-----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, VYkis6D1CeAEY/8BgM/u25HRgFAeiLo4pSsXcWzUG1Y2nEDUVrxfWK3rfWMhrp59 K6EN2t3wfiTpy08Q4I1mXA== 0000919805-98-000008.txt : 19980325 0000919805-98-000008.hdr.sgml : 19980325 ACCESSION NUMBER: 0000919805-98-000008 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980324 SROS: NASD 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: SEC FILE NUMBER: 000-24526 FILM NUMBER: 98571422 BUSINESS ADDRESS: STREET 1: 5718 WESTHEIMER STREET 2: SUITE 600 CITY: HOUSTON STATE: TX ZIP: 77057 BUSINESS PHONE: (713)435-5327 MAIL ADDRESS: STREET 1: 5718 WESTHEIMER STREET 2: SUITE 600 CITY: HOUSTON STATE: TX ZIP: 77057 FORMER COMPANY: FORMER CONFORMED NAME: COASTAL BANC SAVINGS ASSOCIATION DATE OF NAME CHANGE: 19970110 FORMER COMPANY: FORMER CONFORMED NAME: COASTAL BANCORP INC/TX/ DATE OF NAME CHANGE: 19940718 10-K 1 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 THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended DECEMBER 31, 1997 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 (I.R.S. 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) 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. [ ] As of March 13, 1998, the aggregate market value of the 3,989,317 shares of Common Stock of the Registrant issued and outstanding on such date, excluding 1,045,718 shares held by all directors and executive officers of the Registrant as a group, was $131,647,461. This figure is based on the closing sale price of $33.00 per share of the Company's Common Stock on March 13, 1998, as reported in The Wall Street Journal on March 16, 1998. - -------------------------- Number of shares of Common Stock outstanding as of March 13, 1998: 5,035,035 DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents incorporated by reference and the Part of Form 10-K into which the document is incorporated: (1) Portions of the Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1997, are incorporated into Part II, Items 5-8 of this Form 10-K. (2) Portions of the Registrant's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders are incorporated into Part III, Items 10-13 of this Form 10-K. PART I. ITEM 1. BUSINESS - ------------------ COASTAL BANCORP, INC. Coastal Bancorp, Inc. (the "Company") is engaged primarily in the business of serving as the ultimate 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 (the "Association") into the holding company form of organization. The reorganization occurred in July 1994. In addition, in July 1994, the Association converted to a Texas-chartered savings bank operating under the name 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, the Bank became a wholly-owned subsidiary of HoCo and HoCo became a wholly-owned subsidiary of the Company. The reorganizations were treated as combinations similar to a pooling of interests. Accordingly, the financial information and references presented herein have been restated to give effect where appropriate, as if the reorganizations had occurred at the earliest date presented. In October 1997, Coastal Banc Capital Corp. ("CBCC") was formed as a wholly-owned subsidiary of HoCo. CBCC, a registered broker-dealer, was initially formed to trade secured and unsecured whole loan assets primarily for the Bank and for other businesses. At December 31, 1997, HoCo's equity investment in CBCC was $76,000. CBCC had a net loss of $24,000 for the year ended December 31, 1997. On June 30, 1995, the Company issued $50.0 million of 10.0% Senior Notes due June 30, 2002 (the "Senior Notes"). The Senior Notes are redeemable at the Company's option, in whole or in part, on or after June 30, 2000, at par, plus accrued interest to the redemption date. Of the proceeds received from the issuance of the Senior Notes, $44.9 million was used to purchase 11.13% Noncumulative Preferred Stock, Series B, of the Bank (the "Series B Preferred Stock") which is now owned by HoCo. At December 31, 1997, the Company had total consolidated assets of $2.9 billion, total deposits of $1.4 billion, $28.8 million in Series A Preferred Stock and stockholders' equity of $104.8 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 Company is also subject to various reporting and other requirements of the Securities and Exchange Commission (the "SEC"). The Company's executive offices are located at Coastal Banc Plaza, 5718 Westheimer, Suite 600, Houston, Texas 77057, and its telephone number is (713) 435-5000. COASTAL BANC SSB The Bank is a Texas-chartered, Federally insured state savings bank. It is headquartered in Houston, Texas and operates through 37 branch offices in metropolitan Houston, Austin, Corpus Christi and small cities in the south east quadrant of Texas. The Bank was originally acquired by an investor group (which includes a majority of the Board of Directors and the present Chairman of the Board, President and Chief Executive Officer of the Company) in 1986 as a vehicle to take advantage of the failures and consolidation in the Texas banking and thrift industries. The Bank has acquired deposits and branch offices in transactions with the Federal government and other private institutions, in addition to acquiring an independent national bank in 1995, as a base for the Bank's ongoing savings bank business and shift towards commercial banking. 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. Accordingly, although originally organized in 1954, the Bank in its current form effectively commenced operations with the 1986 change in control. By December 31, 1997, the Bank's total assets had increased to $2.9 billion, total deposits were $1.4 billion and stockholders' equity totaled $174.2 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 relatively low credit risk. In carrying out this strategy and to ultimately provide a respectable 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) minimizing credit risk; 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 has implemented the first operating principle, developing and expanding a core deposit base, beginning in 1988 through a series of transactions with the Federal government and private sector financial institutions, gaining in the process entry into additional markets in Houston, Austin, Corpus Christi, San Antonio and south Texas. 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. See "The Southwest Plan Acquisition." Since completion of the Southwest Plan Acquisition, the Bank has entered into six branch office acquisitions and one whole bank acquisition: two with an instrumentality of the Federal government (acting as the receiver of insolvent financial institutions) and five with other private institutions. In each, the Bank generally agreed to acquire certain assets in consideration of the assumption of certain deposit and other liabilities with respect to each institution. In addition, in 1996 the Bank chose to exit two Texas cities, San Antonio and San Angelo. The Bank sold its San Angelo branch and exchanged its three San Antonio branches for one branch in Bay City, Texas. In the first branch acquisition, completed in 1990, the Bank assumed deposits of $151.1 million in connection with the acquisition of nine branch offices, which are primarily located in the northwestern Houston metropolitan area. The acquisition provided the Bank with further penetration in the Houston market. In the second branch acquisition, completed in 1991, the Bank assumed deposits of $71.4 million in connection with the acquisition of an office located in Victoria, Texas. The acquisition of that office expanded the Bank's presence in the small cities market southwest of Houston toward Port Lavaca. In the third branch acquisition, completed in 1993, the Bank assumed deposits of $386.4 million in connection with the acquisition of nine branches located in Corpus Christi, San Antonio, Conroe, Brenham and Sealy. The Corpus Christi and San Antonio branch acquisitions allowed the Bank to enter new markets. In the fourth branch acquisition, also completed in 1993, the Bank assumed deposits of $45.7 million and acquired two branches located in Harlingen and McAllen, two small cities southwest of Houston in the Rio Grande Valley (the "Valley"). As a result of this acquisition, the Bank increased its presence in the Valley. In the fifth branch acquisition, which was completed in December 1994, the Bank assumed deposits of $150.2 million and acquired eight branches located in San Angelo, Marble Falls, Kingsland, Llano, Giddings, Buchanan Dam, Mason and Burnet, which allowed the Bank to enter new markets in central Texas. In 1995, the Bank continued to expand its market presence by opening two de novo branches in the Houston metropolitan area and by completing its first whole bank acquisition. On November 1, 1995, the Bank consummated the acquisition of all of the outstanding capital stock of Texas Capital Bancshares, Inc. ("Texas Capital"). As a result of the acquisition of Texas Capital, Texas Capital Bank, N.A., a national banking association, with five branch offices, located in Houston, Katy, Richmond and Austin and total assets of $170.7 million, was merged with and into the Bank. In 1996, the Bank consummated the sale of its San Angelo location which had $14.9 million in deposits and was acquired in the Bank's December 1994 branch acquisition. In connection with this sale, the Bank recorded a $521,000 gain before applicable income taxes. On September 5, 1996, the Bank consummated the exchange of its three San Antonio branches having deposits of $53.8 million for a branch in Bay City, Texas having deposits of $79.8 million. In 1997, the Bank completed the acquisition of a branch in Port Arthur, Texas having deposits of $54.6 million. All of these transactions resulted in the net assumption of $1.6 billion of deposits and the acquisition of 46 branch offices (after the San Angelo branch sale and the swap of the San Antonio branches). The Bank has also opened six de novo branches since inception. Since its first acquisition, the Bank has been able to achieve operating economies and improve efficiency by closing an aggregate of 16 branch offices and transferring the deposits to other offices located in the same market areas. The Bank will continue to pursue acquisitions as vehicles for growth, although there can be no assurance that the Bank will be able to continue to grow through acquisitions in the future. In the absence of any available, cost-effective acquisitions, management will continue to focus on internally generated earnings growth including the further development of the Bank's commercial lending and growth of commercial business deposits. INTEREST RATE RISK. The Bank has implemented the second operating principle, minimizing interest rate risk, by matching, to the extent possible, the repricing or maturity of its interest-earning assets to its interest-earning liabilities as well as 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 is achieved through management of the composition of its assets and liabilities. The Bank also attempts to achieve an acceptable interest rate spread between interest-earning assets and interest-bearing liabilities by altering the Bank's cost of funds, or, at times, the yield on certain assets in its portfolio. To accomplish this, the Bank has purchased interest rate swaps and caps. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" set forth in Item 7 hereof. The Bank will originate and purchase for retention in its portfolio only those loans and investments which provide a positive interest rate spread over funding liabilities matched with similar maturities. Consistent with this philosophy, a significant portion of the Bank's assets have been invested in adjustable-rate high quality mortgage-backed securities. At December 31, 1997, of the Bank's $1.5 billion of mortgage-backed securities, $1.3 billion or 85.9%, were invested in adjustable rate mortgage-backed securities. To a lesser extent, the Bank has purchased first lien mortgages on single-family residences, a large portion of which are adjustable rate mortgages. At December 31, 1997, $519.8 million, or 41.2% of the Bank's loans receivable portfolio was comprised of adjustable rate single-family residential mortgage loans. The Bank also originates and purchases fixed and adjustable rate long-term, single-family residential loans primarily for sale into the secondary market. Prior to 1996, this and certain other lending functions were performed for the Bank by its wholly-owned mortgage banking subsidiary, CBS Mortgage Corp. ("CBS Mortgage"). Beginning in 1996, the origination function was performed by the Bank. By originating such loans for sale and generally obtaining a commitment for the purchase of such loans at the time that the loan applications are approved, the Bank avoids a significant portion of the interest rate risk associated with holding fixed-rate mortgage loans. CREDIT RISK. The Bank has implemented the third operating principle, minimizing credit risk, by (i) investing a substantial portion of its assets in cash and mortgage-backed securities, and (ii) taking a cautious approach to the development of its direct lending operations, including commercial business lending. At December 31, 1997, of the Company's $2.9 billion in total assets, $1.5 billion or 52.0% of total assets consisted of mortgage-backed securities and $37.1 million or 1.3% of total assets consisted of cash and cash equivalents. At December 31, 1997, the Company's total net loans receivable portfolio amounted to $1.3 billion or 43.3% of total assets comprised primarily of $688.6 million of first lien residential mortgage loans, $178.3 million of commercial real estate loans and $130.3 million of multifamily mortgage loans, which constituted 54.6%, 14.1% and 10.3%, respectively, of the net loans receivable portfolio. The balance of the net loans receivable portfolio, by dollar amount and percent of the portfolio, was comprised of the following: $98.4 million (or 7.8%) of commercial loans to residential mortgage originators ("Warehouse loans"), $46.2 million (or 3.7%) of residential construction loans, $23.4 million (or 1.9%) of consumer and other loans, $23.2 million (or 1.8%) of real estate acquisition and development loans, $32.5 million (or 2.6%) of loans secured by mortgage servicing rights ("MSR loans"), $29.7 million (or 2.4%) of commercial, financial and industrial loans and $10.8 million (or 0.8%) of commercial construction loans. The Company's non-accrual loans as of such date were $17.4 million or 1.38% of total loans receivable, and the Company's total nonperforming assets were $20.5 million, or 0.71% of total assets. See "Lending Activities-General." 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 branch office system which is able to administer and deliver its products and services in an economical manner. The Bank believes that it has significant operating leverage, and that continued incremental growth will not cause its overhead expenses to increase by a corresponding amount. The growth achieved from the Bank's acquisitions has facilitated reduced overhead levels as a proportion of assets and a lower cost of funds from a more meaningful market share of core deposits. The Company's ratio of noninterest expense to average total assets on a consolidated basis has decreased, from 2.71% for the year ended December 31, 1988 to 1.36% for the year ended December 31, 1997. On September 30, 1996, the Bank recorded the one-time SAIF insurance special assessment (the "Special Assessment") of $7.5 million ($4.8 million after applicable income taxes) as a result of the Federal Deposit Insurance Act, as amended (the "FDIA") being signed into law. The Special Assessment pursuant to the FDIA was equal to 65.7 basis points on the SAIF assessment base of deposits existing as of March 31, 1995. Other provisions of the Act provided for a reduction of the SAIF deposit insurance premium rates beginning in the fourth quarter of 1996. The Bank is subject to regulation by the Department, as its chartering authority and by the FDIC, which regulates the Bank and insures its deposits to the fullest extent provided by law. The Bank also is subject to certain regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") and 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. LENDING ACTIVITIES GENERAL. The Bank has taken a cautious approach to the development and growth of its direct lending operations in order to minimize credit risk. In order to avoid incurring undue credit risk, the Bank historically invested a significant percentage of its assets in alternative financial instruments, particularly mortgage-backed securities, most of which have certain repayments guaranteed by the government or Government Sponsored Enterprises ("GSEs"). See "Mortgage-Backed Securities." The Bank will originate and purchase for retention in its portfolio 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. This strategy is designed to achieve an acceptable risk adjusted rate of return, as determined and continuously evaluated by the Board of Directors. In November 1995, the Bank completed the acquisition of Texas Capital and its $103.3 million in loans. The loans acquired from Texas Capital included first lien residential, multifamily, commercial real estate, residential construction, real estate acquisition and development, commercial, financial and industrial and consumer loans. Utilizing this acquisition as a springboard, the Bank implemented its strategic shift towards building a commercial banking business, which has continued through 1997. The Bank's new concept for originating, underwriting and approving all loans over $1.0 million was implemented during the fourth quarter of 1997. The Portfolio Control Center ("PCC") applies Internet and network computer technology to take a loan from application to closing in less time and incorporating more comprehensive credit information. The PCC is also responsible for the day-to-day monitoring and management of the Bank's assets and liabilities. The following table sets forth information concerning the composition of the Bank's net loans receivable portfolio by type of loan at the dates indicated.
At December 31, 1997 1996 1995 ------------ ------------ ----------- Amount Percent Amount Percent Amount Percent ------------ -------- ------------ -------- ----------- -------- (Dollars in thousands) Real-estate mortgage loans: First lien residential $ 689,767 52.33% $ 791,337 61.96% $ 742,880 66.38% Multifamily 131,454 9.97 139,486 10.92 95,297 8.52 Residential construction 83,359 6.33 77,146 6.04 33,935 3.03 Acquisition and development 31,619 2.40 26,132 2.05 15,517 1.39 Commercial 181,315 13.76 119,004 9.32 122,622 10.96 Commercial construction 14,506 1.10 3,963 0.31 -- -- Commercial, warehouse 98,679 7.49 53,573 4.19 48,822 4.36 Commercial, MSR 32,685 2.48 21,380 1.67 21,548 1.93 Commercial, financial and industrial 30,877 2.34 21,965 1.72 19,860 1.77 Loans secured by savings deposits 8,695 0.66 8,849 0.69 8,292 0.74 Consumer and other 15,030 1.14 14,400 1.13 10,316 0.92 ------------ -------- ------------ -------- ----------- -------- Total loans 1,317,986 100.00% 1,277,235 100.00% 1,119,089 100.00% ------------ ======== ------------ ======== ----------- ======== Loans in process (47,893) (38,742) (11,526) Premium (discount) to record purchased loans, net 1,680 479 (1,366) Unearned interest and loan fees (2,926) (2,344) (1,939) Allowance for loan losses (7,412) (6,880) (5,703) ----------- ----------- ----------- Total loans receivable, net $ 1,261,435 $ 1,229,748 $1,098,555 ============ ============ ===========
SCHEDULED MATURITIES. The following table sets forth certain information at December 31, 1997 regarding the principal amount of loans maturing in the Bank's loans receivable portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. First lien residential mortgage, multifamily mortgage and commercial real estate loans are based on their contractual terms to maturity assuming no periodic amortization of principal.
AT DECEMBER 31, 1997 More than More than More than One year one year to three years five years to or less three years to five years ten years --------- ------------ -------------- -------------- (In thousands) First lien residential mortgage $ 2,408 $ 5,366 $ 9,790 $ 28,934 Multifamily mortgage 73,997 49,975 6,286 1,196 Residential construction 37,124 8,678 352 597 Real estate acquisition and development 5,645 18,142 -- -- Commercial real estate 19,464 76,874 38,091 12,659 Commercial construction 8,345 -- 483 819 Commercial, other 122,000 17,928 20,439 1,873 Consumer and other 10,785 5,814 5,036 1,096 --------- ------------ -------------- -------------- Total loans $ 279,768 $ 182,777 $ 80,477 $ 47,174 ========= ============ ============== ============== AT DECEMBER 31, 1997 More than Over ten years to twenty twenty years years Total ------------- --------- ---------- (In thousands) First lien residential mortgage $ 157,838 $485,431 $ 689,767 Multifamily mortgage -- -- 131,454 Residential construction -- -- 46,751 Real estate acquisition and development -- -- 23,787 Commercial real estate 34,228 -- 181,316 Commercial construction 1,406 -- 11,053 Commercial, other -- -- 162,240 Consumer and other 994 -- 23,725 ------------- -------- ----------- Total loans $ 194,466 $485,431 $1,270,093 ============= ======== ===========
The average maturity 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 existing mortgages are substantially lower than current mortgage loan rates (due to refinancings or 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 amounts of loans due after one year from December 31, 1997 by category and which have fixed or adjustable rates.
Interest-Rate Fixed Adjustable Total --------- ----------- -------- (In thousands) First lien residential mortgage $ 167,357 $ 520,002 $687,359 Multifamily mortgage 9,972 47,485 57,457 Residential construction 7,238 2,389 9,627 Real estate acquisition and development -- 18,142 18,142 Commercial real estate 57,089 104,763 161,852 Commercial construction 1,246 1,462 2,708 Commercial, other 13,077 27,163 40,240 Consumer and other 11,575 1,365 12,940 --------- ----------- -------- Total $ 267,554 $ 722,771 $990,325 ========= =========== ========
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 CBS Mortgage for other institutions, GSEs or entities during the periods presented. See "Mortgage Banking Activities."
Year Ended December 31, 1997 1996 1995 ----------- ----------- ----------- (In thousands) First lien mortgage loan originations: Adjustable rate $ 1,458 $ 3,542 $ 985 Fixed rate 4,849 5,471 746 Adjustable rate by correspondent lenders 26,220 67,461 92,911 Fixed rate by correspondent lenders 686 4,058 -- Residential construction and acquisition and development loan originations 145,727 154,182 61,713 Warehouse loan originations 1,174,639 887,252 549,628 MSR loan originations 55,259 69,172 67,578 Multifamily loan originations 81,148 67,657 42,366 Commercial real estate loan originations 171,497 41,170 29,595 Commercial construction originations 12,222 3,806 -- Commercial, financial and industrial loan originations 43,497 30,080 5,100 Consumer loan originations 18,679 22,256 12,429 ----------- ----------- ----------- Total loan originations 1,735,881 1,356,107 863,051 Purchase of residential mortgage loans 108,226 115,928 298,613 Loans acquired (net) in connection with acquisition and disposition transactions -- 1,018 103,319 Purchase of multifamily and commercial real estate loans -- 4,604 25,045 Purchase of consumer loans 70 -- -- ----------- ----------- ----------- Total loan originations and purchases 1,844,177 1,477,657 1,290,028 ----------- ----------- ----------- Foreclosures 4,226 4,363 3,394 Principal repayments and reductions to principal balance 1,790,790 1,339,691 776,084 Residential loans sold 12,855 -- 679 ----------- ----------- ----------- Total foreclosures, repayments and sales of loans 1,807,871 1,344,054 780,157 ----------- ----------- ----------- Amortization of premiums, discounts and fees on loans (2,819) (485) 3,316 Provision for loan losses (1,800) (1,925) (1,664) ----------- ----------- ----------- Net increase in loans receivable $ 31,687 $ 131,193 $ 511,523 =========== =========== ===========
The following table sets forth the number of bulk loan purchases and the amount of first lien residential mortgage loans acquired by the Bank through bulk purchases for the periods indicated.
Year Ended December 31, 1997 1996 1995 -------- -------- -------- (Dollars in thousands) Amount purchased $107,881 $112,395 $296,452 Number of bulk loan purchases 3 9 24
Personnel from the Bank generally analyze loan bid packages, as they become available, and the PCC reviews 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 pricing 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, 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 that it bids on 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 portfolios that meet the Bank's purchase criteria. Beginning in 1994, the Bank has been originating adjustable rate residential mortgage loans through correspondent lenders. The correspondents originate and immediately sell such loans to the Bank. All such loans are underwritten in accordance with the Bank's policies and procedures. During 1997 (before discontinuing this program), loans purchased from the correspondent lenders totaled $26.9 million. The Bank will directly sell mortgage loans and mortgage loan servicing from time to time in order to replace the loans and servicing with instruments which have higher credit quality and which generate less interest rate risk. In 1997, the Bank sold $12.9 million of first lien residential mortgage loans. While the Bank has the general authority to originate and purchase loans secured by real estate located anywhere in the United States, the largest concentration of its residential first lien mortgage and construction loan portfolios is secured by realty located in 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 time of initiation of the program, management of the Bank surveyed the members of the residential construction industry in the Bank's Houston market area and targeted those companies which management believed, based upon its market research, to be financially strong and reputable. Loans are made primarily to fund residential construction. Construction loans are made on pre-sold and speculative residential homes only in well located, viable subdivisions and planned unit developments. 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 above 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, it must make a separate loan application under the line for a specific loan amount. Each loan commitment under a short-term line of credit is separately underwritten and approved after the builder's master file is updated and reviewed. The Bank also funds construction loans outstanding to builders or individuals under individual construction loans. The terms of the Bank's construction loans are generally for nine months 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 85% 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, in 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 $70,000 and $175,000. 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 a panel of homes on substantially the same terms and conditions as loans granted under the Bank's line of credit program. At December 31, 1997, the Bank had $46.8 million in outstanding residential construction loans (net of loans in process). Of the construction loans outstanding at December 31, 1997, $38.7 million were to 22 builders originated under the Bank's line of credit program and $8.1 million were to builders or individuals under individual construction loans. At the present time, the Bank has approved builders in the Houston, Dallas, and Austin metropolitan areas and is selectively soliciting new builders for its residential construction lending program. 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. The Bank does not otherwise actively solicit construction loans directly or through the mass media. 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 through periodic builder reports and inquiries to the builder's suppliers and subcontractors; 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 50%) of speculative to pre-sold homes in the development. MULTIFAMILY MORTGAGE AND COMMERCIAL REAL ESTATE LENDING. The Bank initiated a program in 1993 to actively seek loans secured by multifamily or commercial properties (primarily retail shopping centers). Multifamily mortgage and commercial real estate loans typically involve higher principal amounts and repayment of the loans generally is dependent, 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 for a short to medium term of between one to seven years, and have floating rates or fixed rates based on a spread over similarly fixed borrowings from the FHLB. The properties securing the loans originated by the Bank are generally located in Texas. The Bank attempts to limit its risk exposure by, among other things: lending to proven developers/owners, generally only considering properties with existing operating performance which can be analyzed, requiring conservative debt coverage ratios, and continually monitoring the operation and physical condition of the collateral. At December 31, 1997, multifamily mortgage loans totaling $131.5 million and commercial real estate loans of $181.3 million were outstanding. The decision to increase commercial real estate lending resulted primarily from the improvement in the local economies throughout Texas, which was reflected in improved occupancy in retail centers together with an improvement in the quality of the borrowers seeking such loans. At December 31, 1997, the Bank had outstanding commercial real estate loans totaling approximately $322,000 that were on non-accrual status, $14,000 of which were acquired from Texas Capital. The Bank began seeking multifamily and commercial real estate construction loans in 1996. The Bank will generally underwrite these loans in the same way it currently underwrites its multifamily mortgage loans and will attempt to manage the risk of such loans by requiring that the builders provide more equity in the project than is required in refinancings, lending to those builders with strong financial statements and requiring that borrowers purchase, if required by the movement of general market interest rates, interest rate caps for their loans. At December 31, 1997, commercial construction loans totaling $14.5 million were outstanding, of which $900,000 was on non-accrual status. WAREHOUSE LENDING. Since 1992, the Bank has provided or participates in lines of credit to mortgage companies generally for their origination of single family residential loans which are normally sold no more than 90 days from origination to the Federal National Mortgage Association (the "FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), Government National Mortgage Association ("GNMA") or to private investors. The lines of credit are generally renewable annually. Borrowers pay interest on funds drawn at a floating rate. In addition, the Bank usually receives a fee for each loan file processed. The Bank holds the original mortgage loan notes and other documentation as collateral until repayment of the related lines of credit, except when a third party bank is acting as the lead bank in the lending relationship. Warehouse loans are underwritten in accordance with Bank policies and procedures. Interested loan originators who contact or are contacted by the Bank are asked to prepare a loan application which seeks detailed information on the originator's business. After evaluating the application and independently verifying the applicant's credit history, if the originator appears to be a likely candidate for approval, Bank personnel will visit the originator and review, among other things, its business organization, management, quality control, funding sources, risk management, loan volume and historical delinquency rate, financial condition, contingent obligations and regulatory compliance. The originator pays a fee for this review to offset a portion of the Bank's expense; this amount is deducted from the origination fee if the line of credit is approved. If the originator meets the established criteria, its application is submitted for approval. Bank personnel attempt to minimize the risk of making Warehouse loans 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: (a) by periodically reviewing each originator's financial statements, loan production delinquency and commitment reports; and, (b) on an annual basis, by reviewing the originator's audited financial statements and the auditor's letter to the originator's board of directors. During 1997, the Bank originated $1.2 billion of Warehouse loans and had such loans outstanding of $98.7 million at December 31, 1997. MSR LENDING. Since 1992, the Bank has 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. The mortgage companies receive fees for servicing mortgage loans which include collecting and remitting loan payments to FNMA, FHLMC and other investors. Loans of this nature generally have terms of one to five years, and are 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 are made at adjustable rates of interest tied to LIBOR or the Bank's borrowing rate plus a spread and a commitment fee. MSR loans are 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. Bank personnel closely monitor MSR borrowers on a semi-annual basis by, among other things, reviewing the borrower's financial condition and operations in the same manner as they do 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 does not exceed 75.0% during the life of the loan. If the continuing loan-to-value ratio exceeds that amount, the borrower is asked to repay a portion of the principal balance to maintain the ratio limit. At December 31, 1997, the Bank had $32.7 million in outstanding MSR loans. REAL ESTATE ACQUISITION AND DEVELOPMENT LENDING. The Bank has increased the number of loans originated to residential real estate builders and developers 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 saleable lots. The Bank generally lends only to the major developers with good track records and strong financial capacity and on property where substantially all of the lots to be developed are pre-sold. The term of the loans have generally been from 18 to 24 months at a spread over the prime rate, plus an origination fee. Repayment on the loans is generally made as the lots are sold to builders. Land acquisition and development loans involve additional risks when compared to loans on existing residential properties. 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, 1997, the Bank had $31.6 million of real estate acquisition and development loans outstanding. COMMERCIAL BUSINESS LENDING. Development of a commercial business lending program is a strategic goal of Bank management. The Texas Capital acquisition provided the Bank with an established commercial business lending program to small and medium sized companies primarily in the Houston and Austin metropolitan areas. In 1997, management continued to develop the infrastructure for commercial business lending in most of the Bank's major markets. The commercial, financial and industrial loans ("Commercial Business loans") are generally made to provide working capital financing or purchase 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) at a spread over prime rate 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 the acquired commercial business lending program, while managing the associated credit risk by monitoring borrowers' financial position and underlying collateral securing the loans. At December 31, 1997, Commercial Business loans outstanding totaled $30.9 million, of which $485,000 ($336,000 acquired from Texas Capital) was on non-accrual status. CONSUMER LENDING. The Bank makes available traditional consumer loans, such as home improvement, new and used car financing, new and used boat and recreational vehicle financing and loans secured by savings deposits. 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, 1997, the Bank had $23.7 million in consumer loans outstanding, of which $8.7 million were savings deposit secured loans. At December 31, 1997, loans totaling $53,000 in this category were on non-accrual status. Consumer loans (other than savings 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, 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. The Bank's consumer loan lending territory approximates the markets served by its retail branches. Persons desiring consumer loans are typically individuals who have a pre-existing banking relationship with the Bank. 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 closely 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 attempts to determine an appropriate course of action by 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, 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. All costs incurred from the date of acquisition forward relating to maintaining the property are recorded as a current 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 non-accrual status, previously accrued but unpaid interest is 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, primarily if management believes that the individual loan is in the process of collection and the interest is fully collectible. At December 31, 1997, 1996 and 1995, the Bank had the following loans which were 90 days or more delinquent and were on accrual status:
At December 31, 1997 1996 1995 ----- ------- ----- (Dollars in thousands) First lien single family mortgage $ -- $ 106 $ -- Residential construction 79 52 -- Commercial real estate 91 881 -- Commercial, financial and industrial 120 14 231 Consumer 50 142 -- ----- ------- ----- Total $ 340 $ 1,195 $ 231 ===== ======= =====
The following table sets forth information regarding the Bank's non-accrual loans and REO as of the dates shown.
At December 31, -------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (Dollars in thousands) Non-accrual loans: First lien single family mortgage $ 15,591 $12,238 $12,925 Residential construction -- -- 353 Commercial real estate 322 32 965 Commercial construction 900 -- -- Commercial, financial and industrial 485 496 337 Consumer 53 73 42 ---------- -------- -------- Total non-accrual loans 17,351 12,839 14,622 Total REO and repossessed assets 3,198 3,161 4,216 ---------- -------- -------- Total nonperforming assets $ 20,549 $16,000 $18,838 ========== ======== ======== Ratio of nonperforming assets to total assets 0.71% 0.56% 0.68% ========== ======== ======== Ratio of non-accrual loans to total loans receivable 1.38% 1.04% 1.33% ========== ======== ========
At December 31, 1997, approximately $925,000 in additional interest income would have been recorded in the year then ended on the above loans accounted for on a non-accrual 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. For the year ended December 31, 1997, $827,000 in interest income was included in net income for these same loans prior to the time they were placed on non-accrual status. At December 31, 1997, the Bank had 236 first lien residential mortgage loans in non-accrual status, aggregating $15.6 million, with an average balance of approximately $66,000. A total of 211 of these loans, with an aggregate balance of $12.9 million, were acquired through bulk loan purchases, 2 of these loans, with an aggregate balance of $29,000, were acquired through the Southwest Plan Acquisition and 2 of these loans, with an aggregate balance of $113,000, were acquired in the Texas Capital acquisition. Of the 211 residential mortgage loans acquired through bulk purchases, at December 31, 1997, 32 of such loans totaling $1.3 million were being serviced by other institutions, which constituted 3.8% of the $35.6 million of aggregate loans serviced by others. At December 31, 1997, nonperforming assets included REO with an aggregate book value of $3.2 million and repossessed assets of $12,000. At such date, the Bank's REO consisted of 36 single family residential properties and 5 commercial properties (acquired from Texas Capital). At December 31, 1997, in addition to the loans in non-accrual status, the Bank had $9.8 million in loans classified as substandard, $42,000 classified as doubtful and $10.7 million of loans designated as "special mention" for regulatory purposes. Of these loans, $1.1 million of the substandard loans and $282,000 of the "special mention" loans were acquired from Texas Capital. Loans designated as "special mention" are not currently required to be classified for regulatory purposes but have potential weaknesses or risk characteristics that could result in future problems. On January 1, 1995, the Bank adopted the Financial Accounting Standards Board's (the "FASB") Statement of Financial Accounting Standards No. 114 (Statement 114), "Accounting by Creditors for Impairment of a Loan," as amended by Statement 118. Under Statement 114, a loan is impaired when it is "probable" that a creditor will be unable to collect all amounts due (i.e., both principal and interest) according to the contractual terms of the loan agreement. Statement 114 requires that the measurement of impaired loans be based on (i) the present value of the expected future cash flows discounted at the loan's effective interest rate, (ii) the loan's observable market price, or (iii) the fair value of the loan's collateral. Statement 114 does not apply to large groups of smaller balance homogeneous loans that are collectively evaluated for impairment. The Bank collectively reviews all first-lien residential loans under $500,000 as a group and all consumer and other loans as a group for impairment, excluding loans for which foreclosure is probable. The adoption of Statement 114, as amended by Statement 118, had no material impact on the Bank's consolidated financial statements as the Bank's existing policy of measuring loan impairment was generally consistent with methods prescribed in these standards. 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, 1997, the carrying value of loans that are considered to be impaired under Statement 114 totaled approximately $2.0 million (all of which were on non-accrual) and the related allowance for loan losses on those impaired loans totaled $1.1 million. The average balance of impaired loans during the year ended December 31, 1997 was approximately $897,000. For the year ended December 31, 1997, the Bank did not recognize interest income on loans considered impaired. The Bank had loaned $83.4 million at December 31, 1997, under its residential construction lending program to multiple borrowers who are engaged in similar activities. These borrowers could be similarly impacted by economic conditions in Texas. See "Residential Construction Lending." Except for concentrations in its Warehouse lending lines, the Bank had no other loan concentrations. At December 31, 1997, the Bank had $98.7 million of Warehouse loans outstanding. See "Warehouse Lending." ALLOWANCE FOR LOAN LOSSES. The Bank maintains loan loss allowances to absorb future losses that may be realized 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, ---------------------------- 1997 1996 1995 -------- -------- -------- (Dollars in thousands) Balance at beginning of year $ 6,880 $ 5,703 $ 2,158 Charge-offs(1) (1,416) (851) (404) Recoveries 148 103 17 Provisions for loan losses 1,800 1,925 1,664 Acquisition allowance adjustment(2) -- -- 2,268 -------- -------- -------- Balance at end of the year $ 7,412 $ 6,880 $ 5,703 ======== ======== ======== Ratio of net charge-offs during the period to average net loans outstanding during the period 0.10% 0.06% 0.05% ======== ======== ========
(1)In 1997, $591,000 of the charge-offs were attributable to single family residential loans, $472,000 to Commercial Business loans, $349,000 to consumer and other loans and $4,000 to commercial real estate loans. In 1996, $651,000 of the charge-offs were attributable to single family residential loans, $142,000 to consumer and other loans and $58,000 to Commercial Business loans. In 1995, $359,000 of the charge-offs were attributable to single family residential loans and $45,000 to consumer and other loans. (2)The acquisition allowance adjustment in 1995 represents the amount allocated to the allowance for loan losses during the year in connection with (i) a bulk loan package acquired and (ii) the loans acquired in the Texas Capital acquisition. 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, 1997 1996 1995 ------- ------- ------- (In thousands) First lien residential mortgage $ 2,566 $ 2,217 $ 2,992 Multifamily mortgage 511 369 249 Residential construction 251 223 307 Real estate acquisition and development 316 261 130 Commercial real estate 1,468 1,151 1,072 Commercial construction 203 20 -- Commercial, Warehouse and MSR 494 361 230 Commercial, financial and industrial 1,008 985 395 Consumer and other 233 374 177 Unallocated 362 919 151 ------- ------- ------- $ 7,412 $ 6,880 $ 5,703 ======= ======= =======
The following table sets forth the allocation of the provision (reduction of allowance) for loan losses by loan type during the periods indicated.
