-----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, Szrnr5y9RCisE9gEhtvRNvCEzgfufiaDoSe88mMscgHd1Ps28HWlr+HDRoICnxPE VkiIOu2V8piaeyXwhuiANg== 0000919805-03-000029.txt : 20030325 0000919805-03-000029.hdr.sgml : 20030325 20030325115022 ACCESSION NUMBER: 0000919805-03-000029 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030325 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COASTAL BANCORP INC CENTRAL INDEX KEY: 0000919805 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 760428727 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-24526 FILM NUMBER: 03615209 BUSINESS ADDRESS: STREET 1: 5718 WESTHEIMER STREET 2: SUITE 600 CITY: HOUSTON STATE: TX ZIP: 77057 BUSINESS PHONE: 7134355000 MAIL ADDRESS: STREET 1: 5718 WESTHEIMER STREET 2: SUITE 600 CITY: HOUSTON STATE: TX ZIP: 77057 FORMER COMPANY: FORMER CONFORMED NAME: COASTAL BANCORP INC/TX/ DATE OF NAME CHANGE: 19940718 FORMER COMPANY: FORMER CONFORMED NAME: COASTAL BANC SAVINGS ASSOCIATION DATE OF NAME CHANGE: 19970110 10-K 1 doc1.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2002 ----------------- OR [ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the Transition Period from _________ to _________ Commission File Number: 0-24526 ------- COASTAL BANCORP, INC. --------------------- (Exact name of Registrant as specified in its charter) Texas 76-0428727 --------------------- ---------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 5718 Westheimer, Suite 600 Houston, Texas 77057 -------------------- (Address of principal executive office) (713) 435-5000 -------------- (Registrant's telephone number) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered N/A N/A Securities registered pursuant to section 12(g) of the Act: Common Stock, $0.01 par value per share --------------------------------------- (Title of Class) 9.12% Series A Cumulative Preferred Stock ----------------------------------------- (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). [ X ] As of March 12, 2003, the aggregate market value of the 5,146,878 shares of Common Stock of the Registrant issued and outstanding on such date, excluding 777,034 shares held by all directors and executive officers of the Registrant as a group, was $127,774,239. This figure is based on the closing sale price of $29.24 per share of the Registrant's Common Stock on March 12, 2003, as reported in The Wall Street Journal on March 13, 2003. Number of shares of Common Stock outstanding as of March 12, 2003: 5,146,878 DOCUMENTS INCORPORATED BY REFERENCE The following documents are incorporated by reference into the noted Parts of this Form 10-K: (1) Portions of the Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 2002, are incorporated into Part II, Items 5-8 of this Form 10-K. (2) Portions of the Registrant's definitive proxy statement for its 2003 Annual Meeting of Stockholders ("Proxy Statement") are incorporated into Part III, Items 10-13 of this Form 10-K. PART I. ITEM 1. BUSINESS - ------------------ COASTAL BANCORP, INC. In addition to historical information, this Annual Report on Form 10-K includes certain "forward-looking statements," as defined in the Securities Act of 1933, as amended (the "Securities Act"), and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), based on current management expectations. Coastal Bancorp, Inc.'s (the "Company") actual results could differ materially from those management expectations. Such forward-looking statements include statements regarding the Company's intentions, beliefs or current expectations as well as the assumptions on which such statements are based. Stockholders and potential stockholders are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the Federal government, changes in tax policies, rates and regulations of Federal, state and local tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of the Company's loan and investment portfolios, changes in accounting principles, policies or guidelines, and other economic, competitive, governmental and technological factors affecting the Company's operations, markets, products, services and fees. For a more detailed discussion of these risk factors, see Exhibit 99.3. The Company undertakes no obligation to update or revise any forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. Coastal Bancorp, Inc. is engaged primarily in the business of serving as the parent holding company for Coastal Banc ssb (the "Bank"). The Company was incorporated in March 1994 in connection with the reorganization of Coastal Banc Savings Association, a Texas-chartered thrift institution (the "Association") into the holding company form of organization. In connection with the reorganization, which was completed in July 1994, the Association concurrently converted into a Texas-chartered savings bank and took its present name. In November 1996, in order to minimize state taxes, the Company's corporate structure was again reorganized by forming Coastal Banc Holding Company, Inc. ("HoCo") as a Delaware holding company. HoCo became a wholly-owned subsidiary of the Company, and the Bank became a subsidiary of HoCo. Each of these reorganizations was treated for accounting purposes as combinations similar to a pooling-of-interests. The financial information and references presented herein have been restated to give effect where appropriate to the reorganizations as if they had occurred at the earliest date presented. In October 1997, the Company formed Coastal Banc Capital Corp. ("CBCC") as a wholly-owned subsidiary of HoCo. CBCC is a registered broker-dealer and was originally formed to trade packages of whole loan assets, primarily for the Bank and for other institutional investors and did so until September 2002. Beginning in 2002, a corporate finance group was formed within CBCC to act as an intermediary in raising capital for business customers and to provide merger and acquisition advisory services to buyers and sellers of small to mid-sized companies. In 2003, management of the Company made the decision to discontinue the operations of CBCC effective March 31, 2003 due to the current economic climate. In July 2002, the Company formed Coastal Banc Mortgage Corp. ("CBMC") as a wholly-owned subsidiary of HoCo. CBMC was formed to continue the function of trading whole loan assets for the Bank and for other institutional investors that had been previously performed by CBCC. In June 2000, the Company acquired Coastal Banc Insurance Agency, Inc. ("CBIA") as a wholly-owned subsidiary of the Bank. CBIA was a former affiliate of the Bank and receives fees related to insurance and investment product sales to the Bank's deposit and loan customers. On June 18, 2002, Coastal Bancorp, Inc. ("Bancorp"), through Coastal Capital Trust I (a consolidated trust subsidiary) (the "Trust"), issued 2,000,000 trust preferred securities ("Trust Preferred Securities") with a liquidation preference of $25 per security. The Trust Preferred Securities represent an interest in Bancorp's junior subordinated debentures, which were purchased by the Trust. The junior subordinated debentures are the only assets of the Trust and interest payments from the debentures finance the distributions paid on the Trust Preferred Securities. Distributions on the securities are payable quarterly at the annual rate of 9.0% and are included in interest expense in the consolidated statements of income. The Trust Preferred Securities are subject to mandatory redemption at the liquidation preference, in whole or in part, upon repayment of the junior subordinated debentures at maturity or their earlier redemption. The junior subordinated debentures are redeemable prior to the maturity date of June 30, 2032, at the option of Bancorp on or after June 30, 2007, in whole at any time or in part from time to time. The junior subordinated debentures are also redeemable at any time, in whole, but not in part, upon the occurrence of specific events defined with the trust indenture. Bancorp has the option to defer distributions on the junior subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. A portion of the proceeds from the issuance of the Trust Preferred Securities were used to repurchase 500,000 shares of common stock for $15.0 million from a director of the Company in June 2002. In addition, $28.8 million of the proceeds were used on July 15, 2002, to redeem the Bank's 9.0% Series A Noncumulative Preferred Stock (Nasdaq:CBSAP) through a capital contribution. On August 27, 1998, December 21, 1998, February 25, 1999, April 27, 2000, July 27, 2000 and April 25, 2002, the Board of Directors authorized six separate repurchase plans for up to 500,000 shares each of the outstanding shares of common stock of the Company through an open market repurchase program and privately negotiated repurchases, if any. As of December 31, 2002, a total of 2,729,575 shares had been repurchased under all of the authorized repurchase plans. The Company will continue its practice of taking the opportunity to repurchase common stock with excess capital during times of share price weakness. At December 31, 2002, the Company had total consolidated assets of $2.5 billion, total deposits of $1.6 billion, 9.12% Series A Cumulative Preferred Stock of $27.5 million and common stockholders' equity of $125.4 million. The Company is subject to examination and regulation by the Office of Thrift Supervision (the "OTS"), and the Company and the Bank are subject to examination and regulation by the Texas Savings and Loan Department (the "Department"). The Bank is subject to examination and regulation by the Federal Deposit Insurance Corporation ("FDIC") and by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). The Bank is a member of the Federal Home Loan Bank of Dallas (the "FHLB"), one of the 12 regional banks which comprise the Federal Home Loan Bank System. See "Regulation - Regulation of the Bank." The Company is also subject to various reporting and other requirements of the Securities and Exchange Commission (the "SEC"). See "Regulation - The Company." The Company's executive offices are located at Coastal Banc Plaza, 5718 Westheimer, Suite 600, Houston, Texas 77057-5745, and its telephone number is (713) 435-5000. The Bank operates a website on the Internet for business and marketing purposes at www.coastalbanc.com. (The website is not a part of this ------------------- Form 10-K.) COASTAL BANC SSB The Bank is a Texas-chartered, Federally insured state savings bank. It is headquartered in Houston, Texas and operates through 43 branch offices in metropolitan Houston, Austin, Corpus Christi, the Rio Grande Valley and small cities in the southeast quadrant of Texas. The Bank, which was originally organized in 1954, was acquired in 1986 by an investor group (which includes a majority of the current members of the Board of Directors and the present Chairman of the Board, President and Chief Executive Officer of the Company) as a vehicle to take advantage of the failures and consolidation in the Texas banking and thrift industries. At February 28, 1986 (the date of change in ownership), the Bank had one full service office and total assets of approximately $10.7 million. Since then, the Bank has acquired deposits and branch offices in transactions with the Federal government and other private institutions, and, in 1995, acquired an independent national bank. By December 31, 2002, the Bank had total assets of $2.5 billion, total deposits of $1.6 billion and stockholders' equity of $199.7 million. The Bank attempts to maximize profitability through the generation of net interest income and fee income. To meet this objective, the Bank has implemented a strategy of building its core deposit base while deploying its funds in assets, which provide an attractive return with acceptable credit risk. In carrying out this strategy, and to ultimately provide an attractive rate of return to the Company's shareholders, the Bank adheres to four operating principles: (i) continuing to expand its low cost core deposit base; (ii) minimizing interest rate risk; (iii) controlling credit risk, while increasing the emphasis on commercial business lending; and (iv) maintaining a low level of general overhead expense relative to its peers. These operating principles are briefly discussed below. CORE DEPOSITS. The Bank began to implement the first operating principle, developing and expanding a core deposit base, in 1988 through a series of transactions with the Federal government and competitively priced transactions with private sector financial institutions. In 1988, the Bank became the first acquiror of failed or failing savings institutions under the Federal government's "Southwest Plan." In this transaction (the "Southwest Plan Acquisition"), the Bank acquired from the Federal Savings and Loan Insurance Corporation ("FSLIC"), as receiver for four insolvent savings associations (the "Acquired Associations"), approximately $543.4 million of assets and assumed approximately $543.4 million of deposits and other liabilities. The Bank acquired an aggregate of 14 branch offices from the Acquired Associations in new and existing markets in southwest Houston, west of Houston along the Houston-San Antonio corridor and in the Rio Grande Valley. Since completion of the Southwest Plan Acquisition, the Bank has entered into a series of branch office transactions (including three disposition transactions) and one whole bank acquisition. All of these transactions resulted in the net assumption of $1.8 billion of primarily retail deposits and 58 branch offices (23 of which were subsequently closed or sold). The Bank has also opened seven de novo branches since its inception, six in the Houston metropolitan area and one in Austin. The Bank will continue to pursue acquisitions in Texas as a vehicle for growth, although there can be no assurance that the Bank will be able to continue to do so on an accretive basis in the future, or at all. INTEREST RATE RISK. The Bank has implemented its second operating principle, minimizing interest rate risk, by matching, to the extent possible, the repricing or maturity of its interest-earning assets to the repricing or expected terms of its interest-bearing liabilities. The Bank also tries to match the basis or index (for example, the London Interbank Offered Rate ("LIBOR") or the 11th District Federal Home Loan Bank cost of funds index ("COFI") upon which these assets and liabilities reprice. Generally this matching is achieved through management of the composition of the Bank's assets and liabilities. The Bank may also use interest rate swap and cap agreements to aid in minimizing exposure to interest rate and price fluctuations. In November 2001, to strategically restructure a portion of its asset base to make it less vulnerable to market interest rate and price fluctuations, the Company completed the sale of approximately $845 million of its mortgage-backed securities. The majority of the securities sold were Collateralized Mortgage Obligations ("CMOs") tied to COFI and contained extension risk which caused, on average, high levels of price volatility. Also in November, the Company used a portion of the proceeds of the sale to purchase approximately $512 million of primarily pass thru mortgage-backed securities with an overall shorter expected duration. Coastal reduced borrowings with the remainder of the proceeds from the sale. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" set forth in Item 7 hereof. CREDIT RISK. The Bank has implemented the third operating principle, controlling credit risk while increasing the emphasis on its commercial business lending, by (i) taking a cautious approach to its direct lending operations, including the development of commercial business lending, and (ii) holding a substantial portion of its assets in primarily adjustable rate first lien (single family) residential mortgage loans and mortgage-backed securities. At December 31, 2002, the Company's total loans receivable portfolio (excluding loans held for sale) amounted to $1.8 billion or 71.8% of total assets, $855.6 million, or 47.2%, of which were comprised of first lien single family residential mortgage loans. At December 31, 2002, of the Company's $2.5 billion in total assets, $475.0 million or 18.8% of total assets consisted of mortgage-backed securities. NONINTEREST EXPENSE. The Bank has implemented the fourth operating principle, maintaining a low level of general overhead expense relative to its peers, by operating an efficiently staffed operations and branch office system which is able to economically administer and deliver its products and services. The Company's ratio of noninterest expense to average total assets on a consolidated basis was 2.19% for the year ended December 31, 2002. LENDING ACTIVITIES GENERAL. Coastal is continuing to expand and diversify its loan portfolio in a manner consistent with the operating principles discussed above by emphasizing the origination or purchase for retention in its portfolio of only those loans determined by management to have an acceptable credit risk and which provide a positive interest rate spread over funding liabilities matched with similar maturities and other characteristics. This strategy is designed to achieve an acceptable risk adjusted rate of return, as determined and continuously evaluated by the Board of Directors and management. Since 1995, the Bank has attempted to re-align its lending products to compete with commercial banks in an effort to increase its net interest margin. In doing so, the Bank continues to take a cautious approach to the development and growth of its direct lending operations in its efforts to control credit risk. In November 1995, the Bank acquired its first commercial bank with $103.3 million in loans including first lien residential, multifamily and commercial real estate, residential construction, real estate acquisition and development, commercial, financial and industrial and consumer loans. In 1998, the Bank acquired twelve commercial bank branches (the "1998 Branch Acquisition") and designated them as the foundation for the Bank's Business Banking Centers, which focus on the Bank's commercial banking customers. In an effort to enhance its ability to service its commercial customers, during the fourth quarter of 1997 the Bank implemented a new process for originating, underwriting and approving all loans over $1.0 million. The staff of the Portfolio Control Center ("PCC") is able to incorporate more comprehensive credit information than previously reviewed by the Bank by applying Internet and network computer technology to take a loan from application to closing in less time than before. The PCC staff, as part of the Bank's Asset/Liability Subcommittee, is also responsible for monitoring and managing the Bank's assets and liabilities and their sensitivity to interest rate changes. The following table sets forth information concerning the composition of the Company's net loans receivable portfolio by type of loan at the dates indicated.
At December 31, 2002 2001 2000 1999 1998 --------------- ----------- ----------- ----------- ----------- (In thousands) Real estate mortgage loans: First lien residential $855,633 $880,624 $908,841 $836,005 $690,510 Multifamily 116,020 124,616 224,361 163,059 119,447 Residential construction 123,085 136,035 157,950 136,675 115,714 Acquisition and development 143,463 140,009 133,005 103,357 75,932 Commercial 317,692 319,377 347,921 314,292 257,723 Commercial and multifamily construction 241,128 222,026 90,256 65,934 40,344 Commercial secured by residential mortgage loans held for sale ("Warehouse") -- 11,508 8,518 60,372 173,124 Commercial secured by mortgage servicing rights ("MSR") -- -- -- -- 3,867 Commercial, financial and industrial 135,209 116,029 120,420 100,195 92,218 Loans secured by deposits 14,465 21,238 13,681 13,094 13,164 Consumer and other 33,430 43,384 56,522 63,383 66,989 ------------- ----------- ----------- ----------- ----------- Total loans 1,980,125 2,014,846 2,061,475 1,856,366 1,649,032 ------------- ----------- ----------- ----------- ----------- Loans in process (147,769) (131,064) (142,451) (108,561) (99,790) Allowance for loan losses (18,118) (15,385) (14,507) (10,493) (11,358) Unearned interest and loan fees (2,910) (2,959) (3,864) (2,947) (3,493) Net premium (discount) on purchased loans 1,457 (1,837) (4,425) 716 3,758 ------------- ----------- ----------- ----------- ---------- Total loans receivable, net $1,812,785 $1,863,601 $1,896,228 $1,735,081 $1,538,149 ============= =========== =========== =========== ===========
SCHEDULED MATURITIES. The following table sets forth certain information at December 31, 2002 regarding the principal amount of loans maturing in the Company's loans receivable portfolio (excluding loans held for sale) based on their contractual terms to maturity assuming no periodic amortization of principal. Demand loans, loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
At December 31, 2002 More than More than More than More than Over One year one year to three years five years ten years to twenty or less three years to five years to ten years twenty years years Total --------- ------------ --------------- ------------ ------------- -------- ---------- (In thousands) First lien residential mortgage $ 6,116 $ 13,045 $ 20,662 $ 64,229 $ 477,754 $273,010 $ 854,816 Multifamily mortgage 75,685 35,044 2,869 117 1,683 -- 115,398 Residential construction 72,369 2,624 219 367 -- -- 75,579 Real estate acquisition and development 33,092 51,582 3,417 297 -- -- 88,388 Commercial real estate 102,259 89,940 52,220 28,751 39,534 -- 312,704 Commercial and multifamily construction 43,377 107,966 16,200 4,749 14,308 -- 186,600 Commercial, other 66,512 48,143 12,245 9,394 161 -- 136,455 Consumer and other 10,151 11,025 8,630 6,030 6,935 74 42,845 --------- ------------ --------------- ------------ ------------- -------- ---------- Total loans $ 409,561 $ 359,369 $ 116,462 $ 113,934 $ 540,375 $273,084 $1,812,785 ========= ============ =============== ============ ============= ======== ==========
The average life of loans is generally substantially less than their average contractual terms because of prepayments and, in the case of conventional mortgage loans, due-on-sale clauses, which generally give the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on current mortgages are substantially lower than existing mortgage loan rates (due to refinancings of adjustable-rate and fixed-rate loans at lower rates). Under the latter circumstances, the weighted average yield on loans decreases as higher yielding loans are repaid or refinanced at lower rates. The following table sets forth the amount of loans due after one year from December 31, 2002 by category and which have fixed or adjustable interest rates.
Interest Rate ------------------------------ Fixed Adjustable Total --------------- ------------ ---------- (In thousands) First lien residential mortgage $ 189,117 $ 659,583 $ 848,700 Multifamily mortgage 3,056 36,657 39,713 Residential construction 535 2,675 3,210 Real estate acquisition and development 317 54,979 55,296 Commercial real estate 44,310 166,135 210,445 Commercial and multifamily construction 2,713 140,510 143,223 Commercial, other 21,525 48,418 69,943 Consumer and other 32,275 419 32,694 --------------- ------------ ---------- Total $ 293,848 $ 1,109,376 $1,403,224 =============== ============ ==========
ORIGINATION, PURCHASE AND SALE OF LOANS. The following table sets forth the loan origination, purchase and sale activity of the Bank during the periods indicated. The table does not reflect the activity of loans held for sale or of mortgage loans serviced for third party investors during the periods presented. See "Mortgage Loan Servicing."
Year Ended December 31, 2002 2001 2000 --------------- ----------- ----------- (In thousands) Loan Originations: First lien residential mortgage $ 22,185 $ 49,452 $ 40,957 Home equity 14,691 8,799 6,406 Residential construction and acquisition and development 245,658 281,253 302,839 Warehouse 65,409 159,595 359,270 Multifamily mortgage 7,319 47,779 86,404 Commercial real estate 99,208 151,016 130,581 Commercial and multifamily construction 118,100 70,891 39,724 Commercial, financial and industrial 246,359 141,600 138,959 Consumer and other 38,569 44,641 46,057 --------------- ----------- ----------- Total loan originations 857,498 955,026 1,151,197 Purchase of residential mortgage loans 421,371 250,945 236,362 Purchase of residential construction loans -- -- 608 --------------- ----------- ----------- Total loan originations and purchases 1,278,869 1,205,971 1,388,167 --------------- ----------- ----------- Sale of residential mortgage loans 84,241 -- -- Loans reclassified to held for sale category, net 8,749 -- -- Foreclosures 6,260 5,450 3,672 Principal repayments and reductions to principal balance 1,223,520 1,232,944 1,217,229 --------------- ----------- ----------- Total foreclosures, repayments and reductions to principal balance 1,322,770 1,238,394 1,220,901 --------------- ----------- ----------- Amortization of premiums, discounts and fees on loans (1,115) 3,696 (329) Provision for loan losses (5,800) (3,900) (5,790) --------------- ----------- ----------- Net increase (decrease) in loans receivable $ (50,816) $ (32,627) $ 161,147 =============== =========== ===========
FIRST LIEN RESIDENTIAL MORTGAGE LOAN PURCHASES, SALES AND ORIGINATIONS. The Bank primarily purchases, and also originates, loans secured by first lien mortgages on completed single family residences for its own portfolio. The majority of the Bank's residential mortgage loan portfolio has been acquired through bulk purchases in the traditional secondary market and is secured by real estate located throughout the United States. During 2002, 2001 and 2000, the Bank purchased $421.4 million, $250.9 million and $236.4 million of such loans, respectively. The Bank also originates these types of loans primarily in the geographic areas surrounding the Bank's branch locations. During 2002, 2001 and 2000, the Bank originated residential mortgage loans for portfolio totaling $22.2 million, $49.5 million and $41.0 million, respectively. From time to time, the Bank also sells residential mortgage loans. During 2002, the Bank's management made the decision to liquidate a portion of its mortgage loan portfolio through sales to third party investors. The first sale was in March 2002 when the Bank sold $10.8 million of under-performing mortgage loans. Prior to the sale, the Bank wrote those loans down to fair value and recorded a charge-off to the allowance for loan losses of $761,000. In addition, as of March 31, 2002, the Bank wrote down to fair value and reclassified $9.1 million of other under-performing single-family mortgage loans to the held for sale category. The loans that were reclassified to the held for sale category were written down to fair value as of March 31, 2002 through a charge-off to the allowance for loan losses of $691,000. During the second quarter of 2002, a total of $3.1 million of these under-performing loans held for sale were sold to the same third party investor. As of December 31, 2002, the Bank had reclassified the remaining $3.0 million of these loans held for sale back to the loans receivable portfolio. The second sale was in the fourth quarter of 2002 when the Bank entered into an agreement with a third party to sell approximately $77.0 million of single-family mortgage loans. As of December 31, 2002, $74.4 million of these loans had been sold, $70.1 million of which were sold servicing retained and $4.3 million (which were considered nonperforming loans) were sold servicing released. The remaining $2.6 million, which are under a contract for sale, were reclassified to the held for sale category at December 31, 2002. In connection with this sale and the reclassification of the remaining loans to the held for sale category, the loans were written down to fair value through a charge-off to the allowance for loan losses of $309,000. In addition, the Company recorded a gain of $359,000 on the sale of these loans receivable as a result of the Bank recording the estimated fair value of the mortgage servicing rights retained. See "Mortgage Loan Servicing." The Bank acquires first lien residential mortgage loans for its portfolio through bulk purchases when the prices of these purchases are considered to be favorable. The acquisition of first lien residential mortgage loans has been accomplished primarily through bulk purchases in the traditional secondary market (from mortgage companies, financial institutions, investment banks, CBCC and beginning in 2002, from CBMC). Bulk purchases allow the Bank to obtain these residential mortgage loans without the direct cost of origination activities. Personnel from the Bank generally analyze loan bid packages, as they become available from CBMC, CBCC (through September 2002) and from third parties, and the members of the PCC, along with the Bank's Chief Executive Officer, review the information in the loan packages to determine whether to bid (or make an offer) on a package and the price of such bid (or offer). The bid price with respect to such loan packages is based on a number of factors, including the ability to create spread income with a funding source of comparable maturity, the pricing of alternative investments, particularly mortgage-backed securities, which offer little or no credit risk, assumed prepayment speeds and the credit risk profile of the portfolio offered. The Bank analyzes credit risk in a whole loan package through its due diligence investigation, which is designed to provide management with basic underwriting information on each loan or group of loans, including loan-to-value, payment history, insurance and other documentation. Because the Bank is purchasing loans in bulk, the Bank prices the loan packages to take into consideration, among other things, delinquency and foreclosure assumptions based on the risk characteristics of the loan packages. The Bank intends to continue to make competitive bids on loan packages that meet the Bank's purchase criteria. The Bank offers, but does not actively solicit, a variety of mortgage products designed to respond to consumer needs and competitive factors. Conventional conforming loans that are secured by first liens on completed residential real estate are generally originated for amounts up to 95% of the appraised value or selling price of the mortgaged property, whichever is less. All loans with loan-to-value ratios in excess of 80% generally require the borrower to purchase private mortgage insurance from approved third party insurers. The Bank also originates conventional non-conforming mortgage loans (i.e., loans for single family homes with an original balance in excess of the maximum loan balance amount set by the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"), which is presently $322,700, or loans that do not otherwise meet the criteria established by FNMA or FHLMC). In addition to 15-year and 30-year conventional mortgages, the Bank offers special products designed to provide to its customers lower rates of interest or lower principal and interest payments. Borrowers may choose from a wide variety of combinations of interest rates and points on many products so that they may elect to pay higher points at closing and lower interest over the life of the loan, or pay a higher interest rate and reduce the points payable at closing. In addition, from time to time mortgages are offered in the following categories: those which allow the borrower to make lower monthly payments for the first one, two or three years of the loan; fixed rate mortgages; and adjustable rate mortgages having interest rate adjustments every one, five or seven years based upon a specified independent index. Borrower demand for adjustable rate mortgage loans compared to fixed rate mortgage loans is a function of interest rate levels, consumer expectations for changes in interest rate levels and the difference between interest rates and loan fees offered for fixed rate mortgage loans and for adjustable rate mortgage loans. The Bank's loan origination volume has been subject to some minor seasonal variations, with the heaviest demand in the late spring and summer months. Loan demand is also affected by the general interest rate environment and, to a large measure, by the general state of the local economy. During times of relatively lower market interest rates, demand by previous borrowers for refinancings increases. Refinancings are not solicited by the Bank. However, if a request for a refinancing is received, borrowers are offered current mortgage loan products. Refinancings are generally processed in a manner identical to original originations and charged the same fees. While the Bank has the general authority to originate and purchase loans secured by real estate located anywhere in the United States, the largest concentrations of its first lien residential mortgage and residential construction loan portfolios are secured by real estate located in California and Texas. RESIDENTIAL CONSTRUCTION LENDING. The Bank initiated a construction lending program with local builders in the latter part of 1989 which has grown considerably since its inception. At the initiation of the program, management of the Bank initially surveyed the members of the residential construction industry in the Bank's Houston market area and targeted those companies. The Bank now has expanded its residential construction lending into the Dallas, Austin and Rio Grande Valley markets. Loans are made primarily to fund residential construction. Construction loans are made on pre-sold and speculative residential homes considered by management to be in well located, viable subdivisions and planned unit developments. Most of the builders with whom the Bank does business generally apply for either a non-binding short-term line of credit or for an annual line of credit (subject to covenants) from the Bank for a maximum amount of borrowing to be outstanding at any one time. Upon approval of the line of credit, the Bank issues a letter which indicates to the builder the maximum amount which will be available under the line, the term of the line of credit (which is generally 90 days to one year), the interest rate of the loans to be offered under the line (which is generally set at a rate indexed to The Wall Street Journal prime rate or LIBOR on the outstanding monthly loan balance) and the loan fees payable. When the builder desires to draw upon a short-term line of credit, a separate loan application generally must be made under the line for a specific loan amount. Each loan commitment under a short-term line of credit is separately verified to be in compliance with the terms previously approved with the line of credit. The terms of the Bank's construction loans are typically for one year or less, unless extended by the Bank. If a construction loan is extended, the borrower is generally charged a loan fee for each 90 day extension period. The Bank reserves the right to extend any loan term, but generally does not permit the original term and all extensions to exceed 24 months without amortization of principal either in monthly increments or a lump sum. The loan-to-value ratio (applied to the underlying property that collateralizes the loan) of any residential construction loan may not exceed the lesser of 85% of appraised value or 100% of the actual cost. All individual loans are limited in dollar amount based upon the project proposed by the builder. Draws for lot purchases are generally limited to the contracted sales price of the lot (to include escalations) not to exceed 100% of the lot's appraised value. Other special conditions which the Bank attaches to its construction loans include a requirement that limits the number and dollar amount of loans which may be made based upon unsold inventory. The Bank may also, at its sole discretion, discontinue making any further loans if the builder's unsold inventory exceeds a certain level from all lending sources or if the builder fails to pay its suppliers or subcontractors in a timely manner. The Bank provides construction financing for homes that generally are priced below $450,000, with most homes priced between $125,000 and $300,000. In this price range, the Bank has experienced the shortest duration of term, the highest annualized yield and the least likelihood of defaults because of the generally high number of pre-completion sales. The Bank will also make individual construction loans to builders or individuals on single homes or groups of homes on substantially the same terms and conditions as loans granted under the Bank's line of credit program. At December 31, 2002, the Bank had $76.7 million in outstanding residential construction loans (net of loans in process of $46.4 million) of which $49,000 were on nonaccrual status. At the present time, the Bank has approved builders primarily domiciled in the Houston, Dallas, and Austin metropolitan areas, as well as the Rio Grande Valley area, and is selectively soliciting new builders for its residential construction lending program. In addition, the Bank participates in the funding of residential construction loans with other institutions. Two of the Bank's approved builders are authorized for the funding of loans on properties located outside the state of Texas. At December 31, 2002, there were loans totaling $9.6 million for these builders in the states of Arizona, Florida, New Mexico and Ohio. The Bank intends to continue to do business with the companies involved in its line of credit program and believes that it will continue to have construction loan demand from the builders with whom it currently has an established lending relationship. Construction financing is generally considered to involve a higher degree of risk than long-term financing on improved, occupied residential real estate, due to the lender's reliance on the borrower to add to the estimated value of the property through construction within the budget set forth in the loan application. The Bank attempts to limit its risk exposure by, among other things: limiting the number of borrowers to whom it lends and establishing specific qualification requirements for borrowers generally; continually monitoring the general economic conditions in the market, recent housing starts and sales; continually monitoring the financial position of its borrowers throughout the term of the loan; continually monitoring the progress of the development through site inspections prior to loan disbursements; utilizing only qualified, approved appraisers; and requiring that the builder maintain a pre-approved ratio (generally not greater than 60%) of speculative to pre-sold homes in the development. COMMERCIAL REAL ESTATE AND MULTIFAMILY MORTGAGE LENDING. The Bank initiated a program in 1993 to actively seek loans secured by commercial or multifamily properties. Commercial real estate and multifamily mortgage loans typically involve higher principal amounts and repayment of the loans generally depends, in large part, on sufficient cash flow being generated by the underlying properties to cover operating expenses and loan repayments. Market values may vary as a result of economic events or governmental regulations which are outside the control of the borrower or lender and which can affect the future cash flow of the properties. The loans are generally for a short to medium term of between one to five years, and have floating rates indexed to prime rate or LIBOR or fixed rates based on a spread over similarly fixed borrowings from the FHLB. The properties securing the loans originated by the Bank are primarily located in Texas. The Bank attempts to limit its risk exposure by, among other things: lending to proven developers/owners, only considering properties with existing operating performance which can be analyzed, requiring conservative debt coverage ratios, and continually monitoring the operation of the collateral. At December 31, 2002, commercial real estate loans totaling $317.7 million and multifamily mortgage loans of $116.0 million were outstanding. At December 31, 2002, the Bank had commercial real estate loans totaling approximately $1.3 million that were on nonaccrual status and no multifamily mortgage loans that were on nonaccrual status. The Bank began originating commercial real estate and multifamily construction loans in 1996 primarily for the construction or renovation of income generating facilities. The Bank generally underwrites these loans in the same way it underwrites its multifamily mortgage loans and attempts to manage the risk of such loans by lending to proven developers/owners, requiring that each builder maintain a specified amount of equity in the project, continually monitoring the progress of the development through site inspections prior to loan disbursement and by monitoring other financial strength requirements. At December 31, 2002, commercial and multifamily construction loans totaling $191.5 million (net of loans in process of $49.6 million) were outstanding, none of which were on nonaccrual status. WAREHOUSE LENDING. Beginning in 1992 and through 2002, the Bank provided or participated in lines of credit to mortgage companies generally for their origination of single family residential loans which are typically sold no more than 90 days from origination to FNMA, FHLMC, the Government National Mortgage Association ("GNMA") or to private investors. The lines of credit were generally renewable annually. Borrowers paid interest on funds drawn at a floating rate. In addition, the Bank usually received a fee for each loan file processed under these lines of credit, the Bank (or the lead lender in a participation) held the original mortgage loan notes and other documentation as collateral until repayment of the related lines of credit, except when a third party lender was acting as the lead lender in the lending relationship. Warehouse loans were underwritten in accordance with Bank policies and procedures. Bank personnel attempted to minimize the risk of making Warehouse loans (excluding participations in loans where a third party bank is acting as the lead bank) by, among other things, (i) taking physical possession of the originator's collateral, (ii) directly receiving payment from secondary market investors when the loans are sold and remitting any balance to the borrower after deducting the amount borrowed for that particular loan, (iii) visiting the originator's office from time to time to review its financial and other records and (iv) monitoring each originator by periodically reviewing their financial statements, loan production delinquency and commitment reports and, on an annual basis, by reviewing their audited financial statements and auditor's letter to its board of directors. In loan participations where a third party bank was acting as the lead bank, the Bank relied on the lead bank to perform substantially the same procedures as noted above. During 1999, the Bank experienced significant loan losses in Warehouse and MSR loans due to the default of two borrowers. The first loss was related to the $10.0 million participation purchased in 1998 in a Warehouse loan aggregating $25.0 million to MCA Financial Corp., and certain of its affiliates, of Southfield, Michigan (collectively "MCA"). In late January 1999, due to a lack of liquidity, MCA ceased operations and shortly thereafter was seized by the Michigan Bureau of Financial Institutions. A conservator was appointed to take control of MCA's books and records, marshal its assets and continue its loan servicing operations. A voluntary petition under Chapter 11 of the U.S. Bankruptcy Code was filed in the U.S. Bankruptcy Court for the Eastern District of Michigan for MCA on or about February 10, 1999, by the conservator. Throughout 1999, the Bank worked with the lead lender and the bankruptcy trustee to determine the value of, and sell, the underlying collateral. As of December 31, 1999, the Bank had received only $1.1 million in proceeds from the MCA loan. Due to the uncertainty of the value of the remaining collateral, the Bank charged-off the remaining $8.9 million balance of this loan in 1999 resulting in the additional provision for loan losses of $6.8 million during 1999. The Bank will continue to work with the bankruptcy trustee to recover any funds, if possible, from the collateral or MCA. During the years ended December 31, 2002, 2001 and 2000, Coastal received $288,000, $267,000 and $180,000, respectively, in proceeds from the MCA loan which was recorded as a recovery in the allowance for loan losses in the period received. In the second situation, during 1999, the Bank purchased approximately $10.1 million of the underlying loans securing a $13.2 million Warehouse and servicing rights line of credit due to default by the borrower. The remaining outstanding balance of $990,000 on this Warehouse and servicing rights line of credit was charged-off during 1999. In 1999, the Bank began to decrease its emphasis on Warehouse lending and as of December 31, 2002 had no warehouse borrowers or loans outstanding. During the year ended December 31, 2002, the Bank originated $65.4 million of Warehouse loans. At December 31, 2002, there were no Warehouse loans outstanding. MSR LENDING. Beginning in 1992 and discontinued in 1999, the Bank loaned funds to mortgage companies for their purchase of mortgage servicing rights or to finance the mortgage companies' ongoing operations to originate and retain mortgage servicing. Loans of this nature generally had terms of one to five years, and were generally limited to 70.0% of the price paid by the mortgage company for servicing rights, or of the value of the originated servicing rights (subject to the regulatory maximum for loans to one borrower). MSR loans were made at adjustable rates of interest tied to LIBOR or the Bank's borrowing rate plus a spread and a commitment fee. MSR loans were collateralized by purchased or originated mortgage servicing rights to the remaining cash flows after remittance of payments to FNMA, FHLMC or other investors on the servicing portfolio. MSR loans were underwritten in substantially the same manner as Warehouse loans, where Bank personnel closely monitored MSR borrowers by, among other things, reviewing the borrower's financial condition and operations in the same manner as they did for Warehouse loans and by examining the value of the borrower's MSR portfolio (through evaluation of the estimated future net cash flows from the servicing rights) in order to ensure that the loan-to-value ratio did not exceed 75.0% during the life of the loan. During 1999, the Bank incurred a loss on a Warehouse and servicing rights line of credit due to default of the borrower as discussed previously. The Bank did not have any MSR loans outstanding at December 31, 2002 or 2001. REAL ESTATE ACQUISITION AND DEVELOPMENT LENDING. The Bank originates loans to residential real estate builders and developers as well as to major homebuilders for the acquisition and/or development of vacant land. The proceeds of the loans are generally used to acquire the land and make the site improvements necessary to develop the land into residential lots to be sold to third parties or used by the homebuilders. The Bank generally lends only to developers with good track records and strong financial capacity and on property where a substantial number of the lots to be developed are pre-sold. The term of the loans have generally been from 18 to 36 months at a spread over the prime rate, plus an origination fee. Repayment on the loans is generally made as the lots are sold or used by homebuilders. Land acquisition and development loans involve additional risks when compared to loans on existing residential properties, however, when lending directly to a major homebuilder the risk is mitigated by the strength of the borrower. These loans typically involve relatively large loan balances to single borrowers, and the repayment experience is dependent upon the successful development of the land and the resale of the lots. These risks can be significantly impacted by supply and demand conditions and the general economic conditions in the local market area. At December 31, 2002, the Bank had $91.7 million (net of loans in process of $51.8 million) of real estate acquisition and development loans outstanding. At December 31, 2002, there were two real estate acquisition and development loans to one borrower totaling $5.5 million on nonaccrual status. COMMERCIAL BUSINESS LENDING. Development of a commercial business lending program continues to be a strategic goal of Bank management. The commercial bank acquisition in 1995 provided the Bank with an established commercial business lending program directed to small and medium sized companies primarily in the Houston and Austin metropolitan areas. Since that acquisition, management has continued to develop the infrastructure for commercial business lending in most of the Bank's major markets. In addition, the Bank acquired twelve commercial bank branches in the 1998 Branch Acquisition and significantly increased the Bank's commercial business loan origination capacity. The commercial, financial and industrial loans ("Commercial Business loans") are typically made to provide working capital financing or asset acquisition financing to businesses and are generally secured by the borrower's working capital assets (i.e., accounts receivable, inventory, etc.) or assets purchased by the borrower (i.e., operating assets, equipment, etc.). Commercial Business loans generally have shorter terms (one to five years) which are indexed to prime rate, LIBOR or are fixed and are of greater risk than real estate secured loans because of the type and nature of the collateral. In addition, Commercial Business loan collections are more dependent on the continuing financial stability of the borrower. The Bank intends to continue to expand its commercial business lending programs, while managing the associated credit risk by continually monitoring borrowers' financial position and underlying collateral securing the loans. At December 31, 2002, Commercial Business loans outstanding totaled $135.2 million, with $1.6 million of such loans on nonaccrual status. CONSUMER AND OTHER LENDING. The Bank makes available traditional consumer loans, such as home improvement, home equity, new and used car financing, new and used boat and recreational vehicle financing and loans secured by savings deposits to consumers in the markets served by its retail branches and business banking centers. The interest rate on loans secured by savings deposits is typically set at a rate above that paid on the underlying account and adjusts if the rate on the account changes. At December 31, 2002, the Bank had $33.4 million in consumer and other loans outstanding, with $128,000 of such loans on nonaccrual status, and $14.5 million in loans secured by deposits. Consumer loans (other than deposit secured loans) generally have shorter terms and higher interest rates than mortgage loans, but usually involve greater credit risk than mortgage loans because of the type and nature of the collateral. In addition, consumer lending collections are dependent on the borrower's continuing financial stability, and are thus likely to be adversely affected by job loss, changes in marital status, illness and personal bankruptcy. In many cases, repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation of the underlying collateral. The Bank believes that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans and that consumer loans are important to its efforts to serve the credit needs of the communities that it serves. See "Regulation of the Bank - Community Reinvestment Act." LOANS RECEIVABLE HELD FOR SALE. From time to time, the Bank has loans classified as held for sale. These loans are generally single-family loans purchased with the original intent to resell them or loans that have been reclassified from the loans receivable portfolio to held for sale due to the intent to sell. Loans receivable held for sale are carried at the lower of cost or market value. At December 31, 2002, the Bank had $49.9 million in loans receivable held for sale, $47.3 million of which was due to a loan package purchased in November 2002 with the intent to sell the package to third party investors by the end of January 2003. The remaining $2.6 million were loans reclassified to the held for sale category and are under a contract for sale which is expected to close during the first quarter of 2003. ASSET QUALITY. The Bank, like all financial institutions, is exposed to certain credit risks related to the value of the collateral which secures loans held in its portfolio and the ability of borrowers to repay their loans during the term thereof. Management of the Bank monitors the loan portfolio and the Bank's real estate acquired as a result of foreclosure ("REO") for potential problems on a weekly basis and reports to the Board of Directors on a monthly basis. When a borrower fails to make a required loan payment or other weaknesses are detected in a borrower's financial condition, the Bank determines an appropriate course of action including contacting the borrower. Delinquencies are cured promptly in most cases. If the delinquency on a mortgage loan exceeds 90 days and is not cured through the Bank's normal collection procedures, or an acceptable arrangement is not worked out with the borrower, the Bank will institute measures to remedy the default, usually including commencing a foreclosure action. As a matter of policy, the Bank generally does not accept from the mortgagor a voluntary deed of the secured property in lieu of foreclosure. If foreclosure is effected, the property is sold at a public auction in which the Bank may participate as a bidder. If the Bank is the successful bidder, the foreclosed real estate is then included in the Bank's REO portfolio until it is sold. Upon acquisition, REO is recorded at the lower of unpaid principal balance adjusted for any remaining acquisition premiums or discounts less any applicable valuation allowance or estimated fair value, based on an appraisal, less estimated selling costs. Subsequent to foreclosure, real estate owned is carried at the lower of the new cost basis or fair value, with any further declines in fair value charged to operations. All costs incurred from the date of acquisition forward relating to maintaining the property are recorded as a current period expense. It is the Bank's general policy not to recognize interest income on loans past due 90 days or more. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is generally reversed against current interest income. On a loan-by-loan basis, Bank management may continue to accrue interest on loans that are past due more than 90 days, particularly if management believes that the individual loan is well secured, in the process of collection or renewal and the interest is fully collectible. [THIS SPACE INTENTIONALLY LEFT BLANK] The following table sets forth information regarding the Bank's nonperforming assets as of the dates shown.
At December 31, 2002 2001 2000 -------- -------- -------- (Dollars in thousands) Nonaccrual loans: First lien residential mortgage $ 9,184 $21,744 $16,062 Multifamily real estate -- 82 -- Residential construction 49 218 390 Commercial real estate 1,323 1,174 1,134 Acquisition and development 5,485 6 -- Commercial, financial and industrial 1,609 499 1,152 Consumer and other 128 141 496 --------- -------- -------- Total nonaccrual loans 17,778 23,864 19,234 --------- -------- -------- Loans greater than 90 days delinquent and still accruing interest: First lien residential mortgage -- 62 475 Multifamily real estate 282 -- -- Residential construction 83 755 -- Commercial real estate 302 -- 736 Acquisition and development 59 -- -- Commercial, financial and industrial 43 31 634 Consumer and other -- 1 153 --------- -------- -------- Total loans greater than 90 days delinquent and still accruing interest 769 849 1,998 --------- -------- -------- Total nonperforming loans 18,547 24,713 21,232 --------- -------- -------- Total REO and repossessed assets 4,433 4,607 4,095 --------- -------- -------- Total nonperforming assets $22,980 $29,320 $25,327 ========= ======== ======== Ratio of nonaccrual loans to total loans receivable and loans held for sale 0.95% 1.28% 1.01% ========= ======= ======= Ratio of nonperforming loans to total loans receivable and loans held for sale 1.00% 1.33% 1.12% ========= ======= ======= Ratio of nonperforming assets to total assets 0.91% 1.13% 0.82% ========= ======= =======
Nonperforming loans are those loans on nonaccrual status as well as those loans greater than ninety (90) days delinquent and still accruing interest. At December 31, 2002, the Bank's nonperforming loans decreased, when compared to December 31, 2001, by $6.2 million or 25.0%, to $18.5 million. The decrease in nonperforming loans is mainly due to the Bank's decision to liquidate a portion of its single-family mortgage loan portfolio during 2002 through two loan sales. As discussed previously, the first loan sale was in March 2002 when the Bank sold $10.8 million of its under-performing loans (some of which were considered nonperforming) to a third party investor. The second sale was in December 2002 when the Bank sold $4.3 million of nonperforming loans. At December 31, 2002, nonperforming assets included REO with an aggregate book value of $4.1 million and repossessed assets of $288,000. At such date, the Bank's REO consisted of 49 single family residential properties totaling $2.4 million, 8 commercial properties totaling $1.6 million and 4 residential construction properties totaling $145,000. The Bank actively markets the REO properties held. The Bank has historically incurred minimal losses on the sale of single family REO properties. For the year ended December 31, 2002, approximately $745,000 in additional interest income would have been recorded on the above loans accounted for on a nonaccrual basis if such loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination if held for part of the period. Net income for 2002 included $632,000 in interest income for these same loans prior to the time they were placed on nonaccrual status. The Bank considers a loan to be impaired when, based upon current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. In determining impairment, the Bank considers, among other things, large non-homogeneous loans which may include nonaccrual loans or troubled debt restructurings, and performing loans which exhibit, among other characteristics, high loan-to-value ratios, low debt coverage ratios, or indications that the borrowers are experiencing increased levels of financial difficulty. The Bank bases the measurements of collateral-dependent impaired loans on the fair value of their collateral. The amount by which the recorded investment in the loan exceeds the measure of the fair value of the collateral securing the loan is recognized by recording a valuation allowance. At December 31, 2002, the carrying value of impaired loans totaled approximately $8.5 million and the related allowance for loan losses on those impaired loans totaled $2.4 million. Of the impaired loans outstanding at December 31, 2002, eight loans with a total balance of $551,000 did not have a specific portion of the allowance for loan losses allocated to them at such date. The average balance of impaired loans during the year ended December 31, 2002 was approximately $3.8 million. For the year ended December 31, 2002, the Bank did not recognize interest income on loans considered impaired. The Bank had loaned $123.1 million at December 31, 2002, under its residential construction lending program to multiple borrowers who are engaged in similar activities. Certain of these borrowers could be similarly impacted by economic conditions in the Houston metropolitan area. See "Residential Construction Lending." The Bank had no other loan concentrations. ALLOWANCE FOR LOAN LOSSES. Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses in the appropriate provision required to maintain an adequate allowance to absorb probable losses on its loans receivable portfolio. The following table summarizes activity in the Bank's allowance for loan losses during the periods indicated.
