-----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, Q96FLkzClAIpbrqpS/EivJxS+Zf+sEjiWCqM19prnx0v1mIxWHtWx+luVc1AzqSi lVe/ykQ42wJsVYIf8XUW1A== 0000921085-03-000008.txt : 20030324 0000921085-03-000008.hdr.sgml : 20030324 20030321190316 ACCESSION NUMBER: 0000921085-03-000008 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030324 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: 1934 Act SEC FILE NUMBER: 000-25418 FILM NUMBER: 03612982 BUSINESS ADDRESS: STREET 1: 301 MAIN ST CITY: SALINAS STATE: CA ZIP: 93901 BUSINESS PHONE: 4084226642 MAIL ADDRESS: STREET 1: 301 MAIN STREET CITY: SALINAS STATE: CA ZIP: 93901 FORMER COMPANY: FORMER CONFORMED NAME: SALINAS VALLEY BANCORP DATE OF NAME CHANGE: 19940330 10-K 1 form10k02.txt FORM 10-K FPR THE YEAR ENDED DECEMBER 31, 2002 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, 2002 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-25418 -------- CENTRAL COAST BANCORP --------------------- (Exact name of registrant as specified in its charter) STATE OF CALIFORNIA 77-0367061 ------------------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 301 Main Street, Salinas, California 93901 ------------------------------------ ----- (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code (831) 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 Common Stock (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 [ X]. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ X ] No [ ] The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter was $166,515,208. As of March 7, 2003, the registrant had 9,917,241 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 2003 annual meeting of shareholders. The Index to Exhibits is located at page 78 Page 1 of 125 Pages CENTRAL COAST BANCORP INDEX TO ANNUAL REPORT ON FORM 10-K FOR YEAR ENDED DECEMBER 31, 2002 Part I. Page Item 1. Business 3 Item 2. Properties 17 Item 3. Legal Proceedings 18 Item 4. Submission of Matters to a Vote of Security Holders 18 Part II. Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 19 Item 6. Selected Financial Data 21 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 24 Item 7A. Quantitative and Qualitative Disclosures About Market Risks 47 Item 8. Financial Statements and Supplementary Data 47 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 69 Part III. Item 10. Directors and Executive Officers of the Registrant 69 Item 11. Executive Compensation 69 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 69 Item 13. Certain Relationships and Related Transactions 69 Item 14. Controls and Procedures 70 Part IV. Item 15. Exhibits, Financial Statement Schedules and Reports 72 on Form 8-K Signatures and Certifications under Section 302 of the Sarbanes-Oxley Act 75 Exhibits 10.19 Lease agreement dated July 16, 2002, related to 439 Alvarado Street, Monterey, California 79 23.1 Independent auditors' consent 124 99.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 125 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 operating market areas, including a decline in real estate values in the Company's market areas; (4) the effects of terrorism, the threat of terrorism or the impact of potential military conflicts; (5) changes in the regulatory environment; (6) changes in business conditions and inflation; (7) changes in securities markets; (8) data processing compliance problems; (9) variances in the actual versus projected growth in assets; (10) return on assets; (11) loan losses; (12) expenses; (13) rates charged on loans and earned on securities investments; (14) rates paid on deposits; and (15) fee and other noninterest income earned, as well as other factors. This entire Annual Report should be read to put such forward-looking statements in context and to gain a more complete understanding of the uncertainties and risks involved in the Company's business. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company and the Bank. Central Coast Bancorp (the "Company") is a California corporation, headquartered in Salinas, California and was organized in 1994 to act as a bank holding company for Bank of Salinas. In 1996, the Company acquired Cypress Bank, which was headquartered in Seaside, California. Both banks were state-charted institutions. In July of 1999, the Company merged Cypress Bank into the Bank of Salinas and then renamed Bank of Salinas as Community Bank of Central California (the "Bank"). The Bank is headquartered in Salinas and serves individuals, merchants, small and medium-sized businesses, professionals, agribusiness enterprises and wage earners located in the California Central Coast area. On February 21, 1997, the former 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, the former Cypress Bank opened a new branch office in Monterey, California, so that it might better serve business and individual customers on the Monterey Peninsula. In December 1998, the former Bank of Salinas opened an additional new branch office in Salinas, California, to better provide services to the growing Salinas community. In June of 2000, the Bank opened a new branch office in Watsonville, which is in Santa Cruz County. In October of 2000, another new branch office was opened in Hollister, which is in San Benito County. The opening of these two branch offices was a first step in expanding the Bank's service area to include communities in contiguous counties outside of Monterey County. On April 15, 2002 the Bank opened a new branch in Gilroy, which is located at the southern end of the Santa Clara Valley in Santa Clara County. These three communities are of similar economic make-up to the agricultural based communities the Bank serves in Monterey County. As part of the Bank's continuing strategy to expand its franchise through denovo branches, a new branch was opened in downtown Monterey (Monterey Main) on January 21, 2003. Until August 16, 2001, the Company conducted no significant activities other than holding the shares of the subsidiary Bank. On August 16, 2001 the Company notified the Board of Governors of the Federal Reserve System (the "Board of Governors"), the Company's principal regulator, that the Company was engaged in certain lending activities. The Company purchased a loan from the Bank that the Bank had originated for a local agency that was categorized as a large issuer for taxation purposes. The Company is able to use the tax benefits of such loans. The Company may purchase similar loans in the future. Upon prior notification to the Board of Governors, the Company is authorized to engage in a variety of activities, which are deemed closely related to the business of banking. The Bank operates through its main office in Salinas and through eleven branch offices located in Castroville, Gilroy, Gonzales, Hollister, King City, Marina, Monterey (2), Salinas, Seaside and Watsonville, California. The Bank offers 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 equity, automobile and other installment and term loans. The Bank also currently offers personal and business Visa credit cards. It also offers ATM and Visa debit cards, travelers' checks, safe deposit boxes, notary public, customer courier and other customary bank services. Most of the Bank's 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 Westridge and Monterey Main branch offices are also open from 9:00 a.m. to 1:00 p.m. on Saturdays. Additionally, on a 24-hour basis, customers can bank by telephone or online at the Bank's Internet site, www.community-bnk.com. The Bank 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 Bank has automated teller machines (ATMs) located at each of its branch locations, 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 Bank is insured under the Federal Deposit Insurance Act and each depositor's account is insured up to the legal limits thereon. The Bank is chartered (licensed) by the California Commissioner of Financial Institutions ("Commissioner") and has chosen not to become a member of the Federal Reserve System. The Bank has no subsidiaries. The Company operates an on-site computer system, which provides independent processing of its deposits, loans and financial accounting. The Bank concentrates its lending activities in four principal areas: commercial loans (including agricultural loans); consumer loans; real estate construction loans (both commercial and personal) and real estate-other loans. At December 31, 2002, these four categories accounted for approximately 30%, 2%, 10% and 58% of the Bank's loan portfolio, respectively. The Bank's deposits are attracted primarily from individuals, merchants, small and medium-sized businesses, professionals and agribusiness enterprises. The Bank's 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 Bank. Approximately 50% of the deposits are from commercial customers, 42% are from individuals and 8% are from governmental entities and local agencies. As of December 31, 2002, the Bank served a total of 29 state, municipality and governmental agency depositors with $58,127,000 in deposits. Of this amount $10,000,000 is attributable to certificates of deposit for the State of California. In connection with the deposits of municipalities or other governmental agencies or entities, the Bank is 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, 2002, the Bank had total deposits of $826,502,000. Of this total, $261,242,000 represented noninterest-bearing demand deposits, $127,692,000 represented interest-bearing demand deposits, and $437,568,000 represented interest-bearing savings and time deposits. The principal sources of the Bank's revenues are: (i) interest and fees on loans; (ii) interest on investments (principally government securities); and (iii) interest on Federal Funds sold (funds loaned on a short-term basis to other banks). For the fiscal year ended December 31, 2002, these sources comprised 87.4%, 12.1%, and 0.5%, respectively, of the Bank's 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 Bank's 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 Bank is licensed by the California Commissioner of Financial Institutions. Its deposits are insured by the FDIC, and it has chosen not to become a member of the Federal Reserve System. Consequently, the Bank is subject to the supervision of, and is regularly examined by, the Commissioner and the FDIC. Such supervision and regulation include comprehensive reviews of all major aspects of the Bank's business and condition, including its capital ratios, allowance for probable loan losses and other factors. However, no inference should be drawn that such authorities have approved any such factors. The Company and the Bank are required to file reports with the Commissioner, the FDIC and the Board of Governors of the Federal Reserve System ("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. The Company, and any subsidiaries, which it may acquire or organize, are deemed to be "affiliates" of the Bank 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 Bank to affiliates, and (b) on investments by the Bank in affiliates' stock as collateral for loans to any borrower. The Company and its subsidiaries 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 Bank in conjunction with any liability of the Company under any obligation (demand deposits, 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 Bank 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 Bank 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 Company and the Bank 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 Governors' 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 which includes, among other items, limited life (and in case of banks, cumulative) preferred stock, mandatory convertible securities, subordinated debt and a limited amount of reserve for loan losses. Tier 2 capital may also include up to 45% of the pretax net unrealized gains on certain available-for-sale equity securities having readily determinable fair values (i.e. the excess, if any, of fair market value over the book value or historical cost of the investment security). The federal regulatory agencies reserve the right to exclude all or a portion of the unrealized gains upon a determination that the equity securities are not prudently valued. Unrealized gains and losses on other types of assets, such as bank premises and available-for-sale debt securities, are not included in Tier 2 capital, but may be taken into account in the evaluation of overall capital adequacy and net unrealized losses on available-for-sale equity securities will continue to be deducted from Tier 1 capital as a cushion against risk. 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. The Board of Governors and the FDIC have also adopted a minimum leverage ratio for bank holding companies as a supplement to the risk-weighted capital guidelines. The leverage ratio establishes a minimum Tier 1 ratio of 3% (Tier 1 capital to total assets) for the highest rated bank holding companies or those that have implemented the risk-based capital market risk measure. All other bank holding companies must maintain a minimum Tier 1 leverage ratio of 4% with higher leverage capital ratios required for bank holding companies that have significant financial and/or operational weakness, a high risk profile, or are undergoing or anticipating rapid growth. At December 31, 2002, the Bank and the Company are in compliance with the risk-based capital and leverage ratios described above. See Footnote 13 to the Consolidated Financial Statements in Item 8 "Financial Statements and Supplementary Data" below for a listing of the Company's and the Bank's risk-based capital ratios at December 31, 2002 and 2001. The Board of Governors and FDIC adopted regulations implementing a system of prompt corrective action pursuant to Section 38 of the Federal Deposit Insurance Act and Section 131 of the Federal Deposit Insurance Corporation Improvement Act of 1991 ("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-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 office 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. 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. The 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 Financial Institution Examination Counsel ("FFIEC") utilizes the Uniform Financial Institutions Rating System ("UFIRS") commonly referred to as "CAMELS" to classify and evaluate the soundness of financial institutions. Bank examiners use the CAMELS measurements to evaluate capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk. The federal financial institution agencies have established bases for analysis and standards for assessing a financial institution's capital adequacy in conjunction with the risk-based capital guidelines including analysis of interest rate risk, concentrations of credit risk, risk posed by non-traditional activities, and factors affecting overall safety and soundness. The safety and soundness standards for insured financial institutions include analysis of (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. 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. Community Reinvestment Act ("CRA") regulations 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 branch offices or form bank holding companies. In addition, any bank rated in "substantial noncompliance" with the CRA regulations may be subject to enforcement proceedings. The Bank has a current rating of "outstanding" for CRA compliance. 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 Bank. The payment of cash dividends and/or management fees by the Bank 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 Bank. COMPETITION At June 30, 2002, the competing commercial and savings banks had 63 branch offices in the cities of Castroville, Hollister, Gilroy, Gonzales, King City, Marina, Monterey, Salinas, Seaside and Watsonville where the Bank has its twelve branch offices. Additionally, the Bank competes with thrifts 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 Bank is not authorized nor prepared to offer currently. The Bank has made arrangements with its correspondent banks and with others to provide some of these services for its customers. For borrowers requiring loans in excess of the Bank's legal lending limits, the Bank has offered, and intends 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 its lending limits. As of December 31, 2002, the Bank's aggregate legal lending limits to a single borrower and such borrower's related parties were $13,052,000 on an unsecured basis and $21,754,000 on a fully secured basis based on regulatory capital and reserves of $87,016,000 The Bank's business is concentrated in its service area, which primarily encompasses Monterey County, including the Salinas Valley area and also serves Hollister, in San Benito County, Watsonville, in Santa Cruz County, and Gilroy, in Santa Clara County. The economy of the Bank's service area is dependent upon agriculture, tourism, retail sales, population growth and smaller service oriented businesses. Based upon data as of the most recent practicable date (June 30, 20021), there were 70 operating commercial and savings bank branch offices in Monterey County with total deposits of $4,830,773,000. This was an increase of $355,860,000 over the June 30, 2001 balances. The Bank held a total of $739,306,000 in deposits, representing approximately 15.3% of total commercial and savings banks deposits in Monterey County as of June 30, 2002. In the three new expansion areas in the Cities of Gilroy, Hollister and Watsonville, at June 30, 2002, there were 9, 8 and 11 branch offices with total deposits of $490,438,000, $520,561,000 and $772,272,000, respectively. At that date, the Bank had deposits of $4,487,000, $29,994,000 and $14,989,000 in those three communities. In order to compete with the major financial institutions in their primary service areas, the Bank uses to the fullest extent possible, the flexibility, which is accorded by its independent status. This includes an emphasis on specialized services, local promotional activity, and personal contacts by the Bank's officers, directors and employees. The Bank also seeks 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 Bank's lending limits, the Bank seeks to arrange for such loans on a participation basis with other financial institutions. The Bank also assists those customers requiring services not offered by the Bank to obtain such services from correspondent banks. Banking is a business that depends on interest rate differentials. In general, the difference between the interest rate paid by the Bank to obtain their deposits and other borrowings and the interest rate received by the Bank on loans extended to customers and on securities held in the Bank's portfolio comprise the major portion of the Bank's 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. - -------- 1 "FDIC Institution Office Deposits", June 30, 2002 The interest rate differentials of the Bank, and therefore its 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 Bank are not predictable. In 2001, the Federal Reserve Board lowered rates eleven times for a total of 475 basis points. The Federal Funds rate went from 6.50% at the beginning of the year to 1.75% at the end of the year. Such significant rate changes were not anticipated and they adversely impacted the Bank's net interest income for 2001 and 2002. Additionally, in November of 2002, the Federal Funds rate was lowered by another 50 basis points to 1.25%. Barring any further rate reductions interest margins should remain relatively constant in 2003. The FDIC's bank deposit insurance assessment rates currently 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 Bank's current capital ratios and the Bank's current levels of deposits, the Bank anticipates no change in the assessment rate applicable to the Bank during 2003 from that in 2002. Since 1996, 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 office 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. The federal financial institution agencies, especially the Office of the Comptroller of the Currency ("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. The OCC has issued 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 subject to an expedited application process. In addition, a national bank may apply to the OCC to engage in an activity through a subsidiary in which the bank itself may not engage. In 1999, the Gramm-Leach-Bliley Act was signed into law (the "GLB Act"). The GLB Act eliminates most of the remaining depression-era "firewalls" between banks, securities firms and insurance companies which was established by The Banking Act of 1933, also known as the Glass-Steagall Act ("Glass-Steagall"). Glass-Steagall sought to insulate banks as depository institutions from the perceived risks of securities dealing and underwriting, and related activities. The GLB Act repeals Section 20 of Glass-Steagall which prohibited banks from affiliating with securities firms. Bank holding companies that can qualify as "financial holding companies" can now acquire securities firms or create them as subsidiaries, and securities firms can now acquire banks or start banking activities through a financial holding company. The GLB Act includes provisions which permit national banks to conduct financial activities through a subsidiary that are permissible for a national bank to engage in directly, as well as certain activities authorized by statute, or that are financial in nature or incidental to financial activities to the same extent as permitted to a "financial holding company" or its affiliates. This liberalization of United States banking and financial services regulation applies both to domestic institutions and foreign institutions conducting business in the United States. Consequently, the common ownership of banks, securities firms and insurance firms is now possible, as is the conduct of commercial banking, merchant banking, investment management, securities underwriting and insurance within a single financial institution using a "financial holding company" structure authorized by the GLB Act Prior to the GLB Act, significant restrictions existed on the affiliation of banks with securities firms and on the direct conduct by banks of securities dealing and underwriting and related securities activities. Banks were also (with minor exceptions) prohibited from engaging in insurance activities or affiliating with insurers. The GLB Act removes these restrictions and substantially eliminates the prohibitions under the Bank Holding Company Act on affiliations between banks and insurance companies. Bank holding companies, which qualify as financial holding companies can now insure, guarantee, or indemnify against loss, harm, damage, illness, disability, or death; issue annuities; and act as a principal, agent, or broker regarding such insurance services. In order for a commercial bank to affiliate with a securities firm or an insurance company pursuant to the GLB Act, its bank holding company must qualify as a financial holding company. A bank holding company will qualify if (i) its banking subsidiaries are "well capitalized" and "well managed" and (ii) it files with the Board of Governors a certification to such effect and a declaration that it elects to become a financial holding company. The amendment of the Bank Holding Company Act now permits financial holding companies to engage in activities, and acquire companies engaged in activities, that are financial in nature or incidental to such financial activities. Financial holding companies are also permitted to engage in activities that are complementary to financial activities if the Board of Governors determines that the activity does not pose a substantial risk to the safety or soundness of depository institutions or the financial system in general. These standards expand upon the list of activities "closely related to banking" which have to date defined the permissible activities of bank holding companies under the Bank Holding Company Act. One further effect of the Act is to require that financial institutions respect the privacy of their customers and protect the security and confidentiality of customers' non-public personal information. These regulations require, in general, that financial institutions (1) may not disclose non-public personal information of customers to non-affiliated third parties without notice to their customers, who must have an opportunity to direct that such information not be disclosed; (2) may not disclose customer account numbers except to consumer reporting agencies; and (3) must give prior disclosure of their privacy policies before establishing new customer relationships. The Company and the Bank have not determined whether or when either of them may seek to acquire and exercise new powers or activities under the GLB Act, and the extent to which competition will change among financial institutions affected by the GLB Act has not yet become clear. On October 26, 2001, President Bush signed the USA Patriot Act (the "Patriot Act"), which includes provisions pertaining to domestic security, surveillance procedures, border protection, and terrorism laws to be administered by the Secretary of the Treasury. Title III of the Patriot Act entitled, "International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001" includes amendments to the Bank Secrecy Act which expand the responsibilities of financial institutions in regard to anti-money laundering activities with particular emphasis upon international money laundering and terrorism financing activities through designated correspondent and private banking accounts. Effective December 25, 2001, Section 313(a) of the Patriot Act prohibits any insured financial institution such as the Bank, from providing correspondent accounts to foreign banks which do not have a physical presence in any country (designated as "shell banks"), subject to certain exceptions for regulated affiliates of foreign banks. Section 313(a) also requires financial institutions to take reasonable steps to ensure that foreign bank correspondent accounts are not being used to indirectly provide banking services to foreign shell banks, and Section 319(b) requires financial institutions to maintain records of the owners and agent for service of process of any such foreign banks with whom correspondent accounts have been established. Effective July 23, 2002, Section 312 of the Patriot Act creates a requirement for special due diligence for correspondent accounts and private banking accounts. Under Section 312, each financial institution that establishes, maintains, administers, or manages a private banking account or a correspondent account in the United States for a non-United States person, including a foreign individual visiting the United States, or a representative of a non-United States person shall establish appropriate, specific, and, where necessary, enhanced, due diligence policies, procedures, and controls that are reasonably designed to detect and record instances of money laundering through those accounts. The Company and the Bank are not currently aware of any account relationships between the Bank and any foreign bank or other person or entity as described above under Sections 313(a) or 312 of the Patriot Act. The terrorist attacks on September 11, 2001 have realigned national security priorities of the United States and it is reasonable to anticipate that the United States Congress may enact additional legislation in the future to combat terrorism including modifications to existing laws such as the Patriot Act to expand powers as deemed necessary. The effects which the Patriot Act and any additional legislation enacted by Congress may have upon financial institutions is uncertain; however, such legislation would likely increase compliance costs and thereby potentially have an adverse effect upon the Company's results of operations. On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Act"), which responds to recent issues in corporate governance and accountability. Among other matters, key provisions of the Act and rules promulgated by the Securities and Exchange Commission pursuant to the Act include the following: o Expanded oversight of the accounting profession by creating a new independent public company oversight board to be monitored by the SEC. o Revised rules on auditor independence to restrict the nature of non-audit services provided to audit clients and to require all services provided by the independent auditor to be pre-approved by the audit committee. o Improved corporate responsibility through mandatory listing standards relating to audit committees, certifications of periodic reports by the CEO and CFO and making issuer interference with an audit a crime. o Enhanced financial disclosures, including periodic reviews for largest issuers and real time disclosure of material company information. o Enhanced criminal penalties for a broad array of white-collar crimes and increases in the statute of limitations for securities fraud lawsuits. o Disclosure of whether a company has adopted a code of ethics that applies to the company's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, and disclosure of any amendments or waivers to such code of ethics. The disclosure obligation becomes effective for fiscal years ending on or after July 15, 2003. The ethics code must contain written standards that are reasonably designed to deter wrongdoing and to promote: - Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; - Full, fair, accurate, timely, and understandable disclosure in reports and documents that a registrant files with, or submits to, the Securities and Exchange Commission and in other public communications made by the registrant; - Compliance with applicable governmental laws, rules and regulations; - The prompt internal reporting to an appropriate person or persons identified in the code of violations of the code; and - Accountability for adherence to the code. o Disclosure of whether a company's audit committee of its board of directors has a member of the audit committee who qualifies as an "audit committee financial expert." The disclosure obligation becomes effective for fiscal years ending on or after July 15, 2003. To qualify as an "audit committe financial expert," a person must have: - An understanding of generally accepted accounting principles and financial statements; - The ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves; - Experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the registrant's financial statements, or experience actively supervising one or more persons engaged in such activities; - An understanding of internal controls and procedures for financial reporting; and - An understanding of audit committee functions. A person must have acquired the above listed attributes to be deemed to qualify as an "audit committee financial expert" through any one or more of the following: - Education and experience as a principal financial officer, principal accounting officer, controller, public accountant or auditor or experience in one or more positions that involve the performance of similar functions; - Experience actively supervising a principal financial officer, principal accounting officer, controller, public accountant, auditor or person performing similar functions; - Experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements; or - Other relevant experience. The rule contains a specific safe harbor provision to clarify that the designation of a person as an "audit committee financial expert" does not cause that person to be deemed to be an "expert" for any purpose under Section 11 of the Securities Act of 1933, as amended, or impose on such person any duties, obligations or liability greater that the duties, obligations and liability imposed on such person as a member of the audit committee and the board of directors, absent such designation. Such a designation also does not affect the duties, obligations or liability of any other member of the audit committee or board of directors. o A prohibition on insider trading during pension plan blackout periods. o Disclosure of off-balance sheet transactions. o A prohibition on certain loans to directors and officers. o Conditions on the use of non-GAAP (generally accepted accounting principles) financial measures. o Standards on professional conduct for attorneys requiring attorneys having an attorney-client relationship with a company, among other matters, to report "up the ladder" to the audit committee, another board committee or the entire board of directors certain material violations. o Expedited filing requirements for Form 4 reports of changes in beneficial ownership of securities reducing the filing deadline to within 2 business days of the date a transaction triggers an obligation to report. o Accelerated filing requirements for Forms 10-K and 10-Q by public companies which qualify as "accelerated filers" to be phased-in over a four year period reducing the filing deadline for Form 10-K reports from 90 days after the fiscal year end to 60 days and Form 10-Q reports from 45 days after the fiscal quarter end to 35 days. o Disclosure concerning website access to reports on Forms 10-K, 10-Q and 8-K, and any amendments to those reports, by "accelerated filers" as soon as reasonably practicable after such reports and material are filed with or furnished to the Securities and Exchange Commission. o Proposed rules requiring national securities exchanges and national securities associations to prohibit the listing of any security whose issuer does not meet audit committee standards established pursuant to the Act. These proposed rules would establish audit committee: - Independence standards for members; - Responsibility for selecting and overseeing the issuer's independent accountant; - Responsibility for handling complaints regarding the issuer's accounting practices; - Authority to engage advisers; and - Funding requirements for the independent auditor and outside advisers engaged by the audit committee. The proposed audit committee rules provide a one-year phase-in period for compliance. The Securities and Exchange Commission must adopt final rules by April 26, 2003. The effect of the Act upon the Company is uncertain; however, it is likely that the Company will incur increased costs to comply with the Act and the rules and regulations promulgated pursuant to the Act by the Securities and Exchange Commission and other regulatory agencies having jurisdiction over the Company. The Company does not currently anticipate, however, that compliance with the Act and such rules and regulations will have a material adverse effect upon its financial position or results of its operations or its cash flows. On September 28, 2002, California Governor Gray Davis signed into law the California Corporate Disclosure Act (the "CCD Act"), which became effective January 1, 2003. The CCD Act requires publicly traded corporations incorporated or qualified to do business in California to disclose information about their past history, auditors, directors and officers. The CCD Act requires the Company to disclose: o The name of the company's independent auditor and a description of services, if any, performed for the company during the previous 24 months; o The annual compensation paid to each director and executive officer, including stock or stock options not otherwise available to other company employees; o A description of any loans made to a director at a "preferential" loan rate during the previous 24 months, including the amount and terms of the loans; o Whether any bankruptcy was filed by a company or any of its directors or executive officers within the previous 10 years; o Whether any director or executive officer of a company has been convicted of fraud during the previous 10 years; and o Whether a company violated any federal securities laws or any securities or banking provisions of California law during the previous 10 years for which the company was found liable or fined more than $10,000. The Company does not currently anticipate that compliance with the CCD Act will have a material adverse effect upon its financial position or results of its operations or its cash flows. Certain legislative and regulatory proposals that could affect the Bank and the banking business in general are periodically introduced before the United States Congress, the California State Legislature and Federal and state government agencies. It is not known to what extent, if any, 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 such legislation could subject the Company and the Bank to increases in regulation, disclosure and reporting requirements, competition and the Bank's cost of doing business. In addition to legislative changes, the various federal and state financial institution 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 Bank. As of December 31, 2002, the Company employed 246 persons primarily on a full time basis. None of the Company's employees are represented by a labor union and the Company considers its employee relations to be good. ITEM 2. PROPERTIES The headquarters office and centralized operations of the Company are located at 301 Main Street, Salinas, California. The Company owns and leases properties that house administrative and data processing functions and eleven banking offices. Owned and leased facilities are listed below. 301 Main Street 1658 Fremont Boulevard Salinas, California Seaside, California 23,662 square feet 2,800 square feet Leased (term expires 2007, Leased (term expires 2009 With two 7 1/2 year renewal with one 10 year renewal options) options) Current monthly rent of Current monthly rent of $22,262 $5,273 10601 Merritt Street 228 Reservation Road Castroville, California Marina, California 2,500 square feet 3,000 square feet Owned Leased (term expires 2004 with three 5 year renewal options) Current monthly rent of $3,183 400 Alta Street 599 Lighthouse Avenue Gonzales, California Monterey, California. 5,175 square feet 4,856 square feet Leased (term expires 2003 Leased (term expires 2004 with three 5 year renewal with two 10 year renewal options) options) Current monthly rent of Current monthly rent of $4,132 $6,435 532 Broadway 1915 Main Street King City, California Watsonville, California 4,000 square feet 971 square feet Leased (term expires 2009 Leased (term expires 2003 with two 5 year renewal with two 3 year renewal options) options) Current monthly rent of Current monthly rent of $5,445 $1,641 1285 North Davis Road 491 Tres Pinos Road Salinas, California. Hollister, California 3,200 square feet 2,800 square feet Leased (term expires 2008 Leased (term expires 2006 with two 5 year renewal with one 3 year renewal options) option) Current monthly rent of Current monthly rent of $7,728 $4,060 761 First Street 439 Alvarado Street Gilroy, California Monterey, California 2,670 square feet 5,731 square feet Leased (term expires Leased (term expires 2008 with three 2007 with one five year five year renewal renewal option) options) with a one year purchase option Current monthly rent of Current monthly rent of $5,207 $14,041 The above leases contain options to extend for five to twenty years. Included in the above are two facilities leased from shareholders 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 5 to the Consolidated Financial Statements in Item 8 "Financial Statements and Supplementary Data" included in this report and incorporated here by reference. The foregoing summary descriptions of certain of the above leased premises are qualified in their entirety by reference to the lease agreements listed as exhibits in Part IV, Item 15 of this Form 10-K. ITEM 3. LEGAL PROCEEDINGS There are no material proceedings adverse to the Company or the Bank to which any director, officer, affiliate of the Company or 5% shareholder of the Company or the Bank, or any associate of any such director, officer, affiliate or 5% shareholder of the Company or Bank are a party, and none of the above persons has a material interest adverse to the Company or the Bank. Neither the Company nor the Bank are a party to any pending legal or administrative proceedings (other than ordinary routine litigation incidental to the Company's or the Bank's 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 2002. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) Market Information The Company's common stock is listed on the Nasdaq National Market exchange (trading symbol: CCBN). The table below presents the range of high and low prices for the common stock for the two most recent fiscal years based on information provided to the Company from Nasdaq. The prices have been restated to reflect the 10% stock dividends in February 2001 and 2003 and the 5 for 4 stock split in February 2002. Calendar Year Low High ------------- --- ---- 2002 First Quarter $15.10 $18.64 Second Quarter 15.25 22.04 Third Quarter 16.14 20.91 Fourth Quarter 15.55 18.46 2001 First Quarter $11.82 $14.36 Second Quarter 13.45 19.09 Third Quarter 14.00 18.25 Fourth Quarter 14.29 16.67 The closing price for the Company's common stock was $17.10 as of March 7, 2003. (b) Holders As of March 7, 2003, there were approximately 2,300 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 Bank. The payment of cash dividends by the subsidiary Bank 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 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 Bank to the Company was approximately $11,480,000 as of December 31, 2002. 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 February 2003, a five-for-four stock split in February 2002, and a ten percent stock dividend in 2001. 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 Bank. ITEM 6. SELECTED FINANCIAL DATA The following table presents selected consolidated financial data concerning the business of the Company and its subsidiary Bank. 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. The earnings per share information has been adjusted retroactively to reflect the effect of all stock dividends and stock splits.
