-----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, PEkv6MeDnzg0Qbt5O4ffh0v4L066B20DkmOlqTuFYxs+b3udBHpzqZYqB1gjGPr7 jwgUdADUPM1RbEVcgWsp7Q== 0001012870-99-002159.txt : 19990702 0001012870-99-002159.hdr.sgml : 19990702 ACCESSION NUMBER: 0001012870-99-002159 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19990521 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19990701 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GREATER BAY BANCORP CENTRAL INDEX KEY: 0000775473 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 770387041 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 000-25034 FILM NUMBER: 99658027 BUSINESS ADDRESS: STREET 1: 2860 WEST BAYSHORE ROAD CITY: PALO ALTO STATE: CA ZIP: 94303 BUSINESS PHONE: 4153751555 MAIL ADDRESS: STREET 1: 2860 BAYSHORE ROAD STREET 2: 420 COWPER ST CITY: PALO ALTO STATE: CA ZIP: 943011504 FORMER COMPANY: FORMER CONFORMED NAME: MID PENINSULA BANCORP DATE OF NAME CHANGE: 19941031 FORMER COMPANY: FORMER CONFORMED NAME: SAN MATEO COUNTY BANCORP DATE OF NAME CHANGE: 19920703 8-K 1 FORM 8-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): MAY 21, 1999 GREATER BAY BANCORP (Exact name of registrant as specified in its charter) California 77-0387041 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) COMMISSION FILE NUMBER: 0-25034 2860 West Bayshore Road, Palo Alto, California 94303 (Address of principal executive offices) (Zip Code) (650) 813-8200 (Registrant's telephone number, including area code) ITEM 5. OTHER ITEMS. On May 21, 1999, Greater Bay Bancorp (the "Registrant") completed a merger with Bay Area Bancshares ("BA Bancshares"), the holding company of Bay Area Bank ("BAB") which was accounted for as a pooling-of-interests. Shareholders of BA Bancshares received 1.38682 shares of the Registrant's Common Stock for each outstanding share of BA Bancshares Common Stock. A total of 1,399,321 shares were issued in the transaction. The supplemental consolidated financial statements filed herewith have been prepared accounting for the merger using the pooling-of-interests method of accounting. Upon publication of the Company's financial statements for a period which includes May 21, 1999, their supplemental consolidated financial statements will become the historical financial statements of the Company. ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS. EXHIBIT NO. EXHIBITS - ------- ------- 23.1 Consent of PricewaterhouseCoopers LLP 27.1 Restated Financial Data Schedules for quarters ended September 30, 1998 and June 30, 1998 (included in electronic filing through EDGAR) 27.2 Restated Financial Data Schedules for quarters ended March 31, 1998 and December 31, 1997 (included in electronic filing through EDGAR) 27.3 Restated Financial Data Schedules for quarters ended September 30, 1997 and June 30, 1997 (included in electronic filing through EDGAR) 27.4 Restated Financial Data Schedules for quarters ended March 31, 1997 (included in electronic filing through EDGAR) 27.5 Restated Financial Data Schedules for the years ended December 31, 1998 and 1997 (included in electronic filing through EDGAR) 27.6 Restated Financial Data Schedules for the year ended December 31, 1996 (included in electronic filing through EDGAR) 27.7 Restated Financial Data Schedules for quarters ended March 31, 1999 and December 31, 1998 (included in electronic filing through EDGAR) 99.1 Supplemental Consolidated Financial Statements and Supplementary Data (restated to include BA Bancshares and BAB) For the Years Ended December 31, 1998, 1997 and 1996: Selected Financial Data Management's Discussion and Analysis Consolidated Balance Sheet as of December 31, 1998 and 1997 Consolidated Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements Report of Independent Accountants 99.2 Supplemental Consolidated Financial Statements and Supplementary Data (restated to include BA Bancshares and BAB) For the Quarters Ended March 31, 1999 and 1998: Management's Discussion and Analysis Consolidated Balance Sheet as of March 31, 1999 and December 31, 1998 Consolidated Statements of Operations for the Quarters Ended March 31, 1999 and 1998 Notes to Consolidated Financial Statements 2 SIGNATURES IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934, AS AMENDED, THE REGISTRANT HAS CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED. GREATER BAY BANCORP (Registrant) By: /s/ STEVEN C. SMITH - ------------------- Steven C. Smith Executive Vice President, Chief Administrative Officer and Chief Financial Officer Date: July 1, 1999 3 EXHIBIT INDEX Exhibits. 23.1 Consent of PricewaterhouseCoopers LLP 27.1 Restated Financial Data Schedules for quarters ended September 30, 1998 and June 30, 1998 (included in electronic filing through EDGAR) 27.2 Restated Financial Data Schedules for quarters ended March 31, 1998 and December 31, 1997 (included in electronic filing through EDGAR) 27.3 Restated Financial Data Schedules for quarters ended September 30, 1997 and June 30, 1997 (included in electronic filing through EDGAR) 27.4 Restated Financial Data Schedules for quarters ended March 31, 1997 (included in electronic filing through EDGAR) 27.5 Restated Financial Data Schedules for the years ended December 31, 1998 and 1997 (included in electronic filing through EDGAR) 27.6 Restated Financial Data Schedules for the year ended December 31, 1996 (included in electronic filing through EDGAR) 27.7 Restated Financial Data Schedules for quarters ended March 31, 1999 and December 31, 1998 (included in electronic filing through EDGAR) 99.1 Supplemental Consolidated Financial Statements and Supplementary Data (restated to include BA Bancshares and BAB) For the Years Ended December 31, 1998, 1997 and 1996: Selected Financial Data Management's Discussion and Analysis Consolidated Balance Sheet as of December 31, 1998 and 1997 Consolidated Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements Report of Independent Accountants 99.2 Supplemental Consolidated Financial Statements and Supplementary Data (restated to include BA Bancshares and BAB) For the Quarters Ended March 31, 1999 and 1998: Management's Discussion and Analysis Consolidated Balance Sheet as of March 31, 1999 and December 31, 1998 Consolidated Statements of Operations for the Quarters Ended March 31, 1999 and 1998 Notes to Consolidated Financial Statements 4 EX-23.1 2 CONSENT OF PRICEWATERHOUSECOOPERS LLP EXHIBIT 23.1 [LETTERHEAD OF PRICEWATERHOUSECOOPERS LLP] PricewaterhouseCoopers LLP 555 California Street San Francisco CA 94104 Telephone (415) 393 8500 Facsimile (415) 393 8644 San Francisco, California July 1, 1999 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in this Registration Statement on Form S-4 of Greater Bay Bancorp and Subsidiaries (the Company) of our report dated February 8, 1999, on our audits of the consolidated financial statements at December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998, which report is included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998, and of our report dated July 1, 1999, on our audit of the combination of the historical consolidated financial statements of Greater Bay Bancorp and Subsidiaries and Bay Area Bancshares after restatement for the pooling of interests as described in Note 1 to the supplemental consolidated financial statements, which report is included in the Company's Current Report on Form 8-K filed July 1, 1999. We also consent to the reference to our firm under the caption "Experts." /s/ PricewaterhouseCoopers LLP EX-27.1 3 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GREATER BAY BANCORP'S FILING ON FORM 8-K DATED JULY 1, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS 3-MOS DEC-31-1998 DEC-31-1998 JUL-01-1998 APR-01-1998 SEP-30-1998 JUN-30-1998 68,536 83,588 0 0 102,200 134,700 0 0 311,819 304,967 99,558 46,722 100,674 47,429 940,341 902,010 (21,862) (19,758) 1,686,988 1,625,699 1,420,984 1,407,953 0 0 110,246 99,401 53,000 23,000 0 0 0 0 60,435 58,387 42,323 36,958 1,686,988 1,625,699 24,132 23,197 6,044 4,332 2,822 2,944 32,998 30,473 11,933 10,394 13,947 12,503 21,065 17,970 1,881 1,377 4 42 12,059 12,800 7,424 5,978 7,424 5,978 0 0 0 0 5,015 3,846 0.46 0.35 0.43 0.33 4.90 5.17 3,061 3,903 0 75 0 0 0 0 19,758 18,298 (78) (19) 189 32 21,862 19,758 21,862 19,758 0 0 0 0
EX-27.2 4 RESTATED FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GREATER BAY BANCORP'S FILING ON FORM 8-K DATED JULY 1, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS 3-MOS DEC-31-1998 DEC-31-1997 JAN-01-1998 OCT-01-1997 MAR-31-1998 DEC-31-1997 83,159 64,531 0 0 87,500 82,500 0 0 199,576 167,519 52,110 58,943 52,817 59,650 853,883 819,607 (18,298) (18,032) 1,448,969 1,339,750 1,218,560 1,178,574 0 0 114,719 49,649 23,000 23,000 0 0 0 0 54,758 57,004 37,932 31,523 1,448,969 1,339,750 21,644 21,250 3,912 5,139 2,619 1,153 28,175 27,542 9,556 8,194 11,255 10,429 18,619 17,113 1,036 1,169 8 25 11,324 14,548 6,680 3,608 6,680 3,608 0 0 0 0 4,454 2,301 0.43 0.22 0.40 0.20 5.38 5.99 3,325 3,344 108 158 0 0 0 0 18,032 16,281 (888) (839) 118 21 18,298 18,032 18,298 18,032 0 0 0 0
EX-27.3 5 RESTATED FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GREATER BAY BANCORP'S FILING ON FORM 8-K DATED JULY 1, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS 3-MOS DEC-31-1997 DEC-31-1997 JUL-01-1997 APR-01-1997 SEP-30-1997 JUN-30-1997 61,687 54,315 0 0 68,300 65,900 0 0 110,046 93,569 56,668 60,435 57,375 61,142 767,731 728,539 (16,281) (15,417) 1,212,832 1,135,912 1,077,876 1,006,859 0 0 23,000 23,000 24,873 23,258 0 0 0 0 53,481 53,212 33,602 29,583 1,212,832 1,135,912 20,606 18,892 3,546 3,736 1,388 1,229 25,540 23,857 8,709 8,698 9,629 9,241 15,911 14,616 1,344 2,420 5 8 9,996 9,798 6,785 5,604 6,785 5,604 0 0 0 0 4,292 3,576 0.40 0.34 0.38 0.32 5.77 5.60 5,272 7,064 734 320 0 0 0 0 15,417 13,374 (498) (421) 17 44 16,281 15,417 16,281 15,417 0 0 0 0
EX-27.4 6 RESTATED FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GREATER BAY BANCORP'S FILING ON FORM 8-K DATED JULY 1, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1997 JAN-01-1997 MAR-30-1997 48,779 0 76,500 0 78,158 63,589 64,296 675,157 (13,359) 1,077,907 945,743 0 29,279 23,000 0 0 52,727 27,159 1,077,908 16,847 3,493 774 21,114 7,208 7,739 13,375 2,093 (45) 7,926 5,146 5,146 0 0 3,267 0.36 0.34 4.97 5,535 1,279 0 0 10,138 (257) 20 13,359 13,359 0 0
EX-27.5 7 RESTATED FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GREATER BAY BANCORP'S FILING ON FORM 8-K DATED JULY 1, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR YEAR DEC-31-1998 DEC-31-1997 JAN-01-1998 JAN-01-1997 DEC-31-1998 DEC-31-1997 69,583 64,631 0 0 62,800 82,500 0 0 257,258 167,519 94,599 58,943 94,890 59,609 1,092,603 819,607 (23,379) (18,032) 1,738,189 1,339,750 1,478,947 1,178,574 0 0 99,201 49,648 53,000 23,000 0 0 0 0 62,179 57,005 44,862 31,523 1,738,189 1,339,750 93,915 78,278 20,075 10,323 10,808 9,660 124,798 98,261 43,004 33,565 51,180 37,012 73,618 61,249 6,235 7,026 374 (5) 49,098 42,125 28,005 21,156 28,005 21,156 0 0 0 0 18,943 13,424 1.74 1.29 1.63 1.19 5.10 5.67 2,003 3,344 0 158 0 0 0 0 18,032 11,629 (1,496) (2,074) 425 100 23,379 18,032 23,379 18,032 0 0 0 0
EX-27.6 8 RESTATED FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GREATER BAY BANCORP'S FILING ON FORM 8-K DATED JULY 1, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 60,899 0 39,250 0 73,512 75,257 75,616 631,910 (11,629) 1,023,111 913,846 0 30,150 3,000 0 0 53,991 22,124 1,023,111 57,379 9,222 4,683 71,284 23,744 24,918 46,366 3,029 (255) 38,083 12,698 12,698 0 0 7,763 0.78 0.72 6.02 6,047 1,471 0 0 8,199 (1,096) 697 11,629 11,629 0 0
EX-27.7 9 RESTATED FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GREATER BAY BANCORP'S FILING ON FORM 8-K DATED JULY 1, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS 3-MOS DEC-31-1999 DEC-31-1998 JAN-01-1999 OCT-01-1998 MAR-31-1999 DEC-31-1998 79,244 69,583 0 0 106,400 62,800 0 0 264,640 257,258 97,892 94,599 97,122 94,890 1,234,879 1,092,603 (24,046) (23,379) 1,938,452 1,738,189 1,675,844 1,478,947 0 0 99,370 99,201 50,000 53,000 0 0 0 0 63,392 62,179 49,846 44,862 1,938,452 1,738,189 27,476 25,115 5,343 5,537 1,642 2,500 34,461 33,152 11,796 11,131 13,921 13,475 20,540 19,677 921 1,941 0 320 12,691 12,763 9,485 8,074 5,790 8,074 (88) 0 0 0 5,702 5,628 0.53 0.51 0.50 0.48 4.97 4.90 2,992 2,003 0 0 0 0 0 0 23,379 21,862 (288) (507) 34 84 24,046 23,379 24,046 23,379 0 0 0 0
EX-99.1 10 CONSOLIDATED FINANCIAL STMTS FOR 12/31/98, 97 & 96 Exhibit 99.1 SELECTED FINANCIAL INFORMATION The following table represents the selected financial information at and for the five years ended December 31, 1998:
Years Ended December 31, --------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) 1998 1997* 1996* 1995* 1994* --------------------------------------------------------------------------------- Statement of Operations Data Interest income $ 124,798 $ 98,261 $ 71,284 $ 60,567 $ 46,309 Interest expense 51,180 37,012 24,918 21,184 13,394 -------------------------------------------------------------------------------- Net interest income 73,618 61,249 46,366 39,383 32,915 Provision for loan losses 6,235 7,026 3,029 1,429 2,285 -------------------------------------------------------------------------------- Net interest income after provision 67,383 54,223 43,337 37,954 30,630 for loan losses Other income 8,775 7,896 7,444 5,575 5,953 Nonrecurring - warrant income 945 1,162 - - - -------------------------------------------------------------------------------- Total other income 9,720 9,058 7,444 5,575 5,953 Operating expenses 45,095 40,078 35,292 31,518 27,446 Other expenses - nonrecurring 1,341 (1,287) - 2,135 - -------------------------------------------------------------------------------- Total operating expenses 46,436 38,791 35,292 33,653 27,446 -------------------------------------------------------------------------------- Income before income tax 30,667 24,490 15,489 9,876 9,137 expense & merger and other related nonrecurring costs Income tax expense 10,050 8,784 5,735 3,709 3,431 -------------------------------------------------------------------------------- Income before merger and 20,617 15,706 9,754 6,167 5,706 other related nonrecurring costs Merger and other related 1,674 2,282 1,991 - 608 nonrecurring costs, net of tax -------------------------------------------------------------------------------- Net income $ 18,943 $ 13,424 $ 7,763 $ 6,167 $ 5,098 -------------------------------------------------------------------------------- Per Share Data (1) Income per share (before merger and other related nonrecurring costs) Basic $ 1.90 1.51 $ 0.97 $ 0.65 $ 0.63 Diluted 1.77 1.40 0.91 0.61 0.59 Net income per share Basic $ 1.74 $ 1.29 $ 0.78 $ 0.65 $ 0.56 Diluted 1.63 1.19 0.72 0.56 0.53 Cash dividends per share (2) $ 0.38 $ 0.30 $ 0.22 $ 0.20 $ 0.11 Book value per common share 9.73 8.30 7.47 7.03 6.53 Shares outstanding at year 11,004,529 10,659,726 10,185,989 9,752,993 9,147,971 end Average common shares 10,858,000 10,421,000 10,014,000 9,552,000 9,054,000 outstanding Average common and common 11,637,000 11,254,000 10,747,000 10,087,000 9,685,000 equivalent shares outstanding Performance Ratios Return on average assets 1.32% 1.36% 1.16% 0.89% 1.10% (before merger and other related nonrecurring costs) (3) Return on average common shareholders' equity (before merger and other related nonrecurring costs) (3) 21.21% 18.70% 13.37% 9.56% 12.28% Net interest margin (4) 5.10% 5.67% 6.02% 6.22% 6.98% Balance Sheet Data - At Period End Assets $ 1,738,189 $ 1,339,750 $ 1,023,111 $ 753,188 $ 631,809 Loans, net 1,092,603 819,607 631,187 452,587 394,115 Investment securities 357,511 228,715 150,340 154,268 127,603 Deposits 1,478,947 1,178,574 914,101 668,082 547,062 Subordinated debt 3,000 3,000 3,000 3,000 - Trust Preferred Securities 50,000 20,000 - - - Common shareholders' equity 107,041 88,528 76,115 68,572 59,755 Asset Quality Ratios Nonperforming assets to 0.30% 0.71% 1.71% 2.19% 3.18% total loans and OREO Allowance for loan losses to 2.09% 2.14% 1.80% 1.77% 2.06% total loans Allowance for loan losses to non- performing assets 676.10% 300.88% 105.36% 80.71% 64.69% Net (charge-offs) recoveries -0.12% -0.27% -0.08% -0.40% -0.27% to average loans Regulatory Capital Ratios Leverage Ratio 8.29% 8.50% 7.95% 9.53% 9.74% Tier 1 Capital 10.48% 10.80% 10.09% 12.48% 12.94% Total Capital 12.90% 12.35% 11.70% 14.25% 14.25%
*Restated on a historical basis to reflect the mergers between Greater Bay Bancorp and CNB, PBC, PRB (the parent of Golden Gate), PBFC, and Bay Area Bankshares the parent company of Bay Area Bank) on a pooling- of- interests basis. (1) Restated to reflect 2-for-1 stock split effective as of April 30, 1998. (2) Includes only those dividends declared by Greater Bay, and excludes those dividends paid by Greater Bay's subsidiaries prior to the completion of their mergers with Greater Bay. (3) Including merger and other related nonrecurring items net of tax of $1.7 million in 1998, $2.3 million in 1997, $2.0 million in 1996 and $608,000 in 1994, ROA for 1998, 1997, 1996, 1995 and 1994 would have been 1.21%, 1.16%, 0.93%, 0.82% and 0.81%, respectively, and ROE for 1998, 1997, 1996, 1995 and 1994 would have been 19.48%, 15.98%, 10.64%, 9.48% and 10.89%, respectively. (4) Net interest margin for 1998, 1997 and 1996 includes the lower spread earned on the PBC Special Deposit (see Note 7 to the Financial Statements for details). Excluding the PBC Special Deposit, net interest margin would have been 5.29%, 5.99% and 6.07% for 1998, 1997 and 1996, respectively. (5) Includes available for sale securities and held to maturity securities. 1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Greater Bay Bancorp ("Greater Bay" on a parent-only basis, and the "Company", on a consolidated basis) was formed as the result of the merger in November 1996 between Cupertino National Bancorp, the former holding company for Cupertino National Bank ("CNB"), and Mid-Peninsula Bancorp, the former holding company for Mid-Peninsula Bank ("MPB"). In December 1997 the Company completed a merger with Peninsula Bank of Commerce ("PBC"), whereby PBC became the third wholly owned banking subsidiary of Greater Bay. In May 1998, the Company completed a merger with Pacific Rim Bancorporation ("PRB"), the holding company for Golden Gate Bank ("Golden Gate"), whereby Golden Gate became the fourth wholly owned banking subsidiary of Greater Bay. In August 1998, the Company completed a merger with Pacific Business Funding Corporation ("PBFC"), which now operates as an operating division of CNB and conducts business under the name Pacific Business Funding. In May 1999, the Company completed a merger with Bay Area Bancshares ("BA Bancshares"), the holding company for Bay Area Bank ("BAB"), whereby BAB became the fifth wholly owned subsidiary of Greater Bay. All mergers were accounted for as a pooling of interests. All of the financial information for the Company for the periods prior to the mergers has been restated to reflect the pooling of interests, as if they occurred at the beginning of the earliest reporting period presented. CNB, MPB, PBC, Golden Gate and BAB are referred to collectively herein as the "Banks." The financial information includes the result of the Company's operating divisions, Greater Bay Bank Santa Clara Valley Commercial Banking Group, Greater Bay Corporate Finance Group, Greater Bay Bank Contra Costa Banking Office, Greater Bay International Banking Division, Greater Bay Trust Company, Pacific Business Funding and Venture Banking Group. The following discussion and analysis is intended to provide greater details of the results of operations and financial condition of the Company. The following discussion should be read in conjunction with the information under "Selected Financial Information" and the Company's consolidated financial data included elsewhere in this document. Certain statements under this caption constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include but are not limited to economic conditions, competition in the geographic and business areas in which the Company conducts its operations, fluctuation in interest rates, credit quality and government regulation. Results of Operations The Company reported net income of $18.9 million in 1998, a 41.1% increase over 1997 net income of $13.4 million. The net income in 1997 was an 72.9% increase over 1996 income of $7.8 million. Basic net income per share was $1.74 for 1998, as compared to $1.29 for 1997 and $0.78 for 1996. Diluted net income per share was $1.63, $1.19 and $0.72 for 1998, 1997 and 1996, respectively. The return on average assets and return on average shareholders' equity were 1.21% and 19.48% in 1998, compared with 1.16% and 15.98% in 1997 and 0.93% and 10.64% in 1996, respectively. The Company's operating results included merger and other related nonrecurring costs of $2.7 million ($1.7 million net of tax), $3.3 million ($2.3 million net of tax) and $2.8 million ($2.0 million net of tax) in 1998, 1997 and 1996, respectively. The following table summarizes net income, net income per share and key financial ratios before and after merger and other related nonrecurring costs for the years presented:
After merger and Before merger and other related nonrecurring costs other related nonrecurring costs ----------------------------------------------------- -------------------------------------- (Dollars in thousands, except per share amounts) 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ Net income $ 20,617 $ 15,706 $ 9,754 $ 18,943 $ 13,424 $ 7,763 Net income per share: Basic $ 1.90 $ 1.51 $ 0.97 $ 1.74 $ 1.29 $ 0.78 Diluted $ 1.77 $ 1.40 $ 0.91 $ 1.63 $ 1.19 $ 0.72 Return on average assets 1.32% 1.36% 1.16% 1.21% 1.16% 0.93% Return on average shareholders' equity 21.21% 18.70% 13.37% 19.48% 15.98% 10.64%
The increase in 1998 net income was the result of significant growth in loans, deposits and trust assets. This growth resulted in increases in net interest income, trust fees, depositors' service fees and other fee income. Operating expense increases required to service and support the Company's growth partially offset the increase in revenues. Net income for 1998 and 1997 included $945,000 and $1.2 million, respectively, in warrant income resulting from the warrants received from clients of the Banks. During 1998, the Company donated appreciated warrants to the Greater Bay Bancorp Foundation which triggered the recognition of warrant income of $945,000, net of related employee incentives, and was offset by the donation expense of $1.3 million. The Company also recognized a tax benefit of $551,000 in 1998 from these transactions. 2 The increase in net income in 1997 over 1996 was due primarily to increased growth in interest-earning assets. Additionally, warrant income increased to $1.2 million in 1997, compared with $92,000 in 1996. Net income in 1997 also included approximately $1.7 million ($1.0 million net of tax) of a recovery through insurance of a litigation settlement charge incurred in 1995. The increases were partially offset by the growth in operating expenses. In addition, during 1997 the Company increased its allowance for loan losses to 2.14% of total loans from 1.80% of total loans in 1996. The increase in the allowance for loan losses as a percentage of total loans accounted for $2.8 million of the increased provision for loan losses in 1997. Net Interest Income Net interest income increased 20.2% to $73.6 million in 1998 from $61.2 million in 1997. This increase was primarily due to the $362.2 million, or 33.5%, increase in average interest-earning assets which was partially offset by a 57 basis point decrease in the Company's net yield on interest earning assets. Net interest income increased 32.1% in 1997 from $46.4 million in 1996. This increase was primarily due to the $310.2 million, or 40.3%, increase in average interest-earning assets, which was partially offset by the 35 basis point decrease in the Company's net yield on interest earning assets. The Company's net yield on interest earning assets was reduced by the Special Deposit (discussed in Note 7 of the Notes to the Consolidated Financial Statements). The average deposit balances related to the Special Deposit during 1998, 1997 and 1996 were $88.9 million, $93.4 million and $91.3 million, respectively, on which the Company earned a spread of 2.25%. Excluding the Special Deposit, the 1998, 1997 and 1996 net yield on interest earning assets would have been 5.29%, 5.99% and 6.07%, respectively. 3 The following table presents, for the years indicated, condensed average balance sheet information for the Company, together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities. Average balances are average daily balances.
Years Ended December 31, -------------------------------------------------------------------- 1998 1997 ----------------------------------------------- ------------------- Average Average Yield/ Average (Dollars in thousands) Balance (1) Interest Rate Balance (1) - -------------------------------------------------------------------------------------------------------------------- INTEREST-EARNING ASSETS: Fed funds sold $ 99,691 $ 5,354 5.37% $ 81,384 Other short term securities 96,765 5,454 5.64% 97,586 Investment securities: Taxable 294,533 17,911 6.08% 142,981 Tax-exempt (3) 43,364 2,164 4.99% 20,260 Loans (2) 907,877 93,915 10.34% 737,852 ---------- -------- ---------- Total interest-earning assets 1,442,230 124,798 8.65% 1,080,063 Noninterest-earning assets 117,296 - 77,701 ---------- --------- ---------- Total assets 1,559,526 124,798 1,157,764 ========== --------- ========== INTEREST-BEARING LIABILITIES: Deposits: MMDA, NOW and Savings 817,236 29,377 3.59% 626,477 Time deposits, over $100,000 203,687 10,556 5.18% 143,776 Other time deposits 59,911 3,071 5.13% 68,206 ---------- --------- -------- Total interest-bearing deposits 1,080,834 43,004 3.98% 838,459 Other borrowings 76,637 4,981 6.50% 17,449 Subordinated debt 3,000 345 11.50% 3,000 Trust Preferred Securities 31,671 2,850 9.00% 15,000 ---------- --------- -------- Total interest-bearing liabilities 1,192,142 51,180 4.29% 873,908 ---------- -------- -------- Noninterest-bearing deposits 252,654 188,041 Other noninterest-bearing liabilities 17,510 11,809 Shareholders' equity 97,220 84,006 ---------- -------- Total liabilities and shareholders' equity 1,559,526 51,180 1,157,764 ========== -------- =========== - Net interest income 73,618 ======== Interest rate spread 4.36% Contribution of interest free funds 0.74% Net yield on interest-earnings 5.10% assets(4) Years Ended December 31, ---------------------------------------------------------------- 1997 1996 ---------------------------- ---------------------------------- Average Average Yield/ Average Yield/ (Dollars in thousands) Interest Rate Balance (1) Interest Rate - ---------------------------------------------------------------------------- ---------------------------------- INTEREST-EARNING ASSETS: Fed funds sold $ 4,373 5.37% $ 70,854 $ 3,987 5.63% Other short term securities 5,287 5.42% 12,669 696 5.49% Investment securities: Taxable 9,170 6.41% 134,154 8,171 6.09% Tax-exempt (3) 1,153 5.69% 20,824 1,050 5.04% Loans (2) 78,278 10.61% 531,353 57,380 10.80% -------- -------- ------- Total interest-earning assets 98,261 9.10% 769,854 71,284 9.26% Noninterest-earning assets - 68,153 - --------- -------- ------- Total assets 98,261 838,007 71,284 --------- ======== ------- INTEREST-BEARING LIABILITIES: Deposits: MMDA, NOW and Savings 22,279 3.56% 438,421 14,436 3.29% Time deposits, over $100,000 7,458 5.19% 104,035 5,183 4.98% Other time deposits 3,828 5.61% 67,478 4,125 6.11% -------- -------- ------- Total interest-bearing deposits 33,565 4.00% 609,934 23,744 3.89% Other borrowings 1,640 9.40% 11,138 829 7.44% Subordinated debt 345 11.50% 3,000 345 11.50% Trust Preferred Securities 1,463 9.75% - - 0.00% -------- -------- ------- Total interest-bearing liabilities 37,012 4.24% 624,072 24,918 3.99% -------- -------- ------- Noninterest-bearing deposits 134,777 Other noninterest-bearing liabilities 6,185 Shareholders' equity 72,973 -------- Total liabilities and shareholders' equity 37,012 838,007 24,918 -------- ======== ------- - - Net interest income 61,249 46,366 ========= ======= Interest rate spread 4.86% 5.27% Contribution of interest free funds 0.81% 0.76% Net yield on interest-earnings 5.67% 6.02% assets(4)
(1) Nonaccrual loans are excluded from the average balance and only collected interest on accrual loans is included in the interest column. (2) Loan fees totaling $4.0 million, $4.1 million and $3.0 million are included in loan interest income for 1998, 1997 and 1996, respectively. (3) Tax equivalent yields earned on the tax exempt securities are 7.19%, 8.39% and 7.40% for the years ended December 31, 1998, 1997 and 1996, respectively, using the federal statutory rate of 34%. (4) Net yield on interest-earning assets during the period equals (a) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (b) average interest-earning assets for the period. 4 The most significant impact on the Company's net interest income between periods is derived from the interaction of changes in the volume of and rate earned or paid on interest-earning assets and interest-bearing liabilities. The volume of interest-earning asset dollars in loans and investments, compared to the volume of interest-bearing liabilities represented by deposits and borrowings, combined with the spread, produces the changes in the net interest income between periods. The table below sets forth, for the years indicated, a summary of the changes in average asset and liability balances (volume) and changes in average interest rates (rate).