Year Ended December 31, 2002 2001 2000 1999 1998 ------- -------- ------ -------- ------ (Dollars in thousands) Balance at beginning of year $15,385 $14,507 $10,493 $ 11,358 $ 7,412 Charge-offs (3,878) (4,073) (2,174) (11,830) (1,693) Recoveries 811 1,051 398 390 282 Provision for loan losses 5,800 3,900 5,790 10,575 3,100 Allowance of acquired entities(1) -- -- -- -- 2,257 ------- ------- ------- -------- -------- Balance at end of year $18,118 $15,385 $14,507 $ 10,493 $11,358 ======= ======= ======= ======== ======== Ratio of net charge-offs during the period to average net loans outstanding during the period 0.16% 0.16% 0.09% 0.69% 0.10% ====== ======= ======= ======== ========
________________________ (1) The allowance of acquired entities in 1998 represents the allowance for loan losses recorded in connection with the loans acquired in the 1998 Branch Acquisition. The following table sets forth the charge-offs by type of loan during the periods indicated.
Year Ended December 31, --------------------------------------- 2002 2001 2000 1999 1998 ------ ------ ----- ------- ------ (In thousands) First lien residential mortgage(1) $2,120 $ 648 $ 735 $ 331 $ 544 Residential construction 15 80 -- 26 -- Commercial real estate 118 339 55 10 24 Commercial, Warehouse and MSR -- -- -- 9,924 -- Commercial, financial and industrial 812 782 763 829 648 Consumer and other(2) 813 2,224 621 710 477 ----- ------ ------ ------- ------ Total charge-offs $3,878 $4,073 $2,174 $11,830 $1,693 ===== ====== ====== ======= ======
________________________ (1) In 2002, includes charge-offs totaling $1.8 million related to the Bank's decision to liquidate a portion of the mortgage loan portfolio. See "First Lien Residential Mortgage Loan Purchase, Sales and Originations." (2) In 2001, includes the charge-off of an $818,000 commercial overdraft loan ($450,000 of which was subsequently recovered through insurance proceeds) and $754,000 of charged-off purchased automobile loans, in addition to the charge-offs of other consumer type loans. The following table sets forth the allocation of the allowance for loan losses by type of loan outstanding at the dates indicated.
At December 31, 2002 2001 2000 1999 1998 ------- ------- --------- --------- --------- (In thousands) First lien residential mortgage $ 1,774 $ 2,556 $ 2,408 $ 2,529 $ 3,238 Multifamily mortgage 298 330 608 442 383 Residential construction 369 411 622 384 343 Real estate acquisition and development 2,834 1,407 1,330 1,034 759 Commercial real estate 3,416 2,701 2,574 2,221 2,112 Commercial construction 3,332 2,177 1,480 972 225 Commercial, Warehouse and MSR -- 53 45 256 1,722 Commercial, financial and industrial 2,633 1,891 2,611 1,650 1,750 Consumer and other 485 606 1,119 992 826 Unallocated 2,977 3,253 1,710 13 -- ------ ------- --------- --------- --------- $18,118 $15,385 $ 14,507 $ 10,493 $ 11,358 ======= ======= ========= ========= =========
The following table sets forth the allocation of the provision or the reduction of allowance for loan losses by loan type during the periods indicated.
Year Ended December 31, 2002 2001 2000 1999 1998 ------- ------- --------- ---------- --------- (In thousands) First lien residential mortgage $1,262 $ 746 $ 573 $ (446) $ 1,142 Multifamily mortgage (32) (278) 166 59 (184) Residential construction (27) (131) 238 67 55 Real estate acquisition and development 1,427 77 296 275 443 Commercial real estate 825 464 406 119 82 Commercial construction 1,155 697 508 747 (36) Commercial, Warehouse and MSR (341) (259) (397) 8,456 1,228 Commercial, financial and industrial 1,503 (20) 1,616 561 240 Consumer and other 304 1,061 687 724 846 Unallocated (276) 1,543 1,697 13 (716) ------ ------ -------- --------- --------- $5,800 $ 3,900 $ 5,790 $ 10,575 $ 3,100 ====== ====== ======== ========= ========
Estimating the allowance for loan losses is a critical accounting policy. It is subjective in nature and requires material estimates that may be subject to revision as facts and circumstances warrant. In assessing the adequacy of the allowance, management reviews the size, quality and risk of loans in the portfolio and considers such factors as specific known risks, historical and peer group experience, the existing nonperforming loans and the underlying collateral value on those loans, general economic conditions, particularly as they relate to Coastal's lending areas, industry standards, regulatory policies and other factors related to the collectibility of Coastal's loan portfolio. Based on the ongoing assessment by management, provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level deemed appropriate by management based on probable losses in the loan portfolio. While management uses the best information available to recognize losses on loans, there can be no assurance that future additions to the allowance will not be necessary. When comparing 2002 and 2001, the changes in the provision for loan losses are due to management's continuing evaluation of the overall allowance for loan losses. The increase in the provision for loan losses in 2002 (in the fourth quarter of 2002) was due to management's reevaluation of the allowance for loan losses given the current economic conditions, the decision in 2002 to sell loans which resulted in charge-offs totaling $1.8 million to writedown such loans to fair value, and the changes that have occurred within the mix of Coastal's loan portfolio, in addition to certain specific loans in the portfolio that have warranted greater attention and specific allocations of the allowance for loan losses. While management believes that it has adequately provided for loan losses and that the allowance for loan losses is adequate at December 31, 2002, it will continue to monitor the loan portfolio and make adjustments to its allowance for loan losses as it considers necessary. At December 31, 2002, the Bank's ratio of the allowance for loan losses to nonperforming loans was 97.69% and the ratio of the allowance for loan losses to total loans receivable was 1.00%. The Board of Directors of the Bank reviews its Asset Classification and Allowance Policy ("ACAP") at least annually. The policy provides that the Bank at least annually will establish a monthly provision amount to be added to the allowance for loan losses and the resultant allowance will be "tested" monthly for adequacy based on policy guidelines. Management maintains the allowance for loan losses at a level considered adequate to cover probable losses on the loans receivable portfolio. This allowance covers all loans, including loans deemed to be impaired, loans not impaired, and loans excluded from the impairment test. The adequacy of the allowance is based on management's periodic evaluation of the loan portfolio, which considers, among other things, the size, quality and risk of loans in the portfolio, identification of any adverse situations which may affect the ability of borrowers to repay, assessment of current and future economic conditions, regulatory policies and the estimated value of the underlying collateral, if any. The Bank's management believes that its present allowance for loan losses is adequate based upon, among other considerations, the factors discussed above, its existing nonperforming loans and the underlying collateral value on those loans and its historical and peer group loss experience. Management continues to review its loan portfolio to determine whether its ACAP should be altered in light of current conditions and to make any additional provisions which may be deemed necessary. While management uses the best information available to make such determinations, additional provisions for loan losses may be required to be established in the future should economic or other conditions change substantially. In addition, the FDIC and the Department, as an integral part of their examination processes, periodically review the Bank's allowance for loan losses. These agencies may require the Bank to increase the allowance for loan losses, based on their respective judgments of the information available at the time of the examinations. MORTGAGE LOAN SERVICING. Prior to the sale of its entire mortgage servicing rights portfolio effective March 31, 2000, the Bank serviced residential real estate loans for others, including FNMA, FHLMC and other private investors. Loan servicing for others included collecting and remitting loan payments, accounting for principal and interest, making advances to cover delinquent payments, making inspections as required of mortgaged premises, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults and generally administering the loans. Due to the Bank's declining servicing for others portfolio (with an average remaining loan life of approximately seven years), management decided to sell its entire servicing rights portfolio based on the then current market conditions for loan servicing rights and the expected declining income benefits of that servicing portfolio on an ongoing basis. Effective March 31, 2000, the Bank sold, to a third party, its rights to service approximately $389.1 million of mortgage loans for third party investors, primarily FNMA and FHLMC, pursuant to a purchase and sale agreement. The Bank subserviced those mortgage loans until the transfer to the purchaser was completed in the second quarter of 2000. The Bank recorded a $2.2 million gain on the sale of the above mentioned mortgage servicing rights in 2000. In December 2002, Coastal sold $70.1 million of mortgage loans with servicing retained to a third party investor and recognized the estimated fair value of those servicing rights retained of $359,000, which is recorded in prepaid expenses and other assets in the Company's Consolidated Statement of Financial Condition at December 31, 2002. As of December 31, 2002, Coastal's serviced for others approximately $68.8 million of such loans. See "First Lien Residential Mortgage Loan Purchases, Sales and Originations." The Bank receives fees for servicing mortgage loans for others, which generally range from 0.25% to 0.50% per annum on the declining principal balance of mortgage loans. Such fees serve to compensate the Bank for the costs of performing the servicing function. Other sources of loan servicing revenues include late charges and other ancillary fees. Servicing fees are collected out of the monthly mortgage payments made by borrowers and were recorded net of the amortization of mortgage servicing rights. MORTGAGE-BACKED SECURITIES The Bank maintains a large portfolio of mortgage-backed securities as a means of investing in housing-related mortgage instruments without the costs associated with originating mortgage loans for portfolio retention. At December 31, 2002, the Company's mortgage-backed securities available-for-sale portfolio amounted to $475.0 million, or 18.8%, of total assets. Effective September 30, 2001, Coastal transferred all of its mortgage-backed securities to the available-for-sale category. This was due to management's intent to restructure a portion of the asset base to make it less vulnerable to market interest rate fluctuations. In late November 2001, Coastal completed the sale of approximately $845 million of its mortgage-backed securities and recorded a gain of $169,000. The majority of the securities sold were CMOs tied to COFI and contained extension risk which caused, on average, higher levels of price volatility. Also in November 2001, Coastal used a portion of the proceeds of the sale to purchase approximately $512 million of primarily pass-thru mortgage-backed securities. A consequence of this 2001 securities sale is that any securities purchased by Coastal for approximately two years thereafter are required to be placed in either the available-for-sale or trading category. Securities available-for-sale are securities other than those held-to-maturity or for trading purposes and are recorded at fair value, with unrealized gains and losses excluded from earnings and recorded net of tax as other comprehensive income (loss) in stockholders' equity until realized. Realized gains and losses on securities are recorded in earnings in the year of sale based on the specific identification of each individual security sold. Premiums and discounts on mortgage-backed securities are amortized or accreted as a yield adjustment over the life of the securities using the interest method, with the amortization or accretion being adjusted when the prepayments are received. The following table sets forth the composition of the Company's mortgage-backed securities portfolio at the dates indicated.
At December 31, 2002 2001 2000 ----------- ----------- ------------ (In thousands) Held-to-maturity: CMOs $ -- $ -- $812,460 Agency securities -- -- 66,595 Non-agency securities -- -- 6,273 ---------- --------- --------- -- -- 885,328 Unamortized premium -- -- 1,503 Unearned discount -- -- (1,266) ---------- -------- --------- Total held-to-maturity $ -- $ -- $885,565 ========== ======== ========= Available-for-sale: CMOs $ 83,794 $106,657 $ 77,590 Agency securities 379,569 397,413 19,946 Non-agency securities 2,047 2,572 -- ---------- -------- --------- 465,410 506,642 97,536 ---------- -------- --------- Unamortized premium 8,662 9,873 149 Unearned discount -- -- (141) Net unrealized gain (loss) 950 (2,447) (2,871) ---------- -------- --------- Total available-for-sale $ 475,022 $514,068 $ 94,673 ========== ======== ========= Total mortgage-backed securities $ 475,022 $514,068 $980,238 ========== ======== =========
The mortgage-backed securities which the Company purchases and maintains in portfolio can include FNMA, FHLMC and GNMA certificates, certain privately issued, credit-enhanced mortgage-backed securities which are rated "AAA" or better by the national securities rating agencies and certain types of CMOs. The FNMA, FHLMC and GNMA certificates ("Agency Securities") are modified pass-through mortgage-backed securities, which represent undivided interests in underlying pools of fixed-rate, or certain types of adjustable rate, single family residential mortgages issued by these quasi-governmental (GNMA) and private (FNMA and FHLMC) corporations. FNMA and GNMA provide to the certificate holder a guarantee (which is backed by the full faith and credit of the U.S. government in the case of GNMA certificates) of timely payments of interest and scheduled principal payments, whether or not they have been collected. FHLMC guarantees the timely payment of interest and the full (though not necessarily timely) payment of principal. The guarantees of FNMA and FHLMC are not backed by the full faith and credit of the U.S. government. The mortgage-backed securities acquired by the Company that have been pooled and sold by private issuers, generally large investment banking firms, provide for the timely payments of principal and interest either through insurance issued by a reputable insurer or the right to receive certain payments thereunder is subordinated in a manner which is sufficient to have such mortgage-backed securities generally earn a credit rating of "AAA" or better from one or more of the national securities rating agencies. A CMO is a special type of pay-through debt obligation in which the stream of principal and interest payments on the underlying mortgages or mortgage-backed securities is used to create classes with different maturities and, in some cases, amortization schedules and a residual class of the CMO security being sold, with each such class possessing different risk characteristics. The residual interest sold represents any residual cash flows which result from the excess of the monthly receipts generated by principal and interest payments on the underlying mortgage collateral and any reinvestment earnings thereon, less the cash payments to the CMO holders and any administrative expenses. As a matter of policy, due to the risk associated with residual interests, the Bank does not intend to invest in residual interests in CMOs. Mortgage-backed securities generally yield less than the loans which underlie such securities because of their payment guarantees or credit enhancements which reduce credit risk. In addition, mortgage-backed securities are more liquid than individual mortgage loans and may be used to collateralize obligations of the Bank. Mortgage-backed securities issued or guaranteed by FNMA or FHLMC (except interest-only securities or the residual interests in CMOs) are weighted at no more than 20% for risk-based capital purposes, compared to a weight of 50% to 100% for residential loans. See "Regulation - Regulatory Capital Requirements." The following table sets forth the Company's activities with respect to mortgage-backed securities (including held-to-maturity and available-for-sale) during the periods indicated.
Year Ended December 31, 2002 2001 2000 ---------- ---------- --------- (In thousands) Mortgage-backed securities held-to-maturity purchased $ -- $ -- $ 4,815 Mortgage-backed securities available-for-sale purchased 112,579 512,267 -- Mortgage-backed securities available-for-sale sold -- (844,749) -- Discount accretion (premium amortization), net (3,142) (401) (159) Change in unrealized gain (loss) on mortgage-backed securities available-for-sale 3,397 424 (29) Principal repayments on mortgage-backed securities (151,880) (133,711) (41,266) ---------- --------- -------- Net decrease in mortgage-backed securities $ (39,046) $(466,170) $(36,639) ========== ========== =========
INVESTMENT ACTIVITIES Under the Texas Savings Bank Act (the "Act"), the Bank is permitted to invest in obligations of, or guaranteed as to principal and interest by, the United States or the State of Texas, in the stock or in any obligations or consolidated obligations of the FHLB, and in various other specified instruments. The Bank holds investment securities from time to time to help meet its liquidity requirements and as temporary investments until funds can be utilized to purchase residential mortgage loans, mortgage-backed securities or to originate other loans for the Bank's portfolio. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources." SOURCES OF FUNDS GENERAL. Advances from the FHLB, deposits, sales of securities under agreements to repurchase, as well as maturities of and principal repayments on loans and mortgage-backed securities have been the major sources of funds for use in the Bank's lending and investments, and for other general business purposes. Management of the Bank closely monitors rates and terms of competing sources of funds on at least a weekly basis and utilizes the source which is the most cost effective. DEPOSITS. The Bank attracts a majority of its deposits through its 43 branch offices in metropolitan Houston, Austin, Corpus Christi, the Rio Grande Valley and small cities in the southeast quadrant of Texas. The Bank also obtains deposits through acquisitions. The Bank offers a variety of traditional retail deposit products which currently includes interest-bearing checking, noninterest-bearing checking, savings, money market demand accounts and certificates of deposit which generally range in terms from three to 60 months. Included among these deposit products are individual retirement account certificates. Beginning in 1995 with the acquisition of Texas Capital, the Bank's management has pursued a commercial banking strategy related to deposits designed to increase the level of lower cost transaction and commercial deposit accounts. The Bank offers a range of products for commercial businesses including Small Business Checking, Business Interest Checking, Analysis Checking and Commercial Money Market Accounts. The acquisitions and marketing efforts have resulted in the outstanding balances of demand deposit accounts increasing to 39.7% of total deposits at December 31, 2002 from 32.1% at December 31, 1998. [THIS SPACE INTENTIONALLY LEFT BLANK] Effective January 1, 1998, the Company implemented a program whereby a portion of the balance in noninterest-bearing and interest-bearing checking accounts is reclassified to money market demand accounts under Federal Reserve Regulation D. The amount of such reclassification, reflected in the following table, was approximately $250.9 million ($131.3 million from noninterest bearing and $119.6 million from interest-bearing) at December 31, 2002, $243.3 million ($113.0 million from noninterest-bearing and $130.3 million from interest-bearing) at December 31, 2001, and $136.6 million ($68.1 million from noninterest-bearing and $68.5 million from interest-bearing) at December 31, 2000. The following table shows the distribution of and certain other information relating to the Company's deposits by type at the dates indicated.
At December 31, ---------------------------------------------------------------------- 2002 2001 2000 ------------------- -------------------- -------------------- Percent Percent Percent of of of Amount Deposits Amount Deposits Amount Deposits --------- --------- ---------- --------- ---------- --------- (Dollars in thousands) Demand deposit accounts: Noninterest-bearing checking $ 51,029 3.16% $ 47,712 2.87% $ 80,849 4.83% Interest-bearing checking 14,353 0.89 15,894 0.96 61,046 3.64 Savings 44,603 2.76 45,234 2.72 43,891 2.62 Money market demand (including amounts reclassified from noninterest and interest-bearing checking) 530,659 32.87 505,789 30.47 374,210 22.34 ----------- ------- ---------- -------- --------- ------ Total demand deposit accounts 640,644 39.68 614,629 37.02 559,996 33.43 ----------- ------- ---------- -------- --------- ------ Certificate accounts: Maturing within 1 year 768,407 47.61 950,827 57.26 1,038,522 62.00 1-2 years 131,792 8.16 61,933 3.73 53,378 3.19 2-3 years 35,685 2.21 23,707 1.43 13,678 0.82 3-4 years 4,513 0.28 5,830 0.35 4,284 0.26 4-5 years 33,302 2.06 3,409 0.21 4,745 0.28 Over 5 years 25 -- 51 0.00 323 0.02 ----------- ------- ---------- -------- --------- ------ Total certificate accounts 973,724 60.32 1,045,757 62.98 1,114,930 66.57 ----------- ------- ---------- -------- --------- ------- 1,614,368 100.00% 1,660,386 100.00% 1,674,926 100.00% ======== ======= ======= Premium on purchased deposits, net -- -- 55 ----------- ---------- ---------- Total $ 1,614,368 $1,660,386 $1,674,981 =========== ========== ==========
Prior to the reclassification as discussed above, noninterest-bearing checking accounts, interest-bearing checking accounts and money market demand accounts were as follows at December 31, 2002, 2001 and 2000: 2002 2001 2000 -------- -------- -------- (In thousands) Noninterest-bearing checking $182,290 $160,738 $148,953 Interest-bearing checking 134,034 146,144 129,497 Money market demand accounts 279,717 262,513 237,655 The following table sets forth the average balance of each deposit type and the average rate paid on each deposit type for the periods indicated.
Year Ended December 31, 2002 2001 2000 ------------------------- ---------------------- -------------------- Average Average Average Average Average Average Balance Rate Paid Balance Rate Paid Balance Rate Paid -------------- ---------- ----------- ---------- ---------- ---------- (Dollars in thousands) Demand deposit accounts: Noninterest-bearing checking $ 30,533 --% $ 54,695 --% $ 74,575 --% Interest-bearing checking 8,662 0.64 36,785 2.03 50,622 2.00 Savings 46,935 1.01 46,266 1.76 47,950 2.15 Money market demand(1) 543,206 1.49 439,894 2.00 366,200 2.56 Certificate accounts 1,018,159 3.27 1,103,792 5.39 1,095,760 5.62 ------------ ----------- ---------- Total deposits $ 1,647,495 2.42 $ 1,681,432 4.15 $1,635,107 4.47 ============ =========== ==========
________________________ (1) Includes amounts reclassified from noninterest-bearing and interest-bearing checking accounts pursuant to the Bank's program under Federal Reserve Regulation D as follows:
2002 2001 2000 ---------- -------- -------- (In thousands) Noninterest-bearing checking $ 139,314 $ 95,733 $ 71,053 Interest-bearing checking 126,532 92,200 69,523 ---------- -------- -------- $ 265,846 $187,933 $140,576 ========== ======== ========
The following table presents by various interest rate categories the amounts of certificate accounts at the dates indicated and the amounts of certificate accounts at December 31, 2002 which mature during the periods indicated.
Amounts at December 31, Amounts at December 31, 2002 Maturing In ------------------------ ------------------------------------------------------ One Year Greater than 2002 2001 or Less Two Years Three Years Three Years --------- --------- ----------- ----------- ----------- ----------- (In thousands) Certificate accounts: Less than 2.00% $ 104,358 $ 29,707 $ 101,478 $ 2,874 $ -- $ 6 2.00% to 3.99% 764,982 434,529 635,394 102,619 16,582 10,387 4.00% to 5.99% 97,681 512,263 27,760 25,145 17,420 27,356 6.00 to 7.99% 6,630 69,188 3,702 1,154 1,683 91 8.00 to 9.99% 73 70 73 -- -- -- ---------- ---------- ----------- --------- ------- ------- Total $ 973,724 $1,045,757 $ 768,407 $ 131,792 $35,685 $37,840 ========== ========== ============ ========= ======= =======
Certificates maturing within one year consist primarily of six month and one year certificates. Historically, a majority of such certificate holders roll over their balances into new certificates with similar terms at the Bank's then current interest rates. The following table sets forth the net deposit flows of the Company during the periods indicated.
Year Ended December 31, 2002 2001 2000 ---------- ---------- --------- (In thousands) Decrease due to sale of branches (1) $ (75,275) $ -- $ -- Net increase (decrease) before interest credited (11,848) (86,688) (20,970) Interest credited 41,105 72,093 71,662 ----------- --------- --------- Net deposit increase (decrease) $ (46,018) $(14,595) $ 50,692 =========== ========= =========
(1) For the year ended December 31, 2002, the $75.3 million decrease is due to the sale of five branch offices and the related deposit accounts. The following table sets forth the amount of the Bank's certificates of deposits at December 31, 2002 which are $100,000 or more by time remaining until maturity.
At December 31, 2002 ----------------------------------------------- Number of accounts Deposit Amount ------------------ --------------- (In thousands) Three months or less 550 $ 72,245 Over three through six months 341 37,274 Over six through twelve months 649 79,989 Over twelve months 418 47,523 ------ ------- Total 1,958 $ 237,031 ====== ========
The Bank's deposits are obtained primarily from businesses and residents of Houston, Austin, Corpus Christi, the Rio Grande Valley and small cities in the southeast quadrant of Texas. Currently, the principal methods used by the Bank to attract and retain deposit accounts include competitive interest rates, having branch locations in under-served markets and offering a variety of services for the Bank's commercial business and retail customers. The Bank uses traditional marketing methods to attract new customers and deposits, including newspaper and radio advertising. Through 2002, except as noted below, the Bank has not solicited brokered deposit accounts and generally has not negotiated rates on larger denomination (i.e., jumbo) certificates of deposit. From early 1997 through mid year 2002, the Bank solicitated deposit accounts through a "money desk." Money desk rates were only offered to institutions (primarily credit unions and municipal utility districts) and were generally up to 50 basis points higher than on regular certificate of deposit accounts. The offering of deposits through the "money desk" was discontinued during 2002. The Bank also provides its customers with the opportunity to invest in noninsured mutual funds, including government bond funds, tax-free municipal bond funds, growth funds, income growth funds, and sector funds specific to an industry, which are provided through a third party arrangement with another company, which maintains representatives at the Bank's branch offices. The Bank earns a fee after the payment of all expenses, which was not material to the Bank's results of operations for the years ended December 31, 2002, 2001 or 2000. See "Subsidiaries of the Bank - CoastalBanc Financial Corp", and "Subsidiaries of the Bank - Coastal Banc Insurance Agency, Inc." BORROWINGS. The following table sets forth certain information regarding the borrowings of the Bank at or for the dates indicated.
At or For the Year Ended December 31, -------------------------------------- 2002 2001 2000 ------------- ---------- --------- (Dollars in thousands) FHLB advances: Average balance outstanding $ 683,454 $ 795,009 $ 926,659 Maximum amount outstanding at any month-end during the period 760,139 1,218,145 1,275,541 Balance outstanding at end of period 696,085 690,877 1,150,305 Average interest rate during the period 2.95% 4.90% 6.29% Average interest rate at end of period 2.71% 3.46% 6.48% Securities sold under agreements to repurchase: Average balance outstanding $ -- $ 283,622 $ 249,655 Maximum amount outstanding at any month-end during the period 493,003 605,214 Balance outstanding at end of period -- -- -- Average interest rate during the period -- 3.77% 6.68% Average interest rate at end of period -- -- --
As noted previously, as a result of the asset base restructuring that occurred in November 2001, the Company's total assets decreased during that year. As part of the restructuring, the Company sold mortgage-backed securities of $845 million, purchased $512 million of mortgage-backed securities to replace the assets sold and reduced borrowings with the remainder of the sales proceeds. The Bank obtains long term, fixed rate and short term, variable rate advances from the FHLB upon the security of certain of its first lien residential and multifamily mortgage loans and mortgage-backed securities, provided certain standards related to creditworthiness of the Bank have been met. FHLB advances are generally available for general business purposes to expand lending and investing activities. Borrowings have generally been used to fund the purchase of loans receivable and mortgage-backed securities. Advances from the FHLB are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The programs of the FHLB currently utilized by the Bank include various short-term, fixed rate advances and long term, fixed and variable-rate advances. At December 31, 2002, the Bank had total FHLB advances of $696.1 million at a weighted average interest rate of 2.71%. Of the advances outstanding at December 31, 2002, $170.0 million were short-term advances with an original maturity of less than 90 days. The Bank also obtains funds from the sales of securities to investment dealers under agreements to repurchase ("reverse repurchase agreements"). In a reverse repurchase agreement transaction, the Bank will generally sell a mortgage-backed security agreeing to repurchase the same security on a specified later date at an agreed upon price. The mortgage-backed securities underlying the agreements are delivered to the dealers who arrange the transactions. The dealers may lend the Bank's securities to others in the normal course of their operations; however, such dealers or third party custodians safe-keep the securities which are to be specifically repurchased by the Bank. Reverse repurchase agreements represent a competitive cost funding source for the Bank; however, the Bank is subject to the risk that the lender may default at maturity and not return the collateral. In order to minimize this potential risk, the Bank only deals with large, established investment brokerage firms when entering into these transactions. At December 31, 2002, the Bank did not have any borrowings under reverse repurchase agreements. To a lesser extent, beginning in 1997, the Bank has utilized federal funds purchased from a correspondent bank for overnight borrowing purposes. Federal funds purchased averaged approximately $18,000 during the year ended December 31, 2000, with an average interest rate during the period of 5.56%. There were no federal funds purchased outstanding at any time during 2002 or 2001 or at any month-end during 2000. The Asset/Liability Subcommittee of the Bank attempts to match the maturity of its borrowings with particular repricing dates of certain assets in order to maintain a pre-determined interest rate spread. The Bank's objective is to minimize the increase or decrease in the interest rate spread during periods of fluctuating interest rates from that which was contemplated at the time the assets and liabilities were first put on the Bank's books. The Bank also attempts to alter the interest rate risk associated with its borrowings through the use of interest rate swaps and interest rate caps purchased from selected securities brokers/dealers. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" in Item 7 hereof. SUBSIDIARIES OF THE BANK GENERAL. The Bank is permitted to invest in the capital stock, obligations and other securities of its service corporations in an aggregate amount not to exceed 10% of the Bank's assets. In addition, the Bank may make conforming loans in an amount not exceeding 50% of the Bank's regulatory capital to service corporations of which the Bank owns more than 10% of the stock. At December 31, 2002, the Bank was authorized to have a maximum investment of approximately $252.5 million in its subsidiaries. At December 31, 2002, the Bank had two active wholly-owned subsidiaries, the activities of which are described below. At December 31, 2002, the Bank's aggregate equity investment in its subsidiaries was $423,000. COASTALBANC FINANCIAL CORP. CoastalBanc Financial Corp. ("CBFC") was formed in 1986 to act as an investment advisor to other insured financial institutions. The Bank is the sole stockholder of CBFC. Over the past five years, CBFC has been inactive in its investment advisory capacity. CBFC became active during the last quarter of 1992 in connection with the sale of mutual funds through third party intermediaries. Fees generated, net of expenses, resulted in a net income of $5,000, $27,000 and $37,000 for the years ended December 31, 2002, 2001 and 2000, respectively. COASTAL BANC INSURANCE AGENCY, INC. In 1987, the Bank entered into an Administrative Services Agreement with CBIA, a Texas business corporation licensed under Texas law to act as a life insurance agent. Until June 22, 2000, CBIA was affiliated with the Bank as a result of being wholly-owned by a former executive officer of the Bank. On June 22, 2000, CBIA became a subsidiary of the Bank. CBIA receives fees related to insurance and investment product sales through third party intermediaries to the Bank's deposit and loan customers. Fees generated, net of expenses, resulted in net income of $14,000 for the year ended December 31, 2002, $13,000 for the year ended December 31, 2001 and $74,000 for the period from June 22 to December 31, 2000. Expenses of CBIA include administrative fees paid to the Bank of $575,000 for the year ended December 31, 2002, $510,000 for the year ended December 31, 2001 and $215,000 for the period from June 22 to December 31, 2000. AFFILIATES OF THE BANK COASTAL BANC CAPITAL CORP. CBCC is a direct subsidiary of HoCo and an affiliate of the Bank. CBCC, through its Mortgage Asset Trading Group, has been engaged in the business of purchasing and reselling packages of whole loan assets on behalf of the Bank and institutional investors. These activities continued until September 2002, when the operations of the Mortgage Asset Trading Group were moved to CBMC. Effective January 1, 2002, CBCC formed two new groups in an effort to increase its fee income within its existing business of asset trading and by providing additional services for commercial business customers. The Specialty Finance Group will focus on developing a network of buyers of mortgage loans and to develop the capability of trading in other types of debt instruments. The operations of the Specialty Finance Group were also moved to CBMC in September 2002. The Corporate Finance Group, as an intermediary, will focus on raising capital for its business customers and providing merger and acquisition advisory services to buyers and sellers of companies. The loan packages acquired by CBCC were offered to the Bank on the same terms and at the same time that they were offered to other prospective purchasers. During 2002, CBCC purchased whole loan assets totaling $347.8 million and sold whole loans (including purchase premium) totaling $340.0 million to the Bank and $8.6 million to third party investors. During the year ended December 31, 2002, CBCC recorded gains on the sale of loans to the Bank of $810,000 and gains on the sale of loans to third party investors of $40,000. The $810,000 gain on the sale of loans to the Bank was recorded on the Bank's financial statements as a premium on purchased loans and is being amortized over the life of those loans. All significant intercompany balances and transactions are eliminated in consolidation. At December 31, 2002, HoCo's unconsolidated equity investment in CBCC was $430,000. CBCC had net income (loss) (before intercompany eliminations) of $(29,000), $437,000 and $(21,000) for the years ended December 31, 2002, 2001 and 2000, respectively. Commissions received by CBCC from the Bank are calculated at a market rate and are not greater than those paid to non-affiliates in similar transactions. The Bank and CBCC have entered into a mortgage warehouse revolving loan agreement pursuant to which the Bank has established a $17.0 million revolving line of credit to be drawn upon from time to time by CBCC to finance the acquisition of whole loan assets and the holding of such assets until they are sold. The advances drawn by CBCC are collateralized by such assets purchased and held by CBCC. There were no amounts outstanding on this line of credit at December 31, 2002. All transactions between the Bank and CBCC are within regulatory guidelines. In 2003, management of the Company made the decision to discontinue the operations of CBCC effective March 31, 2003 due to the current economic climate. COASTAL BANC MORTGAGE CORP. CBMC is a direct subsidiary of HoCo and an affiliate of the Bank. Effective September 2002, CBMC began performing the functions previously performed by the Mortgage Asset Trading Group and the Specialty Finance Group of CBCC, which were moved from CBCC to CBMC. In addition, CBMC entered into a marketing service agreement with a third party to enhance the opportunities for both parties related to the business of buying and selling whole loan related assets. The agreement calls for shared revenues for referring business between the parties. During 2002, CBMC purchased whole loan assets totaling $33.5 million and sold whole loans (including purchase premium) totaling $33.6 million to the Bank. During the period ended December 31, 2002, CBMC recorded gains on the sale of loans to the Bank of $86,000. The gain on the sale of the loans to the Bank was recorded on the Bank's financial statements as a premium on purchased loans and is being amortized over the life of those loans. In addition, during 2002, CBMC received $41,000 in brokerage fees from the Bank related to other loan packages sold by the Bank. All significant intercompany balances and transactions are eliminated in consolidation. At December 31, 2002, HoCo's unconsolidated equity investment in CBMC was $34,000. CBMC had net loss (before intercompany eliminations) of $67,000 for the period from CBMC's inception in July 2002 through December 31, 2002. REGULATION Set forth below is a brief description of certain laws and regulations which relate to the regulation of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations. Certain federal banking laws have been recently amended. See "Regulation - The Company-Financial Modernization." THE COMPANY REGULATIONS. The Company and HoCo are registered unitary savings and loan holding companies and are subject to OTS and Department regulation, examination, supervision and reporting requirements. In addition, because the capital stock of the Company is registered under Section 12(g) of the Securities Exchange Act of 1934, the Company is also subject to various reporting and other requirements of the SEC. As a subsidiary of a savings and loan holding company, the Bank is also subject to certain Federal and state restrictions in its dealings with the Company and affiliates thereof. FEDERAL ACTIVITIES RESTRICTIONS. There are generally no restrictions on the activities of a savings and loan holding company which holds only one subsidiary savings bank provided that it meets the grandfather requirement described below. See "The Company - Financial Modernization." However, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution (i.e., a savings association or savings bank), the Director may impose such restrictions as he deems necessary to address such risk, including limiting (i) payment of dividends by the savings institution; (ii) transactions between the savings institution and its affiliates; and (iii) any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Notwithstanding the foregoing, if the savings institution subsidiary of such a holding company fails to meet the Qualified Thrift Lender ("QTL") test, then such unitary holding company also shall become subject to the activities restrictions applicable to multiple savings and loan holding companies and, unless the savings institution requalifies as a QTL within one year thereafter, shall register as, and become subject to the restrictions applicable to, a bank holding company. See "Regulation of The Bank - Qualified Thrift Lender Test." If the Company were to acquire control of another savings institution, other than through merger or other business combination with the Bank, the Company would become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority to approve emergency thrift acquisitions and where each subsidiary savings institution meets the QTL test, as set forth below, the activities of the Company and any of its subsidiaries (other than the Bank or other subsidiary savings institutions) would thereafter be subject to further restrictions. No multiple savings and loan holding company or subsidiary thereof which is not a savings institution shall commence or continue beyond a limited period of time after becoming a multiple savings and loan holding company or subsidiary thereof any business activity, other than: (i) furnishing or performing management services for a subsidiary savings institution; (ii) conducting an insurance agency or escrow business; (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings institution; (iv) holding or managing properties used or occupied by a subsidiary savings institution; (v) acting as trustee under deeds of trust; (vi) those activities authorized by regulation as of March 5, 1987 to be engaged in by multiple savings and loan holding companies; or (vii) unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies, those activities authorized by the Federal Reserve Board as permissible for bank holding companies or financial holding companies. The activities described in (i) through (vi) above may be engaged in only after giving the OTS prior notice and being informed that the OTS does not object to such activities. In addition, the activities described in (vii) above also must be approved by the Director of the OTS prior to being engaged in by a multiple savings and loan holding company. RESTRICTIONS ON ACQUISITIONS. Except under limited circumstances, savings and loan holding companies are prohibited from acquiring, without prior approval of the Director of the OTS, (i) control of any other savings institution or savings and loan holding company or substantially all the assets thereof or (ii) more than 5% of the voting shares of a savings institution or holding company thereof which is not a subsidiary. Except with the prior approval of the Director of the OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company's stock, may acquire control of any savings institution, other than a subsidiary savings institution, or of any other savings and loan holding company. The Director of the OTS may approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings institutions in more than one state only if (i) the multiple savings and loan holding company involved controls a savings institution which operated a home or branch office located in the state of the association to be acquired as of March 5, 1987; (ii) the acquiror is authorized to acquire control of the savings institution pursuant to the emergency acquisition provisions of the Federal Deposit Insurance Act ("FDIA"), or (iii) the statutes of the state in which the institution to be acquired is located specifically permit institutions to be acquired by the state-chartered institutions or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings institutions). FINANCIAL MODERNIZATION. Under the Gramm-Leach-Bliley Act enacted into law on November 12, 1999, no company may acquire control of a savings and loan holding company after May 4, 1999, unless the company is engaged only in activities traditionally permitted to a multiple savings and loan holding company or newly permitted to a financial holding company under Section 4(k) of the Bank Holding Company Act. With limited exceptions, existing savings and loan holding companies and those formed pursuant to an application filed with the OTS before May 4, 1999, may engage in any activity including non-financial or commercial activities provided such companies control only one savings association and that savings association meets the QTL test. Corporate reorganizations are permitted, but the transfer of grandfathered unitary thrift holding company status through acquisition is not permitted. The Company and HoCo qualify to engage in that broader range of activities. TEXAS REGULATIONS. Under the Texas Savings Bank Act ("TSBA"), each registered holding company, such as the Company, is required to file reports with the Department as required by the Texas Savings and Loan Commissioner ("Commissioner") and is subject to such examination as the Commissioner may prescribe. SARBANES-OXLEY ACT OF 2002. On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Act of 2002, which generally establishes a comprehensive framework to modernize and reform the oversight of public company auditing, improve the quality and transparency of financial reporting by those companies and strengthen the independence of auditors. Certain of the new legislation's more significant reforms are noted below. - - The new legislation creates a public company accounting oversight board which is empowered to set auditing, quality control and ethics standards, to inspect registered public accounting firms, to conduct investigations and to take disciplinary actions, subject to SEC oversight and review. The new board will be funded by mandatory fees paid by all public companies. The new legislation also improves the Financial Accounting Standards Board, giving it full financial independence from the accounting industry. - - The new legislation strengthens auditor independence from corporate management by, among other things, limiting the scope of consulting services that auditors can offer their public company audit clients. - - The new legislation heightens the responsibility of public company directors and senior managers for the quality of the financial reporting and disclosure made by their companies. Among other things, the new legislation provides for a strong public company audit committee that will be directly responsible for the appointment, compensation and oversight of the work of the public company auditors. - - The new legislation contains a number of provisions to deter wrongdoing. CEOs and CFOs will have to certify that company financial statements fairly present the company's financial condition. If a misleading financial statement later resulted in a restatement, the CEO and CFO must forfeit and return to the company any bonus, stock or stock option compensation received in the twelve months following the misleading financial report. The new legislation also prohibits any company officer or director from attempting to mislead or coerce an auditor. Among other reforms, the new legislation empowers the SEC to bar certain persons from serving as officers or directors of a public company; prohibits insider trades during pension fund "blackout periods;" directs the SEC to adopt rules requiring attorneys to report securities law violations; and requires that civil penalties imposed by the SEC go into a disgorgement fund to benefit harmed investors. - - The new legislation imposes a range of new corporate disclosure requirements. Among other things, the new legislation requires public companies to report all off-balance-sheet transactions and conflicts, as well as to present any pro forma disclosures in a way that is not misleading and in accordance with requirements to be established by the SEC. The new legislation also accelerated the required reporting of insider transactions, which now generally must be reported by the end of the second business day following a covered transaction; requires that annual reports filed with the SEC include a statement by management asserting that it is responsible for creating and maintaining adequate internal controls and assessing the effectiveness of those controls; and requires companies to disclose whether or not they have adopted an ethics code for senior financial officers, and, if not, why not, and whether the audit committee includes at least one "financial expert," a term which is to be defined by the SEC in accordance with specified requirements. The new legislation also requires the SEC, based on certain enumerated factors, to regularly and systematically review corporate filings. - - The new legislation contains provisions which generally seek to limit and expose to public view possible conflicts of interest affecting securities analysts. - - Finally, the new legislation imposes a range of new criminal penalties for fraud and other wrongful acts, as well as extends the period during which certain types of lawsuits can be brought against a company or its insiders. REGULATION OF THE BANK The Bank is required to file reports with the Department and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions, such as any merger or acquisition with another institution. The regulatory system to which the Bank is subject is intended primarily for the protection of the deposit insurance fund and depositors, not stockholders. The regulatory structure also provides the Department and the FDIC with substantial discretion in connection with their supervisory and enforcement functions. The Department and the FDIC conduct periodic examinations of the Bank in order to assess its compliance with federal and state regulatory requirements. As a result of such examinations, the Department and the FDIC may require various corrective actions. Virtually every aspect of the Bank's business is subject to numerous federal and/or state regulatory requirements and restrictions with respect to such matters as, for example, the nature and amounts of loans and investments that may be made, the issuance of securities, the amount of reserves that must be established against deposits, the establishment of branches, mergers, non-banking activities and other operations. Numerous laws and regulations also set forth special restrictions and procedural requirements with respect to the extension of credit, credit practices, the disclosure of credit terms and discrimination in credit transactions. LIMITATIONS ON TRANSACTIONS WITH AFFILIATES. Transactions between savings institutions and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings institution is any company or entity which controls, is controlled by, or is under common control with the savings institution. In a holding company context, the parent holding company of a savings institution (such as the Company) and any companies which are controlled by such parent holding company are affiliates of the savings institution. Generally, Section 23A limits the extent to which the savings institution or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. Section 23B applies to "covered transactions" as well as certain other transactions and requires that all such transactions be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term "covered transaction" includes the making of loans to, purchase of assets from and, issuance of a guarantee to an affiliate and similar transactions. Section 23B transactions also apply to the provision of services and the sale of assets by a savings association to an affiliate. In addition to the restrictions imposed by Sections 23A and 23B, no savings institution may (i) loan or otherwise extend credit to an affiliate, except for any affiliate which engages only in activities which are permissible for bank holding companies, or (ii) purchase or invest in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings institution. In addition, Sections 22(h) and (g) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% stockholder of a savings institution (a "principal stockholder"), and certain affiliated interests of each of them, may not exceed, together with all other outstanding loans to such person and affiliated interests, the savings institution's loans to one borrower limit (generally equal to 15% of the institution's unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons and also requires prior Board approval for certain loans. In addition, the aggregate amount of extensions of credit by a savings institution to all insiders cannot exceed the institution's unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At December 31, 2002, the Bank was in compliance with the above restrictions. REGULATORY CAPITAL REQUIREMENTS. Federally insured state-chartered banks are required to maintain minimum levels of regulatory capital. These standards generally must be as stringent as the comparable capital requirements imposed on national banks. The FDIC also is authorized to impose capital requirements in excess of these standards on individual banks on a case-by-case basis. Under current FDIC regulations, the Bank is required to comply with three separate minimum capital adequacy requirements: a "Tier 1 capital ratio" and two "risk-based" capital requirements. "Tier 1 capital" generally includes common stockholders' equity (including retained earnings), qualifying noncumulative perpetual preferred stock and any related surplus, and minority interests in the equity accounts of fully consolidated subsidiaries, minus intangible assets, other than properly valued mortgage servicing assets, nonmortgage servicing assets and purchased credit card relationships up to certain specified limits and minus net deferred tax assets in excess of certain specified limits. At December 31, 2002, the Bank did not have any net deferred tax assets in excess of the specified limits. TIER 1 CAPITAL RATIO. FDIC regulations establish a minimum 3.0% ratio of Tier 1 capital to total assets for the most highly-rated state-chartered, FDIC-supervised banks and for all other state-chartered, FDIC-supervised banks, the minimum Tier 1 capital ratio shall not be less than 4.0%. Under FDIC regulations, highly-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity and good earnings. At December 31, 2002, the minimum Tier 1 capital ratio for capital adequacy purposes for the Bank was 4.0% and its actual Tier 1 capital ratio was 6.88%. RISK-BASED CAPITAL REQUIREMENTS. The risk-based capital requirements contained in FDIC regulations generally require the Bank to maintain a minimum ratio of Tier 1 capital to risk-weighted assets of at least 4.00% and a ratio of total risk-based capital to risk-weighted assets of at least 8.00%. To calculate the amount of capital required, assets are placed in one of four categories and given a percentage weight (0%, 20%, 50% or 100%) based on the relative risk of the category. For example, U.S. Treasury Bills and GNMA securities are placed in the 0% risk category. FNMA and FHLMC securities are placed in the 20% risk category, loans secured by one-to-four family residential properties and certain privately issued mortgage-backed securities are generally placed in the 50% risk category and commercial and consumer loans and other assets are generally placed in the 100% risk category. In addition, certain off-balance sheet items are converted to balance sheet credit equivalent amounts and each amount is then assigned to one of the four categories. For purposes of the risk-based capital requirements, "total capital" means Tier 1 capital plus supplementary or Tier 2 capital, so long as the amount of supplementary or Tier 2 capital that is used to satisfy the requirement does not exceed the amount of Tier 1 capital. Supplementary or Tier 2 capital includes, among other things, so-called permanent capital instruments (cumulative or other perpetual preferred stock, mandatory convertible subordinated debt and perpetual subordinated debt), so-called maturing capital instruments (mandatorily redeemable preferred stock, intermediate-term preferred stock, mandatory convertible subordinated debt and subordinated debt), and a certain portion of the allowance for loan losses up to a maximum of 1.25% of risk-weighted assets. At December 31, 2002, the Bank's Tier 1 capital to risk-weighted assets ratio was 10.32% and its total risk-based capital to risk weighted assets ratio was 11.38%. [THIS SPACE INTENTIONALLY LEFT BLANK] The following table sets forth information with respect to each of the Bank's minimum capital adequacy requirements at the dates shown.
At December 31, ---------------------------------------------------------------- 2002 2001 2000 ------------------- -------------------- --------------------- Actual Required(1) Actual Required(1) Actual Required(1) ------- ----------- ------- ----------- ------- ----------- Tier 1 capital to total assets 6.88% 4.00% 7.27% 4.00% 6.22% 4.00% Tier 1 risk-based capital to risk weighted assets 10.32 4.00 11.90 4.00 9.94 4.00 Total risk-based capital risk to risk weighted assets 11.38 8.00 12.79 8.00 10.72 8.00
_____________________________________________ (1)Minimum required ratio for regulatory capital adequacy purposes. The following table sets forth a reconciliation between the Bank's stockholders' equity and each of its three minimum regulatory capital requirements at December 31, 2002.
