-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SxO7sQJoGTUnrVY6ZgS4ZSQNXuFEpTK+S0aRWHKsWYbMJlgbPL2rbedOF41DXmVJ /AbFGde38n+SBkRSWPeucg== 0001047469-98-040998.txt : 19981118 0001047469-98-040998.hdr.sgml : 19981118 ACCESSION NUMBER: 0001047469-98-040998 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPITAL CORP OF THE WEST CENTRAL INDEX KEY: 0001004740 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 770405791 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-27384 FILM NUMBER: 98750188 BUSINESS ADDRESS: STREET 1: 550 W MAIN STREET CITY: MERCED STATE: CA ZIP: 95340 BUSINESS PHONE: 2097252200 MAIL ADDRESS: STREET 1: 550 W MAIN STREET STREET 2: 550 W MAIN STREET CITY: MERCED STATE: CA ZIP: 95340 10-Q 1 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [ X ] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act --- of 1934 for the Quarterly Period Ended September 30, 1998 ------------------ or [ ] Transition Report pursuant to Section 13 or 15(d) of the Securities --- Exchange Act of 1934 for the Transition Period from to ---------- ---------- Commission File Number: 0-27384 --------------------------------------------------- CAPITAL CORP OF THE WEST (Exact name of registrant as specified in its charter) California 77-0405791 (State or other jurisdiction of IRS Employer ID Number incorporation or organization) 550 West Main, Merced, CA 95340 (Address of principal executive offices) Registrant's telephone number, including area code: (209) 725-2200 ----------------- Former name, former address and former fiscal year, if changed since last report: Not applicable -------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- The number of shares outstanding of the registrant's common stock, no par value, as of September 30, 1998 was 4,606,602. No shares of preferred stock, no par value, were outstanding at September 30, 1998. 1 CAPITAL CORP OF THE WEST Table of Contents PART I. -- FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets 3 Consolidated Statements of Income and Comprehensive Income 4 Consolidated Statements of Cash Flows 5 Consolidated Statement of Changes in Stockholders Equity 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures about Market Risk 30 PART II. -- OTHER INFORMATION Item 1. Legal Proceedings 30 Item 2. Changes in Securities 30 Item 3. Defaults Upon Senior Securities 30 Item 4. Submission of matters to a vote of Security Holders 30 Item 5. Other Information 31 Item 6. Exhibits and Reports on Form 8-K 31 SIGNATURES 32
2 Capital Corp of the West Consolidated Balance Sheets (Unaudited)
09/30/98 12/31/97 --------- -------- (In thousands) ASSETS Cash and noninterest-bearing deposits in other banks $ 21,774 $ 21,035 Federal funds sold 30,800 2,400 Time deposits at other financial institutions 500 599 Investment securities available for sale, at fair value 121,224 135,257 Investment securities held to maturity at cost, fair value of $15,798,000, and $12,780,000 at September 30, 1998 and December 31, 1997, respectively 15,715 12,775 Loans, net of allowance for loan losses of $4,545,000, and $3,833,000 at September 30, 1998 and December 31, 1997, respectively 255,569 214,144 Interest receivable 3,188 2,741 Premises and equipment, net 13,574 12,945 Intangible assets 6,060 6,653 Other assets 13,103 12,845 --------- --------- Total assets $ 481,507 $ 421,394 --------- --------- --------- --------- LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-bearing demand $ 68,328 $ 58,836 Negotiable orders of withdrawal 56,991 54,202 Savings 167,552 143,562 Time, under $100,000 80,186 69,534 Time, $100,000 and over 40,818 30,261 --------- --------- Total deposits 413,875 356,395 Short term borrowings 18,103 13,645 Long term borrowings 3,274 8,404 Accrued interest, taxes and other liabilities 2,794 2,702 --------- --------- Total liabilities 438,046 381,146 Preferred Stock, no par value; 10,000,000 shares authorized; None outstanding Common stock, no par value; 20,000,000 shares authorized; 4,606,602 and 4,595,824 issued & outstanding at 34,033 33,928 September 30, 1998, and December 31, 1997 Accumulated other comprehensive income: Unrealized gain on securities available for sale, net 622 195 Retained earnings 8,806 6,125 --------- --------- Total shareholders' equity 43,461 40,248 --------- --------- Total liabilities and shareholders' equity $ 481,507 $ 421,394 --------- --------- --------- ---------
See accompanying notes 3 Capital Corp of the West Consolidated Statements of Income and Comprehensive Income (Unaudited)
For the three months For the nine months ended September 30, ended September 30, 1998 1997 1998 1997 ---- ---- ---- ---- (In thousands) (In thousands) INTEREST INCOME: Interest and fees on loans $ 6,708 $ 5,455 $ 18,488 $ 15,085 Interest on deposits with other financial institutions 16 59 50 240 Interest on taxable investments held to maturity 182 192 551 600 Interest on investments available for sale: Taxable 1,642 731 4,996 1,869 Non-taxable 216 42 483 150 Interest on federal funds sold 257 143 907 235 Total interest income 9,021 6,622 25,475 18,179 INTEREST EXPENSE: Interest on negotiable orders of withdrawal 131 87 372 245 Interest on savings deposits 1,436 1,215 4,316 3,487 Interest on time deposits, under $100,000 1,063 897 3,314 2,314 Interest on time deposits, $100,000 and over 497 157 1,158 456 Interest on other borrowings 321 217 977 478 Total interest expense 3,448 2,573 10,137 6,980 Net interest income 5,573 4,049 15,338 11,199 Provision for loan losses 700 205 1,690 3,681 Net interest income after provision for loan 4,873 3,844 13,648 7,518 losses OTHER INCOME: Service charges on deposit accounts 734 462 2,072 1,195 Income from real estate held for sale or development 56 89 419 600 Other 430 195 1,176 897 Total other income 1,220 746 3,667 2,692 OTHER EXPENSES: Salaries and related benefits 2,055 1,612 5,929 4,643 Premises and occupancy 330 311 980 887 Equipment 581 335 1,625 970 Professional fees 381 153 746 413 Marketing 173 152 463 463 Goodwill and intangible amortization 195 94 584 118 Branch purchase - - 101 - Supplies 143 131 455 382 Other 993 550 2,669 1,882 Total other expenses 4,851 3,338 13,552 9,758 Income before income taxes 1,242 1,252 3,763 452 Provision for income taxes 248 476 1,076 106 ------ ------ ------ ----- Net income $ 994 $ 776 $2,687 $ 346 - -------------------------------------------------------------------------------------------------------------------- Comprehensive Income: Change in unrealized gain on securities available for sale 467 9 427 158 ------ ------ ------ ----- Comprehensive Income $1,461 $ 785 $3,114 $ 504 ------ ------ ------ ----- ------ ------ ------ ----- - -------------------------------------------------------------------------------------------------------------------- Basic earnings per share $ 0.22 $ .20 $ 0.58 $0.12 Diluted earnings per share $ 0.21 $ 0.56
See accompanying notes 4 Capital Corp of the West Consolidated Statements of Cash Flows (Unaudited)
9 months ended 9 months ended 09/30/98 09/30/97 (In thousands) OPERATING ACTIVITIES: Net income $ 2,687 $ 346 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,690 3,681 Depreciation, amortization and accretion, net 2,541 1,124 Benefit for deferred income taxes - 735 Gain on sale of real estate held for sale 363 (600) Net increase in interest receivable & other assets (1,068) (2,000) Net increase in deferred loan fees 85 59 Net increase (decrease) in accrued interest payable & other liabilities 92 (1,130) -------- -------- Net cash provided by operating activities 6,390 2,215 INVESTING ACTIVITIES: Investment security purchases (40,745) (60,707) Proceeds from maturities of investment securities 25,381 10,264 Proceeds from sales of AFS investment securities 26,219 7,718 Net decrease in time deposits in other financial institutions 99 - Proceeds from sales of commercial and real estate loans 6,410 1,415 Net increase in loans (50,088) (29,989) Purchases of premises and equipment (1,912) (5,645) Proceeds from sales of real estate held for sale 478 1,470 -------- -------- Net cash used in investing activities (34,158) (75,474) FINANCING ACTIVITIES: Net increase in demand, NOW and deposits 36,271 15,497 Net increase in certificates of deposit 21,209 25,054 Net (decrease) increase in other borrowings (672) 18,738 Exercise of stock options 105 234 Issuance of common stock - 17,992 Issued shares for benefit plan purchases - 208 Fractional shares purchased (6) (10) -------- -------- Net cash provided by financing activities 56,907 77,713 Net increase in cash and cash equivalents 29,139 4,454 Cash and cash equivalents at beginning of period 23,435 16,717 -------- -------- Cash and cash equivalents at end of period $ 52,574 $ 21,171 -------- -------- -------- -------- SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Investment securities net unrealized gains; net of tax 427 158 Interest paid 10,127 6,921 Income tax payments 200 850 Transfer of securities from available for sale to held to maturity 9,636 11,455 Loans transferred to other real estate owned 478 60
See accompanying notes 5 Capital Corp of the West Consolidated Statement of Changes in Shareholders' Equity (Unaudited) (Amounts in thousands except number of shares)
