properties
are sold, the income is recognized as other income.
OTHER EXPENSE
Total noninterest expense increased $4,872,000 or 36% in 1998 as
compared with an increase of $2,636,000 or 25% in 1997.
Salaries and related benefits increased by $1,825,000 or 30% in 1998, and
$850,000 or 16% in 1997. The salary increases are primarily due to an increase
in full-time equivalent employees to 211 in 1998, compared to 158 in 1997, and
142 in 1996, as well as normal merit increases and related benefit expenses. The
increase in full time equivalent employees is due primarily to the purchase of
three branches of Bank of America in December 1997, two new branch openings in
Modesto in December 1996, increased number of support personnel, and one new
branch opening in April 1996. Premises and occupancy expenses increased $90,000
or 7% in 1998, and $400,000 or 48% in 1997 due to the above discussed branch
openings, the relocation of the Bank's downtown branch and the Company's
administrative headquarters in late 1997 and the purchase of the four thrift
branches in 1996.
Equipment expenses increased $709,000, or 49% in 1998, and $424,000 or 42%
in 1997 due to upgraded computer technology, the additional branches and branch
relocation, as discussed previously and the new technology required to make
check imaging available to the Bank's customer base.
The Bank's professional fees include legal, consulting, audit and
accounting fees. The expenses increased by $651,000 or 118% in 1998 as compared
with a decrease of $203,000 in 1997 over the same period in 1996. The increase
in 1998 is attributable, in part, to outsourcing of internal audits, increased
6
legal fees due to regulatory matters, consultants used to update the Bank's
sales incentive program and others relating to earnings enhancements and
regulatory matters.
Supplies increased by $71,000 or 13% in 1998 primarily related to the new
branch openings. In 1997, the Bank implemented check imaging for deposit
customers, which also increased supplies spending.
Marketing expenses increased by $66,000 or 11% in 1998 and $220,000 or 59%
in 1997. Marketing has continued to increase over the past three years as the
Company consciously promoted various deposit and loan products to assist with
the general growth of the Company.
Other increases relate primarily to overall growth of the Company. In 1998
and 1997, $179,000 and $275,000 related to the branches purchased from Bank of
America were included in other expenses.
PROVISION FOR INCOME TAXES
The Company's provision for income taxes was $930,000 in 1998 compared to a
$26,000 tax benefit in 1997 and a provision for income taxes of $1,163,000 in
1996. The effective income tax rates (computed as income taxes as a percentage
of income before income taxes) were 25%, (7%) and 37% for 1998, 1997 and 1996.
In part the effective tax rate of the Company was reduced in 1998 and 1997 due
to the tax credits earned by the purchase of housing tax credits. Total housing
tax credits for 1998, 1997, and 1996 were approximately $426,000, $71,000, and
$22,000. In addition, during 1998, 1997, and 1996, the Company realized tax
benefits of $239,000, $60,000, and $86,000, from nontaxable interest income
received from bank qualified municipal securities.
FINANCIAL CONDITION
Total assets increased 19% to $499,859,000 at December 31, 1998, compared
to $421,394,000 at December 31, 1997. Net loans grew to $264,158,000 at year end
1998, a 23% increase and deposits grew to $444,210,000, a 25% increase over
1997.
SECURITIES
The following table sets forth the carrying amount (fair value) of
available for sale securities at December 31,
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------
U.S. Treasury & U.S. Government agencies $ 12,711 $ 1,824
State and political subdivisions 30,192 9,640
Mortgage-backed securities 56,048 68,808
Collateralized mortgage obligations 29,264 51,874
Other securities 13,142 3,111
--------- --------
Carrying amount and fair value $ 141,357 $135,257
--------- --------
--------- --------
The following table sets forth the carrying amount (amortized cost) and
fair value of held to maturity securities at December 31,
(Dollars in thousands)
1998 1997
- --------------------------------------------------------------------------
U.S. Treasury and U.S. Government agencies $ 2,024 $ 9,442
Mortgage-backed securities 11,486 3,333
------- -------
Carrying amount (amortized cost) $13,510 $12,775
------- -------
------- -------
Fair value $13,584 $12,780
------- -------
------- -------
Available for sale securities increased $6,100,000 or 5% at December 31,
1998 over the same year end in 1997. This increase was due to the excess cash
obtained through the growth in the Company's deposit base. The Company owns a
large amount of mortgage-backed securities which generally have stated
maturities in excess of 10 years but are subject to substantial prepayments
which effectively accelerate actual maturities. At December 1998 the Company had
no structured notes. See Note 1 and 3 to the Company's Consolidated Financial
Statements for further information concerning the securities portfolio.
7
LOANS
Gross loans increased 23% to $268,933,000 at December 31, 1998, compared to
$217,977,000 at December 31, 1997. The increase in loan volumes in 1998 were due
to the Company's strategic efforts to increase loan production coupled with the
business development efforts by the Company's loan officers.
The Company concentrates its lending activities in five principal areas:
commercial, agricultural, real estate construction, real estate mortgage, and
consumer loans. Interest rates charged for loans made by the Company vary with
the degree of risk, the size and term of the loan, and borrowers' depository
relationships with the Company and prevailing market rates.
The following table presents the composition of the Company's loan
portfolio at December 31, for the years indicated:
1998 1997 1996 1995 1994
----------------------------------------------------------------------------------------------------
DOLLAR PERCENT DOLLAR PERCENT DOLLAR PERCENT DOLLAR PERCENT DOLLAR PERCENT
(Dollars in thousands) AMOUNT OF LOANS AMOUNT OF LOANS AMOUNT OF LOANS AMOUNT OF LOANS AMOUNT OF LOANS
- ---------------------------------------------------------------------------------------------------------------------------------
LOAN CATEGORIES
Commercial $ 37,609 14% $ 34,992 16% $ 27,857 15% $ 20,374 15% $ 15,229 13%
Agricultural 49,636 18 43,558 20 43,929 24 45,189 33 40,598 36
Real estate-construction 13,840 5 12,657 6 13,923 8 12,006 9 11,726 10
Real estate-mortgage 96,957 36 70,802 32 57,098 31 42,128 32 34,743 31
Consumer 70,891 27 55,968 26 40,440 22 14,039 11 11,304 10
-------- --- -------- --- -------- --- -------- --- -------- ---
Total 268,933 100% 217,977 100% 183,247 100% 133,736 100% 113,600 100%
Less allowance for loan
losses (4,775) (3,833) (2,792) (1,701) (1,621)
-------- -------- -------- -------- --------
Net loans $264,158 $214,144 $180,455 $132,035 $111,979
As a result of the Company's loan portfolio mix, the future quality of these
assets could be affected by adverse trends in its region or in the broader
community. These trends are beyond the control of the Company.
CREDIT RISK MANAGEMENT AND ASSET QUALITY
The Company closely monitors the markets in which it conducts its lending
operations and attempts its strategy to control exposure to loans with higher
credit risk. Asset reviews are performed using grading standards and criteria
similar to those employed by bank regulatory agencies. Assets receiving lesser
grades become "classified assets," which includes all nonperforming assets and
potential problem loans and receive an elevated level of attention to improve
the likelihood of collection. The policy of the Company is to review each loan
in the portfolio to identify problem credits. There are three classifications
for problem loans: "substandard," "doubtful" and "loss." Substandard loans have
one or more defined weaknesses and are characterized by the distinct possibility
that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful loans have the weaknesses of substandard loans with the additional
characteristic that the weaknesses make collection or liquidation in full on the
basis of currently existing facts, conditions and values questionable, and there
is a high possibility of loss. A loan classified loss is considered
uncollectible and its continuance as an asset is not warranted.
The level of nonperforming loans and real estate acquired through
foreclosure are two indicators of asset quality. Nonperforming loans are those
in which the borrower fails to perform under the original terms of the
obligation and are categorized as loans past due 90 days or more but still
accruing, loans on nonaccrual status and restructured loans. Loans are generally
placed on nonaccrual status and accrued but unpaid interest is reversed against
current year income when interest or principal payments become 90 days past due
unless the outstanding principal and interest is adequately secured and, in the
opinion of management, are deemed to be collectible. Additionally, loans which
are not 90 days past due may also be placed on nonaccrual status if management
reasonably believes the borrower will not be able to comply with the contractual
loan repayment terms and the collection of principal or interest is in question.
Management defines impaired loans as those loans, regardless of past due
status, in which principal and interest are not expected to be collected under
the original contractual loan repayment terms. An impaired loan is charged-off
at the time management believes the collection of principal and interest process
has been exhausted. At December 31, 1998 and 1997, impaired loans were measured
based upon
8
the present value of future cash flows discounted at the loan's
effective rate, the loan's observable market price, or the fair value of
collateral if the loan is collateral dependent.
The following table summarizes nonperforming assets of the Company at
December 31, for the years indicated:
(Dollars in thousands) 1998 1997 1996 1995 1994
----------------------------------------------------------------
NONPERFORMING ASSETS:
Nonaccrual loans $1,032 $2,611 $4,968 $4,626 $ 653
Accruing loans past due 90 days or more 413 131 600 224 46
------ ------ ------ ------ -----
Total nonperforming loans 1,445 2,742 5,568 4,850 699
Other real estate owned 60 60 1,466 47 -
Repossessed Automobiles 132 138 - - -
------ ------ ------ ------ -----
Total nonperforming assets $1,637 $2,940 $7,034 $4,897 $ 699
------ ------ ------ ------ -----
------ ------ ------ ------ -----
NONPERFORMING ASSETS:
To total loans .61% 1.35% 3.71% 3.04% 3.63%
To total assets .33 .70 2.64 2.34 .39
The Company had nonperforming loans at December 31, 1998 of $1,445,000 as
compared with $2,742,000 at year end 1997 and $5,568,000 at year end 1996.
Included in the 1998 totals, $623,000 are loans secured by first deeds of trust
on real property as compared with $1,635,000 in 1997 and $3,626,000 in 1996.
Impaired loans as of December 31, 1998 were $1,032,000 which had specific
allowances for loan losses of $465,000 as compared with $2,611,000 as of
December 31, 1997 which had specific allowances for loan losses of $598,000.
Other forms of collateral, such as inventory, chattel and equipment, secure the
remaining nonperforming loans as of each date.
Included in the nonperforming and impaired loans in 1996 and 1995 was a
$3,458,000 commercial real estate loan that was completely written-off in 1997.
As a result of this loan write-off, the allowance for loan losses was
replenished which resulted in a provision for loan losses in 1997 of $5,825,000,
compared to provisions of $3,903,000 in 1998 and $1,513,000 in 1996.
At December 31, 1998 and 1997 the Company had $60,000 in one residential
real estate property acquired through foreclosure compared with $1,466,000 as of
December 31, 1996.
ALLOWANCE FOR LOAN LOSSES
In determining the adequacy of the allowance for loan losses, management
takes into consideration the growth trend in the portfolio, examinations by
financial institution supervisory authorities, internal and external credit
reviews, prior loan loss experience of the Company, concentrations of credit
risk, delinquency trends, general economic conditions and the interest rate
environment. The allowance for loan losses is based on estimates and ultimate
future losses and may vary from current estimates. It is always possible that
future economic or other factors may adversely affect the Company's borrowers,
and thereby cause loan losses to exceed the current allowance for loan losses.
The balance in the allowance for loan losses is affected by the amounts
provided from operations, amounts charged off and recoveries of loans previously
charged-off. The Company had a provisions for loan losses in 1998 of $3,903,000
as compared to $5,825,000 in 1997 and $1,513,000 in 1996. See "Results of
Operations -- Provisions for Loan Losses."