Tier 1 Total Tier 1 Risk-based Risk-based Capital Capital Capital -------------- ------------- ------------- (Dollars in thousands) Total stockholders' equity $ 199,674 $ 199,674 $ 199,674 Unrealized gain on securities available-for-sale (616) (616) (616) Less nonallowable assets: Goodwill (21,429) (21,429) (21,429) Mortgage servicing rights (36) (36) (36) Plus allowance for loan losses -- -- 18,118 -------------- ----------- ---------- Total regulatory capital 177,593 177,593 195,711 Minimum required capital 103,315 68,816 137,632 -------------- ----------- ---------- Excess regulatory capital $ 74,278 $ 108,777 $ 58,079 ============== =========== ========== Bank's regulatory capital percentage (1) 6.88% 10.32% 11.38% ============== =========== ========== Minimum regulatory capital adequacy required percentage 4.00% 4.00% 8.00% ============== =========== ========== Bank's regulatory capital percentage in excess of minimum requirement 2.88% 6.32% 3.38% ============== =========== ==========
________________________ (1)Tier 1 capital is computed as a percentage of adjusted average total assets of $2.6 billion. Risk-based capital is computed as a percentage of adjusted risk-weighted assets of $1.7 billion. FDIC INSURANCE PREMIUMS. The deposits of the Bank are insured to the maximum extent permitted by the Savings Association Insurance Fund (the "SAIF") and the Bank Insurance Fund (the "BIF"), both of which are administered by the FDIC, and are backed by the full faith and credit of the U.S. government. As the insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions. The Bank currently pays deposit insurance premiums to the FDIC based on a risk-based assessment system established by the FDIC for all bank and thrift institutions. Under applicable regulations, institutions are assigned to one of three capital groups based solely on the level of an institution's capital - "well capitalized," "adequately capitalized" and "undercapitalized" - which are defined in the same manner as the regulations establishing the prompt corrective action system under Section 38 of the FDIA. These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be healthy to those which are considered to be of substantial supervisory concern. The matrix so created results in nine assessment risk classifications, with rates during the last six months of 2002 ranging from zero for well capitalized, healthy institutions, such as the Bank, to 27 basis points for undercapitalized institutions with substantial supervisory concerns. In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize the predecessor to the SAIF. The current assessment rate is .0168% of insured deposits and is adjusted quarterly. These assessments will continue until the Financing Corporation bonds mature in 2019. SAFETY AND SOUNDNESS STANDARDS. The FDIC and the other federal bank regulatory agencies have established guidelines for safety and soundness, addressing operational and managerial standards, as well as compensation matters for insured financial institutions. Institutions failing to meet these standards are required to submit compliance plans to their appropriate federal regulators. The FDIC and the other agencies have also established guidelines regarding asset quality and earnings standards for insured institutions. The Bank believes that it is in compliance with these guidelines and standards. ACTIVITIES AND INVESTMENTS OF INSURED STATE-CHARTERED BANKS. The activities and equity investments of FDIC-insured, state-chartered banks are limited by Federal law to those that are permissible for national banks. An insured state bank generally may not acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary, (ii) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank's assets, (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors' and officers' liability insurance, and (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met. COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act ("CRA"), as implemented by FDIC regulations, a financial institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC, in connection with its examination of a financial institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. As of the date of its most recent regulatory examination, the Bank was rated "satisfactory" with respect to its CRA compliance. Under revisions to the CRA regulations promulgated in 1995, a new evaluation system became effective that rates institutions based on their actual performance in meeting community credit needs. The system evaluates the degree to which an institution is performing under tests and standards judged in the context of information about the institution, its community, its competitors and its peers with respect to (i) lending, (ii) service delivery systems and (iii) community development. It also specifies that an institution's CRA performance will be considered in an institution's expansion (e.g., branching) proposals and may be the basis for approving, denying or conditioning the approval of an application. QUALIFIED THRIFT LENDER TEST. All savings institutions, including the Bank, are required to meet a QTL test set forth under Section 10(m) of the Home Owners' Loan Act, as amended, ("HOLA") to avoid certain restrictions on their operations and those of their holding company. A savings institution has the option of complying with the QTL test set forth in the HOLA and implementing regulations or by qualifying as a domestic building and loan association as defined in Section 7701(a)(19) of the Code. The QTL test set forth in HOLA requires that a depository institution must have at least 65% of its portfolio assets (which consist of total assets less intangibles, properties used to conduct the savings institution's business and liquid assets not exceeding 20% of total assets) in qualified thrift investments on a monthly average basis in nine of every 12 months. Loans and mortgage-backed securities secured by domestic residential housing, as well as certain obligations of the FDIC and certain other related entities may be included in qualifying thrift investments without limit. Certain other housing-related and non-residential real estate loans and investments, including loans to develop churches, nursing homes, hospitals and schools, and consumer loans and investments in subsidiaries engaged in housing-related activities may also be included. Qualifying assets for the QTL test include investments related to domestic residential real estate or manufactured housing, the book value of property used by an institution or its subsidiaries for the conduct of its business, an amount of residential mortgage loans that the institution or its subsidiaries sold within 90 days of origination, shares of stock issued by any FHLB and shares of stock issued by the FHLMC or the FNMA. The Bank was in compliance with the QTL test as of December 31, 2002, with 75.8% of its assets invested in qualified thrift investments. RESTRICTIONS ON CAPITAL DISTRIBUTIONS. The Bank is required to provide to the OTS not less than 30 days' advance notice of the proposed declaration by its board of directors of any dividend on its capital stock. The OTS may object to the payment of the dividend on safety and soundness grounds. The FDIA prohibits an insured depository institution from paying dividends on its capital stock or interest on its capital notes or debentures (if such interest is required to be paid only out of net profits) or distributing any of its capital assets while it remains in default in the payment of any assessment due the FDIC. Texas law permits the Bank to pay dividends out of current or retained income in cash or additional stock. LEGISLATIVE AND REGULATORY PROPOSALS. Proposals to change the laws and regulations governing the operations and taxation of, and federal insurance premiums paid by, savings banks and other financial institutions and companies that control such institutions are frequently raised in Congress, state legislatures and before the FDIC and other bank regulatory authorities. The likelihood of any major changes in the future and the impact such changes might have on the Bank are impossible to determine. Similarly, proposals to change the accounting treatment applicable to savings banks and other depository institutions are frequently raised by the SEC, the FDIC, the IRS and other appropriate authorities, including, among others, proposals relating to fair market value accounting for certain classes of assets and liabilities. The likelihood and impact of any additional future accounting rule changes and the impact such changes might have on the Bank are impossible to determine. FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB of Dallas, which is one of 12 regional FHLBs that administer the home financing credit function of savings institutions and commercial banks. Each FHLB serves as a source of liquidity for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by its Board of Directors. As of December 31, 2002, the Bank's advances from the FHLB of Dallas amounted to $696.1 million or 27.6% of its total assets. As a member, the Bank is required to purchase and maintain stock in the FHLB of Dallas in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of total advances. At December 31, 2002, the Bank had $41.2 million in FHLB stock, which was in compliance with this requirement. The FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions also could have an adverse effect on the value of FHLB stock in the future. For the year ended December 31, 2002, dividends paid by the FHLB of Dallas to the Bank totaled $1.2 million. FEDERAL RESERVE SYSTEM. The Federal Reserve Board requires all depository institutions to maintain reserves against their transaction accounts (primarily checking accounts) and non-personal time deposits. At December 31, 2002, the Bank was in compliance with such requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy applicable liquidity requirements. Because required reserves must be maintained in the form of vault cash or a noninterest-bearing account at a Federal Reserve Bank, the effect of this reserve requirement is to reduce a bank's earning assets. The amount of funds necessary to satisfy this requirement has not had a material affect on the Bank's operations. TEXAS SAVINGS BANK LAW. As a Texas chartered savings bank, the Bank is subject to regulation and supervision by the Department under the TSBA. The TSBA contains provisions governing the incorporation and organization, location of offices, rights and responsibilities of directors and officers as well as the corporate powers, savings, lending, capital and investment requirements and other aspects of the Bank and its affairs. In addition, the Department is given extensive rulemaking power and administrative discretion under the TSBA, including authority to enact and enforce rules and regulations. The Bank is required under the TSBA to comply with certain capital requirements established by the Department. The TSBA also restricts the amount the Bank can lend to one borrower to that permitted to national banks, which is generally not more than 15% of the Bank's unimpaired capital and unimpaired surplus and, if such loans are fully secured by readily marketable collateral, an additional 10% of unimpaired capital and unimpaired surplus. The Department generally examines the Bank once every year and the current practice is for the Department to conduct a joint examination with the FDIC. The Department monitors the extraordinary activities of the Bank by requiring that the Bank seek the Department's approval for certain transactions such as the establishment of additional offices, a reorganization, merger or purchase and assumption transaction, changes of control, or the issuance of capital obligations. The Department may intervene in the affairs of a savings bank if the savings bank, or its director, officer or agent has: engaged in an unsafe and unsound practice, violated the savings bank's articles of incorporation, violated a statute or regulation, filed materially false or misleading information, committed a criminal act or a breach of fiduciary duty, or if the savings bank is, or is in imminent danger of becoming, insolvent. TAXATION FEDERAL TAXATION. The Company and its subsidiaries, which include the Bank, file a consolidated Federal income tax return on a calendar year basis using the accrual method. Savings banks are subject to provisions of the Code in the same general manner as other corporations. However, prior to 1996, institutions such as the Bank which met certain definitional tests and other conditions prescribed by the Code, benefited from certain favorable provisions regarding their deductions from taxable income for annual additions to their bad debt reserve. In years prior to 1996, the Bank was permitted under the Code to deduct an annual addition to the reserve for bad debts in determining taxable income based on the experience method or the percentage of taxable income method. Due to 1996 legislation, the Bank no longer is able to utilize a reserve method for determining the bad debt deduction, but is allowed to deduct actual net charge-offs. Further, the Bank's post-1987 tax bad debt reserve is being recaptured into income over a six year period. At December 31, 2002, the Bank had approximately $664,000 of post-1987 tax bad debt reserves, for which deferred taxes have been provided. The Bank is not required to provide deferred taxes on its pre-1988 (base year) tax bad debt reserve of approximately $900,000. This reserve may be included in taxable income in future years if the Bank makes distributions to stockholders (including distributions in redemption, dissolution or liquidation) that are considered to result in withdrawals from that excess bad debt reserve, then the amounts considered withdrawn will be included in the savings bank's taxable income. The amount that would be deemed withdrawn from such reserves upon such distribution and which would be subject to taxation at the savings bank level at the normal corporate tax rate would be an amount that, after taxes on such amount, would equal the amount actually distributed plus the amount necessary to pay the tax with respect to the withdrawal. Dividends paid out of a savings bank's current or accumulated earnings and profits as calculated for Federal income tax purposes, however, will not be considered to result in withdrawals from its bad debt reserves to the extent of such earnings and profits, but shall be regarded as taken from such reserves only upon exhaustion of the earnings and profits accounts; however, distributions in redemption of stock, and distributions in partial or complete liquidation of a savings bank will be considered to come first from its loss reserve. The Bank has not conducted a study to determine with certainty the amount of its accumulated earnings and profits for Federal income tax purposes. In addition to regular income taxes, corporations are subject to an alternative minimum tax which is generally equal to 20% of alternative minimum taxable income (taxable income, increased by tax preference items and adjusted for certain regular tax items). Payment of alternative minimum tax gives rise to alternative minimum tax credit carryovers which may be carried forward indefinitely. These credits may be used to offset future regular tax liability to the extent the regular tax liability exceeds future alternative minimum tax. In connection with the Southwest Plan Acquisition, the FSLIC Resolution Fund ("FRF") retained all of the future federal income tax benefits (as defined) derived from the federal income tax treatment of certain items, in addition to net operating loss carryforwards, related to the Southwest Plan Acquisition for which the Bank agreed to pay the FRF when actually realized. The provisions for federal income taxes recorded for the years ended December 31, 2002, 2001 and 2000, represent the gross tax liability computed under these tax sharing provisions before reduction for actual federal taxes paid to the Internal Revenue Service. Alternative minimum taxes paid with the federal return in 2002, 2001 and 2000 are available as credit carryforwards to reduce regular federal tax liabilities in future years, over an indefinite period and were partially utilized beginning in 2000. To the extent these credits were generated due to the utilization of other tax benefits retained by the FRF, they will also be treated as tax benefit items. Although the termination of the assistance agreement related to the Southwest Plan Acquisition was effective March 31, 1994, the FRF will continue to receive the related future net tax benefits as defined. The Company's Federal income tax returns have not been audited by the United States Internal Revenue Service. Generally, the tax returns of the Company since 1999 are subject to review by the Internal Revenue Service. STATE TAXATION The Company, the Bank, CBCC, CBMC, CBFC and CBIA each pay an annual franchise tax equal to the greater of $2.50 per $1,000 of taxable capital apportioned to Texas, or $4.50 per $100 of net taxable earned surplus apportioned to Texas. Taxable earned surplus is the applicable entities' Federal taxable income with certain modifications, such as the exclusion of interest earned on Federal obligations. ITEM 2. PROPERTIES ---------- The Company's business is conducted from 43 offices in Texas. The following table sets forth the location of the offices of the Company, as well as certain additional information relating to these offices as of December 31, 2002.
Owned/Leased Net Book (with Lease Value of Property Percent of Expiration Or Leasehold Total Location Date) Improvements Deposits Deposits - -------------------------------------- ------------------- ----------------------- --------- ----------- (Dollars in thousands) BRANCH OFFICES: - -------------------------------------- 1329 North Virginia Port Lavaca, Texas 77979 Owned $ 108 $ 22,894 1.42% 3207 Westpark Drive Houston, Texas 77005 Owned 2,344 32,454 2.01 8 Braeswood Square Leased; Houston, Texas 77096 December 31, 2006 219 70,162 4.35 408 Walnut Columbus, Texas 78934 Owned 198 47,829 2.96 870 S. Mason, Suite 100 Leased; Katy, Texas 77450 August 31, 2003 13 30,818 1.91 602 Lyons Schulenburg, Texas 78956 Owned 70 26,784 1.66 325 Meyer Street Sealy, Texas 77474 Owned 403 43,042 2.67 116 E. Post Office Weimar, Texas 78962 Owned 28 23,279 1.44 323 Boling Road Wharton, Texas 77488 Owned 95 38,674 2.40 1621 B FM 517 Rd. E. Leased; Dickinson, Texas 77539. September 30, 2003 26 30,714 1.90 300 S. Cage Pharr, Texas 78577 Owned 163 12,540 0.78 295 West Highway 77 San Benito, Texas 78586 Owned 202 20,199 1.25 1260 Blalock, Suite 100 Leased; Houston, Texas 77055 January 20, 2004 1 56,475 3.50 14011 Park Drive, Suite 115 Leased; Tomball, Texas 77375 March 14, 2004 3 25,959 1.61 915-H North Shepherd Leased; Houston, Texas 77008 October 31, 2006 7 40,604 2.52 16000 Stuebner Airline Road, Suite 100 Leased; Spring, Texas 77379 September 30, 2005 5 33,938 2.10 7602 N. Navarro Victoria, Texas 77904 Owned 430 60,586 3.75 (continued)
(continued from previous page) Net Book Owned/Leased Value of (with Lease Property or Percent of Expiration Leasehold Total Location Date) Improvements Deposits Deposits - ---------------------------------- ------------------------- ----------------------- --------- ----------- (Dollars in thousands) 1410 Ed Carey Harlingen, Texas 78550 Owned $ 1,378 $ 10,209 0.63% 4900 N. 10th St., G-1 Leased; McAllen, Texas 78504 August 14, 2006 -- 14,250 0.88 10838 Leopard Street, Suite A Leased; Corpus Christi, Texas 78410 December 31, 2005 1 29,751 1.84 4060 Weber Road Leased; Corpus Christi, Texas 78411 April 30, 2004 6 45,653 2.83 301 E. Main Street Brenham, Texas 77833 Owned 141 57,861 3.58 1192 W. Dallas Leased; Conroe, Texas 77301 December 31, 2003 11 36,321 2.25 2353 Town Center Dr Owned Sugar Land, Texas 77478 999 37,330 2.31 1629 S. Voss Owned Houston, Texas 77057 1,366 27,116 1.68 708 East Austin Giddings, Texas 78942 Owned 205 25,212 1.56 5718 Westheimer, Suite 100 Leased; Houston, Texas 77057 July 31, 2012 22 27,873 1.73 Leased; 2600 S. Gessner, Suite 100 October 31, 2012 Houston, Texas 77063 37 7,879 0.49 1250 Pin Oak Road Katy, Texas 77494 Owned 1,145 17,217 1.07 2120 Thompson Highway Richmond, Texas 77469 Owned 430 30,916 1.92 7200 North Mopac Leased; Austin, Texas 78731 December 31, 2007 3 29,764 1.84 1112 Seventh Street. Leased; Bay City, Texas 77414 April 30, 2007 -- 51,310 3.18 441 Austin Avenue, Suite A Leased; Port Arthur, Texas 77640 June 30, 2004 318 29,189 1.81 ATM Site Owned 1114 Lost Creek Blvd., Suite 100 Leased; Austin, Texas 78746 December 31, 2003 6 5,495 0.34 3302 Boca Chica Leased; Brownsville, Texas 78521 December 31, 2004 22 10,522 0.65 1075 Parades Line Road Brownsville, Texas 78521 Owned 2,633 38,115 2.36 (continued) (continued from previous page) Owned/Leased Net Book (with Lease Value of Property Percent of Expiration or Leasehold Total Location Date) Improvements Deposits Deposits - ------------------------------ ------------------- ----------------------- ---------- ----------- (Dollars in thousands) 2000 N. Conway Mission, Texas 78572 Owned 957 18,320 1.13 509 South Main Leased; McAllen, Texas 78501 December 31, 2005 -- 36,125 2.24 198 South Sam Houston San Benito, Texas 78586 Owned 961 44,652 2.77 502 S. Dixieland Road Harlingen, Texas 78552 Owned 296 8,509 0.53 200 Sugar Road Edinburg, Texas 78539 Owned 156 8,915 0.55 300 S. Closner Edinburg, Texas 78539 Owned 760 24,193 1.50 221 East Van Buren Harlingen, Texas 78550 Owned 3,285 63,540 3.94 2810 1st Street Owned - Rosenberg, Texas 77471 Under Construction 1,021 -- -- 2402 Research Forest Drive Owned - The Woodlands, Texas 77381 Under Construction 953 -- -- ADMINISTRATIVE OFFICE(1) - ------------------------------ Coastal Banc Plaza 5718 Westheimer, Suite 600 Leased; Houston, Texas 77057 July 31, 2012 2,312 261,180 16.16 RECORDS AND RETENTION OFFICE - ------------------------------ 2199 N. Jefferson Leased; La Grange, TX 78945 December 17, 2006 -- -- -- -------- ---------- ------- Total $23,739 $1,614,368 100.00% ======== ========== =======
______________________ (1)Includes location of administrative, primary lending and mortgage servicing offices. The net book value of the Company's investment in premises and equipment totaled $27.3 million at December 31, 2002. At December 31, 2002, the net book value of the Company's electronic data processing equipment, which includes its in-house computer system, local area network and twenty-seven automatic teller machines, was $908,000. ITEM 3. LEGAL PROCEEDINGS ------------------ We are, and have been involved, from time to time, in various claims, complaints, proceedings and litigation relating to activities from the normal course of our operations. Based on the facts currently available to us, we believe that the matters pending at December 31, 2002, are without merit, or will be covered by insurance and any other matters are of such amounts, which upon resolution, are not likely to have a material adverse effect on our consolidated financial condition, results of operations or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ----------------------------------------------------------- Not applicable. PART II - -------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER ------------------------------------------------------------------- MATTERS ------- The information required herein is incorporated by reference from page 59 of the Company's printed Annual Report to Stockholders for fiscal 2002 ("Annual Report"), which is included herein as Exhibit 13. ITEM 6. SELECTED FINANCIAL DATA ------------------------- The information required herein is incorporated by reference from pages 10 through 12 of the Annual Report. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ------------------------------------------------------------------- RESULTS OF OPERATIONS ----------------------- The information required herein is incorporated by reference on pages 13 through 30 of the Annual Report. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ---------------------------------------------------------------- The information required herein is incorporated by reference from pages 23 through 28 of the Annual Report. The Company's principal market risk exposure is to interest rates. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ----------------------------------------------- The financial statements and supplementary data required herein are incorporated by reference from pages 33 through 58 of the Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND ------------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------- Not applicable. PART III - --------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -------------------------------------------------------- The information required herein is incorporated by reference from the definitive Proxy Statement filed with the SEC. Otherwise, the requirements of this Item 10 are not applicable. ITEM 11. EXECUTIVE COMPENSATION ----------------------- The information required herein is incorporated by reference from the definitive Proxy Statement filed with the SEC. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------------- The information required herein is incorporated by reference from the definitive Proxy Statement filed with the SEC. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -------------------------------------------------- The information required herein is incorporated by reference from the definitive Proxy Statement filed with the SEC. ITEM 14. CONTROLS AND PROCEDURES ------------------------- Pursuant to Section 202 of the Sarbanes-Oxley Act of 2002, the Company's management has reviewed the disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) of the Company as of a date within 90 days prior to this annual report (the "Evaluation Date"). Disclosure controls and procedures are the controls and other procedures of the Company that are designed to ensure that the information required to be disclosed by the Company in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time period specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in its reports filed under the Exchange Act is accumulated and communicated to the Company's management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Management believes that such disclosure controls and procedures as of the Evaluation Date were adequate to ensure the material information relating to the Company, including its consolidated subsidiaries, is made known to management by others within the Company and its consolidated subsidiaries. To management's knowledge, there were no significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the Evaluation Date. - ------ PART IV - -------- ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K --------------------------------------------------------------------- (a)(1) The following financial statements are incorporated herein by reference from pages 33 through 58 of the Annual Report. Report of Independent Certified Public Accountants. Consolidated Statements of Financial Condition as of December 31, 2002 and 2001. Consolidated Statements of Operations for each of the years in the three-year period ended December 31, 2002. Consolidated Statements of Comprehensive Income for each of the years in the three-year period ended December 31, 2002. Consolidated Statements of Stockholders' Equity for each of the years in the three-year period ended December 31, 2002. Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2002. Notes to Consolidated Financial Statements. (a)(2) There are no financial statement schedules filed herewith. (a)(3) The following exhibits are filed as part of this report. Exhibit No. ------------ 3.1 Articles of Incorporation of the Company (Incorporated by reference to the Company's Registration Statement on Form S-4 (No. 33-75952) filed on March 2, 1994). 3.2 Bylaws of Company (Incorporated by reference to the Company's Registration Statement on Form S-4 (No. 33-75952) filed on March 2, 1994). 4 Form of Company common stock certificate (Incorporated by reference to the Company's Registration Statement on Form S-4 (No. 33-75952) filed on March 2, 1994). 4.1 Form of Indenture dated as of June 30, 1995, with respect to the Company's 10% Notes, due 2002 (Incorporated by reference to the Company's Registration Statement on Amendment No. 6 to Form S-1 (No. 33-91206) filed on June 16, 1995). 4.2 Certificate of Designations, 9.12% Series A Cumulative Preferred Stock (Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 333-75983) filed on April 9, 1999). 4.3 Form of Indenture of the Corporation relating to the Junior Subordinated Debentures and Amended and Restated Declaration of Trust of Coastal Capital Trust I (Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 333-87370) filed on May 1, 2002). 10.1 1991 Stock Compensation Program (Incorporated by reference to the Company's Registration Statement on Form S-4 (No. 33-75952) filed on March 2, 1994). 10.2 1995 Stock Compensation Program (Incorporated by reference to the Company's Registration Statement Form S-1 (No. 33-91206) filed on April 14, 1995). 10.3 1999 Stock Compensation Program (Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 333-80877) filed on June 17, 1999). 10.4 Change-In-Control Severance Agreements (Incorporated by reference to the Company's 1998 Annual Report on Form 10-K (No. 000-24526) filed on March 23, 1999). 10.5 Form of Amendment No. 1 to Change-In-Control Severance Agreements (Incorporated by reference to the Company's 1999 Annual Report on Form 10-K (No. 000-24526) filed on March 28, 2000). 10.6 Change-In-Control Severance Agreement (Incorporated by reference to the Company's 2000 Annual Report on Form 10-K (No. 000-24526) filed on March 27, 2001). 10.7 2002 Non-employee Director Stock Purchase Plan (Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 333-83966) filed on March 7, 2002). 10.8 Stock Purchase Agreement between the Company and James C. Niver dated April 23, 2002 (Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 333-87370) filed on May 1, 2002). 10.9 Change-In-Control Severance Agreement dated August 22, 2002. 12 Ratio of earnings to combined fixed charges and preferred stock dividends (See Exhibit 13). 13 Annual Report to Stockholders. 28 Form of proxy mailed to stockholders of the Company. 99.1 Certification of the Chairman of the Board and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanese-Oxley Act of 2002. 99.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanese-Oxley Act of 2002. 99.3 Statement of Factors Under Private Securities Litigation Reform Act of 1995. __________________ (b) Form 8-K filed on December 18, 2002, concerning the announcement that the Company completed the sale of its five central Texas branches. (c) See (a)(3) above for all exhibits filed herewith and Exhibit Index. (d) All schedules are omitted as the required information is not applicable or the information is presented in the consolidated financial statements or related notes. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. COASTAL BANCORP, INC. Date: March 25, 2003 By: /s/ Manuel J. Mehos ---------------------- Manuel J. Mehos, Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ Manuel J. Mehos Date: March 25, 2003 - ---------------------- Manuel J. Mehos, Chairman of the Board and Chief Executive Officer /s/ R. Edwin Allday Date: March 25, 2003 - ---------------------- R. Edwin Allday, Director /s/ D. Fort Flowers, Jr. Date: March 25, 2003 - ------------------------- D. Fort Flowers, Jr., Director /s/ Dennis S. Frank Date: March 25, 2003 - ---------------------- Dennis S. Frank, Director /s/ Robert E. Johnson, Jr. Date: March 25, 2003 - ------------------------------ Robert E. Johnson, Jr., Director /s/ Clayton T. Stone Date: March 25, 2003 - ----------------------- Clayton T. Stone, Director /s/ Catherine N. Wylie Date: March 25, 2003 - ------------------------- Catherine N. Wylie, Chief Financial Officer (principal financial and accounting officer) CERTIFICATION ------------- I, Manuel J. Mehos, the Chief Executive Officer of Coastal Bancorp, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Coastal Bancorp, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: March 25, 2003 By /s/ Manuel J. Mehos ------------------- Manuel J. Mehos Chief Executive Officer CERTIFICATION ------------- I, Catherine N. Wylie, the Chief Financial Officer of Coastal Bancorp, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Coastal Bancorp, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: March 25, 2003 By /s/ Catherine N. Wylie ------------------ Catherine N. Wylie Chief Financial Officer EX-13 3 doc2.txt 2002 ANNUAL REPORT COASTAL BANCORP, INC. AND SUBSIDIARIES FINANCIAL HIGHLIGHTS DECEMBER 31, 2002, 2001 AND 2000
December 31, -------------- (Dollars in thousands, except per share data) 2002 2001 2000 -------------- ----------- ----------- FOR THE YEAR ENDED - ------------------------------------------------------------- Net interest income $ 74,847 $ 86,597 $ 84,368 Provision for loan losses 5,800 3,900 5,790 Noninterest income (1) 17,209 11,143 12,024 Noninterest expense 55,893 58,479 58,195 Net income 19,716 21,802 19,924 Diluted earnings per common share before cumulative effect of accounting change 2.99 3.19 2.87 Diluted earnings per common share - reported 2.99 3.17 2.87 Diluted earnings per common share - as adjusted (2) 2.99 3.51 3.25 AT YEAR END - ------------------------------------------------------------- Total assets (3) $ 2,526,144 $2,597,891 $3,091,611 Loans receivable 1,812,785 1,863,601 1,896,228 Mortgage-backed securities held-to-maturity (3) -- -- 885,565 Mortgage-backed securities available-for-sale (3) 475,022 514,068 94,673 Deposits (1) 1,614,368 1,660,386 1,674,981 Borrowed funds (3) 696,085 690,877 1,150,305 Company obligated mandatorily redeemable 9.0% trust preferred securities of Coastal Capital Trust I (4) 50,000 -- -- Senior Notes payable (5) -- 43,875 46,900 Minority interest - preferred stock of Coastal Banc ssb (4) -- 28,750 28,750 Preferred stockholders' equity 27,500 27,500 27,500 Common stockholders' equity (6) 125,385 129,934 110,971 Book value per common share 23.47 21.54 18.89 Tangible book value per common share 19.74 18.15 15.08 SIGNIFICANT RATIOS FOR THE YEAR ENDED - ------------------------------------------------------------- Return (before minority interest) on average assets 0.83% 0.81% 0.74% Return on average common equity 13.71 15.92 16.51 Net interest margin 3.04 2.97 2.87 Interest rate spread including noninterest-bearing deposits 2.94 2.81 2.71 Interest rate spread 2.74 2.56 2.42 Average common equity to average total assets 4.92 4.03 3.47 Noninterest expense to average total assets 2.19 1.94 1.91 ASSET QUALITY RATIOS AT YEAR END - ------------------------------------------------------------- Nonperforming assets to total assets 0.91% 1.13% 0.82% Nonperforming loans to total loans receivable 1.00 1.33 1.12 Allowance for loan losses to nonperforming loans 97.69 62.26 68.32 Allowance for loan losses to total loans receivable 1.00 0.83 0.77
(1) In December 2002, Coastal completed the sale of five of its branches in Central Texas. The sale included deposits of $75.3 million and resulted in a gain of $4.4 million. (2) "As adjusted" excludes the amortization expense (net of any tax effect) recognized in the periods prior to the implementation of Statement of Financial Accounting Standards No. 142 related to the goodwill that is no longer being amortized. (3) In November 2001, Coastal completed the sale of approximately $845 million of its mortgage-backed securities. The transaction was undertaken to strategically restructure a portion of Coastal's asset base. Coastal used approximately $512 million of the proceeds to purchase primarily pass-thru mortgage-backed securities with an overall shorter expected duration and reduced borrowings with the remainder. All of the securities purchased and the remaining securities not sold were placed in the available-for-sale category. See further discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations - General." (4) In June 2002, Coastal issued 2,000,000 trust preferred securities with a liquidation preference of $25 per security for a total of $50.0 million. A portion of the proceeds was used to repurchase 500,000 shares of common stock for $15.0 million from a director of Coastal in June 2002. In addition, $28.8 million of the proceeds were used in July 2002 to redeem Coastal Banc ssb's 9.0% Series A Noncumulative Preferred Stock through a capital contribution to Coastal Banc ssb. (5) Coastal redeemed all of the Senior Notes payable on February 1, 2002 at par plus accrued interest. (6) During the year ended December 31, 2002, Coastal repurchased $21.8 million in common stock. See further discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations - General and - Financial Condition." CORPORATE PROFILE Coastal Bancorp, Inc., a Texas corporation, headquartered in Houston, Texas, is the holding company for Coastal Banc Holding Company, Inc. ("HoCo"), a Delaware unitary savings bank holding company. HoCo is the parent company to Coastal Banc ssb, a Texas-chartered, FDIC-insured, state savings bank. Coastal Banc ssb operates 43 branch offices in metropolitan Houston, Austin, Corpus Christi, the Rio Grande Valley and small cities in the southeast quadrant of Texas. At December 31, 2002, Coastal Banc ssb had $2.5 billion in assets and met the regulatory requirements to be a "well capitalized" institution according to FDIC guidelines. TABLE OF CONTENTS
Letter from the Chairman and Chief Executive Officer Selected Consolidated Financial and Other Data Management's Discussion and Analysis of Financial Condition and Results of Operations Directors and Officers Independent Auditors' Report Consolidated Financial Statements Notes to Consolidated Financial Statements Stock Prices and Dividends Stockholder Information
CHAIRMAN'S LETTER Ferdinand Magellan led a fleet of five ships in 1519 to circumnavigate the globe and explore uncharted waters, including the previously unexplored Pacific Ocean (named by Magellan on this trip). His armada had crude navigation instruments and primitive sailing ships that cruised at a top speed of only four knots and were unable to tack. Almost five centuries later the banking industry finds itself in interest rate territory that is equally uncharted waters. During 2002, the fed funds rate, prime rate, and deposit rates dropped to levels no current American bankers have experienced in their business lives. In contrast to Magellan's experience, today's bankers possess extremely sophisticated analytical and navigation tools. But those tools don't solve a lot in today's interest rate environment where deposit costs can't get much lower, but loan yields can. Instead of worrying about whether borrowers will pay off loans, bankers now worry about borrowers paying off loans. And balance sheet management has turned upside down as bankers tap their collective ruby slippers chanting, "There's no place like 8% prime, there's no place like 5% CD's, there's no place. . ." I have been writing to you every year since 1992, Coastal Banc's (Coastal) first year as a publicly owned company. I do not view my annual letter to the shareholders as a promotional tool; rather I view it as my personal assessment of Coastal's performance for the year and prospects for our company's future. I have as large a stake as anyone does in this company. Therefore, my annual letter to you is pretty much a summarized version of what I think about most of the day, every day. So here's what I'm thinking today: At the end of 2002, Coastal's earning assets were shrinking. It's neither what we planned nor what we want. Coastal's total earning assets as of December 31, 2002 were approximately $2.4 billion, or $68.8 million less than total earning assets at the end of 2001. The reduction in earning assets was primarily due to today's uncharted waters of low interest rates. During 2002, many of Coastal's mortgage borrowers and commercial real estate borrowers refinanced through lenders other than Coastal at lower rates than we were willing to offer. Loan payoffs reached a record payoff level during 2002 of over 40% of the average loan portfolio. It was like running on a treadmill. It seemed that for every new loan Coastal made, an existing loan would refinance somewhere else at an interest rate below our acceptable threshold. Fortunately, we exceeded our loan production goals for 2002. Thus we managed to somewhat mitigate the shrinkage as total loans only decreased by $50.8 million or 2.9% for the year. However, to further exacerbate the dilemma, Coastal, along with the rest of the banking industry, experienced net interest margin compression in the fourth quarter of 2002 as deposit costs crept closer to the 0% floor. Now here's the good news: Coastal had its best year yet for improvements in its core banking business. During 2002, we simplified the organization of Coastal's branches into three regions: Metropolitan Houston, Rio Grande Valley, and the Community Banking Region for our small market branches. We sold five branches in small markets that had limited growth potential in order to redirect those resources to existing and prospective branches in markets with higher growth potential. During 2002, Coastal achieved record growth levels in transaction accounts and deposit service charges. We improved customer penetration for most of Coastal's consumer banking products and introduced several new key products, including free checking and bounce protection. We also introduced a new Internet-based treasury management system at the end of 2002 with the primary goal of increasing the growth rate in commercial deposit customers, a key element for improving net interest margin and fee income growth. Thus during 2002, when Coastal experienced a decline in net loans, we had our best year for improving the potential of Coastal's long-term core earnings growth. The reduction in loans during 2002 coupled with the restructure and reduction of Coastal's securities portfolio in the fourth quarter of 2001 caused a 13.6% decline in net interest income for 2002. However, an increase of 26% in net service charges on deposits and a 4.4% decrease in expenses mitigated the reduction in core earnings for 2002. We also made several balance sheet improvements in 2002. Coastal's non-performing assets declined by 21.6% while the allowance for loan losses increased by 17.8%. Coastal redeemed its 10.0% senior notes and its 9.0% preferred stock, issued $50.0 million of 9% trust preferred securities, and repurchased 729,575 shares of common stock. So Coastal begins 2003 with fewer assets and a declining net interest margin, but with a stronger balance sheet and an increasing rate of fee income growth. As long as we stay on this lending treadmill and deposit costs compress near the 0% floor, growth of net interest income will be difficult. However, just as Magellan's armada eventually circled the globe, interest rates will eventually cycle back to more familiar waters. Then, the torrid pace of refinancings is expected to recede and Coastal's loan portfolio should resume the levels of growth it has experienced in recent years. Until that happens, as a major Coastal shareholder two things give me comfort. First, Coastal's core banking business appears to have as much promise as I've seen in all my years as a shareholder. Fee income growth, product penetration, and customer growth are all improving at an increasing rate, mitigating the adverse effects of the present interest rate environment. More importantly, it means Coastal is moving faster than ever towards accomplishing one of management's goals, that fee income represents a significantly larger percentage of total revenue. Second, even though I'm a banker, just like you I'm a shareholder first. So size doesn't matter to me. The value of my stock is what matters most. In this challenging loan growth environment and this uncertain economy, we will not grow the loan portfolio for the sake of growth. We will strive to improve Coastal's core banking business and make prudent loans. If the new loans aren't enough to provide net loan growth, I prefer to increase loans per share and net interest income per share by effectively investing in Coastal's existing portfolio. We do that by repurchasing Coastal's stock. At times like this, I prefer to invest equity dollars in a portfolio I know. That way when we finally circle the globe and reach smoother economic sailing, Coastal can be better positioned for healthy growth. The best part is you and I will then own a bigger piece of that growth. /s/ Manuel J. Mehos - ------------------------- Manuel J. Mehos Chairman of the Board, President and Chief Executive Officer COASTAL BANCORP, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA The following selected consolidated summary financial and other data of Coastal Bancorp, Inc. and subsidiaries ("Coastal") does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by, the more detailed information contained in the Consolidated Financial Statements and Notes thereto included elsewhere herein.
At December 31, (Dollars in thousands, except per share data) 2002 2001 2000 1999 1998 ---------------- ---------- ---------- ---------- ---------- Balance Sheet Data: Total assets (1) $ 2,526,144 $2,597,891 $3,091,611 $2,947,952 $2,982,161 Loans receivable (2) 1,812,785 1,863,601 1,896,228 1,735,081 1,538,149 Mortgage-backed securities held-to-maturity (1) (2) -- -- 885,565 917,212 1,154,116 Mortgage-backed securities available-for-sale (1) 475,022 514,068 94,673 99,665 96,609 Deposits (3) 1,614,368 1,660,386 1,674,981 1,624,289 1,705,004 Advances from the Federal Home Loan Bank of Dallas ("FHLB") (1) 696,085 690,877 1,150,305 1,096,931 966,720 Securities sold under agreements to repurchase -- -- -- -- 100,000 Company obligated mandatorily redeemable 9.0% trust preferred securities of Coastal Capital Trust I (4) 50,000 -- -- -- -- Senior Notes payable (5) -- 43,875 46,900 46,900 50,000 Minority interest-preferred stock of Coastal Banc ssb (4) -- 28,750 28,750 28,750 28,750 Preferred stockholders' equity 27,500 27,500 27,500 27,500 -- Common stockholders' equity (6) 125,385 129,934 110,971 105,956 112,764
For the Year Ended December 31, 2002 2001 2000 1999 1998 --------- -------- ------- -------- --------- Operating Data: Interest income $ 137,623 $210,612 $237,273 $202,943 $210,814 Interest expense 62,776 124,015 152,905 125,657 143,404 -------- ------ ----- ------ ------ Net interest income 74,847 86,597 84,368 77,286 67,410 Provision for loan losses (7) 5,800 3,900 5,790 10,575 3,100 -------- ------ ----- ------ ------ Net interest income after provision for loan loss 69,047 82,697 78,578 66,711 64,310 Gain on sale of branch offices (3) 4,395 -- -- -- -- Gain on sale of mortgage servicing rights -- -- 2,172 -- -- Writedown of purchased mortgage loan premium -- -- -- -- (709) Gain on sales of mortgage-backed securities available-for-sale, net -- 169 -- -- 1 Loss on derivative instruments (12) (422) -- -- -- Other noninterest income 12,826 11,396 9,852 10,372 7,580 Other noninterest expense (55,893) (58,479) (58,195) (57,810) (48,383) --------- ------- ------- -------- ------- Income before provision for Federal income taxes, minority interest and cumulative effect of accounting change 30,363 35,361 32,407 19,273 22,799 Provision for Federal income taxes (8) (9,140) (10,867) (9,895) (5,659) (3,543) Minority interest - preferred stock dividends of Coastal Banc ssb (1,507) (2,588) (2,588) (2,588) (2,588) Cumulative effect of change in accounting for derivative instruments, net of tax (9) -- (104) -- -- -- --------- ------- ------- ------- -------- Net income $ 19,716 $ 21,802 $ 19,924 $ 11,026 $ 16,668 ========= ======== ======== ======== ======== Net income available to common stockholders $ 17,208 $ 19,294 $ 17,416 $ 9,442 $ 16,668 ========= ======== ======== ======== ======== Basic earnings per common share before cumulative effect of accounting change (9) $ 3.13 $ 3.36 $ 2.94 $ 1.45 $ 2.24 ========= ======== ======== ======== ======== Basic earnings per common share - reported (10) (11) $ 3.13 $ 3.34 $ 2.94 $ 1.45 $ 2.24 ========= ======== ======== ======== ======== Basic earnings per share - as adjusted (11) $ 3.13 $ 3.69 $ 3.32 $ 1.80 $ 2.48 ========= ======== ======== ======== ======== Diluted earnings per common share before cumulative effect of accounting change (9) $ 2.99 $ 3.19 $ 2.87 $ 1.42 $ 2.18 ========= ======== ======== ======== ======== Diluted earnings per common share - reported (10) (11) $ 2.99 $ 3.17 $ 2.87 $ 1.42 $ 2.18 ========= ======== ======== ======== ======== Diluted earnings per share - as adjusted (11) $ 2.99 $ 3.51 $ 3.25 $ 1.76 $ 2.41 ========= ======== ======== ======== ========
(Footnotes appear on page 13) COASTAL BANCORP, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
At or For the Year Ended December 31, 2002 2001 2000 ------------- ------- ------- Selected Ratios: Performance Ratios (12): Return (before minority interest) on average assets 0.83% 0.81% 0.74% Return on average common equity 13.71 15.92 16.51 Dividend payout ratio 15.39 13.80 12.23 Average common equity to average total assets 4.92 4.03 3.47 Net interest margin (13) 3.04 2.97 2.87 Interest rate spread including noninterest-bearing deposits (13) 2.94 2.81 2.71 Interest rate spread (13) 2.74 2.56 2.42 Noninterest expense to average total assets 2.19 1.94 1.91 Average interest-earning assets to average interest-bearing liabilities 112.21 109.63 108.52 Ratio of earnings to combined fixed charges and preferred stock dividends: Excluding interest on deposits 1.94x 1.50x 1.32x Including interest on deposits 1.39 1.23 1.17 Asset Quality Ratios: Nonperforming assets to total assets (14) 0.91% 1.13% 0.82% Nonperforming loans to total loans receivable and loans receivable held for sale 1.00 1.33 1.12 Allowance for loan losses to nonperforming loans 97.69 62.26 68.32 Allowance for loan losses to total loans receivable 1.00 0.83 0.77 Bank Regulatory Capital Ratios (15): Tier 1 capital to total assets 6.88 7.27 6.22 Tier 1 risk-based capital to risk-weighted assets 10.32 11.90 9.94 Total risk-based capital to risk-weighted assets 11.38 12.79 10.72 Other Data: Full-time employee equivalents 626 681 661 Number of full service offices 43 50 50 1999 1998 ------- ------- Selected Ratios: Performance Ratios (12): Return (before minority interest) on average assets 0.47% 0.64% Return on average common equity 8.83 14.96 Dividend payout ratio 22.11 14.35 Average common equity to average total assets 3.66 3.71 Net interest margin (13) 2.75 2.31 Interest rate spread including noninterest-bearing deposits (13) 2.65 2.17 Interest rate spread (13) 2.39 1.96 Noninterest expense to average total assets 1.98 1.61 Average interest-earning assets to average interest-bearing liabilities 108.22 107.33 Ratio of earnings to combined fixed charges and preferred stock dividends: Excluding interest on deposits 1.23x 1.25x Including interest on deposits 1.11 1.14 Asset Quality Ratios: Nonperforming assets to total assets (14) 0.73% 0.99% Nonperforming loans to total loans receivable and loans receivable held for sale 0.99 1.60 Allowance for loan losses to nonperforming loans 61.30 46.28 Allowance for loan losses to total loans receivable 0.60 0.74 Bank Regulatory Capital Ratios (15): Tier 1 capital to total assets 5.76 5.25 Tier 1 risk-based capital to risk-weighted assets 9.68 9.54 Total risk-based capital to risk-weighted assets 10.29 10.23 Other Data: Full-time employee equivalents 666 653 Number of full service offices 50 49
(Footnotes appear on page 13) Footnotes for pages 10 through 12: (1) In November 2001, Coastal completed the sale of approximately $845 million of its mortgage-backed securities. The transaction was undertaken to strategically restructure a portion of Coastal's asset base. Coastal used approximately $512 million of the proceeds to purchase primarily pass-thru mortgage-backed securities with an overall shorter expected duration and reduced borrowings with the remainder. All of the securities purchased and the remaining securities not sold were placed in the available-for-sale category. See further discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations - General." (2) Loans receivable are net of loans in process, premiums, discounts, unearned interest and loan fees and the allowance for loan losses. Mortgage-backed securities held-to-maturity are net of premiums and discounts. (3) In December 2002, Coastal completed the sale of five of its branches in Central Texas. The sale included deposits of $75.3 million and resulted in a gain of $4.4 million. (4) In June 2002, Coastal issued 2,000,000 trust preferred securities with a liquidation preference of $25 per security for a total of $50.0 million. A portion of the proceeds was used to repurchase 500,000 shares of common stock for $15.0 million from a director of Coastal in June 2002. In addition, $28.8 million of the proceeds were used in July 2002 to redeem Coastal Banc ssb's 9.0% Series A Noncumulative Preferred Stock through a capital contribution to Coastal Banc ssb. (5) Coastal redeemed all of the Senior Notes payable on February 1, 2002 at par plus accrued interest. (6) During the years ended December 31, 2002, 2000, 1999 and 1998, Coastal repurchased $21.8 million, $10.9 million, $12.7 million and $7.8 million, respectively, in common stock. (7) During 1999, Coastal recorded a $6.8 million provision for loan losses specific to one loan. (8) During 1998, Coastal successfully resolved an outstanding tax benefit issue with the FDIC. The resolution of the issue resulted in a $3.7 million reversal of accrued income taxes during 1998. (9) Effective January 1, 2001, Coastal adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and for Hedging Activities" ("Statement 133"). On January 1, 2001, Coastal recorded a transition adjustment loss of $160,000, or $104,000 net of the tax effect, to record its derivative instruments at fair value. (10) On April 23, 1998, Coastal declared a 3:2 stock split that was paid on June 15, 1998 to stockholders of record on May 15, 1998. All common stock share data has been adjusted to include the effect of the stock split. (11) The "as adjusted" data excludes the amortization expense (net of the tax effect) recognized in the periods prior to 2002 and the implementation of Statement of Financial Accounting Standards No. 142 related to the goodwill that is no longer being amortized. See further discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations - General." (12) Ratio, yield and rate information is based on average balances for the year. (13) Net interest margin represents net interest income as a percentage of average interest-earning assets. Interest rate spread including noninterest-bearing deposits represents the difference between the weighted average yield on interest-earning assets and the weighted average rate on interest-bearing liabilities and noninterest-bearing deposits. Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate on interest-bearing liabilities. (14) Nonperforming assets consist of nonaccrual loans, loans greater than 90 days delinquent and still accruing, real estate acquired by foreclosure and repossessed assets. (15) Current capital adequacy FDIC regulations require Coastal Banc ssb to maintain Tier 1 capital equal to at least 4.0% of total assets, Tier 1 risk-based capital equal to at least 4.0% of risk-weighted assets and total risk-based capital equal to at least 8.0% of risk-weighted assets. COASTAL BANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Coastal Bancorp, Inc. ("Bancorp") through its wholly-owned subsidiary, HoCo, owns 100 percent of the voting stock of Coastal Banc ssb (the "Bank"), a Texas-chartered, FDIC insured, state savings bank. The consolidated financial statements included herein include the accounts of Bancorp, HoCo, the Bank and subsidiaries of both HoCo and the Bank (collectively known as "Coastal"). In late November 2001, to strategically restructure a portion of its asset base to make it less vulnerable to market interest rate fluctuations, Coastal completed the sale of approximately $845 million of its mortgage-backed securities and recorded a gain of $169,000. Coastal decided to undertake the sale as the then current market environment presented an opportunity for Coastal to sell its large mortgage-backed securities portfolio. The majority of the securities sold were Collateralized Mortgage Obligations ("CMOs") tied to the FHLB 11th District Cost of Funds Index ("COFI") and, due to their relatively long maturities, contained extension risk which caused, on average, higher levels of price volatility. Also in November 2001, Coastal used a portion of the proceeds of the sale to purchase approximately $512 million of primarily pass-thru mortgage-backed securities with an overall shorter expected duration. Coastal reduced borrowings with the remainder of the proceeds from the sale. All the securities purchased and the remaining securities not sold were placed in the available-for-sale category. A consequence of this 2001 securities sale is that any securities purchased by Coastal for approximately two years are required to be placed in either the available-for-sale or trading category. Statement of Financial Accounting Standards No. 141, "Business Combinations" ("Statement 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets ("Statement 142") were issued in July 2001. Statement 141 required, effective January 1, 2002, that Coastal evaluate its existing intangible assets and goodwill and make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Statement 141 also required that Coastal reclassify amounts originally recorded as goodwill pursuant to Statement of Financial Accounting Standards No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions" ("Statement 72") to other intangible assets, as those amounts, under Statement 142, were not subject to the non-amortization provisions. As of January 1, 2002, Coastal had unamortized goodwill that was subject to the non-amortization provisions of Statements 141 and 142 of $5.5 million. As of that same date, Coastal reclassified $16.3 million to other intangible assets and continued to amortize these amounts in 2002. On October 1, 2002, Statement of Accounting Standards No. 147, "Acquisitions of Certain Financial Institutions" ("Statement 147") was issued. Statement 147 amended Statement 72, to exclude from its scope, the acquisitions of financial institutions (other than transactions between two or more mutual enterprises) and provide certain transition provisions for existing intangible assets. Under Statement 147 transition provisions, if the transaction that gave rise to an unidentifiable other intangible asset was considered a business combination, the carrying amount of that asset amount would be reclassified to goodwill and be subject to the non-amortization provisions as of the effective date of the implementation of Statement 142, which in Coastal's case was January 1, 2002. Based on the implementation of Statement 147, Coastal has reclassified as of January 1, 2002, the $16.3 million mentioned above to goodwill and removed the amortization expense recorded in 2002, through restatement of its 2002 financial statements as required by Statement 147. Coastal implemented these statements effective January 1, 2002. In connection with the adoption of these statements, Coastal tested for impairment in accordance with the provisions of Statement 142 during the first quarter of 2002 and did not recognize any transitional impairment losses as the cumulative effect of a change in accounting principle during the period. On February 1, 2002, Coastal redeemed all of the remaining Senior Notes payable outstanding ($43.9 million) at par plus accrued interest to the redemption date. On June 18, 2002, Coastal, through Coastal Capital Trust I (a consolidated trust subsidiary) (the "Trust"), issued 2,000,000 trust preferred securities ("Trust Preferred Securities") with a liquidation preference of $25 per security. The Trust Preferred Securities represent an interest in Bancorp's junior subordinated debentures, which were purchased by the Trust. The junior subordinated debentures are the only assets of the Trust and interest payments from the debentures finance the distributions paid on the Trust Preferred Securities. Distributions on the securities are payable quarterly at the annual rate of 9.0% and are included in interest expense in the consolidated statements of income. The Trust Preferred Securities are subject to mandatory redemption at the liquidation preference, in whole or in part, upon repayment of the junior subordinated debentures at maturity or their earlier redemption. The junior subordinated debentures are redeemable prior to the maturity date of June 30, 2032, at the option of Bancorp on or after June 30, 2007, in whole at any time or in part from time to time. The junior subordinated debentures are also redeemable at any time, in whole, but not in part, upon the occurrence of specific events defined within the trust indenture. Bancorp has the option to defer distributions on the junior subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. A portion of the proceeds from the issuance of the Trust Preferred Securities were used to repurchase 500,000 shares of common stock for $15.0 million from a director of Coastal in June 2002. In addition, $28.8 million of the proceeds were used on July 15, 2002, to redeem the Bank's 9.0% Series A Noncumulative Preferred Stock (Nasdaq:CBSAP) through a capital contribution to Coastal Banc ssb. On August 27, 1998, December 21, 1998, February 25, 1999, April 27, 2000, July 27, 2000 and April 25, 2002, the Board of Directors authorized six separate repurchase plans for up to 500,000 shares each of the outstanding shares of common stock through an open market repurchase program and privately negotiated repurchases, if any. As of December 31, 2002, a total of 2,729,575 shares had been repurchased under all of the authorized repurchase plans. As of December 31, 2002, 2,726,019 shares were held in treasury at an average repurchase price of $19.45 per share for a total cost of $53.0 million. FINANCIAL CONDITION During the fourth quarter of 2002, Coastal sold five of its branches in Central Texas (located in Llano, Burnet, Mason, Kingsland and Marble Falls, Texas) to First State Bank Central Texas. The sale included deposit accounts of $75.3 million and resulted in a gain of $4.4 million. The branches sold had limited growth potential for Coastal. Coastal continually monitors the market and performance of its branch network and opens, purchases or sells branches based on this analysis. During 2002, Coastal's management made the decision to liquidate a portion of its loan receivable portfolio through sales to third party investors. The first sale was in March 2002 when Coastal sold $10.8 million of under-performing mortgage loans. Prior to the sale, Coastal wrote those loans down to fair value and recorded a charge-off to the allowance for loan losses of $761,000. In addition, as of March 31, 2002, Coastal wrote down to fair value and reclassified $9.1 million of other under-performing single-family mortgage loans to the held for sale category. The loans that were reclassified to the held for sale category were written down to fair value as of March 31, 2002 through a charge-off to the allowance for loan losses of $691,000. During the second quarter of 2002, a total of $3.1 million of these under-performing loans held for sale were sold to the same third party investor. As of December 31, 2002, Coastal had reclassified the remaining $3.0 million of these loans held for sale back to the loans receivable portfolio at their current carrying value. The second sale was in the fourth quarter of 2002 when Coastal entered into an agreement with a third party to sell approximately $77.0 million of single-family mortgage loans. As of December 31, 2002, $74.4 million of these loans had been sold, $70.1 million of which were sold servicing retained and $4.3 million (which were considered nonperforming loans) were sold servicing released. The remaining $2.6 million, which are under a contract for sale, were reclassified to the held for sale category at December 31, 2002. In connection with this sale and the reclassification of the remaining loans to the held for sale category, the loans were written down to fair value through a charge-off to the allowance for loan losses of $309,000. In addition, Coastal recorded a gain of $359,000 on the sale of these loans as a result of Coastal recording the estimated fair value of the mortgage servicing rights retained. Overall during 2002, total assets decreased $71.7 million, or 2.8%, when comparing December 31, 2001 to December 31, 2002. This decrease was primarily comprised of a $50.8 million decrease in loans receivable, a $39.0 million decrease in mortgage-backed securities available-for-sale and a $41.0 million decrease in other securities available-for-sale. A primary contributor to the decrease in both loans receivable and mortgage-backed securities available-for-sale was the continuing higher than expected principal paydowns received as a consequence of the extraordinary high levels of refinancings due to the low interest rate environment during 2002. In addition to the principal paydowns, the decrease in loans receivable was due to the loan sales totaling $85.2 million mentioned previously, offset by single-family loan purchases of $421.4 million during 2002. The decrease in other securities available-for-sale was due to the maturity of one security during the year. These decreases were somewhat offset by an increase in loans receivable held for sale of $49.9 million. This was due to one loan package purchased in November 2002 with the intent to sell the package to third party investors by the end of January 2003. There were smaller changes in other asset categories as follows: an $11.0 million increase in Federal funds sold, a $2.8 million increase in prepaid expenses and other assets and a $1.2 million increase in stock in the FHLB, offset by a $1.8 million decrease in cash and cash equivalents, a $3.5 million decrease in accrued interest receivable, a $120,000 decrease in property and equipment and a $382,000 decrease in goodwill. The decrease in goodwill was related to the sale of the five Central Texas branches mentioned previously. Deposits decreased by 2.8%, or $46.0 million, from December 31, 2001 to December 31, 2002 and advances from the FHLB increased 0.75%, or $5.2 million. The decrease in deposits was due to the branch sale in December 2002 as discussed previously, offset by deposit inflows resulting from Coastal's focus on increasing transaction accounts and other changes in deposits. Also noted previously was the redemption of the $43.9 million of Coastal's 10.0% Senior Notes payable in February 2002, the issuance of the $50.0 million Trust Preferred Securities in June 2002 and the $28.8 million redemption of the Bank's 9.0% Series A Noncumulative Preferred Stock in July 2002. Other changes in liabilities included a $1.9 million decrease in advances from borrowers for taxes and insurance and a $1.9 million decrease in other liabilities and accrued expenses. Stockholders' equity decreased 2.9%, or $4.5 million, from December 31, 2001 to December 31, 2002 as a result of $21.8 million in common stock repurchased during 2002, common stock dividends of $2.6 million and preferred stock dividends of $2.5 million, somewhat offset by 2002 net income of $19.7 million, common stock issued of $326,000 due to the exercise of stock options and a $2.2 million change in accumulated other comprehensive gain (loss). RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 2002 The results of operations of Coastal depend primarily on its net interest income, which is the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. Coastal's interest-earning assets consist principally of loans receivable, mortgage-backed securities and other investments. Coastal's interest-bearing liabilities have consisted primarily of deposits, advances from the FHLB, securities sold under agreements to repurchase, federal funds purchased, Trust Preferred Securities and its Senior Notes payable. Coastal's net income is also affected by the level of the provision for loan losses, noninterest income, including service charges on deposit accounts, loan fees, loan servicing income and gains on sales of assets, as well as by its noninterest expense, including compensation and benefits and occupancy costs. The following table sets forth, for the periods and at the dates indicated, information regarding Coastal's average consolidated statements of financial condition. Ratio, yield and rate information is based on average balances for the year.