Common Stock ------------------------- Number Unrealized of Retained Securities shares Amounts earnings Gain, net Total ------------ ----------- ----------- ----------- ----------- Balance, December 31, 1997 4,595,824 $ 33,928 $ 6,125 $ 195 $ 40,248 Exercise of stock option 10,778 105 - - 105 Common stock dividends - - (6) - (6) Change in fair market value of investment securities - - - 427 427 Net income - - 2,687 - 2,687 ------------ ----------- ----------- ----------- ----------- Balance, September 30, 1998 4,606,602 $ 34,033 $ 8,806 $ 622 $ 43,461 ------------ ----------- ----------- ----------- ----------- ------------ ----------- ----------- ----------- -----------
See accompanying notes 6 Capital Corp of the West Notes to Consolidated Financial Statements September 30, 1998 and December 31, 1997 (Unaudited) GENERAL - COMPANY Capital Corp of the West (the "Company" or "Capital Corp") is a bank holding company incorporated under the laws of the State of California on April 26, 1995. On November 1, 1995, the Company became registered as a bank holding company, and is a holder of all of the capital stock of County Bank (the "Bank") and all of the capital stock of Town and Country Finance and Thrift (the "Thrift"). During 1997, the Company formed Capital West Group, a new subsidiary that engages in the financial institution advisory business but is currently inactive. The Company's primary asset is the Bank and the Bank is the Company's primary source of income. The Company's securities consist of 20,000,000 shares of Common Stock, no par value, and 10,000,000 shares of Authorized Preferred Stock. As of September 30, 1998 there were 4,606,602 common shares outstanding, held of record by approximately 1,800 shareholders. There were no preferred shares outstanding at September 30, 1998. The Bank has two wholly owned subsidiaries, Merced Area Investment & Development, Inc. ("MAID") and County Asset Advisors ("CAA"). CAA is currently inactive. All references herein to the "Company" include the Bank, and the Bank's subsidiaries, Capital West Group and the Thrift, unless context otherwise requires. GENERAL - BANK The Bank was organized on August 1, 1977, as County Bank of Merced, a California state banking corporation. The Bank commenced operations on December 22, 1977. In November 1992, the Bank changed its legal name to County Bank. The Bank's securities consist of one class of Common Stock, no par value and is wholly owned by the Company. The Bank's deposits are insured under the Federal Deposit Insurance Act, by the Federal Deposit Insurance Corporation ("FDIC") up to applicable limits stated therein. Like most state-chartered banks of its size in California, it is not a member of the Federal Reserve System. GENERAL - THRIFT The Company acquired the Thrift on September 28, 1996 for a combination of cash and stock with an aggregate value of approximately $5.8 million. The Thrift is an industrial loan company with four offices. It specializes in direct loans to the public and the purchase of financing contracts. It was originally incorporated in 1957. Its deposits (technically known as investment certificates or certificates of deposit rather than deposits) are insured by the FDIC up to applicable limits. BANK'S INDUSTRY AND MARKET AREA The Bank engages in general commercial banking business primarily in Merced, Tuolumne, Mariposa, Madera and Stanislaus counties. The Bank has thirteen branch offices: two in Merced with the branch located in downtown Merced located within the Bank's administrative office building, offices in Atwater, Turlock, Hilmar, Sonora, Los Banos, Mariposa, Livingston, Dos Palos, Madera and two offices in Modesto. The Bank relocated its existing administrative office and existing branch in downtown Merced to a new facility constructed in 1997. The Thrift engages in the general consumer lending business primarily in Stanislaus, Fresno, and Tulare counties from its main office in Turlock; and branch offices located in Modesto, Visalia, and Fresno. 7 OTHER FINANCIAL NOTES All adjustments, in the opinion of Management, which are necessary for a fair presentation of the Company's financial position at September 30, 1998 and December 31, 1997 and the results of operations for the three and nine month periods ended September 30, 1998 and 1997, and the statements of cash flows for the nine month periods ended September 30, 1998 and 1997, have been included. These interim statements are not necessarily indicative of the results for a full year. The accompanying unaudited financial statements have been prepared on a basis consistent with the generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Per share information is based on weighted average number of shares of common stock outstanding during each three-month and nine-month period after giving retroactive effect for the five percent stock dividend declared for shareholders of record May 7, 1998, payable September 1, 1998, and the three-for-two stock split declared for shareholders of record on April 11, 1997, payable on May 2, 1997. Basic earnings per share (EPS) is computed by dividing net income available to shareholders by the weighted average common shares outstanding during the period. Diluted earnings per share is computed by dividing net income available to shareholders by the weighted average common shares outstanding during the period plus potential common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. An EPS adjustment for potential common stock dilution for the three and nine months ended September 30, 1997 has not been presented due to the neutral nature of the adjustment during this time period. The following table provides a reconciliation of the numerator and denominator of the basic and diluted earnings per share computation of the three and nine month periods ending September 30, 1998 and 1997:
For The Three Months For The Nine Months Ended September 30, Ended September 30, --------------------------- --------------------------- (In thousands, except per share data) 1998 1997 1998 1997 ------------ ------------ ------------ ------------ Basic EPS computation: Net income $ 994 $ 776 $ 2,687 $ 346 Average common shares outstanding 4,603 3,944 4,601 2,733 ------------ ------------ ------------ ------------ Basic EPS $ 0.22 $ .20 $ 0.58 $ 0.12 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Diluted EPS Computations: Net income $ 994 $ 2,687 Average common shares outstanding 4,603 4,601 Stock options 155 155 ------------ ------------ 4,758 4,756 ------------ ------------ Diluted EPS $ 0.21 $ 0.56 ------------ ------------ ------------ ------------
8 In June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 is effective for annual periods beginning after December 15, 1997 and is to be applied retroactively to all periods presented. SFAS No. 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS No. 131 supersedes SFAS No. 14, FINANCIAL REPORTING FOR SEGMENTS OF A BUSINESS ENTERPRISE but retains the requirement to report information about major customers. Management does not expect that adoption of SFAS No. 131 will have a material impact on the Company's consolidated financial statements. 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 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, an 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. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS. 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. The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to the Company and its subsidiaries' financial condition, operating results, asset and liability management, liquidity and capital resources and should be read in conjunction with the Consolidated Financial Statements of the Company and the Notes thereto. RESULTS OF OPERATIONS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 OVERVIEW. For the three and nine months ended September 30, 1998, the Company reported net income of $994,000 and $2,687,000 compared with $776,000 and $346,000 for the same periods in 1997, an increase in net income of $218,000 and $2,341,000 respectively. Basic earnings per share were $.22 and $.58 for the three and nine months ending September 30, 1998 compared to net income per share of $.20 and $.12 for the three and nine months ended September 30, 1997. The annualized return on average assets was .85% and .81% for the first three and nine months of 1998 compared with .33% and .16% for the three and nine months ended September 30, 1997. The Company's annualized return on average equity was 9.27% and 8.59% for the three and nine months ended September 30, 1998 compared with 3.57% and 1.91% for the three and nine months ended September 30, 1997. NET INTEREST INCOME. The Company's primary source of income is the difference between interest income and fees derived from earning assets and interest paid on liabilities. The difference between the two is net interest income. Net interest income for the three and nine months ended September 30, 1998 totaled $5,573,000 and $15,338,000 compared with $4,049,000 and $11,199,000 for the same periods in 1997, an increase of $1,524,000 and $4,139,000 or 38% and 37% respectively. Total interest and fees on earning assets were $9,021,000 and $25,475,000 for the three and nine months ended September 30, 1998, an increase of $2,399,000 and $7,296,000 or 36% and 40% from $6,622,000 