9
The following table summarizes the loan loss experience of the Company
for the years ended December 31,
1998 1997 1996 1995 1994
-----------------------------------------------------------------------------
(Dollars in thousands)
ALLOWANCE FOR LOAN LOSSES:
Balance at beginning of year $ 3,833 $ 2,792 $ 1,701 $ 1,621 $ 1,747
Provision for loan losses 3,903 5,825 1,513 228 -
Allowance acquired through merger - - 148 - -
Charge-offs:
Commercial and agricultural 2,539 1,121 518 160 206
Real-estate -- construction - 3,458 - - -
Real-estate -- mortgage 4 - - - -
Consumer 983 471 140 63 42
-------- --------- --------- --------- ---------
Total charge-offs 3,526 5,050 658 223 248
Recoveries:
Commercial and agricultural 135 155 27 66 99
Real-estate -- construction - 1 - - 8
Real-estate -- mortgage 100 - - - -
Consumer 330 110 61 9 15
-------- --------- --------- --------- ---------
Total recoveries 565 266 88 75 122
-------- --------- --------- --------- ---------
Net charge-offs 2,961 4,784 570 148 126
-------- --------- --------- --------- ---------
Balance at end of year $ 4,775 $ 3,833 $ 2,792 $ 1,701 $ 1,621
-------- --------- --------- --------- ---------
-------- --------- --------- --------- ---------
Loans outstanding at year-end $268,933 $ 217,977 $ 183,247 $ 133,734 $ 113,600
Average loans outstanding $242,989 $ 198,120 $ 157,098 $ 120,620 $ 110,690
Net charge-offs to average loans 1.22% 2.41% 0.36% 0.12% 0.11%
Allowance for loan losses
To total loans 1.78 1.76 1.52 1.27 1.43
To nonperforming assets 301.07 136.80 39.69 35.07 231.90
The Company's charge-offs, net of recoveries, were $2,961,000 in 1998 as
compared with $4,784,000 in 1997 and $570,000 in 1996. This represents loan loss
experience ratios of 1.22%, 2.41% and .36% in those respective years stated as a
percentage of average gross loans outstanding for each year. As of December 31,
1998 the allowance for loan losses was $4,775,000 or 1.78% of total loans
outstanding. This compares with an allowance for loan losses of $3,833,000 or
1.76% in 1997 and $2,792,000 or 1.52% in 1996. The increase in net charge-offs
in 1998 and 1997 and were due to the complete write-off of a single commercial
relationship and the complete write-off of one commercial real estate loan
respectively as previously discussed.
LIQUIDITY
To maintain adequate liquidity requires that sufficient resources be
available at all times to meet cash flow requirements of the Company. The need
for liquidity in a banking institution arises principally to provide for deposit
withdrawals, the credit needs of its customers and to take advantage of
investment opportunities as they arise. A company may achieve desired liquidity
from both assets and liabilities. The Company considers cash and deposits held
in other banks, federal funds sold, other short term investments, maturing loans
and investments, receipts of principal and interest on loans, available for sale
investments and potential loan sales as sources of asset liquidity. Deposit
growth and access to credit lines established with correspondent banks and
market sources of funds are considered by the Company as sources of liquidity.
The Company reviews its liquidity position on a regular basis based upon
its current position and expected trends of loans and deposits. Management
believes that the Company maintains adequate amounts of liquid assets to meet
its liquidity needs. These assets include cash and deposits in other banks,
available for sale securities and federal funds sold. The Company's liquid
assets totaled $186,853,000 and $159,291,000 at December 31, 1998 and 1997, and
were 37.3% and 37.8%, of total assets on those dates. The increase in liquid
assets in 1998 is primarily due to a higher than typical federal funds sold
position at December 31, 1998 compared to December 31, 1997. Liquidity is also
affected by collateral requirements
10
of its public agency deposits and certain borrowings. Total pledged
securities were $46,023,000 at December 31, 1998 and $45,812,000 at December
31, 1997.
Although the Company's primary sources of liquidity include liquid assets
and a stable deposit base, the Company maintains lines of credit with certain
correspondent banks and the Federal Reserve Bank aggregating $16,197,000 of
which $5,103,000 was outstanding as of December 31, 1998. This compares with
lines of credit of $27,405,000 of which $16,004,000 was outstanding as of
December 31, 1997. Management believes that the Company maintains adequate
amounts of liquid assets to meet its liquidity needs.
INTEREST RATE RISK MANAGEMENT
The Company's success is largely dependent upon its ability to manage
interest rate risk. Interest rate risk can be defined as the exposure of the
Company's net interest income to adverse movements in interest rates. Although
the Company manages other risks, such as credit and liquidity risk, in the
normal course of its business, management considers interest rate risk to be its
most significant market risk and could potentially have the largest material
effect on the Company's financial condition and results of operations.
Correspondingly, the overall strategy of the Company is to manage interest rate
risk, through balance sheet structure, to be interest rate neutral. The Company
does not currently engage in trading activities or use derivative instruments to
control interest rate risk. Even though such activities may be permitted with
the approval of the Board of Directors, the Company does not intend to engage in
such activities in the immediate future.
The Company's interest rate risk management is the responsibility of the
Asset/Liability Management Committee ("ALCO"), which reports to the Board of
Directors. ALCO establishes policies that monitors and coordinates the Company's
sources, uses and pricing of funds. ALCO is also involved in formulating the
economic projections for the Company's budget and strategic plan. ALCO sets
specific rate sensitivity limits for the Company. ALCO monitors and adjusts the
Company's exposure to changes in interest rates to achieve predetermined risk
targets that it believes are consistent with current and expected market
conditions.
The Company's net income is dependent on its net interest income. Net
interest income is susceptible to interest rate risk to the degree that
interest-bearing liabilities mature or reprice on a different basis than
interest-earning assets. When interest-bearing liabilities mature or reprice
more quickly than interest-earning assets in a given period, a significant
increase in market rates of interest could adversely affect net interest income.
Similarly, when interest-earning assets mature or reprice more quickly than
interest-bearing liabilities, falling interest rates could result in a decrease
in net interest income.
The primary analytical tool used by the Company to gauge interest rate
sensitivity is an analytical model used by many other financial institutions.
Based on the current portfolio mix, this model is used to estimate the effects
of changes in market rates on the Company's net interest income. This model's
estimate of interest rate sensitivity takes into account the differing time
intervals and differing rate change increments of each type of interest
sensitive asset and liquidity. This test measures the impact on net interest
income of change in market interest rates in 100 basis point increments over the
next twelve month period.
Following is the estimated impact of immediate changes in interest rates at
the specified levels at December 31, 1998:
- -------------------------------------------------------------------------------------------------------------
CHANGE IN INTEREST RATES PERCENTAGE CHANGE
(IN BASIS POINTS) NET INTEREST INCOME(1) IN NET INTEREST INCOME
- -------------------------------------------------------------------------------------------------------------
+200 $ (388,000) (1.85%)
-200 $ (204,000) ( .97%)
- -------------------------------------------------------------------------------------------------------------
(1) THE AMOUNT IN THIS COLUMN REPRESENTS THE CHANGE IN NET INTEREST INCOME
FOR 12 MONTHS IN A STABLE INTEREST RATE ENVIRONMENT VERSUS THE NET INTEREST
INCOME IN THE VARIOUS RATE SCENARIOS.
The Company's primary objective in managing interest rate risk is to
minimize the adverse impact of changes in interest rates on the Company's net
interest income and capital, while structuring the Company's asset-liability
structure to obtain the maximum yield-cost spread on that structure. The Company
relies primarily on its asset-liability structure to control interest rate risk.
Based upon the December 31, 1998 mix of interest sensitive assets and
liabilities, given sustained increase in the federal funds rate of 2%, this
model estimates the Company's cumulative net interest
11
income over the next year would decrease by $388,000. This compares with a
cumulative one year expected increase in net interest income of $13,000 as of
December 31, 1997. As this measure of interest rate risk indicates, the
Company is not subject to significant risk of change in its net interest
margin as a result of changes in interest rates.
CAPITAL RESOURCES
Capital serves as a source of funds and helps protect depositors against
potential losses. In 1997, the Company completed a common stock offering which
netted the Company $17,951,000 to add to its capital resources. This addition to
capital was necessary to maintain favorable capital ratios through the Company's
purchase of the three branches from Bank of America, and to support internal
growth on the Company's balance sheet.
The Company is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate mandatory and possibly additional discretionary
actions by the regulators that, if undertaken, could have a material effect on
the Company's financial statements. Management believes, as of December 31,
1998, that the Company, the Bank and the Thrift meet all capital requirements to
which they are subject. The Company's leverage capital ratio at December 31,
1998 was 7.58% as compared with 8.58% as of December 31, 1997. The Company's
risk-based capital ratio at December 31, 1998 was 11.94% as compared to 12.78%
as of December 31, 1997.
Capital ratios are reviewed on a regular basis to ensure that capital
exceeds the prescribed regulatory minimums and is adequate to meet the Company's
future needs. All ratios are in excess of the regulatory definitions of "well
capitalized". Management believes that, under the current regulations, the
Company will continue to meet its minimum capital requirements in the
foreseeable future.
The Company has no formal dividend policy, and dividends are issued solely
at the discretion of the Company's Board of Directors, subject to compliance
with regulatory requirements. In order to pay any cash dividend, the Company
must receive payments of dividends or management fees from the Bank or the
Thrift. There are certain regulatory limitations on the payment of cash
dividends by bank and thrift and companies. Notwithstanding the following
regulatory resolutions, the subsidiaries have the ability to pay cash dividends
at December 31, 1998 of $5,779,000.
As a result of a joint examination of the Bank conducted as of January 12,
1998 by the Federal Deposit Insurance Corporation (the "FDIC") and the
Department of Financial Institutions (the"DFI"), the FDIC and the DFI have
required the Bank to enter into a Memorandum of Understanding requiring the Bank
to do the following:
1) Conduct a comprehensive management review of the Bank's executive
management to maintain a management structure suitable to its needs in
light of its recent rapid growth.
2) Have and retain qualified management with qualifications and experience
commensurate with their duties and responsibilities at the Bank.
3) Develop a plan to reduce the Bank's economic value of equity exposure to
loss from interest rate changes to acceptable levels.
4) Formulate, adopt and implement a comprehensive risk management process that
will strengthen management expertise and improve securities portfolio
management and management information and measurement systems.
5) Establish and maintain an adequate allowance for loan losses and develop
and revise, adopt and implement a comprehensive policy to ensure the
adequacy of the allowance for loan losses.
6) Develop, adopt and implement a plan to control overhead and restore the
Bank's profitability.
7) Correct deficiencies relating to the Year 2000 project.
8) Furnish written progress reports.
As of the date of this report, the Company believes it is in substantial
compliance with all the terms of the agreement.
A Memorandum of Understanding is an enforceable agreement. Failure to
comply with its terms can lead to further enforcement action by bank regulators,
including cease-and-desist orders, imposition of a receiver or conservator,
termination of deposit insurance, imposition of civil money penalties and
removal and prohibition orders against institution-affiliated parties.
12
IMPACT OF INFLATION
The primary impact of inflation on the Company is its effect on interest
rates. The Company's primary source of income is net interest income which is
affected by changes in interest rates. The Company attempts to limit inflation's
impact on its net interest margin through management of rate-sensitive assets
and liabilities and the analysis of interest rate sensitivity. The effect of
inflation on premises and equipment, as well as noninterest expenses, has not
been significant for the periods covered in this report.