- -------------------------------------------------------------------- In thousands (except As of and for the Year Ended December 31 per share data) 2002 2001 2000 1999 1998 - -------------------------------------------------------------------- Operating Results Total Interest Income $50,501 $51,747 $51,415 $41,517 $37,354 Total Interest Expense 13,955 18,360 18,290 13,648 13,319 ------------------------------------------- Net Interest Income 36,546 33,387 33,125 27,869 24,035 Provision for Loan Losses 3,584 2,635 3,983 1,484 159 ------------------------------------------- Net Interest Income After Provision for Loan Losses 32,962 30,752 29,142 26,385 23,876 Noninterest Income 3,665 3,129 2,433 2,231 2,084 Noninterest Expenses 20,496 19,223 17,408 16,043 13,859 ------------------------------------------- Income before Income Taxes 16,131 14,658 14,167 12,573 12,101 Income Taxes 5,603 5,149 5,241 4,522 4,948 ------------------------------------------- Net Income $10,528 $9,509 $ 8,926 $8,051 $ 7,153 ==================================================================== Basic Earnings Per $ 1.06 $ 0.95 $ 0.85 $ 0.75 $ 0.71 Diluted Earnings Per Share 1.02 0.92 0.83 0.73 0.65 ==================================================================== Financial Condition and Capital - Year-End Balances Total Loans $745,353 $606,300 $473,395 $395,597 $312,170 Total Assets 919,132 802,266 706,693 593,445 543,933 Total Deposits 826,502 724,862 633,209 518,189 489,192 Shareholders' Equity 78,076 65,336 59,854 53,305 51,199 - -------------------------------------------------------------------- Financial Condition and Capital - Average Balances Total Loans $668,069 $522,884 $424,172 $352,936 $275,850 Total Assets 858,009 727,198 632,953 562,073 499,354 Total Deposits 772,111 648,664 565,487 494,266 447,598 Shareholders' Equity 72,519 62,918 55,762 52,069 47,587 - -------------------------------------------------------------------- Selected Financial Ratios Return on Average Total Assets 1.23% 1.31% 1.41% 1.43% 1.43% Return on Average Shareholders' Equity 14.52% 15.11% 16.01% 15.46% 15.03% Average Shareholders' Equity to Total Average Assets 8.45% 8.65% 8.81% 9.26% 9.53% - --------------------------------------------------------------------
(a) Average Balance Sheet and Net Interest Margin (1) Distribution of Assets, Liabilities and Equity; Interest Rates and Interest Differential is set forth in Table One in Item 7. - "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, 2002 and is incorporated here by reference. (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 set forth in Table Two in Item 7. - "Management's Discussion and Analysis" and is incorporated here by reference. (b) Investment Portfolio (1) The book value of investment securities at December 31, 2002 and 2001 is set forth in Note 3 to the Consolidated Financial Statements included in Item 8 - "Financial Statements and Supplementary Data" included in this report and is incorporated here by reference. (2) The book value, maturities and weighted average yields of investment securities as of December 31, 2002 are set forth in Table Thirteen in Item 7. - "Management's Discussion and Analysis" included in this report and is incorporated here 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 set forth in Table Three in Item 7. - "Management's Discussion and Analysis" included in this report and is incorporated here by reference. (2) The maturity distribution of the loan portfolio at December 31, 2002 is set forth in Table Twelve in Item 7. - "Management's Discussion and Analysis" included in this report and is incorporated here by reference. (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. A loan is considered to be impaired when it is probable that the borrower will be unable to pay all of the amounts due according to the contractual terms of the loan agreement For further discussion of nonperforming loans, refer to Table Four and the "Risk Elements" section in Item 7. - "Management's Discussion and Analysis" in this report. (d) Summary of Loan Loss Experience (1) An analysis of the allowance for loan losses showing charged off and recovery activity as of December 31, 2002 is summarized in Table Five in Item 7 - "Management's Discussion and Analysis" included in this report and is incorporated here by reference. 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 here by reference. (2) Management believes that any allocation of the allowance for probable loan losses into loan categories lends an appearance of exactness, which does not exist in that the allowance is utilized in total and is available for all loans. Further, management believes that the breakdown of historical losses as shown in Table Five in Item 7 - "Management's Discussion and Analysis" included in this report is a reasonable representation of management's expectation of potential losses inherent in the portfolio. 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. For further discussion, refer to Table Six in Item 7. - "Management's Discussion and Analysis" in this report. (e) Deposits (1) Table One in Item 7. - "Management's Discussion and Analysis" included in this report sets forth the distribution of average deposits for the years ended December 31, 2002, 2001 and 2000 and is incorporated here by reference. (2) Table Eleven in Item 7. - "Management's Discussion and Analysis" included in this report sets forth the maturities of time certificates of deposit of $100,000 or more at December 31, 2002 and is incorporated here by reference. (f) Return on Equity and Assets (1) The Selected Financial Data table at page 21 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 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 operating market areas, including a decline in real estate values in the Company's market areas; (4) the effects of terrorism, the threat of terrorism or the impact of potential military conflicts; (5) changes in the regulatory environment; (6) changes in business conditions and inflation; (7) changes in securities markets; (8) data processing compliance problems; (9) variances in the actual versus projected growth in assets; (10) return on assets; (11) loan losses; (12) expenses; (13) rates charged on loans and earned on securities investments; (14) rates paid on deposits; and (15) fee and other noninterest income earned, as well as other factors. This entire Annual Report should be read to put such forward-looking statements in context and to gain a more complete understanding of the uncertainties and risks involved in the Company's business. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company and the Bank. Critical Accounting Policies - ---------------------------- General Central Coast Bancorp's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. Other estimates that we use are related to the expected useful lives of our depreciable assets. The Company applies Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to Employees" and related interpretations to account for its stock based awards. In addition GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. Allowance for Loan Losses The allowance for loan losses is based on the probable estimated losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting. (1) Statement of Financial Accountings Standards (SFAS) No. 5 "Accounting for Contingencies", which requires that losses be accrued when they are probable of occurring and estimable and (2) SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Our allowance for loan losses has three basic components: the formula allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses an historical loss view as an indicator of future losses and as a result could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The specific allowance uses various techniques to arrive at an estimate of loss. Historical loss information, and fair market value of collateral are used to estimate those losses. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowances. For further information regarding our allowance for credit losses, see page 36. Stock Based Compensation Under APB No. 25, compensation cost for stock options is measured as the excess, if any, of the fair market value of the Company's stock at the date of the grant over the amount required to be paid. Because the Company's stock option plans provide for the issuance of options at a price of no less than the fair market value at the date of the grant, no compensation cost is required to be recognized for the stock option plan. For further information regarding the proforma effect on 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 the date of grant as prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation" see Note 1 and 9 to the Consolidated Financial Statements in Item 8 - Financial Statements and Supplementary Data. Business Organization Central Coast Bancorp (the "Company") is a California corporation, headquartered in Salinas, California and was organized in 1994 to act as a bank holding company for Bank of Salinas. In 1996, the Company acquired Cypress Bank, which was headquartered in Seaside, California. Both banks were state-chartered institutions. In July of 1999, the Company merged Cypress Bank into the Bank of Salinas and then renamed Bank of Salinas as Community Bank of Central California (the "Bank"). As of December 31, 2002, the Bank operated eleven full-service branch offices and one limited-service branch office and conducts online banking through its web site www.community-bnk.com. The Bank is headquartered in Salinas and serves individuals, merchants, small and medium-sized businesses and professionals. The economy in the Bank's service area is heavily weighted towards agribusiness enterprises and the hospitality industry. In June of 2000, the Bank opened a new branch office in Watsonville, which is in Santa Cruz County. In October of 2000, another new branch office was opened in Hollister, which is in San Benito County. The opening of these two branch offices was a first step in expanding the Bank's service area to include communities in contiguous counties outside of Monterey County. On April 15, 2002 the Bank opened a new branch in Gilroy, which is located at the southern end of the Santa Clara Valley in Santa Clara County. These three communities are of similar economic make-up to the agricultural based communities the Bank serves in Monterey County. As part of the Bank's continuing strategy to expand its franchise through denovo branches, a new branch was opened in downtown Monterey (Monterey Main) on January 21, 2003. Until August 16, 2001, the Company conducted no significant activities other than holding the shares of the Bank. On August 16, 2001, the Company notified the Board of Governors of the Federal Reserve System (the "Board of Governors"), the Company's principal regulator, that the Company was engaged in certain lending activities. The Company purchased a loan from the Bank that the Bank had originated for a local agency that was categorized as a large issuer for taxation purposes. The Company is able to use the tax benefits of such loans. The Company may purchase similar loans in the future. Upon prior notification to the Board of Governors, the Company is authorized to engage in a variety of activities, which are deemed closely related to the business of banking. 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. Average balances, including such balances used in calculating certain financial ratios, are generally comprised of average daily balances for the Company. Within "Management's Discussion and Analysis" interest income and net interest income are presented on a tax equivalent basis. Overview For the 19th consecutive year, Central Coast Bancorp earned record net income on a year-over-year basis. Net income for 2002 increased 10.7% to $10,528,000 from $9,509,000 in 2001. Diluted earnings per share for 2002, after giving effect to the 10% stock dividend distributed on February 28, 2003, was $1.02, up 10.9% from the $0.92 reported for 2001. For 2002, the Company realized a return on average equity of 14.5% and a return on average assets of 1.23%, as compared to 15.1% and 1.31% for 2001. At December 31, 2002, the Company had total assets of $919,132,000, which was an increase of $116,866,000 (14.6%) from year-end 2001. At December 31, 2002, loans totaled $745,353,000, up $139,053,000 (22.9%) from the ending balances on December 31, 2001. Deposit growth in 2002, which is net of a $20,000,000 decrease in State of California certificates of deposit, was $101,640,000 (14.0%). Deposits totaled $826,502,000 at year-end 2002 compared to $724,862,000 at year-end 2001. As discussed in last year's annual report, the 475 basis point reduction in the prime interest rate during 2001 had a significant impact on the Company's net interest income. As each rate cut occurred, variable rate loans repriced immediately or, at the latest, by quarter's end. However, rates paid on deposit products were lowered as market conditions allowed and generally lagged the more immediate reduction in loan rates. As a result, the average yield earned on assets in 2001 decreased 116 basis points to 7.89% from 9.05% in 2000. Meanwhile, the average rate paid on liabilities only decreased 49 basis points to 3.80% from 4.29%. This resulted in a decrease in the net interest margin in 2001 compared to 2000 of 73 basis points to 5.15% from 5.88%. The decrease in interest rates in 2001 continued to affect the net interest income in 2002 as the lower rates were in place for the full year. In addition, there was another 50 basis point decrease in the prime interest rate in November 2002. Thus, the average yield on earning assets for 2002 decreased 141 basis points to 6.48%. However, the rates paid on the deposit liabilities adjusted more rapidly in 2002 especially in time deposits as the higher yielding instruments matured and repriced at significantly lower rates. The average rate paid on liabilities for 2002 decreased 138 basis points to 2.42%. The overall effect on the net interest margin was a decrease of 42 basis points to 4.73% in 2002 as compared to the 73 basis point decrease in 2001. The cumulative effect of the two-year growth in average earning assets of $219,237,000 (38.0%) from $577,287,000 in 2000 to $796,524,000 in 2002 very nearly offset the decrease in interest income due to the lower rates. This growth coupled with the lower rates paid on the deposit liabilities resulted in an increase in net interest income of $3,176,000 (9.2%) to $37,665,000 for 2002 compared to an increase of $562,000 in 2001 over 2000. One key measure of the acceptance by our local communities of our banking franchise is provided by the FDIC/OTS Summary of Deposits annual "Market Share Report" issued in December of each year as of June 30th. This year's report states that Community Bank was the third largest bank serving Monterey County with a deposit market share of 15.30% up from 14.37% in 2001. The Bank was just $6.1 million under the second largest. The Bank also increased its market share in each of the communities it serves outside of Monterey County. By year-end 2002, the Bank's deposits had increased an additional $40.4 million from the June 30 totals. The Bank made another step forward in January 2003 by opening a branch in downtown Monterey. We believe our attention to customer service, close involvement with the communities we serve and emphasis on relationship banking have been instrumental to our continuing year-after-year growth in earnings, assets and deposits. For the second straight year, the economic data suggests that the country will continue to have a slow recovery. If the short-term interest rates remain stable, we expect the Bank's net interest margin to hold around the fourth quarter 2002 level of approximately 4.75%. With a relatively constant net interest margin, the year-over-year effect of the 2002 growth in earning assets will support growth in the level of interest income. Other factors that remain key for earnings growth are the continuing development of solid banking relationships, the continued emphasis on loan quality and continued cost control. As we celebrated the Bank's twentieth anniversary in February 2003, we looked forward with cautious optimism based on our evaluation of economic and Bank performance data available to us to continuing our record of continued earnings growth in 2003. (A) Results of Operations - --------------------------- Net Interest Income/Net Interest Margin (fully taxable equivalent basis) Net interest income represents the excess of interest and fees earned on interest-earning assets (loans, securities and federal funds sold) over the interest paid on deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets. These items have been adjusted to give effect to $1,119,000, $1,102,000 and $802,000 in taxable equivalent interest income on tax-free investments for the years ending December 31, 2002, 2001 and 2000. Net interest income for 2002 was $37,665,000, which was a $3,176,000 (9.2%) increase over 2001. The increase was in spite of interest income decreasing $1,229,000 to $51,620,000 in 2002. The year-over-year effect of the 475 basis point decrease in prime rate in 2001 coupled with an additional 50 basis point decrease in November of 2002 caused the yield on average assets in 2002 to decrease 141 basis points to 6.48%. The lower rates reduced interest income by $12,151,000. The largest portion of the decrease ($10,935,000) was related to the loan portfolio, as the average rate earned decreased 167 basis points to 6.74%. The rates earned on the taxable investment portfolio decreased 100 basis points to 5.03%. This decrease reduced interest income on those securities $771,000. Because of the continuing loan demand, the proceeds from maturities of securities and the growth in deposits were utilized to fund the growth in loans. The average balance of taxable investment securities decreased $22,594,000 to $76,894,000. This change reduced interest income by $1,362,000. The growth in the loan portfolio resulted in an increase in the average loan balance of $141,984,000 for 2002. These higher balances added $11,941,000 to interest income and helped to offset the decreases detailed above. The impact on net interest income caused by the lower interest income during 2002 was more than offset by decreases in interest expenses on deposit liabilities resulting in the overall increase in net interest income of $3,176,000. While average balances of deposit bearing liabilities increased $94,032,000 (19.5%), interest expense decreased $4,405,000 (-24.0%) in 2002 from 2001 mainly due to repricing of the time deposits as they matured throughout the year. The average balance of time deposits increased $15,675,000 during 2002 and as a result interest expense increased $807,000. However, the average rate paid on time deposits decreased 192 basis points to 3.23%, which decreased interest expense $5,048,000. Overall, in 2002 the average rate paid on interest-bearing liabilities decreased 138 basis points to 2.42% from 3.80% in 2001. The effect of the above volume and rate changes resulted in a decrease in the net interest margin for 2002 of 42 basis points to 4.73% from 5.15% in 2001. The net interest margin for the 4th quarter of 2002 was 4.75%, which was a decrease of 6 basis points from 4.81% in the 4th quarter of 2001 and down just one basis point from the 3rd quarter of 2002. Assuming a stable rate environment in 2003, management expects the net interest margin to be consistent with the level during the second half of 2002. Net interest income for 2001 was $34,489,000, a $562,000 (1.7%) increase over 2000. The rapidly changing interest rates in 2001 had a significant impact on the Bank's interest income and interest expense during the year. Interest income increased $632,000 (1.2%) to total $52,849,000 in 2001. The average balance of loans outstanding in 2001 was $96,002,000 (23.0%) higher than it was in 2000. This higher volume of loans contributed $9,559,000 to interest income from the prior year results. The average rate received on loans decreased from 9.93% in 2000 to 8.41% in 2001. This decrease of 152 basis points reduced interest income $7,829,000. In December of 2000 and during the first quarter of 2001, the Bank increased its holdings of tax exempt securities. This resulted in an increase of $899,000 in interest earned on tax-exempt securities in 2001, of which, $798,000 was due do higher volume and $101,000 was due to higher rates. Both the average rate and balance decreased on taxable investment securities resulting in a decrease of $1,340,000 in interest income. Interest earned on Fed funds sold was down $657,000 due both to the volume and rates. Overall, the average rate received on earning assets in 2001 decreased 116 basis points to 7.89% from the 9.05% received in 2000. Interest expense was $70,000 higher in 2001 over 2000, as the lower rates paid approximately offset the increase in the volume of interest bearing liabilities. Average balances of interest-bearing liabilities were higher in 2001 by $56,905,000, which added $2,694,000 to interest expense. Average rates paid on interest-bearing liabilities were down 49 basis points for the year. The lower rates reduced interest expense in 2001 by $2,624,000. Interest paid on interest bearing liabilities generally adjusts more slowly in response to market rate changes as time deposits and borrowings adjust at maturity. The effect of the above volume and rate changes resulted in a decrease in the net interest margin for 2001 of 73 basis points to 5.15% from 5.88% in 2000. Table One, Analysis of Net Interest Margin on Earning Assets, and Table Two, Analysis of Volume and Rate Changes on Net Interest Income and Expenses, are provided to enable the reader to understand the components and past trends of the Bank's interest income and expenses. Table One provides an analysis of net interest margin on earning assets setting forth average assets, liabilities and shareholders' equity; interest income earned and interest expense paid and average rates earned and paid; and the net interest margin on earning assets. Table Two presents an analysis of volume and rate change on net interest income and expense. Table One: Analysis of Net Interest Margin on Earning Assets
- ------------------------------------------------------------------------------------------------------------------------------------ (Taxable Equivalent Basis) 2002 2001 2000 Avg. Avg. Avg. Avg. Avg. Avg. In thousands (except Balance Interest Yield Balance Interest Yield Balance Interest Yield percentages) - ------------------------------------------------------------------------------------------------------------------------------------ Assets: Earning Assets Loans (1) (2) $ 655,061 $ 44,141 6.74% $ 513,077 $ 43,135 8.41% $ 417,075 $ 41,405 9.93% Taxable investment securities 76,894 3,867 5.03% 99,488 6,000 6.03% 106,754 7,340 6.88% Tax-exempt investment securities (3) 49,240 3,357 6.82% 48,691 3,307 6.79% 36,601 2,408 6.58% Federal funds sold 15,329 255 1.66% 8,745 407 4.65% 16,857 1,064 6.31% ----------------------- ----------------------- ---------------------- Total Earning Assets 796,524 $ 51,620 6.48% 670,001 $ 52,849 7.89% 577,287 $ 52,217 9.05% ------------ ----------- ----------- Cash & due from banks 47,419 42,551 39,432 Other assets 14,066 14,646 16,234 ----------- ------------ ------------ $ 858,009 $ 727,198 $ 632,953 =========== ============ ============ Liabilities & Shareholders' Equity: Interest bearing liabilities: Demand deposits $ 128,192 $ 1,308 1.02% $ 97,785 $ 1,254 1.28% $ 94,948 $ 1,551 1.63% Savings 178,459 3,718 2.08% 129,358 3,940 3.05% 107,075 3,820 3.57% Time deposits 263,063 8,491 3.23% 247,388 12,732 5.15% 218,330 12,549 5.75% Other borrowings 7,345 438 5.96% 8,496 434 5.11% 5,769 370 6.41% ----------------------- ----------------------- ----------------------- Total interest bearing liabilities 577,059 13,955 2.42% 483,027 18,360 3.80% 426,122 18,290 4.29% ------------ ----------- ----------- Demand deposits 202,397 174,133 145,134 Other Liabilities 6,034 7,120 5,935 ----------- ------------ ------------ Total Liabilities 785,490 664,280 577,191 Shareholders' Equity 72,519 62,918 55,762 ----------- ------------ ------------ $ 858,009 $ 727,198 $ 632,953 =========== ============ ============ Net interest income & Margin (4) $ 37,665 4.73% $ 34,489 5.15% $ 33,927 5.88% ======================= ==================== ====================== - ------------------------------------------------------------------------------------------------------------------------------------ 1. Loans interest includes loan fees of $1,632,000, $1,387,000 and $997,000 in 2001, 2001 and 2000. 2. Average balances of loans include average allowance for loan losses of $13,008,000, $9,807,000 and $7,097,000 and average deferred loan fees of $1,125,000, $978,000 and $719,000 for the years ended December 31, 2002, 2001 and 2000, respectively. 3. Includes taxable-equivalent adjustments for income on securities that is exempt from federal income taxes. The federal statutory tax rate was 35% for 2002, 2001 and 2000. 4. Net interest margin is computed by dividing net interest income by total average earning assets.
Table Two: Volume/Rate Analysis - ------------------------------------------------------------------------------------------------------ Year Ended December 31, 2002 over 2001 (In thousands) Increase (decrease) due to change in: Net Volume Rate (4) Change ------ -------- ------ Interest-earning assets: Net Loans (1)(2) $ 11,941 $ (10,935) $ 1,006 Taxable investment securities (1,362) (771) (2,133) Tax exempt investment securities (3) 37 13 50 Federal funds sold 306 (458) (152) ------------- ------------- ------------- Total 10,922 (12,151) (1,229) ------------- ------------- ------------- Interest-bearing liabilities: Demand deposits 389 (335) 54 Savings deposits 1,498 (1,720) (222) Time deposits 807 (5,048) (4,241) Other borrowings (59) 63 4 ------------- ------------- ------------- Total 2,635 (7,040) (4,405) ------------- ------------- ------------- Interest differential $ 8,287 $ (5,111) $ 3,176 ============= ============= ============= - ------------------------------------------------------------------------------------------------------ Year Ended December 31, 2001 over 2000 (In thousands) Increase (decrease) due to change in: Net Volume Rate (4) Change ------ -------- ------ Interest-earning assets: Net Loans (1)(2) $ 9,559 $ (7,829) $ 1,730 Taxable investment securities (501) (839) (1,340) Tax-exempt investment securities(3) 798 101 899 Federal funds sold (513) (144) (657) ------------- ------------- ------------- Total 9,343 (8,711) 632 ------------- ------------- ------------- Interest-bearing liabilities: Demand deposits 46 (343) (297) Savings deposits 798 (678) 120 Time deposits 1,675 (1,492) 183 Other borrowings 175 (111) 64 ------------- ------------- ------------- Total 2,694 (2,624) 70 ------------- ------------- ------------- Interest differential $ 6,649 $ (6,087) $ 562 ============= ============= ============= - ------------------------------------------------------------------------------------------------------ 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 $1,632,000, $1,387,000 and $997,000 for the years ended December 31, 2002, 2001 and 2000 respectively, have been included in the interest income computation. 3. Includes taxable-equivalent adjustments for income on securities that is exempt from federal income taxes. The federal statutory tax rate was 35% for 2002, 2001 and 2000. 4. The rate / volume variance has been included in the rate variance.
Provision for Loan Losses The Bank provided $3,584,000 for loan losses in 2002 up from $2,635,000 in 2001. The provision in 2002 reflects the change in the mix and continuing growth in the loan portfolio and the continuing uncertain economy. Net loan charge-offs were $102,000 in 2002 compared to $253,000 in 2001. The ratio of net charge-offs to average loans outstanding was 0.02% in 2002 compared to 0.05% in 2001. Nonperforming and restructured loans were $1,820,000 at December 31, 2002, compared to $2,329,000 at December 31, 2001. The ratio of nonperforming and restructured loans to total loans was 0.24% at December 31, 2002 compared to 0.38% at December 31, 2001. The ratio of the allowance for loan losses to total loans - net of deferred fees was 2.04% at December 31, 2002 compared to 1.94% at December 31, 2001. The Bank provided $2,635,000 for loan losses in 2001 as compared to $3,983,000 in 2000. The 2000 provision included $1,185,000 as a reserve for certain classified loans to a single borrower. During 2001, reductions in outstanding balances on those loans allowed for a reallocation of $370,000 of that allowance. The remaining decrease in the amount of the provision for loan losses was due to the change of the mix of loans in the loan portfolio and the individual analysis of loan loss allowance required for each loan type. Net loans charged-off in 2000 were $208,000 or 0.05% of average loans outstanding. The ratio of the allowance for loan losses to total loans - net of deferred fees was 1.98% at December 31, 2000. Service Charges and Fees and Other Income Noninterest income in 2002 increased $536,000 (17.1%) over 2001 to $3,665,000. Service charges accounted for much of the increase rising $418,000 (21.7%) due to increased business activity. Other noninterest income increased $118,000 (9.7%) as mortgage origination fees and other non-deposit related fees also reflected higher levels of activity in 2002. Gains on the sale of available-for-sale securities were $102,000 down $66,000 from the prior year. This decrease was offset by a $79,000 gain on the sale of OREO in 2002 versus $4,000 in 2001. Noninterest income in 2001 increased $696,000 (28.6%) over 2000 to $3,129,000. Service charges and fees related to deposit accounts increased $175,000 (10.0%) due to increased business activity. The low interest rates generated increased business for the Bank's mortgage origination activities. Fees related to this activity doubled to $334,000 in 2001 from $167,000 in 2000. Of the total increase, $362,000 is related to securities transactions. In 2001, the Bank realized gains of $168,000 on the sale of available-for-sale securities versus a loss of $194,000 in 2000. Salaries and Benefits Salary and benefit expenses increased $510,000 (4.4%) to $12,129,000 in 2002 over 2001. Salary expense for the Gilroy branch opened in April 2002 was $271,000 of the increase. Salaries and benefits from all other operations increased $499,000 (4.3%) before a $260,000 one time reduction in health care costs in the first quarter of 2002. Base salaries increased $433,000 (5.0%) due to normal merit increases and staffing additions during the year. At the end of 2002, the full time equivalent (FTE) staff was 239 versus 221 at the end of 2001. Salary and benefit expenses increased $1,538,000 (15.3%) in 2001 over 2000. Salary expense for the two new branches opened in mid to late 2000 was $567,000 of the increase on a year-over-year basis. Salaries and benefits from all other operations were up $971,000 (9.9%). Base salaries increased $653,000 (9.0%) due to normal merit increases and staffing additions during the year. Benefit costs increases were commensurate with the salary increases. At the end of 2000, the full time equivalent (FTE) staff was 211. Occupancy and Furniture and Equipment Occupancy and furniture and equipment expense increased $324,000 (9.3%) to $3,799,000 in 2002 over 2001. Operations of the new Gilroy branch resulted in $117,000 of the increase. Most of the remaining $207,000 increase in this category was related to higher costs for security services, rent on leased buildings and service contracts on computers and equipment. Occupancy and furniture and equipment expense increased $294,000 (9.2%) to $3,475,000 in 2001 over 2000. Operations of the two branches opened in mid to late 2000 resulted in $121,000 of the increase on a year-over-year basis. Higher energy costs added $45,000, an increase of 29.2% exclusive of the new branches. Equipment related expenses and depreciation increased $108,000 (6.5%) after adjusting for the new branches. Other Expenses Other expenses increased $439,000 (10.6%) to $4,568,000 in 2002 over 2001. The higher costs were mostly related to increased business activity related to the Bank's continuing growth. Operating losses for 2002 increased $101,000 from a total of $44,000 in 2001 as the continuing slow economy contributed to an increase in such losses. Other expenses decreased $17,000 to $4,129,000 in 2001 from 2000. Adjusted for the two new branches added in 2000, other expenses were down $29,000. With the declining interest rate environment and the weak economic conditions in 2001, management made a concerted effort to control these costs. The efficiency ratio (fully taxable equivalent) calculated by dividing noninterest expense by the sum of net interest income and noninterest income, for 2002 was 49.6% as compared to 51.1% in 2001. This indicates that the growth in revenues during 2002 outpaced the growth in expenses. The efficiency ratio (fully taxable equivalent) for 2000 was 47.9% . Provision for Taxes The effective tax rate on income was 34.7%, 35.1% and 37.0% in 2002, 2001 and 2000, respectively. In 2002, the interest earned on tax-exempt investment securities and loans increased $412,000 from 2001. Since the overall interest income decreased $1,246,000 in 2002, the tax-exempt income became a larger portion of total income resulting in a favorable reduction in the tax rate. In the fourth quarter of 2000 and in the first quarter of 2001, the Bank purchased approximately $12,600,000 of fixed rate municipal bonds. As a result, the 2001 tax-exempt interest income on a tax equivalent basis increased to 6.26% of total interest income from 4.61% in 2000 and the effective tax rate fell 1.9% in 2001. The effective tax rate was greater than the federal statutory tax rate due to state tax expense of $1,660,000 $1,522,000 and $1,513,000 in 2002, 2001 and 2000. Tax-exempt income of $3,185,000 $2,754,000 and $2,082,000 from investment securities and loans in 2002, 2001 and 2000 helped to reduce the effective tax rate. (B) Balance Sheet Analysis - --------------------------- Central Coast Bancorp's total assets at December 31, 2002 were $919,132,000 compared to $802,266,000 at December 31, 2001, representing an increase of $116,866,000 (14.6%). The average balance of total assets was $858,009,000 in 2002, which represents an increase of $130,811,000 (18.0%) over the average total asset balance of $727,198,000 in 2001. Loans The Bank concentrates its lending activities in four principal areas: commercial loans (including agricultural loans); real estate construction loans (both commercial and personal); real estate-other loans and consumer loans. At December 31, 2002, these four categories accounted for approximately 30%, 10%, 58% and 2% of the Bank's loan portfolio, respectively, as compared to 33%, 14%, 50% and 3% at December 31, 2001. Since 1998, the annual percentage loan growth from the prior year has been 22%, 27%, 20%, 28% and 23%, primarily as a result of the success of the loan calling officer program. The calling program not only has attracted many new loan customers, but also serves as an effective way of ensuring continual contact with existing customers. Real estate-other loans provided the largest percentage (41.5) as well as absolute dollar ($127.3 million) growth in 2002. Construction loans outstanding at the end of 2002 were down $11.1 million as several large projects were completed in the year and were moved into real estate-other. Demand for commercial construction loans remained relatively stable during the year. However, large project residential construction opportunities in Monterey County are becoming limited as there are very few projects receiving governmental approval. There was a decrease in consumer loans, as much of the lending activity to individuals is in home equity lines of credit which are reflected in the real estate-other category. Table Three summarizes the composition of the loan portfolio for the past five years as of December 31:
Table Three: Loan Portfolio Composite - ------------------------------------------------------------------------------------------------------------------------------- In thousands 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------- Commercial $ 224,840 $ 199,761 $ 171,631 $ 159,385 $ 136,685 Real Estate: Construction 74,214 85,314 57,780 35,330 19,929 Other 433,921 306,622 234,890 188,600 144,685 Consumer 13,414 15,653 9,840 13,003 11,545 Deferred Loans Fees (1,036) (1,050) (746) (721) (674) - ------------------------------------------------------------------------------------------------------------------------------- Total Loans 745,353 606,300 473,395 395,597 312,170 Allowance for Loan Losses (15,235) (11,753) (9,371) (5,596) (4,352) - ------------------------------------------------------------------------------------------------------------------------------- Total $ 730,118 $ 594,547 $ 464,024 $ 390,001 $ 307,818 ===============================================================================================================================
The majority of the Bank's loans are direct loans made to individuals, local businesses and agri-businesses. The Bank relies substantially on local promotional activity, personal contacts by Bank officers, directors and employees to compete with other financial institutions. The Bank makes loans to borrowers whose applications include a sound purpose, a viable repayment source and a plan of repayment established at inception and generally backed by a secondary source of repayment. Commercial loans consist of credit lines for operating needs, loans for equipment purchases, working capital, and various other business loan products. Consumer loans include a range of traditional consumer loan products offered by the Bank such as personal lines of credit and loans to finance purchases of autos, boats, recreational vehicles, mobile homes and various other consumer items. The construction loans are generally composed of commitments to customers within the Bank's service area for construction of both commercial properties and custom and semi-custom single family residences. Other real estate loans consist primarily of loans to the Bank's 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%. In general, except in the case of loans with SBA guarantees, the Bank does not make long-term mortgage loans; however, the Bank has informal arrangements in place with mortgage lenders to assist customers in securing single-family mortgage financing. Average net loans in 2002 were $655,061,000 representing an increase of $141,984,000 or 27.7% over 2001. Average net loans in 2001 were $513,077,000 representing an increase of $96,002,000 or 23.0% over 2000. Risk Elements - The Bank 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 Bank contracts with an outside loan review consultant to periodically examine 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 loan 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, the credit quality of the Bank's loans may be influenced by underlying trends in the national and local economic and business cycles. The Bank's business is mostly concentrated in Monterey County. The County's economy is highly dependent on the agricultural and tourism industries. The agricultural industry is also a major driver of the economies of San Benito County and the southern portions of Santa Cruz and Santa Clara Counties, which represent the areas of the Bank's recent branch expansion. As a result, the Bank lends money to individuals and companies dependent upon the agricultural and tourism industries. The Company has significant extensions of credit and commitments to extend credit which are secured by real estate, totaling approximately $568 million at December 31, 2002. Although management believes this real estate concentration has no more than the normal risk of collectibility, a substantial decline in the economy in general, or a decline in real estate values in the Bank's primary market areas in particular, could have an adverse impact on the collectibility of these loans. The ultimate recovery of these loans is generally dependent on the successful operation, sale or refinancing of the real estate. The Bank 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, an appropriate allowance for probable 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. Not withstanding the foregoing, abnormally high rates of impairment due to general/local economic conditions could adversely affect the Company's future prospects and results of operations. In extending credit and commitments to borrowers, the Bank 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 Bank's requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management's evaluation of the creditworthiness 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 Bank secures its collateral by perfecting its interest in business assets, obtaining deeds of trust, or outright possession among other means. Loan losses from lending transactions related to real estate and agriculture compare favorably with the Bank's loan losses on its loan portfolio as a whole. Management believes that its lending policies and underwriting standards will tend to mitigate losses in an economic downturn, however, there is no assurance that losses will not occur under such circumstances. The Bank's loan policies and underwriting standards include, but are not limited to, the following: 1) maintaining a thorough understanding of the Bank's 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 Bank's construction lending officers. In addition, the Bank strives to diversify the risk inherent in the construction portfolio by avoiding concentrations to individual borrowers and on any one project. Nonaccrual, Past Due and Restructured Loans 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. Table Four sets forth nonaccrual loans, loans past due 90 days or more, and restructured loans performing in compliance with modified terms, as of December 31:
Table Four: Non-Performing Loans - ------------------------------------------------------------------------------------------- In thousands 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------- Past due 90 days or more and still accruing Commercial $ - $ 68 $ 215 $ 51 $ 73 Real estate - - 10 303 1,174 Consumer and other 5 12 5 - - - ------------------------------------------------------------------------------------------- 5 80 230 354 1,247 - ------------------------------------------------------------------------------------------- Nonaccrual: Commercial 272 702 329 11 333 Real estate 598 592 - 1,565 543 Consumer and other - - - - - - ------------------------------------------------------------------------------------------- 870 1,294 329 1,576 876 - ------------------------------------------------------------------------------------------- Restructured (in compliance with modified terms)- Commercial 933 955 1,010 - - - ------------------------------------------------------------------------------------------- Total $ 1,808 $ 2,329 $ 1,569 $ 1,930 $ 2,123 ===========================================================================================
Interest due but excluded from interest income on nonaccrual loans was approximately $24,000 in 2002, $45,000 in 2001 and $64,000 in 2000. In 2002 and 2001, interest income recognized from payments received on nonaccrual loans was $40,000 and $69,000, respectively (none was recognized in 2000). 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. At December 31, 2002, the recorded investment in loans that are considered impaired was $2,618,000 of which $870,000 is included in nonaccrual loans, and $933,000 is included in restructured loans above. At December 31, 2001 impaired loans were $2,418,000, of which $1,294,000 are included as non accrual loans above, and $955,000 are included as restructured loans above. Impaired loans had a valuation allowance of $1,165,000 and $536,000, in 2002 and 2001, respectively. The average recorded investments in impaired loans during 2002 and 2001 were $2,338,000 and $2,638,000, respectively. The Company recognized interest income on impaired loans of $143,000, $191,000 and $161,000 in 2002, 2001 and 2000, respectively (including interest income of $66,000 in 2002 and $98,000 in both 2001 and 2000 on restructured loans). 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, 2002. Management is not aware of any potential problem loans, which were accruing and current at December 31, 2002, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms except for one loan which was placed on nonaccrual in February of 2003. Management believes that amounts due on this loan will be fully collected. Other Real Estate Owned The Company held no real estate acquired by foreclosure at December 31, 2002 or 2001. Allowance for Loan Losses The Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on our regular assessments of the probable estimated losses inherent in the loan portfolio and to a lesser extent, unused commitments to provide financing. Determining the adequacy of the allowance is a matter of careful judgment, which reflects consideration of all significant factors that affect the collectibility of the portfolio as of the evaluation date. Our methodology for measuring the appropriate level of the allowance relies on several key elements, which include the formula allowance, specific allowances for identified problem loans and the unallocated reserve. The unallocated allowance contains amounts that are based on management's evaluation of conditions that are not directly measured in the determination of the formula and specific allowances. The formula allowance is calculated by applying loss factors to outstanding loans and certain unused commitments, in each case based on the internal risk grade of such loans and commitments. Changes in risk grades of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and may be adjusted for significant factors that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. At December 31, 2002, the formula allowance was $12,002,000 compared to $9,043,000 at December 31, 2001. The increase in the formula allowance was primarily a result of the growth in loan and loan commitment balances subject to these formula allowances of $148,845,000 in 2002. In addition to the formula allowance calculated by the application of the loss factors to the standard loan categories, certain specific allowances may also be calculated. Quarterly, all criticized loans are analyzed individually based on the source and adequacy of repayment and specific type of collateral, and an assessment is made of the adequacy of the formula reserve relative to the individual loan. A specific allocation either higher or lower than the formula reserve will be calculated based on the higher/lower-than-normal probability of loss and the adequacy of the collateral. At December 31, 2002, the specific allowance was $1,830,000 on a loan base of $32,180,000 compared to a specific allowance of $1,678,000 on a loan base of $18,922,000 at December 31, 2001. The increase in the specific allowance in 2002 was due to the larger base of loans requiring specific valuation allowances. The unallocated allowance contains amounts that are based on management's evaluation of conditions that are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem loans or portfolio segments. At December 31, 2002, the unallocated allowance was $1,402,000 compared to $1,032,000 at December 31, 2001. The conditions evaluated in connection with the unallocated allowance include the following at the balance sheet date: o The current national and local economic and business conditions, trends and developments, including the condition of various market segments within our lending area; o Changes in lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices; o Changes in the nature, mix, concentrations and volume of the loan portfolio; o The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Bank's current portfolio. There can be no assurance that the adverse impact of any of these conditions on the Bank will not be in excess of the unallocated allowance as determined by management at December 31, 2002 and set forth in the preceding paragraph. The allowance for loan losses totaled $15,235,000 or 2.04% of total loans at December 31, 2002 compared to $11,753,000 or 1.94% at December 31, 2001. At those two dates, the allowance represented 837 percent and 505 percent of nonperforming loans. It is the policy of management to maintain the allowance for loan losses at a level adequate for risks inherent in the loan portfolio. Based on information currently available to analyze loan loss potential, including economic factors, overall credit quality, historical delinquency and a history of actual charge-offs, management believes that the loan loss provision and allowance are adequate. However, no prediction of the ultimate level of loans charged off in future years can be made with any certainty. Table Five summarizes, for the years indicated, the activity in the allowance for loan losses.
