-----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, J4l8YB5XiwOy8V/wlSTPsjt4L+zHfLABDoaW4bXSSH4VDme5xRWm5Ic/GnISVOeZ H1mH5ozRwDEvkwQa4d9PIw== 0000891618-98-001368.txt : 19980331 0000891618-98-001368.hdr.sgml : 19980331 ACCESSION NUMBER: 0000891618-98-001368 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CENTRAL COAST BANCORP CENTRAL INDEX KEY: 0000921085 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 770367061 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-25418 FILM NUMBER: 98577298 BUSINESS ADDRESS: STREET 1: 301 MAIN ST CITY: SALINAS STATE: CA ZIP: 93901 BUSINESS PHONE: 4084226642 MAIL ADDRESS: STREET 1: P O BOX 450 CITY: SALINAS STATE: CA ZIP: 93902 FORMER COMPANY: FORMER CONFORMED NAME: SALINAS VALLEY BANCORP DATE OF NAME CHANGE: 19940330 10-K 1 FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997 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 SECURITIES EXCHANGE ACT OF 1934 FOR THE 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 0-25418 CENTRAL COAST BANCORP (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) STATE OF CALIFORNIA 77-0367061 (STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.) OR ORGANIZATION) 301 MAIN STREET, SALINAS, CALIFORNIA 93901 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (408) 422-6642 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- COMMON STOCK NONE (NO PAR VALUE)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] 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 the 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. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant at March 6, 1998 was $106,999,026. As of March 6, 1998, the registrant had 4,808,945 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE The following documents are incorporated by reference into this Form 10-K: Part III, Items 10 through 13 from registrant's definitive proxy statement for the 1998 annual meeting of shareholders. THE INDEX TO EXHIBITS IS LOCATED AT PAGE 57 ================================================================================ 2 PART I ITEM 1. BUSINESS General Development of Business. Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K including, but not limited to, matters described in Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations," are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Changes to such risks and uncertainties, which could impact future financial performance, include, among others, (1) competitive pressures in the banking industry; (2) changes in the interest rate environment; (3) general economic conditions, nationally, regionally and in the operating market areas of the Company and the Banks; (4) changes in the regulatory environment; (5) changes in business conditions and inflation; and (6) changes in securities markets. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company and the Banks. Central Coast Bancorp (the "Company") is a California corporation organized in 1994 to act as the bank holding company of Bank of Salinas and Cypress Bank, state-chartered banks (the "Banks"). The Banks, headquartered in Salinas and Seaside, respectively, serve individuals, merchants, small and medium-sized businesses, professionals, agribusiness enterprises and wage earners located in the Salinas Valley and the Monterey Peninsula. On February 21, 1997, the Bank of Salinas purchased certain assets and assumed certain liabilities of the Gonzales and Castroville branch offices of Wells Fargo Bank. As a result of the transaction the Bank assumed deposit liabilities, received cash, and acquired tangible assets. This transaction resulted in intangible assets, representing the excess of the liabilities assumed over the fair value of the tangible assets acquired. In January 1997, Cypress Bank opened a new branch office in Monterey, California, so that it might better serve business and individual customers on the Monterey Peninsula. Other than holding the shares of the subsidiary Banks, the Company conducts no significant activities. Although, it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the "Board of Governors"), the Company's principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking. The Banks operate through their headquarters offices located in Salinas and Seaside, California and through their branch offices located in Castroville, Gonzales, King City, Marina and Monterey, California. The Banks offer a full range of commercial banking services, including the acceptance of demand, savings and time deposits, and the making of commercial, real estate (including residential mortgage), Small Business Administration, personal, home improvement, automobile and other installment and term loans. They also offer travelers' checks, safe deposit boxes, notary public, customer courier and other customary bank services. The Bank of Salinas and Cypress Bank Offices are open from 9:00 a.m. to 5:00 p.m., Monday through Thursday, and 9:00 a.m. to 6:00 p.m. on Friday. The Bank of Salinas also operates a limited service facility in a retirement home located in Salinas, California. The facility is open from 10:00 a.m. to 12:00 p.m. on Wednesday of each week. The Banks have automated teller machines (ATMs) located at the Castroville, Gonzales, King City, Marina, Monterey and Seaside offices, the Monterey County Fairgrounds, the Soledad Correctional Training Facility Credit Union, Salinas Valley Memorial Hospital and Fort Hunter Liggett which is located in Jolon, California. The Banks are insured under the Federal Deposit Insurance Act and each depositor's account is insured up to the legal limits thereon. The Banks are chartered (licensed) by the California Commissioner of Financial Institutions ("Commissioner") and have chosen not to become a member of the Federal Reserve System. The Banks have no subsidiaries. The Banks also currently offer personal and business Visa credit cards. The Banks have arranged with a correspondent institution to offer trust services to the Banks' customers on request. The Banks operate an on-site computer system which provides independent processing of the Banks' deposits, loans and financial accounting. 2 3 The three areas in which the Banks have directed virtually all of their lending activities are: (i) commercial loans; (ii) consumer loans; and (iii) real estate loans (including residential construction and mortgage loans). As of December 31, 1997, these three categories accounted for approximately 49 percent, 4 percent and 47 percent, respectively, of the Banks' loan portfolio. The Banks' deposits are attracted primarily from individuals, merchants, small and medium-sized businesses, professionals and agribusiness enterprises. The Banks' deposits are not received from a single depositor or group of affiliated depositors the loss of any one of which would have a materially adverse effect on the business of the Banks, nor is a material portion of the Banks' deposits concentrated within a single industry or group of related industries. As of December 31, 1997, the Banks served a total of 31 municipality and governmental agency depositors totaling $26,441,000 in deposits. In connection with the deposits of municipalities or other governmental agencies or entities, the Banks are generally required to pledge securities to secure such deposits, except for the first $100,000 of such deposits which are insured by the Federal Deposit Insurance Corporation ("FDIC"). As of December 31, 1997, the Banks had total deposits of $450,301,000. Of this total, $126,818,000 represented noninterest-bearing demand deposits, $89,107,000 represented interest-bearing demand deposits, and $234,376,000 represented interest-bearing savings and time deposits. The principal sources of the Banks' revenues are: (i) interest and fees on loans; (ii) interest on Federal Funds sold (funds loaned on a short-term basis to other banks) ; and (iii) interest on investments (principally government securities). For the fiscal year ended December 31, 1997 these sources comprised 73 percent, 10 percent, and 17 percent, respectively, of the Banks' total interest income. Supervision and Regulation The common stock of the Company is subject to the registration requirements of the Securities Act of 1933, as amended, and the qualification requirements of the California Corporate Securities Law of 1968, as amended. The Banks' common stock, however, is exempt from such requirements. The Company is also subject to the periodic reporting requirements of Section 13 of the Securities Exchange Act of 1934, as amended, which include, but are not limited to, annual, quarterly and other current reports with the Securities and Exchange Commission. The Banks are licensed by the California Commissioner of Financial Institutions ("Commissioner"), their deposits are insured by the FDIC, and they have chosen not to become members of the Federal Reserve System. The Banks have no subsidiaries. Consequently, the Banks are subject to the supervision of, and are regularly examined by, the Commissioner and the FDIC. Such supervision and regulation include comprehensive reviews of all major aspects of the Banks' business and condition, including their capital ratios, allowance for possible loan losses and other factors. However, no inference should be drawn that such authorities have approved any such factors. The Company and the Banks are required to file reports with the Commissioner, the FDIC and the Board of Governors and provide such additional information as the Commissioner, FDIC and the Board of Governors may require. The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is registered as such with, and subject to the supervision of, the Board of Governors. The Company is required to obtain the approval of the Board of Governors before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5% of the voting shares of such bank. The Bank Holding Company Act prohibits the Company from acquiring any voting shares of, or interest in, all or substantially all of the assets of, a bank located outside the State of California unless such an acquisition is specifically authorized by the laws of the state in which such bank is located. Any such interstate acquisition is also subject to the provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 discussed below. 3 4 The Company, and any subsidiaries which it may acquire or organize, are deemed to be "affiliates" of the Banks within the meaning of that term as defined in the Federal Reserve Act. This means, for example, that there are limitations (a) on loans by the Banks to affiliates, and (b) on investments by the Banks in affiliates' stock as collateral for loans to any borrower. The Company and its subsidiary are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities. In addition, regulations of the Board of Governors promulgated under the Federal Reserve Act require that reserves be maintained by the Banks in conjunction with any liability of the Company under any obligation (promissory note, acknowledgement of advance, banker's acceptance or similar obligation) with a weighted average maturity of less than seven (7) years to the extent that the proceeds of such obligations are used for the purpose of supplying funds to the Banks for use in its banking business, or to maintain the availability of such funds. The Board of Governors and the FDIC have adopted risk-based capital guidelines for evaluating the capital adequacy of bank holding companies and banks. The guidelines are designed to make capital requirements sensitive to differences in risk profiles among banking organizations, to take into account off-balance sheet exposures and to aid in making the definition of bank capital uniform internationally. Under the guidelines, the Company and the Banks are required to maintain capital equal to at least 8.0% of its assets and commitments to extend credit, weighted by risk, of which at least 4.0% must consist primarily of common equity (including retained earnings) and the remainder may consist of subordinated debt, cumulative preferred stock, or a limited amount of loan loss reserves. Assets, commitments to extend credit, and off-balance sheet items are categorized according to risk and certain assets considered to present less risk than others permit maintenance of capital at less than the 8% ratio. For example, most home mortgage loans are placed in a 50% risk category and therefore require maintenance of capital equal to 4% of such loans, while commercial loans are placed in a 100% risk category and therefore require maintenance of capital equal to 8% of such loans. The guidelines establish two categories of qualifying capital: Tier 1 capital comprising core capital elements, and Tier 2 comprising supplementary capital requirements. At least one-half of the required capital must be maintained in the form of Tier 1 capital. Tier 1 capital includes common shareholders' equity and qualifying perpetual preferred stock. However, no more than 25% of the Company's total Tier 1 capital may consist of perpetual preferred stock. The definition of Tier 1 capital for the Banks is the same, except that perpetual preferred stock may be included only if it is noncumulative. Tier 2 capital includes, among other items, limited life (and in the case of banks, cumulative) preferred stock, mandatory convertible securities, subordinated debt and a limited amount of reserve for credit losses. The Board of Governors and the FDIC also adopted minimum leverage ratios for banking organizations as a supplement to the risk-weighted capital guidelines. The leverage ratio is generally calculated using Tier 1 capital (as defined under risk-based capital guidelines) divided by quarterly average net total assets (excluding intangible assets and certain other adjustments). The leverage ratio establishes a limit on the ability of banking organizations, including the Company and the Banks, to increase assets and liabilities without increasing capital proportionately. The Board of Governors emphasized that the leverage ratio constitutes a minimum requirement for well-run banking organizations having diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and a composite rating of 1 under the regulatory rating system for banks and 1 under the regulatory rating system for bank holding companies. Banking organizations experiencing or anticipating significant growth, as well as those organizations which do not exhibit the characteristics of a strong, well-run banking organization described above, will be required to maintain minimum capital ranging generally from 100 to 200 basis points in excess of the leverage ratio. The FDIC adopted a substantially similar leverage ratio for state non-member banks which established (i) a 3 percent Tier 1 minimum capital leverage ratio for highly-rated banks (those with a composite regulatory rating of 1 and not experiencing or anticipating significant growth); and (ii) a 4 percent Tier 1 minimum capital leverage ratio for all other banks, as a supplement to the risk-based capital guidelines. 4 5 At December 31, 1997, the Banks and the Company are in compliance with the risk-based capital and leverage ratios described above. See Item 7 below for a listing of the Company's risk-based capital ratios at December 31, 1997 and 1996. The Company's ability to pay cash dividends is subject to restrictions set forth in the California General Corporation Law. Funds for payment of any cash dividends by the Company would be obtained from its investments as well as dividends and/or management fees from the Banks. The payment of cash dividends and/or management fees by the Banks is subject to restrictions set forth in the California Financial Code, as well as restrictions established by the FDIC. See Item 5 below for further information regarding the payment of cash dividends by the Company and the Banks. Competition At December 31, 1997, there were 34 branches of commercial and savings banks in the cities of Castroville, Gonzales, King City, Marina, Salinas, Seaside and the Monterey Peninsula. Additionally, the Banks compete with savings and loan associations and, to a lesser extent, credit unions, finance companies and other financial service providers for deposit and loan customers. Larger banks may have a competitive advantage because of higher lending limits and major advertising and marketing campaigns. They also perform services, such as trust services, international banking, discount brokerage and insurance services which the Banks are not authorized or prepared to offer currently. The Banks have made arrangements with their correspondent banks and with others to provide such services for its customers. For borrowers requiring loans in excess of the Banks' legal lending limits, the Banks have offered, and intend to offer in the future, such loans on a participating basis with its correspondent banks and with other independent banks, retaining the portion of such loans which is within their lending limits. As of December 31, 1997, the Banks' aggregate legal lending limits to a single borrower and such borrower's related parties were $6,910,000 on an unsecured basis and $11,516,000 on a fully secured basis based on regulatory capital of $46,064,000. Each Bank's business is concentrated in its service area, which primarily encompasses Monterey County, including the Salinas Valley area and to a lesser extent, the contiguous areas of San Benito County, Southern Santa Cruz County, and Santa Clara County. The economy of the Bank of Salinas's service area is primarily dependent upon the agricultural industry. Consequently, Bank of Salinas competes with other financial institutions for deposits from and loans to individuals and companies who are also dependent upon the agricultural industry. The economy of Cypress Bank's service area is primarily dependent on the tourist supported small business industry. Cypress Bank competes with other financial institutions located in their own communities and in surrounding communities. Based upon data as of the most recent practicable date (June 30, 1997(1)), there were 76 operating commercial and savings bank branches in Monterey County with total deposits of $3,470,353,000. The Banks held a total of $450,301,000 in deposits, representing approximately 13.0% of total commercial and savings banks deposits in Monterey County as of June 30, 1997. Of the Banks' competitors, three are independent banks headquartered in Monterey County. The Banks also compete with savings and loans associations in Monterey County. In order to compete with the major financial institutions in their primary service areas, the Banks use to the fullest extent possible the flexibility which is accorded by their independent status. This includes an emphasis on specialized services, local promotional activity, and personal contacts by the Banks' officers, directors and employees. The Banks also seek to provide special services and programs for individuals in its primary service area who are employed in the agricultural, professional and business fields, such as loans for equipment, furniture, tools of the trade or expansion of practices or businesses. In the event there are customers whose loan demands exceed the Banks' lending limits, the Banks seek to arrange for such loans on a - --------------- 1"Data Book Summary of Deposits in all FDIC Insured Commercial and Savings Banks", June 30, 1997 5 6 participation basis with other financial institutions. The Banks also assist those customers requiring services not offered by the Banks to obtain such services from correspondent banks. Banking is a business which depends on interest rate differentials. In general, the difference between the interest rate paid by the Banks to obtain their deposits and other borrowings and the interest rate received by the Banks on loans extended to customers and on securities held in the Banks' portfolio comprise the major portion of the Banks' earnings. Commercial banks compete with savings and loan associations, credit unions, other financial institutions and other entities for funds. For instance, yields on corporate and government debt securities and other commercial paper affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for loans with savings and loan associations, credit unions, consumer finance companies, mortgage companies and other lending institutions. The interest rate differentials of the Banks, and therefore their earnings, are affected not only by general economic conditions, both domestic and foreign, but also by the monetary and fiscal policies of the United States as set by statutes and as implemented by federal agencies, particularly the Federal Reserve Board. This agency can and does implement national monetary policy, such as seeking to curb inflation and combat recession, by its open market operations in United States government securities, adjustments in the amount of interest free reserves that banks and other financial institutions are required to maintain, and adjustments to the discount rates applicable to borrowing by banks from the Federal Reserve Board. These activities influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and timing of any future changes in monetary policies and their impact on the Banks are not predictable. On December 19, 1991, President Bush signed the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). The FDICIA substantially revised banking regulations, certain aspects of the Federal Deposit Insurance Act and established a framework for determination of capital adequacy of financial institutions, among other matters. Under the FDICIA, financial institutions are placed into five capital adequacy categories as follows: (1) well capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. The FDICIA authorized the Board of Governors, the Comptroller and FDIC to establish limits below which financial institutions will be deemed critically undercapitalized, provided that such limits can not be less than two percent (2%) of the ratio of tangible equity to total assets or sixty-five percent (65%) of the minimum leverage ratio established by regulation. Financial institutions classified as undercapitalized or below are subject to limitations including restrictions related to (i) growth of assets, (ii) payment of interest on subordinated indebtedness, (iii) capital distributions, and (iv) payment of management fees to a parent holding company. The FDICIA requires the Board of Governors and FDIC to initiate corrective action regarding financial institutions which fail to meet minimum capital requirements. Such action may result in orders to augment capital such as through sale of voting stock, reduction in total assets, and restrictions related to correspondent bank deposits. Critically undercapitalized financial institutions may also be subject to appointment of a receiver or conservator unless the financial institution submits an adequate capitalization plan. In 1995 the FDIC, pursuant to Congressional mandate, reduced bank deposit insurance assessment rates to a range from $0 to $0.27 per $100 of deposits, dependent upon a bank's risk. Based upon the above risk-based assessment rate schedule, the Banks' current capital ratios and the Banks' current levels of deposits, the Banks anticipate no change in the assessment rate applicable to the Banks during 1998 from that in 1997. The Board of Governors and FDIC adopted regulations effective December 19, 1992, implementing a system of prompt corrective action pursuant to Section 38 of the Federal Deposit Insurance Act and Section 131 of the FDICIA. The regulations establish five capital categories with the following characteristics: (1) "Well capitalized" -- consisting of institutions with a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or greater, and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive; (2) "Adequately capitalized" -- consisting of institutions with a total risk-based capital ratio of 8% or greater, a Tier 1 risk- 6 7 based capital ratio of 4% or greater and a leverage ratio of 4% or greater, and the institution does not meet the definition of a "well capitalized' institution; (3) "Undercapitalized" -- consisting of institutions with a total risk-based capital ratio less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or a leverage ratio of less than 4%; (4) "Significantly undercapitalized" -- consisting of institutions with a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%; (5) "Critically undercapitalized" -- consisting of an institution with a ratio of tangible equity to total assets that is equal to or less than 2%. The regulations established procedures for classification of financial institutions within the capital categories, filing and reviewing capital restoration plans required under the regulations and procedures for issuance of directives by the appropriate regulatory agency, among other matters. The regulations impose restrictions upon all institutions to refrain from certain actions which would cause an institution to be classified within any one of the three "undercapitalized" categories, such as declaration of dividends or other capital distributions or payment of management fees, if following the distribution or payment the institution would be classified within one of the "undercapitalized" categories. In addition, institutions which are classified in one of the three "undercapitalized" categories are subject to certain mandatory and discretionary supervisory actions. Mandatory supervisory actions include (1) increased monitoring and review by the appropriate federal banking agency; (2) implementation of a capital restoration plan; (3) total asset growth restrictions; and (4) limitation upon acquisitions, branch expansion, and new business activities without prior approval of the appropriate federal banking agency. Discretionary supervisory actions may include (1) requirements to augment capital; (2) restrictions upon affiliate transactions; (3) restrictions upon deposit gathering activities and interest rates paid; (4) replacement of senior executive officers and directors; (5) restrictions upon activities of the institution and its affiliates; (6) requiring divestiture or sale of the institution; and (7) any other supervisory action that the appropriate federal banking agency determines is necessary to further the purposes of the regulations. Further, the federal banking agencies may not accept a capital restoration plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company under the guaranty is limited to the lesser of (i) an amount equal to 5 percent of the depository institution's total assets at the time it became undercapitalized, and (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it were "significantly undercapitalized." FDICIA also restricts the solicitation and acceptance of and interest rates payable on brokered deposits by insured depository institutions that are not "well capitalized." An "undercapitalized" institution is not allowed to solicit deposits by offering rates of interest that are significantly higher than the prevailing rates of interest on insured deposits in the particular institution's normal market areas or in the market areas in which such deposits would otherwise be accepted. Any financial institution which is classified as "critically undercapitalized" must be placed in conservatorship or receivership within 90 days of such determination unless it is also determined that some other course of action would better serve the purposes of the regulations. Critically undercapitalized institutions are also prohibited from making (but not accruing) any payment of principal or interest on subordinated debt without the prior approval of the FDIC and the FDIC must prohibit a critically undercapitalized institution from taking certain other actions without its prior approval, including (1) entering into any material transaction other than in the usual course of business, including investment expansion, acquisition, sale of assets or other similar actions; (2) extending credit for any highly leveraged transaction; (3) amending articles or bylaws unless required to do so to comply with any law, regulation or order; (4) making any material change in accounting methods; (5) engaging in certain affiliate transactions; (6) paying excessive compensation or bonuses; and (7) paying interest on new or renewed liabilities at rates which would increase the weighted average costs of funds beyond prevailing rates in the institution's normal market areas. The capital ratio requirements for the "adequately capitalized" category generally are the same as the existing minimum risk-based capital ratios applicable to the Company and the Banks. It is not possible to 7 8 predict what effect the prompt corrective action regulation will have upon the Company and the Banks or the banking industry taken as a whole in the foreseeable future. Under the FDICIA, the federal financial institution agencies have adopted regulations which require institutions to establish and maintain comprehensive written real estate policies which address certain lending considerations, including loan-to-value limits, loan administrative policies, portfolio diversification standards, and documentation, approval and reporting requirements. FDICIA further generally prohibits an insured state bank from engaging as a principal in any activity that is impermissible for a national bank, absent FDIC determination that the activity would not pose a significant risk to the Bank Insurance Fund, and that the bank is, and will continue to be, within applicable capital standards. Similar restrictions apply to subsidiaries of insured state banks. The Company does not currently intend to engage in any activities which would be restricted or prohibited under the FDICIA. The federal banking agencies during 1996 issued a joint agency policy statement regarding the management of interest-rate risk exposure (interest rate risk is the risk that changes in market interest rates might adversely affect a bank's financial condition) with the goal of ensuring that institutions with high levels of interest-rate risk have sufficient capital to cover their exposures. This policy statement reflected the agencies' decision at that time not to promulgate a standardized measure and explicit capital charge for interest rate risk, in the expectation that industry techniques for measurement of such risk will evolve. However, the Federal Financial Institution Examination Counsel ("FFIEC") on December 13, 1996, approved an updated Uniform Financial Institutions Rating System ("UFIRS"). In addition to the five components traditionally included in the so-called "CAMEL" rating system which has been used by bank examiners for a number of years to classify and evaluate the soundness of financial institutions (including capital adequacy, asset quality, management, earnings and liquidity), UFIRS includes for all bank regulatory examinations conducted on or after January 1, 1997, a new rating for a sixth category identified as sensitivity to market risk. Ratings in this category are intended to reflect the degree to which changes in interest rates, foreign exchange rates, commodity prices or equity prices may adversely affect an institution's earnings and capital. The rating system henceforth will be identified as the "CAMELS" system. The federal financial institution agencies have established safety and soundness standards for insured financial institutions covering (1) internal controls, information systems and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset growth; (6) compensation, fees and benefits; and (7) excessive compensation for executive officers, directors or principal shareholders which could lead to material financial loss. If an agency determines that an institution fails to meet any standard, the agency may require the financial institution to submit to the agency an acceptable plan to achieve compliance with the standard. If the agency requires submission of a compliance plan and the institution fails to timely submit an acceptable plan or to implement an accepted plan, the agency must require the institution to correct the deficiency. Under the final rule, an institution must file a compliance plan within 30 days of a request to do so from the institution's primary federal regulatory agency. The agencies may elect to initiate enforcement action in certain cases rather than rely on an existing plan particularly where failure to meet one or more of the standards could threaten the safe and sound operation of the institution. The Board of Governors issued final amendments to its risk-based capital guidelines to be effective December 31, 1994, requiring that net unrealized holding gains and losses on securities available for sale determined in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," are not to be included in the Tier 1 capital component consisting of common stockholders' equity. Net unrealized losses on marketable equity securities (equity securities with a readily determinable fair value), however, will continue to be deducted from Tier 1 capital. This rule has the general effect of valuing available for sale securities at amortized cost (based on historical cost) rather than at fair value (generally at market value) for purposes of calculating the risk-based and leverage capital ratios. On December 13, 1994, the Board of Governors issued amendments to its risk-based capital guidelines regarding concentration of credit risk and risks of non-traditional activities, which were effective January 17, 1995. As amended, the risk-based capital guidelines identify concentrations of credit risk and evaluate an 8 9 institution's ability to manage such risks and the risk posed by non-traditional activities as important factors in assessing an institution's overall capital adequacy. Since 1986, California has permitted California banks and bank holding companies to be acquired by banking organizations based in other states on a "reciprocal" basis (i.e., provided the other state's laws permit California banking organizations to acquire banking organizations in that state on substantially the same terms and conditions applicable to local banking organizations). Some increase in merger and acquisition activity among California and out-of-state banking organizations has occurred as a result of this law, as well as increased competition for loans and deposits. Since October 2, 1995, California law implementing certain provisions of prior federal law has (1) permitted interstate merger transactions; (2) prohibited interstate branching through the acquisition of a branch business unit located in California without acquisition of the whole business unit of the California bank; and (3) prohibited interstate branching through de novo establishment of California branch offices. Initial entry into California by an out-of-state institution must be accomplished by acquisition of or merger with an existing whole bank which has been in existence for at least five years. Community Reinvestment Act ("CRA") regulations effective as of July 1, 1995 evaluate banks' lending to low and moderate income individuals and businesses across a four-point scale from "outstanding" to "substantial noncompliance," and are a factor in regulatory review of applications to merge, establish new branches or form bank holding companies. In addition, any bank rated in "substantial noncompliance" with the CRA regulations may be subject to enforcement proceedings. The Banks have a current rating of "satisfactory" or better for CRA compliance. Recently, the Federal banking agencies, especially the OCC and the Board of Governors, have taken steps to increase the types of activities in which national banks and bank holding companies can engage, and to make it easier to engage in such activities. On November 20, 1996, the OCC issued final regulations permitting national banks to engage in a wider range of activities through subsidiaries. "Eligible institutions" (those national banks that are well capitalized, have a high overall rating and a satisfactory CRA rating, and are not subject to an enforcement order) may engage in activities related to banking through operating subsidiaries after going through a new expedited application process. In addition, the new regulations include a provision whereby a national bank may apply to the OCC to engage in an activity through a subsidiary in which the bank itself may not engage. This OCC regulation could be advantageous to national banks depending on the extent to which the OCC permits national banks to engage in new lines of business. Certain legislative and regulatory proposals that could affect the Bank and the banking business in general are pending or may be introduced before the United States Congress, the California State Legislature and Federal and state government agencies. The United States Congress is considering numerous bills that could reform banking laws substantially. For example, proposed bank modernization legislation under consideration would, among other matters include a repeal of the Glass-Steagall Act restrictions on banks that now prohibit the combination of commercial and investment banks. It is not known to what extent, if any, the legislative proposals will be enacted and what effect such legislation would have on the structure, regulation and competitive relationships of financial institutions. It is likely, however, that many of these proposals would subject the Company and the Banks to increased regulation, disclosure and reporting requirements and would increase competition and the Banks' cost of doing business. In additional to pending legislative changes, the various banking regulatory agencies frequently propose rules and regulations to implement and enforce already existing legislation. It cannot be predicted whether or in what form any such rules or regulations will be enacted or the effect that such and regulations may have on the Company and the Banks. 9 10 ITEM 2. PROPERTIES The headquarters office and centralized operations of the Company are located at 301 Main Street, Salinas, California. Bank of Salinas is headquartered at 301 Main Street, Salinas, California, with branch offices located at 301 Main Street, Salinas, California; 10601 Merritt Street, Castroville, California; 346 Alta Street, Gonzales, California; and 532 Broadway, King City, California. Cypress Bank is headquartered at 1658 Fremont Boulevard in Seaside, California, with branch offices located at 228 Reservation Road, Marina, California and 484 Lighthouse Avenue, Monterey, California. The Marina office is leased from a joint venture that includes affiliates of Central Coast Bancorp. In addition to the monthly rental expense, the Bank paid to the joint venture $18,000 for a security deposit and $12,000 for the January 1994 and last three months rent. In addition to the branch facilities owned by the Company in Castroville and Gonzales, the Company operates its headquarters and other branch offices under facilities leases which expire in November 1998 through February 2000, with options to extend for three to fifteen years. These include facilities leased from a shareholder and from directors at terms and conditions which management believes are consistent with the commercial lease market. Rental rates are adjusted annually for changes in certain economic indices. The annual minimum lease commitments are set forth in Footnote 7 of Item 8 Financial Statements and Supplementary Data included in this report and incorporated herein by reference. The forgoing description of the Lease Agreements is qualified by reference to the Lease Agreements included in Exhibits listed in Part IV of this Form 10-K. ITEM 3. LEGAL PROCEEDINGS There are no material proceedings adverse to the Company or the Banks to which any director, officer, affiliate of the Company or 5% shareholder of the Company or the Banks, or any associate of any such director, officer, affiliate or 5% shareholder of the Company or Banks are a party, and none of the above persons has a material interest adverse to the Company or the Banks. Neither the Company nor the Banks are a party to any pending legal or administrative proceedings (other than ordinary routine litigation incidental to the Company's or the Banks' business) and no such proceedings are known to be contemplated. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1997. 10 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (A) Market Information There is limited trading in and no established public trading market for the Company's common stock. The Company's common stock is not listed on any exchange. Hoefer & Arnett, Incorporated and Ryan Beck are registered as market makers in the Company's stock. Dean Witter Reynolds, Smith Barney and Paine Webber also facilitate trades in the Company's common stock. Based on information provided to the Company from Dean Witter Reynolds and Smith Barney, the range of high and low bids for the common stock for the two most recent fiscal years, restated to reflect all stock dividends and stock splits distributed by the Company and the 10% stock dividend declared in January 1998, are presented below.
