-----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, OXk+kVjCsv1EMZfuZmhTYcvi0xCNs+eSv5Aa90mLqsiZk1ZfjHcMIzMcyDPN1QhA eICaKeHEP2vqx5UjucbO5w== 0001015402-99-000301.txt : 19990402 0001015402-99-000301.hdr.sgml : 19990402 ACCESSION NUMBER: 0001015402-99-000301 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMMUNITY WEST BANCSHARES / CENTRAL INDEX KEY: 0001051343 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 770446957 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-23575 FILM NUMBER: 99580642 BUSINESS ADDRESS: STREET 1: 5638 HOLLISTER AVENUE CITY: GOLETA STATE: CA ZIP: 93117 BUSINESS PHONE: 8056921862 MAIL ADDRESS: STREET 1: 5827 HOLLISTER AVENUE CITY: GOLETA STATE: CA ZIP: 93117 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 AND 12CFR16.3 For the fiscal year ended December 31, 1998 Commission File Number: 000-23575 COMMUNITY WEST BANCSHARES (Exact name of registrant as specified in its charter) California 77-0446957 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5638 Hollister Avenue, Goleta, California 93117 (Address of Principal Executive Offices) (Zip Code) (Registrant's telephone number, including area code) (805)692-1862 Securities registered under Section 12(b) of the Exchange Act: Title of each class Name of each exchange on which registered: Common Stock, no par value National Market tier of The NASDAQ Stock Market Securities registered under Section 12(g) of the Exchange Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act and 12CFR16.3 during the past 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-B is not contained, 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] There were 5,482,571 shares of common stock for the registrant issued and outstanding as of March 3, 1999. The aggregate market value of the voting stock, based on the closing price of the stock on the NASDAQ National Market System on March 3, 1999, held by the nonaffiliates of the registrant was approximately $40,000,000. This Form 10-K contains 70 pages
COMMUNITY WEST BANCSHARES FORM 10-K INDEX PART I PAGES ITEM 1. Description of Business 3 ITEM 2. Description of Property 5 ITEM 3. Legal Proceedings 6 ITEM 4. Submission of Matters to a Vote of Security Holders 6 PART II ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters 7 ITEM 6. Selected Financial Data 8 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk 38 ITEM 8. Consolidated Financial Statements 41 PART III ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 68 ITEM 10. Directors, Executive Officers, Promoters and Control Persons 68 ITEM 11. Executive Compensation 68 ITEM 12. Security Ownership of Certain Beneficial Owners and Management 68 ITEM 13. Certain Relationships and Related Transactions 68 PART IV ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 10-K 68 SIGNATURES 70
2 PART I ITEM 1. DESCRIPTION OF BUSINESS - ----------------------------------- General - ------- Community West Bancshares was incorporated in the State of California on November 26, 1996, for the purpose of forming a financial services holding company. On December 31, 1997, Community West Bancshares ("the Company") acquired a 100% interest in Goleta National Bank ("Goleta"). Effective that date, shareholders of Goleta (NASDAQ:GLTB) became shareholders of the Company (NASDAQ:CWBC) in a one-for-one exchange. On December 14, 1998, the Company acquired a 100% interest in Palomar Savings & Loan Association ("Palomar"). As of that date, shareholders of Palomar (OTCBB:PALO) became shareholders of the Company by receiving 2.11 shares of CWBC for each share of PALO they held. Both acquisitions were accounted for under the pooling-of-interests method. The Company offers a full range of commercial and retail financial services, including the acceptance of demand, savings, and time deposits, and the origination of commercial, U.S. Small Business Administration ("SBA"), accounts receivable, real estate, construction, home improvement, and other installment and term loans. It also offers cash management, remittance processing, electronic banking, merchant credit card processing, online banking, and other financial services to its customers. The financial services industry as a whole offers a broad range of products. Few companies today can effectively offer every product and service available. Accordingly, the Company continually investigates products and services with which it can attain a competitive advantage over others in the financial services industry. In this way, management positions the Company to offer those products and services requested by its customers. The Company has been an approved lender/servicer of loans guaranteed by the SBA since late 1990. The Company originates SBA loans, sells the guaranteed portion into the secondary market, and services the loans. During 1995, the Company was designated as a Preferred Lender by the SBA. As a Preferred Lender, the Company has the ability to move loans through the approval process at the SBA much more quickly than financial institutions which do not have such a designation. As of December 31, 1998, the Company was the only SBA Preferred Lender headquartered in Santa Barbara County. The Company was granted SBA Preferred Lender status in the districts of Los Angeles, Fresno, Sacramento, San Francisco, and Santa Ana, California, Birmingham, Alabama, Atlanta, Georgia and Miami and Jacksonville, Florida. During 1994, the Company established a Mortgage Loan Processing Center. Through the Mortgage Loan Processing Center, the Company takes applications for residential real estate loans and processes those loans for a fee for lenders located throughout the nation. At any point in time, the Company processes loans for 50-70 such lenders. Because it has so many lenders for which it processes, the Company can offer many more loan programs than normally offered by any single institution. By virtue of the large number of loan programs being offered, the Company has developed the ability to remain ahead of its competition. Also in 1994, the Company began offering home improvement loans under Title I of FHA regulations. This is the oldest government insured loan program in existence, having begun in 1934. The Company originates Title I loans and sells them into the secondary market and retains the servicing. In early 1995, the Company was approved as one of a small number of financial institutions to be able to sell Title I loans directly to the Federal National Mortgage Association ("FNMA"). This approval has given the Company a competitive advantage over nonapproved lenders because it can price loans at lower rates to customers and reduce or eliminate fees normally charged to customers, while at the same time increasing the profitability to the Company. During 1996, the Company began offering second mortgage loans ("HLTV") which allow borrowers to receive up to 125% of their home value for debt consolidation, home improvement, school tuition, or any worthwhile cash outlay. There is an upper limit on these loans of $100,000. The Company relies principally on the creditworthiness of the borrower, and to a lesser extent on the underlying collateral, for repayment of these HLTV loans. The loan terms under the program range from one to 25 years. In 1997 and 1998, the Company sold these loans at a premium to third-parties. In March of 1998, the Company began accumulating the majority of these loans for the purposes of securitization. On December 22, 1998, the Company completed the securitization of an $81 million pool of loans. As of December 31, 1998, the Company had accumulated $24 million in loans to be securitized in 1999. 3 In 1996, the Company began accounts receivable financing, providing working capital to small and mid-sized manufacturers, distributors and merchants throughout Southern California. This division complements the Company's SBA and commercial lending products, in addition to generating a high annual yield. Because of the development costs involved, most small community banks have difficulty providing electronic banking services to their customers. From its inception, the Company has invested heavily in the hardware and software necessary to offer today's electronic banking services. In addition to the normal financial services, the Company offers such services as online cash management, automated clearinghouse origination, electronic data interchange, remittance processing, draft preparation and processing, and merchant credit card processing. Not only do these services generate significant fee income, they attract companies with large deposit balances. These services have helped the Company remain at a competitive advantage over most institutions of comprable size and many which are significantly larger than the Company. On October 16, 1997, the Company purchased a 70% interest in Electronic Paycheck, LLC, a California Company that has developed systems to allow companies to pay their employees by issuing them a card or "electronic paycheck". The systems were originally developed to pay factory workers in Kazakhstan. The card is currently being used by companies in the agricultural sector to pay their workers, many of whom do not have bank accounts. The Company provides access to ATM and Point-of-Sale (POS) networks so that the cardholders have access to their cash at thousands of locations virtually worldwide. In September of 1998, the Company opened its second full service Branch in Ventura, California. The Company simultaneously consolidated into that location its Ventura SBA and mortgage loan production office and the accounts receivable financing department. On December 14, 1998, the Company acquired 100% of Palomar. Palomar is a state-chartered full service savings and loan association and is subject to supervision by the OTS, the FDIC, and the Commissioner of the California Department of Financial Institutions. The deposits of the Association are insured up to the applicable limits by the Savings Association Insurance Fund ("SAIF"). The Association is a member of the Federal Home Loan Bank ("FHLB") system. Their main office is located at 355 West Grand Avenue, Escondido, California 92025. A second branch is located at 1815 East Valley Parkway, Suite 1, Escondido, California 92027. It is the Company's intent to maintain Palomar as a separate subsidiary of the Company. Competition and Service Area - ------------------------------- The financial service industry in California is highly competitive with respect to both loans and deposits; and is dominated overall by a relatively small number of major banks with many offices operating over wide geographic areas. Some of the major commercial banks operating in the communities nearby the Company's service areas offer certain services such as trust and investment services and international banking which are not offered directly by the Company or any of its subsidiaries, and by virtue of their greater total capitalization, such institutions have substantially higher lending limits than the Company. To help offset the numerous branch offices of banks, thrifts, and credit unions, as well as competition from mortgage brokers, insurance companies, credit card companies, and brokerage houses within the Company's service areas, the Company, through its subsidiaries, has established loan production offices in Fresno, Costa Mesa, San Rafael, Solvang, Santa Barbara, Anaheim, Escondido and West Covina in California, and in Las Vegas and Reno, Nevada, Woodstock, Georgia, and Jacksonville, Pensacola, and Panama City Beach, Florida. The Company's online capabilities allow it to support these offices from its main computer center in Goleta, California. Part of the Company's strategy is to establish loan production offices in areas where there is high demand for the loan products which it originates. In order to compete for loans and deposits within its primary service area, the Company uses to the fullest extent possible the flexibility which its independent status permits. This includes an emphasis on meeting the specialized banking needs of its customers, including personal contact by the Company's directors, officers, and employees, newspaper publications, direct mailings and other local advertising, and by providing experienced management and staff trained to deal with the specific banking needs of the Company's customers. Management has established a highly personalized banking relationship with the Company's customers and is attuned and responsive to their financial and service requirements. In the event there are customers whose loan demands exceed the Company's lending limits, the Company seeks to arrange for such loans on a participation basis with other financial institutions and intermediaries. The Company also assists those few customers requiring highly specialized services not offered by the Company to obtain such services from correspondent institutions. 