UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1999
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number: 0-28938
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Coast Bancorp
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(Exact name of registrant as specified in its charter)
California 77-0401327
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
740 Front Street, Santa Cruz, California 95060
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(Address of principal executive offices) (Zip Code)
(831) 458-4500
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
/X/ Yes / / No
No. of shares of Common Stock outstanding on March 31, 1999: 4,778,858
---------
COAST BANCORP
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
TABLE OF CONTENTS
PART I
Page
Item 1. Financial Statements 1
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 5
PART II
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
PART I
Item 1. Financial Statements
COAST BANCORP
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
1999 1998
------------ -------------
(unaudited)
ASSETS
Cash and due from banks $ 15,739,000 $ 23,084,000
Federal funds sold 29,000,000 29,000,000
-------------------------------
Total cash and equivalents 44,739,000 52,084,000
Securities:
Available for sale, at fair value 111,333,000 106,960,000
Loans:
Commercial 38,470,000 38,874,000
Real estate-term 95,919,000 95,360,000
Real estate-construction 24,819,000 22,206,000
Installment and other 4,688,000 4,536,000
-------------------------------
Total loans 163,896,000 160,976,000
Unearned income (3,604,000) (3,272,000)
Allowance for credit losses (3,882,000) (3,871,000)
-------------------------------
Net loans 156,410,000 153,833,000
Bank premises and equipment-net 2,301,000 2,408,000
Accrued interest receivable and other assets 9,943,000 9,463,000
-------------------------------
TOTAL ASSETS $324,726,000 $324,748,000
-------------------------------
-------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand $ 67,942,000 $ 75,978,000
Interest-bearing demand 94,718,000 100,707,000
Savings 58,938,000 51,873,000
Time 52,415,000 52,252,000
-------------------------------
Total deposits 274,013,000 280,810,000
Other borrowings 15,712,000 10,416,000
Accrued expenses and other liabilities 3,748,000 3,325,000
-------------------------------
Total liabilities 293,473,000 294,551,000
Commitments and contingencies
STOCKHOLDERS' EQUITY:
Preferred stock-no par value; 10,000,000 shares authorized;
no shares issued - -
Common stock-no par value; 20,000,000 shares authorized; shares
outstanding: 4,778,858 in 1999 and 4,768,678 in 1998 20,771,000 20,689,000
Accumulated other comprehensive income 117,000 317,000
Retained earnings 10,365,000 9,191,000
-------------------------------
Total stockholders' equity 31,253,000 30,197,000
-------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $324,726,000 $324,748,000
-------------------------------
-------------------------------
See notes to unaudited consolidated financial statements
-1-
COAST BANCORP
CONSOLIDATED INCOME STATEMENTS
(unaudited)
THREE MONTHS ENDED MARCH 31,
1999 1998
------------ -------------
Interest income:
Loans, including fees $4,133,000 $4,147,000
Securities:
Taxable 1,338,000 1,225,000
Nontaxable 192,000 145,000
Federal funds sold 374,000 100,000
-------------------------------
Total interest income 6,037,000 5,617,000
Interest expense:
Deposits 1,512,000 1,120,000
Other borrowings 139,000 430,000
-------------------------------
Total interest expense 1,651,000 1,550,000
-------------------------------
Net interest income 4,386,000 4,067,000
Provision for credit losses - 75,000
-------------------------------
Net interest income after provision for credit losses 4,386,000 3,992,000
Noninterest income:
Customer service fees 632,000 622,000
Gain from sale of loans 511,000 668,000
Loan servicing fees 224,000 246,000
Gains (losses) from sale of securities 61,000 (15,000)
Other 44,000 46,000
-------------------------------
Total noninterest income 1,472,000 1,567,000
Noninterest expenses:
Salaries and benefits 1,807,000 1,540,000
Occupancy 295,000 271,000
Equipment 288,000 285,000
Customer services 170,000 165,000
Advertising and promotion 105,000 132,000
Stationery and postage 91,000 97,000
Professional services 79,000 123,000
Data processing 85,000 68,000
Insurance 61,000 60,000
Other 222,000 176,000
-------------------------------
Total noninterest expenses 3,203,000 2,917,000
-------------------------------
Income before income taxes 2,655,000 2,642,000
Income taxes 1,099,000 1,086,000
-------------------------------
Net income $1,556,000 $1,556,000
-------------------------------
-------------------------------
Earnings per share:
Basic $.33 $.32
-------------------------------
-------------------------------
Diluted $.32 $.31
-------------------------------
-------------------------------
See notes to unaudited consolidated financial statements
-2-
COAST BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
THREE MONTHS ENDED MARCH 31,
1999 1998