At December 31, 1997 1996 1995 -------- -------- -------- (In thousands) First lien residential mortgage $ 908 $ (180) $ 1,032 Multifamily mortgage 142 120 23 Residential construction 28 (84) (67) Real estate acquisition and development 55 131 (25) Commercial real estate 321 79 479 Commercial construction 183 20 -- Commercial, Warehouse and MSR 133 131 132 Commercial, financial and industrial 416 618 -- Consumer and other 171 322 90 Unallocated (557) 768 -- -------- -------- -------- $ 1,800 $ 1,925 $ 1,664 ======== ======== ========
Provisions for loan losses, currently $450,000 per quarter, are charged to earnings to bring the total allowance to a level deemed appropriate by management based on such factors as historical experience, the volume and type of lending conducted by the Bank, the amount of nonperforming assets, industry standards, regulatory policies, generally accepted accounting principles, general economic conditions, particularly as they relate to the Bank's lending area, and other factors related to the collectibility of the Bank's loan portfolio. The Bank periodically reviews its loan loss allowance policy, at a minimum, annually. As a result of a comprehensive revision of such policy in 1996, the Bank changed its method of assessing the adequacy of the allowance for loan losses. The revised policy provides that the Bank will annually 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 the allocation methodology described below. The policy provides that any "excess" based on this calculation will be maintained in the allowance for loan losses as "unallocated". The minimum allowance allocation to first lien residential mortgage loans greater than 90 days delinquent is a general allocation of 5% of the aggregate net book value. All other first lien residential mortgage loans are allocated a general allowance of 0.10% of the aggregate net book value. The Bank generally allocates the allowance to multifamily, residential construction, commercial construction, real estate acquisition and development, commercial real estate, Warehouse, MSR, Commercial Business and consumer and other loans in the following percentages of outstanding principal amounts: 0.25%, 0.25%, 0.50%, 1.0%, 0.50%, 0.25%, 0.50%, 1.0% and 1.0%. In addition, a general allowance allocation is calculated on unfunded commitments and letters of credit using the general allowance percentages described above for the applicable loan type. Specific allowances are established by management on specific loans as considered necessary. The Bank's management believes that its present allowance for loan losses is adequate based upon, among other considerations, the factors discussed above, its low level of nonperforming loans and its historical loss experience. Management continues to review its loan portfolio to determine whether its loan loss allowance policy 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 loan loss allowances. These agencies may require the Bank to establish additional loan loss allowances, based on their respective judgments of the information available at the time of the examinations. MORTGAGE BANKING ACTIVITIES LOAN ORIGINATIONS AND SALES. Through 1995, the Bank's wholly-owned subsidiary, CBS Mortgage, originated loans for the Bank and for others secured by first lien mortgages on completed single family residences located principally in the Houston metropolitan area and in geographic areas surrounding the Bank's branch locations. Beginning on January 1, 1996, the origination function was performed by the Bank, with CBS Mortgage's activities then limited to primarily loan servicing. The Bank's present policy is to originate or purchase and then sell to third party investors fixed rate residential mortgage loans principally to avoid the interest rate and credit risk associated with holding fixed rate mortgage loans in portfolio. During the years ended 1997, 1996 and 1995, the Bank (in 1997 and 1996) and CBS Mortgage (in 1995) originated or purchased with the intent to sell $4.1 million, $11.2 million and $8.8 million, respectively, of single family residential mortgage loans and sold $4.4 million, $11.7 million and $8.3 million, respectively, of such loans to secondary market investors ("SMI"). During 1997, 1996 and 1995, the Bank (in 1997 and 1996) and CBS Mortgage (in 1995) originated residential real estate loans for portfolio totaling $6.3 million, $9.0 million, and $1.7 million, respectively. "Pipeline risk," which is inherent in mortgage lending operations, arises when the originator of a loan makes an uncovered commitment to lend funds to a borrower at a locked-in rate of interest over the period of time which is required for the lender to close and/or sell the loan. The risk is that market rates of interest will move higher in the period between the time of commitment and the time of funding the loan, and the lender will thereafter have difficulty finding a buyer for such loan at a break-even or better price. Management of the Bank and of CBS Mortgage believe that its loan origination strategy eliminates to a large extent any "pipeline risk." The majority of applications taken are accepted on the basis that rates will be set immediately prior to closing. Applications that carry a locked-in rate are covered for interest rate risk by the use of the forward sales of mortgage-backed securities or by registering each loan with an investor that offers loan-by-loan protection until closing and delivery to the investor. Through 1995, CBS Mortgage made available a variety of mortgage products designed to respond to consumer needs and competitive factors. Beginning on January 1, 1996, with the transfer of the origination function, these mortgage products were being made available from the Bank, although not actively solicited. 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. 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 FNMA or FHLMC, which is presently $227,150, or loans that do not otherwise meet the criteria established by FNMA or FHLMC) are also originated. Such loans are originated based on underwriting guidelines or standards required by the SMI to whom such loans are intended to be sold. During 1997, fewer than 10% of the mortgage loans originated by the Bank were non-conforming mortgage loans. In addition to 15-year and 30-year conventional mortgages, CBS Mortgage offered and now 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 its customers 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 and CBS Mortgage'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 CBS Mortgage or the Bank. However, if a request for a refinancing is received, borrowers are offered current mortgage loan products. Refinancings are processed in a manner identical to original originations and are charged the same fees as charged for original originations. LOAN SERVICING. CBS Mortgage services residential real estate loans owned by the Bank as well as for others, including FNMA, FHLMC and other private mortgage investors. Loan servicing includes 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. Funds that have been escrowed by borrowers for the payment of mortgage related expenses, such as property taxes and hazard and mortgage insurance premiums, are maintained in non-interest-bearing accounts at the Bank. At December 31, 1997, the Bank had $6.2 million deposited in such escrow accounts. CBS Mortgage receives fees for servicing mortgage loans, which generally range from 0.250% to 0.375% per annum on the declining principal balance of fixed rate mortgage loans and from 0.375% to 0.500% per annum on the declining principal balance of adjustable rate mortgage loans. Such fees serve to compensate CBS Mortgage for the costs of performing the servicing function. Other sources of loan servicing revenues include late charges and other ancillary fees. For the years ended 1997, 1996 and 1995, the Bank earned $1.4 million, $1.6 million and $2.0 million, respectively, in conjunction with CBS Mortgage's loan servicing. Servicing fees are collected by CBS Mortgage out of the monthly mortgage payments made by borrowers and are net of the amortization of mortgage servicing rights. CBS Mortgage's servicing portfolio is subject to reduction by normal amortization, by prepayment or by foreclosure of outstanding loans. At December 31, 1997, 1996 and 1995, CBS Mortgage had an aggregate loan servicing portfolio of $1.6 billion, $1.7 billion and $1.7 billion, respectively. Of these amounts at such respective dates, CBS Mortgage serviced loans for the Bank aggregating $879.6 million, $958.2 million and $824.6 million and loans for others aggregating $675.7 million, $776.7 million and $900.7 million. At December 31, 1997, 56.6% of the dollar value of loans being serviced by CBS Mortgage was for the Bank, 14.9% was being serviced for FHLMC, 26.7% was being serviced for FNMA and 1.8% was being serviced for others. Beginning in 1990, in order to increase the size of its loan servicing portfolio, CBS Mortgage began to purchase bulk packages of mortgage servicing rights from the Federal government and other institutions on a competitive bid basis. The purchased mortgage servicing rights which were acquired in 1990 and 1991 were primarily conventional loans secured by real property. The bulk purchase market for loan servicing was attractive to purchasers in the early 1990s due to the relatively large amounts of such servicing rights that were being sold by banks and thrift institutions due to the introduction of new regulatory capital standards, and by the Resolution Trust Corporation as part of its liquidation function. Prices bid on these bulk offerings ranged from 0.35% to 1.25% of the principal balance of the underlying mortgages. Between 1992 and 1994, CBS Mortgage pursued the purchase of servicing rights from private institutions. The packages of servicing rights purchased from the private institutions during this period were purchased at prices which have generally ranged between 0.82% to 1.47% on the principal balances of the underlying mortgages. No servicing rights were purchased by CBS Mortgage in 1997, 1996 or 1995. As of December 31, 1997, an aggregate of $675.7 million of CBS Mortgage's $1.6 billion servicing portfolio, or 43.4%, was loans serviced for others. At December 31, 1997, CBS Mortgage had no commitments for further purchases of mortgage servicing rights. The amount, if any, by which purchased mortgage servicing rights exceed the lower of 90% of determinable fair market value, 90% of origination cost or current amortized book value must be deducted from capital in calculating regulatory capital. See "Regulation - Regulatory Capital Requirements." At December 31, 1997, there were no deductions from capital for purchased mortgage servicing rights valuation adjustments. The following table sets forth certain information regarding CBS Mortgage's servicing portfolio of mortgage loans for the periods indicated.
Year Ended December 31, 1997 1996 1995 ----------- ----------- ----------- (In thousands) Beginning servicing portfolio $ 1,735,089 $ 1,725,400 $ 1,511,263 ----------- ----------- ----------- Loans originated(1) -- -- 8,810 Bank loan originations 140,673 104,023 68,960 Bank whole loans acquired 126,864 185,176 390,230 ----------- ----------- ----------- Total servicing originated and acquired 267,537 289,199 468,000 ----------- ----------- ----------- Loans sold servicing released -- 47 2,602 Amortization and payoffs 430,373 273,219 246,223 Foreclosures 6,249 6,244 5,038 ----------- ----------- ----------- Total servicing reductions 436,622 279,510 253,863 ----------- ----------- ----------- Ending servicing portfolio $ 1,566,004 $ 1,735,089 $ 1,725,400 =========== =========== ===========
________________________ (1)Loans originated or purchased for the Bank. MORTGAGE-BACKED SECURITIES The Bank maintains a significant 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, 1997, the Company's mortgage-backed securities portfolio (including $170.0 million of mortgage-backed securities available-for-sale), net of unamortized premiums and unearned discounts, amounted to $1.5 billion, or 52.0%, of total assets. By investing in mortgage-backed securities, management seeks to achieve a positive spread over the cost of funds used to purchase these securities. At December 31, 1997, the Company's net mortgage-backed securities had an aggregate market value of $1.5 billion. The following table sets forth the composition of the Company's mortgage-backed securities portfolio at the dates indicated.
At December 31, 1997 1996 1995 ---------------------- --------------------- ---------------------- Amount Percent Amount Percent Amount Percent ------------ -------- ------------ -------- ----------- --------- (Dollars in thousands) Held-to-maturity: REMICS $ 1,232,219 91.59% $ 1,213,849 90.25% $1,241,999 89.00% FNMA certificates 69,906 5.20 77,324 5.75 90,061 6.45 GNMA certificates 28,701 2.13 33,900 2.52 39,363 2.82 Non-agency certificates 14,586 1.08 19,826 1.48 24,091 1.73 Interest-only securities 20 -- 38 -- 55 -- ------------ -------- ------------ -------- ----------- -------- 1,345,432 100.00% 1,344,937 100.00% 1,395,569 100.00% ======== ======== ======== Unamortized premium 2,831 3,153 3,841 Unearned discount (3,173) (3,503) (3,657) ------------ ------------ ----------- Total held-to-maturity $ 1,345,090 $ 1,344,587 $1,395,753 ============ ============ =========== Available-for-sale: REMICS $ 173,717 100.00% $ 185,651 100.00% $ 186,505 99.52% Non-agency certificates -- -- -- -- 908 0.48 ------------ -------- ------------ -------- ----------- -------- 173,717 100.00% 185,651 100.00% 187,413 100.00% ======== ======== ======== Unamortized premium 25 33 44 Unearned discount (247) (255) (284) Net unrealized loss (3,498) (4,773) (759) ----------- ----------- ----------- Total available-for-sale $ 169,997 $ 180,656 $ 186,414 ============ ============ =========== Total mortgage-backed securities $ 1,515,087 $ 1,525,243 $1,582,167 ============ ============ ===========
The mortgage-backed securities which the Bank purchases and maintains in portfolio can include FNMA, FHLMC and GNMA certificates, certain privately issued, credit-enhanced mortgage-backed securities which are rated "A" or better by the national securities rating agencies, certain types of collateralized mortgage obligations ("CMOs") and interest-only ("IO") certificates. The FNMA, FHLMC and GNMA certificates 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 Bank 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 "A" 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 has never invested in, and does not intend to invest in, residual interests in CMOs. CMOs and other mortgage-backed securities may be structured as Real Estate Mortgage Investment Conduits ("REMICs") for U.S. Federal income tax purposes. 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 IO 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 FDIC has issued a statement of policy which states, among other things, that mortgage derivative products (including CMOs and CMO residuals and stripped mortgage-backed securities such as IOs) which possess average life or price volatility in excess of a benchmark fixed rate 30 year mortgage-backed pass-through security are "high-risk mortgage securities," are not suitable investments for depository institutions, and if considered "high risk" at purchase must be carried in the institution's trading account or as assets held for sale, and must be marked to market on a regular basis. In addition, if a security was not considered "high risk" at purchase but was later found to be "high risk" based on the tests, the security may remain in the held-to-maturity portfolio as long as the institution has the positive intent to hold the security to maturity and has a documented plan in place to manage the higher risk. At December 31, 1997, the Bank had mortgage-backed securities considered "high risk" with a recorded booked value of approximately $16.8 million. These securities were not considered "high risk" at purchase, but were later found to be "high risk" based on the results of the required tests. The Bank has the positive intent to hold these securities to maturity and has documented the Bank's plan to manage the higher risk of these securities. If the Bank should elect to consider a new type of security for its portfolio, the Bank intends to ascertain in advance that the security does not fail any of the tests that will qualify it as a "high risk mortgage security." The Bank will not purchase any security that fails such tests unless it has in place a documented plan to manage the higher risk of that security and has approval from the Board of Directors. 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, 1997 1996 1995 --------- --------- --------- (In thousands) Mortgage-backed securities held-to-maturity purchased $ 56,136 $ -- 52,741 Available-for-sale securities sold(1) (11,308) (864) (72,298) Amortization of premiums net of discount accretion (83) (552) (495) Change in unrealized loss on mortgage-backed securities available-for-sale 1,275 (4,013) (24) Principal repayments on mortgage-backed securities (56,176) (51,495) (35,845) --------- --------- --------- Net decrease in mortgage-backed securities $(10,156) $(56,924) $(55,921) ========= ========= =========
(1) Securities sold in 1995 after reclassification from held-to-maturity portfolio pursuant to the FASB's Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." On January 1, 1994, the Company adopted the FASB Statement of Financial Accounting Standards No. 115 (Statement 115), "Accounting for Certain Investments in Debt and Equity Securities." In accordance with Statement 115, the Company classifies securities as either held-to-maturity or available-for-sale. Securities are classified as held-to-maturity when the Company has the positive intent and ability to hold such securities to maturity. Securities held-to-maturity are recorded at amortized cost. Permanent declines in the value of held-to-maturity securities are charged to earnings in the periods in which the declines are determined. 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 as a separate component of stockholders' equity. In connection with the adoption of Statement 115, in 1994 the Company transferred approximately $50.8 million of mortgage-backed securities to the available-for-sale category. 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. In November 1995, the FASB issued the Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." Provisions in this Special Report granted all entities a one-time opportunity, until no later than December 31, 1995, to reassess the appropriateness of the classifications of all securities held and to account for any resulting reclassifications at fair value in accordance with Statement 115. The provisions of the Special Report also directed that any reclassifications as a result of this one-time reassessment would not call into question the intent to hold other debt securities to maturity in the future. In accordance with this Special Report, on November 20, 1995, the Company reclassified approximately $226.6 million of mortgage-backed securities to the available-for-sale category. These mortgage-backed securities reclassified to the available-for-sale category were primarily COFI securities and gave the Company the opportunity to somewhat change the composition of the portfolio by selling certain securities if that was considered necessary. In 1997, 1996 and 1995, the Company sold $11.3 million, $864,000 and $72.3 million, respectively, of mortgage-backed securities available-for-sale. 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 mortgage-backed securities, residential mortgage loans 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 and maturities 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 more cost effective. DEPOSITS. The Bank's market for deposits is competitive, which has necessitated the Bank's emphasis on primarily short term certificate accounts that are more responsive to market interest rates than savings accounts. The Bank offers a traditional line of deposit products which currently includes savings, interest-bearing checking, noninterest-bearing checking, 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. During 1996 and early in 1997, the Bank began to offer a range of products for commercial businesses including Small Business Checking, Business Interest Checking, Analysis Checking and Commercial Money Market Accounts, the amounts of which, in 1997 or 1996, are not material for separate presentation. The following table shows the distribution of and certain other information relating to the Company's deposits by type as of the dates indicated.
At December 31, -------------------------------------- 1997(1) 1996(2) 1995(3) Percent Percent Percent of of of Amount Deposits Amount Deposits Amount Deposits ----------- --------- ----------- --------- ----------- --------- (Dollars in Thousands) Demand deposit accounts: Noninterest-bearing checking $ 101,782 7.40% $ 85,259 6.50% $ 81,207 6.31% Interest-bearing checking 69,972 5.09 56,862 4.34 47,476 3.69 Savings 25,555 1.86 22,135 1.69 22,374 1.74 Money market demand 165,986 12.07 151,046 11.52 165,214 12.83 ----------- --------- ----------- --------- ----------- --------- Total demand deposit accounts 363,295 26.42 315,302 24.05 316,271 24.57 ----------- --------- ----------- --------- ----------- --------- Certificate accounts: Within 1 year 781,455 56.83 772,690 58.94 704,966 54.76 1-2 years 186,734 13.58 158,583 12.10 188,400 14.63 2-3 years 30,028 2.18 40,961 3.12 32,556 2.53 3-4 years 7,292 0.53 18,268 1.39 29,717 2.31 4-5 years 6,153 0.45 5,064 0.39 15,210 1.18 Over 5 years 178 0.01 165 0.01 319 0.02 ----------- --------- ----------- --------- ----------- --------- Total certificate accounts 1,011,840 73.58 995,731 75.95 971,168 75.43 ----------- --------- ----------- --------- ----------- -------- 1,375,135 100.00% 1,311,033 100.00% 1,287,439 100.00% ======== ======= ======== Discount to record savings deposits at fair value, net. (75) (198) (355) ----------- ----------- ----------- Total $1,375,060 $1,310,835 $1,287,084 =========== =========== ===========
_______________ (1)In 1997, the Bank assumed approximately $54.6 million in deposits in connection with the acquisition of one branch office of another financial institution. (2)In 1996, the Bank assumed approximately $11.1 million in net deposits in connection with the exchange of three branch offices for one and the sale of another branch office. (3)In 1995, the Bank assumed approximately $157.2 million in deposits in connection with the acquisition of five branch offices of another financial institution. 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, 1997 1996 1995 ----------- ----------- ----------- (Dollars in Thousands) Average Average Average Average Average Average Balance Rate Paid Balance Rate Paid Balance Rate Paid ----------- ---------- ----------- ---------- ----------- --------- Demand deposit accounts: Noninterest-bearing checking $ 91,293 --% $ 85,469 --% $ 62,164 --% Interest-bearing checking 61,392 1.78 49,181 2.07 29,904 2.06 Savings 23,912 2.29 22,104 2.32 20,162 2.52 Money market demand 158,993 3.63 157,933 3.64 156,730 3.61 Certificate accounts 1,008,845 5.50 970,433 5.42 909,992 5.49 ----------- ---------- ----------- ---------- --------- ------ Total deposits $ 1,344,435 4.68% $ 1,285,120 4.66% $ 1,178,952 4.81% =========== ========== =========== ========== =========== ==========
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, 1997, which mature during the periods indicated.
Amounts at December 31, 1997 Maturing (In thousands) Amounts at December 31, One Year 1997 1996 or Less -------------------------- -------- (In thousands) Certificate accounts: 2.00% to 3.99% $ 7,905 $ 14,835 $ 7,422 4.00% to 5.99% 899,205 871,852 743,317 6.00 to 7.99% 102,029 104,092 28,900 8.00 to 9.99% 2,701 4,686 1,816 10.00% to 11.99% -- 266 -- ---------- -------- -------- Total $1,011,840 $995,731 $781,455 ========== ======== ======== Amounts at December 31, 1997 Maturing (In thousands) Greater than Two Years Three Years Three Years ---------- ---------- ------------- Certificate accounts: 2.00% to 3.99% $ 351 $ 46 $ 86 4.00% to 5.99% 132,851 11,759 11,278 6.00 to 7.99% 52,746 18,223 2,160 8.00 to 9.99% 786 -- 99 10.00% to 11.99% -- -- -- -------- ------- ------- Total $186,734 $30,028 $13,623 ======== ======= =======
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 Bank believes that its pricing strategy will help the Bank to achieve balance levels deemed appropriate by management on a continuing basis. The following table sets forth the net deposit flows of the Bank during the periods indicated.
Year Ended December 31, 1997 1996 1995 -------- --------- --------- (In thousands) Net increase (decrease) before interest credited(1) $ 2,383 $(34,707) $ 91,052 Interest credited 61,842 58,458 56,410 -------- -------- --------- Net deposit increase $ 64,225 $ 23,751 $ 147,462 ======== ========= =========
(1) For the years ended December 31, 1997, 1996 and 1995, reflects the effect of the assumption of $54.6 million, $11.1 million and $157.2 million of net deposit liabilities in connection with branch office transactions in each respective year. The net deposit outflow in 1997 and 1996 (net of acquired deposits) was primarily due to financial disintermediation as described below. The following table sets forth the amount of the Bank's certificates of deposits which are $100,000 or more by time remaining until maturity as of December 31, 1997.
At December 31, 1997 ------------------------- Number of Deposit accounts Amount --------- --------- (Dollars in thousands) Three months or less 273 $ 29,844 Over three through six months 217 23,106 Over six through twelve months 349 38,383 Over twelve months 293 31,260 --------- --------- Total 1,132 $ 122,593 ========= =========
The Bank's deposits are obtained primarily from residents of Houston, Austin, Corpus Christi and small cities in the south east 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 customers. The Bank uses traditional marketing methods to attract new customers and savings deposits, including newspaper advertising. Through 1997, the Bank has not solicited brokered deposit accounts and generally has not negotiated rates on larger denomination (i.e., jumbo) certificates of deposit. The Bank did, however, acquire deposits, classified on the books and records of a prior entity as brokered, through the branch acquisition in 1994. In addition, in early 1997, the Bank has begun the solicitation of deposit accounts through a "money desk." Money desk rates are only offered to institutions (primarily credit unions and municipal utility districts) and are generally up to 50 basis points higher than on regular certificate of deposit accounts. Management of the Bank intensified its deposit product marketing beginning in 1993 in order to increase its share of core deposits in the markets in which it operates. Management believes that the combination of the new packaged deposit products (which generally have higher minimum balance requirements and which provide value-added incentives to the customer, such as, for example, free traveler's checks, reduced or waived monthly service charges and free money orders) plus increased advertising, sales training, branch promotion and cross-selling of products will help maintain the volume of the Bank's deposits and strengthen customer relationships without requiring the Bank to alter its deposit pricing strategy. The Bank's management also believes that such efforts will assist the Bank in maintaining deposits, particularly during periods of relatively low deposit rates, which might otherwise flow out of the institution due to disintermediation (the movement of funds away from savings institutions and into direct investment vehicles such as government and corporate securities and mutual funds). Notwithstanding this plan, the ability of the Bank to attract and maintain deposits and the Bank's cost of funds have been, and will continue to be, significantly affected by general money market conditions. The Bank also provides its customers with the opportunity to invest in 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 financial condition. 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, 1997 1996 1995 --------- ----------- --------- (Dollars in thousands) FHLB advances: Average balance outstanding $ 368,896 $ 387,296 $367,895 Maximum amount outstanding at any month-end during the period 540,475 491,930 405,016 Balance outstanding at end of period 540,475 409,720 312,186 Average interest rate during the period 5.78% 5.62% 6.01% Average interest rate at end of period 5.95% 5.61% 5.88% Securities sold under agreements to repurchase: Average balance outstanding $ 974,136 $ 930,706 $752,427 Maximum amount outstanding at any month-end during the period 1,035,576 1,022,085 993,832 Balance outstanding at end of period 791,760 966,987 993,832 Average interest rate during the period 5.66% 5.52% 5.98% Average interest rate at end of period 6.00% 5.55% 5.78%
Federal funds purchased averaged approximately $161,000 during the year ended December 31, 1997 with an average interest rate during the period of 5.59%. There were no federal funds purchased outstanding at any month-end during 1997 and there were no federal funds purchased outstanding during the years ended December 31, 1996 or 1995. The Bank obtains long term, fixed rate and short term, variable rate advances from the FHLB upon the security of certain of its residential first 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 a variable rate line of credit, various short-term, variable rate advances and long term, fixed and variable-rate advances. At December 31, 1997, the Bank had total FHLB advances of $540.5 million at a weighted average interest rate of 5.95%. 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 either the same or a substantially identical security on a specified later date at a price less than the original sales price. The difference in the sale price and purchase price is the cost of the use of the proceeds. The mortgage-backed securities underlying the agreements are delivered to the dealers who arrange the transactions. For agreements in which the Bank has agreed to repurchase substantially identical securities, the dealers may sell, loan or otherwise dispose of the Bank's securities 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, 1997, the Bank had $791.8 million in borrowings under reverse repurchase agreements at a weighted average interest rate of 6.00%. At December 31, 1997, the Bank had amounts of securities at risk under securities sold under agreements to repurchase with three individual counterparties which exceeded ten percent of stockholders' equity. The amount at risk with Salomon Brothers Inc. was $12.8 million with an average maturity of 344 days at December 31, 1997. The amount at risk with Credit Suisse First Boston Corporation was $16.6 million with an average maturity of 27 days at December 31, 1997. The amount at risk with Goldman, Sachs & Co. was $23.7 million with an average maturity of 8 days at December 31, 1997. To a lesser extent, beginning in 1997, the Bank utilizes federal funds purchased from a correspondent bank for overnight borrowing purposes. The Asset/Liability Subcommittee of the Bank attempts to match the maturity of reverse repurchase agreements 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 attempts to alter the interest rate risk associated with the reverse repurchase agreements through the use of interest rate swaps and interest rate caps purchased from the FHLB and certain large securities 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 10.0% 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, 1997, the Bank was authorized to have a maximum investment of approximately $291.0 million in its subsidiaries. At December 31, 1997, the Bank had two active wholly-owned subsidiaries, the activities of which are described below. At December 31, 1997, the Bank's aggregate equity investment in all of its subsidiaries was $8.4 million and the Bank had a net payable to such subsidiaries totalling $87,000. CBS MORTGAGE CORP. The Bank is the sole stockholder of CBS Mortgage, a Texas corporation formed in 1989 to engage in the business of originating, purchasing, selling and servicing loans secured by first lien mortgages on completed one-to four-family dwelling units. Beginning on January 1, 1996, the origination, purchasing and selling functions of CBS Mortgage were performed by the Bank, with CBS Mortgage's activities then limited to primarily loan servicing. For a detailed discussion of CBS Mortgage's business operations, see "Mortgage Banking Activities." The Bank and CBS Mortgage have entered into a ten year mortgage warehouse revolving loan agreement pursuant to which the Bank has established a $15.0 million revolving line of credit to be drawn upon from time to time by CBS Mortgage to finance the acquisition of servicing rights and, prior to 1996, the origination or acquisition of mortgage loans and the holding of such loans until they were sold, delivered or pledged to secondary market investors. The advances drawn by CBS Mortgage are secured by a promissory note payable upon demand. Interest on the funds advanced by the Bank is payable monthly at the local prime rate plus 1% per annum. The promissory note between the Bank and CBS Mortgage provides that CBS Mortgage is credited an amount equal to the local prime rate less 1% per annum on the average monthly balance of all escrowed funds held by the Bank. The credit is limited in amount to the interest charged by the Bank. As a result of such credit, CBS Mortgage made no interest payments to the Bank under this loan for the year ended December 31, 1997. Principal balances under the loan are generally repaid through servicing income generated from servicing rights. At December 31, 1997, the Bank's equity investment in CBS Mortgage was $8.3 million and had an intercompany payable to CBS Mortgage in the amount of $106,000. CBS Mortgage had net income of $2.3 million, $2.3 million and $1.3 million for the years ended December 31, 1997, 1996 and 1995, respectively. COASTALBANC FINANCIAL CORP. CoastalBanc Financial Corp. ("Financial Corp.") was formed in 1986 to act as an investment advisor to other insured financial institutions. The Bank is the sole stockholder of Financial Corp. Over the past four years, Financial Corp. has been inactive in its investment advisory capacity. Financial Corp. became active during the last quarter of 1992 in connection with the sale of mutual funds through a third party intermediary. Fees generated net of expenses, resulted in a net income of $35,000, $40,000 and $34,000 for the years ended December 31, 1997, 1996 and 1995, respectively. THE SOUTHWEST PLAN ACQUISITION During the latter half of the 1980's, severely depressed economic conditions prevailed in the southwestern United States, and in Texas in particular, which seriously impaired the operating results of many corporations. A large number of savings institutions suffered significant losses, which were attributable to the economic deterioration in the region, as well as, in some instances, to improper or fraudulent practices by persons affiliated with such institutions. In an attempt to address the problems of a record number of savings institution failures, in February 1988 the Federal Home Loan Bank Board as operating head of the FSLIC, announced the establishment of its "Southwest Plan," which was designed to consolidate failed or failing savings institutions located in the southwestern United States with healthy savings institutions, shrink the number of savings institutions in the Southwest and promote the infusion of additional capital into the savings industry through financial assistance and other incentives. During this period, the Bank developed a business strategy oriented toward growth and increasing profitability through prudent acquisitions, with assistance from the Federal government. The strategy was designed to utilize the deposits obtained in such transactions as an inexpensive source of funds for growth, which would facilitate reduced overhead levels as a proportion of assets from economies of scale and lower cost of funds from a more meaningful market share of core deposits. In order to implement this strategy, the Bank decided to participate in the Southwest Plan and on May 13, 1988, the Bank became the first acquiror of failed or failing savings institutions under the FSLIC's Southwest Plan. The Southwest Plan Acquisition was implemented pursuant to the terms of an Assistance Agreement, entered into by the FSLIC and the Bank. The Southwest Plan Acquisition significantly increased the total size and market penetration of the Bank. The FSLIC agreed in the Assistance Agreement to provide the Bank with certain forms of financial assistance, including a guaranteed yield on, and reimbursement for losses incurred or write-downs directed by the government or provided by the Bank with respect to, certain assets acquired from the Acquired Associations (the "Guaranteed Assets") and certain additional forms of financial assistance. On April 15, 1994, the Bank and the FDIC announced the early termination of the Assistance Agreement, effective March 31, 1994. Under the terms of the agreement, the Bank transferred substantially all of its remaining Guaranteed Assets to the FDIC in exchange for cash of $37.4 million and also received cash of $12.7 million for the remaining receivable from the government in order to record acquired assets at fair value. In addition, the Bank repurchased for $5.9 million a warrant to purchase Bank common stock that had been granted to the Federal government. The Federal government will continue to receive the future federal income tax benefits of the net operating loss carryforwards acquired from the Acquired Associations. See "Taxation-Federal Taxation" and Note 17 of the Notes to the Consolidated Financial Statements. 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. 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. 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 deemed 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 thereupon 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. 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 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). 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. 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. The description of statutory provisions and regulations applicable to savings banks set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank. Moreover, because some of the provisions of the FDIA, as amended by the FDICIA, have not yet been fully implemented through the adoption of regulations by the various federal banking agencies, the Bank cannot yet fully assess the impact of these provisions on its operations. In particular, the Bank cannot predict whether it will be in compliance with such new regulations at the time they become effective. Furthermore, the Bank cannot predict what other new regulatory requirements might be imposed in the future. 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, Sections 23A and 23B (i) limit 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 and (ii) require 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, purchase of assets, issuance of a guarantee and similar transactions. 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, 1997, 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 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 rights up to certain specified limits and minus net deferred tax assets in excess of certain specified limits. At December 31, 1997, 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, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, FDIC-supervised banks, which effectively imposes a minimum Tier 1 capital ratio for such other banks of between 4.0% to 5.0%. 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, 1997, the required Tier 1 capital ratio for the Bank was 4.0% and its actual Tier 1 capital ratio was 5.52%. RISK-BASED CAPITAL REQUIREMENTS. The risk-based capital requirements contained in FDIC regulations generally require the Bank to maintain a 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, 1997, the Bank's Tier 1 capital to risk-weighted assets ratio was 11.46% and its total risk-based capital to risk weighted assets ratio was 11.98%. The following table sets forth information with respect to each of the Bank's capital requirements as of the dates shown.