CALENDAR YEAR LOW HIGH ------------- ------ ------ 1997 First Quarter............................................ $14.32 $22.27 Second Quarter........................................... 15.45 21.25 Third Quarter............................................ 20.23 22.73 Fourth Quarter........................................... 17.50 20.57 1996 First Quarter............................................ $ 8.95 $ 9.65 Second Quarter........................................... 9.36 10.46 Third Quarter............................................ 10.45 11.52 Fourth Quarter........................................... 11.52 13.34
The bid price for the Company's common stock was $21.00 as of January 31, 1998. (B) Holders As of January 31, 1998, there were approximately 1,261 holders of the common stock of the Company. There are no other classes of common equity outstanding. (C) Dividends The Company's shareholders are entitled to receive dividends when and as declared by its Board of Directors, out of funds legally available therefor, subject to the restrictions set forth in the California General Corporation Law (the "Corporation Law"). The Corporation Law provides that a corporation may make a distribution to its shareholders if the corporation's retained earnings equal at least the amount of the proposed distribution. The Corporation Law further provides that, in the event that sufficient retained earnings are not available for the proposed distribution, a corporation may nevertheless make a distribution to its shareholders if it meets two conditions, which generally stated are as follows: (1) the corporation's assets equal at least 1 1/4 times its liabilities; and (2) the corporation's current assets equal at least its current liabilities or, if the average of the corporation's earnings before taxes on income and before interest expenses for the two preceding fiscal years was less than the average of the corporation's interest expenses for such fiscal years, then the corporation's current assets must equal at least 1 1/4 times its current liabilities. Funds for payment of any cash dividends by the Company would be obtained from its investments as well as dividends and/or management fees from the Banks. The payment of cash dividends by the subsidiary Banks is subject to restrictions set forth in the California Financial Code (the "Financial Code"). The Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of the lesser of (a) the bank's retained earnings; or (b) the bank's net income for its last three fiscal years, less the amount of any distributions made by the bank or by any majority-owned subsidiary of the bank to the shareholders of the bank during such period. However, a bank may, with the approval of the Commissioner, make a distribution to its shareholders in an amount not exceeding the greater of (a) its retained earnings; (b) its net income for its last fiscal year; or (c) its net income for its 11 12 current fiscal year. In the event that the Commissioner determines that the shareholders' equity of a bank is inadequate or that the making of a distribution by the bank would be unsafe or unsound, the Commissioner may order the bank to refrain from making a proposed distribution. The FDIC may also restrict the payment of dividends if such payment would be deemed unsafe or unsound or if after the payment of such dividends, the bank would be included in one of the "undercapitalized" categories for capital adequacy purposes pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991. Additionally, while the Board of Governors has no general restriction with respect to the payment of cash dividends by an adequately capitalized bank to its parent holding company, the Board of Governors might, under certain circumstances, place restrictions on the ability of a particular bank to pay dividends based upon peer group averages and the performance and maturity of the particular bank, or object to management fees on the basis that such fees cannot be supported by the value of the services rendered or are not the result of an arm's length transaction. Under these provisions and considering minimum regulatory capital requirements, the amount available for distribution from the Banks to the Company was approximately $15,034,000 as of December 31, 1997. To date, the Company has not paid a cash dividend and presently does not intend to pay cash dividends in the foreseeable future. The Company distributed a ten percent stock dividend in 1998, a three-for-two stock split in 1997, a ten percent stock dividend in 1996 and a twelve percent stock dividend in 1995. The Board of Directors will determine payment of dividends in the future after consideration of various factors including the profitability and capital adequacy of the Company and the Banks. 12 13 ITEM 6. SELECTED FINANCIAL DATA The following table presents certain consolidated financial information concerning the business of the Company and its subsidiary Banks. This information should be read in conjunction with the Consolidated Financial Statements, the notes thereto, and Management's Discussion and Analysis included in this report.
YEARS ENDED DECEMBER 31, -------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (DOLLARS AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) OPERATING RESULTS Total Interest Income............... $ 33,916 $ 29,301 $ 26,964 $ 21,646 $ 18,492 Total Interest Expense.............. 12,041 9,859 10,008 7,071 6,198 -------- -------- -------- -------- -------- Net Interest Income....... 21,875 19,442 16,956 14,575 12,294 Provision for Credit Losses......... 64 352 695 1,745 915 -------- -------- -------- -------- -------- Net Interest Income After Provision for Credit Losses................. 21,811 19,090 16,261 12,830 11,379 Other Income........................ 1,765 1,456 1,302 1,315 1,384 Other Expenses...................... 12,573 11,115 10,263 9,170 8,546 -------- -------- -------- -------- -------- Income before Income Taxes.......... 11,003 9,431 7,300 4,975 4,217 Income Taxes........................ 4,500 3,571 2,975 2,046 1,760 -------- -------- -------- -------- -------- NET INCOME.......................... $ 6,503 $ 5,860 $ 4,325 $ 2,929 $ 2,457 ======== ======== ======== ======== ======== BASIC EARNINGS PER SHARE(1)......... $ 1.36 $ 1.26 $ 0.94 $ 0.66 $ 0.56 DILUTED EARNINGS PER SHARE(1)....... 1.26 1.18 0.88 0.63 0.53 FINANCIAL CONDITION AND CAPITAL -- YEAR-END BALANCES Net Loans........................... $251,271 $235,992 $191,000 $179,266 $181,250 Total Assets........................ 497,674 376,832 357,236 310,362 269,820 Deposits............................ 450,301 338,663 326,089 283,823 247,112 Shareholders' Equity................ 43,724 36,332 29,916 25,547 21,932 FINANCIAL CONDITION AND CAPITAL -- AVERAGE BALANCES Net Loans........................... $238,793 $203,117 $173,065 $179,514 $169,829 Total Assets........................ 441,013 355,386 329,502 290,166 265,935 Deposits............................ 396,457 319,110 300,291 265,512 234,228 Shareholders' Equity................ 39,969 33,228 27,684 23,691 20,670 SELECTED FINANCIAL RATIOS Rate of Return on: Average Total Assets.............. 1.47% 1.65% 1.31% 1.01% 0.92% Average Shareholders' Equity...... 16.27% 17.64% 15.62% 12.36% 11.89% Rate of Average Shareholders' Equity to Total Average Assets........... 9.06% 9.35% 8.40% 8.16% 7.77%
- --------------- (1) Earnings per share data has been restated to reflect the adoption of Statement of Financial Accounting Standards No. 128. (A) (1) Distribution of Assets, Liabilities and Equity; Interest Rates and Interest Differential Table I in Management's Discussion and Analysis included in this report sets forth the Company's average balance sheets (based on daily averages) and an analysis of interest rates and the interest rate differential for each of the three years in the period ended December 31, 1997 and is hereby incorporated by reference. 13 14 (2) Volume/Rate Analysis Information as to the impact of changes in average rates and average balances on interest earning assets and interest bearing liabilities is shown in the table below. The variances attributed to simultaneous balance and rate changes have been reflected as rate variances. VOLUME/RATE ANALYSIS (IN THOUSANDS) 1997 OVER 1996 Increase (decrease) due to change in:
NET VOLUME RATE CHANGE ------ ------- ------ INTEREST-EARNING ASSETS: Net Loans(1)(2)(3)........................................ $3,924 $(1,426) $2,498 Investment securities..................................... 1,006 (119) 887 Federal funds sold & other................................ 1,080 150 1,230 ------ ------- ------ Total............................................. 6,010 (1,395) 4,615 ------ ------- ------ INTEREST-BEARING LIABILITIES: Demand deposits........................................... 393 (141) 252 Savings deposits.......................................... (296) (132) (428) Time deposits............................................. 2,214 46 2,260 Other Borrowings.......................................... 98 -- 98 ------ ------- ------ Total............................................. 2,409 (227) 2,182 ------ ------- ------ Interest differential....................................... $3,601 $(1,168) $2,433 ====== ======= ======
(IN THOUSANDS) 1996 OVER 1995 Increase (decrease) due to change in:
NET VOLUME RATE CHANGE ------ ------- ------ INTEREST-EARNING ASSETS: Net loans(1)(2)(3)........................................ $3,426 $ (809) $2,617 Investment securities..................................... 222 194 416 Federal funds sold & other................................ (474) (222) (696) ------ ------- ------ Total............................................. 3,174 (837) 2,337 ------ ------- ------ INTEREST-BEARING LIABILITIES: Demand deposits........................................... (90) (190) (280) Savings deposits.......................................... (392) (388) (780) Time deposits............................................. 818 93 911 ------ ------- ------ Total............................................. 336 (485) (149) ------ ------- ------ Interest differential....................................... $2,838 $ (352) $2,486 ====== ======= ======
- --------------- (1) The average balance of non-accruing loans is immaterial as a percentage of total loans and, as such, has been included in net loans. (2) Loan fees of $1,037,000, $901,000 and $769,000 for the years ended December 31, 1997, 1996 and 1995, respectively have been included in the interest income computation. (3) Rate variance includes impact of interest income recognized from payments received on nonaccrual loans of $619,000 in 1996. 14 15 (B) Investment Portfolio (1) The book value of investment securities at December 31, 1997, 1996 and 1995 is set forth in Table III of Management's Discussion and Analysis included in this report and incorporated herein by reference. (2) The book value, maturities and weighted average yields of investment securities as of December 31, 1997 are set forth in Table III of Management's Discussion and Analysis included in this report and incorporated herein by reference. (3) There were no issuers of securities for which the book value was greater than 10% of shareholders' equity other than U.S. Government and U.S. Government Agencies and Corporations. (C) Loan Portfolio (1) The composition of the loan portfolio is summarized in Table IV of Management's Discussion and Analysis included in this report and is incorporated herein by reference. (2) The following table sets forth the maturity distribution of the loan portfolio at December 31, 1997:
ONE YEAR ONE YEAR THROUGH OVER OR LESS FIVE YEARS FIVE YEARS TOTAL ----------- ----------- ----------- ------------ (IN THOUSANDS) Commercial, financial and agricultural............... $63,907,000 $45,420,000 $16,640,000 $125,967,000 Real estate -- construction............... 14,121,000 524,000 -- 14,645,000 Real estate -- other......... 15,187,000 45,523,000 46,866,000 107,576,000 Installment.................. 6,427,000 2,623,000 155,000 9,205,000 ----------- ----------- ----------- ------------ Total.............. $99,642,000 $94,090,000 $63,661,000 $257,393,000 =========== =========== =========== ============
Loans shown above with maturities greater than one year include $114,231,000 of floating interest rate loans and $43,520,000 of fixed rate loans. (3) Nonperforming Loans The Company's current policy is to cease accruing interest when a loan becomes 90 days past due as to principal or interest, when the full timely collection of interest or principal becomes uncertain or when a portion of the principal balance has been charged off, unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, the accrued and uncollected interest receivable is reversed and the loan is accounted for on the cash or cost recovery method thereafter, until qualifying for return to accrual status. Generally, a loan may be returned to accrual status when all delinquent interest and principal become current in accordance with the terms of the loan agreement or when the loan is both well secured and in process of collection. For further discussion of nonperforming loans, refer to Risk Elements section of Management Discussion Analysis in this report. 15 16 (D) Summary of Loan Loss Experience (1) An analysis of the allowance for loan losses follows:
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 1997 1996 1995 1994 1993 ------------- ------------- ------------- ------------- ------------- (IN THOUSANDS) Average loans outstanding............ $243,593 $207,556 $177,476 $182,812 $172,412 -------- -------- -------- -------- -------- Allowance for possible credit losses at beginning of period.... $ 4,372 $ 4,446 $ 4,068 $ 2,840 $ 2,371 Loans charged off: Real estate............ (100) (207) (52) (45) (46) Installment............ (61) (22) (80) (125) (164) Commercial............. (279) (391) (302) (413) (404) -------- -------- -------- -------- -------- (440) (620) (434) (583) (614) -------- -------- -------- -------- -------- Recoveries of loans previously charged off: Real estate............ 28 11 -- -- -- Installment............ 37 27 29 35 75 Commercial............. 162 156 88 31 93 -------- -------- -------- -------- -------- 227 194 117 66 168 -------- -------- -------- -------- -------- Net loans charged off.... (213) (426) (317) (517) (446) Additions to allowance charged to operating expenses............... 64 352 695 1,745 915 -------- -------- -------- -------- -------- Allowance for possible loans losses at end of period................. $ 4,223 $ 4,372 $ 4,446 $ 4,068 $ 2,840 ======== ======== ======== ======== ======== Ratio of net charge-offs to average loans outstanding............ 0.09% 0.21% 0.18% 0.28% 0.26%
Factors used in determination of the allowance for loan losses are discussed in greater detail in the "Risk Elements" section of Management's Discussion and Analysis included in this report and are incorporated herein by reference. (2) In evaluating the adequacy of the allowance for loan losses, the Company attempts to allocate the allowance for loan losses to specific categories of loans. Management believes that any breakdown or allocation of the allowance for possible loan losses into loan categories lends an appearance of exactness which does not exist in that the allowance is utilized as a single unallocated allowance available for all loans. Further, management believes that the breakdown of historical losses in the preceding table is a reasonable representation of management's expectation of potential losses in the next full year of operation. However, the allowance for loan losses should not be interpreted as an indication of when charge-offs will occur or as an indication of future charge-off trends. (E) Deposits (1) Table I in Management's Discussion and Analysis included in this report sets forth the distribution of average deposits for the years ended December 31, 1997, 1996 and 1995 and is incorporated herein by reference. 16 17 (2) The maturities of time certificates of deposit of $100,000 or more at December 31, 1997 are summarized as follows:
YEAR ENDED DECEMBER 31, 1997 ------------ Three months or less........................................ $25,020,000 Over three months through six months........................ 18,629,000 Over six months through twelve months....................... 24,966,000 Over twelve months.......................................... 17,829,000 ----------- Total............................................. $86,444,000 ===========
3(F) Return on Equity and Assets (1) The table at page 13 of this section sets forth the ratios of net income to average assets and average shareholders' equity, and average shareholders' equity to average assets. As the Company has never paid a cash dividend, the dividend payout ratio is not indicated. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include, but are not limited to, matters described in Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations." Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company and the Banks. Business Organization Central Coast Bancorp (the "Company"), a California corporation organized in 1994, acts as the holding company for Bank of Salinas and Cypress Bank (the "Banks"), state-chartered banks, headquartered in Salinas and Seaside, California, respectively. As of December 31, 1997, the Banks operated seven full-service branches and one limited-service branch in Monterey County, California. Other than its investment in the Banks, the Company currently conducts no other significant business activities, although it is authorized to engage in a variety of activities which are deemed closely related to the business of banking upon prior approval of the Board of Governors, the Company's principal regulator. The Banks offer a full range of commercial banking services, offering a diverse range of traditional banking products and services to individuals, merchants, small and medium-sized businesses, professionals and agribusiness enterprises located in the Salinas Valley and the Monterey Peninsula. On February 21, 1997, the Bank of Salinas purchased certain assets and assumed certain liabilities of the Gonzales and Castroville branch offices of Wells Fargo Bank. As a result of the transaction the Bank assumed deposit liabilities, received cash, and acquired tangible assets. This transaction resulted in intangible assets, representing the excess of the liabilities assumed over the fair value of the tangible assets acquired. In January 1997, Cypress Bank opened a new branch office in Monterey, California, so that it might better serve business and individual customers on the Monterey Peninsula. The following analysis is designed to enhance the reader's understanding of the Company's financial condition and the results of its operations as reported in the Consolidated Financial Statements included in this Annual Report. Reference should be made to those statements and the Selected Financial Data presented elsewhere in this report for additional detailed information. Overview The Company earned net income of $6,503,000 for the year ended December 31, 1997, representing an increase of $643,000 or 11% over 1996 net income of $5,860,000. Net income reported for 1996 represented an 17 18 increase of $1,535,000 or 35% over 1995 net income of $4,325,000. Diluted earnings per share for 1997 was $1.26 compared to $1.18 and $.88 per share for the preceding two years. The improvement in net income in 1997 and 1996 was primarily due to growth in net interest income and noninterest income that outpaced increases in operating expenses. Net income in 1997 and 1996 also benefited from lower provisions for loan losses compared with 1996 and 1995, respectively. Each of these factors is discussed in more detail later in this analysis. Common shareholders' equity increased by $7,392,000 during 1997 to $43,724,000 at December 31, 1997, primarily through the retention of earnings and as the result of exercises of stock options and warrants and related tax benefits. In 1996 and 1995, common shareholders' equity increased by $6,416,000 and $4,369,000 primarily through retention of earnings. It is the objective of management to maintain adequate capital for future growth through retention of earnings. The Company has never declared a cash dividend, however, it distributed a three-for-two stock split in 1997, a ten percent stock dividend during 1996 and a twelve percent stock dividend in the year ended December 31, 1995. Also, the Company declared a 10% stock dividend in January 1998 (to be distributed on March 3, 1998, to shareholders of record as of February 17, 1998). Per share earnings have been adjusted to reflect such stock split and stock dividends and any dilutive effect of common stock equivalents (stock options and warrants outstanding but not exercised) calculated using the treasury stock method as required by SFAS 128 "Earnings Per Share". Earnings Summary Net Interest Income -- Net interest income refers to the difference between the interest paid on deposits and borrowings, and the interest earned on loans and investments. It is the primary component of the net earnings of a financial institution. The primary factors to consider in analyzing net interest income are the composition and volume of earning assets and interest bearing liabilities, the amount of noninterest bearing liabilities and nonaccrual loans, and changes in market interest rates. Net interest income for 1997 was $21,875,000, or 5.5% of average earning assets, representing an increase of $2,433,000 or 12.5% over $19,442,000 and 6.0% of average earning assets in 1996. Net interest income reported in 1996 represented an increase of $2,486,000 or 14.7% from $16,956,000 in 1995. The increases in the net interest income in 1997 and 1996 primarily reflect increases in average earning assets in each of those years. Interest income for 1997 was $33,916,000 compared to $29,301,000 and $26,964,000 for 1996 and 1995, respectively. The increase in interest income in 1997 and 1996 is primarily due to growth in average earning assets. Average earning assets were $398,416,000 in 1997 representing an increase of 22.5% over $325,203,000 in 1996. Average earning assets in 1996 represented an increase of 8.6% over $299,417,000 in 1995. Loan yields averaged 10.4% in 1997 compared to 11.0% and 11.4% in 1996 and 1995, respectively. The trend in loan yields generally corresponds to fluctuations in market interest rates during 1997 and 1996. In addition, interest income in 1996 included approximately $600,000 of previously foregone interest collected on two loans that had been on nonaccrual status. A majority of the Company's loan yields float with the prime rate. The average prime rate was 8.44%, 8.27% and 8.82% in 1997, 1996 and 1995, respectively. Interest expense was $12,041,000 in 1997 representing an increase of $2,182,000 or 22.1% from $9,859,000 in 1996. The increase in interest expense was primarily due to growth in interest bearing core deposits. Average interest-bearing liabilities of $302,166,000 in 1997 represented 75.9% of total deposits compared to $249,233,000 or 78.1% of total deposits in 1996. Interest expense for 1996 decreased $149,000 or 1.5% over $10,008,000 in 1995. The decrease in interest expense in 1996 resulted from a decrease in the average rate paid on average interest-bearing deposits which offset an increase in the volume of such deposits. 18 19 The following table sets forth average balance sheet information, interest income and expense, average yields and rates, and net interest income and margin for the years ended December 31, 1997, 1996 and 1995.