and $18,179,000 for the same three and nine months in 1997. The level of interest income is affected by changes in volume of and rates earned on interest-earning assets. Interest-earning assets consist primarily of loans, investment securities and federal funds sold. The increase in interest income for the three and nine months ended September 30, 1998 was primarily the result of an increase in the volume of interest-earning assets. Average interest-earning assets for the three and nine months ended September 30, 1998 were $414,457,000 and $392,812,000 compared with $275,584,000 and $256,254,000 for the three and nine months ended September 30, 1997, an increase of $138,873,000 and $136,558,000 or 50% and 53% respectively. Interest expense is a function of the volume of and the rates paid on interest-bearing liabilities. Interest-bearing liabilities consist primarily of certain deposits and borrowed funds. Total interest expense was $3,448,000 and $10,137,000 for the three and nine months ended September 30, 1998, compared with $2,573,000 and $6,980,000 for the three and nine months ended September 30, 1997, an increase of $875,000 and $3,157,000 or 34% and 45%, respectively. This increase was primarily the result of an increase in the volume of interest-bearing liabilities. Average interest-bearing liabilities were $354,752,000 and $339,532,000 for the three and nine months ended September 30, 1998 compared with 10 $247,863,000 and $229,029,000 for the same three and nine months in 1997, an increase of $106,889,000 and $110,503,000 or 43% and 48%, respectively. The increase in interest-earning assets and interest-bearing liabilities is primarily the result of the Company's purchase of three branches of Bank of America in December 1997 and the completion of a stock offering in August 1997. The branch purchase increased deposits by $60,849,000 (there were no loans purchased) and the stock offering increased capital by $17,951,000. In addition, two branch offices opened in late 1996 and a third in late 1997 which also contributed to growth. The Company's net interest margin, the ratio of net interest income to average interest-earning assets, was 5.33% and 5.22% for the three and nine months ended September 30, 1998 compared with 5.85% and 5.84% for the same period in 1997. Net interest margin provides a measurement of the Company's ability to employ funds profitably during the period being measured. The Company's decrease in net interest margin was primarily attributable to a moderate change in the mix of interest-earning assets. Loans as a percentage of average interest-earning assets were 62% and 60% for the three and nine months ended September 30, 1998 compared to 60% and 62% for the three and nine months ended September 30, 1997. The lower loans as a percentage of average interest-earning assets for the nine months ending September 30, 1998 was primarily due to the purchase of the three branches of Bank of America in December of 1997. 11 AVERAGE BALANCES AND RATES EARNED AND PAID. The following table presents condensed average balance sheet information for the Company, together with interest rates earned and paid on the various sources and uses of its funds for each of the periods indicated. Nonaccruing loans are included in the calculation of the average balances of loans, but the nonaccrued interest on such loans is excluded. AVERAGE BALANCE SHEET & ANALYSIS OF NET INTEREST EARNINGS
Nine months ended Nine months ended September 30, 1998 September 30, 1997 Average Average Balance Interest Yield/rate Balance Interest Yield/rate (DOLLARS IN THOUSANDS) ASSETS Federal funds sold $ 22,115 $ 907 5.48% $ 5,770 $ 235 5.45% Time deposits at other financial institutions 1,072 50 6.24 5,499 240 5.84 Taxable investment securities: 121,378 5,547 6.11 47,613 2,469 6.93 Nontaxable investment securities (1) 12,734 483 5.07 3,727 150 5.38 Loans, gross: (2) 235,513 18,488 10.50 193,645 15,085 10.42 ------- ------ ----- ------- ------ ----- Total interest-earning assets: 392,812 25,475 8.67% 256,254 18,179 9.48 Allowance for loan losses (4,028) (2,730) Cash and due from banks 20,155 13,528 Premises and equipment, net 13,356 8,909 Interest receivable and other assets 22,390 15,056 ------- ------- Total assets $444,685 $291,017 ------- ------- ------- ------- LIABILITIES AND SHAREHOLDERS' EQUITY Negotiable order of withdrawal 55,721 372 $0.89 $ 36,196 245 0.90 Savings deposits 153,461 4,316 3.76 114,256 3,487 4.08 Time deposits 108,607 4,472 5.51 67,271 2,770 5.51 Other borrowings 21,743 977 6.01 11,306 478 5.65 ------- ------ ----- ------- ------ ----- Total interest-bearing liabilities 339,532 10,137 3.99 229,029 6,980 4.07 Noninterest-bearing deposits 60,420 35,096 Accrued interest, taxes and other liabilities 2,921 2,762 ------- ------- Total liabilities 402,873 266,887 Total shareholders' equity 41,812 24,130 ------- ------- Total liabilities and shareholders' equity $444,685 $291,017 ------- ------- ------- ------- Net interest income and margin (3) $15,338 5.22% $11,199 5.84% ------- ----- ------ ----- ------- ----- ------ -----
(1) Interest on nontaxable securities is not computed on a tax-equivalent basis. (2) Amounts of interest earned includes loan fees of $971,000 and $1,043,000 for September 30, 1998 and 1997 respectively. (3) Net interest margin is computed by dividing net interest income by total average interest-earning assets. 12 NET INTEREST INCOME CHANGES DUE TO VOLUME AND RATE. The following table sets forth, for the periods indicated, a summary of the changes in average asset and liability balances and interest earned and interest paid resulting from changes in average asset and liability balances (volume) and changes in average interest rates and the total net change in interest income and expenses. The changes in interest due to both rate and volume have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each. Net Interest Income Variance Analysis:
September 30, 1998 compared to September 30, 1997 Volume Rate Total ------ ------ ------- (Dollar amounts in thousands) Increase (decrease) in interest income: Federal funds sold $ 670 $ 2 $ 672 Time deposits at other financial institutions (195) 5 (190) Taxable investment securities 3,220 (142) 3,078 Tax-exempt investment securities 336 (3) 333 Loans 3,286 117 3,403 ------ ------ ------ Total 7,317 (21) 7,296 ------ ------ ------ ------ ------ ------ Increase (decrease) interest expense: Interest bearing demand 128 (1) 127 Savings deposits 970 (141) 829 Time deposits 1,702 - 1,702 Other borrowings 467 32 499 ------ ------ ------ Total 3,267 (110) 3,157 ------ ------ ------ ------ ------ ------ Increase in net interest income $ 4,050 $ 89 $4,139 ------ ------ ------ ------ ------ ------
PROVISION FOR LOAN LOSSES. The provision for loan losses for the three and nine months ended September 30, 1998 was $700,000 and $1,690,000 compared with $205,000 and $3,681,000 for the three and nine months ended September 30, 1997. Also see "Allowance for Loan Losses" contained herein. As of September 30, 1998 the allowance for loan losses was $4,545,000 or 1.75% of total loans. At September 30, 1998, nonperforming assets totaled $2,071,000 or .43% of total assets, nonperforming loans totaled $1,988,000 or .76% of total loans and the allowance for loan losses totaled 228% of nonperforming loans. No assurance can be given that nonperforming loans will not increase or that the allowance for loan losses will be adequate to cover losses inherent in the loan portfolio. Also see "Memorandum of Understanding" contained herein. NONINTEREST INCOME. Noninterest income increased by $474,000 and $975,000 or 64% and 36% to $1,220,000 and $3,667,000 for the three and nine months ended September 30, 1998 compared with $746,000 and $2,692,000 in the same period in 1997. Service charges on deposit accounts increased by $272,000 and $877,000 or 59% and 73%, income from the sale of real estate held for sale or development decreased by $33,000 and $181,000 or 37% and 30% and other income increased by $235,000 and $279,000 or 121% and 31% for the three and nine month period ended September 30, 1998 when compared to the same period in 1997. The increases in service charges are primarily due to general growth of the Company and the purchase of three branches from Bank of America in December of 1997. NONINTEREST EXPENSE. Noninterest expenses increased by $1,513,000 and $3,794,000 or 45% and 39% to $4,851,000 and $13,552,000 for the three and nine months ended September 30, 1998 compared with $3,338,000 and $9,758,000 for the same period in 1997. The primary components of noninterest expenses were salaries and employee benefits, furniture and equipment expenses, occupancy expenses, and other operating expenses. 