MARKET FOR COMPANY'S COMMON STOCK AND RELATED STOCK MATTERS
The Company's stock is included for quotation on the Nasdaq National Market
System with a stock quotation symbol of CCOW.
The following table indicates the range of high and low sales prices for
the period shown, based upon information provided by the Nasdaq National Market
System.
- --------------------------------------------------------------------------
1998 High Low
- --------------------------------------------------------------------------
4th quarter $12.00 $9.38
3rd quarter 13.37 9.81
2nd quarter 15.35 12.75
1st quarter $14.28 $11.67
1997 High Low
- --------------------------------------------------------------------------
4th quarter $ 14.00 $ 10.33
3rd quarter 14.50 12.25
2nd quarter 14.13 10.75
1st quarter $ 11.08 $ 8.50
- --------------------------------------------------------------------------
Generally, the Company has retained earnings to support the growth of
the Company and has not paid regular cash dividends. In 1998 the Company paid
a 5% stock dividend for shareholders of record as of May 7, 1998. The Company
declared a 3 for 2 stock split in 1997 for shareholders on record as of April
11, 1997. This resulted in an additional 869,485 shares of stock being issued
in 1997.
YEAR 2000
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium (Year 2000) approaches. The "Year
2000" problem is pervasive and complex as virtually every computer operation
will be affected in some way by the rollover of the two digit year value to 00.
The issue is whether computer systems will properly recognize date sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail.
The impact of Year 2000 ("Y2K") issues on the Company will depend not only
on corrective actions that the Company takes, but also on the way in which Year
2000 issues are addressed by governmental agencies, businesses and other third
parties that provide services or data to, or receive services or data from, the
Company, or whose financial condition or operational capability is important to
the Company
The Company has a Y2K compliance plan that has been approved by the board
of directors. The board of directors is updated monthly on the progress of the
plan. The Company is utilizing both internal and external resources to identify,
correct, or reprogram the systems in order that they be Y2K compliant. The
Company's core banking system, Jack Henry Associates Inc. Silverlake, issued a
new software release in August 1998 that is Y2K compliant.
In addition to a review and testing of the Jack Henry Associates Inc.
Silverlake product, the Company's Y2K plan also addresses internal systems,
customer systems, and vendor systems, including its non-information technology
systems, which might be effected by the century date change. The Company is on
schedule to meet all internal deadlines set in the plan. The Company's Y2K plan
takes a systematic approach to identifying and resolving the hardware and
software problems inherent with this date change.
The Company's Y2K plan is broken into six phases. The awareness phase is
ongoing throughout the project. This started with an internal training program
to raise the awareness of employees to the Y2K problems and the steps being
taken by the Company to resolve these. These training efforts have been
13
expanded to include customers and the general community through community
meetings with civic organizations, and Chambers of Commerce. The inventory
phase, which is completed, included such actions as creating a master
inventory of all systems within the Company which might be affected by Y2K.
The evaluation phase, completed as well, consisted of rating each inventoried
system's importance to the day-to-day operation of the Company. The most
important systems were rated as "mission critical." The renovation phase is
in progress and is 80% completed. During this phase, the vendors for each
software and hardware system have been contacted and either (a) notified the
Company that their product is Y2K compliant, (b) notified the Company as to
when a Y2K compliant product will be available or, (c) notified the Company
that their product is not Y2K compliant and they have no intention of making
it so. The fifth phase is the testing phase, which is 70% complete as of
February 28. 1999. This is by far the costliest and most time consuming part
of the project. Each mission critical system must be tested for Y2K
compliance. This includes the Company's core application software and its
data communications systems. Additionally, the Company is testing many of its
other systems which have been deemed non-mission critical. Implementation is
the last phase and involves putting the new Y2K compliant software into
production. This phase is 60% complete as of February 28, 1999.
The Company continues to have ongoing communication with significant
customers and vendors to determine the extent and provide risk mitigation
strategies for those risks created by third parties' failure to remediate their
own Y2K issues. However, it is not possible, at present, to determine the
financial effect if significant customer and vendor remediation efforts are not
resolved in a timely manner.
The estimated cost to the Company of the Y2K project is projected to be
approximately $400,000. Hard costs consist of 30% of this amount, while the
remainder is made up of soft costs such as meeting time. No major projects have
been delayed or canceled due to these costs. During 1998, the Company has
incurred approximately $80,000 in Y2K plan expenses.
Failure to address all Y2K issues could result in substantial interruptions
to the Company's normal business activities. These interruptions could, in turn,
affect the organizations financial condition as well as the business activities
of its customers. Through the efforts involved in its Y2K project, no major
interruptions are expected. However, due to the uncertainty involved in the Year
2000 problem, all of the effects of the century date change to the organization
cannot be absolutely determined. Given the Y2K project progress to date and with
successful implementation of the remaining phases of the project, management
believes that the Company is well positioned to significantly reduce potential
negative effects that may occur.
Although at this time it is not possible to determine the extent of the
adverse financial effects with any specificity, the Company is preparing a
contingency plan if disruptions occur. The contingency plan would allow the
Company to continue operations in the event the Company, or its key suppliers,
customers, or third party service providers will not be Year 2000 compliant, and
such noncompliance is expected to have a material adverse impact on the
Company's operations. The plan includes, but is not limited to, generating a
paper reprt listing from all the company's systems on the last day of the year,
and having apaper receipts, forms, and other required documents ready in order
to be able to operate manually, without any computer access, beginning in
January, year 2000 if necessary.
The dates on which the Company believes the Y2K Project will be completed
and implemented are based on management's best estimates, which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain financial resources, third-party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved, or that there will not be a delay in, or increased costs associated
with the implementation of the Y2K Project. Specific factors that might cause
differences between the estimates and actual results include, but are not
limited to, the availability and cost of personnel trained in these areas, the
ability to locate and correct all relevant computer code, timely responses to
and corrections by third-parties and suppliers, the ability to implement
interfaces between the new systems and the systems not being replaced, and
similar uncertainties. Due to the general uncertainty inherent in the Year 2000
problem, resulting in part from the uncertainty of the Year 2000 readiness of
third-parties and the interconnection of global businesses, the Company cannot
ensure its ability to timely and cost-effectively resolve problems associated
with the Year 2000 issue that may affect its operations and business, or expose
it to third-party liability.
PROSPECTIVE ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES" ("SFAS 133"), which
14
amends the disclosure requirements of Statement no. 52, "FOREIGN CURRENCY
TRANSLATIONS" and of Statement No. 107, "DISCLOSURES ABOUT FAIR VALUE OF
FINANCIAL INSTRUMENTS." SFAS 133 supersedes Statements No.80 "ACCOUNTING FOR
FUTURE CONTRACTS," No. 105 "DISCLOSURE OF INFORMATION ABOUT FINANCIAL
INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND FINANCIAL INSTRUMENTS WITH
CONCENTRATIONS OF CREDIT RISK" and No. 119, "Disclosure about DERIVATIVE
FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS. Under the
provisions of SFAS 133, the Company is required to recognize all derivatives
as either assets or liabilities in the statement of financial condition and
measure those instruments at fair value. If certain conditions are met, a
derivative may be specifically designated as (a) a hedge of the exposure to
changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash
flows of a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, and available-for-sale security or a foreign-currency-denominated
forecasted transaction. The accounting for changes in the fair value of a
derivative (that is, gains and losses) depends on the intended use of the
derivative and the resulting operation. SFAS 133 is effective for all fiscal
quarters of fiscal years beginning September 15, 1999, with early application
encouraged, but it is permitted only as of the beginning of any fiscal
quarter that begins after the issuance of the statement. SFAS 133 should not
be applied retroactively to financial statements of prior periods. The
Company does not expect that the adoption of SFAS 133 will have a material
impact on its financial condition.
15
Capital Corp of the West
Consolidated Balance Sheets
As of December 31,
------------------
1998 1997
(Dollars in thousands)
ASSETS
Cash and noninterest-bearing deposits in other banks $ 25,771 $ 21,035
Federal funds sold 19,125 2,400
Time deposits at other financial institutions 600 599
Investment securities available for sale, at fair value 141,357 135,257
Investment securities held to maturity, at cost 13,510 12,775
Loans, net 264,158 214,144
Interest receivable 3,272 2,741
Premises and equipment, net 13,319 12,945
Goodwill and other intangible assets 5,865 6,653
Other assets 12,882 12,845
------------ -----------
Total assets $ 499,859 $421,394
------------ -----------
------------ -----------
LIABILITIES
Deposits:
Noninterest-bearing demand $ 80,290 $ 58,836
Negotiable orders of withdrawal 71,526 54,202
Savings 165,781 143,562
Time, under $100,000 84,011 69,534
Time, $100,000 and over 42,602 30,261
------------ -----------
Total deposits 444,210 356,395
Borrowed funds 10,466 22,049
Accrued interest, taxes and other liabilities 2,379 2,702
------------ -----------
Total liabilities 457,055 381,146
SHAREHOLDERS' EQUITY
Preferred stock, no par value; 10,000,000 shares authorized;
none outstanding
Common stock, no par value; 20,000,000 shares authorized;
4,607,102 and 4,376,975 issued and outstanding 37,142 33,928
Retained earnings 5,634 6,125
Accumulated other comprehensive income 28 195
------------ -----------
Total shareholders' equity 42,804 40,248
------------ -----------
Total liabilities and shareholders' equity $ 499,859 $ 421,394
------------ -----------
------------ -----------
See accompanying notes to consolidated financial statements
Capital Corp of the West
Consolidated Statements of Income and Comprehensive Income
Years Ended December 31,
--------------------------------------------------
(Dollars in thousands) 1998 1997 1996
INTEREST INCOME:
Interest and fees on loans $ 25,159 $ 20,646 $ 16,302
Interest on deposits with other financial 57 53 127
institutions
Interest on investment securities held to maturity:
Taxable 1,257 828 60
Interest on investment securities available for sale:
Taxable 6,091 3,810 2,409
Non-taxable 797 231 246
Interest on federal funds sold 1,253 344 207
-------- --------- --------
Total interest income 34,614 25,912 19,351
INTEREST EXPENSE:
Deposits
Negotiable orders of withdrawal 503 345 268
Savings 5,696 4,770 4,350
Time, under $100,000 4,418 3,174 1,808
Time, $100,000 and over 1,725 809 359
-------- --------- --------
Total interest on deposits 12,342 9,098 6,785
Other 1,292 1,092 80
-------- --------- --------
Total interest expense 13,634 10,190 6,865
Net interest income 20,980 15,722 12,486
Provision for loan losses 3,903 5,825 1,513
-------- --------- --------
Net interest income after provision for loan losses 17,077 9,897 10,973
OTHER INCOME:
Service charges on deposit accounts 2,807 1,709 1,274
Income from real estate held for sale or development 540 879 508
Other 1,491 1,264 1,153
-------- --------- --------
Total other income 4,838 3,852 2,935
OTHER EXPENSES:
Salaries and related benefits 7,958 6,133 5,283
Premises and occupancy 1,325 1,235 835
Equipment 2,155 1,446 1,022
Professional fees 1,203 552 755
Supplies 609 538 292
Marketing 656 590 370
Goodwill and intangible amortization 778 111 48
Other 3,560 2,767 2,131
-------- --------- --------
Total other expenses 18,244 13,372 10,736
Income before provision (benefit) for income taxes 3,671 377 3,172
Provision (benefit) for income taxes 930 (26) 1,163
-------- --------- --------
Net income $ 2,741 $ 403 $ 2,009
- --------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME:
Unrealized (loss) gain on securities arising during the period (112) 246 (374)
Less: reclassification adjustment for (gains) losses
included in net income (55) 18 (7)
-------- --------- --------
Comprehensive income $ 2,574 $ 667 $ 1,628
-------- --------- --------
-------- --------- --------