1997 1996 1995 --------------------------- --------------------------- --------------------------- AVG AVG AVG AVG AVG AVG BALANCE INTEREST YIELD BALANCE INTEREST YIELD BALANCE INTEREST YIELD -------- -------- ----- -------- -------- ----- -------- -------- ----- IN THOUSANDS (EXCEPT PERCENTAGES) ASSETS: Earning Assets Loans(1)(2)......................... $238,793 $24,828 10.4% $203,117 $22,330 11.0% $173,065.. $19,713 11.4% Investment Securities............... 99,653 5,823 5.8% 82,883 4,936 6.0% 78,980 4,520 5.7% Other............................... 59,970 3,265 5.4% 39,203 2,035 5.2% 47,372 2,731 5.8% -------- ------- -------- ------- -------- ------- Total Earning Assets.................. 398,416 $33,916 8.5% 325,203 $29,301 9.0% 299,417 $26,964 9.0% ------- ------- ------- Cash & due from banks................. 33,144 22,867 23,198 Other assets.......................... 9,453 7,316 6,887 -------- -------- -------- $441,013 $355,386 $329,502 ======== ======== ======== LIABILITIES & SHAREHOLDERS' EQUITY: Interest bearing liabilities: Demand deposits..................... $ 93,161 $ 1,881 2.0% $ 75,295 $ 1,629 2.2% $ 79,065 $ 1,909 2.4% Savings............................. 95,767 3,875 4.0% 102,819 4,303 4.2% 111,351 5,083 4.6% Time deposits....................... 111,370 6,187 5.6% 71,119 3,927 5.5% 55,966 3,016 5.4% Other borrowings.................... 1,868 98 5.2% 0 0 n/a 0 0 n/a -------- ------- -------- ------- -------- ------- Total interest bearing liabilities.... 302,166 12,041 4.0% 249,233 9,859 4.0% 246,382 10,008 4.1% ------- ------- ------- Demand deposits....................... 96,159 69,877 53,909 Other Liabilities..................... 2,719 3,048 1,527 -------- -------- -------- Total Liabilities..................... 401,044 322,158 301,818 Shareholders' Equity.................. 39,969 33,228 27,684 -------- -------- -------- $441,013 $355,386 $329,502 ======== ======== ======== Net interest income & margin(3)....... $21,875 5.5% $19,442 6.0% $16,956 5.7% ======= ===== ======= ==== ======= ====
- --------------- (1) Loans interest includes loan fees of $1,037,000, $901,000 and $769,000 in 1997, 1996 and 1995, and interest recognized from payments received from payments on nonaccrual loans of $619,000 in 1996. (2) Average balances of loans include average allowance for loan losses of $4,229,000, $4,439,000 and $4,411,000, and average deferred loan fees of $571,000, $613,000 and $536,000 for the years ended December 31, 1997, 1996 and 1995, respectively. (3) Net interest margin is computed by dividing net interest income by total average earning assets. Other Income -- Other income growth is a key to improving overall profitability in a deregulated competitive environment. Noninterest income provides stability to the income stream and enhances overall profitability. Total noninterest income was $1,765,000 for 1997, $1,456,000 for 1996 and $1,302,000 for 1995. The Company's noninterest income is primarily derived from fees earned by the Banks for deposit-related customer services. Income realized from service charges on deposit accounts increased $341,000 or 46.4% to $1,076,000 in 1997 over $735,000 in 1996. Service charge income for 1996 represented an increase of $59,000 or 8.7% over $676,000 recognized in 1995. The increase in income from fees and service charges was largely the result of the increase in deposit accounts as the Banks added more branches as well as growth in the total number of interest bearing and noninterest bearing demand deposit accounts at all branches. The Company also earns income from the sale and servicing of SBA loans. Income from the sale and servicing of such loans was $119,000 in 1997 representing a decrease of $42,000 or 26.1% over $161,000 recognized in 1996. Sale and servicing income in 1996 increased $6,000 or 3.9% over $155,000 in 1995. The decreases and increases in income from the sale and servicing of SBA loans in 1997 and 1996, respectively, were primarily due to decreases and increases in the volume of loans sold. Fees earned on merchant credit card transactions decreased $1,000 or 0.7% to $150,000 in 1997 from $151,000 in 1996. In 1996, merchant card fees represented a decrease of $30,000 or 16.6% over $181,000 in 1995. Fluctuations in merchant card fees are primarily due to fluctuations in merchant retail sales volumes. 19 20 Mortgage origination fees increased $19,000 or 18.3% to $123,000 for 1997 from $104,000 in 1996. In 1996, mortgage origination fees increased $15,000 or 16.9% from $89,000 in 1995. The increases in 1997 and 1996 were due to increases in the volume of mortgage applications processed as a response to lower market interest rates. Other Expense -- Noninterest expense reflects the costs of products and services, systems, facilities and personnel for the Company. The major components of other expense stated as a percentage of average earning assets are as follows: TABLE II OTHER OPERATING EXPENSE TO AVERAGE EARNING ASSETS
1997 1996 1995 ---- ---- ---- Salaries and benefits.................................. 1.90% 1.98% 1.81% Occupancy.............................................. 0.22% 0.22% 0.25% Furniture and equipment................................ 0.20% 0.26% 0.22% Stationary and supplies................................ 0.12% 0.10% 0.08% Professional fees...................................... 0.09% 0.14% 0.22% Customer expenses...................................... 0.09% 0.12% 0.07% Data processing........................................ 0.08% 0.10% 0.09% Marketing.............................................. 0.08% 0.11% 0.09% Shareholder and director............................... 0.06% 0.09% 0.06% Amortization of intangibles............................ 0.05% 0.00% 0.00% Insurance.............................................. 0.05% 0.05% 0.07% Dues and assessments................................... 0.03% 0.02% 0.16% Net cost of other real estate owned.................... 0.00% 0.00% 0.07% Other.................................................. 0.19% 0.23% 0.24% ---- ---- ---- Total........................................ 3.16% 3.42% 3.43% ==== ==== ====
Noninterest expense increased to $12,573,000 in the year ended December 31, 1997 over $11,115,000 and $10,263,000 for the same periods in 1996 and 1995. As a percentage of average earning assets, noninterest expense decreased to 3.16% in 1997 compared to 3.42% in 1996. Noninterest expense as a percentage of average earning assets for 1996 represented a decrease from 3.43% in 1995. Salaries and employee benefits expense for 1997 was $7,586,000, an increase of 17.9% over $6,437,000 in 1996, and represented approximately 1.90% of average earning assets. The increase in 1997 primarily reflects the impact of increased headcount to accommodate growth in the Banks. Salaries and employee benefits expense for 1996 represented an increase of $1,018,000 or 18.8% over $5,419,000 in 1995. Salaries and employee benefits in 1996 included approximately $175,000 of nonrecurring charges for restructuring related to the acquisition of Cypress Bank and $250,000 for a salary continuation plan. The remaining increase was due to increased headcount to accommodate growth and higher contributions to the Company's profit sharing and employee retirement plans. As a percentage of average earning assets, salaries and employee benefits expense was 1.98% in 1996 representing an increase from 1.81% in 1995. Occupancy expense increased $161,000 or 22.1% to $889,000 in 1997 from $728,000 in 1996 and compares to a decrease of $18,000 or 2.4% over $746,000 in 1995. As a percentage of average earning assets, occupancy expense was .22% representing no change from .22% in 1996 and a decrease from .25% in 1995. Furniture and equipment expenses of $800,000 in 1997 represented a decrease of $37,000 or 4.4% over $837,000 in 1996. The decrease in 1997 was primarily due to lower maintenance costs on equipment. Expense for 1996 represented an increase of $165,000 or 24.6% from $672,000 in 1995. The increase in 1996 was primarily due to a one-time charge of approximately $192,000 from restructuring of operations in connection with the acquisition of Cypress Bank. Furniture and equipment expenses represented .20%, .26% and .22% of average earning assets in 1997, 1996 and 1995, respectively. 20 21 Other noninterest expenses were $3,298,000 in 1997 representing an increase of $185,000 or 5.9% from 1996 expenses of $3,113,000. The increase in 1997 was primarily related to increased supplies expenses and amortization of intangibles related to the purchase of two branches in that year. Other noninterest expenses for 1996 decreased $313,000 or 9.1% from $3,426,000 in 1995. The decrease in 1996 is primarily due to decreases in professional fees, deposit insurance premiums and write-downs of other real estate owned. The Company's effective income tax rate was 40.9% for 1997 compared to 37.9% for 1996 and 40.8% for 1995. The primary factor reducing the effective tax rate of the Company in 1996 was a change in the valuation allowance for the deferred tax assets of Cypress Bank. Balance Sheet Analysis Total assets of Central Coast Bancorp at December 31, 1997 were $497,674,000 compared to $376,832,000 in 1996 and $357,236,000 in 1995, representing increases of 32.1% and 5.5%, respectively. Based on average balances, total assets of $441,013,000 in 1997 represent an increase of $85,627,000 or 24.1% over $355,386,000 in 1996. Average total assets in 1996 represent an increase of $25,884,000 or 7.9% over 1995. 21 22 Earning Assets Investment Portfolio -- The scheduled maturities and weighted average yields of the Company's investment securities portfolio as of December 31, 1997 and 1996 are as follows: TABLE III MATURITY AND YIELDS OF INVESTMENT SECURITIES
WEIGHTED AMORTIZED UNREALIZED UNREALIZED MARKET AVERAGE COST GAIN LOSSES VALUE YIELD --------- ---------- ---------- -------- -------- IN THOUSANDS (EXCEPT PERCENTAGES) DECEMBER 31, 1997 AVAILABLE FOR SALE SECURITIES: U.S. Treasury and agency securities Maturing within 1 year..................... $ 32,861 $ -- $ 5 $ 32,856 5.68% Maturing after 1 year but within 5 years... 48,410 184 7 48,587 6.16% Bankers' Acceptances Maturing within 1 year..................... 10,034 -- -- 10,034 5.05% Other........................................ 4 -- -- 4 -- -------- ---- ---- -------- ---- Total available for sale........... $ 91,309 $184 $ 12 $ 91,481 5.87% -------- ---- ---- -------- ---- HELD TO MATURITY SECURITIES: U.S. Treasury and agency securities Maturing within 1 year..................... $ 27,484 $ 7 $ 11 $ 27,480 5.60% Maturing after 1 year but within 5 years... 8,495 66 2 8,559 6.34% Maturing after 5 years but within 10 years................................... 20 -- -- 20 9.05% Maturing after 10 years.................... 857 6 9 854 7.00% State & Political Subdivision Maturing after 5 Years but within 10 years................................... 2,192 -- -- 2,192 5.60% -------- ---- ---- -------- ---- Total held to maturity............. $ 39,048 $ 79 $ 22 $ 39,105 5.79% -------- ---- ---- -------- ---- Total investment securities.................. $130,357 $263 $ 34 $130,586 5.85% ======== ==== ==== ======== ==== DECEMBER 31, 1996 HELD TO MATURITY SECURITIES: U.S. Treasury and agency securities Maturing within 1 year..................... $ 29,358 $ 46 $ 9 $ 29,395 5.72% Maturing after 1 year but within 5 years... 37,460 71 96 37,435 5.80% Maturing after 10 years.................... 1,027 1 44 984 6.06% Corporate Debt Securities Maturing within 1 year..................... 3,028 -- 11 3,017 5.28% Other........................................ 4 -- -- 4 -- -------- ---- ---- -------- ---- Total investment securities.................. $ 70,877 $118 $160 $ 70,835 5.75% ======== ==== ==== ======== ====
The Company designated securities with an estimated market value of $91,481,000 as available-for-sale at December 31, 1997. The amortized cost on that date of securities designated as available-for-sale was $91,309,000 reflecting a net available-for-sale adjustment of $172,000 or 0.2% of amortized cost. No securities were designated as available-for-sale at December 31, 1996 and 1995. During the year ended December 31, 1997, the Company made purchases of securities designated as available-for-sale of $154,353,000 to replace $63,750,000 of maturities and to more fully employ excess liquidity. Investment securities designated as held-to-maturity at December 31, 1997 were carried at an amortized cost of $39,048,000. The estimated market value of the held-to-maturity portfolio on that date was $39,105,000 reflecting a net unrealized gain of $57,000 or 0.1% of amortized cost. The book value of held-to- maturity investment securities at the end of 1997 compared to $70,877,000 and $79,643,000 at December 31, 22 23 1996 and 1995, respectively. During the year ended December 31, 1997, the Company made purchases of securities designated as held-to-maturity of $10,181,000 to replace $41,882,000 of maturities and to more fully employ excess liquidity. Fluctuations in the investment portfolio reflect funding needs for anticipated and actual levels of loan demand. In 1997, investment balances increased as growth in deposits outpaced growth in the loan portfolio. Conversely, in 1996, the Company experienced growth in loan balances that outpaced growth in deposits resulting in generally higher loan to deposit ratios and lower liquidity as compared to 1997. It is the Banks' policy to invest primarily in U.S. Treasury and U.S. Government Agency securities. Further, it is management's intent to reduce the market valuation risk of the investment portfolio by generally limiting the average life of portfolio maturities to 3 years or less. There were no sales of investment securities in 1997, 1996 or 1995. Loan Portfolio -- The following table summarizes the composition of the loan portfolio for the past five years as of December 31: TABLE IV ANALYSIS OF LOANS OUTSTANDING BY TYPE
1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- IN THOUSANDS Commercial.......................... $124,714 $111,545 $ 85,823 $ 78,627 $ 73,083 Installment......................... 9,349 8,230 5,677 6,445 7,384 Real Estate: Construction...................... 14,645 27,997 24,852 24,076 30,159 Other............................. 107,354 93,241 79,644 74,769 74,075 -------- -------- -------- -------- -------- Total Loans............... 256,062 241,013 195,996 183,917 184,701 Allowance for Credit Losses..................... (4,223) (4,372) (4,446) (4,068) (2,840) Deferred Loans Fees............... (568) (649) (550) (583) (611) -------- -------- -------- -------- -------- Total..................... $251,271 $235,992 $191,000 $179,266 $181,250 ======== ======== ======== ======== ========
Average net loans in 1997 were $238,793,000 representing an increase of $35,676,000 or 17.6% over 1996. Average net loans of $203,117,000 in 1996 represented an increase of $30,052,000 or 17.4% from $173,065,000 in 1995. Average net loans comprised 59.9% of average earning assets in 1997 compared to 62.5% and 57.8% in 1996 and 1995, respectively. Net loans outstanding at December 31, 1997 were $251,271,000, which represented an increase of $15,279,000 or 6.5% over $235,992,000 on the same date one year earlier. The overall composition of loan balances at December 31, 1997 compared to 1996 reflected strong growth in commercial and other real estate loans, offsetting a slight decrease in construction loans. At December 31, 1996 net loans outstanding represented an increase of $44,992,000 or 23.6% over $191,000,000 at December 31, 1995. Commercial loans consist of credit lines for operating needs, loans for equipment purchases and working capital, and various other business loan products. At December 31, 1997, the Company had $124,714,000 in commercial loans outstanding representing 48.7% of total gross loans compared to $111,545,000 and 46.3% and $85,823,000 and 43.8% at December 31, 1996 and 1995, respectively. Fluctuations in commercial loan balances in 1997 and 1996 primarily reflect cyclical changes in customer borrowing needs related to changes in the agri-business sector of the local economy. Installment loans include a range of traditional consumer loan products offered by the Company such as personal lines of credit and loans to finance purchases of autos, boats, recreational vehicles, mobile homes and various other consumer items. At December 31, 1997, installment loans outstanding were $9,349,000 representing 3.7% of total loans. This compares to installment loans of $8,230,000 and $5,677,000 representing 3.4% and 2.9% at December 31, 1996 and 1995, respectively. 23 24 The Company's construction loan portfolio decreased $13,352,000 or 47.7% to $14,645,000 at December 31, 1997 from $27,997,000 at December 31, 1996 due to fluctuations in the market and increased competition from traditional and non-traditional sources. This compares to an increase of $3,145,000 or 12.7% in 1996 from $24,852,000 at December 31, 1995. Construction loans expressed as a percentage of total loans were 5.7%, 11.6% and 12.7% at December 31, 1997, 1996 and 1995, respectively. The construction loans outstanding at December 31, 1997 are generally composed of commitments to customers within the Company's service area for construction of custom and semi-custom single family residences. Other real estate loans consist primarily of loans to the Banks' depositors secured by first trust deeds on commercial and residential properties typically with short-term maturities and original loan to value ratios not exceeding 75%. Other real estate loans increased $14,113,000 or 15.1% to $107,354,000 at December 31, 1997 compared to $93,241,000 and $79,644,000 on December 31, 1996 and 1995, respectively. In general, except in the case of loans with SBA guarantees, the Company does not make long-term mortgage loans; however, the Company has informal arrangements in place with mortgage lenders to assist customers in securing single-family mortgage financing. Risk Elements -- The Company assesses and manages credit risk on an ongoing basis through stringent credit review and approval policies, extensive internal monitoring and established formal lending policies. Additionally, the Company contracts with an outside loan review consultant to periodically grade new loans and to review the existing loan portfolio. Management believes its ability to identify and assess risk and return characteristics of the Company's loan portfolio is critical for profitability and growth. Management strives to continue the historically low level of credit losses by continuing its emphasis on credit quality in the loan approval process, active credit administration and regular monitoring. With this in mind, management has designed and implemented a comprehensive loan review and grading system that functions to continually assess the credit risk inherent in the loan portfolio. Ultimately, credit quality may be influenced by underlying trends in the economic and business cycles. The Company's business is concentrated in Monterey County, California whose economy is highly dependent on the agricultural industry. As a result, the Company lends money to individuals and companies dependent upon the agricultural industry. In addition, the Company has significant extensions of credit and commitments to extend credit which are secured by real estate, totalling approximately $146.5 million at December 31, 1997. The ultimate recovery of these loans is generally dependent on the successful operation, sale or refinancing of the real estate. The Company monitors the effects of current and expected market conditions and other factors on the collectibility of real estate loans. When, in management's judgement, these loans are impaired, an appropriate provision for losses is recorded. The more significant assumptions management considers involve estimates of the following: lease, absorption and sale rates; real estate values and rates of return; operating expenses; inflation; and sufficiency of collateral independent of the real estate including, in limited instances, personal guarantees. In extending credit and commitments to borrowers, the Company generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers. The Company's requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management's evaluation of the credit-worthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. The Company secures its collateral by perfecting its interest in business assets, obtaining deeds of trust, or outright possession among other means. Credit losses from lending transactions related to real estate and agriculture compare favorably with the Company's credit losses on its loan portfolio as a whole. In the period spanning the second half of 1993 and continuing through 1995, California's economy began a gradual recovery from the recession that persisted early in the decade. During 1993, real estate values firmed up slightly as housing became more affordable due to the low levels of interest rates, however, economic conditions in California continued to lag behind the national trend toward recovery. During 1994 and 1995, economic conditions in California continued to improve, however, the level of activity remained less vigorous than the national trend. In the year ended 1996, California's economic recovery gained momentum, growing at 24 25 a rate that exceeded the national average. Economic activity and job growth has been particularly strong in the northern portion of the state. As a result, real estate values have firmed and construction activity has increased and in 1997, California is said to have recovered from one of the deepest recessions since the 1930's. At December 31, 1997, construction loans and other real estate secured loans comprised 6% and 42%, respectively, of total loans outstanding. Management believes that its lending policies and underwriting standards will tend to minimize losses in an economic downturn, however, there is no assurance that losses will not occur under such circumstances. The Banks' loan policies and underwriting standards include, but are not limited to, the following: 1) maintaining a thorough understanding of the Banks' service area and limiting investments outside of this area, 2) maintaining a thorough understanding of borrowers' knowledge and capacity in their field of expertise, 3) basing real estate construction loan approval not only on salability of the project, but also on the borrowers' capacity to support the project financially in the event it does not sell within the original projected time period, and 4) maintaining conforming and prudent loan to value and loan to cost ratios based on independent outside appraisals and ongoing inspection and analysis by the Banks' construction lending officers. In addition, the Banks strive to diversify the risk inherent in the construction portfolio by avoiding concentrations to individual borrowers and on any one project. Nonaccrual Loans, Loans Past Due 90 Days and OREO -- Management generally places loans on nonaccrual status when they become 90 days past due, unless the loan is well secured and in the process of collection. Loans are charged off when, in the opinion of management, collection appears unlikely. The following Table sets forth nonaccrual loans and loans past due 90 days or more for December 31: TABLE V NON-PERFORMING LOANS
1997 1996 1995 1994 1993 ---- ---- ---- ------ ------ IN THOUSANDS Past due 90 days or more and still accruing Real estate...................................... $ 6 $ 59 $ 71 $ -- $ 42 Commercial....................................... 73 60 35 -- -- Installment and other............................ -- 90 -- 6 -- ---- ---- ---- ------ ------ 79 209 106 6 42 ---- ---- ---- ------ ------ Nonaccrual: Real estate...................................... 628 419 633 2,697 2,462 Commercial....................................... 188 184 194 99 454 Installment and other............................ -- 1 24 33 43 ---- ---- ---- ------ ------ 816 604 851 2,829 2,959 ---- ---- ---- ------ ------ Total nonperforming loans................ $895 $813 $957 $2,835 $3,001 ==== ==== ==== ====== ======
Interest due but excluded from interest income on nonaccrual loans was approximately $7,000 in 1997, $50,000 in 1996 and $166,000 in 1995. In 1997 and 1996, interest income recognized from payments received on nonaccrual loans was $7,000 and $619,000, respectively. In 1995, no payments received on nonaccrual loans were included in interest income. At December 31, 1997, the recorded investment in loans that are considered impaired was $996,000 of which $816,000 are included as nonaccrual loans above. Such impaired loans had a valuation allowance of $200,000. The average recorded investment in impaired loans during 1997 was $829,000. The Company recognized interest income on impaired loans of $33,000. There were no troubled debt restructurings or loan concentrations in excess of 10% of total loans not otherwise disclosed as a category of loans as of December 31, 1997. Management is not aware of any potential problem loans, which were accruing and current at December 31, 1997, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms. 25 26 Other real estate owned was $105,000, $348,000 and $506,000 at December 31, 1997, 1996 and 1995, respectively. Provision and Allowance for Possible Credit Losses -- The provision for credit losses is based upon management's evaluation of the adequacy of the existing allowance for loans outstanding. This allowance is increased by provisions charged to expense and reduced by loan charge-offs net of recoveries. Management determines an appropriate provision based upon the interaction of three primary factors: (1) the loan portfolio growth in the period, (2) a comprehensive grading and review formula for total loans outstanding, and (3) actual previous charge-offs. The allowance for credit losses totaled $4,223,000 or 1.65% of total loans at December 31, 1997 compared to $4,372,000 or 1.81% at December 31, 1996 and $4,446,000 or 2.27% at December 31, 1995. The decrease in the allowance as a percentage of total loans is primarily due to the increase in loan balances in a generally strong economic environment. It is the policy of management to maintain the allowance for credit losses at a level adequate for known and future risks inherent in the loan portfolio. Based on information currently available to analyze credit loss potential, including economic factors, overall credit quality, historical delinquency and a history of actual charge-offs, management believes that the credit loss provision and allowance is prudent and adequate. However, no prediction of the ultimate level of loans charged off in future years can be made with any certainty. Funding Sources -- Deposits accepted by its subsidiary banks represent the Company's principal source of funds for investment. Deposits are primarily core deposits in that they are demand, savings and time deposits under $100,000 generated from local businesses and individuals. These sources are considered to be relatively more stable, long-term deposit relationships thereby enhancing steady growth of the deposit base without major fluctuations in overall deposit balances. At December 31, 1997, such accounts comprise 80.1% of all deposit balances compared to 87.0% and 91.4% at December 31, 1996 and 1995. Table VI presents the composition of the deposit mix at December 31: TABLE VI COMPOSITION OF DEPOSITS
1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- IN THOUSANDS Demand, non-interest bearing........ $126,818 $ 90,149 $ 68,541 $ 60,407 $ 47,822 Demand, interest bearing............ 89,107 76,392 74,079 70,911 87,588 Savings............................. 99,748 89,650 121,050 100,484 62,188 Time................................ 134,628 82,472 62,419 52,021 49,514 -------- -------- -------- -------- -------- Total..................... $450,301 $338,663 $326,089 $283,823 $247,112 -------- -------- -------- -------- --------