Table Five: Allowance for Loan Losses - ------------------------------------------------------------------------------------------------------------------------------------ Year Ended Year Ended Year Ended Year Ended Year Ended In thousands (except percentages) 12/31/02 12/31/01 12/31/00 12/31/99 12/31/98 - ------------------------------------------------------------------------------------------------------------------------------------ Average loans outstanding $ 669,104 $ 523,862 $ 424,891 $ 353,732 $ 276,437 - ------------------------------------------------------------------------------------------------------------------------------------ Allowance for possible loan losses at beginning of period $ 11,753 $ 9,371 $ 5,596 $ 4,352 $ 4,223 Loans charged off: Commercial (53) (349) (273) (333) (130) Real estate (219) (2) - (41) (16) Consumer (81) (79) (119) (26) (31) - ------------------------------------------------------------------------------------------------------------------------------------ (353) (430) (392) (400) (177) - ------------------------------------------------------------------------------------------------------------------------------------ Recoveries of loans previously charged off: Commercial 214 162 170 143 116 Real estate - - - 7 20 Consumer 37 15 14 10 11 - ------------------------------------------------------------------------------------------------------------------------------------ 251 177 184 160 147 - ------------------------------------------------------------------------------------------------------------------------------------ Net loans charged off (102) (253) (208) (240) (30) Additions to allowance charged to operating expenses 3,584 2,635 3,983 1,484 159 - ------------------------------------------------------------------------------------------------------------------------------------ Allowance for possible loan losses at end of period $ 15,235 $ 11,753 $ 9,371 $ 5,596 $ 4,352 ==================================================================================================================================== Ratio of net charge-offs to average loans outstanding 0.02% 0.05% 0.05% 0.07% 0.01% Provision of allowance for possible loan losses to average loans outstanding 0.54% 0.50% 0.94% 0.42% 0.06% Allowance for possible loan losses to loans net of deferred fees at year end 2.04% 1.94% 1.98% 1.41% 1.39% - ------------------------------------------------------------------------------------------------------------------------------------
As part of its loan review process, management has allocated the overall allowance based on specific identified problem loans and historical loss data. Table Six summarizes the allocation of the allowance for loan losses at December 31, 2002 and 2001.
Table Six: Allowance for Loan Losses by Loan Category - ----------------------------------------------------------------------------------- December 31, 2002 December 31, 2001 ----------------- ----------------- Percent of Percent of loans in each loans in each category to category to In thousands(except percentages) Amount total loans Amount total loans - ----------------------------------------------------------------------------------- Commercial $ 6,750 30% $ 7,397 33% Real estate 6,874 67% 3,019 64% Consumer 209 2% 305 3% - ----------------------------------------------------------------------------------- Total allocated 13,833 100% 10,721 100% Total unallocated 1,402 1,032 - ----------------------------------------------------------------------------------- Total $ 15,235 $ 11,753 ===================================================================================
Deposits At December 31, 2002, deposits were $826,502,000 up from $724,862,000 at the end of 2001. The 2002 year-end balances included $10,000,000 in certificates from the State of California as compared to $30,000,000 at the end of 2001. These deposits are placed in the Bank at its request and are secured by pledged investment securities. The deposit growth in 2002, exclusive of the State of California certificates, was $121,640,000 (17.3%). Management believes the large growth in deposits may have been due in part to customers moving money out of the stock market. We do not anticipate that deposits will increase in 2003 at or near the 2002 growth levels and a recovery in the stock market could potentially result in an outflow of deposits. Capital Resources The current and projected capital position of the Company and the impact of capital plans and long-term strategies are reviewed regularly by management. The Company's capital position represents the level of capital available to support continued operations and expansion. Since October of 1998 and through December 31, 2002, the Board of Directors of the Company has authorized three separate plans to repurchase up to 5% (in each plan) of the outstanding shares of the Company's common stock. Purchases are made from time to time, in the open market and are subject to appropriate regulatory and other accounting requirements. The following common share amounts and average prices paid have been adjusted to give effect to all stock dividends and splits through December 31, 2002. In 2002, the Company did not acquire any shares of its common stock. The Company acquired 313,419 shares of its common stock in the open market during 2001, 513,618 in 2000 and 250,835 in 1999 at average prices of approximately $15.31, $11.88 and $10.66 per share, respectively. The Company completed repurchases under the first and second plans in May 2000 and April 2001, respectively. At December 31, 2002, there were 307,894 shares remaining to repurchase under the third plan. These repurchases are made with the intention to lessen the dilutive impact of issuing new shares to meet stock option plans as well as for capital management objectives. The Company's primary capital resource is shareholders' equity, which increased $12,740,000 or 19.5% from the previous year-end. The ratio of total risk-based capital to risk-adjusted assets was 10.9% at December 31, 2002 compared to 11.1% at December 31, 2001. Tier 1 risk-based capital to risk-adjusted assets was 9.7% at December 31, 2002, compared to 9.9% at December 31, 2001. The capital ratios are slightly lower in 2002 as compared to 2001 as the level of risked-based assets grew at a slightly higher rate than the growth in regulatory capital levels. Table Seven: Capital Ratios As of December 31, ----------------- Central Coast Bancorp 2002 2001 - --------------------- ---- ---- Tier 1 Capital 9.7% 9.9% Total Capital 10.9% 11.1% Leverage 8.6% 8.4% See the discussion of capital requirements in "Supervision and Regulation" and in Footnote 13 - Regulatory Matters in the Consolidated Financial Statements in Item 8 - Financial Statements and Supplementary Data. 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 Bank 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 faster than the corresponding rate that capital grows through retention of earnings the Company generates in the future. In addition to its effects on interest rates, inflation directly affects the Company by increasing the Company's operating expenses. Inflation did not have a material effect upon the Company's results of operations during the year 2002. Market Risk Management Overview. The goal for managing the assets and liabilities of the Bank is to maximize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Bank to undue interest rate risk. The Board of Directors has overall responsibility for the Company's interest rate risk management policies. The Bank has an Asset and Liability Management Committee (ALCO), which establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates. Asset/Liability Management. Activities involved in asset/liability management include but are not limited to lending, accepting and placing deposits, investing in securities and issuing debt. Interest rate risk is the primary market risk associated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To mitigate interest rate risk, the structure of the balance sheet is managed with the goal that movements of interest rates on assets and liabilities are correlated and contribute to earnings even in periods of volatile interest rates. The asset/liability management policy sets limits on the acceptable amount of variance in net interest margin and market value of equity under changing interest environments. The Bank uses simulation models to forecast earnings, net interest margin and market value of equity. Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer modeling techniques, the Company is able to estimate the potential impact of changing interest rates on earnings. A balance sheet forecast is prepared quarterly using inputs of actual loan, securities and interest bearing liabilities (i.e. deposits/borrowings) positions as the beginning base. The forecast balance sheet is processed against three interest rate scenarios. The scenarios include a 200 basis point rising rate forecast, a flat rate forecast and a 200 basis point falling rate forecast which take place within a one year time frame. The net interest income is measured during the first year of the rate changes and in the year following the rate changes. The Company's 2003 net interest income, as forecast below, was modeled utilizing a forecast balance sheet projected from year-end 2002 balances. The following assumptions were used in the modeling activity: o Earning asset growth of 6.0% based on ending balances o Loan growth of 4.0% based on ending balances o Investment and funds sold growth of 22.6% based on ending balances o Deposit growth of 8.8% based on ending balances o Balance sheet target balances were the same for all rate scenarios The following table summarizes the effect on net interest income of a +/-200 basis point change in interest rates as measured against a flat rate (no change) scenario. Table Eight: Interest Rate Risk Simulation of Net Interest Income as of December 31, 2002: Estimated Impact on 2003 Net Interest Income ------ Variation from flat rate scenario (in thousands) +200 $4,286 - 200 ($3,747) The simulations of earnings do not incorporate any management actions, which might moderate the negative consequences of interest rate deviations. Therefore, they do not reflect likely actual results, but serve as conservative estimates of interest rate risk. The Company also uses a second simulation scenario that rate shocks the balance sheet with an immediate parallel shift in interest rates of +/-200 basis points. This scenario provides estimates of the future market value of equity (MVE) and net interest income (NII). MVE measures the impact on equity due to the changes in the market values of assets and liabilities as a result of a change in interest rates. The Bank measures the volatility of these benchmarks using a twelve month time horizon. Using the December 31, 2001 balance sheet as the base for the simulation, the following table summarizes the effect on net interest income of a +/-200 basis point change in interest rates: Table Nine: Interest Rate Risk Simulation of NII as of December 31, 2002 % Change $ Change in NII in NII from Current from Current 12 Mo. Horizon 12 Month Horizon -------------- ---------------- (in thousands) + 200bp 24% $8,585 - 200bp (28%) ($9,851) These results indicate that the balance sheet is asset sensitive since earnings increase when interest rates rise. The magnitude of the NII change is within the Company's policy guidelines. The asset liability management policy limits aggregate market risk, as measured in this fashion, to an acceptable level within the context of risk-return trade-offs. Gap analysis provides another measure of interest rate risk. The Company does not actively use gap analysis in managing interest rate risk. It is presented here for comparative purposes. Interest rate sensitivity is a function of the repricing characteristics of the Bank's portfolio of assets and liabilities. These repricing characteristics are the time frames within which the interest-bearing assets and liabilities are subject to change in interest rates either at replacement, repricing or maturity. Interest rate sensitivity management focuses on the maturity of assets and liabilities and their repricing during periods of changes in market interest rates. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in the Bank's current portfolio that are subject to repricing at various time horizons. The differences are known as interest sensitivity gaps. As reflected in Table Ten, at December 31, 2002, other than immediately, the cumulative gap indicates an asset sensitive position through all time horizons. This interest rate sensitivity table categorizes interest-bearing transaction deposits and savings deposits as repricing immediately. However, as has been observed through interest rate cycles, the deposit liabilities do not reprice immediately. Consequently, the Bank's net interest income varies as though the Bank is asset sensitive, i.e. as interest rates rise net interest income increases and vice versa.
Table Ten: Interest Rate Sensitivity - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2002 Assets and Liabilities Over three which Mature or Reprice: Next day months and Over one and within within and within Over (In thousands) Immediately three months one year five years five years Total - ------------------------------------------------------------------------------------------------------------------------------------ Interest earning assets: Investments $ 1,306 $ 12,240 $ 8,896 $ 40,914 $ 43,967 $ 107,323 Loans, excluding nonaccrual loans and overdrafts 16,709 498,858 49,616 146,951 31,231 743,365 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 18,015 $ 511,098 $ 58,512 $ 187,865 $ 75,198 $ 850,688 ==================================================================================================================================== Interest bearing liabilities: Interest bearing demand $ 127,692 $ - $ - $ - $ - $ 127,692 Savings 181,089 - - - - 181,089 Time certificates - 77,721 137,516 40,440 802 256,479 Other Borrowings - 62 280 2,811 3,507 6,660 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 308,781 $ 77,783 $ 137,796 $ 43,251 $ 4,309 $ 571,920 ==================================================================================================================================== Interest rate sensitivity gap $ (290,766) $ 433,315 $ (79,284) $ 144,614 $ 70,889 Cumulative interest rate sensitivity gap $ (290,766) $ 142,549 $ 63,265 $ 207,879 $ 278,768 - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2001 Interest rate sensitivity gap $ (213,700) $ 287,399 $ (85,838) $ 135,009 $ 118,479 Cumulative interest rate sensitivity gap $ (213,700) $ 73,699 $ (12,139) $ 122,870 $ 241,349 - ------------------------------------------------------------------------------------------------------------------------------------
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 Bank assesses 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, 2002, were approximately $186,982,000 and $5,169,000, 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, loans pledged to the Federal Home Loan Bank of San Francisco ("FHLB-SF") and sellable SBA loans. On December 31, 2002, consolidated liquid assets totaled $74.4 million or 8.1% of total assets as compared to $110.0 million or 13.7% of total consolidated assets on December 31, 2001. In addition to liquid assets, the Bank maintains short-term lines of credit with correspondent banks and has several agreements in place for obtaining brokered certificates of deposit. At December 31, 2002, the Bank had $76,944,000 available under the credit lines and by policy could have negotiated for up to $89,000,000 in brokered CD's. 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 affected by portfolio maturities as well as the effect interest rate fluctuations have on the market values of both assets and liabilities. The Bank holds all of its investment securities in the available-for-sale category. This enables the Bank to sell any of its unpledged securities to meet liquidity needs. In periods of rising interest rates, such as experienced throughout most of 1999 and the first half of 2000, bond prices decreased, which resulted in large unrealized losses within the Bank's investment portfolio. Unrealized losses limit the Bank's ability to sell these securities to provide liquidity without realizing those losses. As a means for providing liquidity from the investment portfolio when there are unrealized losses, the Bank has a master repurchase agreement with a correspondent bank. Such a repurchase agreement allows the Bank to pledge securities as collateral for borrowings to obtain liquidity without having to sell a security at a loss. In a declining interest rate environment such as experienced in 2001 and 2002, as bond prices increase, liquidity is more easily obtained through security sales. The maturity distribution of certificates of deposit in denominations of $100,000 or more is set forth in Table Eleven. These deposits are generally more rate sensitive than other deposits and, therefore, are more likely to be withdrawn to obtain higher yields elsewhere if available. Table Eleven: Certificates of Deposit in Denominations of $100,000 or More - ----------------------------------------------------------- In thousands December 31, 2002 - ----------------------------------------------------------- Three months or less $57,625 Over three months through six months 49,483 Over six months through twelve months 52,896 Over twelve months 33,687 - ----------------------------------------------------------- Total $193,691 =========================================================== Loan demand also affects the Bank's liquidity position. Table Twelve presents the maturities of loans for the period indicated. Table Twelve: Loan Maturities - December 31, 2002 - ------------------------------------------------------------------- One year One year through Over In thousands or less five years five years Total - ------------------------------------------------------------------- Commercial $ 131,017 $ 69,366 $ 24,457 $ 224,840 Real estate - construction 64,944 9,270 - 74,214 Real estate - other 61,400 127,855 244,666 433,921 Consumer 7,089 5,573 752 13,414 - ------------------------------------------------------------------- Total $ 264,450 $ 212,064 $ 269,875 $ 746,389 - ------------------------------------------------------------------- Loans shown above with maturities greater than one year include $281,107,000 of floating interest rate loans and $200,832,000 of fixed rate loans. The maturity distribution and yields of the investment portfolios (on a taxable equivalent basis) are presented in Table Thirteen:
Table Thirteen: Securities Maturities and Weighted Average Yields - ------------------------------------------------------------------------------------- December 31, 2002 December 31, 2001 Weighted Weighted Market Average Market Average In thousands (except percentages) Value Yield Value Yield - ------------------------------------------------------------------------------------- Available for sale securities: U.S. Treasury and agency securities Maturing within 1 year $ 102 1.71% $ 103 2.27% Maturing after 1 year but within 5 years 9 5.63% 47,223 6.21% Maturing after 5 years but within 10 years 8,857 3.24% 17,898 4.62% Maturing after 10 years 32,488 6.34% 10,262 6.87% State & Political Subdivision Maturing within 1 year - - - - Maturing after 1 year but within 5 years 4,017 4.37% 3,823 7.05% Maturing after 5 year but within 10 Years 25,277 4.37% 23,151 6.58% Maturing after 10 years 24,698 4.84% 22,867 6.95% Corporate Debt Securities Maturing within 1 year - - - - Maturing after 10 years 10,569 2.44% 10,590 3.01% Other 1,306 - 1,236 - - ------------------------------------------------------------------------------------- Total investment securities $ 107,323 4.74% $ 137,153 5.96% =====================================================================================
The principal cash requirements of the Company are for expenses incurred in the support of administration and operations of the Bank. These cash requirements are funded through direct reimbursement billings to the Bank. For non-banking functions, the Company is dependent upon the payment of cash dividends by the Bank to service its commitments. The Company expects that the cash dividends paid by the Bank to the Company will be sufficient to meet this payment schedule. Off-Balance Sheet Items The Bank has certain ongoing commitments under operating leases. (See Footnote 5 to the Consolidated Financial Statements in Item 8 "Financial Statements and Supplementary Data" for the terms.) These commitments do not significantly impact operating results. As of December 31, 2002, commitments to extend credit were the only financial instruments with off-balance sheet risk. The Bank has not entered into any contracts for freestanding financial derivative instruments such as futures, swaps, options etc., and did not identify any embedded derivatives. Loan and letter of credit commitments increased to $192,151,000 from $170,076,000 at December 31, 2001. The commitments represent 25.8% of total loans at year-end 2002 versus 28.1% a year ago. The majority of the commitments have a maturity of one year or less. Commitments for home equity lines of credit totaling $20,180,000, which have a ten-year maturity, are the single largest category of commitments exceeding a one-year maturity. Disclosure of Fair Value Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Statements," requires the disclosure of fair value of most financial instruments, whether recognized or not recognized in the financial statements. The intent of presenting the fair values of financial instruments is to depict the market's assessment of the present value of net future cash flows discounted to reflect both current interest rates and the market's assessment of the risk that the cash flows will not occur. In determining fair values, the Company used the carrying amount for cash, short-term investments, accrued interest receivable, short-term borrowings and accrued interest payable as all of these instruments are short term in nature. Securities are reflected at quoted market values. Loans and deposits have a long term time horizon, which required more complex calculations for fair value determination. Loans are grouped into homogeneous categories and broken down between fixed and variable rate instruments. Loans with a variable rate, which reprice quickly, are valued at carrying value. The fair value of fixed rate instruments is estimated by discounting the future cash flows using current rates. Credit risk and repricing risk factors are included in the current rates. Fair value for nonaccrual loans is reported at carrying value and is included in the net loan total. Since the allowance for loan losses exceeds any potential adjustment for nonaccrual valuation, no further valuation adjustment has been made. Demand deposits, savings and certain money market accounts are short term in nature so the carrying value equals the fair value. For deposits that extend over a period in excess of four months, the fair value is estimated by discounting the future cash payments using the rates currently offered for deposits of similar remaining maturities. At year-end 2002, the fair values calculated on the Bank's assets were 0.3% above the carrying values versus 0.5% under the carrying values at year-end 2001. Website Access Information on the Company and its subsidiary Bank may be obtained from the Company's website www.community-bnk.com. Copies of the Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments thereto are available free of charge on the website as soon as they are published by the SEC through a link to the Edgar reporting system maintained by the SEC. Simply select the "Central Coast Bancorp" menu item, then click on the "Central Coast Bancorp SEC Filings" link. Other Matters The terrorist actions on September 11, 2001 and the threat of terror since, and the threat of war with Iraq have had significant adverse effects upon the United States economy. Whether the terrorist activities in the future and the actions of the United States and its allies in combating terrorism on a worldwide basis will adversely impact the Company and the extent of such impact is uncertain. However, such events have had and may continue to have an adverse effect on the economy in the Company's market areas. Such continued economic deterioration could adversely affect the Company's future results of operations by, among other matters, reducing the demand for loans and other products and services offered by the Company, increasing nonperforming loans and the amounts reserved for loan losses, and causing a decline in the Company's stock price. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by Item 7A of Form 10-K is contained in the Market Risk Management section of Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" on page 40. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page ---- Independent Auditors' Report 48 Consolidated Balance Sheets, December 31, 2002 and 2001 49 Consolidated Statements of Income for the years ended December 31, 2002, 2001 and 2000 50 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 51 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2002, 2001 and 2000 52 Notes to Consolidated Financial Statements 53-68 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. 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 subsidiary as of December 31, 2002 and 2001, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2002. 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. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Central Coast Bancorp and subsidiary at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE San Francisco, California January 22, 2003 (February 28, 2003 as to the effects of the stock dividend described in Note 1) Consolidated Balance Sheets Central Coast Bancorp and Subsidiary
- ------------------------------------------------------------------------------- December 31, 2002 2001 - ------------------------------------------------------------------------------- Assets Cash and due from banks $ 63,915,000 $ 55,245,000 Federal funds sold 2,700,000 - - ------------------------------------------------------------------------------- Total cash and equivalents 66,615,000 55,245,000 Available-for-sale securities at fair value 107,323,000 137,153,000 Loans: Commercial 224,840,000 199,761,000 Real estate-construction 74,214,000 85,314,000 Real estate-other 433,921,000 306,622,000 Consumer 13,414,000 15,653,000 Deferred loan fees, net (1,036,000) (1,050,000) - ------------------------------------------------------------------------------- Total loans 745,353,000 606,300,000 Allowance for loan losses (15,235,000) (11,753,000) - ------------------------------------------------------------------------------- Net Loans 730,118,000 594,547,000 - ------------------------------------------------------------------------------- Premises and equipment, net 2,959,000 2,962,000 Accrued interest receivable and other assets 12,117,000 12,359,000 - ------------------------------------------------------------------------------- Total assets $ 919,132,000 $ 802,266,000 =============================================================================== Liabilities and Shareholders' Equity Deposits: Demand, noninterest bearing $ 261,242,000 $ 231,501,000 Demand, interest bearing 127,692,000 105,949,000 Savings 181,089,000 122,861,000 Time 256,479,000 264,551,000 - ------------------------------------------------------------------------------- Total deposits 826,502,000 724,862,000 Accrued interest payable and other liabilities 14,554,000 12,068,000 - ------------------------------------------------------------------------------- Total liabilities 841,056,000 736,930,000 - ------------------------------------------------------------------------------- Commitments and contingencies (Notes 5 and 11) Shareholders' Equity: Preferred stock-no par value; authorized 1,000,000 shares; none outstanding Common stock - no par value; authorized 25,000,000 shares; outstanding: 9,015,675 and 8,963,780 shares at December 31,2002 and 2001 51,289,000 50,898,000 Shares held in deferred compensation trust (373,810 shares in 2002 and 2001), net of deferred obligation - - Retained earnings 25,383,000 14,855,000 Accumulated other comprehensive income (loss), net of taxes of $994,000 in 2002 and $297,000 in 2001 1,404,000 (417,000) - ------------------------------------------------------------------------------- Total shareholders' equity 78,076,000 65,336,000 - ------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 919,132,000 $ 802,266,000 ===============================================================================
See notes to Consolidated Financial Statements Consolidated Statements of Income Central Coast Bancorp and Subsidiary
- ------------------------------------------------------------------------------------------------------------------- Years Ended December 31, 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------- Interest Income Loans (including fees) $ 44,141,000 $ 43,135,000 $ 41,405,000 Investment securities 6,105,000 8,205,000 8,945,000 Federal funds sold 255,000 407,000 1,065,000 - ------------------------------------------------------------------------------------------------------------------- Total interest income 50,501,000 51,747,000 51,415,000 - ------------------------------------------------------------------------------------------------------------------- Interest Expense Interest on deposits 13,517,000 17,926,000 17,921,000 Other 438,000 434,000 369,000 - ------------------------------------------------------------------------------------------------------------------- Total interest expense 13,955,000 18,360,000 18,290,000 - ------------------------------------------------------------------------------------------------------------------- Net Interest Income 36,546,000 33,387,000 33,125,000 Provision for Loan Losses (3,584,000) (2,635,000) (3,983,000) - ------------------------------------------------------------------------------------------------------------------- Net Interest Income after Provision for Loan Losses 32,962,000 30,752,000 29,142,000 - ------------------------------------------------------------------------------------------------------------------- Noninterest Income Service charges on deposits 2,342,000 1,924,000 1,749,000 Other income 1,323,000 1,205,000 684,000 - ------------------------------------------------------------------------------------------------------------------- Total noninterest income 3,665,000 3,129,000 2,433,000 - ------------------------------------------------------------------------------------------------------------------- Noninterest Expenses Salaries and benefits 12,129,000 11,619,000 10,081,000 Occupancy 1,997,000 1,642,000 1,479,000 Furniture and equipment 1,802,000 1,833,000 1,702,000 Other 4,568,000 4,129,000 4,146,000 - ------------------------------------------------------------------------------------------------------------------- Total noninterest expenses 20,496,000 19,223,000 17,408,000 - ------------------------------------------------------------------------------------------------------------------- Income Before Provision for Income Taxes 16,131,000 14,658,000 14,167,000 Provision for Income Taxes 5,603,000 5,149,000 5,241,000 - ------------------------------------------------------------------------------------------------------------------- Net Income $ 10,528,000 $ 9,509,000 $ 8,926,000 =================================================================================================================== Basic Earnings per Share $ 1.06 $ 0.95 $ 0.85 Diluted Earnings per Share $ 1.02 $ 0.92 $ 0.83 ===================================================================================================================
See Notes to Consolidated Financial Statements Consolidated Statements of Cash Flows Central Coast Bancorp and Subsidiary
- ---------------------------------------------------------------------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 - ---------------------------------------------------------------------------------------------------------------------------------- Cash Flows from Operations: Net income $ 10,528,000 $ 9,509,000 $ 8,926,000 Reconciliation of net income to net cash provided by operating activities: Provision for loan losses 3,584,000 2,635,000 3,983,000 Depreciation 1,272,000 1,361,000 1,266,000 Amortization and accretion 782,000 665,000 8,000 Provision for deferred income taxes (1,589,000) (1,260,000) (1,852,000) Loss (gain) on sale of securities (102,000) (168,000) 194,000 Net loss on sale of equipment 17,000 23,000 19,000 Gain on other real estate owned (79,000) (4,000) (67,000) Decrease (increase) in accrued interest receivable and other assets (308,000) 164,000 1,077,000 Increase (decrease) in accrued interest payable and other liabilities (920,000) (2,420,000) 3,492,000 (Decrease) increase in deferred loan fees (14,000) 304,000 25,000 - ---------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operations 13,171,000 10,809,000 17,071,000 - ---------------------------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Proceeds from maturities of available-for-sale securities 119,594,000 46,672,000 70,751,000 Proceeds from sale of available-for-sale securities 16,714,000 77,962,000 19,806,000 Purchase of available-for-sale securities (103,788,000) (108,665,000) (91,174,000) Net change in loans held for sale - - - Net increase in loans (139,141,000) (133,462,000) (78,031,000) Proceeds from sale of other real estate owned 670,000 199,000 - Proceeds from sale of equipment - - - Purchases of equipment (1,286,000) (611,000) (1,132,000) - ---------------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (107,237,000) (117,905,000) (79,780,000) - ---------------------------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Net increase in deposit accounts 101,640,000 91,652,000 115,021,000 Net increase (decrease) in other borrowings 3,575,000 935,000 (11,744,000) Cash received for stock options exercised 221,000 119,000 76,000 Cash paid for shares repurchased - (4,857,000) (6,111,000) - ---------------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 105,436,000 87,849,000 97,242,000 - ---------------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and equivalents 11,370,000 (19,247,000) 34,533,000 Cash and equivalents, beginning of year 55,245,000 74,492,000 39,959,000 - ---------------------------------------------------------------------------------------------------------------------------------- Cash and equivalents, end of year $ 66,615,000 $ 55,245,000 $ 74,492,000 ================================================================================================================================== Noncash Investing and Financing Activities: The Company obtained $591,000 of real estate (OREO) in 2002 in connection with foreclosures of delinquent loans (none in 2001 or 2000). In 2002, 2001 and 2000 stock option exercises and stock repurchases totaling $263,000, $84,000 and $20,000, respectively were performed through a "stock for stock" exercise under the Company's stock option and deferred compensation plans (see Note 9). - ---------------------------------------------------------------------------------------------------------------------------------- Other Cash Flow Information: Interest paid $ 14,491,000 $ 18,695,000 $ 17,121,000 Income taxes paid 6,962,000 8,203,000 5,970,000 ==================================================================================================================================
See Notes to Consolidated Financial Statements Consolidated Statements of Shareholders' Equity Central Coast Bancorp and Subsidiary
- ----------------------------------------------------------------------------------------------------------------------------------- Accumulated Other Years Ended December 31, Common Stock Retained Comprehensive 2002, 2001 and 2000 Shares Amount Earnings Income (Loss) Total - ----------------------------------------------------------------------------------------------------------------------------------- Balances, January 1, 2000 8,050,321 $ 40,223,000 $ 17,784,000 $ (4,702,000) $ 53,305,000 Net income - - 8,926,000 - 8,926,000 Changes in unrealized gains/losses on securities available for sale, net of taxes of $2,449,000 - - - 3,526,000 3,526,000 Reclassification adjustment for losses included in income, net of taxes of $80,000 - - - 114,000 114,000 ----------------- Total comprehensive income 12,566,000 ----------------- 10% stock dividend 805,033 10,266,000 (10,266,000) - - Stock options exercised 16,248 96,000 - - 96,000 Shares repurchased (469,104) (6,131,000) - - (6,131,000) Tax benefit of stock options exercised - 18,000 - - 18,000 - ----------------------------------------------------------------------------------------------------------------------------------- Balances, December 31, 2000 8,402,498 44,472,000 16,444,000 (1,062,000) 59,854,000 Net income - - 9,509,000 - 9,509,000 Changes in unrealized gains/losses on securities available for sale, net of taxes of $511,000 - - - 744,000 744,000 Reclassification adjustment for gains included in income, net of taxes of $69,000 - - - (99,000) (99,000) ----------------- Total comprehensive income 10,154,000 ----------------- 10% stock dividend 836,410 11,098,000 (11,098,000) - - Stock options exercised 38,291 203,000 - - 203,000 Shares repurchased (313,419) (4,940,000) - - (4,940,000) Tax benefit of stock options exercised - 65,000 - - 65,000 - ----------------------------------------------------------------------------------------------------------------------------------- Balances, December 31, 2001 8,963,780 50,898,000 14,855,000 (417,000) 65,336,000 Net income - - 10,528,000 - 10,528,000 Changes in unrealized gains/losses on securities available for sale, net of taxes of $1,334,000 - - - 1,881,000 1,881,000 Reclassification adjustment for gains included in income, net of taxes of $42,000 - - - (60,000) (60,000) ----------------- Total comprehensive income 12,349,000 ----------------- Stock options exercised 51,895 221,000 - - 221,000 Tax benefit of stock options exercised - 170,000 - - 170,000 - ----------------------------------------------------------------------------------------------------------------------------------- Balances, December 31, 2002 9,015,675 $ 51,289,000 $ 25,383,000 $ 1,404,000 $ 78,076,000 - -----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Central Coast Bancorp and Subsidiary Years ended December 31, 2002, 2001 and 2000 Note 1. Significant Accounting Policies and Operations. The consolidated financial statements include Central Coast Bancorp (the "Company") and its wholly-owned subsidiary, Community Bank of Central California (the "Bank"). All material intercompany accounts and transactions are eliminated in consolidation. The accounting and reporting policies of the Company and the Bank conform to accounting principles generally accepted in the United States of America 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. The material estimate that is particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan losses. Community Bank of Central California operates eleven full service branch offices in Monterey, Santa Clara, Santa Cruz and San Benito Counties, serving small and medium sized business customers, as well as individuals. The Bank focuses on business loans and deposit services to customers throughout its service area. Basis of presentation - Stock dividend. On January 27, 2003 the Board of Directors declared a 10% stock dividend, which was distributed on February 28, 2003, to shareholders of record as of February 14, 2003. All earnings per share data and share data related to the stock option information have been retroactively adjusted to reflect the stock dividend. Cash and Cash Equivalents consist of cash on hand, amounts due from banks and Federal funds sold. 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. At December 31, 2002 and 2001 all of the Company's investments were classified as available-for-sale. Loans are stated at the principal amount outstanding, reduced by any charge-offs. 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. The allowance for loan 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, prior loss experience and other factors. 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 allowance, management considers numerous factors such as changes in the 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 charged to the allowance. 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. Other borrowed funds consist of $6,660,000 borrowed from the Federal Home Loan Bank collateralized by certain real estate loans and investment securities. 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, as the Company's stock option plans provide for the issuance of options at a price of no less than the fair market value at the date of the grant. Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, 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 year 1995. Under SFAS No. 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 assumptions: expected life, four years following vesting for 2002, 2001 and 2000; average stock volatility of 16.0% for 2002, 15.6% for 2001 and 15.3% for 2000; risk free interest rates ranging from 2.92% to 6.57% for 2002, 4.14% to 6.57% for 2001, and 4.52% to 6.57% for 2000; and no dividends during the expected term for 2002, 2001 and 2000. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. 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 SFAS No. 123 is as follows.