13 For the three and nine months ended September 30, 1998 compared with the three and nine months ended September 30, 1997, salaries and related benefits increased by $443,000 and $1,286,000 or 27% and 28%, respectively, equipment expenses increased by $246,000 and $655,000 or 73% and 68%, respectively, occupancy expenses increased $19,000 and $93,000 or 6% and 10%, respectively, professional fees increased by $228,000 and $333,000 or 149% and 81%, respectively, marketing expenses increased by $21,000 and $0 or 14% and 0%, respectively, goodwill and intangible amortization expense increased by $101,000 and $466,000 or 107% and 395%, respectively, supplies expense increased by $12,000 and $73,000 or 9% and 19%, respectively, and other expenses increased by $443,000 and $787,000 or 81% and 42%, respectively. The expense increases were primarily the result of expansion, including expenses associated with acquisition of the branches purchased from Bank of America in December, 1997 and the opening of a new branch in Madera in late 1997. PROVISION FOR INCOME TAXES. The Company recorded a $248,000 and $1,076,000 income tax provision for the three and nine months ended September 30, 1998 compared with an income tax provision of $476,000 and $106,000 for the same period in 1997. During the third quarter of 1998, a state Enterprise Zone tax credit of approximately $180,000 was recorded. This credit is the result of certifying eligible employees that work within the Merced-Atwater Enterprise Zone. Income tax expense was further reduced by federal low income housing credits that were obtained from investments in limited partnerships in low-income affordable housing projects. The Company had investments in these partnerships of $4,238,000 as of September 30, 1998 and $4,299,000 as of September 30, 1997, resulting in tax credits of $213,000 and $105,000 respectively. The effective tax rate for the three and nine months ended September 30, 1998 was 20% and 29% compared to 38% and 23% for the three and nine months ended September 30, 1997. INTEREST RATE RISK Interest rate risk is an integral part of managing a banking institution's primary source of income, net interest income. The Company manages the balance between rate-sensitive assets and rate-sensitive liabilities being repriced in any given period with the objective of stabilizing net interest income during periods of fluctuating interest rates. The Company considers its rate-sensitive assets to be those which either contain a provision to adjust the interest rate periodically or mature within one year. These assets include certain loans and investment securities and federal funds sold. Rate-sensitive liabilities are those which allow for periodic interest rate changes within one year and include maturing time certificates, certain savings deposits and interest-bearing demand deposits. The difference between the aggregate amount of assets and liabilities that reprice at various time frames is called the "gap." Generally, if repricing assets exceed repricing liabilities in a time period the Company would be deemed to be asset-sensitive. If repricing liabilities exceed repricing assets in a time period the Company would be deemed to be liability-sensitive. Generally, the Company seeks to maintain a balanced position whereby there is no significant asset or liability sensitivity within a one-year period to ensure net interest margin stability in times of volatile interest rates. This is accomplished through maintaining a significant level of loans, investment securities and deposits available for repricing within one year. 14 The following tables set forth the interest rate sensitivity of the Company's interest-earning assets and interest-bearing liabilities as of September 30,1998, using the interest rate sensitivity gap ratio. For purposes of the following table, an asset or liability is considered rate-sensitive within a specified period when it can be repriced or matures within its contractual terms.
AT SEPTEMBER 30, 1998 ------------------------------------------------------------------------------------- AFTER 3 AFTER 1 BUT YEAR BUT WITHIN WITHIN WITHIN AFTER NONINTEREST- 3 MONTHS 12 MONTHS 5 YEARS 5 YEARS BEARING TOTAL -------- --------- ------- ------- ------- ----- (DOLLARS IN THOUSANDS) ASSETS Time deposits at other banks $ 500 $ - $ - $ - $ - $ 500 Federal funds sold 30,800 - - - - 30,800 Investment securities 33,570 15,726 39,137 48,506 - 136,939 Loans 147,772 34,075 58,551 19,716 - 260,114 --------- --------- -------- ------- ------- Total earning assets 212,642 49,801 97,688 68,222 428,353 Noninterest-earning assets and allowances for loan losses - - - - 53,154 53,154 --------- --------- -------- ------- ------- ------- Total assets $ 212,642 $ 49,801 $ 97,688 $68,222 $53,154 $481,507 LIABILITIES AND SHAREHOLDERS' EQUITY Savings, money market and NOW deposits $ 292,871 $ - $ - $ - $ - $292,871 Time deposits 36,312 67,676 16,804 212 - 121,004 Other interest-bearing liabilities 13,000 5,103 - 3,274 - 21,377 Other liabilities and shareholders' equity - - - - 46,255 46,255 --------- --------- -------- ------- ------- ------- Total liabilities and shareholders' equity 342,183 72,779 16,804 3,486 46,255 $481,507 Incremental gap (129,541) (22,978) 80,884 64,736 6,899 Cumulative gap $(129,541) $(152,519) $(71,635) $(6,899) $ - Cumulative gap as a % of earning assets (30.24)% (35.60)% (16.72)% (1.6)%
The Company was liability-sensitive with a negative cumulative one-year gap of $152,519,000 or 35.60% of interest-earning assets at September 30, 1998. In general, based upon the Company's mix of deposits, loans and investments, increases in interest rates would be expected to result in a decrease in the Company's net interest margin. The interest rate gaps reported in the tables arise when assets are funded with liabilities having different repricing intervals. Since these gaps are actively managed and change daily as adjustments are made in interest rate views and market outlook, positions at the end of any period may not be reflective of the Company's interest rate sensitivity in subsequent periods. Active management dictates that longer-term economic views are balanced against prospects for short-term interest rate changes in all repricing intervals. For purposes of the analysis above, repricing of fixed-rate instruments is based upon the contractual maturity of the applicable instruments. Actual payment patterns may differ from contractual payment patterns. The change in net interest income may not always follow the general expectations of an asset-sensitive or liability-sensitive balance sheet during periods of changing interest rates, because interest rates earned or paid may change by differing increments and at different time intervals for each type of interest-sensitive asset and liability. As a result of these factors, at any given time, the Company may be more sensitive or less sensitive to changes in interest rates than indicated in the above tables. Greater sensitivity would have a more adverse effect on net interest margin if market interest rates were to increase, and a more favorable effect if rates were to decrease. 15 An additional measure of interest rate sensitivity that the Company monitors through a detailed model is its expected change in 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 liability. It then measures the projected impact of changes in market interest rates on the Company's net interest income. Based upon the September 30, 1998 mix of interest-sensitive assets and liabilities, given an immediate and sustained increase in the market interest rates of 2%, this model estimates the Company's cumulative change in net interest income over the next year would decrease by $179,000 or 1% of net interest income. No assurance can be given that the actual net interest income would not decrease by more than $179,000 or 1% in response to a 2% increase in market interest rates or that actual net interest income would not decrease substantially if market interest rates increased by more than 2%. Also see "Memorandum of Understanding" contained herein. At the Bank's most recent examination, the regulators felt that the then current model that was used by the Bank was not adequate for a bank of its current size and complexity. During the second quarter of 1998, the Company contracted with interest rate sensitivity consultants to provide additional expertise in the interest rate sensitivity modeling process and has updated the model it uses for interest rate risk analysis. The estimates stated above were derived from this updated model. FINANCIAL CONDITION Total assets at September 30, 1998 were $481,507,000, an increase of $60,113,000 or 14% compared with total assets of $421,394,000 at December 31, 1997. Net loans were $255,569,000 at September 30, 1998, an increase of $41,425,000 or 19% compared with net loans of $214,144,000 on December 31, 1997. Deposits were $413,875,000 at September 30, 1998, an increase of $57,480,000 or 16% compared with deposits of $356,395,000 at December 31, 1997. The growth of the Company from December 31, 1997 to September 30, 1998 was primarily the result of increased market penetration, particularly in the case of the purchase of three branch offices of Bank of America in December 1997, and the opening of a branch office of County Bank in late 1997. Total shareholders' equity was $43,461,000 at September 30, 1998, an increase of $3,213,000 or 8% from $40,248,000 at December 31, 1997. The growth in shareholders' equity from December 31, 1997 to September 30, 1998 was achieved primarily through the retention of accumulated earnings. INVESTMENT PORTFOLIO. The following table sets forth the carrying amount (fair value) of available for sale investment securities as of September 30, 1998 and December 31, 1997.