The increase in year-end total deposits is attributable to increases in time deposits, noninterest-bearing demand and interest-bearing demand categories resulting from the consistent growth of the Banks combined with the purchase of two branches in February 1997. Average total deposits in 1997 of $396,457,000 represented an increase of $77,347,000 or 24.2% over 1996 totals of $319,110,000. Average total deposits in 1996 represented an increase of $18,819,000 or 6.3% over 1995 totals of $300,291,000. This reflects growth in noninterest-bearing demand and time deposits which were partially offset by decreases in the savings category. Average noninterest bearing demand deposits increased in 1997 to $96,159,000 from $69,877,000 in 1996 and $53,909,000 in 1995 representing an increase of $26,282,000 and $15,968,000 or 37.6% and 29.6%, respectively, between those years as a result of the Company's business development effort which focuses on serving small and medium-size businesses. Average time deposits were $111,370,000 in 1997 compared to $71,119,000 in 1996 and $55,966,000 in 1995 representing an increase of $40,251,000 and $15,153,000 or 56.6% and 27.1% in 1996 and 1995, respectively. Growth in time deposits was primarily due to migration of balances from savings accounts. 26 27 Liquidity and Interest Rate Sensitivity Liquidity -- Liquidity management refers to the Company's ability to provide funds on an ongoing basis to meet fluctuations in deposit levels as well as the credit needs and requirements of its clients. Both assets and liabilities contribute to the Company's liquidity position. Federal funds lines, short-term investments and securities, and loan repayments contribute to liquidity, along with deposit increases, while loan funding and deposit withdrawals decrease liquidity. The Banks assess the likelihood of projected funding requirements by reviewing historical funding patterns, current and forecasted economic conditions and individual client funding needs. Commitments to fund loans and outstanding standby letters of credit at December 31, 1997, were approximately $90,649,000 and $5,272,000, respectively. Such loans relate primarily to revolving lines of credit and other commercial loans, and to real estate construction loans. The Company's sources of liquidity consist of overnight funds sold to correspondent banks, unpledged marketable investments and loans held for sale. On December 31, 1997, consolidated liquid assets totaled $164.2 million or 33.0% of total assets as compared to $85.1 million or 22.6% of total consolidated assets on December 31, 1996. In addition to liquid assets, the subsidiary Banks maintain lines of credit with correspondent banks for up to $25,000,000 available on a short-term basis. Informal agreements are also in place with various other banks to purchase participations in loans, if necessary. The Company serves primarily a business and professional customer base and, as such, its deposit base is susceptible to economic fluctuations. Accordingly, management strives to maintain a balanced position of liquid assets to volatile and cyclical deposits. Liquidity is also affected by portfolio maturities and the effect of interest rate fluctuations on the marketability of both assets and liabilities. In addition, it has been the Banks' policy to restrict maturities in the investment portfolio to not more than three years. The short-term nature of the loan and investment portfolios, and loan agreements which generally require monthly interest payments, provide the Banks with additional secondary sources of liquidity. Another key liquidity ratio is the ratio of gross loans to total deposits, which was 56.9% at December 31, 1997 and 71.2% at December 31, 1996. Interest Rate Sensitivity -- Interest rate sensitivity is a measure of the exposure to fluctuations in the Banks' future earnings caused by fluctuations in interest rates. Such fluctuations result from the mismatch in repricing characteristics of assets and liabilities at a specific point in time. This mismatch, or interest rate sensitivity gap, represents the potential mismatch in the change in the rate of accrual of interest revenue and interest expense from a change in market interest rates. Mismatches in interest rate repricing among assets and liabilities arise primarily from the interaction of various customer businesses (i.e., types of loans versus the types of deposits maintained) and from management's discretionary investment and funds gathering activities. The Company attempts to manage its exposure to interest rate sensitivity, but due to its size and direct competition from the major banks, it must offer products which are competitive in the market place, even if less than optimum with respect to its interest rate exposure. The Company's natural position is asset-sensitive (based upon the significant amount of variable rate loans and the repricing characteristics of its deposit accounts). This natural position provides a hedge against rising interest rates, but has a detrimental effect during times of interest rate decreases. 27 28 The following table quantifies the Company's interest rate exposure at December 31, 1997 based upon the known repricing dates of certain assets and liabilities and the assumed repricing dates of others. This table displays a static view of the Company's interest rate sensitivity position and does not consider the dynamics of the balance sheet and interest rate movements. TABLE VII INTEREST RATE SENSITIVITY
OVER THREE NEXT DAY MONTHS AND OVER ONE ASSETS AND LIABILITIES AND WITHIN WITHIN AND WITHIN OVER WHICH MATURE OR REPRICE IMMEDIATELY THREE MONTHS ONE YEAR FIVE YEARS FIVE YEARS TOTAL ----------------------- ----------- ------------ ------------ ----------- ----------- --------- IN THOUSANDS Interest earning assets: Federal funds sold........... $ 64,706 $ -- $ -- $ -- $ -- $ 64,706 Investment securities........ 4 50,386 19,986 57,084 3,069 130,529 Loans, excluding Nonaccrual loans and overdrafts....... 4,384 188,422 8,816 42,802 10,261 254,685 --------- -------- -------- -------- -------- --------- Total.............. $ 69,094 $238,808 $ 28,802 $ 99,886 $ 13,330 $ 449,920 ========= ======== ======== ======== ======== ========= Interest bearing Liabilities: Interest bearing demand...... $ 89,107 $ -- $ -- $ -- $ -- $ 89,107 Savings...................... 99,748 -- -- -- -- 99,748 Time certificates............ 11 39,120 70,928 24,509 60 134,628 Other Borrowings............. -- 289 -- -- -- 289 --------- -------- -------- -------- -------- --------- Total.............. $ 188,866 $ 39,409 $ 70,928 $ 24,509 $ 60 $ 323,772 ========= ======== ======== ======== ======== ========= Interest rate sensitivity gap........................ $(119,772) $199,399 $(42,126) $ 75,377 $ 13,270 Cumulative interest rate sensitivity gap............ $(119,772) $ 79,627 $ 37,501 $112,878 $126,148 Ratios: Interest rate sensitivity gap........................ 0.37 6.06 0.41 4.08 222.17 Cumulative interest rate sensitivity gap............ 0.37 1.35 1.13 1.35 1.39
It is management's objective to maintain stability in the net interest margin in times of fluctuating interest rates by maintaining an appropriate mix of interest sensitive assets and liabilities. The Banks strive to achieve this goal through the composition and maturities of the investment portfolio and by adjusting pricing of its interest bearing liabilities, however, as noted above, the ability to manage its interest rate exposure may be constrained by competitive pressures. Quantitative and Qualitative Disclosures About Market Risk Derivative financial instruments include futures, forwards, interest rate swaps, option contracts, and other financial instruments with similar characteristics. The Company currently does not enter into futures, forwards, swaps or options. However, the Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require collateral from the borrower if deemed necessary by the Company. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party up to a stipulated amount and with specified terms and conditions. Commitments to extend credit and standby letters of credit are not recorded as an asset or liability by the Company until the instrument is exercised. 28 29 The Company's exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximize income. Management realizes certain risks are inherent and that the goal is to identify and minimize the risks. Tools used by management include the standard GAP report and the quarterly interest rate shock simulation report. The Company has no market risk sensitive instruments held for trading purposes. The following table presents the scheduled repricing of market risk sensitive instruments at December 31, 1997:
OVER ONE YEAR TWO YEARS THREE YEARS FOUR YEARS FIVE YEARS FIVE YEARS TOTAL -------- --------- ----------- ---------- ---------- ---------- -------- IN THOUSANDS (EXCEPT PERCENTAGES) Interest earning assets: Federal funds sold....... $ 64,706 $ -- $ -- $ -- $ -- $ -- $ 64,706 5.4% 5.4% Investment securities.... 70,376 30,059 20,550 4,474 2,000 3,070 130,529 5.6% 6.2% 6.1% 6.2% 6.4% 6.3% 5.8% Loans.................... 204,330 4,255 12,836 7,892 17,819 10,261 257,393 9.9% 9.6% 9.2% 9.2% 9.0% 9.2% 9.8% -------- ------- ------- ------- ------- ------- -------- Total.......... $339,412.. $34,314 $33,386 $12,366 $19,819 $13,331 $452,628 ======== ======= ======= ======= ======= ======= ======== Interest bearing liabilities: Interest bearing demand................. $ 89,107 $ -- $ -- $ -- $ -- $ -- $ 89,107 2.0% 2.0% Savings.................. 99,748 -- -- -- -- -- 99,748 3.9% 3.9% Time certificates........ 110,059 17,819 6,232 272 186 60 134,628 5.5% 5.9% 6.3% 6.0% 6.1% 5.5% 5.6% Other Borrowings......... 289 -- -- -- -- -- 289 5.3% 5.3% -------- ------- ------- ------- ------- ------- -------- Total.......... $299,203 $17,819 $ 6,232 $ 272 $ 186 $ 60 $323,772 ======== ======= ======= ======= ======= ======= ========
Balance sheet carrying amounts and estimated fair values of financial instruments at December 31, 1997 were as follows:
ESTIMATED FAIR TOTAL VALUE -------- -------------- ASSETS Federal funds sold.......................... $ 64,706 $ 64,706 Securities.................................. 130,529 130,586 Loans held for sale......................... 1,331 1,453 Loans, net.................................. 251,271 256,361 LIABILITIES Demand deposits............................. 215,925 215,925 Savings..................................... 99,748 99,748 Time certificates........................... 134,628 135,542 Other Borrowings............................ 289 289
29 30 Capital Resources The Company's total shareholders' equity was $43,724,000 at December 31, 1997 compared to $36,332,000 as of December 31, 1996 and $29,916,000 as of December 31, 1995. The Company and the Banks are subject to regulations issued by the Board of Governors and the FDIC which require maintenance of a certain level of capital. These regulations impose two capital standards: a risk-based capital standard and a leverage capital standard. Under the Board of Governor's risk-based capital guidelines, assets reported on an institution's balance sheet and certain off-balance sheet items are assigned to risk categories, each of which has an assigned risk weight. Capital ratios are calculated by dividing the institution's qualifying capital by its period-end risk-weighted assets. The guidelines establish two categories of qualifying capital: Tier 1 Capital (defined to include common shareholders' equity and noncumulative perpetual preferred stock) and Tier 2 capital defined to include limited life (and in the case of banks, cumulative) preferred stock, mandatory convertible securities, subordinated debt and a limited amount of reserves for loan and lease losses. Each institution is required to maintain a risk-based capital ratio (including Tier 1 and Tier 2 capital) of 8%, of which at least half must be Tier 1 capital. Under the Board of Governors' leverage capital standard an institution is required to maintain a minimum ratio of Tier 1 capital to the sum of its quarterly average total assets and quarterly average reserve for loan losses, less intangibles not included in Tier 1 capital. Period-end assets may be used in place of quarterly average total assets on a case-by-case basis. A minimum leverage ratio of 3% is required for institutions which have been determined to be in the highest of five categories used by regulators to rate financial institutions and which are not experiencing or anticipating significant growth. All other organizations are required to maintain leverage ratios of at least 100 to 200 basis points above the 3% minimum. The table below presents the capital and leverage ratios of the Company as of:
DECEMBER 31, 1997 DECEMBER 31, 1996 ----------------- ----------------- AMOUNT RATIO AMOUNT RATIO -------- ----- -------- ----- (DOLLARS IN THOUSANDS) RISK-BASED CAPITAL RATIOS Tier 1 Capital................................. $ 41,968 14.0% $ 36,332 14.1% -------- -------- Total Capital.................................. $ 45,782 15.2% $ 39,562 15.4% -------- -------- Total risk-adjusted assets..................... $300,576 $257,305 -------- -------- LEVERAGE RATIO Tier 1 Capital to average total assets......... $ 41,968 9.6% $ 36,332 10.1% -------- -------- Quarterly average total assets................. $439,257 $358,027 -------- --------
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") substantially revised banking regulations and established a framework for determination of capital adequacy of financial institutions. Under the FDICIA, financial institutions are placed into one of five capital adequacy categories as follows: (1) "well capitalized" consisting of institutions with a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or greater, and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive; (2) "adequately capitalized" consisting of institutions with a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and a leverage ratio of 4% or greater, and the institution does not meet the definition of a "well capitalized" institution; (3) "undercapitalized" consisting of institutions with a total risk-based capital ratio less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or a leverage ratio of less than 4%; (4) "significantly undercapitalized' consisting of institutions with a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%; and, (5) "critically undercapitalized" consisting of an institution with a ratio of tangible equity to total assets that is equal to or less than 2%. 30 31 Financial institutions classified as undercapitalized or below are subject to various limitations including, among other matters, certain supervisory actions by bank regulatory authorities and restrictions related to (i) growth of assets, (ii) payment of interest on subordinated indebtedness, (iii) payment of dividends or other capital distributions, and (iv) payment of management fees to a parent holding company. The FDICIA requires the bank regulatory authorities to initiate corrective action regarding financial institutions which fail to meet minimum capital requirements. Such action may, among other matters, require that the financial institution augment capital and reduce total assets. Critically undercapitalized financial institutions may also be subject to appointment of a receiver or conservator unless the financial institution submits an adequate capitalization plan. Inflation The impact of inflation on a financial institution differs significantly from that exerted on manufacturing, or other commercial concerns, primarily because its assets and liabilities are largely monetary. In general, inflation primarily affects the Company indirectly through its effect on market rates of interest, and thus the ability of the Banks to attract loan customers. Inflation affects the growth of total assets by increasing the level of loan demand, and potentially adversely affects the Company's capital adequacy because loan growth in inflationary periods can increase at rates higher than the rate that capital grows through retention of earnings which the Company may generate in the future. In addition to its effects on interest rates, inflation directly affects the Company by increasing the Company's operating expenses. Inflation has not materially affected the results of operations during the three year period ended December 31, 1997. Accounting Pronouncements In June 1996, SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" was issued. The Statement establishes standards for when transfers of financial assets, including those with continuing involvement by the transferor, should be considered a sale. SFAS No. 125 also establishes standards for when a liability should be considered extinguished. This statement is effective for transfers of assets and extinguishments of liabilities after January 1, 1997. In December 1996, the Financial Accounting Standards Board ("FASB") reconsidered certain provisions of SFAS No. 125 and issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125" to defer for one year the effective date of implementation for transactions related to repurchase agreements, dollar-roll repurchase agreements, securities lending and similar transactions. Earlier adoption or retroactive application of this statement with respect to any of its provisions is not permitted. Management believes that the effect of adoption on the Company's financial statements will not be material. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). The Company adopted SFAS 128 in the fourth quarter of 1997 and restated earnings per share (EPS) data for prior periods to conform with SFAS 128. SFAS 128 replaces current EPS reporting requirements and requires a dual presentation of basic and diluted EPS. Basic EPS excludes dilution and is computed by dividing net income by the weighted average of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. In June 1997, the Financial Accounting Standards Board adopted Statements of Financial Accounting Standards No. 130 "Reporting Comprehensive Income", which requires that an enterprise report, by major components and as a single total, the change in its net assets during the period from nonowner sources; and No. 131 "Disclosures about Segments of an Enterprise and Related Information", which establishes annual and interim reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas, and major customers. Adoption of these statements will not impact the Company's consolidated financial position, results of operations or cash flows. Both statements are effective for fiscal years beginning after December 15, 1997, with earlier application permitted. 31 32 Other Matters As the year 2000 approaches, a critical issue has emerged regarding how existing application software programs and operating systems can accommodate this date value. In brief, many existing application software products in the marketplace were designed to only accommodate a two digit date position which represents the year (e.g., "95" is stored on the system and represents the year 1995). As a result, the year 1999 (i.e., "99") could be the maximum date value these systems will be able to accurately process. This is not just a banking problem, as corporations around the world and in all industries are similarly impacted. Management is in the process of working with its software vendors to assure that the Company is prepared for the year 2000. Also, the Company has put procedures in place to inquire whether the systems of key borrowers are year 2000 compliant. At present, the Company does not have an estimate of the total cost of evaluating and fixing any potential year 2000 problems. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by Item 7A of Form 10-K is contained in Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations." ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Report................................ 33 Consolidated Balance Sheets, December 31, 1997 and 1996..... 34 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995.......................... 35 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995.......................... 36 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995.......................... 37 Notes to Consolidated Financial Statements.................. 38
All schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements or notes thereto. 32 33 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders of Central Coast Bancorp: We have audited the accompanying consolidated balance sheets of Central Coast Bancorp and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements give retroactive effect to the merger of Central Coast Bancorp and Cypress Coast Bank, which has been accounted for as a pooling of interests as described in Note 2 to the consolidated financial statements. We did not audit the statements of income, shareholders' equity and cash flows of Cypress Coast Bank for the year ended December 31, 1995, which statements reflect net interest income of $1,999,000 and net income of $437,000. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Cypress Coast Bank for 1995, is based solely on the report of such other auditors. 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 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 and the report of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Central Coast Bancorp and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Salinas, California January 30, 1998 33 34 CONSOLIDATED BALANCE SHEETS CENTRAL COAST BANCORP AND SUBSIDIARIES
DECEMBER 31, ---------------------------- 1997 1996 ------------ ------------ ASSETS Cash and due from banks..................................... $ 39,891,000 $ 37,522,000 Federal funds sold.......................................... 64,706,000 23,135,000 ------------ ------------ Total cash and equivalents........................ 104,597,000 60,657,000 Interest-bearing deposits in other financial institutions... -- 999,000 Securities: Available-for-sale........................................ 91,481,000 -- Held-to-maturity.......................................... 39,048,000 70,877,000 (Market value: 1997, $39,105,000; 1996, $70,835,000) Loans held for sale......................................... 1,331,000 447,000 Loans: Commercial................................................ 124,714,000 111,545,000 Real estate-construction.................................. 14,645,000 27,997,000 Real estate-other......................................... 107,354,000 93,241,000 Installment............................................... 9,349,000 8,230,000 ------------ ------------ Total loans....................................... 256,062,000 241,013,000 Allowance for credit losses................................. (4,223,000) (4,372,000) Deferred loan fees, net..................................... (568,000) (649,000) ------------ ------------ Net Loans......................................... 251,271,000 235,992,000 ------------ ------------ Premises and equipment, net................................. 2,001,000 1,140,000 Accrued interest receivable and other assets................ 7,945,000 6,720,000 ------------ ------------ Total assets................................................ $497,674,000 $376,832,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand, noninterest bearing............................... $126,818,000 $ 90,149,000 Demand, interest bearing.................................. 89,107,000 76,392,000 Savings................................................... 99,748,000 89,650,000 Time...................................................... 134,628,000 82,472,000 ------------ ------------ Total Deposits.................................... 450,301,000 338,663,000 Accrued interest payable and other liabilities.............. 3,649,000 1,837,000 ------------ ------------ Total liabilities........................................... 453,950,000 340,500,000 ------------ ------------ Commitments and contingencies (Notes 7 and 13) Shareholders' Equity: Preferred stock - no par value; authorized 1,000,000 shares; no shares issued Common stock - no par value; authorized 30,000,000 shares; Issued and outstanding: 4,368,469 shares in 1997 and 4,273,227 shares in 1996...................... 31,644,000 30,856,000 Retained earnings......................................... 11,979,000 5,476,000 Net unrealized gains on available-for-sale securities, net of tax................................................. 101,000 -- ------------ ------------ Shareholders' equity........................................ 43,724,000 36,332,000 ------------ ------------ Total liabilities and shareholders' equity.................. $497,674,000 $376,832,000 ============ ============
See notes to Consolidated Financial Statements 34 35 CONSOLIDATED STATEMENTS OF INCOME CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, ----------------------------------------- 1997 1996 1995 ----------- ----------- ----------- INTEREST INCOME Loans (including fees)............................ $24,828,000 $22,330,000 $19,713,000 Investment securities............................. 5,823,000 4,936,000 4,520,000 Other............................................. 3,265,000 2,035,000 2,731,000 ----------- ----------- ----------- Total interest income..................... 33,916,000 29,301,000 26,964,000 ----------- ----------- ----------- INTEREST EXPENSE Interest on deposits.............................. 11,943,000 9,859,000 9,998,000 Other............................................. 98,000 -- 10,000 ----------- ----------- ----------- Total interest expense.................... 12,041,000 9,859,000 10,008,000 ----------- ----------- ----------- Net Interest Income................................. 21,875,000 19,442,000 16,956,000 Provision for Credit Losses......................... (64,000) (352,000) (695,000) ----------- ----------- ----------- Net Interest Income after Provision for Credit Losses............................................ 21,811,000 19,090,000 16,261,000 ----------- ----------- ----------- OTHER INCOME Service charges on deposits....................... 1,076,000 735,000 676,000 Other income...................................... 689,000 721,000 626,000 ----------- ----------- ----------- Total other income........................ 1,765,000 1,456,000 1,302,000 ----------- ----------- ----------- OTHER EXPENSES Salaries and benefits............................. 7,586,000 6,437,000 5,419,000 Occupancy......................................... 889,000 728,000 746,000 Furniture and equipment........................... 800,000 837,000 672,000 Other............................................. 3,298,000 3,113,000 3,426,000 ----------- ----------- ----------- Total other expenses...................... 12,573,000 11,115,000 10,263,000 ----------- ----------- ----------- Income Before Income Taxes.......................... 11,003,000 9,431,000 7,300,000 Provision for Income Taxes.......................... 4,500,000 3,571,000 2,975,000 ----------- ----------- ----------- Net Income................................ $ 6,503,000 $ 5,860,000 $ 4,325,000 =========== =========== =========== Basic Earnings per Share............................ $ 1.36 $ 1.26 $ 0.94 Diluted Earnings per Share.......................... $ 1.26 $ 1.18 $ 0.88 =========== =========== ===========
See Notes to Consolidated Financial Statements 35 36 CONSOLIDATED STATEMENTS OF CASH FLOWS CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, ------------------------------------------- 1997 1996 1995 ------------- ------------ ------------ CASH FLOWS FROM OPERATIONS: Net income........................................ $ 6,503,000 $ 5,860,000 $ 4,325,000 Reconciliation of net income to net cash provided by operating activities: Provision for credit losses.................... 64,000 352,000 695,000 Depreciation................................... 513,000 557,000 469,000 Amortization and accretion..................... (369,000) (42,000) (292,000) Deferred income taxes.......................... 31,000 (300,000) (168,000) Net (gain) loss on sale of equipment........... (19,000) 52,000 -- Write-down (gain on sale) of other real estate owned........................................ (21,000) (87,000) 215,000 Increase in accrued interest receivable And other assets............................... (1,779,000) (787,000) (184,000) Increase in accrued interest payable And other liabilities.......................... 1,939,000 606,000 251,000 Increase (decrease) in deferred loan fees......... (81,000) 99,000 (32,000) ------------- ------------ ------------ Net cash provided by operations........... 6,781,000 6,310,000 5,279,000 ------------- ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Net (increase) decrease in interest-bearing Deposits in financial institutions............. 999,000 3,493,000 (1,693,000) Proceeds from maturities of investment securities Available-for-sale............................. 63,750,000 -- -- Held-to-Maturity............................... 41,882,000 56,969,000 63,117,000 Purchase of investment securities Available-for-sale............................. (154,353,000) -- -- Held-to-Maturity............................... (10,181,000) (48,161,000) (72,972,000) Net change in loans held for sale................. (884,000) 93,000 195,000 Net increase in loans............................. (15,723,000) (45,485,000) (12,962,000) Proceeds from sale of other real estate owned..... 725,000 287,000 163,000 Proceeds from sale of equipment................... 31,000 1,000 -- Capital expenditures.............................. (1,386,000) (417,000) (317,000) ------------- ------------ ------------ Net cash used by investing activities..... (75,140,000) (33,220,000) (24,469,000) ------------- ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposit accounts.................. 111,638,000 12,574,000 42,265,000 Net increase in short-term borrowings............. 289,000 -- -- Proceeds from sale of stock....................... 380,000 319,000 32,000 Fractional shares repurchased..................... (8,000) (5,000) -- ------------- ------------ ------------ Net cash provided by financing activities.............................. 112,299,000 12,888,000 42,297,000 ------------- ------------ ------------ Net increase (decrease) in cash and equivalents... 43,940,000 (14,022,000) 23,107,000 Cash and equivalents, beginning of year........... 60,657,000 74,679,000 51,572,000 ------------- ------------ ------------ Cash and equivalents, end of year................. $ 104,597,000 $ 60,657,000 $ 74,679,000 ============= ============ ============ NONCASH INVESTING AND FINANCING ACTIVITIES: In 1997, 1996 and 1995 the Company obtained $461,000, $42,000 and $566,000, respectively of real estate (OREO) in connection with foreclosures of delinquent loans. OTHER CASH FLOW INFORMATION: Interest paid..................................... $ 11,367,000 $ 9,852,000 $ 9,853,000 Income taxes paid................................. 3,497,000 4,063,000 3,219,000
See Notes to Consolidated Financial Statements 36 37 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY CENTRAL COAST BANCORP AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 ------------------------------------------------------------------------ NET UNREALIZED COMMON STOCK GAIN ON AVAILABLE- ----------------------- RETAINED FOR-SALE SHARES AMOUNT EARNINGS SECURITIES TOTAL --------- ----------- ----------- ------------------ ----------- Balances, January 1, 1995..... 3,444,846 $22,440,000 $ 3,107,000 $ -- $25,547,000 12% stock dividend (including fractional shares).................. 355,326 3,376,000 (3,376,000) -- -- Sale of stock............... 1,944 10,000 -- -- 10,000 Stock options exercised..... 5,565 22,000 -- -- 22,000 Tax benefit of stock options exercised................ -- 12,000 -- -- 12,000 Net Income.................. -- -- 4,325,000 -- 4,325,000 --------- ----------- ----------- -------- ----------- Balances, December 31, 1995... 3,807,681 25,860,000 4,056,000 -- 29,916,000 10% stock dividend.......... 380,768 4,440,000 (4,440,000) -- -- Fractional shares repurchased.............. (653) (5,000) -- -- (5,000) Stock options and warrants exercised................ 85,431 319,000 -- -- 319,000 Tax benefit of stock options exercised................ -- 242,000 -- -- 242,000 Net Income.................. -- -- 5,860,000 -- 5,860,000 --------- ----------- ----------- -------- ----------- Balances, December 31, 1996... 4,273,227 30,856,000 5,476,000 -- 36,332,000 Fractional shares repurchased.............. (347) (8,000) -- (8,000) Stock options and warrants exercised................ 95,589 380,000 -- -- 380,000 Net change in unrealized gain on available-for-sale securities (net of taxes of $71,000).............. -- -- -- 101,000 101,000 Tax benefit of stock options exercised................ -- 416,000 -- -- 416,000 Net income.................. -- -- 6,503,000 -- 6,503,000 --------- ----------- ----------- -------- ----------- Balances, December 31, 1997... 4,368,469 $31,644,000 $11,979,000 $101,000 $43,724,000 ========= =========== =========== ======== ===========