As of December 31, 1997 1996 1995 ------- ------- ------- Actual Required Actual Required Actual Required ------- --------- ------- --------- ------- --------- Tier 1 capital to total assets 5.52% 4.00% 5.35% 4.00% 5.30% 4.00% Tier 1 risk-based capital to risk weighted assets 11.46 4.00 11.77 4.00 12.36 4.00 Total risk-based capital risk to risk weighted assets 11.98 8.00 12.30 8.00 12.84 8.00
The following table sets forth a reconciliation between the Bank's stockholders' equity and each of its three regulatory capital requirements at December 31, 1997.
Tier 1 Total Tier 1 Risk-based Risk-based Capital Capital Capital --------- ------------ ------------ (Dollars in thousands) Total stockholders' equity $174,224 $ 174,224 $ 174,224 Unrealized loss on securities available-for-sale 2,274 2,274 2,274 Less nonallowable assets: Goodwill (15,717) (15,717) (15,717) Plus allowances for loan and lease losses -- -- 7,412 --------- ------------ ------------ Total regulatory capital 160,781 160,781 168,193 Minimum required capital 116,570 56,136 112,271 --------- ------------ ------------ Excess regulatory capital $ 44,211 $ 104,645 $ 55,922 ========= ============ ============ Bank's regulatory capital percentage (1) 5.52% 11.46% 11.98% Minimum regulatory capital required percentage 4.00% 4.00% 8.00% --------- ------------ ------------ Bank's regulatory capital percentage in excess of requirement 1.52% 7.46% 3.98% ========= ============ ============
_______________ (1) Tier 1 capital is computed as a percentage of total assets of $2.9 billion. Risk-based capital is computed as a percentage of adjusted risk-weighted assets of $1.4 billion. FDIC INSURANCE PREMIUMS. The deposits of the Bank are insured to the maximum extent permitted by 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 SAIF-member institutions. In addition, because the Bank acquired approximately $54.6 million in deposits as a result of the Port Arthur branch acquisition on June 21, 1997, $79.8 million in deposits as a result of the Bay City branch acquisition on September 5, 1996 and $157.2 million in deposits from Texas Capital as of November 1, 1995, the Bank became responsible for paying deposit insurance premiums on such deposits at the BIF premium rate. 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, prior to the FDIA, as amended, being signed into law, ranging from .23% for well capitalized, healthy SAIF-member institutions to .31% for undercapitalized SAIF-member institutions with substantial supervisory concerns. On November 14, 1995, the FDIC adopted a new assessment rate schedule of zero to 27 basis points (subject to a $2,000 minimum) for BIF members (or institutions, like the Bank, having BIF deposits) while retaining the existing assessment rate schedule for SAIF-member institutions. On September 30, 1996, amendments to the FDIA were signed into law. The FDIA and implementing regulations provided that all SAIF-member institutions would pay a special one time assessment of 65.7 basis points on the SAIF assessment base as of March 31, 1995 to recapitalize the SAIF, which in the aggregate, would be sufficient to bring the reserve ratio in the SAIF to 1.25% of insured deposits. The Bank's special assessment amounted to $7.5 million ($4.8 million after applicable income taxes) pursuant to the FDIA. In addition to the recapitalization provisions, the FDIA equalized the rate schedule for SAIF and BIF institutions with the rates ranging from zero to 27 basis points beginning October 1, 1996. At December 31, 1997, the Bank was categorized as well capitalized. The FDIA provided for FICO debt sharing by banks and thrifts with proration sharing in the year 2000. Prior to the year 2000, SAIF insured institutions will pay approximately 6.5 basis points for FICO, while BIF insured institutions will pay approximately 1.3 basis points. The FICO provisions of the FDIA also prohibit deposit migration strategies to avoid SAIF premiums. The FDIA also provided for the merger of the BIF and the SAIF on January 1, 1999, with such merger being conditioned upon the prior elimination of the federal thrift charter. Under Section 593 of the Internal Revenue Code, thrift institutions such as the Bank, which meet certain definitional tests primarily relating to their assets and the nature of their business, are permitted to establish a tax reserve for bad debts and to make annual additions thereto, which additions may, within specified limitations, be deducted in arriving at their taxable income. The Bank's deduction with respect to "qualifying loans" which are generally loans secured by certain interests in real property, prior to 1996, could be computed using an amount based on the Bank's actual loss experience (the "experience method") or a percentage of taxable income, computed without regard to this deduction, and with additional modifications and reduced by the amount of any permitted addition to the non-qualifying reserve. See "Taxation-Federal Taxation." Effective January 1, 1996, the Bank is unable to make additions to its tax bad debt reserve, is permitted to deduct bad debts only as they occur and is additionally required to recapture (i.e. take into taxable income) over a six year period, the excess of the balance of its bad debt reserve as of December 31, 1995 over the balance of such reserve as of December 31, 1987. Such recapture requirements can be suspended for each of two successive taxable years beginning January 1, 1996, in which the Bank originates a minimum amount of certain residential loans based upon the average of the principal amounts of such loans made by the Bank during its six taxable years preceding 1996. At December 31, 1997, the Bank had approximately $3.9 million of post-1987 tax bad debt reserves, for which deferred taxes have been provided. REGULATORY CAPITAL REQUIREMENTS. The FDIA requires the Federal banking agencies to revise their risk-based capital guidelines to, among other things, take adequate account of interest rate risk. The Federal banking agencies continue to consider modification of the capital requirements applicable to banking organizations. In August 1995, the Federal banking agencies amended their risk-based capital guidelines to provide that the banking agencies will include in their evaluations of a bank's capital adequacy an assessment of the bank's exposure to declines in the economic value of the bank's capital due to changes in interest rates. The agencies also issued a proposed policy statement that describes the process that the agencies will use to measure and assess the exposure of a bank's capital to changes in interest rates. The agencies stated that after they and the banking industry gain sufficient experience with the measurement process, the agencies would issue proposed regulations for establishing explicit charges against capital to account for interest rate risk. The FDIA also requires the FDIC and the other Federal banking agencies to revise their risk-based capital standards, with appropriate transition rules, to ensure that they take into account concentration of credit risk and the risks of non-traditional activities and to ensure that such standards reflect the "actual performance and expected risk of loss of multifamily mortgages," of which the Bank had $131.5 million at December 31, 1997. See "Business - Lending Activities." In December 1995, the FDIC and the other Federal banking agencies promulgated final amendments to their respective risk-based capital requirements which would explicitly identify concentration of credit risk and certain risks arising from nontraditional activities, and the management of such risks as important factors to consider in assessing an institution's overall capital adequacy. The FDIC may now require higher minimum capital ratios based on certain circumstances, including where the institution has significant risks from concentration of credit or certain risks arising from non-traditional activities. The Federal banking agencies have agreed to adopt for regulatory purposes Statement 115, which, among other things, generally adds a new element to stockholders' equity under generally accepted accounting principles by including net unrealized gains and losses on certain securities. In December 1994, the FDIC issued final amendments to its regulatory capital requirements which would require that the net amount of unrealized losses from available-for-sale equity securities with readily determinable fair values be deducted for purposes of calculating the Tier 1 capital ratio. All other net unrealized holding gains (losses) on available-for-sale securities are excluded from the definition of Tier 1 capital. At December 31, 1997, the Bank had $173.5 million of securities available-for-sale with $3.5 million of aggregate net unrealized losses thereon. SAFETY AND SOUNDNESS STANDARDS. Each Federal banking agency is required to prescribe, for all insured depository institutions and their holding companies, standards relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits and such other operational and managerial standards as the agency deems appropriate. The compensation standards would prohibit employment contracts or other compensatory arrangements that provide excess compensation, fees or benefits or could lead to material financial loss to the institution. In addition, each Federal banking agency also is required to adopt for all insured depository institutions and their holding companies standards that specify (i) a maximum ratio of classified assets to capital, (ii) minimum earnings sufficient to absorb losses without impairing capital, (iii) to the extent feasible, a minimum ratio of market value to book value for publicly-traded shares of the institution or holding company, and (iv) such other standards relating to asset quality, earnings and valuation as the agency deems appropriate. On July 10, 1995, the Federal banking agencies, including the FDIC, adopted final rules and proposed guidelines concerning safety and soundness required to be prescribed by regulations pursuant to Section 39 of the FDIA. In general, the standards relate to operational and managerial matters, asset quality and earnings and compensation. The operational and managerial standards cover internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. Under the asset quality and earnings standards, which were adopted by the Federal Banking agencies in October 1996, the Bank would be required to establish and maintain systems to identify problem assets and prevent deterioration in those assets and evaluate and monitor earnings to ensure that earnings are sufficient to maintain adequate capital reserves. If an insured institution fails to meet any of the standards promulgated by the regulators, then such institution will be required to submit a plan within 30 days to the FDIC specifying the steps that it will take to correct the deficiency. In the event that an insured institution fails to submit or fails in any material respect to implement a compliance plan within the time allowed by the FDIC, Section 39 of the FDIA provides that the FDIC must order the institution to correct the deficiency and may restrict asset growth, require the savings institution to increase its ratio of tangible equity to assets, restrict the rates of interest that the institution may pay or take any other action that would better carry out the purpose of prompt corrective action. The Bank believes that it has been and will continue to be in compliance with each of the standards as they have been adopted by the FDIC. Finally, each Federal banking agency is required to prescribe standards for the employment contracts and other compensation arrangements of executive officers, employees, directors and principal stockholders of insured depository institutions that would prohibit compensation and benefits and arrangements that are excessive or that could lead to a material financial loss for the institution. In February 1996, the FDIC adopted final regulations regarding the payment of severance and indemnification to management officials and other affiliates of insured institutions (institution affiliated parties or "IAPs"). The limitations on severance or "golden parachute" payments apply to "troubled" institutions which seek to enter into contracts with IAPs. A golden parachute payment is generally considered to be any payment to an IAP which is contingent on the termination of that person's employment and is received when the insured institution is in a troubled condition. The definition of golden parachute payment does not include payment pursuant to qualified retirement plans, non-qualified bona fide deferred compensation plans, nondiscriminatory severance pay plans, other types of common benefit plans, state statutes and death benefits. Certain limited exceptions to the golden parachute payment prohibition are provided for in cases involving the hiring of an outside executive, unassisted changes of control and where the FDIC provides written permission to make such payment. The limitations on indemnification payments apply to all insured institutions, their subsidiaries and affiliated holding companies. Generally, this provision prohibits such entities from indemnifying an IAP for that portion of the costs sustained with regard to a civil or administrative enforcement action commenced by any Federal banking agency which results in a final order or settlement pursuant to which the IAP is assessed a civil monetary penalty, removed from office, prohibited from participating in the affairs of an insured institution or required to cease and desist from taking certain affirmative actions. Nevertheless, institutions or holding companies may purchase commercial insurance to cover such expenses (except for judgments or penalties) and the institutions or holding company may advance legal expenses to the IAP if its board of directors makes certain specific findings and the IAP agrees in writing to reimburse the institution if it is ultimately determined that the IAP violated a law, regulation or other fiduciary duty. 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 savings 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 savings 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. In May 1995, the FDIC and other Federal banking agencies promulgated final revisions to their regulations concerning the CRA. The revised regulations generally are intended to provide clearer guidance to financial institutions on the nature and extent of their obligations under the CRA and the methods by which the obligations will be assessed and enforced. Among other things, the revised regulations substitute for the current process-based assessment factors a new evaluation system that would rate institutions based on their actual performance in meeting community credit needs. In particular, the revised system will evaluate 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. The revised regulations also specify 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. Management of the Bank currently is unable to predict the effects of the regulations under the CRA as recently adopted. 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. Under Section 2303 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996, a savings institution can comply 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, 1997, with 86.9% 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 distribute 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, 1997, the Bank's advances from the FHLB of Dallas amounted to $540.5 million or 18.6% 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, 1997, the Bank had $27.8 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, 1997, dividends paid by the FHLB of Dallas to the Bank totaled $1.3 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, 1997, 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, officers and members 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, the Bank and its subsidiaries file a consolidated Federal income tax return on a calendar year basis using the accrual method. Savings banks are subject to provisions of the Internal Revenue Code ("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 recently enacted legislation, the Bank will no longer be able to utilize a reserve method for determining the bad debt deduction, but will be allowed to deduct actual net charge-offs. Further, the legislation requires the Bank to recapture, into taxable income, over a six year period, the excess of the balance of its bad debt reserve as of December 31, 1995 over the balance of such reserve as of December 31, 1987. At December 31, 1997, the Bank had approximately $3.9 million 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). The preference items generally applicable to savings banks include (i) prior to 1996, 100% of the excess of a savings bank's bad debt deduction computed under the percentage of income method over the amount that would have been allowable under the experience method and (ii) an amount equal to 75% of the amount by which a savings bank's adjusted current earnings (alternative minimum taxable income computed without regard to this preference, adjusted for certain items) exceeds its alternative minimum taxable income without regard to this preference. The amounts received by the Bank pursuant to the Assistance Agreement were included in its adjusted current earnings. 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 Assistance Agreement, an instrumentality of the Federal government was obligated to provide the Bank with financial assistance in connection with various matters that arose under the Assistance Agreement. Payments to the Bank pursuant to the Assistance Agreement were taxed under the applicable provisions of the Code which were in effect in 1988. These provisions of the Code provide generally that payments from such instrumentality to the Bank pursuant to the Assistance Agreement were not included in the Bank's income and the Bank was not required to reduce its basis in the Guaranteed Assets by the amount of such financial assistance. Accordingly, the Bank was not required to pay Federal income taxes with respect to any amount of the assistance payments it received pursuant to the Assistance Agreement. The Assistance Agreement did, however, require the Bank, in effect, to pay to such instrumentality 100% of the Federal and state "net tax benefits," as defined, which are realized by the Bank from excluding from its income the payments received pursuant to the Assistance Agreement on a tax-free basis. The amount of assistance payments from that governmental instrumentality was reduced by the amount of tax benefit realized by the Bank by excluding assistance payments from its taxable income. Accordingly, the Bank, in effect, was passing back to that governmental instrumentality the entire tax benefit derived from the tax exemption provided by the Code provisions which were in effect in 1988. Further, the tax laws in 1988 which applied to the Southwest Plan Acquisition provided that generally applicable limitations on the ability of an acquiring corporation to utilize the net operating loss carryforwards, and built-in losses, as defined, of acquired financial institutions did not apply in the case of the acquisition of assets from insolvent savings and loan associations. The generally applicable rules limit the rate at which the net operating loss carryforwards and built-in (i.e., previously unrecognized) losses of an acquired corporation may be used by a corporation which acquires "control" of the corporation which generated the loss. Pursuant to this exception which existed in 1988 to the generally applicable law, the Bank is allowed to use the net operating losses and built-in losses of all of the Acquired Associations except for one without limitation. The net operating loss of one association is not available to the Bank because such association's deposits at the time of its acquisition did not represent at least 20% of the Bank's total deposits and equity as required by the applicable provisions of the Code in 1988. The Assistance Agreement required that the tax benefit derived by the Bank from utilizing net operating loss carryforwards acquired from three of the four Acquired Associations also be applied to reduce the amount of assistance payments payable to the Bank by the government instrumentality. The Bank's Consolidated Statements of Operations, therefore, includes a provision for Federal income taxes which includes amounts credited to that governmental instrumentality in lieu of Federal income taxes paid to the Internal Revenue Service with certain adjustments. Although the termination of the Assistance Agreement was effective March 31, 1994, that governmental instrumentality will continue to receive the future federal income tax benefits of the net operating loss carryforwards acquired from the Acquired Associations. The Company's Federal income tax returns have not yet been audited by the United States Internal Revenue Service. The tax returns of the Company (and the Acquired Associations) since 1988 are subject to review by the Internal Revenue Service. STATE TAXATION The Company pays 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 Company's 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 37 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, 1997.
Net Book Value of Property Owned/Leased or Percent of (with Lease Expiration Leasehold Total Location Date) Improvements Deposits Deposits - ------------------------ ---------------------- ------------ -------- --------- (Dollars in thousands) BRANCH OFFICES: - ----------------------------- 1329 North Virginia Owned Port Lavaca, Texas 77979 $ 174 $ 30,537 2.21% 8 Greenway Plaza, Suite 100 Leased; Houston, Texas 77046 November 1, 1998 21 20,151 1.46 8 Braeswood Square Leased; Houston, Texas 77096 December 31, 2006 497 63,055 4.57 408 Walnut Owned Columbus, Texas 78934 301 57,271 4.15 870 S. Mason, #100 Leased; Katy, Texas 77450 August 31, 2003 51 24,277 1.76 602 Lyons Owned Schulenburg, Texas 78956 91 32,657 2.37 325 Meyer Street Owned Sealy, Texas 77474 599 41,499 3.01 116 E. Post Office Owned Weimar, Texas 78962 42 26,257 1.90 323 Boling Road Owned Wharton, Texas 77488 134 47,084 3.41 1621 Pine Drive Leased; Dickinson, Texas 77539 September 30, 1998 -- 43,773 3.17 295 West Highway 77 Owned San Benito, Texas 78586 240 21,094 1.53 1260 Blalock, Suite 100 Leased; Houston, Texas 77055 January 20, 1999 50 57,372 4.16 620 W. Main Owned Tomball, Texas 77375 133 27,628 2.00 915-H North Shepherd Leased; Houston, Texas 77008 October 31, 2001 182 32,592 2.36 6810 FM 1960 West Leased; Houston, Texas 77069 September 30, 2000 -- 31,313 2.27 7602 N. Navarro Owned Victoria, Texas 77904 192 83,485 6.06 2308 So. 77 Sunshine Strip Leased; Harlingen, Texas 78550 October 31, 1998 622 19,238 1.39 4900 N. 10th St., G-1 Leased; McAllen, Texas 78504 August 14, 2001 161 16,291 1.18 10838 Leopard Street, Suite B Leased; Corpus Christi, Texas 78410 December 31, 1998 2 42,358 3.07 4060 Weber Road Leased; Corpus Christi, Texas 78411 April 30, 1999 4 61,508 4.47 301 E. Main Street Owned Brenham, Texas 77833 181 63,089 4.57 1192 W. Dallas Leased; Conroe, Texas 77301 December 31, 1999 -- 51,148 3.71 2353 Town Center Dr. Owned Sugar Land, Texas 77478 1,112 18,223 1.32 1629 S. Voss Owned Houston, Texas 77057 1,472 21,671 1.57 531-A Highway 1431 Leased; Kingsland, Texas 78639 December 31, 1999 -- 20,122 1.46 209 W. Moreland Owned Mason, Texas 76856 53 17,104 1.24 904 Highway 281 North Owned Marble Falls, Texas 78654 180 11,329 0.82 101 East Polk Owned Burnet, Texas 78611 100 19,643 1.42 907 Ford Owned Llano, Texas 78643 174 16,138 1.17 708 East Austin Owned Giddings, Texas 78942 280 24,741 1.79 5718 Westheimer, Suite 100 Leased; Houston, Texas 77057 July 31, 2012 135 38,553 2.80 7909 Parkwood Circle Drive Owned Houston, Texas 77036 244 11,166 0.81 1250 Pin Oak Road Owned Katy, Texas 77494 1,185 17,128 1.24 2120 Thompson Highway Owned Richmond, Texas 77469 492 41,785 3.03 7200 North Mopac Leased; Austin, Texas 78731 December 31, 2002 8 36,766 2.67 1112 Seventh Street Leased; Bay City, Texas 77414 April 30, 2002 -- 76,595 5.56 441 Austin Avenue Owned Port Arthur, Texas 77640 669 50,052 3.63 13695 Research Blvd Under Construction Austin, Texas 78750 446 -- -- ADMINISTRATIVE OFFICE(1) - ------------------------------ Coastal Banc Plaza Leased; 5718 Westheimer, Suite 600 July 31, 2012 3,093 64,642 4.69 Houston, Texas 77057 RECORDS & RETENTION OFFICE: - ------------------------------ 227 Meyer St Owned Sealy, Texas 77474 63 -- - ------------- --------- ----------- Total $ 13,383 $1,379,335 100.00% ============= ========== ===========
______________________ (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 $22.3 million at December 31, 1997. At December 31, 1997, the net book value of the Company's electronic data processing equipment, which includes its in-house computer system, local area network and fifteen automatic teller machines, was $3.9 million. ITEM 3. LEGAL PROCEEDINGS ------------------ The Company is involved in routine legal proceedings occurring in the ordinary course of business which, in the aggregate, are believed by management to be immaterial to the financial condition of the Company. 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 53 of the Company's printed Annual Report to Stockholders for fiscal 1997 ("Annual Report"), which is included herein as Exhibit 13. ITEM 6. SELECTED FINANCIAL DATA ------------------------- The information required herein is incorporated by reference from pages 8 through 11 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 11 through 23 of the Annual Report. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ------------------------------------------------------------- The information required herein is incorporated by reference from pages 18 through 19 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 25 through 52 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 Securities and Exchange Commission. 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 Securities and Exchange Commission. 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 Securities and Exchange Commission. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -------------------------------------------------- The information required herein is incorporated by reference from the definitive Proxy Statement filed with the Securities and Exchange Commission. PART IV - -------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K --------------------------------------------------------------- (a)(1) The following financial statements are incorporated herein by reference from pages 25 through 52 of the Annual Report. Report of Independent Certified Public Accountants. Consolidated Statements of Financial Condition as of December 31, 1997 and 1996. Consolidated Statements of Operations for each of the years in the three-year period ended December 31, 1997. Consolidated Statements of Stockholders' Equity for each of the years in the three-year period ended December 31, 1997. Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 1997. 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. Page - ----------- ------- 3.1 Articles of Incorporation of the Company . . . . . . . . . * 3.2 Bylaws of Company. . . . . . . . . . . . . . . . . . . . . * 4 Form of Company common stock certificate . . . . . . . . . * 4.1 Form of Indenture dated as of June 30, 1995, with respect to the Company's 10% Notes, due 2002 . . . . . . . . . . . ** 10.1 1991 Stock Compensation Program. . . . . . . . . . . . . . * 10.2 1995 Stock Compensation Program. . . . . . . . . . . . . . *** 10.3 Change-In-Control Severance Agreements . . . . . . . . . . E-1 12 Ratio of earnings to combined fixed charges and preferred stock dividends (See Exhibit 13) 13 Annual Report to Stockholders. . . . . . . . . . . . . . . E -13 27 Financial Data Schedule (electronically filed) 28 Form of proxy to be mailed to stockholders of the Company. E -73
__________________ * Incorporated by reference to the Company's Registration Statement on Form S-4 (No. 33-75952) filed on March 2, 1994. ** 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. *** Incorporated by reference to the Company's Registration Statement on Form S-1 (No. 33-91206) filed on April 14, 1995. (b)(1) Form 8-K filed by the Company on May 5, 1997 concerning the declaration of dividends for the first quarter of 1997. (b)(2) Form 8-K filed by the Company on October 21, 1997 concerning the formation of Coastal Banc Capital Corp., a wholly-owned subsidiary of Coastal Banc Holding Company, Inc. (b)(3) Form 8-K filed by the Company on March 11, 1998 concerning the resolution of an outstanding tax benefit issue with the Federal Deposit Insurance Corporation. (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 24, 1998 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 24, 1998 - ----------------------------- Manuel J. Mehos, Chairman of the Board and Chief Executive Officer /s/ R. Edwin Allday Date: March 24, 1998 - ---------------------------- R. Edwin Allday, Director /s/ D. Fort Flowers, Jr. Date: March 24, 1998 - ---------------------------- D. Fort Flowers, Jr., Director /s/ Dennis S. Frank Date: March 24, 1998 - ---------------------------- Dennis S. Frank, Director /s/ Robert E. Johnson, Jr. Date: March 24, 1998 - ---------------------------- Robert E. Johnson, Jr., Director /s/ James C. Niver Date: March 24, 1998 - ----------------------------- James C. Niver, Director /s/ Clayton T. Stone Date: March 24, 1998 - ----------------------- Clayton T. Stone, Director /s/ Catherine N. Wylie Date: March 24, 1998 - ------------------------- Catherine N. Wylie, Chief Financial Officer (principal financial and accounting officer) EX-27 2
9 This schedule contains summary financial information extracted from the consolidated statement of financial condition, the consolidated statement of operations and notes thereto found in exhibit 13 of the Company's Form 10-K for the year ended December 31, 1997 and is qualified in its entirety by reference to such financial statements 12-MOS DEC-31-1997 DEC-31-1997 37,096 0 0 0 169,997 1,345,090 1,324,968 1,261,435 7,412 2,911,410 1,375,060 1,112,679 49,285 269,556 0 0 50 104,780 2,911,410 106,962 92,755 1,639 201,356 62,912 144,423 56,933 1,800 237 42,132 19,385 11,563 0 0 11,563 2.32 2.25 2.02 17,351 340 0 0 6,880 1,416 148 7,412 7,412 0 0
EX-13 3 EXHIBIT 13 COASTAL BANCORP, INC. AND SUBSIDIARIES FINANCIAL HIGHLIGHTS DECEMBER 31, 1997, 1996 AND 1995
December 31, ------------ (dollars in thousands, except per share data) 1997 1996 1995 - ----------------------------------------------------- ----------- ----------- ----------- FOR THE YEAR ENDED Net interest income $ 56,933 $ 56,426 $ 43,932 Provision for loan losses 1,800 1,925 1,664 Noninterest income 6,384 6,091 5,162 SAIF insurance special assessment (1) -- 7,455 -- Other noninterest expense 39,544 37,927 29,823 Net income available to common stockholders 11,563 6,951 8,542 Diluted earnings per share before the 1996 SAIF insurance special assessment (2) 2.25 2.34 1.71 Diluted earnings per share 2.25 1.38 1.71 - ----------------------------------------------------- ----------- ----------- ----------- AT YEAR END Total assets $2,911,410 $2,875,907 $2,786,528 Loans receivable 1,261,435 1,229,748 1,098,555 Mortgage-backed securities held-to-maturity 1,345,090 1,344,587 1,395,753 Mortgage-backed securities available-for-sale 169,997 180,656 186,414 Savings deposits 1,375,060 1,310,835 1,287,084 Borrowed funds 1,332,235 1,376,707 1,306,018 Senior Notes payable 50,000 50,000 50,000 Preferred Stock of the Bank 28,750 28,750 28,750 Stockholders' equity 104,830 94,148 91,679 Book value per common share 20.67 18.70 18.27 Tangible book value per common share 17.74 15.70 14.71 - ----------------------------------------------------- ----------- ----------- ----------- SIGNIFICANT RATIOS FOR THE YEAR ENDED Return on average assets before the 1996 SAIF insurance special assessment (2) 0.49% 0.51% 0.45% Return on average equity before the 1996 SAIF insurance special assessment (2) 11.68 12.53 9.71 Interest rate spread including noninterest-bearing savings deposits 1.85 1.89 1.61 Interest rate spread 1.67 1.72 1.46 Net interest margin 2.02 2.06 1.82 Average equity to average total assets 3.41 3.30 3.56 Noninterest expense to average total assets before the 1996 SAIF insurance special assessment (2) 1.36 1.35 1.21 - ----------------------------------------------------- ----------- ----------- ----------- ASSET QUALITY RATIOS AT YEAR END Nonperforming assets to total assets 0.71% 0.56% 0.68% Nonperforming loans to total loans receivable 1.38 1.04 1.33 Allowance for loan losses to nonperforming loans 42.72 53.59 39.00 Allowance for loan losses to total loans receivable 0.59 0.56 0.52 - ----------------------------------------------------- ----------- ----------- -----------
(1) On September 30, 1996, Coastal recorded the one-time Savings Association Insurance Fund ("SAIF") insurance special assessment (the "special assessment") of $7.5 million as a result of the Deposit Insurance Funds Act of 1996 (the "Act") being signed into law. The special assessment pursuant to the Act was 65.7 basis points on the SAIF assessment base as of March 31, 1995. (2) These ratios are calculated before the after-tax (as applicable) effect of the special assessment of $4.8 million recorded on September 30, 1996. CORPORATE PROFILE Coastal Bancorp, Inc., 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, state savings bank. Coastal Banc ssb operates 37 branch offices in metropolitan Houston, Austin, Corpus Christi and small cities in the south east quadrant of Texas. At December 31, 1997, Coastal Banc ssb had $2.9 billion in assets and was considered to be a "well capitalized" institution according to Federal Deposit Insurance Corporation ("FDIC") guidelines. TABLE OF CONTENTS (Page numbers in printed Annual Report)
Letter from the Chairman and Chief Executive Officer 2 Selected Consolidated Financial and Other Data . . . 8 Management's Discussion and Analysis . . . . . . . . 11 Independent Auditors' Report . . . . . . . . . . . . 25 Consolidated Financial Statements. . . . . . . . . . 26 Notes to Consolidated Financial Statements . . . . . 31 Stock Prices . . . . . . . . . . . . . . . . . . . . 53 Stockholder Information. . . . . . . . . . . . . . . 54