At Year Ended December 31, 2002 December 31, 2002 Average Yield/ Yield/Rate Balance Interest Rate ---------------------- ------------- --------- ------- (Dollars in thousands) ASSETS Interest-earning assets: Loans receivable (1) 5.52% $ 1,931,931 $ 118,970 6.16% Mortgage-backed securities 3.37 467,744 17,114 3.66 Other securities 2.29 8,242 172 2.09 Federal funds sold 1.13 9,337 151 1.62 FHLB stock (2) 2.75 40,491 1,188 2.93 Other 1.27 1,776 28 1.58 ------ -------------- -------- ------ Total interest-earning assets 4.99 2,459,521 137,623 5.60 Noninterest-earning assets (3) ----- 90,900 -------- ------ --------- Total assets $ 2,550,421 ========= LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing deposits 2.39% $ 1,477,648 $ 39,825 2.70% Advances from the FHLB 2.71 683,454 20,173 2.95 Securities sold under agreements to repurchase and federal funds purchased -- -- -- -- Trust Preferred Securities of Coastal Capital Trust I 9.00 26,986 2,400 9.00 Senior Notes payable -- 3,726 378 10.00 ------ -------------- -------- ----- Total interest-bearing liabilities 2.64 2,191,814 62,776 2.86 Noninterest-bearing liabilities ------ 190,260 -------- ----- -------- Total liabilities 2,382,074 ----------- Minority interest - preferred stock of Coastal Banc ssb 15,359 Preferred stockholders' equity 27,500 Common stockholders' equity 125,488 -------- Total liabilities and stockholders' equity $ 2,550,421 ========= Net interest income; interest rate spread 2.35% $ 74,847 2.74% Net interest-earning assets; net interest yield on ====== ========= ===== interest-earning assets $ 267,707 3.04% Ratio of average interest-earning assets to average ========= ===== interest-bearing liabilities 1.12x =========
_______________ (1) Nonaccruing loans are included in total loans, but are immaterial. (2) In 2000, includes a $1.1 million special dividend received. See further discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Net Income." (3) Includes goodwill, accrued interest receivable, property and equipment, cash, prepaid expenses and other assets.
Year Ended December 31, 2001 Average Yield/ Balance Interest Rate ------------------------------ --------- ------- (Dollars in thousands) ASSETS Interest-earning assets: Loans receivable (1) $ 1,942,701 $ 155,214 7.99% Mortgage-backed securities 905,441 52,873 5.84 Other securities 6,690 176 2.63 Federal funds sold 7,776 266 3.42 FHLB stock (2) 45,700 1,960 4.29 Other 3,017 123 4.08 ------------------------------ ------- ----- Total interest-earning assets 2,911,325 210,612 7.23 Noninterest-earning assets (3) 98,487 ------- ----- ------------------------------ Total assets $ 3,009,812 ============================== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing deposits $ 1,531,004 $ 69,828 4.56% Advances from the FHLB 795,009 38,917 4.90 Securities sold under agreements to repurchase and federal funds purchased 283,622 10,682 3.77 Trust Preferred Securities of Coastal Capital Trust I -- -- -- Senior Notes payable 45,868 4,588 10.00 ------------------------------ ------- ----- Total interest-bearing liabilities 2,655,503 124,015 4.67 Noninterest-bearing liabilities 176,861 ------- ----- ------------------------------ Total liabilities 2,832,364 Minority interest - preferred stock of Coastal Banc ssb 28,750 Preferred stockholders' equity 27,500 Common stockholders' equity 121,198 ------------------------------ Total liabilities and stockholders' equity $ 3,009,812 ============================== Net interest income; interest rate spread $ 86,597 2.56% Net interest-earning assets; net interest yield on ======== ===== interest-earning assets $ 255,822 2.97% ============================== ===== Ratio of average interest-earning assets to average interest-bearing liabilities 1.10x ==============================
_______________ (1) Nonaccruing loans are included in total loans, but are immaterial. (2) In 2000, includes a $1.1 million special dividend received. See further discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Net Income." (3) Includes goodwill, accrued interest receivable, property and equipment, cash, prepaid expenses and other assets.
Year Ended December 31, 2000 Average Yield/ Balance Interest Rate ------------------------------ --------- ------- (Dollars in thousands) ASSETS Interest-earning assets: Loans receivable (1) $ 1,881,124 $ 168,105 8.94% Mortgage-backed securities 1,002,055 64,246 6.41 Other securities 1,000 63 6.30 Federal funds sold 3,042 194 6.38 FHLB stock (2) 55,810 4,612 8.26 Other 895 53 5.92 ------------------------------ ------- ----- Total interest-earning assets 2,943,926 237,273 8.06 Noninterest-earning assets (3) 100,626 ------- ----- ------------------------------ Total assets $ 3,044,552 ============================== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing deposits $ 1,489,479 $ 73,216 4.92% Advances from the FHLB 926,659 58,328 6.29 Securities sold under agreements to repurchase and federal funds purchased 249,673 16,671 6.68 Trust Preferred Securities of Coastal Capital Trust I -- -- -- Senior Notes payable 46,900 4,690 10.00 ------------------------------ ------- ----- Total interest-bearing liabilities 2,712,711 152,905 5.64 Noninterest-bearing liabilities 170,083 ------- ----- ------------------------------ Total liabilities 2,882,794 Minority interest - preferred stock of Coastal Banc ssb 28,750 Preferred stockholders' equity 27,500 Common stockholders' equity 105,508 ------------------------------ Total liabilities and stockholders' equity $ 3,044,552 ============================== Net interest income; interest rate spread $ 84,368 2.42% ======== ===== Net interest-earning assets; net interest yield on interest-earning assets $ 231,215 2.87% ============================== ===== Ratio of average interest-earning assets to average interest-bearing liabilities 1.09x ==============================
_______________ (1) Nonaccruing loans are included in total loans, but are immaterial. (2) In 2000, includes a $1.1 million special dividend received. See further discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Net Income." (3) Includes goodwill, accrued interest receivable, property and equipment, cash, prepaid expenses and other assets. The following table analyzes net interest income in terms of changes in the volume of interest-earning assets and interest-bearing liabilities and changes in yields and rates. The table reflects the extent to which changes in Coastal's interest income and interest expense are attributable to changes in volume (change in volume multiplied by prior year rate) and changes in rate (changes in rate multiplied by prior year volume). Changes attributable to the combined impact of volume and rate have been allocated proportionately to changes due to volume and changes due to rate.
Year Ended December 31, ------------------------------------------------------------------ 2002 vs 2001 2001 vs 2000 Increase (Decrease) Due To Increase (Decrease) Due To ------------------------------ ------------------------------- Volume Rate Net Volume Rate Net ----------- -------- --------- --------- -------- -------- (In thousands) INTEREST INCOME Loans receivable $ (857) $(35,387) $(36,244) $ 5,381 $(18,272) $(12,891) Mortgage-backed securities (20,177) (15,582) (35,759) (5,916) (5,457) (11,373) Other securities 36 (40) (4) 169 (56) 113 Federal funds sold 45 (160) (115) 194 (122) 72 FHLB stock (1) (204) (568) (772) (726) (1,926) (2,652) Other (38) (57) (95) 102 (32) 70 --------- --------- --------- -------- --------- -------- Total (21,195) (51,794) (72,989) (796) (25,865) (26,661) --------- --------- --------- -------- --------- --------- INTEREST EXPENSE Interest-bearing deposits (2,362) (27,641) (30,003) 2,024 (5,412) (3,388) Securities sold under agreements to repurchase and federal funds purchased (5,341) (5,341) (10,682) 2,032 (8,021) (5,989) Advances from the FHLB (4,886) (13,858) (18,744) (7,596) (11,815) (19,411) Trust Preferred Securities of Coastal Capital Trust I 1,200 1,200 2,400 -- -- -- Senior Notes payable (4,210) -- (4,210) (102) -- (102) --------- --------- --------- -------- --------- -------- Total (15,599) (45,640) (61,239) (3,642) (25,248) (28,890) --------- --------- --------- -------- --------- -------- Net change in net interest income $ (5,596) $ (6,154) $(11,750) $ 2,846 $ (617) $ 2,229 ========= ========= ========= ======== ========= ========
_______________ (1) In 2000, includes a $1.1 million special dividend received. See further discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Net Income." NET INCOME Coastal reported net income of $19.7 million for the year ended December 31, 2002, $21.8 million for the year ended December 31, 2001 and $19.9 million for the year ended December 31, 2000. When comparing net income for 2002 to 2001, the primary contributor to the decrease in net income was decreased net interest income. Net interest income decreased $11.8 million from 2001 to 2002, as a result of Coastal's smaller asset size as compared to 2001, lower market interest rates and record high principal paydowns received on Coastal's mortgage-backed securities and mortgage loan portfolios. In addition to the decreased net interest income, the provision for loan losses increased $1.9 million due to management's reevaluation of the overall allowance for loan losses given the changes that have occurred within the mix of Coastal's loan portfolio, current economic conditions and the decision in 2002 to sell loans which resulted in charge-offs totaling $1.8 million to writedown such loans to fair value, in addition to specific loans in the portfolio that have warranted greater attention and specific allocations of the allowance for loan losses. These decreases to net income were only somewhat offset by a $6.1 million increase in noninterest income, a $2.6 million decrease in noninterest expense, a $1.7 million decrease in the provision for Federal income taxes and a $1.1 million decrease in the expense for minority interest (preferred stock dividends of Coastal Banc ssb) due to the redemption of the preferred stock during 2002. The increase in noninterest income was primarily due to the $4.4 million gain on the sale of the five Central Texas branches and the $359,000 gain on the sale of the group of loans with servicing rights retained during the period. The increase is also due to a $2.1 million increase in service charges on deposit accounts and the $422,000 fair value loss on derivative instruments recorded in 2001 (compared to a $12,000 fair value loss recorded during 2002), offset by a $702,000 decrease in the gain on the sale of real estate owned and various smaller changes in other categories of noninterest income. The decrease in noninterest expense was primarily due to the $2.8 million decrease in the amortization of goodwill as discussed earlier. In addition, Coastal experienced decreases of $869,000 and $1.3 million in office occupancy and data processing, respectively. These decreases were partially offset by an increase of $1.1 million in compensation, payroll taxes and other benefits, a $519,000 increase in advertising expense, a $153,000 increase in postage and delivery expense and a $599,000 increase in other noninterest expense. The decrease in the provision for Federal income taxes was due to the decreased income before Federal income taxes, minority interest and cumulative effect of accounting change. When comparing net income for 2001 to 2000, the increase was comprised of the following: a $2.2 million increase in net interest income, a $1.9 million decrease in the provision for loan losses, somewhat offset by a $881,000 decrease in noninterest income, a $284,000 increase in noninterest expense and a $972,000 increase in the provision for Federal income taxes. The increase in net interest income was due primarily to the increase in net interest margin to 2.97% for the year ended December 31, 2001 from 2.87% for 2000, which included a FHLB special dividend of $1.1 million in 2000. Net interest margin, excluding the FHLB special dividend, was 2.83% for the year ended December 31, 2000. The decrease in the provision for loan losses when comparing 2001 to 2000 was due to management's quarterly evaluation of the allowance for loan losses throughout 2001 and a belief that the allowance at December 31, 2001 was adequate considering the composition of the loans receivable portfolio, the existing nonperforming loans, historical and peer group loss experience, delinquency trends and current economic conditions. The decrease in noninterest income was primarily due to the $2.2 million gain recorded on the sale of Coastal's mortgage servicing rights in 2000, offset by a $838,000 increase in service charges on deposit accounts, a $621,000 increase in the gain on the sale of real estate owned, in addition to smaller changes in other categories of noninterest income. The increase in noninterest expense was due to a $1.6 million increase in compensation, payroll taxes and other benefits, partially offset by a decrease of $84,000 in office occupancy, a $317,000 decrease in data processing, a $225,000 decrease in the amortization of goodwill and a decrease of $688,000 in other noninterest expense. The increase in the provision for Federal income taxes was due to the increased income before Federal income taxes, minority interest and cumulative effect of accounting change. NET INTEREST INCOME Net interest income amounted to $74.8 million in 2002, an $11.8 million, or 13.6% decrease from 2001. The decrease in net interest income was primarily due to Coastal's smaller average asset size, the loan sales mentioned previously and continuing higher than expected principal payments received on Coastal's mortgage-backed securities and mortgage loan portfolios. When comparing 2002 to 2001, average interest-earning assets decreased $451.8 million, $437.7 million of which was the decrease in mortgage-backed securities primarily due to the 2001 restructuring mentioned previously. In addition, during 2002, due to the extraordinary levels of prepayments due to refinancings of home mortgages, Coastal experienced higher principal paydowns totaling approximately $152 million on its mortgage-backed securities portfolio and $342 million on its mortgage loan portfolio during the year. Net interest margin increased to 3.04% in 2002 from 2.97% in 2001. Interest rate spread, defined to exclude noninterest-bearing deposits increased to 2.74% in 2002 from 2.56% in 2001. Management also calculates an alternative interest rate spread which includes noninterest-bearing deposits. Under this calculation, the interest rate spreads for 2002 and 2001 were 2.94% and 2.81%, respectively. Net interest margin and interest rate spread are affected by the changes in the amount and composition of interest-earning assets and interest-bearing liabilities, in addition to changes in the applicable interest rates on those assets and liabilities. Net interest income amounted to $86.6 million in 2001, a $2.2 million, or 2.6%, increase over 2000. The increase in net interest income was primarily due to the increase in net interest margin to 2.97% in 2001 from 2.87% in 2000 and an increase in interest rate spread, defined to exclude noninterest-bearing deposits, to 2.56% in 2001 from 2.42% in 2000. In addition, net interest-earning assets increased by $24.6 million in 2001 from 2000. Management also calculates an alternative interest rate spread which includes noninterest-bearing deposits. Under this calculation, the interest rate spreads for 2001 and 2000 were 2.81% and 2.71%, respectively. Net interest margin and interest rate spread are affected by the changes in the amount and composition of interest-earning assets and interest-bearing liabilities, in addition to changes in the applicable interest rates on those assets and liabilities. The overall increase in net interest margin and spread was primarily due to the 0.97% decrease in the average rate paid on interest-bearing liabilities, only partially offset by a 0.83% decrease in the average rate received on interest-earning assets. Total interest income amounted to $137.6 million during 2002, a $73.0 million, or 34.7% decrease from 2001. This decrease was due to the decrease in average interest-earning assets of $451.8 million and a decrease in the average yield on those assets of 1.63%. As discussed previously, the decrease in average interest-earning assets was due to the restructuring in 2001 and the high levels of principal paydowns received on Coastal's mortgage-backed securities and mortgage loans during the year. When comparing the two periods, the average balance of mortgage-backed securities decreased $437.7 million and the average balance of loans receivable decreased $10.8 million. The average yield on loans receivable decreased 1.83% and the average yield on mortgage-backed securities decreased 2.18%. The decrease in the overall average yield on interest-earning assets was due to continuing declining market rates throughout 2002. Total interest income amounted to $210.6 million during 2001, a $26.7 million, or 11.2%, decrease from 2000 (which includes the $1.1 million FHLB special dividend received in 2000). The decrease was due to a decrease in average interest-earning assets of $32.6 million and a decrease in the average yield of 0.83%. The decrease in average interest-earning assets was due, in part, to the decrease in Coastal's asset size as a result of the restructuring of Coastal's asset base in late November 2001 as previously described. When comparing the two periods, the average balance of mortgage-backed securities decreased $96.6 million due to the restructuring and principal payments received throughout 2001. In addition, the average balance of FHLB stock decreased $10.1 million due to the decreased amounts required to be maintained based on the decreased level of FHLB advances outstanding. These decreases were partially offset by a $61.6 million increase in the average balance of loans receivable and smaller increases in other interest-earning asset categories. The average yield on loans receivable decreased 0.95% and the average yield on mortgage-backed securities decreased 0.57% when comparing the year ended December 31, 2001 to December 31, 2000. The decrease in the overall average yield was due to the declining market rates during 2001. Total interest expense amounted to $62.8 million in 2002, a $61.2 million, or 49.4% decrease from 2001. The decrease in interest expense was due to the $463.7 million decrease in the average balance of interest-bearing liabilities and a 1.81% decrease in the average rate paid on those liabilities. When comparing 2002 to 2001, average securities sold under agreements to repurchase decreased $283.6 million, average FHLB advances decreased $111.6 million and average interest-bearing deposits decreased $53.4 million. The average balance of Senior Notes payable decreased $42.1 million due to their repurchase on February 1, 2002 and the average balance of Trust Preferred Securities increased $27.0 million due to their issuance on June 18, 2002. The overall decrease in the average rate paid on interest-bearing liabilities was due to the continued declining wholesale funding and deposit costs because of the decline in market interest rates throughout 2002. Total interest expense amounted to $124.0 million in 2001, a $28.9 million, or 18.9%, decrease from 2000. The decrease in interest expense was due primarily to a 0.97% decrease in the average rate paid on interest-bearing liabilities and a slight decrease in the average balance of those liabilities during 2001 when compared to 2000. The overall decrease in the average rate paid on interest-bearing liabilities was due to lower wholesale funding and deposit costs because of the decline in market interest rates during 2001. When comparing 2001 to 2000, average FHLB advances decreased $131.7 million with the average rate decreasing by 1.39%, average interest-bearing deposits increased $41.5 million and the average rate on those deposits decreased by 0.36% and average securities sold under agreements to repurchase and federal funds purchased increased $34.0 million with the average rate decreasing 2.91%. The decrease in interest expense on Senior Notes payable was due to the $1.0 million decrease in the average balance as a result of repurchases. PROVISION FOR LOAN LOSSES AND THE ALLOWANCE FOR LOAN LOSSES - CRITICAL ACCOUNTING POLICY Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain an adequate allowance. Estimating the allowance for loan losses is a critical accounting policy. It is subjective in nature and requires material estimates that may be subject to revision as facts and circumstances warrant. In assessing the adequacy of the allowance, management reviews the type, size, quality and risk of loans in the portfolio and considers such factors as specific known risks, historical and peer group experience, the existing nonperforming loans and the underlying collateral value on those loans, general economic conditions, particularly as they relate to Coastal's lending areas and other factors related to the collectibility of Coastal's loan portfolio. Based on the ongoing assessment by management, provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level deemed appropriate by management based on probable losses in the loan portfolio. While management uses the best information available to recognize losses on loans, there can be no assurance that future additions to the allowance will not be necessary. For the years ended December 31, 2002, 2001 and 2000, the provision for loan losses was $5.8 million, $3.9 million and $5.8 million, respectively. The changes in the provision for loan losses, when comparing the periods, are due to management's continuing evaluation of the overall allowance for loan losses. The increase in the provision for loan losses in 2002 (in the fourth quarter of 2002) was due to management's reevaluation of the allowance for loan losses given the changes that have occurred within the mix of Coastal's loan portfolio, current economic conditions and the decision in 2002 to sell loans which resulted in charge-offs totaling $1.8 million to writedown such loans to fair value, in addition to certain specific loans in the portfolio that have warranted greater attention and specific allocations of the allowance for loan losses. While management believes that it has adequately provided for loan losses and that the allowance for loan losses is adequate at December 31, 2002, it will continue to monitor the loan portfolio and make adjustments to its allowance for loan losses as it considers necessary. Nonperforming loans are those loans on nonaccrual status as well as those loans greater than ninety (90) days delinquent and still accruing interest. At December 31, 2002, Coastal's nonperforming loans decreased, when compared to December 31, 2001, by $6.2 million or 25.0%, to $18.5 million. The decrease in nonperforming loans is mainly due to Coastal's decision to liquidate a portion of its single-family mortgage loan portfolio during 2002 through two loan sales. As discussed previously, the first loan sale was in March 2002 when Coastal sold $10.8 million of its under-performing loans (some of which were considered nonperforming) to a third party investor. The second sale was in December 2002 when Coastal sold $4.3 million of nonperforming loans. At December 31, 2002, 2001 and 2000, Coastal had nonperforming loans as follows:
December 31, --------------- 2002 2001 2000 --------------- ------- ------- (In thousands) Nonaccrual loans receivable: First lien residential $ 9,184 $21,744 $16,062 Residential construction 49 218 390 Multifamily real estate -- 82 -- Commercial real estate 1,323 1,174 1,134 Acquisition and development 5,485 6 -- Commercial, financial and industrial 1,609 499 1,152 Consumer and other 128 141 496 ---------------- ------- ------- 17,778 23,864 19,234 ---------------- ------- ------- Loans greater than 90 days delinquent and still accruing interest: First lien residential -- 62 475 Residential construction 83 755 -- Multifamily real estate 282 -- -- Commercial real estate 302 -- 736 Acquisition and development 59 -- -- Commercial, financial and industrial 43 31 634 Consumer and other -- 1 153 ---------------- ------- ------- 769 849 1,998 ---------------- ------- ------- Total nonperforming loans $ 18,547 $24,713 $21,232 ================ ======= =======
Coastal's asset quality ratios are as follows:
December 31, ------------- 2002 2001 2000 ------- ------ ------ Nonperforming loans to total loans receivable and loans receivable held for sale 1.00% 1.33% 1.12% Allowance for loan losses to nonperforming loans 97.69 62.26 68.32 Allowance for loan losses to total loans receivable 1.00 0.83 0.77
NONINTEREST INCOME Total noninterest income increased $6.1 million, or 54.4%, to $17.2 million in 2002, compared to $11.1 million for 2001. This increase was primarily due to Coastal's sale in December 2002 of five of its branches in Central Texas that resulted in a gain of $4.4 million. In addition, service charges on deposit accounts increased $2.1 million due to Coastal's continued focus on increasing transaction accounts and the related fee income, including Coastal's new Free Checking and Bounce Protection features on retail checking accounts introduced during August 2002. Other increases in noninterest income were due to a $359,000 gain on the sale of loans recorded in 2002 and the $422,000 fair value loss on derivative instruments recorded in 2001 (compared to a $12,000 fair value loss recorded during 2002). These increases were only partially offset by a $100,000 decrease in loan fees, a $702,000 decrease in the gain on the sale of real estate owned, a $169,000 decrease in the gain on the sale of mortgage-backed securities mentioned previously and a $218,000 decrease in other noninterest income. The decrease in the gain on the sale of real estate owned was primarily due to the gain of $603,000 recorded in 2001 on one commercial real estate owned property. The decrease in other noninterest income was primarily due to $300,000 in insurance proceeds received in 2001 for reimbursement of certain deposit losses in prior years. Total noninterest income decreased $881,000, or 7.3%, to $11.1 million in 2001, compared to $12.0 million for 2000. The decrease in noninterest income was primarily due to the $2.2 million gain recorded on the sale of Coastal's mortgage servicing rights during the first quarter of 2000 and the fair value loss on derivative instruments of $422,000 recorded in 2001 pursuant to the adoption of Statement 133 on January 1, 2001. The net fair value loss for the year ended December 31, 2001 was primarily attributable to Coastal's interest rate swap positions, which were liquidated in June 2001. These decreases in noninterest income, when comparing 2001 to 2000, were somewhat offset by the $169,000 gain that Coastal recorded on the sale of mortgage-backed securities mentioned previously. In addition, there were increases of $838,000 in service charges on deposit accounts, $621,000 in the gain on sale of real estate owned and $84,000 in other noninterest income, comparing 2001 to 2000. The increase in service charges on deposit accounts was due to Coastal's continuing focus on increasing transaction accounts and the related fee income. The increase in the gain on the sale of real estate owned was primarily due to a $603,000 gain on the sale of one real estate owned commercial property during the third quarter of 2001. The increase in other noninterest income was primarily due to $300,000 in insurance proceeds received in 2001 for reimbursement of certain deposit account losses incurred in prior years, offset by a $244,000 decrease in loan servicing income due to the 2000 sale of Coastal's mortgage servicing rights. NONINTEREST EXPENSE Total noninterest expense amounted to $55.9 million during 2002, a decrease of $2.6 million, or 4.4%, over 2001. The decrease in noninterest expense was primarily due to the $2.8 million decrease in the amortization of goodwill due to the implementation of Statements 142 and 147 as of January 1, 2002. In addition, Coastal experienced decreases of $869,000 and $1.3 million in office occupancy and data processing, respectively. The decrease in office occupancy was primarily due to certain assets becoming fully depreciated during 2001 and 2002. The decrease in data processing expense was due to the conversion of the Rio Grande Valley Region branches to Coastal's primary deposit and loan data processing system and the item processing functions brought in-house during the third quarter of 2001. These decreases were partially offset by an increase of $1.1 million in compensation, payroll taxes and other benefits, a $519,000 increase in advertising expense, a $153,000 increase in postage and delivery expense and a $599,000 increase in other noninterest expense. The increase in compensation, payroll taxes and other benefits was due to the increase in staff needed to bring the item processing functions in-house during the third quarter of 2001, normal merit increases for existing staff and additional personnel needed to continue Coastal's focus on commercial banking products, lending and providing other services to commercial business customers. The increase in advertising and postage and delivery expenses were primarily due to Coastal's continued focus on increasing transaction deposit accounts. The increase in other noninterest expense was primarily due to the $401,000 reversal of an accrued franchise tax liability during the 2001 period and smaller changes in various other categories. Total noninterest expense amounted to $58.5 million during 2001, an increase of $284,000, or 0.5%, over 2000. The increase in noninterest expense was due to a $1.6 million, or 5.5%, increase in compensation, payroll taxes and other benefits, a $119,000 increase in advertising and a $133,000 increase in postage and delivery, partially offset by a decrease of $84,000 in office occupancy, a $317,000 decrease in data processing, a $225,000 decrease in the amortization of goodwill and a decrease of $940,000 in other noninterest expense. The increase in compensation, payroll taxes and other benefits was primarily due to normal merit increases for existing staff, in addition to the staff increases for the item processing functions brought in-house during the third quarter of 2001 and additional personnel needed to continue Coastal's focus on commercial business products and lending. The increase in advertising and postage and delivery expenses were primarily due to Coastal's efforts to increase transaction deposit accounts. The decrease in data processing expense was due to the conversion to a new mortgage loan data processing system in the second quarter of 2001, the conversion of the branches in the Rio Grande Valley to Coastal's primary deposit and loan data processing system during the third quarter of 2001 and the item processing functions brought in-house during the third quarter of 2001. The decrease in the amortization of goodwill was due to certain goodwill amounts becoming fully amortized during 2001. The decrease in other noninterest expense was due to a $428,000 decrease of debt issuance costs relating to the Senior Notes payable becoming fully amortized in 2001 and the $401,000 reversal of an accrued franchise tax liability determined not to be payable, offset by other smaller changes in various categories. PROVISION FOR FEDERAL INCOME TAXES Coastal incurred no regular Federal income taxes in 2002, 2001 or 2000 primarily due to the utilization of the net operating loss carryovers acquired in May 1988 from the savings and loan associations obtained in connection with the Federal Savings and Loan Insurance Corporation's Southwest Plan (the "Southwest Plan Acquisition") and because payments to Coastal pursuant to the related assistance agreement in prior years were excludable from taxable income, which resulted in Coastal reporting losses each year for tax purposes. However, pursuant to the terms of the Southwest Plan Acquisition assistance agreement, the FSLIC Resolution Fund ("FRF") retained all of the future tax benefits to be derived from the Federal income tax treatment of the assistance payments received from the FRF and from the utilization of the net operating loss carryovers acquired. The amount of tax benefit to Coastal during these years (which corresponds to the amount of Federal taxes which Coastal would have paid in these years but for the tax-exempt nature of the assistance payments from the FRF and the utilization of the net operating loss carryovers) is recorded in Coastal's Consolidated Statements of Income as its provision for Federal income taxes, which also includes alternative minimum taxes paid. The alternative minimum taxes recorded during these years are available as credit carryforwards to reduce future regular Federal income taxes over an indefinite period. Beginning in 2000, these alternative minimum tax credit carryforwards were used to offset regular income taxes. The provisions for Federal income taxes were $9.1 million in 2002, $10.9 million in 2001 and $9.9 million in 2000 with the effective tax rates being 30.1%, 30.7%, and 30.5%, respectively. Although the termination of the agreement with the FRF was effective March 31, 1994, the FRF will continue to receive the future Federal income tax benefits of the net operating loss carryforwards acquired, which are expected to continue through 2003. ASSET AND LIABILITY MANAGEMENT During 2001, as previously mentioned, Coastal entered into a transaction to strategically restructure a portion of its asset base to make it less vulnerable to market interest rate fluctuations. In late November 2001, Coastal completed the sale of approximately $845 million of its mortgage-backed securities. The majority of the securities sold were CMOs tied to the COFI index and contained extension risk which caused, on average, higher levels of price volatility. Coastal replaced approximately $512 million of these securities with primarily pass-thru securities with an overall shorter expected duration. This restructuring was undertaken to decrease the price volatility of the Bank's investments and to improve the stability of future earnings. Coastal's asset and liability management process is utilized to measure and manage its interest rate risk exposure, which is Coastal's primary market risk. Interest rate risk can be defined as the exposure of Coastal's net interest income to adverse movements in interest rates. The principal determinant of the exposure of Coastal's earnings to interest rate risk is the timing difference between the repricing or maturity of Coastal's interest-earning assets and the repricing or maturity of its interest-bearing liabilities. In order to minimize interest rate risk and achieve an acceptable interest rate spread between interest-earning assets and interest-bearing liabilities, Coastal endeavors to match the timing of the repricing or maturities as well as the basis (for example, the London Interbank Offered Rate ("LIBOR") or cost of funds rate) of its interest-earning assets to its interest-bearing liabilities. Coastal also may use interest rate swap and cap agreements to aid in minimizing exposure to interest rate fluctuations. Coastal's asset and liability management strategy is formulated and monitored by the Asset/Liability Committee of the Board of Directors of the Bank (the "Board"). The Board's written policies and procedures are implemented by the Asset/Liability Subcommittee (the "Subcommittee"), a management-staffed committee composed of the Chief Executive Officer, Chief Banking Officer, the Senior Vice President of Retail Banking and the Treasury Manager, in addition to members of the Bank's Portfolio Control Center. The Subcommittee meets monthly to review, among other things, the sensitivity of Coastal's assets and liabilities to interest rate changes, including those transactions attributable to altering the interest rate risk, the purchase and sale activity and maturities of investments and borrowings. In accordance therewith, the Subcommittee reviews Coastal's liquidity, cash flow needs, maturities of investments, deposits and borrowings, interest rate matching, core deposit activity, current market conditions and interest rates on both a local and national level. To effectively measure and manage interest rate risk, the Asset/Liability Committee of the Board and the Subcommittee regularly review interest rate risk by forecasting the impact of alternative interest rate scenarios on net income, net interest income and on Coastal's economic value of equity ("EVE"), which is defined as the difference between the market value of Coastal's existing assets and liabilities, including the effects of off-balance sheet instruments, and by evaluating such impact against the guidelines established by the Board for allowable changes in net interest income and EVE. Coastal utilizes the market-value analysis to address the change in the equity value of Coastal's balance sheet arising from movements in interest rates by computing the net present value of Coastal's assets, liabilities and off-balance sheet instruments. The extent to which assets have gained or lost value in relation to the gains or losses of liabilities determines the appreciation or depreciation in equity on a market-value basis. Economic value analysis is intended to evaluate the impact of immediate and sustained changes in interest rates on the market value of the current balance sheet. From these analyses, interest rate risk is quantified and appropriate strategies are formulated and implemented on an ongoing basis. The following table presents an analysis of the sensitivity in Coastal's annual net interest income and EVE based on the indicated changes in interest rates at December 31, 2002 and 2001. The interest rate scenarios presented in the table include interest rates at December 31, 2002 and 2001 and, for the net interest income calculation, interest rates are adjusted by the indicated changes over a four-quarter period with net interest income being measured for the following calendar year, and for the EVE calculation, the interest rate adjustments consist of instantaneous and parallel changes in the yield curve. Each rate scenario reflects assumptions relating to the estimated effect of prepayments and repricing of applicable assets and liabilities.
Estimated Change In Net Interest Income EVE --------------------- -------------------- Change December 31, December 31, In Interest Rates --------------------- -------------------- (in basis points) 2002 2001 2002 2001 - --------------- ------ -------- ------- ------- +200 3.78% (6.20)% 2.91% (0.74)% +100 1.87 (3.11) 3.88 0.89 0 -- -- -- -- - -100 (0.33) (0.70) (3.85) (3.90) - -200 (2.61) (2.51) (4.97) (6.42)
There are limitations inherent in any methodology used to estimate the exposure to changes in interest rates. It is not possible to fully model the market risk in instruments with leverage, option or prepayment risks. Therefore, this analysis is not intended to be a forecast of the actual effect of a change in interest rates on Coastal. Management of Coastal believes that all of the assumptions used in this analysis to evaluate the vulnerability of Coastal's operations to changes in interest rates take into account historical experience and considers them reasonable; however, the interest rate sensitivity of Coastal's assets and liabilities and the estimated effects of changes in interest rates on Coastal's net interest income and EVE indicated in the above analysis could vary substantially if different assumptions were used or if actual experience differs from the historical experience. The EVE is significantly impacted by the estimated effect of prepayment risk on the value of mortgage-backed securities and loans receivable as market interest rates change. Prepayment risk arises due to the possibility that the cash flow experience of an asset may change as interest rates change. When interest rates increase, mortgage-related assets will generally not be prepaid and conversely, when interest rates decrease, prepayments increase. Prepayments affect Coastal's net spread and the duration match of its assets and liabilities. Coastal has prepayment risk on its mortgage-backed securities and loans receivable held at a premium due to the fact that the amortization of the capitalized premiums on those assets will accelerate when the underlying loans are prepaid. Coastal attempts to anticipate its prepayment risk by extrapolation from past prepayment behavior after adjusting for expected interest rate levels and other economic factors and utilizes these assumptions when analyzing its risk exposure. There is also a risk of an inverted yield curve. In this situation, assuming the rates under one year would be inverted, Coastal's net interest income would be negatively affected. As assets, primarily the one-year treasury securities and whole loans, reprice at the lower one-year rate, the one-month borrowings would reprice at the higher one-month LIBOR rate causing a decline in net interest income. The magnitude of this risk depends on the steepness of the inversion, which part of the curve inverts and the duration of the inverted curve. A more conventional but limited asset and liability monitoring tool involves analyzing the extent to which assets and liabilities are "interest rate sensitive" and measuring an institution's interest rate sensitivity "gap." While this conventional gap measure may be useful, it is limited in its ability to predict trends in future earnings and to predict the effect of changing interest rates. It makes no assumptions about changes in prepayment tendencies, deposit or loan maturity preferences or repricing time lags that may occur in response to a change in the interest rate environment. An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity "gap" is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to increase net interest income, while a positive gap would tend to adversely affect net interest income. Given Coastal's current position based on this "gap" analysis, however, Coastal's net interest spread would benefit over time from a gradual increase in interest rates, in which its assets may be redeployed at higher yields. If interest rates were to fall, yields earned on interest rate sensitive investments would be reduced, while longer term fixed liability costs, such as Coastal's certificates of deposit, would not immediately change. While this analysis takes into account repricing and maturities of assets and liabilities, it fails to consider all the interest rate sensitivities of those asset and liability accounts. The following table summarizes the contractual maturities or repricing characteristics of Coastal's interest-earning assets and interest-bearing liabilities at December 31, 2002. The principal balance of adjustable rate assets is included in the period in which they are first scheduled to adjust or could be adjusted rather than in the period in which they mature. Coastal's one-year cumulative gap position at December 31, 2002 was positive $199.3 million or 7.89% of total assets. This is a snapshot of the position as of such date. The position changes frequently and may not be indicative of Coastal's position at any other time. Other material assumptions are set forth in the footnotes to the table.