4 Employees - --------- As of December 31, 1998, the Company employed 257 persons, including 2 principal officers. The Company's employees are not represented by a union or covered by a collective bargaining agreement. Management of the Company believes that, in general, its employee relations are very positive. ITEM 2. DESCRIPTION OF PROPERTY - ----------------------------------- The Company owns the following property: - --------------------------------------------- The Goleta National Bank Main office, located at 5827 Hollister Avenue, Goleta, California. This 4,000 square foot facility houses the bank's main office, and a separate 400 square foot building provides additional office space. The Company leases the following properties: - ------------------------------------------------- The Company leases, under three separate leases, four suites in an office building at 5638 Hollister Avenue, Goleta, California, from an independent third party. The leases are for terms expiring from May 31, 2000 to May 31, 2003, with a current monthly rent of $9,701 per month for all four suites. The leases also provide the Company with two additional consecutive options of three years each to extend the leases. The suites consist of approximately 7,590 square feet of office space. These suites house the company's Corporate Office, Finance, Data Processing, Compliance, Human Resources, and Electronic Business Services departments of the Company, as well as the offices of the Company's subsidiary, Electronic Paycheck, LLC. The Company leases approximately 1,500 square feet of office space located at 310 South Pine Avenue, Goleta, California, from an independent third party. The lease is month to month, with a current monthly rent of $960 per month. This facility houses the Special Assets and Loan Collection departments of the Company. The Company leases under two separate leases approximately 2,718 square feet of office space located at 3891 State Street, Santa Barbara, California, from an independent third party. The leases are for terms expiring November 1, 1999 and March 31, 2001, with a current monthly rent of $7,195 per month for both leases. The leases also provide the Company with two additional consecutive options of three years each to extend the lease. This facility houses the Retail and Wholesale Mortgage Lending departments of the Company. The Company leases approximately 3,431 square feet of office space located at 1463 South Victoria Avenue, Ventura, California, from an independent third party. The lease is for a term expiring July 20, 2002, with a current monthly rent of $5,555 per month. The lease also provides the Company with one option of three years to extend the lease. This facility houses the new Ventura Branch office, as well as Mortgage, SBA Lending and the Accounts Receivable Financing department of the Company. The Company leases approximately 4,921 square feet of space located at 4025 East La Palma Avenue Suite 201A, Anaheim, California, from an independent third party. The lease is for a term expiring February 28, 2000, with a current monthly rent of $5,905 per month. This facility houses the Anaheim Loan Production office of the Company. In addition, the Company also leases approximately 1,000 square feet of office space located at 100 North Citrus Street Suite 238 in West Covina, California, from an independent third party with a current monthly rent of $2,099. The lease is for a term expiring January 31, 2000. The Company leases approximately 1,032 square feet of storefront space located at 4170 South Decatur, Unit D-4, Las Vegas, Nevada, from an independent third party. The lease is for a term expiring February 28, 2000, with a current monthly rent of $1,858 per month. This facility houses the Las Vegas, Nevada Loan Production office of the Company. 5 The Company leases approximately 6,380 square feet of space located at 5383 Hollister Avenue, 2nd Floor, Goleta, California, from an independent third party. The lease is for a term expiring November 30, 2002, with a current monthly rent of $8,613 per month. The lease also provides the Company with two options of three years to extend the lease. This facility houses the Alternative Mortgage lending, and SBA lending departments of the Company. The Company also leases small executive suites on a month-to-month basis in Bakersfield, Fresno, Modesto, San Rafael and Costa Mesa, California. The Company also has executive suites in Woodstock, Georgia, and Jacksonville, Pensacola, and Panama City Beach, Florida and Reno, Nevada. These offices allow the Company to have a local presence for the production of loans while controlling the underwriting and funding of the loans at the main office in Goleta. The Company also leases on a month-to-month basis two storage units and a portion of a parking lot, all, are located in Goleta. The Company also leases approximately 7,000 square feet of office space at 355 West Grand Avenue, Escondido, California, which houses the main branch office of Palomar. The lease is for a term expiring November 20, 2007, with a ten year option to renew and a current monthly rent of $12,971. A second Escondido branch office which is located at 1815 East Valley Parkway, Suite 1 has a current monthly rent of $1,200 and a lease expiration of August 16, 2002, with no renewal option. The third Escondido office, which is located at 283 South Escondido Boulevard Suite E, has approximately 2,482 square feet of office space, a current monthly rent of $2,200 and a lease that expires on August 9, 2000, with three additional one year periods as renewal options and is used for mortgage operations. These leases are all with independent third parties. The Company's total occupancy expense for the year ended December 31, 1998, was $2,739,000. Management believes that its existing facilities are adequate for its present purposes. ITEM 3. LEGAL PROCEEDINGS - ---------------------------- From time to time the Company is party to claims and legal proceedings arising in the ordinary course of business. After taking into consideration information furnished by counsel to the Company, management believes that the ultimate aggregate liability represented thereby, if any, will not have a material adverse effect on the Company's financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - --------------------------------------------------------------------- A special meeting of security holders of the Company was held October 29, 1998. The security holders voted on and approved a plan for the acquisition of Palomar. Under this plan, Palomar becomes a wholly owned subsidiary of Community West Bancshares. There was a total of 3,077,991, or 75.1%, proxies voted out of 4,098,062 possible votes. The following indicates how the votes were cast:
FOR AGAINST ABSTAIN NON-VOTES Number of Votes Received 3,057,197 13,740 7,054 1,020,071 Percentage of Total Shares 74.6% 0.3% 0.2% 24.9%
The security holders also voted and passed a change in the bylaws to increase the number of Board members from ten to eleven. This proposal received 3,140,626, or 76.6%, votes out of 4,098,062 possible votes. The following indicates how the votes were cast:
FOR AGAINST ABSTAIN NON-VOTES Number of Votes Received 3,021,988 61,064 57,574 957,436 Percentage of Total Shares 73.7% 1.5% 1.4% 23.4%
6 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER ---------------------------------------------------------------------- MATTERS ------- As of the close of business December 31, 1997, the common stock for Goleta National Bank, symbol "GLTB", was converted to Community West Bancshares common stock, symbol "CWBC". On January 5, 1998, NASDAQ National Market ("NASDAQ") listed the new common stock symbol "CWBC" for trading and the old symbol "GLTB" was removed. On December 18, 1998, the Company acquired Palomar (OTCBB:PALO), both the table and the paragraph below relate to CWBC and its predecessor GLTB. Prior to listing on NASDAQ, the stock was traded OTC under the symbol "GLTB". OTC quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. The common stock was listed on NASDAQ on November 19, 1996, under the symbol "GLTB". During the secondary stock offering which took place in the third quarter of 1996, warrants were issued. Each warrant entitled the holder to purchase two shares of common stock at an exercise price of $4.375 per share. The warrants expired on June 30, 1998, and were traded OTC under the new symbol "CWBCW". The following table sets forth the high and low sales prices on a per share basis for the common stock and a per warrant basis for the warrants, as reported by the respective exchanges for the period indicated:
Common Stock(1) Warrants Low High Low High ------ ------- ----- ------ 1997 First Quarter 5 1/4 8 1/4 3 1/2 7 1/2 Second Quarter 6 5/8 7 5/8 7 1/2 7 1/2 Third Quarter 6 3/8 9 3/4 5 3/4 7 Fourth Quarter 8 3/8 9 1/2 6 1/2 10 1/2 1998 First Quarter 9 1/4 13 1/4 9 5/8 16 1/2 Second Quarter 11 7/8 14 5/16 9 15 Third Quarter 9 1/4 14 N/A N/A Fourth Quarter 8 1/8 11 N/A N/A (1) As adjusted by NASDAQ for the 1996 and 1998 2-for-1 stock splits.
On March 26, 1999, the last reported sale price per share for the Company's stock was $8 1/2. The Company has declared and paid cash dividends per share of $.03, $.03, and $.04 in 1994, 1995, and 1996, respectively. The Company declared and issued a 10% stock dividend in 1995, and effected a 2-for-1 stock split in 1996 and again in 1998. The Company has declared two quarterly dividends of $.04 per share one which was paid on January 20, 1999 for shareholders of record as of January 5, 1999 and a second to be paid on April 26, 1999, for shareholders of record as of April 12, 1999. The Company had 717 shareholders of record of its common stock as of December 31, 1998. 7 ITEM 6. SELECTED FINANCIAL DATA - ----------------------------------- SUMMARY OF EARNINGS The following Summary of Earnings of the Company for the years ended December 31, 1998, 1997, 1996, 1995, and 1994 have been derived from the audited financial statements included elsewhere in this document.