- -------------------------------------------------------------------------------------------- Years Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------------------- Net Income - As Reported $ 10,528,000 $ 9,509,000 $ 8,926,000 Compensation expense from amortization of fair value of stock awards, net of taxes of $64,000, $121,000 and $260,000 in 2002, 2001 and 2000 (86,000) (176,000) (377,000) - -------------------------------------------------------------------------------------------- Pro Forma Net Income $ 10,442,000 $ 9,333,000 $ 8,549,000 ============================================================================================ Basic Earnings per Share - As Reported $ 1.06 $ 0.95 $ 0.85 Pro Forma Basic Earnings per Share $ 1.06 $ 0.94 $ 0.82 Diluted Earnings per Share - As Reported $ 1.02 $ 0.92 $ 0.83 Pro Forma Diluted Earnings per Share $ 1.01 $ 0.90 $ 0.80 ============================================================================================
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 loan losses, 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. Derivative Instruments and hedging activities. The Company did not enter into freestanding derivative contracts and was not involved in any hedging activities and did not identify any embedded derivatives requiring bifurcation and separate valuation during 2002, 2001 or 2000. Comprehensive income includes net income and other comprehensive income, which represents the changes in its net assets during the period from non-owner sources. The Company's only source of other comprehensive income is derived from unrealized gain and loss on securities available-for-sale and is presented net of tax in the accompanying statements of shareholders' equity. Segment reporting. The Company operates a single line of business with no customer accounting for more than 10% of its revenue. Management evaluates the Company's performance as a whole and does not allocate resources based on the performance of different lending or transaction activities. Accordingly, the Company and its subsidiary operate as one business segment. Recently issued accounting pronouncements. Effective January 1, 2002, the Company adopted SFAS No. 141, "Business Combinations" which addresses the elimination of pooling accounting treatment in business combinations and the financial accounting and reporting for acquired goodwill and other intangible assets at acquisition and SFAS No.142, "Goodwill and Other Intangible Assets" which addresses financial accounting and reporting for acquired goodwill and other intangible assets at acquisition in transactions other than business combinations covered by SFAS No.141, and the accounting treatment of goodwill and other intangible assets after acquisition and initial recognition in the financial statements. The adoption of these statements did not have a material effect on the Company's consolidated financial position, results of operations, or cash flows. Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting For The Impairment Or Disposal Of Long-Lived Assets". SFAS No. 144 supersedes SFAS No. 121, "Accounting For The Impairment Of Long-Lived Assets And For Long-Lived Assets To Be Disposed Of" and the accounting and reporting provisions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting The Results Of Operations - Reporting The Effects Of Disposal Of A Segment Of A Business, And Extraordinary, Unusual and Infrequently Occurring Events And Transactions". SFAS No. 144 unifies the accounting treatment for various types of long-lived assets to be disposed of, and resolves implementation issues related to SFAS No. 121. The adoption of SFAS No. 144 did not have a material effect on the Company's financial position, results of operations, or cash flows. Effective April 1, 2002, the Company adopted SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". SFAS No. 145 rescinds and amends these statements to eliminate any inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions including clarification that gains or losses from normal extinguishments of debt need not be classified as extraordinary items. The adoption of SFAS No. 145 did not have a material effect on the Company's financial position, results of operations, or cash flows. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue No. 94-3, a liability for an exit cost was recognized at the date of the Company's commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized. Effective October 1, 2002, the Company adopted SFAS No. 147, "Acquisitions of Certain Financial Institutions - an Amendment of FASB Statements No. 72 and 144 and FASB Interpretation No.9", which removes acquisitions of financial institutions from the scope of both Statement 72 and Interpretation 9 and requires those transactions be accounted for in accordance with FASB Statements No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". This Statement is effective for acquisitions on or after October 1, 2002 with earlier application permitted for the transition provisions for previously recorded unidentifiable intangible assets. The adoption of SFAS No. 147 did not have a material effect on the Company's financial position, results of operations, or cash flows. Effective December 31, 2002 the Company adopted SFAS No. 148, "Accounting for Stock Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No, 123", which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of No. 123 to require prominent disclosures in both annual and interim financial statements within the Significant Accounting Policies footnote about the method of accounting for stock-based employee compensation and the effect of the method used (intrinsic value or fair value) on reported results. The Company continues to account for stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and presents the required disclosures in accordance with SFAS No. 123 as amended by SFAS No. 148. The adoption of SFAS No. 148 did not have a material effect on the Company's financial position, results of operations, or cash flows. Note 2. Cash and Due from Banks. The Company, through its bank subsidiary, is required to maintain reserves with the Federal Reserve Bank. Reserve requirements are based on a percentage of deposits. At December 31, 2002 the Company maintained reserves of approximately $1,609,000 in the form of vault cash and balances at the Federal Reserve to satisfy regulatory requirements. Note 3. Securities. The Company's investment securities portfolio as of December 31, 2002 and 2001 consisted of the following:
- ------------------------------------------------------------------------------------- Amortized Unrealized Unrealized Market In thousands Cost Gain Loss Value - ------------------------------------------------------------------------------------- December 31, 2002 Available for sale securities: U.S. Treasury and Agency Securities $ 40,027 $ 1,429 $ - $ 41,456 State & Political Subdivision 52,045 1,985 38 53,992 Corporate Debt Securities 11,547 - 978 10,569 Other 1,306 - - 1,306 - ------------------------------------------------------------------------------------- Total investment securities $ 104,925 $ 3,414 $ 1,016 $ 107,323 ===================================================================================== December 31, 2001 Available for sale securities: U.S. Treasury and Agency Securities $ 74,578 $ 961 $ 53 $ 75,486 State & Political Subdivision 50,523 186 868 49,841 Corporate Debt Securities 11,530 - 940 10,590 Other 1,236 - - 1,236 - ------------------------------------------------------------------------------------- Total investment securities $ 137,867 $ 1,147 $ 1,861 $ 137,153 =====================================================================================
The amortized cost and estimated fair value of debt securities at December 31, 2002, based on projected average life, are shown in the next table. Projected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. - ---------------------------------------------------------------------------- Amortized Market In thousands Cost Value - ---------------------------------------------------------------------------- Available for sale securities: Maturing within 1 year $ 102 $ 102 Maturing after 1 year but within 5 years 3,907 4,026 Maturing after 5 years but within 10 years 33,280 34,134 Maturing after 10 years 66,330 67,755 Other 1,306 1,306 - ---------------------------------------------------------------------------- Total investment securities $ 104,925 $ 107,323 ============================================================================ At December 31, 2002 and 2001, securities with a market value of $90,952,000 and $120,472,000 were pledged as collateral for deposits of public funds and other purposes as required by law or contract. In 2002, security sales resulted in gross realized losses of $23,000 and gross realized gains of $125,000. In 2001, security sales resulted in gross realized losses of $26,000 and gross realized gains of $194,000. In 2000, such sales resulted in gross realized losses of $194,000 and no gross realized gains. Note 4. Loans and allowance for loan 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 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 $571,000,000. 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 reserves for losses are provided. 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. Loan losses from lending transactions related to real estate and agriculture compare favorably with the Company's loan losses on its loan portfolio as a whole. The activity in the allowance for loan losses is summarized as follows: - ---------------------------------------------------------------------- In thousands 2002 2001 2000 - ---------------------------------------------------------------------- Balance, beginning of year $ 11,753 $ 9,371 $ 5,596 Provision charged to expense 3,584 2,635 3,983 Loans charged off (353) (430) (392) Recoveries 251 177 184 - ---------------------------------------------------------------------- Balance, end of year $ 15,235 $ 11,753 $ 9,371 ====================================================================== 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 level of allowances to be maintained and the loan loss allowance ratio, management uses a formula allowance calculated by applying loss factors to outstanding loans and certain unused commitments and an unallocated allowance for amounts that are based on management's evaluation of conditions that are not directly measured in the determination of the specific and formula allowances. In determining these allowances, 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 loan losses at December 31, 2002 is adequate, 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. Non-performing loans at December 31 are summarized below: - ---------------------------------------------------------------------- In thousands 2002 2001 - ---------------------------------------------------------------------- Past due 90 days or more and still accruing: Real estate $ - $ 68 Commercial - - Consumer and other 5 12 - ---------------------------------------------------------------------- 5 80 - ---------------------------------------------------------------------- Nonaccrual: Real estate 598 592 Commercial 272 702 Consumer and other - - - ---------------------------------------------------------------------- 870 1,294 - ---------------------------------------------------------------------- Restructured (in compliance with modified terms) - Commercial 933 955 - ---------------------------------------------------------------------- Total nonperforming loans $ 1,808 $ 2,329 ====================================================================== Interest due but excluded from interest income on nonaccrual loans was approximately $24,000, $45,000 and $64,000 in 2002, 2001 and 2000 respectively. In 2002 and 2001, interest income recognized from payments received on nonaccrual loans was $40,000 and $69,000, respectively (none was recognized in 2000). At December 31, 2002, the recorded investment in loans that are considered impaired under SFAS No. 114 was $2,618,000 of which $870,000 are included as nonaccrual loans above, and $933,000 are included as restructured loans above. At December 31, 2001, the recorded investment in loans that was considered impaired under SFAS No. 114 was $2,418,000 of which $1,294,000 are included as nonaccrual loans above, and $955,000 are included as restructured loans above. Such impaired loans had valuation allowances totaling $1,165,000 and $536,000, in 2002 and 2001, respectively, based on the estimated fair values of the collateral. The average recorded investment in impaired loans during 2002 and 2001 was $2,338,000 and $2,638,000, respectively. The Company recognized interest income on impaired loans of $143,000, $191,000 and $161,000 in 2002, 2001 and 2000, respectively (including interest income of $66,000 in 2002 and $98,000 in both 2001 and 2000 on restructured loans). At December 31, 2002, there were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual. The Company held no real estate acquired by foreclosure at December 31, 2002 or 2001. Note 5. Premises and equipment. Premises and equipment owned by the Company at December 31 are summarized as follows: - --------------------------------------------------------------------- In thousands 2002 2001 - --------------------------------------------------------------------- Land $ 121 $ 121 Building 265 265 Furniture and equipment 7,175 6,606 Leasehold improvement 2,685 2,460 - --------------------------------------------------------------------- 10,246 9,452 Accumulated depreciation and amortization (7,287) (6,490) - --------------------------------------------------------------------- Premises and equipment, net $ 2,959 $ 2,962 ===================================================================== The Company also leases facilities under agreements that expire in March 2003 through October 2009 with options to extend for five to twenty years. These include two 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 $793,000, $675,000 and $634,000, including rent expense to shareholders of $130,000, $133,000 and $122,000 in 2002, 2001 and 2000 respectively. The minimum annual rental commitments under these leases, including the remaining rental commitment under the leases to shareholders are as follows: - --------------------------------------------------------------------- Operating In thousands Leases - --------------------------------------------------------------------- 2003 $ 969 2004 923 2005 808 2006 675 2007 446 Thereafter 326 - --------------------------------------------------------------------- Total $ 4,147 ===================================================================== Note 6. Income Taxes. The provision for income taxes is as follows: - --------------------------------------------------------------------- In thousands 2002 2001 2000 - --------------------------------------------------------------------- Current: Federal $ 5,063 $ 4,577 $ 5,160 State 2,129 1,832 1,933 - --------------------------------------------------------------------- Total 7,192 6,409 7,093 - --------------------------------------------------------------------- Deferred: Federal (1,120) (950) (1,432) State (469) (310) (420) - --------------------------------------------------------------------- Total (1,589) (1,260) (1,852) - --------------------------------------------------------------------- Total $ 5,603 $ 5,149 $ 5,241 ===================================================================== A reconciliation of the Federal income tax rate to the effective tax rate is as follows: - --------------------------------------------------------------------- 2002 2001 2000 - --------------------------------------------------------------------- Statutory Federal income tax rate 35.0% 35.0% 35.0% State income taxes (net of Federal income tax benefit) 6.8% 6.9% 7.1% Tax exempt interest income (6.7%) (6.4%) (5.0%) Other (0.4%) (0.4%) (0.1%) - --------------------------------------------------------------------- Effective tax rate 34.7% 35.1% 37.0% ===================================================================== The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2002 and 2001, are presented below: - --------------------------------------------------------------------- In thousands 2002 2001 - --------------------------------------------------------------------- Deferred tax assets: Provision for loan losses $ 6,831 $ 5,206 Unrealized (gain) loss on available for sale securities (994) 297 Salary continuation plan 862 755 Depreciation and amortization 108 209 State income taxes 52 127 Excess serving rights 10 12 Interest on nonaccrual loans 18 20 Other 240 203 - --------------------------------------------------------------------- Net deferred tax asset $ 7,127 $ 6,829 ===================================================================== The Company believes that it is more likely than not that it will realize the above deferred tax assets in future periods; therefore, no valuation allowance has been provided against its deferred tax assets. Note 7. Other Noninterest Expense. Other expense for the years ended December 31, 2002, 2001 and 2000 consists of the following: - --------------------------------------------------------------------- In thousands 2002 2001 2000 - --------------------------------------------------------------------- Marketing $ 565 $ 473 $ 644 Professional fees 540 457 430 Customer expenses 526 525 413 Stationary and supplies 370 372 377 Data processing 268 272 314 Amortization of intangibles 257 257 257 Shareholder and director 245 229 253 Dues and assessments 245 177 179 Insurance 226 216 216 Other 1,326 1,151 1,063 - --------------------------------------------------------------------- Total $ 4,568 $ 4,129 $ 4,146 ===================================================================== Note 8. Earnings Per Share. Basic earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period, as adjusted to give effect to all stock splits and dividends. Diluted earnings per share reflects the potential dilution that could occur if options or other contracts to issue common stock were exercised and converted into common stock. There was no difference in the numerator used in the calculation of basic earnings per share and diluted earnings per share. The denominator used in the calculation of basic earnings per share and diluted earnings per share for each of the years ended December 31 is reconciled as follows:
- ----------------------------------------------------------------------------------------- In thousands (expect per share data) 2002 2001 2000 - ----------------------------------------------------------------------------------------- Basic Earnings Per Share Net income $ 10,528 $ 9,509 $ 8,926 Weighted average common shares outstanding 9,898 9,951 10,467 ------------------------------------------ Basic earnings per share $ 1.06 $ 0.95 $ 0.85 ========================================================================================= Diluted Earnings Per Share Net Income $ 10,528 $ 9,509 $ 8,926 Weighted average common shares outstanding 9,898 9,951 10,467 Dilutive effect of outstanding options 460 433 309 ------------------------------------------ Weighted average common shares outstanding - Diluted 10,358 10,384 10,776 ------------------------------------------ Diluted earnings per share $ 1.02 $ 0.92 $ 0.83 =========================================================================================
Note 9. 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 shares of common stock. All stock option information has been adjusted to give effect to all stock splits and dividends. Options are granted at a price not less than the fair market value of the common 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. The weighted average value of options granted in 2002, 2001 and 2000 was $4.77, $4.50 and $3.84 per share, respectively. As of December 31, 2002, 1,922,075 shares are available for future grants under the plans. Activity under the stock option plans is as follows: - -------------------------------------------------------------------- Weighted Average Exercise Shares Price - -------------------------------------------------------------------- Balances, January 1, 2000 818,084 exercisable at a weighted average exercise price of $5.50 932,643 $5.94 Granted (weighted average fair value $3.84 per share) 265,064 10.64 Expired (9,075) 10.58 Exercised (19,658) 4.85 - -------------------------------------------------------------------- Balances, December 31, 2000 862,524 exercisable at a weighted average exercise price of $5.76 1,168,974 7.00 Granted (weighted average fair value $4.50 per share) 5,500 14.44 Exercised (48,164) 4.23 - -------------------------------------------------------------------- Balances, December 31, 2001 937,230 exercisable at a weighted average exercise price of $6.44 1,126,310 5.27 Granted (weighted average fair value $4.77 per share) 11,000 18.05 Expired (2,521) 14.55 Exercised (71,785) 5.28 - -------------------------------------------------------------------- Balances, December 31, 2002 963,764 exercisable at a weighted average exercise price of $6.85 1,063,004 $6.72 - -------------------------------------------------------------------- Additional information regarding options outstanding as of December 31, 2002 is as follows: - --------------------------------------------------------------------- Options Outstanding Options Exercisable ------------------- ------------------- Weighted Average Remaining Weighted Weighted Contractual Average Average Range of Number Life Exercise Number Exercise Exercise Prices Outstanding (years) Price Exercisable Price - --------------------------------------------------------------------- $3.71 - 4.84 230,253 2.4 $3.89 230,253 $3.89 5.90 - 5.97 433,454 3.9 5.92 433,454 5.92 9.25 - 11.90 382,797 6.6 10.47 298,223 10.42 14.45 - 16.08 16,500 9.4 16.33 1,834 14.45 - --------------------------------------------------------------------- 3.71 - 16.08 1,063,004 4.6 $7.34 963,764 $6.85 ===================================================================== 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 25% 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 2002, 2001 and 2000 which are funded currently, totaled $134,000, $129,000 and $114,000, respectively. Salary Continuation Plan The Company has a salary continuation plan for three officers, which provides for a stated retirement benefit for each participant upon reaching age 63. The Company accrues such post-retirement benefits over the vesting periods (of five or ten years) based on a discount rate of 7.5%. In the event of a change in control of the Company, the officers' benefits will fully vest. The Company recorded compensation expense of $101,000, $94,000 and $292,000 in 2002, 2001 and 2000. Accrued compensation payable under the salary continuation plan totaled $1,335,000 and $1,233,000 at December 31, 2002 and 2001. Deferred Compensation Plan The Company has a deferred compensation plan for the benefit of the Board of Directors and certain officers. In addition to the deferral of compensation, the plan allows participants the opportunity to defer taxable income derived from the exercise of stock options. The participant's may, after making an election to defer receipt of the option shares for a specified period of time, use a "stock-for-stock" exercise to tender to the Company mature shares with a fair value equal to the exercise price of the stock options exercised. The Company simultaneously delivers new shares to the participant equal to the value of shares surrendered and the remaining shares under option are placed in a trust administered by a third- party trust company, to be distributed in accordance with the terms of each participant's election to defer. During 2002, 2001 and 2000 no shares were tendered under the plan. At December 31, 2002, 373,810 shares (with a fair value of approximately $7,386,000) were held in the Deferred Compensation Trust. Note 10. Disclosures About Fair Value of Financial Instruments. The estimated 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, 2002 December 31, 2001 Carrying Estimated Carrying Estimated In thousands Amount Fair Value Amount Fair Value - --------------------------------------------------------------------- Financial Assets Cash and equivalents $ 66,615 $ 66,615 $ 55,245 $ 55,245 Securities 107,323 107,323 137,153 137,153 Loans, net 730,118 733,124 594,547 598,475 Financial Liabilities Demand deposits 388,934 388,934 337,450 337,450 Time Deposits 256,479 259,233 264,551 267,362 Savings 181,089 181,089 122,861 122,861 Other borrowings 9,716 9,716 6,141 6,141 - --------------------------------------------------------------------- The following estimates and assumptions were used to estimate the fair value of the financial instruments. Cash and equivalents - The carrying amount is a reasonable estimate of fair value. Securities - Fair values of 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 loan 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. Other Borrowings - The carrying amount is a reasonable estimate of fair value. 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, 2002 and 2001, therefore, have not been included in the table above. Note 11. Commitments and Contingencies. The Company is involved in certain legal actions arising from normal business activities. Management, based upon the advise of legal counsel, believes the ultimate resolution of all pending legal actions will not have a material effect on the financial statements. 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 $186,982,000 and $166,386,000 at December 31, 2002 and 2001 and standby letters of credit and financial guarantees of $5,169,000 and $3,690,000 at December 31, 2002 and 2001. The Bank does not anticipate any losses as a result of these commitments. Approximately $30,858,000 of loan commitments outstanding at December 31, 2002 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 Bank's 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 Bank's 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 12. 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, 2002 is as follows: - --------------------------------------------------------------------- Beginning Balance Additions Repayments Ending Balance - --------------------------------------------------------------------- $4,015,000 $10,172,000 $10,585,000 $3,602,000 ===================================================================== Committed lines of credit, undisbursed loans and standby letters of credit to directors and officers were approximately $3,226,000 and $6,021,000 at December 31, 2002 and 2001. Note 13. 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 defined) and a minimum leverage ratio of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2002 that the Company meets all capital adequacy requirements to which it is subject. As of December 31, 2002 and 2001, the most recent notifications from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as "well capitalized" the Bank must maintain minimum 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 Bank's 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, 2002: Total Capital (to Risk Weighted Assets) Company $ 86,334,000 10.9% $ 63,321,000 8.0% N/A Community Bank 79,470,000 10.2% 62,607,000 8.0% $ 78,259,000 10.0% Tier 1 Capital (to Risk Weighted Assets) Company 76,374,000 9.7% 31,660,000 4.0% N/A Community Bank 69,621,000 8.9% 31,304,000 4.0% 46,955,000 6.0% Tier 1 Capital (to Risk Average Assets) Company 76,374,000 8.6% 35,576,000 4.0% N/A Community Bank 69,621,000 7.9% 35,324,000 4.0% 44,155,000 5.0% ----------------------------------------------------------------- As of December 31, 2001: Total Capital (to Risk Weighted Assets) Company $ 73,518,000 11.1% $ 52,971,000 8.0% N/A Community Bank 65,318,000 10.0% 52,202,000 8.0% $ 65,252,000 10.0% Tier 1 Capital (to Risk Weighted Assets) Company 65,198,000 9.9% 26,486,000 4.0% N/A Community Bank 57,117,000 8.8% 26,101,000 4.0% 39,151,000 6.0% Tier 1 Capital (to Risk Average Assets) Company 65,198,000 8.4% 30,896,000 4.0% N/A Community Bank 57,117,000 7.5% 30,470,000 4.0% 38,088,000 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 Bank. 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 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 Bank to the Company was approximately $11,480,000 as of December 31, 2002. The Bank is subject to certain restrictions under the Federal Reserve Act, including restrictions on the extension of credit to affiliates. In particular, the Bank is prohibited from lending to the Company unless the loans are secured by specified types of collateral. Such secured loans and other advances from the Bank is limited to 10% of Bank shareholders' equity, or a maximum of $7,139,000 at December 31, 2002. No such advances were made during 2002 or 2001. Note 14. Central Coast Bancorp (Parent Company Only) The condensed financial statements of Central Coast Bancorp follow (in thousands): Condensed Balance Sheets - ------------------------------------------------------------------------ December 31, 2002 2001 - ------------------------------------------------------------------------ Assets: Cash - interest bearing account with Bank $ 2,585 $ 997 Loans 3,936 7,063 Investment in Bank 71,322 57,672 Premises and equipment, net 1,142 1,174 Other Assets 1,747 1,149 - ------------------------------------------------------------------------ Total assets $ 80,732 $ 68,055 ======================================================================== Liabilities and Shareholders' Equity Liabilities $ 2,656 $ 2,719 Shareholders' Equity 78,076 65,336 - ------------------------------------------------------------------------ Total liabilities and shareholders' equity $ 80,732 $ 68,055 ======================================================================== Condensed Income Statements - ------------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 - ------------------------------------------------------------------------- Management fees $ 10,164 $ 9,888 $ 8,700 Interest income 322 109 - Other income - 3 - Cash dividends received from the Bank - 10,500 7,000 - ------------------------------------------------------------------------- Total income 10,486 20,500 15,700 Operating expenses 10,162 9,812 9,257 - ------------------------------------------------------------------------- Income before income taxes and equity in undistributed net income of Bank 324 10,688 6,443 Provision (credit) for income taxes 42 66 (206) Equity in undistributed net income of Bank 10,246 (1,113) 2,277 - ------------------------------------------------------------------------- Net income 10,528 9,509 8,926 Other comprehensive income (loss) 1,821 645 3,640 - ------------------------------------------------------------------------- Total comprehensive income $ 12,349 $ 10,154 $ 12,566 ========================================================================= Condensed Statements of Cash Flows - --------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 - --------------------------------------------------------------------- Increase (decrease) in cash: Operations: Net income $ 10,528 $ 9,509 $ 8,926 Adjustments to reconcile net income to net cash provided by operations: Equity in undistributed net income of Bank (10,246) 1,113 (2,277) Depreciation 710 841 778 Gain on sale of equipment 8 17 - (Increase) decrease in other assets (181) (1,324) (127) Increase in liabilities 107 1,000 380 - --------------------------------------------------------------------- Net cash provided by operations 926 11,156 7,680 - --------------------------------------------------------------------- Investing Activities: Contribution to subsidiary (2,000) - - Net (increase) decrease in loans 3,127 (7,063) - Purchases of equipment (686) (302) (612) - --------------------------------------------------------------------- Net cash provided by (used in) investing activities 441 (7,365) (612) - --------------------------------------------------------------------- Financing Activities: Stock repurchases - (4,857) (6,111) Stock options exercised 221 119 94 - --------------------------------------------------------------------- Net cash used in financing activities 221 (4,738) (6,017) - --------------------------------------------------------------------- Net increase (decrease) in cash 1,588 (947) 1,051 Cash balance, beginning of year 997 1,944 893 - --------------------------------------------------------------------- Cash balance, end of year $ 2,585 $ 997 $1,944 ===================================================================== Note 15. Selected Quarterly Information (unaudited)
- ---------------------------------------------------------------------------------------------------------------- In thousands (except per share data) 2002 2001 Three months ended Dec.31 Sep.30 June 30 Mar.31 Dec.31 Sep.30 June 30 Mar.31 - ---------------------------------------------------------------------------------------------------------------- Interest income $12,951 $ 13,012 $ 12,631 $ 11,907 $ 12,331 $ 13,052 $ 12,944 $ 13,420 Interest expense 3,276 3,536 3,518 3,625 3,930 4,681 4,823 4,926 - ---------------------------------------------------------------------------------------------------------------- Net interest income 9,675 9,476 9,113 8,282 8,401 8,371 8,121 8,494 Provision for loan losses 1,536 925 900 223 1,680 760 75 120 - ---------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 8,139 8,551 8,213 8,059 6,721 7,611 8,046 8,374 Total noninterest income 944 992 962 767 777 927 775 650 Total noninterest expenses 5,429 5,257 5,225 4,585 4,759 4,749 4,776 4,939 - ---------------------------------------------------------------------------------------------------------------- Income before taxes 3,654 4,286 3,950 4,241 2,739 3,789 4,045 4,085 Provision for income taxes 1,257 1,438 1,403 1,505 680 1,421 1,522 1,526 - ---------------------------------------------------------------------------------------------------------------- Net income $ 2,397 $ 2,848 $ 2,547 $ 2,736 $ 2,059 $ 2,368 $ 2,523 $ 2,559 ================================================================================================================ Per common share: Basic earnings per share $ 0.25 $ 0.29 $ 0.25 $ 0.27 $ 0.21 $ 0.24 $ 0.25 $ 0.25 Diluted earnings per share 0.24 0.27 0.25 0.26 0.20 0.24 0.24 0.24 - ----------------------------------------------------------------------------------------------------------------