------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $1,556,000 $1,556,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for credit losses - 75,000
Depreciation and amortization (54,000) 35,000
(Gains) losses on securities transactions (61,000) 15,000
Deferred income taxes 42,000 132,000
Proceeds from loan sales 25,602,000 17,282,000
Origination of loans held for sale (22,148,000) (18,313,000)
Accrued interest receivable and other assets (522,000) (1,359,000)
Accrued expenses and other liabilities 422,000 955,000
Increase in unearned income 626,000 533,000
Other operating activities 135,000 (66,000)
-------------------------------
Net cash provided by operating activities 5,598,000 845,000
-------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities Available for sale
12,145,000 5,329,000
Proceeds from maturities of securities 5,590,000 4,357,000
Purchases of securities available for sale (22,442,000) (19,308,000)
Net increase in loans (6,363,000) (3,091,000)
Purchases of bank premises and equipment (73,000) (195,000)
-------------------------------
Net cash used in investing activities (11,143,000) (12,908,000)
-------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits (6,796,000) 19,680,000
Net proceeds from other borrowings 5,296,000 (5,043,000)
Repurchase of common stock - (675,000)
Payment of cash dividends (382,000) (309,000)
Exercise of stock options 82,000 43,000
-------------------------------
Net cash (used in) provided by financing activities (1,800,000) 13,696,000
-------------------------------
Net (decrease) increase in cash and equivalents (7,345,000) 1,633,000
Cash and equivalents, beginning of period 52,084,000 30,853,000
-------------------------------
Cash and equivalents, end of period $44,739,000 $32,486,000
-------------------------------
-------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION CASH PAID DURING THE PERIOD FOR:
Interest $1,761,000 $1,616,000
Income taxes - 331,000
NON-CASH INVESTING AND FINANCING TRANSACTIONS:
Additions to other real estate owned $- $190,000
See notes to unaudited consolidated financial statements
-3-
COAST BANCORP
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 1999 and 1998
- -------------------------------------------------------------------------------
1. BASIS OF PRESENTATION - These financial statements reflect, in
management's opinion, all adjustments, consisting of adjustments of a
normal recurring nature, which are necessary for a fair presentation of
Coast Bancorp's financial position and results of operations and cash
flows for the periods presented. The results of interim periods are not
necessarily indicative of results of operations expected for the full
year. These financial statements should be read in conjunction with the
audited consolidated financial statements for 1998 included in the
Company's Annual Report on Form 10-K.
2. EARNINGS PER SHARE - Basic earnings per share is computed by dividing net
income by the number of weighted average common shares outstanding. Diluted
earnings per share reflects potential dilution from outstanding stock
options, using the treasury stock method. The number of weighted average
shares used in computing basic and diluted earnings per share are as
follows:
THREE MONTHS ENDED
MARCH 31,
-----------------------
1999 1998
--------- ---------
Basic shares 4,773,483 4,839,901
Dilutive effect of stock options 102,770 120,683
-----------------------
Diluted shares 4,876,253 4,960,584
-----------------------
-----------------------
3. COMPREHENSIVE INCOME - The Company's source of other comprehensive income is
unrealized gains and losses on securities available for sale. Total
comprehensive income was as follows:
THREE MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
---------- ----------
Net income $1,556,000 $1,556,000
Other comprehensive income (200,000) (163,000)
--------------------------
Total comprehensive income $1,356,000 $1,393,000
--------------------------
--------------------------
-4-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Net income for each of the three months ended March 31, 1999 and 1998 was
$1,556,000.
During the first quarter of 1999 an increase in net interest income combined
with a decrease in the provision for credit losses was offset by a decrease
in noninterest income and increases in noninterest expenses and income tax
expense.
EARNINGS SUMMARY
NET INTEREST INCOME
Net interest income refers to the difference between interest and fees earned
on loans and investments and the interest paid on deposits and other borrowed
funds. It is the largest component of the net earnings of a financial
institution. The primary factors to consider in analyzing net interest income
are the composition and volume of earning assets and interest-bearing
liabilities, the amount of noninterest bearing liabilities and nonaccrual
loans, and changes in market interest rates.
Table I sets forth average balance sheet information, interest income and
expense, average yields and rates, and net interest income and net interest
margin for the three months ended March 31, 1999 and 1998.