- --------------------------------------------------------------------------------------------------------------
Basic earnings per share $ 0.60 $ 0.12 $ 0.81
Diluted earnings per share $ 0.58 $ 0.11 $ 0.77
See accompanying notes to consolidated financial statements
Capital Corp of the West
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31,
--------------------------------------------
(Dollars in thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 2,741 $ 403 $ 2,009
Adjustments to reconcile net income to net cash provided (used)
by operating activities:
Provision for loan losses 3,903 5,825 1,513
Depreciation, amortization and accretion, net 3,374 1,661 1,023
Provision (benefit) for deferred income taxes 310 499 (327)
Gain (loss) on sale of real estate held for sale 354 (879) (348)
Net increase in interest receivable & other assets (686) (4,012) (5,044)
Net decrease (increase) in mortgage loans held for sale - 880 (376)
Net (decrease) increase in deferred loan fees (1,085) 167 54
Net (decrease) increase in accrued interest payable & other (763) 703 1,330
liabilities
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities 8,148 5,247 (166)
- ---------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Investment security purchases - available for sale securities (46,213) (23,360) (17,198)
Investment security purchases - mortgage-backed securities
and collateralized mortgage obligations (27,863) (119,734) (9,795)
Proceeds from maturities of investment securities 3,127 7,433 9,530
Proceeds from sales of held to maturity investment securities - 2,013 -
Proceeds from maturities of mortgage-backed securities and
collateralized mortgage obligations 35,752 13,861 8,069
Proceeds from sales of available for sale investment
securities 9,088 12,833 14,590
Proceeds from sales of mortgage-backed securities and
collateralized mortgage obligations 18,131 2,410 -
Net (increase) decrease in time deposits in other financial
institutions (1) 2,502 -
Proceeds from sales of commercial and real estate loans 6,826 5,972 3,230
Net increase in loans (60,136) (45,717) (35,017)
Purchases of premises and equipment (2,090) (7,904) (2,768)
Proceeds from sales of premises and equipment - - 9
Construction of real estate held for sale or development - - (417)
Proceeds from sales of real estate held for sale or
development 478 1,470 765
Purchase of subsidiary - - (183)
Purchase of intangible assets - (4,343) -
- ---------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (62,901) (152,564) (29,185)
- ---------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net increase in demand, NOW and savings deposits 60,997 71,856 13,812
Net increase in certificates of deposit 26,818 46,194 9,109
Net (decrease) increase in other borrowings (11,583) 17,378 3,896
Issuance of common stock - 17,951 -
Issued shares for benefit plan purchases - 217 162
Fractional shares purchased (6) - (86)
Exercise of stock options, net (12) 439 208
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 76,214 154,035 27,101
- ---------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 21,461 6,718 (2,250)
Cash and cash equivalents at beginning of year 23,435 16,717 18,967
- ---------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 44,896 $ 23,435 $ 16,717
- ---------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of non-cash investing and financing activities:
Investment securities net unrealized (losses) gains, net of taxes $ (167) $ 264 $ (381)
Interest paid 13,524 10,073 6,244
Income tax payments 1,564 1,185 1,126
Transfer of securities from available for sale to held to maturity 9,636 11,455 -
Loans transferred to other real estate owned 478 64 1,524
- ---------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Capital Corp of the West
Consolidated Statements of Shareholders' Equity
COMMON STOCK ACCUMULATED
----------------------------- OTHER
NUMBER OF RETAINED COMPREHENSIVE
(Dollars in thousands ) SHARES AMOUNTS EARNINGS INCOME TOTAL
- -----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 1,990 $ 9,870 $ 4,911 $ 312 $ 15,093
- -----------------------------------------------------------------------------------------------------------------------------
5% stock dividend and $.03 per share
cash dividend, including payment
for fractional shares 123 1,112 (1,198) - (86)
Exercise of stock options 33 208 - - 208
Issuance of shares pursuant to
401K & ESOP plans 18 162 - - 162
Acquisition of Town & Country
Finance & Thrift 427 3,969 - - 3,969
Change in fair value of investment
securities, net of tax effect of
($247) - - - (381) (381)
Net income - - 2,009 - 2,009
- -----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 2,591 $ 15,321 $ 5,722 $ (69) $ 20,974
- -----------------------------------------------------------------------------------------------------------------------------
Exercise of stock options 47 439 - - 439
Issuance of shares pursuant to
401K & ESOP plans 14 217 - - 217
Issuance of shares pursuant to
stock offering 1,725 17,951 - - 17,951
Change in fair value of investment
securities, net of tax effect of
$172 - - - 264 264
Net income - - 403 - 403
- -----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 4,377 $ 33,928 $ 6,125 $ 195 $ 40,248
- -----------------------------------------------------------------------------------------------------------------------------
5% stock dividend, including payment
for fractional shares 219 3,226 (3,232) - (6)
Exercise of stock options 11 109 - - 109
Net change in fair market value of
Investment securities, net of tax
effect of ($106,000) - - - (167) (167)
Adjustment - stock option plan - (121) - - (121)
Net income - - 2,741 - 2,741
- -----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 4,607 $37,142 $ 5,634 $ 28 $ 42,804
- -----------------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Capital Corp of the West (the "Company") is a registered bank holding
Company, which provides a full range of banking services to individual and
business customers primarily in the Central San Joaquin Valley, through its
subsidiaries. The following is a description of the more significant policies.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements of Capital
Corp of the West includes its subsidiaries; County Bank (the "Bank"), and Town &
Country Finance and Thrift (the "Thrift") and Capital West Group ("CWG"). CWG, a
subsidiary formed in 1996, became inactive in 1997. The Bank also has one active
subsidiary, Merced Area Investment and Development, Inc. ("MAID"). All
significant intercompany balances and transactions are eliminated.
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles and prevailing practices in the
financial services industry. In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reported period. Actual results could
differ from those estimates applied in the preparation of the consolidated
financial statements. Certain reclassifications have been made to prior years'
consolidated financial statements to conform to the 1998 presentation.
CASH AND CASH EQUIVALENTS: The Company maintains deposit balances with various
banks which are necessary for check collection and account activity charges.
Cash in excess of immediate requirements is invested in federal funds sold or
other short term investments. Generally, federal funds are sold for periods from
one to thirty days. Cash, noninterest bearing deposits in other banks and
federal funds sold are considered to be cash and cash equivalents for the
purposes of the consolidated statements of cash flows. At December 31, 1998, the
Company's cash reserve balances as required by the Federal Reserve Bank were
approximately $243,000.
INVESTMENT SECURITIES: Investment securities consist of U.S. treasury, federal
agencies, states and counties municipal securities, corporate bonds,
mortgage-backed securities, collateralized mortgage obligations, and equity
securities. Investment securities are classified into one of three categories.
These categories include trading, available for sale, and held to maturity. The
category of each security is determined based on the Company's investment
objectives, operational needs and intent. The Company does not purchase
securities with the intent of actively trading them.
Securities available for sale may be sold prior to maturity and are
available for future liquidity requirements. These securities are carried at
fair value. Unrealized gains and losses on securities available for sale are
excluded from earnings and are reported net of tax as a separate component of
shareholders' equity until realized.
Securities held to maturity are classified as such where the Company has
the ability and positive intent to hold them to maturity. These securities are
carried at cost, adjusted for amortization of premiums and accretion of
discounts. Unrealized losses due to fluctuations in fair value of securities
held to maturity or available for sale, are recognized when it is determined
that an other than temporary decline in value has occurred.
Premiums and discounts are amortized or accreted over the life of the
related investment security as an adjustment to yield using the effective
interest method. Dividend and interest income are recognized when earned.
Realized gains and losses for securities classified as available for sale or
held to maturity, are included in earnings and are derived using the specific
identification method for determining the cost of securities sold.
LOANS: Loans are carried at the principal amount outstanding, net of unearned
income, including deferred loan origination fees and costs. Nonrefundable loan
origination and commitment fees and the direct costs associated with originating
or acquiring the loans are deferred and amortized as an adjustment to interest
income over the life of the related loan.
Interest income on loans is accrued based on contract interest rates and
principal amounts outstanding. Loans which are more than 90 days delinquent with
respect to interest or principal, are placed on nonaccrual status, unless the
outstanding principal and interest is adequately secured and, in the opinion of
management, remains collectible. Uncollected accrued interest is reversed
against interest income, and
1
interest is subsequently recognized only as received until the loan is
returned to accrual status. Interest accruals are resumed when such loans are
brought fully current with respect to interest and principal and when, in the
judgment of management, the loans are estimated to be fully collectable as to
both principal and interest.
A loan is considered impaired, if it is probable that the Company will be
unable to collect the scheduled payments of principal and interest when due
according to the contractual terms of the loan agreement. Any allowance on
impaired loans is measured based upon the present value of future cash flows
discounted at the loan's effective rate, the loan's observable market price, or
the fair value of collateral if the loan is collateral dependent. Interest on
impaired loans is recognized on a cash basis. In general, these statements are
not applicable to large groups of small balance homogenous loans that are
collectively evaluated for impairment, such as residential mortgage and consumer
installment loans. Income recognition on impaired loans conforms to the method
the Company uses for income recognition on nonaccrual loans. Interest income on
nonaccrual loans is recorded on a cash basis. Payments may be treated as
interest income or return of principal depending upon management's opinion of
the ultimate risk of loss on the individual loan. Cash payments are treated as
interest income when management believes the remaining principal balance is
fully collectible.
ALLOWANCE FOR LOAN LOSSES: The allowance is maintained at the level considered
to be adequate for potential loan losses based on management's assessment of
various factors affecting the loan portfolio, which include: growth trends in
the portfolio, historical experience, concentrations of credit risk, delinquency
trends, general economic conditions, and internal and external credit reviews.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for credit
losses. Such agencies may require the Company to recognize additions to the
allowance for loan losses based on their judgment of information available to
them at the time of their examination. Additions to the allowance for loan
losses, in the form of provision for loan losses, are reflected in current
operating results, while charge-offs to the allowance for loan losses are made
when a loss is determined to have occurred. Management uses the best information
available on which to base estimates, however, ultimate losses may vary from
current estimates.
GAIN OR LOSS ON SALE OF LOANS AND SERVICING RIGHTS: The Company services both
sold and retained portions of United States Small Business Administration (SBA)
loans and a portfolio of mortgage loans. The Company applies the provisions for
loan losses of Statement of Financial Accounting Standards (SFAS) No. 125,
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS
OF LIABILITIES. This statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of liabilities
based on consistent application of a financial-components approach that focuses
on control. It distinguishes transfers of financial assets that are sales from
transfers that are secured borrowings. In addition, it requires that servicing
assets and other retained interests in transferred assets be measured by
allocating the previous carrying amount of the transferred assets between the
assets sold, if any, based on their relative fair values at the date of
transfer. Liabilities and derivatives incurred or obtained by transferors as
part of a transfer of financial assets are to be initially measured at fair
value. Servicing assets and liabilities, which are carried at the lower of cost
or market, are to be subsequently amortized in proportion to and over the period
of, estimated net servicing income or loss and assessed for asset impairment or
increased obligation based on fair value.