Year Ended December 31,(1) ----------------------------------------------------------- (Dollars in thousands, except per share data) 1998 1997 1996 1995 1994 ---------- ---------- ---------- ----------- ---------- Interest income $ 20,547 $ 13,553 $ 12,460 $ 11,970 $ 9,921 Interest expense 9,257 6,361 5,990 6,255 4,290 ---------- ---------- ---------- ----------- ---------- Net interest income 11,290 7,192 6,470 5,715 5,631 Provision for loan losses 429 191 651 1,122 705 ---------- ---------- ---------- ----------- ---------- Net interest income after provision for loan losses 10,861 7,001 5,819 4,593 4,926 Other income 14,036 9,911 6,977 4,661 2,586 Other expenses 20,075 13,446 10,904 8,371 6,062 ---------- ---------- ---------- ----------- ---------- Income before provision for income taxes 4,822 3,466 1,892 883 1,450 Provision for income taxes 1,941 1,316 688 (209) 631 ---------- ---------- ---------- ----------- ---------- Net income $ 2,881 $ 2,150 $ 1,204 $ 1,092 $ 819 ========== ========== ========== =========== ========== Net income per share - Basic $ 0.57 $ 0.49 $ 0.32 $ .32 $ .24 Number of shares used in net income per share calculation (2) - Basic 5,069,596 4,383,878 3,723,832 3,446,030 3,415,994 Net income per share - Diluted $ 0.55 $ 0.43 $ 0.31 $ .31 $ .24 Number of shares used in net income per share calculation (2) - Diluted 5,243,738 4,956,148 3,878,022 3,495,882 3,434,928
Year Ended December 31, ----------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ----------- ---------- Net Loans $ 165,935 $ 128,385 $ 113,807 $ 109,221 $ 105,180 Total Assets 252,034 173,920 160,937 151,586 142,570 Deposits 223,545 152,691 143,106 137,594 127,913 Total Liabilities 227,481 156,265 145,951 140,645 132,774 Total Equity 24,553 17,655 14,986 10,941 9,796 (1) See Notes to Financial Statements for a summary of significant accounting policies and other related data. (2) Earnings per common share information is based on the weighted average number of common shares outstanding during each period. Earnings per share amounts have been adjusted to reflect the 2-for-1 stock splits in 1996 and 1998 and the acquisition of Palomar.
The following table sets forth selected ratios for the periods indicated:
Year Ended December 31, -------------------------------------- 1998 1997 1996 1995 1994 ------ ------ ------ ------ ------ Net earnings to average stockholder equity 13.65% 13.17% 9.29% 10.53% 8.36% Net earnings to average total assets 1.35% 1.28% .77% .74% .57% Total interest expense to total interest income 45.05% 46.93% 48.07% 52.26% 43.24% Other operating income to other operating expense 69.92% 73.71% 63.99% 55.68% 42.66% Dividend payout ratio - - 6.25% 4.69% 10.42% Equity to assets ratio 8.18% 9.76% 8.19% 7.05% 6.87%
8 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATIONS -------------- Introduction - ------------ This discussion is designed to provide a better understanding of significant trends related to the Company's financial condition, results of operations, liquidity, capital resources, and interest rate sensitivity. It should be read in conjunction with the audited financial statements and notes thereto and the other financial information appearing elsewhere in this filing. Results of Operations - ----------------------- The following table sets forth for the periods indicated, the increase or decrease of certain items in the statements of income of the Company as compared to the prior periods:
For the Year Ended December 31, ---------------------------------------------------------------------------- 1998 versus 1997 1997 versus 1996 1996 versus 1995 ------------------------ ------------------------ ------------------------ Amount of Percent of Amount of Percent of Amount of Percent of increase increase increase increase increase increase (decrease) (decrease) (decrease) (decrease) (decrease) (decrease) ----------- ----------- ----------- ----------- ----------- ----------- INTEREST INCOME: Loans, including fees $7,116,792 60.50% $1,132,035 10.65% $ 594,911 5.93% Federal funds sold 56,807 9.22% 187,402 43.70% 24,723 6.12% Time deposits in other financial institutions (106,353) -46.31% 32,844 16.69% (75,179) -27.64% Investment securities (73,155) -7.75% (259,702) -21.57% (54,084) -4.30% Total interest income 6,994,091 51.61% 1,092,579 8.77% 490,371 4.10% INTEREST EXPENSE ON DEPOSITS 2,895,815 45.53% 370,633 6.19% (264,759) -4.23% NET INTEREST INCOME 4,098,276 56.99% 721,946 11.16% 755,130 13.21% PROVISION FOR LOAN LOSSES 238,421 125.12% (459,940) -70.71% (471,144) -42.01% NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,859,855 55.13% 1,181,886 20.31% 1,226,274 26.70% OTHER INCOME: Gains from loan sales 2,003,850 45.65% 1,744,565 65.95% 123,016 4.88% Loan origination fees - sold or brokered loans 684,710 22.78% 909,950 43.42% 1,335,999 175.91% Document processing fees 828,353 101.10% 309,705 60.77% 425,864 508.28% Loan servicing fees 249,310 34.96% (54,793) -7.13% 82,032 11.96% Service charges (74,609) -7.76% 315,544 48.83% 233,171 56.45% Other income 433,317 2,035.02% (290,651) -93.17% 115,742 58.99% Total other income 4,124,931 41.62% 2,934,320 42.06% 2,315,824 49.69%
(continued on next page) 9
For the Year Ended December 31, ---------------------------------------------------------------------------- 1998 versus 1997 1997 versus 1996 1996 versus 1995 ------------------------ ------------------------ ------------------------ Amount of Percent of Amount of Percent of Amount of Percent of increase increase increase increase increase increase (decrease) (decrease) (decrease) (decrease) (decrease) (decrease) ----------- ----------- ----------- ----------- ----------- ----------- OTHER EXPENSES: Salaries and employee benefits 4,747,669 58.46% 1,932,743 31.23% 1,537,462 33.06% Occupancy expenses 1,003,060 57.79% 337,764 24.16% 198,571 16.56% Other operating expenses 507,908 44.19% (496,152) -30.15% 383,568 30.40% Advertising expense 203,548 31.86% 291,175 83.76% 9,245 2.73% Professional services 334,086 65.91% 155,918 44.43% (74,979) -17.60% Postage & freight (379,767) -44.69% 279,220 48.94% 378,703 197.42% Data processing/ATM processing 147,395 60.73% 23,484 10.71% 71,860 48.77% Office supply expense 64,768 32.01% 18,102 9.83% 28,719 18.47% Total other expenses 6,628,667 49.30% 2,542,254 23.32% 2,533,149 30.26% INCOME BEFORE PROVISION FOR INCOME TAXES 1,356,119 39.13% 1,573,952 83.19% 1,008,949 114.25% PROVISION FOR INCOME TAXES 625,004 47.48% 627,873 91.20% 896,978 -430.21% NET INCOME $ 731,115 34.01% $ 946,079 78.61% $ 111,971 10.26% =========== =========== =========== =========== =========== ===========
Net Interest Income and Net Interest Margin - ------------------------------------------------- The Company's earnings partially depend upon the difference between the income received from its loan portfolio and investment securities and the interest paid on its liabilities, including interest paid on deposits. This difference is "net interest income." The net interest income, when expressed as a percentage of average total interest-earning assets, is referred to as the net interest margin on interest-earning assets. The Company's net interest income is affected by the change in the level and the mix of interest-earning assets and interest-bearing liabilities, referred to as volume changes. The Company's net yield on interest-earning assets is also affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes. Interest rates charged on the Company's loans are affected principally by the demand for such loans, the supply of money available for lending purposes and competitive factors. These factors are in turn affected by general economic conditions and other factors beyond the Company's control, such as federal economic policies, the general supply of money in the economy, legislative tax policies, governmental budgetary matters and the actions of the FRB.