-5-
Table I Components of Net Interest Income
THREE MONTHS ENDED MARCH 31,
-----------------------------------------------------------------
1999 1998
------------------------------ -------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
-------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
Assets:
Loans (1)(2) $162,669 $4,133 10.2% $150,687 $4,147 11.0%
Securities:
Taxable 83,758 1,338 6.4% 73,348 1,225 6.7%
Nontaxable (3) 15,178 291 7.7% 10,654 219 8.2%
Federal funds sold 32,029 374 4.7% 7,769 100 5.1%
------------------ -------------------
Total earning assets 293,634 6,136 8.4% 242,458 5,691 9.4%
Cash and due from banks 15,950 17,386
Allowance for credit losses (3,901) (3,642)
Unearned income (3,284) (2,411)
Bank premises and equipment, net 2,377 2,074
Other assets 9,238 8,274
-------- --------
Total assets $314,014 $264,139
-------- --------
-------- --------
Interest-bearing liabilities:
Deposits:
Demand $ 93,381 408 1.8% $77,779 376 1.9%
Savings 57,681 522 3.6% 27,026 213 3.2%
Time 50,773 582 4.6% 40,563 531 5.2%
------------------ -------------------
Total deposits 201,835 1,512 3.0% 145,368 1,120 3.1%
Borrowed funds 11,264 139 4.9% 30,526 430 5.6%
------------------ -------------------
Total interest-bearing liabilities 213,099 1,651 3.1% 175,894 1,550 3.5%
Demand deposits 66,804 57,286
Other liabilities 3,312 2,582
Stockholders' equity 30,799 28,377
-------- --------
Total liabilities and
stockholders' equity $314,014 $264,139
-------- --------
-------- --------
Net interest income and margin $4,485 6.1% $4,141 6.8%
------ ------
------ ------
(1) Tax exempt income includes $99,000 and $74,000 in 1999 and 1998, to
adjust to a fully taxable equivalent basis using the federal statutory rate
of 34%.
(2) Loan fees totaling $326,000 and $317,000 are included in loan interest
income for the three months ended March 31, 1999 and 1998.
(3) Average nonaccrual loans totaling $1,033,000 and $327,000 are included in
average loans for the three months ended March 31, 1999 and 1998.
(4) Annualized
-6-
For the three months ended March 31, 1999, net interest income, on a fully
taxable-equivalent basis, was $4,485,000 or 6.1% of average earning assets,
an increase of 8% over $4,141,000 or 6.8% of average earning assets in the
comparable period in 1998. The increase in 1999 reflects higher levels of
earning assets.
Interest income, on a fully taxable-equivalent basis, was $6,136,000 and
$5,690,000 for the three months ended March 31, 1999 and 1998. The increase
in 1999 resulted from the growth in average earning assets. Loan yields
averaged 10.2% and 11.0% for the three months ended March 31, 1999 and 1998.
Approximately 85% of the Bank's loans have variable interest rates indexed
to the prime rate. The Bank's average prime rate was 7.75% and 8.50% for
each of the three month periods ended March 31, 1999 and 1998. Average
earning assets were $293,634,000 and $242,458,000 for the three months ended
March 31, 1999 and 1998. The growth in average earning assets resulted from
increased levels of deposits which were invested primarily in loans and
securities.
The increase in interest income during 1999 on a fully taxable-equivalent
basis, was partially offset by an increase in interest expense. The average
rate paid on interest bearing deposits was 3.1% and 3.5% for the three
month periods ended March 31, 1999 and 1998.
NONINTEREST INCOME
Table 2 summarizes the sources of noninterest income for the periods indicated:
Table 2 - Noninterest Income
(Dollars in thousands)
THREE MONTHS ENDED
MARCH 31,
------------------
1999 1998
------ ------
Customer service fees $ 632 $ 622
Gain on sale of loans 511 668
Loan servicing fees 224 246
Gains (losses) from sale of securities 61 (15)
Other 44 46
Total noninterest income $1,472 $1,567
------------------
------------------
Gains on sale of loans decreased as a result of a lower volume of Small
Business Administration (SBA) loans sold and a decline in market prices for
SBA loans in 1999 compared to 1998. The Company sells SBA loans and FHLMC
conforming mortgage loans with SBA loan sales providing the primary source of
gains on sale.
-7-
NONINTEREST EXPENSES
The major components of noninterest expenses stated in dollars and as a
percentage of average earning assets are set forth in Table 3 for the periods
indicated.