CHAIRMAN'S LETTER Since Coastal Bancorp, Inc. ("Coastal") went public in 1992, all of our annual reports have shared two traits: each had a large wave on its cover and each of my letters to Coastal's shareholders ended with the promise that our principal goal is to maximize shareholder return. The 1997 Annual Report is no exception - - the large wave on the cover is still building and you can anticipate how this letter will end. But this year's letter has a new twist because the biggest Coastal news for 1997 is shareholder return. So shareholder return gets opening coverage as well as closing coverage this year. Coastal stock price was up $12.00 per share, or 52% in 1997! That increase is by far a record dollar and percentage increase for Coastal. At the end of 1997, Coastal's stock price closed at $34.875 per share, also a record high. Part of the reason for the increase was a roaring bull market in 1997 coupled with strong investor demand for bank stocks. But contributing equally to the strong stock performance is investor recognition of Coastal's successful transition to full service commercial banking. This unprecedented Coastal stock performance occurred during a year of somewhat disappointing earnings. Core earnings for 1997 were short of management's goal by roughly 25 cents per share and were in line with 1996 core earnings. The earnings shortfall was directly attributable to temporary changes in the wholesale funding market in the second half of the year coupled with unusually high mortgage prepayments on an adjustable rate whole loan package purchased in June of 1997. As a result, Coastal's net interest margin suffered almost 20 basis points of erosion in the third and fourth quarters. In early January 1998, however, both problems have eased and Coastal has started on the path back to spreads achieved in the first half of 1997. We are pleased, however, that investors have focused on Coastal's continuing success in our shift to commercial banking rather than the temporary market phenomena. After a detailed discussion of 1997 earnings, I will describe the progress we made toward our ongoing strategic goals and tell you about Coastal's future opportunities in the new banking business, which is evolving rapidly into a more multidimensional enterprise. 1997 EARNINGS Earnings for 1997 were $14.2 million or $2.25 per share, a 1.6% decline from 1996 earnings of $14.4 million or $2.34 per share before the after-tax effect of the one-time Savings Association Insurance Fund ("SAIF") special assessment imposed in 1996 by the FDIC (the "1996 special assessment"). Earnings for 1996, after the special assessment, were $9.5 million or $1.38 per share. Per share data during 1997 and 1996 were based on 5.1 million and 5.0 million common shares outstanding (used in the diluted earnings per share calculation). The special assessment was a one-time assessment charged (pursuant to 1996 federal legislation) by the FDIC on September 30, 1996, to all SAIF-insured financial institutions at the rate of $0.657 per $100 of SAIF deposits as of March 31, 1995. The assessment was intended to restore the SAIF to its minimum required level and eventually equalize FDIC insurance premiums for both Bank Insurance Fund and SAIF members. As a result of the legislation, Coastal's FDIC insurance premiums dropped to approximately $0.0648 per $100 of deposits from the rate of $.23 per $100 of deposits which was in effect prior to the legislation. The 1996 special assessment, after taxes, was $4.8 million, or $0.96 per share. Despite the net interest margin compression experienced in the second half of the year, core revenues once again reached a new record high. Net interest income after provision for loan losses reached $55.1 million during 1997, compared to $54.5 million in 1996, and loan fees, service charges on deposit accounts and loan servicing income reached $5.4 million during 1997, compared to $5.0 million during 1996. However, noninterest expenses reached $39.5 million during 1997, compared to $37.9 million during 1996 (excluding the 1996 special assessment). At December 31, 1997, Coastal had total assets of $2.9 billion, total deposits of $1.4 billion in 37 branch offices and common stockholders' equity of $104.8 million. The higher wholesale funding costs and resulting net interest margin compression during the second half of the year were primarily attributable to an anomaly in the spread between the London Interbank Offered Rate ("LIBOR") and the Treasury rate (the "TED spread"). For example, the TED spread historically (6 year average) has been 40 basis points, but for the fourth quarter of 1997 was 63 basis points which would have equated to an additional 9 cents per share for the quarter had the spread been consistent with the 6 year average. In addition, Coastal experienced unusually high payoffs related to an adjustable rate whole loan package purchased in the second quarter of the year. As a result, higher than normal amortization of purchased mortgage loan premiums coupled with a higher borrowing cost caused compression in Coastal's net interest margin. However, as previously stated, both the wholesale funding anomaly and the mortgage payoff trend appear to be improving in early 1998. THE BALANCE SHEET SHOWS SIGNS OF OUR COMMERCIAL STRATEGY Closer examination of the changes in components of the balance sheet at the end of 1997 will reveal evidence that Coastal's strategic direction into commercial loans and commercial deposits is producing tangible results. Management was somewhat disappointed that the rapid decline in the mortgage portfolio and unusually high funding costs overshadowed growth in commercial loans and increases in low cost business deposits. Consider this: The single family mortgage portfolio had principal reductions of $243.0 million in 1997 but for the year only decreased $101.5 million from $791.3 million at the end of 1996 to $689.8 million at the end of 1997. Total loans, however, increased during the same period by over $30 million, from $1.23 billion at the end of 1996 to $1.26 billion at the end of 1997. Thus, all categories of commercial loans experienced sufficient growth to offset the $101.5 million decrease in single family mortgage loans and still provided for overall loan growth. Furthermore, even though single family mortgage rates declined during 1997, the weighted average yield on the loan portfolio at year end increased from 8.23% at December 31, 1996 to 8.30% at December 31, 1997, fulfilling our primary objective of higher yielding, floating index loans that come with a shift to commercial banking. And consider this: Evidence of Coastal's campaign to promote low rate commercial transaction accounts - another primary objective of our commercial banking strategy - lies in the deposit numbers. Wholesale borrowing costs were substantially higher in 1997 when compared to 1996, but Coastal's year end 1997 weighted-average cost of deposits was 4.67%, unchanged from 1996. As of the end of 1997, certificates of deposit at rates above 5% increased by over $50 million while certificates of deposit at rates below 5% actually decreased in comparison to year end 1996. Coastal's overall cost of deposits did not increase, however, because low cost transaction accounts increased by almost $50 million. Coastal commenced its strategic shift into commercial banking in 1996 with the primary objectives of increasing Coastal's net interest margin and fee income while decreasing Coastal's vulnerability to volatile market interest rates. After two full years of introducing commercial bank services and products, you can clearly see the results of our strategy within the changing composition of the loan and deposit portfolios. But this is just the beginning. We will continue to allocate more resources to commercial customers because, so far, the results are a strategic success. TIME TO CHANGE THE BANKING FORMULA Now that we have a commercial platform and commercial customers, we are real bankers, right? Coastal will make commercial loans at prime, graciously accept their business deposits without paying interest, earn a healthy spread and juicy account fees, and live happily ever after, right? We wish. But it doesn't work that way any more. In today's market, a typical commercial customer expects either a fixed rate loan or a loan at a small spread tied to LIBOR. They expect the deposits to be swept at the end of each day to an interest-bearing account, which may be located at their friendly neighborhood brokerage house. Eventually, that brokerage house will find a way to finance the rest of the customer's needs. Traditional banking profit strategies are commonly based on the view that a fixed formula amount of marginal overhead sustains a predictable amount of spread income and fee income. This approach is flawed because overhead is perceived as a machine that generates a given amount of loans, deposits and, thus, spread income, which will remain on the balance sheet for a minimum period of time. Any further growth requires a formula-derived amount of marginal overhead growth. As long as a constant level of interest rate spread can be maintained, the traditional formula works and the required level of returns on equity can be achieved. The trouble is, when the yield on new loans is declining and the cost of deposits is climbing, the formula no longer works. Thus, the incremental overhead must produce increasingly more loans and deposits for the formula to work. All because the spreads produced by loans and the amount of time the loans and deposits remain on the balance sheet are both declining. Profits per the typical commercial banking customer have been roughly cut in half, and they remain on the books for a much shorter period of time. This is nothing more than a gross margin squeeze; therefore, it must be fixed by increasing total revenues per customer and reducing marginal expenses per customer. Banks must sell more services per business customer, reduce the turnover and, most importantly, offer business customers services that traditionally have not been the domain of the banking industry. Based on this new formula, Coastal's strategy employs technology to increase the number of business customers per dollar of overhead. Then we migrate down the customers' balance sheets to provide services heretofore provided by that friendly neighborhood brokerage firm. TECHNOLOGY BRIDGES LOCAL PRESENCE With the exception of commercial loans to medium sized businesses, most traditional banking loans have reached a level of standardization whereby a local presence doesn't provide a bank much of a competitive advantage. Consumer loans, mortgage loans, and small business loans are sold through the mail and on the Internet. Commercial real estate mortgage loans are provided by national conduits and mortgage Real Estate Investment Trusts. Non-local creditors now offer commercial construction loans. Coastal will continue to offer and profitably produce all of these types of loans. Several of these categories are a big part of our current loan portfolio. However, at this mature stage of the loan cycle, they are becoming increasingly difficult to originate at a profitable yield without taking additional credit risk - not an option for Coastal. Medium-sized business banking loans, on the other hand, have not completely turned into standardized commodities without geographical ties. Location still counts for something. Credit decisions and loan pricing rely on less standardized information, and someone from the lending organization must have a certain amount of continuous contact with the customer. However, we still have to solve the dilemma of reduced customer profitability, particularly given the intense competition of today's mature lending cycle. The best way to maintain profit growth in this environment is by producing many more customers with the same amount of overhead. Rather than take more credit risk with a fewer customers, Coastal chooses to take less credit risk with more customers. But to do this, a revolutionary platform for processing more customers faster (but at the same level of risk) was needed. Last year in my letter to you I described the Portfolio Control Center ("PCC"), Coastal's new concept for originating, underwriting and approving commercial loans. The PCC, operating full time, applies Internet and network computer technology to an interactive, dynamic process for taking a commercial loan from application to closing in less time and incorporating more comprehensive credit information. The PCC allows the loan officer to manage more new customers and a larger portfolio of existing customers. In last year's letter, the PCC was a concept. Today it is a reality. The PCC became fully operational during the fourth quarter of 1997. The bulk of Coastal's commercial loan production now originates through the PCC. As a result, loan velocity has substantially improved and the loan officers are getting immediate feedback, freeing their time to pursue more customers. "SOUTH" BALANCE SHEET SERVICES But increasing the number of business customers is only half the battle. Coastal must provide a larger universe of services to its business customers in order to maintain adequate profitability per customer over a longer period of time. Providing products principally for the "north" side of the balance sheet - - working capital loans, cash management, etc. - is not enough. It's time to begin the migration south on the customer balance sheet and provide services that traditionally were the domain of the investment bankers - alternative financing, raising capital, merger and acquisition services, etc. The local advantage we have in business banking will provide a similar advantage in investment banking. This strategy has a dual purpose: First, it provides an avenue for Coastal to be able to provide most balance sheet services, rather than saying "I'm sorry, we don't do that." Second, for the long term it provides Coastal a means to become less reliant on credit risk to produce earnings growth. Let me explain. The traditional investment banking balance sheet is more of a virtual bank balance sheet: The credit risk passes through to other investors but a snapshot of the transaction (spread, fee, gain, loss) at the time of funding remains in retained earnings. On the other hand, the traditional bank balance sheet maintains the credit risk of its customers on its balance sheet and the spread remains throughout the life of the relationship. Investment banks must continue to replenish their balance sheets with new transactions, therefore they must pay the necessary expenses. Banks don't have to replenish as often, but sometimes pay in the form of credit losses. As long as Coastal has low cost deposits, loan spreads on a risk-adjusted basis will continue to be profitable. But as business customers continue to sweep their deposits into interest-bearing accounts and spreads continue to contract, certain types of credit risk may not be justifiable. The "credit expense" for some of our potential customers reduces the margin on the spread to an unacceptable level. Operating only as a traditional bank, we would turn the customer away. But with certain investment banking capabilities, Coastal could keep the customer, pass the credit risk through to other investors, and replenish the balance sheet with another transaction. The important change to note here is that Coastal will have a choice. Today, our only choice is whether to take credit risk. Equipped with these new capabilities, Coastal will be able to increase the number and type of business customers, increase the revenue potential from each customer, and better manage the credit expense imbedded in our balance sheet. During the fourth quarter of 1997, Coastal formed Coastal Banc Capital Corp. ("CBCC"). The initial purpose of this corporation is to trade whole mortgages and purchase mortgages for Coastal's balance sheet. Ultimately CBCC is intended to operate as an investment banking company. This phase of our business may take some time to develop. Once developed, Coastal will be equipped to satisfy the non-traditional needs of our local customers. With the growth of CBCC, all local businesses will become a potential revenue source. LOW COST DEPOSITS IN LOW COST BRANCHES To more effectively manage the delivery of a full complement of new commercial products introduced during 1997, Coastal reallocated its branch banking resources according to market needs. Adhering to its successful formula of low overhead and low risk, management implemented a three-tier branch system. Group 1 branches offer Coastal's full line of commercial and retail products, both lending and deposits. Group 2 branches offer full commercial and retail deposit services, but only retail lending services. Group 3 branches offer only retail services. The strategy allowed the successful introduction of new commercial products without a significant increase in overall branch overhead. However, one experimental aspect of the new program presented an important lesson in small community business banking. Under the new guidelines, six branches were initially established as Group 1 branches, three of which were in small-city markets where Coastal did not have an established commercial customer base. By the end of 1997, the experiment revealed to management that unless a branch in a small city market has an established clientele, the amount of resources needed to properly establish a commercial customer base is prohibitive for a low-cost operator such as Coastal. Therefore, during 1998, Coastal has reduced its Group 1 branches to four branches in the Houston, Austin and Victoria markets. During 1997, Coastal acquired a $54.6 million branch in Port Arthur, Texas from Wells Fargo Bank (Texas). Coastal will continue to seek strategic acquisitions of whole banks and branches of banks within our markets and adjacent to our markets. However, at present, acquisition prices have become prohibitively expensive. Until acquisition prices become more reasonable for Coastal, management will develop new branch locations that have the best business potential and complement Coastal's existing branch structure. Two new branches are planned for 1998, one in Austin and one in Houston. Due to certain budget parameters, we are limited to establishing a maximum of two new branches per year. As I previously discussed, the primary reason Coastal maintained a low cost of deposits in 1997 while new certificates of deposits were issued at higher rates was a significant increase in transaction accounts such as money market, checking and business checking accounts. The acquisition of the Port Arthur branch, checking and money market account promotional campaigns coupled with strategic initiatives to convert commercial loan customers to checking and cash management customers made a significant positive impact on Coastal's cost of deposits, sensitivity to interest rate changes and deposit product fee income. Fees on deposit products, both retail and commercial, increased by 26.4% to $2.3 million in 1997 as compared to $1.8 million in 1996. In this mature stage of the lending cycle, quality loan growth will continue to be challenging. Since Coastal does not plan to lower its credit standards for the sake of loan growth and earnings growth, the most effective and safest way to improve earnings is to reduce Coastal's cost of deposits. A major strategic focus for Coastal in 1998 will be to continue the promising trend in transaction accounts established in 1997 and introduce additional strategies for further reducing Coastal's cost of deposits. We will improve our certificate of deposit pricing strategies with the goal of reducing rates in Coastal's least price sensitive markets. We will aggressively market commercial cash management accounts and introduce an off-balance sheet sweep account in the second quarter of 1998 in order to attract more commercial depositors. And we will implement new product and customer-level profitability measurements. A principal factor in measuring profitability will be the amount by which the measured product reduces Coastal's cost of funds. STEPPING INTO A NEW BANKING ERA On the weekend of July 4, 1997, Coastal moved into its new corporate headquarters, Coastal Banc Plaza, a few miles southwest of downtown Houston. The timing was appropriate. By mid-1997, Coastal had shed its thrift veneer and established itself as a leading independent banking institution in Houston. Now Coastal will confront its biggest challenge. Since we were founded in 1986, Coastal has fed on the remnants of collapsed markets in Texas. We bought loans, deposits and banks when everyone else was skeptical. We ventured into lending markets in Texas before everyone was absolutely sure it was safe. Now, the world of finance has arrived in Texas and crowded Coastal's domain. Our former banking frontier is now a bustling metropolis of out-of-state financiers. Notwithstanding the crowd, we have found a way to win: geography, technology, velocity and "yes." Geography because we are local, and have been for a while. Our customer's individual banker will not change every six months. Technology because we use it for local delivery of custom commercial products rather than for building and selling volumes of standardized products. Velocity because we use geography and technology to respond immediately. And "yes," because we are migrating south down our customers' balance sheets. It will take a little while, but one day Coastal will provide financial services for the entire customer balance sheet. One day our response to all commercial customers will be: "Yes, we can do that for you." Each year I re-state Coastal's commitment to the four operating principles that brought us to where we are today. They have served us well since 1986, and if you examine our present strategy, you will find those principles firmly entrenched. We talked about reducing our cost of funds, selling more transaction accounts, and using technology to deliver more commercial loans per overhead dollar, but we reallocate resources to do so rather than spending new resources. Translation: Maintain a low cost operation. We increase the proportion of transaction deposit accounts and floating index commercial loans. Translation: Minimize interest rate risk. We strive to make more loans with less credit risk and introduce services that will eventually provide us a credit risk choice. Translation: Minimize credit risk. But these three principles are designed and strictly adhered to in order to execute, in all market conditions, our most important principle and overall Coastal objective (I told you it would end this way again): Maximize shareholder return. /s/ Manuel J. Mehos - --- ----------------- Manuel J. Mehos Chairman of the Board 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, 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (in thousands except per share data and selected ratios) Balance Sheet Data Total assets $2,911,410 $2,875,907 $2,786,528 $2,299,769 $1,928,550 Mortgage-backed securities held-to-maturity (1) 1,345,090 1,344,587 1,395,753 1,605,839 1,324,904 Mortgage-backed securities available-for-sale 169,997 180,656 186,414 32,249 -- Loans receivable (1) 1,261,435 1,229,748 1,098,555 587,032 450,104 Guaranteed Assets (2) -- -- -- -- 68,928 Savings deposits 1,375,060 1,310,835 1,287,084 1,139,622 1,023,105 Securities sold under agreements to repurchase 791,760 966,987 993,832 645,379 -- Advances from the Federal Home Loan Bank of Dallas ("FHLB") 540,475 409,720 312,186 386,036 788,867 Senior Notes payable 50,000 50,000 50,000 -- -- Preferred Stock of the Bank 28,750 28,750 28,750 28,750 28,750 Stockholders' equity 104,830 94,148 91,679 84,680 79,254
For the Year Ended December 31, 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (in thousands except per share data and selected ratios) Operating Data (10) Interest income $201,356 $194,611 $170,286 $129,037 $ 90,024 Interest expense 144,423 138,185 126,354 88,519 53,578 -------- -------- -------- -------- --------- Net interest income 56,933 56,426 43,932 40,518 36,446 Provision for loan losses 1,800 1,925 1,664 934 1,151 -------- -------- -------- -------- --------- Net interest income after provision for loan losses 55,133 54,501 42,268 39,584 35,295 Gain (loss) on sales of mortgage-backed securities available-for-sale, net 237 (4) 81 192 -- Gain on sale of branch office -- 521 -- -- -- Other noninterest income 6,147 5,574 5,081 6,539 3,888 SAIF insurance special assessment (3) -- (7,455) -- -- -- Other noninterest expense (39,544) (37,927) (29,823) (25,731) (22,882) -------- -------- -------- -------- --------- Income before provision for Federal income taxes, minority interest and cumulative effect of accounting change 21,973 15,210 17,607 20,584 16,301 Provision for Federal income taxes (7,822) (5,671) (6,477) (4,333) (4,925) Minority interest in income of consolidated subsidiary -- -- -- (211) (643) Cumulative effect of change in accounting for income taxes (4) -- -- -- -- 973 Net income before preferred stock dividends 14,151 9,539 11,130 16,040 11,706 -------- -------- -------- -------- --------- Preferred stock dividends of the Bank (2,588) (2,588) (2,588) (2,588) (395) Net income available to common stockholders 11,563 6,951 8,542 13,452 11,311 ======== ======== ======== ======== ========= Diluted earnings per share before cumulative effect of accounting change (4) 2.25 1.38 1.71 2.64 1.92 Diluted earnings per share 2.25 1.38 1.71 2.64 2.10
COASTAL BANCORP, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
At or For the Year Ended December 31, ------------------------------------- 1997 1996 1995 1994 1993 ------- ------- ------- ------- ------- Selected Ratios Performance Ratios (5) (10): Return on average assets before the 1996 SAIF insurance special assessment (6) 0.49% 0.51% 0.45% 0.71% 0.75% Return on average assets after the 1996 SAIF insurance special assessment 0.49 0.34 0.45 0.71 0.75 Return on average equity before the 1996 SAIF insurance special assessment (6) 11.68 12.53 9.71 16.57 15.16 Return on average equity after the 1996 SAIF insurance special assessment 11.68 7.50 9.71 16.57 15.16 Dividend payout ratio before the 1996 SAIF insurance special assessment (6) 19.83 16.82 18.56 8.83 -- Dividend payout ratio after the 1996 SAIF insurance special assessment 19.83 28.55 18.56 8.83 -- Average equity to average total assets 3.41 3.30 3.56 3.59 4.77 Net interest margin (7) 2.02 2.06 1.82 1.84 2.42 Interest rate spread including noninterest-bearing savings deposits (7) 1.85 1.89 1.61 1.68 2.30 Interest rate spread (7) 1.67 1.72 1.46 1.57 2.21 Noninterest expense to average total assets before the 1996 SAIF insurance special assessment (6) 1.36 1.35 1.21 1.14 1.46 Noninterest expense to average total assets after the 1996 SAIF insurance special assessment 1.36 1.61 1.21 1.14 1.46 Average interest-earning assets to average interest-bearing liabilities 106.72 106.75 106.78 106.71 105.91 Ratio of earnings to combined fixed charges and preferred stock dividends before the 1996 SAIF insurance special assessment (6): Excluding interest on deposits 1.23X 1.25X 1.21X 1.33X 1.64X Including interest on deposits 1.13 1.14 1.12 1.19 1.28 Ratio of earnings to combined fixed charges and preferred stock dividends after the 1996 SAIF insurance special assessment: Excluding interest on deposits 1.23 1.15 1.21 1.33 1.64 Including interest on deposits 1.13 1.09 1.12 1.19 1.28 Asset Quality Ratios: Nonperforming assets to total assets (8) 0.71% 0.56% 0.68% 0.30% 0.22% Nonperforming loans to total loans receivable 1.38 1.04 1.33 1.04 0.91 Allowance for loan losses to nonperforming loans 42.72 53.59 39.00 35.37 37.32 Allowance for loan losses to total loans receivable 0.59 0.56 0.52 0.37 0.34 Bank Regulatory Capital Ratios (9): Tangible capital to adjusted total assets N/A N/A N/A N/A 5.11 Tier 1 capital to total assets 5.52 5.35 5.30 4.54 5.17 Tier 1 risk-based capital to risk-weighted assets 11.46 11.77 12.36 12.37 N/A Total risk-based capital to risk-weighted assets 11.98 12.30 12.84 12.63 18.63 Other Data: Full-time employee equivalents 451 433 390 298 288 Number of full service offices 37 37 40 34 26
FOOTNOTES TO SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (1) Mortgage-backed securities held-to-maturity are net of premiums and discounts. Loans receivable are net of loans in process, premiums, discounts, unearned interest and loan fees and the allowance for loan losses. (2) Guaranteed Assets were governed by the Assistance Agreement in connection with the Southwest Plan Acquisition in 1988. Coastal and the FDIC terminated the Assistance Agreement, effective March 31, 1994, pursuant to which Coastal transferred substantially all the Guaranteed Assets back to the FDIC in exchange for cash. (3) On September 30, 1996, Coastal recorded the special assessment of $7.5 million as a result of the Act being signed into law. The special assessment pursuant to the Act was 65.7 basis points on the SAIF assessment base as of March 31, 1995. See Note 18 of the Notes to Consolidated Financial Statements. (4) Coastal adopted the Financial Accounting Standards Board's Statement No. 109 as of January 1, 1993. The cumulative effect of this change in accounting for income taxes of $973,000 was determined as of January 1, 1993. Prior years' financial statements were not restated to apply the provisions of Statement No. 109. (5) Ratio, yield and rate information are based on year-to-date average balances. (6) These ratios are calculated before the after-tax effect of the special assessment of $4.8 million recorded on September 30, 1996. See Note 18 of the Notes to Consolidated Financial Statements. (7) Net interest margin represents net interest income as a percentage of average interest-earning assets. Interest rate spread including noninterest-bearing savings 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 savings 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. (8) Nonperforming assets consist of nonaccrual loans, real estate acquired by foreclosure and repossessed assets but do not include Guaranteed Assets acquired in the Southwest Plan Acquisition. See Note 2 above. (9) Prior to the conversion of the Bank to a state savings bank in July 1994, Office of Thrift Supervision ("OTS") regulations required the Bank to maintain tangible capital equal to at least 1.5% of adjusted total assets, minimum core or Tier 1 capital equal to at least 3.0% of adjusted total assets and a minimum ratio of total capital to risk-weighted assets of 8.0%. Current FDIC regulations require the Bank 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. (10) Certain 1996, 1995, 1994 and 1993 balances have been reclassified to conform to the 1997 presentation. Such reclassifications had no effect on net income or total stockholders' equity. COASTAL BANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Coastal Bancorp, Inc. was incorporated on March 8, 1994 in connection with the proposed reorganization of Coastal Banc Savings Association (the "Association") into the holding company form of organization, which 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 (the "Bank"). As a result of the reorganization, Coastal Bancorp, Inc. ("Bancorp") became the owner of 100% of the voting stock of the Bank and each share of the Association's common stock now represents one share of common stock of Bancorp. The holders of the 9.0% Noncumulative Preferred Stock, Series A, of the former Coastal Banc Savings Association now own an equal number of shares of 9.0% Noncumulative Preferred Stock, Series A, of the Bank. 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, the Bank became a wholly-owned subsidiary of HoCo and HoCo became a wholly-owned subsidiary of Bancorp. On September 30, 1996, Coastal recorded the special assessment of $7.5 million ($4.8 million after applicable income taxes) as a result of the Act being signed into law. The special assessment pursuant to the Act was 65.7 basis points on the SAIF deposit assessment base as of March 31, 1995. Other provisions of the Act provided for a reduction of the SAIF deposit insurance premium rates beginning in the fourth quarter of 1996. On June 30, 1995, Bancorp issued $50.0 million of 10.0% Senior Notes due June 30, 2002. The Senior Notes are 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. Of the proceeds received from the issuance of the Senior Notes, $44.9 million was used to purchase the 11.13% Noncumulative Preferred Stock, Series B, of the Bank which is now owned by HoCo. FINANCIAL CONDITION Total assets increased 1.23% or $35.5 million from December 31, 1996 to December 31, 1997. The net increase resulted primarily from the increase in loans receivable of $31.7 million, an increase in cash and amounts due from depository institutions of $9.4 million and an increase in property and equipment of $7.3 million offset by a decrease of $10.7 million in mortgage-backed securities available-for-sale. The increase in loans receivable consisted primarily of increases of $62.3 million, $45.1 million and $11.3 million, in commercial real estate mortgage loans, commercial loans secured by residential mortgage loans held for sale, and commercial loans secured by mortgage servicing rights, respectively, offset by a $101.6 million decrease in first lien residential mortgage loans due to principal reductions and payoffs received. The increase in property and equipment was due primarily to the acquisition of assets related to the relocation of Coastal's corporate headquarters in July of 1997. The relocation consolidated Coastal's administrative, primary lending and mortgage servicing offices. The decrease in mortgage-backed securities available-for-sale was primarily due to the sale of $11.3 million of securities in this category. At December 31, 1997, loans receivable as a percentage of total assets increased to 43.3% as compared to 42.8% at December 31, 1996, as part of management's plan to increase the loans receivable portfolio to approximately 50% of total assets within three to five years. Savings deposits increased 4.9% or $64.2 million from December 31, 1996 to December 31, 1997. This increase was primarily due to a branch acquisition of $54.6 million in deposits completed on June 21, 1997. Advances from the FHLB increased by 31.9% or $130.8 million and securities sold under agreements to repurchase decreased 18.1% or $175.2 million from December 31, 1996 to December 31, 1997. The reallocation of borrowings during such period was directly attributable to Coastal's change in funding sources to take advantage of more favorable interest rates and the deployment of cash received from the branch acquisition. Common stockholders' equity increased 11.4% or $10.7 million from December 31, 1996 to December 31, 1997 due to 1997 net income available to common stockholders of $11.6 million and a $829,000 decrease in the unrealized loss on securities available-for-sale, offset by common stock dividends declared of $2.3 million. RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1997 The results of operations of Coastal Bancorp, Inc. and subsidiaries depend primarily on its net interest income, which is the difference between interest income on interest-earning assets and interest expense on its interest-bearing liabilities. Coastal's interest-earning assets consist principally of mortgage-backed securities, loans receivable and other investments. Coastal's interest-bearing liabilities consist primarily of savings deposits, securities sold under agreements to repurchase, advances from the FHLB and its Senior Notes. Coastal's net income is also affected by its level of noninterest income, including loan fees and service charges on deposit accounts, loan servicing income, and gains on sales of assets, as well as by its noninterest expense, including compensation and benefits and occupancy costs and, in 1996, the special assessment. The following table sets forth, for the periods and at the dates indicated, information regarding Coastal's average balance sheets. Ratio, yield and rate information is based on year-to-date average balances.