1998 1997 1996 ------------ ------------ ------------ Interest Income $20,546,598 $13,552,507 $12,459,928 Interest Expense 9,256,700 6,360,885 5,990,252 Net Interest Income $11,289,898 $ 7,191,622 $ 6,469,676 ============ ============ ============ Net Interest Margin 5.5% 4.7% 4.6%
Total interest income increased from $13,552,507 in 1997 to $20,546,598 in 1998, representing a 51.6% increase in 1998 over 1997. This increase in 1998 over 1997 was reflected by a 35.0% increase because of an increase in interest-earnings assets added with a 16.6% increase because of higher rates earned on those assets. Total interest expense increased from $6,360,885 in 1997 to $9,256,700 in 1998, representing a 45.5% increase in 1998 compared to 1997. This increase was reflected by a 41.4% increase in interest-bearing liabilities and a 4.1% increase in rates paid on deposits. The result of these changes was net interest income increased from $7,191,622 in 1997 to $11,289,898 in 1998. 10 Total interest income increased from $12,459,928 in 1996 to $13,552,507 in 1997, representing an 8.8% increase in 1997 over 1996. This increase in 1997 over 1996 was reflected by a 11.4% increase because of an increase in interest-earnings assets offset with a decrease of 2.6% because of lower rates. Total interest expense increased from $5,990,252 in 1996 to $6,360,885 in 1997, representing a 6.2% increase in 1997 compared to 1996. This increase was reflected by a 4.1% increase in interest-bearing liabilities and a 2.1% increase in rates paid on deposits. The result of these changes was net interest income increased from $6,469,676 in 1996 to $7,191,622 in 1997. The following table sets forth the changes in interest income and expense attributable to changes in rates and volumes:
Analysis of Changes in Net Interest Income - ------------------------------------------ Year Ended December 31, ---------------------------------------------------------------------------------------- (Dollars in Thousands) 1998 Versus 1997 1997 Versus 1996 1996 Versus 1995 ---------------------------- ---------------------------- ---------------------------- Change Change Change Change Change Change Total Due to Due to Total Due to Due to Total Due to Due to Change Rate Volume Change Rate Volume Change Rate Volume -------- -------- -------- -------- -------- -------- -------- -------- -------- Time deposits in other financial institutions $ (106) 15 (121) $ 32 10 22 $ (75) (97) 22 Federal funds sold 57 (17) 74 188 25 163 25 (37) 62 Investment securites (73) 114 (187) (259) (325) 66 (54) (143) 89 Loans, net 7,116 1,381 5,735 1,132 60 1,072 595 354 241 -------- -------- -------- -------- -------- -------- -------- -------- -------- Total interest-earning assets 6,994 1,493 5,501 1,093 (230) 1,323 491 77 414 -------- -------- -------- -------- -------- -------- -------- -------- -------- Interest-bearing demand 71 277 (206) 16 (24) 40 (19) (19) 0 Savings 122 (130) 252 (68) (26) (42) (115) (136) 21 Time certificates of deposit 2,636 58 2,578 511 119 392 (83) (141) 58 Federal funds purchased 85 - 85 - - - - - - Other borrowings (18) (11) (7) (88) 22 (110) (47) (11) (36) -------- -------- -------- -------- -------- -------- -------- -------- -------- Total interest-bearing liabilities 2,896 194 2,702 371 91 280 (264) (307) 43 -------- -------- -------- -------- -------- -------- -------- -------- -------- Net interest income $ 4,098 $ 1,299 $ 2,799 $ 722 $ (321) $ 1,043 $ 755 $ 384 $ 371 ======== ======== ======== ======== ======== ======== ======== ======== ========
The change in interest income or interest expense that is attributable to both changes in rate and changes in volume has been allocated to the change due to rate and the change due to volume in proportion to the relationship of the absolute amounts of changes in each. Provision for Loan Losses - ---------------------------- The provision for loan losses corresponds directly to the level of the allowance that management deems sufficient to offset potential loan losses. The balance in the loan loss allowance reflects the amount which, in management's judgment, is adequate to provide for these potential loan losses, after weighing the mix of the loan portfolio, current economic conditions, past loan experience and such other factors as deserve recognition in estimating loan losses. Each month management reviews the allowance for possible loan losses and makes additional transfers to the allowance, as needed. Management allocated $428,969 as a provision for loan losses in 1998, $190,548 in 1997 and $650,488 in 1996. Loans charged off, net of recoveries, in 1998 were $367,111, in 1997 were $503,017 and in 1996 were $625,106. The ratio of the allowance for loan losses to total gross loans was 1.3% at December 3l, 1998, 1.6% at December 31, 1997, and 2.0% at December 31, 1996. In management's opinion, the balance of the allowance for loan losses at December 31, 1998, was sufficient to absorb foreseeable losses in the loan portfolio at that time. Other Income - ------------- Other income increased from $6,976,637 in 1996, to $9,910,957 in 1997, and to $14,035,888 in 1998, representing a $2,934,320 or 42.1% increase in 1997 over 1996 and $4,124,931 or a 41.6% increase in 1998 over 1997. The Company continued to emphasize generating noninterest income. These year to year gains are a reflection of the increases in SBA loan originations, sales, and servicing, as well as increased growth in mortgage loan processing over the years. In addition, fees from electronic banking services have increased dramatically over the last three years. The Company's percentage coverage of other expenses with other income was 64.0% in 1996, to 73.7% in 1997 and 69.9% in 1998. 11 Other Expenses - --------------- Other expenses include salaries and employee benefits, occupancy and equipment, and other operating expenses. The continued growth of the Company required additional staff and overhead expense to support the continued high level of customer service and the increased cost of occupying the Company's offices. Although compensation expenses have grown significantly, approximately 40% of the Company personnel derive some or all of their compensation based on income production. This means that a significant portion of compensation is tied to increases in revenues instead of being a fixed expense. Other expenses increased from $10,903,774 in 1996 to $13,446,028 in 1997 and to $20,074,695 in 1998, representing a 23.3% in 1997 over 1996 and a 49.3% increase in 1998 over 1997. The increases in other expenses for the periods compared were primarily because of compensation related to loan originations and sales, the increase in the number of loan production and processing offices, the upgrading of data processing hardware and software, and costs related to the Palomar acquisition in 1998. The following table compares the various elements of other expenses as a percentage of average assets for the three years ended December 31, (in thousands except percentage amounts.)
Salaries and Other Average Total Other Employee Occupancy Operating Assets (1) Expense Benefits Expenses Expenses ----------- ------------ --------- ---------- ---------- December 31, 1998 $ 224,419 8.94% 5.73% 1.22% 1.99% December 31, 1997 $ 165,536 8.12% 4.90% 1.05% 2.17% December 31, 1996 $ 152,871 7.13% 4.05% 0.91% 2.17% (1) Based on the average of daily balances.
Income Taxes - ------------- Income taxes were $1,941,355 in 1998, $1,316,351 in 1997, and $688,478 in 1996. The effective income tax rate was 40.3%, 38% and 36.4% for 1998, 1997 and 1996. Net Income - ----------- The net income of the Company was $2,880,767 in 1998, $2,149,652 in 1997, and $1,203,573 in 1996. Earnings per share were $.57 basic and $.55 diluted in 1998; $.49 basic and $.43 diluted in 1997; and $.32 basic and $.31 diluted in 1996; as adjusted to reflect the 1996 and 1998 2-for-1 stock splits and the 1995 10% stock dividend. The increases in net income for the past three years were the result of several factors. First, the earning assets of the Company have increased, resulting in an increase in net interest income. Second, the origination and sale of SBA loans has continued to grow, resulting in increased gains on sales and increased servicing income. Third, the increased volume of business in the Mortgage Loan Processing Center and Home Equity Lending Department, increased fee income, income from loan sales, and servicing income. Offsetting the income increase was an overall increase in expenses related to the production of income. Capital Resources - ------------------ The Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 was signed into law on December 19, 1991. Regulations implementing the prompt corrective action provisions of FDICIA include significant changes to the legal and regulatory environment for insured depository institutions, including reductions in insurance coverage for certain kinds of deposits, increased supervision by the federal regulatory agencies, increased reporting requirements for insured institutions, and new regulations concerning internal controls, accounting, and operations. 12 The prompt corrective action regulations define specific capital categories based on institution's capital ratios. The capital categories, in defining order, are "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." To be considered "well capitalized" an institution must have a core capital ratio of at least 5% and a total risk-based capital ratio of at least 10%. Additionally, FDICIA imposed in 1994 a new Tier I risk-based capital ratio of at least 6% to be considered "well capitalized." Tier I risk-based capital is, primarily, common stock and retained earnings less goodwill and other intangible assets. Management believes, as of December 31, 1998, the Company exceeds all capital adequacy requirements to which it is subject. As of December 31, 1998 and 1997, the most recent notification from the FDIC categorized the Company as "well capitalized." There are no conditions or events since that notification which management believes have changed the Company's category. The Company's actual capital ratios are presented below.