Table 3 - Noninterest Expenses
(Dollars in thousands)
THREE MONTHS ENDED MARCH 31,
-------------------------------------
1999 1998
---- ----
Salaries and benefits $1,807 2.46% $1,540 2.54%
Occupancy 295 .40% 271 .45%
Equipment 288 .39% 285 .47%
Customer services 170 .23% 165 .27%
Advertising and promotion 105 .14% 132 .22%
Stationery and postage 91 .12% 97 .16%
Data processing 85 .12% 68 .11%
Professional services 79 .11% 123 .20%
Insurance 61 .08% 60 .10%
Other 222 .30% 176 .29%
-------------------------------------
Total noninterest expenses $3,203 4.58% $2,917 4.86%
-------------------------------------
-------------------------------------
The increases in 1999 were primarily related to higher staff and occupancy
costs and increases in data processing and other noninterest expenses
partially offset by decreases in advertising and promotion and professional
services. The increase in noninterest expenses reflects the opening of a new
branch in August 1998 and the growth in total loans, deposits and assets. The
decrease in noninterest expense as a percentage of average earning assets is
the result of the rate of growth in average earning assets in 1999 exceeding
the rate of increase in noninterest expenses.
INCOME TAXES
The Company's effective tax rate was 41.4% for the three months ended March
31, 1999 compared to 41.1% for the same period in 1998. Changes in the
effective tax rate for the Company are primarily due to fluctuations in the
proportion of tax exempt income generated from investment securities to
pre-tax income.
BALANCE SHEET ANALYSIS
Total assets were $324.7 million at March 31, 1999, no material change from
the end of 1998. Based on average balances, first quarter 1999 average total
assets of $314.0 million represent an increase of 19% over the first quarter
of 1998.
EARNING ASSETS
LOANS
Total gross loans at March 31, 1999 were $163.9 million, a 2% increase from
$161.0 million at December 31, 1998. Average loans in the three months of
1999 were $162,669,000 representing an increase of 8% over the same period in
1998. The 1999 increases primarily reflected growth in average real estate
loans which in the opinion of the Company is due to improved local economic
conditions.
Risk Elements
Lending money involves an inherent risk of nonpayment. Through the
administration of loan policies and monitoring of the portfolio, management
seeks to reduce such risks. The allowance for credit losses is an estimate to
provide a financial buffer for losses, both identified and unidentified, in
the loan portfolio.
-8-
Nonaccrual Loans, Loans Past Due and OREO
The accrual of interest is discontinued and any accrued and unpaid interest
is reversed when the payment of principal or interest is 90 days past due
unless the amount is well secured and in the process of collection. Income on
such loans is then recognized only to the extent that cash is received and
where the future collection of principal is probable. At March 31, 1999
nonaccrual loans totaled $1,033,000 or .63% of total loans compared to
$1,108,000 or .69% of total loans at December 31, 1998.
Table 4 presents the composition of nonperforming assets at March 31, 1999.
Table 4 Nonperforming Assets
(dollars in thousands)
MARCH 31, 1999
--------------
Nonperforming Assets:
Loans Past Due 90 Days or More $ -
Nonaccrual Loans 1,033
------
Total Nonperforming Loans 1,033
OREO -
------
Total Nonperforming Assets $1,033
------
------
Nonperforming Loans as a Percent of Total Loans 0.63%
OREO as a Percent of Total Assets -
Nonperforming Assets as a Percent of Total Assets 0.32%
Allowance for Credit Losses $3,882
As a Percent of Total Loans 2.37%
As a Percent of Nonaccrual Loans 376%
As a Percent of Nonperforming Loans 376%
PROVISION AND ALLOWANCE FOR CREDIT LOSSES
Management has established an evaluation process designed to determine the
adequacy of the allowance for credit losses. This process attempts to assess
the risk of loss inherent in the portfolio by segregating the allowance for
credit losses into three components: "historical losses;" "specific;" and
"margin for imprecision." The "historical losses" component is calculated as
a function of the prior four years loss experience for commercial, real
estate and consumer loan types. The four years are assigned weightings of
35%, 30%, 20% and 15% beginning with the most recent year. The "specific"
component is established by allocating a portion of the allowance to
individual classified credits on the basis of specific circumstances and
assessments. The "margin for imprecision" component is an unallocated portion
that supplements the first two components as a conservative margin to guard
against unforeseen factors. The "historical losses" and "specific" components
include management's judgment of the effect of current and forecasted
economic conditions on the ability of the Company's borrowers' to repay; an
evaluation of the allowance for credit losses in relation to the size of the
overall loan portfolio; an evaluation of the composition of, and growth
trends within, the loan portfolio; consideration of the relationship of the
allowance for credit losses to nonperforming loans; net charge-off trends;
and other factors. While this evaluation process utilizes historical and
other objective information, the classification of loans and the
establishment of the allowance for credit losses, relies, to a great extent,
on the judgment and experience of management. We evaluate the adequacy of our
allowance for credit losses quarterly.