See Notes to Consolidated Financial Statements 37 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 NOTE 1. SIGNIFICANT ACCOUNTING POLICIES AND OPERATIONS. The consolidated financial statements include Central Coast Bancorp (the "Company") and its wholly-owned subsidiaries, Bank of Salinas and Cypress Bank (the "Banks"). All material intercompany accounts and transactions are eliminated in consolidation. The accounting and reporting policies of the Company and the Banks conform to generally accepted accounting principles and prevailing practices within the banking industry. In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for credit losses and the carrying value of other real estate owned. Management uses information provided by an independent loan review service in connection with the determination of the allowance for loan losses. Bank of Salinas operates four branches in the Salinas Valley and Cypress Bank operates three branches on the Monterey Peninsula, serving small and medium sized business customers, as well as individuals. The Banks focus on business loans and deposit services to customers throughout Monterey and San Benito counties. Investment Securities are classified at the time of purchase into one of three categories: held-to-maturity, trading or available-for-sale. Investment securities classified as held-to-maturity are measured at amortized cost based on the Company's positive intent and ability to hold such securities to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term and are carried at market value with a corresponding recognition of unrecognized holding gain or loss in the results of operations. The remaining investment securities are classified as available-for-sale and are measured at market value with a corresponding recognition of the unrealized holding gain or loss (net of tax effect) as a separate component of shareholders' equity until realized. Accretion of discounts and amortization of premiums arising at acquisition are included in income using methods approximating the effective interest method. Gains and losses on sales of investments, if any, are determined on a specific identification basis. Loans are stated at the principal amount outstanding, reduced by any charge-offs or specific valuation allowance. Loan origination fees and certain direct loan origination costs are deferred and the net amount is recognized using the effective yield method, generally over the contractual life of the loan. Interest income is accrued as earned. The accrual of interest on loans is discontinued and any accrued and unpaid interest is reversed when principal or interest is ninety days past due, when payment in full of principal or interest is not expected or when a portion of the principal balance has been charged off. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Senior management may grant a waiver from nonaccrual status if a loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, the accrued and unpaid interest receivable is reversed and the loan is accounted for on the cash or cost recovery method thereafter, until qualifying for return to accrual status. Generally, a loan may be returned to accrual status when all delinquent interest and principal become current in accordance with the original terms of the loan agreement or when the loan is both well secured and in process of collection. Loans held for sale are stated at the lower of cost or aggregate market value. The allowance for credit losses is an amount that management believes will be adequate to absorb losses inherent in existing loans and commitments to extend credit, based on evaluations of collectibility and prior loss experience. The allowance is established through a provision charged to expense. Loans are charged against the allowance when management believes that the collectibility of the principal is unlikely. In evaluating the adequacy of the reserve, management considers numerous factors such as changes in the 38 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 composition of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current and anticipated local economic conditions that may affect the borrowers' ability to pay. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral-dependent. Real estate and other assets acquired in satisfaction of indebtedness are recorded at the lower of estimated fair market value net of anticipated selling costs or the recorded loan amount, and any difference between this and the loan amount is treated as a loan loss. Costs of maintaining other real estate owned, subsequent write downs and gains or losses on the subsequent sale are reflected in current earnings. Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the lesser of the lease terms or estimated useful lives of the assets, which are generally 3 to 30 years. Intangible assets representing the excess of the purchase price over the fair value of tangible net assets acquired, are being amortized on a straight-line basis over seven years and are included in other assets. Stock Compensation. The Company accounts for its stock-based awards using the intrinsic value method in accordance with Accounting Principles Board No. 25, Accounting for Stock Issued to Employees and its related interpretations. No compensation expense has been recognized in the financial statements for employee stock arrangements. Note 11 to the Consolidated Financial Statements contains a summary of the pro forma effects to reported net income and earnings per share as if the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. Income taxes are provided using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences of differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities arise principally from differences in reporting provisions for credit losses, net operating loss carryforwards, interest on nonaccrual loans, depreciation, state franchise taxes and accruals related to the salary continuation plan. 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. Earnings per share. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128), which is effective in 1997. The Company has restated earnings per share data for prior periods to conform with SFAS 128. SFAS 128 replaces previous earnings per share reporting requirements and requires a dual presentation of basic and diluted earnings per share. Basic earnings per share is computed by dividing net income by the weighted average of common shares outstanding for the period (4,773,000, 4,651,000 and 4,606,000 in 1997, 1996 and 1995, respectively). Diluted earnings per share reflects the potential dilution that could occur if outstanding stock options and stock purchase warrants were exercised. Diluted earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period plus the dilutive effect of options and warrants (388,000, 321,000 and 282,000 in 1997, 1996 and 1995, respectively). All earnings per share information has been adjusted retroactively for stock dividends of 12% in January 1995, 10% in July 1996 and January 1998, and a 3-for-2 stock split in March 1997. 39 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 Stock dividend. On January 20, 1998 the Board of Directors declared a 10% stock dividend, to be distributed on March 3, 1998, to shareholders of record as of February 17, 1998. All share and per share data including stock option and warrant information have been retroactively adjusted to reflect the stock dividend. New Accounting Pronouncements. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, which requires that an enterprise report, by major components and as a single total, the change in its net assets during the period from nonowner sources, and No. 131, Disclosures about Segments of an Enterprise and Related Information, which establishes annual and interim reporting standards or an enterprise's business segments and related disclosures about its products, services, geographic areas and major customers. Both statements will become effective in 1998. Adoption of these statements will not impact the Company's consolidated financial position, results of operations or cash flows. NOTE 2. ACQUISITION OF CYPRESS COAST BANK On May 31, 1996, the Company completed its acquisition of Cypress Coast Bank ("Cypress") whereby Cypress became a subsidiary of the Company and continues to operate from its offices in Seaside and Marina. Cypress shareholders received 587,741 shares of common stock of the Company in a tax-free exchange. At May 31, 1996, Cypress had unaudited total assets of $46.9 million, including $29.8 million in net loans and total unaudited liabilities of $42.7 million, including $42.5 million in deposits. The transaction has been accounted for as a pooling-of-interests. NOTE 3. BRANCH ACQUISITION On February 21, 1997, the Bank of Salinas purchased certain assets and assumed certain liabilities of the Gonzales and Castroville branch offices of Wells Fargo Bank. As a result of the transaction the Bank assumed deposit liabilities ($34 million), received cash ($31 million), and acquired tangible assets ($1 million). This transaction resulted in intangible assets, representing the excess of the liabilities assumed over the fair value of the tangible assets acquired. NOTE 4. CASH AND DUE FROM BANKS The Company, through its bank subsidiaries, is required to maintain reserves with the Federal Reserve Bank. Reserve requirements are based on a percentage of deposits. At December 31, 1997 the Company maintained reserves of approximately $9,331,000 in the form of vault cash and balances at the Federal Reserve to satisfy regulatory requirements. 40 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 NOTE 5. SECURITIES The scheduled maturities and weighted average yields of the Company's investment securities portfolio as of December 31, 1997 and 1996 are as follows:
WEIGHTED AMORTIZED UNREALIZED UNREALIZED MARKET AVERAGE COST GAIN LOSSES VALUE YIELD --------- ---------- ---------- -------- -------- (IN THOUSANDS) DECEMBER 31, 1997 Available for sale securities: U.S. Treasury and agency securities Maturing within 1 year.................. $ 32,861 $ -- $ 5 $ 32,856 5.68% Maturing after 1 year but within 5 years................................. 48,410 184 7 48,587 6.16% Bankers' Acceptances Maturing within 1 year.................. 10,034 -- -- 10,034 5.05% Other........................................ 4 -- -- 4 -- -------- ---- ---- -------- ----- Total available for sale........... $ 91,309 $184 $ 12 91,481 5.87% -------- ---- ---- -------- ----- Held to maturity securities: U.S. Treasury and agency securities Maturing within 1 year.................. $ 27,484 $ 7 $ 11 $ 27,480 5.60% Maturing after 1 year but within 5 years................................. 8,495 66 2 8,559 6.34% Maturing after 5 years but within 10 years................................. 20 -- -- 20 9.05% Maturing after 10 years................. 857 6 9 854 7.00% State and Political Subdivision Maturing after 5 years but within 10 years................................. 2,192 -- -- 2,192 5.60% -------- ---- ---- -------- ----- Total held to maturity............. $ 39,048 $ 79 $ 22 $ 39,105 5.79% -------- ---- ---- -------- ----- Total investment securities........ $130,357 $263 $ 34 $130,586 5.85% ======== ==== ==== ======== ===== DECEMBER 31, 1996 Held to maturity securities: U.S. Treasury and agency securities Maturing within 1 year.................. $ 29,358 $ 46 $ 9 $ 29,395 5.72% Maturing after 1 year but within 5 years................................. 37,460 71 96 37,437 5.80% Maturing after 10 years................. 1,027 1 44 984 6.06% Corporate Debt Securities Maturing within 1 year.................. 3,028 -- 11 3,017 5.28% Other........................................ 4 -- -- 4 -- -------- ---- ---- -------- ----- Total investment securities........ $ 70,877 $118 $160 $ 70,835 5.75% ======== ==== ==== ======== =====
At December 31, 1997 and 1996, securities with a book value of $57,289,000 and $45,834,000 were pledged as collateral for deposits of public funds and other purposes as required by law or contract. There were no sales of securities in 1997, 1996 or 1995. NOTE 6. LOANS AND ALLOWANCE FOR CREDIT LOSSES The Company's business is concentrated in Monterey County, California whose economy is highly dependent on the agricultural industry. As a result, the Company lends money to individuals and companies 41 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 dependent upon the agricultural industry. In addition, the Company has significant extensions of credit and commitments to extend credit which are secured by real estate, the ultimate recovery of which is generally dependent on the successful operation, sale or refinancing of real estate, totaling approximately $146.5 million. The Company monitors the effects of current and expected market conditions and other factors on the collectibility of real estate loans. When, in management's judgment, these loans are impaired, appropriate provision for losses are recorded. The more significant assumptions management considers involve estimates of the following: lease, absorption and sale rates; real estate values and rates of return; operating expenses; inflation; and sufficiency of collateral independent of the real estate including, in limited instances, personal guarantees. In extending credit and commitments to borrowers, the Company generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers. The Company's requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management's evaluation of the credit worthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. The Company secures its collateral by perfecting its interest in business assets, obtaining deeds of trust, or outright possession among other means. Credit losses from lending transactions related to real estate and agriculture compare favorably with the Company's credit losses on its loan portfolio as a whole. The activity in the allowance for credit losses is summarized as follows:
1997 1996 1995 ------ ------ ------ (IN THOUSANDS) Balances, beginning of year...................... $4,372 $4,446 $4,068 Provision charged to expense..................... 64 352 695 Loans charged off................................ (440) (620) (434) Recoveries....................................... 227 194 117 ------ ------ ------ Balance, end of year............................. $4,223 $4,372 $4,446 ====== ====== ======
In determining the provision for estimated losses related to specific major loans, management evaluates its allowance on an individual loan basis, including an analysis of the credit worthiness, cash flows and financial status of the borrower, and the condition and the estimated value of the collateral. Specific valuation allowances for secured loans are determined by the excess of recorded investment in the loan over the fair market value or net realizable value where appropriate, of the collateral. In determining overall general valuation allowances to be maintained and the loan loss allowance ratio, management evaluates many factors including prevailing and forecasted economic conditions, regular reviews of the quality of loans, industry experience, historical loss experience, composition and geographic concentrations of the loan portfolio, the borrowers' ability to repay and repayment performance and estimated collateral values. Management believes that the allowance for credit losses at December 31, 1997 is prudent and warranted, based on information currently available. However, no prediction of the ultimate level of loans charged off in future years can be made with any certainty. 42 43 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 Nonperforming loans at December 31 are summarized below:
1997 1996 ----- ----- (IN THOUSANDS) Past due 90 days or more and still accruing Real estate............................................... $ 6 $ 59 Commercial................................................ 73 60 Installment and other..................................... -- 90 ---- ---- 79 209 ---- ---- Nonaccrual: Real estate............................................... 628 419 Commercial................................................ 188 184 Installment and other..................................... -- 1 ---- ---- 816 604 ---- ---- Total nonperforming loans......................... $895 $813 ==== ====
Interest due but excluded from interest income on nonaccrual loans was approximately $7,000 in 1997, $50,000 in 1996 and $166,000 in 1995. In 1997 and 1996, interest income recognized from payments received on nonaccrual loans was $7,000 and $619,000, respectively. In 1995, no payments received on nonaccrual loans were included in interest income. At December 31, 1997 and 1996, the recorded investment in loans that are considered impaired under SFAS No. 114 was $995,000 and $965,000 of which $816,000 and $541,000 are included as nonaccrual loans above. Such impaired loans had valuation allowances totalling $200,000 and $446,000 based on the estimated fair values of the collateral. The average recorded investment in impaired loans during 1997 and 1996 was $829,000 and $1,376,000. The Company recognized interest income on impaired loans of $33,000 and $13,000 in 1997 and 1996, respectively. Other real estate owned included in other assets was $105,000 and $348,000 (net of a $185,000 valuation allowance in 1996) at December 31, 1997 and 1996, respectively. NOTE 7. PREMISES AND EQUIPMENT Premises and equipment at December 31 are summarized as follows:
1997 1996 ------ ------ (IN THOUSANDS) Land....................................................... $ 145 $ -- Building................................................... 478 -- Furniture and equipment.................................... 4,073 3,450 Leasehold improvement...................................... 1,161 1,079 ------ ------ 5,857 4,529 Accumulated depreciation and amortization.................. (3,856) (3,389) ------ ------ Premises and equipment, net................................ $2,001 $1,140 ====== ======
The Company's facilities leases expire in November 1998 through February 2000 with options to extend for three to fifteen years. These include four facilities leased from shareholders at terms and conditions which management believes are consistent with the market. Rental rates are adjusted annually for changes in certain economic indices. Rental expense was approximately $422,000, $406,000 and $397,000, including lease expense to shareholders of $152,000, $174,000 and $170,000 in 1997, 1996 and 1995, respectively. The 43 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 minimum annual rental commitments under these leases, including the remaining rental commitment under the leases to shareholders, are as follows:
OPERATING LEASES ---------------- (IN THOUSANDS) 1998.......................................... $419 1999.......................................... 327 2000.......................................... 4 ---- Total............................... $750 ====
NOTE 8. INCOME TAXES The provision for income taxes is as follows:
1997 1996 1995 ------ ------ ------ (IN THOUSANDS) Current: Federal........................................ $3,255 $2,830 $2,287 State.......................................... 1,214 1,041 856 ------ ------ ------ Total.................................. 4,469 3,871 3,143 ------ ------ ------ Deferred: Federal........................................ 32 (289) (125) State.......................................... (1) (11) (43) ------ ------ ------ Total.................................. 31 (300) (168) ------ ------ ------ Total.................................. $4,500 $3,571 $2,975 ====== ====== ======
A reconciliation of the Federal income tax rate to the effective tax rate is as follows:
1997 1996 1995 ---- ---- ---- Statutory Federal income tax rate.................. 35.0% 35.0% 35.0% State income taxes (net of Federal income tax benefit)......................................... 7.2% 7.6% 7.8% Change in the valuation allowance for deferred taxes............................................ -- (4.0)% (2.5)% Tax exempt interest income......................... (0.8)% -- -- Other.............................................. (0.5)% (0.7)% 0.5% ---- ---- ---- Effective tax rate................................. 40.9% 37.9% 40.8% ==== ==== ====
44 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1997 and 1996, respectively, are presented below:
1997 1996 ------ ------ (IN THOUSANDS) Deferred tax assets (liabilities): Provision for credit losses.............................. $1,609 $1,699 State income taxes....................................... 185 152 Salary continuation plan................................. 165 113 Depreciation and amortization............................ 161 16 Excess serving rights.................................... 110 97 Unrealized gain on available-for-sale investment securities............................................ (71) -- Accrual to cash adjustments.............................. 45 (51) Interest on nonaccrual loans............................. 22 25 Net operating loss....................................... -- 187 OREO valuation reserve................................... -- 97 Other.................................................... 3 33 ------ ------ Net deferred tax asset..................................... $2,229 $2,368 ====== ======
NOTE 9. DETAIL OF OTHER EXPENSE Other expense for the years ended December 31, 1997, 1996 and 1995 consists of the following:
1997 1996 1995 ------ ------ ------ (IN THOUSANDS) Professional fees................................ $ 358 $ 454 $ 644 Customer expenses................................ 340 379 213 Marketing........................................ 302 345 253 Data processing.................................. 334 330 261 Stationary and supplies.......................... 466 319 247 Shareholder and director......................... 249 284 187 Amortization of intangibles...................... 209 -- -- Insurance........................................ 180 176 215 Dues and assessments............................. 123 65 487 Write down of other real estate owned............ -- -- 215 Other............................................ 737 761 704 ------ ------ ------ Total.................................. $3,298 $3,113 $3,426 ====== ====== ======
NOTE 10. STOCK PURCHASE WARRANTS During 1995 and 1994, warrants were issued in connection with the sale of the Company's common stock at a rate of one warrant for every share of stock purchased. The warrants are exercisable at $5.23 and expire on June 30, 1999. During 1997 and 1996, respectively 4,700 and 24,125 warrants were exercised (none in 1995) and at December 31, 1997, 123,090 warrants were outstanding. 45 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 NOTE 11. EMPLOYEE BENEFIT PLANS The Company has two stock option plans under which incentive stock options or nonqualified stock options may be granted to certain key employees or directors to purchase authorized, but unissued, common stock. Shares may be purchased at a price not less than the fair market value of such stock on the date of grant. Options vest over various periods not in excess of ten years from date of grant and expire not more than ten years from date of grant. Activity under the stock option plans adjusted for stock dividends and the stock split is as follows:
WEIGHTED AVERAGE SHARES PRICE PER SHARE PRICE -------- --------------- -------- Balances, January 1, 1995.................. 556,520 $ 1.77 - 5.90 $ 2.98 Granted (wt. avg. fair value $2.42 per share)................................ 207,743 4.35 - 8.82 7.38 Canceled................................. (37,870) 3.21 - 7.72 5.38 Exercised................................ (6,734) 1.77 - 5.90 3.27 -------- -------------- ------ Balances, December 31, 1995................ 719,659 1.77 - 8.82 4.13 Granted (wt. avg. fair value $3.64 per share)................................ 353,100 10.05 - 13.03 12.91 Expired.................................. (19,883) 1.77 - 7.72 4.15 Exercised................................ (69,849) 1.77 - 5.90 2.79 -------- -------------- ------ Balances, December 31, 1996................ 983,027 1.77 - 13.03 7.07 Granted (wt. avg. fair value $4.33 per share)................................ 30,250 12.43 - 20.63 13.92 Expired.................................. (76,591) 2.90 - 12.27 10.46 Exercised................................ (100,447) 1.77 - 7.72 3.56 -------- -------------- ------ Balances, December 31, 1997................ 836,239 $ 1.77 - 20.63 $ 7.43 ======== ============== ======
Additional information regarding options outstanding as of December 31, 1997 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------ ---------------------------- WEIGHTED AVERAGE REMAINING WEIGHTED WEIGHTED RANGE OF NUMBER CONTRACTUAL AVERAGE NUMBER AVERAGE EXERCISE PRICES OUTSTANDING LIFE (YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE - --------------- ----------- ---------------- -------------- ----------- -------------- $ 2.90 343,728 2.1 $ 2.90 274,982 $ 2.90 5.90 - 7.71 160,806 7.6 7.35 95,831 7.41 8.81 - 12.43 326,205 9.9 12.01 119,284 11.97 20.63 5,500 11.0 20.63 -- -- ------------- ------- ---- ------ ------- ------ $2.90 - 20.63 836,239 6.3 $ 7.43 490,097 $ 5.99 ============= ======= ==== ====== ======= ======
At December 31, 1997, 565,066 shares were available for additional grants. 401(K) SAVINGS PLAN The Company has a 401(k) Savings Plan under which eligible employees may elect to make tax deferred contributions from their annual salary, to a maximum established annually by the IRS. The Company matches 20% of the employees' contributions. The Company may make additional contributions to the plan at the discretion of the Board of Directors. All employees meeting age and service requirements are eligible to participate in the Plan. Company contributions vest after 3 years of service. Company contributions during 1997, 1996 and 1995 which are funded currently, totaled $56,000, $46,000 and $43,000, respectively. 46 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 SALARY CONTINUATION PLAN In 1996 the Company established a salary continuation plan for five officers which provides for retirement benefits upon reaching age 63. During 1997 two of such officers terminated their employment with the Company without vesting in the plan. The Company accrues such post-retirement benefits over the vesting periods (of five or ten years). In the event of a change in control of the Company, the officers' benefits will fully vest. The Company accrued compensation expense of $117,000 and $250,000 in 1997 and 1996, respectively. EMPLOYEE STOCK OWNERSHIP PLAN Effective January 1, 1996, the Company established an employee stock ownership plan. Under this plan, the Company intends to make contributions which will be invested primarily in Company stock. All full time employees meeting the age and service requirements are eligible to participate and will receive a share of each company contribution either in proportion to their annual compensation expense or in an equal amount for each eligible employee at the discretion of the Company. Contributions vest to each employee based on their years of service (three to seven years). Upon retirement, employees will receive the value of the amounts which have been accumulated in their accounts in the form of Company stock. Contributions to the plan are at the discretion of the Company. Company contributions during 1996 totaled $50,000. No contributions were made in 1997. ADDITIONAL STOCK PLAN INFORMATION As discussed in Note 1, the Company continues to account for its stock-based awards using the intrinsic value method in accordance with Accounting Principles Board No. 25, Accounting for Stock Issued to Employees and its related interpretations. No compensation expense has been recognized in the financial statements for employee stock arrangements. Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, (SFAS 123) requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method as of the beginning of fiscal 1995. Under SFAS 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: expected life, four years following vesting; average stock volatility of 13%; risk free interest rates ranging from 5.47% to 6.18%; and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. If the computed fair values of the 1997, 1996 and 1995 awards had been amortized to expense over the vesting period of the awards, pro forma net income would have been $6,345,000 ($1.33 basic and $1.23 diluted earnings per share), $5,348,000 ($1.15 basic and $1.08 diluted per share) and $4,203,000 ($0.91 basic and $0.86 diluted earnings per share) in 1997, 1996 and 1995, respectively. However, the impact of outstanding non-vested stock options granted prior to 1995 has been excluded from the pro forma calculation; accordingly, the 1997, 1996 and 1995 pro forma adjustments are not indicative of future period pro forma adjustments, when the calculation will apply to all applicable stock options. NOTE 12. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures About Fair Value of Financial Instruments". The estimated 47 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 fair value amounts have been determined by using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation techniques may have a material effect on the estimated fair value amounts.