To Be Well For Capital Capitalized Under Adequacy Prompt Corrective Actual Purposes Action Provisions ------ -------- ----------------- Amount Ratio Amount Ratio Amount Ratio ----------- ------ ----------- ------ ----------- ------ As of December 31, 1998: Total Capital (to Risk Weighted assets) Consolidated . . . . . . . . . . . . . . . $26,109,980 15.27% $13,674,814 8.00% $17,093,519 10.00% Goleta National Bank . . . . . . . . . . . $16,152,794 13.88% $ 9,309,968 8.00% $11,637,460 10.00% Palomar Savings and Loan . . . . . . . . . $ 6,492,000 12.45% $ 4,172,240 8.00% $ 5,215,300 10.00% Tier I Capital (to Risk Weighted assets) Consolidated . . . . . . . . . . . . . . . $23,972,867 14.02% $ 6,837,407 4.00% $10,256,111 6.00% Goleta National Bank . . . . . . . . . . . $14,698,113 12.63% $ 4,654,984 4.00% $ 6,982,476 6.00% Tier I Capital (to Average Assets) Consolidated . . . . . . . . . . . . . . . $23,972,867 9.49% $10,102,001 4.00% $12,627,501 5.00% Goleta National Bank . . . . . . . . . . . $14,698,113 8.07% $ 7,285,310 4.00% $ 9,106,638 5.00% Core Capital (to Adjusted Tangible Assets) Palomar Savings and Loan . . . . . . . . . $ 5,865,000 7.11% $ 3,299,000 4.00% $ 4,124,200 5.00% Tangible Capital (to Tangible Assets) Palomar Savings and Loan . . . . . . . . . $ 5,865,000 7.11% $ 1,237,260 1.50% N/A N/A
To Be Well For Capital Capitalized Under Adequacy Prompt Corrective Actual Purposes Action Provisions ------ -------- ----------------- Amount Ratio Amount Ratio Amount Ratio ----------- ------ ---------- ------ ----------- ------ As of December 31, 1997: Total Capital (to Risk Weighted assets) Consolidated . . . . . . . . . . . . . . . $18,535,374 15.88% $9,336,643 8.00% $11,670,804 10.00% Goleta National Bank . . . . . . . . . . . $12,990,366 17.36% $5,986,344 8.00% $ 7,482,930 10.00% Palomar Savings and Loan . . . . . . . . . $ 6,055,541 13.49% $3,591,129 8.00% $ 4,488,911 10.00% Tier I Capital (to Risk Weighted assets) Consolidated . . . . . . . . . . . . . . . $17,071,672 14.63% $4,668,321 4.00% $ 7,002,482 6.00% Goleta National Bank . . . . . . . . . . . $12,054,016 16.11% $2,992,928 4.00% $ 4,489,391 6.00% Tier I Capital (to Average Assets) Consolidated . . . . . . . . . . . . . . . $17,071,672 9.84% $6,939,541 4.00% $ 8,674,427 5.00% Goleta National Bank . . . . . . . . . . . $12,054,016 12.63% $3,917,582 4.00% $ 4,771,978 5.00% Core Capital (to Adjusted Tangible Assets) Palomar Savings and Loan . . . . . . . . . $ 5,494,541 6.99% $3,144,229 4.00% $ 3,930,287 5.00% Tangible Capital (to Tangible Assets) Palomar Savings and Loan . . . . . . . . . $ 5,494,541 6.99% $1,179,086 1.50% N/A N/A
Schedule of Assets, Liabilities and Stockholders' Equity - -------------------------------------------------------------- The following schedule shows the average balances of the Company's assets, liabilities and stockholders' equity accounts as a percentage of average total assets for the periods indicated. 13
(Dollars in Thousands) Year Ended December 31, ---------------------------------------------------------- 1998 1997 1996 ------------------ ------------------ ------------------ Amount Percent Amount Percent Amount Percent --------- ------- --------- ------- --------- ------- ASSETS - ----------------------------------------------- Cash and due from banks $ 6,196 2.8% $ 5,354 3.2% $ 4,322 2.8% Federal funds sold 13,121 5.8% 11,675 7.1% 8,565 5.6% Time deposits in other financial institutions 2,160 1.0% 4,006 2.4% 3,609 2.4% FRB/FHLB Stock 791 0.3% 713 0.4% 636 0.4% Investment securities 16,137 7.2% 16,076 9.7% 18,086 11.8% Trading securities 44 0.0% - 0.0% - 0.0% Loans: Commercial 13,487 6.0% 13,637 8.2% 14,300 9.3% Real estate 70,125 31.2% 76,642 46.3% 74,476 48.7% Unguaranteed portions of loans insured by SBA 27,081 12.1% 21,345 12.9% 15,617 10.2% Installment 12,267 5.5% 5,054 3.1% 6,531 4.3% Loan participations purchased 4,016 1.8% 1,333 0.8% 746 0.5% Less: allowance for loan loss (2,092) -0.9% (2,175) -1.3% (2,340) -1.5% Less: net deferred loan fees and premiums (129) -0.1% (195) -0.1% (175) -0.1% Less: discount on loan pool purchase (703) -0.3% (488) -0.3% (423) -0.3% --------- ------- --------- ------- --------- ------- Net loans 124,052 55.3% 115,153 69.6% 108,732 71.1% Loans held for sale 51,952 23.1% 6,351 3.8% 1,692 1.1% Other real estate owned 181 0.1% 316 0.2% 715 0.5% Premises and equipment, net 3,619 1.6% 2,683 1.6% 2,016 1.3% Servicing asset 1,088 0.5% 788 0.5% 1,705 1.1% Accrued interest receivable and other assets 5,078 2.4% 2,421 1.5% 2,793 1.9% TOTAL ASSETS $224,419 100.0% $165,536 100.0% $152,871 100.0% ========= ======= ========= ======= ========= ======= LIABILITIES AND STOCKHOLDERS' EQUITY - ----------------------------------------------- Deposits: Noninterest-bearing demand 20,950 9.3% 17,307 10.5% 14,169 9.3% Interest-bearing demand 20,511 9.1% 17,755 10.7% 16,339 10.7% Savings 24,404 10.9% 21,906 13.2% 23,259 15.2% Time certificates, $100,000 or more 44,216 19.7% 27,235 16.4% 22,311 14.6% Other time certificates 91,907 41.0% 63,673 38.5% 61,601 40.3% --------- ------- --------- ------- --------- ------- Total deposits 201,988 90.0% 147,876 89.3% 137,679 90.1% Other Borrowings 234 0.1% 405 0.2% 2,000 1.3% Federal funds purchased 1,479 0.7% - 0.0% - 0.0% Accrued interest payable and other liabilities 2,358 1.0% 1,105 0.7% 672 0.4% --------- ------- --------- ------- --------- ------- Total liabilities 206,059 91.8% 149,386 90.2% 140,351 91.8% Stockholders' equity Common stock 13,379 6.0% 12,595 7.6% 10,470 6.8% Retained earnings 4,968 2.2% 3,556 2.2% 2,076 1.4% Unrealized gain/(loss) on AFS securities 13 0.0% (1) 0.0% (26) 0.0% Treasury stock - 0.0% - 0.0% - 0.0% --------- ------- --------- ------- --------- ------- Total stockholders' equity 18,360 8.2% 16,150 9.8% 12,520 8.2% TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $224,419 100.0% $165,536 100.0% $152,871 100.0% ========= ======= ========= ======= ========= =======
14 Investment Portfolio - --------------------- The following table summarizes the year-end carrying value balances and distributions of the Company's investment securities.
December 31, ------------------------------------ (Dollars rounded to thousands) 1998 1997 1996 ---------- ----------- ----------- U.S. Treasury Securities $1,256,000 $ 1,751,000 $ 1,998,000 FRB Stock 264,000 251,000 156,000 FHLB Stock 546,000 512,000 482,000 GNMA Securities 4,228,000 3,874,000 4,171,000 FNMA Securities 1,893,000 7,425,000 5,732,000 FHLMC Securities 1,420,000 1,017,000 1,184,000 Mutual Fund - - 981,000 $9,607,000 $14,830,000 $14,704,000 ========== =========== ===========
In addition to the above, as of December 31, 1998 and 1997 the Company holds interest only strip assets in the amount of $10,914,900 and $2,528,587. These interest only strips represent the present value of the right to the excess cash flows generated by the sold loans that represent the difference between (a) interest at the stated rate paid by borrowers and (b) the sum of (i) pass-through interest paid to third-party investors, (ii) stipulated servicing fees and (iii) estimated loan portfolio losses. The Company determines the present value of this anticipated cash flow stream at the time of the loan sale close, utilizing valuation assumptions appropriate for each particular transaction. The significant valuation assumptions are related to the anticipated average lives of the loans sold, the anticipated prepayment speeds and the anticipated credit losses related thereto. In order to determine the present value of this excess cash flow, the Company currently applies an estimated market discount rate of 11% for SBA and FHA Title 1 loans and 13% for HLTV loans to the expected pro forma gross cash flows, which are calculated utilizing the weighted average lives of the loans. The annual prepayment rate of the loans is a function of full and partial prepayments and defaults. In the interest only strips' fair value estimates, the Company makes assumptions of the prepayment rates of the underlying loans, which the Company believes are reasonable. During fiscal 1998, the Company utilized proprietary prepayment curves generated by the Company reaching an approximate maximum annual rate of 8%, 15% and 18.25% for SBA, FHA Title 1, and HLTV loans. The following table summarizes the amounts, terms, distributions, and yields of the Company's investment securities as of December 31, 1998.