Year Ended December 31, 1998 Compared with December 31, 1997 favorable (unfavorable) ---------------------------------------------- (Dollars in thousands) (1) Volume Rate Net - ----------------------------------------------------------------------------------------------------------- Interest-earning assets: Fed funds sold $ 984 $ (3) $ 981 Other short term securities (44) 211 167 Investment securities: Taxable 9,720 (979) 8,741 Tax-exempt 1,315 (304) 1,011 Loans 18,038 (2,401) 15,637 -------- -------- ------- Total interest-earning assets 30,012 (3,475) 26,537 -------- -------- ------- Interest-bearing liabilities: Deposits: MMDA, NOW and Savings 6,784 314 7,098 Time deposits, over $100,000 3,108 (10) 3,098 Other time deposits (466) (291) (757) -------- -------- -------- Total interest-bearing deposits 9,426 13 9,439 Other borrowings 5,561 (2,220) 3,341 Trust Preferred Securities 1,625 (238) 1,387 -------- -------- -------- Total interest-bearing liabilities 16,613 (2,445) 14,168 -------- -------- -------- Increase (decrease) in net interest income 13,399 (1,030) 12,369 ======== ======== ======== Year Ended December 31, 1997 Compared with December 31, 1996 favorable (unfavorable) ---------------------------------------------- (Dollars in thousands) (1) Volume Rate Net - ------------------------------------------------------------------------------------------------------------ Interest-earning assets: Fed funds sold $ 593 $ (207) $ 386 Other short term securities 4,665 (74) 4,591 Investment securities: Taxable 538 461 999 Tax-exempt (28) 131 103 Loans 22,299 (1,401) 20,898 -------- -------- -------- Total interest-earning assets 28,066 (1,090) 26,977 -------- -------- -------- Interest-bearing liabilities: Deposits: MMDA, NOW and Savings 6,192 1,651 7,843 Time deposits, over $100,000 1,980 295 2,275 Other time deposits 45 (342) (297) -------- -------- -------- Total interest-bearing deposits 8,217 1,604 9,821 Other borrowings 470 341 811 Trust Preferred Securities - 1,463 1,463 -------- -------- -------- Total interest-bearing liabilities 8,686 3,408 12,094 -------- -------- -------- Increase (decrease) in net interest income 19,380 (4,497) 14,883 ======== ======== ========
(1) The change in interest income and expense not attributable to specific volume and rate changes has been allocated proportionately between the volume and rate changes. Interest income in 1998 increased 27.0% to $124.8 million from $98.3 million in 1997. This was primarily due to the significant increase in loans, the Company's highest yielding interest-earning asset, and investment securities. Loan volume increases were the result of the continuing economic improvement in the Company's market areas, as well as the addition of experienced relationship managers and significant business development efforts by the Company's relationship managers. The increase was partially offset by a decline in the yield earned on average interest-earning assets. Average interest-earning assets increased $362.2 million, or 33.5%, to $1.4 billion in 1998, compared to $1.1 billion in 1997. Of this total increase, average loans increased $170.0 million, or 23.04%, to $907.9 million, or 62.9% of average interest-earning assets, in 1998 from $737.9 million, or 68.32% of average interest-earning assets in 1997. Investment securities, Federal funds sold and other short-term securities, increased 56.1% to $534.4 million, or 37.1% of average interest-earning assets in 1998, from $342.2 million, or 31.7% of average interest-earning assets in 1997. The average yield on interest-earning assets declined 45 basis points to 8.65% in 1998 from 9.1% in 1997 primarily due to a decline in the average yield on loans which was caused by increased competition for quality borrowers in the Company's market area and the shift in the mix between lower yielding investments and higher yielding loans. Loans represented approximately 62.9% of total interest-earning assets in 1998 compared to 68.3% in 1997. If loans would have remained at 68.3% of total interest earning assets in 1998, the yield on interest-earning assets would have been 8.90% and the interest rate spread would have been 4.61%. The average yield on loans declined 27 basis points to 10.34% in 1998 from 10.61% in 1997 primarily due to declines in market interest rates. Interest expense in 1998 increased 38.3% to $51.2 million from $37.0 million in 1997. This increase was due to greater volumes of interest-bearing liabilities coupled with slightly higher interest rates paid on interest-bearing liabilities. Average interest-bearing liabilities increased 36.4% to $1.2 billion in 1998 from $873.9 million in 1997 due primarily to the efforts of the Banks' relationship managers in generating core deposits from their client relationships and the deposits derived from the activities of the Greater Bay Trust Company and the Venture Banking Group. During 1998, average noninterest-bearing deposits increased to $252.7 million from $188.0 million in 1997. Due to that increase, noninterest-bearing deposits comprised 18.9% of total deposits at year-end 1998, compared 18.3% at year-end 1997. As a result of the foregoing, the Company's interest rate spread declined to 4.36% in 1998 from 4.86% in 1997, and the net yield on interest-earning assets declined in 1998 to 5.10% from 5.67% in 1997. 5 Interest income increased 37.8% to $98.3 million in 1997 from $71.3 million in 1996, as a result of the increase in average interest-earning assets offset by a decline in the yields earned. Average interest-earning assets increased 40.3% to $1.1 billion in 1997 from $769.9 million in 1996 principally as a result of increase in loans. The yield on the higher volume of average interest-earning assets declined 16 basis points to 9.10% in 1997 from 9.26% in 1996, primarily as a result of increased competition for loans. Interest expense in 1997 increased 48.5% to $37.0 million from $24.9 million in 1996 primarily as a result of the increase in volume of interest-bearing liabilities in addition an increase in rates paid on interest-bearing liabilities. As a result of the utilization of higher cost long term borrowings which provide additional capital to the Company, the average rate paid on average interest-bearing liabilities increased 25 basis points to 4.24% in 1997 from 3.99% in 1996. Corresponding to the growth in average interest-earning assets, average interest-bearing liabilities increased 40.0% to $873.9 million in 1997 from $624.1 million in 1996. As a result of the foregoing, the Company's interest rate spread declined to 4.86% in 1997 from 5.27% in 1996 and the net yield on interest-earning assets declined to 5.67% in 1997 from 6.02% in 1996. Certain client service expenses were incurred by the Company with respect to its noninterest-bearing liabilities. These expenses include messenger services, check supplies and other related items and are included in operating expenses. Had they been included in interest expense, the impact of these expenses on the Company's net yield on interest-earning assets would have been as follows for each of the years presented.
-------------------------------------------- (Dollars in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------ Average noninterest bearing demand deposits $252,654 $188,041 $134,777 Client service expenses 563 459 474 Client service expenses, annualized 0.22% 0.24% 0.35% IMPACT ON NET YIELD ON INTEREST-EARNING ASSETS: Net yield on interest-earning assets 5.10% 5.67% 6.02% Impact of client service expense -0.04% -0.04% -0.06% -------------------------------------------- Adjusted net yield on interest-earning assets (1) 5.07% 5.63% 5.96% ============================================
(1) Noninterest-bearing liabilities are included in cost of funds calculations to determine adjusted net yield of spread The impact on the net yield on interest-earning assets is determined by offsetting net interest income by the cost of client service expense, which reduces the yield on interest-earning assets. The cost for client service expense reflects the Company's efforts to manage its client service expenses. Provision for Loan Losses The provision for loan losses creates an allowance for future loan losses. The loan loss provision for each year is dependent on many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management's assessment of the quality of the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in the Company's market area. The Company performs a monthly assessment of the risk inherent in its loan portfolio, as well as a detailed review of each asset determined to have identified weaknesses. Based on this analysis, which includes reviewing historical loss trends, current economic conditions, industry concentrations and specific reviews of assets classified with identified weaknesses, the Company makes a provision for loan losses. Specific allocations are made for loans where the probability of a loss can be defined and reasonably determined. The balance of the provision for loan losses is based on historical data, delinquency trends, economic conditions in the Company's market area and industry averages. Annual fluctuations in the provision for loan losses result from management's assessment of the adequacy of the allowance for loan losses, and ultimate loan losses may vary from current estimates. 6 The provision for loan losses in 1998 was $6.2 million, compared to $7.0 million in 1997 and $3.0 million in 1996. In addition, in connection with the mergers, the Company made an additional provision for loan losses of $183,000, $1.4 million and $800,000 in 1998, 1997 and 1996, respectively, to conform to the Companys' reserve allocation methodologies. Although loans outstanding have increased substantially, nonperforming loans, comprised of nonaccrual loans, restructured loans, and accruing loans past due 90 days or more, declined to $2.3 million, or 0.21% of loans outstanding, at December 31, 1998, from $4.6 million, or 0.54% of loans outstanding, at December 31, 1997 and $9.3 million, or 1.45% of loans outstanding, at December 31, 1996. For further information on nonperforming and classified loans and the allowance for loan losses, see--"Nonperforming and Classified Assets" herein. Other Income Total other income increased to $9.7 million in 1998, compared to $9.1 million in 1997 and $7.4 million in 1996. The following table sets forth information by category of other income for the years indicated.
Years Ended December 31, ------------------------------------------ (Dollars in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------- Trust fees $2,473 $2,049 $1,426 ATM network revenue 1,946 2,026 1,839 Service charges and other fees 1,748 1,826 1,640 Gain on sale of SBA loans 1,037 883 537 Gain (loss) on investments, net 374 (5) (255) Other income 1,197 1,117 2,165 ------------------------------------------ Total, recurring 8,775 7,896 7,352 Warrant income 945 1,162 92 ------------------------------------------ Total $9,720 $9,058 $7,444 ==========================================
The increase in other income in 1998 was primarily the result of a $424,000 increase in trust fees, and a $154,000 increase in the gain on sale of SBA loans. The increase in trust fees was due to significant growth in assets under management by Greater Bay Trust Company. Trust assets increased to $649.3 million at December 31, 1998, compared to $577.7 million at December 31, 1997. The increase in the gain on sale of SBA loans was due to an increase in the origination and subsequent sale of SBA loans. Other income in 1998 included warrant income of $945,000, net of related employee incentives. The Company occasionally receives warrants to acquire common stock from companies that are in the start-up or development phase. The timing and amount of income derived form the exercise and sale of client warrants typically depend upon factors beyond the control of the Company, and cannot be predicted with any degree of accuracy and are likely to vary materially from period to period. The increase in other income in 1997 was primarily the result of $1.1 million increase in warrant income in 1997, a $623,000 increase in trust fees, and a $346,000 increase in the gain on sale of SBA loans. The increase in trust fees was due to significant growth in assets under management by Greater Bay Trust Company. Trust assets increased to $577.7 million at year-end 1997, compared to $418.0 million at December 31, 1996. The increase in the gain on sale of SBA loans was due to an increase in the origination and subsequent sale of SBA loans. 7 Operating Expenses The following table sets forth the major components of operating expenses for the years indicated.
Years Ended December 31, ----------------------------------------------- (Dollars in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Compensation and benefits $25,585 $22,961 $19,338 Occupancy and equipment 7,176 6,198 5,381 Professional services and legal costs 2,320 2,412 2,130 Contribution to GBB Foundation 1,341 - - Client service expenses 563 459 474 ATM network expenses 526 558 628 FDIC insurance and regulatory assessments 365 319 169 Expenses on other real estate owned 76 177 175 Recovery of legal settlement - (1,700) - Other 8,485 7,407 6,997 ----------------------------------------------- Total operating expenses, excluding merger and other related nonrecurring costs $46,437 $38,792 $35,292 Mergers and other related nonrecurring costs 2,661 3,333 2,791 ----------------------------------------------- Total operating expenses $49,098 $42,125 $38,083 =============================================== Efficiency ratio, excluding trust 58.34% 58.99% 69.63% Efficiency ratio, excluding trust, merger and other related nonrecurring costs 55.02% 54.10% 64.26% Efficiency ratio, excluding trust and nonrecurring items (1) 53.98% 56.96% 64.26% Total operating expenses to average assets 3.15% 3.64% 4.54% Total operating expenses to average assets, excluding merger and other related nonrecurring costs 2.98% 3.35% 4.21%
- ------------- (1) Nonrecurring items include warrant income of $945,000, $1.2 million and $92,000 for 1998, 1997 and 1996, respectively, merger and related nonrecurring items of $2.7 million, $3.3 million and $2.8 million for 1998, 1997 and 1996, respectively, and the $1.7 million recovery of legal settlement in 1997. Operating expenses totaled $49.0 million for 1998, compared to $42.1 million for 1997 and $38.0 million for 1996. The ratio of operating expenses to average assets was 3.15% in 1998, 3.64% in 1997, and 4.54% in 1996. Excluding these items, operating expense to average assets would have been 2.98% in 1998, 3.35% in 1997 and 4.21% in 1996. The efficiency ratio is computed by dividing total operating expenses by net interest income and other income. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same (or greater) volume of income while a decrease would indicate a more efficient allocation of resources. The Company's efficiency ratio for 1998 was 58.91%, compared to 59.92% in 1997 and 70.77% in 1996. During 1998, Greater Bay established the Greater Bay Bancorp Foundation (the "Foundation"). The Foundation was formed to provide a vehicle through which the Company, its officers and directors can provide support to the communities in which the Company does business. The Foundation focuses its support on initiatives related to education, health and economic growth. To support the Foundation, in 1998 the Company contributed appreciated warrants, which had an unrealized gain of $1.3 million. Concurrently, the Company recorded $1.3 million of expense for the contribution to the Foundation, which is included in other expenses. As indicated by the improvements in the efficiency ratio and ratio of total operating expenses to average assets, the Company has been able to achieve increasing economies of scale. In 1998, average assets increased 34.7% from 1997, while operating expenses, excluding nonrecurring cost, increased only 12.5%. From 1996 to 1997, average assets increased 38.2%, while operating expenses, excluding nonrecurring costs increased only 13.6%. Compensation and benefits expenses increased in 1998 to $25.6 million, compared to $23.0 million in 1997 and $19.3 million in 1996. The increase in compensation and benefits is due primarily to the additions in personnel made in 1998 and 1997 to accommodate the growth of the Company. The increase in occupancy and equipment, client service expense, FDIC insurance and regulatory assessments and other operating expenses was related to the growth in the Company's loans, deposits and trust assets. 8 Income Taxes The Company's effective income tax rate for 1998 was 32.4%, compared to 36.6% in 1997 and 38.8% in 1996. The effective rates were lower than the statutory rate of 41.2% due to tax-exempt income on municipal securities, tax benefit related to the donation of appreciated warrants to the Foundation, as discussed above and were partially offset by non-deductible merger costs. Financial Condition Total assets increased 29.7% to $1.7 billion at December 31, 1998, compared to $1.3 billion at December 31, 1997. Total assets increased 30.9% in 1997 from $1.0 billion at December 31, 1996. The increases in 1998 and 1997 were primarily due to increases in the Company's loan portfolio funded by growth in deposits. Loans Total gross loans increased 33.2% to $1.1 billion at December 31, 1998, compared to $841.0 million at December 31, 1997. Total gross loans increased 30.2% in 1997 from $646.6 million at year-end 1996. The increases in loan volumes in 1998 and 1997 were primarily due to an improving economy in the Company's market areas coupled with the business development efforts by the Company's relationship managers. The Company's loan portfolio is concentrated in commercial (primarily manufacturing, service and technology) and real estate lending, with the balance in consumer loans. While no specific industry concentration is considered significant, the Company's lending operations are located in a market area that is dependent on the technology and real estate industries and supporting service companies. Thus, the Company's borrowers could be adversely impacted by a downturn in these sectors of the economy. This could, in turn, reduce the demand for loans and adversely impact the borrowers' abilities to repay their loans, while also decreasing the Company's net interest margin. The following table presents the composition of the Company's loan portfolio at the dates indicated.
As of December 31, ---------------------------------------------------------------- 1998 1997 1996 ---------------------------------------------------------------- (Dollars in thousands) Amount % Amount % Amount % - --------------------------------------------------------------------------------------------------------------------- Commercial $ 483,668 44.3% $383,426 46.8% $322,178 51.0% Real estate construction and land 215,274 19.7 137,889 16.8 106,983 16.9 Real estate term 332,478 30.4 230,986 28.2 157,114 24.9 Consumer and other 88,458 8.1 88,702 10.8 60,325 9.5 ---------------------------------------------------------------- Total loans, gross 1,119,878 102.5 841,003 102.6 646,600 102.3 Deferred fees and discounts, net (3,896) (0.4) (3,364) (0.4) (3,061) (0.5) ---------------------------------------------------------------- Total loans, net of deferred fees 1,115,982 102.1 837,639 102.2 643,539 101.8 Allowance for loan losses (23,379) (2.1) (18,032) (2.2) (11,629) (1.8) ---------------------------------------------------------------- Total loans, net $1,092,603 100.0% $819,607 100.0% $631,910 100.0% ================================================================ As of December 31, -------------------------------------------- 1995 1994 -------------------------------------------- (Dollars in thousands) Amount % Amount % - ------------------------------------------------------------------------------------------------- Commercial $239,421 52.8% $214,504 53.6% Real estate construction and land 56,908 12.6 43,330 10.8 Real estate term 122,801 27.1 111,401 27.9 Consumer and other 44,933 9.9 42,086 10.5 -------------------------------------------- Total loans, gross 464,063 102.4 411,321 102.9 Deferred fees and discounts, net (2,505) (0.6) (3,031) (0.8) -------------------------------------------- Total loans, net of deferred fees 461,558 101.8 408,290 102.1 Allowance for loan losses (8,199) (1.8) (8,465) (2.1) -------------------------------------------- Total loans, net $453,359 100.0% $399,825 100.0% ============================================
The following table presents the maturity distribution of the Company's commercial, real estate construction and land and real estate term portfolios and the sensitivity of such loans to changes in interest rates at December 31, 1998. 9
Real estate construction Real estate (Dollars in thousands) Commercial and land term - ----------------------------------------------------------------------------------- Loans maturing in: One year or less: Fixed rate $ 66,490 $ 6,179 $ 18,612 Variable rate 211,103 183,401 81,936 One to five years: Fixed rate 20,904 - 38,626 Variable rate 101,012 11,751 56,242 After five years: Fixed rate 35,516 2,311 82,882 Variable rate 48,644 11,632 54,180 ----------------------------------------------- Total $483,668 $215,274 $332,478 ===============================================
Nonperforming and Classified Assets Management generally places loans on nonaccrual status when they become 90 days past due, unless they are well secured and in the process of collection. When a loan is placed on nonaccrual status, any interest previously accrued but not collected is generally reversed from income. Loans are charged off when management determines that collection has become unlikely. Restructured loans are those where the Banks have granted a concession on the interest paid or original repayment terms due to financial difficulties of the borrower. Other real estate owned ("OREO") consists of real property acquired through foreclosure on the related collateral underlying defaulted loans. The following table sets forth information regarding nonperforming assets at the dates indicated.
As of December 31, ------------------------------------------------------------------------ (Dollars in thousands) 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------------- Nonperforming loans Nonaccrual loans $2,003 $3,344 $ 6,047 $ 5,303 $ 6,801 Accruing loans past due 90 days or more - 158 1,471 855 1,518 Restructured loans 327 1,062 1,828 1,530 1,972 ----------------------------------------------------------------------- Total nonperforming loans 2,330 4,564 9,346 7,688 10,291 Other real estate owned 966 1,429 1,691 2,471 2,794 ----------------------------------------------------------------------- Total nonperforming assets $3,296 $5,993 $11,037 $10,159 $13,085 ------------------------------------------------------------------------ Nonperforming assets to total loans and other real estate owned 0.30% 0.71% 1.71% 2.19% 3.18%
At December 31, 1998, the Company had $2.0 million in nonaccrual loans. Interest income foregone on nonperforming loans outstanding at year-end totaled $121,000, $532,000 and $760,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company records OREO at the lower of carrying value or fair value less estimated costs to sell. Estimated losses that result from the ongoing periodic valuation of these properties are charged to earnings through a provision for losses on foreclosed property in the period in which they are identified. At December 31, 1998, OREO acquired through foreclosure had a carrying value of $966,000, compared to $1.4 million at December 31, 1997. The Company had $327,000 and $1,062,000 of restructured loans as of December 31, 1998 and 1997, respectively. There were no principal reduction concessions allowed on restructured loans during 1998. Principal reduction concessions totaling 10 $387,000 were permitted on restructured loans during the year ended December 31, 1997. Interest income from restructured loans totaled $16,000 and $82,000 for the years ended December 31, 1998 and 1997. Foregone interest income, which totaled $11,000 and $10,000 for the years ended December 31, 1998 and 1997, respectively, would have been recorded as interest income if the loans had accrued interest in accordance with their original terms prior to the restructurings. The policy of the Company is to review each loan in the portfolio to identify problem credits. There are three classifications for problem loans: "substandard," "doubtful" and "loss." Substandard loans have one or more defined weakness and are characterized by the distinct possibility that the Banks will sustain some loss if the deficiencies are not corrected. Doubtful loans have the weaknesses of substandard loans with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable; and there is a high possibility of loss of some portion of the principal balance. A loan classified as "loss" is considered uncollectible and its continuance as an asset is not warranted. The following table sets forth the classified assets at the dates indicated.
As of December 31, -------------------------------------- (Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------- Substandard $12,515 $15,733 $ 8,993 Doubtful 1,188 1,894 3,809 Loss - 49 231 Other real estate owned 966 1,429 1,691 -------------------------------------- Classified assets $14,669 $19,105 $14,724 ====================================== Classified assets to total loans and other real estate owned 1.31% 2.28% 2.29% Allowance for loan losses to total classified assets 159.38% 94.38% 78.98%
With the exception of these classified assets, management was not aware of any loans outstanding as of December 31, 1998 where the known credit problems of the borrower would cause management to have serious doubts as to the ability of such borrowers to comply with their present loan repayment terms and which would result in such loans being included in nonperforming or classified asset tables at some future date. Management cannot, however, predict the extent to which economic conditions in the Company's market areas may worsen or the full impact that such an environment may have on the Company's loan portfolio. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured loans, or other real estate owned in the future. 11 Allowance For Loan Losses The allowance for loan losses is established through a provision for loan losses based on management's evaluation of risk inherent in the Company's loan portfolio and economic conditions in the Company's market areas. See "Provision for Loan Losses" herein. The allowance is increased by provisions charged against earnings and reduced by net loan charge-offs. Loans are charged-off when they are deemed to be uncollectible; recoveries are generally recorded only when cash payments are received. The following table sets forth information concerning the Company's allowance for loan losses at the dates and for the years indicated.
(Dollars in thousands) 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------------------ Period end loans outstanding $1,119,878 $841,003 $645,877 $463,292 $410,994 Average loans outstanding: 907,877 $737,852 $531,354 $424,186 $328,741 Allowance for loan losses: Balance at beginning of period 18,032 $ 11,629 $ 8,199 $ 8,465 $ 7,077 Charge-offs: Commercial (1,295) (1,550) (693) (1,187) (800) Real estate construction and land (7) (243) (127) (410) (388) Real estate term - (54) (84) - - Consumer and other (194) (227) (192) (483) (169) ------------------------------------------------------------------------ Total charge-offs (1,496) (2,074) (1,096) (2,080) (1,357) ------------------------------------------------------------------------ Recoveries: Commercial 391 90 371 223 394 Real estate construction and land - - 283 3 1 Real estate term - 1 24 - 48 Consumer and other 34 9 19 159 17 ------------------------------------------------------------------------ Total recoveries 425 100 697 385 460 ------------------------------------------------------------------------ Net charge-offs (1,071) (1,974) (399) (1,695) (897) Provision charged to income (1) 6,418 8,377 3,829 1,429 2,285 ------------------------------------------------------------------------ Balance at end of period $ 23,379 $ 18,032 $ 11,629 $ 8,199 $ 8,465 ------------------------------------------------------------------------ Net recoveries (charge-offs) to average loans outstanding during the period -0.12% -0.27% -0.08% -0.40% -0.27% Allowance as a percentage of average loans outstanding 2.58% 2.44% 2.19% 1.93% 2.57% Allowance as a percentage of period end loans outstanding 2.09% 2.14% 1.80% 1.77% 2.06% Allowance as a percentage of non-performing loans 1,003.39% 395.09% 124.43% 106.65% 82.26%
(1) Includes $183,000, $1.4 million and $800,000 in 1998, 1997 and 1996, respectively, to conform to the Companys' practices for reserve methodologies. These amounts are included in mergers and related nonrecurring costs. Management considers changes in the size and character of the loan portfolio, changes in nonperforming and past due loans, historical loan loss experience, and the existing and prospective economic conditions when determining the adequacy of the allowance for loan losses. Although management believes that the allowance for loan losses is adequate to provide for both potential losses and estimated inherent losses in the portfolio, future provisions will be subject to continuing evaluations of the inherent risk in the portfolio and if the economy declines or asset quality deteriorates, additional provisions could be required. 12 The table as follows provides a summary of the allocation of the allowance for loan losses for specific loan categories at the dates indicated. The allocation presented should not be interpreted as an indication that charges to the allowance for loan losses will be incurred in these amounts or proportions, or that the portion of the allowance allocated to each loan category represents the total amounts available for future losses that may occur within these categories. The unallocated portion of the allowance for loan losses and the total allowance is applicable to the entire loan portfolio.