SEPTEMBER 30 DECEMBER 31 -------------------------------------- 1998 1997 (In thousands) AVAILABLE FOR SALE SECURITIES: U.S. Treasury and U.S. Government agencies $ 12,468 $ 1,824 State and political subdivisions 19,783 9,640 Mortgage-backed securities 44,930 68,808 Collateralized mortgage obligations 33,980 51,874 Corporate debt securities 4,344 - Other securities 5,719 3,111 --------- --------- Carrying amount and fair value $ 121,224 $ 135,257 --------- --------- --------- ---------
16 The following table sets forth the carrying amount (amortized cost) and fair value of held to maturity securities at September 30, 1998 and December 31, 1997.
September 30 December 31 ------------------------------ (In thousands) 1998 1997 HELD TO MATURITY SECURITIES: U.S. Treasury and U.S. Government agency $ 3,029 $ 9,442 Mortgage-backed securities 12,686 3,333 -------- -------- Carrying amount (amortized cost) $ 15,715 $ 12,775 -------- -------- -------- -------- Fair value $ 15,798 $ 12,780 -------- -------- -------- --------
The following table sets forth the maturities of the Company's investment securities at September 30, 1998 and the weighted average yields of such securities calculated on the basis of the cost and effective yields based on the scheduled maturity of each security. Maturities of mortgage-backed securities are stipulated in their respective contracts. However, actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call prepayment penalties. Yields on municipal securities have not been calculated on a tax-equivalent basis.
AT SEPTEMBER 30, 1998 ---------------------------------------------------------------------------------------- WITHIN ONE YEAR ONE TO 5 YEARS FIVE TO TEN YEARS OVER TEN YEARS TOTAL AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT (In thousands) Available for Sale Securities: Treasury and U.S. Government agency $ 504 4.97% $ 6,098 4.99% - - $ 8,895 5.99% $ 15,497 State and political 267 3.26 793 3.61 241 4.06 18,482 4.61 19,783 Mortgage-backed securities 66 5.77 126 6.41 2,086 5.77 39,624 6.15 41,902 Collateralized mortgage obligations 3,008 6.34 19,970 5.99 3,034 6.01 7,967 6.38 33,979 Corporate debt securities - - 4,344 5.47 - - - - 4,344 Other securities 2,500 4.25 - - - - 3,219 5,719 ------------------------------------------------------------------------------------------- Carrying amount and fair value 6,345 5.27 31,331 5.66 5,361 5.82 78,187 5.53 121,224 ------------------------------------------------------------------------------------------- Held to maturity securities: Treasury and U.S. Government agency - - - - 2,029 6.41 1,000 7.07 3,029 Mortgage-backed securities - - - - - - 12,686 6.78 12,686 ------------------------------------------------------------------------------------------- Carrying amount (amortized cost) - - - - 2,029 6.41 13,686 6.80 15,715 ------------------------------------------------------------------------------------------- Total securities $6,345 5.27% $31,331 5.66% $7,390 5.99% $91,873 5.73% $136,939 ------ ----- ------- ----- ------ ----- ------- ----- -------- ------ ----- ------- ----- ------ ----- ------- ----- --------
In the above table, mortgage-backed securities and collateralized mortgage obligations are shown maturing at the contractual maturity date rather than in accordance with their principal amortization schedules. The Company does not own securities of a single issuer whose aggregate book value is in excess of 10% of its total equity. Also see "Memorandum of Understanding" contained herein. 17 LOAN PORTFOLIO. The following table shows the composition of the Company's loan portfolio at the dates indicated.
AT SEPTEMBER 30, AT DECEMBER 31, ------------------------------------------------------------------ (In thousands) 1998 1997 ---- ---- PERCENT PERCENT DOLLAR AMOUNT OF LOANS DOLLAR AMOUNT OF LOANS Loan Categories: Commercial $ 38,475 15% $ 34,992 16% Agricultural 49,783 19 43,558 20 Real estate construction 13,863 5 12,657 6 Real estate mortgage 87,734 34 70,802 32 Consumer 70,259 27 55,968 26 --------- ---- --------- ---- Total 260,114 100% 217,977 100% --------- ---- --------- ---- ---- Less allowance for loan losses (4,545) (3,833) --------- --------- ---- Net loans $ 255,569 $ 214,144 --------- --------- --------- ---------
The table that follows shows the maturity distribution of the portfolio of commercial, agricultural, real estate construction, real estate mortgage, and consumer loans at September 30, 1998:
AT SEPTEMBER 30, 1998 ------------------------------------------------------------------ AFTER 1 BUT WITHIN 1 YEAR WITHIN 5 YEARS AFTER 5 YEARS TOTAL ------------------------------------------------------------------ (IN THOUSANDS) Commercial and agricultural: Loans with floating interest rates $ 52,689 $ 13,316 $ 6,154 $ 72,159 Loans with fixed interest rates 5,402 7,950 2,747 16,099 -------- -------- -------- -------- Subtotal 58,091 21,266 8,901 88,258 -------- -------- -------- -------- Real estate construction: Loans with floating interest rates 7,935 1,773 833 10,541 Loans with fixed interest rates 2,219 968 135 3,322 -------- -------- -------- -------- Subtotal 10,154 2,741 968 13,863 -------- -------- -------- -------- Real estate mortgage 8,601 40,923 38,210 87,734 Consumer 24,546 37,879 7,834 70,259 -------- -------- -------- -------- Total $101,392 $102,809 $ 55,913 $260,114 -------- -------- -------- -------- -------- -------- -------- --------
18 The table that follows shows the maturity distribution of the portfolio of commercial, agricultural, real estate construction, real estate mortgage, and consumer loans at December 31, 1997:
AT DECEMBER 31, 1997 ------------------------------------------------------------------ AFTER 1 BUT WITHIN 1 YEAR WITHIN 5 YEARS AFTER 5 YEARS TOTAL ------------------------------------------------------------------ (IN THOUSANDS) Commercial and agricultural: Loans with floating interest rates $ 44,792 $ 16,249 $ 3,410 $ 64,451 Loans with fixed interest rates 6,916 6,350 833 14,099 -------- -------- -------- -------- Subtotal 51,708 22,599 4,243 78,550 Real estate-construction: Loans with floating interest rates 6,394 1,602 2,100 10,096 Loans with fixed interest rates 1,433 989 139 2,561 -------- -------- -------- -------- Subtotal 7,827 2,591 2,239 12,657 -------- -------- -------- -------- Real estate-mortgage 7,654 39,829 23,319 70,802 Consumer 33,609 21,450 909 55,968 -------- -------- -------- -------- Total $100,798 $ 86,469 $ 30,710 $217,977 -------- -------- -------- -------- -------- -------- -------- --------
OFF-BALANCE SHEET COMMITMENTS. The following table shows the distribution of the Company's undisbursed loan commitments at the dates indicated.
SEPTEMBER DECEMBER 31, 30, 1998 1997 ---- ---- (IN THOUSANDS) Letters of credit $ 2,806 $ 3,233 Commitments to extend credit 78,306 55,248 ------- ------- Total $81,112 $58,481 ------- ------- ------- -------
OTHER INTEREST-EARNING ASSETS. The following table relates to other interest-earning assets not disclosed previously for the dates indicated. This item consists of a salary continuation plan for the Company's executive management and deferred retirement benefits for participating board members. The plan is informally linked with universal life insurance policies for the salary continuation plan. Income from these policies is reflected in noninterest income.