-9-
It is the policy of management to maintain the allowance for credit losses at
a level adequate for known and inherent risks in the loan portfolio. Based on
information currently available to analyze loan loss potential, including
economic factors, overall credit quality, historical delinquency and a
history of actual charge-offs, management believes that the loan loss
provision and allowance are adequate; however, no assurance of the ultimate
level of credit losses can be given with any certainty. Loans are charged
against the allowance when management believes that the collectibility of the
principal is unlikely. An analysis of activity in the allowance for credit
losses is presented in Table 5.
TABLE 5 Allowance for Credit Losses
(Dollars in thousands)
THREE MONTHS ENDED
MARCH 31, 1999
------------------
Total Loans Outstanding $163,896
Average Total Loans 162,669
Allowance for credit losses:
Balance, January 1 $ 3,871
Charge-offs by Loan Category:
Commercial -
Installment and other 3
Real Estate construction -
Real Estate-term -
--------
Total Charge-Offs 3
Recoveries by Loan Category:
Commercial 13
Installment and other -
Real Estate construction -
Real Estate-term 1
--------
Total Recoveries 14
Net Charge-Offs (recoveries) (11)
Provision Charged to Expense -
--------
--------
Balance, March 31 $ 3,882
--------
--------
Ratios:
Net Charge-offs to Average Loans (0.01)%
Reserve to Total Loans 2.37%
OTHER INTEREST-EARNING ASSETS
For the three months ended March 31, 1999, the average balance of investment
securities and federal funds sold totaled $130,965,000, down from $91,771,000
for the same period in 1998. The 1999 increase resulted from investing
additional liquidity in federal funds sold and investment securities.
Additional liquidity was generated by the excess of the increase in average
deposits over the increase in average loans. Management also uses borrowed
funds to increase earning assets and enhance the Company's interest rate risk
profile.
-10-
FUNDING
Deposits represent the Company's principal source of funds for investment.
Deposits are primarily core deposits in that they are demand, savings, and
time deposits under $100,000 generated from local businesses and individuals.
These sources represent relatively stable, long term deposit relationships
which minimize fluctuations in overall deposit balances. During 1998, we
accepted a $15 million time deposit from the State of California, which was
increased to $20 million during 1999, in part to replace borrowed funds and
to increase earning assets. The State of California time deposit is renewable
approximately every three months at a rate similar to the three month U.S.
Treasury bill. The Bank has never used brokered deposits.
Deposits decreased $6,797,000 from year-end or 2% to $274,013,000 as of March
31, 1999. Average total deposits in the three months of 1999 of $268,639,000
increased from $202,654,000 in the same period in 1998.
Another source of funding for the Company is borrowed funds. Management uses
borrowed funds to increase earning assets, prudently leverage capital and
minimize interest rate risk. Typically, these funds result from the use of
advances from the FHLB and agreements to sell investment securities with a
repurchase at a designated future date, also known as repurchase agreements.
Repurchase agreements are conducted with major banks and investment brokerage
firms. The maturity of these arrangements for the Bank is typically 30 to 90
days. Advances from the FHLB may vary in maturity from 1 to 10 years.
Advances from the FHLB at March 31, 1999 totaled $15,000,000, payable at
maturity in 2003 and 2004. The advances are callable by the FHLB beginning in
February 1999 ($10,000,000) and March 2000 ($5,000,000) and bear interest at
a weighted average of 4.9%. The average balance of borrowed funds was
$11,264,000 and $30,526,000 during the first quarter of 1999 and 1998,
respectively. The decrease in average borrowed funds reflects the
substitution of the $15,000,000 in time deposits from the State of California
for borrowed funds.
LIQUIDITY AND INTEREST RATE SENSITIVITY
Liquidity management refers to the Company's ability to provide funds on an
ongoing basis to meet fluctuations in deposit levels as well as the credit
needs and requirements of its clients. Both assets and liabilities contribute
to the Bank's liquidity position. Federal funds lines, short-term investments
and securities, and loan repayments contribute to liquidity, along with
deposit increases, while loan funding and deposit withdrawals decrease
liquidity. The Company assesses the likelihood of projected funding
requirements by reviewing historical funding patterns, current and forecasted
economic conditions and individual client funding needs. The Bank maintains
informal lines of credit with its correspondent banks for short-term
liquidity needs. These informal lines of credit are not committed facilities
by the correspondent banks and no fees are paid by the Bank to maintain them.
The Bank manages its liquidity by maintaining a majority of its investment
portfolio in liquid investments in addition to its federal funds sold.