--------------------------------------------------------------------------------------------- 1998 1997 1996 1995 --------------------------------------------------------------------------------------------- % of Category % of Category % of Category % of Category to Gross to Gross to Gross to Gross (Dollars in thousands) Amount Loans Amount Loans Amount Loans Amount Loans - ------------------------------------------------------------------------------------------------------------------------------------ Commercial $ 9,221 43.19% $ 6,145 45.59% $ 4,503 49.83% $ 3,163 51.59% Real estate construction and land 2,104 19.22 1,329 16.40 1,887 16.55 1,201 12.26 Real estate term 2,129 29.69 1,724 27.47 1,269 24.30 1,275 26.46 Consumer and other 1,629 7.90 915 10.54 1,226 9.32 918 9.69 --------------------------------------------------------------------------------------------- Total allocated 15,083 10,113 8,885 6,557 Unallocated 8,296 7,919 2,744 1,642 --------------------------------------------------------------------------------------------- Total $23,379 100.00% $18,032 100.00% $11,629 100.00% $ 8,199 100.00% ============================================================================================= -------------------------------- 1994 -------------------------------- % of Category to Gross (Dollars in thousands) Amount loans - ------------------------------------------------------------------------ Commercial $ 4,331 52.15% Real estate construction and land 1,280 10.53 Real estate term 1,074 27.08 Consumer and other 778 10.24 -------------------------------- Total allocated 7,463 Unallocated 1,002 -------------------------------- Total $ 8,465 100.00% ================================
At December 31, 1998, the allowance for credit losses was $23.4 million, consisting of a $15.1 million allocated allowance and a $8.3 million unallocated allowance. The unallocated allowance is composed of two elements. The first element consists of an amount up to 20% of the allocated allowance which recognizes the model and estimation risk associated with the allocated allowances. The second element is based upon management's evaluation of various conditions, the effects of which are not directly measured in determining the allocated allowance. The evaluation of the inherent loss regarding these conditions involves a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated allowance include the following conditions that existed December 31, 1998: . Specific industry conditions within portfolio segments, particularly involving the high technology sector and the impact of foreign economic forces upon that sector; . Seasoning of the loan portfolio and growth in loan volumes; . The strength and duration of the current business cycle and existing general economic and business conditions affecting our key lending areas; . Credit quality trends, including trends in nonperforming loans expected to result from changes in existing conditions; and . The results of bank regulatory examinations and the findings of our internal credit examiners. The Officers' Loan Committee reviews these conditions quarterly in discussion with our senior relationship managers. If any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's estimate of the effect of this condition may be reflected as an allocated allowance applicable to this credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's evaluation of the probable loss concerning this condition is reflected in the unallocated allowance. The allowance for credit losses is based upon estimates of probable losses inherent in the loan portfolio. The amount actually observed for these losses can vary significantly from the estimated amounts. Our methodology includes several features that are intended to reduce the differences between estimated and actual losses. The historical loss analysis, which reviews the losses over 1, 3 and 5 year periods, and evaluations of the current business cycle and economic conditions are used to establish the loan loss factors for problem graded loans which are designed to be self-correcting by taking into account our recent loss experience. Similarly, by basing the pass graded loan loss factors on historical loss experience, the methodology is designed to take our recent loss experience into account. Loan loss factors are adjusted quarterly based upon the level of net chargeoffs expected by management in the next twelve months. Furthermore, our methodology permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management's judgment, significant factors that affect the collectibility of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the probable estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available. The Company recorded provisions in 1998 to bring the allowance for credit losses to a level deemed appropriate by management based upon management's application of the loan loss allowance methodology discussed above. In particular, in the 13 assessment as of December 31, 1998, management focused on factors affecting elements of the high technology sector and the impact of foreign economic forces upon that sector, including seasoning of the loan portfolio coupled with growth in loan volumes and the strength and duration of the current business cycle coupled with existing general economic and business conditions affecting our key lending areas. Investment Securities The Company's investment portfolio is managed to meet the Company's liquidity needs through proceeds from scheduled maturities and is utilized for pledging requirements for deposits of state and political subdivisions and securities sold under repurchase agreements. The portfolio is comprised of U.S. Treasury securities, U.S. government agency securities, mortgage-backed securities, obligations of states and political subdivisions and a modest amount of equity securities, including Federal Reserve Bank stock and Federal Home Loan Bank stock. The Company does not include federal funds sold and certain other short- term securities as investment securities. These other investments are included in cash and cash equivalents. Investment securities classified as available for sale are recorded at fair market value, while investment securities classified as held to maturity are recorded at cost. Unrealized gains or losses, net of the deferred tax effect, are reported as increases or decreases in shareholders' equity for available for sale securities. The amortized cost and estimated market value of investment securities at December 31, 1998 and 1997 is as follows:
Gross Gross As of December 31, 1998 Amortized Unrealized Unrealized Market (Dollars in thousands) Cost Gains Losses Value - -------------------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE SECURITIES: U.S. Treasury obligations $ 4,408 $ 26 $ - $ 4,434 U.S. agency notes 29,125 23 (2) 29,146 Mortgage-backed securities 154,260 990 (67) 155,183 Tax-exempt securities 32,952 563 - 33,515 Corporate securities 35,517 60 (597) 34,980 ------------------------------------------------------------------------ Total securities available for sale 256,262 1,662 (666) 257,258 ------------------------------------------------------------------------ HELD TO MATURITY SECURITIES: U.S. Treasury obligations 1,764 2 (2) 1,764 U.S. agency notes 28,495 22 (58) 28,459 Mortgage-backed securities 36,191 174 (202) 36,163 Tax-exempt securities 27,759 760 (15) 28,504 ------------------------------------------------------------------------ Total securities held to maturity 94,209 958 (277) 94,890 ------------------------------------------------------------------------ - - - - Other securities 6,044 - - 6,044 ------------------------------------------------------------------------ Total investment securities 356,515 2,620 (943) 358,192 ------------------------------------------------------------------------ As of December 31, 1997 Amortized Unrealized Unrealized Market (Dollars in thousands) Cost Gains Losses Value - -------------------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE SECURITIES: U.S. Treasury obligations $ 10,095 $ 52 $ (2) $ 10,145 U.S. agency notes 39,346 52 (63) 39,335 Mortgage-backed securities 103,027 357 (187) 103,197 Tax-exempt securities 7,018 199 (5) 7,212 Corporate securities 7,568 62 - 7,630 ------------------------------------------------------------------------ Total securities available for sale 167,054 722 (257) 167,519 ------------------------------------------------------------------------ HELD TO MATURITY SECURITIES: U.S. Treasury obligations 501 1 - 502 U.S. agency notes 22,307 205 (12) 22,500 Mortgage-backed securities 19,970 344 (11) 20,303 Tax-exempt securities 15,845 512 (53) 16,304 ------------------------------------------------------------------------ Total securities held to maturity 58,623 1,062 (76) 59,609 ------------------------------------------------------------------------ Other securities 2,573 - - 2,573 ------------------------------------------------------------------------ Total investment securities 228,250 1,784 (333) 229,701 ------------------------------------------------------------------------
14 The tax effected net unrealized gain on available for sale securities was $579,000 as of December 31, 1998. The following table shows the amortized cost and estimated market value of the Company's investment securities by maturity at December 31, 1998. 2000 2004 Through Through 2009 and (Dollars in thousands) (1) 1999 2003 2008 Thereafter Total - ---------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE SECURITIES: U.S. Treasury obligations $ 4,308 $ 100 $ - $ - $ 4,408 U.S. agency notes (2) 16,333 - 12,792 - 29,125 Mortgage-backed securities (3) - 4,306 8,941 141,013 154,260 Tax-exempt securities - 1,601 4,561 26,790 32,952 Corporate securities 4,016 991 - 30,510 35,517 -------------------------------------------------------------- Total securities available for sale 24,657 6,998 26,294 198,313 256,262 -------------------------------------------------------------- Market value $24,704 $ 7,076 $26,601 $198,877 $257,258 -------------------------------------------------------------- HELD TO MATURITY SECURITIES: U.S. Treasury obligations 1,764 - - - 1,764 U.S. agency notes (2) 3,005 23,990 1,500 - 28,495 Mortgage-backed securities (3) 1,265 6,053 8,508 20,365 36,191 Tax-exempt securities 1,462 3,598 5,252 17,447 27,759 -------------------------------------------------------------- Total securities held to maturity 7,496 33,641 15,260 37,812 94,209 -------------------------------------------------------------- Market value 7,541 33,714 8,447 45,188 94,890 -------------------------------------------------------------- COMBINED INVESTMENT SECURITIES PORTFOLIO: Total investment securities $32,153 $40,639 $41,554 $236,125 $350,471 -------------------------------------------------------------- Total market value $32,245 $40,790 $35,048 $244,065 $352,148 -------------------------------------------------------------- Weighted average yield-total portfolio 5.73% 5.74% 5.25% 6.84% 6.23% --------------------------------------------------------------
(1) Other securities are comprised of equity investments and have no stated maturity and therefore are excluded from this table. (2) Certain notes issued by U.S. Agencies may be called, without penalty, at the discretion of the issuer. This may cause the actual maturities to differ significantly from the contractual maturity dates. (3) Mortgage-backed securities are shown at contractual maturity; however, the average life of these mortgage-backed securities may differ due to principal prepayments. For additional information concerning the investments portfolio, see Note 3 of Notes to Consolidated Financial Statements. 15 Deposits The Company emphasizes developing total client relationships with its customers in order to increase its core deposit base. Deposits reached $1.5 billion at December 31, 1998, an increase of 25.5% compared to deposits of $1.2 billion at December 31, 1997. In 1997, deposits increased 28.9% from $914.1 million at December 31, 1996. The increase in deposits was primarily due to the continued marketing efforts directed at commercial business clients in the Company's market areas, coupled with an increase in deposits related to business development activities of the Greater Bay Trust Company and the Venture Banking Group. PBC holds $89.6 million in one demand deposit account (the "Special Deposit"). The Special Deposit represents the proposed settlement of a class action lawsuit not involving the Company. Due to the uncertainty of the time the Special Deposit will remain with PBC, management has invested a significant portion of the proceeds from this deposit in agency securities with maturities of less than 90 days. As previously discussed, the interest rate spread on the Special Deposit was approximately 2.25%, which resulted in a decrease in overall interest rate spreads. Noninterest-bearing demand deposit accounts increased 21.9% to $302.0 million at December 31, 1998, compared to $247.7 million a year earlier. Money market deposit accounts ("MMDA"), negotiable order of withdrawal accounts ("NOW") and savings accounts reached $922.6 million at year-end 1998, an increase of 36.6% from $675.6 million at December 31, 1997. MMDA, NOW and savings accounts were 62.4% of total deposits at December 31, 1998, as compared to 57.3% at December 31, 1997. Time certificates of deposit totaled $254.4 million, or 17.2% of total deposits, at December 31, 1998, compared to $255.2 million, or 21.7% of total deposits, at December 31, 1997. Note 7 of the Notes to the Consolidated Financial Statements presents the maturity distribution of time certificates of deposits at December 31, 1998. As of December 31, 1997, the Company had $10.0 million in brokered deposits outstanding. There were no such deposits as of December 31, 1998. For additional information concerning deposits, see Note 7 of Notes to Consolidated Financial Statements. Other Borrowings Other borrowings consisted of Federal Funds purchased and securities sold under agreements to repurchase, Federal Home Loan advances, and promissory notes. Note 9 of the Notes to the Consolidated Financial Statements provides the amounts outstanding, the short and long term classification, the weighted interest rate and the general terms of these borrowings. Liquidity and Cash Flow The objective of liquidity management is to maintain each Bank's ability to meet the day-to-day cash flow requirements of its clients who either wish to withdraw funds or require funds to meet their credit needs. The Company must manage its liquidity position to allow the Banks to meet the needs of their clients while maintaining an appropriate balance between assets and liabilities to meet the return on investment expectations of its shareholders. The Company monitors the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. In addition to liquidity from core deposits and repayments and maturities of loans and investments, the Banks utilize brokered deposit lines, sell securities under agreements to repurchase and borrow overnight federal funds. In 1997 the Company issued $20.0 million in Trust Preferred Securities ("TPS") to enhance its regulatory capital base, while also providing added liquidity. In 1998, the Company completed a second offering of TPS in an aggregate amount of $30.0 million. Greater Bay invested $15.0 million of the net proceeds in the Company's subsidiary banks to increase their capital level. The Company intends to use the remaining net proceeds for general corporate purposes or to provide additional capital to the Banks, as it is needed. Under applicable regulatory guidelines, $35.7 million of the TPS qualifies as Tier I capital, and the remaining portion qualifies as Tier 2 capital. As the Company's shareholders' equity increases, the amount of the additional TPS that will count as Tier I capital will increase. 16 Greater Bay is a company separate and apart from the Banks. It must provide for its own liquidity. Substantially all of Greater Bay's revenues are obtained from management fees, interest received on its investments and dividends declared and paid by the Banks. There are statutory and regulatory provisions that could limit the ability of the Banks to pay dividends to Greater Bay. At December 31, 1998, the Banks had approximately $24.6 million in the aggregate available to be paid as dividends to Greater Bay. Management of Greater Bay believes that such restrictions will not have an impact on the ability of Greater Bay to meet its ongoing cash obligations. As of December 31, 1998, Greater Bay did not have any material commitments for capital expenditures. Net cash provided by operating activities, consisting primarily of net income, totaled $23.0 million for 1998, $17.5 million for 1997 and $12.2 million for 1996. Cash used for investing activities totaled $435.7 million in 1998, $272.5 million in 1997 and $180.3 million in 1996. The funds used for investing activities primarily represent increases in loans and investment securities for each year reported. For the year ended December 31, 1998, net cash provided by financing activities was $372.0 million, compared to $296.1 million in 1997 and $260.1 million in 1996. Historically, the primary financing activity of the Company has been through deposits. In 1998, 1997 and 1996, deposit gathering activities generated cash of $300.4 million, $264.5 million and $245.5 million, respectively. This represents a total of 80.7%, 89.3% and 94.4% of the financing cash flows for 1998, 1997 and 1996, respectively. The increase in financing activities other than deposits are a result of the Company entering into $70.0 million in long-term low cost borrowing agreements in 1998, and the issuance of TPS of $30.0 million and $20.0 million in 1998 and 1997, respectively, which were issued principally to provide capital to the Company (see Capital Resources--below). Capital Resources Shareholders' equity at December 31, 1998 increased to $107.0 million from $88.5 million at December 31, 1997 and from $76.1 million at December 31, 1996. Greater Bay paid dividends of $0.40, $0.43 and $0.25 per share in December 31, 1998, 1997 and 1996, respectively. In 1998, PBFC made a distribution of $1.2 million to its shareholders. In 1997, PBC declared an annual dividend of $3.20 per share, PRB declared and paid a dividend of $100,000 to its sole shareholder and PBFC made a distribution of $208,000 to its shareholders. In 1996, Cupertino National Bancorp declared and paid a dividend of $0.10 per share, PBC declared an annual dividend of $1.35 per share and PBFC made a distribution of $227,000 to its shareholders. The Company has provided a substantial portion of its capital requirements through the retention of earnings. The Company supplemented its capital base by issuing $30.0 million of TPS in 1998 and $20.0 million of TPS in 1997, which, subject to certain limitations, qualify as Tier 1 capital. A banking organization's total qualifying capital includes two components, core capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core capital, which must comprise at least half of total capital, includes common shareholders' equity, qualifying perpetual preferred stock, trust preferred securities and minority interests, less goodwill. Supplementary capital includes the allowance for loan losses (subject to certain limitations), other perpetual preferred stock, trust preferred securities, certain other capital instruments and term subordinated debt. The Company's major capital components are shareholders' equity and TPS in core capital, and the allowance for loan losses and subordinated debt in supplementary capital. At December 31, 1998, the minimum risk-based capital requirements to be considered adequately capitalized were 4.0% for core capital and 8.0% for total capital. Federal banking regulators have also adopted leverage capital guidelines to supplement risk-based measures. The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (not risk-adjusted) for the preceding quarter. The minimum leverage ratio is 3.0%, although certain banking organizations are expected to exceed that amount by 1.0% or more, depending on their circumstances. 17 Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991, the Federal Reserve, the OCC and the FDIC have adopted regulations setting forth a five-tier system for measuring the capital adequacy of the financial institutions they supervise. The capital levels of the Company at December 31, 1998 and the two highest levels recognized under these regulations are as follows. Tier 1 Total Leverage Risk-Based Risk-Based Ratio Capital Ratio Capital Ratio - ----------------------------------------------------------------------------- Company 8.01% 10.12% 13.01% Well-capitalized 5.00% 6.00% 10.00% Adequately capitalized 4.00% 4.00% 8.00% The Company's leverage ratio was 8.01% at December 31, 1998, compared to 8.6% at December 31, 1997. At December 31, 1998, the Company's risk-based capital ratios were 10.12% for Tier 1 risk-based capital and 13.01% for total risk-based capital, compared to 10.93% and 12.48%, respectively, as of December 31, 1997. These ratios all exceeded the well-capitalized guidelines shown above. In addition, at December 31, 1997, each of the Banks had levels of capital that exceeded the well-capitalized guidelines. For additional information on the capital levels and capital ratios of the Company and each of the Banks, see Note 17 of Notes to Consolidated Financial Statements. The Company anticipates that the economic and business conditions in its market areas will continue to expand in 1999, resulting in continued growth in earnings and deposits. To support this continuing growth or future acquisition opportunities, it may be necessary for the Company to raise additional capital through the sale of either debt or equity securities in order for the Company and each of the Banks to remain well-capitalized under applicable regulations. Quantitative and Qualitative Disclosures about Market Risk The Company's financial performance is impacted by, among other factors, interest rate risk and credit risk. The Company utilizes no derivatives to mitigate its credit risk, relying instead on loan review and an adequate loan loss reserve see "--Allowance for Loan Losses" herein. Interest rate risk is the risk of loss in value due to changes in interest rates. This risk is addressed by the Company's Asset Liability Management Committee ("ALCO"), which includes senior management representatives. The ALCO monitors and considers methods of managing interest rate risk by monitoring changes in net portfolio values ("NPV") and net interest income under various interest rate scenarios. The ALCO attempts to manage the various components of the Company's balance sheet to minimize the impact of sudden and sustained changes in interest rates on NPV and net interest income. The Company's exposure to interest rate risk is reviewed on at least a quarterly basis by the Board of Directors and the ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the Company's change in NPV in the event of hypothetical changes in interest rates and interest liabilities. If potential changes to NPV and net interest income resulting from hypothetical interest rate swings are not within the limits established by the Board, the Board may direct management to adjust its asset and liability mix to bring interest rate risk within Board-approved limits. In order to reduce the exposure to interest rate fluctuations, the Company has developed strategies to manage its liquidity, lengthen the effective maturities of certain interest-earning assets, and shorten the effective maturities of certain interest-bearing liabilities. The Company has focused its investment activities on securities with generally medium-term (7 years to 10 years) maturities or average lives. The Company has utilized short-term borrowings and deposit marketing programs to adjust the term to repricing of its liabilities. Interest rate sensitivity analysis is used to measure the Company's interest rate risk by computing estimated changes in NPV of its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. NPV represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for core deposit valuations and off-balance sheet items. This analysis assesses the risk of loss in 18 market rate sensitive instruments in the event of sudden and sustained increases and decreases in market interest rates of 100 basis points. The following table presents the Company's projected change in NPV for these rate shock levels as of December 31, 1998. All market rate sensitive instruments presented in this table are classified as either held to maturity or available for sale. The Company has no trading securities. Projected Change Change in -------------------------- Interest Rates NPV Dollars Percentage - ------------------------------------------------------------------ 100 basis point rise $116,954 4,856 4.2% Base scenario $114,884 - 0.0% 100 basis point decline $117,639 (5,198) -4.4% The preceding table indicates that at December 31, 1998, in the event of a sudden and sustained increase in prevailing market interest rates, the Company's NPV would be expected to increase. NPV is calculated based on the net present value of estimated cash flows utilizing market prepayment assumptions and market rates of interest provided by independent broker quotations and other public sources. Computation of forecasted effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposits decay, and should be not relied upon as indicative of actual future results. Further, the computations do not contemplate any actions the ALCO could undertake in response to changes in interest rates. Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. Actual values may differ from those projections presented should market conditions vary from assumptions used in the calculation of the NPV. Certain assets, such as adjustable-rate loans, which represent one of the Company's loan products, have features which restrict changes in interest rate on a short-term basis and over the life of the assets. In addition, the proportion of adjustable-rate loans in the Company's portfolio could decrease in future periods if market interest rates remain at or decrease below current levels due to refinancing activity. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the NPV. Finally, the ability of many borrowers to repay their adjustable-rate mortgage loans may decrease in the event of significant interest rate increases. Interest Rate Risk Management Interest rate risk management is a function of the repricing characteristics of the Company's portfolio of assets and liabilities. Interest rate risk management focuses on the maturity structure of assets and liabilities and their repricing characteristics during periods of changes in market interest rates. Effective interest rate risk management seeks to ensure that both assets and liabilities respond to changes in interest rates within an acceptable time frame, thereby minimizing the effect of interest rate movements on net interest income. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in the Company's current portfolio that are subject to repricing at various time horizons: one day or immediate, two days to six months, seven to twelve months, one to three years, four to five years, over five years and on a cumulative basis. The differences are known as interest sensitivity gaps. 19 The following table shows interest sensitivity gaps for different intervals as of December 31, 1998.
Immediate 2 Days To 7 Months to 1 Year to 4 Years More than Total Rate Non-Rate (Dollars in thousands) or One Day 6 Months 12 Months 3 Years to 5 Years 5 Years Sensitive Sensitive Total - ----------------------------------------------------------------------------------------------------------------------------------- Assets Cash and due from banks $ 386 $ - $ - $ - $ - $ - $ 386 $ 69,197 $ 69,583 Fed funds sold 62,800 - - - - - 62,800 - 62,800 Investment securities 111,994 27,916 46,099 97,375 17,810 128,239 429,433 - 429,433 Other securities - - - - - - - 5,654 5,654 Loans 653,122 277,431 36,774 65,716 22,737 63,545 1,119,325 553 1,119,878 Loan losses/unearned fees - - - - - - - (27,275) (27,275) Other assets - - - - - - - 78,116 78,116 --------------------------------------------------------------------------------------------------------- Total assets $828,302 $305,347 $82,873 $163,091 $ 40,547 $191,784 $1,611,944 $ 126,245 $1,738,189 --------------------------------------------------------------------------------------------------------- Liabilities and Equity Deposits $926,134 $220,932 $34,495 $ 19,818 $ 668 $ 32 $1,202,079 $ 276,868 $1,478,947 Other borrowings - - 40,635 34,450 - - 75,085 - 75,085 Subordinated debt - - - - 3,000 - 3,000 - 3,000 Trust preferred securities - - - - - 50,000 50,000 - 50,000 Other liabilities - - - - - - - 24,116 24,116 Shareholders' equity - - - - - - - 107,041 107,041 --------------------------------------------------------------------------------------------------------- Total liabilities and equity $926,134 $220,932 $75,130 $ 54,268 $ 3,668 $ 50,032 $1,330,164 $ 408,025 $1,738,189 --------------------------------------------------------------------------------------------------------- Gap $(97,832) $ 84,415 $ 7,743 $108,823 $ 36,879 $141,752 $ 281,780 $(281,780) - Cumulative Gap $(97,832) $(13,417) $(5,674) $103,149 $140,028 $281,780 $ 281,780 $ - - Cumulative Gap/total assets -5.63% -0.77% -0.33% 5.93% 8.06% 16.21% 17.80% - -
The foregoing table indicates that the Company had a one year gap of $(5.7) million, or (0.33)% of total assets, at December 31, 1998. In theory, this would indicate that at December 31, 1998, $5.7 million more in liabilities than assets would reprice if there was a change in interest rates over the next 365 days. Thus, if interest rates were to increase, the gap would tend to result in a higher net interest margin. However, changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing of both the asset and its supporting liability can remain the same, thus impacting net interest income. This characteristic is referred to as a basis risk and, generally, relates to the repricing characteristics of short-term funding sources such as certificates of deposit. The impact of fluctuations in interest rates on the Company's projected next twelve month net interest income and net income has been evaluated through an interest rate shock simulation modeling analysis that includes various assumptions regarding the repricing relationship of assets and liabilities, as well as the anticipated changes in loan and deposit volumes over differing rate environments. As of December 31, 1998, the analysis indicates that the Company's net interest income would increase a maximum of 10.2% if rates rose 200 basis points immediately and would decrease a maximum of 11.2% if rates declined 200 basis points immediately. In addition, the results indicate that notwithstanding the Company's gap position, which would indicate that the net interest margin increases when rates rise, the Company's net interest margin increases during rising rate periods due to the basis risk imbedded in the Company's interest- bearing liabilities. In addition, while this analysis indicates the probable impact of interest rate movements on the Company's net interest income, it does not take into consideration other factors that would impact this analysis. These factors would include management's and ALCO's actions to mitigate the impact to the Company and the impact of the Company's credit risk profile during periods of significant interest rate movements. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities which are not reflected in the interest sensitivity analysis table. These prepayments may have significant effects on the Company's net interest margin. Because of these factors and others, an interest sensitivity gap report may not provide a complete assessment of the Company's exposure to changes in interest rates. Year 2000 Compliance State of Readiness The Company has undertaken a major project to ensure that its internal operating systems will be fully capable of processing year 2000 transactions. This project is overseen by the Greater Bay Year 2000 Project Team (the "Year 2000 Project Team"), which reports monthly progress to the Company's Board of Directors. The Company is determining the potential impact of the year 2000 on the ability of the Company's computerized information systems to accurately process information that may be date-sensitive. Any of the Company's programs that recognize 20 a date using "00" as the year 1900 rather than the year 2000 could result in errors or system failures. The Company utilizes a number of computer programs across its entire operation. The initial phase of the project was to assess and identify all internal business processes requiring modification and to develop comprehensive renovation plans as needed. This phase was largely completed in mid-1998. The second phase was to execute those renovation plans and begin testing systems by simulating year 2000 data conditions. This phase was largely completed in 1998. Final testing and implementation is planned to be completed during the first half of 1999. The Company relies upon third-party software vendors and service providers for substantially all of its electronic data processing and does not operate any proprietary programs which are critical to the Company's operations. Thus, the focus of the Company is to monitor the progress of its primary software providers towards compliance with year 2000 issues and prepare to test actual data of the company in simulated processing of future sensitive dates. As well as evaluating its own internal operating systems, the Company has also initiated discussions with its major customers and suppliers as to their ability to meet year 2000 requirements. The Year 2000 Project Team previously has identified and sought information from significant third party suppliers regarding their year 2000 compliance. Suppliers providing system interdependencies also have been identified, and testing with such suppliers also will occur during this phase of the project. The Year 2000 Project Team continues to work with all targeted suppliers to determine their year 2000 status. As of this time, the Year 2000 Project Team has not identified any significant issues with the identified suppliers. The Company also has identified customers who have a material relationship with the Company and requested such customers to complete a year 2000 survey, which will be used by the Company to assess the overall risk to the Company resulting from such customers' year 2000 compliance. Costs to Address the Year 2000 Issue The Company has budgeted anticipated expenditures of $300,000 to $500,000 in 1998 and 1999 to ensure that its systems are ready for processing information in the year 2000. The Company estimates that it has incurred out-of-pocket expenses of approximately $146,000 in 1998 in connection with year 2000 issues. In addition, the Company has incurred certain costs relating to reallocation of internal resources to address year 2000 issues. The Company expects that the cost of remedial action for its noncompliant year 2000 IT systems will not be material. The Company has not completed its assessment of the year 2000 issue, but currently believes that costs of addressing it will not have a material adverse impact on the Company's financial position. However, if the Company and third parties upon which it relies are unable to address this issue in a timely manner, it could result in a material financial risk to the Company. In order to assure that this does not occur, the Company plans to devote all resources required to resolve any significant year 2000 issues in a timely manner. Risks Presented by the Year 2000 Issue As the Company continues to assess the year 2000 issue, it may identify systems that present a year 2000 risk. In addition, if any third-party software vendors and service providers upon who the Company relies fail to appropriately address their year 2000 issues, such failure could have a material adverse effect on the Company's business, financial condition and operating results. Should the Company and/or its significant suppliers fail to timely identify, address and correct material year 2000 issues, such failure could have a material adverse impact on the Company's ability to operate. The range of adverse impacts may include the requirement to pay significant overtime to manually process certain transactions and added costs to process certain banking activity through a centralized administrative function. In addition, if corrections made by such suppliers to address year 2000 issues are incompatible with the Company's systems, the year 2000 issue could have a material adverse impact on the Company's operations. Despite the Company's activities in regards to the year 2000 issue, there can be no assurance that partial or total systems interruptions or the costs necessary to update hardware and software would not have a material adverse effect upon the Company's business, financial condition, results of operations and business prospects. Contingency Plans The Year 2000 Project Team currently is in the process of developing contingency plans for year 2000 readiness. The Company has engaged a third party company, which specializes in developing contingency plans for financial institutions for 21 year 2000, to assist the Company in analyzing the impact of year 2000 on its business. This business impact analysis was completed in 1998 and the Company's contingency plans for year 2000 readiness currently are substantially complete. There can be no assurance, however, that such contingency plans will be successful. Recent Events On May 24, 1999 the Company completed a merger with Bay Area Bancshares ("BA Bancshares"), the holding company of Bay Area Bank, a California state charted bank ("BAB"). Per the agreement provides for BA Bancshares shareholders received approximately 1,399,000 shares of Greater Bay stock, in a tax-free exchange accounted for as a pooling-of-interests. Following the transaction, the shareholders of BA Bancshares will own approximately 12.7% of the combined company. As of December 31, 1998 BA Bancshares had $155.3 million in assets, $136.4 million in deposits, and $14.4 million in shareholders' equity. BAB's office is located in Redwood City, California. The combined Company, on a pro- forma basis had total assets of approximately $1.7 billion and equity of over $107.0 million at December 31, 1998. The transaction is anticipated to be accretive to the Company's core earnings in 1999 based on anticipated reductions in operating expenses and revenue enhancements resulting from an expanded product line, increased lending capacity and an increased market awareness that can be utilized by BAB. Management of each of the organizations believe that significant opportunities exist to enhance the spectrum of financial services offered to both existing and future clients of BAB while also increasing market penetration in the San Francisco Peninsula market areas. Recent Accounting Developments In July 1998, the Financial Accounting Standards Board reconfirmed its decision to review the accounting for business combinations. That approach includes considering either adopting one method to account for business combinations or reducing the difference in accounting outcomes between the pooling and purchase methods rather than just modifying the conditions specific for pooling-of-interests accounting. The Board issued an Invitation to Comment on a position paper entitled, Methods of Accounting for Business Combinations: Recommendation of the G4+1 for Achieving Convergence, on December 15, 1998, in order to solicit comments on certain issues that will be addressed by the Board as part of its business combinations project. This position paper concludes that the use of a single method of accounting is preferable and that the purchase method is the appropriate method to use. As such there is a possibility that the pooling of interests method of accounting that the Company has used to account for its previous mergers may not be available at some point in the future. A portion of the Company's business strategy is to pursue acquisition opportunities so as to expand its market presence and maintain growth levels. A change in the accounting for business combinations could have a negative impact on the Company's ability to realize those business strategies. 22 GREATER BAY BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
As of December 31, ----------------------------------- (Dollars in thousands) 1998* 1997* - ------------------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $ 69,583 $ 64,631 Federal funds sold 62,800 82,500 Other short term securities 77,576 103,549 ----------------------------------- Cash and cash equivalents 209,959 250,680 Investment securities: Available for sale, at fair value 257,258 167,519 Held to maturity, at amortized cost (fair value 1998: $94,890 1997: $59,609) 94,209 58,623 Other securities 6,044 2,573 ----------------------------------- Investment securities 357,511 228,715 Total loans: Commercial 483,668 383,426 Real estate construction and land 215,274 137,889 Real estate term 332,478 230,986 Consumer and other 88,458 88,702 Deferred loan fees and discounts (3,896) (3,364) ----------------------------------- Total loans, net of deferred fees 1,115,982 837,639 Allowance for loan losses (23,379) (18,032) ----------------------------------- Total loans, net 1,092,603 819,607 Property, premises and equipment 11,380 9,151 Interest receivable and other assets 66,736 31,597 ----------------------------------- Total assets $1,738,189 $1,339,750 =================================== LIABILITIES AND SHAREHOLDERS' EQUITY Total deposits $1,478,947 $1,178,574 Other borrowings 75,085 33,355 Subordinated debt 3,000 3,000 Company obligated mandatorily redeemable cumulative trust preferred securities of subsidiary trusts holding solely junior subordinated debentures 50,000 20,000 Other liabilities 24,116 16,293 ----------------------------------- Total liabilities 1,631,148 1,251,222 ----------------------------------- Commitments and contingencies SHAREHOLDERS' EQUITY Preferred stock, no par value: 4,000,000 shares authorized; none issued - - Common stock, no par value: 24,000,000 shares authorized; 11,004,529 and 10,659,726 shares issued and outstanding as of December 31, 1998 and 1997, respectively** 62,179 57,005 Accumulated other comprehensive income (loss) (98) 221 Retained earnings 44,960 31,302 ----------------------------------- Total shareholders' equity 107,041 88,528 ----------------------------------- Total liabilities and shareholders' equity $1,738,189 $1,339,750 ===================================
*Restated on a historical basis to reflect the mergers with Pacific Rim Bancorporation, Pacific Business Funding Corporation, and Bay Area Bankshares on a pooling of interests basis. **Restated to reflect 2-for-1 stock split declared for shareholders of record at April 30, 1998. See notes to consolidated financial statements. 23 GREATER BAY BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, -------------------------------------------- (Dollars in thousands, except per share amounts) 1998* 1997* 1996* - ---------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Interest on loans $ 93,915 $78,278 $57,379 Interest on investment securities: Taxable 17,911 9,170 8,171 Tax - exempt 2,164 1,153 1,051 -------------------------------------------- Total interest on investment securities 20,075 10,323 9,222 Other interest income 10,808 9,660 4,683 -------------------------------------------- Total interest income 124,798 98,261 71,284 -------------------------------------------- INTEREST EXPENSE Interest on deposits 43,004 33,565 23,744 Interest on long term borrowings 6,752 2,165 370 Interest on other borrowings 1,424 1,282 804 -------------------------------------------- Total interest expense 51,180 37,012 24,918 -------------------------------------------- Net interest income 73,618 61,249 46,366 Provision for loan losses 6,235 7,026 3,029 -------------------------------------------- Net interest income after provision for loan losses 67,383 54,223 43,337 -------------------------------------------- OTHER INCOME Trust fees 2,473 2,049 1,426 ATM network revenue 1,946 2,026 1,839 Service charges and other fees 1,748 1,826 1,640 Gain on sale of SBA loans 1,037 883 537 Warrant income 945 1,162 92 Gain (loss) on sale of investments, net 374 (5) (255) Other income 1,197 1,117 2,165 -------------------------------------------- Total other income 9,720 9,058 7,444 -------------------------------------------- OPERATING EXPENSES Compensation and benefits 25,585 22,961 19,338 Occupancy and equipment 7,176 6,198 5,381 Merger and other related nonrecurring costs 2,661 3,333 2,791 Contribution to GBB Foundation 1,341 - - Recovery of legal settlement - (1,700) - ATM network expenses 526 558 628 Other expenses 11,809 10,775 9,945 -------------------------------------------- Total operating expenses 49,098 42,125 38,083 -------------------------------------------- Net income before provision for income taxes 28,005 21,156 12,698 Provision for income taxes 9,062 7,732 4,935 -------------------------------------------- Net income $ 18,943 $13,424 $ 7,763 ============================================ Net income per share - basic** $ 1.74 $ 1.29 $ 0.78 ============================================ Net income per share - diluted** $ 1.63 $ 1.19 $ 0.72 ============================================