As of December 31, 2002 More than More than More than Three months three months one year to three years to or less to one year three years five years ----------------------- -------------- ------------- ---------------- (Dollars in thousands) INTEREST-SENSITIVE ASSETS Loans, net (1)(2): First lien mortgage-single family fixed rate $ 2,455 $ 5,553 $ 30,927 $ 25,394 First lien mortgage-single family adjustable rate 58,799 528,248 118,101 3,366 First lien mortgage-multifamily fixed rate -- 178 1,310 1,388 First lien mortgage-multifamily variable rate 110,502 121 -- -- Construction and acquisition and development, net of loans in process 342,471 4,532 518 374 Commercial real estate 264,826 3,563 14,265 6,687 Commercial 111,385 3,545 17,236 3,471 Consumer and other 5,073 5,464 10,958 8,400 Mortgage-backed securities available-for-sale(1)(2) 420,488 41,172 -- -- Other securities available-for-sale -- -- 1,543 -- Other interest-earning assets (3) 69,987 -- -- -- ----------------------- -------------- ------------- ---------------- Total interest-sensitive assets 1,385,986 592,376 194,858 49,080 ----------------------- -------------- ------------- ---------------- Noninterest-sensitive assets Total assets INTEREST-SENSITIVE LIABILITIES: Interest-bearing deposits (4): Interest-bearing checking accounts $ 14,353 $ -- $ -- $ -- Savings accounts 44,603 -- -- -- Money market demand accounts 399,398 -- -- -- Certificate accounts 233,773 534,634 167,477 37,815 Advances from the FHLB 456,573 95,742 107,976 11,131 Trust Preferred Securities -- -- -- -- ----------------------- -------------- ------------- ---------------- Total interest-sensitive liabilities 1,148,700 630,376 275,453 48,946 ----------------------- -------------- ------------- ---------------- Noninterest-sensitive liabilities Total liabilities Stockholders' equity Total liabilities and stockholders' equity Gap during the period $ 237,286 $ (38,000) $ (80,595) $ 134 Cumulative gap $ 237,286 $ 199,286 $ 118,691 $ 118,825 Interest-sensitive assets as a % of interest-sensitive liabilities (cumulative) 120.66% 111.20% 105.78% 105.65% Interest-sensitive assets as a % of total assets (cumulative) 54.87 78.32 86.03 87.97 Ratio of gap to total assets 9.39 (1.50) (3.19) 0.01 Ratio of cumulative gap to total assets 9.39 7.89 4.70 4.70 More than More than five years to ten years to Over ten years twenty years twenty years Totals --------------- -------------- -------------- ---------- INTEREST-SENSITIVE ASSETS Loans, net (1)(2): First lien mortgage-single family fixed rate $ 20,826 $ 57,911 $ 48,483 $ 191,549 First lien mortgage-single family adjustable Rate 4,639 -- -- 713,153 First lien mortgage-multifamily fixed rate -- 1,899 -- 4,775 First lien mortgage-multifamily variable rate -- -- -- 110,623 Construction and acquisition and development, net of loans in process 1,278 1,394 -- 350,567 Commercial real estate 13,321 10,042 -- 312,704 Commercial 818 -- -- 136,455 Consumer and other 5,992 6,884 74 42,845 Mortgage-backed securities available-for-sale(1)(2) -- 12,484 878 475,022 Other securities available-for-sale -- -- 245 1,788 Other interest-earning assets (3) -- -- -- 69,987 --------------- -------------- -------------- ---------- Total interest-sensitive assets 46,874 90,614 49,680 2,409,468 --------------- -------------- -------------- Noninterest-sensitive assets 116,676 ---------- Total assets $2,526,144 ========== INTEREST-SENSITIVE LIABILITIES: Interest-bearing deposits (4): Interest-bearing checking accounts $ -- $ -- $ -- $ 14,353 Savings accounts -- -- -- 44,603 Money market demand accounts -- -- -- 399,398 Certificate accounts 25 -- -- 973,724 Advances from the FHLB 8,407 16,256 -- 696,085 Trust Preferred Securities -- -- 50,000 50,000 --------------- -------------- -------------- ---------- Total interest-sensitive liabilities 8,432 16,256 50,000 2,178,163 --------------- -------------- -------------- ---------- Noninterest-sensitive liabilities 195,096 ---------- Total liabilities 2,373,259 Stockholders' equity 152,885 ---------- Total liabilities and stockholders' equity $2,526,144 ========== Gap during the period $ 38,442 $ 74,358 $ (320) Cumulative gap $ 157,267 $ 231,625 $ 231,305 Interest-sensitive assets as a % of interest-sensitive liabilities (cumulative) 107.45% 110.88% 110.62% Interest-sensitive assets as a % of total assets (cumulative) 89.83 93.41 95.38 Ratio of gap to total assets 1.52 2.94 (0.01) Ratio of cumulative gap to total assets 6.23 9.17 9.16
(1) Fixed-rate mortgage loans, consumer loans and fixed-rate securities are based on contractual maturities (assuming no periodic amortization). (2) Variable and adjustable rate mortgage loans and adjustable rate mortgage-backed securities are included in the period in which they first reprice (assuming no periodic amortization). (3) Includes FHLB stock, federal funds sold and other interest-earning investments. (4) Includes checking accounts, savings accounts and money market accounts that are interest-bearing. Effective January 1, 1998, Coastal implemented a program whereby a portion of the balances in noninterest-bearing and interest-bearing checking accounts is reclassified to money market demand accounts under Federal Reserve Regulation D. Fixed-rate certificate accounts are based on contractual maturities. DERIVATIVE INSTRUMENTS Coastal is a party to derivative instruments in the normal course of business to reduce its exposure to fluctuations in interest rates. These derivative instruments have included interest rate swap agreements where Coastal makes fixed interest payments and receives payments based on a floating index and, currently, interest rate cap agreements, as described below. Effective January 1, 2001, Coastal adopted Statement 133, which requires companies to recognize all derivatives as either assets or liabilities in the consolidated statement of financial condition and measure all derivatives at fair value. The interest rate swap and cap agreements held by Coastal on December 31, 2000 were determined to not qualify for hedge accounting, therefore on implementation of Statement 133, Coastal recorded a transition adjustment to record these derivative instruments at fair value. On January 1, 2001, Coastal recorded a transition adjustment loss of $160,000, or $104,000 net of the tax effect, as the cumulative effect of the change in accounting for derivative instruments to record the fair value of Coastal's derivative instruments in the consolidated statements of income. For the year ended December 31, 2001, Coastal recorded an additional fair value loss on these derivative instruments of $422,000. The fair value changes in the derivative instruments during 2001 were primarily attributable to Coastal's interest rate swap agreements, which were totally liquidated in June 2001. As of December 31, 2002 and 2001, interest rate cap agreements were Coastal's only derivative instruments. Coastal totally liquidated its interest rate swap positions in June of 2001. The interest rate swap agreements previously held by Coastal provided for Coastal to make fixed interest payments and receive payments based on a floating LIBOR index, as defined in each agreement. The net effect of the interest rate swaps to Coastal was to increase interest expense by $35,000 for the year ended December 31, 2001 and decrease interest expense by $212,000 for the year ended December 31, 2000. See Note 16 of the Notes to Consolidated Financial Statements. Coastal has interest rate cap agreements with third parties, primarily sophisticated investment banking firms. The agreements provide for the third parties to make payments to Coastal whenever a defined floating rate exceeds rates ranging from 8.0% to 9.0%, depending on the agreement. Payments on the interest rate cap agreements are based on the notional principal amount of the agreements; no funds were actually borrowed or are to be repaid. The fair value of the interest rate cap agreements was zero at December 31, 2002 and $37,000 at December 31, 2001, which are the recorded book values of such agreements at such dates due to the implementation of Statement 133. The interest rate cap agreements are used to alter the interest rate sensitivity of a portion of Coastal's mortgage-backed securities and loans receivable. As such, the amortization of the purchase price and interest income from the interest rate cap agreements are recorded in "interest income on mortgage-backed securities or loans receivable," as appropriate, in the accompanying consolidated statements of income. The net decrease in interest income related to the interest rate cap agreements was approximately $25,000 for each of the years ended December 31, 2002, 2001, and 2000. No payments were made to Coastal under the interest rate cap agreements during the years ended December 31, 2002, 2001 or 2000. LIQUIDITY AND CAPITAL RESOURCES Coastal's total assets were $2.5 billion at December 31, 2002 and $2.6 billion at December 31, 2001. Preferred stockholders' equity amounted to $27.5 million and common stockholders' equity was $125.4 million at December 31, 2002. The regulatory capital of Coastal Banc ssb exceeded all three of the Bank's regulatory capital adequacy requirements at December 31, 2002. At December 31, 2002, the Bank's core capital amounted to 6.88% of adjusted total assets, compared to the requirement of 4.0%, its Tier 1 risk-based capital amounted to 10.32% of risk-adjusted assets as compared to the requirement of 4.0% and its total risk-based capital amounted to 11.38% of risk-adjusted assets, compared to a requirement of 8.0%. Coastal's primary sources of funds consist of deposits bearing market rates of interest, advances from the FHLB, securities sold under agreements to repurchase and principal and interest payments on loans receivable and mortgage-backed securities. Coastal uses its funding resources principally to meet its ongoing commitments to fund maturing deposits and deposit withdrawals, repay borrowings, purchase loans receivable and mortgage-backed securities, fund existing and continuing loan commitments, maintain its liquidity, meet operating expenses and fund stock purchases and acquisitions of other banks and thrifts, either on a branch office or whole bank acquisition basis. At December 31, 2002, Coastal had binding commitments to originate or purchase loans totaling approximately $26.5 million and had $147.8 million of undisbursed loans in process. In addition, at December 31, 2002, Coastal had commitments under lines of credit to originate loans, primarily construction and other, of approximately $146.1 million and letters of credit outstanding of $14.2 million. Scheduled maturities of certificates of deposit during the twelve months following December 31, 2002 totaled $768.4 million. Management believes that Coastal has adequate resources to fund all its commitments. INFLATION AND CHANGING PRICES The Consolidated Financial Statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most commercial companies, substantially all of the assets and liabilities of Coastal are monetary in nature. As a result, interest rates have a more significant impact on Coastal's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the prices of goods and services. RECENT ACCOUNTING STANDARDS Statement of Financial Accounting Standards ("SFAS") No. 140 ("Statement 140"), "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," replaced SFAS No. 125 ("Statement 125"), "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," but carried over most of Statement 125's provisions without change. Statement 140 elaborates on the qualifications necessary for a special-purpose entity, clarifies sales accounting criteria in certain circumstances, refines accounting for collateral and adds disclosures for collateral, securitizations and retained interests in securitized assets. Statement 140 was effective for transactions occurring after March 31, 2001. The adoption of Statement 140 did not have a material impact on Coastal. In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("Statement 144") was issued. Statement 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. Statement 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Statement 144 requires companies to separately report discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Statement 144 was adopted by Coastal as of January 1, 2002, and did not have a material effect on Coastal's Consolidated Financial Statements. SFAS Statement No. 148 ("Statement 148") "Accounting for Stock-Based Compensation - Transition and Disclosure" was issued in December 2002. Statement 148 amends SFAS Statement No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement 148 amends the disclosure requirements to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Coastal has adopted the disclosure provisions included in Statement 148 in the notes to Coastal's Consolidated Financial Statements for the years ended December 31, 2002, 2001 and 2000. In January 2003, the Financial Accounting Standards Board directed its staff to prepare a ballot draft of Statement No. 149, "Accounting for Certain Financial Instruments with Characteristics of Liabilities and Equity" ("Statement 149"). When issued, Statement 149 will establish standards for issuers' classification as liabilities in the statement of financial condition certain financial instruments that have characteristics of both liabilities and equity. The final Statement 149 is expected to be issued in the first quarter of 2003 and will be effective upon issuance for all contracts created or modified after the date the statement is issued and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Statement 149 will be effected by reporting the cumulative effect of a change in accounting principle for contracts created before the issuance date and still existing at the beginning of that interim period. The adoption of Statement 149 when issued is not expected to have a material effect on Coastal's Consolidated Financial Statements. FORWARD-LOOKING INFORMATION "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995: The statements contained in this Annual Report to stockholders which are not historical facts contain forward looking information with respect to plans, projections or future performance of Coastal, the occurrence of which involve certain risks and uncertainties detailed in Coastal's filings with the Securities and Exchange Commission ("SEC"). The above discussion should be read in conjunction with the information contained in the Consolidated Financial Statements and the Notes thereto. The above information contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"), and are subject to the safe harbor created by the Reform Act. The words "estimate," "project," "anticipate," "expect," "intend," "believe," "plans," and similar expressions are intended to identify forward-looking statements. Because such forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. Factors, all of which are difficult to predict and many of which are beyond the control of Coastal, that could cause actual results to differ materially include, but are not limited to: risks related to changes in market rates of interest, changes in our loan portfolio, including the risks associated with our non-traditional lending (loans other than single-family residential mortgage loans such as multifamily, real estate acquisition and development, commercial real estate, commercial business and commercial construction loans), the possibility that Coastal's allowance for loan losses proves to be inadequate, Coastal's ability to attract core deposits, the concentration of Coastal's loan portfolio in Texas and California to the extent that the economies of those states experience problems, Coastal's acquisition strategy, including risks of adversely changing results of operations and factors affecting Coastal's ability to consummate further acquisitions; risks involved in Coastal's ability to quickly and efficiently integrate the operations of acquired entities with those of Coastal; changes in business strategies, changes in general market rates of interest and in economic and business conditions, and changes in the laws and regulations applicable to Coastal; and other factors as discussed herein. Coastal Bancorp, Inc. and Subsidiaries DIRECTORS AND OFFICERS BOARD OF DIRECTORS OF COASTAL BANCORP, INC., COASTAL BANC SSB AND SUBSIDIARIES (AS NOTED) MANUEL J. MEHOS Chairman of the Board, President and Chief Executive Officer of Coastal Bancorp, Inc.; Chairman of the Board, President and Chief Executive Officer of Coastal Banc Holding Company, Inc.; Chairman of the Board of Coastal Banc Capital Corp., a wholly-owned subsidiary of Coastal Banc Holding Company, Inc.; Chairman of the Board, President and Chief Executive Officer of the Bank, a wholly-owned subsidiary of Coastal Banc Holding Company, Inc.; Chairman of the Board and Chief Executive Officer of Coastal Banc Mortgage Corp., a wholly-owned subsidiary of Coastal Banc Holding Company, Inc.; and Chief Executive Officer of CoastalBanc Financial Corp., a wholly-owned subsidiary of the Bank, Houston, Texas R. EDWIN ALLDAY Self employed consultant who provides management consulting services to non-profit organizations, Houston, Texas D. FORT FLOWERS, JR. President of Sentinel Trust Company, a Texas Limited Banking Association, providing fiduciary and investment management services to affluent families, their closely held corporations and foundations, Houston, Texas, and Director and Vice Chairman of the Board of New Covenant Trust Company, a National Trust Company DENNIS S. FRANK Chief Executive Officer and President of Silvergate Capital Corporation, a financial institution holding company controlling Silvergate Bank, La Jolla, California and President and Chief Executive Officer of DSF Management Corp., a private investment company, Houston, Texas ROBERT E. JOHNSON, JR. Partner, law firm of Johnson & Johnson, Austin, Texas CLAYTON T. STONE Executive Vice President of Hines Interests Limited Partnership, a real estate developer, Houston, Texas CORPORATE OFFICERS OF COASTAL BANCORP, INC. MANUEL J. MEHOS Chairman of the Board, President and Chief Executive Officer CATHERINE N. WYLIE Senior Executive Vice President, Chief Financial Officer, Chief Operations Officer and Treasurer LINDA B. FRAZIER Senior Vice President, Secretary and General Counsel CORPORATE OFFICERS OF COASTAL BANC HOLDING COMPANY, INC. MANUEL J. MEHOS Chairman of the Board, President and Chief Executive Officer CATHERINE N. WYLIE Director, Senior Executive Vice President, Chief Financial Officer, Chief Operations Officer and Treasurer LINDA B. FRAZIER Director, Senior Vice President and Secretary LINDA S. BUBACZ Director, Assistant Treasurer and Assistant Secretary CORPORATE OFFICERS OF COASTAL BANC SSB MANUEL J. MEHOS President and Chief Executive Officer CATHERINE N. WYLIE Senior Executive Vice President - Chief Financial Officer and Chief Operations Officer ROBERT V. NEW Executive Vice President - Chief Banking Officer DAVID R. GRAHAM Executive Vice President - Commercial Real Estate Lending WALTER A. PAWKETT Executive Vice President - Commercial Lending - Rio Grande Valley H. EDWARD SELKE, JR. Executive Vice President - Chief Credit Officer MICHAEL TURNER Executive Vice President - Commercial Lending COASTAL A HISTORICAL PERSPECTIVE Coastal was acquired by an investor group in 1986 as a vehicle to take advantage of the failures and consolidation in the Texas banking and thrift industries. At February 28, 1986 (the date of the change in ownership), Coastal had one full service office and total assets of approximately $10.7 million. In May 1988, Coastal became the first acquirer of failed or failing savings institutions under the Federal government's "Southwest Plan." In this transaction, Coastal acquired from the Federal Savings and Loan Insurance Corporation, as receiver for four insolvent savings associations, 14 additional branch offices and approximately $543.4 million of assets and assumed $543.4 million in deposits and other liabilities. Since completion of the Southwest Plan acquisition and through 2002, Coastal entered into seven branch acquisitions and one whole bank acquisition: two with an instrumentality of the Federal government and six with private institutions. In each transaction, Coastal agreed to acquire certain assets in consideration of the assumption of certain deposit liabilities. In 1996, Coastal also exchanged three branches for one resulting in a net deposit increase of $26.0 million and sold one branch in separate transactions. In 2002, Coastal sold five branches with $75.3 million in deposits. All of these transactions resulted in the net assumption of $1.8 billion of deposits and the net acquisition of 53 branch offices. Coastal has also opened seven de novo branches since inception. Coastal has been able to achieve operating economies and improve efficiency by closing an aggregate of 18 branch offices and transferring the deposits to other offices located in the same market area. At December 31, 2002, Coastal had total assets of approximately $2.5 billion and total deposits of approximately $1.6 billion with 43 branch offices in metropolitan Houston, Austin, Corpus Christi, the Rio Grande Valley and small cities in the southeast quadrant of Texas. Independent Auditors' Report ---------------------------- The Board of Directors Coastal Bancorp, Inc.: We have audited the accompanying consolidated statements of financial condition of Coastal Bancorp, Inc. and subsidiaries as of December 31, 2002 and 2001 and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial condition of Coastal Bancorp, Inc. and subsidiaries at December 31, 2002 and 2001 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. As discussed in notes 2 and 8 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangibles in 2002. /s/ KPMG LLP - -------------- January 24, 2003 Houston, Texas
COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 2002 AND 2001 (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS 2002 2001 - ------------------------------------------------------------- ---------- ---------- Cash and cash equivalents $ 39,766 $ 41,537 Federal funds sold (Note 4) 27,755 16,710 Loans receivable held for sale (Note 6) 49,886 -- Loans receivable, net (Notes 6 and 12) 1,812,785 1,863,601 Mortgage-backed securities available-for-sale, at fair value (Notes 5, 12, 13, and 16) 475,022 514,068 Other securities available-for-sale, at fair value 1,788 42,827 Accrued interest receivable (Note 7) 9,781 13,243 Property and equipment (net of accumulated depreciation and amortization of $26,050 in 2002 and $23,779 in 2001) 27,341 27,461 Stock in the Federal Home Loan Bank of Dallas ("FHLB") 41,221 40,032 Goodwill (Note 8) 21,429 21,811 Prepaid expenses and other assets (Notes 9, 10, 16 and 18) 19,370 16,601 ---------- ---------- Total assets $2,526,144 $2,597,891 ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY --------------------------------------- Liabilities: Deposits (Note 11) $1,614,368 $1,660,386 Advances from the FHLB (Note 12) 696,085 690,877 Company obligated mandatorily redeemable 9.0% trust preferred securities of Coastal Capital Trust I (Note 14) 50,000 -- Senior Notes payable (Note 15) -- 43,875 Advances from borrowers for taxes and insurance 2,407 4,259 Other liabilities and accrued expenses 10,399 12,310 --------- ---------- Total liabilities 2,373,259 2,411,707 --------- ---------- Minority interest - 9.0% noncumulative preferred stock of Coastal Banc ssb (Note 21) -- 28,750 Commitments and contingencies (Notes 6, 16, 19 and 24) Stockholders' equity (Notes 5, 21, 22 and 23): Preferred Stock, no par value; authorized shares 5,000,000; 9.12% Cumulative, Series A, 1,100,000 shares issued and outstanding 27,500 27,500 Common Stock, $.01 par value; authorized shares 30,000,000; 7,867,029 shares issued and 5,141,010 shares outstanding at December 31, 2002; 7,835,178 shares issued and 5,835,178 shares outstanding at December 31, 2001 79 78 Additional paid-in capital 35,736 35,366 Retained earnings 141,986 127,425 Accumulated other comprehensive income (loss) - net unrealized gain (loss) on securities available-for-sale 619 (1,590) Treasury stock at cost (2,726,019 shares in 2002 and 2,000,000 shares in 2001) (53,035) (31,345) ----------- ----------- Total stockholders' equity 152,885 157,434 ----------- ----------- Total liabilities and stockholders' equity $2,526,144 $2,597,891 ========== ==========
See accompanying notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2000 --------- --------- -------- Interest income: Loans receivable $118,970 $155,214 $168,105 Mortgage-backed securities 17,114 52,873 64,246 FHLB stock, federal funds sold and other interest-earning assets 1,539 2,525 4,922 --------- --------- -------- 137,623 210,612 237,273 --------- --------- -------- Interest expense: Deposits 39,825 69,828 73,216 Advances from the FHLB 20,173 38,917 58,328 Other borrowed money -- 10,682 16,671 Company obligated mandatorily redeemable 9.0% trust preferred securities of Coastal Capital Trust I 2,400 -- -- Senior Notes payable 378 4,588 4,690 --------- --------- -------- 62,776 124,015 152,905 --------- --------- -------- Net interest income 74,847 86,597 84,368 Provision for loan losses (Note 6) 5,800 3,900 5,790 --------- --------- -------- Net interest income after provision for loan losses 69,047 82,697 78,578 --------- --------- -------- Noninterest income: Service charges on deposit accounts 9,894 7,803 6,965 Loan fees 1,148 1,248 1,247 Gain on sale of branch offices (Note 3) 4,395 -- -- Gain on sale of loans receivable 359 -- -- Gain on sale of mortgage servicing rights -- -- 2,172 Gain on sale of mortgage-backed securities available-for-sale -- 169 -- Loss on derivative instruments (12) (422) -- Gain on sale of real estate owned, net 117 819 198 Other 1,308 1,526 1,442 --------- --------- -------- 17,209 11,143 12,024 --------- --------- -------- Noninterest expense: Compensation, payroll taxes and other benefits 31,914 30,785 29,187 Office occupancy 10,044 10,913 10,997 Data processing 1,691 3,008 3,325 Amortization of goodwill (Note 8) -- 2,800 3,025 Advertising 1,953 1,434 1,315 Postage and delivery 1,654 1,501 1,368 Other 8,637 8,038 8,978 --------- --------- -------- 55,893 58,479 58,195 --------- --------- -------- Income before provision for Federal income taxes, minority interest and cumulative effect of accounting change 30,363 35,361 32,407 Provision for Federal income taxes (Note 18) 9,140 10,867 9,895 --------- --------- -------- Income before minority interest and cumulative effect of accounting change 21,223 24,494 22,512 Minority interest - preferred stock dividends of Coastal Banc ssb (Note 21) 1,507 2,588 2,588 --------- --------- -------- Income before cumulative effect of accounting change 19,716 21,906 19,924 Cumulative effect of accounting for derivative instruments (Note 16) -- (104) -- --------- --------- -------- Net income $ 19,716 $ 21,802 $ 19,924 ========= ========= ======== Net income available to common stockholders $ 17,208 $ 19,294 $ 17,416 ========= ========= ======== Basic earnings per common share before cumulative effect of accounting change $ 3.13 $ 3.36 $ 2.94 ========= ========= ======== Basic earnings per common share (Notes 8 and 23) $ 3.13 $ 3.34 $ 2.94 ========= ========= ======== Diluted earnings per common share before cumulative effect of accounting change $ 2.99 $ 3.19 $ 2.87 ========= ========= ======== Diluted earnings per common share (Notes 8 and 23) $ 2.99 $ 3.17 $ 2.87 ========= ========= ========
See accompanying notes to Consolidated Financial Statements. COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (IN THOUSANDS)
2002 2001 2000 ------- ------- -------- Net income $19,716 $21,802 $19,924 Other comprehensive income (loss), net of tax: Change in net unrealized gains (losses) on securities available-for- sale, net of reclassification adjustment and tax effects (Note 5) 2,209 277 (19) ------- ------- -------- Comprehensive income $21,925 $22,079 $19,905 ======= ======= ========
See accompanying notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (IN THOUSANDS) Accumulated Additional other Preferred Common paid-in Retained comprehensive Treasury Stock Stock capital earnings income (loss) stock Total ---------- ------- ----------- ---------- --------------- ---------- --------- Balance - December 31, 1999 $ 27,500 $ 76 $ 32,683 $ 95,508 $ (1,848) $ (20,463) $133,456 Dividends on Preferred Stock (Note 22) -- -- -- (2,508) -- -- (2,508) Dividends on Common Stock (Note 22) -- -- -- (2,130) -- -- (2,130) Exercise of stock options (Note 19) -- 1 629 -- -- -- 630 Purchase of treasury stock at cost (Note 22) -- -- -- -- -- (10,882) (10,882) Change in net unrealized gain (loss) on securities available-for-sale (Note 5) -- -- -- -- (19) -- (19) Net income for 2000 -- -- -- 19,924 -- -- 19,924 ------ ---- ------ ------- ------- ------- -------- Balance - December 31, 2000 27,500 77 33,312 110,794 (1,867) (31,345) 138,471 Dividends on Preferred Stock (Note 22) -- -- -- (2,508) -- -- (2,508) Dividends on Common Stock (Note 22) -- -- -- (2,663) -- -- (2,663) Exercise of stock options (Note 19) -- 1 2,054 -- -- -- 2,055 Change in net unrealized gain (loss) on securities available-for-sale, net of reclassification adjustment and tax effects (Note 5) -- -- -- -- 277 -- 277 Net income for 2001 -- -- -- 21,802 -- -- 21,802 ------ ---- ------ ------- ------- ------- -------- Balance - December 31, 2001 27,500 78 35,366 127,425 (1,590) (31,345) 157,434 Dividends on Preferred Stock (Note 22) -- -- -- (2,508) -- -- (2,508) Dividends on Common Stock (Note 22) -- -- -- (2,647) -- -- (2,647) Exercise of stock options (Note 19) -- 1 325 -- -- -- 326 Purchase of treasury stock at cost (Note 22) -- -- -- -- -- (21,753) (21,753) Issuance of treasury shares -- -- 45 -- -- 63 108 Change in net unrealized gain (loss on securities available-for-sale (Note 5) -- -- -- -- 2,209 -- 2,209 Net income for 2002 -- -- -- 19,716 -- -- 19,716 ------ ---- ------ ------- ------- ------- -------- Balance - December 31, 2002 $ 27,500 $ 79 $ 35,736 $ 141,986 $ 619 $ (53,035) $152,885 ======= ==== ======= ======= ======= ======== ======== See accompanying notes to Consolidated Financial Statements. COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (IN THOUSANDS) 2002 2001 2000 ---------- ---------- ---------- Cash flows from operating activities: Net income $ 19,716 $ 21,802 $ 19,924 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization of property and equipment, mortgage servicing rights and prepaid expenses and other assets 8,714 8,325 9,601 Net premium amortization (discount accretion) 4,583 (3,115) 349 Provision for loan losses 5,800 3,900 5,790 Amortization of goodwill -- 2,800 3,025 Originations and purchases of loans receivable held for sale (67,300) (20,550) (25,461) Sales of loans receivable held for sale 22,858 20,723 25,618 Gain on sale of branch offices (4,395) -- -- Gain on sale of loans receivable (359) -- -- Gain on sale of mortgage servicing rights -- -- (2,172) Loss on derivative instruments 12 582 -- Gain on sale of mortgage-backed securities available-for-sale -- (169) -- Decrease (increase) in: Accrued interest receivable 3,462 5,529 (2,622) Other, net (1,088) (37,242) 32,212 Stock dividends from the FHLB (1,189) (1,973) (4,603) ---------- --------- --------- Net cash provided by (used in) operating activities (9,186) 612 61,661 ---------- --------- --------- Cash flows from investing activities: Net change in federal funds sold (11,045) (15,841) (869) Purchases of mortgage-backed securities held-to-maturity -- -- (4,815) Purchase of mortgage-backed securities available-for-sale (112,579) (512,267) -- Purchase of U.S. Treasury securities held-to-maturity -- -- (1,493) Purchase of other securities available-for-sale (1,786) (43,064) -- Principal repayments on mortgage-backed securities held-to-maturity -- 73,725 36,326 Principal repayments on mortgage-backed securities available-for-sale 151,880 59,986 4,940 Proceeds from maturity of U.S. Treasury securities held-to-maturity -- 1,500 300 Proceeds from maturity of other securities available-for-sale 42,500 -- -- Proceeds from sales of mortgage-backed securities available-for-sale -- 844,918 -- Purchases of loans receivable (421,371) (250,945) (236,970) Sale of loans receivable 84,241 -- -- Other changes in loans receivable 367,971 277,918 66,032 Purchases of property and equipment, net (3,908) (3,781) (2,340) Purchase of FHLB stock -- (28,485) (35,649) Proceeds from sales of FHLB stock -- 48,431 39,000 Proceeds from sale of mortgage servicing rights -- -- 5,001 Sale of branch offices (70,127) -- -- ---------- --------- --------- Net cash provided by (used in) investing activities 25,776 452,095 (130,537) ---------- --------- ---------
COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED (IN THOUSANDS) 2002 2001 2000 ------------- ------------ ------------ Cash flows from financing activities: Net change in deposits $ 29,257 $ (14,540) $ 50,826 Advances from the FHLB 22,097,904 8,031,619 9,567,857 Principal payments on advances from the FHLB (22,092,696) (8,491,047) (9,514,483) Proceeds from securities sold under agreements to repurchase and federal funds purchased -- 3,591,744 2,418,869 Repayments of securities sold under agreements to repurchase and federal funds purchased -- (3,591,744) (2,418,869) Proceeds from issuance of 9.0% Trust Preferred Securities 48,125 -- -- Redemption or repurchase of Senior Notes payable (43,875) (3,025) -- Redemption of Coastal Banc ssb 9.0% Noncumulative Preferred Stock (28,750) -- -- Net increase (decrease) in advances from borrowers for taxes and insurance (1,852) (791) 1,198 Exercise of stock options for purchase of Common Stock 326 2,055 630 Purchase of treasury stock (21,753) -- (10,882) Issuance of treasury shares 108 -- -- Dividends paid (5,155) (5,171) (4,638) ---------- --------- --------- Net cash provided by (used in) financing activities (18,361) (480,900) 90,508 ---------- --------- --------- Net increase (decrease) in cash and cash equivalents (1,771) (28,193) 21,632 Cash and cash equivalents at beginning of year 41,537 69,730 48,098 ---------- --------- --------- Cash and cash equivalents at end of year $ 39,766 $ 41,537 $ 69,730 =========== ========== =========== Supplemental schedule of cash flows: Interest paid $ 64,400 $ 126,730 $ 153,413 Income taxes paid 12,977 13,113 5,392 Supplemental schedule of noncash investing and financing activities: Net transfer of loans to held for sale category $ 8,749 $ -- $ -- Real estate owned acquired through foreclosure of loans receivable 6,260 5,450 3,672 Net transfer of mortgage-backed securities to available-for-sale category -- 811,748 --
See accompanying notes to Consolidated Financial Statements. COASTAL BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002 and 2001 (1) ORGANIZATION AND BACKGROUND Coastal Banc Savings Association (the "Association") was acquired by an investor group in 1986 as a vehicle to take advantage of the failures and consolidation in the Texas banking and thrift industries. The Association acquired deposits in transactions with the federal government and other private institutions as a base for developing an ongoing thrift and banking business. The Association's first acquisition was in 1988 under the Federal Savings and Loan Insurance Corporation's ("FSLIC") Southwest Plan, whereby the FSLIC provided financial and other forms of assistance in connection with the acquisition of insolvent FSLIC-insured institutions (the "Acquired Associations"). Coastal Bancorp, Inc. ("Bancorp") was incorporated on March 8, 1994 as a first-tier subsidiary of the Association in connection with the proposed reorganization of the Association into the holding company form of organization. The reorganization of the Association into the holding company form of organization occurred on July 29, 1994. In addition, effective July 29, 1994, the Association converted to a Texas-chartered savings bank known as Coastal Banc ssb. On November 30, 1996, Coastal Banc Holding Company, Inc. ("HoCo") was created as a Delaware unitary savings bank holding company in accordance with the terms of an agreement and plan of reorganization dated August 19, 1996 (the "Agreement"). Pursuant to the terms of the Agreement, Coastal Banc ssb became a subsidiary of HoCo and HoCo became a wholly-owned subsidiary of Bancorp. The reorganizations were accounted for in a manner similar to that in pooling-of-interests accounting and all financial statements issued after consummation of the reorganization reflect the consolidated operations as if the reorganization had taken place prior to the periods covered by such consolidated financial statements. Coastal Banc ssb is a financial services provider to consumers and businesses. At December 31, 2002, Coastal Banc ssb operated 43 branch offices in metropolitan Houston, Austin, Corpus Christi, the Rio Grande Valley and small cities in the southeast quadrant of Texas. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION The following significant accounting policies, together with those disclosed elsewhere in the Consolidated Financial Statements or notes thereto, are followed by Coastal Bancorp, Inc. and subsidiaries in preparing and presenting the consol-idated financial statements. BASIS OF CONSOLIDATED FINANCIAL STATEMENTS The consolidated financial statements include the accounts of Coastal Bancorp, Inc., its wholly-owned subsidiaries, HoCo, its wholly-owned subsidiaries, and Coastal Capital Trust I (collectively, "Coastal"). HoCo's wholly-owned subsidiaries are Coastal Banc ssb, Coastal Banc Capital Corp. and Coastal Banc Mortgage Corp. Coastal Banc ssb's wholly-owned subsidiaries are CoastalBanc Financial Corp. and Coastal Banc Insurance Agency, Inc. (collectively, the "Bank"). All significant intercompany balances and transactions have been eliminated in consolidation. Certain amounts within the accompanying consolidated financial statements and the related notes have been reclassified to conform to the current year presentation. Such reclassifications had no effect on net income or total stockholders' equity as previously reported. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results may differ from those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents are comprised primarily of cash on hand and interest-earning and noninterest-earning deposits in other banks with original maturities of three months or less. LOANS RECEIVABLE Loans receivable are stated at the principal balance outstanding adjusted for loans in process, the allowance for loan losses, unearned interest and loan fees and the premium on purchased loans. Interest on loans receivable is primarily computed on the outstanding principal balance at appropriate rates of interest. The net premium or discount on purchased loans is being amortized or accreted using the level yield method, adjusted for prepayments. Periodically, loans receivable may be transferred to the held for sale category. When moved, the loan is recorded in the held for sale category at the lower of cost or market with any writedowns to market value recorded as a charge-off to the allowance for loan losses. If a loan is moved from the held for sale category to the loans receivable portfolio, the loan is moved at the current carrying value of the loan. It is the general policy of Coastal to stop accruing interest income and place the recognition of interest on a cash basis when any loan is past due more than 90 days as to principal and interest. However, other factors may cause management to continue to accrue interest on such loans. When a loan is placed on nonaccrual, any interest previously accrued but not collected is reversed against current interest income. Coastal considers a loan to be impaired when, based upon current information and events, it is probable that Coastal will be unable to collect all amounts due according to the contractual terms of the loan agreement. In determining impairment, Coastal considers, among other things, large non-homogeneous loans which may include nonaccrual loans or troubled debt restructurings, and performing loans which exhibit, among other characteristics, high loan-to-value ratios, low debt coverage ratios, or indications that the borrowers are experiencing increased levels of financial difficulty. Coastal bases the measurements of collateral-dependent impaired loans on the fair value of that collateral. The amount by which the recorded investment in the loan exceeds the measure of the fair value of the collateral securing the loan is recognized by recording a valuation allowance. Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, Coastal does not separately identify individual consumer and residential loans for impairment disclosures. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level determined to be adequate by management to absorb probable losses on loans receivable. The adequacy of the allowance is based on management's evaluation of the type, size, quality and risks of the loans in the loans receivable portfolio and its consideration of such factors as historical and peer group loss experience, identification of adverse situations which may affect the ability of borrowers to repay, assessment of current and future economic conditions and the estimated net realizable value of the underlying collateral. This evaluation is inherently subjective, as it requires material estimates that are susceptible to significant change. While management uses available information to estimate losses on loans receivable, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review Coastal's allowance for loan losses. Such agencies may require Coastal to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. SALES OF LOANS RECEIVABLE Loans are sold periodically to institutional and private investors. When Coastal sells whole mortgage loans, it may retain the right to service the loans. Gains or losses on such sales are recognized at the time of sale and depend, in part, on the previous carrying amount of the assets involved in the sale, allocated between the assets sold and the retained interests based on their relative fair value at the date of transfer. LOANS RECEIVABLE HELD FOR SALE Loans receivable held for sale are carried at the lower of cost or market as determined by outstanding commitments from investors or current investor market yield requirements calculated on the aggregate loan basis. LOAN FEES Loan origination and commitment fees, as well as certain direct loan origination and commitment costs, are deferred and amortized into income over the lives of the related loans using a method that approximates the level yield method. When the loans receivable are paid off or sold, the remaining loan fees are recognized as income in that period. MORTGAGE-BACKED AND OTHER SECURITIES Coastal classifies securities as held-to-maturity, available-for-sale or trading. Securities are classified as held-to-maturity when Coastal has the positive intent and ability to hold such securities to maturity. Securities held-to-maturity are recorded at amortized cost. Securities available-for-sale are securities other than those held-to-maturity or trading and are recorded at fair value, with unrealized gains and losses excluded from earnings and recorded net of tax as other comprehensive income (loss) in stockholders' equity until realized. Realized gains and losses on securities classified as available-for-sale are recorded in earnings in the year of sale based on the specific identification of each individual security sold. Trading securities are carried at fair value with any realized or unrealized gains or losses recognized in current earnings. Coastal held no trading account securities at December 31, 2002 or 2001. Coastal records mortgage-backed and other securities transactions as of the settlement date. There were no pending transactions as of December 31, 2002 or 2001. Premiums and discounts on mortgage-backed and other securities are amortized or accreted as a yield adjustment over the life of the securities using the interest method, with the amortization or accretion being adjusted when the prepayments are received. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost less accumulated depreciation and amortization. Coastal computes depreciation and amortization on a straight-line basis over the estimated useful lives (15-30 years for buildings and 2-10 years for furniture and equipment) of the respective assets. Leasehold improvements are amortized on a straight-line basis over the lesser of the terms of the respective lease or the estimated useful lives of the related assets. STOCK IN THE FEDERAL HOME LOAN BANK OF DALLAS As a member of the FHLB System, Coastal is required to purchase and maintain stock in the FHLB in an amount equal to the greater of 1% of the aggregate unpaid balance of loans and securities secured by single family and multi-family properties, 0.3% of total assets, or 5% of total FHLB advances. FHLB stock is redeemable at par value at the discretion of the FHLB. GOODWILL On January 1, 2002, Coastal adopted Statement of Financial Accounting Standards No. 141, "Business Combinations" ("Statement 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement 142"). Statement 141 eliminated the pooling of interests method of accounting for business combinations and requires that the purchase method of accounting be used for all business combinations. Statement 141 also required, effective January 1, 2002, that Coastal evaluate its existing intangible assets and goodwill that were acquired in prior purchase business combinations, and make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Statement 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Statement 141 required that Coastal reclassify amounts originally recorded as goodwill pursuant to Statement of Financial Accounting Standard No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions" ("Statement 72") to other intangible assets, as those amounts, under Statement 142, were not subject to non-amortization provisions. On October 1, 2002, Statement of Accounting Standards No. 147, "Acquisitions of Certain Financial Institutions" ("Statement 147") was issued. Statement 147 amended Statement 72, to exclude from its scope, the acquisitions of financial institutions (other than transactions between two or more mutual enterprises) and provide certain transition provisions for existing intangible assets. Under Statement 147 transition provisions, if the transaction that gave rise to an unidentifiable other intangible asset was considered a business combination, the carrying amount of that asset amount would be reclassified to goodwill and be subject to the non-amortization provisions as of the effective date of the implementation of Statement 142, which in Coastal's case was January 1, 2002. In connection with the adoption of these statements, Coastal tested for impairment in accordance with the provisions of Statement 142 during the first quarter of 2002 and did not recognize any transitional impairment losses as the cumulative effect of a change in accounting principle. In years 2001 and prior, goodwill resulting from acquisitions was amortized on a straight-line basis over the estimated period of benefit, not to exceed fifteen years. During these years, Coastal evaluated the recorded goodwill amounts for impairment to determine whether events and circumstances had developed to warrant revision of the estimated benefit periods. MORTGAGE SERVICING RIGHTS The amount capitalized as mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues. Coastal periodically evaluates the carrying value of the mortgage servicing rights for impairment based on the fair value of those rights. The fair value of mortgage servicing rights is determined by discounting the present value of the estimated future net servicing revenues using a discount rate commensurate with the risks involved based on management's best estimate of remaining loan lives. This method of valuation incorporates assumptions that market participants would use in their estimate of future servicing income and expense, including assumptions about prepayments, defaults and interest rates. For purposes of measuring impairment, the loans underlying the mortgage servicing rights are stratified on the basis of interest rate and type (fixed or adjustable). The amount of impairment is the amount by which the mortgage servicing rights, net of accumulated amortization, exceed their fair value by strata. Impairment, if any, is recognized through a valuation allowance and a charge to current operations. REAL ESTATE OWNED Real estate owned represents real estate acquired through foreclosure and is initially recorded at the lower of unpaid principal balance adjusted for any acquisition premiums or discounts remaining less any applicable valuation allowance or estimated fair value less estimated selling costs. Subsequent to foreclosure, real estate owned is carried at the lower of the new cost basis or fair value, with any further declines in fair value charged to operations. FEDERAL INCOME TAXES Coastal files a consolidated federal income tax return with all of its subsidiaries. Federal income taxes are allocated on the basis of each entity's contribution to consolidated taxable income. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. DERIVATIVE INSTRUMENTS USED FOR INTEREST RATE RISK MANAGEMENT Coastal is a party to derivative instruments in the normal course of business to reduce its exposure to fluctuations in interest rates. These derivative instruments have included interest rate swap agreements and interest rate cap agreements. Effective January 1, 2001, Coastal adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and for Hedging Activities" ("Statement 133"). Statement 133 requires companies to recognize all derivatives as either assets or liabilities in the statement of financial condition and measure all derivatives at fair value. The interest rate swap and cap agreements held by Coastal on December 31, 2000 were determined to not qualify for hedge accounting, therefore on implementation of Statement 133, Coastal recorded a transition adjustment to record these derivative instruments at fair value. See Note 16. Prior to the adoption of Statement 133 (in years 2000 and prior), the fair values of any derivative instruments were not recognized in the consolidated financial statements. STOCK OPTIONS Statement of Financial Accounting Standards No. 148 ("Statement 148") "Accounting for Stock-Based Compensation - Transition and Disclosure" was issued in December 2002. Statement 148 amends Financial Accounting Standards Board Statement No. 123 "Accounting for Stock-Based Compensation" ("Statement 123") to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement 148 amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Coastal has adopted the disclosure provisions included in Statement 148 in the notes to the consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 contained herein. As provided by Statement 123, Coastal accounts for its stock compensation programs in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Under this method, no stock-based compensation expense is reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share as if Coastal had applied the fair value recognition provisions of Statement 123 as amended by Statement 148.