At Year Ended December 31, 1997 December 31,1997 Yield/ Average Yield/ Rate Balance Interest Rate ----------------- --------- -------- ------- (Dollars in thousands) ASSETS Interest-earning assets: Loans receivable 8.30% $1,281,493 $ 106,962 8.35% Mortgage-backed securities 6.25 1,514,541 92,755 6.12 U.S. Treasury security -- 3 -- -- Securities purchased under agreements to resell and federal funds sold -- 4,024 251 6.24 FHLB stock 6.00 21,663 1,292 5.96 Interest-earning deposits in other depository institutions 5.89 2,416 96 3.97 ------ ---------- -------- ------ Total interest-earning assets 7.17 2,824,140 201,356 7.13 ------ ---------- ------- ------ Noninterest-earning assets (1) 81,400 ---------- Total assets (2) $2,905,540 ========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing savings deposits 5.04% $1,253,142 $ 62,912 5.02% Securities sold under agreements to repurchase and federal funds purchased 6.00 974,297 55,189 5.66 Advances from the FHLB 5.95 368,896 21,322 5.78 Senior Notes payable 10.00 50,000 5,000 10.00 ------ ---------- -------- ----- Total interest-bearing liabilities 5.60 2,646,335 144,423 5.46 ------ ---------- -------- ------ Noninterest-bearing liabilities 131,431 ---------- Total liabilities 2,777,766 Preferred Stock of the Bank 28,750 Stockholders' equity 99,024 ---------- Total liabilities and stockholders' equity $2,905,540 ========== Net interest income; interest rate spread 1.57% $ 56,933 1.67% ======= ========= ===== Net interest-earning assets; net interest yield on interest-earning assets $ 177,805 2.02% ========== ====== Ratio of average interest-earning assets to average interest-bearing liabilities 1.07x ========== Year Ended December 31, 1996 Average Yield/ Balance Interest Rate ------- -------- ---- (Dollars in thousands) ASSETS Interest-earning assets: Loans receivable $ 1,156,933 $ 97,935 8.47% Mortgage-backed securities 1,556,966 95,155 6.11 U.S. Treasury security 1,002 54 5.39 Securities purchased under agreements to resell and federal funds sold -- -- -- FHLB stock 21,853 1,288 5.89 Interest-earning deposits in other depository institutions 4,149 179 4.31 ----------- ------- ----- Total interest-earning assets 2,740,903 194,611 7.10 ----------- -------- ------ Noninterest-earning assets (1) 71,344 ----------- Total assets (2) $ 2,812,247 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing savings deposits $ 1,199,651 $ 60,076 5.01% Securities sold under agreements to repurchase and federal funds purchased 930,706 51,360 5.52 Advances from the FHLB 387,296 21,749 5.62 Senior Notes payable 50,000 5,000 10.00 ----------- ------- ------ Total interest-bearing liabilities 2,567,653 138,185 5.38 ----------- -------- ------ Noninterest-bearing liabilities 123,160 ----------- Total liabilities 2,690,813 Preferred Stock of the Bank 28,750 Stockholders' equity 92,684 ----------- Total liabilities and stockholders' equity $ 2,812,247 =========== Net interest income; interest rate spread $ 56,426 1.72% ======== ====== Net interest-earning assets; net interest yield on interest-earning assets $ 173,250 2.06% =========== ====== Ratio of average interest-earning assets to average interest-bearing liabilities 1.07x =========== Year Ended December 31, 1995 Average Yield/ Balance Interest Rate ------- -------- ------ (Dollars in thousands) ASSETS Interest-earning assets: Loans receivable $ 765,404 $ 66,405 8.68% Mortgage-backed securities 1,625,044 102,194 6.29 U.S. Treasury security 667 39 5.85 Securities purchased under agreements to resell and federal funds sold -- -- -- FHLB stock 20,297 1,318 6.49 Interest-earning deposits in other depository institutions 3,958 330 8.34 ----------- -------- ------ Total interest-earning assets 2,415,370 170,286 7.05 ----------- -------- ------ Noninterest-earning assets (1) 56,370 ----------- Total assets (2) $ 2,471,740 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing savings deposits $ 1,116,788 $ 56,716 5.08% Securities sold under agreements to repurchase and federal funds purchased 752,427 45,022 5.98 Advances from the FHLB 367,895 22,116 6.01 Senior Notes payable 25,000 2,500 10.00 ----------- --------- ------ Total interest-bearing liabilities 2,262,110 126,354 5.59 ----------- -------- ------ Noninterest-bearing liabilities 92,919 ----------- Total liabilities 2,355,029 Preferred Stock of the Bank 28,750 Stockholders' equity 87,961 ----------- Total liabilities and stockholders' equity $ 2,471,740 =========== Net interest income; interest rate spread $ 43,932 1.46% ======== ====== Net interest-earning assets; net interest yield on interest-earning assets $ 153,260 1.82% =========== ====== Ratio of average interest-earning assets to average interest-bearing liabilities 1.07x ===========
(1) Includes goodwill, accrued interest receivable, property and equipment, cash, mortgage servicing rights, prepaid expenses and other assets. (2) Nonaccruing loans are included in total assets, but are immaterial. 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, Year Ended December 31, 1997 vs 1996 1996 vs 1995 ----------------------------- ---------------------------- Increase (Decrease) Due To Increase (Decrease) Due To ----------------------------- ---------------------------- Volume Rate Net Volume Rate Net -------- --------- -------- --------- -------- --------- (in thousands) INTEREST INCOME Loans receivable $10,431 $ (1,404) $ 9,027 $ 33,176 $(1,646) $ 31,530 Mortgage-backed securities (2,558) 158 (2,400) (4,182) (2,857) (7,039) U.S. Treasury security (27) (27) (54) 18 (3) 15 Securities purchased under agreements to resell and federal funds sold 126 125 251 -- -- -- FHLB stock (11) 15 4 97 (127) (30) Interest-earning deposits in other depository institutions (70) (13) (83) 15 (166) (151) -------- --------- -------- --------- -------- --------- Total 7,891 (1,146) 6,745 29,124 (4,799) 24,325 -------- --------- -------- --------- -------- --------- INTEREST EXPENSE Interest-bearing savings deposits 2,714 122 2,836 4,152 (792) 3,360 Securities sold under agreements to repurchase and federal funds purchased 2,484 1,345 3,829 10,010 (3,672) 6,338 Advances from the FHLB (1,042) 615 (427) 1,122 (1,489) (367) Senior Notes payable -- -- -- 2,500 -- 2,500 -------- --------- -------- --------- -------- --------- Total 4,156 2,082 6,238 17,784 (5,953) 11,831 -------- --------- -------- --------- -------- --------- Net change in net interest income . $ 3,735 $ (3,228) $ 507 $ 11,340 $ 1,154 $ 12,494 ======== ========= ======== ========= ======== =========
NET INCOME Coastal reported net income before preferred stock dividends of $14.2 million for the year ended December 31, 1997, $14.4 million for the year ended December 31, 1996, before the after-tax effect of the 1996 special assessment, and $11.1 million for the year ended December 31, 1995, respectively, a decrease of $234,000 or 1.6% in 1997 and an increase of $3.3 million or 29.2% in 1996 in each case in comparison to the prior year. The $234,000 decrease in 1997 was primarily due to a $507,000 increase in net interest income, a $125,000 decrease in the provision for loan losses and a $293,000 increase in noninterest income offset by a $1.6 million increase in noninterest expense (excluding the 1996 special assessment). The increase in noninterest income is due to a $568,000 increase in loan fees and service charges on deposit accounts, a $237,000 gain on sales of mortgage-backed securities available-for-sale in 1997 and a $164,000 increase in other noninterest income, offset by a $159,000 decrease in loan servicing income and the $521,000 gain on the sale of a branch office recognized in 1996. The $1.6 million increase in noninterest expense (excluding the 1996 special assessment) was primarily due to the overall compensation and occupancy expenses related to an increase in personnel hired for the expansion of the loan products offered and the continuing development of commercial business lending programs. In addition, occupancy expenses also increased due to the acquisition of assets and other expenses related to the relocation of Coastal's corporate headquarters and consolidation of its administrative, primary lending and mortgage servicing offices in the third quarter of 1997. These increases were somewhat offset by the $1.1 million decrease in insurance premiums (primarily deposit insurance premiums). In addition, other noninterest expense and data processing expense decreased $646,000 and $202,000, respectively. The $3.3 million increase in net income before preferred stock dividends in 1996 was primarily due to a $12.5 million increase in net interest income, a $929,000 increase in noninterest income, offset by a $8.1 million increase in noninterest expense before the $7.5 million special assessment. The increase in noninterest income was primarily a result of increased loan fees and service charges on deposit accounts of $952,000 and the $521,000 gain on the sale of a branch office, partially offset by a decrease in loan servicing income of $391,000. The increase in noninterest expense before the $7.5 million special assessment was primarily due to increased operating expenses as a result of the Texas Capital Bancshares, Inc. ("Texas Capital") acquisition on November 1, 1995. The increased noninterest expense was also due to overall compensation and occupancy expenses related to the expansion of the loan product base being offered by Coastal to its customers, primarily relating to the continuing development of commercial business lending programs, the May 1996 bank data processing conversion and the June 1996 conversion of the five former Texas Capital locations to the new data processing system. Coastal converted its bank data processing system to a PC based client server technology throughout its branch network to enable the branch offices to offer a more expanded product base (including loan and deposit products) and to automate and upgrade the work flow in the customer contact areas, allowing branch office employees a better opportunity to serve their customers. The cost during the period related to the data processing conversion was approximately $360,000. Net income before preferred stock dividends and after the after-tax effect of the special assessment was $9.5 million for the year ended December 31, 1996. NET INTEREST INCOME Net interest income amounted to $56.9 million in 1997, a $507,000, or 0.9% increase over 1996. The increase in net interest income was due to a slight increase in average net interest-earning assets of $4.6 million offset by the overall decrease in interest rate spread, defined to exclude noninterest-bearing deposits, from 1.72% in 1996 to 1.67% in 1997. Management also calculates an alternative net interest spread which includes noninterest-bearing deposits. Under this calculation, the net interest spreads for 1997 and 1996 were 1.85% and 1.89%, respectively. Net interest rate spread is affected by the changes in the amount and composition of interest-earning assets and interest-bearing liabilities and their concomitant interest rates. The decrease in the net interest spread in 1997 was primarily due to the increase in the average yield on interest-earning assets from 7.10% in 1996 to 7.13% in 1997, offset by the increase in the average interest rates on interest-bearing liabilities from 5.38% in 1996 to 5.46% in 1997. During 1997, Coastal experienced a tightening in net interest income due primarily to higher borrowing costs and the anomaly that the spread between the London Interbank Offered Rate ("LIBOR") and the Treasury rate (the "TED" spread) has been much wider than usual. The TED spread historically (6 year average) has been 40 basis points, but for 1997 was 56 basis points, which would equate to an additional $1.4 million in net income or $0.27 per share (after tax) for the year had the spread been consistent with the 6 year average. While management believes that the higher borrowing costs are temporary due to the TED spread and usual year-end pricing, efforts are continuing to replace borrowings with lower cost deposits and to maintain reasonable operating expenses during this period. In addition, interest income for the last six months of 1997 was reduced by the additional amortization of premium on purchased mortgage loans of approximately $1.3 million. This amortization was attributable to prepayments related to an adjustable rate whole loan package purchased in the second quarter of the year. Management believes the prepayments could continue at least through the first quarter of 1998, depending on interest rate movements. Net interest income amounted to $56.4 million in 1996, a $12.5 million, or 28.4% increase over 1995. This increase in net interest income was due to an increase in average net interest-earning assets of $20.0 million and an increase in interest rate spread, defined to exclude noninterest-bearing deposits, from 1.46% in 1995 to 1.72% in 1996. The net interest spread including noninterest-bearing deposits for 1996 and 1995 was 1.89% and 1.61%, respectively. The increase in the net interest spread in 1996 was primarily due to the decrease in the average interest rates on interest-bearing liabilities from 5.59% in 1995 to 5.38% in 1996 and a slight increase in the average yield on interest-earning assets from 7.05% in 1995 to 7.10% in 1996. Total interest income amounted to $201.4 million during 1997, a $6.7 million, or 3.5% increase from 1996. A $9.0 million, or 9.2%, increase in interest earned on loans receivable during 1997 resulted from a $124.6 million, or 10.8%, increase in the average balance of loans receivable offset partially by a decrease of 12 basis points in the yield earned compared to 1996. A $2.4 million, or 2.5%, decrease in interest earned on mortgage-backed securities during 1997 was due to a $42.4 million, or 2.7%, decrease in the average balance of mortgage-backed securities due to principal payments received and the sale of $11.3 million of mortgage-backed securities available-for-sale. In addition, interest earned on federal funds sold, certificates of deposits and other investments increased slightly by $118,000, or 7.8%, due primarily to the increase in the average balance of such assets, through growth and the branch acquisition, of $1.1 million during 1997. Total interest income amounted to $194.6 million during 1996, a $24.3 million, or 14.3%, increase from 1995. A $31.5 million, or 47.5%, increase in interest earned on loans receivable during 1996 resulted primarily from a $391.5 million, or 51.2%, increase in the average balance of loans receivable offset partially by a decrease in the yield earned of 21 basis points compared to 1995. A $7.0 million, or 6.9%, decrease in interest earned on mortgage-backed securities during 1996 was due to a $68.1 million, or 4.2%, decrease in the average balance of mortgage-backed securities due to principal payments received and a decrease in the yield earned of 18 basis points. In addition, interest earned on federal funds sold, certificates of deposits and other investments decreased $166,000, or 9.8%, due to the lower average yield earned during 1996. Total interest expense amounted to $144.4 million in 1997, a $6.2 million, or 4.5%, increase from 1996. Interest expense on other borrowed money increased $3.8 million, or 7.5%, due to the $43.6 million, or 4.7%, increase in the average balance of securities sold under agreements to repurchase and federal funds purchased and a 14 basis point increase in the interest rates paid. A $2.8 million, or 4.7%, increase in interest on savings deposits was primarily due to a $53.5 million, or 4.5%, increase in the average balance of interest-bearing savings deposits. Interest expense on advances from the FHLB decreased $427,000, or 2.0%, due to the decrease in the average balance of advances from the FHLB of $18.4 million, or 4.8%, offset by a 16 basis point increase in the average rates paid. Total interest expense amounted to $138.2 million in 1996, an $11.8 million, or 9.4%, increase from 1995. A $6.3 million, or 14.1%, increase in interest paid on other borrowed money was due to a $178.3 million increase in the average balance of securities sold under agreements to repurchase and federal funds purchased offset by a 46 basis point decrease in interest rates paid. A $3.4 million, or 5.9% increase in interest paid on savings deposits was due to a $82.9 million, or 7.4%, increase in the average balance of interest-bearing deposits offset by a 7 basis point decrease in interest rates paid. The interest expense of $5.0 million on the Senior Notes payable in 1996 was due to the issuance of $50.0 million of the 10.0% Senior Notes on June 30, 1995. These increases were somewhat offset by the $367,000 decrease in interest paid on advances from the FHLB. The decrease in interest paid on advances from the FHLB was due to a 39 basis point decrease in interest rates paid offset by a $19.4 million increase in the average balance. PROVISION FOR LOAN LOSSES Management established provisions for loan losses of $1.8 million, $1.9 million and $1.7 million for the years ended December 31, 1997, 1996 and 1995, respectively. Provisions for loan losses, currently $450,000 per quarter, are charged to earnings to bring the total allowance for loan losses to a level deemed appropriate by management based on such factors as historical loss experience, the volume and type of lending conducted by Coastal, the amount of nonperforming assets, industry standards, regulatory policies, generally accepted accounting principles, general economic conditions, particularly as they relate to Coastal's lending areas, and other factors related to the collectibility of Coastal's loan portfolio. Coastal's asset quality ratios have remained relatively consistent from December 31, 1995 to December 31, 1997. Nonperforming loans as a percentage of total loans receivable was 1.4%, 1.0% and 1.3% at December 31, 1997, 1996 and 1995, respectively. The allowance for loan losses as a percentage of nonperforming loans was 42.7%, 53.6% and 39.0% at December 31, 1997, 1996 and 1995, respectively. The allowance for loan losses as a percentage of total loans receivable was 0.6%, 0.6% and 0.5% at December 31, 1997, 1996 and 1995, respectively. Coastal's management believes that its present allowance for loan losses is adequate, based upon, among other factors, its low level of nonperforming assets and minimal loss experience. Management will continue to review its loan loss policy as Coastal's loan portfolio grows and diversifies to determine if changes to the policy are necessary. NONINTEREST INCOME Total noninterest income amounted to $6.4 million during 1997, an increase of $293,000, or 4.8%, over 1996. The increase in noninterest income is primarily due to an increase of $568,000 in loan fees and service charges on deposit accounts, a $237,000 gain on sales of mortgage-backed securities available-for-sale in 1997 and a $164,000 increase in other noninterest income, offset by the decrease of $159,000 in loan servicing income, due to the reducing servicing portfolio, and the $521,000 gain on the sale of a branch office recorded in 1996. The increase in loan fees and service charges on deposit accounts consisted of an increase of $87,000 in loan fees and a $481,000 increase in service charges on deposit accounts, primarily due to the increase in transaction type deposit accounts from 1996 to 1997 and the 1997 branch acquisition which consisted of 53.5% transaction type deposit accounts. The gain on the sales of mortgage-backed securities available-for-sale was the result of the sale of securities with a book value of $11.3 million during 1997. Total noninterest income amounted to $6.1 million during 1996, an increase of $929,000, or 18.0%, over 1995. The increase in noninterest income was primarily due to an increase of $952,000 in loan fees and service charges on deposit accounts and a $521,000 gain recorded as a result of the sale of a branch office in May 1996 offset by a decrease of $391,000 in loan servicing income in 1996 from 1995. The increase in loan fees and service charges on deposit accounts consisted of a $46,000 increase in loan fees and a $906,000 increase in service charges on deposit accounts primarily due to the Texas Capital acquisition. Coastal also experienced slight decreases of $85,000 and $68,000 in the gain (loss) on sales of mortgage-backed securities available-for-sale and other noninterest income, respectively. NONINTEREST EXPENSE Total noninterest expense amounted to $39.5 million during 1997, an increase of $1.6 million, or 4.3%, over 1996 before the effect of the 1996 special assessment. Compensation, payroll taxes and other benefits and office occupancy increased $2.2 million and $1.3 million, respectively, primarily due to the overall increase in personnel hired for the expansion of the loan products offered and the continuing development of the commercial business lending programs. In addition, occupancy expenses also increased due to the acquisition of assets and other expenses related to the relocation of Coastal's corporate headquarters and consolidation of its administrative, primary lending and mortgage servicing offices in the third quarter of 1997. Of the $1.3 million increase in occupancy expenses, approximately $128,000 were nonrecurring expenses incurred due to the relocation. The amortization of goodwill increased $56,000 during 1997 due primarily to the 1997 branch acquisition and the related goodwill recorded. These increases were somewhat offset by decreases of $1.1 million, $646,000 and $202,000 in insurance premiums, other noninterest expenses and data processing expense, respectively. The decrease in insurance premiums was due to the decrease in deposit insurance premiums pursuant to the reduced assessment rates applicable to Coastal as a result of the passage of the Act in 1996. The decrease in data processing expenses was primarily due to the expenses incurred in 1996 related to the May 1996 bank data processing conversion and the conversion in June of 1996 of the five former Texas Capital locations acquired in 1995 to the new data processing system. Total noninterest expense, excluding the $7.5 million special assessment (before applicable income taxes), amounted to $37.9 million during 1996, an increase of $8.1 million, or 27.2%, over 1995. Compensation, payroll taxes and other benefits and office occupancy expense increased $4.5 million and $1.4 million to $16.5 million and $6.0 million, respectively, primarily due to the operation of the five offices acquired from Texas Capital on November 1, 1995, two de novo branches opened in March 1995 and staffing increases related to the expansion of the loan product base available to customers and the continuing development of the commercial business lending programs and to the overtime and contract labor utilized for the data processing conversion. The amortization of goodwill increased by $511,000, also due primarily to the Texas Capital acquisition. Data processing expenses increased $678,000 due to the Texas Capital acquisition, the May 1996 bank data processing conversion and the conversion in June 1996 of the former Texas Capital locations acquired in 1995 to the new data processing system. Expenses related to real estate owned increased by $484,000 and other expenses (including advertising) increased $1.5 million, or 23.8%, over the prior year. Insurance premiums decreased $1.0 million, or 32.2%, due to the $636,000 refund of the fourth quarter 1996 SAIF assessment payment as a result of the re-capitalization of SAIF pursuant to the Act and an overall decrease in assessment rate applicable in 1996 as compared to the rate applicable in 1995. PROVISION FOR FEDERAL INCOME TAXES Coastal generated no regular Federal taxable income in 1997, 1996 or 1995 primarily due to the utilization of the net operating loss carryovers acquired from the associations obtained in connection with the Southwest Plan Acquisition and because payments to Coastal pursuant to the 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 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 Operations as its provision for Federal income taxes, which also includes alternative minimum taxes paid. The alternative minimum taxes recorded during these years will be available as credit carryforwards to reduce future Federal regular income taxes over an indefinite period. The provisions for Federal income taxes were $7.8 million in 1997, $5.7 million in 1996 and $6.5 million in 1995. Although the termination of the Assistance Agreement was effective March 31, 1994, the FRF will continue to receive the future Federal income tax benefits of the net operating loss carryforwards acquired. ASSET AND LIABILITY MANAGEMENT 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, LIBOR or cost of funds rate) of its interest-earning assets to its interest-bearing liabilities. Coastal also uses interest rate swap and cap agreements to aid in minimizing exposure to interest rate fluctuations. These strategies are described below. 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 and Chief Lending Officers of the Bank, in addition to members of the Bank's Portfolio Control Center. The Subcommittee meets regularly 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. A representative of the Subcommittee also meets with members of Coastal's banking, treasury and marketing areas to participate in pricing and funding decisions with respect to Coastal's overall asset and liability composition. 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 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 using selected interest rate scenarios. 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 interest rate shifts of the current yield curve upon 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. Based on Coastal's December 31, 1997 interest rate sensitivity position, management believes that at December 31, 1997 an immediate 100 basis point increase in interest rates could cause a short term decrease in net interest income due to timing differences but would not have a significant impact over a twelve month period. There can be no assurance that this conclusion will not change as the assumptions utilized by management to reach such conclusion change over time. The following table presents an analysis of the sensitivity in Coastal's net interest income over a four-quarter period and the EVE based on the indicated changes in interest rates at December 31, 1997 and 1996. The interest rate scenarios presented in the table include interest rates at December 31, 1997 and 1996 and, for the net interest income calculation, as adjusted by the indicated changes in interest rates over a four-quarter period, and for the EVE calculation, as adjusted by instantaneous and parallel changes in interest rates of upward and downward of up to 200 basis points. Each rate scenario reflects unique prepayment and repricing assumptions.
Estimated Change In Change Net Interest Income EVE In Interest Rates December 31, December 31, (in basis points) 1997 1996 1997 1996 - ------------------- ------- ------ ------- ------- +200 (7.41)% 0.96% (21.07)% (36.81)% +100 (3.76) (0.35) (6.52) (17.02) 0 -- -- -- -- - -100 3.52 1.57 0.18 7.02 - -200 7.25 1.37 (6.54) 3.78
There are limitations inherent in any methodology used to estimate the exposure to changes in market interest rates. Therefore, this analysis is not intended to be a forecast of the actual effect of a change in market 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 on which it is based. The EVE is significantly impacted by the estimated effect of prepayment risk on the value of mortgage-backed securities, loans receivable and mortgage servicing rights 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, assets will generally not be prepaid and conversely, when interest rates decrease, prepayments increase. The magnitude of the risk that a higher yielding asset will prepay is a direct function of interest rate variability over the life of the assets. 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 and on its mortgage servicing rights 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. 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 deposits, would not immediately change. While this interest-sensitivity analysis takes into account repricing and maturities of assets and liabilities, it fails to consider 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 adjusted for the effects of interest rate swaps and caps at December 31, 1997. The principal balance of adjustable rate assets is included in the period in which they are first scheduled to adjust rather than in the period in which they mature. Other material assumptions are set forth in the footnotes to the table.
As of December 31, 1997 More than Three months three months or less to one year -------------------------------- (Dollars in thousands) INTEREST-SENSITIVE ASSETS Loans, net (1)(2): First lien mortgage-single family fixed rate $ 665 $ 1,094 First lien mortgage-single family adjustable rate 56,558 383,485 First lien mortgage-multifamily fixed rate 6,075 7,724 First lien mortgage-multifamily variable rate 106,583 -- Construction and acquisition and development, net of loans in process 71,848 86 Commercial real estate 120,797 1,343 Commercial 146,867 1,120 Consumer and other 7,447 4,537 Mortgage-backed securities held-to-maturity(1)(2) 1,131,883 -- Mortgage-backed securities available-for-sale (1)(2) 169,997 -- Other interest-earning assets (3) 32,038 -- ----------- ---------- Total interest-sensitive assets 1,850,758 399,389 ----------- ---------- Noninterest-sensitive assets Total assets INTEREST-SENSITIVE LIABILITIES: Savings deposits (4): Interest-bearing checking accounts $ 69,972 $ -- Savings accounts 25,555 -- Money market accounts 165,986 -- Certificate accounts (including discount) 257,263 524,117 Securities sold under agreements to repurchase 647,048 144,712 Advances from the FHLB 307,100 13,819 Senior Notes payable -- -- ----------- ---------- Total interest-sensitive liabilities 1,472,924 682,648 ----------- ---------- Noninterest-sensitive liabilities Total liabilities Preferred Stock of the Bank Common stockholders' equity Total liabilities and stockholders' equity Gap during the period $ 377,834 $(283,259) Effect of interest rate swaps and caps(5) 84,847 (43,400) ----------- ---------- Cumulative gap after effect of interest rate swaps and caps $ 462,681 $ 136,022 =========== ========== Interest-sensitive assets as a % of interest-sensitive liabilities (cumulative) 125.65% 104.39% Interest-sensitive assets as a % of total assets (cumulative) 63.57 77.29 Ratio of gap after effect of interest rate swaps and caps to total assets 15.89 (11.22) Ratio of cumulative gap after effect of interest rate swaps and caps to total assets 15.89 4.67 As of December 31, 1997 ----------------------------------- More than More than one year to three years to three years five years ----------------------------------- (Dollars in thousands) INTEREST-SENSITIVE ASSETS Loans, net (1)(2): First lien mortgage-single family fixed rate $ 3,553 $ 7,051 First lien mortgage-single family adjustable rate 60,158 14,980 First lien mortgage-multifamily fixed rate 8,023 674 First lien mortgage-multifamily variable rate -- -- Construction and acquisition and development, net of loans in process 6,223 422 Commercial real estate 16,848 7,013 Commercial 2,062 9,620 Consumer and other 5,143 4,272 Mortgage-backed securities held-to-maturity(1)(2) -- 1 Mortgage-backed securities available-for-sale (1)(2) -- -- Other interest-earning assets (3) -- -- ----------- ----------- Total interest-sensitive assets 102,010 44,033 ----------- ----------- Noninterest-sensitive assets Total assets INTEREST-SENSITIVE LIABILITIES: Savings deposits (4): Interest-bearing checking accounts $ -- $ -- Savings accounts -- -- Money market accounts -- -- Certificate accounts (including discount) 216,762 13,445 Securities sold under agreements to repurchase -- -- Advances from the FHLB 128,421 78,343 Senior Notes payable -- 50,000 ----------- ----------- Total interest-sensitive liabilities 345,183 141,788 ----------- ----------- Noninterest-sensitive liabilities Total liabilities Preferred Stock of the Bank Common stockholders' equity Total liabilities and stockholders' equity Gap during the period $ (243,173) $ (97,755) Effect of interest rate swaps and caps(5) (21,920) -- ----------- ----------- Cumulative gap after effect of interest rate swaps and caps $ (129,071) $ (226,826) =========== =========== Interest-sensitive assets as a % of interest-sensitive liabilities (cumulative) 94.06% 90.68% Interest-sensitive assets as a % of total assets (cumulative) 80.79 82.30 Ratio of gap after effect of interest rate swaps and caps to total assets (9.11) (3.36) Ratio of cumulative gap after effect of interest rate swaps and caps to total assets (4.43) (7.79) As of December 31, 1997 ----------------------------------- More than More than five years to ten years to ten years twenty years ----------------------------------- (Dollars in thousands) INTEREST-SENSITIVE ASSETS Loans, net (1)(2): First lien mortgage-single family fixed rate $ 19,267 $ 71,073 First lien mortgage-single family adjustable rate 4,403 -- First lien mortgage-multifamily fixed rate 1,185 -- First lien mortgage-multifamily variable rate -- -- Construction and acquisition and development, net of loans in process 591 1,149 Commercial real estate 6,201 26,068 Commercial 913 -- Consumer and other 1,039 981 Mortgage-backed securities held-to-maturity(1)(2) -- -- Mortgage-backed securities available-for-sale (1)(2) -- -- Other interest-earning assets (3) -- -- ----------- ----------- Total interest-sensitive assets 33,599 99,271 ----------- ----------- Noninterest-sensitive assets Total assets INTEREST-SENSITIVE LIABILITIES: Savings deposits (4): Interest-bearing checking accounts $ -- $ -- Savings accounts -- -- Money market accounts -- -- Certificate accounts (including discount) 178 -- Securities sold under agreements to repurchase -- -- Advances from the FHLB 7,041 5,751 Senior Notes payable -- -- ----------- ----------- Total interest-sensitive liabilities 7,219 5,751 ----------- ----------- Noninterest-sensitive liabilities Total liabilities Preferred Stock of the Bank Common stockholders' equity Total liabilities and stockholders' equity Gap during the period $ 26,380 $ 93,520 Effect of interest rate swaps and caps(5) (19,527) -- ----------- ----------- Cumulative gap after effect of interest rate swaps and caps $ (219,973) $ (126,453) =========== =========== Interest-sensitive assets as a % of interest-sensitive liabilities (cumulative) 91.70% 95.24% Interest-sensitive assets as a % of total assets (cumulative) 83.46 86.87 Ratio of gap after effect of interest rate swaps and caps to total assets (0.24) 3.21 Ratio of cumulative gap after effect of interest rate swaps and caps to total assets (7.56) (4.34) As of December 31, 1997 ------------------------------ Over twenty years Totals ------------------------------ (Dollars in thousands) INTEREST-SENSITIVE ASSETS Loans, net (1)(2): First lien mortgage-single family fixed rate $ 66,125 $ 168,828 First lien mortgage-single family adjustable rate 169 519,753 First lien mortgage-multifamily fixed rate -- 23,681 First lien mortgage-multifamily variable rate -- 106,583 Construction and acquisition and development, net of loans in process -- 80,319 Commercial real estate -- 178,270 Commercial -- 160,582 Consumer and other -- 23,419 Mortgage-backed securities held-to-maturity(1)(2) 213,206 1,345,090 Mortgage-backed securities available-for-sale (1)(2) -- 169,997 Other interest-earning assets (3) -- 32,038 --------- ----------- Total interest-sensitive assets 279,500 2,808,560 --------- Noninterest-sensitive assets 102,850 ----------- Total assets $ 2,911,410 =========== INTEREST-SENSITIVE LIABILITIES: Savings deposits (4): Interest-bearing checking accounts $ -- $ 69,972 Savings accounts -- 25,555 Money market accounts -- 165,986 Certificate accounts (including discount) -- 1,011,765 Securities sold under agreements to repurchase -- 791,760 Advances from the FHLB -- 540,475 Senior Notes payable -- 50,000 --------- ----------- Total interest-sensitive liabilities -- 2,655,513 --------- Noninterest-sensitive liabilities 122,317 ----------- Total liabilities 2,777,830 Preferred Stock of the Bank 28,750 Common stockholders' equity 104,830 ----------- Total liabilities and stockholders' equity $ 2,911,410 =========== Gap during the period $ 279,500 Effect of interest rate swaps and caps(5) -- --------- Cumulative gap after effect of interest rate swaps and caps $ 153,047 ========= Interest-sensitive assets as a % of interest-sensitive liabilities (cumulative) 105.76 Interest-sensitive assets as a % of total assets (cumulative) 96.47 Ratio of gap after effect of interest rate swaps and caps to total assets 9.60 Ratio of cumulative gap after effect of interest rate swaps and caps to total assets 5.26