Liquidity is measured by various ratios, including the liquidity ratio of net
liquid assets compared to total assets. As of March 31, 1999, this ratio was
31.2%. Other key liquidity ratios are the ratios of loans to deposits and
federal funds sold to deposits, which were 59.8% and 10.6%, respectively, as
of March 31, 1999.
INTEREST RATE SENSITIVITY
Interest rate sensitivity is a measure of the exposure of the Company's
future earnings due to changes in interest rates. If assets and liabilities
do not reprice simultaneously and in equal volumes, the potential for such
exposure exists. It is management's objective to achieve a near-matched to
modestly asset-sensitive cumulative position at one year, such that the net
interest margin of the Company increases as market interest rates rise and
decreases when short-term interest rates decline.
-11-
One quantitative measure of the "mismatch" between asset and liability
repricing is the interest rate sensitivity "gap" analysis. All
interest-earning assets and funding sources are classified as to their
expected repricing or maturity date, whichever is sooner. Within each time
period, the difference between asset and liability balances, or "gap," is
calculated. Positive cumulative gaps in early time periods suggest that
earnings will increase if interest rates rise. Negative gaps suggest that
earnings will decline when interest rates rise. Table 6 presents the gap
analysis for the Company at March 31, 1999. Mortgage backed securities are
reported in the period of their expected repricing based upon estimated
prepayments developed from recent experience.
Table 6 Interest Rate Sensitivity
(Dollars in thousands)
NEXT DAY OVER THREE
AND WITHIN MONTHS AND OVER ONE
THREE WITHIN ONE AND WITHIN OVER FIVE
IMMEDIATELY MONTHS YEAR FIVE YEARS YEARS TOTAL
----------- ---------- ----------- ---------- --------- --------
(DOLLARS IN THOUSANDS)
As of March 31, 1999
Rate Sensitive Assets:
Federal Funds Sold $ 29,000 $ - $ - $ - $ - $ 29,000
Investment Securities:
Treasury and Agency Obligations - 1,000 2,500 4,600 - 8,100
Mortgage-Backed Securities - 2,727 7,956 29,278 32,973 72,934
Municipal Securities - - 225 3,177 12,112 15,514
Corporate Securities - - - - 13,261 13,261
Other - - - - 1,524 1,524
-----------------------------------------------------------------------------
Total Investment Securities - 3,727 10,681 37,055 59,870 111,333
Loans Excluding Nonaccrual Loans 138,050 1,808 3,725 7,816 11,464 162,863
-----------------------------------------------------------------------------
Total Rate Sensitive Assets $167,050 $ 5,535 $ 14,406 $44,871 $71,334 $303,196
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Rate Sensitive Liabilities:
Deposits:
Demand and Savings $153,653 $ - $ - $ - $ - $153,653
Time - 39,099 10,591 2,725 - 52,415
-----------------------------------------------------------------------------
Total Interest-bearing
Deposits 153,653 39,099 10,591 2,725 - 206,068
Other Borrowings - 712 - 15,000 - 15,712
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Total Rate Sensitive
Liabilities $153,653 $ 39,811 $ 10,591 $17,725 $ - $221,780
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Gap $ 13,397 $(34,276) $ 3,815 $27,146 $71,334 $ 81,416
Cumulative Gap $ 13,397 $(20,879) $(17,064) $10,082 $81,416
-12-
The Company's positive cumulative total gap results from the exclusion from
the above table of noninterest-bearing demand deposits, which represent a
significant portion of the Company's funding sources. The Company maintains a
negative cumulative gap in the next day and within three months and the over
three months and within one year time periods and a positive cumulative gap
in all other time periods. The Company's experience indicates money market
deposit rates tend to lag changes in the prime rate which immediately impact
the prime-based loan portfolio. Even in the Company's negative gap time
periods, rising rates result in an increase in net interest income. Should
interest rates stabilize or decline in future periods, it is reasonable to
assume that the Company's net interest margin, as well as net interest
income, may decline correspondingly.
CAPITAL RESOURCES
Management seeks to maintain adequate capital to support anticipated asset
growth and credit risks, and to ensure that the Company and the Bank are in
compliance with all regulatory capital guidelines. The primary source of new
capital for the Company has been the retention of earnings. The Company does
not have any material commitments for capital expenditures as of March 31,
1999.
The Company pays a quarterly cash dividend on its common stock as part of
efforts to enhance shareholder value. The Company's goal is to maintain a
strong capital position that will permit payment of a consistent cash
dividend which may grow commensurately with earnings growth.