The Bank recognizes a gain and a related asset for the fair value of the
rights to service loans for others when loans are sold. In accordance with SFAS
No. 125, the fair value of the servicing assets are estimated based upon the
present value of the estimated expected future cash flows. The cash flows are
calculated using a discount rate commensurate with the risk involved and include
estimates of future revenues and expenses, including assumptions about defaults
and prepayments. The Company measures the impairment of the servicing asset
based on the difference between the carrying amount of the servicing asset and
its current fair value. As of December 31, 1998 and 1997, there was no
impairment in mortgage servicing assets.
A gain or loss is recognized to the extent that the sales proceeds and the
fair value of the servicing asset exceed or are less than the book value of the
loan. Additionally, a normal cost for servicing the loan is considered in the
determination of the gain or loss.
2
When servicing rights are sold, a gain or loss is recognized at the closing
date to the extent that the sale proceeds, less costs to complete the sale,
exceed or are less than the carrying value of the servicing rights held.
Real estate mortgage loans held for sale are carried at the lower of cost
or market at the balance sheet date or the date on which investors have
committed to purchase such loans. Gains or losses are recognized at the time of
sale and are calculated based on the amounts received and the book value of the
loans sold.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation and amortization are
computed on the straight line basis over the estimated useful life of each
type of asset. Estimated useful lives range up to 35 years for buildings, up
to the lease term for leasehold improvements, and 3 to 15 years for furniture
and equipment.
REAL ESTATE HELD FOR SALE OR DEVELOPMENT: Real estate held for sale or
development is recorded at the lower of cost or net realizable value.
Revenue recognition on the disposition of real estate is dependent upon
the transaction meeting certain criteria relating to the nature of the
property sold and the terms of the sale. Under certain circumstances, revenue
recognition may be deferred until these criteria are met.
INTANGIBLE ASSETS: Goodwill, representing the excess of purchase price over
the fair value of net assets acquired, resulted from the purchase of the
Thrift by the Company. Goodwill is being amortized over 18 years. Core
deposit intangibles resulting from the Thrift and branch purchases (as
discussed in Note 2), are amortized over 10 and 7 years, respectively.
Intangible assets are reviewed on a periodic basis for impairment. If such
impairment is indicated, recoverability of the asset is assessed based upon
expected undiscounted net cash flows.
OTHER REAL ESTATE: Other real estate is comprised of property acquired
through foreclosure proceedings or acceptance of deeds-in-lieu of
foreclosure. Losses recognized at the time of acquiring property in full or
partial satisfaction of debt are charged against the allowance for loan
losses. Other real estate is recorded at the lower of the related loan
balance or fair value, less estimated disposition costs. Fair value of other
real estate is generally based on an independent appraisal of the property.
Any subsequent costs or losses are recognized as noninterest expense when
incurred.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF:
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets
to be held and used is measured by a comparison of the carrying amount of an
asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceed the
fair value of the assets. Assets to be disposed of are reported at the lower
of the carrying amount or fair value less costs to sell.
INVESTMENT TAX CREDITS: The Company has investments in limited partnerships
which own low income affordable housing that provides the investor affordable
housing income tax credits. As an investor in these partnerships, the Company
receives tax benefits in the form of tax deductions from partnership
operating losses and income tax credits. These income tax credits are earned
over a 10 year period as a result of the investment meeting certain criteria
and are subject to recapture over a 15 year period. The expected benefit
resulting from the affordable housing income tax credits is recognized in the
period in which the tax benefit is recognized in the Company's consolidated
tax returns. These investments are accounted for using the cost method and
are evaluated at each reporting period for impairment. The Bank had
investments in these partnerships of $4,300,000 as of December 31, 1998 and
1997.
DEFERRED COMPENSATION: The Company has purchased single premium universal
life insurance policies in conjunction with implementation of salary
continuation plans for certain members of management and a deferred
compensation plan for certain members of the Board of Directors. The Company
is the owner and beneficiary of these plans. The cash surrender value of the
insurance policies is recorded in other assets and these values totaled
$4,111,000 and $3,389,000 as of December 31, 1998 and 1997. Income from these
policies is recorded in other income and the load, mortality and surrender
charges have been recorded in
3
other expenses. An accrued liability is recorded to reflect the present value
of the expected retirement benefits for the salary continuation plans and the
deferred compensation benefits.
INCOME TAXES: The Company files a consolidated federal income tax return and a
combined state franchise tax return. The provision for income taxes includes
federal income and state franchise taxes. Income tax expense is allocated to
each entity of the Company based upon the analysis of the tax consequences of
each company on a stand alone basis.
The Company accounts for income taxes under the asset and liability method.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
STOCK OPTION PLAN: The Company accounts for its stock option plan in accordance
with Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES, and related interpretations. As such, compensation expense
would be recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price.
EARNINGS PER SHARE: Basic earnings per share (EPS) includes no dilution and is
computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution of securities that could share in the earnings
of an entity. The number of shares outstanding for 1998, 1997, and 1996 have
been adjusted to reflect the 5% dividend declared in 1998 and 1996, and the 3
for 2 stock split that occurred in 1997.
COMPREHENSIVE INCOME: On January 1, 1998, the Company adopted SFAS No. 130,
REPORTING COMPREHENSIVE INCOME. SFAS No. 130 establishes standards for reporting
and presentation of comprehensive income and its components in a full set of
financial statements. Comprehensive income consists of net income and unrealized
gains (losses) on securities and is presented in the consolidated statements of
income and comprehensive income. The statement requires only additional
disclosures in the consolidated financial statements; it does not affect the
Company's financial position or results of operations. Prior year financial
statements have been reclassified to conform to the requirements of SFAS No.
130.
SEGMENT REPORTING: On January 1, 1998,the Company adopted SFAS No. 131,
FINANCIAL REPORTING FOR SEGMENTS OF A BUSINESS ENTERPRISE. SFAS No. 131 requires
corporations to disclose certain financial information by "industry segment" as
defined by the statement. As of December 31, 1998 the Company does not have
separate reportable segments.
NOTE 2. ACQUISITIONS
On December 11, 1997 the Company acquired, for $5,310,000, deposits and
buildings of three former branches of Bank of America. These branches were
merged into the Bank, and added $60,849,000 in deposits and $967,000 in
buildings and equipment. The transaction was accounted for under the purchase
method of accounting. In connection with the transaction, the Bank recorded a
core deposit intangible of $4,343,000, which is being amortized using the
straight line method over 7 years.
In conjunction with the purchase of the branches, the Company completed a
capital offering which increased common stock shares outstanding by 1,725,000
and increased shareholders' equity by $17,951,000. This capital was used to
support the purchase of the branches and for general Company growth.
Effective June 28, 1996, the Company purchased the Thrift for a total
purchase price of $5,823,000. The purchase was made using a combination of stock
and cash. The transaction was accounted for under the purchase method of
accounting and the Thrift is operated as a separate subsidiary by the Company.
In connection with this transaction, goodwill of $2,023,000 was recorded which
will be amortized over an estimated 18 years. A core deposit intangible of
$460,000, to be amortized over 10 years was recorded, along with a fair value
adjustment to loans of $185,000 to be amortized over three years.
4
NOTE 3. INVESTMENT SECURITIES
The amortized cost and estimated market value of investment securities at
December 31, are summarized below:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
(Dollars in thousands) COST GAINS LOSSES VALUE
1998
AVAILABLE FOR SALE SECURITIES:
U.S. Treasury & U.S. Government agencies $ 12,631 $ 101 $ 21 $ 12,711
State & political subdivisions 30,177 393 378 30,192
Mortgage-backed securities 56,214 189 355 56,048
Collateralized mortgage obligations 29,305 128 169 29,264
Corporate debt securities 9,718 210 50 9,878
--------- ------- -------- ---------
Total debt securities 138,045 1,021 973 138,093
Equity securities 3,264 - - 3,264
--------- ------- -------- ---------
Total available for sale securities 141,309 1,021 973 141,357
--------- ------- -------- ---------
HELD TO MATURITY SECURITIES:
U.S. Treasury & U.S. government agencies 2,024 12 - 2,036
Mortgage-backed securities 11,486 66 4 11,548
--------- ------- -------- ---------
Total held to maturity securities 13,510 78 4 13,584
--------- ------- -------- ---------
Total investment securities $ 154,819 $ 1,099 $ 977 $ 154,941
========= ========= ======== =========
1997
AVAILABLE FOR SALE SECURITIES:
U.S. Treasury & U.S. Government agencies $ 1,819 $ 6 $ 1 $ 1,824
State & political subdivisions 9,484 156 - 9,640
Mortgage-backed securities 68,599 350 141 68,808
Collateralized mortgage obligations 51,924 88 138 51,874
--------- ------- -------- ---------
Total debt securities 131,826 600 280 132,146
Equity securities 3,111 - - 3,111
--------- ------- -------- ---------
Total available for sale securities 134,937 600 280 135,257
--------- ------- -------- ---------
HELD TO MATURITY SECURITIES:
U.S. Treasury & U.S. Government agencies 9,442 2 10 9,434
Mortgage-backed securities 3,333 13 - 3,346
--------- ------- -------- ---------
Total held to maturity securities 12,775 15 10 12,780
--------- ------- -------- ---------
Total investment securities $ 147,712 $ 615 $ 290 $ 148,037
========= ========= ======== =========
At December 31, 1998 and 1997, investment securities with carrying
values of approximately $46,023,000 and $45,812,000, respectively, were pledged
as collateral for deposits of public funds, government deposits, the Bank's use
of the Federal Reserve Bank's discount window and Federal Home Loan Bank line of
credit. The Bank is a member of the Federal Home Loan Bank and carried balances,
stated at cost, of $3,109,000 and $2,955,000 of Federal Home Loan Bank stock as
of December 31, 1998 and 1997. The Company recognized gross gains on the sale of
securities of $13,000, $17,000 and $68,000, in 1998, 1997, and 1996. Gross
losses of $16,000, $49,000 and $57,000 were recognized in 1998, 1997, and 1996.
In August 1998, mortgage-backed securities with a market value of
$9,636,000 were transferred from the available for sale portfolio to the held to
maturity portfolio at market value. The unrealized holding gain at the date of
transfer shall continue to be reported as a separate component of shareholders'
equity, but shall be amortized over the remaining life of the securities as an
adjustment of yield in a manner consistent with the amortization of a premium or
discount.
The carrying and estimated fair values of debt securities at December 31,
1998 by contractual maturity, are shown on the following table. Actual
maturities may differ from contractual maturities because issuers generally have
the right to call or prepay obligations with or without call or prepayment
penalties.
AMORTIZED ESTIMATED
(Dollars in thousands) COST FAIR VALUE
- ------------------------------------------------------------------------------------
AVAILABLE FOR SALE DEBT SECURITIES:
One year or less $ 915 $ 923
One to five years 10,758 10,985
Five to ten years 1,667 1,668
Over ten years 39,186 39,228
Mortgage-backed securities and CMOs 85,519 85,289
---------- ----------
Total available for sale debt securities $ 138,045 $ 138,093
========== ==========
HELD TO MATURITY DEBT SECURITIES:
One year or less $ - $ -
One to five years - -
Five to ten years 1,024 1,035
Over ten years 1,000 1,001
Mortgage-backed securities and CMOs 11,486 11,548
---------- ----------
Total held to maturity debt securities $ 13,510 $ 13,584
========== ==========
NOTE 4. LOANS
Loans at December 31 consisted of the following:
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------------------
Commercial $ 37,609 $ 34,992
Agricultural 49,636 43,558
Real estate - mortgage 96,957 70,802
Real estate - construction 13,840 12,657
Consumer 70,891 55,968
---------- ---------
Gross loans 268,933 217,977
Less allowance for loan losses 4,775 3,833
---------- ----------
Net loans $ 264,158 $ 214,144
========== ==========
These loans are net of deferred loan fees of $841,000 in 1998 and
$932,000 in 1997.