AT SEPTEMBER 30, AT DECEMBER 31, 1998 1997 ---- ---- (IN THOUSANDS) Cash surrender value of life insurance $4,063 $3,389 ------ ------ ------ ------
NONPERFORMING ASSETS. Nonperforming assets include nonaccrual loans, loans 90 days or more past due, restructured loans and other real estate owned. Nonperforming loans are those which the borrower fails to perform in accordance with the original terms of the obligation and include loans on nonaccrual status, loans past due 90 days or more and restructured loans. The Company generally places loans on nonaccrual status and accrued but unpaid interest is reversed against the current year's income when interest or principal payments become 90 days or more past due unless the outstanding principal and interest is adequately secured and, in the opinion of 19 management, is deemed in the process of collection. 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 where management believes the remaining principal balance is fully collectible. Additional loans 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 collection of principal or interest is in question. A "restructured loan" is a loan on which interest accrues at a below market rate or upon which certain principal has been forgiven so as to aid the borrower in the final repayment of the loan, with any interest previously accrued, but not yet collected, being reversed against current income. Interest is reported on a cash basis until the borrower's ability to service the restructured loan in accordance with its terms is established. The Company had no restructured loans as of the dates indicated in the above table. The following table summarizes nonperforming assets of the Company at September 30, 1998 and December 31, for the years indicated: September 30, December 31, 1998 1997 ---- ---- (In thousands) Nonaccrual loans $ 1,494 $ 2,611 Accruing loans past due 90 days or more 494 131 ------- ------- Total nonperforming loans 1,988 2,742 Other real estate owned 60 60 Repossessed automobiles 23 - ------- ------- Total nonperforming assets $ 2,071 $ 2,802 ------- ------- ------- ------- Nonperforming assets: To total loans .80% 1.26% To total assets .43% .66%
Interest income on loans on nonaccrual status during the nine months ended September 30, 1998, and the nine months ended September 30, 1997, that would have been recognized if the loans had been current in accordance with their original terms was approximately $143,000 and $111,000, respectively. At September 30, 1998, nonperforming assets represented .43% of total assets, and nonperforming loans represented .80% of total loans. Nonperforming loans that were secured by first deeds of trust on real property were $671,000 at September 30, 1998 and $1,635,000 at December 31, 1997. Other forms of collateral such as inventory and equipment secured the remaining nonperforming loans as of each date. No assurance can be given that the collateral securing nonperforming loans will be sufficient to prevent losses on such loans. The increase in nonperforming loans and nonperforming assets as of September 30, 1998 compared with their levels as of December 31, 1997, was due primarily to an increase in delinquent agricultural loans coupled with an increase in repossessed automobiles. At September 30, 1998, the Company had $60,000 in one property acquired through foreclosure. The property is carried at the lower of its estimated market value, as evidenced by an independent appraisal, or the recorded investment in the related loan, less estimated selling expenses. At foreclosure, if the fair value of the real estate is less than the Company's recorded investment in the related loan, a charge is made to the allowance for loan losses. The Company does not expect to sell this property during 1998. No assurance can be given that the Company will sell such property during 1998 or at any time or the amount for which such property might be sold. 20 In addition to property acquired through foreclosure, the Company has investments in residential real estate lots in various stages of development in Merced County through MAID. MAID held one property for sale or development at September 30, 1998. This investment was completely written off in 1995, although County Bank still retains title to this property. During the first nine months of 1998, fifty-three lots were sold for a pre-tax gain of $354,000. Management defines impaired loans, regardless of past due status on loans, as those on 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 process has been exhausted. At September 30, 1998 and December 31, 1997, impaired loans were measured based on 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. Impaired loans at September 30, 1998 were 1,494,000 (all of which were also nonaccrual loans), on account of which the Company had made provisions to the allowance for loan losses of $502,000. Except for loans that are disclosed above, there were no assets as of September 30, 1998, where known information about possible credit problems of borrower causes management to have serious doubts as to the ability of the borrower to comply with the present loan repayment terms and which may become nonperforming assets. Given the magnitude of the Company's loan portfolio, however, it is always possible that current credit problems may exist that may not have been discovered by management. ALLOWANCE FOR LOAN LOSSES The following table summarizes the loan loss experience of the Company for the nine months ended September 30, 1998 and 1997, and for the year ended December 31,1997. SEPTEMBER 30 DECEMBER 31 ----------------------- ------------ 1998 1997 1997 ---- ---- ---- ALLOWANCE FOR LOAN LOSSES: Balance at beginning of period $ 3,833 $ 2,792 $ 2,792 Provision for loan losses 1,690 3,681 5,825 Charge-offs: Commercial and agricultural 667 500 1,121 Real estate construction - 3,458 3,458 Real estate mortgage 4 - - Consumer 727 406 471 -------- -------- -------- Total charge-offs 1,398 4,364 5,050 -------- -------- -------- Recoveries Commercial and agricultural 119 123 155 Real estate-construction - 1 1 Real estate-mortgage - - - Consumer 301 63 110 -------- -------- -------- Total recoveries 420 187 266 -------- -------- -------- Net charge-offs 978 4,177 4,784 -------- -------- -------- Balance at end of period $ 4,545 $ 2,296 $ 3,833 -------- -------- -------- -------- -------- -------- Loans outstanding at period-end $260,114 $208,465 $217,977 -------- -------- -------- -------- -------- -------- Average loans outstanding $235,513 $193,645 $198,140 -------- -------- -------- -------- -------- -------- Net charge-offs to average loans .26% 2.16% 2.41% Allowance for loan losses To total loans 1.75% 1.08% 1.76% To nonperforming assets 219.46% 105.27% 136.80%
21 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. In determining the adequacy of the allowance for loan losses, management takes into consideration growth trends in the portfolio, examination of financial institution supervisory authorities, prior loan loss experience for the Company, concentrations of credit risk, delinquency trends, general economic conditions, the interest rate environment and internal and external credit reviews. In addition, the risks management considers vary depending on the nature of the loan. The normal risks considered by management with respect to agricultural loans include the fluctuating value of the collateral, changes in weather conditions and the availability adequate water resources in the Company's local market area. The normal risks considered by management with respect to real estate construction loans include fluctuation in real estate values, the demand for improved commercial and industrial properties and housing, the availability of permanent financing in the Company's market area and borrowers' ability to obtain permanent financing. The normal risks considered by management with respect to real estate mortgage loans include fluctuations in the value of real estate. Additionally, the Company relies on data obtained through independent appraisals for significant properties to determine loss exposure on nonperforming loans. The balance in the allowance is affected by the amounts provided from operations, amounts charged off and recoveries of loans previously charged off. The Company recorded provisions for loan losses in the first nine months of 1998 of $1,690,000 compared with $3,681,000 in the same period of 1997. The increase in loan loss provisions in 1997 was primarily due to increased reserves established for a commercial real estate development loan that was charged off in 1997 and, to a lesser extent, reserves to support the general loan growth of the Company. The Company's charge-offs, net of recoveries, were $978,000 for the nine months ended September 30, 1998 compared with $4,177,000 for the same nine months in 1997. The increase in net charge-offs for the year ended December 31, 1997 was primarily due to the write-off of a commercial real estate loan with a balance of $3,458,000. As of September 30, 1998, the allowance for loan losses was $4,545,000 or 1.72% of total loans outstanding, compared with $3,833,000 or 1.76% of total loans outstanding as of December 31, 1997 and $2,296,000 or 1.08% of total loans outstanding as of September 30, 1997. From 1992 to 1996, loan losses were relatively low and stable. In 1997, the Company experienced loan problems and made provisions at levels not previously experienced. As a result, the Company concluded that its historical method of determining the appropriate levels for its allowance and provisions for loan losses should be revised. The Company therefore adopted a new methodology of determining the appropriate level of its allowance for loan losses. This method applies relevant risk factors to the entire loan portfolio, including nonperforming loans. The methodology is based, in part, on the Company's loan grading and classification system. The Company grades its loans through internal reviews and periodically subjects loans to external reviews which then are assessed by the Company's audit committee. Credit reviews are performed on a monthly basis and the quality grading process occurs on a quarterly basis. Risk factors applied to the performing loan portfolio are based on the Company's pastloss history considering the current portfolio's characteristics, current economic conditions and other relevant factors. General reserves are applied to various categories of loans at percentages ranging up to 1.8% based on the Company's assessment of credit risks for each category. Risk factors are applied to the carrying value of each classified loan: (i) loans internally graded "Watch" or "Special Mention" carry a risk factor from 1.0% to 2.0%; (ii) "Substandard" loans carry a risk factor from 15% to 40% depending on collateral securing the loan, if any; (iii) "Doubtful" loans carry a 50% risk factor; and (iv) "Loss" loans are charged off 100%. In addition, a portion of the allowance is specially allocated to identified problem credits. The analysis also includes reference to factors such as the delinquency status of the loan portfolio, inherent risk by type of loans, industry statistical data, recommendations made by the Company's regulatory authorities and outside loan reviewers, and current 22 economic environment. Important components of the overall credit rating process are the asset quality rating process and the internal loan review process. The allowance is based on estimates and ultimate future losses 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. In addition, there can be no assurance that future economic or other factors will not adversely affect the Company's borrowers, or that the Company's asset quality may deteriorate through rapid growth, failure to enforce underwriting standards, failure to maintain appropriate underwriting standards, failure to maintain an adequate number of qualified loan personnel, failure to identify and monitor potential problem loans or for other reasons, and thereby cause loan losses to exceed the current allowance. The following table summarizes a breakdown of the allowance for loan losses by loan category and the allocation in each category as a percentage of total loan allowance in each category at the dates indicated:
SEPTEMBER 30, DECEMBER 31, 1998 1997 -------------- ------------- AMOUNT AMOUNT TO TOTAL TO TOTAL LOANS IN LOANS IN AMOUNT CATEGORY AMOUNT CATEGORY ------ -------- ------ -------- (DOLLARS IN THOUSANDS) Commercial and agricultural $ 2,278 50% $ 1,868 48% Real estate- construction 63 2 640 17 Real estate- mortgage 1,556 34 1,058 28 Consumer 648 14 267 7 ------- ---- ------- ---- Total $ 4,545 100% $ 3,833 100% ------- ---- ------- ---- ------- ---- ------- ----
The allocation of the allowance to loan categories is an estimate by management of the relative risk characteristics of loans in those categories. No assurance can be given that losses in one or more loan categories will not exceed the portion of the allowance allocated to that category or even exceed the entire allowance. EXTERNAL FACTORS AFFECTING ASSET QUALITY. As a result of the Company's loan portfolio mix, the future quality of its assets could be affected by adverse economic trends in its region or in the agricultural community. These trends are beyond the control of the Company. California is an earthquake-prone region. Accordingly, a major earthquake could result in material loss to the Company. At times the Company's service area has experienced other natural disasters such as floods and droughts. The Company's properties and substantially all of the real and personal property securing loans in the Company's portfolio are located in California. The Company faces the risk that many of its borrowers face uninsured property damage, interruption of their businesses or loss of their jobs from earthquakes, floods or droughts. As a result these borrowers may be unable to repay their loans in accordance with their terms and the collateral for such loans may decline significantly in value. The Company's service area is a largely agricultural region and therefore is highly dependent on a reliable supply of water for irrigation purposes. The area obtains nearly all of its water from the run-off of melting snow in the mountains of the Sierra Nevada to the east. Although such sources have usually been available in the past, water supply can be adversely affected by light snowfall over one or more winters or by any diversion of water from its present natural courses. Any such natural disaster could impair the ability of many of the Company's borrowers to meet their obligations to the Company. Parts of California experienced significant floods in early 1998. The Company has completed an analysis of its collateral as a result of the recent floods. Current estimates indicate that there were no material adverse effects to the collateral position of the Company as a result of these events. No assurance can be given that future flooding will not have an adverse impact on the Company and its 23 borrowers and depositors. During the second quarter of 1998, an additional $200,000 was added to the loan loss reserve for possible losses to agricultural loans due to adverse weather conditions. LIQUIDITY. In order to maintain adequate liquidity, the Company must have sufficient resources available at all times to meet its cash flow requirements. 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, payments of principal and interest on loans and 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 liability liquidity. The Company reviews its liquidity position on a regular basis based upon its current position and expected trends of loans and deposits. These assets include cash and deposits in other banks, available-for-sale securities and federal funds sold. The Company's liquid assets totaled $174,298,000 and $159,291,000 on September 30, 1998 and December 31, 1997, respectively, and constituted 36.2% and 37.8%, respectively, of total assets on those dates. Liquidity is also affected by the collateral requirements of its public deposits and certain borrowings. Total pledged securities were $75,478,000 at September 30, 1998 compared with $45,812,000 at December 31, 1997. When the Company acquired three Bank of America branches in December 1997, it acquired approximately $60,849,000 in deposits and no loans. In addition, the capital offering raised additional cash of $17,951,000. The Company initially invested this cash in liquid assets but intends over time to invest a larger portion of these funds in higher yielding assets such as loans. Although the Company's primary sources of liquidity include liquid assets and a stable deposit base, the Company maintains lines of credit with the Federal Reserve Bank of San Francisco, Federal Home Loan Bank of San Francisco and Pacific Coast Bankers' Bank aggregating $27,379,000, of which $16,003,000 was outstanding as of September 30, 1998 and $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. The Company's liquidity might be insufficient if deposit withdrawals were to exceed anticipated levels. Deposit withdrawals can increase if a company experiences financial difficulties or receives adverse publicity for other reasons, or if its pricing, products or services are not competitive with those offered by other institutions. CAPITAL RESOURCES. Capital serves as a source of funds and helps protect depositors against potential losses. The primary source of capital for the Company has been internally generated capital through retained earnings. In 1997, the Company completed a common stock offering which netted the Company approximately $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's shareholders' equity increased by $3,213,000 or 8% from December 31, 1997 to September 30, 1998. 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 September 30, 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 September 30, 1998 was 8.15% as compared with 8.58% as of December 31, 1997. The Company's total risk based capital ratio at September 30, 1998 was 12.37% as compared to 12.78% as of December 31,1997. The Company's and Bank's actual capital amounts and ratios as of September 30, 1998 are as follows: 24
To Be Well Capitalized For Capital Under Prompt Actual Adequacy Purposes Corrective Dollars in thousands Action Provisions: - -------------------------------------------------------------------------------------------------------------------------- Consolidated Amount Ratio Amount Ratio Amount Ratio - --------------------------------------------------------------------------------------------------------------------------- As of September 30, 1998 Total capital (to risk weighted assets) $ 40,833 12.37% $ 26,400 8.0% $ 33,000 10.0% Tier 1 capital (to risk weighted assets) 36,703 11.12 13,200 4.0 19,800 6.0 Leverage ratio* 36,703 8.15 18,403 4.0 23,004 5.0 The Bank: - --------------------------------------------------------------------------------------------------------------------------- As of September 30, 1998 Total capital (to risk weighted assets) $ 32,426 11.32% $ 22,925 8.0% $ 27,115 10.0% Tier 1 capital (to risk weighted assets) 28,836 10.06 11,463 4.0 16,269 6.0 Leverage ratio* 28,836 6.90 16,710 4.0 20,888 5.0 - ---------------------------------------------------------------------------------------------------------------------------
* The leverage ratio consist 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. 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. DEPOSITS. Deposits are the Company's primary source of funds. At September 30, 1998, the Company had a deposit mix of 40% in savings deposits, 29% in time deposits, 15% in interest-bearing checking accounts and 16% in noninterest-bearing demand accounts. Noninterest-bearing demand deposits enhance the Company's net interest income by lowering its costs of funds. The Company obtains deposits primarily from the communities it serves. No material portion of its deposits has been obtained from or is dependent on any one person or industry. The Company's business is not seasonal in nature. The Company accepts deposits in excess of $100,000 from customers. These deposits are priced to remain competitive. At September 30, 1998, the Company had no brokered deposits. In December 1997, the Company acquired three branches of Bank of America. It acquired $60,849,000 in deposits. Deposits in these three acquired branches as of September 30, 1998 were approximately $62,364,000. Maturities of time certificates of deposits of $100,000 or more outstanding at September 30, 1998 and December 31, 1997 are summarized as follows:
AT SEPTEMBER 30, 1998 AT DECEMBER 31, 1997 --------------------- -------------------- (IN THOUSANDS) Three months or less $ 11,041 $ 8,404 Over three to six months 17,928 7,799 Over six to twelve months 6,714 7,870 Over twelve months 5,135 6,188 -------- -------- Total $ 40,818 $ 30,261 -------- -------- -------- --------
25 BORROWED FUNDS At September 30 1998 and December 31, 1997, the Company's borrowed funds consisted of the following:
SEPTEMBER 30 DECEMBER 31 ------------ ----------- (Dollars in thousands) 1998 1997 Securities sold under agreements to repurchase; dated March 25, 1998; fixed rate of 5.74%; payable on March 25, 1999 $ 2,100 $ 2,459 Unsecured loan from unaffiliated bank dated July 26, 1996; effective interest rate of 9%; interest payable quarterly at prime + .50%; principal payable quarterly at $135,714; final payment due on April 30 1998 - 286 FHLB loan, dated December 18, 1997; effective rate of 5.61%; rate reprices monthly based on the 1 month LIBOR; payable on December 18, 1998 10,900 10,900 FHLB loan, dated January 16, 1997; variable rate of 5.68%; rate reprices monthly based on the 1 month LIBOR; payable on January 25, 1999 5,000 5,000 FHLB loan, dated July 15, 1994; fixed rate of 7.58% payable on July 15, 1999 103 104 Long-term note from unaffiliated bank dated December 22, 1997; fixed rate of 7.80%; principal and interest payable monthly at $25,047; payments calculated as fully amortizing over 25 years with a 10 year call 3,274 3,300 ------- ------- Total $21,377 $22,049 ------- ------- ------- -------