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 2003 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. 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 2003 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 2003 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 2003 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 14. CONTROLS AND PROCEDURES Quarterly Evaluation of the Company's Disclosure Controls and Internal Controls. Within the 90 days prior to the date of this annual report on Form 10-K, the Company evaluated the effectiveness of the design and operation of its "disclosure controls and procedures" (Disclosure Controls), and its "internal controls and procedures for financial reporting" (Internal Controls). This evaluation (the Controls Evaluation) was done under the supervision and with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO). Rules adopted by the SEC require that in this section of the annual report on Form 10-K we present the conclusions of the CEO and the CFO about the effectiveness of our Disclosure Controls and Internal Controls based on and as of the date of the Controls Evaluation. CEO and CFO Certifications. Appearing immediately following the Signatures section of this annual report on Form 10-K there are two separate forms of "Certifications" of the CEO and the CFO. The first form of Certification is required in accord with Section 302 of the Sarbanes-Oxley Act of 2002 (the Section 302 Certification). This section of the annual report on Form 10-K which you are currently reading is the information concerning the Controls Evaluation referred to in the Section 302 Certifications and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented. Disclosure Controls and Internal Controls. Disclosure Controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 (Exchange Act), such as this annual report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's (SEC) rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Internal Controls are procedures which are designed with the objective of providing reasonable assurance that (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP"). Limitations on the Effectiveness of Controls. The Company's management, including the CEO and CFO, does not expect that our Disclosure Controls or our Internal Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Scope of the Controls Evaluation. The CEO/CFO evaluation of our Disclosure Controls and our Internal Controls included a review of the controls' objectives and design, the controls' implementation by the Company and the effect of the controls on the information generated for use in this annual report on Form 10-K. In the course of the Controls Evaluation, we sought to identify risks related to data errors, controls problems or acts of fraud and to confirm that appropriate controls were in place to mitigate these risks. This type of evaluation will be done on a quarterly basis so that the conclusions concerning controls effectiveness can be reported in our quarterly reports on Form 10-Q and annual report on Form 10-K. Our Internal Controls are also evaluated on an ongoing basis by our Internal Audit Service Providers, by other personnel in our Finance organization and by our independent auditors in connection with their audit and review activities. The overall goals of these various evaluation activities are to monitor our Internal Controls and to make modifications as necessary; our intent in this regard is that the Internal Controls will be maintained as dynamic systems that change (including with improvements and corrections) as conditions warrant. Among other matters, we sought in our evaluation to determine whether there were any "significant deficiencies" or "material weaknesses" in the Company's Internal Controls, or whether the Company had identified any acts of fraud involving personnel who have a significant role in the company's Internal Controls. This information was important both for the Controls Evaluation generally and because items 5 and 6 in the Section 302 Certifications of the CEO and CFO require that the CEO and CFO disclose that information to our Board's Audit Committee and to our independent auditors and to report on related matters in this section of the annual report on Form 10-K. In the professional auditing literature, "significant deficiencies" are referred to as "reportable conditions"; these are control issues that could have a significant adverse effect on the ability to record, process, summarize and report financial data in the financial statements. A "material weakness" is defined in the auditing literature as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and not be detected within a timely period by employees in the normal course of performing their assigned functions. We also sought to deal with other controls matters in the Controls Evaluation, and in each case if a problem was identified, we considered what revision, improvement and/or correction to make in accord with our on-going procedures. In accord with SEC requirements, the CEO and CFO note that, since the date of the Controls Evaluation to the date of this annual report on Form 10-K, there have been no significant changes in Internal Controls or in other factors that could significantly affect Internal Controls, including any corrective actions with regard to significant deficiencies and material weaknesses. Conclusions. Based upon the Controls Evaluation, our CEO and CFO have concluded that, subject to the limitations noted above, the Company's Disclosure Controls and Internal Controls (as defined in Exchange Act Rule13a-14(c)) are adequate and effective in timely alerting them to material information relating to the Company required to be included in the Company's filings with the SEC under the Securities Exchange Act of 1934. PART IV ITEM 15. 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, as amended, incorporated by reference from Exhibit 10.18 to the Registrant's 2001 Annual Report on Form 10-K filed with the Commission on March 26, 2002. (3.2) Bylaws, as amended, incorporated by reference from Exhibit 3.2 to Form 10-Q, filed with the Commission on August 13, 2001. (4.1) Specimen form of Central Coast Bancorp stock certificate, incorporated by reference from the Registrant's 1994 Annual Report on Form 10-K 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 Registrant's 1994 Annual Report on Form 10-K 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. *(10.4) 1994 Stock Option Plan, as amended and restated, incorporated by reference from Exhibit 9.9 to Registration Statement on Form S-8, No. 33-89948, filed with the Commission on November 15, 1996. *(10.5) 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 November 15, 1996. *(10.6) 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 November 15, 1996. *(10.7) 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 November 15, 1996. *(10.8) 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. *(10.9) 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. *(10.10) Form of Executive Employment Agreement incorporated by reference from Exhibit 10.13 to the Company's 1996 Annual Report on Form 10-K filed with the Commission on March 31, 1997. *(10.11) Form of Executive Salary Continuation Agreement incorporated by reference from Exhibit 10.14 to the Company's 1996 Annual Report on Form 10-K filed with the Commission on March 31, 1997. *(10.12) Form of Indemnification Agreement incorporated by reference from Exhibit D to the Proxy Statement filed with the Commission on September 3, 1996, in connection with Registrant's 1996 Annual Shareholders' Meeting held on September 23, 1996. (10.13) Purchase and Assumption Agreement for the Acquisition of Wells Fargo Bank Branches incorporated by reference from Exhibit 10.17 to the Registrant's 1996 Annual Report on Form 10-K filed with the Commission on March 31, 1997. (10.14) Lease agreement dated November 27, 2001 related to 491 Tres Pinos Road, Hollister, California incorporated by reference from Exhibit 10.17 to the Registrant's 2001 Annual Report on Form 10-K filed with the Commission on March 26, 2002. (10.15) Lease agreement dated February 11, 2002, related to 761 First Street, Gilroy, California incorporated by reference from Exhibit 10.18 to the Registrant's 2001 Annual Report on Form 10-K filed with the Commission on March 26, 2002. (10.16) Lease agreement dated November 18, 2002, related to 439 Alvarado Street, Monterey. (21.1) The Registrant's only subsidiary is its wholly owned subsidiary, Community Bank of Central California. (23.1) Independent Auditors' Consent (99.1) Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 the Sarbanes-Oxley Act of 2002 *Denotes management contracts, compensatory plans or arrangements. (b) Reports on Form 8-K. A current report on Form 8-K was filed with the Commission on January 22, 2003, reporting a press release dated January 22, 2003 regarding the Company's operating results for the quarter and year ended December 31, 2002, and a second report on Form 8-K was filed with the Commission on January 28, 2003, reporting a press release dated January 28, 2003 regarding the Company's 10% stock dividend declared on January 27, 2003. An Annual Report for the fiscal year ended December 31, 2002, and Notice of Annual Meeting and Proxy Statement for the Company's 2003 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. SIGNATURES Pursuant to the requirements of Section 13 or 14(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 20, 2003 By: /s/ NICK VENTIMIGLIA -------------------------------------- Nick Ventimiglia, Chief Executive Officer (Principal Executive Officer) Date: March 20, 2003 By: /s/ ROBERT STANBERRY -------------------------------------- Robert Stanberry, Chief Financial Officer (Principal Financial and Accounting 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/ C. EDWARD BOUTONNET Director 3/20/03 - ----------------------- (C. Edward Boutonnet) Director 3/20/03 - ----------------------- (Bradford G. Crandall) /s/ ALFRED P. GLOVER Director 3/20/03 - ----------------------- (Alfred P. Glover) /s/ MICHAEL T. LAPSYS Director 3/20/03 - ----------------------- (Michael T. Lapsys) /s/ ROBERT M. MRAULE Director 3/20/03 - ----------------------- (Robert M. Mraule) /s/ DUNCAN L. MCCARTER Director 3/20/03 - ----------------------- (Duncan L. McCarter) /s/ LOUIS A. SOUZA Director 3/20/03 - ----------------------- (Louis A. Souza) /s/ MOSE E. THOMAS Director 3/20/03 - ----------------------- (Mose E. Thomas) /s/ NICK VENTIMIGLIA Chairman and CEO 3/20/03 - ----------------------- (Nick Ventimiglia) CERTIFICATIONS UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Nick Ventimiglia, certify that: 1. I have reviewed this annual report on Form 10-K of Central Coast Bancorp. 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report. 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and (c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls. 6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 20, 2003 /s/NICK VENTIMIGLIA ----------------------- Nick Ventimiglia, Chief Executive Officer I, Robert M. Stanberry, certify that: 1. I have reviewed this annual report on Form 10-K of Central Coast Bancorp. 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report. 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and (c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls. 6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 20, 2003 /s/ ROBERT STANBERRY ----------------------- Robert M Stanberry, Senior Vice President and Chief Financial Officer EXHIBIT INDEX Exhibit Sequential Number Description Page Number - ------ ----------- ----------- 10.16 Lease agreement dated November 18, 2002, related to 439 Alvarado Street, Monterey, California 79 23.1 Independent auditors'consent 124 99.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 the Sarbanes-Oxley Act of 2002 125 EX-10 3 exhibit10x16.txt EXHIBIT 10.16 LEASE FOR MONTEREY DOWNTOWN BRANCH EXHIBIT 10.16 OFFICE LEASE 439 ALVARADO STREET, MONTEREY, CALIFORNIA CALIFORNIA BANK & TRUST, a California corporation as Landlord, and CENTRAL COAST BANCORP., a California corporation dba COMMUNITY BANK OF CENTRAL CALIFORNIA, as Tenant. SUMMARY OF BASIC LEASE INFORMATION The undersigned hereby agree to the following terms of this Summary of Basic Lease Information (the "Summary"). This Summary is hereby incorporated into and made a part of the attached Office Lease (this Summary and the Office Lease to be known collectively as the "Lease") which pertains to the office building (the "Building") which is located at 439 Alvarado Street, Monterey, California 93940. Each reference in the Office Lease to any term of this Summary shall have the meaning as set forth in this Summary for such term. In the event of a conflict between the terms of this Summary and the Office Lease, the terms of the Office Lease shall prevail. Any capitalized terms used herein and not otherwise defined herein shall have the meaning as set forth in the Office Lease. TERMS OF LEASE (References are to the Office Lease) DESCRIPTION 1. Date: November 18, 2002. 2. Landlord: CALIFORNIA BANK & TRUST, a California corporation. 3. Address of Landlord California Bank & Trust (Section 29.19): 300 Lakeside Drive, 8th Floor Oakland, California 94612 Attention: Ms. Victoria Underwood, Vice President with a copy to: California Bank & Trust 11622 El Camino Real, Suite 200 San Diego, California 92130 Attention: Mr. David Russell Senior Vice President, Director of Corporate Real Estate Facilities 4. Tenant: CENTRAL COAST BANCORP., a California corporation, dba COMMUNITY BANK OF CENTRAL CALIFORNIA 5. Address of Tenant 301 Main Street (Section 29.19): Salinas, California 93901 Attention: Mr. Harry Wardwell (Prior to Lease Commencement Date) and 439 Alvarado Street Monterey, California 93940 Attention: Branch Manager (After Lease Commencement Date) 6. Premises (Article 1): Approximately 5,731 rentable square feet of space located on the first floor, as set forth in Exhibit A attached hereto. 7. Term (Article 2). 7.1 Lease Term: Five (5) years. 7.2 Lease Commencement The earlier of (i)the date Date: Tenant commences business in the Premises, and (ii) January 1, 2003. 7.3 Lease Expiration Date: The last day of the month in which the 5th anniversary of the Lease Commencement Date occurs. 8. Base Rent (Article 3): Monthly Monthly Rental Rate Annual Installment per Rentable Lease Year Base Rent of Base Rent Square Foot 1 $168,491.40 $14,040.95 $2.45* * Subject to increase as provided in Section 3.2 of the Office Lease 9. Tenant's Share of Direct Approximately 49% Expenses (Article 4): 10. Security Deposit: Waived. 11. Parking Pass Ratio Thirteen (13) unreserved parking (Article 28): passes. 12. Brokers None. (Section 29.23): The foregoing terms of this Summary are hereby agreed to by Landlord and Tenant. "Landlord": CALIFORNIA BANK & TRUST, a California corporation By: /s/ DAVID RUSSELL David Russell, Sr. Vice President, Director of Corporate Real Estate Facilities By: /s/ VICTORIA UNDERWOOD Victoria Underwood, Vice President "Tenant": CENTRAL COAST BANCORP., a California corporation, dba COMMUNITY BANK OF CENTRAL CALIFORNIA By: /s/ HARRY O. WARDWELL Its: S.V.P. Branch Administrator By: /s/ CAROL FRANCHI Its: S.V.P. Operations Administrator Table of Contents ARTICLE 1 REAL PROPERTY, BUILDING AND PREMISES..................1 ARTICLE 2 LEASE TERM............................................1 ARTICLE 3 BASE RENT.............................................3 ARTICLE 4 ADDITIONAL RENT.......................................4 ARTICLE 5 USE OF PREMISES.......................................7 ARTICLE 6 SERVICES AND UTILITIES................................8 ARTICLE 7 REPAIRS...............................................9 ARTICLE 8 ADDITIONS AND ALTERATIONS.............................9 ARTICLE 9 COVENANT AGAINST LIENS...............................10 ARTICLE 10 INSURANCE............................................11 ARTICLE 11 DAMAGE AND DESTRUCTION...............................12 ARTICLE 12 NONWAIVER............................................13 ARTICLE 13 CONDEMNATION.........................................14 ARTICLE 14 ASSIGNMENT AND SUBLETTING............................14 ARTICLE 15 SURRENDER OF PREMISES; OWNERSHIP AND REMOVAL OF TRADE FIXTURES.......................................17 ARTICLE 16 HOLDING OVER.........................................17 ARTICLE 17 ESTOPPEL CERTIFICATES................................17 ARTICLE 18 SUBORDINATION........................................18 ARTICLE 19 DEFAULTS; REMEDIES...................................18 ARTICLE 20 COVENANT OF QUIET ENJOYMENT..........................20 ARTICLE 21 ENVIRONMENTAL WORK...................................20 ARTICLE 22 TERMINATION ON SALE..................................20 ARTICLE 23 SIGNS................................................21 ARTICLE 24 COMPLIANCE WITH LAW..................................21 ARTICLE 25 LATE CHARGES.........................................21 ARTICLE 26 LANDLORD'S RIGHT TO CURE DEFAULT; PAYMENTS BY TENANT...............................................22 ARTICLE 27 ENTRY BY LANDLORD....................................22 ARTICLE 28 TENANT PARKING.......................................22 ARTICLE 29 MISCELLANEOUS PROVISIONS.............................23 ARTICLE 30 PURCHASE OPTION......................................25 EXHIBITS EXHIBIT A..OUTLINE OF FLOOR PLAN OF PREMISES EXHIBIT B..NOTICE OF LEASE TERM DATES EXHIBIT C..RULES AND REGULATIONS Index Additional Rent..................................................5 Affiliate.......................................................22 Affiliated Assignee.............................................22 Alterations.....................................................12 Ancillary Areas.................................................10 Base Rent........................................................4 BOMA.............................................................1 Brokers.........................................................33 Building.........................................................1 Bureau...........................................................5 Calendar Year....................................................5 Common Areas.....................................................1 Control.........................................................22 Direct Expenses..................................................5 Environmental Work..............................................26 Estimate.........................................................8 Estimate Statement...............................................8 Estimated Expense................................................9 Expense Year.....................................................5 Five Star.......................................................27 Force Majeure...................................................32 Holidays........................................................10 Index............................................................5 Interest Notice..................................................3 Landlord.........................................................1 Landlord Parties................................................14 Lease............................................................1 Lease Commencement Date..........................................2 Lease Expiration Date............................................2 Lease Term.......................................................2 Lease Year.......................................................2 Notices.........................................................32 Operating Expenses...............................................6 Option Notice....................................................2 Option Rent......................................................2 Option Rent Notice...............................................3 Option Terms.....................................................2 Original Tenant..................................................2 Outside Agreement Date...........................................3 Parking Facilities...............................................1 Premises.........................................................1 Proposition 13...................................................7 Real Property....................................................1 Rent.............................................................5 Rules and Regulations............................................9 Statement........................................................8 Subject Space...................................................19 Subleasing Costs................................................20 Summary..........................................................1 Systems and Equipment............................................7 Tax Expenses.....................................................7 Tenant...........................................................1 Tenant Improvements.............................................12 Tenant's Share...................................................8 Tenant's Signage................................................27 Transfer Notice.................................................19 Transfer Premium................................................20 Transferee......................................................19 Transfers.......................................................19 OFFICE LEASE This Office Lease, which includes the preceding Summary of Basic Lease Information (the "Summary") attached hereto and incorporated herein by this reference (the Office Lease and Summary to be known sometimes collectively hereafter as the "Lease"), dated as of the date set forth in Section 1 of the Summary, is made by and between CALIFORNIA BANK & TRUST, a California corporation ("Landlord"), and CENTRAL COAST BANCORP., a California corporation dba COMMUNITY BANK OF CENTRAL CALIFORNIA ("Tenant"). ARTICLE 1.. REAL PROPERTY, BUILDING AND PREMISES 1.1 Real Property, Building and Premises. Upon and subject to the terms, covenants and conditions hereinafter set forth in this Lease, Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the premises set forth in Section 6 of the Summary (the "Premises"), which Premises are located in the "Building," as that term is defined in the Summary. The outline of the floor plan of the Premises is set forth in Exhibit A attached hereto. The Building, the parking facilities serving the Building ("Parking Facilities"), the outside areas, land and other improvements surrounding the Building which are designated from time to time by Landlord as common areas appurtenant to or servicing the Building, and the land upon which any of the foregoing are situated, are herein sometimes collectively referred to as the "Real Property." Tenant is hereby granted the right to the nonexclusive use of the common corridors and hallways, stairwells, elevators, restrooms and other public or common areas located on the Real Property ("Common Areas"); provided, however, that the manner in which such Common Areas are maintained and operated shall be at the sole discretion of Landlord and the use thereof shall be subject to such Rules and Regulations as Landlord may make from time to time. Landlord reserves the right to make alterations or additions to or to change the location of elements of the Real Property and the Common Areas. 1.2 Condition of the Premises. Tenant agrees to lease the Premises in its current "as is" condition and Tenant acknowledges that the Premises is acceptable for the conduct of Tenant's intended business operations. Except as specifically set forth in this Lease, Landlord shall not be obligated to provide or pay for any improvement work or services related to the improvement of the Premises. Tenant also acknowledges that Landlord has made no representation or warranty regarding the condition of the Premises or the Building except as specifically set forth in this Lease. 1.3 Verification of Rentable Square Feet of Premises and Building. For purposes of this Lease, "rentable square feet" shall be calculated pursuant to the Standard Method for Measuring Floor Area in Office Buildings, ANSI Z65.1 - 1996 ("BOMA"). At Landlord's discretion, the number of rentable square feet of the Premises and the Building shall be subject to verification from time to time by Landlord's space measurement consultant, and such verification shall be made in accordance with the provisions of this Article 1. Tenant's architect may consult with Landlord's space measurement consultant regarding verification of the number of rentable square feet of the Premises; however, the determination of Landlord's space measurement consultant shall be conclusive and binding upon the parties. In the event that Landlord's space measurement consultant determines that the amounts thereof shall be different from those set forth in this Lease, Landlord shall modify all amounts, percentages and figures appearing or referred to in this Lease to conform to such corrected rentable square footage (including, without limitation, the amount of the "Rent," as that term is defined in Article 4 of this Lease). If such modification is made, it will be confirmed in writing by Landlord to Tenant. ARTICLE 2.. LEASE TERM 2.1 Initial Term. The terms and provisions of this Lease shall be effective as of the date of this Lease except for the provisions of this Lease relating to the payment of Rent. The term of this Lease (the "Lease Term") shall be as set forth in Section 7.1 of the Summary and shall commence on the date (the "Lease Commencement Date") set forth in Section 7.2 of the Summary and shall terminate on the date (the "Lease Expiration Date") set forth in Section 7.3 of the Summary, unless this Lease is sooner terminated as hereinafter provided. For purposes of this Lease, the term "Lease Year" shall mean each consecutive twelve (12) month period during the Lease Term; provided, however, that the first Lease Year shall commence on the Lease Commencement Date and end on the last day of the eleventh month thereafter and the second and each succeeding Lease Year shall commence on the first day of the next calendar month; and further provided that the last Lease Year shall end on the Lease Expiration Date. At any time during the Lease Term, Landlord may deliver to Tenant a notice of Lease Term dates in the form as set forth in Exhibit C, attached hereto, which notice Tenant shall execute and return to Landlord within five (5) days of receipt thereof. 2.2 Option Terms. Landlord hereby grants to the originally named Tenant ("Original Tenant") three (3) options to extend the Lease Term for periods of five (5) years each (the "Option Terms"), which options shall be exercisable only by written notice ("Option Notice") delivered by Tenant to Landlord as provided in Section 2.2.2 below, provided that, as of the date of delivery of such notice and, at Landlord's option, as of the last day of the initial Lease Term (or previous Option Term, as applicable), Tenant is not in default under this Lease after expiration of applicable cure periods. The rights contained in this Section 2.2 shall be personal to the Original Tenant and may only be exercised by the Original Tenant (and not any assignee, sublessee or other transferee of the Original Tenant's interest in this Lease) if the Original Tenant occupies the entire Premises as of the date of the Option Notice. In no event shall Tenant (i) be entitled to exercise the second (2nd) option unless the Lease Term has been previously extended for the first Option Term, (ii) be entitled to exercise the third (3rd) option unless the first Option Term has been previously extended for the second (2nd) Option Term, or (iii) be entitled to extend the Lease Term beyond the third (3rd) Option Term. 2.2.1......Option Rent. The initial Base Rent payable by Tenant during each Option Term (the "Option Rent") shall be equal to the then prevailing fair market rent for the Premises as of the commencement date of the Option Term, but not below Base Rent payable by Tenant immediately prior to the applicable Option Term. The initial Base Rent for each Option Term shall then be subject to increase as provided in Section 3.2 of this Lease below. The then prevailing fair market rent shall be the rental rate, including all escalations, at which tenants, as of the commencement of the Option Term, are entering into leases for non-sublease, non-encumbered space comparable in size, location and quality to the Premises for a term of approximately the Option Term, which comparable space is located in comparable buildings in Monterey, California, taking into consideration the following concessions: (a) rental abatement concessions, if any, being granted such tenants in connection with such comparable space and (b) tenant improvements or allowances provided or to be provided for such comparable space, taking into account, and deducting the value of, the existing improvements in the Premises, with such value to be based upon the age, quality and layout of the improvements and the extent to which the same could be utilized by Tenant based upon the fact that the precise tenant improvements existing in the Premises are specifically suitable to Tenant. 2.2.2......Exercise of Options. The options contained in this Section 2.2 shall be exercised by Tenant, if at all, only in the following manner: (i) Tenant shall deliver written notice ("Interest Notice") to Landlord on or before the date which is twelve (12) months prior to the expiration of the initial Lease Term (or previous Option Term, as applicable), stating that Tenant is interested in exercising its option; (ii) Landlord, after receipt of Tenant's notice, shall deliver notice (the "Option Rent Notice") to Tenant not less than ten (10) months prior to the expiration of the initial Lease Term (or previous Option Term, as applicable), setting forth the Option Rent; and (iii) if Tenant wishes to exercise such option, Tenant shall, on or before the earlier of (A) the date occurring eight (8) months prior to the expiration of the initial Lease Term (or previous Option Term, as applicable), and (B) the date occurring thirty (30) days after Tenant's receipt of the Option Rent Notice, exercise the option by delivering the Option Notice to Landlord and upon, and concurrent with such exercise, Tenant may, at its option, object to the Option Rent contained in the Option Rent Notice. Failure of Tenant to deliver the Interest Notice to Landlord on or before the date specified in (i) above or to deliver the Option Notice to Landlord on or before the date specified in (iii) above shall be deemed to constitute Tenant's failure to exercise its option to extend. If Tenant timely and properly exercises its option to extend, the Lease Term or previous Option Term (as applicable) shall be extended for the Option Term upon all of the terms and conditions set forth in this Lease, except that the Rent shall be as indicated in the Option Rent Notice unless Tenant, concurrently with Tenant's Option Notice, objects to the Option Rent contained in the Option Rent Notice, in which case the parties shall follow the procedure and the Option Rent shall be determined, as set forth in Section 2.2.3 below. 2.2.3......Determination of Option Rent. If Tenant timely and appropriately objects to the Option Rent in Tenant's Option Notice, Landlord and Tenant shall attempt to agree upon the Option Rent using their best good-faith efforts. If Landlord and Tenant fail to reach agreement within thirty (30) days following Tenant's Option Notice ("Outside Agreement Date"), then each party shall make a separate determination of the Option Rent which shall be submitted to each other and to arbitration in accordance with the following items (i) through (vii): (i) Landlord and Tenant shall each appoint, within ten (10) days of the Outside Agreement Date, one arbitrator who shall by profession be a current real estate broker or appraiser of comparable commercial properties in the immediate vicinity of the Building, and who has been active in such field over the last five (5) years. The determination of the arbitrators shall be limited solely to the issue of whether Landlord's or Tenant's submitted Option Rent is the closest to the actual Option Rent as determined by the arbitrators, taking into account the definition of prevailing fair market rent in Section 2.2.1 above (i.e., the arbitrators may only select Landlord's or Tenant's determination of Option Rent and shall not be entitled to make a compromise determination). (ii) The two arbitrators so appointed shall within five (5) business days of the date of the appointment of the last appointed arbitrator agree upon and appoint a third arbitrator who shall be qualified under the same criteria set forth hereinabove for qualification of the initial two arbitrators. (iii)The three arbitrators shall within fifteen (15) days of the appointment of the third arbitrator reach a decision as to whether the parties shall use Landlord's or Tenant's submitted Option Rent, and shall notify Landlord and Tenant thereof. (iv) The decision of the majority of the three arbitrators shall be binding upon Landlord and Tenant. (v) If either Landlord or Tenant fails to appoint an arbitrator within ten (10) days after the applicable Outside Agreement Date, the arbitrator appointed by one of them shall reach a decision, notify Landlord and Tenant thereof, and such arbitrator's decision shall be binding upon Landlord and Tenant. (vi) If the two arbitrators fail to agree upon and appoint a third arbitrator, or both parties fail to appoint an arbitrator, then the appointment of the third arbitrator or any arbitrator shall be dismissed and the matter to be decided shall be forthwith submitted to arbitration under the provisions of the American Arbitration Association, but subject to the instruction set forth in this Section 2.2.3. (vii)The cost of arbitration shall be paid by Landlord and Tenant equally. ARTICLE 3.. BASE RENT 3.1 Initial Base Rent. Tenant shall pay, without notice or demand, to Landlord at such place as Landlord may from time to time designate in writing, in currency or a check for currency which, at the time of payment, is legal tender for private or public debts in the United States of America, base rent ("Base Rent") as set forth in Section 8 of the Summary, payable in equal monthly installments as set forth in Section 8 of the Summary in advance on or before the first day of each and every month during the Lease Term, without any setoff or deduction whatsoever. The Base Rent for the first full month of the Lease Term shall be paid at the time of Tenant's execution of this Lease. If any rental payment date (including the Lease Commencement Date) falls on a day of the month other than the first day of such month or if any rental payment is for a period which is shorter than one month, then the rental for any such fractional month shall be a proportionate amount of a full calendar month's rental based on the proportion that the number of days in such fractional month bears to the number of days in the calendar month during which such fractional month occurs. All other payments or adjustments required to be made under the terms of this Lease that require proration on a time basis shall be prorated on the same basis. 3.2 Base Rent Increases. The Base Rent shall be increased on the first day of each anniversary of the Lease Commencement Date throughout the Term, including any applicable Option Term, if applicable, in accordance with percentage increases, if any, in the Consumer Price Index-Urban Wage Earners and Clerical Workers (San Francisco-Oakland-San Jose, CA, All Items, Base 1982-1984 = 100) (the "Index"), as published by the United States Department of Labor, Bureau of Labor Statistics (the "Bureau"). The Index for each September during the Term, and the Option Terms, if applicable, shall be compared with the Index for September, 2002 and effective as of the next anniversary of the Lease Commencement Date, the Base Rent shall be increased for the next Lease Year in accordance with the percentage increase, if any, between such Indexes; provided, however, that in no event shall the increase in Base Rent be less than three percent (3%) per annum nor greater than six percent (6%) per annum of the Base Rent payable for the immediately preceding Lease Year. Landlord shall use commercially reasonable efforts to calculate and give Tenant written notice of any such increase in Base Rent prior to each Lease Year. Should the Bureau discontinue the publication of the Index, or publish the same less frequently or on a different schedule, or alter the same in some other manner, including, but not limited to, changing the name of the Index or the geographic area covered by the Index, Landlord, in its sole discretion, shall adopt a substitute index or procedure which reasonably reflects and monitors consumer prices. ARTICLE 4.. ADDITIONAL RENT 4.1 Additional Rent. In addition to paying the Base Rent specified in Article 3 of this Lease, Tenant shall pay as additional rent "Tenant's Share" of the annual "Direct Expenses," as those terms are defined in Sections 4.2.6 and 4.2.2 of this Lease, respectively. Such additional rent, together with any and all other amounts payable by Tenant to Landlord pursuant to the terms of this Lease, shall be hereinafter collectively referred to as the "Additional Rent." The Base Rent and Additional Rent are herein collectively referred to as the "Rent." All amounts due under this Article 4 as Additional Rent shall be payable for the same periods and in the same manner, time and place as the Base Rent. Without limitation on other obligations of Tenant which shall survive the expiration of the Lease Term, the obligations of Tenant to pay the Additional Rent provided for in this Article 4 shall survive the expiration of the Lease Term. 4.2 Definitions. As used in this Article 4, the following terms shall have the meanings hereinafter set forth: 4.2.1......"Calendar Year" and "Expense Year" shall mean each calendar year in which any portion of the Lease Term falls, through and including the calendar year in which the Lease Term expires. 4.2.2......"Direct Expenses" shall mean "Operating Expenses" and "Tax Expenses." 4.2.3......"Operating Expenses" shall mean all expenses, costs and amounts of every kind and nature which Landlord shall pay during any Expense Year because of or in connection with the ownership, management, maintenance, repair, restoration or operation of the Real Property, including, without limitation, any amounts paid for (i) the cost of supplying all utilities, the cost of operating, maintaining, repairing, renovating and managing the utility systems, mechanical systems, sanitary and storm drainage systems, and the cost of supplies and equipment and maintenance and service contracts in connection therewith; (ii) the cost of licenses, certificates, permits and inspections and the cost of contesting the validity or applicability of any governmental enactments which may affect Operating Expenses; (iii) the cost of insurance carried by Landlord, in such amounts as Landlord may reasonably determine or as may be required by any mortgagees or the lessor of any underlying or ground lease affecting the Real Property and/or the Building; (iv) the cost of landscaping, relamping, and all supplies, tools, equipment and materials used in the operation, repair and maintenance of the Building; (v) the cost of parking area repair, restoration, and maintenance, including, but not limited to, repainting, restriping, and cleaning; (vi) fees, charges and other costs, including consulting fees, legal fees and accounting fees, of all contractors engaged by Landlord in connection with the management, operation, maintenance and repair of the Building and Real Property; (vii) any equipment rental agreements or management agreements (including the cost of any management fee and the fair rental value of any office space provided thereunder); (viii) wages, salaries and other compensation and benefits of all persons engaged in the operation, management, maintenance or security of the Building; (ix) payments under any easement, license, operating agreement, declaration, restrictive covenant, underlying or ground lease (excluding rent), or instrument pertaining to the sharing of costs by the Building; (x) operation, repair, maintenance and replacement of all "Systems and Equipment," as that term is defined in Section 4.2.4 of this Lease, and components thereof; (xi) the cost of alarm and security service, window cleaning, trash removal, replacement of wall and floor coverings, ceiling tiles and fixtures in lobbies, corridors, restrooms and other common or public areas or facilities, maintenance and replacement of curbs and walkways, repair to roofs and re-roofing; (xii) amortization (including interest on the unamortized cost) of the cost of acquiring or the rental expense of personal property used in the maintenance, operation and repair of the Building and Real Property; and (xiii) the cost of any capital improvements or other costs (i) which are intended as a labor-saving device or to effect other economies in the operation or maintenance of the Building, or (ii) made to the Building after the Lease Commencement Date that are required under any governmental law or regulation; provided, however, that if any such cost described in (I) or (II) above is a capital expenditure, such cost shall be amortized (including interest on the unamortized cost) over its useful life as Landlord shall reasonably determine. If Landlord is not furnishing any particular work or service (the cost of which, if performed by Landlord, would be included in Operating Expenses) to a tenant who has undertaken to perform such work or service in lieu of the performance thereof by Landlord, Operating Expenses shall be deemed to be increased by an amount equal to the additional Operating Expenses which would reasonably have been incurred during such period by Landlord if it had at its own expense furnished such work or service to such tenant. If the Building is not fully occupied during all or a portion of any Expense Year, Landlord shall make an appropriate adjustment to the variable components of Operating Expenses for such year or applicable portion thereof, employing sound accounting and management principles, to determine the amount of Operating Expenses that would have been paid had the Building been fully occupied. Notwithstanding the foregoing or anything to the contrary contained herein, Operating Expenses shall not include any costs incurred by Landlord in connection with the Environmental Work (as that term is defined in Article 21 below) or any other costs incurred in connection with the abatement or remediation of hazardous or toxic materials; however, Tenant shall be solely responsible for any and all costs incurred in connection with removal or remediation of hazardous or toxic materials introduced into the Premises or the Real Property by Tenant as further provided in Section 5.2 below. 