Nonaccrual loans totaled $1,032,000, $2,611,000 and $4,968,000 at
December 31, 1998, 1997 and 1996. Foregone interest on nonaccrual loans was
approximately $91,000, $189,000 and $497,000 for the years ending December
31, 1998, 1997 and 1996.
Impaired loans are loans for which it is probable that the Company will
not be able to collect all amounts due. At December 31, 1998 and 1997, the
recorded investment in loans for which impairment was recognized totaled
$1,032,000 and $2,611,000 which had valuation allowance for loan losses of
$114,000 in 1998 and $598,000 in 1997. The average outstanding balance of
impaired loans for the years ended December 31, 1998, 1997 and 1996 was
$1,876,000, $4,715,000, and $6,248,000, on which $134,000, $471,000 and
$625,000, was recognized as interest income.
At December 31, 1998 and 1997, the collateral value method was used to
measure impairment for all loans classified as impaired. The following table
shows the recorded investment in impaired loans by loan category at December
31:
6
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------------
Commercial $ 106 $ 1,711
Agricultural 668 630
Real estate - 5
Consumer and other 258 265
-------- --------
$ 1,032 $ 2,611
======== ========
Following is a summary of changes in the allowance for loan losses during the
years ended December 31:
(Dollars in thousands) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------
Balance at beginning of year $ 3,833 $ 2,792 $ 1,701
Allowance for loan losses acquired through Thrift - - 148
Loans charged-off (3,526) (5,050) (658)
Recoveries of loans previously charged-off 565 266 88
Provision for loan losses 3,903 5,825 1,513
-------- -------- --------
Balance at end of year $ 4,775 $ 3,833 $ 2,792
======== ======== ========
In the ordinary course of business, the Company, through its subsidiaries,
has made loans to certain directors and officers and their related businesses.
In management's opinion, these loans are granted on substantially the same
terms, including interest rates and collateral, as those prevailing on
comparable transactions with unrelated parties, and do not involve more than the
normal risk of collectibility.
Changes to loans to, or guaranteed by, directors and executive offices and
their related businesses at December 31, are summarized as follows:
(Dollars in thousands) 1998 1997
- ----------------------------------------------------------------------------
Balance at beginning of year $ 415 $ 573
Loan advances and renewals 532 497
Loans matured or collected (623) (578)
Other changes (44) (77)
------ ------
Balance at end of year $ 280 $ 415
====== ======
Other changes in 1998 and 1997 represent loans to former directors and
executive officers of the Company who are no longer related parties.
NOTE 5. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31:
(Dollars in Thousands) 1998 1997
- ---------------------------------------------------------------------------------------
Land $ 1,349 $ 1,349
Buildings 8,214 7,952
Leasehold improvements 894 640
Furniture and equipment 9,534 8,179
------- -------
Subtotal 19,991 18,120
Less accumulated depreciation and amortization 6,672 5,175
------- -------
Premises and equipment, net $13,319 $12,945
======= =======
Included in the totals above is construction in progress of $308,000 and
$307,000 at December 31, 1998 and 1997 respectively.
NOTE 6. BORROWED FUNDS
At December 31, 1998 and 1997 the Company's borrowed funds consisted of the
following:
(Dollars in Thousands) 1998 1997
- -------------------------------------------------------------------------------------------------------------
7
Securities sold under agreements to repurchase; dated March 25, 1998;
fixed rate of 5.74%;
payable on March 25, 1999 $ 2,100 $ -
Securities sold under agreements:
to repurchase; dated March 17, 1997;
fixed rate of 5.57%; payable on March 18, 1998 - 2,459
Unsecured loan from unaffiliated bank dated July 16, 1996; effective
interest rate of 9%; interest payable quarterly at prime +
.50%; principal payable quarterly at $135,711; final payment due
on April 30, 1998 - 286
FHLB loan, dated December 18, 1997;
effective rate of 5.89%; rate reprices monthly based on the 1 month
LIBOR; payable on December 18, 1998 - 10,900
FHLB loan, dated January 16, 1997;
variable rate of 5.75%; rate reprices monthly based on the 1 month
LIBOR; paid in full on January 15, 1999 5,000 5,000
FHLB loan, dated July 15, 1991; fixed rate of 7.58%; payable on July 15, 1999 103 104
Long-term note from unaffiliated bank dated December 11, 1997; fixed rate of
7.80%; principal and interest payable monthly at $15,017;
payments calculated as fully amortizing over 15 years with a 10 year call 3,263 3,300
------ ------
Total borrowed funds $ 10,466 $ 22,049
======== ========
In 1998, the Company replaced its maturing repurchase agreement with a
similar repurchase agreement. No other repurchase agreements were entered into
in 1998. Interest expense recorded in 1998 for securities sold under agreements
to repurchase was $126,000. The repurchase agreement disclosed above is
collateralized by two securities with a market value of $2,146,000 at December
31, 1998. Securities under this repurchase agreement are held in the custody of
independent securities brokers.
In 1997 the Company actively sold securities under agreements to
repurchase. These transactions averaged $11,177,000 in 1997, with a maximum
balance borrowed of $53,550,000 at November 30, 1997. Securities under these
repurchase agreements were held in the custody of independent securities
brokers.
The Company maintains a line of credit with the Federal Home Loan Bank of
San Francisco (FHLB). Based on the FHLB stock requirements at December 31, 1998,
this line provided for maximum borrowings of $16,197,000 of which $5,103,000 was
outstanding, leaving $11,094,000 available. At December 31, 1998 this borrowing
line is collateralized by securities with a market value of $17,050,000.
Interest expense related to FHLB borrowings totaled $906,000, $308,000, and
$8,000 in 1998, 1997, and 1996.
The Company incurred interest expense of $274,000, $78,000, and $72,000 in
1998, 1997, and 1996, related to the notes with unaffiliated banks. The
long-term note dated December 11, 1997 is secured by Company land and buildings.
Principal payments required to service the Company's borrowings during the
next five years are:
(Dollars in thousands)
- ------------------------------------------
1999 $ 7,251
2000 52
2001 56
2002 61
2003 66
Thereafter 2,980
--------
Total borrowed funds $ 10,466
========
8
Interest expense related to federal funds purchased was $2,000 in 1998. No
federal funds were purchased in 1997. At December 31, 1998 and 1997 the Company
had unused lines of credit of $2,000,000 and $5,500,000. Compensating balance
arrangements are not significant to the operations of the Company.
NOTE 7. REAL ESTATE OPERATIONS
As of December 31, 1998, MAID held one real estate project, including
unimproved land and a single family improved lot. The Bank has reduced its
carrying value of its remaining projects to zero.
Summarized below is condensed financial information of MAID:
CONDENSED BALANCE SHEETS December 31,
(Dollars in thousands) 1998 1997
- -------------------------------------------------------------------------------
ASSETS:
Cash on deposit with County Bank $ 88 $ 442
Notes receivable and other 156 356
------ -------
Total assets 244 798
LIABILITIES AND SHAREHOLDER'S EQUITY:
Accounts payable and other 244 301
Shareholder's equity - 497
------ -------
Total liabilities and shareholder's
equity $ 244 $ 798
====== =======
CONDENSED STATEMENT OF OPERATIONS
(Dollars in thousands) 1998 1997 1996
Revenues $ 354 $ 876 $ 812
Expenses 22 66 287
Other, net - - (81)
------ ----- -----
Income before income taxes $ 332 $ 810 $ 444
====== ===== =====
NOTE 8. INCOME TAXES
The provision for income taxes for the years ended December 31 is comprised
of the following:
(Dollars in thousands) FEDERAL STATE TOTAL
- -----------------------------------------------------------------------------
1998
Current $ 567 $ 53 $ 620
Deferred 223 87 310
------- ------ -------
$ 790 $ 140 $ 930
======= ====== =======
1997
Current $ (484) $ (41) $ (525)
Deferred 456 43 499
------- ------ -------
$ (28) $ 2 $ (26)
======= ====== =======
1996
Current $ 1,049 $ 441 $ 1,490
Deferred (283) (44) (327)
------- ------ -------
$ 766 $ 397 $ 1,163
======= ====== =======
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December
31, 1998 and 1997 consists of the following:
9
(Dollars in Thousands) 1998 1997
- ---------------------------------------------------------------------------------
DEFERRED TAX ASSETS:
Real estate subsidiary $ 947 $ 1,336
Allowance for loan losses 940 937
Nonaccrual interest 80 184
Tax Credits 329 -
Fixed assets - 11
Other 300 223
------- --------
Total gross deferred tax assets 2,596 2,691
Less valuation allowance (20) (20)
------- --------
Deferred tax assets $ 2,576 $ 2,671
======= ========
DEFERRED TAX LIABILITIES:
Fixed assets $ 169 $ -
State franchise taxes 178 208
Investment in partnerships 64 30
Investment securities unrealized gain 19 125
Other 154 112
------- --------
Total gross deferred tax liabilities 584 475
------- --------
Net deferred tax assets $ 1,992 $ 2,196
======= ========
In assessing the realizability of deferred tax assets, management
considers whether it is more likely that some portion or all of the deferred
tax assets will be realized. The ultimate realization of deferred tax assets
is dependent upon the generation of future taxable income during the periods
in which those temporary differences become deductible. Management considers
the scheduled reversal of deferred tax liabilities, projected future taxable
income, and tax planning strategies in making this assessment. Based upon the
level of historical taxable income and projections for future taxable income
over the periods which the deferred tax assets are deductible, management
believes it is more likely than not the Company will realize the benefits of
these deductible differences, net of the existing valuation allowances at
December 31, 1998 and 1997.
A reconciliation of the provision for income taxes to the statutory
federal income tax rate follows:
(Dollars in thousands) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------
Statutory (34%) federal income tax rate due $ 1,248 $ 128 $ 1,078
State franchise tax, net of federal income tax benefit 263 14 263
Tax exempt interest income, net (239) (60) (86)
Housing tax credits (426) (71) (22)
Intangible amortization 33 36 -
Cash surrender value Life Insurance (69) - -
State tax benefit lost due to net operating loss
limitations - 20 -
Decrease in valuation allowance for deferred tax
assets - (150) -
Other 120 57 (70)
------- ------ -------
Provision for income taxes $ 930 $ (26) $ 1,163
====== ====== =======
NOTE 9. REGULATORY MATTERS
The Company is subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet minimum capital
requirements can initiate 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 must meet
specific capital guidelines that involve quantitative measures of the Company's
assets, liabilities, and certain off-balance sheet items as calculated under
regulatory
10
accounting practices. The Company's capital amounts and classification are
also subject to qualitative judgments by the regulators about components,
risk weighting and other factors.
First, a bank must meet a minimum Tier I (as defined in the regulations)
capital ratio ranging from 3% to 5% based upon the bank's CAMEL (capital
adequacy, asset quality, management, earnings and liquidity) rating.
Second, a bank must meet minimum total risk based capital to risk
weighted assets ratio of 8%. Risk based capital and asset guidelines vary
from Tier I capital guidelines by redefining the components of capital,
categorizing assets into different risk classes, and including certain
off-balance sheet items in the calculation of the capital ratio. The effect
of the risk based capital guidelines is that banks with high exposure will be
required to raise additional capital while institutions with low risk
exposure could, with the concurrence of regulatory authorities, be permitted
to operate with lower capital ratios. In addition, a bank must meet minimum
Tier I capital to average assets ratio of 4%.