*Restated on a historical basis to reflect the mergers with Peninsula Bank of Commerce, Pacific Rim Bancorporation, Pacific Business Funding Corporation, and Bay Area Bankshares on a pooling of interests basis. **Restated to reflect 2-for-1 stock split declared for shareholders of record at April 30, 1998. See notes to consolidated financial statements. 24 GREATER BAY BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, --------------------------------------------- (Dollars in thousands) 1998* 1997* 1996* - ----------------------------------------------------------------------------------------------------------------------------------- Net income $18,943 $13,424 $7,763 --------------------------------------------- Other comprehensive income (loss): Unrealized gains on securities: Unrealized holding gains arising during period (net of taxes of $420, $157 and $323 for the years ended December 31, 1998, 1997 and 1996, respectively) 578 313 447 Less: reclassification adjustment for gains (losses) included in net income (net of taxes of $154, $(2) and $(105) for the years ended December 31, 1998, 1997 and 1996, respectively) 220 (3) (150) --------------------------------------------- Net change 358 316 597 Cash flow hedge: Cummulative transition effect of adopting SFAS No. 133 (net of taxes of $(744) as of October 1, 1998 (1,063) - - Change in market value of hedge during the period (net of taxes of $294 for the year ended December 31, 1998) 418 - - Less: reclassification adjustment for swap settlements in net income (net of taxes of $(23) for the year ended December (32) - - 31, 1998) --------------------------------------------- Net change (677) - - Other comprehensive income (loss) (319) 316 597 --------------------------------------------- Comprehensive income $18,624 $13,740 $8,360 =============================================
*Restated on a historical basis to reflect the mergers with Peninsula Bank of Commerce, Pacific Rim Bancorporation, Pacific Business Funding Corporation, and Bay Area Bankshares on a pooling of interests basis. See notes to consolidated financial statements. 25 GREATER BAY BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Total Common Stock Preferred Stock Other Share- For the years ended December 31, 1998, 1997 and 1996 -------------------------------------- Comprehensive Retained holders' (Dollars in thousands, except per share amounts) Shares** Amount Shares** Amount Income(Loss) Earnings Equity - ----------------------------------------------------------------------------------------------------------------------------------- Greater Bay Bancorp, prior to pooling 7,364,692 $40,108 $(609) $12,885 $ 52,384 Shares issued to Pacific Rim Bancorporation shareholders 950,748 8,000 - - 8,000 Pacific Rim Bancorporation accumulated other comprehensive income and retained earnings prior to pooling - - (93) 338 245 Shares issued to Pacific Business Funding Corporation shareholders 298,000 51 - - 51 Pacific Business Funding Corporation retained earnings prior to pooling - - (185) (185) Shares issued to Bay Area Bancshares shareholders 1,139,553 4,053 1,387 10 - - 4,063 Bay Area Bancshares retained earnings prior to pooling 10 4,005 4,015 ----------------------------------------------------------------------- Balance, December 31, 1995, restated to reflect pooling 9,752,993 52,212 1,387 10 (692) 17,043 68,573 Net income - - - 7,764 7,764 Other comprehensive income, net of taxes - - 597 - 597 Stock options exercised, including related tax benefit 399,789 1,773 - - 1,773 Stock issued in Employee Stock Purchase Plan 21,264 137 - - 137 401(k) employee stock purchase 10,556 87 - - 87 Preferred stock converted to common 1,387 10 (1,387) (10) - Cash dividend $0.25 per share (1) - - - - - (2,814) (2,814) ----------------------------------------------------------------------- Balance, December 31, 1996* 10,185,989 54,219 - - (95) 21,993 76,117 Net income - - - 13,424 13,424 Other comprehensive income, net of taxes - - 316 - 316 Stock options exercised, including related tax benefit 407,265 2,548 - - 2,548 Stock issued in Employee Stock Purchase Plan 30,320 347 - - 347 401(k) employee stock purchase 36,152 531 - - 531 Cash dividend $0.41 per share (1) - - - (4,755) (4,755) ----------------------------------------------------------------------- Balance, December 31, 1997* 10,659,726 57,645 221 30,662 88,528 Net income - - - 18,943 18,943 Other comprehensive loss, net of taxes - - (319) - (319) Stock options exercised, including related tax benefit 278,650 3,718 - - 3,718 Stock issued in Employee Stock Purchase Plan 29,670 656 - - 656 401(k) employee stock purchase 36,483 1,060 - - 1,060 Cash dividend $0.47 per share (1) - - - (5,545) (5,545) ----------------------------------------------------------------------- Balance, December 31, 1998* 11,004,529 $63,079 $(98) $44,060 $107,041 =======================================================================
(1) Excluding dividends paid by Greater Bays subsidiaries prior to the completion of their mergers with Greater Bay, Greater Bay paid dividends of $0.40, $0.43 and $0.25 per share in December 31, 1998, 1997 and 1996, respectively. In 1998, Pacific Business Funding Corporation made a distribution of $1.2 million to its shareholdersand BA Bancshares declared and paid a dividend of $408,000. In 1997, Peninsula Bank of Commerce declared an annual dividend of $3.20 per share, Pacific Rim Bancorporation declared and paid a dividend of $100,000 to its sole shareholder and Pacific Business Funding Corporation made a distribution of $208,000 to its shareholders and BA Bancshares declared and paid a dividend of $334,000. In 1996, Cupertino National Bancorp declared and paid a dividend of $0.10, Peninsula Bank of Commerce declared an annual dividend of $1.35 per share and Pacific Business Funding Corporation made a distribution of $227,000 to its shareholders. * Restated on a historical basis to reflect the mergers with Cupertino National Bancorp, Peninsula Bank of Commerce, Pacific Rim Bancorporation, Pacific Business Funding Corporation and Bay Area Bancshares on a pooling of interests basis. ** Restated to reflect 2-for-1 stock split declared for shareholders of record at April 30, 1998. See notes to consolidated financial statements. 26
GREATER BAY BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, -------------------------------------------------- (Dollars in thousands) 1998* 1997* 1996* - ----------------------------------------------------------------------------------------------------------------------------- Cash flows - operating activities Net income $ 18,943 $ 13,424 $ 7,763 Reconcilement of net income to net cash from operations: Provision for loan losses 6,235 7,026 3,029 Depreciation and amortization 2,024 1,990 1,756 Deferred income taxes (2,020) (4,200) (1,382) (Gain) loss on sale of investments, net (374) 5 255 (Gain) loss on sale of other assrts - - (2) Proceeds from sale of loans held for sale - 735 49 Changes in: Accrued interest receivable and other assets (9,061) (8,675) (1,577) Accrued interest payable and other liabilities 6,674 6,903 1,930 Deferred loan fees and discounts, net 532 303 352 --------- --------- --------- Operating cash flows, net 22,953 17,511 12,173 --------- --------- --------- Cash flows - investing activities Maturities and partial paydowns on of investment securities: Held to maturity 61,591 28,993 28,626 Available for sale 441,778 48,645 33,490 Purchase of investment securities: Held to maturity (97,743) (15,343) (31,698) Available for sale (725,442) (150,740) (54,269) Other securities (3,401) - - Proceeds from sale of available for sale securities 195,863 14,598 31,430 Loans, net (280,095) (195,554) (185,461) Investment in other real estate owned - (500) 1,266 Purchase of property, premises and equipment (4,735) (2,596) (3,419) Purchase of insurance policies (23,480) - (240) --------- --------- --------- Investing cash flows, net (435,664) (272,497) (180,275) --------- --------- --------- Cash flows - financing activities Net change in deposits 300,372 264,473 245,514 Net change in other borrowings - short term (26,006) 10,830 14,150 Proceeds from other borrowings - long term 70,000 3,025 2,015 Principal repayment - long term borrowings (2,265) (865) (775) Proceeds from company obligated madatorily redeemable - - - preferred securities of subsidiary trusts holding solely junior - - - subordinated debentures 30,000 20,000 - Proceeds from sale of common stock 5,434 3,426 1,997 Cash dividends (5,545) (4,755) (2,813) --------- --------- --------- Financing cash flows, net 371,990 296,134 260,088 --------- --------- --------- Net change in cash and cash equivalents (40,721) 41,148 91,986 Cash and cash equivalents at beginning of period 250,680 209,532 117,546 --------- --------- --------- Cash and cash equivalents at end of period $ 209,959 $ 250,680 $ 209,532 ========= ========= ========= Cash flows - supplemental disclosures Cash paid during the period for: Interest $ 49,922 $ 36,630 $ 24,895 ========= ========= ========= Income taxes $ 11,855 $ 12,485 $ 6,469 ========= ========= ========= Non-cash transactions: Additions to other real estate owned $ 450 $ 1,723 $ 817 ========= ========= =========
*Restated on a historical basis to reflect the mergers with Peninsula Bank of Commerce, Pacific Rim Bancorporation, Pacific Business Funding Corporation, and Bay Area Bankshares on a pooling of interests basis. See notes to consolidated financial statements. 27 GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1998, 1997 and 1996 NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Nature of Operations Greater Bay Bancorp ("Greater Bay," on a parent-only basis, and the "Company" on a consolidated basis) is a California corporation and bank holding company that was incorporated on November 14, 1984 as San Mateo County Bancorp. The name was changed to Mid-Peninsula Bancorp on October 7, 1994 as a result of the merger between Mid-Peninsula Bank and San Mateo County Bancorp and its wholly owned subsidiary, WestCal National Bank. The name was further changed to Greater Bay Bancorp on November 27, 1996 as a result of the merger between Mid-Peninsula Bancorp and Cupertino National Bancorp (see Note 2). Upon consummation of the merger with Cupertino National Bancorp, Greater Bay became a multi-bank holding company for two wholly owned subsidiaries. On December 23, 1997 the Company merged with Peninsula Bank of Commerce, adding a third wholly owned banking subsidiary to the group. On May 8, 1998, the Company merged with Pacific Rim Bancorporation ("PRB"), the former holding company of Golden Gate Bank ("Golden Gate"), adding a fourth wholly owned banking subsidiary to the group. On May 21, 1999, the Company merged with Bay Area Bancshares ("BA Bancshares"), the former holding company of Bay Area Bank ("BAB"), adding a fifth wholly owned banking subsidiary of the group. The five wholly owned bank subsidiaries are Mid-Peninsula Bank ("MPB"), Cupertino National Bank ("CNB"), Peninsula Bank of Commerce ("PBC"), Golden Gate and BAB, collectively the "Banks." On August 31, 1998, the Company merged with Pacific Business Funding Corporation ("PBFC"). Subsequent to the completion of the merger the assets and liabilities of PBFC were assigned to CNB. PBFC has been reformed as an operating division of CNB and conducts business under the name Pacific Business Funding. MPB commenced operations in October 1987 and is a state chartered bank regulated by the Federal Reserve Bank ("FRB") and Department of Financial Institutions of the State of California ("DFI"). CNB commenced operations in May 1985 and is a national banking association regulated by the Office of the Comptroller of Currency ("OCC"). PBC commenced operations in September 1981 and is a state chartered bank regulated by the FRB and the DFI. Golden Gate commenced operations in 1976 and is a state chartered bank regulated by the FRB and the DFI. On March 3, 1997 GBB Capital I, a statutory business trust, was formed for the exclusive purpose of issuing and selling Cumulative Trust Preferred Securities ("TPS") (see Note 8) and using the proceeds from the sale of the TPS to acquire Junior Subordinated Debentures issued by Greater Bay. On May 18, 1998 GBB Capital II, a statutory business trust, was formed for the exclusive purpose of issuing and selling additional TPS and using the proceeds from the sale of the TPS to acquire Junior Subordinated Debentures issued by Greater Bay. The Company provides a wide range of commercial banking services to small and medium-sized businesses, real estate developers, property managers, business executives, professionals and other individuals. The Company operates throughout Silicon Valley, the San Francisco Peninsula and the Contra Costa Tri Valley Region, with offices located in San Jose, Cupertino, Santa Clara, Palo Alto, Redwood City, San Mateo, Millbrae, San Bruno, San Francisco and Walnut Creek. Consolidation and Basis of Presentation The supplemental consolidated financial statements include the accounts of Greater Bay and its wholly owned subsidiaries, MPB, CNB, PBC, Golden Gate, BAB, GBB Capital I and GBB Capital II and its operating divisions Greater Bay Bank Santa Clara Valley Commercial Banking Group, Greater Bay Corporate Finance Group, Greater Bay Bank Contra Costa Banking Office, Greater Bay International Banking Division, Greater Bay Trust Company, Pacific Business Funding and Venture Banking Group. All significant intercompany transactions and balances have been eliminated. Certain reclassifications have been made to prior years' consolidated financial statements to conform to the 1998 presentation. The accounting and reporting policies of the Company conform to generally accepted accounting principles and the prevailing practices within the banking industry. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of certain revenues and expenses during the reporting period. Actual results could differ from those estimates. 28 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold and agency securities with original maturities of less than ninety days. Generally, federal funds are sold for one-day periods. As discussed in Note 7, PBC holds $89.6 million in one demand deposit account whose funds are comprised of proceeds from a lawsuit settlement. Due to the uncertainty of the time this special deposit (the "Special Deposit") will remain with PBC, management has invested a significant portion of the proceeds in agency securities with maturities of less than 90 days. Those securities have been classified as cash and equivalents. MPB, CNB, PBC, and Golden Gate are required by the Federal Reserve System to maintain noninterest-earning cash reserves against certain of their deposit accounts. At December 31, 1998, the required combined reserves totaled approximately $19.4 million. Investment Securities The Company classifies its investment securities in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Investment securities classified as held to maturity are reported at amortized cost; available for sale securities are reported at fair value with net unrealized gains and losses reported (net of taxes) as a component of shareholders' equity. The Company does not have any trading securities. A decline in the market value of any available for sale or held to maturity security below cost that is deemed other than temporary, results in a charge to earnings and the corresponding establishment of a new cost basis for the security. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses for securities classified as available for sale and held to maturity are included in earnings and are derived using the specific identification method for determining the cost of securities sold. Required investments in Federal Reserve Bank and Federal Home Loan Bank stocks for MPB, CNB, PBC, and Golden Gate are recorded at cost. Loans Loans held for investment are carried at amortized cost. The Company's loan portfolio consists primarily of commercial and real estate loans generally collateralized by first and second deeds of trust on real estate as well as business assets and personal property. Interest income is accrued on the outstanding loan balances using the simple interest method. Loans are generally placed on nonaccrual status when the borrowers are past due 90 days and when full payment of principal or interest in not expected. At the time a loan is placed on nonaccrual status, any interest income previously accrued but not collected is generally reversed and amortization of deferred loan fees is discontinued. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest. The Company charges loan origination and commitment fees. Net loan origination fees and costs are deferred and amortized to interest income over the life of the loan, using the effective interest method. Loan commitment fees are amortized to interest income over the commitment period. When a loan is sold, unamortized fees and capitalized direct costs are recognized in the consolidated statements of operations. Other loan fees and charges representing service costs for the repayment of loans, for delinquent payments or for miscellaneous loan services are recognized when earned. 29 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 Sale and Servicing of Small Business Administration ("SBA") Loans The Company originates loans to customers under SBA programs that generally provide for SBA guarantees of 70% to 90% of each loan. The Company generally sells the guaranteed portion of the majority of the loans to an investor and retains the unguaranteed portion and servicing rights in its own portfolio. Funding for the SBA programs depend on annual appropriations by the U.S. Congress. Gains on these sales are earned through the sale of the guaranteed portion of the loan for an amount in excess of the adjusted carrying value of the portion of the loan sold. The Company allocates the carrying value of such loans between the portion sold, the portion retained and a value assigned to the right to service the loan. The difference between the adjusted carrying value of the portion retained and the face amount of the portion retained is amortized to interest income over the life of the related loan using a method which approximates the interest method. Allowance for Loan Losses The Company adopted SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118 ("SFAS No. 114 and No. 118"), on January 1, 1995. Under these standards, a loan is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Under these standards, any allowance on impaired loans is generally based on one of three methods. It requires that impaired loans be measured at either, 1) the present value of expected cash flows at the loan's effective interest rate, 2) the loan's observable market price, or 3) the fair market value of the collateral of the loan. In general, these statements are not applicable to large groups of smaller-balance loans that are collectively evaluated for impairment such as credit cards, residential mortgage and/or consumer installment loans. Income recognition on impaired loans conforms to the method the Company uses for income recognition on nonaccrual loans. The allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide for known losses in the loan portfolio. The allowance is based upon a number of factors, including prevailing and anticipated economic trends, industry experience, industry and geographic concentrations, estimated collateral values, management's assessment of credit risk inherent in the portfolio, delinquency trends, historical loss experience, specific problem loans and other relevant factors. Additions to the allowance, in the form of provisions, are reflected in current operating results, while charge-offs to the allowance are made when a loss is determined to have occurred. Because the allowance for loan losses is based on estimates, ultimate losses may vary from the current estimates. Other Real Estate Owned Other real estate owned ("OREO") consists of properties acquired through foreclosure and is stated at the lower of carrying value or fair value less estimated costs to sell. Development and improvement costs relating to the OREO are capitalized. Estimated losses that result from the ongoing periodic valuation of these properties are charged to current earnings with a provision for losses on foreclosed property in the period in which they are identified. resulting allowance for OREO losses is decreased when the property is sold. Operating expenses of such properties, net of related income, are included in other expenses. Gains and losses on the disposition of OREO are included in other income. Property, Premises and Equipment Property, premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, which is determined by asset classification, as follows: Buildings................................................ 40 years Building Improvements.................................... 10 years Furniture and fixtures................................... 7 years Automobiles.............................................. 5 years Computer equipment....................................... 2-5 years Other equipment.......................................... 5-7 years 30 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 Amortization of leasehold improvements is computed on a straight-line basis over the shorter of the lease term or the estimated useful lives of the asset, which is generally 10 years. Income Taxes Deferred incomes taxes reflect the estimated future tax effects of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. Derivatives and Hedging Activities The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), effective October 1, 1998. In accordance with the transition provisions of SFAS No. 133, the Company recorded a net-of-tax cumulative-effect-type adjustment of $1,063,000 in accumulated other comprehensive income to recognize at fair value all derivatives that are designated as cash-flow hedging instruments. There were no net gains or losses on derivatives that had been previously deferred or gains and losses on derivatives that were previously deferred as adjustments to the carrying amount of hedged items. All derivatives are recognized on the balance sheet at their fair value. On the date the derivative contract is entered into, the Company designates the derivative as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow" hedge). Changes in the fair value of a derivative that is highly effective as--and that is designated and qualifies as--a cash-flow hedge are recorded in other comprehensive income, until earnings are affected by the variability of cash flows (e.g., when periodic settlements on a variable-rate asset or liability are recorded in earnings). The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as cash-flow hedges to specific liabilities on the balance sheet. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item; (2) the derivative expires or is sold, terminated, or exercised; or (3) management determines that designation of the derivative as a hedge instrument is no longer appropriate. In these situations where hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current-period earnings. All gains or losses that were accumulated in other comprehensive income will be recognized immediately in earnings upon the discontinuance of hedge accounting. Comprehensive Income On January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income". This statement requires companies to classify items of other comprehensive income by their nature in the financial statements and display the accumulated other comprehensive income separately from retained earnings in the equity section of the balance sheet. The changes to the balances of accumulated other comprehensive income are as follows:
Accumulated Other Unrealized Gains Cash Flow Comprehensive (Dollars in thousands) on Securities Hedges Income (Loss) - ----------------------------------------------------------------------------------------------------------------------- Balance - December 31, 1997 $221 $ - $ 221 Current period change 358 (677) (319) ------------------------------------------------------------------------------------------ Balance - December 31, 1998 $579 $(677) $ (98) ------------------------------------------------------------------------------------------
31 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 Per Share Data Net income per share is stated in accordance with SFAS No. 128 "Earnings per Share". Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the year. Diluted net income per share is computed by dividing net income by the weighted average number of common shares plus common equivalent shares outstanding including dilutive stock options. All years presented include the effect of the 2-for-1 stock split effective as of April 30, 1998. The following table provides a reconciliation of the numerators and denominators of the basic and diluted net income per share computations for the years ended December 31, 1998, 1997 and 1996. 32 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996
For the year ended December 31, 1998 ------------------------------------------------------------------------- Income Shares Per Share (Dollars in thousands, except per share amounts) (Numerator) (Denominator) Amount - ---------------------------------------------------------------------------------------------------------------------------------- Net income $ 18,943 Basic net income per share: Income available to common shareholders 18,943 10,857,952 $ 1.74 Effect of dilutive securities: Stock options - 779,284 - ------------------------------------------------------------------------- Diluted net income per share: Income available to common shareholders and assumed conversions $ 18,943 11,637,235 $ 1.63 ------------------------------------------------------------------------- For the year ended December 31, 1997 ------------------------------------------------------------------------- Income Shares Per Share (Dollars in thousands, except per share amounts) (Numerator) (Denominator) Amount - ---------------------------------------------------------------------------------------------------------------------------------- Net income $ 13,424 Basic net income per share: Income available to common shareholders 13,424 10,420,562 $ 1.29 Effect of dilutive securities: Stock options - 833,295 - ------------------------------------------------------------------------- Diluted net income per share: Income available to common shareholders and assumed conversions $ 13,424 11,253,857 $ 1.19 ------------------------------------------------------------------------- For the year ended December 31, 1996 ------------------------------------------------------------------------- Income Shares Per Share (Dollars in thousands, except per share amounts) (Numerator) (Denominator) Amount - ---------------------------------------------------------------------------------------------------------------------------------- Net income $ 7,763 $ - Basic net income per share: Income available to common shareholders 7,763 10,013,995 $ 0.78 Effect of dilutive securities: Stock options - 732,616 - ------------------------------------------------------------------------- Diluted net income per share: Income available to common shareholders and assumed conversions $ 7,763 $10,746,611 $ 0.72 -------------------------------------------------------------------------
33 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 There were options to purchase 51,000 shares that were considered anti- dilutive whereby the options' exercise price was greater than the average market price of the common shares, during the year ended December 31, 1998. There were no options that were considered anti-dilutive during the years ended December 31, 1997 and 1996. Weighted average shares outstanding and all per share amounts included in the consolidated financial statements and notes thereto are based upon the increased number of shares giving retroactive effect to the 1996 merger with Cupertino National Bancorp at a 0.81522 conversion ratio, the 1997 merger with PBC at a 0.96550 conversion ratio, the 1998 mergers with PRB and PBFC at a total of 950,748 and 298,000 shares, respectively, and the 1999 merger with BA Bancshares at a 1.38682 conversion ratio. Segment Information In 1998, the Company adopted SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131".) SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise", replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the company's reportable segments. SFAS No. 131 also requires disclosures about products and services, geographic areas, and major customers. The adoption of SFAS No. 131 did not affect results of operations or financial position but did affect the disclosure of segment information. NOTE 2--MERGERS On May 21, 1999 BA Bancshares, the former holding company of BAB, merged with and into the Company. Upon consummation of the merger, the outstanding shares of BAB were converted into an aggregate of 1,399,000 shares of the Company stock. The stock was issued to former BA Bancshares shareholders in a tax-free exchange accounted for as a pooling-of-interests. On August 31, 1998, PBFC, an asset-based specialty finance company merged with and into the Company. Upon consummation of the merger, the outstanding shares of PBFC were converted into an aggregate of 298,000 shares of the Company's stock. The stock was issued to former PBFC shareholders, in a tax-free exchange accounted for as a pooling-of-interests. On May 8, 1998, PRB, the former holding company of Golden Gate, merged with and into the Company. Upon consummation of the merger, the outstanding shares of PRB were converted into an aggregate of 950,748 shares of the Company's stock. The stock was issued to former PRB's sole shareholder in a tax-free exchange accounted for as a pooling-of-interests. On December 23, 1997, the Company consummated a merger with PBC. Pursuant to terms of the merger agreement, the Company issued approximately 664,000 shares (approximately 1,328,000 shares, as adjusted to reflect the 2-for-1 stock split) of its common stock in exchange for the outstanding common stock of PBC at an exchange ratio of 0.9655 of the Company's common stock for each share of PBC's common stock. The merger was accounted for as a pooling-of-interests. On November 27, 1996, the Company consummated a merger with Cupertino National Bancorp. Pursuant to the terms of the merger agreement, the Company issued approximately 1,586,000 shares (approximately 3,172,000 shares, as adjusted for the 2-for-1 stock split) of its common stock in exchange for the outstanding common stock of Cupertino National Bancorp at an exchange ratio of 0.81522 of the Company's common stock for each share of Cupertino National Bancorp's common stock. The merger was accounted for as a pooling-of-interests. 34 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 The following table sets forth the separate results of operations for Greater Bay, PBC, PRB, PBFC and BA Bancshares for the periods indicated:
Years ended December 31, Net Interest Income Net Income ------------------- ------------------- 1998 Greater Bay $65,448 $16,578 BA Banchshares 8,170 2,365 ------------------- ------------------- Combined $73,618 $18,943 =================== =================== 1997 Greater Bay $47,776 $10,013 PRB 4,750 996 PBFC 1,942 610 BA Bancshares 6,781 1,805 ------------------- ------------------- Combined $61,249 $13,424 =================== =================== 1996 Greater Bay $28,824 $ 3,503 PBC 6,149 1,835 PRB 4,039 541 PBFC 1,492 469 BA Bancshares 5,862 1,415 ------------------- ------------------- Combined $46,366 $ 7,763 =================== ===================
In all mergers, certain reclassifications were made to conform to the Company's financial presentation. The results of operations previously reported by the separate enterprises for the periods before the merger was consummated and that are included in the current combined amounts presented in the accompanying consolidated financial statements are summarized below. The following table sets forth the composition of the operations of the Company and PBFC, PRB and PBC for the periods indicated.
PBFC PRB PBC Six months ended Three months ended Nine months ended (Dollars in thousands) June 30, 1998 March 31, 1998 September 30, 1997 - ------------------------ ------------------- -------------------- ----------------- Net interest income: Greater Bay Bancorp $30,077 $13,366 $27,922 Acquired entity 1,154 1,285 6,851 ------------------- -------------------- ----------------- Combined $31,231 $14,651 $34,773 =================== ==================== ================= Provision for loan losses: Greater Bay Bancorp $ 2,243 $ 866 $ 5,287 Acquired entity 100 70 105 ------------------- -------------------- ----------------- Combined $ 2,343 $ 936 $ 5,392 =================== ==================== ================= Net income: Greater Bay Bancorp $ 6,628 $ 3,646 $ 6,097 Acquired entity 344 60 2,573 ------------------- -------------------- ----------------- Combined $ 6,972 $ 3,706 $ 8,670 =================== ==================== =================
The following table sets forth the composition of the combined operations of Mid-Peninsula Bancorp and Cupertino National Bancorp for the period indicated. 35 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996
Three months ended (Dollars in thousands) September 30, 1996 - ----------------------------------------------------------- Net Interest Income: Mid-Peninsula Bancorp $ 8,878 Cupertino National Bancorp 11,487 -------- Combined $ 20,365 ======== Provision for loan losses: Mid-Peninsula Bancorp $ 427 Cupertino National Bancorp 864 -------- Combined $ 1,291 ======== Net income: Mid-Peninsula Bancorp $ 2,373 Cupertino National Bancorp 1,548 -------- Combined $ 3,921 ========
There were no significant transactions between the Company and PBFC, the Company and PRB, the Company and PBC or between Mid-Peninsula Bancorp and Cupertino National Bancorp prior to the mergers. All intercompany transactions have been eliminated. 36 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 NOTE 3--INVESTMENT SECURITIES The amortized cost and estimated market value of investment securities is summarized below:
Gross Gross As of December 31, 1998 Amortized Unrealized Unrealized Market (Dollars in thousands) Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE SECURITIES: U.S. Treasury obligations $ 4,408 $ 26 $ - $ 4,434 U.S. agency notes 29,125 23 (2) 29,146 Mortgage-backed securities 154,260 990 (67) 155,183 Tax-exempt securities 32,952 563 - 33,515 Corporate securities 35,517 60 (597) 34,980 ---------------------------------------------------------------------------- Total securities available for sale 256,262 1,662 (666) 257,258 ---------------------------------------------------------------------------- HELD TO MATURITY SECURITIES: U.S. Treasury obligations 1,764 2 (2) 1,764 U.S. agency notes 28,495 22 (58) 28,459 Mortgage-backed securities 36,191 174 (202) 36,163 Tax-exempt securities 27,759 760 (15) 28,504 ---------------------------------------------------------------------------- Total securities held to maturity 94,209 958 (277) 94,890 ---------------------------------------------------------------------------- - - - - Other securities 6,044 - - 6,044 ---------------------------------------------------------------------------- Total investment securities 356,515 2,620 (943) 358,192 ---------------------------------------------------------------------------- As of December 31, 1997 Amortized Unrealized Unrealized Market (Dollars in thousands) Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE SECURITIES: U.S. Treasury obligations $ 10,095 $ 52 $ (2) $ 10,145 U.S. agency notes 39,346 52 (63) 39,335 Mortgage-backed securities 103,027 357 (187) 103,197 Tax-exempt securities 7,018 199 (5) 7,212 Corporate securities 7,568 62 - 7,630 ---------------------------------------------------------------------------- Total securities available for sale 167,054 722 (257) 167,519 ---------------------------------------------------------------------------- HELD TO MATURITY SECURITIES: U.S. Treasury obligations 501 1 - 502 U.S. agency notes 22,307 205 (12) 22,500 Mortgage-backed securities 19,970 344 (11) 20,303 Tax-exempt securities 15,845 512 (53) 16,304 ---------------------------------------------------------------------------- Total securities held to maturity 58,623 1,062 (76) 59,609 ---------------------------------------------------------------------------- Other securities 2,573 - - 2,573 ---------------------------------------------------------------------------- Total investment securities 228,250 1,784 (333) 229,701 ----------------------------------------------------------------------------
37 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 The following table shows amortized cost and estimated market value of the Company's investment securities by year of maturity as of December 31, 1998. 2000 2004 Through Through 2009 and (Dollars in thousands) (1) 1999 2003 2008 Thereafter Total - ----------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE SECURITIES: U.S. Treasury obligations $ 4,308 $ 100 $ - $ - $ 4,408 U.S. agency notes (2) 16,333 - 12,792 - 29,125 Mortgage-backed securities (3) - 4,306 8,941 141,013 154,260 Tax-exempt securities - 1,601 4,561 26,790 32,952 Corporate securities 4,016 991 - 30,510 35,517 -------------------------------------------------------------- Total securities available for sale 24,657 6,998 26,294 198,313 256,262 -------------------------------------------------------------- Market value $24,704 $ 7,076 $26,601 $198,877 $257,258 -------------------------------------------------------------- HELD TO MATURITY SECURITIES: U.S. Treasury obligations 1,764 - - - 1,764 U.S. agency notes (2) 3,005 23,990 1,500 - 28,495 Mortgage-backed securities (3) 1,265 6,053 8,508 20,365 36,191 Tax-exempt securities 1,462 3,598 5,252 17,447 27,759 -------------------------------------------------------------- Total securities held to maturity 7,496 33,641 15,260 37,812 94,209 -------------------------------------------------------------- Market value 7,541 33,714 8,447 45,188 94,890 -------------------------------------------------------------- COMBINED INVESTMENT SECURITIES PORTFOLIO: Total investment securities $32,153 $40,639 $41,554 $236,125 $350,471 -------------------------------------------------------------- Total market value $32,245 $40,790 $35,048 $244,065 $352,148 -------------------------------------------------------------- Weighted average yield-total portfolio 5.73% 5.74% 5.25% 6.84% 6.23% --------------------------------------------------------------
(1) Other securities are comprised of equity investments and have no stated maturity and therefore are excluded from this table. (2) Certain notes issued by U.S. Agencies may be called, without penalty, at the discretion of the issuer. This may cause the actual maturities to differ significantly from the contractual mat urity dates. (3) Mortgage-backed securities are shown at contractual maturity; however, the average life of these mortgage-backed securities may differ due to principal prepayments. Investment securities with a carrying value of $108.0 million and $38.8 million were pledged to secure deposits, borrowings and for other purposes as required by law or contract at December 31, 1998 and 1997, respectively. Investments in the FRB and the FHLB are required in order to maintain membership and support activity levels. Proceeds and realized losses and gains on sales of investment securities for the years ended December 31, 1998, 1997 and 1996 are presented below: 38 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------- Proceeds from sale of available for sale securities $195,863 $14,598 $31,430 Available for sale securities-gains (losses) (1) $ 374 $ (5) $ (255)
(1) Includes $466,000 of charges in 1996 to conform accounting practices, which is included in merger and other related nonrecurring costs. NOTE 4--LOANS AND ALLOWANCE FOR LOAN LOSSES The following summarizes the activity in the allowance for loan losses for the years ended December 31, 1998, 1997 and 1996:
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------- Balance, January 1 $18,032 $11,629 $ 8,199 Provision for loan 6,418 8,377 3,829 losses (1) Loan charge-offs (1,496) (2,074) (1,096) Recoveries 425 100 697 --------------------------------------------- Balance, December 31 $23,379 $18,032 $11,629 ---------------------------------------------
(1) Includes $183,000, $1.4 million and $800,000 of charges in 1998, 1997 and 1996, respectively, to conform accounting practices for the Banks' reserve methodologies and is included in merger and related nonrecurring costs in the consolidated statements of operations The following table sets forth nonperforming loans as of December 31, 1998, 1997 and 1996. Nonperforming loans are defined as loans which are on nonaccrual status, loans which have been restructured, and loans which are 90 days past due but are still accruing interest. Interest income foregone on nonperforming loans outstanding at year end totaled $121,000, $532,000, and $760,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Interest income recognized on the nonperforming loans approximated $80,000, $206,000, and $508,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------- Nonaccrual loans $2,003 $3,344 $6,047 Accruing loans past due 90 days or more - 158 1,471 Restructured loans 327 1,062 1,828 Total nonperforming loans $2,330 $4,564 $9,346 ---------------------------------------------
At December 31, 1998 and 1997, the recorded investment in loans, for which impairment has been recognized in accordance with SFAS No. 114 and No. 118, was approximately $2.0 million and $3.2 million, respectively, with corresponding valuation allowances of $732,000 and $661,000, respectively. For the years ended December 31, 1998 and 1997, the average recorded 39 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 investment in impaired loans was approximately $3.5 million and $5.4 million, respectively. The Company did not recognize interest income on impaired loans during the twelve months ended December 31, 1998, 1997 and 1996. The Company had $327,000 and $1,062,000 of restructured loans as of December 31, 1998 and 1997, respectively. Principal reduction concessions totaling $387,000 were permitted on restructured loans during the year ended December 31, 1997. There were no principal reduction concessions allowed on restructured loans during 1998. Interest income from restructured loans totaled $16,000, $82,000 and $317,000 for the years ended December 31, 1998, 1997 and 1996. Foregone interest income, which totaled $11,000, $10,000 and $8,000 for the years ended December 31, 1998, 1997 and 1996 would have been recorded as interest income if the loans had accrued interest in accordance with their original terms prior to the restructurings. NOTE 5--OTHER REAL ESTATE OWNED At December 31, 1998 and 1997, other real estate owned (''OREO'') consisted of properties acquired through foreclosure with a carrying value of $966,000 and $1.4 million, respectively. These balances are included in interest receivable and other assets in the accompanying consolidated balance sheets. There was no allowance for estimated losses. The following summarizes OREO operations, which are included in operating expenses, for the years ended December 31, 1998, 1997 and 1996.