4.2.4......"Systems and Equipment" shall mean any plant, machinery, transformers, duct work, cable, wires, and other equipment, facilities, and systems designed to supply heat, ventilation, air conditioning and humidity or any other services or utilities, or comprising or serving as any component or portion of the electrical, gas, steam, plumbing, sprinkler, communications, alarm, security, or fire/life safety systems or equipment, or any other mechanical, electrical, electronic, computer or other systems or equipment which serve the Building in whole or in part. 4.2.5......"Tax Expenses" shall mean all federal, state, county, or local governmental or municipal taxes, fees, charges or other impositions of every kind and nature, whether general, special, ordinary or extraordinary, (including, without limitation, real estate taxes, general and special assessments, transit taxes, leasehold taxes or taxes based upon the receipt of rent, including gross receipts or sales taxes applicable to the receipt of rent, unless required to be paid by Tenant, personal property taxes imposed upon the fixtures, machinery, equipment, apparatus, systems and equipment, appurtenances, furniture and other personal property used in connection with the Building), which Landlord shall pay during any Expense Year because of or in connection with the ownership, leasing and operation of the Real Property or Landlord's interest therein. For purposes of this Lease, Tax Expenses shall be calculated as if the tenant improvements in the Building were fully constructed and the Real Property, the Building, and all tenant improvements in the Building were fully assessed for real estate tax purposes, and accordingly, during the portion of any Expense Year occurring during the Base Year, Tax Expenses shall be deemed to be increased appropriately. 4.2.5.1....Tax Expenses shall include, without limitation: (i) Any tax on Landlord's rent, right to rent or other income from the Real Property or as against Landlord's business of leasing any of the Real Property; (ii) Any assessment, tax, fee, levy or charge in addition to, or in substitution, partially or totally, of any assessment, tax, fee, levy or charge previously included within the definition of real property tax, it being acknowledged by Tenant and Landlord that Proposition 13 was adopted by the voters of the State of California in the June 1978 election ("Proposition 13") and that assessments, taxes, fees, levies and charges may be imposed by governmental agencies for such services as fire protection, street, sidewalk and road maintenance, refuse removal and for other governmental services formerly provided without charge to property owners or occupants. It is the intention of Tenant and Landlord that all such new and increased assessments, taxes, fees, levies, and charges and all similar assessments, taxes, fees, levies and charges be included within the definition of Tax Expenses for purposes of this Lease; and (iii) Any assessment, tax, fee, levy, or charge allocable to or measured by the area of the Premises or the rent payable hereunder, including, without limitation, any gross income tax with respect to the receipt of such rent, or upon or with respect to the possession, leasing, operating, management, maintenance, alteration, repair, use or occupancy by Tenant of the Premises, or any portion thereof. 4.2.5.2....If Tax Expenses for any period during the Lease Term or any extension thereof are increased after payment thereof by Landlord for any reason, including, without limitation, error or reassessment by applicable governmental or municipal authorities, Tenant shall pay Landlord upon demand Tenant's Share of such increased Tax Expenses. 4.2.5.3....Notwithstanding anything to the contrary contained in this Section 4.2.5, there shall be excluded from Tax Expenses (i) all excess profits taxes, franchise taxes, gift taxes, capital stock taxes, inheritance and succession taxes, estate taxes, federal and state income taxes, and other taxes to the extent applicable to Landlord's general or net income (as opposed to rents, receipts or income attributable to operations at the Building), (ii) any items included as Operating Expenses, and (iii) any items paid by Tenant under Section 4.4 of this Lease. 4.2.6......"Tenant's Share" shall mean the percentage set forth in Section 9 of the Summary. Tenant's Share was calculated by multiplying the number of rentable square feet of the Premises by 100 and dividing the product by the total rentable square feet in the Building. 4.3 Calculation and Payment of Additional Rent. 4.3.1......Calculation of Excess. For each Expense Year ending or commencing within the Lease Term, Tenant shall pay to Landlord, in the manner set forth in Section 4.3.2, below, and as Additional Rent, an amount equal to Tenant's Share of Direct Expenses. 4.3.2......Statement of Actual Direct Expenses and Payment by Tenant. Landlord shall endeavor to give to Tenant on or before the first day of April following the end of each Expense Year, a statement (the "Statement") which shall state the Direct Expenses incurred or accrued for such preceding Expense Year. Upon receipt of the Statement for each Expense Year ending during the Lease Term Tenant shall pay, with its next installment of Base Rent due, the full amount of Tenant's Share of Direct Expenses for such Expense Year, less the amounts, if any, paid during such Expense Year as Estimated Expense. The failure of Landlord to timely furnish the Statement for any Expense Year shall not prejudice Landlord from enforcing its rights under this Article 4. Even though the Lease Term has expired and Tenant has vacated the Premises, when the final determination is made of Tenant's Share of the Direct Expenses for the Expense Year in which this Lease terminates, Tenant shall promptly pay to Landlord an amount as calculated pursuant to the provisions of Section 4.3.1 of this Lease. The provisions of this Section 4.3.2 shall survive the expiration or earlier termination of the Lease Term. 4.3.3......Statement of Estimated Direct Expenses. Landlord shall have the option, but not the obligation, to give Tenant a yearly expense estimate statement (the "Estimate Statement") which shall set forth Landlord's reasonable estimate (the "Estimate") of what the total amount of Direct Expenses for the then-current Expense Year shall be (the "Estimated Expense"). If Landlord exercises its option to so provide Tenant with an Estimate Statement, Tenant shall pay, with its next installment of Base Rent due, a fraction of the Estimated Expense for the then-current Expense Year (reduced by any amounts paid pursuant to the last sentence of this Section 4.3.3). Such fraction shall have as its numerator the number of months which have elapsed in such current Expense Year to the month of such payment, both months inclusive, and shall have twelve (12) as its denominator. Until a new Estimate Statement is furnished, Tenant shall pay monthly, with the monthly Base Rent installments, an amount equal to one-twelfth (1/12) of the total Estimated Expense set forth in the previous Estimate Statement delivered by Landlord to Tenant. 4.4 Taxes and Other Charges for Which Tenant Is Directly Responsible. Tenant shall reimburse Landlord upon demand for any and all taxes or assessments required to be paid by Landlord (except to the extent included in Tax Expenses by Landlord), excluding state, local and federal personal or corporate income taxes measured by the net income of Landlord from all sources and estate and inheritance taxes, when: 4.4.1......Said taxes are measured by or reasonably attributable to the cost or value of Tenant's equipment, furniture, fixtures and other personal property located in the Premises, or by the cost or value of any leasehold improvements made in or to the Premises by or for Tenant; or 4.4.2......Said taxes are assessed upon or with respect to the possession, leasing, operation, management, maintenance, alteration, repair, use or occupancy by Tenant of the Premises or any portion of the Real Property (including the Parking Facilities). ARTICLE 5.. USE OF PREMISES 5.1 Permitted Use. Tenant shall use the Premises solely for operation of a commercial bank branch and associated ancillary uses permitted by law and consistent with the character of the Building as a first-class office building, and Tenant shall not use or permit the Premises to be used for any other purpose or purposes whatsoever. Tenant's permitted use shall include automated teller machine(s) and/or night depository facilities with necessary lighting and appurtenant fixtures, machinery and equipment, subject to Tenant's receipt of all applicable permits and approvals and Landlord's approval of plans and specifications therefore, subject to Tenant's removal obligations under Section 8.5 below. 5.2 Prohibited Uses. Tenant further covenants and agrees that it shall not use, or suffer or permit any person or persons to use, the Premises, the Parking Facilities or any other Common Areas or any part thereof for any use or purpose contrary to the provisions of Exhibit C attached hereto ("Rules and Regulations"), or in violation of the laws of the United States of America, the State of California, or the ordinances, regulations or requirements of the local municipal or county governing body or other lawful authorities having jurisdiction over the Building. Tenant shall comply with all recorded covenants, conditions, and restrictions, and the provisions of all ground or underlying leases, now or hereafter affecting the Real Property. Tenant shall not use or allow another person or entity to use any part of the Premises for the storage, use, treatment, manufacture or sale of any hazardous or toxic material. Tenant shall be solely responsible for removal or remediation as may be required by law should hazardous or toxic materials be introduced into the Premises or the Real Property by Tenant, its agents, employees or independent contractors provided that nothing contained herein shall permit Tenant to utilize or release hazardous or toxic materials. 5.3 Use of Ancillary Areas. In addition to Tenant's use of the Premises, Tenant shall have the exclusive right, throughout the Lease Term, to use of the conference room on the second (2nd) floor of the Building and the non-exclusive right to use the restrooms and kitchen areas on the mezzanine level of the Building, in common with other tenants and occupants of the Building; provided, however, if Tenant constructs, pursuant to Article 8 below, restroom facilities within its Premises, then Tenant shall no longer have the right to use such mezzanine restrooms. Such second (2nd) floor conference room and mezzanine restrooms and mezzanine kitchen area may be collectively referred to herein as the "Ancillary Areas." ARTICLE 6.. SERVICES AND UTILITIES 6.1 Standard Tenant Services. Landlord shall provide the following services on all days during the Lease Term, unless otherwise stated below. 6.1.1......Subject to all governmental rules, regulations and guidelines applicable thereto, Landlord shall provide heating and air conditioning when necessary for normal comfort for normal office use in the Premises, from Monday through Friday, during the period from 8 a.m. to 6 p.m., and on Saturday during the period from 9:00 a.m. to 12:00 noon, except for the date of observation of New Year's Day, Presidents' Day, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, Christmas Day and other locally or nationally recognized holidays (collectively, the "Holidays"). 6.1.2......Landlord shall provide adequate electrical wiring and facilities and power for normal general office use as determined by Landlord. Tenant shall bear the cost of replacement of lamps, starters and ballasts for lighting fixtures within the Premises. 6.1.3......Landlord shall provide city water from the regular Building outlets for drinking, lavatory and toilet purposes. Tenant acknowledges that Tenant shall be solely responsible for providing janitorial service to the Premises and Landlord shall have no responsibility therefor. 6.2 Overstandard Tenant Use. Tenant shall not, without Landlord's prior written consent, use heat-generating machines, machines other than normal office machines, or equipment or lighting other than building standard lights in the Premises, which may affect the temperature otherwise maintained by the air conditioning system or increase the water normally furnished for the Premises by Landlord pursuant to the terms of Section 6.1 of this Lease. If such consent is given, Landlord shall have the right to install supplementary air conditioning units or other facilities in the Premises, including supplementary or additional metering devices, and the cost thereof, including the cost of installation, operation and maintenance, increased wear and tear on existing equipment and other similar charges, shall be paid by Tenant to Landlord upon billing by Landlord. If Tenant uses electricity, water or heat or air conditioning in excess of that supplied by Landlord pursuant to Section 6.1 of this Lease, Tenant shall pay to Landlord, upon billing, the cost of such excess consumption, the cost of the installation, operation, and maintenance of equipment which is installed in order to supply such excess consumption, and the cost of the increased wear and tear on existing equipment caused by such excess consumption, and Landlord may install devices to separately meter any increased use and in such event Tenant shall pay the increased cost directly to Landlord, on demand, including the cost of such additional metering devices. If Tenant desires to use heat, ventilation or air conditioning during hours other than those for which Landlord is obligated to supply such utilities pursuant to the terms of Section 6.1 of this Lease, Tenant shall give Landlord such prior notice, as Landlord shall from time to time establish as appropriate, of Tenant's desired use and Landlord shall supply such utilities to Tenant at such hourly cost to Tenant as Landlord shall from time to time establish. Amounts payable by Tenant to Landlord for such use of additional utilities shall be deemed Additional Rent hereunder and shall be billed on a monthly basis. Landlord may increase the hours or days during which air conditioning, heating and ventilation are provided to the Premises and the Building to accommodate the usage by tenants occupying two-thirds or more of the rentable square feet of the Building or to conform to practices of other buildings in the area comparable to the Building. 6.3 Interruption of Use. Tenant agrees that Landlord shall not be liable for damages, by abatement of Rent or otherwise, for failure to furnish or delay in furnishing any service (including telephone and telecommunication services), or for any diminution in the quality or quantity thereof, when such failure or delay or diminution is occasioned, in whole or in part, by repairs, replacements, or improvements, by any strike, lockout or other labor trouble, by inability to secure electricity, gas, water, or other fuel at the Building after reasonable effort to do so, by any accident or casualty whatsoever, by act or default of Tenant or other parties, or by any other cause beyond Landlord's reasonable control; and such failures or delays or diminution shall never be deemed to constitute an eviction or disturbance of Tenant's use and possession of the Premises or relieve Tenant from paying Rent or performing any of its obligations under this Lease. Furthermore, Landlord shall not be liable under any circumstances for a loss of, or injury to, property or for injury to, or interference with, Tenant's business, including, without limitation, loss of profits, however occurring, through or in connection with or incidental to a failure to furnish any of the services or utilities as set forth in this Article 6. ARTICLE 7.. REPAIRS Tenant shall, at Tenant's own expense, keep the Premises, including all improvements, fixtures and furnishings therein, in good order, repair and condition at all times during the Lease Term. In addition, Tenant shall, at Tenant's own expense but under the supervision and subject to the prior approval of Landlord, and within any reasonable period of time specified by Landlord, promptly and adequately repair all damage to the Premises and replace or repair all damaged or broken fixtures and appurtenances; provided however, that, at Landlord's option, or if Tenant fails to make such repairs, Landlord may, but need not, make such repairs and replacements, and Tenant shall pay Landlord the cost thereof, including a percentage of the cost thereof (to be uniformly established for the Building) sufficient to reimburse Landlord for all overhead, general conditions, fees and other costs or expenses arising from Landlord's involvement with such repairs and replacements forthwith upon being billed for same. Landlord may, but shall not be required to, enter the Premises at all reasonable times to make such repairs, alterations, improvements and additions to the Premises or to the Building or to any equipment located in the Building as Landlord shall desire or deem necessary or as Landlord may be required to do by governmental or quasi-governmental authority or court order or decree. Tenant hereby waives and releases its right to make repairs at Landlord's expense under Sections 1941 and 1942 of the California Civil Code or under any similar law, statute, or ordinance now or hereafter in effect. ARTICLE 8.. ADDITIONS AND ALTERATIONS 8.1 Landlord's Consent to Alterations. Tenant may not make any improvements, alterations, additions or changes to the Premises (collectively, the "Alterations") without first procuring the prior written consent of Landlord to such Alterations, which consent shall be requested by Tenant not less than thirty (30) days prior to the commencement thereof, and which consent shall not be unreasonably withheld by Landlord. The existing leasehold improvements in the Premises together with any Alterations thereto made by Tenant pursuant to this Article 8 may be referred to herein as the "Tenant Improvements." 8.2 Manner of Construction. Landlord may impose, as a condition of its consent to all Alterations or repairs of the Premises or about the Premises, such requirements as Landlord in its sole discretion may deem desirable, including, but not limited to, the requirement that upon Landlord's request, Tenant shall, at Tenant's expense, remove such Alterations upon the expiration or any early termination of the Lease Term, and/or the requirement that Tenant utilize for such purposes only contractors and materials approved by Landlord. Tenant shall construct such Alterations and perform such repairs in conformance with any and all applicable rules and regulations of any federal, state, county or municipal code or ordinance and pursuant to a valid building permit (a copy of which shall be delivered to Landlord), issued by the appropriate governmental authorities, in conformance with Landlord's construction rules and regulations. Landlord's approval of the plans, specifications and working drawings for Tenant's Alterations shall create no responsibility or liability on the part of Landlord for their completeness, design sufficiency, or compliance with all laws, rules and regulations of governmental agencies or authorities. All work with respect to any Alterations must be done in a good and workmanlike manner and diligently prosecuted to completion. In performing the work of any such Alterations, Tenant shall have the work performed in such manner as not to obstruct access to the Building or the common areas for any other tenant of the Building, and as not to obstruct the business of Landlord or other tenants in the Building, or interfere with the labor force working in the Building. Upon completion of any Alterations, Tenant agrees to cause a Notice of Completion to be recorded in the office of the County Recorder in accordance with Section 3093 of the Civil Code of the State of California or any successor statute, and Tenant shall deliver to Landlord a reproducible copy of the "as built" drawings of the Alterations. 8.3 Payment for Improvements. In the event Tenant orders any Alteration or repair work directly from Landlord, or from the contractor selected by Landlord, the charges for such work shall be deemed Additional Rent under this Lease, payable upon billing therefor, either periodically during construction or upon the substantial completion of such work, at Landlord's option. Upon completion of such work, Tenant shall deliver to Landlord, if payment is made directly to contractors, evidence of payment, contractors' affidavits and full and final waivers of all liens for labor, services or materials. Whether or not Tenant orders any work directly from Landlord, Tenant shall pay to Landlord a percentage of the cost of such work (such percentage, which shall vary depending upon whether or not Tenant orders the work directly from Landlord, to be established on a uniform basis for the Building) sufficient to compensate Landlord for all overhead, general conditions, fees and other costs and expenses arising from Landlord's involvement with such work. 8.4 Construction Insurance. In the event that Tenant makes any Alterations, Tenant agrees to carry "Builder's All Risk" insurance in an amount approved by Landlord covering the construction of such Alterations, and such other insurance as Landlord may require, it being understood and agreed that all of such Alterations shall be insured by Tenant pursuant to Article 10 of this Lease immediately upon completion thereof. In addition, Landlord may, in its discretion, require Tenant to obtain a lien and completion bond or some alternate form of security satisfactory to Landlord in an amount sufficient to ensure the lien-free completion of such Alterations and naming Landlord as a co-obligee. 8.5 Landlord's Property. All Alterations, improvements, fixtures and/or equipment which may be installed or placed in or about the Premises, and all signs installed in, on or about the Premises, from time to time, shall be at the sole cost of Tenant and shall be and become the property of Landlord, except that upon expiration or earlier termination of this Lease and upon request from Landlord, Tenant shall remove any wiring, cabling, decals, signage and similar items introduced by Tenant into the Premises and shall also remove any automated teller machine(s) and after-hours depositories from the Building and any associated machinery, lightening and equipment, and shall repair damage resulting from such removal and match finishes of the Building to Landlord's reasonable satisfaction. Furthermore, Landlord may, by written notice to Tenant prior to the end of the Lease Term, or given upon any earlier termination of this Lease, require Tenant at Tenant's expense to remove any Alterations and to repair any damage to the Premises and Building caused by such removal. If Tenant fails to complete such removal and/or to repair any damage caused by the removal of any Alterations, Landlord may do so and may charge the cost thereof to Tenant. ARTICLE 9.. COVENANT AGAINST LIENS Landlord shall have the right at all times to post and keep posted on the Premises any notice which it deems necessary for protection from such liens. Tenant covenants and agrees not to suffer or permit any lien of mechanics or materialmen or others to be placed against the Real Property, the Building or the Premises with respect to work or services claimed to have been performed for or materials claimed to have been furnished to Tenant or the Premises, and, in case of any such lien attaching or notice of any lien, Tenant covenants and agrees to cause it to be immediately released and removed of record. Notwithstanding anything to the contrary set forth in this Lease, in the event that such lien is not released and removed within ten (10) days after the date notice of such lien is delivered by Landlord to Tenant, Landlord, at its sole option, may immediately take all action necessary to release and remove such lien, without any duty to investigate the validity thereof, and all sums, costs and expenses, including reasonable attorneys' fees and costs, incurred by Landlord in connection with such lien shall be deemed Additional Rent under this Lease and shall immediately be due and payable by Tenant. ARTICLE 10. INSURANCE 10.1 Indemnification and Waiver. To the extent not prohibited by law, Landlord, its partners and their respective officers, agents, servants, employees, and independent contractors (collectively, "Landlord Parties") shall not be liable for any damage either to person or property or resulting from the loss of use thereof, which damage is sustained by Tenant or by other persons claiming through Tenant. Tenant shall indemnify, defend, protect, and hold harmless Landlord Parties from any and all loss, cost, damage, expense and liability (including without limitation court costs and reasonable attorneys' fees) incurred in connection with or arising from any cause in, on or about the Premises and/or the Ancillary Areas (including, without limitation, those incurred in connection with or arising from the Environmental Work) either prior to, during, or after the expiration of the Lease Term, provided that the terms of the foregoing indemnity shall not apply to the gross negligence or willful misconduct of Landlord. The provisions of this Section 10.1 shall survive the expiration or sooner termination of this Lease with respect to any claims or liability occurring prior to such expiration or termination. 10.2 Tenant's Compliance with Landlord's Fire and Casualty Insurance. Tenant shall, at Tenant's expense, comply with all insurance company requirements pertaining to the use of the Premises. If Tenant's conduct or use of the Premises causes any increase in the premium for such insurance policies, then Tenant shall reimburse Landlord for any such increase. Tenant, at Tenant's expense, shall comply with all rules, orders, regulations or requirements of the American Insurance Association (formerly the National Board of Fire Underwriters) and with any similar body. 10.3 Tenant's Insurance. Tenant shall maintain the following coverages in the following amounts. 10.3.1.....Commercial General Liability Insurance covering the insured against claims of bodily injury, personal injury and property damage arising out of Tenant's operations, assumed liabilities or use of the Premises, including a Broad Form Commercial General Liability endorsement covering the insuring provisions of this Lease and the performance by Tenant of the indemnity agreements set forth in Section 10.1 of this Lease, for limits of liability not less than: Bodily Injury and Property Damage Liability $3,000,000 each occurrence $3,000,000 annual aggregate Personal Injury Liability $3,000,000 each occurrence $3,000,000 annual aggregate 0% Insured's participation 10.3.2.....Physical Damage Insurance covering (i) all office furniture, trade fixtures, office equipment, merchandise and all other items of Tenant's property on the Premises installed by, for, or at the expense of Tenant, (ii) the Tenant Improvements, including any Tenant Improvements which Landlord permits to be installed above the ceiling of the Premises or below the floor of the Premises, and (iii) all other improvements, alterations and additions to the Premises, including any improvements, alterations or additions installed at Tenant's request above the ceiling of the Premises or below the floor of the Premises. Such insurance shall be written on an "all risks" of physical loss or damage basis, for the full replacement cost value new without deduction for depreciation of the covered items and in amounts that meet any co-insurance clauses of the policies of insurance and shall include a vandalism and malicious mischief endorsement, sprinkler leakage coverage and earthquake sprinkler leakage coverage. 10.3.3.....Loss of income and extra expense insurance in such amounts as will reimburse Tenant for direct or indirect loss of earnings attributable to all perils commonly insured against by prudent tenants or attributable to prevention of access to the Premises or to the Building as a result of such perils. 10.3.4.....Workers' Compensation and Employer's Liability coverage in amounts required by law. 10.4 Form of Policies. The minimum limits of policies of insurance required of Tenant under this Lease shall in no event limit the liability of Tenant under this Lease. All insurance shall (i) be issued by an insurance company having a rating of not less than A-X in Best's Insurance Guide or which is otherwise acceptable to Landlord and licensed to do business in the State of California; and (ii) provide that said insurance shall not be canceled or coverage changed unless thirty (30) days' prior written notice shall have been given to Landlord and any mortgagee or ground or underlying lessor of Landlord. In addition, the insurance described in Section 10.3.1 above shall (a) name Landlord, and any other party specified by Landlord, as an additional insured; (b) specifically cover the liability assumed by Tenant under this Lease including, but not limited to, Tenant's obligations under Section 10.1 of this Lease; (c) be primary insurance as to all claims thereunder and provide that any insurance required by Landlord is excess and is non-contributing with any insurance requirement of Tenant; and (d) contain a cross-liability endorsement or severability of interest clause acceptable to Landlord. Tenant shall deliver all policies or certificates thereof to Landlord on or before the Lease Commencement Date and at least thirty (30) days before the expiration dates thereof. In the event Tenant shall fail to procure such insurance, or to deliver such policies or certificate, Landlord may, at its option, procure such policies for the account of Tenant, and the cost thereof shall be paid to Landlord as Additional Rent within five (5) days after delivery to Tenant of bills therefor. 10.5 Subrogation. Landlord and Tenant agree to have their respective insurance companies issuing property damage and loss of income and extra expense insurance waive any rights of subrogation that such companies may have against Landlord or Tenant, as the case may be, so long as the insurance carried by Landlord and Tenant, respectively, is not invalidated thereby. As long as such waivers of subrogation are contained in their respective insurance policies, Landlord and Tenant hereby waive any right that either may have against the other on account of any loss or damage to the extent such loss or damage is insurable under such policies of insurance. 10.6 Additional Insurance Obligations. Tenant shall carry and maintain during the entire Lease Term, at Tenant's sole cost and expense, increased amounts of the insurance required to be carried by Tenant pursuant to this Article 10, and such other reasonable types of insurance coverage and in such reasonable amounts covering the Premises and Tenant's operations therein, as may be reasonably requested by Landlord. ARTICLE 11. DAMAGE AND DESTRUCTION 11.1 Repair of Damage to Premises by Landlord. Tenant shall promptly notify Landlord of any damage to the Premises resulting from fire or any other casualty. If the Premises or any common areas of the Building serving or providing access to the Premises shall be damaged by fire or other casualty, Landlord shall promptly and diligently, subject to reasonable delays for insurance adjustment or other matters beyond Landlord's reasonable control, and subject to all other terms of this Article 11, restore the base, shell, and core of the Premises and such common areas. Such restoration shall be to substantially the same condition of the base, shell, and core of the Premises and common areas prior to the casualty, except for modifications required by zoning and building codes and other laws or by the holder of a mortgage on the Building, or the lessor of a ground or underlying lease with respect to the Real Property and/or the Building, or any other modifications to the common areas deemed desirable by Landlord, provided access to the Premises and any common restrooms serving the Premises shall not be materially impaired. Notwithstanding any other provision of this Lease, upon the occurrence of any damage to the Premises, Tenant shall assign to Landlord (or to any party designated by Landlord) all insurance proceeds payable to Tenant under Tenant's insurance required under Section 10.3.2(ii) and (iii) of this Lease, and Landlord shall repair any injury or damage to the Tenant Improvements installed in the Premises and shall return such Tenant Improvements to their original condition; provided that if the cost of such repair by Landlord exceeds the amount of insurance proceeds received by Landlord from Tenant's insurance carrier, as assigned by Tenant, the cost of such repairs shall be paid by Tenant to Landlord prior to Landlord's repair of the damage. In connection with such repairs and replacements, Tenant shall, prior to the commencement of construction, submit to Landlord, for Landlord's review and approval, all plans, specifications and working drawings relating thereto, and Landlord shall select the contractors to perform such improvement work. Such submittal of plans and construction of improvements shall be performed in accordance with procedures reasonably designated by Landlord. Landlord shall not be liable for any inconvenience or annoyance to Tenant or its visitors, or injury to Tenant's business resulting in any way from such damage or the repair thereof; provided however, that if such fire or other casualty shall have damaged the Premises or common areas necessary to Tenant's occupancy, and if such damage is not the result of the negligence or willful misconduct of Tenant or Tenant's employees, contractors, licensees, or invitees, Landlord shall allow Tenant a proportionate abatement of Rent to the extent Landlord is reimbursed from the proceeds of rental interruption insurance purchased by Landlord as part of Operating Expenses, during the time and to the extent the Premises are unfit for occupancy for the purposes permitted under this Lease, and not occupied by Tenant as a result thereof. 11.2 Landlord's Option to Repair. Notwithstanding the terms of Section 11.1 of this Lease, Landlord may elect not to rebuild and/or restore the Premises and/or Building and instead terminate this Lease by notifying Tenant in writing of such termination within sixty (60) days after the date Landlord learns of the necessity for repairs as the result of damage, such notice to include a termination date giving Tenant ninety (90) days to vacate the Premises, but Landlord may so elect only if the Building shall be damaged by fire or other casualty or cause, whether or not the Premises are affected, and one or more of the following conditions is present: (i) repairs cannot reasonably be completed within one hundred twenty (120) days after the date Landlord learns of the necessity for repairs as the result of damage (when such repairs are made without the payment of overtime or other premiums); (ii) the holder of any mortgage on the Building or ground or underlying lessor with respect to the Real Property and/or the Building shall require that the insurance proceeds or any portion thereof be used to retire the mortgage debt, or shall terminate the ground or underlying lease, as the case may be; or (iii) the damage is not fully covered, except for deductible amounts, by Landlord's insurance policies. 11.3 Waiver of Statutory Provisions. The provisions of this Lease, including this Article 11, constitute an express agreement between Landlord and Tenant with respect to any and all damage to, or destruction of, all or any part of the Premises, the Building or any other portion of the Real Property, and any statute or regulation of the State of California, including, without limitation, Sections 1932(2) and 1933(4) of the California Civil Code, with respect to any rights or obligations concerning damage or destruction in the absence of an express agreement between the parties, and any other statute or regulation, now or hereafter in effect, shall have no application to this Lease or any damage or destruction to all or any part of the Premises, the Building or any other portion of the Real Property. 11.4 Damage Near End of Term. In the event that the Premises or the Building is destroyed or damaged to any substantial extent during the last twelve (12) months of the Lease Term, then notwithstanding anything contained in this Article 11, Landlord shall have the option to terminate this Lease by giving written notice to Tenant of the exercise of such option within thirty (30) days after Landlord learns of the necessity for repairs as the result of such damage or destruction, in which event this Lease shall cease and terminate as of the date of such notice, Tenant shall pay the Base Rent and Additional Rent, properly apportioned up to such date of damage, and both parties hereto shall thereafter be freed and discharged of all further obligations hereunder, except as provided for in provisions of this Lease which by their terms survive the expiration or earlier termination of the Lease Term. ARTICLE 12. NONWAIVER No waiver of any provision of this Lease shall be implied by any failure of Landlord to enforce any remedy on account of the violation of such provision, even if such violation shall continue or be repeated subsequently, any waiver by Landlord of any provision of this Lease may only be in writing, and no express waiver shall affect any provision other than the one specified in such waiver and that one only for the time and in the manner specifically stated. No receipt of monies by Landlord from Tenant after the termination of this Lease shall in any way alter the length of the Lease Term or of Tenant's right of possession hereunder or after the giving of any notice shall reinstate, continue or extend the Lease Term or affect any notice given Tenant prior to the receipt of such monies. ARTICLE 13. CONDEMNATION 13.1 Permanent Taking. If the whole or any part of the Premises or Building shall be taken by power of eminent domain or condemned by any competent authority for any public or quasi-public use or purpose, or if any adjacent property or street shall be so taken or condemned, or reconfigured or vacated by such authority in such manner as to require the use, reconstruction or remodeling of any part of the Premises or Building, or if Landlord shall grant a deed or other instrument in lieu of such taking by eminent domain or condemnation, Landlord shall have the option to terminate this Lease upon ninety (90) days' notice, provided such notice is given no later than one hundred eighty (180) days after the date of such taking, condemnation, reconfiguration, vacation, deed or other instrument. If more than twenty-five percent (25%) of the rentable square feet of the Premises is taken, or if access to the Premises is substantially impaired, Tenant shall have the option to terminate this Lease upon ninety (90) days' notice, provided such notice is given no later than one hundred eighty (180) days after the date of such taking. Landlord shall be entitled to receive the entire award or payment in connection therewith, except that Tenant shall have the right to file any separate claim available to Tenant for any taking of Tenant's personal property and fixtures belonging to Tenant and removable by Tenant upon expiration of the Lease Term pursuant to the terms of this Lease, and for moving expenses, so long as such claim does not diminish the award available to Landlord, its ground lessor with respect to the Real Property or its mortgagee, and such claim is payable separately to Tenant. All Rent shall be apportioned as of the date of such termination, or the date of such taking, whichever shall first occur. If any part of the Premises shall be taken, and this Lease shall not be so terminated, the Rent shall be proportionately abated. Tenant hereby waives any and all rights it might otherwise have pursuant to Section 1265.130 of The California Code of Civil Procedure. 