Year Ended December 31, 2002 2001 2000 ---------- ------- -------- (In thousands, except per share data) Net income available to common stockholders, as reported $ 17,208 $19,294 $17,416 Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects (425) (463) (626) ---------- -------- -------- Proforma net income available to common stockholders $ 16,783 $18,831 $16,790 ========== ======== ======== Earnings per common share: Basic - as reported $ 3.13 $ 3.34 $ 2.94 ========== ======== ======== Basic - proforma $ 3.06 $ 3.26 $ 2.84 ========== ======== ======== Diluted - as reported $ 2.99 $ 3.17 $ 2.87 ========== ======== ======== Diluted - proforma $ 2.92 $ 3.10 $ 2.77 ========== ======== ========
EARNINGS PER COMMON SHARE Basic earnings per common share ("EPS") is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. The computation of diluted EPS assumes the issuance of common shares for all dilutive-potential common shares outstanding during the reporting period. The dilutive effect of stock options is considered in earnings per common share calculations, if dilutive, using the treasury stock method. CONSOLIDATED STATEMENTS OF CASH FLOWS For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from depository institutions with original maturities of three months or less. RECENT ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards No. 140 ("Statement 140"), "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," replaced Statement of Financial Accounting Standards No. 125 ("Statement 125"), "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," but carried over most of Statement 125's provisions without change. Statement 140 elaborates on the qualifications necessary for a special-purpose entity, clarifies sales accounting criteria in certain circumstances, refines accounting for collateral and adds disclosures for collateral, securitizations and retained interests in securitized assets. Statement 140 was effective for transactions occurring after March 31, 2001. The adoption of Statement 140 did not have a material impact on Coastal. In August 2001, Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("Statement 144") was issued. Statement 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. Statement 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Statement 144 requires companies to separately report discontinued operations and extends t hat reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Statement 144 was adopted by Coastal as of January 1, 2002, and did not have a material effect on Coastal's Consolidated Financial Statements. Coastal adopted Statements 141, 142 and 147 effective January 1, 2002. See Note 8. Statement 148 "Accounting for Stock-Based Compensation - Transition and Disclosure" was issued in December 2002. Statement 148 amends Statement 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement 148 amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Coastal has adopted the disclosure provisions included in Statement 148 in the notes to the consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 contained herein. In January 2003, the Financial Accounting Standards Board directed its staff to prepare a ballot draft of Statement No. 149, "Accounting for Certain Financial Instruments with Characteristics of Liabilities and Equity" ("Statement 149"). When issued, Statement 149 will establish standards for issuers' classification as liabilities in the statement of financial condition certain financial instruments that have characteristics of both liabilities and equity. The final Statement 149 is expected to be issued in the first quarter of 2003 and will be effective upon issuance for all contracts created or modified after the date the statement is issued and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Statement 149 will be effected by reporting the cumulative effect of a change in accounting principle for contracts created before the issuance date and still existing at the beginning of that interim period. The adoption of Statement 149 when issued is not expected to have a material effect on Coastal's Consolidated Financial Statements. (3) SALE OF BRANCH OFFICES On December 12, 2002, Coastal consummated the sale of five of its branches in Central Texas (located in Llano, Burnet, Mason, Kingsland and Marble Falls, Texas) to First State Bank Central Texas. As a result of this sale, Coastal recorded a $4.4 million gain before applicable income taxes. Coastal acquired these locations in the 1994 acquisition of Texas Trust Savings Bank, FSB. In connection with the sale of these branch offices, Coastal recorded the following reductions of assets and liabilities (in thousands): Deposits sold $75,275 Accrued interest payable sold 128 Property and equipment sold 443 Reduction of goodwill 382 Other assets sold 368 (4) FEDERAL FUNDS SOLD An analysis of federal funds sold for the years ended December 31, 2002, 2001 and 2000 is as follows (dollars in thousands):
2002 2001 2000 -------- -------- -------- Federal funds sold: Balance outstanding at December 31, $27,755 $16,710 $ 869 Maximum outstanding at any month-end 38,980 17,011 10,000 Average balance outstanding 9,337 7,776 3,042 Average interest rate 1.62% 3.42% 6.38%
(5) MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE Mortgage-backed securities available-for-sale at December 31, 2002 are as follows (dollars in thousands):
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ----------- ------------ -------- Agency securities $ 387,636 $ 1,983 $ (470) $389,149 CMOs - Non-agency 84,376 67 (644) 83,799 Non-agency securities 2,060 14 -- 2,074 ---------- ----------- ------------ -------- $ 474,072 $ 2,064 $ (1,114) $475,022 ========== =========== ============ ========
Mortgage-backed securities available-for-sale at December 31, 2001 are as follows (in thousands):
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ----------- ------------ -------- Agency securities $ 406,437 $ 319 $ (2,455) $404,301 CMOs - Non-agency 107,488 82 (418) 107,152 Non-agency securities 2,590 34 (9) 2,615 ---------- ----------- ------------ -------- $ 516,515 $ 435 $ (2,882) $514,068 ========== =========== ============ ========
Effective September 30, 2001, Coastal transferred all of its mortgage-backed securities held-to-maturity to the available-for-sale category. This was due to management's intent to restructure a portion of the asset base to be less vulnerable to market interest rate fluctuations. In late November 2001, Coastal entered into a transaction and sold $845 million of its mortgage-backed securities. Also in November, Coastal used a portion of the proceeds of the sale to purchase approximately $512 million of primarily pass-thru mortgage-backed securities. All of the securities purchased and the remaining securities not sold were placed in the available-for-sale category. Proceeds from sales of mortgage-backed securities available-for-sale during 2001 were $844.9 million. Gross gains of $2.5 million and gross losses of $2.3 million were realized on those sales in 2001. There were no sales of mortgage-backed securities available-for-sale during 2002 or 2000. A portion of Coastal's mortgage-backed securities portfolio is pledged as collateral to secure advances from the FHLB. See Note 12. (6) LOANS RECEIVABLE Loans receivable at December 31, 2002 and 2001 are as follows (dollars in thousands):
2002 2001 ----------- ----------- Real estate mortgage loans: First lien mortgage, primarily residential $ 855,633 $ 880,624 Commercial 317,692 319,377 Multifamily 116,020 124,616 Residential construction 123,085 136,035 Acquisition and development 143,463 140,009 Commercial construction 241,128 222,026 Commercial loans, secured by residential mortgage loans held for sale -- 11,508 Commercial, financial and industrial 135,209 116,029 Loans secured by deposits 14,465 21,238 Consumer and other loans 33,430 43,384 ----------- ----------- 1,980,125 2,014,846 ----------- ----------- Loans in process (147,769) (131,064) Allowance for loan losses (18,118) (15,385) Unearned interest and loan fees (2,910) (2,959) Premium (discount) on purchased loans, net 1,457 (1,837) ----------- ----------- $1,812,785 $1,863,601 ========== =========== Weighted average yield 5.52% 6.90% ========== ===========
In the normal course of business, Coastal enters into various transactions which, in accordance with accounting principles generally accepted in the United States of America, are not included on the balance sheets. These transactions are referred to as "off-balance sheet commitments." Coastal enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit which involve elements of credit risk in excess of the amounts recognized in the balance sheets. Coastal minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. Coastal enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Customers use credit commitments to ensure that funds will be available for working capital purposes, for capital expenditures and to ensure access to funds under specified terms and conditions. Substantially all of Coastal's commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for loan losses. At December 31, 2002, Coastal had outstanding commitments to originate or purchase approximately $26.5 million of first lien mortgage and other loans and had commitments under lines of credit to originate primarily construction and other loans of approximately $146.1 million. In addition, at December 31, 2002, Coastal had letters of credit of approximately $14.2 million outstanding. A portion of Coastal's first lien and multifamily mortgage loan portfolio is pledged as collateral to secure advances from the FHLB. See Note 12. Included in loans receivable at December 31, 2002 and 2001 are loans totaling approximately $17.8 million and $23.9 million, respectively, which are on nonaccrual (loans which are 90 days or more delinquent or on which the collection of interest is considered doubtful). During the years ended December 31, 2002, 2001 and 2000, Coastal recognized interest income on these nonaccrual loans (outstanding as of the period end) of approximately $632,000, $811,000 and $706,000, respectively, whereas approximately $745,000, $1.4 million and $1.2 million, respectively, in additional interest income would have been recorded if such loans had been performing in accordance with their original terms. At December 31, 2002 and 2001, the carrying value of impaired loans was approximately $8.5 million and $3.8 million, respectively, and the related allowance for loan losses on those impaired loans totaled $2.4 million and $554,000, respectively. Of the impaired loans outstanding, eight loans with a balance of $551,000 at December 31, 2002 and nineteen loans with a balance of $1.3 million at December 31, 2001 did not have specific portions of the allowance for loan losses allocated to them at each respective date. The average recorded investment in impaired loans during the years ended December 31, 2002, 2001 and 2000 was approximately $3.8 million, $4.4 million and $3.5 million, respectively. For the years ended December 31, 2002, 2001 and 2000, Coastal did not recognize interest income on loans considered impaired. An analysis of activity in the allowance for loan losses is as follows (in thousands):
Years ended December 31, ---------------------------- 2002 2001 2000 -------- -------- -------- Balance, beginning of year $15,385 $14,507 $10,493 Provision for loan losses 5,800 3,900 5,790 Charge-offs (3,878) (4,073) (2,174) Recoveries 811 1,051 398 ------- ------- ------- Balance, end of year $18,118 $15,385 $14,507 ======= ======= =======
During the first quarter of 2002, management made the decision to liquidate a portion of its under-performing single-family mortgage loans. On March 22, 2002, Coastal sold $10.8 million of these under-performing loans to a third party investor. Prior to the sale, Coastal wrote these loans down to fair value and recorded a charge-off to the allowance for loan losses of $761,000. In addition, as of March 31, 2002, Coastal wrote down to fair value and reclassified $9.1 million of other under-performing single-family mortgage loans to the held for sale category. The loans that were reclassified to the held for sale category were written down to fair value as of March 31, 2002 through a charge-off to the allowance for loan losses of $691,000. During the second quarter of 2002, a total of $3.1 million of these under-performing loans held for sale were sold to the same third party investor. As of December 31, 2002, Coastal had reclassified the remaining $3.0 million of these loans held for sale back to the loans receivable portfolio at their current carrying value. During the fourth quarter of 2002, management decided to liquidate a group of loans that were acquired in three separate transactions. In December 2002, Coastal sold $74.4 million of these loans to a third party investor (some of these loans were sold servicing retained). Prior to the sale, Coastal wrote these loans down to fair value and recorded a charge-off to the allowance for loan losses of $277,000. In connection with this sale, Coastal recorded a gain of $359,000 on the sale of these loans as a result of Coastal recognizing the estimated fair value of the mortgage servicing rights retained. In addition, as of December 31, 2002, Coastal wrote down to fair value and reclassified $2.6 million of additional loans, which are under a contract for sale, to the held for sale category. The loans that were reclassified to the held for sale category were written down to fair value as of December 31, 2002 through a charge-off to the allowance for loan losses of $32,000. (7) ACCRUED INTEREST RECEIVABLE Accrued interest receivable at December 31, 2002 and 2001 is as follows (in thousands):
2002 2001 ------ ------- Loans receivable $7,946 $ 9,894 Mortgage-backed securities 1,807 2,474 FHLB stock, federal funds sold and other interest-earning assets 28 875 ------ ------- $9,781 $13,243 ====== =======
(8) GOODWILL On January 1, 2002, Coastal adopted Statement 141. Statement 141 eliminated the pooling of interests method of accounting for business combinations and requires that the purchase method of accounting be used for all business combinations. Statement 141 also required, effective January 1, 2002, that Coastal evaluate its existing intangible assets and goodwill that were acquired in prior purchase business combinations, and make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Statement 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Statement 141 required that Coastal reclassify amounts originally recorded as goodwill pursuant to Statement 72 to other intangible assets, as those amounts, under Statement 142, were not subject to the non-amortization provisions. As of January 1, 2002, Coastal had unamortized goodwill that was subject to the non-amortization provision of Statements 141 and 142 of $5.5 million. As of that same date, Coastal reclassified $16.3 million to other intangible assets and continued to amortize these amounts in 2002. On October 1, 2002, Statement 147 was issued. Statement 147 amended Statement 72, to exclude from its scope, the acquisitions of financial institutions (other than transactions between two or more mutual enterprises) and provide certain transition provisions for existing intangible assets. Under Statement 147 transition provisions, if the transaction that gave rise to an unidentifiable other intangible asset was considered a business combination, the carrying amount of that asset amount would now be reclassified to goodwill and be subject to the non-amortization provisions as of the effective date of the implementation of Statement 142, which in Coastal's case was January 1, 2002. Based on the implementation of Statement 147, Coastal has reclassified the $16.3 million mentioned above to goodwill and removed the amortization expense recorded in 2002, through restatement of its 2002 financial statements as required by Statement 147. In connection with the adoption of these statements, Coastal tested for impairment in accordance with the provisions of Statement 142 during the first quarter of 2002 and did not recognize any transitional impairment losses as the cumulative effect of a change in accounting principle. Pursuant to the transition provisions of Statement 142, presented below are as adjusted net income and earnings per share amounts to exclude the amortization expense (net of any tax effect) recognized in the periods prior to the implementation related to the goodwill that is no longer being amortized (in thousands, except per share data).
Years Ended December 31, ------------------------------- 2002 2001 2000 ------------- ------- ------- Net income: As reported $ 19,716 $21,802 $19,924 Add back: goodwill amortization, net of tax -- 2,036 2,248 ------------- ------- ------- As adjusted $ 19,716 $23,838 $22,172 ============= ======= ======= Basic earnings per share: As reported $ 3.13 $ 3.34 $ 2.94 Add back: goodwill amortization, net of tax -- 0.35 0.38 ------------- ------- ------- As adjusted $ 3.13 $ 3.69 $ 3.32 ============= ======= ======= Diluted earnings per share: As reported $ 2.99 $ 3.17 $ 2.87 Add back: goodwill amortization, net of tax -- 0.34 0.37 ------------- ------- ------- As adjusted $ 2.99 $ 3.51 $ 3.25 ============= ======= =======
(9) MORTGAGE SERVICING RIGHTS Effective March 31, 2000, Coastal sold its mortgage servicing rights portfolio and recorded a nonrecurring gain of $2.2 million. Pursuant to a purchase and sale agreement, Coastal sold its rights to service approximately $389.1 million of mortgage loans for third party investors. In December 2002, Coastal sold $70.1 million of mortgage loans with servicing retained and recognized the estimated fair value of those servicing rights retained of $359,000, which is included in prepaid expenses and other assets. As of December 31, 2002, Coastal services for others approximately $68.8 million of such loans which are not included in the consolidated financial statements. An analysis of the activity of mortgage servicing rights for the years ended December 31, 2002 and 2000 is as follows (in thousands):
2002 2000 ----- -------- Balance, beginning of year $ -- $ 3,035 Additions 359 -- Amortization -- (167) Sales of servicing rights -- (2,868) ----- -------- Balance, end of year $ 359 $ -- ===== ========
(10) REAL ESTATE OWNED Included in prepaid expenses and other assets is real estate owned at December 31, 2002 and 2001 of approximately $4.1 million and $4.4 million, respectively. (11) DEPOSITS Deposits, their stated rates and the related weighted average interest rates at December 31, 2002 and 2001 are summarized below (dollars in thousands). Effective January 1, 1998, Coastal implemented a program whereby a portion of the balance of noninterest-bearing and interest-bearing checking accounts is reclassified to money market demand accounts under Federal Reserve Regulation D. The amount of such reclassification, reflected in the following table, was approximately $250.9 million ($131.3 million from noninterest-bearing and $119.6 million from interest-bearing) at December 31, 2002 and $243.3 million ($113.0 million from noninterest-bearing and $130.3 million from interest-bearing) at December 31, 2001.
2002 2001 -------------------------- ---------------------------- Stated Rate Amount Stated Rate Amount -------------- ---------- ------------ ------------ Noninterest-bearing checking 0.00% $ 51,029 0.00% $ 47,712 Interest-bearing checking 0.50 - 1.00 14,353 0.50 - 1.00 15,894 Savings accounts 0.50 - 1.24 44,603 0.50 - 1.24 45,234 Money market demand accounts (including amounts reclassified from noninterest and interest-bearing checking) 0.00 - 2.13 530,659 0.00 - 2.23 505,789 ----------- ----------- 640,644 614,629 ----------- ----------- Certificate accounts Less than 2.00 104,358 Less than 2.00 29,707 2.00 - 2.99 558,337 2.00 - 2.99 171,523 3.00 - 3.99 206,645 3.00 - 3.99 263,006 4.00 - 4.99 63,234 4.00 - 4.99 356,314 5.00 - 5.99 34,447 5.00 - 5.99 155,949 6.00 - 6.99 6,524 6.00 - 6.99 68,979 7.00 - 7.99 106 7.00 - 7.99 209 8.00 - 8.99 73 8.00 - 8.99 70 ----------- ----------- 973,724 1,045,757 ----------- ----------- $1,614,368 $1,660,386 =========== =========== Weighted average rate 2.12% 3.02% =========== ===========
Prior to the reclassification as discussed above, noninterest-bearing checking accounts, interest-bearing checking accounts and money market demand accounts were as follows at December 31, 2002 and 2001 (in thousands):
December 31, 2002 December 31, 2001 ------------------ ------------------ Noninterest-bearing checking $ 182,290 $ 160,738 Interest-bearing checking 134,034 146,144 Money market demand accounts 279,717 262,513
The scheduled maturities of certificate accounts outstanding at December 31, 2002 were as follows (in thousands):
Year Ending December 31, - ------------------------ 2003 $768,407 2004 131,792 2005 35,685 2006 4,513 2007 33,302 Subsequent years 25 -------- $973,724 ========
The aggregate amount of certificate accounts with balances of $100,000 or more was approximately $237.0 million and $248.0 million at December 31, 2002 and 2001, respectively. (12) ADVANCES FROM THE FEDERAL HOME LOAN BANK OF DALLAS Advances from the FHLB for the years ended December 31, 2002, 2001 and 2000 are summarized as follows (dollars in thousands):
2002 2001 2000 --------- ----------- ----------- Balance outstanding at end of year $696,085 $ 690,877 $1,150,305 Average balance outstanding 683,454 795,009 926,659 Maximum outstanding at any month-end 760,139 1,218,145 1,275,541 Average interest rate during the year 2.95% 4.90% 6.29% Average interest rate at end of year 2.71% 3.46% 6.48%
The scheduled maturities and related weighted average interest rates on advances from the FHLB at December 31, 2002 are summarized as follows (dollars in thousands):
Due during the year Weighted Average ending December 31, Interest Rate Amount - ------------------- ----------------- -------- 2003 2.49% $302,315 2004 2.56 139,608 2005 2.62 218,368 2006 4.95 9,980 2007 6.67 1,151 2008 5.35 2,378 2009 8.01 3,502 2010 6.73 987 2011 6.54 1,248 2012 5.76 292 2013 5.64 8,259 2014 5.45 2,907 2015 6.66 1,647 2017 5.43 1,993 2018 5.05 1,450 -------- 2.71% $696,085 ================= ========
The FHLB advances are secured by certain first lien and multifamily mortgage loans and mortgage-backed securities with an aggregate carrying value of approximately $700.0 million at December 31, 2002. (13) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS PURCHASED Coastal enters into sales of securities under agreements to repurchase ("reverse repurchase agreements"). Fixed coupon reverse repurchase agreements are treated as financing arrangements, and the obligations to repurchase securities sold are reflected as a liability in the consolidated statements of financial condition. The dollar amounts of securities underlying the agreements are recorded in the respective asset accounts. Coastal did not have any securities sold under agreements to repurchase at December 31, 2002 or 2001. However, securities sold under agreements to repurchase averaged approximately $283.6 million and $249.7 million during 2001 and 2000, respectively, and the maximum outstanding amounts at any month-end during 2001 and 2000 were approximately $493.0 million and $605.2 million, respectively. Federal funds purchased averaged approximately $18,000 during the year ended December 31, 2000. There were no Federal funds purchased outstanding at any time during 2002 or 2001. (14) COMPANY OBLIGATED MANDATORILY REDEEMABLE 9.0% TRUST PREFERRED SECURITIES On June 18, 2002, Coastal, through Coastal Capital Trust I (a consolidated trust subsidiary) (the "Trust"), issued 2,000,000 trust preferred securities ("Trust Preferred Securities") with a liquidation preference of $25 per security. The Trust Preferred Securities represent an interest in Bancorp's junior subordinated debentures, which were purchased by the Trust. The junior subordinated debentures are the only assets of the Trust and interest payments from the debentures finance the distributions paid on the Trust Preferred Securities. Distribution on the securities are payable quarterly at the annual rate of 9.0% and are included in interest expense in the consolidated statements of income. The Trust Preferred Securities are subject to mandatory redemption at the liquidation preference, in whole or in part, upon repayment of the junior subordinated debentures at maturity or their earlier redemption. The junior subordinated debentures are redeemable prior to the maturity date of June 30, 2032, at the option of Bancorp on or after June 30, 2007, in whole at any time or in part from time to time. The junior subordinated debentures are also redeemable at any time, in whole, but not in part, upon the occurrence of specific events defined within the trust indenture. Bancorp has the option to defer distribution on the junior subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. A portion of the proceeds from the issuance of the Trust Preferred Securities were used to repurchase 500,000 shares of common stock for $15.0 million from a director of Bancorp in June 2002. In addition, $28.8 million of the proceeds were used on July 15, 2002, to redeem the Bank's 9.0% Series A Noncumulative Preferred Stock (Nasdaq:CBSAP) through a capital contribution to Coastal Banc ssb. (15) SENIOR NOTES PAYABLE On June 30, 1995, Coastal issued $50.0 million of 10.0% Senior Notes due June 30, 2002. The Senior Notes were redeemable at Coastal's option, in whole or in part, on or after June 30, 2000, at par, plus accrued interest to the redemption date. Interest on the Senior Notes was payable quarterly. On January 28, 1999, the Board of Directors authorized the repurchase, on an unsolicited basis, of the Senior Notes in an amount and on such terms considered appropriate by management. During 2001 and 1999, Coastal repurchased $3.0 and $3.1 million, respectively, of the Senior Notes outstanding at par. On February 1, 2002, (the "Redemption Date"), Coastal redeemed all of its 10.0% Senior Notes outstanding ($43.9 million). The redemption price was par plus accrued interest to the Redemption Date. (16) DERIVATIVE INSTRUMENTS Coastal is a party to derivative instruments in the normal course of business to reduce its exposure to fluctuations in interest rates. These derivative instruments have included interest rate swap agreements where Coastal makes fixed interest payments and receives payments based on a floating index and interest rate cap agreements, as described below. Effective January 1, 2001, Coastal adopted Statement 133 as discussed in Note 2. Statement 133 requires companies to recognize all derivatives as either assets or liabilities in the consolidated statement of financial condition and measure all derivatives at fair value. The interest rate swap and cap agreements held by Coastal on December 31, 2000 were determined to not qualify for hedge accounting, therefore on implementation of Statement 133, Coastal recorded a transition adjustment to record these derivative instruments at fair value. On January 1, 2001, Coastal recorded a transition adjustment loss of $160,000, or $104,000 net of the tax effect, as the cumulative effect of the change in accounting for derivative instruments to record the fair value of Coastal's derivative instruments in the consolidated statements of income. For the year ended December 31, 2001, Coastal recorded an additional fair value loss on these derivative instruments of $422,000. The fair value changes in the derivative instruments during 2001 were primarily attributable to Coastal's interest rate swap agreements, which were totally liquidated in June 2001. As of December 31, 2002, interest rate cap agreements were Coastal's only derivative instruments and were recorded at fair value pursuant to Statement 133. As of December 31, 2002, Coastal has interest rate cap agreements with third parties with notional amounts totaling $107.6 million. The current agreements provide for the third parties to make payments to Coastal whenever a defined floating rate exceeds rates ranging from 8.0% to 9.0%, depending on the agreement. All of Coastal's current agreements expire in 2003. Payments on the interest rate cap agreements are based on the notional principal amount of the agreements; no funds were actually borrowed or are to be repaid. The fair value of the interest rate cap agreements was zero at December 31, 2002 and $37,000 at December 31, 2001, which is the recorded book value of the agreements at such dates due to the implementation of Statement 133. The interest rate cap agreements are used to alter the interest rate sensitivity of a portion of Coastal's mortgage-backed securities and loans receivable. As such, the amortization of the purchase price and interest income from the interest rate cap agreements are recorded in "interest income on mortgage-backed securities or loans receivable" as appropriate. The net decrease in interest income related to interest rate cap agreements was approximately $25,000 for each of the years ended December 31, 2002, 2001 and 2000. No payments were made to Coastal under the interest rate cap agreements during the years ended December 31, 2002, 2001 or 2000. Coastal totally liquidated its interest rate swap positions in June of 2001. The interest rate swap agreements previously held by Coastal provided for Coastal to make fixed interest payments and receive payments based on a floating LIBOR index, as defined in each agreement. The weighted average interest rate of payments received on all of the interest rate swap agreements was approximately 4.84% in 2001 and 6.50% in 2000. The weighted average interest rate of payments made on all of the interest rate swap agreements was approximately 5.21% in 2001 and 5.94% in 2000. Payments on the interest rate swap agreements were based on the notional principal amount of the agreements; no funds were actually borrowed or are to be repaid. Coastal recorded net interest expense or income related to these agreements on a monthly basis in interest expense in the accompanying consolidated statements of income. The net interest income increase or (decrease) related to these agreements was approximately ($35,000) and $212,000 for the years ended December 31, 2001 and 2000, respectively. Market risk, or the risk of loss due to movement in market prices or rates is quantified by Coastal through a risk monitoring process of marking to market the portfolio to expected market level changes in an instantaneous shock of plus and minus 200 basis points on a quarterly basis. This process discloses the effects on market values of the assets and liabilities, unrealized gains and losses, including off-balance sheet items, as well as potential changes in net interest income. Coastal is exposed to credit loss in the event of nonperformance by the counterparty to the swap or cap and controls this risk through credit monitoring procedures. The notional principal amount does not represent Coastal's exposure to credit loss. (17) FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments," requires that Coastal disclose estimated fair values for its financial instruments. The fair value estimates presented herein are based on relevant information available to management as of December 31, 2002 and 2001. Because the reporting requirements exclude certain financial instruments and all nonfinancial instruments, the aggregate fair value amounts presented herein do not represent management's estimate of the underlying value of Coastal. The fair value estimates, methods and assumptions used are set forth below for Coastal's financial instruments (in thousands):
At At December 31, 2002 December 31, 2001 ------------------------------------- ------------------------------- Carrying Fair Carrying Fair Value Value Value Value ------------------ ------------------ ---------- ------------------- Financial assets: Cash and cash equivalents $ 39,766 $ 39,766 $ 41,537 $ 41,537 Federal funds sold 27,755 27,755 16,710 16,710 Loans receivable held for sale 49,886 49,886 -- -- Loans receivable 1,812,785 1,837,157 1,863,601 1,892,609 Mortgage-backed securities available-for-sale 475,022 475,022 514,068 514,068 Other securities available-for-sale 1,788 1,788 42,827 42,827 Stock in the FHLB 41,221 41,221 40,032 40,032 Interest rate cap agreements -- -- 37 37 Accrued interest receivable 9,781 9,781 13,243 13,243 Financial liabilities: Deposits 1,614,368 1,625,659 1,660,386 1,671,265 Advances from the FHLB 696,085 702,067 690,877 693,654 Company obligated mandatorily redeemable 9.0% trust preferred securities of Coastal Capital Trust I 50,000 51,300 -- -- Senior Notes payable -- -- 43,875 43,875 Accrued interest payable 4,298 4,298 6,050 6,050 Off-balance sheet instruments: Commitments to extend credit -- 320,379 -- 255,301
CASH AND CASH EQUIVALENTS Carrying value approximates fair value because of the short maturity of these instruments and absence of any anticipated credit concerns. FEDERAL FUNDS SOLD Carrying value approximates fair value because of the short maturity of these instruments and absence of any anticipated credit concerns. LOANS RECEIVABLE HELD FOR SALE AND LOANS RECEIVABLE The fair values of loans receivable are estimated for segregated groupings of loans with similar financial characteristics. Loans are segregated by type, such as residential mortgage, commercial and consumer. Residential mortgage loans are further subdivided into fixed and adjustable rate loans including single family, multifamily and construction. The fair value of single family residential loans is estimated based on current investor market prices and yields for mortgage-backed securities with similar maturities, interest rate indexes and prepayment characteristics. The fair value of multifamily residential, construction, commercial and consumer loans are estimated using factors that reflect the credit and interest rate risk in these loans. SECURITIES AVAILABLE-FOR-SALE The fair values of mortgage-backed and other securities are estimated based on published market prices or market prices from investment dealers and companies. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. STOCK IN THE FHLB The carrying amount of the stock in the FHLB approximates fair value because it is redeemable at its par value. INTEREST RATE CAP AGREEMENTS The fair values of interest rate cap agreements are based on the discounted value of the differences between contractual interest rates and current market rates for similar agreements. ACCRUED INTEREST RECEIVABLE Carrying value approximates fair value. DEPOSITS The fair value of deposits with short-term or no stated maturity, such as noninterest-bearing checking, interest-bearing checking, savings accounts and money market demand accounts is equal to the amounts payable as of December 31, 2002 and 2001. The fair value of certificate accounts is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. ADVANCES FROM THE FHLB The fair value of advances from the FHLB is estimated based on quoted market prices for similar agreements or current rates offered to Coastal for borrowings with similar remaining maturities. TRUST PREFERRED SECURITIES OF COASTAL CAPITAL TRUST I AND SENIOR NOTES PAYABLE The fair values of the Trust Preferred Securities and of the Senior Notes payable are based on quoted market prices for similar securities. ACCRUED INTEREST PAYABLE Carrying value approximates fair value. COMMITMENTS TO EXTEND CREDIT The fair value of commitments to extend credit is estimated using current interest rates and committed interest rates. (18) FEDERAL INCOME TAXES The acquisition of the Acquired Associations under the FSLIC's Southwest Plan on May 13, 1988 qualified for tax-free reorganization status under Section 368(a)(3)(D) of the Internal Revenue Code of 1986 as amended ("IRC"). Accordingly, the tax bases of assets of the Acquired Associations carried over to Coastal. In connection with this acquisition, the FSLIC Resolution Fund ("FRF") retained all of the future federal income tax benefits derived from the federal income tax treatment of certain items, in addition to net operating loss carryforwards related to the acquisition for which Coastal agreed to pay the FRF when actually realized. The provisions for federal income taxes recorded for the years ended December 31, 2002, 2001 and 2000, represent the gross tax liability computed under these tax sharing provisions before reduction for actual federal taxes paid to the Internal Revenue Service. Alternative minimum taxes paid with the federal return in 2002, 2001 and 2000 are available as credit carryforwards to reduce regular federal tax liabilities in future years, over an indefinite period and were partially utilized beginning in 2000. To the extent these credits were generated due to the utilization of other tax benefits retained by the FRF, they will also be treated as tax benefit items. Although the termination of the agreement with the FRF was effective March 31, 1994, the FRF will continue to receive the future federal income tax benefits from the net operating loss carryforwards acquired from the Acquired Associations. The components of the provision for federal income tax expense (benefit) for the years ended December 31, 2002, 2001 and 2000 are as follows (in thousands):
2002 2001 2000 ------- -------- -------- Current $9,349 $13,153 $13,141 Deferred (209) (2,286) (3,246) ------ ------- -------- $9,140 $10,867 $ 9,895 ====== ======= ========
A reconciliation of the expected federal income taxes using a corporate tax rate of 35% for the years ended December 31, 2002, 2001 and 2000 is as follows (in thousands):
2002 2001 2000 -------- -------- -------- Computed expected tax provision $10,627 $12,376 $11,343 FDIC tax benefit of preferred stock dividends (1,405) (1,784) (1,784) Net purchase accounting adjustments -- 222 282 Other, net (82) 53 54 ------- ------- -------- $ 9,140 $10,867 $ 9,895 ======= ======= ========
Significant temporary differences that give rise to the deferred tax assets and liabilities as of December 31, 2002 and 2001 are as follows (in thousands):
2002 2001 ------ ------ Deferred tax assets: Loans receivable, principally due to allowance for loan losses $6,002 $4,811 Unrealized loss on securities available-for-sale -- 855 Intangible assets 122 841 Property and equipment 2,014 1,683 Other 106 130 ------ ------ 8,244 8,320 ------ ------ Deferred tax liabilities: Unrealized gain on securities available-for-sale $ 333 $ -- FHLB stock 1,147 703 Other 126 -- ------ ------ 1,606 703 ------ ------ Net deferred tax asset $6,638 $7,617 ====== ======
No valuation allowance on deferred tax assets has been established as management believes that it is more likely than not that the existing deductible temporary differences will reverse during periods in which Coastal generates net taxable income. In years prior to 1996, Coastal was permitted under the IRC to deduct an annual addition to a reserve for bad debts in determining taxable income. This addition differs from the provision for loan losses for financial reporting purposes. Due to enacted legislation, Coastal is no longer able to utilize a reserve method for determining the bad debt deduction but is allowed to deduct actual charge-offs. Further, Coastal's post-1987 tax bad debt reserve will be recaptured into income. The reserve is being recaptured over a six-year period. At December 31, 2002, Coastal had approximately $664,000 post-1987 tax bad debt reserves, for which deferred taxes have been provided. Coastal is not required to provide deferred taxes on its pre-1988 (base year) tax bad debt reserve of $928,000. This reserve may be included in taxable income in future years if the Bank pays dividends in excess of its accumulated earnings and profits (as defined in the IRC) or in the event of a distribution in partial or complete liquidation of the Bank. (19) STOCK COMPENSATION PROGRAMS In December 1991, the Board of Directors adopted the 1991 Stock Compensation Program (the "1991 Program") for the benefit of officers and other selected key employees of Coastal. The 1991 Program was approved by stockholders in December 1991. Four kinds of rights, evidenced by four plans, are contained in the 1991 Program and are available for grant: incentive stock options, compensatory stock options, stock appreciation rights and performance share awards. The maximum aggregate number of shares of Common Stock available pursuant to the 1991 Program was equal to 10% of Coastal's issued and outstanding shares of Common Stock at the date of adoption of the 1991 Program. Coastal reserved the shares for future issuance under the 1991 Program. The stock options were granted at a price not less than the fair market value on the date of the grant, are exercisable ratably over a four-year period and may be outstanding for a period up to ten years from the date of grant. Generally, no stock option may be exercised until the employee has remained in the continuous employment of Coastal for six months after the option was granted. On March 23, 1995 and March 25, 1999, the Board of Directors adopted the 1995 and 1999 Stock Compensation Programs, respectively, (the "New Programs"). The New Programs are substantially similar to the 1991 Program and were approved by stockholders in April 1995 and April 1999, respectively. The Board of Directors reserved 382,891 and 340,000, respectively, shares of Common Stock for issuance under the New Programs. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2002, 2001 and 2000:
2002 2001 2000 ------------ ------------ ------------ Assumptions: Expected annual dividends $0.48/share $0.48/share $0.36/share Expected volatility 26.99% 37.20% 37.21% Risk-free interest rate 1.61% 4.30% 6.40% Expected life in years 10 10 10
A summary of the status of the stock options as of December 31, 2002, 2001 and 2000 and changes during the years then ended is as follows:
2002 2001 2000 --------------------- ---------------------- -------------------------- Weighted- Weighted- Weighted Number Average Number Average Number Average of Exercise Of Exercise of Exercise Shares Price Shares Price Shares Price --------- ---------- ---------- ---------- --------- --------------- Outstanding at beginning of year 604,899 $ 14.516 766,979 $ 14.047 722,412 $ 13.726 Granted 36,031 30.863 10,000 28.900 132,000 14.750 Exercised (34,776) 11.915 (157,556) 13.048 (61,395) 10.253 Forfeited/cancelled (1,500) 14.854 (14,524) 15.579 (26,038) 17.653 -------- --------- --------- Outstanding at end of year 604,654 $ 15.639 604,899 $ 14.516 766,979 $ 14.047 ======== ========= ======== Options exercisable at end of year 543,631 502,337 578,340 ========= ========== ========= Weighted-average fair value of options granted during the year (per share) $ 8.771 $ 12.622 $ 6.356 ========= ========== =========
The following table summarizes information about stock options outstanding at December 31, 2002:
Options outstanding Options exercisable ----------------------------------------------------------- ------------------------------ Weighted-Average Number Remaining Weighted-Average Number Weighted-Average Range of Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price - ------------------------- ------------------- ------------------- ----------------- ----------- ----------------- $8.583 to $12.500 201,208 2.3 years $ 10.679 201,208 $ 10.679 $14.750 to $20.333 325,165 6.1 years $ 15.673 298,665 $ 15.755 $25.125 to $30.960 78,281 7.8 years $ 28.248 43,758 $ 26.522 ------------------ ---------- 604,654 5.1 years $ 15.639 543,631 $ 14.742 ================== ===========
(20) EMPLOYEE BENEFITS Coastal maintains a 401(k) profit sharing plan. Coastal's contributions to this plan were approximately $563,000, $566,000 and $518,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Pursuant to this plan, employees can contribute up to 15% of their qualifying compensation into the plan. Beginning January 1, 1990, Coastal matched 25% of the employee contributions up to 15% of their qualifying compensation. Beginning July 1, 1998, Coastal has matched 50% of the employee contributions up to 6% of their qualifying compensation and 25% of the employee contributions from 7% to 15% of their qualifying compensation. (21) COASTAL BANC SSB PREFERRED STOCK On October 21, 1993, the Bank issued 1,150,000 shares of 9.0% Noncumulative Preferred Stock, no par Series A, at a price of $25 per share to the public. Dividends on this preferred stock were payable quarterly at the annual rate of $2.25 per share, when, as and if declared by the Board of Directors of the Bank. At any time on or after December 15, 1998, this preferred stock could be redeemed in whole or in part only at the Bank's option at $25 per share plus unpaid dividends (whether or not earned or declared) for the then current dividend period to the date fixed for redemption. With a portion of the proceeds from the issuance of the Trust Preferred Securities, the Bank redeemed from the stockholders of record all of the outstanding 9.0% Series A Noncumulative Preferred Stock on July 15, 2002 (see note 14). The redemption price was $25.185 per share, which represented the stated value of the Preferred Stock, plus accrued and unpaid dividends to the date of redemption. (22) STOCKHOLDERS' EQUITY COASTAL BANCORP, INC. PREFERRED STOCK On May 11, 1999, Bancorp issued 1,100,000 shares of 9.12% Series A Cumulative Preferred Stock, no par value, to the public at a price of $25 per share ("Bancorp Preferred Stock"). Dividends on the preferred stock are payable quarterly at the annual rate of $2.28 per share. The preferred stock is callable on May 15, 2003 at Bancorp's option. Pursuant to Coastal's tax benefit agreement with the FRF, Coastal receives a tax benefit for dividends on this preferred stock. The ongoing quarterly benefit will be approximately $219,000, or 4 cents per diluted share (as of December 31, 2002), and is expected to continue through 2003. COMMON STOCK DIVIDENDS On January 24, April 25, July 25 and October 24, 2002, Coastal declared a dividend of $0.12 per share of Common Stock outstanding for the stockholders of record as of February 15, May 15, August 15, and November 15, 2002, respectively. On January 25, 2001, Coastal declared a dividend of $0.10 per share of Common Stock outstanding for the stockholders of record as of February 15, 2001. On April 26, July 26 and October 25, 2001, Coastal declared a dividend of $0.12 per share on Common Stock outstanding for the stockholders of record as of May 15, August 15 and November 15, 2001, respectively. On January 28 and April 28, 2000, Coastal declared a dividend of $0.08 per share of Common Stock outstanding for the stockholders of record as of February 15 and May 15, 2000, respectively. On July 28 and October 27, 2000, Coastal declared a dividend of $0.10 per share on Common Stock outstanding for the stockholders of record as of August 15 and November 15, 2000, respectively. TREASURY STOCK On August 27, 1998, December 21, 1998, February 25, 1999, April 27, 2000, July 27, 2000 and April 25 2002, the Board of Directors authorized six separate repurchase plans for up to 500,000 shares each of the outstanding shares of common stock through an open-market repurchase program and privately negotiated repurchases, if any. As of December 31, 2002 and 2001, 2,729,575 and 2,000,000 shares, respectively, had been repurchased under all authorized repurchase plans. As of December 31, 2002, 2,726,019 shares were held in treasury at an average repurchase price of $19.46 per share for a total cost of $53.0 million. (23) EARNINGS PER COMMON SHARE The following summarizes information related to the computation of basic and diluted EPS for the years ended December 31, 2002, 2001 and 2000 (dollars in thousands, except per share data):
2002 2001 2000 ----------- ----------- ----------- Net income $ 19,716 $ 21,802 $ 19,924 Preferred stock dividends (2,508) (2,508) (2,508) ----------- ----------- ----------- Net income available to common stockholders $ 17,208 $ 19,294 $ 17,416 ========== ========== =========== Weighted average number of common shares outstanding used in basic EPS calculation 5,491,615 5,773,313 5,917,845 Add assumed exercise of outstanding stock options as adjustments for dilutive securities 258,916 305,021 140,316 ----------- ----------- ----------- Weighted average number of common shares outstanding used in diluted EPS calculation 5,750,531 6,078,334 6,058,161 ========== ========== =========== Basic EPS before cumulative effect of accounting change $ 3.13 $ 3.36 $ 2.94 ========== ========== =========== Basic EPS $ 3.13 $ 3.34 $ 2.94 ========== ========== =========== Diluted EPS before cumulative effect of accounting change $ 2.99 $ 3.19 $ 2.87 ========== ========== =========== Diluted EPS $ 2.99 $ 3.17 $ 2.87 ========== ========== ===========
(24) COMMITMENTS AND CONTINGENCIES Coastal is involved in various litigation arising from acquired entities as well as in the normal course of business. In the opinion of management, the ultimate liability, if any, from these actions should not be material to the consolidated financial statements. At December 31, 2002, the minimum rental commitments under all noncancelable operating leases with initial or remaining terms of more than one year were as follows (in thousands):
Year ending December 31, Amount - ------------------- ------- 2003 $ 2,846 2004 2,505 2005 2,463 2006 2,367 2007 2,100 2008 and thereafter 8,094
Rent expense for the years ended December 31, 2002, 2001 and 2000 amounted to approximately $3.4 million, $3.2 million and $3.0 million, respectively. (25) REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the FDIC. 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 Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (as defined in the applicable regulations) of Tier 1 (core) capital to total assets, Tier 1 risk-based capital to risk weighted assets and total risk-based capital to risk-weighted assets. Management believes, as of December 31, 2002, that the Bank met the capital adequacy requirements to which it is subject. As of December 31, 2002, the most recent notification from the FDIC categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum Tier 1 (core), Tier 1 risk-based and total risk-based ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the institution's category. The Bank's regulatory capital amounts and ratios, as of December 31, 2002 and 2001, in relation to its existing regulatory capital requirements for capital adequacy purposes as of such dates are as follows (dollars in thousands):
Minimum For Capital Well-Capitalized Actual Adequacy Purposes Requirements --------------------- ----------------------- ---------------------- Amount Ratio Amount Ratio Amount Ratio ------- ------- --------- -------- ------- --------- As of December 31, 2002: Tier 1 (core) $177,593 6.88% $ 103,315 4.00% $129,144 5.00% Tier 1 risk-based 177,593 10.32 68,816 4.00 103,224 6.00 Total risk-based 195,711 11.38 137,632 8.00 172,040 10.00 As of December 31, 2001: Tier 1 (core) $205,021 7.27% $ 112,834 4.00% $141,043 5.00% Tier 1 risk-based 205,021 11.90 68,921 4.00 103,381 6.00 Total risk-based 220,406 12.79 137,841 8.00 172,302 10.00
(26) PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Coastal Bancorp, Inc. is as follows (in thousands): Coastal Bancorp, Inc. Condensed Statements of Financial Condition -------------------------------------------
December 31, ------------- 2002 2001 ------------- -------- Assets: Cash and cash equivalents $ 139 $ 2,751 Investment in subsidiaries 200,835 196,156 Mortgage-backed securities available-for-sale 344 445 Other assets 3,189 2,524 ------------- -------- $ 204,507 $201,876 ============== ======== Liabilities and stockholders' equity: Junior subordinated debentures $ 51,546 $ -- Senior Notes payable -- 43,875 Payable to the Bank 5 447 Other liabilities 71 120 ------------- -------- Total liabilities 51,622 44,442 Total stockholders' equity 152,885 157,434 ------------- -------- $ 204,507 $201,876 ============= ========
Coastal Bancorp, Inc. Condensed Statements of Income ------------------------------
Years ended December 31, 2002 2001 2000 ------- ------- ------- Income: Dividends from subsidiaries $ 7,749 $ 7,664 $ 7,132 Equity in undistributed earnings of subsidiaries, net of income tax 13,158 16,128 15,200 Interest and other income 17 184 507 ------- ------- ------- 20,924 23,976 22,839 ------- ------- ------- Expense: Interest expense 2,873 4,590 4,690 Noninterest expense 286 6 872 ------- ------- ------- 3,159 4,596 5,562 ------- ------- ------- Federal income tax benefit 1,951 2,422 2,647 ------- ------- ------- Net income $ 19,716 $21,802 $19,924 ======= ======= =======
Coastal Bancorp, Inc. Condensed Statements of Cash Flows ----------------------------------
Years ended December 31, 2002 2001 2000 ---------- -------- ---------- Cash flows from operating activities: Net income $ 19,716 $ 21,802 $ 19,924 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Equity in undistributed earnings of subsidiaries (13,158) (16,128) (15,200) Net decrease in other assets and other liabilities 15,150 2,843 9,547 ---------- -------- ---------- Net cash provided by operating activities 21,708 8,517 14,271 ---------- -------- ---------- Cash flows from investing activities: Net decrease in mortgage-backed securities 101 346 195 ---------- -------- ---------- Net cash provided by investing activities 101 346 195 ---------- -------- ---------- Cash flows from financing activities: Redemption or repurchase of Senior Notes payable (43,875) (3,025) -- Proceeds from issuance of junior subordinated debentures 45,928 -- -- Exercise of stock options for purchase of Common Stock 326 2,055 630 Purchase of treasury stock (21,753) -- (10,882) Issuance of treasury shares 108 Dividends paid (5,155) (5,171) (4,638) ---------- -------- ---------- Net cash used in financing activities (24,421) (6,141) (14,890) ---------- -------- ---------- Net increase (decrease) in cash and cash equivalents (2,612) 2,722 (424) Cash and cash equivalents at beginning of year 2,751 29 453 ---------- -------- ---------- Cash and cash equivalents at end of year $ 139 $ 2,751 $ 29 ========= ======== =========
(27) SELECTED QUARTERLY FINANCIAL DATA Selected quarterly financial data is presented in the following tables for the years ended December 31, 2002 and 2001 (in thousands, except per share data):
2002 Quarter Ended (unaudited) ------------------------------------------------------- March 31, June 30, September 30, December 31, ------------- --------- -------------- ------------- Interest income $ 35,406 $ 35,183 $ 34,031 $ 33,003 Interest expense 16,687 15,456 15,672 14,961 ------------- --------- -------------- ------------- Net interest income 18,719 19,727 18,359 18,042 Provision for loan losses 900 900 900 3,100 Noninterest income 2,509 2,954 3,054 8,692 Noninterest expense 13,716 13,819 13,880 14,478 ------------- --------- -------------- ------------- Income before provision for Federal income taxes and minority interest 6,612 7,962 6,633 9,156 Provision for Federal income taxes 1,884 2,360 2,045 2,851 Minority interest - preferred stock dividends of Coastal Banc ssb 647 647 213 -- ------------- --------- -------------- ------------- Net income $ 4,081 $ 4,955 $ 4,375 $ 6,305 ============= ========= ============== ============= Basic earnings per common share $ 0.59 $ 0.76 $ 0.72 $ 1.10 ============= ========= ============== ============= Diluted earnings per common share $ 0.57 $ 0.72 $ 0.68 $ 1.05 ============= ========= ============== =============
The financial data above for the quarters ended March 31, and June 30, 2002 have been restated from those amounts previously reported as required by Statement 147 which was adopted by Coastal effective January 1, 2002.