Management believes, as of December 31, 1998, that the Company and the
Bank meet all capital adequacy requirements to which they are subject. As of
December 31, 1998, the most recent notification, the FDIC categorized the
Bank as meeting the ratio test for a well capitalized bank under the
regulatory framework for prompt corrective action. To be categorized as
adequately capitalized, the Bank must meet the minimum ratios as set forth in
the following table. There are no conditions or events since that
notification that management believes have changed the institution's
classification.
The Company has no formal dividend policy, and dividends are issued
solely at the discretion of the Company's Board of Directors subject to
compliance with regulatory requirements. In order to pay any cash dividends,
the Company must receive payments of dividends or management fees from the
Bank or the Thrift. There are certain regulatory limitations on the payment
of cash dividends by banks and thrift and loan companies.
As a result of a joint examination of the Bank conducted as of January
12, 1998 by the the FDIC and the DFI, have required the Bank to enter into a
Memorandum of Understanding requiring the Bank to do the following:
1) Conduct a comprehensive management review of the Bank's executive
management to maintain a management structure suitable to its needs in
light of its recent rapid growth.
2) Have and retain qualified management with qualifications and experience
commensurate with their duties and responsibilities at the Bank.
3) Develop a plan to reduce the Bank's economic value of equity exposure to
loss from interest rate changes to acceptable levels.
4) Formulate, adopt and implement a comprehensive risk management process that
will strengthen management expertise and improve securities portfolio
management and management information and measurement systems.
5) Establish and maintain an adequate reserve for loan losses and develop and
revise, adopt and implement a comprehensive policy to ensure the adequacy
of the allowance for loan losses.
6) Develop, adopt and implement a plan to control overhead and restore the
Bank's profitability.
7) Correct deficiencies relating to the Year 2000
project.
8) Furnish written progress reports.
As of the date of this report, the Company believes it is in substantial
compliance with all the terms of the agreement.
A Memorandum of Understanding is an enforceable agreement. Failure to
comply with its terms can lead to further enforcement action by bank regulators,
including cease-and-desist orders, imposition of a receiver or conservator,
termination of deposit insurance, imposition of civil money penalties and
removal and prohibition orders against institution-affiliated parties.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain Minimum amounts and ratios (set forth in the
following table.
11
The Company's and Bank's actual capital amounts and ratios as of
December 31, 1998 are as follows:
TO BE WELL CAPITALIZED
(Dollars in thousands) FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS:
----------------- ------------------ ------------------------
THE COMPANY: AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------------------------------------------------------------------------
Total capital (to risk weighted assets) $41,235 11.94 % $27,635 8.0 % $34,544 10.0 %
Tier I capital (to risk weighted assets) 36,911 10.69 13,818 4.0 20,726 6.0
Leverage ratio(1) 36,911 7.58 19,450 4.0 24,312 5.0
THE BANK:
Total capital (to risk weighted assets) 33,511 11.11 24,129 8.0 30,162 10.0
Tier I capital (to risk weighted assets) 29,732 9.86 12,065 4.0 18,097 6.0
Leverage ratio(1) $29,732 6.73 $19,472 4.0 $24,340 5.0
(1) THE LEVERAGE RATIO CONSISTS OF TIER 1 CAPITAL DIVIDED BY QUARTERLY
AVERAGE ASSETS. THE MINIMUM LEVERAGE RATIO IS 3 PERCENT FOR BANKING
ORGANIZATIONS THAT DO NOT ANTICIPATE SIGNIFICANT GROWTH AND THAT HAVE
WELL-DIVERSIFIED RISK, EXCELLENT ASSET QUALITY AND IN GENERAL, ARE CONSIDERED
TOP-RATED BANKS.
NOTE 10. COMMITMENTS AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET CREDIT
RISK
At December 31, 1998, the Company has operating lease rental commitments
for remaining terms of one to ten years. The Company has options to renew one
of its leases for a period of 15 years. The minimum future commitments under
noncancelable lease agreements having terms in excess of one year at December
31, 1998 are as follows:
(Dollars in thousands)
------------------------------------------------
1999 $ 470
2000 296
2001 244
2002 244
2003 243
Thereafter 622
-------
Total minimum lease payments $ 2,119
=======
Rent expense was approximately $619,000, $513,000, and $391,000 for the
years ended December 31, 1998, 1997 and 1996.
In the ordinary course of business, the Company enters into various
types of transactions which involve financial instruments with off-balance
sheet risk. These instruments include commitments to extend credit and
standby letters of credit and are not reflected in the accompanying balance
sheet. These transactions may involve, to varying degrees, credit and
interest risk in excess of the amount, if any, recognized in the balance
sheet.
The Company's off-balance sheet credit risk exposure is the contractual
amount of commitments to extend credit and standby letters of credit. The
Company applies the same credit standards to these contracts as it uses in
its lending process. Additionally, commitments to extend credit and standby
letters of credit bear similar credit risk characteristics as outstanding
loans.
Financial instruments whose contractual amount represents risk:
As of December 31
--------------------
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------------------
Commitments to extend credit $ 76,984 $ 55,238
Standby letters of credit 2,694 3,243
Commitments to extend credit are agreements to lend to customers. These
commitments have specified interest rates and generally have fixed expiration
dates but may be terminated by the Company if
12
certain conditions of the contract are violated. Although currently subject
to drawdown, many of these commitments are expected to expire or terminate
without funding. Therefore, the total commitment amounts do not necessarily
represent future cash requirements. Collateral held relating to these
commitments varies, but may include securities, equipment, inventory and real
estate.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of the customer to a third party. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Collateral held for
standby letters of credit is based on an individual evaluation of each
customer's credit worthiness, but may include cash, equipment, inventory and
securities.
The Company because of the nature of its business, is subject to various
threatened or filed legal cases. The Company, based on the advice of legal
counsel, does not expect such cases will have a material, adverse effect on
its financial position or results of operations.
NOTE 11. TIME DEPOSITS
At December 31, 1998 the aggregate maturities for time deposits are as
follows:
(Dollars in thousands)
---------------------------------------
1999 $ 107,939
2000 14,822
2001 3,029
2002 572
2003 251
NOTE 12. CONCENTRATIONS OF CREDIT RISK
The Bank's business activity is with customers located primarily within
Merced, Stanislaus, Mariposa Madera and Tuolumne counties. The Bank
specializes in real estate, real estate construction, commercial and dairy
lending. Although the Bank has a diversified loan portfolio, a significant
portion of its customers' ability to repay loans is dependent upon economic
factors affecting residential real estate, construction, dairy, agribusiness
and consumer goods retailing. Generally, loans are secured by various forms
of collateral. The Bank's loan policy requires sufficient collateral be
secured as necessary to meet the Bank's relative risk criteria for each
borrower. The Bank's collateral consists primarily of real estate, dairy
cattle, accounts receivable, inventory, equipment and marketable securities.
A small portion of the Bank's loans are not supported by specific collateral
but rather by the general financial strength of the borrower.
The Thrift's business activity is with customers located primarily
within Stanislaus, Tulare and Fresno counties. The Thrift specializes in
direct consumer loans and the purchase of financing contracts principally
from automobile dealerships and furniture stores. Generally, loans are
secured by various forms of collateral. The Thrift's collateral consists
primarily of automobiles and flooring inventory. A small portion of the
Thrift's loans are not supported by specific collateral but rather by the
general financial strength of the borrower. In addition, the contracts are
purchased from the dealers with recourse to the dealer and dealer reserves
are established for each borrower.
Although the slowdown in the real estate market has been a factor in the
local economy for the last several years and has played a role in reducing
economic growth in California, it is management's opinion that the underlying
strength and diversity of the Central Valley's economy should mitigate a
severe deterioration in the borrowers' ability to repay their obligations to
the Company.
NOTE 13. EMPLOYEE BENEFIT PLANS
The Company has a noncontributory employee stock ownership plan ("ESOP")
and an employee savings plan covering substantially all employees. During 1998,
1997, and 1996, the Company contributed approximately $193,000, $119,000, and
$114,000, to the ESOP and $70,000, $71,000, and $38,000, to the employee savings
plan.
Under provisions of the ESOP, the Company can make discretionary
contributions to be allocated based on eligible individual annual compensation,
as approved by the Board of Directors. Contributions to the ESOP are recognized
as compensation expense. For the years December 31, 1998, 1997, and 1996, the
ESOP owned 130,441, 158,363, 106,247, shares of the Company's stock. ESOP shares
are included in the weighted average number of shares outstanding for earnings
per share computations.
13
The employee savings plan allowed participating employees to contribute up
to $10,000 in 1998. The Company will match 25% of the employees elective
contribution, as defined, not to exceed 6% of eligible annual compensation.
NOTE 14. STOCK OPTION PLAN
In 1992, shareholders approved the adoption of an incentive stock option
plan for bank management and a nonstatutory stock option plan for directors. The
maximum number of shares issuable under the plans was 126,000. Options are
available for grant under the plans at prices that approximate fair market value
at the date of grant. Options granted under both plans become exercisable 25% at
the time of grant and 25% each year thereafter and expire 10 years from the date
of grant. In 1995, shareholders approved an amendment to the stock option plans
increasing the number of authorized but unissued shares available for future
grant of the Company's common stock to 450,000.
A summary of the status of the Company's stock options as of December 31,
1998, 1997, and 1996, and changes during the years ended on those dates,
follows:
1998 1997 1996
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER EXERCISE NUMBER OF EXERCISE
SHARES PRICE OF SHARES PRICE SHARES PRICE
----------------------------------------------------------------------------
Outstanding at beginning of year 297,350 $ 6.65 289,745 $ 5.84 266,850 $ 5.58
Granted 39,000 13.56 62,000 12.86 44,250 8.95
Exercised (11,402) 7.51 (49,257) 7.19 (35,046) 4.59
Forfeited (17,195) 10.96 (5,118) 8.89 - -
Stock dividend declared 15,458 6.65 - - 13,691 5.58
------ ------- -------
Outstanding at end of year 323,211 $ 7.28 297,370 $ 6.65 289,745 $ 5.84
======= ====== ======= ======= ======= =======
Options exercisable at end of year 267,395 $ 6.16 237,933 $ 5.79 232,840 $ 5.25
The following table summarizes information about options outstanding at
December 31, 1998:
OPTIONS OUTSTANDING OPTIONS
--------------------------- EXERCISABLE
RANGE OF NUMBER WEIGHTED WEIGHTED WEIGHTED
EXERCISE OF SHARES REMAINING AVERAGE NUMBER AVERAGE
PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ---------------------------------------------------------------------------------------------------------
$ 4 - 6 186,031 3.62 Years $ 4.54 186,031 $ 4.54
6 - 9 49,572 6.73 7.65 44,246 7.60
9 - 16 87,608 8.75 12.75 37,118 12.58
-------- ------
$ 4 - 16 323,211 5.51 $ 7.28 267,395 $ 6.16
======== =======
The number of shares and exercise price per share has been adjusted for stock
dividends and stock splits during the period.
The per share weighted average fair value of stock options granted during
1998,1997 and 1996 was $13.55, $11.96, and $8.59 on the date of grant using the
Black Scholes option pricing model with the following weighted average
assumptions: 1998-1996 expected dividend yield 0%; 1998-1996 expected volatility
of 30 percent, risk free interest rate of 4.64%, 5.71%, and 5.18%; and, an
expected life of 7 years.