(Dollars in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------ Real estate operations, net $ 77 $ 247 $ 190 Gain on sale of other real estate owned (1) (124) (15) Provision for estimated losses - 54 - ------------------------------------------------- Net loss from other real estate operations $ 76 $ 177 $ 175 -------------------------------------------------
NOTE 6--PROPERTY, PREMISES AND EQUIPMENT Property, premises and equipment at December 31, 1998 and 1997 are composed of the following:
(Dollars in thousands) 1998 1997 - ------------------------------------------------------------------------------------ Land $ 417 $ 417 Building and premises 1,561 1,377 Leasehold improvements 4,929 4,996 Furniture and equipment 12,553 10,576 Automobiles 179 178 ------------------------------- Total 19,639 17,544 Accumulated depreciation and amortization (8,259) (8,393) ------------------------------- Premises and equipment, net $11,380 $ 9,151 -------------------------------
Depreciation and amortization amounted to $2.6 million, $2.4 million and $2.0 million for the years ended December 31, 1998, 1997 and 1996, respectively, and have been included in occupancy and equipment expense in the accompanying consolidated statements of operations. 40 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 NOTE 7--DEPOSITS Deposits as of December 31, 1998 and 1997 are as follows:
(Dollars in thousands) 1998 1997 - ----------------------------------------------------------------------------------- Demand, noninterest-bearing $ 302,006 $ 247,743 MMDA, NOW and Savings 922,581 675,632 Time certificates, $100,000 and over 190,312 203,408 Other time certificates 64,048 51,791 ---------------------------------------- Total deposits $1,478,947 $1,178,574 ----------------------------------------
The following table sets forth the maturity distribution of time certificates of deposit at December 31, 1998.
December 31, 1998 ---------------------------------------------------------------------------- Seven to One to More Three months Four to six twelve three than (Dollars in thousands) or less months months years three years Total - ---------------------------------------------------------------------------------------------------------------- Time deposits, $100,000 and over $133,649 $32,440 $18,734 $ 5,489 $ - $190,312 Other time deposits 29,845 16,400 13,103 4,668 32 64,048 ---------------------------------------------------------------------------- Total $163,494 $48,840 $31,837 $10,157 $32 $254,360 ----------------------------------------------------------------------------
At December 31, 1998 and 1997, the Company held $89.6 million and $88.1 million, respectively from a single depositor. Due to the uncertainty of the time the deposit will remain outstanding, management has invested a significant portion in agency securities with maturities of less than 90 days. NOTE 8--COMPANY OBLIGATED MANDATORILY REDEEMABLE CUMULATIVE TRUST PREFERRED SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES GBB Capital I and GBB Capital II (the "Trusts") are Delaware business trusts wholly-owned by Greater Bay and were formed for the purpose of issuing Company Obligated Manditorily Redeemable Preferred Securities of Subsidiary Trusts Holding Soley Junior Subordinated Debentures ("TPS"). The TPS are individually described below. Interest on the TPS are payable quarterly and is deferrable, at the option of the Company, for up to five years. Following the issuance of each TPS, the Trusts used the proceeds from the TPS offerings to purchase a like amount of Junior Subordinated Deferrable Interest Debentures (the "Debentures") of Greater Bay. The Debentures bear the same terms and interest rates as the related TPS. The Debentures are the sole assets of the Trusts and are eliminated, along with the related income statement effects, in the consolidated financial statements. Greater Bay has fully and unconditionally guaranteed all of the obligations of the Trusts. Under applicable regulatory guidelines, a portion of the TPS will qualify as Tier I capital, and the remaining portion will qualify as Tier II capital. On March 30, 1997, GBB Capital I completed a public offering of 800,000 shares of 9.75% Cumulative Trust Preferred Securities ("TPS I") in an aggregate amount of $20.0 million. The TPS I accrue interest at an annual rate of 9.75% on the $20.0 million liquidation amount of $25 per share of TPS I. The TPS I are mandatorily redeemable, in whole or in part, upon repayment of the Debentures at their stated maturity of April 1, 2027 or their earlier redemption. The Debentures are redeemable prior to maturity at the option of the Company, on or after April 1, 2002, in whole at any time or in part from time to time. On August 12, 1998, GBB Capital II completed an offering of 30,000 shares of Floating Rate Trust Preferred Securities, Series A ("the Series A Securities") in an aggregate amount of $30.0 million. The Series A Securities issued in the offering were sold in a private transaction pursuant to an applicable exemption from registration under the Securities Act. In November 1998, the Company, through GBB Capital II, completed an offer to exchange the Series A Securities for a like amount of its registered 41 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 Floating Rate Trust Preferred Securities, Series B ("TPS II"). The exchange offer was conducted in accordance with the terms of the initial issuance of the Series A Securities. The TPS II accrue interest at a variable rate of interest, initially at 7.1875%, on the liquidation amount of $1,000 per share of TPS II. The interest rate resets quarterly and is equal to 3-month LIBOR plus 150 basis points. As part of this transaction, the Company concurrently entered into an interest rate swap to fix the cost of the offering at 7.55% for 10 years (see note 10). The TPS II are mandatorily redeemable, in whole or in part, upon repayment of the Debentures at their stated maturity of September 15, 2028 or their earlier redemption. The Debentures are redeemable prior to maturity at the option of the Company, on or after September 15, 2008, in whole at any time or in part from time to time. The total amount of TPS outstanding at December 31, 1998 and 1997 was $50.0 million and $20.0 million, respectively and the dividends paid on TPS was $2.8 million and $1.5 million in 1998 and 1997, respectively. 42 The GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 NOTE 9--BORROWINGS Other borrowings are detailed as follows:
(Dollars in thousands) 1998 1997 - ---------------------------------------------------------------------------------------- Other borrowings: Short term borrowings: Securities sold under agreements to repurchase $ - $19,480 Other short term notes payable 135 2,675 Advances under credit line - 7,750 FHLB advances 500 - Total short term borrowings 635 29,905 ---------------------------------- Long term borrowings: Securities sold under agreements to repurchase 50,000 - FHLB advances 22,000 1,000 Promissory notes 2,450 2,450 Total other long term borrowings 74,450 3,450 ---------------------------------- Total other borrowings $75,085 $33,355 ================================== Subordinated notes, due September 15, 2005 $ 3,000 $ 3,000 Total subordinated debt $ 3,000 $ 3,000 ==================================
During the years ended December 31, 1998 and 1997, the average balance of securities sold under short term agreements to repurchase was $11,648,000 and $5,278,000, respectively, and the average interest rates during those periods were 5.35% and 5.71%, respectively. Securities sold under short term agreements to repurchase generally mature within 90 days of dates of purchase. The maximum outstanding at any month end was $30.2 million and $19.5 million for the years ended December 31, 1998 and 1997 respectively. During the years ended December 31, 1998 and 1997, the average balance of federal funds purchased was $293,000 and $1,523,000, respectively, and the average interest rates during those periods were 5.53% and 5.32%, respectively. There were no such balances outstanding at December 31, 1998 or 1997. The maximum amount outstanding at any month end was $0 and $9.2 million for the years ended December 31, 1998 and 1997 respectively. The short term FHLB advances have an average interest rate of 6.04%. The advances are collateralized by securities pledged to the FHLB. The Company has sold securities under long term agreements to repurchase which mature in the year 2003 and have an average interest rate of 5.21%. The counterparties to these agreements have put options which give them the right to demand early repayment. As of December 31, 1998, $40.0 million of these borrowings are subject to early repayment beginning in 1999 and $10.0 million are subject to early repayment beginning in 2000. The long term FHLB advances will mature in the year 2003 and have an average interest rate of 5.17%. The advances are collateralized by loans and securities pledged to the FHLB. Under the terms of the advances, the FHLB has a put on $20 million of the advances option which gives it the right to demand early repayment beginning in 1999. The promissory notes, which bear an interest rate of 13.76% and will mature April 15, 2000, were offered to PBFC's officers along with other accredited investors within the definition of Rule 501 under the Securities Act of 1933, as amended. The notes are redeemable by the Company at any time. 43 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 The subordinated notes, which will mature on September 15, 2005, were offered to members of Cupertino National Bank's Board of Directors and bank officers along with other accredited investors within the definition of Rule 501 under the Securities Act of 1933, as amended. The notes bear an interest rate of 11.5%. The notes are redeemable by the Company any time after September 30, 1998 at a premium ranging from 0% to 5%. The notes qualify as Tier 2 capital for the Company. NOTE 10--DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES The Company currently uses a single interest-rate swap to convert its floating-rate debt (the TPS II) to fixed rates. This swap was entered into concurrently with the issuance of the debt being hedged. This swap is accounted for as a cash flow hedge under SFAS No. 133. This swap possesses a term equal to the non-callable term of the debt, with a fixed pay rate and a receive rate indexed to rates paid on the debt and a notional amount equal to the amount of the debt being hedged. As the specific terms and notional amount of the swap exactly match those of the debt being hedged the Company meets the "no ineffectiveness" criteria of SFAS No. 133. As such the swap is assumed to be 100% effective and all changes in the market value of the hedge are recorded in other comprehensive income with no impact on the income statement for any ineffective portion. As of December 31, 1998, the unrealized loss on the cash flow hedge was $677,000, net of income taxes, which was included in the balance of accumulated other comprehensive income. The floating rate TPS II combined with the cash flow hedge created a synthetic fixed rate debt instrument. The unrealized loss on the cash flow hedge approximated the unrealized loss the Company would have incurred if it had issued a fixed rate debt instrument. Under current accounting practices, as required by SFAS No. 133, the Company was required to record the unrealized loss on the synthetic fixed rate debt instrument, but it would not have been required to record an unrealized loss if it had issued fixed rate debt. The notional amount of the swap is $30.0 million with a term of 10 years expiring on September 15, 2008. The Company intends to use the swap as a hedge of the related debt for 10 years. The periodic settlement date of the swap results in the reclassifying as earnings the gains or losses that are reported in accumulated comprehensive income. For the year ended December 31, 1998 the Company recognized a net settlement expense of $55,000 for the swap. The estimated net amount of the existing losses at December 31, 1998 that is expected to be reclassified as earnings within the next twelve months, assuming no change in interest rates, would be approximately $147,000, net of taxes. For the years ended December 31, 1997 and 1996, the Company did not have any derivative instruments. The Company minimizes the credit (or repayment) risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company's credit committee. NOTE 11--INCOME TAXES Income tax expense was comprised of the following for the years ended December 31, 1998, 1997 and 1996:
(Dollars in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------ Current: Federal $ 9,056 $ 9,157 $ 5,050 State 3,242 2,802 1,403 ----------------------------------------------- Total current 12,298 11,959 6,453 Deferred: Federal (2,534) (3,320) (925) State (702) (907) (593) ----------------------------------------------- Total deferred (3,236) (4,227) (1,518) ----------------------------------------------- Total expense $ 9,062 $ 7,732 $ 4,935 ===============================================
44 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and liabilities at December 31, 1998 and 1997 are as follows:
Years Ended December 31, --------------------------------- (Dollars in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------ Loan loss reserves $ 7,839 $5,509 State income taxes 2,336 1,944 Deferred compensation 1,762 1,195 Net operating losses 167 336 Unrealized gains 70 (247) Purchase accounting adjustments 22 72 Accumulated depreciation 87 110 Other (261) (461) --------------------------------- Net deferred tax asset $12,022 $8,458 =================================
Management believes that the Company will fully realize its total deferred income tax assets as of December 31, 1998 based upon the Company's recoverable taxes from prior carryback years, its total deferred income tax liabilities and its current level of operating income. At December 31, 1998, the Company had a federal tax net operating loss carryforward of approximately $478,000 expiring in years 2010, 2011, and 2012. Under provisions of the United States income tax laws these loss carryovers are subject to limitation due to the acquisition of Pacific Rim Bancorporation in 1998. Management does not believe that these limitations will prevent the realization of the benefit of the loss carryovers during the carryover periods. A reconciliation from the statutory income tax rate to the consolidated effective income tax rate follows, for the years ended December 31, 1998, 1997 and 1996:
Years Ended December 31, ----------------------------------------- (Dollars in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------- Statutory federal tax rate 34.9% 34.9% 34.8% California franchise tax expense net of federal income tax benefit 5.9% 6.3% 7.1% Tax exempt income (2.3)% (1.8)% (3.6)% Nondeductible merger costs, net (0.3)% 0.0% 2.1% Contribution of appreciated (1.7)% 0.0% 0.0% securities Other, net (4.1)% (2.8)% (1.7)% ----------------------------------------- Effective income tax rate 32.4% 36.6% 38.8% -----------------------------------------
45 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 NOTE 12--OPERATING EXPENSES Merger and other related nonrecurring costs for the years ended December 31, 1998, 1997 and 1996 were comprised of the following:
(Dollars in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------- Financial advisory and professional fees $1,101 $1,083 $1,000 Charges to conform accounting practices 183 1,350 1,266 Other costs 1,377 900 525 --------------------------------------- Total $2,661 $3,333 $2,791 =======================================
Other costs include severance and other compensation expenses, charges for the write-off of assets retired as a result of the merger, and other expenses including printing costs and filing fees. In July 1995, the Company settled a lawsuit of $1.1 million, net of tax. The Company recovered those losses through insurance coverage for this settlement in 1997. However, due to the uncertainty associated with the recovery, the Company reflected the settlement expense as a charge to 1995 earnings, and the associated recovery in 1997 as a recovery to earnings. Other expenses for the years ended December 31, 1998, 1997 and 1996 were comprised of the following:
(Dollars in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------- Legal and other professional fees $ 2,320 $ 2,412 $ 2,130 Telephone, postage and supplies 2,015 1,618 1,406 Marketing and promotion 1,388 1,457 1,222 Directors fees 730 816 673 Client services 563 459 474 Data processing 430 478 514 Insurance 339 313 225 FDIC insurance and regulatory - - - assessments 365 319 169 Other real estate owned 76 177 175 Other 3,583 2,726 2,957 --------------------------------------- 11,809 10,775 9,945 Contribution to GBB Foundation 1,341 - - --------------------------------------- Total $12,650 $10,775 $ 9,945 =======================================
NOTE 13--EMPLOYEE BENEFIT PLANS Stock Option Plan On November 19, 1997, the Company's shareholders approved an amendment of the Greater Bay Bancorp 1996 Stock Option Plan (the "Bancorp Plan"), to increase by 912,652 the number of shares of Greater Bay stock issuable under the Bancorp Plan. This was done to accommodate the increased number of eligible employees as a result of the merger with PBC. 46 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 Effective November 27, 1996, the Company's shareholders approved the original Bancorp Plan and authorized an increase in the number of shares previously available for issuance under the Mid-Peninsula Bancorp Plan from 914,074 to 1,503,128 shares to accommodate the merger of Mid-Peninsula Bancorp and Cupertino National Bancorp. Under the terms of the merger, all stock option plans of Cupertino National Bancorp and Mid-Peninsula Bancorp were terminated at the time of the merger and all outstanding options from these plans were assumed by the Bancorp Plan. Outstanding options from the Mid-Peninsula Bancorp plan of 432,652 and outstanding options from the Cupertino National Bancorp plan of 502,146 (converted at a ratio of 0.81522) were assumed by the Bancorp Plan. Options issued under the Bancorp Plan may be granted to employees and nonemployee directors and may be either incentive or nonqualified stock options as defined under current tax laws. The exercise price of each option must equal the market price of the Company's stock on the date of grant. The term of an option may not exceed 10 years and generally vest over a five year period. At December 31, 1998 the total authorized shares issuable under the Bancorp Plan was approximately 2,260,000 shares and the number of shares available for future grants was approximately 828,000 shares. All shares amounts have been restated to reflect the 2-for-1 stock split declared for shareholders of record as of April 30, 1998. 47 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 Stock-Based Compensation In October 1995, the Financial Accounting Standards Board issued SFAS No. 123 "Accounting for Stock-Based Compensation" ("SFAS No. 123"). Under the provisions of SFAS No. 123, the Company is encouraged, but not required, to measure compensation costs related to its employee stock compensation plans under the fair market value method. If the Company elects not to recognize compensation expense under this method, it is required to disclose the pro forma net income and net income per share effects based on the SFAS No. 123 fair value methodology. The Company implemented the requirements of SFAS No. 123 in 1996 and has elected to adopt the disclosure provisions of this statement. At December 31, 1998, the Company had one stock option plan, which is described above. The Company applies Accounting Principles Board ("APB") Opinion No. 25 and related interpretations in accounting the Bancorp Plan. Accordingly, no compensation cost has been recognized for its stock option plan. Had compensation for the Company's stock option plan been determined consistent with SFAS No. 123, the Company's net income per share would have been reduced to the pro forma amounts indicated below (the following reflects the impact of the 2-for-1 stock split):
December 31, ------------------------------------------------- (Dollars in thousands, except per share amounts) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------ Net Income: As reported $18,943 $13,424 $7,763 Pro forma $18,045 $12,999 $7,483 Basic net income per share As reported $ 1.74 $ 1.29 $ 0.78 Pro forma $ 1.66 $ 1.25 $ 0.75 Diluted net income per share As reported $ 1.63 $ 1.19 $ 0.72 Pro forma $ 1.55 $ 1.16 $ 0.70
The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted average assumptions for grants in 1998, 1997 and 1996, respectively; dividend yield of 1.75%, 1.8% and 2.0%; expected volatility of 39.84%, 22.9% and 19.3%; risk free rates of 4.54%, 6.3% and 6.0%. No adjustments have been made for forfeitures. The actual value, if any, that the option holder will realize from these options will depend solely on the increase in the stock price over the option price when the options are exercised. A summary of the Company's stock option plan as of December 31, 1998, 1997, and 1996 and changes during the years ended on those dates is presented below (as adjusted for the 2 for 1 stock split):
1998 1997 1996 ------------------------------------------------------------------------------- Weighted Weighted Weighted Shares Average Shares Average Shares Average (000's) Exercise Price (000's) Exercise Price (000's) Exercise Price - ------------------------------------------------------------------------------------------------------------------------------ Outstanding at beginning of year 1,295 $10.93 1,321 $ 7.01 1,499 $ 5.12 Granted 564 31.15 409 22.50 496 10.09 Exercised (281) 6.90 (414) 4.23 (397) 3.93 Forfeited (65) 16.39 (21) 5.27 (32) 6.03 ----------------------------------------------------------------------------------- Outstanding at end of year 1,512 17.83 1,295 11.27 1,566 7.62 ----------------------------------------------------------------------------------- Options exercisable at year-end 726 9.28 780 7.37 629 6.30 ----------------------------------------------------------------------------------- Weighted average fair value of options granted during the year $11.58 $ 6.25 $ 2.88 -----------------------------------------------------------------------------------
48 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 The following table summarizes information about stock options outstanding at December 31, 1998 (as adjusted for the 2-for-1 stock split).