DECEMBER 31, 1997 DECEMBER 31, 1996 ---------------------- --------------------- CARRYING ESTIMATED CARRYING ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE -------- ----------- -------- ---------- IN THOUSANDS FINANCIAL ASSETS Cash and cash equivalents............................ $104,597 $104,597 $ 60,657 $ 60,657 Interest-bearing deposits in other financial institutions....................................... -- -- 999 999 Securities........................................... 130,529 130,586 70,877 70,835 Loans held for sale.................................. 1,331 1,453 447 483 Loans, net........................................... 251,271 256,361 235,992 236,060 FINANCIAL LIABILITIES Demand deposits...................................... 215,925 215,925 166,541 166,541 Time deposits........................................ 134,628 135,542 82,472 82,863 Savings deposits..................................... 99,748 99,748 89,650 89,650 Other borrowings..................................... 289 289 -- --
The following estimates and assumptions were used to estimate the fair value of the financial instruments. Cash and cash equivalents -- The carrying amount is a reasonable estimate of fair value. Interest-bearing deposits in other financial institutions and securities -- Fair values of interest-bearing deposits in other financial institutions and securities are based on quoted market prices or dealer quotes. If a quoted market price was not available, fair value was estimated using quoted market prices for similar securities. Loans, net -- Fair values for certain commercial, construction, revolving customer credit and other loans were estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and similar maturities, adjusted for the allowance for credit losses. Certain adjustable rate loans have been valued at their carrying values, if no significant changes in credit standing have occurred since origination and the interest rate adjustment characteristics of the loan effectively adjust the interest rate to maintain a market rate of return. For adjustable rate loans which have had changes in credit quality, appropriate adjustments to the fair value of the loans are made. Demand, time and savings deposits -- The fair value of noninterest-bearing and adjustable rate deposits and savings is the amount payable upon demand at the reporting date. The fair value of fixed-rate interest-bearing deposits with fixed maturity dates was estimated by discounting the cash flows using rates currently offered for deposits of similar remaining maturities. Off-balance sheet instruments -- The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit-worthiness of the counterparties. The fair values of standby and commercial letters of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. The fair values of such off-balance sheet instruments were not significant at December 31, 1997 and 1996 and, therefore, have not been included in the table above. 48 49 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 NOTE 13. COMMITMENTS AND CONTINGENCIES In the normal course of business there are various commitments outstanding to extend credit which are not reflected in the financial statements, including loan commitments of approximately $90,649,000 and standby letters of credit and financial guarantees of $5,272,000 at December 31, 1997. The Bank does not anticipate any losses as a result of these transactions. Approximately $15,871,000 of loan commitments outstanding at December 31, 1997 relate to construction loans and are expected to fund within the next twelve months. The remainder relate primarily to revolving lines of credit or other commercial loans. Many of these loan commitments are expected to expire without being drawn upon. Therefore the total commitments do not necessarily represent future cash requirements. Stand-by letters of credit are commitments written by the Bank to guarantee the performance of a customer to a third party. These guarantees are issued primarily relating to purchases of inventory by the Banks' commercial customers, are typically short-term in nature and virtually all such commitments are collateralized. Most of the outstanding commitments to extend credit are at variable rates tied to the Banks' reference rate of interest. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit issued is the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The Company controls the credit risk of the off-balance sheet financial instruments through the normal credit approval and monitoring process. NOTE 14. RELATED PARTY LOANS The Company makes loans to officers and directors and their associates subject to loan committee approval and ratification by the Board of Directors. These transactions are on substantially the same terms as those prevailing at the time for comparable transactions with unaffiliated parties and do not involve more than normal risk of collectibility. An analysis of changes in related party loans for the year ended December 31, 1997 is as follows:
BEGINNING BALANCE ADDITIONS REPAYMENTS ENDING BALANCE - ----------------- ---------- ---------- -------------- $9,746,000 $6,726,000 $7,353,000 $9,119,000
Committed lines of credit, undisbursed loans and standby letters of credit to directors and officers at December 31, 1997 were approximately $7,299,000. NOTE 15. REGULATORY MATTERS The Company is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly, additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Capital adequacy guidelines and the regulatory framework for prompt corrective action require that the Company meet specific capital adequacy guidelines that involve quantitative measures of the Company's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weighting and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as 49 50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 defined) and a minimum leverage ratio of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 1997 that the Company meets all capital adequacy requirements to which it is subject. As of December 31, 1997 and 1996, the most recent notifications from the Federal Deposit Insurance Corporation categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Banks must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The following table shows the Company's and the Banks' actual capital amounts and ratios at December 31, as well as the minimum capital ratios to be categorized as "well capitalized" under the regulatory framework:
TO BE CATEGORIZED WELL CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS: ------------------- ------------------ ------------------ AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ----------- ----- ---------- ----- ---------- ----- As of December 31, 1997: Total Capital (to Risk Weighted Assets): COMPANY............................ 45,782,000 15.2% 24,046,000 8.0% N/A Bank of Salinas.................... 38,877,000 14.5% 21,514,000 8.0% 26,892,000 10.0% Cypress Bank....................... 5,012,000 14.6% 2,739,000 8.0% 3,423,000 10.0% Tier 1 Capital (to Risk Weighted Assets): COMPANY............................ 41,968,000 14.0% 12,023,000 4.0% N/A Bank of Salinas.................... 35,501,000 13.2% 10,757,000 4.0% 16,135,000 6.0% Cypress Bank....................... 4,584,000 13.4% 1,369,000 4.0% 2,054,000 6.0% Tier 1 Capital (to Average Assets): COMPANY............................ 41,968,000 9.6% 17,570,000 4.0% N/A Bank of Salinas.................... 35,501,000 8.9% 15,869,000 4.0% 19,837,000 5.0% Cypress Bank....................... 4,584,000 8.8% 2,084,000 4.0% 2,605,000 5.0% As of December 31, 1996: Total Capital (to Risk Weighted Assets): COMPANY............................ 39,562,000 15.4% 20,584,000 8.0% N/A Bank of Salinas.................... 34,134,000 15.1% 18,043,000 8.0% 22,554,000 10.0% Cypress Bank....................... 4,700,000 15.1% 2,493,000 8.0% 3,117,000 10.0% Tier 1 Capital (to Risk Weighted Assets): COMPANY............................ 36,332,000 14.1% 10,292,000 4.0% N/A Bank of Salinas.................... 31,302,000 13.9% 9,021,000 4.0% 13,532,000 6.0% Cypress Bank....................... 4,309,000 13.8% 1,247,000 4.0% 1,870,000 6.0% Tier 1 Capital (to Average Assets): COMPANY............................ 36,332,000 10.1% 14,321,000 4.0% N/A Bank of Salinas.................... 31,302,000 10.1% 9,326,000 3.0% 15,543,000 5.0% Cypress Bank....................... 4,309,000 9.1% 1,887,000 4.0% 2,358,000 5.0%
The ability of the Company to pay cash dividends in the future will largely depend upon the cash dividends paid to it by its subsidiary Banks. Under State and Federal law regulating banks, cash dividends declared by a Bank in any calendar year generally may not exceed its net income for the preceding three fiscal 50 51 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 years, less distributions to the Company, or its retained earnings. Under these provisions, and considering minimum regulatory capital requirements, the amount available for distribution from the Banks to the Company was approximately $15,034,000 as of December 31, 1997. The Banks are subject to certain restrictions under the Federal Reserve Act, including restrictions on the extension of credit to affiliates. In particular, the Banks are prohibited from lending to the Company unless the loans are secured by specified types of collateral. Such secured loans and other advances from the Banks are limited to 10% of Bank shareholders' equity, or a combined maximum of $4,174,000 at December 31, 1997. No such advances were made during 1997 or 1996. NOTE 16. CENTRAL COAST BANCORP (PARENT COMPANY ONLY) The condensed financial statements of Central Coast Bancorp follow (in thousands): CONDENSED BALANCE SHEETS
DECEMBER 31, ------------------ 1997 1996 ------- ------- Assets: Cash -- interest bearing account with Bank................ $ 191 $ 74 Investment in Banks....................................... 41,841 35,611 Premises and equipment, net............................... 491 68 Other Assets.............................................. 1,916 844 ------- ------- Total assets...................................... $44,439 $36,597 ======= ======= Liabilities and Shareholders' Equity Liabilities............................................... $ 715 $ 265 Shareholders' Equity...................................... 43,724 36,332 ------- ------- Total liabilities and shareholders' equity........ $44,439 $36,597 ======= =======
CONDENSED INCOME STATEMENTS
YEARS ENDED DECEMBER 31, --------------------------- 1997 1996 1995 ------- ------ ------ Management fees............................................. $ 3,624 $ 840 Other income................................................ 11 -- Cash dividends received from Banks.......................... 2,000 500 $ 600 ------- ------ ------ Total income...................................... 5,635 1,340 600 Operating expenses.......................................... 6,386 1,737 437 ------- ------ ------ Income (loss) before income taxes and equity in undistributed net income of Banks......................... (751) (397) 163 Provision (credit) for income taxes......................... (1,125) (352) (66) Equity in undistributed net income of Banks................. 6,129 5,905 4,096 ------- ------ ------ Net income........................................ $ 6,503 $5,860 $4,325 ======= ====== ======
51 52 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CENTRAL COAST BANCORP AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, ----------------------------- 1997 1996 1995 ------- ------- ------- Increase (decrease) in cash: Operations: Net income................................................ $ 6,503 $ 5,860 $ 4,325 Adjustments to reconcile net income to net cash provided (used) by operations: Equity in undistributed net income of Banks............ (6,129) (5,905) (4,096) Depreciation........................................... 71 1 -- (Increase) decrease in other assets.................... (656) (522) (34) Increase (decrease) in liabilities..................... 450 80 194 ------- ------- ------- Net cash provided (used) by operations................. 239 (486) 389 ------- ------- ------- Investing Activities -- Capital expenditures...................................... (494) (69) -- ------- ------- ------- Financing Activities: Short-term borrowings..................................... -- -- (125) Fractional shares repurchased............................. (8) (5) -- Stock options exercised................................... 380 319 22 ------- ------- ------- Net cash provided (used) by financing activities....... 372 314 (103) ------- ------- ------- Net increase (decrease) in cash........................ 117 (241) 286 Cash balance, beginning of year........................... 74 315 29 ------- ------- ------- Cash balance, end of year................................. $ 191 $ 74 $ 315 ======= ======= =======
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 by Item 10 of Form 10-K is incorporated by reference to the information contained in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors, executive officers and ten percent or more shareholders of the Company's equity securities, to file with the Securities and Exchange Commission initial reports of ownership and reports of changes of ownership of the Company's equity securities. Officers, directors and ten percent or more shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and written representations that no other reports were required, during the fiscal year ended December 31, 1997, except for Director Boutonnet who failed to timely file one report on Form 3, all Section 16(a) filing requirements applicable to its executive 52 53 officers, directors and beneficial owners of ten percent or more of the Company's equity securities appear to have been met. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 of Form 10-K is incorporated by reference to the information contained in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 of Form 10-K is incorporated by reference to the information contained in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 of Form 10-K is incorporated by reference to the information contained in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A)(1) FINANCIAL STATEMENTS. Listed and included in Part II, Item 8. (2) FINANCIAL STATEMENT SCHEDULES. Not applicable. (3) EXHIBITS. (2.1) Agreement and Plan of Reorganization and Merger by and between Central Coast Bancorp, CCB Merger Company and Cypress Coast Bank dated as of December 5, 1995, incorporated by reference from Exhibit 99.1 to Form 8-K filed with the Commission on December 7, 1995. (3.1) Articles of Incorporation, incorporated by reference from Exhibit 4.8 to Registration Statement on Form S-8 No. 33-89948, filed with the Commission on March 3, 1995. (3.2) Bylaws, incorporated by reference from Exhibit 4.9 to Registration Statement on Form S-8 No. 33-89948, filed with the Commission on March 3, 1995. (4.1) Specimen form of Central Coast Bancorp stock certificate incorporated by reference from the Company's 1994 Annual Report on Form 10K filed with the Commission on March 31, 1995. (10.1) Lease agreement dated December 12, 1994, related to 301 Main Street, Salinas, California incorporated by reference from the Company's 1994 Annual Report on Form 10K filed with the Commission on March 31, 1995. (10.2) King City Branch Lease incorporated by reference from Exhibit 10.3 to Registration Statement on Form S-4 No. 33-76972, filed with the Commission on March 28, 1994. (10.3) Amendment to King City Branch Lease incorporated by reference from Exhibit 10.4 to Registration Statement on Form S-4 No. 33-76972, filed with the Commission on March 28, 1994.
53 54 *(10.4) 1982 Stock Option Plan, as amended, incorporated by reference from Exhibit 4.2 to Registration Statement on Form S-8 No. 33-89948, filed with the Commission on March 3, 1995. *(10.5) Form of Nonstatutory Stock Option Agreement under the 1982 Stock Option Plan incorporated by reference from Exhibit 4.6 to Registration Statement on Form S-8 No. 33-89948, filed with the Commission on March 3, 1995. *(10.6) Form of Incentive Stock Option Agreement under the 1982 Stock Option Plan incorporated by reference from Exhibit 4.7 to Registration Statement on Form S-8 No. 33-89948, filed with the Commission on March 3, 1995. *(10.7) 1994 Stock Option Plan incorporated by reference from Exhibit 4.1 to Registration Statement on Form S-8 No. 33-89948, filed with the Commission on March 3, 1995. *(10.8) Form of Nonstatutory Stock Option Agreement under the 1994 Stock Option Plan incorporated by reference from Exhibit 4.3 to Registration Statement on Form S-8 No. 33-89948, filed with Commission on March 3, 1995. *(10.9) Form of Incentive Stock Option Agreement under the 1994 Stock Option Plan incorporated by reference from Exhibit 4.4 to Registration Statement on Form S-8 No. 33-89948, filed with the commission on March 3, 1995. *(10.10) Form of Director Nonstatutory Stock Option Agreement under the 1994 Stock Option Plan incorporated by reference from Exhibit 4.5 to Registration Statement on Form S-8 No. 33- 89948, filed with the commission on March 3, 1995. *(10.11) Form of Bank of Salinas Indemnification Agreement for directors and executive officers incorporated by reference from Exhibit 10.9 to Amendment No. 1 to Registration Statement on Form S-4 No. 33-76972, filed with the Commission on April 15, 1994. *(10.12) 401(k) Pension and Profit Sharing Plan Summary Plan Description incorporated by reference from Exhibit 10.8 to Registration Statement on Form S-4 No. 33-76972, filed with the Commission on March 28, 1994. *(10.13) Specimen form of Employment Agreement incorporated by reference from Exhibit 10.13 to the Company's 1996 Annual Report on Form 10K filed with the Commission on March 31, 1997. *(10.14) Specimen form of Executive Salary Continuation Agreement incorporated by reference from Exhibit 10.14 to the Company's 1996 Annual Report on Form 10K filed with the Commission on March 31, 1997. *(10.15) 1994 Stock Option Plan, as amended, incorporated by reference from Exhibit A to the Proxy Statement filed with the Commission on September 3, 1996 in connection with Central Coast Bancorp's 1996 Annual Shareholders' Meeting held on September 23, 1996. (10.16) Specimen of Indemnification Agreement, incorporated by reference from Exhibit D to the Proxy Statement filed with the Commission on September 3, 1996 in connection with Central Coast Bancorp's 1996 Annual Shareholders' Meeting held on September 23, 1996. (10.17) Purchase and Assumption Agreement for the Acquisition of Wells Fargo Bank Branches incorporated by reference from Exhibit 10.17 to the Company's 1996 Annual Report on Form 10K filed with the Commission on March 31, 1997. *(10.18) Employee Stock Ownership Plan and Trust Agreement incorporated by reference from Exhibit 10.18 to the Company's 1996 Annual Report on Form 10K filed with the Commission on March 31, 1997. (10.19) Lease agreement dated March 7, 1997, related to 484 Lighthouse Avenue, Monterey, California (21.1) The Registrant's only subsidiaries are its wholly-owned subsidiaries, Bank of Salinas and Cypress Bank
54 55 (23.1) Independent auditors' consent (27.1) Financial Data Schedule
- --------------- * Denotes management contracts, compensatory plans or arrangements. (B) REPORTS ON FORM 8-K. Filed with the Commission on December 8, 1997 An Annual Report for the fiscal year ended December 31, 1997, and Notice of Annual Meeting and Proxy Statement for the Company's 1998 Annual Meeting will be mailed to security holders subsequent to the date of filing this Report. Copies of said materials will be furnished to the Commission in accordance with the Commission's Rules and Regulations. 55 56 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. CENTRAL COAST BANCORP Date: March 19, 1998 By: /s/ NICK VENTIMIGLIA ------------------------------------ Nick Ventimiglia, President and Chief Executive Officer (Principal Executive Officer) Date: March 19, 1998 By: /s/ JAYME C. FIELDS ------------------------------------ Jayme C. Fields, Controller (Principle Accounting and Finance Officer) Pursuant to the requirements of the Securities Exchange Act of 1934 this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ ANDREW E. AUSONIO Director March 19, 1998 - -------------------------------------------------------- Andrew E. Ausonio /s/ C. EDWARD BOUTONNET Director March 19, 1998 - -------------------------------------------------------- C. Edward Boutonnet /s/ BRADFORD G. CRANDALL Director March 19, 1998 - -------------------------------------------------------- Bradford G. Crandall /s/ ALFRED P. GLOVER Director March 19, 1998 - -------------------------------------------------------- Alfred P. Glover /s/ RICHARD C. GREEN Director March 19, 1998 - -------------------------------------------------------- Richard C. Green /s/ MICHAEL T. LAPSYS Director March 19, 1998 - -------------------------------------------------------- Michael T. Lapsys /s/ ROBERT M. MRAULE Director March 19, 1998 - -------------------------------------------------------- Robert M. Mraule /s/ DUNCAN L. MCCARTER Director March 19, 1998 - -------------------------------------------------------- Duncan L. McCarter /s/ LOUIS A. SOUZA Director March 19, 1998 - -------------------------------------------------------- Louis A. Souza /s/ MOSE E. THOMAS Director March 19, 1998 - -------------------------------------------------------- Mose E. Thomas /s/ NICK VENTIMIGLIA Chairman, President and CEO March 19, 1998 - -------------------------------------------------------- Nick Ventimiglia
56 57 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 10.19 Lease agreement dated March 7, 1997, related to 484 Lighthouse Avenue, Monterey, California 23.1 Independent auditors' consent 27.1 Financial Data Schedule
57 EX-10.19 2 LEASE AGREEMENT DATED MARCH 7, 1997 1 Exhibit 10.19 484 Lighthouse LEASE A. G. Davi, Ltd. Post Office Box 2350 Monterey, CA 93942-2350 408-373-2222 82 2
INDEX Paragraph 1. Definition 2. Premises 1 3. Term of Lease 1 4. Rental 1 5. Adjustment of Fixed Rent 2 6. Security Deposit 2 7. Governmental Intervention 2 8. Designation of Maintenance, Repair of Common Area 2 9. Purpose 4 10. Compliance with Law 4 11. Use and Cleanliness and quiet Enjoyment 4 12. Assignment and Sub-Letting 4 13. Acceptance of Premises 5 14. Liens 5 15. Accession 6 16. Waste 6 17. Holdover Tenancy 6 18. Fire and Glass Insurance 6 19. Liability Insurance 7 20. Personal Property Taxes 7 21. Damage and or Destruction of Demised Premises 7 22. Prohibitive Acts 7 23. Inspection 8 24. Bankruptcy or Insolvency 8 25. Default and Reentry 8 26. Lessor and Lessee Liability 9 27. Late Payment Charges and Interest on Delinquencies 9 28. Attorney's Fees 9 29. Non-Waiver or Breach 9 30. Condemnation 10 31. Utilities 10 32. Heirs and Assigns 10 33. Notices 10 34. Construction 11 35. Layout of Demised Premises and Surrounding Area Owned by Lessor 11 36. Number and Gender 11 37. Marginal Titles 11 38. Modification and Voidance of Prior Agreements 11 39. Time of Essence 11 40. Payments not in Substitution 11 41. Conveyance by Lessor 11 42. Signs and Advertising 12 43. Statement of Lessee 12 44. Cleaning, Janitorial, Garbage and Refuse Collection 12 45. Alterations/Improvements 12 46. Subordination 12 47. Hazardous Material 13 Exhibit A Lease Particulars 15 Exhibit B Schematic Diagram 16 Addendum No. 1 17 Option to extend Term 18
83 3 LEASE This Lease, made and entered into on the date appearing in the signature block hereof, by and between J.V. Rossi. (hereinafter referred to as Lessor), and Cypress Bank a California Corporation hereinafter referred to as Lessee). WITNESSES: 1. DEFINITIONS: 1) Lease Year. For the purpose of this Lease, a "lease year" is a period during the lease term commencing on the first day of the lease term (except that if the lease term commences on a day other than the first day of a calendar month, then the "lease year" shall commence on the first day of the next succeeding calendar month) and ending at midnight twelve (12) full calendar months thereafter; provided, however that the last lease year shall end at the end of the lease term, except that if such period includes less than the whole of a calendar month, that portion of the calendar month included within the period is a month. 2) Common Area. As used in this Lease, the term "common area" shall include all areas and facilities in, upon or about the Center, by Lessor for the non-exclusive use of Lessee in common with other authorized users. It is understood and agreed that the common area is not a portion of the premises demised to Lessee hereunder. 3) Floor Area. The term "floor area" means that actual number of square feet of floor space within the exterior faces of the exterior walls (except party and interior walls. In which case the center thereof instead of the exterior faces shall be used) of the buildings, including vacant space therein. The term "floor area" refers to gross floor area, and no deductions shall be made from the "floor area" by reason of columns, stairs, or other interior construction or equipment. The total "floor area" of the demised premises and the total "floor area" of the buildings, including the "floor area" of the demised premises is hereby defined, fixed, determined and agreed by Lessee and Lessor as set forth above and shown on Exhibit "A" attached hereto and shall be conclusive upon the parties hereto. 4) MRWPCA. The term "MRWPCA" shall mean Monterey Regional Water Pollution Control Agency. 5) CENTER. The term "Center" shall include: shopping center, professional office building, mixed-use properties, single and multi-tenant properties, industrial, retail, warehouse, and other general commercial properties, all of which may be improved or unimproved, owned by Lessor. 2. PREMISES: In consideration of the terms, covenants, conditions and obligations herein contained, to be kept, performed and complied with by Lessee, and upon the condition that Lessee keeps, performs and complies with said terms, covenants, conditions and obligations, Lessor does hereby demise to Lessee, and Lessee does hereby rent from Lessor those certain premises described in Exhibit "A" attached hereto (hereinafter demised premises), located at 484 Lighthouse, Suites 101,103, 93940, (hereinafter Center). This Lease is of real property in a Multi-Use Shopping Center within the meaning of the Bankruptcy Code. 11 U.S.C. Section 365(b)(3). 3. TERM OF LEASE: The term of this Lease shall be for the approximate number of years appearing as the Approximate Term on Exhibit "A" attached hereto and shall commence on the Commencement Date as it appears in said Exhibit "A" and shall terminate on the Expiration Date as it appears on said Exhibit "A", unless earlier terminated. If Lessor, for any reason whatsoever, cannot deliver possession of the said premises to Lessee at the commencement of the term hereof, this Lease shall not be void or voidable, nor shall Lessor be liable to Lessee for any loss or damage resulting therefrom, but in that event there shall be a proportionate reduction of rent covering the period between the commencement of the said term and the time when Lessor can deliver possession. 4. RENTAL: Lessee hereby covenants to pay to Lessor, at the time and place and computed in the manner hereinafter set forth, as rental for the demised premises for each month. As hereinafter defined, during the term of this Lease, no less than the Initial Fixed Rent appearing in Exhibit "A" as adjusted from time to time in accordance with the provisions of paragraph 5, below. Initial Fixed Rent as so adjusted shall be called the Then Fixed Rent and shall be paid, and MRWPCA charges, monthly, in advance, on the first day of each month during the lease term. Rental payments and charges shall not be reduced by any claims, demands, or off-sets against Lessor of any kind whatsoever. Notwithstanding anything in this Lease to the contrary, all amounts payable by Lessee to or on behalf of Lessor under this Lease, whether or not expressly denominated as rent, shall constitute rent for the purposes of the Bankruptcy Code, 11 U.S.C. Section 502(b)(6). 84 4 5. ADJUSTMENT OF FIXED RENT: Notwithstanding the provisions of paragraph 4, the fixed rent shall be adjusted on the first day of the second lease year and thereafter at twelve-month intervals for so long as this Lease or any extension thereof shall be in effect, unless otherwise agreed in writing by Lessor and Lessee as follows: on the first day of the second lease year and on the first day of each lease year thereafter (the adjustment dates), the Then Fixed Rent shall become the product of multiplying the Then Fixed Rent attached hereto, by the annual percentage increase as reflected in the Consumer Price Index for All Urban Consumers in the San Francisco - Oakland area as published by the Bureau of Labor Statistics, United States Department of Labor or any successor index, for the calendar month preceding the adjustment dates. 6. SECURITY DEPOSIT: On or before the date of execution of this Lease, Lessee has delivered to Lessor, receipt of which is hereby acknowledged by Lessor, the following payments, as they appear on Exhibit "A" attached hereto: 1) the Initial Monthly Payment consisting of the Initial Fixed Rent plus the first month's common-area, MRWPCA and other charges or reimbursements, as applicable, and 2) the Security Deposit, for the full and faithful performance by Lessee of all of the covenants, conditions, terms and obligations of this Lease to be performed and kept by Lessee. If Lessee shall have fully and faithfully complied with all of the terms, covenants, conditions and obligations of this Lease, the security deposit shall be returned to Lessee within fifteen days after Lessee has vacated the demised premises. If Lessee defaults in respect to any of the terms, covenants, conditions and obligations of this Lease, including but not limited to nonpayment of rent, Lessor may use, apply or retain the whole or any part of the security deposit for the payment of any rent in default or for reimbursement of Lessor for any sums which Lessor may spend or be required to spend by reason of Lessee's default. The application by Lessor of all or any part of said security deposit shall not preclude Lessor from thereafter exercising each and all of Lessor's other rights and remedies upon such default of Lessee. Should Lessor resort to any portion or all of the security deposit then, and in that event, Lessee agrees to pay to Lessor the amount for which resort to the security deposit was had and necessary to restore the security deposit to the original sum required hereunder. Lessee will receive no interest on any portion of the security deposit. 