2001 Quarter Ended (unaudited) -------------------------------------------------------- March 31, June 30, September 30, December 31, -------------- --------- -------------- ------------- Interest income $ 60,165 $ 56,423 $ 50,850 $ 43,174 Interest expense 37,860 34,005 29,341 22,809 -------------- --------- -------------- ------------- Net interest income 22,305 22,418 21,509 20,365 Provision for loan losses 900 1,200 900 900 Noninterest income. 1,822 2,984 3,477 2,860 Noninterest expense 14,682 14,573 14,904 14,320 -------------- --------- -------------- ------------- Income before provision for Federal income taxes, minority interest and cumulative effect of accounting change 8,545 9,629 9,182 8,005 Provision for Federal income taxes 2,614 2,992 2,836 2,425 Minority interest - preferred stock dividends of Coastal Banc ssb 647 647 647 647 Cumulative effect of change in accounting for derivative instruments (104) -- -- -- -------------- --------- -------------- ------------- Net income $ 5,180 $ 5,990 $ 5,699 $ 4,933 ============== ========= ============== ============= Basic earnings per common share $ 0.80 $ 0.93 $ 0.88 $ 0.74 ============== ========= ============== ============= Diluted earnings per common share $ 0.76 $ 0.89 $ 0.83 $ 0.70 ============== ========= ============== =============
COASTAL BANCORP, INC. AND SUBSIDIARIES STOCK PRICES AND DIVIDENDS The following table sets forth the high and low price range and dividends by quarter for the two years ended December 31, 2002 of the Common Stock of Bancorp (Nasdaq: CBSA), Preferred Stock of Bancorp (Nasdaq: CBSAO), Trust Preferred Securities of the Trust (Nasdaq: CBSAN) and the Series A Preferred Stock of the Bank (Nasdaq: CBSAP) as listed and quoted on The Nasdaq Stock Market(R): COASTAL BANCORP, INC. COMMON STOCK ("CBSA"):
2002 2001 --------------------------- --------------------------- High Low Dividends High Low Dividends ------- ------ ---------- ------- ------- ---------- First Quarter $34.600 $28.950 $ 0.120 $28.063 $23.000 $ 0.100 Second Quarter 34.520 29.780 0.120 32.150 26.000 0.120 Third Quarter 32.010 27.550 0.120 39.410 31.890 0.120 Fourth Quarter 32.350 27.269 0.120 37.000 26.600 0.120
COASTAL BANCORP, INC. CUMULATIVE PREFERRED STOCK, SERIES A ("CBSAO"):
2002 2001 -------------------------- ---------------------------- High Low Dividends High Low Dividends ------- ------- ---------- ------- ------- ---------- First Quarter $25.350 $24.600 $ 0.570 $25.125 $21.625 $ 0.570 Second Quarter 25.600 25.050 0.570 25.220 24.100 0.570 Third Quarter 25.500 25.000 0.570 25.250 24.850 0.570 Fourth Quarter 25.700 25.060 0.570 25.150 24.400 0.570
COASTAL CAPITAL TRUST I TRUST PREFERRED SECURITIES ("CBSAN"):
2002 ------------------------------ High Low Distributions ------- ------ ------------- First Quarter (1) $ -- $ -- $ -- Second Quarter 25.280 25.000 -- Third Quarter 25.730 25.000 0.638 Fourth Quarter 25.690 24.900 0.563
COASTAL BANC SSB NONCUMULATIVE PREFERRED STOCK, SERIES A ("CBSAP"):
2002 2001 ---------------------------- ---------------------------- High Low Dividends High Low Dividends ------- ---------- ------- ------- ---------- First Quarter $25.350 $24.580 $ 0.563 $25.000 $22.000 $ 0.563 Second Quarter 25.650 24.900 0.563 25.000 23.850 0.563 Third Quarter 25.200 25.000 0.185 25.250 24.530 0.563 Fourth Quarter (2) -- -- -- 25.150 24.380 0.563
(1) These securities were issued on June 18, 2002. (2) These securities were redeemed on July 15, 2002. Coastal Bancorp, Inc. STOCKHOLDER INFORMATION ANNUAL MEETING The Annual Meeting of Stockholders of Coastal Bancorp, Inc. will be held at the corporate offices of Coastal Bancorp, Inc. at 5718 Westheimer, Houston, Texas in the Coastal Banc auditorium, Suite 1101, on April 24, 2003 at 12:00 noon. TRANSFER AGENT AND REGISTRAR Mellon Investor Services LLC Overpeck Centre 85 Challenger Road Ridgefield Park, New Jersey 07660-2104 (800) 851-9677 www.melloninvestor.com INDEPENDENT PUBLIC ACCOUNTANTS KPMG LLP 700 Louisiana Street Houston, Texas 77002 SPECIAL COUNSEL Elias, Matz, Tiernan & Herrick L.L.P. 734 15th Street, N.W. Washington, D.C. 20005 INQUIRIES, PUBLICATIONS AND FINANCIAL INFORMATION (INCLUDING COPIES OF THE ANNUAL REPORT AND FORM 10-K AT NO CHARGE UPON WRITTEN REQUEST) Manuel J. Mehos Chairman of the Board and Chief Executive Officer or Catherine N. Wylie Senior Executive Vice President and Chief Financial Officer Coastal Bancorp, Inc. Coastal Banc Plaza 5718 Westheimer, Suite 600 Houston, Texas 77057 (713) 435-5000 www.coastalbanc.com STOCK LISTING AND OTHER INFORMATION The common stock of Coastal Bancorp, Inc. ("Bancorp") is quoted on The Nasdaq Stock Market(R) under the symbol "CBSA." As of February 25, 2003, there were 5,146,130 shares of Common Stock of Bancorp issued and outstanding and the approximate number of registered stockholders was 169, representing approximately 1,500 beneficial stockholders at such record date. On March 25, 1992, Coastal Banc Savings Association (the "Association") issued 3,092,076 shares of Common Stock at $8.33 per share in its initial public offering. As of such date, the Common Stock of the Association was registered under the Securities Exchange Act of 1934 (the "Exchange Act") and also became listed for quotation on The Nasdaq Stock Market(R). The Common Stock issued by the Association became the Common Stock of Bancorp on July 29, 1994, as a result of the holding company reorganization of the Association. On May 11, 1999, Bancorp issued 1,100,000 shares of 9.12% Series A Cumulative Preferred Stock, no par value, at $25 per share. As of such date, the Preferred Stock of Bancorp was registered under the Exchange Act. The preferred stock is callable on May 15, 2003 at Bancorp's option. The Bancorp Preferred Stock is listed and quoted on The Nasdaq Stock Market(R) under the symbol "CBSAO". As of February 25, 2003, there were 1,100,000 shares of Preferred Stock issued and outstanding and held by approximately 58 registered stockholders, representing approximately 1,400 beneficial stockholders at such record date. On June 18, 2002, the Trust issued 2,000,000 trust preferred securities with a liquidation preference of $25 per security. As of such date, the Trust Preferred Securities were registered under the Exchange Act. The Trust Preferred Securities are subject to mandatory redemption at the liquidation preference, in whole or in part, upon repayment of the junior subordinated debentures by Bancorp at maturity on June 30, 2032 or their earlier redemption. The Trust Preferred Securities are listed and quoted on The Nasdaq Stock Market under the symbol "CBSAN." As of February 25, 2003, there were 2,000,000 Trust Preferred Securities issued and outstanding. Bancorp declared dividends on the Common Stock payable during 2002. A quarterly dividend in the amount of $0.12 per share was paid on March 15, June 15, September 15 and December 15, 2002. On March 15, 2003, Bancorp paid a quarterly dividend in the amount of $0.12 per share on its Common Stock. Bancorp will continue to review its dividend policy in view of the operating performance of the Bank, and may declare dividends on the Common Stock in the future if such payments are deemed appropriate and in compliance with applicable law and regulations. Prior to the declaration of dividends, Bancorp must notify the Office of Thrift Supervision, the holding company's primary federal regulator, which may object to the dividends on the basis of safety and soundness. EX-10.9 4 doc7.txt CHANGE OF CONTROL AGREEMENT EXHIBIT 10.9 EXECUTIVE SEVERANCE AGREEMENT THIS AGREEMENT is entered into and effective this 22nd day of August 2002, ("Effective Date") by and between Coastal Bancorp, Inc. (the "Company") and Coastal Banc ssb (the "Bank") and Robert V. New (the "Employee"). WHEREAS, the Employee had heretofore been employed by the Company and the Bank as an executive officer, and the Company and the Bank deems it to be in their best interest to enter into this Agreement as additional incentive to the Employee to continue as an executive employee of the Company and the Bank; and WHEREAS, the parties desire by this writing to set forth their understanding as to their respective rights and obligations in the event a "change in control" (as defined herein) occurs with respect to the Bank or the Company; NOW, THEREFORE, the undersigned parties AGREE as follows: 1. Defined Terms -------------- When used anywhere in the Agreement, the following terms shall have the meaning set forth herein. (a) "Change in Control" shall mean any one of the following events: (i) where, during any period of two consecutive years, individuals (the "Continuing Directors") who at the beginning of such period constitute the Board of Directors of the Bank or the Company (the "Existing Board") cease for any reason to constitute at least two-thirds thereof, provided that any individual whose election or nomination for election as a member of the Existing Board was approved by a vote of at least two-thirds of the Continuing Directors then in office shall be considered a Continuing Director following: (A) the acquisition by a person of ownership, holding or power to vote more than 25% of the Bank's or the Company's voting stock, (B) the acquisition by any person of the ability to control the election of a majority of any class or classes of the Bank's or the Company's directors, or (C) the acquisition of a controlling influence over the management or policies of the Bank or the Company defined as set forth in 12 C.F.R. 574.4(b),(c) and (d) by any person or to persons acting as a "group" (within the meaning of Section 13(d) of the Securities Exchange Act of 1934), or (ii) the sale, exchange, lease, transfer or other disposition (in one or more transactions) to any person of all or a substantial part of the assets, liabilities or business of the Company or the Bank, (iii) any merger or consolidation or share exchange of the Company or the Bank with any other person which subsequent thereto the Company or the Bank is not the surviving entity, or (iv) any change in business of the Company or the Bank such that the Company does not own the voting stock of an insured depository institution or the business of the Bank is not as an insured depository institution. Notwithstanding the foregoing, in the case of (i) or (ii) or (iii) hereof, change of ownership or control of the Bank by the Company itself to or among direct or indirect wholly-owned subsidiaries of the Company shall not constitute a Change in Control. For purposes of this paragraph only, the term "person" refers to an individual or a corporation, limited liability company, partnership, trust, association, joint venture, pool, syndicate, sole proprietorship, unincorporated organization or any other form of entity not specifically listed herein. The decision of the Bank's non-employee directors as to whether or not a Change in Control, as defined herein, has occurred, and the date of such occurrence, shall be conclusive and binding. (b) "Code" shall mean the Internal Revenue Code of 1986, as amended from time to time, and as interpreted through applicable rulings and regulations in effect from time to time. (c) "Code Sec. 280G Maximum" shall mean product of 2.99 and the "base amount" as defined in Code Sec. 280G(b)(3). (d) "Good Reason" shall mean any of the following events, which has not been consented to in advance by the Employee in writing: (i) the requirement that the Employee move his personal residence, or perform his principal executive functions, more than thirty (30) miles from his primary office as of the date of the Change in Control; (ii) a material (defined to be 10% or more) reduction in the Employee's base compensation as in effect on the date of the Change in Control or as the same may be increased from time to time; (III) a successor to the Company or the Bank fails or refuses to assume the Company's and the Bank's obligations under this Agreement; (IV) the Company, the Bank or successor thereto breaches any provision of this Agreement; or (V) the Employee is terminated for other than just cause after the Change in Control. (e) "Just Cause" shall mean, in the good faith determination of the Company's and the Bank's Boards of Directors, the Employee's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease-and-desist order, or material breach of any provision of this Agreement. The Employee shall have the right to make a presentation to the Board of Directors with counsel prior to the rendering of such determination by the Board. The Employee shall have no right to receive compensation or other benefits for any period after termination for Just Cause. No act, or failure to act, on the Employee's part shall be considered "willful" unless he has acted, or failed to act, with an absence of good faith and without a reasonable belief that his action or failure to act was in the best interest of the Bank and the Company. (f) "Protected Period" shall mean the period that begins on the date six months before a Change in Control and ends on the later of the third annual anniversary of the Change in Control or the expiration date of this Agreement. 2. Trigger Events --------------- The Employee shall be entitled to collect the severance benefits set forth in Section 3 of this Agreement in the event that (a) a Change of Control has occurred and the Employee voluntarily terminates his employment within the 30-day period beginning on the first anniversary of the date of the occurrence of a Change in Control, (b) the Employee voluntarily terminates employment within 90 days of an event that both occurs during the Protected Period and constitutes Good Reason, or (c) the Bank, the Company, or their successor(s) in interest terminate the Employee's employment for any reason other than Just Cause during the Protected Period. 3. Amount of Severance Benefit ------------------------------ (a) If the Employee becomes entitled to collect severance benefits pursuant to Section 2(a) hereof, the Company and/or the Bank shall pay Employee one (1) times the annual salary and bonus or incentive compensation (not including stock compensation plans) paid to Employee by the Company and/or the Bank during the immediately preceding year of the term of employment, such sum to be paid within five (5) days of the date that Employee's employment actually ceases. (b) If the Employee becomes entitled to collect severance benefits pursuant to Section 2(b) or 2(c) hereof, the Company and/or the Bank shall pay Employee 2.00 times the annual salary and bonus or incentive compensation (not including stock compensation plans) paid to Employee by the Company and/or the Bank during the immediately preceding year of the term of employment, such sum to be paid within five (5) days of the date that Employee's employment actually ceases. (c) The provisions of this Agreement shall not reduce any amounts otherwise payable to the Employee or in any way diminish the employee's rights, whether existing now or hereafter under any benefit plan of the Company or the Bank. The Employee shall not be obligated to mitigate any payments entitled to be received hereunder. (d) The foregoing payments and benefits shall be paid to the Employee's beneficiaries by testate or intestate succession in the event of Employee's death during the period during which such payments and benefits are being provided. (e) In the event that the Employee and the Company or the Bank, as the case may be (hereinafter, in this Section 3(e), the "Company") agree that the Employee has collected an amount exceeding the Code Sec.280G Maximum, the parties agree as follows: (i) In the calendar year that the Employee is entitled to receive a payment or benefits under the provisions of this Agreement, the independent accountants of the Company shall determine if an excess parachute payment (as defined in Section 4999 of the Code, as amended, and any successor provision thereto) exists. Such determination shall be made after taking any reductions permitted pursuant to Section 280G of the Code and the regulations thereunder. Any amount determined to be an excess parachute payment after taking into account such reductions shall be hereafter referred to as the "Initial Excess Parachute Payment". As soon as practicable after a Change in Control of the Company, the Initial Excess Parachute Payment shall be determined. Immediately following a Change in Control of the Company or the Bank, the Company or the Bank shall pay the Employee, subject to applicable withholding requirements under applicable state or federal law an amount equal to: (a) twenty (20) percent of the Initial Excess Parachute Payment (or such other amount equal to the tax imposed under Section 4999 of the Code), and (b) such additional amount (tax allowance) as may be necessary to compensate the Employee for the payment by the Employee of state and federal income and excise taxes on the payment provided under Clause (a) and on any payments under this Clause (b). In computing such tax allowance, the payment to be made under Clause (a) shall be multiplied by the "gross up percentage" ("GUP"). The GUP shall be determined as follows: GUP = Tax Rate --------- 1 - Tax Rate The Tax Rate for purposes of computing the GUP shall be the highest marginal federal and state income and employment-related tax rate, including any applicable excise tax rate, applicable to the Employee in the year in which the payment under Clause (a) is made. (ii) Notwithstanding the foregoing, if it shall subsequently be determined in a final judicial determination or a final administrative settlement to which the Employee is a party that the excess parachute payment is defined in Section 4999 of the Code, reduced as described above, is different from the Initial Excess Parachute Payment (such different amount being hereafter referred to as the "Determinative Excess Parachute Payment") then the Company's independent accountants shall determine the amount (the "Adjustment Amount") the Employee must pay to the Company or the Bank or the Company or the Bank must pay to the Employee in order to put the Employee (or the Company or the Bank, as the case may be) in the same position the Employee (or the Company or the Bank, as the case may be) would have been if the Initial Excess Parachute Payment had been equal to the Determinative Excess Parachute Payment. In determining the Adjustment Amount, the independent accountants shall take into account any and all taxes (including any penalties and interest) paid by or for the Employee or refunded to the Employee or for the Employee's benefit. As soon as practicable after the Adjustment Amount has been so determined, the Company or the Bank shall pay the Adjustment Amount to the Employee or the Employee shall repay the Adjustment Amount to the Company or the Bank, as the case may be. (iii) In any calendar year that the Employee receives payments of benefits under this Agreement, the Employee shall report on his state and federal income tax returns such information as is consistent with the determination made by the independent accountants of the Company as described above. The Company and the Bank shall indemnify and hold the Employee harmless from any and all losses, costs and expenses (including without limitation, reasonable attorney's fees, interest, fines and penalties) which the Employee incurs as a result of so reporting such information. Employee shall promptly notify the Company and the Bank in writing whenever the Employee receives notice of the institution of a judicial or administrative proceeding, formal or informal, in which the federal tax treatment under Section 4999 of the Code of any amount paid or payable under this the Employment Agreement is being reviewed or is in dispute. The Company or the Bank shall assume control at its expense over all legal and accounting matters pertaining to such federal tax treatment (except to the extent necessary or appropriate for the Employee to resolve any such proceeding with respect to any matter unrelated to amounts paid or payable pursuant to this contract) and the Employee shall cooperate fully with the Company or the Bank in any such proceeding. The Employee shall not enter into any compromise or settlement or otherwise prejudice any rights the Company or the Bank may have in connection therewith without prior consent of the Company or the Bank. 4. Term of the Agreement ------------------------ This Agreement shall remain in effect for the period commencing on the Effective Date and ending either (i) the date on which the Board of Directors terminates this Agreement by giving one year prior written notice or (ii) the date on which the Employee terminates employment with the Company or the Bank; provided that the Employee's rights hereunder shall continue following the termination of his employment with the Company or the Bank under any of the circumstances described in Section 2 hereof. 5. Termination or Suspension Under Federal Law ------------------------------------------------ Any payments made to the Employee pursuant to this Agreement, or otherwise, are subject to and conditioned upon their compliance with 12 U.S.C. Sec.1828(k) and any regulations promulgated thereunder. 6. Expense Reimbursement ---------------------- In the event that any dispute arises between the Employee and the Company or the Bank as to the terms or interpretations of this Agreement, whether instituted by formal legal proceedings or otherwise, including any action that the Employee takes to enforce the terms of this Agreement or to defend against any action taken by the Company or the Bank, the Employee shall be reimbursed for all costs and expenses, including reasonable attorneys' fees, arising from such dispute, proceedings or actions, provided that the Employee shall obtain a final judgment in favor of the Employee in a court or competent jurisdiction or in binding arbitration under the rules of the American Arbitration Association. Such reimbursement, which may be in advance of any final judgment or determination in arbitration, if requested in writing by the Employee, shall be paid within ten (10) days of Employee's furnishing to the Company or the Bank written evidence, which may be in the form, among other things, or a canceled check or receipt, of any costs or expenses incurred by the Employee. 7. Successors and Assigns ------------------------ (a) This Agreement shall inure to the benefit of and be binding upon any corporate or other successor or assign of the Company or the Bank which shall acquire, directly or indirectly, by merger, consolidation, purchase or otherwise, all or substantially all of the assets or stock of the Bank or Company. This Agreement shall inure to the benefit of and be enforceable by the Employee's personal and legal representatives, executors, administrators, successors, heirs, devisees and legatees. If the Employee should die while any amounts are still payable to him/her hereunder, all such amounts shall be paid in accordance with the terms of this Agreement to the Employee's devisee, legatee or other designee, or if there be no such designee, to the Employee's Estate. (b) Since the Company and the Bank are contracting for the unique and personal skills of the Employee, the Employee shall be precluded from assigning or delegating his rights or duties hereunder without first obtaining the written consent of the Company or the Bank. 8. Amendments ---------- No amendments or additions to this Agreement shall be binding unless made in writing and signed by all of the parties, except as herein otherwise specifically provided. No waiver by either party hereto at any time of any breach by the other party hereto, or of compliance with, any condition or provision of this Agreement to be performed by such other party will be deemed to be a waiver of similar or dissimilar provisions or conditions, at the same or any prior or subsequent time. 9. Applicable Law --------------- Except to the extent preempted by Federal law, the laws of the State of Texas shall govern this Agreement in all respects, whether as to its validity, construction, capacity, performance or otherwise. 10. Severability ------------ The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 11. Entire Agreement ----------------- This Agreement, together with any understanding or modifications thereof as agreed to in writing by the parties, shall constitute the entire agreement between the parties hereto. 12. Notices ------- For purposes of this Agreement, notices and other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by U.S. registered or certified mail, return receipt requested, postage prepaid, as follows: If to the Company or the Bank: Chairman/CEO, Coastal Bancorp, Inc., 5718 Westheimer, Suite 600, Houston, Texas 77057. If to the Employee: Employee Name & Address Signature Page to Follow IN WITNESS WHEREOF, the parties have executed this Agreement on the day and year first herein above written. ATTEST: COASTAL BANCORP, INC. /s/ Linda B. Frazier By: /s/ Manuel J. Mehos - ----------------------- ---------------------- Secretary Manuel J. Mehos Chairman and Chief Executive Officer By: /s/ Robert Johnson, Jr. -------------------------- Robert Johnson, Jr. Chairman, Compensation Committee ATTEST: COASTAL Banc ssb /s/ Linda B. Frazier By: /s/ Manuel J. Mehos - ------------------------- ---------------------- Secretary Manuel J. Mehos Chairman and Chief Executive Officer By: /s/ Robert Johnson, Jr. -------------------------- Robert Johnson, Jr. Chairman, Compensation Committee WITNESS /s/ Catherine N. Wylie /s/ Robert V. New - --------------------------- -------------------- Robert V. New EX-28 5 doc3.txt PROXY STATEMENT March 25, 2003 Dear Stockholder: You are cordially invited to attend the Annual Meeting of the Stockholders (the "Annual Meeting") of Coastal Bancorp, Inc. (the "Company"). The meeting will be held at the corporate offices of Coastal Bancorp, Inc., at 5718 Westheimer, Houston, Texas, in the Coastal Banc auditorium, Suite 1101, on Thursday, April 24, 2003, at 12:00 noon, Central Time. The attached Notice of Annual Meeting and Proxy Statement describes the formal business to be transacted at the meeting. Stockholders will vote to elect two directors and to ratify the selection of KPMG LLP by the Board of Directors to act as the Company's independent public accountants for fiscal 2003. The Company's Board of Directors believes that these proposals are in the best interests of the Company and its stockholders and recommends that stockholders vote "FOR" the proposals at the Annual Meeting. Directors and officers of the Company and representatives of the Company's independent public accountants will be present at the Annual Meeting to respond to any questions that our stockholders may have. It is very important that you be represented at the Annual Meeting regardless of the number of shares you own or whether you are able to attend the meeting in person. Let me urge you to mark, sign and date your proxy card today and return it in the postage paid envelope provided, even if you plan to attend the Annual Meeting. This will not prevent you from voting in person, but will ensure that your vote is counted if you are unable to attend. Your continued support of, and interest in, Coastal Bancorp, Inc. is appreciated. Sincerely, /s/ Manuel J. Mehos ---------------------- Manuel J. Mehos Chairman of the Board, President and Chief Executive Officer COASTAL BANCORP, INC. COASTAL BANC PLAZA 5718 WESTHEIMER, SUITE 600 HOUSTON, TEXAS 77057 NOTICE OF ANNUAL MEETING OF STOCKHOLDERS TO BE HELD APRIL 24, 2003 NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders (the "Annual Meeting") of Coastal Bancorp, Inc. (the "Company") will be held at the corporate offices of Coastal Bancorp, Inc., at 5718 Westheimer, Suite 1101, Houston, Texas 77057 at 12:00 noon, Central Time, on April 24, 2003. At the meeting, the holders of the Company's common stock will act on the following matters, all of which are more completely set forth in the accompanying Proxy Statement: (1) To elect two directors of the Company to serve until the annual meeting of stockholders in the year 2006 and until their successors are elected and qualified; (2) To ratify the appointment of KPMG LLP as the Company's independent public accountants for the fiscal year ending December 31, 2003; and, (3) To transact such other business as may properly come before the Annual Meeting, or any adjournment or postponement thereof. Except with respect to procedural matters incident to the conduct of the Annual Meeting, management of the Company is not aware of any matters other than those set forth above which may properly come before the Annual Meeting. The Board of Directors has fixed February 25, 2003 for the determination of the holders of the Company's common stock entitled to notice of, and to vote at, the Annual Meeting and any adjournment or postponement thereof. Only those stockholders of record as of the close of business on that date will be entitled to vote at the Annual Meeting or at any such adjournment or postponement. BY ORDER OF THE BOARD OF DIRECTORS /s/ Linda B. Frazier ----------------------- Linda B. Frazier Secretary Houston, Texas March 25, 2003 YOU ARE CORDIALLY INVITED TO ATTEND THE ANNUAL MEETING. EACH SHAREHOLDER AND GUEST MAY BE REQUIRED TO PRESENT A VALID PICTURE IDENTIFICATION FOR ADMISSION. CAMERAS, RECORDING DEVICES AND OTHER ELECTRONIC DEVICES WILL NOT BE PERMITTED AT THE MEETING. IT IS IMPORTANT THAT YOUR SHARES BE REPRESENTED REGARDLESS OF THE NUMBER YOU OWN. EVEN IF YOU PLAN TO BE PRESENT, YOU ARE URGED TO COMPLETE, SIGN, DATE AND RETURN THE ENCLOSED PROXY PROMPTLY IN THE ENVELOPE PROVIDED. IF YOU ATTEND THIS MEETING, YOU MAY VOTE IN PERSON OR BY PROXY. ANY PROXY GIVEN MAY BE REVOKED BY YOU IN WRITING OR IN PERSON AT ANY TIME PRIOR TO THE EXERCISE THEREOF. COASTAL BANCORP, INC. 2003 ANNUAL MEETING OF STOCKHOLDERS PROXY STATEMENT TABLE OF CONTENTS PROXY STATEMENT 1 BACKGROUND INFORMATION 2 VOTING SECURITIES AND BENEFICIAL OWNERSHIP THEREOF 2 INFORMATION WITH RESPECT TO NOMINEES FOR DIRECTOR, DIRECTORS WHOSE TERMS CONTINUE AND EXECUTIVE OFFICERS 6 STOCKHOLDER NOMINATIONS 8 BOARD OF DIRECTORS MEETINGS AND COMMITTEES OF COASTAL BANCORP, INC. AND COASTAL BANC SSB 8 BOARD FEES 9 2002 NON-EMPLOYEE DIRECTOR STOCK PURCHASE PLAN 10 SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE 10 REPORT OF THE AUDIT COMMITTEE 10 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION 13 EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS 13 EXECUTIVE COMPENSATION 14 REPORT OF COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS ON COMPENSATION DURING FISCAL 2002 14 SUMMARY COMPENSATION TABLE 16 EXECUTIVE SEVERANCE AGREEMENTS 17 AGGREGATE OPTIONS GRANTED IN LAST FISCAL YEAR 19 AGGREGATE OPTIONS EXERCISED IN LAST YEAR AND FISCAL YEAR - END OPTION VALUES 20 DISCLOSURE OF EQUITY COMPENSATION PLAN INFORMATION 20 COMPARATIVE STOCK PERFORMANCE GRAPH 21 TRANSACTIONS WITH MANAGEMENT 23 PROPOSAL TO RATIFY THE SELECTION OF INDEPENDENT PUBLIC ACCOUNTANTS 23 FEES BILLED TO THE COMPANY BY KPMG LLP DURING FISCAL 2002 23 STOCKHOLDER PROPOSALS 24 PROXY SOLICITATION 25 OTHER MATTERS 25 ANNUAL REPORT AND FINANCIAL STATEMENTS 25 APPENDIX - -------- AUDIT COMMITTEE CHARTER A-1 COASTAL BANCORP, INC. PROXY STATEMENT ANNUAL MEETING OF STOCKHOLDERS This Proxy Statement is furnished to the holders of the common stock, $.01 par value per share (the "Common Stock"), of Coastal Bancorp, Inc. (the "Company") in connection with the solicitation of proxies on behalf of the Board of Directors of the Company, to be used at the Annual Meeting of Stockholders (the "Annual Meeting") to be held at the corporate offices of Coastal Bancorp, Inc., at 5718 Westheimer, Houston, Texas in the Coastal Banc auditorium, Suite 1101, at 12:00 noon, Central Time, on April 24, 2003 and at any adjournment or postponement thereof for the purposes set forth in the Notice of Annual Meeting of Stockholders. This Proxy Statement is expected to be mailed to stockholders on or about March 25, 2003. Each proxy solicited hereby, if properly signed and returned to the Company, will be voted in accordance with the instructions contained therein if it is not revoked prior to its use. IF NO CONTRARY INSTRUCTIONS ARE GIVEN, EACH PROXY RECEIVED WILL BE VOTED: (I) FOR THE ELECTION OF THE BOARD'S NOMINEES AS DIRECTORS OF THE COMPANY; (II) FOR THE PROPOSAL TO RATIFY THE APPOINTMENT OF KPMG LLP AS THE COMPANY'S INDEPENDENT PUBLIC ACCOUNTANTS FOR THE FISCAL YEAR ENDING DECEMBER 31, 2003; AND (III) UPON THE TRANSACTION OF SUCH OTHER BUSINESS AS MAY PROPERLY COME BEFORE THE ANNUAL MEETING, IN ACCORDANCE WITH THE BEST JUDGMENT OF THE PERSONS APPOINTED AS PROXIES. ANY HOLDER OF COMMON STOCK WHO RETURNS A SIGNED PROXY BUT FAILS TO PROVIDE INSTRUCTIONS AS TO THE MANNER IN WHICH SUCH SHARES ARE TO BE VOTED WILL BE DEEMED TO HAVE VOTED IN FAVOR OF THE MATTERS SET FORTH IN THE PRECEDING SENTENCE. Any stockholder giving a proxy has the power to revoke it at any time before it is exercised by (i) filing with the Secretary of the Company written notice of revocation thereof (Linda B. Frazier, Coastal Bancorp, Inc., Coastal Banc Plaza, 5718 Westheimer, Suite 600, Houston, Texas 77057-5745), (ii) submitting a duly executed proxy bearing a later date; or (iii) by appearing at the Annual Meeting and giving the Secretary notice of his or her intention to vote in person. Proxies solicited hereby may be exercised only at the Annual Meeting and any adjournment or postponement thereof and will not be used for any other meeting. BACKGROUND INFORMATION ON COASTAL BANCORP, INC. AND SUBSIDIARIES Coastal Bancorp, Inc. is engaged primarily in the business of serving as the parent holding company for Coastal Banc ssb (the "Bank"). The Company was incorporated in March 1994 in connection with the reorganization of Coastal Banc Savings Association, a Texas-chartered thrift institution (the "Association") into the holding company form of organization. In connection with the reorganization, which was completed in July 1994, the Association concurrently converted into a Texas-chartered savings bank and took its present name. In November 1996, in order to minimize state taxes, the Company's corporate structure was again reorganized by forming Coastal Banc Holding Company, Inc. ("HoCo") as a Delaware holding company. HoCo became a wholly-owned subsidiary of the Company and the Bank became a subsidiary of HoCo. Coastal Bancorp, Inc. is a registered unitary savings and loan holding company regulated by the Office of Thrift Supervision, a division of the U.S. Department of the Treasury. VOTING SECURITIES AND BENEFICIAL OWNERSHIP THEREOF Only holders of record of the Company's Common Stock at the close of business on February 25, 2003 (the "Record Date") will be entitled to notice of, and to vote at, the Annual Meeting. On the Record Date, there were 5,146,130 shares of Common Stock outstanding and the Company had no other class of voting equity securities outstanding. Only holders of Company Common Stock will be entitled to vote at the Annual Meeting and each share of Common Stock will be entitled to one vote on all matters properly presented. Stockholders of the Company are not permitted to cumulate their votes for the election of directors. The presence in person or by proxy of at least a majority of the outstanding shares of Common Stock entitled to vote is necessary to constitute a quorum at the Annual Meeting. Directors will be elected by a plurality of the votes cast at the Annual Meeting. The affirmative vote of a majority in interest of those present (in person or by proxy) at the Annual Meeting is required to approve the proposal to ratify the appointment of the Company's independent public accountants. Abstentions will be counted for purposes of determining the presence of a quorum at the Annual Meeting. Because of the required votes, abstentions will have the same effect as a vote against the proposal to ratify the appointment of the Company's independent public accountants, but will not be counted as votes cast for the election of directors and, thus, will have no effect on the voting for the election of directors. Under the applicable rules, all of the proposals for consideration at the Annual Meeting are considered "discretionary" items upon which brokerage firms may vote in their discretion on behalf of their clients if such clients have not furnished voting instructions. Thus, there are no proposals to be considered at the Annual Meeting which are considered "non-discretionary" and for which there will be "broker non-votes." At February 25, 2003, directors, executive officers and their affiliates beneficially owned 1,193,727 shares of Common Stock or 21.46% of the total shares of Common Stock outstanding on such date. It is anticipated that all of such shares will be voted for the election of the nominees of the Company's Board of Directors and in favor of the proposal to ratify the selection of KPMG LLP as the Company's independent public accountants. The following table sets forth the beneficial ownership of the Common Stock as of February 25, 2003, with respect to (i) any person or entity who is known to the Company to be the beneficial owner of 5% or more of the Common Stock; (ii) each nominee for director; (iii) each director of the Company; (iv) each of the executive officers named in the summary compensation table (see "Executive Compensation - Summary Compensation Table") and (v) all directors and executive officers of the Company and its wholly-owned subsidiary, Coastal Banc Holding Company, Inc. ("HoCo") and its subsidiary, Coastal Banc ssb, as a group. The address for all directors and executive officers of the Company, HoCo and the Bank is Coastal Banc Plaza, 5718 Westheimer, Suite 600, Houston, Texas 77057. Except as set forth below, as of February 25, 2003, the Company was aware of no other person or entity unaffiliated with the Company that was the beneficial owner of 5% or more of the Common Stock.
AMOUNT OF SHARES OF COMMON STOCK NAME BENEFICIALLY OWNED (AND ADDRESS) OF AS OF FEBRUARY 25, PERCENT OF BENEFICIAL OWNER 2003(1) CLASS - ---------------------------------------------------------------------------------------- Manuel J. Mehos, Chairman of the Board, President and Chief Executive Officer Coastal Bancorp, Inc., Coastal Banc Holding Company, Coastal Banc ssb and Coastal Banc Mortgage Corp., Chief Executive Officer of CoastalBanc Financial Corp. and Co-Chairman of Coastal Banc Capital Corp. 671,750 (4) 12.08% Tontine Partners, L.P. 200 Park Avenue, Suite 3900 New York, New York 10166 513,850 (2) (6) 9.24 First Manhattan Co. 437 Madison Avenue New York, New York 10022 510,427 (2) 9.18 Dimensional Fund Advisors, Inc. 1299 Ocean Avenue, 11th Floor Santa Monica, California 90401 436,150 (2) 7.84 Systematic Financial Management, L.P. 300 Frank W. Burr Blvd. Glenpointe East, 7th Floor Teaneck, New Jersey 07666 359,230 (2) 6.46 (continued on next page)
AMOUNT OF SHARES OF COMMON STOCK NAME BENEFICIALLY OWNED (AND ADDRESS) OF AS OF FEBRUARY 25, PERCENT OF BENEFICIAL OWNER 2003(1) CLASS - ---------------------------------------------------------------------------------------- DePrince, Race & Zollo, Inc. 201 South Orange Avenue, Suite 850 Orlando, Florida 32801 358,650 (2) 6.45 D. Fort Flowers, Jr., Director Coastal Bancorp, Inc. and Coastal Banc ssb 274,890 (3) 4.94 Catherine N. Wylie, Sr. Executive Vice President and Chief Financial Officer Coastal Bancorp, Inc., Coastal Banc Holding Company, Inc., Coastal Banc ssb, Coastal Banc Mortgage Corp., the President of Coastal Banc Capital Corp. and President of CoastalBanc Financial Corp. and Coastal Banc Insurance Agency, Inc. 95,954 (4) (5) 1.72 Gary R. Garrett, Co-Chairman Coastal Banc Capital Corp. and President of Coastal Banc Mortgage Corp 80,586 (4) 1.45 David R. Graham, Executive Vice President - -Commercial Real Estate Lending Coastal Banc ssb 31,321 (4) * Robert E. Johnson, Jr., Director Coastal Bancorp, Inc. and Coastal Banc ssb 20,448 * Michael A. Presley, Director Coastal Banc Capital Corp. and Executive Vice President of Coastal Banc Mortgage Corp. 9,000 * Robert V. New, Executive Vice President and Chief Banking Officer Coastal Banc ssb 3,750 (4) * Dennis S. Frank, Director Coastal Bancorp, Inc. and Coastal Banc ssb 3,237 * Robert Edwin Allday, Director Coastal Bancorp, Inc. and Coastal Banc ssb 2,420 * Clayton T. Stone, Director Coastal Bancorp, Inc. and Coastal Banc ssb 371 * (continued on next page) AMOUNT OF SHARES OF COMMON STOCK NAME BENEFICIALLY OWNED (AND ADDRESS) OF AS OF FEBRUARY 25, PERCENT OF BENEFICIAL OWNER 2003(1) CLASS - ---------------------------------------------------------------------------------------- All directors and executive officers of the Company and the Bank as a group (11 persons) 1,193,727 (4) 21.46
_____________________________ * Represents less than 1.0% of the Common Stock beneficially owned. (1) Based upon information furnished by the respective individuals and filings pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The information is not necessarily indicative of beneficial ownership for any other purpose. Under regulations promulgated pursuant to the Exchange Act, shares are deemed to be beneficially owned by a person if he or she directly or indirectly has or shares (i) voting power, which includes the power to vote or to direct the voting of the shares, or (ii) investment power, which includes the power to dispose or to direct the disposition of the shares. Unless otherwise indicated, the named beneficial owner has sole voting and dispositive power with respect to the shares. (2) Based on a Schedule 13G filed under the Exchange Act. (3) Of such shares, 269,520 are owned by a trust over which Mr. Flowers has shared voting and dispositive power with three other co-trustees. (4) Under applicable regulations, a person is deemed to have beneficial ownership of any shares of Common Stock which may be acquired within sixty (60) days of the Record Date pursuant to the exercise of outstanding stock options. Shares of Common Stock which are subject to stock options are deemed to be outstanding for the purpose of computing the percentage of outstanding Common Stock owned by such person or group but not deemed outstanding for the purpose of computing the percentage of Common Stock owned by any other person or group. The amounts set forth in the table include 80,172, 14,212, 228,250, 3,750, 7,500 and 82,809 shares which may be received upon the exercise of stock options by Messrs. Garrett, Graham, Mehos, New, Presley and Ms. Wylie, respectively, pursuant to stock options. For all directors and executive officers as a group, the number of shares includes 416,693 shares of Common Stock subject to outstanding stock options. (5) Ms. Wylie is also the beneficial owner of 2,000 shares of the Company's 9.12% Cumulative Preferred Stock, Series A and 500 shares of Coastal Capital Trust I 9.0% Trust Preferred Stock. (6) Based on information disclosed by the group of reporting persons set forth herein on a Schedule 13G filed with the Securities and Exchange Commission on February 4, 2003, the following entities may be deemed to be the beneficial owners of the common stock: Tontine Partners, L.P., 36,450 shares; Tontine Overseas Associates, L.L.C., 47,500 shares; and Tontine Financial Partners, L.P., 429,900 shares. The address for these entities is the same as set forth in the chart above. INFORMATION WITH RESPECT TO THE NOMINEES FOR DIRECTOR, DIRECTORS WHOSE TERMS CONTINUE AND EXECUTIVE OFFICERS ELECTION OF DIRECTORS Coastal Bancorp, Inc. is a Texas corporation, formed pursuant to the Texas Business Corporation Act which requires that the business and affairs of the Company shall be managed by or under the direction of the Board of Directors. The Company's Articles of Incorporation provide that the Company's Board of Directors be divided into three classes as nearly equal in number as possible, with one class to be elected annually, and the Bylaws state that members of each class are to be elected for a term of office to expire at the third succeeding annual meeting of stockholders and when their respective successors have been elected and qualified. The number of directors is determined from time to time by resolution of the Board. As of June 30, 2002, James C. Niver resigned from the Board of Directors for personal reasons. The Board of Directors filled the vacancy left by Mr. Niver's resignation by electing Mr. Clayton T. Stone to the Board effective July 1, 2002 to serve until this Annual Meeting. Mr. Stone is currently a nominee for director to be elected at this Annual Meeting. Two directors are to be elected at this Annual Meeting to hold office until the Annual Meeting in 2006 or until their successors are elected and qualified. These directors have consented to serve if elected. The information set forth below relating to a director's tenure is as of the date he was first elected as director of either the Association or the Company, where applicable. There are no arrangements or understandings between the Company and any person pursuant to which such person has been selected as a nominee, and no director is related to any other director or executive officer of the Company or the Bank by blood, marriage or adoption. INFORMATION WITH RESPECT TO CONTINUING DIRECTORS Information concerning those members of the Board whose terms do not expire in 2003, including age, tenure and principal position with the Company and principal occupation during the past five years, as well as the year his term will expire, is set forth below: R. EDWIN ALLDAY. Age 52. Director since 1986. Mr. Allday is a self-employed consultant who provides management-consulting services for non-profit organizations. From September 1993 to January 1999, Mr. Allday was a senior consultant with The Dini Partners, Inc., Houston, Texas, a company that provides counseling in philanthropy and non-profit company management. His term as a director of the Company will expire in 2004. D. FORT FLOWERS, JR. Age 41. Director since 1992. Mr. Flowers is the President and a Director of Sentinel Trust Company, a Texas Limited Banking Association, Houston, Texas, providing fiduciary and investment management services to affluent families, their closely held corporations and foundations, a position he has held since January 1997. Mr. Flowers is a Director and the Vice Chairman of the Board of New Covenant Trust Company, a National Trust Company. Mr. Flowers was Chairman of the Board of DIFCO, Inc., a railroad car engineering and manufacturing company from before the time he became a director until August 1997 when that company was sold. His term as a director of the Company will expire in 2004. DENNIS S. FRANK. Age 47. Director since 1988. Mr. Frank is the Chairman of the Board, Chief Executive Officer and President of Silvergate Capital Corporation, a financial institution holding company controlling Silvergate Bank, La Jolla, California a position he has held since December 1996. Additionally, he has been the President of DSF Management Company, a private investment company, located in Houston, Texas, since March 1994. His term as a director of the Company will expire in 2004. ROBERT E. JOHNSON, JR. Age 49. Director since 1986. Mr. Johnson is a partner in the law firm of Johnson & Johnson, Austin, Texas. His term as a director of the Company will expire in 2005. INFORMATION WITH RESPECT TO THE NOMINEES FOR DIRECTOR Unless otherwise directed, each proxy executed and returned by a stockholder will be voted "FOR" the election of the nominees listed below. If any nominee should be unable or unwilling to stand for election at the time of the Annual Meeting, the Board of Directors will nominate, and the persons named as proxies will vote, for any replacement nominee or nominees recommended by the Board of Directors. At this time, the Board of Directors knows of no reason why the nominees listed below may not be able to serve as a director if elected. Information concerning the nominees for director, including age, tenure, principal position with the Company and his principal occupation during the past five years, as well as the year his term will expire, is set forth below: MANUEL J. MEHOS. Age 49. Director since 1986. Mr. Mehos is the Chairman of the Board, President and Chief Executive Officer of the Company, Coastal Banc Holding Company, Inc., Coastal Banc Mortgage Corp. and the Bank as well as the Chief Executive Officer of CoastalBanc Financial Corp., a Bank subsidiary and the Co-Chairman of Coastal Banc Capital Corp., an affiliate of the Bank. He is also a Director and President of CoastalBanc Investment Corporation, which is a wholly-owned subsidiary of the Bank. The Company, the Bank, its subsidiaries and affiliates are located in Houston, Texas. CoastalBanc Investment Corporation is presently inactive. If elected, his term as a director of the Company will expire in 2006. CLAYTON T. STONE. Age 69. Director from August 1995 until November 1998 and July 2002 to present. Mr. Stone has been an officer of Hines Interests Limited Partnership for 22 years, serving as Executive Vice President for 15 years. During a ten-year retirement period from Hines, Mr. Stone served as a consultant to various clients in real estate investments and litigation advisory services. If elected, his term will expire in 2006. THE BOARD OF DIRECTORS RECOMMENDS THAT THE ABOVE NOMINEES BE ELECTED DIRECTORS OF THE COMPANY. STOCKHOLDER NOMINATIONS The Company's Articles of Incorporation govern nominations for election to the Board of Directors and require that all nominations for election to the Board of Directors, other than those made by the Board, be made by a stockholder who has complied with the notice provisions in the Articles. Written notice of a stockholder's nomination must be communicated to the attention of the Company's Secretary and either delivered to, or mailed and received at, the principal executive offices of the Company not less than 60 days prior to the anniversary date of the mailing of the proxy materials by the Company in connection with the immediately preceding annual meeting of stockholders of the Company, and with respect to a special meeting of stockholders for the election of directors, on the close of business on the tenth day following the date on which notice of such meeting is first given to stockholders. Such notice shall include specified matters as set forth in the Articles of Incorporation. If the nomination is not made in accordance with the requirements set forth in the Articles of Incorporation, the defective nomination will be disregarded at the Annual Meeting. The Company did not receive any nominations from stockholders for the Annual Meeting. BOARD OF DIRECTORS MEETINGS AND COMMITTEES OF COASTAL BANCORP, INC. AND COASTAL BANC SSB The Company's Board of Directors has responsibility for establishing broad corporate policies and overall performance of Coastal. However, it is not involved in the day-to-day operating details of the Company's business. Members of the Board are kept informed of the Company's business through various documents and reports provided by the Chairman of the Board and other Officers of the Company and by participating in Board and Board Committee meetings. Each Director has access to all books, records and reports of Coastal, and members of management are available at all times to answer any Director's questions. Regular meetings of the Board of Directors of the Company are held at least quarterly and special meetings may be called at any time as necessary. During the year ended December 31, 2002, the Board of Directors of the Company held eight (8) meetings. All incumbent directors of the Company attended at least seventy-five percent (75%) of the Board meetings held during the period in which he served as a director in 2002. The Board of Directors of the Company is authorized by its Bylaws to elect members of the Board to committees of the Board which may be necessary or appropriate for the conduct of the business of the Company. The Board of Directors as a whole acts as a Nominating Committee. This is the only Committee of the Company. Regular meetings of the Board of Directors of the Bank are held at least quarterly and special meetings may be called at any time as necessary. During the year ended December 31, 2002, the Board of Directors of the Bank held nine (9) meetings. All incumbent directors of the Bank attended at least seventy-five percent (75%) of the aggregate of the total number of Board meetings held during the period in which he served as a director and the total number of meetings held by committees of the Board of Directors of the Bank on which he served in 2002. The members of the Board of Directors of the Company are also the members of the Board of Directors of the Bank. The Board of Directors of the Bank is authorized by its Bylaws to elect members of the Board to committees of the Board which may be necessary or appropriate for the conduct of the business of the Bank. At December 31, 2002, the Bank had various committees, including an Audit, Compensation, Asset/Liability and Directors' Loan Review Committee. Audit Committee. The Audit Committee of the Bank's Board is responsible for reviewing the reports of the independent public accountants and examination reports of regulatory authorities, monitoring the internal audit functions (whether in-house or outsourced), which reports directly to this Committee, and generally overseeing compliance with internal policies and procedures pursuant to the Audit Committee Charter (the "Charter"). The Audit Committee members are Messrs. Flowers (Chairman), Allday and Johnson. The members are "independent" as defined in Rule 4200(a)(14) of the listing standards of the Nasdaq Stock Market. This Committee met seven (7) times during 2002. See "Report of the Audit Committee." Compensation Committee. The Compensation Committee reviews the compensation of senior executive officers and recommends to the Board adjustments in such compensation based on a number of factors, including the profitability of the Bank. Messrs. Johnson (Chairman), Flowers and Stone comprise the Compensation Committee, which met five (5) times during 2002. See "Executive Compensation - Report of the Compensation Committee of the Board of Directors on Compensation During Fiscal 2002." Asset/Liability Committee. The Asset/Liability Committee met one (1) time in 2002 to review and analyze the investment securities portfolio, ascertain that the Bank's interest rate risk policy is followed and to confirm that policies and procedures for all investment securities are adequate and appropriate. The Committee also makes interest rate risk assessments and formulates asset/liability management policy. This Committee consists of Messrs. Frank (Chairman), Allday and Mehos. Directors' Loan Review Committee. The Directors' Loan Review Committee met twelve (12) times in 2002 to approve and/or review certain loans. The Committee can approve any class or type of loan which is authorized for investment by the Board. Specified loan authority limits are further delegated to the Portfolio Control Center ("PCC") or an individual officer of the Bank. The Directors' Loan Review Committee consists of Messrs. Stone (Chairman), Flowers and Mehos. BOARD FEES During 2002, each non-employee director of the Company and the Bank was paid a fee of $4,000 for attendance at each Board meeting, $500 for each committee meeting attended and $1,000 for each Loan Review Committee meeting attended in the months in which the Board met and $500 for the other months attended. When the Board of Directors of the Company meets on the same day as the Board of Directors of the Bank, only one attendance fee is paid for that date. No fees are paid for non-attendance; attendance by conference telephone is similarly not compensated. Directors are also reimbursed for reasonable travel expenses. Directors who are also employees of the Company and the Bank receive no fees for attendance at Board or committee meetings. 2002 NON-EMPLOYEE DIRECTOR STOCK PURCHASE PLAN On January 24, 2002, the Board of Directors of the Company approved the 2002 Non-Employee Director Stock Purchase Plan (the "Stock Purchase Plan"). This Stock Purchase Plan provides eligible members of the Company's Board of Directors with an opportunity to purchase shares of the Company's common stock with up to half of their Director and Committee fees. The maximum number of shares of common stock that may be issued over the term of the Plan will not exceed twenty-five thousand (25,000) shares. A total of 3,556 shares were issued during 2002 under the 2002 Non-Employee Stock Purchase Plan. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE OF THE EXCHANGE ACT Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") requires that the Company's officers, directors and beneficial owners of more than 10% of any class of equity securities of the Company file reports to indicate ownership and changes in ownership with the Securities and Exchange Commission and to furnish the Company with copies of such reports. Based upon a review of the copies of such forms, the Company believes that during the year ended December 31, 2002, all Section 16(a) filing requirements applicable to the Company's officers and directors and to beneficial owners of more than 10% of the Company's equity securities were complied with. REPORT OF THE AUDIT COMMITTEE The following Report of the Audit Committee of the Board of Directors does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act of 1933, as amended (the "Securities Act"), or the Exchange Act, except to the extent the Company specifically incorporates this Report by reference therein. During fiscal 2002, the Audit Committee of the Board of Directors ratified and approved the Audit Committee Charter (the "Charter"), which was originally approved by the Board of Directors on August 24, 2000. The complete text of the Charter, which reflects standards set forth in SEC regulations and the rules of the Nasdaq Stock Market, is reproduced in Appendix A to this proxy statement. As set forth in more detail in the Charter, the Audit Committee's (the "Committee") primary duties and responsibilities are to: - - Monitor the integrity of the Company's financial statements, consolidated accounting and financial controls and financial reporting process and systems of internal compliance. - - Monitor the selection, independence and performance of the Company's independent public accountants and internal auditing, compliance and loan review functions; and - - Provide an avenue of communication among independent public accountants, management, the internal audit function (whether in-house or outsourced), the Audit Committee and the Board of Directors. The Committee has implemented procedures to ensure that during the course of each fiscal year it devotes the attention that it deems necessary or appropriate to each of the matters assigned to it under the Charter. To carry out its responsibilities, the Committee met seven (7) times during fiscal 2002. In overseeing the preparation of the Company's financial statements for the year ended December 31, 2002, the Committee met separately with both management and KPMG LLP, the Company's independent public accountants, to review and discuss the financial statements prior to their issuance and to discuss significant accounting issues. Management advised the Committee that all financial statements were prepared in accordance with accounting principles generally accepted in the United States of America, and the Committee discussed the financial statements with management and KPMG LLP. The Committee's review included discussion with the independent public accountants of matters required to be discussed pursuant to Statement on Auditing Standards No. 61 (Communications With Audit Committees). The Committee also discussed with KPMG LLP matters relating to its independence including disclosures required to be made to the Committee by the Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees). In addition, the Committee reviewed major initiatives and programs aimed at strengthening the effectiveness of the Company's internal control structure. As a part of the process, the Committee continued to monitor the scope and adequacy of the Company's internal auditing program reviewing staffing levels and steps taken to implement recommended improvements in internal procedures and controls. On the basis of these reviews and discussions, the Committee recommended to the Board of Directors that the Board approve the inclusion of the Company's audited financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, for filing with the Securities and Exchange Commission. Management is responsible for the Company's financial reporting process including its system of internal control, and for the preparation of consolidated financial statements in accordance with generally accepted accounting principles. The Company's independent auditors are responsible for auditing those financial statements. The Audit Committee's responsibility is to monitor and review these processes. It is not the Audit Committee's duty or its responsibility to conduct auditing or accounting reviews or procedures. The members of the Audit Committee are not employees of the Company and they may not be, and do not represent themselves to be or to serve as, accountants or auditors by profession or experts in the fields of accounting or auditing. Therefore, the Audit Committee relied, without independent verification, on management's representation that the financial statements have been prepared with integrity and objectivity and in conformity with accounting principles generally accepted in the United States of America and on the representations of the independent auditors included in their report on the Company's financial statements. The Audit Committee's oversight does not provide the Audit Committee with an independent basis to determine that management has maintained appropriate accounting and financial reporting principles or policies, or appropriate internal controls and procedures designed to assure compliance with accounting standards and applicable laws and regulations. Furthermore, the Audit Committee's considerations and discussions with management and the independent auditors do not assure that the Company's financial statements are presented in accordance with accounting principles generally accepted in the United States of America, that the audit of the Company's financial statements has been carried out in accordance with generally accepted auditing standards or that the Company's independent accountants are, in fact, "independent." By the Committee: D. Fort Flowers, Jr. (Chairman) R. Edwin Allday Robert E. Johnson, Jr. [THIS SPACE INTENTIONALLY LEFT BLANK] COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION None of the members of the Board's Compensation Committee is or has been an officer or employee of the Company nor on any other committee of the board of directors of another entity performing similar functions. No transactions with the Company affecting the members of the Compensation Committee, or their affiliates, occurred during fiscal 2002. EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS The following table sets forth information concerning executive officers of the Company, the Bank or other subsidiaries who do not serve on the Company's Board of Directors. All executive officers are elected by the Board of Directors of the Company or the Bank or of the respective subsidiary, as applicable, and serve until their successors are elected and qualified. No such executive officer is related to any director or other executive officer of the Company or the Bank or its subsidiaries by blood, marriage or adoption, and there are no arrangements or understandings between a director and any other person pursuant to which such person was elected an executive officer. Position with the Company and/or the Bank and other subsidiaries Name Age Principal Occupation During Last Five Years - ---- --- --------------------------------------------------- Gary R. Garrett 55 Co-Chairman of Coastal Banc Capital Corp., an affiliate of the Bank, as of January 2002 and President of Coastal Banc Mortgage Corp, an affiliate of the Bank since July 2002. Previous to this he was Senior Executive Vice President of the Bank from July 1999 until December 2001; Executive Vice President of the Bank from August 1993 to July 1999; Chief Lending Officer of the Bank from 1995 to December 2001; and Senior Vice President-Mortgage Lending of the Bank from October 1991 to August 1993. David R. Graham 59 Executive Vice President of the Bank since August 1993; Senior Vice President-Commercial Real Estate Lending of the Bank from May 1988 to August 1993; and a Director of CoastalBanc Financial Corp. Robert V. New 51 Executive Vice President and Chief Banking Officer of the Bank since December 2001. From 1988 until December 2001, Mr. New held various Senior Vice President positions at Bank of America/Nations Bank and NCNB. Michael A. Presley 49 President of Coastal Banc Capital Corp., an affiliate of the Bank since August 1997 and Executive Vice President of Coastal Banc Mortgage Corp., an affiliate of the Bank since July 2002. From February 1992 until August 1997, Mr. Presley held the position of First Vice President at Morgan Keegan & Co. Catherine N. Wylie 49 Senior Executive Vice President of the Company, Coastal Banc Holding Company, Inc. and the Bank since July 1999 and a Director of Coastal Banc Holding Company, Inc., and of each of the Bank's subsidiaries; Chief Financial Officer of the Company and the Bank since October 1993; Chief Operations Officer since May 1999; Senior Executive Vice President of Coastal Banc Holding Company, Inc. from November 1996 to July 1999, of the Company from July 1994 to July 1999 and of the Bank from August 1993 to July 1999; Controller of the Bank from April 1989 to October 1993; also President/Treasurer of CoastalBanc Financial Corp. since October 1990; also President/Secretary/Treasurer of Coastal Banc Insurance Agency, Inc. since June 2000. Director, Senior Executive Vice President, Treasurer and Principal of Coastal Banc Capital Corp., an affiliate of the Bank, since August 1997. Director, Senior Executive Vice President and Treasurer of Coastal Banc Mortgage Corp. since July 2002. EXECUTIVE COMPENSATION The following Report of the Compensation Committee of the Board of Directors on Compensation During Fiscal 2002 and the stock performance graph included elsewhere in this Proxy Statement do not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act, or the Exchange Act, except to the extent the Company incorporates this Report or the performance graphs by reference therein. REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS ON COMPENSATION DURING FISCAL 2002. Officers of the Company are also Officers of the Bank and do not receive separate compensation for their services to the Company. The Compensation Committee of the Board of Directors of the Bank (the "Committee") is composed entirely of independent outside directors. See "Information With Respect to the Nominees for Director, Directors Whose Terms Continue and Executive Officers" and "Board of Directors Meetings and Committees of Coastal Bancorp, Inc. and Coastal Banc ssb." The Committee is responsible for reviewing the compensation of senior executive officers of the Bank and recommending senior executive compensation proposals to the Bank's Board of Directors for approval. The Committee evaluates the base salaries of the Bank's senior executive officers annually. A senior executive officer's base salary is determined mid-year and is based upon longevity with the Bank, the effectiveness of such individual in performing his or her duties, peer averages at the position in question and the Bank's overall performance. No particular weight is assigned to these variables. The base salary component alone, while designed to be competitive with peer group averages, is not designed to produce top levels of compensation for the Bank's senior executive officers when compared to its peer group. The incentive component, as described below, which requires the Company to achieve returns at a pre-specified level before additional compensation is paid, is the element which is designed to make total compensation for each of the Bank's senior executive officers comparable or better than the comparable executive compensation for the senior executive officers in the Bank's peer group. Based upon the foregoing, Mr. Mehos, the Chief Executive Officer, earned $360,000 in base salary during 2002. The amount of incentive compensation is related to the financial performance of the Company. No cash incentive compensation will be paid to the Bank's senior executive officers unless the Committee determines the Bank is safe and sound in the following areas: capital adequacy, earnings composition, earnings capability, liquidity, risk management (classified assets), strategic planning, and compliance with laws and regulations. During 2002, the Committee paid incentive awards totaling $497,013 to the senior executive officers of the Bank. See "Summary Compensation Table." During 2002, the Compensation Committee reviewed employee performance to determine whether to issue stock compensation. The Compensation Committee authorizes grants of stock options, stock grants and other types of stock awards permitted under the Company's stock compensation programs based on recommendations from the Company's Chief Executive Officer. The Compensation Committee has the discretion to determine, among other things, to whom stock compensation is granted, the form of the compensation, the amount of the compensation, the vesting period, if any and the exercise price, if any. During 2002, the Committee granted incentive stock options to purchase an aggregate 36,031 shares of Company common stock to four employees under the Company's 1999 Stock Compensation Plan. By the Committee: Robert E. Johnson, Jr. D. Fort Flowers, Jr. Clayton T. Stone [THIS SPACE INTENTIONALLY LEFT BLANK] SUMMARY COMPENSATION TABLE To meet the goal of providing shareholders a concise, comprehensive overview of compensation awarded, earned or paid in the reporting period, the Summary Compensation Table is utilized by the Company. The Summary Compensation Table includes individual compensation information with respect to the Chief Executive Officer and the five other most highly compensated executive officers of the Company and its subsidiaries and affiliates whose total compensation exceeded $100,000 for services rendered in all capacities during the fiscal years ended December 31, 2002, 2001 and 2000.