Options Outstanding ------------------------------------------------------------------- ---------------------------------- Number Weighted Number Exercise Outstanding Average Weighted Average Exercisable Weighted Average Price Range (000's) Exercise Price Remaining Life (years) (000's) Exercise Price - ------------------------------------------------------------------------------------------ ---------------------------------- $3.06 - $4.68 83 $ 3.70 1.7 83 $ 3.70 $4.86 - $9.38 512 6.78 5.7 426 6.57 $10.88 - $17.00 221 11.34 7.9 121 11.49 $17.13 - $25.00 389 22.41 8.4 103 21.20 $25.38 - $30.00 78 27.85 9.4 - - $31.50 - $38.50 474 33.61 9.9 - -
401(k) Savings Plan The Company has a 401(k) tax deferred savings plan under which eligible employees may elect to defer a portion of their salary (up to 15%) as a contribution to the plan. The Company matches the employees contributions at a rate set by the Board of Directors (currently 62.5% of the first 8% of deferral of an individual's total compensation). The matching contribution vests ratably over the first four years of employment. The Company has merged the 401(k) plans of PBC and Golden Gate into the Company's plan. For the years ended December 31, 1998, 1997 and 1996, the Company contributed $812,000, $672,000 and $379,000, respectively to the 401(k) plans. Employee Stock Purchase Plan The Company has established an Employee Stock Purchase Plan, as amended, under section 423(b) of the Internal Revenue Code which allows eligible employees to set aside up to 15% of their compensation toward the purchase of the Company's stock for an aggregate total of 267,868 shares. Under the plan the purchase price is 85% of the lower of the fair market value at the beginning or end of each three month offering period. During 1998, employees purchased 29,670 shares of common stock for an aggregate purchase price of $656,000 compared to the purchase of 30,320 shares of common stock for an aggregate purchase price of $347,000 in 1997 and 21,264 shares of common stock for an aggregate purchase price of $137,000 in 1996. There were 104,646 shares remaining in the plan available for purchase by employees at December 31, 1998. All shares amounts have been restated to reflect the 2-for-1 stock split declared to shareholders of record as of April 30, 1998. Supplemental Employee Compensation Benefits Agreements The Company has entered into supplemental employee compensation benefits agreements with certain executive and senior officers. Under these agreements, the Company is generally obligated to provide for each such employee or their beneficiaries, during a period of up to 15 to 20 years after the employee's death, disability or retirement, annual benefits as defined in each specific agreement. The estimated present value of future benefits to be paid is being accrued over the vesting period of the participants. Expenses accrued for this plan for the years ended December 31, 1998, 1997 and 1996 totaled $841,000, $590,000 and $367,000, respectively. The related accumulated accrued liability of at December 31, 1998 is approximately $2.2 million. Depending on the agreement, the Company and the employees are beneficiaries of life insurance policies that have been purchased as a method of financing the benefits under the agreements. At December 31, 1998 and 1997, the Company's cash surrender value of these policies was approximately $32.4 million and $9.4 million, respectively and is included in other assets. Income earned on those policies were $499,000, $444,000 and $378,000 for years ended December 31, 1998, 1997 and 1996, respectively. 49 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 Stock Appreciation Rights BA Bancshares has a stock appreciation rights (SAR) plan under which the Board of Directors may award up to 200,000 units to employees. The SAR can be redeemed for the amount by which the fair market value of a share of common stock on the date of exercise exceeds the SAR's grant price as established by the Board. The SAR becomes fully exercisable based on a vesting schedule established by the Board which generally does not exceed five years. Each SAR expires ten years from the date the SAR awarded. Compensation cost recognized for SAR's granted under the plan totaled approximately $111,000, $222,000 and $75,000 for 1998, 1997 and 1996, respectively. The SAR plan was cancelled prior to the close of the merger between BA Bancshares and the Company and all benefits accrued under this plan were disbursed in 1999. Deferred Compensation Plan Effective November 19, 1997, the Company adopted the Greater Bay Bancorp 1997 Elective Deferral Compensation Plan (the "Deferred Plan") that allows eligible officers and directors of the Company to defer a portion of their bonuses, director fees and other compensation. The deferred compensation will earn interest calculated annually based on a short-term interest reference rate. All participants are fully vested at all times in their contributions to the Deferred Plan. At December 31, 1998, $834,000 of deferred compensation under this plan is included in other liabilities in the accompanying consolidated balance sheets. Additionally, under deferred compensation agreements that were established at PBC prior to its merger with the Company, there was approximately $1.1 million of deferred compensation which is included in other liabilities. Change of Control In the event of a change in control, the supplemental employee compensation benefits agreements with certain executive and senior officers may require payments to be made by the Company that are currently not recognized in the accompanying consolidated financial statements. NOTE 14--RELATED PARTY TRANSACTIONS Loans made to executive officers, directors and their affiliates, are made subject to approval by the Directors' Loan Committee and the Board of Directors. An analysis of total loans to related parties for the years ended December 31, 1998 and 1997 is shown below:
(Dollars in thousands) 1998 1997 - ------------------------------------------------------------------- Balance, January 1 $ 17,704 $ 11,923 Additions 32,924 16,584 Repayments (13,128) (10,803) ---------------------------- Balance, December 31 $ 37,500 $ 17,704 ============================ Undisbursed commitments, at year end $ 5,862 $ 8,572 ============================
50 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 NOTE 15--COMMITMENTS AND CONTINGENT LIABILITIES Lease Commitments The Company leases certain facilities at which it conducts its operations. Future minimum lease commitments under all noncancelable operating leases as of December 31, 1998 are below:
(Dollars in thousands) Years Ended December 31, - ------------------------------------------------------------------ 1999 $ 3,792 2000 3,855 2001 3,887 2002 3,410 2003 1,871 Thereafter 8,864 ------------- Total $25,679 =============
The Company subleases that portion of the available space that is not utilized. Sublease rental income for the years ended December 31, 1998, 1997, and 1996 was $607,000, $882,000, and $309,000, respectively. Gross rental expense for the years ended December 31, 1998, 1997, and 1996 was $3.5 million, $3.2 million, and $2.4 million, respectively. Other Commitments and Contingent Liabilities In the normal course of business, various commitments and contingent liabilities are outstanding, such as guarantees and commitments to extend credit, that are not reflected in the accompanying consolidated financial statements. Commitments to fund loans were $521.4 million and $367.0 million and standby letters of credit were $17.1 million and $16.3 million, at December 31, 1998 and 1997, respectively. The Company's exposure to credit loss is limited to amounts funded or drawn; however, at December 31, 1998, no losses are anticipated as a result of these commitments. Loan commitments which have fixed expiration dates and require the payment of a fee are typically contingent upon the borrower meeting certain financial and other covenants. Approximately $135.9 million of these commitments relate to real estate construction and land loans and are expected to fund within the next 12 months. However, the remainder relates primarily to revolving lines of credit or other commercial loans, and many of these commitments are expected to expire without being drawn upon, therefore the total commitments do not necessarily represent future cash requirements. The Banks evaluate each potential borrower and the necessary collateral on an individual basis. Collateral varies, but may include real property, bank deposits, debt or equity securities, or business assets. Stand-by letters of credit are conditional commitments written by the Banks to guarantee the performance of a client to a third party. These guarantees are issued primarily related to purchases of inventory by the Banks' commercial clients, and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to clients, and the Banks accordingly use evaluation and collateral requirements similar to those for loan commitments. In the ordinary course of business there are various assertions, claims and legal proceedings pending against the Company. Management is of the opinion that the ultimate resolution of these proceedings will not have a material adverse effect on the consolidated financial position or results of operations of the Company. NOTE 16--SHAREHOLDERS' RIGHTS PLAN In 1998 Greater Bay adopted a shareholder rights plan designed to maximize the long-term value of the Company and to protect the Company's shareholders from improper takeover tactics and takeover bids that are not fair to all shareholders. 51 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 In accordance with the plan, preferred share purchase rights were distributed as a dividend at the rate of one right for each common share held of record as of the close of business on November 28, 1998. The rights, which are not immediately exercisable, entitle the holders to purchase one one-hundredth of a share of Series A Preferred Stock at a price of $145.00 upon the occurrence of certain triggering events. In the event of an acquisition not approved by the Board, each right enables its holder (other than the acquirer) to purchase the Preferred Stock at 50% of the market price. Further, in the event the Company is acquired in an unwanted merger or business combination, each right enables the holder to purchase shares of the acquiring entity at a similar discount. Under certain circumstances, the rights may be exchanged for common shares of the Company. The Board may, in its sole discretion, redeem the rights at any time prior to any of the triggering events. The rights can be exercised and separate rights certificates distributed only if any of the following events occur: acquisition by a person of 10% or more of the Company's common share; a tender offer for 10% or more of the Company's common shares; or ownership of 10% or more of the Company's common shares by a shareholder whose actions are likely to have a material adverse impact on the Company or shareholder interests. The rights will initially trade automatically with the common shares. The rights are not deemed by the Board of Directors to be presently exercisable. NOTE 17--REGULATORY MATTERS The Company and the Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of the Banks' assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum capital amounts and ratios (as defined in the regulations) and are set forth in the table below. At December 31, 1998 and 1997 the Company and the Banks met all capital adequacy requirements to which they are subject. As of December 31, 1998, the most recent notification from the regulators categorized the Company and the Banks as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Company and the Banks must maintain minimum total risk-based, Tier 1 risk- based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that determination that management believes have changed the institution's category. The Company and the Bank's actual 1998 and 1997 capital amounts and ratios are as follows: 52 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996
To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions As of December 31, 1998 ------------------- ----------------------- ----------------------- (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio - --------------------------------------------------------------------- ----------------------- ----------------------- Total Capital (To Risk Weighted Assets): Greater Bay Bancorp $175,468 12.90% $ 108,779 8.00% N/A Bay Area Bank 15,800 13.77 9,179.36 8.00 $11,474 10.00% Cupertino National Bank 59,224 10.12 46,822 8.00 58,527 10.00 Golden Gate Bank 10,194 11.01 7,406 8.00 9,257 10.00 Mid-Peninsula Bank 47,111 11.51 32,747 8.00 40,934 10.00 Peninsula Bank of Commerce 18,256 12.37 11,809 8.00 14,761 10.00 Tier 1 Capital (To Risk Weighted Assets): Greater Bay Bancorp $142,440 10.48% $ 54,390 4.00% N/A Bay Area Bank 14,365 12.52 4,590 4.00 $ 6,885 6.00% Cupertino National Bank 48,845 8.35 23,411 4.00 35,116 6.00 Golden Gate Bank 9,036 9.76 3,703 4.00 5,554 6.00 Mid-Peninsula Bank 41,990 10.26 16,373 4.00 24,560 6.00 Peninsula Bank of Commerce 16,408 11.12 5,904 4.00 8,857 6.00 Tier 1 Capital Leverage (To Average Assets): Greater Bay Bancorp $142,440 8.29% $ 68,701 4.00% N/A Bay Area Bank 14,365 10.34 4,589.68 4.00 $ 6,948 5.00% Cupertino National Bank 48,845 7.47 26,138 4.00 32,673 5.00 Golden Gate Bank 9,036 9.30 5,243 4.00 6,554 5.00 Mid-Peninsula Bank 41,990 8.54 15,927 3.00 26,544 5.00 Peninsula Bank of Commerce 16,408 6.65 9,759 4.00 12,198 5.00 To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions As of December 31, 1997 ------------------- ----------------------- ----------------------- (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio - --------------------------------------------------------------------- ----------------------- ----------------------- Total Capital (To Risk Weighted Assets): Greater Bay Bancorp $122,445 12.35% $ 79,293 8.00% N/A Bay Area Bank 11,850 12.79% 7,411 8.00 $ 9,264 10.00% Cupertino National Bank 40,201 10.03 32,118 8.00 40,147 10.00 Golden Gate Bank 9,408 12.80 5,878 8.00 7,347 10.00 Mid-Peninsula Bank 34,727 11.88 23,416 8.00 29,269 10.00 Peninsula Bank of Commerce 15,252 14.33 8,525 8.00 10,657 10.00 Tier 1 Capital (To Risk Weighted Assets): Greater Bay Bancorp $107,008 10.80% $ 39,646 4.00% N/A Bay Area Bank 10,692 11.54 3,705 4.00 $ 5,558 6.00% Cupertino National Bank 32,126 8.02 16,059 4.00 24,088 6.00 Golden Gate Bank 8,523 11.60 2,939 4.00 4,408 6.00 Mid-Peninsula Bank 31,064 10.63 11,708 4.00 17,562 6.00 Peninsula Bank of Commerce 13,917 13.08 4,263 4.00 6,394 6.00 Tier 1 Capital Leverage (To Average Assets): Greater Bay Bancorp $107,008 8.50% $ 50,378 4.00% N/A Bay Area Bank 10,692 9.49 4,505 4.00 $ 5,631 5.00% Cupertino National Bank 32,126 7.08 18,189 4.00 22,737 5.00 Golden Gate Bank 8,523 9.30 3,666 4.00 4,582 5.00 Mid-Peninsula Bank 31,064 8.54 10,935 3.00 18,225 5.00 Peninsula Bank of Commerce 13,917 6.65 8,401 4.00 10,501 5.00
53 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 NOTE 18--RESTRICTIONS ON SUBSIDIARY TRANSACTIONS Total dividends which may be declared by the Banks without receiving prior approval from regulatory authorities are limited to the lesser of the Banks' retained earnings or the net income of the Banks for the latest three fiscal years, less dividends previously declared during that period. The Banks are subject to certain restrictions under the Federal Reserve Act, including restrictions on the extension of credit to affiliates. In particular, the Banks are prohibited from lending to Greater Bay unless the loans are secured by specified types of collateral. Such secured loans and other advances from the Banks are limited to 10% of the Bank's shareholders' equity, or a maximum of $9.3 million at December 31, 1998. No such advances were made during 1998 or exist as of December 31, 1998. NOTE 19--PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS The financial statements of Greater Bay Bancorp (parent company only) are presented below: Parent Company Only--Balance Sheets
December 31, (Dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------------- Assets: Cash and cash equivalents $ 6,071 $ 5,430 Investment in subsidiaries 131,686 97,282 Other investments 17,936 5,717 Subordinated debentures issued by subsidiary 3,000 3,000 Other assets 9,457 3,993 ------------------------------ Total assets $168,150 $115,422 ============================== Liabilities and shareholders' equity: Subordinated debt 54,547 - Other liabilities 6,562 3,276 ------------------------------ Total liabilities 61,109 3,276 Shareholders' equity: Common stock 71,648 64,257 Accumulated other comprehensive income (96) - Retained earnings 35,489 - ------------------------------ Total shareholders' equity 107,041 64,257 ------------------------------ Total liabilities and shareholders' equity $168,150 $ 67,533 ==============================
54 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 Parent Company Only--Income Statements
Years Ended December 31, (Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------- Income: Interest income $ 1,021 $ 400 $ 533 Other income 47 477 367 ------------------------------------------- Total 1,068 877 900 ------------------------------------------- Provision for loan losses - - 113 Expenses: Interest expense 3,195 1,458 - Salaries 8,908 5,978 135 Occupancy and equipment 1,966 1,154 461 Other expenses 5,324 2,599 1,709 Less: rentals and fees received from Banks (15,866) (10,201) (460) ------------------------------------------- Total 3,527 988 1,845 ------------------------------------------- Loss before taxes and equity - - in undistributed net income of subsidiaries (2,459) (111) (1,058) Income tax expense (1,616) (249) 21 ------------------------------------------- Income (loss) before equity in undistributed - net income of subsidiaries (843) 138 (1,079) ------------------------------------------- Equity in undistributed net income of - - subsidiaries 19,786 13,286 8,842 ------------------------------------------- Net income $ 18,943 $ 13,424 $ 7,763 ===========================================
55 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 Parent Company Only--Statements of Cash Flows
Years Ended December 31, ----------------------------------------------------- (Dollars in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Cash flows-operating activities Net income $ 18,943 $ 13,424 $ 7,763 Reconciliation of net income to net cash from operations: Equity in undistributed net income of subsidiaries (19,786) (13,286) (8,842) Net change in other assets (4,443) (1,926) 271 Net change in other liabilities 2,135 2,547 155 ----------------------------------------------------- Operating cash flow, net (3,151) 759 (653) ----------------------------------------------------- Cash flows-investing activities Purchases of available for sale securities (84,130) (8,293) - Proceeds from sale and maturities of available for sale securities 71,939 3,156 - Proceeds from sale of OREO 407 - - Principal repayment of loans receivable - - 113 Dividends from subsidiaries 3,249 3,617 769 Capital contribution to the subsidiaries (17,500) (13,818) (1,003) ----------------------------------------------------- Investing cash flows, net (26,035) (15,338) (121) ----------------------------------------------------- Cash flows-financing activities Net increase in notes receivable (63) (470) - Proceeds from issuance of subordinated debt 30,000 20,618 - Proceeds from exercise of stock options and employees stock purchases 5,435 3,426 2,034 Payment of cash dividends (5,545) (4,320) (2,588) ----------------------------------------------------- Financing cash flows, net 29,827 19,254 (554) ----------------------------------------------------- Net increase in cash and cash equivalents 641 4,675 (1,215) Cash and cash equivalents at the beginning of the year 5,430 755 1,970 ----------------------------------------------------- Cash and cash equivalents at end of the year $ 6,071 $ 5,430 $ 755 =====================================================
56 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 NOTE 20--FAIR VALUE OF FINANCIAL INSTRUMENTS Fair value estimates, methods and assumptions are set forth below for the Company's financial instruments. The estimated fair value of financial instruments of the Company as of December 31, 1998 and 1997 are as follows:
1998 1997 ------------------------------------------------------------ Carrying Carrying (Dollars in thousands) Amount Fair Value Amount Fair Value - ---------------------------------------------------------------------------------------------------------------------- Financial assets: Cash and due from banks $ 69,583 $ 69,583 $ 64,631 $ 64,631 Short term investments 140,376 140,376 186,049 185,880 Investment securities 357,511 359,184 228,715 231,701 Loans, net 1,092,603 1,097,956 819,607 801,539 Accrued interest receivable - - - - Financial liabilities: Deposits: Demand, noninterest-bearing 302,006 302,006 247,743 247,743 MMDA, NOW and Savings 922,581 922,581 675,632 675,633 Time certificates, $100,000 and over 190,312 182,595 203,408 203,156 Other time certificates 64,048 78,292 51,791 51,773 Other borrowings 75,085 76,656 33,355 20,481 Subordinated debt 3,000 2,999 3,000 3,337 Company obligated mandatory redeemable preferred securities of subsidiary trust holding solely junior subordinated debentures 50,000 49,829 20,000 21,210
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value. Cash and Cash Equivalents The carrying value reported in the balance sheet for cash and cash equivalents approximates fair value. Investment Securities The carrying amounts for short-term investments approximate fair value because they mature in 90 days or less and do not present unanticipated credit concerns. The fair value of longer term investments, except certain state and municipal securities, is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, as such, fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued. Loans Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage and consumer. Each loan category is further segmented into fixed and adjustable rate interest terms. 57 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 The fair value of performing fixed rate loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. The fair value of performing variable rate loans is judged to approximate book value for those loans whose rates reprice in less than 90 days. Rate floors and rate ceilings are not considered for fair value purposes as the number of loans with such limitations is not significant. Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information. Deposit Liabilities and Borrowings The fair value for all deposits without fixed maturities and short term borrowings is considered to be equal to the carrying value. The fair value for fixed rate time deposits and subordinated debt are estimated by discounting future cash flows using interest rates currently offered on time deposits or subordinated debt with similar remaining maturities. Derivative Instruments The fair value of the single interest rate swap the Company uses as a cash flow hedge on the TPS II is estimated by discounting future cash flows using current interest rates. The fair value of the hedge is presented in the above table with the fair value of the related TPS II. Commitments to Extend Credit and Standby Letters of Credit The majority of the Company's commitments to extend credit carry current market interest rate if converted to loans. Because these commitments are generally unassignable by either the Company or the borrower, they only have value to the Company and the borrower. The estimated fair value approximates the recorded deferred fee amounts and is excluded from the table. Limitations Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale, at one time, the Company's entire holdings of a particular financial instrument. Fair value estimates are based on judgments regarding future expected loss experience, current economic condition, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have significant effect on fair value estimates and have been considered in many of the estimates. NOTE 21--SUBSEQUENT EVENT On May 21, 1999 the Company completed a merger with Bay Area Bancshares ("BA Bancshares"), the holding company of Bay Area Bank ("BAB"). Per the terms of the agreement BA Bancshares shareholders received approximately 1,399,000 shares of Greater Bay Bancorp stock, in a tax-free exchange to be accounted for as a pooling-of-interest. Following the 58 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996 transaction, the shareholders of BA Bancshares own approximately 12.7% of the combined company. BAB's office is located in Redwood City, California. NOTE 22--ACTIVITY OF BUSINESS SEGMENTS In 1998 the Company adopted SFAS No. 131. The prior year's segment information has been restated to present the Company's two reportable segments, community banking and trust operations. The accounting policies of the segments are the same as those described in the "Summary of Significant Accounting Policies." Segment data includes intersegment revenue, as well as charges allocating all corporate-headquarters costs to each of its operating segments. The Company evaluates the performances of its segments and allocates resources to them based on net interest income, other income, net income before income taxes, total assets and deposits. The Company is organized primarily along community banking and trust divisions. Eleven of the divisions have been aggregated into the "community banking" segment. Community banking provides a range of commercial banking services to small and medium-sized businesses, real estate developers, property managers, business executives, professional and other individuals. The GBB Trust division has been shown as the "trust operations" segment. The Company's business is conducted principally in the U.S.; foreign operations are not material. The following table shows each segments key operating results and financial position for the years ended or as of December 31, 1998, 1997 and 1996:
1998 1997 1996 -------------------------- -------------------------- -------------------------- Community Trust Community Trust Community Trust (Dollars in thousands) banking operations banking operations banking operations - ------------------------------------------------------------------------------------------------------------------------- Net interest income $ 74,732 $ 859 $ 61,926 $ 141 $ 44,899 $ 501 Other income 7,185 2,488 6,939 2,092 5,962 1,340 Operating expenses 43,675 2,429 37,745 1,966 31,776 1,898 Net income before income taxes (1) 29,546 918 21,000 267 13,813 (57) Total assets 1,691,640 - 1,313,920 - 1,011,484 - Deposits 1,411,408 67,539 1,112,253 66,321 872,384 41,717 Assets under management - 649,336 - 577,746 - 418,053
(1) Includes intercompany earnings alloaction charge which is eliminated in consolidation A reconciliation of total segment net interest income and other income combined, net income before income taxes, and total assets to the consolidated numbers in each of these categories for the years ended December 31, 1998, 1997 and 1996 is presented below. 59 THE GREATER BAY BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years December 31, 1998, 1997 and 1996
(Dollars in thousands) 1998 1997 1996 - ------------------------------------------------- ----------------- ----------------- ----------------- Net interest income and other income Total segment net interest income and other income $ 85,264 $ 71,098 $ 52,702 Parent company net interest income and other income 1,782 2,162 4,647 ----------------- ----------------- ----------------- Consolidated net interest income and other income 87,046 73,260 57,349 ================= ================= ================= Net income before taxes Total segment net income before taxes $ 30,464 $ 21,267 $ 13,756 Parent company net income before taxes (2,459) (111) (1,058) ----------------- ----------------- ----------------- Consolidated net income before taxes $ 28,005 21,156 12,698 ================= ================= ================= Total assets Total segment assets $ 1,691,640 $ 1,313,920 $ 1,011,483 Parent company assets 46,549 25,830 11,628 ----------------- ----------------- ----------------- Consolidated total assets $ 1,738,189 $ 1,339,750 $ 1,023,111 ================= ================= =================
NOTE 23--QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
December 31, September 30, June 30, March 31, ------------------- ------------------ ------------------ ------------------- (Dollars in thousands, except per share data) (1) 1998 1997 1998 1997 1998 1997 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------------- Interest income $33,152 $27,540 $32,998 $25,540 $30,473 $23,857 $28,175 $21,324 Net interest income 19,637 17,051 18,961 15,851 17,940 14,536 16,880 13,571 Provision for loan losses 1,941 1,169 1,881 1,344 1,377 2,420 1,036 2,093 Other income 3,101 2,212 2,313 2,214 2,185 3,207 2,121 1,425 Other expenses 12,763 11,215 11,522 9,996 10,826 9,798 11,325 7,783 Income before taxes 8,074 6,939 7,961 6,785 7,952 5,604 6,680 5,160 Net income 5,628 2,301 5,015 4,292 3,846 3,576 4,454 3,255 Net income per share: Basic $ 0.51 $ 0.20 $ 0.46 $ 0.41 $ 0.35 $ 0.34 $ 0.43 $ 0.31 Diluted $ 0.48 $ 0.18 $ 0.43 $ 0.43 $ 0.33 $ 0.37 $ 0.39 $ 0.34
*Quarterly amounts have been restated on a historical basis to reflect the mergers with Peninsula Bank of Commerce, Pacific Rim Bancorporation, Pacific Business Funding Corporation and Bay Area Bancshares on a pooling of interests basis. 60 REPORT OF INDEPENDENT ACCOUNTANTS San Francisco, California June 30, 1999 The Board of Directors and Shareholders Greater Bay Bancorp In our opinion, the accompanying supplemental consolidated balance sheets and the related supplemental consolidated statements of operations, comprehensive income, shareholders' equity, and cash flows present fairly, in all material respects, the financial position of Greater Bay Bancorp and Subsidiaries (the Company) at December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These supplemental financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these supplemental financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards, which require that we plan and perform the audits to obtain reasonable assurance about whether the supplemental financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As discussed in Note 1 to the supplemental consolidated financial statements, the Company changed its method of accounting for derivative instruments in 1998. /s/ PricewaterhouseCoopers LLP 61 EX-99.2 11 CONSOLIDATED FINANCIAL STMTS FOR 3/31/99 & 98 Exhibit 99.2
GREATER BAY BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS March 31, 1999* December 31, (Dollars in thousands) (unaudited) 1998* - ----------------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 79,244 $ 69,583 Federal funds sold 106,400 62,800 Other short term securities 67,209 77,576 ------------------------------------------- Cash and cash equivalents 252,853 209,959 Investment securities: Available for sale, at fair value 264,640 257,258 Held to maturity, at amortized cost (fair value $97,122 and $94,890 at March 31, 1999 and December 31, 1998, respectively) 97,502 94,209 Other securities 6,091 6,044 ------------------------------------------- Investment securities 368,233 357,511 Loans: Commercial 594,546 483,668 Real estate construction and land 219,993 215,274 Real estate term 352,820 332,478 Consumer and other 96,469 88,458 Deferred loan fees and discounts (4,903) (3,896) ------------------------------------------- Total loans, net of deferred fees 1,258,925 1,115,982 Allowance for loan losses (24,046) (23,379) ------------------------------------------- Total loans, net 1,234,879 1,092,603 Property, premises and equipment 12,994 11,380 Interest receivable and other assets 69,493 66,736 ------------------------------------------- Total assets $1,938,452 $1,738,189 =========================================== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand, noninterest-bearing $ 316,054 $ 302,006 MMDA, NOW and savings 996,855 922,581 Time certificates, $100,000 and over 298,959 190,312 Other time certificates 63,976 64,048 ------------------------------------------- Total deposits 1,675,844 1,478,947 Other borrowings 72,635 75,085 Subordinated debt - 3,000 Company obligated mandatorily redeemable cumulative trust preferred securities of subsidiary trust holding solely junior subordinated debentures 50,000 50,000 Other liabilities 26,735 24,116 ------------------------------------------- Total liabilities 1,825,214 1,631,148 ------------------------------------------- Commitments and contingencies SHAREHOLDERS' EQUITY Preferred stock, no par value: 4,000,000 shares authorized; none issued - - Common stock, no par value: 24,000,000 shares authorized; 11,135,924 and 11,004,529 shares issued and outstanding as of March 31, 1999 and December 31, 1998, respectively 63,392 62,179 Accumulated other comprehensive income (loss) 388 (98) Retained earnings 49,458 44,960 ------------------------------------------- Total shareholders' equity 113,238 107,041 ------------------------------------------- Total liabilities and shareholders' equity $1,938,452 $1,738,189 =========================================== * Restated on an historical basis to reflect the merger with Bay Area Bancshares ("BA Bancshares") on a pooling of interests basis. See notes to consolidated financial statements.
1
GREATER BAY BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Three Months Ended March 31, --------------------------------------------------- (Dollars in thousands, except per share amounts) (unaudited) 1999* 1998* - ----------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Interest on loans $27,476 $21,644 Interest on investment securities: Taxable 4,597 3,584 Tax - exempt 746 328 --------------------------------------------------- Total interest on investment securities 5,343 3,912 Other interest income 1,642 2,619 --------------------------------------------------- Total interest income 34,461 28,175 --------------------------------------------------- INTEREST EXPENSE Interest on deposits 11,796 9,556 Interest on long term borrowings 2,019 890 Interest on other borrowings 106 809 --------------------------------------------------- Total interest expense 13,921 11,255 --------------------------------------------------- Net interest income 20,540 16,920 Provision for loan losses 921 1,036 --------------------------------------------------- Net interest income after provision for loan losses 19,619 15,884 --------------------------------------------------- OTHER INCOME Trust fees 721 550 ATM network revenue 527 451 Service charges and other fees 419 480 Gain on sale of SBA loans 284 244 Gain on sale of investments, net - 8 Other income (loss) 602 (109) --------------------------------------------------- Total, recurring 2,553 1,624 Warrant income 4 497 --------------------------------------------------- Total other income 2,557 2,121 --------------------------------------------------- OPERATING EXPENSES Compensation and benefits 7,169 6,098 Occupancy and equipment 2,355 1,638 Telephone, postage and supplies 593 497 Legal and other professional fees 575 541 Marketing and promotion 407 165 Client services 261 157 FDIC insurance and regulatory assessments 100 97 Insurance 57 79 Other real estate owned 21 23 Contribution to the GBB Foundation - 701 Other 1,153 1,329 --------------------------------------------------- Total operating expenses 12,691 11,325 --------------------------------------------------- Income before provision for income taxes and extraordinary items 9,485 6,680 Provision for income taxes 3,695 2,226 --------------------------------------------------- Net income before extraordinary items 5,790 4,454 Extraordinary items (88) - --------------------------------------------------- Net income $ 5,702 $ 4,454 =================================================== Net income per share - basic** $0.53 $0.43 =================================================== Net income per share - diluted** $0.50 $0.40 ===================================================
* Restated on an historical basis to reflect the merger with Pacifi c Rim Bancorporation ("PRB"), Pacific Business Funding Corporation and Bay Area Bancshares ("BA Bancshares") on a pooling of interests basis. ** Restated to reflect 2-for-1 stock split declared for shareholders of record as of April 30, 1998. See notes to consolidated financial statements. 2 GREATER BAY BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended March 31, ------------------------------------------------- (Dollars in thousands) (unaudited) 1999* 1998* - ------------------------------------------------------------------------------------------------------------------------------- Net income $5,702 $4,454 ------------------------------------------------- Other comprehensive income: Unrealized gains on securities: Unrealized holding gains arising during period (net of taxes of $(276) and $79 for the three months ended March 31, 1999 and 1998, respectively) (395) 113 Less: reclassification adjustment for gains included in net income (net of taxes of $0 and $3 for the three months ended March 31, 1999 and 1998, respectively) - 5 ------------------------------------------------- Net change (395) 108 Cash flow hedge: Net derivative gains arising during period (net of taxes of $586 for the three months ended March 31, 1999) 838 - Less: reclassification adjustment for swap settlements included in net income (net of taxes of $(30) for the three months ended March 31, 1999 and 1998) (43) - ------------------------------------------------- Net change 881 - ------------------------------------------------- Other comprehensive income 486 108 ------------------------------------------------- Comprehensive income $6,188 $4,562 =================================================
* Restated on an historical basis to reflect the merger with Pacific Rim Bancorporation ("PRB"), Pacific Business Funding Corporation and Bay Area Bancshares ("BA Bancshares") on a pooling of interests basis. See notes to consolidated financial statements. 3 GREATER BAY BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, ------------------------------------------------- (Dollars in thousands) (unaudited) 1999* 1998* - ---------------------------------------------------------------------------------------------------------------------- Cash flows - operating activities Net income $ 5,702 $ 4,454 Reconcilement of net income to net cash from operations: Provision for loan losses 921 1,036 Depreciation and amortization 1,131 760 Deferred income taxes (251) (17) (Gain) loss on sale of investments, net - 44 Changes in: Accrued interest receivable and other assets (1,255) (2,201) Accrued interest payable and other liabilities 4,119 12,333 Deferred loan fees and discounts, net 893 200 --------------------- -------------------- Operating cash flows, net 11,260 16,609 --------------------- -------------------- Cash flows - investing activities Maturities and partial paydowns on of investment securities: Held to maturity 4,094 7,223 Available for sale 16,487 25,145 Purchase of investment securities: Held to maturity (7,315) (440) Available for sale (43,600) (59,381) Other securities (47) (44) Proceeds from sale of available for sale securities 18,595 2,308 Loans, net (144,088) (35,584) Proceeds from sale of other real estate owned 345 - Purchase of property, premises and equipment (2,356) (676) Purchase of insurance policies (1,935) (18,122) --------------------- -------------------- Investing cash flows, net (159,820) (79,571) --------------------- -------------------- Cash flows - financing activities Net change in deposits 196,897 40,038 Net change in other borrowings - short term (2,451) (7,213) Proceeds from other borrowings - long term - 60,000 Principal repayment - long term borrowings (3,000) - Proceeds from sale of common stock 1,294 718 Cash dividends (1,286) (1,125) --------------------- -------------------- Financing cash flows, net 191,454 92,418 --------------------- -------------------- Net change in cash and cash equivalents 42,894 29,456 Cash and cash equivalents at beginning of period 209,959 250,680 --------------------- -------------------- Cash and cash equivalents at end of period $ 252,853 $280,136 ===================== ==================== Cash flows - supplemental disclosures Cash paid during the period for: Interest $ 13,388 $ 10,274 Income taxes $ 400 $ 1,830 Non-cash transactions: Additions to other real estate owned $ - $ 105
* Restated on an historical basis to reflect the merger with Pacific Rim Bancorporation ("PRB"), Pacific Business Funding Corporation and Bay Area Bancshares ("BA Bancshares") on a pooling of interests basis. See notes to consolidated financial statements. 4 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of March 31, 1999 and 1998 and for the Three months ended March 31, 1999 and 1998 NOTE 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The results of operations for the quarter ended March 31, 1999 are not necessarily indicative of the results expected for any subsequent quarter or for the entire year ended December 31, 1999. The financial statements should be read in conjunction with the consolidated financial statements, and the notes thereto, included in the Annual Report on Form 10-K for the year-end December 31, 1998. Consolidation and Basis of Presentation The supplemental consolidated financial statements include the accounts of Greater Bay Bancorp ("Greater Bay" on a parent-only basis, and the "Company" on a consolidated basis) and its wholly owned subsidiaries, Mid- Peninsula Bank ("MPB"), Cupertino National Bank ("CNB"), Peninsula Bank of Commerce ("PBC"), Golden Gate Bank ("Golden Gate"), Bay Area Bank ("BAB"), GBB Capital I and GBB Capital II and its operating divisions Greater Bay Bank Santa Clara Valley Commercial Banking Group, Greater Bay Corporate Finance Group, Greater Bay Bank Contra Costa Banking Office, Greater Bay International Banking Division, Greater Bay Trust Company, Pacific Business Funding and Venture Banking Group. All significant intercompany transactions and balances have been eliminated. Certain reclassifications have been made to prior years' consolidated financial statements to conform to the current presentation. The accounting and reporting policies of the Company conform to generally accepted accounting principles and the prevailing practices within the banking industry. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of certain revenues and expenses during the reporting period. Actual results could differ from those estimates. Comprehensive Income On January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income". This statement requires companies to classify items of other comprehensive income by their nature in the financial statements and display the accumulated other comprehensive income separately from retained earnings in the equity section of the balance sheet. The changes to the balances of accumulated other comprehensive income are as follows:
Accumulated Unrealized Gains Cash Flow Other Comprehensive (Dollars in thousands) on Securities Hedges Income (Loss) - --------------------------------------------------------------------------------------------------------- Balance - as of December 31, 1998 $ 579 $(677) $(98) Current period change (395) 881 486 ----------------------------------------------------------------- Balance - as of March 31, 1999 $ 184 $ 204 $ 388 =================================================================
5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) As of March 31, 1999 and 1998 and for the Three months ended March 31, 1999 and 1998 Per Share Data Net income per share is stated in accordance with SFAS No. 128 "Earnings per Share". Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the year. Diluted net income per share is computed by dividing net income by the weighted average number of common shares plus common equivalent shares outstanding including dilutive stock options. All years presented include the effect of the 2-for-1 stock split effective as of April 30, 1998. The following table provides a reconciliation of the numerators and denominators of the basic and diluted net income per share computations for the three months ended March 31, 1999 and 1998.