(1) Fixed-rate mortgage loans, consumer loans and fixed-rate mortgage-backed 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 reprice (assuming no periodic amortization). (3) Includes interest-bearing deposit accounts and FHLB stock. (4) Interest-bearing checking accounts, savings accounts and money market accounts are all assumed to be interest-rate sensitive. Fixed-rate certificate accounts are based on contractual maturities. (5) Amounts represent the notional principal amount of the interest rate swaps and certain interest rate cap agreements which are designed to protect Coastal against rising interest rates, which are currently "in the money." INTEREST RATE RISK MANAGEMENT Coastal enters into interest rate swap and interest rate cap agreements with selected broker/dealers who are primarily government securities dealers ("Brokers") to reduce its exposure to floating interest rates on a portion of its adjustable rate liabilities. An interest rate swap is an agreement where one party (generally Coastal) agrees to pay a fixed rate of interest on a notional principal amount to a second party (generally the Broker) in exchange for receiving from the second party a variable rate of interest on the same notional amount for a predetermined period of time. No actual assets are exchanged in a swap of this type and interest payments are generally netted. Coastal enters into this type of transaction in order to maintain a spread position between certain assets and liabilities in the event that interest rates increase. If Coastal pays a fixed rate and receives a variable rate, the variable rate to be received by Coastal will reprice at the same time and at a similar rate as the funding liabilities which are altered by the swap and will thereby offset, to a certain degree, increases in funding costs. Under any other interest rate scenario, the swap will have a negative impact on net interest income. At December 31, 1997, Coastal was a party to interest rate swap agreements which have an aggregate notional amount of $45.8 million and expire from 1998 to 2005. With respect to such agreements, Coastal makes weighted-average fixed interest payments ranging from 6.00 to 6.93%, and receives payments based on the floating three-month LIBOR. Coastal records net interest income or expense relating to the swap agreements on a monthly basis in interest expense on other borrowed money. The net effect of the interest rate swaps to Coastal for the year ended December 31, 1997 was to increase interest expense by approximately $431,000. See Note 15 of the Notes to Consolidated Financial Statements. An interest rate cap is a guarantee given by one party, referred to as the issuer (the Broker), to another party, referred to as the purchaser (Coastal), in exchange for the payment of a premium, that if interest rates rise above a specified rate on a specified interest rate index, the issuer will pay to the purchaser the difference between the then current market rate and the specified rate on a notional principal amount for a predetermined period of time. No funds are actually borrowed or repaid. The principal purpose of purchasing these caps is to prevent the occurrence of a negative spread relating to certain adjustable rate mortgage-backed securities and loans receivable in Coastal's portfolio during a period in which the cost of funds borrowed to acquire such assets rises above the contractual interest rate ceiling on the asset purchased. Interest rate caps generally decrease the interest margin because Coastal receives no payment from the issuer (until the rate index rises above the rate cap) but continues to amortize the prepaid premium. At December 31, 1997, Coastal had interest rate cap agreements, which expire from 1998 to 2001, covering an aggregate notional amount of $231.2 million, of which $118.2 million are covering certain of Coastal's loans receivable, and are triggered, depending on the particular contract, whenever the defined floating rate exceeds 5.0% to 12.5%. The purchase price or premium of the interest rate cap agreements paid by Coastal is capitalized and included in prepaid expenses and other assets and is amortized over the life of the agreements using the straight-line method. For the year ended December 31, 1997, the interest rate caps resulted in an overall decrease in interest income of approximately $218,000. See Note 15 of the Notes to Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES Coastal's assets approximated $2.9 billion at December 31, 1997 and 1996. Stockholders' equity amounted to $104.8 million, or $20.93 per share, at December 31, 1997. The regulatory capital of Coastal's subsidiary, Coastal Banc ssb, exceeded all three of the Bank's regulatory capital requirements at December 31, 1997. At December 31, 1997, the Bank's core capital amounted to 5.52% of adjusted total assets, compared to the requirement of 4.0%, its Tier 1 risk-based capital amounted to 11.46% of risk-adjusted assets as compared to the requirement of 4.0% and its total risk-based capital amounted to 11.98% of risk-adjusted assets, compared to a requirement of 8.0%. Coastal's primary sources of funds consist of savings deposits bearing market rates of interest, securities sold under agreements to repurchase and federal funds purchased, advances from the FHLB and principal and interest payments on loans receivable and mortgage-backed securities. On June 21, 1997, Coastal acquired a branch which resulted in the assumption of $54.6 million in savings deposits. Coastal uses its funding resources principally to meet its ongoing commitments to fund maturing deposits and deposit withdrawals, repay borrowings, purchase mortgage-backed securities and loans receivable, fund existing and continuing loan commitments, maintain its liquidity, meet operating expenses and fund acquisitions of other banks and thrifts, either on a branch office or whole bank acquisition basis. At December 31, 1997, Coastal had binding commitments to originate or purchase loans totaling approximately $50.2 million and had $47.9 million of undisbursed loans in process. In addition, at December 31, 1997, Coastal had commitments under lines of credit to originate primarily construction and other loans of approximately $119.3 million and letters of credit outstanding of $1.7 million. Scheduled maturities of certificates of deposit during the twelve months following December 31, 1997 totaled $781.5 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 generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars, 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. YEAR 2000 Coastal formally initiated a project during the first quarter of 1997 to ensure that its operational and financial systems will not be adversely affected by year 2000 software problems. A year 2000 project team has been formed with representatives from all areas of Coastal including executive management. An inventory of all core systems and products that could be affected by the year 2000 date change has been developed. The software for Coastal's systems is primarily provided through third party service bureaus and software vendors. Coastal is requiring its software providers and vendors to demonstrate and represent that the products provided are or will be year 2000 compliant and has planned an internal program of testing for compliance beginning in 1998. Management does not expect the costs of bringing Coastal's systems into year 2000 compliance to have a material impact on Coastal's consolidated financial position. RECENT ACCOUNTING STANDARDS A discussion of recently issued accounting pronouncements and their impact on the Consolidated Financial Statements is provided in Note 2 to the Consolidated Financial Statements. FORWARD-LOOKING INFORMATION 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 Coastal's acquisition strategy, including risks of adversely changing results of operations and factors affecting Coastal's ability to consummate further acquisitions; changes in general economic and business conditions; changes in market rates of interest; changes in the laws and regulations applicable to Coastal; the risks associated with the Bank's non-traditional lending (loans other than single-family residential mortgage loans such as multifamily, real estate acquisition and development, commercial real estate and commercial loans); and changes in business strategies and other factors as discussed in Coastal's Annual Report on Form 10-K as filed with the Securities and Exchange Commission. 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.; and President of CBS Asset Corp., and Chief Executive Officer of CoastalBanc Financial Corp., each wholly-owned subsidiaries of the Bank R. EDWIN ALLDAY Consultant for The Dini Partners, Inc., a company that provides counseling in philanthropy and non-profit management, 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 of The Ohio Bank, Findlay, Ohio DENNIS S. FRANK Chief Executive Officer and President of Silvergate Bancorp, a thrift and loan holding company, and of Silvergate Thrift and Loan, La Mesa, 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 JAMES C. NIVER Retired, former President of Century Land Company, a residential real estate development company, Houston, Texas CLAYTON T. STONE Executive Vice President of Hines Interests Limited Partnership, Aspen, Colorado CORPORATE OFFICERS OF COASTAL BANCORP, INC. MANUEL J. MEHOS Chairman of the Board, President and Chief Executive Officer CATHERINE N. WYLIE Executive Vice President, Chief Financial Officer and Treasurer LINDA B. FRAZIER Vice President and Secretary CORPORATE OFFICERS OF COASTAL BANC HOLDING COMPANY, INC. MANUEL J. MEHOS Chairman of the Board, President and Chief Executive Officer CATHERINE N. WYLIE Director, Executive Vice President, Chief Financial Officer and Treasurer LINDA B. FRAZIER Director, Vice President and Secretary BARBARA A. STEEN Director, Assistant Treasurer and Assistant Secretary CORPORATE OFFICERS OF COASTAL BANC SSB MANUEL J. MEHOS President and Chief Executive Officer JOHN D. BIRD Executive Vice President - Chief Administrative Officer GARY R. GARRETT Executive Vice President - Chief Lending Officer DAVID R. GRAHAM Executive Vice President - Real Estate Lending Group SANDRA S. ORR Executive Vice President - Chief Investment Officer NANCY S. VADASZ Executive Vice President - Market and Product Strategies CATHERINE N. WYLIE Executive Vice President - Chief Financial Officer COASTAL A HISTORICAL VIEWPOINT 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 1997, Coastal entered into six branch acquisitions and one whole bank acquisition: two with an instrumentality of the Federal government and five with private institutions. In each transaction, Coastal agreed to acquire certain assets in consideration of the assumption of certain deposit liabilities with respect to each institution. 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. All of these transactions resulted in the net assumption of $1.6 billion of deposits and the net acquisition of 46 branch offices. Coastal has also opened six de novo branches since inception. Coastal has been able to achieve operating economies and improve efficiency by closing an aggregate of 16 branch offices and transferring the deposits to other offices located in the same market area. At December 31, 1997, Coastal had total assets of approximately $2.9 billion and total deposits of approximately $1.4 billion with 37 branch offices in metropolitan Houston, Austin, Corpus Christi and small cities in the south east 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, 1997 and 1996 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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, 1997 and 1996 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP - ----------------------------- January 15, 1998 Houston, Texas
COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 1997 AND 1996 (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS 1997 1996 - ------------------------------------------------------ ---------- ---------- Cash and amounts due from depository institutions $ 37,096 $ 27,735 Loans receivable (Notes 6 and 11) 1,261,435 1,229,748 Mortgage-backed securities held-to-maturity (market value of $1,324,968 in 1997 and $1,308,598 in 1996) (Notes 5, 11, 12, 14 and 15) 1,345,090 1,344,587 Mortgage-backed securities available-for-sale, at market value (Notes 5, 11, 12 and 14) 169,997 180,656 U.S. Treasury security available-for-sale, at market value -- 11 Mortgage loans held for sale -- 298 Accrued interest receivable (Note 7) 14,813 14,690 Property and equipment (net of accumulated depreciation and amortization of $8,100 in 1997 and $7,009 in 1996) 22,250 14,987 Stock in the Federal Home Loan Bank of Dallas ("FHLB") 27,801 25,971 Goodwill (net of accumulated amortization of $11,270 in 1997 and $9,430 in 1996) 15,717 15,596 Mortgage servicing rights (Note 8) 5,653 6,810 Prepaid expenses and other assets (Notes 9, 15 and 17) 11,558 14,818 ---------- ---------- $2,911,410 $2,875,907 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY --------------------------------------- Liabilities: Savings deposits (Note 10) $1,375,060 $1,310,835 Advances from the FHLB (Note 11) 540,475 409,720 Securities sold under agreements to repurchase (Note 12) 791,760 966,987 Senior Notes payable (Note 13) 50,000 50,000 Advances from borrowers for taxes and insurance 3,975 4,676 Other liabilities and accrued expenses 16,560 10,791 ----------- ----------- Total liabilities 2,777,830 2,753,009 ----------- ----------- 9.0% noncumulative preferred stock of Coastal Banc ssb (Note 22) 28,750 28,750 Commitments and contingencies (Notes 6, 15, 19 and 24) Stockholders' equity (Notes 5, 19, 21 and 23): Preferred Stock, no par value; authorized shares 5,000,000; no shares issued -- -- Common Stock, $.01 par value; authorized shares 30,000,000; 5,008,926 and 4,966,941 shares issued and outstanding in 1997 and 1996 50 50 Additional paid-in capital 33,186 32,604 Retained earnings 73,868 64,597 Unrealized loss on securities available-for-sale (2,274) (3,103) ----------- ----------- Total stockholders' equity 104,830 94,148 ----------- ----------- $2,911,410 $2,875,907 =========== ===========
See accompanying notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995 -------- --------- -------- Interest income: Mortgage-backed securities $ 92,755 $ 95,155 $102,194 Loans receivable 106,962 97,935 66,405 Federal funds sold, certificates of deposits and other investments 1,639 1,521 1,687 -------- --------- -------- 201,356 194,611 170,286 -------- --------- -------- Interest expense: Savings deposits 62,912 60,076 56,716 Other borrowed money 55,189 51,360 45,022 Senior Notes payable 5,000 5,000 2,500 Advances from the FHLB: Short-term 8,562 6,622 1,703 Long-term 12,760 15,127 20,413 -------- --------- -------- 144,423 138,185 126,354 -------- --------- -------- Net interest income 56,933 56,426 43,932 Provision for loan losses (Note 6) 1,800 1,925 1,664 -------- --------- -------- Net interest income after provision for loan losses 55,133 54,501 42,268 -------- --------- -------- Noninterest income: Loan fees and service charges 4,018 3,450 2,498 on deposit accounts Loan servicing income, net 1,406 1,565 1,956 Gain on sale of branch office (Note 3) -- 521 -- Gain (loss) on sales of mortgage-backed securities available-for-sale, net 237 (4) 81 Other 723 559 627 -------- --------- -------- 6,384 6,091 5,162 -------- --------- -------- Noninterest expense: Compensation, payroll taxes and other benefits 18,754 16,547 12,029 Office occupancy 7,312 6,002 4,590 Insurance premiums 1,091 2,199 3,244 Data processing 2,245 2,447 1,769 Amortization of goodwill 1,840 1,784 1,273 Other 8,302 8,948 6,918 SAIF insurance special assessment (Note 18) -- 7,455 -- -------- --------- -------- 39,544 45,382 29,823 -------- --------- -------- Income before provision 21,973 15,210 17,607 for Federal income taxes Provision for Federal income taxes (Note 17) 7,822 5,671 6,477 -------- --------- -------- Net income before preferred 14,151 9,539 11,130 stock dividends Preferred stock dividends of Coastal Banc ssb 2,588 2,588 2,588 -------- -------- -------- Net income available to common stockholders $ 11,563 $ 6,951 $ 8,542 ======== ========= ======== Basic earnings per share (Note 21) $ 2.32 $ 1.40 $ 1.72 ======== ========= ======== Diluted earnings per share (Note 21) $ 2.25 $ 1.38 $ 1.71 ======== ========= ========
See accompanying notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS) Unrealized loss on Additional securities Common paid-in Retained available-for- Stock capital earnings sale Total ------- ----------- ---------- -------------- ------ Balance - December 31, 1994 $ 50 $ 32,434 $ 52,674 $ (478) $ 84,680 Dividends on preferred stock of Coastal Banc ssb -- -- (2,588) -- (2,588) Dividends on Common Stock -- -- (1,585) -- (1,585) Exercise of stock options (Note 19) -- 58 -- -- 58 Unrealized loss on securities transferred to available-for- sale (Note 5) -- -- -- (1,556) (1,556) Change in net unrealized holding gain (loss) on securities available- for-sale (Note 5) -- -- -- 1,540 1,540 Net income for 1995 -- -- 11,130 -- 11,130 ------- ----------- ---------- ---------------- --------- Balance - December 31, 1995 50 32,492 59,631 (494) 91,679 Dividends on preferred stock of Coastal Banc ssb -- -- (2,588) -- (2,588) Dividends on Common Stock -- -- (1,985) -- (1,985) Exercise of stock options (Note 19) -- 112 -- -- 112 Change in net unrealized holding gain (loss) on securities available- for-sale (Note 5) -- -- -- (2,609) (2,609) Net income for 1996 -- -- 9,539 -- 9,539 ------- ----------- ---------- ---------------- --------- Balance - December 31, 1996 50 32,604 64,597 (3,103) 94,148 Dividends on preferred stock of Coastal Banc ssb -- -- (2,588) -- (2,588) Dividends on Common Stock -- -- (2,292) -- (2,292) Exercise of stock options (Note 19) -- 582 -- -- 582 Change in net unrealized holding gain (loss) on securities available- for-sale (Note 5) -- -- -- 829 829 Net income for 1997 -- -- 14,151 -- 14,151 ------- ----------- ---------- ---------------- --------- Balance - December 31, 1997 $ 50 $ 33,186 $ 73,868 $ (2,274) $104,830 ======= =========== ========== ================ =========
COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS) 1997 1996 1995 ---------- ---------- ---------- Cash flows from operating activities: Net income before preferred stock dividends $ 14,151 $ 9,539 $ 11,130 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 7,485 6,098 5,191 Net premium amortization (discount accretion) 3,025 1,146 (2,236) Provision for loan losses 1,800 1,925 1,664 Amortization of goodwill 1,840 1,784 1,273 Originations and purchases of mortgage loans held for sale (8,063) (19,739) (8,812) Sales of mortgage loans held for sale 8,361 20,158 8,268 (Gain) loss on sales of mortgage-backed securities available-for-sale (237) 4 (81) Gain on sale of branch office -- (521) -- Decrease (increase) in: Accrued interest receivable (123) 853 (4,852) Other, net 9,668 (3,024) 6,003 Stock dividends from the FHLB (1,287) (1,288) (1,318) ------- -------- -------- Net cash provided by operating activities 36,620 16,935 16,230 ------- -------- -------- Cash flows from investing activities: Purchases of mortgage-backed securities held-to-maturity (56,136) -- (52,741) Purchase of U.S. Treasury security available-for-sale -- (11) -- Principal repayments on mortgage-backed securities held-to-maturity 55,549 50,616 35,742 Principal repayments on mortgage-backed securities available-for-sale 627 879 103 Proceeds from maturity of U.S. Treasury security available-for-sale 11 4,000 -- Proceeds from sales of mortgage-backed securities available-for-sale 11,545 860 72,379 Purchases of loans receivable (135,202) (190,612) (416,569) Net decrease in loans receivable 94,670 53,678 6,623 Purchases of property and equipment, net (9,825) (4,273) (3,579) Purchase of FHLB stock (9,543) (7,924) (2,984) Proceeds from sales of FHLB stock 9,000 5,000 3,245 Capitalization of mortgage servicing rights (116) -- -- Cash and cash equivalents received in business combination transactions, net of disposition transaction in 1996 52,093 11,652 34,311 ------- -------- -------- Net cash provided (used) by investing activities 12,673 (76,135) (323,470) ------- -------- --------
See accompanying notes to Consolidated Financial Statements.
COASTAL BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED (IN THOUSANDS) 1997 1996 1995 ------------- ------------ ------------ Cash flows from financing activities: Net decrease (increase) in savings deposits $ 9,539 $ 12,497 $ (10,336) Advances from the FHLB 3,560,603 3,629,022 746,899 Principal payments on advances from the FHLB (3,429,848) (3,531,488) (820,749) Proceeds from securities sold under agreements to repurchase and federal funds purchased 9,834,639 9,276,713 8,648,728 Repayments of securities sold under agreements to repurchase and federal funds purchased (10,009,866) (9,303,558) (8,300,275) Proceeds from issuance of Senior Notes payable, net -- -- 47,635 Exercise of stock options for purchase of common stock, net 582 112 58 Net increase (decrease) in advances from borrowers for taxes and Insurance (701) (1,834) 3,109 Dividends paid (4,880) (4,573) (4,173) ------------ --------- ------------ Net cash provided (used) by financing activities (39,932) 76,891 310,896 ------------ --------- ------------ Net increase in cash and cash equivalents 9,361 17,691 3,656 Cash and cash equivalents at beginning of year 27,735 10,044 6,388 ------------ --------- ------------ Cash and cash equivalents at end of year $ 37,096 $ 27,735 $ 10,044 ============ =========== ============ Supplemental schedule of cash flows--interest paid $ 142,532 $ 139,926 $ 123,030 ============ =========== ============ Supplemental schedule of noncash investing and financing activities: Transfer of mortgage-backed securities to available- for-sale category $ -- $ -- $ 226,591 ============ =========== ============ Foreclosures of loans receivable $ 4,226 $ 4,363 $ 3,394 ============ =========== ============
See accompanying notes to Consolidated Financial Statements. COASTAL BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1997 and 1996 (1) ORGANIZATION AND BACKGROUND ORGANIZATION Coastal Bancorp, Inc. was incorporated on March 8, 1994 as a first-tier subsidiary of Coastal Banc Savings Association (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. As a result of the reorganization, Coastal Bancorp, Inc. ("Bancorp") became the owner of 100% of the voting stock of Coastal Banc ssb. The holders of the 9.0% Noncumulative Preferred Stock, Series A, of the former Coastal Banc Savings Association now own an equal number of shares of the 9.0% Noncumulative Preferred Stock, Series A, of 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 wholly-owned 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. BACKGROUND Coastal Banc ssb 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. Coastal Banc ssb acquired deposits in transactions with the federal government and other private institutions as a base for developing an ongoing thrift and banking business. Coastal Banc ssb'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"). (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 consolidated financial statements. BASIS OF CONSOLIDATED FINANCIAL STATEMENTS The consolidated financial statements include the accounts of Coastal Bancorp, Inc., its wholly-owned subsidiary, HoCo and its wholly-owned subsidiaries, Coastal Banc ssb and subsidiaries and Coastal Banc Capital Corp. (collectively, "Coastal"). Coastal Banc ssb's subsidiaries include CoastalBanc Financial Corp., CBS Mortgage Corp. and CBS Asset Corp. (collectively with Coastal Banc ssb, 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. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with generally accepted accounting principles 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. INVESTMENT AND MORTGAGE-BACKED SECURITIES Coastal classifies securities as either held-to-maturity or available-for-sale. 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 as a separate component of stockholders' equity. On January 1, 1994, Coastal adopted the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115 ("Statement 115"), "Accounting for Certain Investments in Debt and Equity Securities." In November 1995, the Financial Accounting Standards Board issued the Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." Provisions in this Special Report granted all entities a one-time opportunity, until no later than December 31, 1995, to reassess the appropriateness of the classifications of all securities held and to account for any resulting reclassifications at fair value in accordance with Statement 115. The provisions of the Special Report also directed that any reclassifications as a result of this one-time reassessment would not call into question the intent to hold other debt securities to maturity in the future. In accordance with this Special Report, on November 20, 1995, Coastal reclassified approximately $226,591,000 of mortgage-backed securities to the available-for-sale category and recorded an unrealized loss of approximately $1,556,000 in stockholders' equity. 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. Coastal records investment and mortgage-backed securities transactions as of the settlement date. There were no pending transactions as of December 31, 1997 or 1996. Premiums and discounts on investment and 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. TRADING ACCOUNT SECURITIES Trading account securities are recorded at market value; however, at December 31, 1997 and 1996, there were no trading account securities held. Gains or losses on the revaluation or sale of trading account securities are included in noninterest income. 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 to record purchased loans. Interest on loans receivable is primarily computed on the outstanding principal balance at appropriate rates of interest. The net premium to record purchased loans is being amortized using the level yield method, adjusted for prepayments. 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 as to principal and interest more than 90 days. When a loan is placed on nonaccrual, any interest previously accrued but not collected is reversed against current interest income. Coastal adopted Statement of Financial Accounting Standards No. 114 ("Statement 114"), "Accounting by Creditors for Impairment of a Loan," as amended by Statement 118, effective January 1, 1995. Under Statement 114, a loan is impaired when it is "probable" that a creditor will be unable to collect all amounts due (i.e., both principal and interest) according to the contractual terms of the loan agreement. Statement 114 requires that the measurement of impaired loans be based on (i) the present value of the expected future cash flows discounted at the loan's effective interest rate, (ii) the loan's observable market price, or (iii) the fair value of the loan's collateral. Statement 114 does not apply to large groups of smaller balance homogeneous loans that are collectively evaluated for impairment. Coastal collectively reviews all first-lien residential loans under $500,000 as a group and all consumer and other loans as a group for impairment, excluding loans for which foreclosure is probable. The adoption of Statement 114, as amended by Statement 118, had no material impact on Coastal's consolidated financial statements as Coastal's existing policy of measuring loan impairment was generally consistent with methods prescribed in these standards. 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 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. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level determined to be adequate by management to absorb future losses on loans receivable. The adequacy of the allowance is based on management's evaluation of the loans receivable portfolio and its consideration of such factors as historical 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. 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, gains or losses on such sales are recognized at the time of sale and are determined by the difference between net sales proceeds and the unpaid principal balance of the loans sold, adjusted for any yield differential, servicing fees and servicing costs applicable to future years. Coastal continues to collect loan payments and provide normal services to the borrower under loan servicing agreements with the investors on those loans sold with servicing retained. The investor is paid its share of the principal and interest collected, net of a service fee retained by Coastal. MORTGAGE LOANS HELD FOR SALE Mortgage loans 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 the level yield method. When the loans receivable are sold, the remaining loan fees are recognized as income in the period of the sale. 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, .3% of total assets, or 5% of total FHLB advances. FHLB stock is redeemable at par value at the discretion of the FHLB. GOODWILL Goodwill resulting from acquisitions is amortized on a straight-line basis over the estimated period of benefit, not to exceed fifteen years. Coastal evaluates the recorded goodwill amounts for impairment on an ongoing basis to determine whether events and circumstances have developed that warrant revision of the estimated benefit periods. 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 3-10 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. MORTGAGE SERVICING RIGHTS Coastal adopted the Financial Accounting Standards Board's Statement No. 122 ("Statement 122"), "Accounting for Mortgage Servicing Rights -- an amendment of FASB Statement No. 65" effective January 1, 1996. Statement 122 eliminated the accounting distinction between rights to service mortgage loans for others that are acquired through loan origination activities and those acquired through purchase transactions. On January 1, 1997, Coastal adopted Financial Accounting Standards Board's Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," which supersedes Statement 122, and requires, among other things, that the book value of loans be allocated between mortgage servicing rights and the related loans at the time of the loan sale or securitization, if servicing is retained. 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 Bancorp files a consolidated federal income tax return with HoCo, Coastal Banc Capital Corp., the Bank and all of the Bank's wholly-owned 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. OFF-BALANCE SHEET INSTRUMENTS USED FOR INTEREST RATE RISK MANAGEMENT Coastal enters into interest rate swap and cap agreements to manage its sensitivity to interest rate risk. For interest rate risk management swap and cap agreements, interest income or interest expense is accrued over the terms of the agreements and transaction fees are deferred and amortized to interest income or expense over the terms of the agreements. The fair values of interest rate swap and cap agreements used for interest rate risk management are not recognized in the consolidated financial statements. STOCK OPTIONS Prior to January 1, 1996, Coastal accounted 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. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, Coastal adopted the Financial Accounting Standards Board's Statement No. 123 ("Statement 123"), "Accounting for Stock-Based Compensation," which permits entities to recognize as expense over the vesting period the fair value on the date of grant of all stock-based awards. Alternatively, Statement 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value based method defined in Statement 123 had been applied. Coastal has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of Statement 123. EARNINGS PER SHARE Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("Statement 128") was issued in February 1997. Statement 128 establishes standards for computing and presenting earnings per share ("EPS") and replaces the presentation of primary EPS with a presentation of basic EPS. Statement 128 also requires dual presentation of basic and diluted EPS for entities with complex capital structures as well as a reconciliation of the basic EPS computation to the diluted EPS computation. Statement 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. Coastal adopted Statement 128 in 1997, accordingly, all prior period EPS data presented in the accompanying consolidated financial statements has been restated to conform to the requirements of Statement 128. Basic EPS is calculated by dividing net income available to common stockholders, by the weighted average number of common shares outstanding. 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 are considered in earnings per 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. RECENT ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards No. 127, "Deferral of Certain Provisions of FASB Statement No. 125," requires that certain provisions of Statement of Financial Accounting Standards No. 125 ("Statement 125") are not effective until January 1, 1998. The deferred provisions relate to secured borrowings and collateral for all transactions and transfers of financial assets for repurchase agreements, dollar rolls, securities lending, and similar transactions. Implementation of the deferred portion of Statement 125 should have no material effect on Coastal's Consolidated Financial Statements. Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("Statement 130") requires that all components of comprehensive income and total comprehensive income be reported on one of the following: (1) the statement of operations, (2) the statement of stockholders' equity, or (3) a separate statement of comprehensive income. Comprehensive income is comprised of net income and all changes to stockholders' equity, except those due to investments by owners (changes in paid-in capital) and distributions to owners (dividends). Statement 130 is effective for fiscal years beginning after December 15, 1997. The implementation of Statement 130 should have no material impact on Coastal's Consolidated Financial Statements. Statement of Financial Accounting Standards No. 131, "Disclosure About Segments of an Enterprise and Related Information" ("Statement 131") requires public companies to report certain information about their operating segments in their annual financial statements and quarterly reports issued to shareholders. It also requires public companies to report certain information about their products and services, the geographic areas in which they operate, and their major customers. Statement 131 is effective for fiscal years beginning after December 15, 1997. Implementation of Statement 131 should have no material effect on Coastal's Consolidated Financial Statements. (3) ACQUISITION AND DISPOSITION TRANSACTIONS PORT ARTHUR BRANCH ACQUISITION On June 21, 1997, Coastal consummated the purchase of the Port Arthur, Texas branch of Wells Fargo Bank (Texas). Summarized below are the assets and liabilities recorded at fair value at the date of the acquisition (in thousands):
Cash $52,093 Goodwill 1,961 Property and equipment 693 ------- Total assets $54,747 ======= Deposits 54,563 Accrued interest payable and other liabilities 184 ------- Total liabilities $54,747 =======
BRANCH SWAP On September 5, 1996, Coastal consummated the exchange of certain branch locations with Compass Bank. Coastal sold its three San Antonio branches having deposits of approximately $53.8 million to Compass Bank and purchased the Compass Bay City branch having deposits of approximately $79.8 million. Summarized below are the net assets and liabilities recorded at fair value at the date of the swap (in thousands):
Cash and cash equivalents $25,274 Loans receivable 1,173 Goodwill 72 Property and equipment (103) Other assets 5 -------- $26,421 ======== Deposits 25,992 Other liabilities 429 -------- $26,421 ========
SAN ANGELO BRANCH SALE On May 24, 1996, Coastal consummated the sale of its San Angelo location, which had approximately $14.9 million in deposits, to First State Bank, N.A., a subsidiary of Independent Bankshares, Inc., headquartered in Abilene, Texas. As a result of this sale, Coastal recorded a $521,000 gain before applicable income taxes. Coastal acquired this location in the 1994 acquisition of Texas Trust Savings Bank, FSB. In connection with the sale of this branch office, Coastal recorded the following reductions of assets and liabilities (in thousands):
Savings deposits sold $14,850 Accrued interest payable and other liabilities sold 69 Loans receivable sold 155 Property and equipment sold 438 Reduction of goodwill 179
TEXAS CAPITAL BANCSHARES, INC. ACQUISITION On November 1, 1995, Coastal consummated the acquisition of all the issued and outstanding common stock of Texas Capital Bancshares, Inc. for a purchase price of approximately $21.1 million. Summarized below are the assets and liabilities recorded at fair value at the date of the acquisition (in thousands):
Cash and cash equivalents, net of purchase price $ 34,311 Loans receivable 103,319 Goodwill 9,769 U.S. Treasury security available-for-sale 3,993 Property and equipment 2,782 Real estate owned 2,430 Other assets 2,471 -------- Total assets $159,075 ======== Deposits 157,209 Other liabilities 1,866 -------- Total liabilities $159,075 ========
The acquisitions described above have been accounted for as purchases and, accordingly, all assets and liabilities acquired were adjusted to and recorded at estimated fair values as of the acquisition dates. The transactions described above are not material to the consolidated financial position or results of operations of Coastal; therefore pro forma information is not presented. (4) SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND FEDERAL FUNDS SOLD An analysis of securities purchased under agreements to resell ("repurchase agreements") and federal funds sold for the year ended December 31, 1997 is as follows (dollars in thousands):
Repurchase agreements: Balance outstanding at December 31, 1997 $ -- Maximum outstanding at any month-end -- Average balance outstanding 1,973 Average interest rate 6.89% Federal funds sold: Balance outstanding at December 31, 1997 $ -- Maximum outstanding at any month-end 10,500 Average balance outstanding 2,051 Average interest rate 5.61%
The securities underlying the repurchase agreements are delivered by entry into Coastal's account maintained at a third-party custodian designated by Coastal under a written custodial agreement that explicitly recognizes Coastal's interest in the securities. There were no repurchase agreements or federal funds sold outstanding during 1996 or 1995. (5) MORTGAGE-BACKED SECURITIES Mortgage-backed securities at December 31, 1997 are as follows (in thousands):
Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- ---------- ------------ ---------- Held-to-maturity: REMICS - Agency $ 950,689 $ 5,022 $ (20,478) $ 935,233 REMICS - Non-agency 279,131 701 (5,610) 274,222 FNMA certificates 71,887 144 (683) 71,348 GNMA certificates 28,808 566 -- 29,374 Non-agency securities 14,555 239 (23) 14,771 Interest-only securities 20 -- -- 20 ----------- ----------- ------------ ----------- $ 1,345,090 $ 6,672 $ (26,794) $ 1,324,968 =========== =========== ============ =========== Available-for-sale: REMICS - Agency $ 171,167 $ 579 $ (4,044) $ 167,702 REMICS - Non-agency 2,328 -- (33) 2,295 ----------- ----------- ------------ ----------- $ 173,495 $ 579 $ (4,077) $ 169,997 =========== =========== ============ ============
Mortgage-backed securities at December 31, 1996 are as follows (in thousands):
Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- ------------ ------------ ---------- Held-to-maturity: REMICS - Agency $ 932,488 $ 4,730 $ (31,142) $ 906,076 REMICS - Non-agency 278,612 834 (9,958) 269,488 FNMA certificates 79,628 72 (1,072) 78,628 GNMA certificates 34,031 282 -- 34,313 Non-agency securities 19,790 363 (95) 20,058 Interest-only securities 38 -- (3) 35 ----------- ----------- ------------ ----------- $ 1,344,587 $ 6,281 $ (42,270) $ 1,308,598 =========== =========== ============ =========== Available-for-sale: REMICS - Agency $ 182,467 $ 1,207 $ (5,946) $ 177,728 REMICS - Non-agency 2,962 -- (34) 2,928 ----------- ----------- ------------ ----------- $ 185,429 $ 1,207 $ (5,980) $ 180,656 =========== =========== ============ ===========
As discussed in Note 2 to the Consolidated Financial Statements, pursuant to the Financial Accounting Standards Board's Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities," Coastal reclassified, in 1995, approximately $226,591,000 of mortgage-backed securities to the available-for-sale category and recorded an unrealized loss of approximately $1,556,000 in stockholders' equity. Proceeds from sales of mortgage-backed securities available-for-sale during 1997, 1996 and 1995 were approximately $11,545,000, $860,000 and $72,379,000, respectively. Gross gains of approximately $237,000 were realized on these sales in 1997 and gross losses of approximately $4,000 were realized on these sales in 1996. Gross gains and gross losses of approximately $209,000 and $128,000, respectively, were realized on these sales in 1995. (6) LOANS RECEIVABLE Loans receivable at December 31, 1997 and 1996 are as follows (in thousands):
1997 1996 ------------ ------------ Real estate mortgage loans: First lien mortgage, primarily residential $ 689,767 $ 791,337 Multifamily 131,454 139,486 Residential construction 83,359 77,146 Acquisition and development 31,619 26,132 Commercial 181,315 119,004 Commercial construction 14,506 3,963 Commercial loans, secured by residential mortgage loans held for sale 98,679 53,573 Commercial loans, secured by mortgage servicing rights 32,685 21,380 Commercial, financial and industrial 30,877 21,965 Loans secured by savings deposits 8,695 8,849 Consumer and other loans 15,030 14,400 ------------ ------------ 1,317,986 1,277,235 Loans in process (47,893) (38,742) Allowance for loan losses (7,412) (6,880) Unearned interest and loan fees (2,926) (2,344) Premium to record purchased loans, net 1,680 479 ------------ ------------ $ 1,261,435 $ 1,229,748 ============ ============ Weighted average yield 8.30% 8.23% ============ ============