7. GOVERNMENTAL INTERVENTION: In the event that Lessee's occupancy of the demised premises shall be prohibited, restricted, modified or interfered with in any respect by or as a result of any action of any governmental authority or agency then Lessee shall comply with any and all lawful orders made by any such governmental agency having jurisdiction in the premises and in the event that Lessee's occupancy shall be prohibited by reason of the intervention of such governmental agency then Lessee's sole remedy hereunder shall be an option to cancel this Lease and from and after the giving of written notice of the exercise of such option to cancel this Lease neither party hereto shall thereafter have any further obligations whatsoever by reason of this Lease. Lessee shall obtain any and all governmental approvals, authorizations, and permits necessary to enable Lessee to operate Lessee's business or practice in the premises and shall comply with any and all conditions and requirements imposed thereon, all at Lessee's sole cost and expense. Lessor shall have no obligation for obtaining any such approvals, authorizations or permits nor shall Lessor have any obligations or responsibility by reason of any governmental intervention, prohibition, condition or qualification with respect to Lessee's occupancy of the demised premises or Lessee's business or practice conducted therein regardless of whether any such governmental action be based upon any action or inaction of Lessor or action or inaction of Lessee. Lessor makes no warranties or representations with respect to the status or need for any governmental approvals, authorizations or permits by either Lessor or Lessee, and Lessee assumes full and complete responsibility for determining what permits, approvals and authorizations, if any are required, necessary or desirable. 8. DESIGNATION. MAINTENANCE, REPAIR OF COMMON AREAS: 1) Within and about the Center Lessor will from time to time provide and designate for the general use and convenience (among others) of Lessee and other lessees of all or any part of the Center and their respective employees, clients, customers and guests, certain common areas. 2) These shall include, but are not limited to sidewalks, landscaped areas, driveways, entrances, exits, lighting standards, lighting fixtures, exterior stairways, corridors, interior stairs, balconies and similar areas and improvements, loading and delivery areas, refuse disposal areas, and other areas and facilities that may be provided and designated by Lessor from time to time for the general use and convenience. 3) If Lessee defaults in making any payments required by this Subparagraph 3) Lessor may, in addition to other remedies under this Lease or provided by law, deny Lessee and its employees, patients, clients, sub-tenants, licensees, agents, service suppliers, customers 85 5 and patrons, the right to use any part of the common area, and may withhold all privileges herein granted so long as Lessee remains in such default. 4) In addition to the other rights herein reserved. Lessor shall have the right, in its sole discretion: a) To determine the nature and extent of the common area, whether the same shall contain surface, underground or multi-decked parking, and at any time to make such changes in the physical character, size, location, number, layout and operation of the common area as Lessor may deem advisable, including, but not limited to, the locating and relocating of driveways, entrances, exits, the direction and flow of traffic, vehicle parking spaces, the installation of restricted use areas and other changes to the common area in general : b) To establish and at any time to change, alter, amend and to enforce against Lessee and other users of the common area such reasonable rules and regulations, of which Lessor shall give Lessee written notice, as may be deemed necessary and advisable for the proper and efficient operation and maintenance of the common area and the Center. Lessee agrees to conform to and abide by all such rules and regulations in its use of the common area; c) To designate or prescribe upon written notice to Lessee, certain parts or sections within the common area in close proximity to the buildings, in which Lessee's employees, agents, sub-tenants, and concessionaires shall be forbidden to park their automobiles and, in the event that Lessor makes such a designation. Lessor may require such persons to use only such space in the common area or available public space outside thereof as is not so restricted. Upon written request of Lessor, Lessee shall, within seven days thereafter, furnish to Lessor the automobile license numbers of the automobiles customarily used by the above-specified persons. 9. PURPOSE: Lessee covenants that during Lessee's occupancy of the demised premises, Lessee will use the demised premises solely for the purpose of operating the practice or business appearing as Business Purpose in Exhibit "A" attached hereto. Lessee further covenants that Lessee will not at any time during Lessee's occupancy, use the premises for any other purpose without the written consent of Lessor first had and obtained. 10. COMPLIANCE WIM LAW: Lessee covenants that during Lessee's occupancy of the demised premises Lessee shall at Lessee's own cost and expense, promptly and properly observe, comply with and execute, all present and future orders, regulations, directions, rules, laws, ordinances and requirements of governmental authorities, including, but not limited to, state, municipal, county and federal governments and their departments, bureaus, boards and officials and the Board of Fire Underwriters and any other board or organization exercising similar functions arising from the use or occupancy of, or applicable in any manner to the demised premises or privileges appurtenant to or connected with the enjoyment of the demised premises. 11. USE AND CLEANLINESS AND OUIET ENJOYMENT: Lessee covenants that during Lessee's occupancy of the demised premises. Lessee will not permit said premises to be used for any improper, illegal or immoral purposes or permit Lessee's business to be carried on in such a manner, or Lessee's employees, clients, patients or customers to behave in such a manner as to be noisy, offensive or bothersome to other tenants or to others in the vicinity of the demised premises. Lessee further covenants to keep said premises and all windows therein clean at all times and free from dust, dirt or other unsightly substances and to deposit Lessee's refuse only in those areas designated by Lessor in writing from time to time. 12. ASSIGNMENT AND SUB-LETTING: 1) Lessee shall not sell, transfer, assign, mortgage or hypothecate this Lease or any interest in this Lease nor permit the use of the demised premises by any person or persons other than Lessee, nor sublet the premises or any part thereof without the written consent of Lessor first had and obtained, which consent shall not unreasonably be withheld. Consent to any of the aforementioned acts shall not operate as a waiver of the necessity of first obtaining the written consent of Lessor to any such subsequent act and the terms of any such consent shall be binding upon any person holding by, under or through any such written consent. Lessee agrees that the consent of Lessor shall not be deemed or considered withheld by reason of the fact that in the event of the sale of the business operated by Lessee on the demised premises, Lessor requires as a condition of the assignment of the Lease that the terms and 86 6 conditions of this Lease be modified, including but not limited to those terms and conditions concerning the security deposit or rent, or that a new lease be entered into. Lessee agrees that the consent of Lessor shall not be deemed or considered unreasonably withheld if Lessor refuses to consent to the assignment of this Lease to any person, firm or corporation other than an entity similar to that operated by Lessee with a financial statement and condition satisfactory to Lessor. In any event, if Lessor shall consent to any sublease, sale, transfer, assignment, mortgage or hypothecation of this Lease or any interest in this Lease, or if Lessee shall without such consent have sub leased, sold, transferred assigned, mortgaged or hypothecated this Lease or any or all of Lessee's interest therein then, without otherwise limiting any other remedies Lessor may have by law or under the provisions of this Lease, Lessor shall be entitled to receive and Lessee shall assign to and promptly pay to Lessor, any and all consideration that exceeds the monies owed by Lessee to Lessor under the terms of this Lease which are received by Lessee for or in connection with any such sublease, sale, transfer, assignment, mortgage or hypothecation of this Lease, including but not limited to all rent received by any sublessee that exceeds the amount of the Then Fixed Rent owed or paid by Lessee to Lessor and all transfer fees and the like, but excluding the sale price in the case of a sale of the business. 2) If this Lease is assigned to any person or entity pursuant to the provisions of the Bankruptcy Code, 11 V.S.C. Section 101 et seq., any and all monies or other considerations payable or otherwise to be delivered in connection with such assignment shall be paid or delivered to Lessor, shall be and remain the exclusive property of Lessor and shall not constitute property of Lessee or of the estate of Lessee within the meaning of said Bankruptcy Code. Any and all monies and or other considerations constituting Lessor's property under the preceding sentence not paid or delivered to Lessor shall be held in trust for the benefit of Lessor and be promptly paid or delivered to Lessor. 3) Any person or entity to which this Lease is assigned pursuant to the provisions of the Bankruptcy Code, aa U.S.C. Section 101 et seq., shall be deemed without further act or deed to have assumed all of the obligations arising under this Lease on and after the date of such assignment. Any such assignee shall, upon demand, execute and deliver to Lessor an instrument confirming such assumption. 13. ACCEPTANCE OF PREMISES: The entry by Lessee upon the demised premises shall be conclusive evidence against Lessee as an admission that every part of the demised premises is accepted "as is", and Lessee hereby agrees that Lessor has no responsibility for any cleaning, maintenance or repair of any part of said premises including but not limited to the plumbing, heating equipment, electrical wiring, fixtures, floors, ceilings, walls and their coverings and any contents situate therein; provided, however, that Lessor shall maintain the roof and exterior walls of the demised premises. Lessor shall have no responsibility in any respect for damages to property of Lessee caused by, water, flooding, waves or fluids of any nature or origin whatsoever. As part of the consideration for the rental, Lessee agrees to maintain the demised premises in a good, tenantable condition at all times during the term hereof, without cost to Lessor and further covenants that said premises shall not be altered, improved, or changed in any respect without the written consent of Lessor first had and obtained. Lessee hereby waives any and all benefits and rights to which Lessee might become entitled by reasons of Sections 1941 and 1942 of the Civil Code of California and any and all other provisions of any law that permit a Lessee to make repairs at the expense of a Lessor or to terminate a Lease by reason of the condition of the premises. 14. LIENS: Lessee covenants to keep the demised premises and any alterations, improvements and changes thereof, free and clear of liens of every kind and character whatsoever during Lessee's occupancy thereof, no matter what the source thereof, or the reason therefor, which may arise from the use or occupancy of said premises by Lessee, or from any work, labor or materials furnished to or performed upon said premises. Lessee further covenants to indemnify and hold Lessor free and harmless of and from any and all loss or damage howsoever arising by virtue of any such liens or claims of lien including any expense reasonably incurred by Lessor in defense against such claims. Lessor shall have the right to post and maintain on the demised premises such notices of non-responsibility or non-liability, as Lessor may deem appropriate to avoid any liability for liens. 15. ACCESSION: All alterations, improvements, additions or fixtures, including cabinets, shelves, panels, counters, built-in desks or other furniture, other than trade or professional equipment, fixtures and furniture not affixed to realty, that may be made, constructed or installed upon the demised premises by either Lessee or Lessor and that in any manner are attached to the floors, walls or ceilings, shall become and be the property of Lessor without cost and, at the 87 7 termination of this Lease, shall remain upon and be surrendered with the premises as a part thereof without disturbance, molestation or damage thereto. Any floor covering that may be cemented, nailed, tacked or otherwise affixed to the floor of the demised premises shall become and be the property of Lessor. Any light fixture that may be installed by Lessee in, upon or about the demised premises shall become and be the property of Lessor whether such fixture be affixed by screws, bolts, nails, glue or otherwise. 16. WASTE: Lessee shall not commit nor suffer to be committed any waste, legal, equitable or otherwise, to or upon the demised premises or any part thereof and covenants that at the expiration of the term hereof or any sooner termination thereof, Lessee will quit and surrender up said premises to Lessor peaceably and quietly and in as clean and good condition as said premises now are or may be put into, reasonable use and wear excepted. 17. HOLD-OVER TENANCY: Lessor and Lessee agree that there shall be no renewal of this Lease, except upon execution of a written agreement, and that the fact that the Lessee may continue in possession of the premises without the written consent of Lessor shall not operate to renew this Lease. If Lessee should continue to occupy the demised premises after the expiration of the term hereof without the written consent of Lessor, Lessee shall be deemed a tenant at sufferance and hereby explicitly agrees to continue to be bound, at Lessor's discretion, by the terms and conditions of this Lease. This provision for holdover tenancy is not to be construed as limiting the rights or remedies otherwise available to Lessor to remove Lessee, or, to limit the rights of Lessor or Lessee to resolve any dispute relating to rental for any option period. 18. FIRE AND GLASS INSURANCE: During the term hereof Lessee shall maintain in full force and effect upon all of Lessee's trade fixtures, "tenants" betterments and improvements, equipment, inventory and stock in trade in the demised premises a policy or policies of fire insurance issued by an approved California insurance company rated A+ XIV with all risk coverage endorsement to the extent of at least ninety percent of the replacement cost of such items. As long as this Lease is in effect, the proceeds of any such policy shall be used for the repair or replacement of the fixtures and equipment so insured. Lessor shall have no interest in the insurance upon Lessee's fixtures and equipment and Lessor will cooperate with Lessee in the settlement of any claim or loss by Lessee, provided that Lessee gives to Lessor satisfactory assurance that the proceeds of such insurance will be used in compliance with the requirement hereinabove contained respecting repair or replacement of said fixtures and equipment. During the term hereof Lessee shall also maintain in full force and effect at Lessee's expense a policy or policies of plate glass insurance, insuring Lessor's and Lessee's interests, as they may appear, covering all glass situate in the demised premises. Lessee shall also maintain at Lessee's cost fire legal liability equal to the value of the space rented by Lessee on a replacement cost basis. Lessor is to be named as its interest may appear as regards Lessee's tenants' betterments and improvements on the fire insurance policy of the Lessee, and Lessee is to provide sufficient amount of coverage to at least ninety percent coinsurance with a replacement cost endorsement and inflation guard endorsement of not less that a ten percent annual increase or cost-of-construction average increase as published by F. W. Dodge Systems, McGraw-Hill, in the Daily Pacific Builder, or other index agreed upon by the Lessor and Lessee, whichever is higher. Lessee covenants during the term of this Lease to reimburse Lessor for Lessee's share of any and all increases beyond the initial lease year for Fire Insurance premiums paid by Lessor for coverage of the real property of the Center. Lessee's share shall be calculated by prorating among Lessee and other lessees of the Center and vacant but leasable space of the Center, based upon square footage of floor space, any and all such premium costs paid by Lessor during each Lease Year. Each such reimbursement shall be paid by Lessee to Lessor within fifteen (15) days after Lessor has first billed Lessee or, at Lessor's discretion, shall be paid in monthly increments, on the first day of each month, together with such other monthly payments as are provided for herein. 19. LIABILITY INSURANCE: Lessee shall procure, at Lessee's own expense, on or before the date of the commencement of the term of this Lease and shall maintain continuously during the entire term hereof, public liability insurance in the amount of 5,500,000.00 or more for the injury or death of any one person and 5,000,000.00 or more for the injury or death of any number of persons in any one accident and property damage liability insurance in the amount of 5,500,000.00 or more. All of said policies of insurance shall provide that among the insured thereunder shall be included Lessor herein and all other persons whom Lessor may be required to keep insured. All of said policies of insurance shall be obtained from companies satisfactory to Lessor and shall contain an endorsement that such insurance shall not be canceled except after ten days written notification to Lessor. Lessee shall deliver to Lessor certificates evidencing the insurance 88 8 coverage herein provided for. Lessee shall pay the insurance premiums on all insurance coverage herein provided for when due. 20. PERSONAL PROPERTY TAXES AND REIMBURSEMENT FOR REAL PROPERTY TAXES: Lessee shall pay before delinquency any and all taxes, assessments, license fees and public charges levied, assessed, or imposed upon Lessee's fixtures, furniture, appliances, or personal property located in, upon, or about the demised premises, or on account of or by reason of any business or other activity conducted by Lessee in, upon or about the demised premises. Lessee further covenants during the term of this Lease to reimburse Lessor for increases beyond the initial lease year for Lessee's share of any and all property taxes and assessments levied upon the land and improvements of the Center, which such share shall be calculated by prorating among Lessee, other lessees of the Center and vacant but leasable space of the buildings of the Center, based upon square footage of floor space, all those real property taxes and assessments which may from time to time be levied upon the Center by the County and/or of Monterey, or by any other competent government body. Any such taxes and assessments which are payable by Lessee shall be paid by Lessee to Lessor within fifteen days after Lessor has first billed Lessee for such payments or, at the discretion of Lessor, shall be paid in monthly increments, on the first day of each month, together with such other monthly payments as are provided for herein. 21. DAMAGE OR DESTRUCTION OF DEMISED PREMISES: If the demised premises or the building in which they are situate are totally destroyed or damaged more than thirty percent in value by fire or the elements during the term of this Lease, Lessor shall thereupon have an election to terminate this Lease. If Lessor should exercise such election to terminate this Lease, all rights and obligations herein shall cease and terminate, except for rent and other sums accrued and unpaid to date of such destruction or damage. Written notice terminating this Lease pursuant to Lessor's aforesaid election shall be given to Lessee not later than sixty days after any such damage or destruction. If the demised premises or the building in which they are situate be so damaged by fire or the elements and Lessor does not exercise Lessor's election to terminate said Lease as hereinabove provided, and Lessor restores said demised premises at its own expense, then this Lease shall remain in full force and effect. In the event that repairs are to be made pursuant to this paragraph. Lessor shall be entitled to and shall have possession of the necessary parts of said premises for such purpose, and if there is any substantial interference with Lessee's, business on account of such repairs. Lessee shall be entitled to a proportionate reduction of rent during the time that said repairs are being made. If Lessor should elect to repair or rebuild because of any damage or destruction, as hereinabove provided. Lessor's obligation shall be limited to restoration of the demised premises or the building in which they are situate to a condition similar to that provided by Lessor at the commencement of the term hereof, or to any reasonable substitute therefor so long as such substitute meets applicable Code requirements, and Lessee shall fully repair or replace all exterior signs, trade fixtures, equipment, display cases, and other installations originally installed by Lessee at its own expense including but not limited to all of Lessee's betterments and leasehold improvements. 22. PROHIBITED ACTS: Lessee covenants not to do and not permit to be done, anything in, on or about the premises, and not to bring, nor keep anything therein which will in any way affect fire or other insurance upon the entire property, building, or any of its contents other than as shall be specifically allowed elsewhere in this Lease, nor which will violate any law or regulation which now may be or which in any way may obstruct or interfere with the rights of others, or injure, or annoy them. Lessee and Lessor further covenant that should there be an increase in fire or other insurance rates on any insurance held by Lessor on the demised premises which increase is caused by or is attributable to the equipment, installations, alterations, or the business conducted by Lessee, the monthly rental to be paid by Lessee shall be raised correspondingly to cover the increase in such insurance rates. 23. INSPECTION: Lessor and Lessor's agents shall have the right to enter into and upon the demised premises at all reasonable times, and in emergencies at all times, for the purposes of inspecting the same, protecting Lessor's reversion, making repairs, additions, or alterations to the premises or to any property owned or controlled by Lessor, or, for any lawful purposes. At any time within ninety days prior to the expiration of the term hereof, Lessor shall have access to the premises for the purpose of exhibiting them to prospective tenants for their inspection and for posting for lease or for rent signs upon the premises. 24. BANKRUPTCY OR INSOLVENCY: 1) If Lessee should execute a voluntary assignment hereof without the written consent of Lessor first had and obtained, or, if there should occur any assignment hereof by operation of law 89 9 on account of any act of Lessee, or, if Lessee, or any member of Lessee if Lessee be a partnership or joint venture, should file any petition in bankruptcy or any petition for extension or composition of creditors, or become insolvent, or make any assignment of any of Lessee's property for the benefit of Lessee's creditors, or, if any involuntary bankruptcy proceedings should be initiated against Lessee and Lessee fails to obtain the dismissal of such proceedings within ninety days after same are filed or, if any receiver be appointed of the business or of the assets of Lessee, this Lease, at the election of Lessor, shall thereupon immediately terminate, and said lease or any interest in said leasehold shall not be assignable by any process of law, or be treated as an asset of Lessee thereafter, nor shall it pass under the control of any trustee or assignee of Lessee by virtue of any such proceeding or act of Lessee. If any such act or proceeding shall occur, Lessor may terminate this Lease by the mailing of written notice to the Lessee's Address For Notice as shown in Exhibit A attached hereto, stating Lessor's election to so terminate, and all rights of Lessee hereunder shall thereupon terminate, and Lessor may promptly re-enter upon said premises. 2) Lessee shall not at any time during the term hereof permit its net worth, determined in accordance with generally accepted accounting principles consistently applied, to fall below 550,000. If Lessee defaults in the payment of any installment of rent or of any other monies due to Lessor under the terms of this Lease, Lessee shall deliver to Lessor, within five calendar days after demand by Lessor, a balance sheet of Lessee as of a date not more than thirty days prior to the first day of the month during which said installment of rent or other payment was due hereunder, certified by Lessee to present fairly the financial position of Lessee as of the date of such balance sheet. If Lessee fails to deliver its balance sheet in accordance with the provisions of the preceding sentence, Lessee shall conclusively be deemed to be in default of this Lease under the first sentence of this paragraph and, since the obligations of Lessee under this paragraph are a material obligation of Lessee's tenancy under this Lease, Lessor shall, upon such default, have the right to terminate this Lease immediately by written notice of termination handed or mailed to Lessee. Lessee expressly agrees that upon receipt of such notice of termination of Lease under the provisions of this paragraph, Lessee will peaceably and quietly vacate the premises no later than thirty days after the dispatch by Lessor of such notice to Lessee. 25. DEFAULT AND RE-ENTRY: If Lessee defaults in the payment of any rent as required hereby to be paid or, if Lessee defaults in the performance of any term, covenant, condition, or obligation required hereby to be performed by Lessee and such default continues for a period of ten days after written notice is mailed to Lessee of such default, then, in addition to any other remedy Lessor may have by operation of law. Lessor shall have the right, without any other or further notice or demand, to enter upon the premises, and eject all persons from the premises and remove all property therefrom, using such lawful force as may be necessary to so do, in which case Lessor shall not be responsible for the care or safety of persons or property so removed and Lessee hereby waives any and all claim for loss or damage to property or persons so removed from the demised premises by Lessor pursuant hereto, and Lessor, in the case of any such default by Lessee in the payment of rent or in the performance of any one of the terms, covenants, conditions, or obligations herein contained, may declare this Lease terminated, take possession as above provided, and retain all prepaid rentals and other prepaid expenses or deposits as Lessor's damages or Lessor may, without terminating this Lease or declaring a forfeiture of Lessee's rights hereunder, retain all prepaid rentals and other prepaid expenses or deposits, re-let the premises or any part thereof, as the agent and for the account of Lessee upon such terms and conditions as Lessor may deem advisable, either with or without any unattached equipment or fixtures left remaining in the demised premises by Lessee, in which event the rents received on such re-letting and retained prepayments or deposits shall be applied first to the expenses of such re-letting and collection of rent, including any necessary renovation and alteration of the premises, and reasonable attorney's fees, and any actual real estate commissions paid, and thereafter the balance of any such rents, retained pre-payments or deposits shall be applied to the payment of all sums due or to become due to Lessor hereunder and, if a sufficient sum shall not be thus realized to pay such sums and other charges. Lessee shall pay to Lessor any deficiency monthly, notwithstanding Lessor may have received rental in excess of the rental stipulated in this Lease in previous or subsequent months, and Lessor may bring an action therefor as such monthly deficiency shall arise, in which event Lessor shall be entitled to recover reasonable attorney's fees for commencing and prosecuting such suit. Lessor shall be entitled to each and all of Lessor's remedies, and the election to proceed with one may not be construed as excluding the subsequent use of any other. The remedies herein granted to Lessor shall not be construed to be any limitation of any rights, or remedies otherwise available to Lessor, but shall be construed to be in addition thereto. Any reentry by Lessor as aforesaid shall be allowed by Lessee without hindrance and Lessor shall not be liable in damages 90 10 for any such reentry, or be guilty of trespass or forcible entry. In the event Lessee breaches this Lease, whether or not he abandons the demised premises, this Lease shall continue in effect for so long as Lessor does not terminate Lessee's right to possession, and Lessor may enforce all of its rights and remedies under said Lease, including the right to the rental provided for herein as it becomes due under this Lease. In the event Lessor terminates Lessee's right to possession of the demised premises, any damages Lessor may recover for Lessee's default of rent or other agreement contained herein shall include the worth at the time of the award of such damages of the amount by which the unpaid rent for the balance of the term after the time of the award of such damages exceeds the amount of such rental loss for the balance of the term of which Lessee proves could be reasonably avoided. 