For the three months ended March 31, 1999 For the three months ended March 31, 1998 ----------------------------------------------- -------------------------------------------- (Dollars in thousands, Average Average except per Income Shares Per Share Income Shares Per Share share amounts) (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount - -------------------------------------------------------------------------- -------------------------------------------- Net income $ 5,702 $ 4,454 Basic net income per share: Income available to common shareholders 5,702 11,087,000 $ 0.53 4,454 10,717,000 $ 0.43 Effect of dilutive securities: Stock options -- 631,000 -- -- 938,000 -- ---------------------------------------------------------------------------------------- Diluted net income per share: Income available to common shareholders and assumed conversions $ 5,702 11,718,000 $ 0.50 $ 4,454 11,655,000 $ 0.40 =========================================================================================
There were options to purchase 475,125 shares that were considered anti- dilutive whereby the options' exercise price was greater than the average market price of the common shares, during the three months ended March 31, 1999. There were no options that were considered anti-dilutive during the three months ended March 31, 1998. Weighted average shares outstanding and all per share amounts included in the consolidated financial statements and notes thereto are based upon the increased number of shares giving retroactive effect to the 1998 mergers with PRB, PBFC and BA Bancshares at a total of 950,748, 298,000 and 1,399,321 shares, respectively. Segment Information In 1998, the Company adopted SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise", replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the company's reportable segments. SFAS No. 131 also requires disclosures about products and services, geographic areas, and major customers. The adoption of SFAS No. 131 did not affect results of operations or financial position but did affect the disclosure of segment information. 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) As of March 31, 1999 and 1998 and for the Three months ended March 31, 1999 and 1998 NOTE 2-MERGERS On January 26, 1999 Greater Bay and Bay Area Bancshares ("BA Bancshares"), the holding company of BAB, signed a definitive agreement for a merger between the two companies. The terms of the agreement provide for BA Bancshares shareholders to receive approximately 1,399,000 shares of Greater Bay stock subject to certain adjustments, in a tax-free exchange to be accounted for as a pooling-of-interest. Following the transaction, the shareholders of BA Bancshares will own approximately 12.7% of the combined company. The transaction was completed in May 1999. BAB's office is located in Redwood City, California. In all mergers, certain reclassifications were made to conform to the Company's financial presentation. The results of operations previously reported by the separate enterprises for the periods before the merger was consummated and that are included in the current combined amounts presented in the accompanying consolidated financial statements are summarized below. The following table sets forth the composition of the operations of the Company and BA Bancshares for the period indicated.
As of (Dollars in thousands) March 31, 1999 - ---------------------------------------------------------- Net interest income: Greater Bay Bancorp $18,360 Bay Area Bancshares 2,180 ------------------ Combined $20,540 ================== Provision for loan losses: Greater Bay Bancorp $ 861 Bay Area Bancshares 60 ------------------ Combined $ 921 ================== Net income: Greater Bay Bancorp $ 5,058 Bay Area Bancshares 644 ------------------ Combined $ 5,702 ==================
There were no significant transactions between the Company and BA Bancshares prior to the merger. All intercompany transactions have been eliminated. 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) As of March 31, 1999 and 1998 and for the Three months ended March 31, 1999 and 1998 NOTE 3--BORROWINGS Other borrowings are detailed as follows:
March 31, December 31, (Dollars in thousands) 1999 1998 - ---------------------------------------------------------------------------------------------- Other borrowings: Short term borrowings: Short term notes payable $ 135 $ 135 FHLB advances 500 500 -------------------------------------------- Total short term borrowings 635 635 -------------------------------------------- Long term borrowings: Securities sold under agreements to repurchase 50,000 50,000 FHLB advances 22,000 22,000 Promissory notes - 2,450 -------------------------------------------- Total other long term borrowings 72,000 74,450 -------------------------------------------- Total other borrowings $72,635 $75,085 ============================================ Subordinated notes, due September 15, 2005 $ - $ 3,000 -------------------------------------------- Total subordinated debt $ - $ 3,000 ============================================
During the three months ended March 31, 1998, the average balance of securities sold under short term agreements to repurchase was $23.3 million and the average interest rate during that period was 5.65%. No such borrowings were outstanding during the three months ended March 31, 1999. Securities sold under short term agreements to repurchase generally mature within 90 days of dates of purchase. During the three months ended March 31, 1998, the average balance of federal funds purchased was $547,000 and the average interest rate during that period was 5.25%. There were no such balances outstanding during the three months ended March 31, 1999. The short term FHLB advances have an average interest rate of 6.04%. The advances are collateralized by securities pledged to the FHLB. The Company has sold securities under long term agreements to repurchase which mature in the year 2003 and have an average interest rate of 5.21%. The counterparties to these agreements have put options which give them the right to demand early repayment. As of December 31, 1998, $40.0 million of these borrowings are subject to early repayment beginning in 1999 and $10.0 million are subject to early repayment beginning in 2000. The long term FHLB advances will mature in the year 2003 and have an average interest rate of 5.17%. The advances are collateralized by loans and securities pledged to the FHLB. Under the terms of the advances, the FHLB has a put option on $20.0 million of the advances which gives it the right to demand early repayment beginning in 1999. 8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) As of March 31, 1999 and 1998 and for the Three months ended March 31, 1999 and 1998 The promissory notes, which bear an interest rate of 13.76% and will mature April 15, 2000, were offered to PBFC's officers along with other accredited investors within the definition of Rule 501 under the Securities Act of 1933, as amended. These notes were redeemed by the Company in January 1999. On March 15, 1999 the Company redeemed the $3.0 million in subordinated debt issued in 1995. The Company paid a premium of $150,000 ($88,000 net of tax) on the payoff of the debt. The premium was recorded, net of taxes, as an extraordinary item in March 1999. NOTE 4--ACTIVIY OF BUSINESS SEGMENTS In 1998 the Company adopted SFAS No. 131. The prior year's segment information has been restated to present the Company's two reportable segments, community banking and trust operations. The accounting policies of the segments are the same as those described in the "Summary of Significant Accounting Policies." Segment data includes intersegment revenue, as well as charges allocating all corporate-headquarters costs to each of its operating segments. The Company evaluates the performances of its segments and allocates resources to them based on net interest income, other income, net income before income taxes, total assets and deposits. The Company is organized primarily along community banking and trust divisions. Eleven of the divisions have been aggregated into the "community banking" segment. Community banking provides a range of commercial banking services to small and medium-sized businesses, real estate developers, property managers, business executives, professional and other individuals. The trust division has been shown as the "trust operations" segment. The Company's business is conducted principally in the U.S.; foreign operations are not material. The following table shows each segment's key operating results and financial position for the three month ended March 31, 1999 and 1998:
Three Months Ended Three Months Ended March 31, 1999 March 31, 1998 ------------------------------------------------------------- Community Trust Community Trust (Dollars in thousands) Banking Operations Banking Operations - --------------------------------------------------------------------------------------------------------- Net interest income (1) $ 21,352 $ 57 $ 17,268 $ 177 Other income 1,754 725 1,555 562 Operating expenses, excluding merger and other related nonrecurring costs 12,416 719 11,119 558 Net income before income taxes (1) 9,768 64 6,668 181 Total assets 1,916,627 -- 1,466,265 -- Deposits 1,630,367 45,477 1,187,588 55,298 Assets under management -- 630,840 -- 578,290 (1) Includes intercompany earnings allocation charge which is eliminated in consolidation.
A reconciliation of total segment net interest income and other income combined, net income before income taxes, and total assets to the consolidated numbers in each of these categories for the three months ended March 31, 1998 and 1997 is presented below. 9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) As of March 31, 1999 and 1998 and for the Three months ended March 31, 1999 and 1998
Three Months Ended Three Months Ended March 31, 1999 March 31, 1998 ------------------------ ------------------------ Net interest income and other income Total segment net interest income and other income $ 23,888 $ 19,562 Parent company net interest income and other income (791) (521) ------------------------ ------------------------ Consolidated net interest income and other income 23,097 19,041 ======================== ======================== Net income before taxes Total segment net income before taxes 9,832 6,849 Parent company net income before taxes (347) (169) ------------------------ ------------------------ Consolidated net income before taxes 9,485 6,680 ======================== ======================== Total assets Total segment assets 1,916,627 1,466,265 Parent company assets 21,825 10,784 ------------------------ ------------------------ Consolidated total assets $1,938,452 $1,477,049 ======================== ========================
NOTE 5--CASH DIVIDEND The Company declared a cash dividend of $0.12 cents per share payable on April 15, 1999 to shareholders of record as of March 31, 1999. 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Greater Bay Bancorp ("Greater Bay", on a parent-only basis, and the "Company", on a consolidated basis) was formed as the result of the merger in November 1996 between Cupertino National Bancorp, the former holding company for Cupertino National Bank ("CNB"), and Mid-Peninsula Bancorp, the former holding company for Mid-Peninsula Bank ("MPB"). In December 1997 the Company completed a merger with Peninsula Bank of Commerce ("PBC"), whereby PBC became the third wholly owned banking subsidiary of Greater Bay. In May 1998, the Company completed a merger with Pacific Rim Bancorporation ("PRB"), the holding company for Golden Gate Bank ("Golden Gate"), whereby Golden Gate became the fourth wholly owned banking subsidiary of Greater Bay. In August 1998, the Company completed a merger with Pacific Business Funding Corporation ("PBFC"), which now operates as an operating division of CNB and conducts business under the name Pacific Business Funding. In May 1999, the Company completed a merger with Bay Area Bancshares ("BA Bancshares"), the holding company of Bay Area Bank ("BAB"), whereby BAB became the fifth wholly owned banking subsidiary of Greater Bay. All mergers were accounted for as a pooling of interests. All of the financial information for the Company for the periods prior to the mergers has been restated to reflect the pooling of interests, as if they occurred at the beginning of the earliest reporting period presented. CNB, MPB, PBC, Golden Gate and BAB are referred to collectively herein as the "Banks." The financial information includes the results of the Company's operating divisions, Greater Bay Bank Santa Clara Valley Commercial Banking Group, Greater Bay Corporate Finance Group, Greater Bay Bank Contra Costa Banking Office, Greater Bay International Banking Division, Greater Bay Trust Company, Pacific Business Funding and Venture Banking Group. The following discussion and analysis is intended to provide greater details of the results of operations and financial condition of the Company. The following discussion should be read in conjunction with the information under "Selected Financial Information" and the Company's consolidated financial data included elsewhere in this document. Certain statements under this caption constitute "forward- looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include but are not limited to economic conditions, competition in the geographic and business areas in which the Company conducts its operations, fluctuation in interest rates, credit quality and government regulation. RESULTS OF OPERATIONS The Company reported net income of $5.7 million for the first quarter of 1999, a 28.0% increase over the first quarter of 1998 net income of $4.5 million. Basic net income per share was $0.53 for the first quarter of 1999, as compared to $0.43 for the first quarter of 1998. Diluted net income per share was $0.50 and $0.40 for the first quarter of 1999 and 1998, respectively. The return on average assets and return on average shareholders' equity were 1.27% and 20.92% for the first quarter of 1999, compared with 1.32% and 20.11% for the first quarter in 1998, respectively. The Company's operating results included extraordinary items of $150,000 ($88,000 net of tax) for the first quarter of 1999 related to the early retirement of $3.0 million of subordinated debt of the Company. The following table summarizes net income, net income per share and key financial ratios before and after extraordinary items for the three months ended March 31, 1999: 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Before After extraordinary extraordinary (Dollars in thousands, except per share amounts) items items ----------------- ----------------- Net income $ 5,790 5,702 Net income per share: Basic $ 0.54 $ 0.53 Diluted $ 0.51 $ 0.50 Return on average assets 1.29% 1.27% Return on average shareholders' equity 21.25% 20.92%
The increase in first quarter 1999 net income as compared to the same period in 1998 was principally the result of significant growth in loans and deposits. This growth, partially offset by a decline in interest rate spreads, resulted in a $3.6 million increase in net interest income. Operating expenses increased by $2.1 million, excluding the contribution to the Greater Bay Bancorp Foundation (the "Foundation") discussed below. Operating expense increases reflect additional efforts required to service and support the Company's growth. Net income for the three months ended March 31, 1999 and 1998 included $4,000 and $497,000, respectively, in warrant income resulting from the warrants received from clients of the Banks. During 1998, the Company donated appreciated warrants to the Foundation. The contribution of the warrants triggered recognition of warrant income of $497,000, net of related employee incentives, and a donation expense of $701,000. The Company recognized a tax benefit of $288,000 from these transactions. The 1999 increase in other income relates to a 1998 write-down on equity securities in accordance with APB 18 of $484,000. This increase was partially offset by a decrease in warrant income. 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Net Interest Income Net interest income increased 21.4% to $20.5 million for the first quarter of 1999 from $16.9 million for the first quarter of 1998. This increase was primarily due to the $402.0 million, or 31.5%, increase in average interest- earning assets which was partially offset by a 41 basis point decrease in the Company's net yield on interest earning assets. The following table presents, for the quarters indicated, condensed average balance sheet information for the Company, together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities. Average balances are average daily balances.
Three Months Ended Three Months Ended March 31, 1999 December 31, 1998 -------------------------- ---------------------------- Average Average Average Yield/ Average Yield/ (Dollars in thousands) Balance Interest Rate Balance Interest Rate - ------------------------------------------------------------------------------------------- ------------------------------------- INTEREST-EARNING ASSETS: Federal funds sold $ 66,932 $ 783 4.74% $ 86,667 $ 1,110 5.08% Other short term investments 68,743 859 5.07% 86,477 1,313 6.02% Investment securities: Taxable 291,269 4,597 6.40% 350,300 5,071 5.74% Tax-exempt (1) 62,720 746 4.82% 58,985 716 4.82% Loans (2), (3) 1,187,214 27,476 9.39% 1,009,858 24,942 9.80% ------------ ----------- ------------ ----------- Total interest-earning assets 1,676,878 34,461 8.33% 1,592,286 33,152 8.26% Noninterest-earning assets 142,000 138,789 ------------ ----------- ------------ ----------- Total assets $1,818,878 34,461 $1,731,075 33,152 ============ ----------- ============ ----------- INTEREST-BEARING LIABILITIES: Deposits: MMDA, NOW and savings $ 931,181 7,782 3.39% $ 907,239 7,681 3.36% Time deposits, over $100,000 276,887 3,228 4.73% 211,481 2,668 5.01% Other time deposits 63,735 786 5.00% 62,783 772 4.88% ------------ ----------- ------------ ----------- Total interest-bearing deposits 1,271,803 11,796 3.76% 1,181,503 11,121 3.73% Other borrowings 73,496 1,054 5.82% 84,697 1,268 5.94% Subordinated debt 2,443 71 11.79% 3,000 86 11.37% Trust Preferred Securities 50,000 1,000 8.11% 50,000 1,000 7.93% ------------ ----------- ------------ ----------- Total interest-bearing liabilities 1,397,742 13,921 4.04% 1,319,199 13,475 4.05% Noninterest bearing deposits 285,766 286,271 Other noninterest-bearing liabilities 24,857 20,895 Shareholders' equity 110,513 104,710 ------------ ----------- ------------ ----------- Total shareholders' equity and liabilities $1,818,878 13,921 $1,731,075 13,475 ============ ----------- ============ ----------- Net interest income $20,540 $19,677 =========== =========== Interest rate spread 4.29% 4.21% Contribution of interest free funds 0.67% 0.70% Net yield on interest-earning assets (4) 4.96% 4.91% Three Months Ended March 31, 1998 -------------------------- Average Average Yield/ (Dollars in thousands) Balance Interest Rate - -------------------------------------------------------------------------------------------- INTEREST-EARNING ASSETS: Federal funds sold $ 87,394 $ 1,161 5.39% Other short term investments 102,475 1,765 6.99% Investment securities: Taxable 219,490 3,584 6.62% Tax-exempt (1) 26,223 328 5.07% Loans (2), (3) 839,310 21,337 10.31% ------------ ----------- Total interest-earning assets 1,274,892 28,175 8.96% Noninterest-earning assets 88,950 ------------ ----------- Total assets $1,363,842 28,175 ============ ----------- INTEREST-BEARING LIABILITIES: Deposits: MMDA, NOW and savings $ 721,142 $ 6,565 3.69% Time deposits, over $100,000 192,366 2,486 5.24% Other time deposits 57,264 747 5.29% ------------ ----------- Total interest-bearing deposits 970,772 9,798 4.09% Other borrowings 57,004 883 6.28% Subordinated debt 3,000 86 11.63% Trust Preferred Securities 20,000 488 9.90% ------------ ----------- Total interest-bearing liabilities 1,050,776 11,255 4.34% Noninterest bearing deposits 206,558 Other noninterest-bearing liabilities 16,685 Shareholders' equity 89,823 ------------ ----------- Total shareholders' equity and liabilities $1,363,842 11,255 ============ ----------- Net interest income $16,920 =========== Interest rate spread 4.62% Contribution of interest free funds 0.76% Net yield on interest-earning assets (4) 5.38%
(1) The tax equivalent yields earned on the tax exempt securities are 6.97%, 6.97% and 7.34% for the quarters ended March 31, 1999, December 31, 1998 and March 31, 1998, respectively, using the federal statuary rate of 34%. (2) Nonaccrual loans are excluded in the average balance. (3) Interest income includes loan fees of $1,004,000, $998,000 and $960,000 for the quarters ended March 31, 1999, December 31, 1998 and March 31, 1998, respectively. (4) Net yield on interest-earning assets during the period equals (a) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (b) average interest-earning assets for the period. 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The most significant impact on the Company's net interest income between periods is derived from the interaction of changes in the volume of and rate earned or paid on interest-earning assets and interest-bearing liabilities. The volume of interest-earning asset dollars in loans and investments, compared to the volume of interest-bearing liabilities represented by deposits and borrowings, combined with the spread, produces the changes in the net interest income between periods. The table below sets forth, for the quarters indicated, a summary of the changes in average asset and liability balances (volume) and changes in average interest rates (rate).
Three Months Ended March 31, 1999 Three Months Ended March 31, 1999 Compared with December 31, 1998 Compared with March 31, 1998 favorable / (unfavorable) favorable / (unfavorable) (Dollars in thousands)(1) Volume Rate Net Volume Rate Net - ---------------------------------------------------------------------------------------------- --------------------------------- INTEREST EARNED ON INTEREST-EARNING ASSETS Federal funds sold $ (253) $ (74) $ (327) $ (250) $ (128) $ (378) Other short term investments (256) (198) (454) (494) (412) (906) Investment securities: Taxable (966) 492 (474) 1,139 (126) 1,013 Tax-exempt 30 0 30 435 (17) 418 Loans 3,721 (1,187) 2,534 8,228 (2,089) 6,139 --------------------------------- --------------------------------- Total interest income 2,275 (966) 1,309 9,057 (2,771) 6,286 --------------------------------- --------------------------------- INTEREST EXPENSE ON INTEREST-BEARING LIABILITIES Deposits: MMDA, NOW and savings (76) (25) (101) (1,799) 582 (1,217) Time deposits over $100,000 (723) 163 (560) (1,009) 267 (742) Other time deposits (5) (9) (14) (82) 43 (39) --------------------------------- --------------------------------- Total interest-bearing deposits (805) 130 (675) (2,890) 892 (1,998) Other borrowings 185 29 214 (242) 71 (171) Subordinated debt 18 (3) 15 16 (1) 15 TPS (0) 0 - (616) 104 (512) --------------------------------- --------------------------------- Total interest expense (603) 157 (446) (3,732) 1,066 (2,666) --------------------------------- --------------------------------- Net increase (decrease) in net interest income $1,673 $ (810) $ 863 $ 5,325 $(1,705) $ 3,620 ================================= =================================
(1) Changes in interest income and expense which are not attributable specifically to either volume or rate, are allocated proportionately between both variances. Nonaccrual loans are excluded in average loans. Interest income for the first quarter of 1999 increased 22.3% to $34.5 million from $28.2 million for the first quarter of 1998. This was primarily due to the significant increase in loans, the Company's highest yielding interest- earning asset, and investment securities. Loan volume increases were the result of the continuing economic improvement in the Company's market areas, as well as the addition of experienced relationship managers and significant business development efforts by the Company's relationship managers. The increase was partially offset by a decline in the yield earned on average interest-earning assets. Average interest-earning assets increased $402.0 million, or 31.5%, to $1.7 billion for the first quarter of 1999, compared to $1.3 million for the first quarter of 1998. Of this total increase, average loans increased $347.9 million, or 41.5%, to $1.2 billion, or 70.8% of average interest-earning assets, for the first quarter of 1999 from $839.3 million, or 65.3% of average interest- earning assets for the first quarter of 1998. Investment securities, Federal funds sold and other short-term securities, increased 12.4% to $489.7 million, or 29.2% of average interest-earning assets for the first quarter of 1999, from $435.6 million, or 34.2% of average interest-earning assets for the first quarter of 1998. The average yield on interest-earning assets declined 63 basis points to 8.33% for the first quarter of 1999 from 8.96% for the first quarter of 1998 primarily due to a decline in the average yield on loans. The average yield on loans declined 92 basis points to 9.39% for the first quarter of 1999 from 10.31% for the first quarter of 1998 primarily due to declines in market interest rates and increased competition for quality borrowers in the Company's market area 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Interest expense for the first quarter of 1999 increased 23.7% to $13.9 million from $11.3 million for the first quarter of 1998. This increase was due to increased volume of interest-bearing liabilities offset by lower interest rates paid on interest-bearing liabilities. Average interest-bearing liabilities increased 33.0% to $1.4 billion for the first quarter of 1999 from $1.1 million for the first quarter of 1998 due primarily to the efforts of the Banks' relationship managers in generating core deposits from their client relationships. During the first quarter of 1999, average noninterest-bearing deposits increased to $285.8 million from $206.6 million for the first quarter of 1998. Due to that increase, noninterest-bearing deposits comprised 18.3% of total deposits at March 31, 1999, compared to 17.5% at March 31, 1998. As a result of the foregoing, the Company's interest rate spread declined to 4.29% for the first quarter of 1999 from 4.62% for the first quarter of 1998, and the net yield on interest-earning assets declined for the first quarter of 1999 to 4.96% from 5.38% for the first quarter 1998. PBC holds $89.6 million in one demand deposit account (the "Special Deposit"). The Special Deposit represents the proposed settlement of a class action lawsuit not involving the Company. Due to the uncertainty of the time the Special Deposit will remain with PBC, management has invested a significant portion of the funds from this deposit in agency securities with maturities of less than 90 days. The Company's net yield on interest earning assets was reduced by the Special Deposit. The average deposit balances related to the Special Deposit during the first quarter of 1999 and 1998 were $89.9 million and $91.6 million, respectively, on which the Company earned a spread of 1.76%. Excluding the Special Deposit, the first quarter 1999 and 1998 net yield on interest earning assets would have been 5.02% and 5.53%, respectively. Excluding the Special Deposit, the first quarter 1999 and 1998 interest rate spread would have been 4.32% and 4.73%, respectively. Certain client service expenses were incurred by the Company with respect to its noninterest-bearing liabilities. These expenses include messenger services, check supplies and other related items and are included in operating expenses. Had they been included in interest expense, the impact of these expenses on the Company's net yield on interest-earning assets would have been as follows for each of the quarters presented.
Three Months Ended March 31, ------------------------------------ (Dollars in thousands) 1999 1998 - ---------------------------------------------------------------------------------------------------- Average noninterest bearing demand deposits $ 285,766 $ 206,558 Client service expenses 261 157 Client service expenses, annualized 0.37% 0.31% IMPACT ON NET YIELD ON INTEREST-EARNING ASSETS: Net yield on interest-earning assets 4.96% 5.38% Impact of client service expense (0.06)% (0.05)% ------------------------------------ Adjusted net yield on interest-earning assets (1) 4.90% 5.33% ====================================
(1) Noninterest-bearing liabilities are included in cost of funds calculations to determine adjusted net yield of spread. The impact on the net yield on interest-earning assets is determined by offsetting net interest income by the cost of client service expense, which reduces the yield on interest-earning assets. The cost for client service expense reflects the Company's efforts to control its interest expense. 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Provision for Loan Losses The provision for loan losses creates an allowance for future loan losses. The loan loss provision for each year is dependent on many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management's assessment of the quality of the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in the Company's market area. The Company performs a monthly assessment of the risk inherent in its loan portfolio, as well as a detailed review of each asset determined to have identified weaknesses. Based on this analysis, which includes reviewing historical loss trends, current economic conditions, industry concentrations and specific reviews of assets classified with identified weaknesses, the Company makes a provision for loan losses. Specific allocations are made for loans where the probability of a loss can be defined and reasonably determined. The balance of the provision for loan losses is based on historical data, delinquency trends, economic conditions in the Company's market area and industry averages. Annual fluctuations in the provision for loan losses result from management's assessment of the adequacy of the allowance for loan losses, and ultimate loan losses may vary from current estimates. The provision for loan losses for the first quarter of 1999 was $921,000, compared to $1.0 million for the first quarter of 1998. Although loans outstanding have increased substantially, nonperforming loans, comprised of nonaccrual loans, restructured loans, and accruing loans past due 90 days or more, declined from $4.3 million, or 0.50% of loans outstanding, at March 31, 1998, to $3.5 million or 0.28% of loans outstanding at March 31, 1999. For further information on nonperforming and classified loans and the allowance for loan losses, see--"Nonperforming and Classified Assets" herein. Other Income Total other income increased to $2.6 million for the first quarter of 1999 compared to $2.1 million for the first quarter of 1998. The following table sets forth information by category of other income for the quarters indicated.
At and for the three month periods ended March 31, December 31, September 30, June 30, March 31, -------------------------------------------------------------------- (Dollars in thousands) 1999 1998 1998 1998 1998 ============================================================================================================ Trust fees $ 721 $ 664 $ 642 $ 617 $ 550 ATM network revenue 527 498 518 479 451 Service charges and other fees 419 426 431 411 480 Gain on sale of SBA loans 284 282 290 221 244 Gain on sale of investments, net - 320 4 42 8 Other 602 597 294 415 (109) -------------------------------------------------------------------- Total, recurring 2,553 2,787 2,179 2,185 1,624 Warrant income 4 314 134 - 497 -------------------------------------------------------------------- Total $ 2,557 $ 3,101 $ 2,313 $ 2,185 $ 2,121 ====================================================================
16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The increase in other income for the first quarter of 1999 as compared to the same period in 1998 was primarily the result of a $171,000 increase in trust fees, $76,000 increase in ATM network revenue and a $40,000 increase in the gain on sale of SBA loans. The increase in trust fees was due to significant growth in assets under management by Greater Bay Trust Company. Trust assets increased to $630.8 million at March 31, 1999, compared to $576.3 million at March 31, 1998. The increase in the gain on sale of SBA loans was due to an increase in the origination and subsequent sale of SBA loans. Other other income for the first quarter of 1998 included a $484,000 write- down on equity securities in accordance with APB 18. Excluding the write-down on equity securities, other income would have been $291,000 for the first quarter of 1998. Other income in 1998 included warrant income of $497,000, net of related employee incentives. The Company occasionally receives warrants to acquire common stock from companies that are in the start-up or development phase. The timing and amount of income derived from the exercise and sale of client warrants typically depend upon factors beyond the control of the Company, and cannot be predicted with any degree of accuracy and are likely to vary materially from period to period. Operating Expenses The following table sets forth the major components of operating expenses for the quarters indicated.
At and for the three month periods ended March 31, December 31, September 30, June 30, March 31, -------------------------------------------------------------------- (Dollars in thousands) 1999 1998 1998 1998 1998 ================================================================================================================================ Compensation and benefits $ 7,169 $ 6,537 $ 6,587 $ 6,363 $ 6,098 Occupancy and equipment 2,355 1,908 1,852 1,778 1,638 Telephone, postage and supplies 593 578 474 435 497 Professional services and legal costs 575 689 537 553 541 Marketing and promotion 407 876 409 385 165 Client services 261 142 128 136 157 Directors' fees 165 192 175 184 192 FDIC insurance and regulatory assessments 100 92 93 83 97 Expenses on other real estate owned 21 (6) 43 (8) 23 Contribution to GBB Foundation - 448 192 - 701 Other 1,045 1,307 1,032 917 1,216 -------------------------------------------------------------------- Total operating expenses, excluding merger costs $ 12,691 $ 12,763 $ 11,522 $ 10,826 $ 11,325 Merger costs - - 537 1,974 - -------------------------------------------------------------------- Total operating expenses $ 12,691 $ 12,763 $ 12,059 $ 12,800 $ 11,325 ==================================================================== Efficiency ratio, excluding trust 53.65% 55.38% 55.64% 63.35% 58.83% Efficiency ratio, excluding trust and before merger costs 53.65% 55.38% 53.01% 53.10% 58.83% Total operating expenses to average assets* 2.83% 2.99% 2.94% 3.44% 3.37% Total operating expenses to average assets, before merger costs* 2.83% 2.99% 2.81% 2.91% 3.37%
*Annualized Operating expenses totaled $12.7 million for the first quarter of 1999, compared to $11.3 million for the first quarter of 1998. The ratio of operating expenses to average assets was 2.83% for the first quarter of 1999 and 3.37% for the first quarter of 1998. The efficiency ratio is computed by dividing total operating expenses by net interest income and other income. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (or greater) volume of income while a decrease would indicate a more efficient allocation of resources. The Company's efficiency ratio for the first quarter of 1999 was 55.46%, compared to 59.48% for the first quarter of 1998. As indicated by the improvements in the efficiency ratio and ratio of total operating expenses to average assets, the Company has been able to achieve increasing economies of scale. For the first quarter of 1999, average assets increased 33.4% from the first quarter of 1998, while operating expenses, excluding nonrecurring cost, increased only 12.1%. Compensation and benefits expenses increased for the first quarter of 1999 to $7.2 million, compared to $6.1 million for the first quarter of 1998. The increase in compensation and benefits is due primarily to the addition of personnel in the first quarter of 1999 to accommodate the growth of the Company. The increase in occupancy and equipment; telephone, postage, and supplies; professional services and legal costs; marketing and promotion; and client service expense was related to the growth in the Company's loans, deposits and assets. Income Taxes The Company's effective income tax rate for the first quarter of 1999 was 39.0%, compared to 33.3% in the first quarter of 1998. The effective rates were lower than the statutory rate of 41.2% due to tax-exempt income on municipal securities, and were partially offset by the impact of merger and other related nonrecurring costs. For the first quarter of 1998, the Company was able to reduce its effective tax rate through the donation of appreciated warrants to the Foundation, as discussed above. FINANCIAL CONDITION Total assets increased 46.7%, on an annualized basis to $1.9 billion at March 31, 1999, compared to $1.7 billion at December 31, 1998. The increase in the first quarter of 1999 was primarily due to increases in the Company's loan portfolio funded by growth in deposits. Loans Total gross loans increased 52.0%, on an annualized basis, to $1.3 billion at March 31, 1999, compared to $1.1 billion at December 31, 1998. The increases in the loan volume in the first quarter of 1999 was primarily due to an improving economy in the Company's market areas coupled with the business development efforts of the Company's relationship managers. The Company's loan portfolio is concentrated in commercial (primarily manufacturing, service and technology) and real estate lending, with the balance in consumer loans. While no specific industry concentration is considered significant, the Company's lending operations are located in a market area that is dependent on the technology and real estate industries and supporting service companies. Thus, the Company's borrowers could be adversely impacted by a downturn in these sectors of the economy. This could, in turn, reduce the demand for loans and adversely impact the borrowers' abilities to repay their loans, while also decreasing the Company's net interest margin. 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The following table presents the composition of the Company's loan portfolio at the dates indicated.