The Company applies APB Opinion No. 25 in accounting for its plan and,
accordingly, no compensation cost has been recognized for its stock options in
the accompanying consolidated financial statements. Had the Company determined
compensation cost based on the fair value at the grant date for its stock
options under SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, the
Company's net income would have been reduced to the proforma amounts indicated
as follows:
(Dollars in thousands) 1998 1997 1996
- ---------------------------------------- ------------------- ------------------ ---------------
Net income
As reported $ 2,741 $ 403 $ 2,009
Proforma 2,504 241 1,857
14
BASIC EARNINGS PER SHARE
As reported 0.60 0.12 0.81
Proforma 0.54 0.07 0.75
Proforma net income reflects only options granted in 1996 through 1998.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 113 is not reflected in the proforma net income amounts presented
above because compensation cost is reflected over the options' vesting period of
three years and compensation cost for options granted prior to January 1, 1996
is not considered.
NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company in estimating its fair value disclosures for financial
instruments used the following methods and assumptions:
FINANCIAL ASSETS:
CASH AND CASH EQUIVALENTS: For these assets, the carrying amount is a reasonable
estimate for fair value.
INVESTMENTS: Fair values for available for sale and
held to maturity investment securities are based on quoted market prices where
available. If quoted market prices were not available, fair values were based
upon quoted market prices of comparable instruments.
NET LOANS: The fair value
of loans is estimated by utilizing discounted future cash flow calculations
using the interest rates currently being offered for similar loans to borrowers
with similar credit risks and for the remaining or estimated maturities
considering prepayments. The carrying value of loans is net of the allowance for
loan losses and unearned loan fees.
LOANS HELD FOR SALE: The fair value of loans
held for sale is the carrying value as the loans are under commitments to be
sold at carrying value.
FINANCIAL LIABILITIES:
DEPOSITS: The fair values disclosed for deposits generally paid upon demand
(i.e. noninterest bearing and interest-bearing demand) savings and money market
accounts are considered equal to their respective carrying amounts as reported
on the consolidated balance sheets. The fair value of fixed rate certificates of
deposit is estimated using the rates currently offered for deposits of similar
remaining maturities.
BORROWINGS: For these instruments, the fair value is
estimated using rates currently available for similar loans with similar credit
risk and for the remaining maturities.
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT: The fair value of
commitments is estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counter parties. For fixed rate loan
commitments, fair value also considers the difference between current levels of
interest rates and the committed rates. The fair value of letters of credit are
based on fees currently charged for similar agreements or on the estimated cost
to terminate them or otherwise settle the obligation with the counter parties at
the reporting date.
Fair values for financial instruments are management's estimates of the
values at which the instruments could be exchanged in a transaction between
willing parties. These estimates are subjective and may vary significantly from
amounts that would be realized in actual transactions. In addition, other
significant assets are not considered financial assets including, any mortgage
banking operations, deferred tax assets, and premises and equipment. Further,
the tax ramifications related to the realization of the unrealized gains and
losses can have a significant effect on the fair value estimates and have not
been considered in any of these estimates.
(Dollars in thousands) CARRYING AMOUNT FAIR VALUE
- ----------------------------------------------------------------------------------------
1998
FINANCIAL ASSETS:
Cash and cash equivalents $ 44,896 $ 44,896
Time deposits at other financial
institutions 600 600
15
INVESTMENT SECURITIES:
Available for sale 141,357 141,357
Held to maturity 13,510 13,584
Net loans 264,158 263,551
FINANCIAL LIABILITIES
DEPOSITS:
Noninterest bearing demand 80,290 80,290
Interest bearing demand 71,526 71,526
Savings and money market 165,781 165,781
Time deposits 126,613 126,823
Borrowings $ 10,466 $ 10,470
CARRYING AMOUNT FAIR VALUE
- ----------------------------------------------------------------------------------------
OFF-BALANCE SHEET:
Commitments $ 76,984 $ 7,698
Standby letters of credit 2,694 269
CARRYING AMOUNT FAIR VALUE
- ----------------------------------------------------------------------------------------
1997
FINANCIAL ASSETS:
Cash and cash equivalents $ 23,435 $ 23,435
Time deposits in other financial 599 599
institutions
INVESTMENT SECURITIES:
Available for sale 135,257 135,257
Held to maturity 12,775 12,780
Net loans 214,144 214,741
FINANCIAL LIABILITIES
DEPOSITS:
Noninterest-bearing demand 58,836 58,836
Interest bearing demand 54,202 54,202
Savings and money market 143,562 143,562
Time deposits 99,795 100,280
Borrowings 22,049 22,049
CONTRACT AMOUNT FAIR VALUE
- ----------------------------------------------------------------------------------------
OFF-BALANCE SHEET:
Commitments $ 55,238 $ 5,524
Standby letters of credit 3,243 324
NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS
As of December 31, 1998 and 1997 the Company had no derivative financial
instruments.
NOTE 17. RECONCILIATION OF BASIC AND DILUTED NET EARNINGS PER SHARE.
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------------
(Dollars in thousands except per share amounts) INCOME SHARES PER-SHARE
(Numerator) (Denominator) Amount
--------------- ---------------- -------------
Basic EPS
Income available to common shareholders $ 2,741 4,602 $ 0.60
=========
16
Effect of Dilutive Securities:
Stock Options
- 123
--------------- ----------------
Diluted EPS
Income available to common shareholders +
assumed conversions $ 2,741 4,725 $ 0.58
=============== ================ ========
YEAR ENDED DECEMBER 31, 1997
------------------------------------------------
INCOME SHARES PER-SHARE
(Numerator) (Denominator) Amount
-------------- ---------------- -------------
Basic EPS
Income available to common shareholders $ 403 3,467 $ 0.12
=========
Effect of Dilutive Securities:
Stock Options - 136
-------------- ----------------
Diluted EPS
Income available to common shareholders +
assumed conversions $ 403 3,603 0.11
============== ================ ==========
YEAR ENDED DECEMBER 31, 1996
------------------------------------------------
INCOME SHARES PER-SHARE
(Numerator) (Denominator) Amount
-------------- ---------------- -------------
Basic EPS
Income available to common shareholders $ 2,009 2,485 $ 0.81
=========
Effect of Dilutive Securities:
Stock Options - 111 -
------------ --------------
Diluted EPS
Income available to common shareholders +
assumed conversions $ 2,009 2,596 $ 0.77
============ ============= ========
NOTE 18. PARENT COMPANY ONLY FINANCIAL INFORMATION
This information should be read in conjunction with the other notes to the
consolidated financial statements. The following is the condensed balance sheets
of the Company as of December 31, 1998 and 1997 and the condensed statements of
income and cash flows for the years ended December 31, 1998, 1997 and 1996:
CONDENSED BALANCE SHEETS
DECEMBER 31,
(Dollars in thousands) 1998 1997
- ---------------------------------------------------- ---------------- -- -----------------
ASSETS
Cash and short-term investments $ 1,370 $ 2,638
Investment in County Bank 33,479 30,977
Investment in Town and Country 5,882 5,103
Net premises and equipment 6,301 5,245
Other assets 246 381
--------- ----------
Total assets $ 47,278 $ 44,344
========= ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
LIABILITIES
Borrowed funds $ 3,262 $ 3,586
Capitalized lease 1,014 -
Other liabilities 198 510
---------- ----------
Total liabilities $ 4,474 $ 4,096
SHAREHOLDERS' EQUITY
Common stock $ 37,142 $ 33,928
Accumulated other comprehensive income 28 195
Retained earnings 5,634 6,125
---------- ----------
17
Total shareholders' equity 42,804 40,248
Total liabilities and shareholders' equity $ 47,278 $ 44,344
========= =========
CONDENSED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
-----------------------
(Dollars in thousands) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------
INCOME
Dividends from subsidiaries $ - $ 90 $ 100
Interest 102 52 -
Lease income 503 - -
Management fees from subsidiaries 2,299 1,949 693
------- -------- --------
Total income 2,904 2,091 793
EXPENSES
Interest on borrowings 274 71 28
Capitalized lease interest 42 - -
Salaries and related benefits 1,299 827 197
Other noninterest expense 1,469 828 236
------- -------- --------
Total other expenses 3,084 1,726 461
Income before taxes and equity in
undistributed earnings (180) 365 332
Income tax benefit (expense) 72 (109) (9)
Equity in undistributed income of subsidiaries 2,849 147 1,686
--------- -------- --------
Net income $ 2,741 $ 403 $ 2,009
========= ======== ========
CONDENSED STATEMENTS OF CASH FLOWS
DECEMBER 31,
----------------------
(Dollars in thousands) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 2,741 $ 403 $ 2,009
ADJUSTMENTS TO RECONCILE NET INCOME TO NET
CASH PROVIDED BY OPERATING ACTIVITIES:
Equity in undistributed earnings of subsidiaries (2,849) (147) (1,686)
Decrease (increase) in other assets 446 (305) 9
Increase in other liabilities (312) 281 175
--------- --------- ---------
Net cash provided by operating activities 26 232 507
INVESTING ACTIVITIES:
Capital contribution to subsidiary bank (600) (14,000) -
Purchase of Thrift - - (1,574)
Purchase of premises and equipment (1,366) (5,245) -
Dividends from subsidiaries - 90 100
--------- --------- ---------
Net cash used in investing activities (1,966) (19,155) (1,474)
FINANCING ACTIVITIES:
Proceeds from stock offering - 17,951 -
Net additions in other borrowings 690 2,795 791
Issuance of common stock related to exercise of
stock options and employee benefit plans (12) 661 370
17
Cash dividends and fractional shares (6) (5) (86)
--------- --------- ---------
Net cash provided by financing activities 672 21,402 1,075
(Decrease) increase in cash and cash equivalents (1,268) 2,479 108
Cash and cash equivalents at beginning of year 2,638 159 51
--------- --------- ---------
Cash and cash equivalents at end of year $ 1,370 $ 2,638 $ 159
========= ======== ========
NOTE 19. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
1998 QUARTER ENDED
-----------------------------------------------------------
(Dollars in thousands) Dec 31 Sept 30 June 30 Mar 31
- -------------------------------------------------------------------------------------------------
Interest income $ 9,139 $ 9,021 $ 8,362 $ 8,092
Interest expense 3,497 3,448 3,386 3,303
Net interest income 5,642 5,573 4,976 4,789
Provision for loan losses 2,213 700 738 252
Other income 1,171 1,220 1,389 1,058
Other expenses 4,692 4,851 4,378 4,323
Income before income taxes (92) 1,242 1,249 1,272
Income taxes (benefit) (146) 248 393 435
Net income $ 54 $ 994 $ 856 $ 837
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Basic earnings per share (1) $ 0.01 $ 0.22 $ 0.19 $ 0.18
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1997 Quarter Ended
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Dec 31 Sept 30 June 30 Mar 31
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Interest income $ 7,733 $ 6,622 $ 5,956 $ 5,601
Interest expense 3,210 2,573 2,335 2,072
Net interest income 4,523 4,049 3,621 3,529
Provision for loan losses 2,144 205 3,236 240
Other income 1,160 746 1,212 734
Other expenses 3,614 3,338 3,180 3,240
(Loss) income before income taxes (75) 1,252 (1,583) 783
Income taxes (benefit) (132) 476 (640) 270
Net income (loss) $ 57 $ 776 $ (943) $ 513
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Basic earnings (loss) per share $ .01 $ .23 $ (.36 ) $ .20
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(1) BASIC EARNINGS PER SHARE IS BASED UPON THE WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING DURING EACH PERIOD. FULL YEAR WEIGHTED AVERAGE SHARES DIFFER
FROM QUARTERLY WEIGHTED AVERAGE SHARES AND, THEREFORE, ANNUAL EARNINGS PER SHARE
MAY NOT EQUAL THE SUM OF THE QUARTERS.
19