In the normal course of business, Coastal enters into various transactions which, in accordance with generally accepted accounting principles, 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, 1997, Coastal had outstanding commitments to originate or purchase approximately $50,174,000 of first lien mortgage and other loans and had commitments under lines of credit to originate primarily construction and other loans of approximately $119,308,000. In addition, at December 31, 1997, Coastal had letters of credit of approximately $1,711,000 outstanding. A portion of Coastal's first lien mortgage loan portfolio is pledged as collateral to secure advances from the FHLB (Note 11). Included in loans receivable at December 31, 1997 and 1996 are loans totaling approximately $17,351,000 and $12,839,000, 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, 1997, 1996 and 1995, Coastal recognized interest income on these nonaccrual loans (outstanding as of the period end) of approximately $827,000, $507,000, and $303,000, respectively, whereas approximately $925,000, $816,000 and $499,000, respectively, in additional interest income would have been recorded if such loans had been performing in accordance with their original terms. At December 31, 1997 and 1996, the carrying value of loans that are considered to be impaired under Statement 114 totaled approximately $2,029,000 and $725,000, respectively (all of which are on nonaccrual) and the related allowance for loan losses on those impaired loans totaled $1,138,000 and $524,000, respectively. The average recorded investment in impaired loans during the years ended December 31, 1997, 1996 and 1995 was approximately $897,000, $846,000 and $311,000, respectively. For the years ended December 31, 1997, 1996 and 1995, 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, 1997 1996 1995 -------- ------- ------- Balance, beginning of year $ 6,880 $5,703 $2,158 Provision for loan losses 1,800 1,925 1,664 Charge-offs, net of recoveries (1,268) (748) (387) Acquisition allowance adjustment -- -- 2,268 -------- ------- ------- Balance, end of year $ 7,412 $6,880 $5,703 ======== ======= =======
The adoption of Statement 114, as amended by Statement 118, effective January 1, 1995, did not result in additional provisions for loan losses during the years ended December 31, 1997, 1996 or 1995. (7) ACCRUED INTEREST RECEIVABLE Accrued interest receivable at December 31, 1997 and 1996 is as follows (in thousands):
1997 1996 ------- ------- Mortgage-backed securities $ 6,684 $ 6,606 Loans receivable 8,124 8,084 Federal fund sold, certificates of deposits and other investments 5 -- ------- ------- $14,813 $14,690 ======= =======
(8) MORTGAGE SERVICING RIGHTS Coastal services for others loans receivable which are not included in the consolidated financial statements. The total amounts of such loans were approximately $675,737,000, $776,694,000, and $900,702,000 at December 31, 1997, 1996 and 1995, respectively. At December 31, 1997 and 1996, Coastal serviced approximately $2,177,000 and $2,750,000 of loans sold with recourse, respectively. An analysis of activity of mortgage servicing rights for the years ended December 31, 1997, 1996 and 1995 is as follows (in thousands):
Years ended December 31, 1997 1996 1995 -------- -------- --------- Balance at beginning of period $ 6,810 $ 8,323 $ 9,925 Additions 116 -- -- Amortization (1,273) (1,513) (1,597) Adjustments -- -- (5) --------- --------- --------- Balance at end of period $ 5,653 $ 6,810 $ 8,323 ========= ========= =========
At December 31, 1997, the estimated fair value of Coastal's recognized mortgage servicing rights was $7,402,000. (9) REAL ESTATE OWNED Included in prepaid expenses and other assets is real estate owned at December 31, 1997 and 1996 of approximately $3,186,000 and $3,161,000, respectively. (10) SAVINGS DEPOSITS Savings deposits and the related weighted average interest rates at December 31, 1997 and 1996 are summarized as follows (dollars in thousands):
1997 1996 ---------------------------- ------------------------------ Stated Rate Amount Stated Rate Amount ---------------- ------------ ---------------- ------------ Noninterest-bearing checking 0.00% $ 101,782 0.00% $ 85,259 Interest-bearing checking 1.49 - 2.00 69,972 2.00 56,862 Savings accounts 2.18 - 2.75 25,555 2.28 - 2.75 22,135 Money market demand accounts 2.96 - 4.51 165,986 3.15 - 4.51 151,046 -------------- ------------ ------------- ------------ 363,295 315,302 ------------ ------------ Certificate accounts 2.00 - 2.99 5,142 2.00 - 2.99 12,930 3.00 - 3.99 2,763 3.00 - 3.99 1,905 4.00 - 4.99 64,478 4.00 - 4.99 95,087 5.00 - 5.99 834,727 5.00 - 5.99 776,765 6.00 - 6.99 94,405 6.00 - 6.99 91,128 7.00 - 7.99 7,624 7.00 - 7.99 12,964 8.00 - 8.99 1,854 8.00 - 8.99 3,515 9.00 - 9.99 847 9.00 - 9.99 1,171 10.00 - 10.99 -- 10.00 - 10.99 249 11.00 - 11.99 -- 11.00 - 11.99 17 --------------- ------------ --------------- -------- 1,011,840 995,731 ------------ -------- Discount to record savings deposits at fair value, net (75) (198) ------------ ------------ $ 1,375,060 $ 1,310,835 ============ ============ Weighted average rate 4.67% 4.67% ============ ============
The scheduled maturities of certificate accounts outstanding at December 31, 1997 were as follows (in thousands):
Year Ended December 31, ----------------------- 1998 $ 781,455 1999 186,734 2000 30,028 2001 7,292 2002 6,153 Subsequent years 178 ----------- $ 1,011,840 ===========
The aggregate amount of certificate accounts with balances of $100,000 or more was approximately $122,593,000, and $109,371,000 at December 31, 1997 and 1996, respectively. (11) ADVANCES FROM THE FEDERAL HOME LOAN BANK OF DALLAS Advances from the FHLB for the years ended December 31, 1997, 1996 and 1995 are summarized as follows (dollars in thousands):
1997 1996 1995 -------- --------- --------- Balance outstanding at end of year $540,475 $409,720 $312,186 Average balance outstanding 368,896 387,296 367,895 Maximum outstanding at any month-end 540,475 491,930 405,016 Average interest rate during the year 5.78% 5.62% 6.01% Average interest rate at end of year 5.95% 5.61% 5.88%
The scheduled maturities and related weighted average interest rates on advances from the FHLB at December 31, 1997 are summarized as follows (dollars in thousands):
Due during the year Weighted Average ended December 31,. Interest Rate Amount - ------------------- ----------------- -------- 1998 5.84% $320,919 1999 6.08 120,411 2000 6.16 8,010 2001 6.22 8,656 2002 5.89 69,687 2004 6.52 2,854 2006 6.91 3,115 2007 6.78 1,072 2009 8.25 4,469 2011 6.78 1,282 ----------------- -------- 5.95% $540,475 ================= ========
At December 31, 1997, Coastal had a $50,000,000 unused line of credit with the FHLB. The FHLB advances are secured by certain first lien mortgage loans and mortgage-backed securities with an aggregate carrying value of approximately $540,500,000 at December 31, 1997. (12) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS PURCHASED Securities sold under agreements to repurchase at December 31, 1997 and 1996 are as follows (dollars in thousands):
Repurchase Repurchase Repurchase Liability Liability Liability Maturing Maturing Maturing in up to in 30 to in over 30 days 90 days 90 days Total ----------- ----------- ----------- ----------- December 31, 1997: - ------------------------------- Book value of mortgage-backed securities sold $ 693,058 $ -- $ 157,530 $ 850,588 Market value of mortgage-backed securities sold 682,669 -- 154,427 837,096 Repurchase liability 647,048 -- 144,712 791,760 Weighted average interest rate 6.00% Weighted average maturity 75 days December 31, 1996: - ------------------------------- Book value of mortgage-backed securities sold $ 755,512 $ 138,720 $ 156,987 $1,051,219 Market value of mortgage-backed securities sold 738,861 136,188 152,233 1,027,282 Repurchase liability 695,132 127,143 144,712 966,987 Weighted average interest rate 5.55% Weighted average maturity 126 days
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. At December 31, 1997 and 1996, $791,760,000 and $940,320,000, respectively, of the agreements relating to the mortgage-backed securities were agreements to repurchase the same securities, while $26,667,000, of the agreements at December 31, 1996 were agreements to repurchase substantially identical securities. Securities sold under agreements to repurchase at December 31, 1997 mature in 1998. Securities sold under agreements to repurchase averaged approximately $974,136,000, $930,706,000 and $752,427,000 during 1997, 1996 and 1995, respectively, and the maximum outstanding amounts at any month-end during 1997, 1996 and 1995 were approximately $1,035,576,000, $1,022,085,000 and $993,832,000, respectively. At December 31, 1997, Coastal had amounts of securities at risk under securities sold under agreements to repurchase with three individual counterparties which exceeded ten percent of stockholders' equity. The amount at risk with Salomon Brothers Inc. was $12,818,000 with an average maturity of 344 days at December 31, 1997. The amount at risk with Credit Suisse First Boston Corporation was $16,621,000 with an average maturity of 27 days at December 31, 1997. The amount at risk with Goldman, Sachs & Co. was $23,656,000 with an average maturity of 8 days at December 31, 1997. Federal funds purchased averaged approximately $161,000 during the year ended December 31, 1997. There were no federal funds purchased outstanding at any month-end during 1997 and there were no federal funds purchased outstanding during the years ended December 31, 1996 or 1995. (13) SENIOR NOTES PAYABLE On June 30, 1995, Coastal issued $50.0 million of 10.0% Senior Notes due June 30, 2002. The Senior Notes are 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 is payable quarterly. (14) INTEREST RATE RISK MANAGEMENT Coastal's strategy to manage interest rate risk is to minimize interest rate risk rather than hedge market values. Generally, Coastal minimizes its exposure to interest rate fluctuations by the origination and purchase of adjustable-rate mortgage loans, adjustable-rate mortgage-backed securities and the use of interest rate swap and interest rate cap agreements. Coastal's goal is to minimize the timing differences between the repricing or maturity of its assets and the repricing or maturity of its liabilities, without speculation of interest rates, to alter interest rate risk as much as possible to withstand interest rate changes. Coastal's approach to minimizing interest rate risk is through the structure of its balance sheet whereby asset purchases are closely matched with funding sources that have similar rate movement and repricing terms. (15) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK Coastal is a party to financial instruments with off-balance sheet risk in the normal course of business to reduce its own exposure to fluctuations in interest rates. These financial instruments include interest rate swap agreements, interest rate cap agreements and financial futures contracts. INTEREST RATE AGREEMENTS Coastal is a party to interest rate swap and interest rate cap agreements in order to reduce its exposure to floating interest rates on a portion of its variable rate assets and borrowings. At December 31, 1997, Coastal had interest rate swap and cap agreements on notional amounts totaling $45,847,000 and $231,229,000, respectively. Coastal has entered into interest rate swap agreements with various investment companies. The agreements provide 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 5.76% in 1997 and 5.56% in 1996. The weighted average interest rate of payments made on all of the interest rate swap agreements was approximately 6.51% in 1997 and 6.35% in 1996. Payments on the interest rate swap agreements are based on the notional principal amount of the agreements; no funds were actually borrowed or are to be repaid. Coastal records net interest expense or income related to these agreements on a monthly basis in "interest expense on other borrowed money" in the accompanying consolidated statements of operations. The interest expense related to these agreements was approximately $431,000, $593,000 and $24,000, for the years ended December 31, 1997, 1996 and 1995, respectively. Coastal had pledged approximately $6,405,000 and $6,123,000 of mortgage-backed securities to secure interest rate swap agreements at December 31, 1997 and 1996, respectively. The terms of the interest rate swap agreements outstanding at December 31, 1997 and 1996 are summarized as follows (dollars in thousands):
Floating Fair Value Rate at at End of Notional LIBOR Fixed End of Period Maturity Amount Index Rate Period gain (loss) - --------------------- --------- ----------- ------ --------- ------------ (unaudited) At December 31, 1997: 1998 $ 4,400 Three-month 6.709% 5.875% $ (28) 1999 14,600 Three-month 6.926 5.875 (239) 2000 4,800 Three-month 6.170 5.906 (99) 2,520 Three-month 6.000 5.906 -- 2005 19,527 Three-month 6.500 5.879 (230) --------- ------------ $ 45,847 $ (596) ========= ============ At December 31, 1996: 1997 $ 5,000 One-month 4.990% 5.633% $ 6 6,000 Three-month 6.493 5.500 (65) 1998 4,400 Three-month 6.709 5.500 (111) 1999 14,600 Three-month 6.926 5.500 (619) 2000 4,800 Three-month 6.170 5.543 (64) 2,660 Three-month 6.000 5.617 24 2005 23,442 Three-month 6.500 5.500 (15) --------- ------------ $ 60,902 $ (844) ========= ============
Coastal has interest rate cap agreements with third parties. The agreements provide for the third parties to make payments to Coastal whenever a defined floating rate exceeds rates ranging from 5.00% to 12.50%, 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 purchase prices of the interest rate cap agreements are capitalized and included in "prepaid expenses and other assets" in the accompanying consolidated statements of financial condition and are amortized over the life of the agreements using the straight-line method. The unamortized portion of the purchase price was approximately $286,000 and $1,070,000 at December 31, 1997 and 1996, respectively, with the estimated fair value of the agreements being $300,000 and $639,000 at December 31, 1997 and 1996, respectively. The interest rate cap agreements are used to alter the interest rate sensitivity of a portion of Coastal's mortgage-backed securities, loans receivable and their related funding sources. 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 operations. The net increase (decrease) in interest income related to the interest rate cap agreements was approximately $(218,000), $(518,000) and $681,000 for the years ended December 31, 1997, 1996, and 1995, respectively. Interest rate cap agreements outstanding at December 31, 1997 expire as follows (dollars in thousands):
Year of Strike rate Notional expiration range amount - ---------- ------------------ --------- 1998 5.00 - 12.50% $ 156,400 1999 7.25 - 11.00 63,564 2000 8.50 - 9.50 8,000 2001 7.50 3,265 --------- $ 231,229 =========
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. The fluctuation in the market value, however, has no effect on the level of earnings of Coastal because the securities are categorized as "held-to-maturity" and Coastal has the positive intent and ability to hold these to maturity. 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. FINANCIAL FUTURES Coastal has used financial futures contracts in its asset/liability management function to alter the interest rate sensitivity of Coastal's net interest income. In 1992, Coastal discontinued this hedging strategy. The net unamortized contract losses on closed positions were approximately $1,207,000 and $1,410,000 at December 31, 1997 and 1996, respectively. (16) 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, 1997 and 1996. 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, 1997 December 31, 1996 ---------------------------- -------------------------- Carrying Fair Carrying Fair Value Value Value Value ---------- ----------- ------------ ----------- Financial assets: Cash and cash equivalents $ 37,096 $ 37,096 $ 27,735 $ 27,735 Loans receivable 1,261,435 1,283,023 1,229,748 1,247,527 Mortgage-backed securities held-to-maturity 1,345,090 1,324,968 1,344,587 1,308,598 Securities available-for-sale 169,997 169,997 180,667 180,667 Mortgage loans held for sale -- -- 298 301 Stock in the FHLB 27,801 27,801 25,971 25,971 Interest rate cap agreements 286 300 1,070 639 Financial liabilities: Savings deposits 1,375,060 1,377,431 1,310,835 1,313,385 Advances from the FHLB 540,475 541,645 409,720 409,478 Securities sold under agreements to repurchase 791,760 791,742 966,987 966,881 Senior Notes payable 50,000 50,750 50,000 51,000 Off-balance sheet instruments: Interest rate swap agreements -- (596) -- (844) Commitments to extend -- 171,193 -- 134,698 credit
CASH AND CASH EQUIVALENTS Carrying value approximates fair value because of the short maturity of these instruments and absence of any anticipated credit concerns. 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. MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY AND SECURITIES AVAILABLE-FOR-SALE The fair values of mortgage-backed 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. MORTGAGE LOANS HELD FOR SALE The fair value of mortgage loans held for sale is estimated based on outstanding commitments from investors or current investor market yields calculated on an aggregate loan basis. STOCK IN THE FHLB The carrying amount of the stock in the FHLB approximates fair value. INTEREST RATE CAP AND SWAP AGREEMENTS The fair values of interest rate cap and swap agreements are based on the discounted value of the differences between contractual interest rates and current market rates for similar agreements. SAVINGS 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, 1997 and 1996. 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 AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE The fair values of advances from the Federal Home Loan Bank of Dallas and securities sold under agreements to repurchase are estimated based on quoted market prices for similar agreements or current rates offered to Coastal for borrowings with similar remaining maturities. SENIOR NOTES PAYABLE The fair value of Senior Notes payable is based on quoted market prices for similar securities. COMMITMENTS TO EXTEND CREDIT The fair value of commitments to extend credit is estimated using current interest rates and committed interest rates. (17) 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, 1997, 1996 and 1995, 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 1997, 1996 and 1995 will be available as credit carryforwards to reduce regular federal tax liabilities in future years, over an indefinite period. 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 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, 1997, 1996 and 1995 are as follows (in thousands):
1997 1996 1995 ------- ------- ------- Current $7,831 $5,920 $6,665 Deferred (9) (249) (188) ------- ------- ------- $7,822 $5,671 $6,477 ======= ======= =======
A reconciliation of the expected federal income taxes using a corporate tax rate of 35% for the years ended December 31, 1997, 1996 and 1995 is as follows (in thousands):
1997 1996 1995 ------- ------ ------ Computed expected tax provision $7,691 $5,324 $6,162 Net purchase accounting adjustments 282 287 104 Other, net (151) 60 211 ------- ------ ------ $7,822 $5,671 $6,477 ======= ====== ======
Significant temporary differences that give rise to the deferred tax assets and liabilities as of December 31, 1997 and 1996 are as follows (in thousands):
1997 1996 ------- ------ Deferred tax assets: Loans receivable, principally due to purchase accounting discount and allowance for loan losses $1,277 $1,247 Property and equipment 134 100 Real estate owned, principally 331 320 due to unrealized writedowns Unrealized loss on securities available-for-sale 1,224 1,670 Goodwill 383 268 Other 208 163 ------ ------ 3,557 3,768 ------ ------ Deferred tax liabilities: Mortgage-backed securities, principally due to deferred hedging losses 422 494 FHLB stock 703 451 Other 111 47 ------ ------ 1,236 992 ------ ------ Net deferred tax asset $2,321 $2,776 ====== ======
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 recently enacted legislation, Coastal will no longer be able to utilize a reserve method for determining the bad debt deduction but will be allowed to deduct actual charge-offs. Further, Coastal's post-1987 tax bad debt reserve will be recaptured into income. The reserve will be recaptured over a six year period. At December 31, 1997, Coastal had approximately $3,935,000 of 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. (18) SAVINGS ASSOCIATION INSURANCE FUND ("SAIF") INSURANCE SPECIAL ASSESSMENT On September 30, 1996, Coastal recorded the one-time SAIF insurance special assessment (the "special assessment") of $7,455,000 as a result of the Deposit Insurance Funds Act of 1996 (the "Act") being signed into law. The special assessment pursuant to the Act was 65.7 basis points on the SAIF deposit assess- ment base as of March 31, 1995. (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 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 Program was equal to 10% of Coastal's issued and outstanding shares of Common Stock. Coastal reserved the shares for future issuance under the 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 employ of Coastal for six months after the option was granted. On March 23, 1995, the Board of Directors adopted the 1995 Stock Compensation Program ("the New Program"). The New Program is substantially similar to the 1991 Program and was approved by stockholders in April 1995. The Board reserved 255,261 shares of Common Stock for issuance under the New Program. Coastal applies APB Opinion No. 25 and related interpretations in accounting for its stock compensation programs. Accordingly, no compensation cost has been recognized for its stock option rights. Had Coastal determined compensation cost based on the fair value at the grant date for its stock options under Statement 123, Coastal's net income available to common stockholders and diluted earnings per share would have been reduced to the pro forma amounts indicated below.
Years ended December 31, --------------------------------- 1997 1996 1995 ------- ------ ------ Net income available to common stockholders (in thousands): As reported $11,563 $6,951 $8,542 Pro forma $11,169 $6,739 $8,446 Diluted earnings per share: As reported $ 2.25 $ 1.38 $ 1.71 Pro forma $ 2.17 $ 1.34 $ 1.69
Pro forma net income and diluted earnings per share reflect only options granted in 1997, 1996 and 1995. Therefore, the full impact of calculating compensation cost for stock options under Statement 123 is not reflected in the pro forma net income or diluted earnings per share amounts presented above because compensation cost is reflected over the options' vesting period of 4 years and compensation cost for options granted prior to January 1, 1995 is not considered. 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 1997, 1996 and 1995:
1997 1996 1995 ------------ ------------ ------------ Assumptions: Expected annual dividends $0.48/share $0.40/share $0.32/share Expected volatility 22.30% 20.97% 23.24% Risk-free interest rate 6.87% 6.46% 6.38% Expected life 10 years 10 years 10 years
A summary of the status of the stock options as of December 31, 1997, 1996 and 1995 and changes during the years then ended is as follows:
1997 1996 1995 --------- --------- --------- 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 340,087 $ 14.989 242,907 $ 13.828 178,611 $ 13.084 Granted 125,400 23.526 112,000 17.383 77,446 15.500 Exercised (41,985) 13.869 (9,071) 12.372 (5,249) 11.088 Forfeited (10,605) 20.291 (5,749) 16.733 (7,901) 15.214 -------- ---------- -------- ---------- --------- ---------- Outstanding at end of year 412,897 $ 17.559 340,087 $ 14.989 242,907 $ 13.828 ======== ========== ======== ========== ========= ========== Options exercisable at end of year 253,861 209,999 151,141 ======= ======= ======= Weighted-Average fair value of options granted during the year (per share) $ 9.28 $ 6.56 $ 7.83 ======= ======= =======
The following table summarizes information about stock options outstanding at December 31, 1997:
Options outstanding ---------------------------------------------------------- Weighted-Average Weighted-average Number Remaining Exercise Price Range of Exercise Prices Outstanding Contractual Life - ------------------------- ------------------- ---------------- ------------------- 10.625 to $12.875 90,136 5.0 years $ 11.564 15.500 to $18.750 203,461 7.7 years $ 16.693 22.750 to $30.500 119,300 9.4 years $ 23.565 ------------------- ------------- $ ------- 412,897 7.6 years 17.559 =================== ============= $ ======= Options exercisable ------------------------------------------- Number Weighted-Average Range of Exercise Prices Exercisable Exercise Price - ------------------------- ------------------------- ---------------- 10.625 to $12.875 90,136 $ 11.564 15.500 to $18.750 135,150 $ 16.600 22.750 to $30.500 28,575 $ 23.262 ------------------- --------------- 253,861 $ 15.562 =================== ===============
(20) EMPLOYEE BENEFITS Coastal maintains a 401(k) profit sharing plan. Coastal's contributions to this plan were approximately $157,000, $105,000 and $94,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Pursuant to this plan, employees can contribute up to 15% of their qualifying compensation into the plan. Beginning January 1, 1990, Coastal has matched 25% of the employee contributions up to 15% of their qualifying compensation. (21) EARNINGS PER SHARE The following summarizes information related to the computation of basic and diluted EPS for the years ended December 31, 1997, 1996 and 1995 (dollars in thousands, except per share data).
1997 1996 1995 ---------- ---------- ---------- Net income available to common stockholders $ 11,563 $ 6,951 $ 8,542 ========== ========== ========== Weighted average number of common shares outstanding used in basic EPS calculation 4,983,994 4,962,456 4,955,731 Add assumed exercise of outstanding stock options as adjustments for dilutive securities 164,436 75,461 35,642 ---------- ---------- ---------- Weighted average number of common shares outstanding used in diluted EPS calculation 5,148,430 5,037,917 4,991,373 ========== ========== ========== Basic EPS $ 2.32 $ 1.40 $ 1.72 ========== ========== ========== Diluted EPS $ 2.25 $ 1.38 $ 1.71 ========== ========== ==========
(22) 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 the Preferred Stock are 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, the Preferred Stock may 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. (23) STOCKHOLDERS' EQUITY On April 24, July 24 and October 23, 1997, Coastal declared a dividend of $0.12 per share of Common Stock outstanding for the stockholders of record of May 15, August 15, and November 15, 1997, respectively. Prior to April 24, 1997, Coastal declared a dividend of $0.10 per share of Common Stock outstanding for the stockholders of record of February 15, 1997. On January 25, April 25, July 25, and October 24, 1996, Coastal declared a dividend of $0.10 per share of Common Stock outstanding for the stockholders of record of February 15, May 15, August 15, and November 15, 1996, respectively. On January 26, April 27, July 27, and October 26, 1995, Coastal declared a dividend of $0.08 per share of Common Stock outstanding for the stockholders of record on February 21, May 15, August 15, and November 15, 1995, respectively. (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, 1997, 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 - --------------------- ------- 1998 $ 2,376 1999 2,225 2000 2,182 2001 2,134 2002 and thereafter 18,297
Rent expense for the years ended December 31, 1997, 1996 and 1995 amounted to approximately $2,290,000, $2,000,000 and $1,465,000, respectively. (25) REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation ("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, 1997, that the Bank met capital adequacy requirements to which it is subject. As of December 31, 1997, 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, 1997 and 1996, 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 -------------------- ---------------- --------------- Capital Requirement Amount Ratio Amount Ratio Amount Ratio - ------------------------- -------- ---------- -------- ------ ------- ------ As of December 31, 1997: Tier 1 (core) $160,781 5.52% $116,570 4.00% 145,713 5.00% Tier 1 risk-based 160,781 11.46 56,136 4.00 84,204 6.00 Total risk-based 168,193 11.98 112,271 8.00 140,339 10.00 As of December 31, 1996: Tier 1 (core) $152,932 5.35% $114,377 4.00% 142,971 5.00% Tier 1 risk-based 152,932 11.77 51,970 4.00 77,955 6.00 Total risk-based 159,812 12.30 103,940 8.00 129,925 10.00
(26) PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Coastal Bancorp, Inc. is as follows (in thousands):
Coastal Bancorp, Inc. Statements of Financial Condition December 31, --------------------------------- 1997 1996 -------- -------- Assets: Cash and cash equivalents $ 1,570 $ 871 Investment in subsidiary 145,550 136,675 Mortgage-backed securities held-to-maturity 1,761 2,079 Other assets 6,731 5,125 -------- -------- Total assets $155,612 $144,750 ======== ======== Liabilities and stockholders' equity: Senior Notes payable $ 50,000 $ 50,000 Other liabilities 782 602 -------- -------- Total liabilities 50,782 50,602 Total stockholders' equity 104,830 94,148 -------- -------- Total liabilities and stockholders' equity $155,612 $144,750 ======== ========
Coastal Bancorp, Inc. Statements of Operations ------------------------ Years ended December 31, 1997 1996 1995 ------- ------- ------- Income: Dividends from subsidiary $ 7,293 $ 7,001 $ 4,093 Equity in undistributed earnings of subsidiary, net of income tax 7,946 3,686 6,332 Interest income 131 143 66 ------- ------- ------- Total income 15,370 10,830 10,491 ------- ------- ------- Expense: Interest expense 5,000 5,000 2,500 Noninterest expense 786 891 464 ------- ------- ------- Total expense 5,786 5,891 2,964 ------- ------- ------- Federal income tax benefit 1,979 2,012 1,015 ------- ------- ------- Net income available to common stockholders $11,563 $ 6,951 $ 8,542 ======= ======= =======
Coastal Bancorp, Inc. Statements of Cash Flows ------------------------ Years ended December 31, 1997 1996 1995 -------- -------- --------- Cash flows from operating activities: Net income available to common stockholders $11,563 $ 6,951 $ 8,542 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiary (7,946) (3,686) (6,332) Net increase in other assets and other liabilities (1,426) (1,262) (890) -------- -------- --------- Net cash provided by operating activities 2,191 2,003 1,320 -------- -------- --------- Cash flows from investing activities: Transfer of mortgage-backed securities From subsidiary -- -- (2,517) Net decrease in mortgage-backed securities 318 336 102 Investment in subsidiary (100) -- (44,930) -------- -------- --------- Net cash provided (used) by investing activities 218 336 (47,345) -------- -------- --------- Cash flows from financing activities: Exercise of stock options for purchase of Common stock 582 112 58 Issuance of Senior Notes payable, net -- -- 47,635 Dividends paid (2,292) (1,985) (1,585) -------- -------- --------- Net cash provided (used) by financing activities (1,710) (1,873) 46,108 -------- -------- --------- Net increase in cash and cash equivalents 699 466 83 Cash and cash equivalents at beginning of year 871 405 322 -------- -------- --------- Cash and cash equivalents at end of year $ 1,570 $ 871 $ 405 ======== ======== =========
(27) SELECTED QUARTERLY FINANCIAL DATA Selected quarterly financial data is presented in the following tables for the years ended December 31, 1997 and 1996 (in thousands, except per share data):
1997 Quarter Ended (unaudited) March 31, June 30, September 30, December 31, ---------- --------- -------------- ------------- Interest income $ 49,604 $ 49,898 $ 51,251 $ 50,603 Interest expense 34,956 35,634 37,052 36,781 ---------- --------- -------------- ------------- Net interest income 14,648 14,264 14,199 13,822 Provision for loan losses 450 450 450 450 Gain on sales of mortgage-backed Securities available-for-sale -- -- 237 -- Noninterest income 1,469 1,550 1,506 1,622 Noninterest expense 9,557 9,894 10,175 9,918 ---------- --------- -------------- ------------- Income before provision for Federal income taxes 6,110 5,470 5,317 5,076 Federal income taxes 2,225 2,004 1,953 1,640 Preferred stock dividends of Coastal Banc ssb 647 647 647 647 ---------- --------- -------------- ------------- Net income available to common Stockholders $ 3,238 $ 2,819 $ 2,717 $ 2,789 ========== ========= ============== ============= Basic earnings per share $ 0.65 $ 0.57 $ 0.54 $ 0.56 ========== ========= ============== ============= Diluted earnings per share $ 0.63 $ 0.55 $ 0.52 $ 0.54 ========== ========= ============== =============
1996 Quarter Ended (unaudited) March 31, June 30, September 30, December 31, ---------- --------- --------------- ------------- Interest income $ 48,554 $ 48,200 $ 48,242 $ 49,615 Interest expense 34,707 33,902 34,228 35,348 ---------- --------- --------------- ------------- Net interest income 13,847 14,298 14,014 14,267 Provision for loan losses 575 450 450 450 Gain on sale of branch office -- 521 -- -- Noninterest income 1,295 1,289 1,419 1,567 Noninterest expense 9,140 9,897 9,593 9,297 SAIF insurance special assessment -- -- 7,455 -- ---------- --------- --------------- ------------- Income (loss) before provision for Federal income taxes 5,427 5,761 (2,065) 6,087 Federal income taxes 1,987 2,103 (636) 2,217 Preferred stock dividends of Coastal Banc ssb 647 647 647 647 ---------- --------- --------------- ------------- Net income (loss) available to Common stockholders $ 2,793 $ 3,011 $ (2,076) $ 3,223 ========== ========= =============== ============= Basic earnings (loss) per share $ 0.56 $ 0.61 $ (0.42) $ 0.65 ========== ========= =============== ============= Diluted earnings (loss) per share $ 0.56 $ 0.60 $ (0.41) $ 0.63 ========== ========= =============== =============
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, 1997 of the Common Stock of Bancorp ("CBSA") and the Series A Preferred Stock of the Bank ("CBSAP") as listed and quoted on the NASDAQ National Market System. COASTAL BANCORP, INC. COMMON STOCK:
1997 1996 ---------------------------- ----------------------------- High Low Dividends High Low Dividends ------- ------- ---------- ------- ------- ---------- First Quarter $28.250 $22.375 $ 0.100 $18.750 $16.625 $ 0.100 Second Quarter 29.750 22.750 0.120 18.875 17.000 0.100 Third Quarter 33.250 29.000 0.120 20.375 16.500 0.100 Fourth Quarter 35.000 28.125 0.120 24.750 19.875 0.100
COASTAL BANC SSB PREFERRED STOCK, SERIES A:
1997 1996 ---------------------------- ----------------------------- High Low Dividends High Low Dividends ------- ------- ---------- ------- ------- ---------- First Quarter $25.500 $25.000 $ 0.563 $25.750 $24.750 $ 0.563 Second Quarter 25.500 24.875 0.563 24.875 24.500 0.563 Third Quarter 26.000 25.125 0.563 25.250 24.625 0.563 Fourth Quarter 25.625 25.000 0.563 25.250 24.875 0.563