March 31, December 31, 1999 1998 ------------------------------------------------------------ (Dollars in thousands) Amount % Amount % - ------------------------------------------------------------------------------------------------------------ Commercial $ 594,546 48.1% $ 483,668 44.3% Real estate construction and land 219,993 17.7 215,274 19.7 Real estate term 352,820 28.6 332,478 30.4 Consumer and other 96,469 7.8 88,458 8.1 ------------------------------------------------------------ Total loans, gross 1,263,828 102.4 1,119,878 102.5 Deferred fees and discounts, net (4,903) -0.4 (3,896) -0.4 ------------------------------------------------------------ Total loans, net of deferred fees 1,258,925 101.9 1,115,982 102.1 Allowance for loan losses (24,046) -1.9 (23,379) -2.1 ------------------------------------------------------------ Total loans, net $1,234,879 100.0% $1,092,603 100.0% ============================================================
Nonperforming and Classified Assets Management generally places loans on nonaccrual status when they become 90 days past due, unless they are well secured and in the process of collection. When a loan is placed on nonaccrual status, any interest previously accrued but not collected is generally reversed from income. Loans are charged off when management determines that collection has become unlikely. Restructured loans are those where the Banks have granted a concession on the interest paid or original repayment terms due to financial difficulties of the borrower. Other real estate owned ("OREO") consists of real property acquired through foreclosure on the related collateral underlying defaulted loans. 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The following table sets forth information regarding nonperforming assets at the dates indicated.
At and for the three month periods ended March 31, December 31, September 30, June 30, March 31, -------------------------------------------------------------------------- (Dollars in thousands) 1999 1998 1998 1998 1998 ================================================================================================================================ Nonperforming loans Nonaccrual loans $ 2,992 $ 2,003 $ 3,061 $ 3,903 $ 3,325 Accruing loans past due 90 days or more - - - 75 108 Restructured loans 482 327 377 531 903 -------------------------------------------------------------------------- Total nonperforming loans 3,474 2,330 3,438 4,509 4,336 Other real estate owned 620 966 905 1,001 1,001 -------------------------------------------------------------------------- Total nonperforming assets $ 4,094 $ 3,296 $ 4,343 $ 5,510 $ 5,337 ========================================================================== Nonperforming assets to total loans and other real estate owned 0.33% 0.30% 0.45% 0.60% 0.61%
At March 31, 1999, the Company had $3.0 million in nonaccrual loans. Interest income foregone on nonaccrual loans outstanding totaled $67,000 and $100,000 for the three months ended March 31, 1999 and 1998, respectively. The Company records OREO at the lower of carrying value or fair value less estimated costs to sell. Estimated losses that result from the ongoing periodic valuation of these properties are charged to earnings through a provision for losses on foreclosed property in the period in which they are identified. At March 31, 1999, OREO acquired through foreclosure had a carrying value of $620,000, compared to $1.1 million at December 31, 1998. The Company had $482,000 and $327,000 of restructured loans as of March 31, 1999 and December 31, 1998, respectively. There were no principal reduction concessions allowed on restructured loans during the first quarter of 1999 or 1998. Interest income from restructured loans totaled $9,000 and $4,000 for the three months ended March 31, 1999 and 1998. Foregone interest income, which totaled $8,000 and $3,000 for the three months ended March 31, 1999 and 1998, respectively, would have been recorded as interest income if the loans had accrued interest in accordance with their original terms prior to the restructurings. The policy of the Company is to review each loan in the portfolio to identify problem credits. There are three classifications for problem loans: "substandard," "doubtful" and "loss." Substandard loans have one or more defined weaknesses and are characterized by the distinct possibility that the Banks will sustain some loss if the deficiencies are not corrected. Doubtful loans have the weaknesses of substandard loans with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable; and there is a high possibility of loss of some portion of the principal balance. A loan classified as "loss" is considered uncollectible and its continuance as an asset is not warranted. 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The following table sets forth the classified assets at the dates indicated.
At and for the three month periods ended March 31, December 31, September 30, June 30, March 31, -------------------------------------------------------------------------- (Dollars in thousands) 1999 1998 1998 1998 1998 ================================================================================================================================ Substandard $ 15,284 $ 12,515 $ 12,949 $ 9,213 $ 9,308 Doubtful 1,019 1,188 1,266 1,041 1,096 Loss - - - - 47 Other real estate owned 620 966 905 1,001 1,001 -------------------------------------------------------------------------- Classified assets $ 16,923 $ 14,669 $ 15,120 $ 11,255 $ 11,452 ========================================================================== Classified assets to total loans and other real estate owned 1.34% 1.31% 1.57% 1.22% 1.31% Allowance for loan losses to total classified assets 142.09% 159.38% 144.59% 175.55% 159.77%
With the exception of these classified assets, management was not aware of any loans outstanding as of March 31, 1999 where the known credit problems of the borrower would cause management to have serious doubts as to the ability of such borrowers to comply with their present loan repayment terms and which would result in such loans being included in nonperforming or classified asset tables at some future date. Management cannot, however, predict the extent to which economic conditions in the Company's market areas may worsen or the full impact that such an environment may have on the Company's loan portfolio. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured loans, or other real estate owned in the future. Allowance For Loan Losses The allowance for loan losses is established through a provision for loan losses based on management's evaluation of risk inherent in the Company's loan portfolio and economic conditions in the Company's market areas. See "Provision for Loan Losses" herein. The allowance is increased by provisions charged against earnings and reduced by net loan charge-offs. Loans are charged- off when they are deemed to be uncollectible; recoveries are generally recorded only when cash payments are received. 21 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The following table sets forth information concerning the Company's allowance for loan losses at the dates and for the quarters indicated.
At and for the three month periods ended March 31, December 31, September 30, June 30, March 31, ---------------------------------------------------------------------- (Dollars in thousands) 1999 1998 1998 1998 1998 =================================================================================================================================== Period end loans outstanding $ 1,258,925 $ 1,115,982 $ 962,203 $ 921,767 $ 872,180 Average loans outstanding $ 1,184,161 $ 1,012,950 $ 929,687 $ 892,074 $ 844,932 Allowance for loan losses: Balance at beginning of period $ 23,379 $ 21,862 $ 19,758 $ 18,297 $ 18,032 Charge-offs: Commercial (224) (53) (52) - (734) Real estate construction and land - - - (4) - Real estate term - - - - (2) Consumer and other (64) (455) (27) (14) (153) ---------------------------------------------------------------------- Total charge-offs (288) (508) (79) (18) (889) ---------------------------------------------------------------------- Recoveries: Commercial 21 38 156 31 108 Real estate construction and land - - - - - Real estate term - - - - 1 Consumer and other 13 46 33 1 9 ---------------------------------------------------------------------- Total recoveries 34 84 189 32 118 ---------------------------------------------------------------------- Net charge-offs (254) (424) 110 14 (771) Provision charged to income (1) 921 1,941 1,994 1,447 1,036 ---------------------------------------------------------------------- Balance at end of period $ 24,046 $ 23,379 $ 21,862 $ 19,758 $ 18,297 ====================================================================== Quarterly net charge-offs to average loans outstanding during the period, annualized 0.09% 0.17% -0.05% -0.01% 0.37% Year to date net charge-offs to average loans outstanding during the period, annualized 0.09% 0.04% -0.02% 0.00% 0.37% Allowance as a percentage of average loans outstanding 2.03% 2.31% 2.35% 2.21% 2.17% Allowance as a percentage of period end loans outstanding 1.91% 2.09% 2.27% 2.14% 2.10% Allowance as a percentage of non-performing loans 692.17% 1003.39% 635.89% 438.19% 421.98%
___________________ (1) Includes $113,000 in the third quarter of 1998 and $70,000 in the second quarter of 1998 to conform practices to the Company's reserve methodologies, which is included in mergers and related nonrecurring costs. Management considers changes in the size and character of the loan portfolio, changes in nonperforming and past due loans, historical loan loss experience, and the existing and prospective economic conditions when determining the adequacy of the allowance for loan losses. Although management believes that the allowance for loan losses is adequate to provide for both potential losses and estimated inherent losses in the portfolio, future provisions will be subject to continuing evaluations of the inherent risk in the portfolio and if the economy declines or asset quality deteriorates, additional provisions could be required. At March 31, 1999, the allowance for credit losses was $24.0 million, consisting of a $13.4 million allocated allowance and a $10.6 million unallocated allowance. The unallocated allowance is composed of two elements. The first element consists of an amount up to 20% of the allocated allowance which recognizes the model and estimation risk associated with the allocated allowances. The second element is based upon management's evaluation of various conditions, the effects of which are not directly measured in determining the allocated allowance. The evaluation of the inherent loss regarding these conditions involves a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated allowance include the following conditions that existed at March 31, 1999: . Specific industry conditions within portfolio segments, particularly involving the high technology sector and the impact of foreign economic forces upon that sector; 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) . Seasoning of the loan portfolio and growth in loan volumes; . The strength and duration of the current business cycle and existing general economic and business conditions affecting our key lending areas; . Credit quality trends, including trends in nonperforming loans expected to result from changes in existing conditions; and . The results of bank regulatory examinations and the findings of our internal credit examiners. The Officers' Loan Committee reviews these conditions quarterly in discussion with our senior relationship managers. If any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's estimate of the effect of this condition may be reflected as an allocated allowance applicable to this credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's evaluation of the probable loss concerning this condition is reflected in the unallocated allowance. The allowance for credit losses is based upon estimates of probable losses inherent in the loan portfolio. The amount actually observed for these losses can vary significantly from the estimated amounts. Our methodology includes several features that are intended to reduce the differences between estimated and actual losses. The historical loss analysis, which reviews the losses over 1, 3 and 5 year periods, and evaluations of the current business cycle and economic conditions are used to establish the loan loss factors for problem graded loans which are designed to be self-correcting by taking into account our recent loss experience. Similarly, by basing the pass graded loan loss factors on historical loss experience, the methodology is designed to take our recent loss experience into account. Loan loss factors are adjusted quarterly based upon the level of net charge-offs expected by management in the next twelve months. Furthermore, our methodology permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management's judgement, significant factors that affect the collectibility of the portfolio as the evaluation date are not reflected in the loss factors. By assessing the probable estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available. The Company recorded provisions in 1999 to bring the allowance for credit losses to a level deemed appropriate by management based upon management's application of the loan loss allowance methodology discussed above. In particular, in the assessment as of March 31, 1999, management focused on factors affecting elements of the high technology sector and the impact of foreign economic forces upon that sector, including seasoning of the loan portfolio coupled with growth in loan volumes and the strength and duration of the current business cycle coupled with existing general economic and business conditions affecting our key lending areas. 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Liquidity and Cash Flow The objective of liquidity management is to maintain each Bank's ability to meet the day-to-day cash flow requirements of its clients who either wish to withdraw funds or require funds to meet their credit needs. The Company must manage its liquidity position to allow the Banks to meet the needs of their clients while maintaining an appropriate balance between assets and liabilities to meet the return on investment expectations of its shareholders. The Company monitors the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. In addition to liquidity from core deposits and repayments and maturities of loans and investments, the Banks utilize brokered deposit lines, sell securities under agreements to repurchase and borrow overnight federal funds. In 1997 the Company issued $20.0 million in Trust Preferred Securities ("TPS") to enhance its regulatory capital base, while also providing added liquidity. In 1998, the Company completed a second offering of TPS in an aggregate amount of $30.0 million. Greater Bay invested $15.0 million of the net proceeds in the Banks to increase their capital level. The Company intends to use the remaining net proceeds for general corporate purposes or to provide additional capital to the Banks, as it is needed. Under applicable regulatory guidelines, $37.7 million of the TPS qualifies as Tier I capital, and the remaining portion qualifies as Tier 2 capital. As the Company's shareholders' equity increases, the amount of the additional TPS that will count as Tier I capital will increase. Greater Bay is a company separate and apart from the Banks. It must provide for its own liquidity. Substantially all of Greater Bay's revenues are obtained from management fees, interest received on its investments and dividends declared and paid by the Banks. There are statutory and regulatory provisions that could limit the ability of the Banks to pay dividends to Greater Bay. At March 31, 1999, the Banks had approximately $27.7 million in the aggregate available to be paid as dividends to Greater Bay. Management of Greater Bay believes that such restrictions will not have an impact on the ability of Greater Bay to meet its ongoing cash obligations. As of March 31, 1999, Greater Bay did not have any material commitments for capital expenditures. There are statutory and regulatory provisions that could limit the ability of the Banks to pay dividends to Greater Bay. Net cash provided by operating activities, consisting primarily of net income and increases in interest payable and other liabilities, totaled $11.3 million for the first quarter of 1999 and $16.6 million for the first quarter 1998. Cash used for investing activities totaled $160.0 million for the first quarter of 1999 and $79.6 million for the first quarter 1998. The funds used for investing activities primarily represent increases in loans and investment securities for each year reported. For the three months ended March 31, 1999, net cash provided by financing activities was $191.4 million, compared to $92.4 million for the first quarter of 1998. Historically, the primary financing activity of the Company has been through deposits. For the first quarter 1999 and 1998, deposit gathering activities generated cash of $196.9 million and $40.0 million, respectively. This represents a total of 102.8% and 43.3% of the financing cash flows for the first quarter of 1999 and 1998, respectively. Capital Resources Shareholders' equity at March 31, 1999 increased to $113.2 million from $107.0 million at December 31, 1998. Greater Bay paid dividends of $0.12 and $0.40 per share during the three months ended March 31, 1999 and the twelve months ended December 31, 1998, respectively. In 1998, PBFC made a distribution of $227,000 to its shareholders. 24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company has provided a substantial portion of its capital requirements through the retention of earnings. The Company supplemented its capital base by issuing $30.0 million of TPS in 1998 and $20.0 million of TPS in 1997, which, subject to certain limitations, qualify as Tier 1 capital. A banking organization's total qualifying capital includes two components, core capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core capital, which must comprise at least half of total capital, includes common shareholders' equity, qualifying perpetual preferred stock, trust preferred securities and minority interests, less goodwill. Supplementary capital includes the allowance for loan losses (subject to certain limitations), other perpetual preferred stock, trust preferred securities, certain other capital instruments and term subordinated debt. The Company's major capital components are shareholders' equity and TPS in core capital, and the allowance for loan losses and subordinated debt in supplementary capital. At March 31, 1999, the minimum risk-based capital requirements to be considered adequately capitalized were 4.0% for core capital and 8.0% for total capital. Federal banking regulators have also adopted leverage capital guidelines to supplement risk-based measures. The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (not risk-adjusted) for the preceding quarter. Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991, the Federal Reserve, the OCC and the FDIC have adopted regulations setting forth a five-tier system for measuring the capital adequacy of the financial institutions they supervise. The capital levels of the Company at March 31, 1999 and the two highest levels recognized under these regulations are as follows. These ratios all exceeded the well-capitalized guidelines shown below.
Tier 1 Total Leverage Risk-Based Risk-Based Ratio Capital Ratio Capital Ratio ------------ --------------- --------------- Company 7.99% 9.45% 11.83% Well-capitalized 5.00% 6.00% 10.00% Adequately capitalized 4.00% 4.00% 8.00%
In addition, at March 31, 1999, each of the Banks had levels of capital that exceeded the well-capitalized guidelines. The Company anticipates that the economic and business conditions in its market areas will continue to expand in 1999, resulting in continued growth in earnings and deposits. To support this continuing growth or future acquisition opportunities, it may be necessary for the Company to raise additional capital through the sale of either debt or equity securities in order for the Company and each of the Banks to remain well-capitalized under applicable regulations. Quantitative and Qualitative Disclosures about Market Risk The Company's financial performance is impacted by, among other factors, interest rate risk and credit risk. The Company utilizes no derivatives to mitigate its credit risk, relying instead on loan review and an adequate loan loss reserve (see "--Allowance for Loan Losses" herein). 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Interest rate risk is the risk of loss in value due to changes in interest rates. This risk is addressed by the Company's Asset Liability Management Committee ("ALCO"), which includes senior management representatives. The ALCO monitors and considers methods of managing interest rate risk by monitoring changes in net portfolio values ("NPV") and net interest income under various interest rate scenarios. The ALCO attempts to manage the various components of the Company's balance sheet to minimize the impact of sudden and sustained changes in interest rates on NPV and net interest income. The Company's exposure to interest rate risk is reviewed on at least a quarterly basis by the Board of Directors and the ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the Company's change in NPV in the event of hypothetical changes in interest rates and interest liabilities. If potential changes to NPV and net interest income resulting from hypothetical interest rate swings are not within the limits established by the Board, the Board may direct management to adjust its asset and liability mix to bring interest rate risk within Board-approved limits. In order to reduce the exposure to interest rate fluctuations, the Company has developed strategies to manage its liquidity, lengthen the effective maturities of certain interest-earning assets, and shorten the effective maturities of certain interest-bearing liabilities. The Company has focused its investment activities on securities with generally medium-term (7 years to 10 years) maturities or average lives. The Company has utilized short-term borrowings and deposit marketing programs to adjust the term to repricing of its liabilities. Interest rate sensitivity analysis is used to measure the Company's interest rate risk by computing estimated changes in NPV of its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. NPV represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market rate sensitive instruments in the event of sudden and sustained increases and decreases in market interest rates of 100 basis points. The following table presents the Company's projected change in NPV for these rate shock levels as of March 31, 1999. All market rate sensitive instruments presented in this table are classified as either held to maturity or available for sale. The Company has no trading securities.
(Dollars in thousands) Change in Projected Change ---------------------------- Interest Rates MVPE Dollars Percentage - ------------------------------------------------------------------------------ 100 basis point rise $ 191,611 $ 7,956 4.3% Base scenario 183,655 - - 100 basis point decline 175,885 (7,771) (4.2)%
The preceding table indicates that at March 31, 1999, in the event of a sudden and sustained decrease in prevailing market interest rates, the Company's NPV would be expected to decrease. NPV is calculated based on the net present value of estimated cash flows utilizing market prepayment assumptions and market rates of interest provided by independent broker quotations and other public sources. Computation of forecasted effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposits decay, and should not be relied upon as indicative of actual future results. Further, the computations do not contemplate any actions the ALCO could undertake in response to changes in interest rates. 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. Actual values may differ from those projections presented should market conditions vary from assumptions used in the calculation of the NPV. Certain assets, such as adjustable-rate loans, which represent one of the Company's loan products, have features which restrict changes in interest rate on a short-term basis and over the life of the assets. In addition, the proportion of adjustable-rate loans in the Company's portfolio could decrease in future periods if market interest rates remain at or decrease below current levels due to refinancing activity. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the NPV. Finally, the ability of many borrowers to repay their adjustable-rate mortgage loans may decrease in the event of significant interest rate increases. Interest Rate Risk Management Interest rate risk management is a function of the repricing characteristics of the Company's portfolio of assets and liabilities. Interest rate risk management focuses on the maturity structure of assets and liabilities and their repricing characteristics during periods of changes in market interest rates. Effective interest rate risk management seeks to ensure that both assets and liabilities respond to changes in interest rates within an acceptable time frame, thereby minimizing the effect of interest rate movements on net interest income. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in the Company's current portfolio that are subject to repricing at various time horizons: one day or immediate, two days to six months, seven to twelve months, one to three years, four to five years, over five years and on a cumulative basis. The differences are known as interest sensitivity gaps. The following table shows interest sensitivity gaps for different intervals as of March 31, 1999.
Immediate 2 Days to 7 Months to 1 Year to 4 Years to More than Total Rate or One Day 6 Months 12 Months 3 Years 5 Years 5 Years Sensitive ----------------------------------------------------------------------------------- Assets (Dollars in thousands) Cash and Due $ 10,911 $ - $ - $ - $ - $ - $ 10,911 Federal Funds Sold 106,400 - - - - - 106,400 Investment Securities - 139,928 40,064 82,537 24,235 142,777 429,541 Loans 741,588 334,252 42,183 53,980 30,245 51,934 1,254,182 Allowance for Loan Losses/Unearned Fees - - - - - - - Other Assets - - - - - - - ----------------------------------------------------------------------------------- Total Assets $ 858,899 $474,180 $82,247 $136,517 $ 54,480 $ 194,711 $1,801,034 =================================================================================== Liabilities and Equity Deposits $1,014,010 $311,354 $36,024 $ 8,089 $ 672 $ - $1,370,149 Other Borrowings - 501 134 2,000 70,000 - 72,635 Trust Preferred Securities - - - - - 50,000 50,000 Other Liabilities - - - - - - - Shareholders Equity - - - - - - - ----------------------------------------------------------------------------------- Total Liab/Equity $1,014,010 $311,855 $36,158 $ 10,089 $ 70,672 $ 50,000 $1,492,784 =================================================================================== Gap $ (155,111) $162,325 $46,089 $126,428 $(16,192) $ 144,711 $ 308,250 Cumulative Gap $ (155,111) $ 7,214 $53,303 $179,731 $163,539 $ 308,250 $ 616,500 Cumulative Gap/Total Assets -8.7% 0.4% 3.0% 10.1% 9.2% 17.3% 34.6% Non-Rate Sensitive Total ----------------------------- Assets Cash and Due $ 68,334 $ 79,245 Federal Funds Sold - 106,400 Investment Securities 5,900 435,441 Loans 9,646 1,263,828 Allowance for Loan Losses/Unearned Fees (28,949) (28,949) Other Assets 82,487 82,487 ----------------------------- Total Assets $ 137,418 $1,938,452 ============================= Liabilities and Equity Deposits $ 305,695 $1,675,844 Other Borrowings - 72,635 Trust Preferred Securities - 50,000 Other Liabilities 26,735 26,735 Shareholders Equity 113,238 113,238 ----------------------------- Total Liab/Equity $ 445,668 $1,938,452 ============================= Gap $ (308,250) $ - Cumulative Gap $ - $ - Cumulative Gap/Total Assets - -
27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The foregoing table indicates that the Company had a one year gap of $131 million, or 7.4% of total assets, at March 31, 1999. In theory, this would indicate that at March 31, 1999, $131 million more in assets than liabilities would reprice if there was a change in interest rates over the next 365 days. Thus, if interest rates were to increase, the gap would tend to result in a higher net interest margin. However, changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing of both the asset and its supporting liability can remain the same, thus impacting net interest income. This characteristic is referred to as basis risk and, generally, relates to the repricing characteristics of short-term funding sources such as certificates of deposit. The impact of fluctuations in interest rates on the Company's projected next twelve month net interest income and net income has been evaluated through an interest rate shock simulation modeling analysis that includes various assumptions regarding the repricing relationship of assets and liabilities, as well as the anticipated changes in loan and deposit volumes over differing rate environments. As of March 31, 1999, the analysis indicates that the Company's net interest income would increase a maximum of 23.0% if rates rose 200 basis points immediately and would decrease a maximum of 23.2% if rates declined 200 basis points immediately. In addition, the results indicate that notwithstanding the Company's gap position, which would indicate that the net interest margin increases when rates rise, the Company's net interest margin increases during rising rate periods due to the basis risk imbedded in the Company's interest- bearing liabilities. The Company has revised the assumptions used in performing this analysis following a detailed review of its ALCO pricing history. As a result, the anticipated impact of interest rate changes on the Company's net interest income has increased since December 31, 1999. While the overall analysis indicates the probable impact of interest rate movements on the Company's net interest income, it does not take into consideration other factors that would impact this analysis. These factors would include management's and ALCO's actions to mitigate the impact to the Company and the impact of the Company's credit risk profile during periods of significant interest rate movements. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities which are not reflected in the interest sensitivity analysis table. These prepayments may have significant effects on the Company's net interest margin. Because of these factors and others, an interest sensitivity gap report may not provide a complete assessment of the Company's exposure to changes in interest rates. Year 2000 Compliance State of Readiness The Company has undertaken a major project to ensure that its internal operating systems will be fully capable of processing year 2000 transactions. This project is overseen by the Greater Bay Year 2000 Project Team (the "Year 2000 Project Team"), which reports monthly progress to the Company's Board of Directors. The Company is determining the potential impact of the year 2000 on the ability of the Company's computerized information systems to accurately process information that may be date-sensitive. Any of the Company's programs that recognize a date using "00" as the year 1900 rather than the year 2000 could result in errors or system failures. The Company utilizes a number of computer programs across its entire operation. The initial phase of the project was to assess and identify all internal business processes requiring modification and to develop comprehensive renovation plans as needed. This phase was largely completed in mid-1998. The second phase was to execute those renovation plans and begin testing systems by simulating year 2000 data conditions. This phase was largely completed in 1998. Testing and implementation is planned to be completed during the first half of 1999. 28 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company relies upon third-party software vendors and service providers for substantially all of its electronic data processing and does not operate any proprietary programs which are critical to the Company's operations. Thus, the focus of the Company is to monitor the progress of its primary software providers towards compliance with year 2000 issues and prepare to test actual data of the Company in simulated processing of future sensitive dates. As well as evaluating its own internal operating systems, the Company has also initiated discussions with its major customers and suppliers as to their ability to meet year 2000 requirements. The Year 2000 Project Team previously has identified and sought information from significant third party suppliers regarding their year 2000 compliance. Suppliers providing system interdependencies also have been identified, and testing with such suppliers also will occur during this phase of the project. The Year 2000 Project Team continues to work with all targeted suppliers to determine their year 2000 status. As of this time, the Year 2000 Project Team has not identified any significant issues with the identified suppliers. The Company also has identified customers who have a material relationship with the Company and requested such customers to complete a year 2000 survey, which will be used by the Company to assess the overall risk to the Company resulting from such customers' year 2000 compliance. Costs to Address the Year 2000 Issue The Company has budgeted an anticipated total expenditure of $300,000 in 1999 to ensure that its systems are ready for processing information in the year 2000. The Company estimates that it has incurred out-of-pocket expenses of approximately $118,000 and $146,000 in the three months ended March 31, 1999 and the year ended December 31, 1998 in connection with year 2000 issues. In addition, the Company has incurred certain costs relating to reallocation of internal resources to address year 2000 issues. The Company expects that the cost of remedial action for its noncompliant year 2000 systems will not be material. Greater Bay completed the Awareness and Assessment Phases, as defined by the FFIEC, for its computer systems and bank facilities in 1998 and continues to update its assessment as needed. We have identified our mission-critical systems, assessed the state of Year 2000 compliance of those systems and implemented a plan to repair or replace non-compliant systems. The Company currently believes that costs of addressing Year 2000 issues will not have a material adverse impact on the Company's financial position. However, if the Company and third parties upon which it relies are unable to address this issue in a timely manner, it could result in a material financial risk to the Company. In order to assure that this does not occur, the Company plans to devote all resources required to resolve any significant year 2000 issues in a timely manner. Risks Presented by the Year 2000 Issue As the Company continues to assess the year 2000 issue, it may identify systems that present a year 2000 risk. In addition, if any third-party software vendors and service providers upon whom the Company relies fail to appropriately address their year 2000 issues, such failure could have a material adverse effect on the Company's business, financial condition and operating results. Should the Company and/or its significant suppliers fail to timely identify, address and correct material year 2000 issues, such failure could have a material adverse impact on the Company's ability to operate. The range of adverse impacts may include the requirement to pay significant overtime to manually process certain transactions and added costs to process certain banking activity through a centralized administrative function. In addition, if corrections made by such suppliers to address year 2000 issues are incompatible with the Company's systems, the year 2000 issue could have a material adverse impact on the Company's operations. 29 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Despite the Company's activities in regards to the year 2000 issue, there can be no assurance that partial or total systems interruptions or the costs necessary to update hardware and software would not have a material adverse effect upon the Company's business, financial condition, results of operations and business prospects. Contingency Plans The Year 2000 Project Team currently is in the process of developing contingency plans for year 2000 readiness. The Company has engaged a third party company, which specializes in developing contingency plans for financial institutions for year 2000, to assist the Company in analyzing the impact of year 2000 on its business. This business impact analysis was completed in 1998 and the Company's contingency plans for year 2000 readiness currently are substantially complete. There can be no assurance, however, that such contingency plans will be successful. Recent Events On April 30, 1999 the Company and Bay Commercial Services, the parent of Bay Bank of Commerce, signed a definitive agreement for a merger between the two companies. The agreement provides for Bay Commercial Services shareholders to receive approximately 943,000 shares of Greater Bay stock subject to the approval of Bay Commercial Services shareholders and certain adjustments based on movements in the Company's stock price, in a tax-free exchange to be accounted for as a pooling-of-interests. Following the transaction, the shareholders of Bay Commercial Services will own approximately 11.9% of the combined company. The transaction is expected to be completed in the fourth quarter of 1999 subject to regulatory approvals. As of March 31, 1999, Bay Commercial Services had $145.9 million in assets, $134.0 million in deposits, and $12.0 million in shareholders' equity. Bay Bank of Commerce has banking offices in San Leandro, San Ramon and Hayward, California. The combined Company, on a pro-forma basis after giving effect to the merger of Bay Area Bancshares and Bay Commercial Services, would have had total assets of approximately $2.1 billion and equity of over $125.0 million at March 31, 1999. The transaction is anticipated to be accretive to the Company's core earnings (excluding one-time merger costs) in 1999 based on anticipated reductions in operating expenses and revenue enhancements resulting from an expanded product line, increased lending capacity and an increased market awareness that can be utilized by Bay Commercial Services. Management believes that significant opportunities exist to enhance the spectrum of financial services offered to both existing and future clients of Bay Commercial Services while also increasing market penetration in the East Bay market areas. Recent Accounting Developments In April 1999, the Financial Accounting Standards Board ("FASB") reached tentative conclusions on the future of the pooling-of-interests method of accounting for business combinations. These tentative decisions include the decision that the pooling-of-interests method of accounting will no longer be an acceptable method to account for business combinations between independent parties and that there should be a single method of accounting for all business combinations, and that method is the purchase method. The FASB agreed that the purchase method should be applied prospectively to business combination transactions that are initiated after the final standard is issued. The FASB has indicated that it expects an exposure draft to be issued during the third quarter of 1999 and expects a final standard will be issued and become effective in the fourth quarter of 2000. A portion of the Company's business strategy is to pursue acquisition opportunities so as to expand its market presence and maintain growth levels. A change in the accounting for business combinations could have a negative impact on the Company's ability to realize those business strategies. 30 -----END PRIVACY-ENHANCED MESSAGE-----