During 1997, the Board of Directors approved a stock repurchase program
authorizing open market purchases of up to 3% of the shares outstanding, or
approximately 145,837 shares, in order to enhance long term shareholder
value. As of March 31, 1999, 145,500 shares had been purchased under the
program.
The Company and the Bank are subject to capital adequacy guidelines issued by
the federal bank regulatory authorities. Under these guidelines, the minimum
total risk-based capital requirement is 10.0% of risk-weighted assets and
certain off-balance sheet items for a "well capitalized" depository
institution. At least 6.0% of the 10.0% total risk-based capital ratio must
consist of Tier 1 capital, defined as tangible common equity, and the
remainder may consist of subordinated debt, cumulative preferred stock and a
limited amount of the allowance for credit losses.
The federal regulatory authorities have established minimum capital leverage
ratio guidelines for state member banks. The ratio is determined using Tier 1
capital divided by quarterly average total assets. The guidelines require a
minimum of 5.0% for a "well capitalized" depository institution.
The Bank's risk-based capital ratios were in excess of regulatory guidelines
for a "well capitalized" depository institution as of March 31, 1999, and
December 31, 1998. Capital ratios for the Company and the Bank are set forth
in Table 7:
Table 7 Capital Ratios
Consolidated:
MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
Total risk-based capital ratio 15.9% 15.4%
Tier 1 risk-based capital ratio 14.6% 14.2%
Tier 1 leverage ratio 9.9% 9.5%
Coast Commercial Bank:
MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
Total risk-based capital ratio 15.2% 14.8%
Tier 1 risk-based capital ratio 13.9% 13.6%
Tier 1 leverage ratio 9.4% 9.3%
-13-
YEAR 2000
The year 2000 problem exists because many computer systems use only the last
two digits to refer to a year. This convention could affect date-sensitive
calculations that treat "00" as the year 1900 rather than 2000. Another issue
is that the year 2000 is a leap year and some programs may not properly
provide for February 29, 2000.
This discussion of the implications of the year 2000 problem for us contains
numerous forward-looking statements on inherently uncertain information. The
cost of the project and the date on which we plan to complete the internal
year 2000 modifications are based on management's best estimates, which were
derived utilizing a number of assumptions of future events including the
continued availability of internal and external resources, third party
modifications and other factors. We cannot guarantee, however, these
estimates, and actual results could differ. Moreover, although management
believes it will be able to make the necessary modifications in advance,
there can be no guarantee that the failure to modify the systems would not
have a material adverse impact on us.
Readiness Preparation
Our plan to address the year 2000 issues includes a process of inventory,
analysis, modification, testing and certification, and implementation. In
1997 we alerted our business customers of the year 2000 problem and are now
assessing the readiness preparations of our major customers and suppliers.
Reviews of our information systems and information provided by our primary
vendors, large customers and suppliers have not identified any year 2000
readiness issues which appear to be unresolvable by December 31, 1999.
Our major critical information system is our core transaction processing
software which provides transaction processing for loans, deposits and
general ledger. The vendor supplying our core transaction processing software
has provided evidence of year 2000 readiness. Efforts continue to ascertain
the year 2000 readiness of various systems that integrate information into
the core processing software. To date, no significant information systems
have been found not ready for year 2000. Among the major actions remaining is
the testing of the core processing software and other systems which integrate
into the core processing software. Other purchased software and systems
supported by external parties are also being tested as part of the year 2000
program. In addition, contingency plans are being developed to reduce the
impact of potential events that may occur. We cannot guarantee, however, the
systems of vendors or customers with which we conduct business will be
completed on a timely basis, or that contingency plans will shield operations
from failures that may occur.
We do not significantly rely on embedded technology in our critical
processes. Embedded technology typically controls operations such as power
management and related facilities functions. Year 2000 risks associated with
embedded technology in our facilities appear low.
We rely on suppliers and customers, and we are addressing year 2000 issues
with both groups. We have identified vendors upon whom there is significant
reliance and made inquiries regarding year 2000 readiness plans and status.
Appropriate measures to minimize risk will be undertaken with those that
appear to pose a significant risk. Replacements may be effected where
necessary. We have, however, no viable alternative for some suppliers, such
as power distribution and local telephone companies. We are still evaluating
these companies, and we will use the results as information for contingency
planning. As with all financial institutions, we place a high degree of
reliance on the systems of other institutions, including government agencies,
to settle transactions. Principal settlement methods associated with major
payment systems will be tested as part of their integration with the core
processing system.
We also rely on our customers to make necessary preparations for year 2000 so
that their business operations will not be interrupted, thus threatening
their ability to honor their financial commitments. Borrowers, funding
sources and large depositors are being reviewed to determine those with
financial volumes sufficiently large to warrant inquiry and assessment of the
year 2000 readiness preparation. Financial volumes include loans and unused
commitments, collected deposit balances, ACH, and foreign exchange, etc.