13.2 Temporary Taking. Notwithstanding anything to the contrary contained in this Article 13, in the event of a temporary taking of all or any portion of the Premises for a period of one hundred and eighty (180) days or less, then this Lease shall not terminate but the Base Rent and the Additional Rent shall be abated for the period of such taking in proportion to the ratio that the number of rentable square feet of the Premises taken bears to the total number of rentable square feet of the Premises. Landlord shall be entitled to receive the entire award made in connection with any such temporary taking. ARTICLE 14. ASSIGNMENT AND SUBLETTING 14.1 Transfers. Tenant shall not, without the prior written consent of Landlord, assign, mortgage, pledge, hypothecate, encumber, or permit any lien to attach to, or otherwise transfer, this Lease or any interest hereunder, permit any assignment or other such foregoing transfer of this Lease or any interest hereunder by operation of law, sublet the Premises or any part thereof, or permit the use of the Premises by any persons other than Tenant and its employees (all of the foregoing are hereinafter sometimes referred to collectively as "Transfers" and any person to whom any Transfer is made or sought to be made is hereinafter sometimes referred to as a "Transferee"). If Tenant shall desire Landlord's consent to any Transfer, Tenant shall notify Landlord in writing, which notice (the "Transfer Notice") shall include (i) the proposed effective date of the Transfer, which shall not be less than forty-five (45) days nor more than one hundred eighty (180) days after the date of delivery of the Transfer Notice, (ii) a description of the portion of the Premises to be transferred (the "Subject Space"), (iii) all of the terms of the proposed Transfer and the consideration therefor, including a calculation of the "Transfer Premium," as that term is defined in Section 14.3 below, in connection with such Transfer, the name and address of the proposed Transferee, and a copy of all existing and/or proposed documentation pertaining to the proposed Transfer, including all existing operative documents to be executed to evidence such Transfer or the agreements incidental or related to such Transfer, and (iv) current financial statements of the proposed Transferee certified by an officer, partner or owner thereof, and any other information required by Landlord, which will enable Landlord to determine the financial responsibility, character, and reputation of the proposed Transferee, nature of such Transferee's business and proposed use of the Subject Space, and such other information as Landlord may reasonably require. Any Transfer made without Landlord's prior written consent shall, at Landlord's option, be null, void and of no effect, and shall, at Landlord's option, constitute a default by Tenant under this Lease. Whether or not Landlord shall grant consent, Tenant shall pay Landlord's review and processing fees, as well as any reasonable legal fees incurred by Landlord, within thirty (30) days after written request by Landlord. 14.2 Landlord's Consent. Landlord shall not unreasonably withhold its consent to any proposed Transfer of the Subject Space to the Transferee on the terms specified in the Transfer Notice. The parties hereby agree that it shall be reasonable under this Lease and under any applicable law for Landlord to withhold consent to any proposed Transfer where one or more of the following apply, without limitation as to other reasonable grounds for withholding consent: 14.2.1.....The Transferee is of a character or reputation or engaged in a business which is not consistent with the quality of the Building, or would be a significantly less prestigious occupant of the Building than Tenant; 14.2.2.....The Transferee intends to use the Subject Space for purposes which are not permitted under this Lease; 14.2.3.....The Transferee is either a governmental agency or instrumentality thereof; 14.2.4.....The Transfer will result in more than a reasonable and safe number of occupants per floor within the Subject Space; 14.2.5.....The Transferee is not a party of reasonable financial worth and/or financial stability in light of the responsibilities involved under the Lease on the date consent is requested; 14.2.6.....The proposed Transfer would cause Landlord to be in violation of another lease or agreement to which Landlord is a party, or would give an occupant of the Building a right to cancel its lease; or 14.2.7.....Either the proposed Transferee, or any person or entity which directly or indirectly, controls, is controlled by, or is under common control with, the proposed Transferee, is negotiating with Landlord to lease space in the Building at such time. If Landlord consents to any Transfer pursuant to the terms of this Section 14.2 (and does not exercise any recapture rights Landlord may have under Section 14.4 of this Lease), Tenant may within six (6) months after Landlord's consent, but not later than the expiration of said six-month period, enter into such Transfer of the Premises or portion thereof, upon substantially the same terms and conditions as are set forth in the Transfer Notice furnished by Tenant to Landlord pursuant to Section 14.1 of this Lease, provided that if there are any changes in the terms and conditions from those specified in the Transfer Notice (i) such that Landlord would initially have been entitled to refuse its consent to such Transfer under this Section 14.2, or (ii) which would cause the proposed Transfer to be more favorable to the Transferee than the terms set forth in Tenant's original Transfer Notice, Tenant shall again submit the Transfer to Landlord for its approval and other action under this Article 14 (including Landlord's right of recapture, if any, under Section 14.4 of this Lease). Notwithstanding any contrary provision of this Lease, if Tenant or any proposed Transferee claims that Landlord has unreasonably withheld or delayed its consent to a proposed Transfer or otherwise has breached its obligations under this Article 14, Tenant's and such Transferee's only remedy shall be to seek a declaratory judgment and/or injunctive relief, and Tenant, on behalf of itself and, to the extent permitted by law, such proposed Transferee waives all other remedies against Landlord, including without limitation, the right to seek monetary damages or to terminate this Lease. 14.3 Transfer Premium. If Landlord consents to a Transfer, as a condition thereto which the parties hereby agree is reasonable, Tenant shall pay to Landlord fifty percent (50%) of any "Transfer Premium," as that term is defined in this Section 14.3, received by Tenant from such Transferee. "Transfer Premium" shall mean all rent, additional rent or other consideration payable by such Transferee in excess of the Rent and Additional Rent payable by Tenant under this Lease on a per rentable square foot basis if less than all of the Premises is transferred, after deducting the reasonable expenses incurred by Tenant for (i) any changes, alterations and improvements to the Premises in connection with the Transfer, and (ii) any brokerage commissions in connection with the Transfer (collectively, the "Subleasing Costs"). "Transfer Premium" shall also include, but not be limited to, key money and bonus money paid by Transferee to Tenant in connection with such Transfer, and any payment in excess of fair market value for services rendered by Tenant to Transferee or for assets, fixtures, inventory, equipment, or furniture transferred by Tenant to Transferee in connection with such Transfer. 14.4 Landlord's Option as to Subject Space. Notwithstanding anything to the contrary contained in this Article 14, Landlord shall have the option, by giving written notice to Tenant within thirty (30) days after receipt of any Transfer Notice, to (i) recapture the Subject Space, or (ii) take an assignment or sublease of the Subject Space from Tenant. Such recapture, or sublease or assignment notice shall cancel and terminate this Lease, or create a sublease or assignment, as the case may be, with respect to the Subject Space as of the date stated in the Transfer Notice as the effective date of the proposed Transfer until the last day of the term of the Transfer as set forth in the Transfer Notice. In the event of a recapture by Landlord, if this Lease shall be canceled with respect to less than the entire Premises, the Rent reserved herein shall be prorated on the basis of the number of rentable square feet retained by Tenant in proportion to the number of rentable square feet contained in the Premises, and this Lease as so amended shall continue thereafter in full force and effect, and upon request of either party, the parties shall execute written confirmation of the same. If the Subject Space shall be assigned or subleased by Tenant to Landlord, the rent for the Subject Space payable by Landlord to Tenant shall be the lesser of (i) the effective Base Rent plus the Additional Rent payable by Tenant under this Lease for the Subject Space on a prorated basis based upon the number of rentable square feet in the Subject Space, or (ii) the effective rent (taking into account all concessions made by Tenant to the Transferee) set forth in the Transfer Notice, and all other provisions of this Lease shall remain in full force and effect, and upon request of either party, the parties shall execute a written confirmation of the same. If Landlord declines, or fails to elect in a timely manner to recapture, sublease or take an assignment of the Subject Space under this Section 14.4, then, provided Landlord has consented to the proposed Transfer, Tenant shall be entitled to proceed to transfer the Subject Space to the proposed Transferee, subject to provisions of the last paragraph of Section 14.2 of this Lease. 14.5 Effect of Transfer. If Landlord consents to a Transfer, (i) the terms and conditions of this Lease shall in no way be deemed to have been waived or modified, (ii) such consent shall not be deemed consent to any further Transfer by either Tenant or a Transferee, (iii) Tenant shall deliver to Landlord, promptly after execution, an original executed copy of all documentation pertaining to the Transfer in form reasonably acceptable to Landlord, (iv) Tenant shall furnish upon Landlord's request a complete statement, certified by an independent certified public accountant, or Tenant's chief financial officer, setting forth in detail the computation of any Transfer Premium Tenant has derived and shall derive from such Transfer, and (v) no Transfer relating to this Lease or agreement entered into with respect thereto, whether with or without Landlord's consent, shall relieve Tenant or any guarantor of the Lease from liability under this Lease. Landlord or its authorized representatives shall have the right at all reasonable times to audit the books, records and papers of Tenant relating to any Transfer, and shall have the right to make copies thereof. If the Transfer Premium respecting any Transfer shall be found understated, Tenant shall, within thirty (30) days after demand, pay the deficiency and Landlord's costs of such audit, and if understated by more than ten percent (10%), Landlord shall have the right to cancel this Lease upon thirty (30) days' notice to Tenant. 14.6 Affiliate Transfers. Notwithstanding anything to the contrary contained in this Article 14, an assignment or subletting of all or a portion of the Premises to an affiliate ("Affiliate") of Tenant (an entity which is controlled by, controls, or is under common control with, Tenant), shall not be deemed a Transfer under this Article 14, provided that (i) Tenant notifies Landlord of any such assignment or sublease and promptly supplies Landlord with any documents or information requested by Landlord regarding such assignment or sublease or such affiliate, (ii) such Affiliate has a net worth calculated in accordance with generally accepted accounting principles which is at least equal to that of Tenant as of the date of this Lease, and (iii) such assignment or sublease is not a subterfuge by Tenant to avoid its obligations under this Lease. An assignee of Tenant's entire interest in this Lease pursuant to the immediately preceding sentence may be referred to herein as an "Affiliated Assignee." "Control," as used in this Article 15, shall mean the ownership, directly or indirectly, of greater than fifty percent (50%) of the voting securities of, or possession of the right to vote, in the ordinary direction of its affairs, of greater than fifty percent (50%) of the voting interest in, an entity. ARTICLE 15. SURRENDER OF PREMISES; OWNERSHIP AND REMOVAL OF TRADE FIXTURES 15.1 Surrender of Premises. No act or thing done by Landlord or any agent or employee of Landlord during the Lease Term shall be deemed to constitute an acceptance by Landlord of a surrender of the Premises unless such intent is specifically acknowledged in a writing signed by Landlord. The delivery of keys to the Premises to Landlord or any agent or employee of Landlord shall not constitute a surrender of the Premises or effect a termination of this Lease, whether or not the keys are thereafter retained by Landlord, and notwithstanding such delivery Tenant shall be entitled to the return of such keys at any reasonable time upon request until this Lease shall have been properly terminated. The voluntary or other surrender of this Lease by Tenant, whether accepted by Landlord or not, or a mutual termination hereof, shall not work a merger, and at the option of Landlord shall operate as an assignment to Landlord of all subleases or subtenancies affecting the Premises. 15.2 Removal of Tenant Property by Tenant. Upon the expiration of the Lease Term, or upon any earlier termination of this Lease, Tenant shall, subject to the provisions of this Article 15, quit and surrender possession of the Premises to Landlord in as good order and condition as when Tenant took possession and as thereafter improved by Landlord and/or Tenant, reasonable wear and tear and repairs which are specifically made the responsibility of Landlord hereunder excepted. Upon such expiration or termination, Tenant shall, without expense to Landlord, remove or cause to be removed from the Premises all debris and rubbish, and such items of furniture, equipment, free-standing cabinet work, and other articles of personal property owned by Tenant or installed or placed by Tenant at its expense in the Premises, and such similar articles of any other persons claiming under Tenant and Tenant shall repair at its own expense all damage to the Premises and Building resulting from such removal. ARTICLE 16. HOLDING OVER If Tenant holds over after the expiration of the Lease Term hereof, with or without the express or implied consent of Landlord, such tenancy shall be at sufferance only, and shall not constitute a renewal hereof or an extension for any further term, and in such case Base Rent shall be payable at a monthly rate equal to twice the Base Rent applicable during the last rental period of the Lease Term under this Lease. Such month-to-month tenancy shall be subject to every other term, covenant and agreement contained herein. Nothing contained in this Article 16 shall be construed as consent by Landlord to any holding over by Tenant, and Landlord expressly reserves the right to require Tenant to surrender possession of the Premises to Landlord as provided in this Lease upon the expiration or other termination of this Lease. The provisions of this Article 16 shall not be deemed to limit or constitute a waiver of any other rights or remedies of Landlord provided herein or at law. If Tenant fails to surrender the Premises upon the termination or expiration of this Lease, in addition to any other liabilities to Landlord accruing therefrom, Tenant shall protect, defend, indemnify and hold Landlord harmless from all loss, costs (including reasonable attorneys' fees) and liability resulting from such failure, including, without limiting the generality of the foregoing, any claims made by any succeeding tenant founded upon such failure to surrender, and any lost profits to Landlord resulting therefrom. ARTICLE 17. ESTOPPEL CERTIFICATES Within ten (10) days following a request in writing by Landlord, Tenant shall execute and deliver to Landlord an estoppel certificate, which, as submitted by Landlord, shall be in a form designated by Landlord or by any prospective mortgagee or purchaser of the Project, or any portion thereof, and shall also contain any other information reasonably requested by Landlord or Landlord's mortgagee or prospective mortgagee. Tenant shall execute and deliver whatever other instruments may be reasonably required for such purposes. Failure of Tenant to timely execute and deliver such estoppel certificate or other instruments shall constitute an acceptance of the Premises and an acknowledgment by Tenant that statements included in the estoppel certificate are true and correct, without exception. ARTICLE 18. SUBORDINATION This Lease is subject and subordinate to all present and future ground or underlying leases of the Real Property and to the lien of any mortgages or trust deeds, now or hereafter in force against the Real Property and the Building, if any, and to all renewals, extensions, modifications, consolidations and replacements thereof, and to all advances made or hereafter to be made upon the security of such mortgages or trust deeds, unless the holders of such mortgages or trust deeds, or the lessors under such ground lease or underlying leases, require in writing that this Lease be superior thereto. Tenant covenants and agrees in the event any proceedings are brought for the foreclosure of any such mortgage, or if any ground or underlying lease is terminated, to attorn, without any deductions or set-offs whatsoever, to the purchaser upon any such foreclosure sale, or to the lessor of such ground or underlying lease, as the case may be, if so requested to do so by such purchaser or lessor, and to recognize such purchaser or lessor as the lessor under this Lease. Tenant shall, within five (5) days of request by Landlord, execute such further instruments or assurances as Landlord may reasonably deem necessary to evidence or confirm such attornment and/or the subordination or superiority of this Lease to any such mortgages, trust deeds, ground leases or underlying leases. Tenant hereby irrevocably authorizes Landlord to execute and deliver in the name of Tenant any such instrument or instruments if Tenant fails to do so, provided that such authorization shall in no way relieve Tenant from the obligation of executing such instruments of subordination or superiority. Tenant waives the provisions of any current or future statute, rule or law which may give or purport to give Tenant any right or election to terminate or otherwise adversely affect this Lease and the obligations of the Tenant hereunder in the event of any foreclosure proceeding or sale. ARTICLE 19. DEFAULTS; REMEDIES 19.1 Events of Default. The occurrence of any of the following shall constitute a default of this Lease by Tenant: 19.1.1.....Any failure by Tenant to pay any Rent or any other charge required to be paid under this Lease, or any part thereof, when due; or 19.1.2.....Any failure by Tenant to observe or perform any other provision, covenant or condition of this Lease to be observed or performed by Tenant where such failure continues for fifteen (15) days after written notice thereof from Landlord to Tenant; provided however, that any such notice shall be in lieu of, and not in addition to, any notice required under California Code of Civil Procedure Section 1161 or any similar or successor law; and provided further that if the nature of such default is such that the same cannot reasonably be cured within a fifteen (15)-day period, Tenant shall not be deemed to be in default if it diligently commences such cure within such period and thereafter diligently proceeds to rectify and cure said default as soon as possible; or 19.1.3.....Abandonment or vacation of the Premises by Tenant. Abandonment is herein defined to include, but is not limited to, any absence by Tenant from the Premises for three (3) business days or longer while in default of any provision of this Lease. 19.2 Remedies Upon Default. Upon the occurrence of any event of default by Tenant, Landlord shall have, in addition to any other remedies available to Landlord at law or in equity, the option to pursue any one or more of the following remedies, each and all of which shall be cumulative and nonexclusive, without any notice or demand whatsoever. 19.2.1.....Terminate this Lease, in which event Tenant shall immediately surrender the Premises to Landlord, and if Tenant fails to do so, Landlord may, without prejudice to any other remedy which it may have for possession or arrearages in rent, enter upon and take possession of the Premises and expel or remove Tenant and any other person who may be occupying the Premises or any part thereof, without being liable for prosecution or any claim or damages therefor; and Landlord may recover from Tenant the following: (i) The worth at the time of award of any unpaid rent which has been earned at the time of such termination; plus (ii) The worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; plus (iii) The worth at the time of award of the amount by which the unpaid rent for the balance of the Lease Term after the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; plus (iv) Any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, specifically including but not limited to, brokerage commissions and advertising expenses incurred, expenses of remodeling the Premises or any portion thereof for a new tenant, whether for the same or a different use, and any special concessions made to obtain a new tenant; and (v) At Landlord's election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by applicable law. The term "rent" as used in this Section 19.2 shall be deemed to be and to mean all sums of every nature required to be paid by Tenant pursuant to the terms of this Lease, whether to Landlord or to others. As used in Paragraphs 19.2.1(i) and (ii), above, the "worth at the time of award" shall be computed by allowing interest at the rate set forth in Article 25 of this Lease, but in no case greater than the maximum amount of such interest permitted by law. As used in Paragraph 19.2.1(iii) above, the "worth at the time of award" shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). 19.2.2.....Landlord shall have the remedy described in California Civil Code Section 1951.4 (lessor may continue lease in effect after lessee's breach and abandonment and recover rent as it becomes due, if lessee has the right to sublet or assign, subject only to reasonable limitations). Accordingly, if Landlord does not elect to terminate this Lease on account of any default by Tenant, Landlord may, from time to time, without terminating this Lease, enforce all of its rights and remedies under this Lease, including the right to recover all rent as it becomes due. 19.3 Sublessees of Tenant. If Landlord elects to terminate this Lease on account of any default by Tenant, as set forth in this Article 19, Landlord shall have the right to terminate any and all subleases, licenses, concessions or other consensual arrangements for possession entered into by Tenant and affecting the Premises or may, in Landlord's sole discretion, succeed to Tenant's interest in such subleases, licenses, concessions or arrangements. In the event of Landlord's election to succeed to Tenant's interest in any such subleases, licenses, concessions or arrangements, Tenant shall, as of the date of notice by Landlord of such election, have no further right to or interest in the rent or other consideration receivable thereunder. 19.4 Form of Payment After Default. Following the occurrence of an event of default by Tenant, Landlord shall have the right to require that any or all subsequent amounts paid by Tenant to Landlord hereunder, whether in the cure of the default in question or otherwise, be paid in the form of cash, money order, cashier's or certified check drawn on an institution acceptable to Landlord, or by other means approved by Landlord, notwithstanding any prior practice of accepting payments in any different form. 19.5 Waiver of Default. No waiver by Landlord or Tenant of any violation or breach of any of the terms, provisions and covenants herein contained shall be deemed or construed to constitute a waiver of any other or later violation or breach of the same or any other of the terms, provisions, and covenants herein contained. Forbearance by Landlord in enforcement of one or more of the remedies herein provided upon an event of default shall not be deemed or construed to constitute a waiver of such default. The acceptance of any Rent hereunder by Landlord following the occurrence of any default, whether or not known to Landlord, shall not be deemed a waiver of any such default, except only a default in the payment of the Rent so accepted. 19.6 Efforts to Relet. For the purposes of this Article 19, Tenant's right to possession shall not be deemed to have been terminated by efforts of Landlord to relet the Premises, by its acts of maintenance or preservation with respect to the Premises, or by appointment of a receiver to protect Landlord's interests hereunder. The foregoing enumeration is not exhaustive, but merely illustrative of acts which may be performed by Landlord without terminating Tenant's right to possession. ARTICLE 20. COVENANT OF QUIET ENJOYMENT Landlord covenants that Tenant, on paying the Rent, charges for services and other payments herein reserved and on keeping, observing and performing all the other terms, covenants, conditions, provisions and agreements herein contained on the part of Tenant to be kept, observed and performed, shall, during the Lease Term, peaceably and quietly have, hold and enjoy the Premises subject to the terms, covenants, conditions, provisions and agreements hereof without interference by any persons lawfully claiming by or through Landlord. The foregoing covenant is in lieu of any other covenant express or implied. ARTICLE 21. ENVIRONMENTAL WORK Tenant acknowledges that Landlord will be removing an underground storage tank(s) from the Real Property and will also be performing associated environmental work (collectively, the "Environmental Work"). Such Environmental Work may prevent Tenant from utilizing the Parking Facilities for an undetermined period of time. Consequently, Tenant shall not be required to pay for parking under this Lease until the Environmental Work has been completed to a level sufficient for the Parking Facilities to be reopened, as determined by Landlord and Landlord has received any other necessary clearances to reopen the Parking Facilities. While Landlord agrees to use commercially reasonable efforts to minimize any disruption to Tenant's business operations throughout the course of the Environmental Work, Tenant shall not otherwise be entitled to any abatement of rent as a result of such work nor shall Tenant be deemed to be constructively evicted from the Premises as a result of such work and Tenant agrees to hold Landlord harmless from any and all claims arising from the presence of environmental products in the soil of the Real Property and from such Environmental Work. ARTICLE 22. TERMINATION ON SALE Landlord and Tenant acknowledge that Landlord was previously in escrow to sell the Real Property to Five Star, LLC ("Five Star") and that Tenant was previously in discussions to lease the Premises from Five Star upon Five Star's close of escrow for the Real Property. If Landlord, in its sole discretion, ultimately sells the Real Property to Five Star, or any person or company which is affiliated with, related to, employed by, controlled by, controlling or under common control with Five Star, then this Lease shall automatically terminate upon the close of escrow for such sale. However, if Landlord, in its sole discretion, sells the Real Property to any other purchaser, this Lease between Landlord and Tenant shall remain in full force and effect through the Lease Expiration Date (as may be extended pursuant to Section 2.2 above) and the immediately preceding sentence of this Article 22 shall be null and void and of no further force and effect. Tenant agrees to indemnify, defend and hold Landlord harmless from and against any and all claims, costs, expenses and liabilities asserted or alleged by Five Star and/or any of its affiliates, employees, members, officers or principals arising out of or in connection (i) with Landlord and Tenant entering into this Lease, (ii) Landlord's grant of the Purchase Option to Tenant, (iii) Tenant's exercise of the Purchase Option, and/or (iv) Tenant's purchase of the Real Property as a result of Tenant's exercise of the Purchase Option, such defense to be provided by counsel acceptable to Landlord in its sole and absolute discretion. ARTICLE 23. SIGNS 23.1 In General. Tenant shall be entitled, at its sole cost and expense, to the following (collectively, "Tenant's Signage"): (i) signs on the exterior of the Building at the approximate location of the signs which were previously installed when Landlord operated a bank branch at the Building and (ii) identification signage within the Premises. The location, quality, design, style, lighting and size of Tenant's Signage shall be subject to Landlord's prior written approval, in its reasonable discretion. Tenant's rights to Tenant's Signage shall be personal to Original Tenant and may not be transferred. Upon the expiration or earlier termination of this Lease, Tenant shall be responsible, at its sole cost and expense, for the removal of Tenant's Signage and the repair of all damage to the Building caused by such removal. If Tenant fails to timely remove Tenant's Signage, Landlord may cause such signage to be removed and to repair damage resulting from such removal, in which case Tenant shall be responsible for all such costs so incurred by Landlord. 23.2 Prohibited Signage and Other Items. Any signs, notices, logos, pictures, names or advertisements which are installed and that have not been individually approved by Landlord may be removed without notice by Landlord at the sole expense of Tenant. ARTICLE 24. COMPLIANCE WITH LAW Tenant shall not do anything or suffer anything to be done in or about the Premises which will in any way conflict with any law, statute, ordinance or other governmental rule, regulation or requirement now in force or which may hereafter be enacted or promulgated. At its sole cost and expense, Tenant shall promptly comply with all such governmental measures, other than the making of structural changes or changes to the Building's life safety system. Should any standard or regulation now or hereafter be imposed on Landlord or Tenant by a state, federal or local governmental body charged with the establishment, regulation and enforcement of occupational, health or safety standards for employers, employees, landlords or tenants, then Tenant agrees, at its sole cost and expense, to comply promptly with such standards or regulations. The judgment of any court of competent jurisdiction or the admission of Tenant in any judicial action, regardless of whether Landlord is a party thereto, that Tenant has violated any of said governmental measures, shall be conclusive of that fact as between Landlord and Tenant. ARTICLE 25. LATE CHARGES If any installment of Rent or any other sum due from Tenant shall not be received by Landlord or Landlord's designee within five (5) days after said amount is due, then Tenant shall pay to Landlord a late charge equal to five percent (5%) of the amount due plus any attorneys' fees incurred by Landlord by reason of Tenant's failure to pay Rent and/or other charges when due hereunder. The late charge shall be deemed Additional Rent and the right to require it shall be in addition to all of Landlord's other rights and remedies hereunder or at law and shall not be construed as liquidated damages or as limiting Landlord's remedies in any manner. In addition to the late charge described above, any Rent or other amounts owing hereunder which are not paid within three (3) days after the date they are due shall thereafter bear interest until paid at a rate equal to twelve percent (12%) per annum, provided that in no case shall such rate be higher than the highest rate permitted by applicable law. ARTICLE 26. LANDLORD'S RIGHT TO CURE DEFAULT; PAYMENTS BY TENANT 26.1 Landlord's Cure. All covenants and agreements to be kept or performed by Tenant under this Lease shall be performed by Tenant at Tenant's sole cost and expense and without any reduction of Rent. If Tenant shall fail to perform any of its obligations under this Lease, within a reasonable time after such performance is required by the terms of this Lease, Landlord may, but shall not be obligated to, after reasonable prior notice to Tenant, make any such payment or perform any such act on Tenant's part without waiving its right based upon any default of Tenant and without releasing Tenant from any obligations hereunder. 26.2 Tenant's Reimbursement. Except as may be specifically provided to the contrary in this Lease, Tenant shall pay to Landlord, within fifteen (15) days after delivery by Landlord to Tenant of statements therefor sums equal to expenditures reasonably made and obligations incurred by Landlord in connection with the remedying by Landlord of Tenant's defaults pursuant to the provisions of Section 26.1. ARTICLE 27. ENTRY BY LANDLORD Landlord reserves the right at all reasonable times and upon reasonable notice to the Tenant to enter the Premises to (i) inspect them; (ii) show the Premises to prospective purchasers, mortgagees or tenants, or to the ground or underlying lessors; (iii) post notices of nonresponsibility; or (iv) alter, improve or repair the Premises or the Building if necessary to comply with current building codes or other applicable laws, or for structural alterations, repairs or improvements to the Building. Notwithstanding anything to the contrary contained in this Article 27, Landlord may enter the Premises at any time to (A) perform services required of Landlord; (B) take possession due to any breach of this Lease in the manner provided herein; and (C) perform any covenants of Tenant which Tenant fails to perform. Any such entries shall be without the abatement of Rent and shall include the right to take such reasonable steps as required to accomplish the stated purposes. Tenant hereby waives any claims for damages or for any injuries or inconvenience to or interference with Tenant's business, lost profits, any loss of occupancy or quiet enjoyment of the Premises, and any other loss occasioned thereby. For each of the above purposes, Landlord shall at all times have a key with which to unlock all the doors in the Premises, excluding Tenant's vaults, safes and special security areas designated in advance by Tenant. In an emergency, Landlord shall have the right to use any means that Landlord may deem proper to open the doors in and to the Premises. Any entry into the Premises in the manner hereinbefore described shall not be deemed to be a forcible or unlawful entry into, or a detainer of, the Premises, or an actual or constructive eviction of Tenant from any portion of the Premises. ARTICLE 28. TENANT PARKING Subject to Article 21 above, Tenant shall be entitled to the parking set forth in Section 11 of the Summary to park in the Parking Facilities. Subject to Article 21 above, Tenant shall pay to Landlord for automobile parking passes on a monthly basis (i) $35.00 per unreserved parking pass per month for the first three (3) Lease Years, (ii) $38.50 per unreserved parking pass per month for the fourth (4th) Lease Year, and (iii) the prevailing rate for parking in the vicinity of the Building thereafter. Tenant's continued right to use the parking passes is conditioned upon Tenant abiding by all rules and regulations which are prescribed from time to time for the orderly operation and use of the Parking Facilities and upon Tenant's cooperation in seeing that Tenant's employees and visitors also comply with such rules and regulations. Landlord specifically reserves the right to (i) change the size, configuration, design, layout, location and all other aspects of the Parking Facilities and/or (ii) perform repairs to the Parking Facilities, and Tenant acknowledges and agrees that, subject to Article 21 above, Landlord may, without incurring any liability to Tenant and without any abatement of Rent under this Lease, from time to time, close-off or restrict access to the Parking Facilities for purposes of permitting or facilitating any such construction, alteration, improvements or repairs with respect to the Parking Facilities or to accommodate or facilitate renovation, alteration, construction or other modification of other improvements or structures located on the Real Property. The parking rates charged by Landlord for Tenant's parking passes shall be exclusive of any parking tax or other charges imposed by governmental authorities in connection with the use of such parking, which taxes and/or charges shall be paid directly by Tenant or the parking users, or, if directly imposed against Landlord, Tenant shall reimburse Landlord for all such taxes and/or charges concurrent with its payment of the parking rates described herein. ARTICLE 29. MISCELLANEOUS PROVISIONS 29.1 Terms. The necessary grammatical changes required to make the provisions hereof apply either to corporations or partnerships or individuals, men or women, as the case may require, shall in all cases be assumed as though in each case fully expressed. 29.2 Binding Effect. Each of the provisions of this Lease shall extend to and shall, as the case may require, bind or inure to the benefit not only of Landlord and of Tenant, but also of their respective successors or assigns, provided this clause shall not permit any assignment by Tenant contrary to the provisions of Article 14 of this Lease. 29.3 No Air Rights. No rights to any view or to light or air over any property, whether belonging to Landlord or any other person, are granted to Tenant by this Lease. If at any time any windows of the Premises are temporarily darkened or the light or view therefrom is obstructed by reason of any repairs, improvements, maintenance or cleaning in or about the Building, the same shall be without liability to Landlord and without any reduction or diminution of Tenant's obligations under this Lease. 29.4 Transfer of Landlord's Interest. Tenant acknowledges that Landlord has the right to transfer all or any portion of its interest in the Real Property and Building and in this Lease, and Tenant agrees that in the event of any such transfer, Landlord shall automatically be released from all remaining liability under this Lease and Tenant agrees to look solely to such transferee for the performance of Landlord's obligations hereunder after the date of transfer. Tenant further acknowledges that Landlord may assign its interest in this Lease to a mortgage lender as additional security and agrees that such an assignment shall not release Landlord from its obligations hereunder and that Tenant shall continue to look to Landlord for the performance of its obligations hereunder. 