The decrease in the borrowings are primarily due to amortized principal payments on available lines of credit with the Federal Home Loan Bank to purchase securities and the origination of a loan to assist in financing the new administrative building and main branch. RETURN ON EQUITY AND ASSETS
Nine months ended Nine months ended Year ended September 30 September 30 December 31 1998 1997 1997 ---- ---- ---- Annualized return on average assets .81% .16% .13% Annualized return on average equity 8.59% 1.91% 1.46% Average equity to average assets 9.40% 8.29% 8.76%
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 on interest expenses, has not been significant for the periods covered in this report. 26 REAL ESTATE DEVELOPMENT ACTIVITIES California law allows state-chartered banks to engage in real estate development activities. The Bank established MAID in 1987 pursuant to this authorization. After changes in federal law effectively required that these activities be divested as prudently as possible but in any event before 1997, MAID reduced its activities and embarked on a plan to liquidate its real estate holdings. In 1995, the uncertainty about the effect of the investment in MAID on the results of future operations caused management to write off its remaining investment of $2,881,000 in real property development. At September 30, 1998, MAID held one real estate project including improved and unimproved land in various stages of development. MAID continues to develop this project, and any amounts realized upon sale or other disposition of this asset above its current carrying value of zero will result in noninterest income at the time of such sale or disposition. During the first nine months of 1998, 53 lots were sold which resulted in the recognition of approximately $354,000 in noninterest income. Although the Company expects that the sale or disposition of its remaining project will result in some positive contribution to noninterest income at some time in the future, no assurance can be given as to whether or when such sale or disposition will be completed or that the amount, if any, that the Company will ultimately realize on such asset or whether such amount will exceed the future expenses required to hold and complete development of the project. The amounts, if any, realized on future disposition of this property will depend on conditions in the local real estate market and the demand, if any, for new development. The Company's regulatory deadline for completing its divestiture of this asset is December 31, 2000. YEAR 2000 General 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 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. State of Readiness The Company has a Year 2000 (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 Year 2000 compliant. The Bank's core banking system, Jack Henry Associates Inc. Silverlake, issued a new software release in August 1998 that is Year 2000 compliant. In addition to a review and testing of the Jack Henry Associates Inc. Silverlake product, Capital Corp of the West's Year 2000 (Y2K) plan also addresses internal systems, customer systems, and vendor 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 regulatory agencies have identified several areas within the Y2K plan that need additional review. These areas include, but are not limited to, improvement in Y2K communication between subsidiaries, increased focus on core and other similarly important "mission critical" systems, and the need to establish firm test dates for the most important systems. The Company is in the process of insuring these additional concerns are addressed within the Y2K plan. The 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 are now being expanded to include customers and the general community through 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 27 rating each inventoried system's importance to the day-to-day operation of the organization. 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 30% complete. 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 20% complete. 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 Year 2000 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. Costs 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 the first nine months of 1998, the Company has incurred approximately $75,000 in plan expenses. Risks 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 Year 2000 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. Although at this time it is not possible to determine the extent of the adverse financial effects, with any specificity, the Company is preparing contingency plans if disruptions occur. 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 exist. Contingency Plan A contingency plan is in the process of being developed in order to structure a methodology that 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. Also see "Memorandum of Understanding" contained herein. CAUTIONARY STATEMENT FOR THE PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The Company is including the following cautionary statement to take advantage of the "safe harbor" provisions of the PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 for any forward-looking statement made by, or on behalf of, the Company. The factors identified in this cautionary statement are important factors (but not necessarily all important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by, or on behalf of, the company. 28 Where any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, the Company cautions that, while it believes such assumptions or bases to be reasonable and makes them in good faith, assumed facts or bases almost always vary from actual results, and the differences between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, the Company, or its management, expresses an expectation or belief as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result, or be achieved or accomplished. Taking into account the foregoing, the following are identified as important risk factors that could cause actual results to differ materially from those expressed in any forward-looking statement made by, or on behalf of, the company: The ability to meet financial and human resources requirements, including the funding of the Company's capital program from operations, is subject to changes in the deposit base, which the company has only limited control and to a lesser extent its ability to consistently; and the effect of domestic legislation of federal, state and municipal governments that have jurisdiction in regard to taxes, the environment and human resources. The dates on which the Company believes the Year 2000 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 Year 2000 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. MEMORANDUM OF UNDERSTANDING 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 reserve for loan losses and develop and revise, adopt and implement a comprehensive policy to ensure the adequacy of the allowance. 6) Develop, adopt and implement a plan to control overhead and restore the Bank's profitability. 29 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the normal course of business, the Company is exposed to market risk which includes both price and liquidity risk. Price risk is created from fluctuations in interest rates and the mismatch in repricing characteristics of assets, liabilities, and off balance sheet instruments at a specified point in time. Mismatches in interest rate repricing among assets and liabilities arise primarily through the interaction of the various types of loans versus the types of deposits that are maintained as well as from management's discretionary investment and funds gathering activities. Liquidity risk arises from the possibility that the Company may not be able to satisfy current and future financial commitments or that the Company may not be able to liquidate financial instruments at market prices. Risk management policies and procedures have been established and are utilized to manage the Company's exposure to market risk. On September 30, 1998, the interest rate position of the Company was relatively neutral as the impact of a gradual parallel 100 basis-point rise or fall in interest rates over the next 12 months was estimated to be approximately 1-2% of net interest income when compared to stable rates. See "BUSINESS - Selected Statistical Information - Interest Rate Sensitivity" and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Risk Management." PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is a party to routine litigation in the ordinary course of its business. In the opinion of management, pending and threatened litigation is not likely to have a material adverse effect on the financial condition or results of operations of the Company. Also see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Memorandum of Understanding." contained herein. ITEM 2. CHANGES IN SECURITIES. None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS. None 30 ITEM 5. OTHER INFORMATION. In the opinion of management, there is no additional information relating to these periods being reported which warrants inclusion in the report. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits.
Exhibits Description of Exhibits 3.1 Articles of Incorporation, incorporated by reference from (filed as * Exhibit 3.1 of the Company's September 30, 1996 Form 10Q filed with the SEC on or about November 14, 1996). 3.2 Bylaws (filed as Exhibit 3.2 of the Company's September 30, 1996 Form * 10Q filed with the SEC on or about November 14, 1996.) 10 Employment agreement between Thomas T. Hawker and Capital Corp. * 10.1 Administration Construction Agreement (filed as Exhibit 10.4 of * the Company's 1995 Form 10K filed with the SEC on or about March 31, 1996). 10.2 Stock Option Plan (filed as Exhibit 10.6 of the Company's 1995 Form 10K * filed with the SEC on or about March 31, 1996). 10.3 401 (k) Plan (filed as Exhibit 10.7 of the Company's 1995 Form 10K * filed with the SEC on or about March 31, 1996 10.4 Employee Stock Ownership Plan (filed as Exhibit 10.8 of the Company's * 1995 Form 10K filed with the SEC on or about March 31, 1996).
(b) REPORTS ON FORM 8-K None * DENOTES DOCUMENTS WHICH HAVE BEEN INCORPORATED BY REFERENCE. 31 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. CAPITAL CORP OF THE WEST (Registrant) By /s/ Thomas T. Hawker ----------------------------------- Thomas T. Hawker President and Chief Executive Officer By /s/ Janey E. Boyce ----------------------------------- Janey E. Boyce Principal Financial Officer 32 EX-27 2 EXHIBIT 27
9 1,000 9-MOS DEC-31-1997 JAN-01-1998 SEP-30-1998 21,774 500 30,800 0 121,224 15,715 15,798 260,114 4,545 481,507 413,875 18,103 2,794 3,274 0 0 34,033 9,428 481,507 18,488 6,030 957 25,475 9,160 10,137 15,338 1,690 0 13,552 3,763 3,763 0 0 2,687 .58 .56 8.67 1,494 494 0 0 3,833 1,398 420 4,545 4,545 0 0
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