26. LESSOR-LESSEE LIABILITY: Lessor shall not be liable for any loss or damage that may result to any property belonging to Lessee, located in, on, or about said demised premises from any cause whatsoever, nor shall Lessor be liable for any damage or injury to any person or property occurring or arising in, on, or about the demised premises from any cause whatever. Lessee hereby covenants to save and hold Lessor, his agent or manager harmless from and to defend Lessor against any suit or claim or demand for damage or injury to any person or properties sustained in, on, or about the demised premises from any cause whatever during the term hereof. 27. LATE PAYMENT CHARGES AND INTEREST ON DELINOUENCIES: Time is of the essence of each and every obligation, covenant and condition of this Lease. In addition to any other remedies of which Lessor may avail itself. Lessor shall be entitled to the following late payment penalties: If Lessee fails to pay to Lessor any payment or any portion thereof that becomes due under the terms and conditions of this Lease by 5:00 PM on the fifth day after such payment has become so due, then Lessee agrees to pay to Lessor a one-time late payment fee of the greater of 10X of the overdue amount or 5,100.00. In addition to the aforesaid late payment fee, Lessee also agrees to pay to Lessor on the first day of each month during and after the term of this Lease, on any amounts then still overdue, interest at the rate of the lesser of one percent per month (12X per annum) or the maximum rate permitted by law. The forgoing shall apply to any and all payments that Lessor may from time to time be entitled to receive from Lessee under the various provisions of this Lease and which are not received by Lessor within five days of their respective due dates as specified herein. Lessor may bill Lessee from time to time for any such late payment fees or interest then owing and Lessee shall pay to Lessor the full amount of such billed fees or interest within five days of receipt of such bill. Failure of Lessor to so bill Lessee shall not relieve Lessee of Lessee's obligation to pay such fees and interest to Lessor. 28. ATTORNEYS' FEES: If either party hereto should bring suit against the other party hereto for the breach of any term, covenant, condition or obligation herein contained to be kept, by such other party, for the recovery of any sum due hereunder, or to recover possession of the premises, or for any summary action for forfeiture of this Lease, or to prevent further violations of any of the terms, covenants, conditions or obligations, or, for any other relief, then the prevailing party in such suit for summary action shall be entitled to a reasonable attorney's fee to be fixed by the court. 29. NON-WAIVER OF BREACH: Lessor's failure to take advantage of any default or breach of covenant on the part of Lessee shall not be construed to be a waiver thereof: nor shall any custom or practice which may grow up between the parties hereto in the course of administering this Lease be construed to waive or to lesson the right of Lessor to insist upon the performance of any and all terms, covenants, conditions, and obligations hereof, or to exercise any right given Lessor on account of any default. A waiver of a particular breach or default shall not be deemed to be a waiver of the same or any other subsequent breach or default. Lessor's consent to or the approval of any act by Lessee requiring Lessor's consent or approval shall not be deemed to waive or render unnecessary Lessor's consent to or approval of any subsequent or similar act by Lessee. 30. CONDEMNATION: 1) If title to all of the premises is taken for any public or quasi public use under any statute, or by right of eminent domain, or by private purchase in lieu of eminent domain, or if title to so much of the premises is so taken that, in the sole opinion of Lessor, a reasonable amount of reconstruction of the premises will not result in the premises being a practical improvement, or reasonably suitable for Lessee's continued occupancy for the uses and purposes for which the premises are leased, then, in either event, this Lease shall terminate on the date that possession of the premises, or part of the premises, is taken, unless Lessor elects that said lease continue. 91 11 2) If this Lease continues under provisions of paragraph A. above, the Then-Fixed Rent shall be reduced in the same proportion that the floor area of the portion of the premises so taken (less any additions to the premises by reconstruction) bears to the original floor area of the premises. Lessor shall, at Lessor's own cost and expense, make all necessary repairs or alterations to the building in which the premises are located so as to constitute the portion of the building not taken as a useable unit. There shall be an equitable abatement of rent during such restoration period. 3) All compensation awarded or paid upon a total or partial taking of the fee title of the premises shall belong to Lessor, whether such compensation be awarded or paid as compensation for diminution in value of the leasehold or of the fee provided, however, that Lessor shall not be entitled to any award made to Lessee for depreciation or damage to, or cost of removal of stock and fixtures, if any. 4) Each party agrees to execute and deliver to the other all instruments that may be required to carry out the provisions of this paragraph, and Lessee shall assign to Lessor and appoint Lessor to act for Lessee in all matters of condemnation except for Lessee's specific rights to damages as set forth in C. above. 31. UTILITIES: Lessee will, during the term of this Lease or any extensions or holdover periods thereof, pay for all charges for utilities and sanitary services furnished to or performed upon the demised premises including but not limited to electricity, gas, telephone, water, sewer, including MRWPCA charges and city surcharges, garbage, trash, insect and rodent control. Lessee shall, if feasible, pay for the above services directly to the public utility or other supplier. In the case of MRWPCA charges which are attributable to the demised premises but are billed to Lessor, Lessee agrees to reimburse Lessor as provided for herein. Lessor makes no representation or warranty whatsoever as to the availability of water, gas, electricity, or any other utility service for Lessee's intended use and Lessee acknowledges that Lessee has made Lessee's own investigation with respect to the availability of any and all utility services required by Lessee and that Lessee is satisfied with respect to such availability and that Lessor has no obligation whatsoever with respect thereto. To the extent that such is permissible or can be accomplished, from time to time, in accordance with applicable rules and regulations, and in Lessor's sole opinion at reasonable cost. Lessor shall use Lessor's best efforts to obtain, install and pay for an individual meter for each of the utility services required by Lessee upon Lessee's demised premises. If, for any reason, Lessor cannot obtain an individual or separate meter for Lessee's demised premises, then Lessor shall utilize Lessor's best efforts to make any such required utility services available to Lessee through Lessor's existing meters and Lessor shall bill to Lessee and Lessee shall pay to Lessor within ten days of a statement therefor such amount as lessor shall determine to be Lessee's fair and equitable share of any such utilities and Lessor's determination in this regard shall be final, binding and conclusive upon Lessee. 32. HEIRS AND ASSIGNS: Except as herein otherwise provided, all terms, conditions, covenants and obligations contained in this Lease shall be binding upon and inure to the benefit of the heirs, successors, legal representatives and assigns of the parties hereto. 33. NOTICES: All notices, statements, demands, requests, approvals, authorizations, offers, agreements, appointments or designations under this Lease by either party to the other shall be in writing and shall be served personally upon the other party or deposited in the United States mail, certified mail, return receipt requested, postage prepaid, and addressed to Lessee at Lessee's Address For Notice as it appears on Exhibit A attached hereto, or to such other address as Lessee may from time to time designate to Lessor in writing, and addressed to Lessor at A. G. Davi, Ltd., Post Office Box 2350, Monterey, California, 93942-2350, or at such other address as Lessor may from time to time designate to Lessee in writing. 34. CONSTRUCTION: Each term, covenant, condition and obligation of this Lease to be performed by Lessee shall be construed to be both a covenant and a condition. 35. LAYOUT OF ME DEMISED PREMISES AND SURROUNDING AREA OWNED BY LESSOR: Lessor does not guarantee a continuance of the passage of light and air over the demised premises or over any of the real property adjoining the demised premises and Lessor expressly reserves all air space over the demised premises. Any reference in this Lease with respect to the location of buildings, open, controlled or other parking areas, and other improvements shall not be deemed to be a warranty or representation. Lessor hereby reserves the right at any time to make any alterations or additions to or to build additional stories on any presently existing buildings owned by Lessor. Lessor also reserves the right to construct other buildings or improvements upon the surrounding real property which may be owned by Lessor from time to time, and to make alterations or additions thereto and to build additional stories on any such buildings and to modify and 92 12 reallocate space within the center. Lessor further reserves rights-of-way and easements in, over, under, and through Lessee's demised premises for sprinkler and fire-detection system purposes, power and telephone lines, plumbing lines and conduits for all utilities, together with the right to locate, relocate, and maintain the same at any and all times and from time to time in, upon, over, or under Lessee's demised premises without any rebate of rent or liability for any interruption or disturbance caused by Lessor, its agents, servants or employees, or by any utility company employee or representative: provided, however, that Lessor shall use reasonable discretion in exercising its rights pursuant to this sentence. 36. NUMBER AND GENDER: When required by the context, whenever the singular number is used in this Lease, it shall include the plural, the masculine gender shall include the feminine and neuter genders, and the word "person" shall include corporation, firm, partnership, or association. If there be more than one Lessee, the obligations imposed herein upon Lessee shall be joint and several. 37. MARGINAL TITLES: The marginal headings or titles to the paragraphs of this Lease are not a part of this Lease and shall have no effect upon the construction and interpretation of any part of this Lease. 38. MODIFICATION AND VOIDANCE OF PRIOR AGREEMENTS: This instrument contains all the agreements and conditions made between the parties to this lease and may not be modified orally or in any other manner than by an agreement in writing signed by all of the parties to this Lease or other respective successor or successors in interest. This Lease supersedes any and all prior written and oral agreements between Lessor and Lessee, which such agreements, if any, are void and of no further effect. 39. TIME OF ESSENCE: Time is of the essence of each term, covenant, condition and obligation of this Lease. 40. PAYMENTS NOT IN SUBSTITUTION: Except as otherwise expressly stated, each payment required to be made by Lessee shall be in addition to and not in substitution for other payments to be made by Lessee. 41. CONVEYANCE BY LESSOR: If, during the term of this Lease, Lessor shall sell Lessor's interest in the demised premises, then from and after the effective date of such sale Lessor shall be released and discharged from any and all obligations and responsibilities under this Lease except those already accrued; provided, however, that any such purchaser shall assume all of Lessor's obligations to be performed hereunder, including the obligation to refund the security deposit at the expiration of this term. 42. SIGNS AND ADVERTISING: Except as herein provided, no sign, advertisement, or notice or other thing shall be inscribed, painted or otherwise displayed, or screens, awnings, shades, decorations, symbols, fixtures or any other thing affixed or placed on or about any part of the outside of the demised premises (or inside of the demised premises where such may be seen through windows or otherwise by passers-by) except of such color, size, or style, and in such place on or in said premises as shall first be fixed, designated and approved by Lessor in writing and Lessee hereby agrees that Lessor may at Lessor's discretion, at any time enter the demised premises and remove such thing that has not been so approved without the need to first consult with Lessee. 43. STATEMENT OF LESSEE: Lessee shall at any time and from time to time upon not less than fifteen days prior written request by Lessor, execute, acknowledge and deliver to Lessor a statement in writing certifying that this Lease is unmodified and in full force and effect if such is the fact (or if there has been any modification thereof that the same is in full force and effect as modified and stating the modifications) and the dates to which rentals and other charges have been paid in advance, if any. It is expressly understood and agreed that any such statement delivered pursuant to this paragraph may be relied upon by any prospective purchaser of the complex or estate of Lessor or by the mortgagee or assignee of any mortgagee of any mortgage or the trustee or beneficiary of any deed of trust constituting a lien upon the leased premises or upon property including the leased premises or any part thereof. 44. CLEANING, JANITORIAL SERVICE, GARBAGE AND REFUSE COLLECTION AND REIMBURSEMENT: Lessor shall have no responsibility for the furnishing of any janitorial or cleaning service, to the demised premises. Janitorial and cleaning service within the demised premises and refuse collection shall be the sole responsibility and at the sole cost of Lessee. Lessee covenants and agrees to 93 13 obtain sufficient janitorial and cleaning service, and refuse collection, to maintain the demised premises in a neat and orderly condition at all times. Lessee further agrees to deposit Lessee's refuse and garbage only in those areas designated in writing by Lessor from time to time. Lessor shall arrange for the collection and removal of Lessee's and other lessees' garbage and refuse which is so deposited, and shall advance on behalf of Lessee and other lessees the cost of such service. Lessor may bill Lessee and other lessees for their respective prorata shares of such costs, in which case Lessee agrees to reimburse Lessor for such advances within fifteen days of receipt of said bill. At Lessor's discretion such advances shall be paid by Lessee to Lessor in monthly increments on the first day of each month, together with such other monthly payments as are provided for herein. 45. ALTERATIONS/IMPROVEMENTS: Lessee shall not make any improvements on the property without Lessor's consent. In making any alterations that Lessee has a right to make. Lessee shall comply with the following: 1) Lessee shall submit reasonably detailed plans and specifications of the proposed alterations before the commencement of such Lessor approved alterations. 2) The alterations shall not commence until five (5) days after Lessor has received notice from Lessee stating the date the construction is to commence so that Lessor can post and record an appropriate notice of non-responsibility. 3) The proposed improvements shall be approved by all the appropriate government agencies, and all applicable permits and authorizations shall be obtained before commencement of the alterations. All approved improvements shall be completed in the standard workmanship quality. 4) The proposed improvements shall be approved by all the appropriate government agencies, and all applicable laws. 5) Before commencing the alterations and at all times during construction, Lessee shall maintain insurance as provided for in paragraphs 18 and 19. In addition, contractor shall be licensed and insured and a Certificate of Insurance with liability insurance in the amount of 51,000,000.00 and Worker's Compensation Insurance shall be provided by Lessee's contractor to Lessor within 10 days prior to commencement of any work and said certificate shall name Lessor as additionally insured. 6) Lessee shall pay all costs for construction done by it or caused to be done by it on the premises as permitted by this Lease. Lessee shall keep the improvements and land free and clear of all mechanics' liens resulting from construction done by or for Lessee. 46. SUBORDINATION: This Lease is and shall be subordinate to any encumbrance now of record or recorded after the date of this Lease affecting the building, other improvement, and land of which the premises are a part. Such subordination is effective without any further act of Lessee. Lessee shall from time to time upon request from Lessor execute and deliver any documents or instruments that may be required by a lender to effect any subordination. If Lessee fails to execute and deliver any such documents or instruments. Lessee irrevocably constitutes and appoints Lessor as Lessee's special attorney in fact to execute and deliver any such documents or instrument. 47. HAZARDOUS MATERIALS: 1) Hazardous Materials. Tenant shall not at any time during the term of this Lease use, generate, store, or dispose of, on, under or about the Premises any hazardous substance, hazardous waste, toxic substance, pollutants, contaminants, or related materials, ("Hazardous Materials"), except those, if any, listed in Exhibit "A", attached hereto and made a part hereof. For the purpose of this covenant, Hazardous Materials shall include, but shall not be limited to, substances defined as "hazardous substances" or "pollutants or contaminants" in the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. Section 9601 etseq., those substances defined as "hazardous waste" by the Resource Conservation and Recovery Act, as amended, 42 U.S.C.Section 6901 et seq., and by Section 25117 of the California Health and Safety Code, and those substances defined as "hazardous substances" in Section 25316 of the California Health and Safety Code, and the regulations adopted and publication promulgated pursuant to said laws. Lessee shall indemnify, defend, and hold Lessor harmless from and against all liability, including all foreseeable and enforceable consequential damages, directly or indirectly arising out of the use, generation, storage or disposal of Hazardous Materials, including, without limitation, the cost of any required or necessary repair, clean-up or detoxification and the preparation of any closure or other required plans, to the full extent that such action is attributable, directly or indirectly, to the use, generation, storage or disposal of Hazardous Materials on the Premises at any time. Lessee shall provide written notice to the Lessor of any present or future hazardous substance release that Lessee Knows or has reasonable cause to believe is or will be present on or under the Premises, within a 94 14 reasonable period of time after such release is discovered or believed by the Lessee to be present. (See Health and Safety Code Section 25359.7) 2) Hazardous Materials Report. Lessee agrees that if Lessee is unable for any reason to complete the certification provided for in Paragraph 1.3. below, Lessee shall obtain and deliver to Lessor within five days before or after the termination of this Lease a hazardous substance report concerning the Premises ("Hazardous Materials Report"), the purpose of which Hazardous Materials Report shall be to affirm that Lessee shall be in compliance with all applicable laws, ordinances, rules, regulations of any governmental agency having jurisdiction concerning the use, storage and/or dispositions of hazardous materials on the Premises at the termination of this Lease or any extension thereof. The Hazardous Material Report shall be obtained by Lessee at its sole cost and expense, for the purposes of this report, a "hazardous material" is defined as any substance the existence or effect of which is subject to Federal, State or Local regulation, investigation, correction or removal as potentially injurious to public health or welfare. Lessor and Lessee acknowledge that extensive Local, State and Federal legislation establishes broad liability upon owners and/or users of real property for the investigation and correction of such hazardous material conditions. The Hazardous Material Report shall be in writing, and shall be prepared by a licensed contractor or engineer competent to perform such investigation on behalf of Lessee. If the Hazardous Materials Report shall indicate a condition requiring correction or posing a potential liability to Lessor, Lessee shall forthwith cure the condition(s) specified in the Hazardous Materials Report at Lessee's sole cost and expense, prior to the termination of this Lease. 3) Hazardous Materials Certification by Lessee. Lessee may elect to execute an indemnification agreement and notarized certification under penalty or perjury substantially as follows, in lieu of the report described in Paragraph 1.2 above: i) That no hazardous materials other than those if any, listed in Exhibit "A" have been introduced to the Premises. ii) That there be no spillage of hazardous materials listed in Exhibit "A" and that such materials have been properly stored in closed containers in accordance with the law. iii) That Lessee agrees to pay the cost of cleaning up any contamination resulting from Lessee's use or occupancy of the Premises and hold harmless and indemnify Lessor and Lessor's agents for any claims that result therefrom. Lessee shall deliver such certification to Lessor within five days before or after the termination for any reason of Lessee's occupancy of the Premises. If Lessee fails to so deliver such certification within the time required. Lessee shall comply with the provisions of Paragraph 1.2. above. IN WITNESS WHEREOF, the parties hereto have set their hands on the date first hereinabove written. LESSOR LESSEE - ------ ------ J.V. Rossi Cypress Bank By: /S/ A.G. Davi By: /S/ Thomas Sa ------------------------------- ------------------------------- A.G. Davi Ltd., Agent for Owner Officer of Corporation Date: 3/6/97 Date: 3/3/97 ----------------------------- ------------------------------ 95 15 Exhibit "A" Lease particulars (this page) and schematic location (next page-not to scale) of Demised premise, common area, located within 484 Lighthouse, Suite 101.102 and 103. Monterey, CA, 93940: 1) Lessee Cypress Bank, a California Corporation 2) Demised Premises 484 Lighthouse, Suite 101, and 103 Monterey, CA 93940 3) Approximate Term 36 Months 4) Commencement Date 3-1-97 5) Expiration Date 2-28-2000 6) Approximate Area of Demised Premises 1598 sq ft +/- 7) % of Occupancy Not Applicable 8) Business Purpose Retail Financial Institution 9) Security Deposit $1997.00 10) Address for Lessee 484 Lighthouse, Suite 101&103 Notice Monterey, CA 93940 11) Calculation of Monthly Payment: Initial Fixed Rent $ 1997.00 Garbage $ 26.42 MRWPCA $ 9.48 Initial Monthly Payment $ 2032.90 12) Due Upon Execution of Lease: Security Deposit $ 1997.00 Sec Dep Paid $(1309.00) Initial Payment $ 2032.90 Total Due $ 2720.90 96 16 Exhibit "B" (Schematic Drawing) (Not to Scale) FIRST FLOOR 97 17 ADDENDUM NO. 1 TO LEASE THIS ADDENDUM, is to that Lease for the premises known as 484 Lighthouse Avenue, Suite 10-1 &103, Monterey, California. WHEREAS, this is an addendum to the Lease dated March 1, 1997, between J. V. Rossi, Lessor, and Cypress Bank, a California Corporation, Lessee, for the premises at 484 Lighthouse, Suite 101 and 103, Monterey, CA. 93940. NOW THEREFORE, Lessor and Lessee do further agree as follows: CONDITION TO LEASE. This Lease is conditioned upon satisfaction of the following: a. Lessee obtaining approval of this lease transaction and Lessee's contemplated use of the Premises by the Federal Deposit Insurance Corporation ("FDIC") and the State of California Department of Banking ("State Banking Department"). Presently, the Lessee is seeking and has applied for such approval from the FDIC and State Banking Department. If Lessee does not obtain approval of this lease transaction and Lessee's contemplated use by the FDIC or State Banking Department within (60) days after full execution of this Lease, then this Lease shall terminate. b. Lessee shall have First Right of Refusal to Lease approximately 250 sq.ft. of office space upstairs as soon as available. c. Lessee shall have the right to install an ATM on blank wall on far right of building. Lessee shall obtain proper permits and incur all costs. D. Lessee shall have the right to make existing space and new space one, including any removing and adding walls. Lessee shall incur all expenses. Lessee shall submit all plans to Lessor for approval. PARKING. Lessee shall have six designated parking spaces. Lessee and Lessor agree that the Parking area shall be solely for the purpose of the daily parking of passenger automobiles owned, leased, controlled or authorized by Lessee, Lessor an other tenants. Lessee agrees to use such parking area solely for said purpose and in accordance with provisions of this agreement and releases Lessor of any obligation and all obligation or responsibility to prevent the use of said area by persons and vehicles not conforming to such purpose, not licensed by Lessor or not authorized by Lessee or other tenants. Lessee further release and indemnifies Lessor against any claims for loss or damage to vehicles, their occupants or contents which are parked or driven in the Parking Area or on other grounds of the Building. Lessee agrees to be responsible for policing parking and that parking will be limited to Lessee's assigned spaces. TERMINATION OF LEASE. This Lease terminates the previous Lease signed and dated 12/27/96 between J.V. Rossi, Lessor, and Cypress Bank, Lessee for the premises at 484 Lighthouse, Suite 101, Monetery, Ca, 93940. IN WITNESS WHEREOF, the parties hereto have executed this Addendum to be effective,March 1, 1997. LESSOR: LESSEE: J.V. Rossi Cypress Bank, a California Corporation /s/ A.G. Davi /s/ Thomas Sa - -------------------------------- -------------------------------------- A.G. Davi, LTd., Agent for Owner Officer of Corporation Date: 3/6/97 Date: 3/7/97 98 18 OPTION TO EXTEND TERM If Lessee is not in default in the performance of any of Lessee's obligations hereunder, Lessor hereby grants to Lessee an option to extend the term of this Lease, subject to similar terms and conditions thereof, for an additional period, of three years, such additional term to commence upon the date following the final day of the original term granted herein, and subject to the agreement of the fair market rental for such option period by Lessor and Lessee. To exercise Lessee's option, Lessee shall give to Lessor notice in writing by registered or certified mail, postage prepaid with the return receipt requested, addressed to Lessor at Lessor's address for notice provided herein, not sooner than eight (8) months prior to the expiration of the original term hereof and not later than six (6) months prior to the expiration of the original term hereof. Upon receipt of the notice of Lessee's exercise of said option, Lessor and Lessee shall endeavor to reach an agreement upon the rental for the term of said option period. If such agreement cannot be accomplished sixty (60) days prior to the date on which the term of said option period commences, the option right is hereby terminated. Lessee agrees to permit a "For Lease" sign in window of demised premise, if agreement is not reached, as required above. IN WITNESS WHEREOF, the above-named parties hereto have: A) set their hands the date first hereinabove written, B) acknowledge receipt of a copy hereof, and C) have read, understand and agree to all of the above. LESSOR LESSEE J.V. Rossi Cypress Bank, a California Corporation /s/ A.G. Davi /s/ Thomas Sa - -------------------------------- -------------------------------------- A.G. Davi, Ltd., Agent for Owner By Officer of Corporation Date: 3/6/97 Date: 3/7/97 99 EX-23.1 3 INDEPENDENT AUDITORS' CONSENT 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 33-89948 of Central Coast Bancorp on Form S-8 of our report dated January 30, 1998, appearing in the Annual Report on Form 10-K of Central Coast Bancorp for the year ended December 31, 1997. DELOITTE & TOUCHE LLP Salinas, California March 23, 1998 EX-27.1 4 FINANCIAL DATA SCHEDULE
9 This schedule contains summary financial information extracted from (a) Item 7 - "Financial Statements and Supplementary Data" and is qualified in its entirety by reference to such (b) financial statements included in this report and incorporated herein by reference. 1,000 U.S. DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 39,891 0 64,706 0 91,481 39,048 39,105 257,393 4,223 497,674 450,301 0 3,649 0 0 0 31,644 11,979 497,674 24,828 5,823 3,265 33,916 11,943 12,041 21,875 64 0 12,573 11,003 11,003 0 0 6,503 1.36 1.26 6 816 79 0 0 4,372 440 227 4,223 4,223 0 0
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