-14-
The population of customers with loans and unused commitments outstanding
("borrowers") pose the highest risk level of concern for any lender. Business
purpose borrowings exceeding $50,000 were assigned one of three year 2000
risk levels: low, medium or high. Borrowers representing 3% and 28% of
outstanding loans were assigned high and medium year 2000 risk levels,
respectively.
Ongoing reassessments with risk mitigation plans will be made for all levels
of risk. Customers with low and medium risk will be reassessed annually,
while customers with high risk will be reassessed at least quarterly. The
risk mitigation plan will evaluate whether year 2000 issues will materially
affect the customer's cash flows, asset account values related to its balance
sheet, and/or collateral pledged to us. The risk mitigation plan is
incorporated into the normal credit review process.
Cost
Amounts expensed in the first three months of 1999 were not significant to
our financial position or results of operations. Although the remaining costs
associated with achieving year 2000 compliance have not yet been determined,
management believes the amounts expensed during 1999 will not have a material
effect on the our financial position, results of operations or cash flows. In
addition, we may also replace certain equipment and software to ensure year
2000 readiness. The cost of the replacement items will be expensed over the
useful lives of those assets. During 1998, six existing automated teller
machines were replaced with new machines at a cost of approximately $300,000
due in part to year 2000 issues with the existing equipment. The cost of
other identified replacement items and contingency equipment is estimated at
less than $100,000. Estimated total costs could change as our analysis
continues.
Risks
The principal risks associated with the year 2000 problem can be grouped into
three categories:
- we do not successfully ready our operations for the next century,
- disruption of our operations due to operational failures of third
parties, and
- business interruption among fund providers and obligors such that
expected funding and repayment does not take place.
The only risk largely under our control is preparing our internal operations
for the year 2000. We, like other financial institutions, are heavily
dependent on our computer systems. The complexity of these systems and their
interdependence make it impracticable to switch to alternative systems
without interruptions if necessary modifications are not completed on
schedule. Management believes it will be able to make the necessary
modifications on schedule.
Failure of third parties may jeopardize our operations, but the seriousness
of this risk depends on the nature and duration of the failures. The most
serious impact on our operations from suppliers would result if basic
services such as telecommunications, electric power suppliers and services
provided by other financial institutions and governmental agencies were
disrupted. Some public disclosure about readiness preparation among basic
infrastructure and other suppliers is now available. We are unable, however,
to estimate the likelihood of significant disruptions among our basic
infrastructure suppliers. In view of the unknown probability of occurrence
and impact on operations, we consider the loss of basic infrastructure
services to be the most reasonably likely worst case year 2000 scenario.
Operational failures among our customers could affect their ability to
continue to provide funding or meet obligations when due. The information we
develop in the customer assessments described earlier allows us to identify
those customers that exhibit a risk of not making the adequate preparations
for the century change. We are taking appropriate actions to manage these
risks.
Program Assessment
Senior management and banking regulators regularly assess our year 2000
preparations. Additionally, a consulting and services firm has been retained
to review and advise senior management on internally developed testing plans
for critical systems.
-15-
Contingency Plans
We are developing remediation contingency plans and business resumption
contingency plans specific to the year 2000. Remediation contingency plans
address the actions to be taken if the current approach to remediating a
system is falling behind schedule or otherwise appears in jeopardy of failing
to deliver a year 2000 ready system when needed. Business resumption
contingency plans address the actions that would be taken if critical
business functions can not be carried out in the normal manner upon entering
the next century due to system or supplier failure. Most contingent action
plans prepared at this time involve manual processing of transactions. Given
the size, scope and complexity of our operations, manual processing appears a
viable alternative for most information systems other than the core
processing system.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
On April 21, 1999, the Coast Bancorp Board of Directors declared a
cash dividend of eight cents ($0.08) per share, payable May 27, 1999, to
shareholders of record on May 7, 1999.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
Exhibit Number
3.1 Articles of incorporation of Coast Bancorp, as amended January 20, 1999
27 Financial Data Schedule
b. Reports on Form 8-K
Not applicable
-16-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COAST BANCORP
--------------------------------------
(REGISTRANT)
Date: April 26, 1999
/s/ HARVEY J. NICKELSON
--------------------------------------
Harvey J. Nickelson
President and Chief Executive Officer
/s/ BRUCE H. KENDALL
---------------------------------------
Bruce H. Kendall
Senior Vice President
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
-17-