29.5 Prohibition Against Recording. Neither this Lease, nor any memorandum, affidavit or other writing with respect thereto, shall be recorded by Tenant or by anyone acting through, under or on behalf of Tenant. 29.6 Landlord's Title. Landlord's title is and always shall be paramount to the title of Tenant. Nothing herein contained shall empower Tenant to do any act which can, shall or may encumber the title of Landlord. 29.7 Captions. The captions of Articles and Sections are for convenience only and shall not be deemed to limit, construe, affect or alter the meaning of such Articles and Sections. 29.8 Relationship of Parties. Nothing contained in this Lease shall be deemed or construed by the parties hereto or by any third party to create the relationship of principal and agent, partnership, joint venturer or any association between Landlord and Tenant, it being expressly understood and agreed that neither the method of computation of Rent nor any act of the parties hereto shall be deemed to create any relationship between Landlord and Tenant other than the relationship of landlord and tenant. 29.9 Application of Payments. Landlord shall have the right to apply payments received from Tenant pursuant to this Lease, regardless of Tenant's designation of such payments, to satisfy any obligations of Tenant hereunder, in such order and amounts as Landlord, in its sole discretion, may elect. 29.10 Time of Essence. Time is of the essence of this Lease and each of its provisions. 29.11 Partial Invalidity. If any term, provision or condition contained in this Lease shall, to any extent, be invalid or unenforceable, the remainder of this Lease, or the application of such term, provision or condition to persons or circumstances other than those with respect to which it is invalid or unenforceable, shall not be affected thereby, and each and every other term, provision and condition of this Lease shall be valid and enforceable to the fullest extent possible permitted by law. 29.12 No Warranty. In executing and delivering this Lease, Tenant has not relied on any representation, including, but not limited to, any representation whatsoever as to the amount of any item comprising Additional Rent or the amount of the Additional Rent in the aggregate or that Landlord is furnishing the same services to other tenants, at all, on the same level or on the same basis, or any warranty or any statement of Landlord which is not set forth herein or in one or more of the exhibits attached hereto. 29.13 Landlord Exculpation. It is expressly understood and agreed that notwithstanding anything in this Lease to the contrary, and notwithstanding any applicable law to the contrary, the liability of Landlord and the Landlord Parties hereunder (including any successor landlord) and any recourse by Tenant against Landlord or the Landlord Parties shall be limited solely and exclusively to an amount which is equal to the lesser of (a) the interest of Landlord in the Building or (b) the equity interest Landlord would have in the Building if the Building were encumbered by third-party debt in an amount equal to eighty percent (80%) of the value of the Building (as such value is determined by Landlord), and neither Landlord, nor any of the Landlord Parties shall have any personal liability therefor, and Tenant hereby expressly waives and releases such personal liability on behalf of itself and all persons claiming by, through or under Tenant. 29.14 Entire Agreement. It is understood and acknowledged that there are no oral agreements between the parties hereto affecting this Lease and this Lease supersedes and cancels any and all previous negotiations, arrangements, brochures, agreements and understandings, if any, between the parties hereto or displayed by Landlord to Tenant with respect to the subject matter thereof, and none thereof shall be used to interpret or construe this Lease. This Lease and any side letter or separate agreement executed by Landlord and Tenant in connection with this Lease and dated of even date herewith contain all of the terms, covenants, conditions, warranties and agreements of the parties relating in any manner to the rental, use and occupancy of the Premises, shall be considered to be the only agreement between the parties hereto and their representatives and agents, and none of the terms, covenants, conditions or provisions of this Lease can be modified, deleted or added to except in writing signed by the parties hereto. All negotiations and oral agreements acceptable to both parties have been merged into and are included herein. 29.15 Right to Lease. Landlord reserves the absolute right to effect such other tenancies in the Building as Landlord in the exercise of its sole business judgment shall determine to best promote the interests of the Building. Tenant does not rely on the fact, nor does Landlord represent, that any specific tenant or type or number of tenants shall, during the Lease Term, occupy any space in the Building. 29.16 Force Majeure. Any prevention, delay or stoppage due to strikes, lockouts, labor disputes, acts of God, inability to obtain services, labor, or materials or reasonable substitutes therefor, governmental actions, civil commotions, fire or other casualty, and other causes beyond the reasonable control of the party obligated to perform, except with respect to the obligations imposed with regard to Rent and other charges to be paid by Tenant pursuant to this Lease (collectively, the "Force Majeure"), notwithstanding anything to the contrary contained in this Lease, shall excuse the performance of such party for a period equal to any such prevention, delay or stoppage and, therefore, if this Lease specifies a time period for performance of an obligation of either party, that time period shall be extended by the period of any delay in such party's performance caused by a Force Majeure. 29.17 Waiver of Redemption by Tenant. Tenant hereby waives for Tenant and for all those claiming under Tenant all right now or hereafter existing to redeem by order or judgment of any court or by any legal process or writ, Tenant's right of occupancy of the Premises after any termination of this Lease. 29.18 Notices. All notices, demands, statements or communications (collectively, "Notices") given or required to be given by either party to the other hereunder shall be in writing, shall be sent by United States certified or registered mail, postage prepaid, return receipt requested, or delivered personally (i) to Tenant at the appropriate address set forth in Section 5 of the Summary, or to such other place as Tenant may from time to time designate in a Notice to Landlord; or (ii) to Landlord at the addresses set forth in Section 3 of the Summary, or to such other firm or to such other place as Landlord may from time to time designate in a Notice to Tenant. Any Notice will be deemed given on the date it is delivered or refused. If Tenant is notified of the identity and address of Landlord's mortgagee or ground or underlying lessor, Tenant shall give to such mortgagee or ground or underlying lessor written notice of any default by Landlord under the terms of this Lease by registered or certified mail, and such mortgagee or ground or underlying lessor shall be given a reasonable opportunity to cure such default prior to Tenant's exercising any remedy available to Tenant. 29.19 Joint and Several. If there is more than one Tenant, the obligations imposed upon Tenant under this Lease shall be joint and several. 29.20 Attorneys' Fees. If either party commences litigation against the other for the specific performance of this Lease, for damages for the breach hereof or otherwise for enforcement of any remedy hereunder, the parties hereto agree to and hereby do waive any right to a trial by jury and, in the event of any such commencement of litigation, the prevailing party shall be entitled to recover from the other party such costs and reasonable attorneys' fees as may have been incurred, including any and all costs incurred in enforcing, perfecting and executing such judgment. 29.21 Governing Law. This Lease shall be construed and enforced in accordance with the laws of the State of California. 29.22 Submission of Lease. Submission of this instrument for examination or signature by Tenant does not constitute a reservation of or an option for lease, and it is not effective as a lease or otherwise until execution and delivery by both Landlord and Tenant. 29.23 Brokers. Landlord and Tenant hereby warrant to each other that they have had no dealings with any real estate broker or agent in connection with the negotiation of this Lease, excepting only the real estate brokers or agents specified in Section 12 of the Summary (the "Brokers"), and that they know of no other real estate broker or agent who is entitled to a commission in connection with this Lease. Each party agrees to indemnify and defend the other party against and hold the other party harmless from any and all claims, demands, losses, liabilities, lawsuits, judgments, and costs and expenses (including without limitation reasonable attorneys' fees) with respect to any leasing commission or equivalent compensation alleged to be owing on account of the indemnifying party's dealings with any real estate broker or agent other than the Brokers. ARTICLE 30. PURCHASE OPTION 30.1 Purchase Notice and Price. Landlord hereby grants to Tenant the one-time right and option to purchase the Real Property (the "Purchase Option") on the terms set forth in this Section 30. Landlord shall provide Tenant with written notice ("Trigger Notice") upon any date selected by Landlord which is on or before November 30, 2003. The Trigger Notice shall specify the amount determined by Landlord to be the purchase price ("Purchase Price") for the Real Property. The Purchase Price shall, in any event, be a minimum of Two Million Two Hundred Twenty-Five Thousand Dollars ($2,225,000.00) and the Purchase Price shall be paid all cash by Tenant as of the close of Escrow. The Purchase Option shall be exercised by Tenant, if at all, by written notice ("Exercise Notice") to Landlord within ten (10) days after the Trigger Notice. Tenant's failure to deliver the Exercise Notice to Landlord within said ten (10) day period shall be deemed to constitute Tenant's election not to exercise the Purchase Option, in which case the Purchase Option shall terminate. In any event the Purchase Option shall be of no force or effect after December 31, 2003. 30.2 Conditions Precedent to Effectiveness of Purchase Option. Notwithstanding anything to the contrary contained in this Section 30, Tenant's exercise of the Purchase Option shall be effective only if all of the conditions precedent set forth hereinbelow are true and correct during the period commencing upon the date Tenant delivers the Exercise Notice and continuing until the Closing Date (as that term is defined below), unless Landlord, in Landlord's sole discretion, elects to waive any such condition precedent in writing: (i) Tenant shall not then be in default under this Lease; and (ii) Tenant shall not have assigned its interest in this Lease or in the Purchase Option to other than an Affiliated Assignee. 30.3 Actions of Parties. Within ten (10) days following Landlord's receipt of the Exercise Notice, the parties shall proceed to open an escrow for the purchase and sale of the Premises ("Escrow") with an escrow and title company reasonably selected by Landlord ("Title/Escrow Holder") by delivering a fully executed copy of a definitive Purchase and Sale Agreement and Joint Escrow Instructions (the "Purchase Agreement") to Title/Escrow Holder. In addition, concurrently with delivery of the Purchase Agreement to Title/Escrow Holder, Tenant shall deliver to Title/Escrow Holder a good faith deposit in the amount of Ninety Thousand Dollars ($90,000.00), which deposit shall be applied to the Purchase Price and shall be nonrefundable to Tenant except in the event of Landlord's default under the Purchase Agreement. The Purchase Agreement shall specify that said deposit shall be delivered to Landlord by Title/Escrow Holder as liquidated damages in the event of Tenant's default under the Purchase Agreement. The Purchase Agreement shall be prepared by Landlord and incorporate the terms and provisions set forth in this Section 30 and any other commercially reasonable and standard provisions approved by the parties. 30.4 Closing Date. The close of Escrow shall occur on or before the date (the "Closing Date") which is twenty-one (21) days after Tenant delivers the Exercise Notice to Landlord. This Lease, including Tenant's obligation to pay Rent, shall remain in effect until the close of Escrow. 30.5 No Contingencies to Tenant's Obligations. After Tenant's delivery of the Exercise Notice, there shall be no contingencies or conditions precedent to Tenant's obligations to close Escrow except for (i) Landlord's delivery to Title/Escrow Holder on or before the Closing Date of a duly executed and acknowledged grant deed conveying title to the Real Property to Tenant and (ii) the agreement by the Title/Escrow Holder to deliver to Tenant the Title Policy described in Section 30.6 below. Notwithstanding the foregoing, upon Tenant's written request, Landlord shall provide Tenant with copies of any written correspondence then received by Landlord and in Landlord's possession from governmental entities regarding the condition of the Real Property. 30.6 Title. Title to the Real Property shall be evidenced by either a standard CLTA or ALTA Owner's Form Policy of Title Insurance issued by the Title/Escrow Holder ("Title Policy") in the amount of the Purchase Price showing title to the Real Property vested in Tenant. Tenant shall have the option to obtain an ALTA Title Policy by providing written notice to Landlord of Tenant's agreement to pay for the cost of the survey and the additional cost of an ALTA Title Policy in accordance with Section 30.7 below. 30.7 Costs and Prorations. Landlord shall pay for all premiums for a CLTA Title Policy, all documentary transfer and other taxes imposed in connection with the sale of the Real Property, one-half (1/2) of all Escrow fees and costs, and any document recording charges and taxes imposed in connection with the sale of the Real Property. Tenant shall pay one-half (1/2) of all Escrow fees and costs, the additional premium imposed in the event Tenant elects to obtain an ALTA Title Policy over the premium for a CLTA Title Policy and any costs (including survey costs) associated with an ALTA Title Policy and the costs associated with any title endorsements. All other costs and expenses shall be apportioned between Landlord and Tenant in accordance with the customary practice for comparable real estate transactions in Monterey, California. 30.8 Representations. Tenant acknowledges that the Purchase Option has been granted by Landlord to Tenant based on the understanding that exercise of the Purchase Option is entirely voluntary by Tenant, and that the conveyance of the Real Property by Landlord to Tenant is and shall be on an "AS IS" basis, with absolutely no representations or warranties, express or implied, regarding the condition or nature of the Real Property and any improvements thereon except for the following representations. (i) Landlord and Tenant each represent to each other than they have the legal power, right and authority to enter into this Lease and the instruments referenced in this Section 30; (ii) Landlord and Tenant represent to each other that neither the execution of this Lease and the instruments referenced herein, nor the incurrence of the obligations set forth herein, nor the consummation of the transaction herein contemplated conflict with or result in the material breach of any terms, conditions or provisions of, or constitute a default under any agreement or instrument to which Landlord or Tenant, as applicable, is a party; and (iii)Any representations and warranties specifically set forth in this Lease. The parties agree to indemnify the other, and to defend and hold the other harmless, from all losses, damages, costs and expenses incurred relating to the Real Property which arise from a breach of the representations made above. Such representations shall survive, and shall not merge into, the close of Escrow and the recordation of the grant deed for the Real Property. 30.9 Sale to Five Star. Landlord and Tenant acknowledge that Landlord shall be entitled to sell the Real Property, at Landlord's sole discretion, to Five Star (as that term is defined in Article 22 above) or any person or company which is affiliated with, related to, employed by, controlled by, controlling or under common control with Five Star, in which case the Purchase Option shall be null and void and, as indicated in Article 22 above, this Lease shall automatically terminate upon the close of escrow for such sale. IN WITNESS WHEREOF, Landlord and Tenant have caused this Lease to be executed the day and date first above written. "Landlord": CALIFORNIA BANK & TRUST, a California corporation By: /s/ DAVID RUSSELL David Russell, Sr. Vice President, Director of Corporate Real Estate Facilities By: /s/ VICTORIA UNDERWOOD Victoria Underwood, Vice President "Tenant": CENTRAL COAST BANCORP., a California corporation, dba COMMUNITY BANK OF CENTRAL CALIFORNIA By: /s/ HARRY O. WARDWELL Its: S.V.P. branch Administrator By: /s/ CAROL FRANCHI Its: S.V.P. Operations Administrator EXHIBIT A OUTLINE OF FLOOR PLAN OF PREMISES [ graphic omitted] EXHIBIT B NOTICE OF LEASE TERM DATES To: Re: Office Lease dated _______________, 2002, between _____________________, a _________________________________________ ("Landlord"), and _______________________________, a _____________________ ("Tenant") concerning Suite _______ on floor(s) _______ of the Office Building located at _________________________________. Ladies and Gentlemen: In accordance with the Office Lease (the "Lease"), we wish to advise you and/or confirm as follows: 1. That the Lease Term shall commence as of ________________ for a term of _______________ ending on _______________. 2. That in accordance with the Lease, Rent commenced to accrue on _______________________. 3. If the Lease Commencement Date is other than the first day of the month, the first billing will contain a pro rata adjustment. Each billing thereafter, with the exception of the final billing, shall be for the full amount of the monthly installment as provided for in the Lease. 4. Rent is due and payable in advance on the first day of each and every month during the Lease Term. Your rent checks should be made payable to ____________________________________ at ________________________________. 5. The exact number of rentable square feet within the Premises is _______ square feet. 6. Tenant's Share as adjusted based upon the exact number of rentable square feet within the Premises is _______%. "Landlord": _________________________________, a _________________________ By: Its: ____________________ Agreed to and Accepted as of _____________, 200_. "Tenant": , a By: Its: By: Its: EXHIBIT C RULES AND REGULATIONS Tenant shall faithfully observe and comply with the following Rules and Regulations. Landlord shall not be responsible to Tenant for the nonperformance of any of said Rules and Regulations by or otherwise with respect to the acts or omissions of any other tenants or occupants of the Building. 1. Tenant shall not alter any lock or install any new or additional locks or bolts on any doors or windows of the Premises without obtaining Landlord's prior written consent. Tenant shall bear the cost of any lock changes or repairs required by Tenant. 2. All doors opening to public corridors shall be kept closed at all times except for normal ingress and egress to the Premises, unless electrical hold backs have been installed. 3. Landlord reserves the right to close and keep locked all entrance and exit doors of the Building during such hours as are customary for comparable buildings in the vicinity of the Building. Tenant, its employees and agents must be sure that the doors to the Building are securely closed and locked when leaving the Premises if it is after the normal hours of business for the Building. The Landlord and its agents shall in no case be liable for damages for any error with regard to the admission to or exclusion from the Building of any person. In case of invasion, mob, riot, public excitement, or other commotion, Landlord reserves the right to prevent access to the Building during the continuance of same by any means it deems appropriate for the safety and protection of life and property. 4. Landlord shall have the right to prescribe the weight, size and position of all safes and other heavy property brought into the Building. Safes and other heavy objects shall, if considered necessary by Landlord, stand on supports of such thickness as is necessary to properly distribute the weight. Landlord will not be responsible for loss of or damage to any such safe or property in any case. All damage done to any part of the Building, its contents, occupants or visitors by moving or maintaining any such safe or other property shall be the sole responsibility of Tenant and any expense of said damage or injury shall be borne by Tenant. 5. Landlord shall have the right to control and operate the public portions of the Building, the public facilities, the heating and air conditioning, and any other facilities furnished for the common use of tenants, in such manner as is customary for comparable buildings in the vicinity of the Building. 6. Tenant shall not disturb, solicit, or canvass any occupant of the Building and shall cooperate with Landlord or Landlord's agents to prevent same. 7. The toilet rooms, urinals, wash bowls and other apparatus shall not be used for any purpose other than that for which they were constructed, and no foreign substance of any kind whatsoever shall be thrown therein. The expense of any breakage, stoppage or damage resulting from the violation of this rule shall be borne by the tenant who, or whose employees or agents, shall have caused it. 8. Tenant shall not overload the floor of the Premises, nor mark, drive nails or screws, or drill into the partitions, woodwork or plaster or in any way deface the Premises or any part thereof without Landlord's consent first had and obtained. 9. Except for vending machines intended for the sole use of Tenant's employees and invitees, no vending machine or machines of any description other than usual office machines shall be installed, maintained or operated upon the Premises without the written consent of Landlord. 10. Tenant shall not use or keep in or on the Premises or the Building any kerosene, gasoline or other inflammable or combustible fluid or material. 11. Tenant shall not use any method of heating or air conditioning other than that which may be supplied by Landlord, without the prior written consent of Landlord. 12. Tenant shall not use, keep or permit to be used or kept, any foul or noxious gas or substance in or on the Premises, or permit or allow the Premises to be occupied or used in a manner offensive or objectionable to Landlord or other occupants of the Building by reason of noise, odors, or vibrations, or interfere in any way with other Tenants or those having business therein. 13. Tenant shall not bring into or keep within the Building or the Premises any animals, birds, bicycles or other vehicles. 14. No cooking shall be done or permitted by any tenant on the Premises, nor shall the Premises be used for the storage of merchandise, for lodging or for any improper, objectionable or immoral purposes. Notwithstanding the foregoing, Underwriters' laboratory-approved equipment and microwave ovens may be used in the Premises for heating food and brewing coffee, tea, hot chocolate and similar beverages, provided that such use is in accordance with all applicable federal, state and city laws, codes, ordinances, rules and regulations, and does not cause odors which are objectionable to Landlord and other Tenants. 15. Landlord will approve where and how telephone and telegraph wires are to be introduced to the Premises. No boring or cutting for wires shall be allowed without the consent of Landlord. The location of telephone, call boxes and other office equipment affixed to the Premises shall be subject to the approval of Landlord. 16. Tenant, its employees and agents shall not loiter in the entrances or corridors, nor in any way obstruct the sidewalks, lobby, halls, stairways or elevators, and shall use the same only as a means of ingress and egress for the Premises. 17. Tenant shall not waste electricity, water or air conditioning and agrees to cooperate fully with Landlord to ensure the most effective operation of the Building's heating and air conditioning system, and shall refrain from attempting to adjust any controls. This includes the closing of exterior blinds, disallowing the sun rays to shine directly into areas adjacent to exterior windows. 18. Tenant shall store all its trash and garbage within the interior of the Premises. No material shall be placed in the trash boxes or receptacles if such material is of such nature that it may not be disposed of in the ordinary and customary manner of removing and disposing of trash and garbage without violation of any law or ordinance governing such disposal. All trash, garbage and refuse disposal shall be made only through entry-ways and elevators provided for such purposes at such times as Landlord shall designate. 19. Tenant shall comply with all safety, fire protection and evacuation procedures and regulations established by Landlord or any governmental agency. 20. Tenant shall assume any and all responsibility for protecting the Premises from theft, robbery and pilferage, which includes keeping doors locked and other means of entry to the Premises closed, when the Premises are not occupied. 21. Landlord may waive any one or more of these Rules and Regulations for the benefit of any particular tenant or tenants, but no such waiver by Landlord shall be construed as a waiver of such Rules and Regulations in favor of any other tenant or tenants, nor prevent Landlord from thereafter enforcing any such Rules or Regulations against any or all tenants of the Building. 22. No awnings or other projection shall be attached to the outside walls of the Building without the prior written consent of Landlord. No curtains, blinds, shades or screens shall be attached to or hung in, or used in connection with, any window or door of the Premises without the prior written consent of Landlord. All electrical ceiling fixtures hung in offices or spaces along the perimeter of the Building must be fluorescent and/or of a quality, type, design and bulb color approved by Landlord. 23. The sashes, sash doors, skylights, windows, and doors that reflect or admit light and air into the halls, passageways or other public places in the Building shall not be covered or obstructed by Tenant, nor shall any bottles, parcels or other articles be placed on the windowsills. 24. The washing and/or detailing of or, the installation of windshields, radios, telephones in or general work on, automobiles shall not be allowed on the Real Property. 25. Tenant shall comply with any non-smoking ordinance adopted by any applicable governmental authority. 26. Tenant and Tenant's employees, agents, contractors and other invitees shall not be permitted to bring firearms into the Building or surrounding areas at any time. 27. Landlord reserves the right at any time to change or rescind any one or more of these Rules and Regulations, or to make such other and further reasonable Rules and Regulations as in Landlord's judgment may from time to time be necessary for the management, safety, care and cleanliness of the Premises and Building, and for the preservation of good order therein, as well as for the convenience of other occupants and tenants therein. Landlord shall not be responsible to Tenant or to any other person for the nonobservance of the Rules and Regulations by another tenant or other person. Tenant shall be deemed to have read these Rules and Regulations and to have agreed to abide by them as a condition of its occupancy of the Premises. GUARANTY OF LEASE The undersigned ("Guarantor"), as a material inducement to and in consideration of the execution by CALIFORNIA BANK & TRUST, a California corporation ("Landlord") of that certain Office Lease (the "Lease") dated November 18, 2002 between Landlord and CENTRAL COAST BANCORP., a California corporation, dba COMMUNITY BANK OF CENTRAL CALIFORNIA ("Tenant"), relating to premises in that certain building located at 439 Alvarado Street, Monterey, California, hereby agrees as follows: 1. Guarantor hereby unconditionally guarantees the performance of, and unconditionally promises to perform, all of the obligations of Tenant under the Lease and any and all extensions and modifications thereof, including, but not limited to, the obligation to pay rent thereunder. 2. In such manner, upon such terms and at such times as Landlord shall deem best, and without notice to or the consent of Guarantor, Landlord may alter, compromise, extend or change the time or manner for the performance of any obligation hereby guaranteed, substitute or add any one or more guarantors, accept additional or substituted security for the performance of any such obligation, or release or subordinate any security therefor, any and all of which may be accomplished without any effect on the obligations of Guarantor hereunder. No exercise or non-exercise by Landlord of any right hereby given, no dealing by Landlord with Tenant, any other guarantor or other person, and no change, impairment or suspension of any right or remedy of Landlord shall in any way affect any of the obligations of Guarantor hereunder or any security furnished by Guarantor or give Guarantor any recourse against Landlord. 3. Guarantor hereby waives and agrees not to assert or take advantage of the following: (a) Any right to require Landlord to proceed against Tenant or any other person or to proceed or exhaust any security held by Landlord at any time or to pursue any other remedy in Landlord's power before proceeding against Guarantor, including the provisions of Sections 2845 and 2850 of the Civil Code of California; (b) Any defense that may arise by reason of the incapacity, lack of authority, bankruptcy, death or disability of any other person or persons or the failure of Landlord to file or enforce a claim against the estate (in administration, bankruptcy or any other proceeding) of any other person or persons, including the provisions of Section 2810 of the Civil Code of California; (c) Any right to receive demands, protests and notices of any kind including, but not limited to, notice of the existence, creation or incurring of any new or additional obligation or of any action or non-action on the part of Tenant, Landlord or any other person; (d) Any defense based on an election of remedies including, but not limited to, any action by Landlord which shall destroy or otherwise impair any subrogation right of Guarantor or the right of Guarantor to proceed against Tenant for reimbursement, or both; (e) Any duty on the part of Landlord to disclose to Guarantor any facts Landlord may now or hereafter know about Tenant, regardless of whether Landlord has reason to believe that such facts materially increase the risk beyond that which Guarantor intends to assume or has reason to believe that such facts are unknown to Guarantor or has a reasonable opportunity to communicate such facts to Guarantor, it being understood and agreed that Guarantor is fully responsible for being and keeping informed of the financial condition of Tenant and of all circumstances bearing on the risk of nonperformance of any obligation hereby guaranteed; (f) Any right to receive notice of or to consent to any amendments that may hereafter be made to the Lease, including the provisions of Section 2819 of the Civil Code of California; and (g) Any defense based on the fact that Guarantor's obligations hereunder are larger or more burdensome than that of Tenant's under the Lease, including the provisions of Section 2809 of the Civil Code of California. 4. Until all obligations hereby guaranteed shall have been fully performed, Guarantor shall have no right of subrogation and waives any right to enforce any remedy which Landlord now has or may hereafter have against Tenant and any benefit of, and any right to participate in, any security now or hereafter held by Landlord, including the provisions of Sections 2847, 2848 and 2849 of the Civil Code of California. Guarantor agrees that nothing contained herein shall prevent Landlord from suing on the Lease or from exercising any rights available to Landlord thereunder and that the exercise of any of the aforesaid rights shall not constitute a legal or equitable discharge of Guarantor. Guarantor expressly waives any and all benefits under the second sentence of California Civil Code Section 2822(a). In addition, Guarantor agrees that Landlord (and not Tenant) shall have the right to designate the portion of Tenant's obligations under the Lease that is satisfied by a partial payment by Tenant. 5. All existing and future obligations of Tenant to Guarantor, or any person owned in whole or in part by Guarantor, and the right of Guarantor to cause or permit itself or such person to withdraw any capital invested in Tenant are hereby subordinated to all obligations hereby guaranteed, and, without the prior written consent of Landlord, such obligations to Guarantor shall not be performed, and such capital shall not be withdrawn, in whole or in part, while Tenant is in default under the Lease. 6. All rights, powers and remedies of Landlord hereunder and under any other agreement now or at any time hereafter in force between Landlord and Guarantor shall be cumulative and not alternative, and such rights, powers and remedies shall be in addition to all rights, powers and remedies given to Landlord at law or in equity. This Guaranty of Lease is in addition to and exclusive of the guarantee of any other guarantor of any obligation of Tenant to Landlord. 7. The obligations of Guarantor hereunder are independent of the obligations of Tenant under the Lease, and, in the event of any default hereunder or under the Lease, a separate action or actions may be brought and prosecuted against Guarantor, whether or not Tenant is joined therein or a separate action or actions are brought against Tenant. Landlord may maintain successive actions for other defaults. Landlord's rights hereunder shall not be exhausted by its exercise of any of its rights or remedies or by any such action or by any number of successive actions until and unless all obligations hereby guaranteed shall have been fully performed. 8. Guarantor shall pay to Landlord, without demand, reasonable attorneys' fees and all costs and other expenses which Landlord shall expend or incur in collecting or compromising any obligation hereby guaranteed or in enforcing this Guaranty of Lease against Guarantor, whether or not suit is filed including, but not limited to, attorneys' fees, costs and other expenses incurred by Landlord in connection with any insolvency, bankruptcy, reorganization, arrangement or other similar proceeding involving Guarantor which in any way affects the exercise by Landlord of its rights and remedies hereunder. 9. Should any one or more provisions of this Guaranty of Lease be determined to be illegal or unenforceable, all other provisions shall nevertheless be effective. 10. This Guaranty of Lease shall inure to the benefit of Landlord and its successors and assigns, and shall bind the heirs, executors, administrators, successors and assigns of Guarantor. This Guaranty of Lease may be assigned by Landlord concurrently with the transfer of title to property covered by the Lease, and, when so assigned, Guarantor shall be liable to the assignees without in any manner affecting the liability of Guarantor hereunder. 11. Upon full performance of all obligations hereby guaranteed, this Guaranty of Lease shall be of no further force or effect. 12. No provision of this Guaranty of Lease or right of Landlord hereunder can be waived or modified, nor can Guarantor be released from Guarantor's obligations hereunder, except by a writing duly executed by Landlord. 13. When the context and construction so require, all words used in the singular herein shall be deemed to have been used in the plural and the masculine shall include the feminine and neuter and vice versa. The word "person" as used herein shall include any individual, company, firm, association, partnership, corporation, trust or other legal entity of any kind whatsoever. 15. This Guaranty of Lease shall be governed by and construed in accordance with the laws of the State of California. In any action brought under or arising out of this Guaranty of Lease, Guarantor hereby consents to the jurisdiction of any competent court within the State of California and hereby consents to service of process by any means authorized by California law. This Guaranty of Lease shall constitute the entire agreement of Guarantor with respect to the subject matter hereof, and no representation, understanding, promise or condition concerning the subject matter hereof shall be binding upon Landlord unless expressed herein. November _25__, 2002 COMMUNITY BANK OF CENTRAL CALIFORNIA, a California corporation By: /s/ HARRY O. WARDWELL Its: S.V.P. Branch Administrator By: /s/ CAROL FRANCHI Its: S.V.P. Operations Administrator EX-23 4 exhibit23x1.txt EXHIBIT 23.1 AUDITORS' CONSENT 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 22, 2003 (February 28, 2003 as to the effects of the stock dividend information in Note 1), appearing in this Annual Report on Form 10-K of Central Coast Bancorp for the year ended December 31, 2002. /s/ DELOITTE & TOUCHE DELOITTE & TOUCHE LLP San Francisco, California March 21, 2003 EX-99 5 exhibit99x1.txt EXHIBIT 99.1 SARBANES-OXLEY SECTION 906 CERT EXHIBIT 99.1 Certification of Central Coast Bancorp pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 regarding Annual Report on Form 10-K for the year ended December 31, 2002 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of the undersigned officers of Central Coast Bancorp, a California corporation (the "Company"), does hereby certify that: 3. The Company's Annual Report on Form 10-K for the year ended December 31, 2002 (the "Form 10-K") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 4. Information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 20, 2003 /s/ NICK VENTIMIGLIA ----------------------- Nick Ventimiglia Chief Executive Officer Dated: March 20, 2003 /s/ ROBERT M. STANBERRY ----------------------- Robert M. Stanberry Senior Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----