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 23, 1998 at 11:00 a.m. TRANSFER AGENT AND REGISTRAR ChaseMellon Shareholder Services, L.L.C. Overpeck Centre 85 Challenger Road Ridgefield Park, New Jersey 07660 (800) 851-9677 www.chasemellon.com INDEPENDENT AUDITORS KPMG Peat Marwick LLP 700 Louisiana Street, Suite 2700 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) Manuel J. Mehos Chairman of the Board and Chief Executive Officer or Catherine N. Wylie 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. is listed on the over-the-counter market and quoted on the NASDAQ National Market System under the symbol "CBSA." As of February 26, 1998, there were 5,035,030 shares of Common Stock of Coastal Bancorp, Inc. issued and outstanding and the approximate number of registered stockholders was 29, representing approximately 1,500 beneficial stockholders at such record date. On March 25, 1992, Coastal Banc Savings Association (the "Association") issued 2,061,384 shares of Common Stock at $12.50 per share in its initial public offering. As of such date, the Common Stock of the Association became registered under the Securities Exchange Act of 1934 and also became listed for quotation on the NASDAQ National Market System. The Common Stock issued by the Association became the Common Stock of Coastal Bancorp, Inc. on July 29, 1994, as a result of the holding company reorganization of the Association. On October 21, 1993, the Association issued 1,150,000 shares of 9.0% Noncumulative Preferred Stock, Series A, at $25.00 per share. As of such date, the Preferred Stock of the Association became registered under the Securities Exchange Act of 1934. After the reorganization into a holding company form of ownership and conversion of the Association to a Texas-chartered savings bank, the Preferred Stock of the Association became the Preferred Stock of Coastal Banc ssb. The Preferred Stock is redeemable at any time on or after December 15, 1998, only at the option of the Bank, in whole or in part, at a redemption price of $25.00 per share plus accrued and unpaid dividends. The Preferred Stock is listed and quoted on the NASDAQ National Market System under the symbol "CBSAP." As of February 26, 1998, there were 1,150,000 shares of Preferred Stock issued and outstanding and held by approximately 197 registered stockholders, representing approximately 1,900 beneficial stockholders at such record date. Coastal declared dividends on the Common Stock payable during 1997. Quarterly dividends in the amount of $.10 per share were paid on March 15, 1997, and quarterly dividends in the amount of $.12 per share were paid on June 15, 1997, September 15, 1997 and December 15, 1997. On March 15, 1998, Coastal paid a quarterly dividend in the amount of $.12 per share on its Common Stock. Coastal 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, Coastal 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 4 EXHIBIT 10.3 CHANGE-IN-CONTROL SEVERANCE AGREEMENTS EXECUTIVE SEVERANCE AGREEMENT THIS AGREEMENT is entered into and effective this 26th day of June, 1997, ("Effective Date") by and between Coastal Bancorp, Inc. (the "Company") and Coastal Banc ssb (the "Bank") and Catherine N. Wylie (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 280G Maximum" shall mean product of 2.99 and the "base amount" as defined in Code 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 2.99 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 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 or the Bank, 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 on the earlier of (i) the date 36 months after the Effective Date, and (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. 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 of the Board and Chief Executive Officer, Coastal Bancorp, Inc., 5718 Westheimer, Suite 600, Houston, Texas 77057. If to the Employee: Catherine N. Wylie 3225 Bellefontaine Houston, Texas 77025 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 of the Board and Chief Executive Officer By: /s/ James C. Niver ----------------------------- James C. Niver Chairman, Compensation Committee ATTEST: COASTAL BANC SSB /s/ Linda B. Frazier By: /s/ Manuel J. Mehos - ------------------------- ---------------------------- Secretary Manuel J. Mehos, Chairman of the Board and Chief Executive Officer WITNESS /s/ Pamela S. Watkins By: /s/ Catherine N. Wylie - -------------------------- --------------------------- Pamela S. Watkins Gary R. Garrett Executive Vice President/ Chief Financial Officer EXECUTIVE SEVERANCE AGREEMENT THIS AGREEMENT is entered into and effective this 26th day of June, 1997, ("Effective Date") by and between Coastal Bancorp, Inc. (the "Company") and Coastal Banc ssb (the "Bank") and Gary R. Garrett (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 280G Maximum" shall mean product of 2.99 and the "base amount" as defined in Code 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 2.99 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 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 or the Bank, 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. 4. Term of the Agreement ------------------------ This Agreement shall remain in effect for the period commencing on the Effective Date and ending on the earlier of (i) the date 36 months after the Effective Date, and (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. 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 of the Board and Chief Executive Officer, Coastal Bancorp, Inc., 5718 Westheimer, Suite 600, Houston, Texas 77057. If to the Employee: Gary R. Garrett 1231 Creekford Sugar Land, Texas 77478 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 of the Board and Chief Executive Officer By: /s/ James C. Niver ----------------------------- James C. Niver Chairman, Compensation Committee ATTEST: COASTAL BANC SSB /s/ Linda B. Frazier By: /s/ Manuel J. Mehos - ------------------------- ---------------------------- Secretary Manuel J. Mehos, Chairman of the Board and Chief Executive Officer WITNESS /s/ Pamela S. Watkins By: /s/ Gary R. Garrett - -------------------------- --------------------------- Pamela S. Watkins Gary R. Garrett Executive Vice President/ Chief Lending Officer \\enterprise\data\acctexe\watkins\word\form-10k\1997\ex-10.3edgared.doc EX-28 5 EXHIBIT 28 FORM OF PROXY TO BE MAILED TO STOCKHOLDERS OF THE COMPANY March 24, 1998 Dear Stockholder: You are cordially invited to attend the Annual Meeting of the stockholders 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 23, 1998, at 11:00 a.m., Central Time. The attached Notice of Annual Meeting and Proxy Statement describe the formal business to be transacted at the meeting. Stockholders will vote to elect directors and ratify the Company's independent auditors. The Company's Board of Directors believes that these proposals are in the best interest of the Company and its stockholders and recommends that stockholders vote "for" them at the Annual Meeting. Directors and officers of the Company and representatives of the Company's independent auditors will be present 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 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 23, 1998 NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders ("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 at 11:00 a.m., Central Time, on April 23, 1998 for the following purposes, all of which are more completely set forth in the accompanying Proxy Statement: (1) To elect three directors of the Company to serve until the annual meeting of stockholders in the year 2001 and until their successors are elected and qualified; (2) To ratify the appointment of KPMG Peat Marwick LLP as the Company's independent auditors for the fiscal year ending December 31, 1998; 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 26, 1998 for the determination of stockholders 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 24, 1998 YOU ARE CORDIALLY INVITED TO ATTEND THE ANNUAL 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. 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 to be held at the corporate offices of Coastal Bancorp, Inc., at 5718 Westheimer, Houston, Texas in the Coastal Banc auditorium, Suite 1101, at 11:00 a.m., Central Time, on April 23, 1998 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 24, 1998. 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 PEAT MARWICK LLP AS THE COMPANY'S INDEPENDENT AUDITORS FOR THE FISCAL YEAR ENDING DECEMBER 31, 1998; 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), (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. was incorporated in Texas in March 1994 in connection with the reorganization of Coastal Banc Savings Association (the "Association") into the holding company form of organization, which occurred on July 29, 1994. In addition, effective July 29, 1994, the Association, which had been a Texas-chartered savings and loan association, converted to a Texas-chartered savings bank known as Coastal Banc ssb (the "Bank"). Effective November 30, 1996, the Bank engaged in a further holding company reorganization whereby Coastal Banc Holding Company, Inc., a Delaware corporation ("HoCo"), became a first-tier wholly-owned subsidiary of the Company. As a result of these reorganizations, the Company owns 100% of the voting stock of HoCo and HoCo owns 100% of the voting stock of the Bank. In addition, HoCo owns 100% of the stock of Coastal Banc Capital Corp. ("CBCC"). HoCo has no operations other than holding the voting common stock of CBCC and the Bank. The 9.0% Noncumulative Preferred Stock, Series A, issued by the Association on October 21, 1993 continues to represent, on a share for share basis, the 9.0% Noncumulative Preferred Stock, Series A, of the Bank. Coastal Bancorp, Inc. is a registered unitary savings and loan holding company regulated by the Office of Thrift Supervision. VOTING SECURITIES AND BENEFICIAL OWNERSHIP THEREOF Only holders of record of the Company's Common Stock at the close of business on February 26, 1998 ("Record Date") will be entitled to notice of, and to vote at, the Annual Meeting. On the Record Date, there were 5,035,035 shares of Common Stock outstanding and the Company had no other class of 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 of the total votes present at the Annual Meeting is required for approval of the proposal to ratify the appointment of the Company's independent auditors. 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 auditors, 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 26, 1998, directors, executive officers and their affiliates beneficially owned 1,045,718 shares of Common Stock or 20.12% 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 all of the proposals of the Board described herein. The following table sets forth the beneficial ownership of the Common Stock as of February 26, 1998, 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 subsidiary, Coastal Banc ssb, as a group. The address for all directors and executive officers of the Company and the Bank is Coastal Banc Plaza, 5718 Westheimer, Suite 600, Houston, Texas 77057. Except as set forth below, as of February 26, 1998, 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 26, Percent of Beneficial Owner 1998(1) Class - ----------------------------------------- -------------------- -------- First Manhattan Co.. . . . . . . . . . . . . 481,010(2) 9.26% 437 Madison Avenue New York, New York 10022 Friedman, Billings, Ramsey Group, Inc. . . . 410,625(2) 7.90 1001 19th Street North Arlington, Virginia 22209-1710 Robert Edwin Allday, Director. . . . . . . . 0(3) * Coastal Bancorp, Inc. and Coastal Banc ssb D. Fort Flowers, Jr., Director . . . . . . . 179,880(4) 3.46 Coastal Bancorp, Inc. and Coastal Banc ssb Dennis S. Frank, Director. . . . . . . . . . 20,000 * Coastal Bancorp, Inc. and Coastal Banc ssb Robert E. Johnson, Jr., Director . . . . . . 12,880(5) * Coastal Bancorp, Inc. and Coastal Banc ssb Manuel J. Mehos, Chairman of the Board,. . . 363,750(6) 7.00 President and Chief Executive Officer Coastal Bancorp, Inc., Coastal Banc Holding Company, Inc. and Coastal Banc ssb James C. Niver, Director . . . . . . . . . . 368,952(7) 7.10 Coastal Bancorp, Inc. and Coastal Banc ssb Clayton T. Stone, Director . . . . . . . . . 600 * Coastal Bancorp, Inc. and Coastal Banc ssb John D. Bird, Executive Vice President,. . . 23,666(6) * Chief Administrative Officer and Assistant Secretary Coastal Banc ssb Gary R. Garrett, Executive Vice President and. 25,548(6) * Chief Lending Officer Coastal Banc ssb David R. Graham, Executive Vice President -. . 9,411(6) * Real Estate Lending Coastal Banc ssb Nancy S. Vadasz, Executive Vice President -. . 14,060(6) * Market and Product Strategies Coastal Banc ssb Catherine N. Wylie, Executive Vice President . 26,971(6) * and Chief Financial Officer Coastal Bancorp, Inc., Coastal Banc Holding Company, Inc. and Coastal Banc ssb All directors and executive officers of the. . 1,045,718(6) 20.12 Company and the Bank as a group (12 persons)
* Represents less than 1.0% of the Common Stock outstanding. (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) Mr. Allday is the beneficial owner of 2,000 shares of the Bank's 9.0% Noncumulative Preferred Stock, Series A. (4) Of such shares, 176,880 are owned by a trust over which Mr. Flowers has shared voting and dispositive power with two other co-trustees. (5) Shares are held in trust for his minor children for which Mr. Johnson serves as trustee. (6) Under applicable regulations, a person is deemed to have beneficial ownership of any shares of Common Stock which may be acquired within 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 23,666, 25,548, 9,411, 63,750, 14,060 and 25,021 shares which may be received upon the exercise of stock options by Messrs. Bird, Garrett, Graham and Mehos and Mmes. Vadasz and Wylie, respectively, pursuant to stock options. For all directors and executive officers as a group, the number of shares includes 161,456 shares of Common Stock subject to outstanding stock options. (7) Mr. Niver is the co-trustee with his wife of a trust which holds such shares for their benefit. INFORMATION WITH RESPECT TO 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. On July 27, 1995, the Board of Directors voted to increase the size of the Board from seven to eight members and elected Mr. Clayton T. Stone to fill such vacancy effective August 24, 1995. Mr. Stone stood for election by the stockholders at the 1996 annual meeting and was elected to a three year term. Effective April 1, 1996, Mr. Donald Bonham retired from the Board of Directors for personal reasons. The Board of Directors has not nominated anyone to replace Mr. Bonham as of the date hereof. Three of the positions on the Board are to be elected in 1998. Prior to the formation of the Company, these individuals served as directors of the Association. The information set forth below relating to their tenure as directors is as of the date they were first elected as directors 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 AND NOMINEES FOR DIRECTORS Information concerning those members of the Board whose terms do not expire in 1998, 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: ROBERT E. JOHNSON, JR. Age 44. 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 1999. MANUEL J. MEHOS. Age 43. 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 Capital Corp., and the Bank and also Chief Executive Officer of CoastalBanc Financial Corp., a Bank subsidiary. He is also a director of each of the Bank's subsidiaries and is the President of CBS Asset Corp., CBS Builders, Inc. and CoastalBanc Investment Corporation, which are wholly-owned subsidiaries of the Bank, all of which are located in Houston, Texas. CBS Asset Corp., CBS Builders, Inc. and CoastalBanc Investment Corporation are presently inactive. Mr. Mehos also currently serves on the Finance Commission of Texas. His term as a director of the Company will expire in 2000. JAMES C. NIVER. Age 68. Director since 1986. Mr. Niver is retired and from 1972 until 1995 was employed by Century Land Company, Houston, Texas, retiring as its President. His term as a director of the Company will expire in 2000. CLAYTON T. STONE. Age 63. Director since August 1995. Mr. Stone is an Executive Vice President of Hines Interests Limited Partnership, Aspen, Colorado since 1996. Mr. Stone came out of retirement to take this position. Prior to 1996 he was an independent business consultant and a retired officer of Gerald D. Hines Interests, Houston, Texas. His term as a director of the Company will expire in 1999. THE NOMINEES Unless otherwise directed, each proxy executed and returned by a stockholder will be voted "FOR" the election of each of the nominees listed below. If any person named as a 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 any of 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 principal occupation during the past five years, as well as the year his term will expire, is set forth below: R. EDWIN ALLDAY. Age 47. Director since 1986. Mr. Allday is a private investor and in September 1993 became a senior consultant with The Dini Partners, Inc., Houston, Texas, a company that provides counseling in philanthropy and non-profit company management. Mr. Allday was an independent consultant for community relations for charitable organizations from March 1990 to June 1993. From August 1988 to March 1990, Mr. Allday was the Chief Operating Officer of the American Leadership Forum, a non-profit organization which teaches business leadership skills located in Houston, Texas. From March 1982 to August 1988, Mr. Allday was the General Manager of Anglia Companies, a family-owned investment management business in Houston, Texas. If elected, his term as a director of the Company will expire in 2001. D. FORT FLOWERS, JR. Age 36. Director since 1992. Mr. Flowers is the President 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. Additionally, 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. Mr. Flowers is also a director of The Ohio Bank, Findlay, Ohio. If elected, his term as a director of the Company will expire in 2001. DENNIS S. FRANK. Age 41. Director since 1988. Mr. Frank is the Chairman of the Board, Chief Executive Officer and President of Silvergate Bancorp, La Mesa, California, a position he has held since December 1996. Additionally, he has been the President and Chief Executive Officer of DSF Management Corp., a private investment company, located in Houston, Texas, since March 1994. Prior to that, Mr. Frank was the Manager of the Association's Capital Markets Division from July 1988 to April 1993 and a consultant to the Association from April 1993 to April 1994. If elected, his term as a director of the Company will expire in 2001. THE BOARD OF DIRECTORS RECOMMENDS THAT THE ABOVE NOMINEES BE ELECTED AS 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 Regular meetings of the Board of Directors of the Company are held quarterly and special meetings may be called at any time as necessary. During the year ended December 31, 1997, the Board of Directors of the Company held ten meetings. No incumbent director of the Company attended fewer than 75% of the aggregate of the total number of Board meetings held during the period in which he served as a director in 1997 except Mr. Frank who attended 70%. The Board of Directors 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. At December 31, 1997, there were no committees of the Board of the Company. Regular meetings of the Board of Directors of the Bank are held monthly and special meetings may be called at any time as necessary. During the year ended December 31, 1997, the Board of Directors of the Bank held twelve meetings. No incumbent director of the Bank attended fewer than 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 1997. 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, 1997, the Bank had an Audit, Compensation, Asset/Liability, Directors' Loan Review and a Community Reinvestment Act Committee of the Board. The Audit Committee of the Bank's Board is responsible for reviewing the reports of the independent auditors and examination reports of regulatory authorities, monitoring the functions of the internal audit department, which reports directly to this Committee, and generally overseeing compliance with internal policies and procedures. The Audit Committee members are Messrs. Niver (Chairman), Allday and Johnson. This Committee met seven times during 1997. 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. Niver (Chairman), Flowers and Johnson comprise the Compensation Committee, which met four times during 1997. See "Executive Compensation - Report of the Board of Directors on Compensation During Fiscal 1997." The Asset/Liability Committee met four times in 1997 to authorize investment categories, overall investment limitations and brokers to be utilized, to review trade recommendations and past trades of the Asset/Liability Subcommittee (composed of certain officers) and compliance of the Bank's investment activities with the Bank's Investment and Interest Rate Risk Policies and with Board recommendations. The Committee also makes interest rate risk assessments and formulates asset/liability management policy for the forthcoming quarterly period. This Committee consists of Messrs. Frank (Chairman), Flowers, Mehos and Stone. The Directors' Loan Review Committee met twenty-six times in 1997 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 management loan committee, the management construction loan committee or an individual officer of the Bank. The Directors' Loan Review Committee consists of Messrs. Mehos (Chairman), Flowers, Frank, Niver, and Stone. The Community Reinvestment Act ("CRA") Committee was established to monitor the Bank's efforts in serving the credit needs of the residents of the communities in which it does business, including those credit-worthy persons having low and moderate incomes. The CRA Committee has appointed a CRA Officer who is responsible for developing and administering the Bank's CRA program and for training the Bank's staff to comply with CRA regulations, and Bank policies and procedures. The CRA Officer chairs a management CRA Committee which works to oversee that the Bank meets the procedural requirements of the CRA. The CRA Committee is composed of Messrs. Allday (Chairman), Frank, Mehos and Johnson and met two times in 1997. BOARD FEES Through February 26, 1998, each non-employee director of the Company and the Bank was paid a fee of $1,550 for each Board meeting attended and a fee of $300 for each committee meeting attended. From February 26, 1998, forward however, each non-employee director of the Company and the Bank that attends the monthly Directors' Loan Review Committee and any additional ad hoc PCC meeting will be paid a maximum of $600 per month for all meetings. When Board and committee meetings of the Company are held on the same day as meetings of the Board and committees of the Bank, only one 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. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE OF THE EXCHANGE ACT Section 16(a) of the Exchange Act requires the Company's officers and directors of the Company to 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, 1997, all Section 16(a) filing requirements applicable to the Company's officers and directors of the Company and/or the Bank were complied with. EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS The following table sets forth information concerning executive officers of the Bank or its subsidiaries who do not serve on the Bank's Board of Directors. All executive officers are elected by the Board of Directors of the Bank or of the respective subsidiary and serve until their successors are elected and qualified. No executive officer is related to any director or other executive officer of 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 Bank and Name Age Principal Occupation During Last Five Years - --------------- ---- ------------------------------------------------ John D. Bird . . . 54 Executive Vice President since August 1993, Chief Administrative Officer since June 1993, and Assistant Secretary since March 1986; Chief Operations Officer from March 1986 to June 1993; President and sole stockholder of Coastal Banc Insurance Agency, Inc., an affiliate of the Bank, since May 1987. Gary R. Garrett. . 51 Executive Vice President since August 1993 and a director of each of the Bank's subsidiaries; Chief Lending Officer since 1995; Senior Vice President --Mortgage Lending from October 1991 to August 1993; Chief Executive Officer and President of CBS Mortgage Corp. since August 1993; Executive Vice President, CBS Mortgage Corp. from January 1989 to August 1993. Director and Executive Vice President of Coastal Banc Capital Corp., an affiliate of the Bank, since August 1997. David R. Graham. . 54 Executive Vice President since August 1993 and a director of each of the Bank's subsidiaries; Senior Vice President--Real Estate Lending Division from May 1988 to August 1993. Senior Vice President of CBS Asset Corp. since April 1993. Nancy S. Vadasz. . 44 Executive Vice President since June of 1994, Senior Vice President since September 1991. Catherine N. Wylie 43 Executive Vice President of Coastal Banc Holding Company, Inc. since November, 1996, of the Company since July 1994 and of the Bank since August 1993 and a director of Coastal Banc Holding Company, Inc., and of each of the Bank's subsidiaries; Chief Financial Officer since October 1993; Controller from April 1989 to October 1993; also Executive Vice President/Treasurer of each of the Bank's subsidiaries since October 1990. Director and Executive Vice President of Coastal Banc Capital Corp., an affiliate of the Bank since August 1997.
EXECUTIVE COMPENSATION REPORT OF THE BOARD OF DIRECTORS ON COMPENSATION DURING FISCAL 1997. Officers of the Company do not receive compensation for their services. 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 Nominees for Director, Directors Whose Terms Continue and Executive Officers - Board of Directors Meetings and Committees of Coastal Bancorp, Inc. and Coastal Banc ssb." The Committee is responsible for reviewing the compensation of executive officers of the Bank and recommending executive compensation proposals to the Bank's Board of Directors for approval. The Board of Directors of the Bank has a compensation philosophy pursuant to which executive compensation is designed to be at least comparable with average executive compensation for the Bank's peers, which are generally considered to be companies of approximately the same size and in the same industry. Companies included are independent financial companies, banks and savings and loan associations ranging from $900 million to $4.0 billion in asset size. In May 1992, the Bank retained an executive compensation consultant to review its executive compensation policies. The consultant developed a compensation program for the Bank's executive officers which is a combination of base salary plus incentive compensation linked to the Bank's profitability. The Committee evaluates the base salaries of the Bank's executive officers annually. An executive officer's base salary is determined 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 executive officers when compared to its peer group. The incentive component, as described below, which requires the Bank 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 executive officers comparable or better than the comparable executive compensation for the executive officers in the Bank's peer group. Based upon the foregoing, Mr. Mehos, the Chief Executive Officer, earned $264,000 in base salary during 1997. The amount of incentive compensation is related to the performance of the Bank. No cash incentive compensation will be paid to the Bank's 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 1997, the Board of Directors determined that no incentive awards to its Executive Management would be paid unless a 7.5% return on average equity ("ROE") was achieved. Any earnings from extraordinary items or unsound practices are excluded from such calculations at the Board's discretion. Gains on sales of securities from the investment account, net of losses of sales from the investment account, are deducted from the earnings pool. During 1997, the compensation committee calculated that the Company achieved a 11.68% ROE. Accordingly, during 1997, a bonus pool of $255,900 in the aggregate was established and incentive awards were paid to the three top executive officers of the Bank. See "Summary Compensation Table." By the Committee: /s/ James C. Niver ----------------------- James C. Niver (Chairman) D. Fort Flowers, Jr. Robert E. Johnson, Jr. 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 four other most highly compensated executive officers of the Bank and its subsidiaries whose total compensation exceeded $100,000 for services rendered in all capacities during the fiscal years ended December 31, 1997, 1996 and 1995.
ANNUAL COMPENSATION ---------------------- NAME AND PRINCIPAL POSITION(1) Year SALARY(2) BONUS(3) - ------------------------------ ---- ---------- --------- Manuel J. Mehos Chairman of the Board, 1997 $ 264,000 $ 127,900 President and . . . . . . . . 1996 241,000 131,228 Chief Executive Officer . . . 1995 222,000 0 John D. Bird 1997 130,630 30,000 Executive Vice President and . 1996 121,000 40,000 Chief Administrative Officer. 1995 111,565 0 Gary R. Garrett 1997 164,800 64,000 Executive Vice President and . 1996 160,000 70,000 Chief Lending Officer . . . . 1995 113,300 0 David R. Graham 1997 124,630 32,895 Executive Vice President . . . 1996 121,000 40,000 Real Estate Lending Division. 1995 110,335 0 Catherine N. Wylie 1997 164,800 64,000 Executive Vice President and . 1996 160,000 70,000 Chief Financial Officer . . . 1995 113,300 0 ALL NAME AND PRINCIPAL AWARDS OTHER POSITION(1) OPTIONS(4) COMPENSATION(5) - ------------------------------ ---------- ---------------- Manuel J. Mehos Chairman of the Board, . . . . 22,000 $ 2,000 President and . . . . . . . . 30,000 1,425 Chief Executive Officer . . . 19,000 2,310 John D. Bird 5,000 8,000 Executive Vice President and . 5,000 7,425 Chief Administrative Officer. 4,448 8,310 Gary R. Garrett 11,000 5,000 Executive Vice President and . 10,000 4,425 Chief Lending Officer . . . . 5,445 4,700 David R. Graham 8,000 2,000 Executive Vice President . . . 7,500 1,425 Real Estate Lending Division. 4,881 2,310 Catherine N. Wylie 11,000 5,000 Executive Vice President and . 10,000 4,425 Chief Financial Officer . . . 5,445 4,060
(1) Principal positions are for fiscal 1997. (2) Does not include amounts attributable to miscellaneous benefits received by executive officers of the Bank, including use of Bank owned vehicles. In the opinion of management of the Company, the costs to the Company of providing such benefits to any individual executive officer during the year ended December 31, 1997, 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 the subsequent year. (4) Free standing stock options; see "- Option Grants in Last Fiscal Year." (5) Includes for the named individuals employer matching contributions accrued pursuant to the Company's Profit Sharing (401k) Plan and any car allowances. EXECUTIVE SEVERANCE AGREEMENTS On June 26, 1997, the Company extended the term of the executive severance agreements (the "Executive Severance Agreements") with Mr. Garrett and Ms. Wylie (the "Employees" or "Employee") out one year to expire June 26, 2000. The Executive Severance Agreements provide for the payment of certain severance benefits to Mr. Garrett 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 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 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 of an amount equal to 2.99 times their 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 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. Other than the foregoing, the Company has not entered into any employment contracts with any of its officers. 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 which 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. The Executive Severance Agreement remains in effect for the modified period commencing on June 26, 1997 (the "Effective Date") and ending on the earlier of (i) June 26, 2000, or (ii) the date on which the Employee terminates his or her 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. OPTION GRANTS IN LAST FISCAL YEAR On March 23, 1995, the Board of Directors adopted the 1995 Stock Compensation Program (the "New Program"). Stockholders of the Company approved the New Program at the April 27, 1995 annual meeting. The New Program is substantially similar to the 1991 Program, as described below. The Board reserved 255,261 shares of Common Stock for issuance under the New Program at the time of adoption. There were 125,400 options issued under the New Program in 1997. The Board of Directors adopted the 1991 Stock Compensation Program (the "1991 Program") for the benefit of officers and other selected key employees of the Company and the Bank who were deemed to be responsible for the future growth of the Company. Stockholders of the Company approved the program at a Special Meeting of Stockholders held in December 1991. In connection with the reorganization of the Association in 1994, the 1991 Program was adopted by the Company, and approved by stockholders for the benefit of officers and key employees of the Company and the Bank and its subsidiaries. An aggregate of 241,001 shares of authorized but unissued shares of Company Common Stock were originally reserved for future issuance under the 1991 Program. All shares of the 1991 Program have been issued. Shares issuable under the New Program and the 1991 Program (collectively, the "Programs") pursuant to the exercise of stock options and/or the granting of stock appreciation rights and performance shares, are subject to modification or adjustment to reflect changes in the Company's capitalization. Of the shares reserved for issuance under the Programs, 30,968 shares are not currently subject to option at February 28, 1998. The Programs will remain in effect for a term of ten years from the date of adoption unless sooner terminated in accordance with the provisions of the Programs. Four kinds of rights, evidenced by four plans, are contained in the Programs and are available for grant: (i) incentive stock options; (ii) compensatory stock options; (iii) stock appreciation rights; and (iv) performance share awards. The Programs are administered by Messrs. Niver, Flowers and Johnson (the "Program Administrators"). The Program Administrators are given absolute discretion under each Program to select the persons to whom options, rights and awards will be granted and to determine the number of shares subject to each option, right or award. Only regular, full-time employees of the Company or the Bank, or any subsidiary of the Company or the Bank are eligible for selection by the Program Administrators to participate in the Programs. Non-employee directors are not eligible to receive awards under the Programs. The option prices per share for incentive stock options granted under the Programs may not be less than the fair market value of the Company's Common Stock on the date of the grant; provided, however, that if any employee owns more than 10% of the combined voting power of all classes of stock of the Company, the purchase price for shares acquired pursuant to the exercise of an option shall not be less than 110% of the fair market value of the Common Stock. The per share exercise price for compensatory options granted under the Programs may be equal to or less than the fair market value on the date of grant. The purchase price for shares of Common Stock subject to incentive or compensatory options may be paid in cash, by check, or if permitted by the Program Administrators at the time the option is granted, by shares of Common Stock, or by a combination thereof. In the event of a change in control of the Company, as defined, all incentive and compensatory stock options previously granted may become immediately exercisable notwithstanding any existing installment limitation which may be established by the Program Administrators, provided that the exercisability of an option may not be accelerated prior to the six month anniversary of the date the option is granted. 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.
PERCENT OF OPTIONS TOTAL OPTIONS GRANTED GRANTED TO EXERCISE (NO. OF EMPLOYEES PRICE NAME SHARES)(1) IN FISCAL YEAR PER SHARE - ----------------- ---------- -------------- --------- Manuel J. Mehos. . 9,000 7.18% $29.25 Manuel J. Mehos. . 13,000 10.37 22.75 John D. Bird . . . 5,000 3.99 22.75 Gary R. Garrett. . 11,000 8.77 22.75 David R. Graham. . 8,000 6.38 22.75 Catherine N. Wylie 11,000 8.77 22.75 GRANT DATE EXPIRATION PRESENT NAME DATE VALUE(2) - ---------------- ---------- ----------- Manuel J. Mehos. . 6/26/07 $107,829 Manuel J. Mehos. . 4/24/07 115,999 John D. Bird . . . 4/24/07 44,615 Gary R. Garrett. . 4/24/07 98,153 David R. Graham. . 4/24/07 71,384 Catherine N. Wylie 4/24/07 98,153
(1) Total options granted in 1997 were 125,400 shares. The options vest 25% during the first 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 on April 24, 1997 and June 26, 1997, respectively, were as follows: an expected volatility rate of 22.19% and 23.18%, a risk free rate of return of 6.93% and 6.49%, a dividend yield of $.48 per share per year and the expiration date of April 24, 2007 and June 26, 2007, respectively. 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.
Shares Number of Unexercised Acquired on Value Options at Fiscal Year-End Name Exercise Realized(2) Exercisable Unexercisable - ------------ -------- ----------- ----------- ------------- Manuel J. Mehos. . -- -- 63,750 36,250 John D. Bird . . . -- -- 23,666 7,362 Gary R. Garrett. . -- -- 25,548 14,611 David R. Graham. . 14,894 249,364 9,411 10,970 Catherine N. Wylie -- -- 25,021 14,611 Value of Unexercised in-the-Money Options at Fiscal Year-End(1) ------------------ Name Exercisable Unexercisable - ------------- ----------- ------------- Manuel J. Mehos. . $1,179,031 $516,344 John D. Bird . . . 503,666 111,701 Gary R. Garrett. . 512,346 215,780 David R. Graham. . 162,208 163,424 Catherine N. Wylie 499,748 215,780
(1) Based upon a closing market price for the Company's Common Stock as of December 31, 1997 of $34.875. (2) Based upon actual sales price at the time of exercise and sale. COMPARATIVE STOCK PERFORMANCE GRAPH The stock performance graph below compares the cumulative total stockholder return of the Company's Common Stock from December 31, 1992 to December 31, 1997 with the cumulative total return of the National Association of Securities Dealers Automated Quotations ("NASDAQ") Market Index and certain SNL 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, 1992 and the reinvestment of all dividends. The Company did not pay dividends on the Company's Common Stock during 1992 or 1993. In 1994, the Company paid its first dividend of $.08 per share on June 15, 1994. Quarterly dividends of the same amount were paid on September 15, 1994, December 15, 1994, March 15, 1995, June 15, 1995, September 15, 1995, and December 15, 1995. The Board of Directors voted at the January 25, 1996 regularly scheduled Board Meeting to increase the dividend for the fourth quarter of 1995 from $.08 per share to $.10 per share. Quarterly dividends of $.10 per share were paid on March 15, 1996, June 15, 1996, September 15, 1996 and December 15, 1996. During 1997 the Company paid quarterly dividends in the amount of $.10 per share for March 15, 1997 and quarterly dividends of $.12 per share for June 15, 1997, September 15, 1997 and December 15, 1997. Comparison of Five Year-Cumulative Total Return Performance
Index Period Ending 12/31/92 12/31/93 12/31/94 Coastal Bancorp, Inc. 100.00 103.92 114.32 NASDAQ - Total US . . 100.00 114.80 112.21 OTC Thrifts . . . . . 100.00 138.34 139.72 Index Period Ending 12/31/95 12/31/96 12/31/97 Coastal Bancorp, Inc. 142.03 189.66 293.98 NASDAQ - Total US . . 158.70 195.19 239.53 OTC Thrifts . . . . . 212.45 276.38 448.90
Notes: A. 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 acquired, and add them to the index calculation as they become publicly traded companies. All companies in existence at a certain time are included in the calculations. B. 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. Prepared by SNL Securities LP Charlottesville, VA 22902 CERTAIN TRANSACTIONS The Company may make home mortgage or consumer loans to directors, officers and employees. Any such loan will be made in the ordinary course of business and on the same terms and conditions, including interest rates and collateral, as those prevailing for comparable transactions at that time with non-affiliated parties. The Company had no loans to directors or executive officers outstanding at the year ended 1997. As a result of the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") on August 9, 1989, Section 22(h) of the Federal Reserve Act became applicable to a savings institution, such as the Bank. This law generally provides that any credit extended by a savings institution to its executive officers, directors and, to the extent otherwise permitted, principal stockholder(s), or any related interest of the foregoing, must (i) be on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions by the savings association with non-affiliated parties; (ii) be pursuant to underwriting standards that are no less stringent than those applicable to comparable transactions with non-affiliated parties; (iii) not involve more than the normal risk of repayment or present other unfavorable features; and (iv) not exceed, in the aggregate, the institution's unimpaired capital and surplus, as defined. In 1987, the Bank entered into an Administrative Services Agreement with Coastal Banc Insurance Agency, Inc. ("CBIA"), a Texas business corporation licensed under Texas law to act as a life insurance agent. CBIA is wholly-owned by an executive officer of the Bank who receives no salary or dividends from CBIA. CBIA has granted to the Bank the legal ownership of all of its books and records and the stockholder of CBIA has granted to the Bank the right to assign all of its stock in CBIA to any other properly licensed life insurance agent in the Bank's sole discretion. The Bank has agreed to provide to CBIA certain services, including but not limited to employee training, office space, furniture, fixtures, equipment, clerical services, data processing and other services as well as marketing leads and information to assist CBIA in the sale of annuities underwritten by an independent annuity company to the Bank's deposit and loan customers. In consideration for such services, CBIA has agreed to pay the Bank a flat fee which is subject to renegotiation on a quarterly basis. The fee payable to the Bank was last negotiated on December 19, 1997, and was $220,000 for the year ended December 31, 1997. Such fee represented substantially all of CBIA's net income for the year then ended. RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS The Board of Directors of the Company has appointed KPMG Peat Marwick LLP as independent auditors for the Company for the year ending December 31, 1998, and has further directed that the selection of auditors be submitted for ratification by the stockholders at the Annual Meeting. The Company has been advised by KPMG Peat Marwick LLP 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 Peat Marwick LLP will have one or more representatives at the Annual Meeting who will have an opportunity to make a statement, if he or she so desires, and will be available to respond to appropriate questions. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" RATIFICATION OF THE APPOINTMENT OF KPMG PEAT MARWICK LLP AS INDEPENDENT AUDITORS FOR FISCAL 1998. 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, no later than November 24, 1998. 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, 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 1998 Annual Meeting. OTHER MATTERS Management is not aware of any business to come before the 1998 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. 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 its subsidiary may solicit proxies personally or by telephone without additional compensation. ANNUAL REPORT AND FINANCIAL STATEMENTS A copy of the Company's Annual Report for the year ended December 31, 1997 ("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, 1997, 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. 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 24, 1998 template1 EX-27 6
9 This schedule contains summary financial information extracted from the consolidated statement of financial condition, the consolidated statement of operations and notes thereto found in exhibit 13 of the Company's Form 10-k for the year ended December 31, 1997 and is qualified in its entirety by reference to such financial statements 12-MOS DEC-31-1996 DEC-31-1996 27,735 0 0 0 180,667 1,344,587 1,308,598 1,229,748 6,880 2,875,907 1,310,835 1,011,402 44,217 415,305 0 0 50 94,098 2,875,907 97,935 95,155 1,521 194,611 60,076 138,185 56,426 1,925 (4) 47,970 12,622 6,951 0 0 6,951 1.40 1.38 2.06 12,839 1,195 0 0 5,703 851 103 6,880 6,880 0 0
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