ANNUAL COMPENSATION --------------------------------------- LONG TERM OTHER AWARDS ALL NAME AND PRINCIPAL ANNUAL STOCK OPTIONS OTHER POSITION(1) YEAR SALARY(2) BONUS(3) COMPENSATION(4) GRANTED(5) COMPENSATION(6) - -------------------- ----- ---------- --------- -------------- ------------ --------------- Manuel J. Mehos 2002 $ 360,000 $ 257,013 $ 5,500 15,000 * Chairman of the Board 2001 360,000 269,230 4,285 -- * President and Chief 2000 343,200 255,947 2,558 26,000 * Executive Officer of the Company and the Bank Gary R. Garrett 2002 234,000 -- 6,293 -- * President, Coastal 2001 234,000 134,614 8,250 -- * Banc Mortgage Corp. 2000 234,000 127,973 6,070 13,000 * David R. Graham 2002 165,000 41,000 5,500 5,000 * Executive Vice President 2001 148,890 39,873 4,722 -- * - - Commercial Real Estate 2000 142,138 34,258 2,800 5,000 * Lending of the Bank Robert V. New (7) 2002 180,000 90,000 2,860 5,000 * Executive Vice President 2001 -- -- -- 10,000 -- and Chief Banking Officer of 2000 -- -- -- -- -- the Bank Michael A. Presley (8) 2002 282,481 -- 5,689 -- * Executive Vice President, 2001 440,165 -- 5,129 -- * Coastal Banc Mortgage Corp. 2000 240,509 -- 2,734 -- * Catherine N. Wylie 2002 275,000 150,000 10,500 11,031 * Sr. Executive Vice President, 2001 250,000 134,614 13,250 -- * Chief Financial Officer and 2000 234,000 127,973 25,810 13,000 * Chief Operations Officer of the Company and the Bank
______________________ (1) Principal positions are for fiscal 2002. (2) Does not include amounts attributable to miscellaneous benefits received by executive officers of the Bank, including use of Bank-owned vehicles and reimbursement of educational expenses. In the opinion of management of the Company, the costs to the Bank of providing such benefits to any individual executive officer during the year ended December 31, 2002 did not exceed the lesser of $50,000 or 10% of the total of annual salary and bonus reported for the individual. (3) Includes lump sum cash bonuses earned for the fiscal year stated and paid, in some cases,in the subsequent year. (4) Includes, for the named individuals, employer matching contributions accrued pursuant to the Company's Profit Sharing (401(k)) Plan, any car allowances and educational reimbursements. The amounts set for the in the table include $5,500 $6,293, $5,500, $2,860, $5,689 and $5,500 which were 401(k) Bank matched funds for Messrs. Mehos, Garrett, Graham, New, Presley and Ms. Wylie, respectively. The amounts also include $5,000 for Ms. Wylie's annual compensation paid from CoastalBanc Financial Corp. (5) Free standing stock options; see "Aggregate Options Granted in Last Fiscal Year." (6) Asterisk (*) denotes amount less than $50,000 or 10% of total annual salary and bonus. (7) Mr. New began employment with the Bank on December 31, 2001. (8) Mr. Presley is not an officer of the Bank or the Company but is Executive Vice President of Coastal Banc Mortgage Corp., an affiliate of the Bank. His salary consists 100% of commissions on the sale of whole loan related assets to the Bank and to other third party entities. EXECUTIVE SEVERANCE AGREEMENTS Other than as set forth below, the Company has not entered into any employment contracts with any of its officers. On May 31, 1999, the Company and the Bank extended the term of the executive severance agreements (the "Executive Severance Agreements") with Mr. Garrett and Ms. Wylie (together the "Employees", each, individually an "Employee") for a continuous term of thirty-six (36) months, subject to annual review of such provision. On February 22, 2001, the Company and the Bank entered into an Executive Severance Agreement with Mr. Mehos. On August 22, 2002, the Company and the Bank entered into the same type of agreement with Mr. New. The Executive Severance Agreements provide for the payment of certain severance benefits to Messrs. Mehos, Garrett, New and Ms. Wylie in the event of a trigger event under the Executive Severance Agreements, which means (i) the occurrence of a change in control of the Company as defined below, or (ii) the voluntary termination within 90 days of an event which occurs during the "Protected Period" (i.e., the period six months before and three years after a change of control or after the expiration of the Executive Severance Agreement) and constitutes "Good Reason" (as defined below), or (iii) termination of the Employee's employment for any reason other than "Just Cause" during the Protected Period. If a trigger event occurs, the Employees will be entitled to (x) payment by the Company or the Bank for a trigger event described in (i) above of one times the annual salary and bonus for incentive compensation (not including stock compensation plans) paid to the Employee during his or her immediately preceding year of employment or (y) the payment by the Company or the Bank for a trigger event described in (ii) or (iii) above of an amount equal to 2.99 times their annual salary (except for Mr. New's Executive Severance Agreement which sets forth an amount equal to 2.0 times his annual salary) plus bonuses paid during the immediately preceding year; and (z) the Company will cause any and all outstanding options to purchase stock of the Company held by each Employee to become immediately vested and exercisable in full. The Executive Severance Agreement also provides that the Company will reimburse the Employee for all costs and expenses, including reasonable attorney's fees incurred by the Employee to enforce rights or benefits under such agreements. Under the Executive Severance Agreements, a "Change In Control" of the Company would be deemed to occur if (i) the Company is not the surviving entity in any merger, consolidation, or other reorganization, (ii) the sale, exchange, lease, transfer or other disposition to any person of all or a substantial part of the assets, liabilities, or business of the Company or the Bank, (iii) any change in business of the Company or the Bank such that the Company does not own the voting stock of the Bank or the business of the Bank is not as an insured depository institution, (iv) any person or entity including a "group" as contemplated by Section 13(d)(3) of the Exchange Act acquires or gains ownership or control (including, without limitation, power to vote) of more than 25% of the outstanding shares of the Bank's or the Company's voting stock, or (v) as a result of or in connection with a contested election of directors, the persons who were directors of the Bank or the Company before such election cease to constitute at least two-thirds of the Board of Directors. Under the Executive Severance Agreements (a) "Good Reason" means any of the following events, which has not been consented to in advance by the Employee in writing: (i) the requirement that the Employee move his or her personal residence, or perform his or her principal executive functions, more than thirty (30) miles from his or her primary office as of the date of the Change in Control; (ii) a material (defined to be 10% or more) reduction in the Employee's base compensation as in effect on the date of the Change in Control or as the same may be increased from time to time; (iii) a successor to the Company or the Bank fails or refuses to assume the Company's and the Bank's obligations under the Executive Severance Agreement; (iv) the Company, the Bank or successor thereto breaches any provision of the Executive Severance Agreement; or (v) the Employee is terminated for other than Just Cause after the Change in Control; and (b) "Just Cause" means, in the good faith determination of the Company's and the Bank's Boards of Directors, the Employee's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease-and-desist order, or material breach of any provision of the Executive Severance Agreement. The Employee shall have the right to make a presentation to the Board of Directors with counsel prior to rendering of such determination by the Board. The Employee shall have no right to receive compensation or other benefits for any period after termination for Just Cause. No act, or failure to act, on the Employee's part shall be considered "willful" unless he has acted, or failed to act, with the absence of good faith and without a reasonable belief that his action or failure to act was in the best interest of the Bank and the Company. In the event that the Employee and the Company or the Bank agree that the Employee will be paid an amount under the Executive Severance Agreement that triggers the requirement to pay the excise tax required under Section 280G of the Internal Revenue Code of 1986, as amended, the Company or the Bank will reimburse the Employee for all such excise taxes. Effective June 28, 2001, the Company terminated the automatic extension provision of Mr. Garrett's Severance Agreement, with the resulting effect that it will terminate no later than June 27, 2004. The Executive Severance Agreements for Ms. Wylie and Mr. Mehos were renewed for an additional one year term subject to the terms of the May 31, 1999 modification and remain in effect for the modified period ending on the earlier of (i) a rolling three year period, or (ii) the date on which the Employee voluntarily terminates his or her employment with the Company or the Bank. Mr. New's Executive Severance Agreement began on August 22, 2002 and remains in effect for 2002 ending on the earlier of (i) a rolling three year period, or (ii) the date on which he voluntarily terminates his employment with the Company or the Bank. Any payments made to the Employee pursuant to the Executive Severance Agreement, or otherwise, are subject to and conditioned upon their compliance with the Federal Deposit Insurance Act and any regulations promulgated by the Federal Deposit Insurance Corporation thereunder. AGGREGATE OPTIONS GRANTED IN LAST FISCAL YEAR The following table sets forth individual grants of options that were made during the last fiscal year to the executive officers named in the Summary Compensation Table. This table is intended to allow stockholders to ascertain the number and size of option grants made during the fiscal year, the expiration date of the grants and the potential realizable present value of such options under specified assumptions. The Grant Date Present Value is a hypothetical value of the options as of their date of grant and has been calculated using the Black-Scholes option-pricing model, as permitted by SEC rules, based upon a set of assumptions set forth in the footnote to the table. It should be noted that this model is only one method of valuing options, and the Company's use of the model should not be interpreted as an endorsement of its accuracy. The actual value of the options may be significantly different, and the value actually realized, if any, will depend upon the excess of the market value of the common stock over the option exercise price at the time of exercise, which is unpredictable.
PERCENT OF OPTIONS TOTAL OPTIONS GRANTED GRANTED TO EXERCISE GRANT DATE (NO. OF EMPLOYEES PRICE EXPIRATION PRESENT NAME SHARES)(1) IN FISCAL YEAR PER SHARE DATE VALUE(2) - ------------------- ---------- --------------- --------- ---------- ---------- Manuel J. Mehos 15,000 41.63% $ 30.90 06-27-12 $131,565 Catherine N. Wylie 3,531 9.80 30.44 02-11-12 30,970 Catherine N. Wylie 7,500 20.81 30.90 06-27-12 65,783 Robert V. New 5,000 13.88 30.90 06-27-12 43,855 David R. Graham 5,000 13.88 30.96 05-24-12 43,855 Gary R. Garrett -- -- -- -- -- ---------- --------------- 36,031 100.00% ========== ===============
______________________ (1) Total options granted in 2002 were 36,031 shares. The options vest 25% during the first calendar year and an additional 25% for each of the next three years. (2) The potential realizable value of the grant of options is the present value of the grant at the date of grant using a variation of the Black-Scholes option-pricing model. Assumptions used to calculate the present value of the options granted in 2002, were as follows: an expected volatility rate of 26.99%, a risk free rate of return of 1.606%, a dividend yield of $0.48 per share per year and the expiration date of ten years, respectively. The approach used in developing the assumptions upon which the Black-Scholes valuations were calculated is consistent with the requirements of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation." AGGREGATE OPTIONS EXERCISED IN LAST YEAR AND FISCAL YEAR-END OPTION VALUES The following table sets forth, with respect to the executive officers named in the Summary Compensation Table, information with respect to the aggregate amount of options exercised during the last fiscal year, any value realized thereon, the number of unexercised options at the end of the fiscal year (exercisable and unexercisable) and the value with respect thereto.
VALUE VALUE OF UNEXERCISED SHARES REALIZED NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS AT ACQUIRED ON UPON OPTIONS AT FISCAL YEAR-END FISCAL YEAR-END(3) NAME EXERCISE EXERCISE(2) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ------------------ ----------- --------- -------------------------- -------------------------- Manuel J. Mehos -- $ -- 228,250 17,750 $4,217,208 $ 130,712 Gary R. Garrett -- -- 80,172 3,250 1,472,777 57,200 David R. Graham -- -- 14,212 5,250 203,300 29,737 Robert V. New -- -- 3,750 11,250 10,438 31,312 Michael A. Presley -- -- 7,500 -- 90,150 -- Catherine N. Wylie 12,745(1) 283,707 82,809 11,523 1,474,299 62,258
_____________________ (1) Ms. Wylie exercised options to acquire 12,745 shares of stock. (2) Value Realized Upon Exercise is the difference between the exercise price and the market price at the time of exercise. (3) In accordance with SEC rules, values are calculated by subtracting the exercise price from the fair market value of the underlying common stock. For purposes of this table, fair market value is deemed to be $32.35 per share, which was the closing sale price of the common stock on the Nasdaq National Market on December 31, 2002. DISCLOSURE OF EQUITY COMPENSATION PLAN INFORMATION AS OF DECEMBER 31, 2002 The following table provides information on all existing Stock Option Plans as of December 31, 2002.
NUMBER OF SECURITIES WEIGHTED-AVERAGE EXERCISE NUMBER OF SECURITIES TO BE ISSUED UPON PRICE OF OUTSTANDING REMAINING AVAILABLE FOR EXERCISE OF OUTSTANDING OPTIONS, WARRANTS FUTURE ISSUANCE UNDER PLAN CATEGORY OPTIONS, WARRANTS AND RIGHTS AND RIGHTS EQUITY COMPENSATION PLANS - ------------- ---------------------------- ----------------------- ------------------------- Equity compensation plans approved by stockholders 604,654 (1) $ 15.64 31,046 Equity compensation plans not approved by stockholders 3,556 (2) 30.53 21,444 ------- ------ ------ Total 608,210 15.73 52,490 ======= ====== ======
(1) Includes the 1991, 1995 and 1999 Employee Stock Option Plans. (2) Includes the 2002 Non-Employee Stock Option Plan. COMPARATIVE STOCK PERFORMANCE GRAPH The stock performance graph below compares the cumulative total stockholder return of the Company's Common Stock from December 31, 1997 to December 31, 2002 with the cumulative total return of the National Association of Securities Dealers Automated Quotations ("Nasdaq") Market Index and certain thrift institutions traded on the Nasdaq, as compiled by SNL Securities, L.P. in its OTC Thrift Index, assuming an investment of $100 on December 31, 1997 and the reinvestment of all dividends. In 1997, the Company paid quarterly dividends in the amount of $.10 per share on March 15, 1997 and quarterly dividends of $.12 per share on June 15, 1997, September 15, 1997 and December 15, 1997. In 1998, the Company split the stock 3:2 at which time the $.12 per share dividend, adjusted for the split was $.08 per share. During 1998 and 1999, the Company paid quarterly dividends in the amount of $.08 per share, as adjusted for the stock split, on March 15, 1998, June 15, 1998, September 15, 1998, December 15, 1998, March 15, 1999, June 15, 1999, September 15, 1999 and December 15, 1999. During 2000, the Company paid quarterly dividends in the amount of $.08 per share on March 15, 2000 and June 15, 2000. Quarterly dividends paid for the September 15, 2000 and December 15, 2000 periods were $.10 per share. During 2001, the Company paid quarterly dividends in the amount of $.10 per share on March 15, 2001 and dividends in the amount of $.12 per share on June 15, 2001, September 15, 2001 and December 15, 2001. During 2002, the Company paid quarterly dividends in the amount of $.12 per share on March 15, 2002, June 15, 2002, September 15, 2002 and December 15, 2002. [THIS SPACE INTENTIONALLY LEFT BLANK] COMPARISON OF FIVE YEAR-CUMULATIVE TOTAL RETURN PERFORMANCE COASTAL BANCORP, INC. [GRAPHIC OMITED] -----------------
PERIOD ENDING ------------------------------------------------------------------ INDEX 12/31/97 12/31/98 12/31/99 12/31/00 12/31/01 12/31/02 Coastal Bancorp, Inc. 100.00 76.40 77.82 109.02 133.24 151.53 Nasdaq - Total US 100.00 140.99 261.48 157.42 124.89 86.33 SNL OTC Thrift Index 100.00 87.44 75.20 94.33 121.06 154.43 SNL $1B-$5B Thrift Index 100.00 89.76 80.38 97.16 138.52 177.39 SNL $1B-$5B Bank Index 100.00 99.77 91.69 104.05 126.42 145.94
______________ Notes: (1) Each Index is weighted for all companies that fit the criteria of that particular Index. The Index is calculated to exclude companies as they are merged out of existence, and add them to the Index calculation as they become publicly traded companies. All companies in the particular Index that were in existence at December 31, 2002 are included in the calculations. (2) Each Index value measures dividend re-investment by assuming dividends are received in cash on the ex-date and re-invested back into the company stock paying the dividend on the same day. The stock price on the ex-date is used to calculate how many shares can be bought with the dividend. TRANSACTIONS WITH MANAGEMENT Certain of the Company's Directors, Executive Officers and Associates of Directors or Executive Officers were customers of or had various transactions with Coastal and its subsidiaries in the ordinary course of business in 2002. These transactions cover a wide range of banking services, both person and corporate. Without exception, all services were provided to the Directors, Executive Officers and their Associates at market rates consistent with published for schedules. Similar additional transactions may be expected to take place in the ordinary course of business in the future. Although various laws and regulations governing the Company and its subsidiaries allow Coastal and its subsidiaries to make loans to a limited extent to its Executive Officers, any loans and loan commitments and sales of commercial paper involving Executive Officers, Directors or their affiliates were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other person and did not involve more than the normal risk of collectibility or other unfavorable features. At December 31, 2002, there were no loans outstanding to Directors, Executive Officers or their associates. PROPOSAL TO RATIFY THE SELECTION OF INDEPENDENT PUBLIC ACCOUNTANTS The Board of Directors of the Company has selected KPMG LLP as independent public accountants for the Company and the Bank for the year ending December 31, 2003, and has further directed that the selection of independent public accountants be submitted for ratification by the stockholders at the Annual Meeting. KPMG LLP has advised the Company that neither the firm nor any of its associates has any relationship with the Company or its subsidiaries other than the usual relationship that exists between independent public accountants and clients. KPMG LLP provided certain non-audit services to the Company and the Bank in 2002 which are described below under "Other Fees". A representative of KPMG LLP is expected to be present at the Annual Meeting with the opportunity to make a statement if he or she so desires and will be available to respond to appropriate questions. FEES BILLED TO THE COMPANY BY KPMG LLP DURING FISCAL 2002 Audit Fees: - ------------ Fees paid by the Company to KPMG LLP for audit services during the Company's fiscal years ended 2002 and 2001 for examination of the Company's annual consolidated financial statements, including those consolidated financial statements in the Company's quarterly reports on Form 10-Q, were $242,500 and $246,500, respectively. Other Fees: - ------------ Other fees paid by the Company to KPMG LLP during the Company's fiscal years ended 2002 and 2001 were $60,000 and $0 for services rendered during the 2002 issuance of the 9.0% Trust Preferred Securities, $36,345 and $30,125 for preparation of the Company's 2001 and 2000 income tax returns and $10,750 and $10,300 for the 2001 and 2000 fiscal years audits of the Bank's 401(k) Plan. All non-audit services were reviewed by the Audit Committee which concluded that the performance of such service by KPMG LLP was compatible with the maintenance of that firm's independence in the conduct of its auditing functions. Stockholder ratification of the selection of KPMG LLP as the Company's independent public accountants is not required by the Company's Bylaws or other applicable legal requirement. However, the Board is submitting the selection of KPMG LLP to the stockholders for ratification as a matter of good corporate practice. In the event that stockholders fail to ratify the selection, the Audit Committee and the Board will reconsider whether or not to retain that firm. Even if the selection is ratified, the Board at its discretion may direct the appointment of a different independent accounting firm at any time during the year if it determines that such a change would be in the best interest of the Company and its stockholders. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" RATIFICATION OF THE APPOINTMENT OF KPMG LLP AS INDEPENDENT PUBLIC ACCOUNTANTS FOR FISCAL 2003. STOCKHOLDER PROPOSALS Any proposal which a stockholder wishes to have presented at the next Annual Meeting of Stockholders of the Company and included in the proxy materials used by the Company in connection with such meeting must be received at the corporate headquarters office of the Company at Coastal Banc Plaza, 5718 Westheimer, Suite 600, Houston, Texas 77057-5745, no later than November 26, 2003. If such proposal is in compliance with all of the requirements of Rule 14a-8 promulgated under the Exchange Act, it will be included in the Proxy Statement and set forth on the form of proxy issued for the next Annual Meeting of Stockholders. It is urged that any such proposals be sent by certified mail, return receipt requested. Stockholder proposals which are not submitted for inclusion in the Company's proxy materials pursuant to Rule 14a-8 under the Exchange Act may be brought before an annual meeting pursuant to the Company's Articles of Incorporation, which provide that business must be properly brought before the meeting by or at the direction of the Board of Directors, or otherwise properly brought before the meeting by a stockholder. For business to be properly brought before an annual meeting by a stockholder (whether or not it is submitted for inclusion in the Company's proxy materials), the stockholder must have given timely notice thereof in writing to the Secretary of the Company. To be timely, a stockholder's notice must be delivered to, or mailed and received at, the principal executive offices of the Company not less than 60 days prior to the anniversary date of the mailing of proxy materials by the Company in connection with the immediately preceding annual meeting of stockholders of the Company. A stockholder's notice shall set forth as to each matter the stockholder proposes to bring before an annual meeting such information specified in the Company's Articles of Incorporation. If the proposal is not made in accordance with the terms of the Articles of Incorporation, such proposal will not be acted upon at the Annual Meeting. No stockholder proposals were received by the Company in connection with the 2003 Annual Meeting. PROXY SOLICITATION The cost of the solicitation of proxies will be borne by the Company. The Company will reimburse brokerage firms and other custodians, nominees and fiduciaries for reasonable expenses incurred by them in sending proxy materials to the beneficial owners of the Company's Common Stock. In addition to solicitations by mail, directors, officers and employees of the Company or the Bank may solicit proxies personally or by telephone without additional compensation. The Company has not retained a professional proxy solicitation firm to assist in the solicitation of proxies or for related services. OTHER MATTERS Management is not aware of any business to come before the 2003 Annual Meeting other than those matters described above in this Proxy Statement and possibly, procedural matters incident to the conduct of the meeting. However, if any other matters should properly come before the meeting, it is intended that the proxies solicited hereby will be voted with respect to those other matters in accordance with the judgment of the persons voting the proxies. ANNUAL REPORT AND FINANCIAL STATEMENTS A copy of the Company's Annual Report for the year ended December 31, 2002 ("Annual Report") accompanies this Proxy Statement. The Annual Report is not a part of the proxy solicitation materials. UPON RECEIPT OF A WRITTEN REQUEST, THE COMPANY WILL FURNISH TO ANY STOCKHOLDER, WITHOUT CHARGE, A COPY OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2002, AND ANY EXHIBITS THERETO REQUIRED TO BE FILED WITH THE SECURITIES AND EXCHANGE COMMISSION UNDER THE EXCHANGE ACT. SUCH WRITTEN REQUEST SHOULD BE DIRECTED TO CATHERINE N. WYLIE, CHIEF FINANCIAL OFFICER, COASTAL BANCORP, INC., COASTAL BANC PLAZA, 5718 WESTHEIMER, SUITE 600, HOUSTON, TEXAS 77057-5745. THE FORM 10-K IS NOT A PART OF THE PROXY SOLICITATION MATERIALS. By Order of the Board of Directors /s/ Linda B. Frazier ----------------------- Linda B. Frazier Secretary March 25, 2003 APPENDIX A AUDIT COMMITTEE CHARTER COASTAL BANCORP, INC. 1. Audit Committee Purpose and Authority The Audit Committee (the "Committee") of Coastal Bancorp, Inc., its subsidiaries and affiliates (the "Company") is appointed by the Board of Directors (the "Board") to assist the Board in fulfilling its oversight responsibilities to financial institution regulators, the shareholders, potential shareholders and the investment community. The Committee's primary duties and responsibilities are to: Monitor the integrity of the Company's financial statements, consolidated accounting and financial controls, the financial reporting process, in addition to the Company's systems of internal controls. Monitor the selection, independence and performance of the Company's independent auditors, the Company's internal auditing function (whether inhouse or outsourced) and the Company's loan review function. Evaluate, and where appropriate, replace the independent auditors or the outsourced internal audit firm, if applicable. Provide an avenue of communication among the independent auditors, management, the internal audit function (whether inhouse or outsourced) and the Board. It is the expectation of the Committee that management will fulfill is responsibility of bringing any significant matters to the attention of the Committee. The Committee has the authority to conduct any investigation appropriate to fulfill its responsibilities and shall have unrestricted access to the personnel records, systems and facilities of the Company and the Company's independent public accountants, internal and external legal counsel and consultants. The Committee shall have the authority to request any officer or employee of the Company or the Company's outside counsel or independent auditors to attend a meeting of the Committee or to meet with any members of, or consultants to, the Committee. The Committee has the ability to retain, at the Bank's expense, special legal, accounting or other consultants or experts it deems necessary in the performance of its duties. The Committee may also require that the Company's legal counsel disclose at the Board meetings the existence of any legal matter that might have a significant impact on the Company's financial statements, and notify the members of the Committee of any significant legal matters that might arise between Board meetings. Any change in the employment status, title or scope of responsibilities of the Company's independent auditors or the Company's internal auditing function (whether inhouse or outsourced) must be approved in writing by the Committee. 2. Audit Committee Composition and Meetings Committee members shall meet the requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act of 1991 and the National Association of Securities Dealers (NASD). The Committee shall be comprised of three or more directors as determined and appointed by the Board, each of whom shall be independent nonexecutive directors, free from any relationship that would interfere with the exercise of his or her independent judgment. A director of the Company with any of the following relationships will not be considered independent: (i) employment by the Company or any of its affiliates for the current year or during any part of the past three years; (ii) acceptance of any compensation from the Company or any of its affiliates in excess of $60,000.00 during the Company's previous fiscal year, other than compensation for board service, benefits under a tax-qualified retirement plan, or non-discretionary compensation; (iii) member of the immediate family of an individual who is, or has been in any part of the past three years, employed by the Company or any of its affiliates as an executive officer; (iv) partnership in, or a controlling shareholder or an executive offer of, any for-profit business organization to which the Company made, or from which the Company received, payments (other than those arising solely from investments in the Company's securities) that exceed five percent (5%) of the company's or business organization's gross revenues for that year, or $200,000.00, whichever is more, in any of the past three years; or (v) employment as an executive officer of another entity where any of the Company's executives serve on that entity's compensation committee. All members of the Committee shall have a basic understanding of finance and accounting and be able to read and understand fundamental financial statements, and at least two members of the Committee shall have accounting or related financial management expertise. The Committee will meet at least quarterly on the date of a normally scheduled meeting of the Board. The Chairman of the Committee may schedule additional meetings as required. Meetings of the Committee will be conducted in private with a member of the internal audit firm/department and/or any other employee, officer, outside counsel or independent auditors of the Company as the Committee or the Board deems necessary or appropriate. 3. Audit Committee Responsibilities and Duties Review Procedures - ------------------ Review and reassess the adequacy of this charter at least annually. Submit the charter to the Board for approval and have the document published at least every three years in accordance with SEC regulations. Review the Company's annual audited financial statements prior to filing or distribution. This review may include discussion with management and the Company's independent auditors concerning any significant issues regarding accounting principles, practices and judgments employed in the preparation of the annual consolidated financial statements. In consultation with management, the independent auditors and the internal audit firm/department members, consider the integrity of the Company's financial reporting processes and controls. Discuss significant financial risk exposures and the steps management has taken to monitor, control and report such exposures. Review significant findings prepared by the independent auditors and the internal audit firm/department together with management's responses. Review with the financial management of the Company and the independent auditors any significant issues that arise during any interim period for which the Company discloses financial results. Independent Auditors - --------------------- The independent auditors are ultimately accountable to the Committee and the Board. The Committee shall review the independence and performance of the auditors and annually recommend to the Board the appointment or discharge of the independent auditors when circumstances warrant. Approve the fees and other significant compensation to be paid to the independent auditors. On an annual basis, the Committee shall meet separately with the independent auditors to review and discuss with them all significant relationships said independent auditors have with the Bank that could impair their independence. Review the independent auditor's engagement letter. Discuss the results of the year end audit with the independent auditors including those matters required to be communicated to audit committees in accordance with AICPA SAS 61. Internal Audit Firm/Department and Legal Compliance - -------------------------------------------------------- Review the budget, audit plan, activities, organizational structure and qualifications of the internal audit firm/department as needed. Review significant reports prepared by the internal audit firm/department together with management's responses and follow-up to those reports. Review all Suspicious Activity Reports and other reports concerning any significant fraud or regulatory noncompliance that occurs at the Company. On at least an annual basis, review with the Company's general counsel any legal matters that could have a significant impact on the Company's financial statements. Other Audit Committee Responsibilities - ----------------------------------------- Annually prepare a report to shareholders as required by the Securities and Exchange Commission. The report should state whether the Committee has: (i) reviewed and discussed the audited financial statements with management; (ii) discussed with the independent auditors the matters required to be discussed by SAS No. 61, including: (a) the methods used to account for significant transactions; (b) the effect of significant accounting policies in controversial or emerging areas for which there is a lack of authoritative guidance or consensus; (c) the process used by management in formulating particularly sensitive accounting estimates and the basis for the auditor's conclusions regarding the reasonableness of those estimates; and (d) disagreements with management over the application of accounting principles, the basis for management's accounting estimates, and the disclosures in the financial statements; (iii) received written disclosures from the independent auditors regarding their independence as required by Independence Standards Board Standard No. 1, and has discussed the independent auditors' independence with the independent auditors; and (iv) based on the foregoing, recommend to the Board that the audited financial statements be included in the Company's annual report for the last fiscal year for filing with the SEC. Perform any other activities consistent with this charter, the Company's by-laws, and governing law that the Committee or the Board deems necessary or appropriate. Review examination reports rendered by regulatory authorities and evaluate the adequacy of management's response. 4. Safe Harbor Statement While the Committee has the responsibilities and powers set forth in this charter, it is not the duty of the Committee to plan or conduct audits or to determine that the Company's financial statements are complete, accurate and in accordance with generally accepted accounting principles. That is the responsibility of management and the independent auditors. Nor is it the duty of the Committee to conduct investigations or to resolve disagreements, if any, between members of management. EX-99.1 6 doc4.txt CEO CERTIFICATION EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Coastal Bancorp, Inc. (the "Company") on Form 10-K for the year ended December 31, 2002 as filed with the Securities and Exchange Commission on March 25, 2003 (the "Report"), I, Manuel J. Mehos, Chairman of the Board and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 25, 2003 By /s/ Manuel J. Mehos ------------------- Manuel J. Mehos Chairman of the Board and Chief Executive Officer EX-99.2 7 doc5.txt CFO CERTIFICATION EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Coastal Bancorp, Inc. (the "Company") on Form 10-K for the year ended December 31, 2002 as filed with the Securities and Exchange Commission on March 25, 2003 (the "Report"), I, Catherine N. Wylie, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated March 25, 2003 By /s/ Catherine N. Wylie ----------------------- Catherine N. Wylie Chief Financial Officer EX-99.3 8 doc6.txt FORWARD LOOKING STATEMENT EXHIBIT 99.3 STATEMENT OF FACTORS UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 From time to time, Coastal Bancorp, Inc. ("Coastal" or "we," "us," "our" and other terms referring to Coastal Bancorp, Inc. and Coastal Banc ssb) has made and will make forward-looking statements. These statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements often use words such as "anticipate," "target," "expect," "estimate," "intend," "plan," "goal," "believe" or other words of similar meaning. Forward-looking statements give Coastal's current expectations or forecasts of future events, circumstances or results. Our disclosure in this report, including in the Section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A"), contains forward-looking statements. We also may make forward-looking statements in its other documents filed with the Securities and Exchange Commission (the "SEC") and in other written materials. In addition, Coastal's senior management may make forward-looking statements orally to analysts, investors, representatives of the media and others. Any forward-looking statements made by or on behalf of Coastal speak only as of the date they are made. We do not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made. The reader should, however, consult any further disclosures of a forward-looking nature we may make in our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. All forward-looking statements, by their nature, are subject to risks and uncertainties. Coastal's actual future results may differ materially from those set forth in our forward-looking statements. Factors that might cause our future financial performance to vary from that described in our forward-looking statements include the credit, market, operational, liquidity, interest rate and other risks discussed in the MD&A section of this report and in other periodic reports filed with the SEC. In addition, the following discussion sets forth certain risks and uncertainties that we believe could cause our actual future results to differ materially from expected results. However, other factors besides those listed below or discussed in Coastal's reports to the SEC also could adversely affect our results, and the reader should not consider any such list of factors to be a complete set of all potential risks or uncertainties. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995. WE ARE VULNERABLE TO CHANGES IN INTEREST RATES. Our ability to make a profit, like that of most financial institutions, substantially depends upon our net interest income, which is the difference between the interest income we earn on our interest-earning assets, such as loans and investment securities, and the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings. Certain assets and liabilities, however, may react in different degrees to changes in market interest rates. Further, interest rates on some types of assets and liabilities may fluctuate prior to changes in broader market interest rates, while rates on other types may lag behind. Additionally, some of our assets, such as adjustable rate mortgages, have features, including payment and rate caps, which restrict changes in their interest rates. Factors such as inflation, recession, unemployment, money supply, acts of terrorism, international disorders, instability in domestic and foreign financial markets, and other factors beyond our control may affect interest rates. Changes in market interest rates will also affect the level of voluntary prepayments on our loans and the receipt of payments on our mortgage-backed securities resulting in the receipt of proceeds that may be reinvested at a lower rate than the loan or mortgage-backed security being prepaid. Although we pursue an asset-liability management strategy designed to manage our risk resulting from changes in market interest rates, changes in interest rates can still have a material adverse effect on our profitability. OUR EXPOSURE TO CREDIT RISK WILL INCREASE AS WE INCREASE OUR COMMERCIAL BANKING ACTIVITIES. As we increase our focus on commercial business banking and attempt to increase our net interest margin, a gradual increase in our consolidated credit risk is likely to occur. One of our main strategies is to replace lower-yielding first lien single-family residential mortgage loans and mortgage-backed securities with commercial and consumer loans. Generally, commercial loans (including commercial and multi-family real estate loans) are considered to be riskier than first lien, single-family residential loans because they have larger balances to a single borrower or group of related borrowers and because their repayment generally relies on the success of the borrowing enterprise. In addition, consumer loans are usually secured by depreciating assets (such as cars and boats) and collections are dependent on the borrowers' continuing financial stability, which is more likely to be adversely affected by job loss, divorce, illness and personal bankruptcy. Accordingly, we expect higher loan losses on this type of lending. If we have to provide for loan losses that are higher than our historical experience, our results of operations and financial condition could be adversely affected. OUR ALLOWANCE FOR LOAN LOSSES MAY BE INADEQUATE TO COVER LOSSES ACTUALLY INCURRED, WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION. We maintain an allowance for loan losses in an amount management believe is sufficient to provide for known and inherent risks in our loan portfolio. If we incur actual losses on our loans in excess of our allowance for loan losses, our profitability may be adversely affected. THE CONCENTRATION OF OUR LOAN PORTFOLIO IN TEXAS AND CALIFORNIA SUBJECTS US TO RISK TO THE EXTENT THE CALIFORNIA AND TEXAS ECONOMIES EXPERIENCE PROBLEMS. A substantial portion of the loans we originate and purchase are secured by properties located in Texas and California or are made to businesses which operate in those states. As a result, a large number of borrowers may be affected by adverse changes in the economic conditions occurring in those states. The Texas economy has been historically sensitive to business cycles, particularly those in the oil and gas industry. Unfavorable economic conditions in Texas could significantly increase the number of borrowers which are unable to pay their loans on a timely basis and cause a decline in the value of the properties securing our loans which could have an adverse effect on our results of operations and financial condition. The California economy experienced a major slowdown in 2001 which continued in 2002. Economic conditions in California are subject to various uncertainties at this time, including the long-term impact of the electrical power crisis and the decline in the technology sector. If economic conditions in California continue to decline, we expect that our level of problem assets could increase accordingly. WE MAY FAIL TO IDENTIFY OR CONSUMMATE ADDITIONAL ACQUISITIONS. Our business strategy has historically relied, in part, upon our ability to obtain low cost deposits, expand into new markets and enhance our presence in existing markets by identifying and acquiring branches of other financial institutions or whole banks that meet our acquisition criteria. In pursuing these opportunities, we compete with other financial institutions with similar acquisition strategies, many of which are larger than we are and have greater financial and other resources than we have. We will compete for potential acquisitions based on a number of factors, including price, terms and conditions, size, access to capital and our ability to offer cash, stock or other forms of consideration. We cannot assure you that we will be able to identify suitable acquisition candidates or, once a suitable acquisition candidate is identified, that we will be able to consummate the acquisition on terms and conditions acceptable to us or at all. WE MAY FAIL TO INTEGRATE OUR ACQUISITIONS SUCCESSFULLY. We have grown through the acquisition of branches of other financial institutions or of whole banks. To a certain extent, our success is tied to our ability to integrate the operations, management, products and services of the entities we acquire. After each acquisition, we must expend substantial managerial, operating, financial and other resources to integrate these entities. In particular, we must install and standardize adequate operational and control systems, deploy or modify certain equipment, implement marketing efforts in new as well as existing locations and employ and maintain qualified personnel. Our operating results may be adversely affected if we fail to properly integrate companies we acquire. COMPETITION WITH OTHER FINANCIAL INSTITUTIONS COULD ADVERSELY AFFECT OUR PROFITABILITY. We face substantial competition in purchasing and originating loans and in attracting deposits. This competition in purchasing and originating loans comes principally from banks, other savings institutions, mortgage banking companies and other lenders and purchasers of loans. Many of our competitors enjoy competitive advantages including greater financial resources, a wider geographic presence or more accessible branch office locations, the ability to offer additional services or more favorable pricing alternatives and lower origination and operating costs. This competition could result in a decrease in loans originated or purchased by us that could adversely affect our results of operations, and financial condition. In attracting deposits, we compete with insured depository institutions such as savings institutions, credit unions and banks, as well as institutions offering uninsured investment alternatives including money market funds. These competitors may offer higher interest rates than we do, which could result in either our attracting fewer deposits or in our being required to increase our rates in order to attract deposits. Increased deposit competition could increase our cost of funds and adversely affect our ability to generate the funds necessary for our lending operations, thereby adversely affecting our results of operations and financial condition. CHANGES IN STATUTES AND REGULATIONS COULD ADVERSELY AFFECT US. We are subject to extensive regulation and supervision by federal and state authorities. Such supervision and regulation establish a comprehensive framework of activities in which an institution may engage, and are intended primarily for the protection of the federal deposit insurance fund and our depositors. This regulatory structure also provides our regulators with significant discretion in the performance of their supervisory and enforcement duties. Any change in such regulation, whether by our regulators or as a result of legislation subsequently enacted by the Congress of the United States or the Texas legislature, could have a substantial impact on our operations and us. Additional legislation and regulations may be enacted or adopted in the future that could significantly affect our powers, authority and operations, which could have a material adverse effect on our operations. -----END PRIVACY-ENHANCED MESSAGE-----