After One Year One Year or Less to Five Years Over Five Years Total ------------------ ---------------- ------------------ ------------------ Amount Yield Amount Yield Amount Yield Amount Yield ---------- ------ -------- ------ ---------- ------ ---------- ------ U.S. Treasury Securities $1,256,000 6.3% $ - N/A% $ - N/A% $1,256,000 6.9% FRB Stock - N/A 264,000 6.4 - N/A 264,000 6.4 FHLB Stock - N/A 546,000 5.6 - N/A 546,000 5.6 GNMA Securities - N/A - N/A 4,228,000 6.6 4,228,000 6.6 FNMA Securities - N/A - N/A 1,893,000 6.7 1,893,000 6.7 FHLMC Securities - N/A - N/A 1,420,000 6.7 1,420,000 6.7 ---------- ------ -------- ------ ---------- ------ ---------- ------ Totals $1,256,000 6.3% $810,000 5.9% $7,541,000 6.6% $9,607,000 6.6% ========== ====== ======== ====== ========== ====== ========== ======
15 The Investment Policy of the Company sets forth the types and maturities of investments the Company, and its subsidiaries, may hold. Loan Portfolio - --------------- The Company's largest lending categories are commercial loans, real estate loans, unguaranteed portion of loans insured by the SBA, installment loans, loans held for sale and real estate loan participations purchased. Loans are carried at face amount, less payments collected, the allowance for possible loan losses, deferred loan fees and discounts on loans purchased. Interest on all loans is accrued daily on primarily a simple interest basis. It is generally the Company's policy to place loans on nonaccrual status when they are 90 days past due. Thereafter, interest income is no longer recognized. Problem loans are maintained on accrual status only when management of the Company is confident of full repayment within a very short period of time. The rates of interest charged on variable rate loans are set at specified increments in relation to the Company's published prime lending rate or other appropriate indices and vary as those indices vary. At December 31, 1998, approximately 63% of the Company's loan portfolio was comprised of variable interest rate loans. At December 31, 1997, variable rate loans comprised approximately 71% of the Company's loan portfolio. At December 31, 1996, variable rate loans comprised approximately 74% of the Company's loan portfolio. Distribution of Loans - ----------------------- The distribution of the Company's total loans by type of loan as of the dates indicated is shown in the following table (dollars in thousands):
December 31, ----------------------------------------------------------------------- 1998 1997 1996 ----------------------- ---------------------- ---------------------- Percentage Percentage Percentage to Gross to Gross to Gross Type of loan Loan Balance Loans Loan Balance Loans Loan Balance Loans ------------- -------- ------------ -------- ------------ -------- Commercial $ 10,613,000 6.3% $ 13,195,000 10.1% $ 14,017,000 12.0% Real estate 64,875,000 38.4 76,190,000 58.1 75,214,000 64.4 Unguaranteed portion of loans insured by SBA 26,687,000 15.8 19,602,000 15.0 14,708,000 12.6 Installment 5,638,000 3.3 4,057,000 3.1 4,306,000 3.7 Loan participations purchased 2,287,000 1.4 2,247,000 1.7 709,000 0.6 Loans held for sale 58,836,000 34.8 15,739,000 12.0 7,767,000 6.7 ------------- -------- ------------ -------- ------------ -------- GROSS LOANS 168,936,000 100.0% 131,030,000 100.0% 116,721,000 100.0% Less: Allowance for loan losses 2,129,000 2,067,000 2,380,000 Deferred loan fees and premiums 113,000 150,000 190,000 Discount on loan pool purchase 759,000 428,000 344,000 ------------- ------------ ------------ NET LOANS $ 165,935,000 $128,385,000 $113,807,000 ============= ============ ============
Commercial Loans - ----------------- In addition to traditional commercial loans made to business customers, the Company also extends business lines of credit. On business credit lines, the Company specifies a maximum amount which it stands ready to lend to the customer during a specified period, in return for which the customer agrees to maintain its primary banking relationship with the Company. The purpose for which such loans will be used and the security therefor, if any, are determined before the Company's commitment is extended. Normally, the Company does not make loan commitments in material amounts for periods in excess of one year. 16 Real Estate Loans - ------------------- Real estate loans are primarily made for the purpose of purchasing, improving or constructing single family residences, and commercial and industrial properties. The majority of the Company's real estate loans are collateralized by first and second liens on single family homes. Maturities on such loans are generally 15 to 30 years. A large part of the Company's real estate construction loans are first and second trust deeds on the construction of owner-occupied single family dwellings. The Company also makes real estate construction loans on commercial properties. These consist of first and second trust deeds collateralized by the related real property. Construction loans are generally written with terms of six to twelve months and usually do not exceed a loan to appraised value of 80%. Some real estate loans are secured by nonresidential property. These loans are often secured by office buildings or other commercial property. Loan-to-value ratios are generally restricted to 70% of appraised value of the underlying real property. Unguaranteed Portion of Loans Guaranteed by the SBA - ---------------------------------------------------------- The Company is approved as a Preferred Lender by the SBA. Loans made by the Company under programs offered by the SBA are generally made to small businesses for the purchase of businesses, purchase or construction of facilities, purchase of equipment or working capital. The loans generally carry guarantees from the SBA ranging from 75% - 90% of the balance loaned. Borrowers are required to provide adequate collateral for these loans, similar to other commercial loans. The SBA does allow less-collateralized loans for its "Low Doc" program, loans of less than $100,000. When the Company originates SBA loans, it sells the guaranteed portion of the loans into the secondary market. The Company retains the unguaranteed portion of the loans, as well as the servicing on the loans, for which it is paid a fee. The loans are all variable rate based upon the Wall Street Journal Prime Rate. The servicing spread is a minimum of 1.00% on all loans. The gains recognized by the Company on the sales of the guaranteed portion of these loans and the ongoing servicing income received, are significant revenue streams for the Company. Installment Loans - ------------------ While not a large portion of its loan portfolio, the Company does originate installment loans, also known as, consumer loans. These loans are comprised of automobile, small equity lines of credit and general personal loans. These loans are primarily variable rate with terms of five years or less. Maturity of Loans and Sensitivity of Loans to Changes in Interest Rates - -------------------------------------------------------------------------------- The following table sets forth the amount of gross loans outstanding, as of December 31, 1998, 1997, and 1996, which, based on the remaining scheduled repayments of principal, have the ability to be repriced or are due in less than one year, in one to five years, or in more than five years.
1998 1997 1996 ------------------------- ------------------------ ------------------------ (Dollars rounded to thousands) Fixed Variable Fixed Variable Fixed Variable ----------- ------------ ----------- ----------- ----------- ----------- Less than One Year $ 5,431,000 $105,173,000 $ 9,307,000 $92,907,000 $ 6,752,000 $85,762,000 One Year to Five Years 10,487,000 775,000 8,166,000 24,000 9,221,000 34,000 After Five Years 47,070,000 - 20,626,000 - 14,952,000 - ----------- ------------ ----------- ----------- ----------- ----------- Total $62,988,000 $105,948,000 $38,099,000 $92,931,000 $30,925,000 $85,796,000 =========== ============ =========== =========== =========== ===========
17 The following table shows the Company's loan commitments outstanding at the dates indicated:
December 31, 1998 1997 1996 ----------- ----------- ----------- Commercial $10,693,000 $12,298,000 $ 7,412,000 Real estate 12,306,000 3,595,000 3,423,000 Loans guaranteed by the SBA 4,230,000 4,177,000 1,195,000 Installment loans 1,502,000 1,473,000 1,576,000 Standby letters of credit 35,000 30,000 2,204,000 Total commitments $28,766,000 $21,573,000 $15,810,000 =========== =========== ===========
Based upon prior experience and prevailing economic conditions, it is anticipated that approximately 80% of the commitments at December 31, 1998, will be exercised during 1999. Summary of Loan Losses Experience - ------------------------------------- As a natural corollary to the Company's lending activities, some loan losses are experienced. The risk of loss varies with the type of loan being made and the creditworthiness of the borrower over the term of the loan. The degree of perceived risk is taken into account in establishing the structure of, and interest rates and security for, specific loans and for various types of loans. The Company attempts to minimize its credit risk exposure by use of thorough loan application and approval procedures. The Company maintains a program of systematic review of its existing loans. Loans are graded for their overall quality. Those loans which the Company's management determines require further monitoring and supervision are segregated and reviewed on a periodic basis. Significant problem loans are reviewed on a monthly basis by the Company's Loan Committee. The recorded investment in loans that are considered to be impaired under SFAS No. 114 was as follows:
December 31, 1998 1997 1996 ----------- ----------- ----------- Impaired loans without specific valuation allowances $4,450,345 $2,461,168 $1,111,388 Impaired loans with specific valuation allowances 813,652 1,266,964 2,490,435 Specific valuation allowance allocated to impaired loans (464,336) (521,994) (736,853) Impaired loans, net $4,799,661 $3,206,138 $2,864,970 =========== =========== =========== Average investment in impaired loans $4,009,400 $3,056,054 $3,620,236 =========== =========== =========== Interest Income recognized on impaired loans $ 288,607 $ 360,309 $ 190,559 =========== =========== ===========
It is the Company's policy to place loans on nonaccrual status when they are 90 days past due. Thereafter, interest income is no longer recognized. As such, interest income may be recognized on impaired loans to the extent they are not past due by 90 days or more. Upon the adoption of SFAS No. 114, the Company classified all loans on nonaccrual status as impaired. Accordingly, the impaired loans disclosed above include all loans that were on nonaccrual status. Financial difficulties encountered by certain borrowers may cause the Company to restructure the terms of their loans to facilitate loan payments. In accordance with the provisions of SFAS No. 114, a troubled loan that is restructured subsequent to the adoption of SFAS No. 114 would generally be considered impaired, while a loan restructured prior to adoption would not be considered impaired if, at the date of measurement, it was probable that the Company would collect all amounts due under the restructured terms. Accordingly, the balance of impaired loans disclosed above includes all troubled debt restructured loans that, as of December 31, 1998, 1997, and 1996 are considered impaired. 18
December 31, 1998 1997 1996 ---------- ---------- ---------- Nonaccrual loans $2,971,000 $1,714,000 $ 634,000 Troubled debt restructured loans, gross $1,313,000 $3,289,000 $2,238,000 Interest foregone on nonaccrual loans and troubled debt restructuring outstanding $ 414,000 $ 203,000 $ 226,000 Loans 30 through 90 days past due with interest accruing $ 678,000 $ 631,000 $ 838,000
The Company charges off that portion of any loan which management considers to represent a loss. A loan is generally considered by management to represent a loss in whole or in part when an exposure beyond any collateral value is apparent, servicing of the unsecured portion has been discontinued or collection is not anticipated based on the borrower's financial condition and general economic conditions in the borrower's industry. The principal amount of any loan which is declared a loss is charged against the Company's allowance for loan losses. The following table summarizes the Company's loan loss experience for the periods indicated:
Year Ended December 31, 1998 1997 1996 ------------- ------------- ------------- Balances: Average gross loans $180,319,000 $124,603,000 $113,556,000 Gross loans at end of period 168,936,000 131,030,000 116,721,000 Loans charged off 402,000 520,000 647,000 Recoveries of loans previously charged off 35,000 17,000 22,000 ------------- ------------- ------------- Net loans charged off 367,000 503,000 625,000 ------------- ------------- ------------- Allowance for loan losses 2,129,000 2,067,000 2,380,000 Provisions for loan losses 429,000 191,000 650,000 Ratios: Net loan charge-offs to average loans 0.2% 0.4% 0.5% Net loan charge-offs to loans at end of period 0.2% 0.4% 0.5% Allowance for loan losses to average loans 1.2% 1.7% 2.1% Allowance for loan losses to loans held to maturity at end of period 2.0% 1.8% 2.2% Net loan charge-offs to allowance for loan losses at end of period 17.2% 24.4% 26.2% Net loan charge-offs to provision for loan losses 85.5% 263.9% 96.0%
The Company's allowance for loan losses is designed to provide for loan losses which can be reasonably anticipated. The allowance for loan losses is established through charges to operating expenses in the form of provisions for loan losses. Actual loan losses or recoveries are charged or credited, directly to the allowance for loan losses. The amount of the allowance is determined by management of the Company. Among the factors considered in determining the allowance for loan losses are the current financial condition of the Company's borrowers and the value of the security, if any, for their loans. Estimates of future economic conditions and their impact on various industries and individual borrowers are also taken into consideration, as are the Company's historical loan loss experience and reports of banking regulatory authorities. Because these estimates, factors and evaluations are primarily judgmental, no assurance can be given as to whether or not the Company will sustain loan losses substantially higher in relation to the size of the allowance for loan losses or that subsequent evaluation of the loan portfolio may not require substantial changes in such allowance. At December 31, 1998, 1997, and 1996, the allowance was 2.0%, 1.8%, and 2.2%, of the gross held to maturity loans then outstanding, respectively. Although the current level of the allowance is deemed adequate by management, future provisions will be subject to continuing reevaluation of risks in the loan portfolio. 19 Management of the Company reviews with the Board of Directors the adequacy of the allowance for possible loan losses on a quarterly basis. The loan loss provision is adjusted when specific items reflect a need for such an adjustment. Management believes that there were no material loan losses during the last fiscal year that have not been charged off. Management also believes that the Company has adequately reserved for all individual items in its portfolio which may result in a material loss to the Company. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE SUMMARY OF EARNINGS - Provision for Loan Losses". Interest Rates and Differentials - ----------------------------------- Certain information concerning interest-earning assets and interest-bearing liabilities and yields thereon is set forth in the following table. Amounts outstanding are daily average balances:
(Dollars in thousands) Year Ended December 31, 1998 1997 1996 --------- --------- --------- Interest-earning assets: Time deposits in other financial institutions: Average outstanding $ 2,160 $ 4,006 $ 3,609 Average yield 5.7% 5.7% 5.5% Interest income $ 123 $ 230 $ 197 Federal funds sold: Average outstanding $ 13,121 $ 11,675 $ 8,565 Average yield 5.1% 5.3% 5.0% Interest income $ 673 $ 616 $ 429 U.S. Government investment securities: Average outstanding $ 13,456 $ 14,234 $ 15,519 Average yield 6.1% 6.3% 6.5% Interest income $ 824 $ 891 $ 1,014 Federal Reserve Bank/Federal Home Loan Bank stock investment securities: Average outstanding $ 791 $ 713 $ 636 Average yield 6.1% 6.5% 5.8% Dividend income $ 48 $ 46 $ 37 Mutual Funds: Average outstanding $ - $ 115 $ 2,567 Average yield 0.0% 6.1% 6.0% Interest income $ - $ 7 $ 153 Loans: Average outstanding (1) $176,003 $121,505 $110,425 Average yield 10.7% 9.7% 9.6% Interest income $ 18,879 $ 11,763 $ 10,630 Total interest-earning assets: Average outstanding $205,531 $152,248 $141,341 Average yield 10.0% 8.9% 8.8% Interest income $ 20,547 $ 13,553 $ 12,460 (1) includes nonaccrual loans
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(Dollars in thousands) Year Ended December 31, 1998 1997 1996 --------- --------- --------- Interest-bearing liabilities: Interest-bearing demand deposits: Average outstanding $ 20,511 $ 17,755 $ 16,339 Average yield 2.8% 2.9% 3.0% Interest expense $ 579 $ 508 $ 492 Savings deposits: Average outstanding $ 24,404 $ 21,906 $ 23,259 Average yield 3.3% 3.2% 3.3% Interest expense $ 817 $ 695 $ 763 Time certificates of deposit: Average outstanding $136,123 $ 90,908 $ 83,912 Average yield 5.7% 5.6% 5.5% Interest expense $ 7,764 $ 5,129 $ 4,619 Federal funds purchased: Average outstanding $ 1,479 $ - $ - Average yield 5.7% 0.0% 0.0% Interest expense $ 85 $ - $ - Borrowings from FHLB: Average outstanding $ 234 $ 405 $ 2,000 Average yield 5.1% 6.9% 5.9% Interest expense $ 12 $ 29 $ 116 Total interest-bearing liabilities: Average outstanding $182,751 $130,974 $125,510 Average yield 5.1% 4.9% 4.8% Interest expense $ 9,257 $ 6,361 $ 5,990 Net interest income $ 11,290 $ 7,192 $ 6,470 Average net interest margin on interest- earning assets 5.5% 4.7% 4.6%
Liquidity Management - --------------------- The Company has an asset and liability management program allowing the Company to maintain its interest margins during times of both rising and falling interest rates and to maintain sufficient liquidity. Liquidity of the Company at December 31, 1998, was 51.7%, at December 31, 1997, was 31.3%, based on liquid assets (consisting of cash and due from banks, deposits in other financial institutions, security investments, federal funds sold and loans available for sale) divided by total assets. Management believes it maintains adequate liquidity levels. At times when the Company has more funds than it needs for its reserve requirements or short term liquidity needs, the Company increases its securities investments and sells federal funds. It is management's policy to maintain a substantial portion of its portfolio of assets and liabilities on a short-term or highly liquid basis in order to maintain rate flexibility and to meet loan funding and liquidity needs. The Company has two federal funds lines of credit with its correspondent banks totaling $6,500,000. In addition the company, through its subsidiary Palomar Savings and Loan, has a line of credit with Federal Home Loan Bank of 25% of its total assets which was $20,600,000 at December 31, 1998. 21 The following table shows the Company's average deposits for each of the periods indicated below, based upon average daily balances:
(Dollars in thousands) Year Ended December 31, ----------------------------------------------------------- 1998 1997 1996 ------------------ ------------------ ------------------- Average Percent Average Percent Average Percent Balance of Total Balance of Total Balance of Total -------- -------- -------- -------- -------- --------- Noninterest-bearing demand $ 20,951 10.4% $ 17,307 11.7% $ 14,160 10.3% Interest-bearing demand 20,512 10.1 17,755 12.0 16,339 11.9 Savings 24,404 12.1 21,906 14.8 23,259 16.9 TCDs of $100,000 or more 44,216 21.9 27,235 18.4 22,311 16.2 Other TCDs 91,907 45.5 63,673 43.1 61,601 44.7 Total Deposits $201,990 100.0% $147,876 100.0% $137,670 100.0% ======== ======== ======== ======== ======== ======
Deposits - -------- The maturities of time certificates of deposit ("TCDs") were as follows:
December 31, 1998 December 31, 1997 ----------------- ----------------- TCDs over TCDs over $100,000 Other TCDs $100,000 Other TCDs ----------- ----------- ----------- ----------- Less than three months $36,080,000 $55,362,000 $14,243,000 $21,629,000 Over three months through six months 7,016,000 12,395,000 5,599,000 10,851,000 Over six months through twelve months 15,911,000 17,558,000 10,956,000 22,120,000 Over twelve months through five years 2,735,000 10,164,000 100,000 6,546,000 Total $61,742,000 $95,479,000 $30,898,000 $61,146,000 =========== =========== =========== ===========
While the deposits of the Company may fluctuate up and down somewhat with local and national economic conditions, management of the Company does not believe that such deposits, or the business of the Company in general, are seasonal in nature. Liability management is monitored by the Chief Financial Officer daily and by the Asset/Liability Committee of the Company's Board of Directors which meets quarterly. Year 2000 - ---------- As the year 2000 approaches, a critical issue has emerged regarding how existing application software programs and operating systems can accommodate this date value. In brief, many existing application software products in the marketplace were designed to only accommodate a two digit date position which represents the year (for example, '98' is stored on the system and represents the year as 1998). As a result, the year 1999 could be the maximum date value these systems will be able to accurately process. A time-sensitive software may recognize a date using "00" as the year 1900 rather than year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in similar normal business activities. The Company has adopted a plan of action to minimize the risk of the year 2000 event including the establishment of an oversight committee. This plan is fully supported by management and the Board of Directors. The committee's goal is to achieve a year 2000 date conversion with no effect on customers or disruption to business operations. The plan consists of five phases; awareness, assessment, renovation, validation, and implementation. In the awareness phase, the committee was formed consisting of members from all departments within the Company. This team defined the Year 2000 issue, how and where it would impact the Company. The assessment phase determined the size of the issue and which systems were determined as critical to the operations of the Company. During the renovation phase, systems, hardware, and software were tested for compliance and any non-compliant systems were replaced. Nothing determined as critical needed replacement. During the validation phase, further testing is done on any new equipment or systems installed. At the end of 1998, the Company re-tested all systems in a mock exercise as if it was January 2000. In 1999, customer awareness of the Year 2000 issue and what the Company has done to address the issue will intensify. This will be, but is not limited to, mailings to our customers, public announcements, and training for Company employees to address customer concerns. 22 The Company has initiated formal communications with all of its vendors, including the U.S. Government, to determine their Year 2000 compliance readiness. The Company is reviewing the extent the interface systems are vulnerable to any third parties' year 2000 issues. There can be no guarantee that the systems of other companies on which the Company systems rely will be timely converted and would not have an adverse effect on the Company's systems. Many of the Company's systems include new hardware and software purchased from vendors who have represented that these systems are already year 2000 compliant. The Company is in the process of obtaining assurances from vendors that timely updates will be made available to make all remaining systems compliant. Management does not anticipate the Company will be required to purchase any additional hardware or software to be year 2000 compliant. However, management has incurred and will continue to incur some administrative costs relative to the identification and testing of the Company's electronic data processing systems. The costs and timing of the year 2000 project is based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third party modification plans and other factors. As of December 31, 1998, the Company had incurred $111,476 in expenses getting Year 2000 compliant and anticipates spending $100,000 in 1999. However, there can be no guarantee that these estimates will be achieved and actual results could differ from these plans. SUPERVISION AND REGULATION - COMMUNITY WEST BANCSHARES - ------------------------------------------------------------ GENERAL - ------- Banking is a complex and highly regulated industry. The primary goals of the regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of those goals, congress has created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the banking industry. The description of and the references to the status and regulations below are brief summaries and do not purport to be complete. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed. The Company is also a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the Commissioner. Regulations have not yet been proposed or adopted or steps otherwise taken to implement the Commissioner's powers under this statute. Community West Bancshares (the "Company") is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the "Act"), and is subject to supervision by the Federal Reserve Board (the "FRB"). As a bank holding company, the Company is required to file with the FRB an annual report and such other additional information as the FRB may require pursuant to the Act. The FRB may also make examinations of the Company and its subsidiaries. The Act requires prior approval by the FRB for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares, or substantially all the assets, of any bank or for a merger or consolidation by a bank holding company with any other bank holding company. Transactions With Affiliates - ------------------------------ The Company has two wholly-owned banking subsidiaries, Goleta National Bank, a national banking association (the "Bank"), and Palomar Savings and Loan Association, a California state-chartered savings bank ("Palomar")(together, "the Subsidiaries"). 23 The Company, the subsidiaries and any other subsidiaries it may acquire, either by purchase or merger, or subsequently organize, are deemed to be affiliates within the meaning of the Act. Pursuant thereto, loans by the Subsidiaries to affiliates, investments by the Subsidiaries in affiliates' stock, and taking affiliates' stock by the Subsidiaries as collateral for loans to any borrower will be limited to 10% of an affiliate's capital, in the case of any one affiliate, and will be limited to 20% of an affiliate's capital in the case of all affiliates. In addition, such transactions must be on terms and conditions that are consistent with safe and sound banking practices; in particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Act. Such restrictions also prevent a bank holding company and its other affiliates from borrowing from a banking subsidiary of the bank holding company unless the loans are secured by marketable collateral of designated amounts. The Company and the Subsidiaries are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities. Bank Holding Company Liquidity - --------------------------------- The Company is a legal entity, separate and distinct from the Subsidiaries. Although there exists an ability to raise capital on its own behalf or borrow from external sources, the Company's primary source of funds is through dividends paid the Subsidiaries. However, regulatory restraints may restrict or totally preclude the Subsidiaries from paying dividends to the Company. The Bank may pay the Company a cash dividend, when and as declared by the Bank's Board of Directors, out of funds legally available therefore, as specified and limited by regulations promulgated by the Office of the Comptroller of the Currency, (the "OCC"). Under OCC regulations, funds available for a national bank's cash dividends are restricted to the lesser of: (i) a bank's retained earnings or (ii) a bank's net income for the current and past two fiscal years (less any dividends made during such period), unless approved by the OCC. Furthermore, if the OCC determines that a dividend would cause a bank's capital to be impaired or that payment would cause it to be undercapitalized, it can prohibit payment of a dividend is an unsafe and unsound banking practice. Palomar's ability to declare and pay a cash dividend is subject to the Office of Thrift Supervision's (the "OTS") regulations which impose limitations upon all capital distributions by savings associations, such as cash dividends, payment to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash out merger and other distributions charged against capital. In general, Palomar may not declare or pay a cash dividend on its capital stock if the payment would cause Palomar to fail to meet one of its regulatory capital requirements. Palomar must also provide the OTS with 30 days advance notice of any proposed dividend declaration. Under OTS regulations, an association that meets its capital requirements, both before and after the proposed distribution, and has not been notified by the OTS that it is in need of more than normal supervision (a "Tier 1 association") may, after prior notice to, but without the approval of the OTS, make capital distributions during a calendar year up to the higher of: (i)100% of its net income to date during the calendar year plus the amount that would reduce by one-half its surplus capital ratio at the beginning of the calendar year, or (ii) 75% of its net income over the most recent four-quarter period. A Tier 1 association may make capital distributions in excess of the above amount if it gives notice to the OTS and the OTS does not object to the distribution. At December 31, 1998 Palomar was deemed to be a Tier 1 association. On January 19, 1999, the OTS issued Amended Regulations (the "Amended Regulations") regarding capital distributions, to conform its requirements to the OTS's prompt corrective action regulation and to conform to the rules of other banking extent possible. The Amended Regulations are effective April 1, 1999. Under the Amended Regulations, an institution that would at least remain adequately capitalized after making a capital distribution, and was not owned by a bank holding company, would no longer be required to provide notice to the OTS prior to making a capital distribution. "Troubled" associations and undercapitalized associations would also be allowed to make capital distributions, but only after filing an application and receiving subsequent OTS approval. Such applications would only be approved under certain limited circumstances. The Amended Regulations only apply to OTS regulated institutions which are not bank holding company subsidiaries. Currently, it is not contemplated that Palomar will cease to be the Company's subsidiary and would, therefore, continue to be the Company's subsidiary and would, therefore, continue to be exempt from the Amended Regulations. 24 Under the Financial Institutions Supervisory Act, the FDIC also has the authority to prohibit an insured institution from making distributions it considers to be unsafe and unsound. Since the Subsidiaries are FDIC insured institutions, it is therefore possible, depending upon their financial conditions and other relevant factors, that the FDIC could prohibit payment of dividends to the Company. Limitations on Business Activities - ------------------------------------- With certain limited exceptions, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or furnishing services to or performing services for its authorized subsidiaries. A bank holding company may, however, engage or acquire an interest in a company that engages in activities which the FRB has determined to be closely related to banking or managing or controlling banks as to be properly incident thereto. In making such a determination, the FRB is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests, or unsound banking practices. Although the future scope of permitted activities is uncertain and cannot be predicted, some of the activities that the FRB has determined by regulation to be closely related to banking are: (i) making or acquiring loans or other extensions of credit for its own account or for the account of others; (ii) servicing loans and other extensions of credit for any person; (iii) operating an industrial bank, Morris Plan bank, or industrial loan company, as authorized under state law, so long as the institution is not a bank; (iv) operating a trust company in the manner authorized by federal or state law, so long as the institution is not a bank and does not make loans or investments or accept deposits, except as permitted under the FRB's Regulation Y; (v) subject to certain limitations, acting as an investment or financial adviser to investment companies and other persons; (vi) leasing personal and real property or acting as agent, broker, or adviser in leasing such property in accordance with various restrictions imposed by Regulation Y, including a restriction that it is reasonably anticipated that each lease will compensate the lessor for not less than the lessor's full investment in the property; (vii) making equity and debt investments in corporations or projects designed primarily to promote community welfare; (viii) providing financial, banking, or economic data processing and data transmission services, facilities, data bases, or providing access to such services, facilities, or data bases; (ix) acting as principal, agent, or broker for insurance directly related to extensions of credit which are limited to assuring the repayment of debts in the event of death, disability, or involuntary unemployment of the debtor; (x) acting as agent or broker for insurance directly related to extensions of credit by a finance company subsidiary; (xi) owning, controlling, or operating a savings association provided that the savings association engages only in activities permitted for bank holding companies under Regulation Y; (xii) providing courier services of limited character; (xiii) providing management consulting advice to non-affiliated bank and nonbank depository institutions, subject to the limitations imposed by Regulation Y; (xiv) selling money orders, travelers' checks and U.S. Savings Bonds; (xv) appraisal of real estate and personal property; (xvi) acting as an intermediary for the financing of commercial or industrial income-producing real estate; (xvii) providing securities brokerage services, related securities credit activities pursuant to Regulation T, and other incidental activities; (xviii) underwriting and dealing in obligations of the U.S., general obligations of states and their political subdivisions, and other obligations authorized for state member banks under federal law; and (xix) providing general information and statistical forecasting, advisory and transactional services with respect to foreign exchange through a separately incorporated subsidiary. Federal law prohibits a holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, for example, the Subsidiaries may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer must obtain or provide some additional credit, property or services from or to the subsidiaries other than a loan, discount, deposit or trust services; or (ii) the customer must obtain or provide some additional credit, property or service from or to the Company or any of the subsidiaries; or (iii) the customer may not obtain some other credit, property or services from competitors, except reasonable requirements to assure soundness of credit extended. Capital Adequacy - ----------------- The FRB's risk-based capital adequacy guidelines for bank holding companies and state member banks, discussed in more detail below (see "SUPERVISION AND REGULATION - THE SUBSIDIARIES - RECENT LEGISLATION AND REGULATORY CHANGES - 2. Risk-Based Capital Guidelines"), assign various risk percentages to different categories of assets, and capital is measured as a percentage of risk assets. While in many cases total risk assets calculated in accordance with the guidelines is less than total assets calculated absent the rating, certain non-balance sheet assets, including loans sold with recourse, legally binding loan commitments and standby letters of credit, are treated as risk assets, with the assigned rate varying with the type of asset. As a result, it is possible that total risk assets for purposes of the guidelines exceeds total assets under generally accepted accounting principles, thereby reducing the capital-to-assets ratio. Under the terms of the guidelines, bank holding companies are expected to meet capital adequacy guidelines based both on total assets and on total risk assets. 25 SUPERVISION AND REGULATION - THE SUBSIDIARIES GENERAL - ------- The Bank is a national banking association chartered under the laws of the United States and is also a member of the Federal Reserve System. As such, it is subject to regulation, supervision and regular examination by the FRB and the OCC. Palomar is a California state-chartered full-service savings and loan association and is therefore to regulation, supervision and regular examination by the California Department of Financial Institutions (the "DFI") and the OTS. Palomar is also a member of the Federal Home Loan Bank System (the "FHLB") and is therefore subject to the FHLB's regulations, supervision and regular examinations. The deposit of the Bank and Palomar are also insured by the maximum applicable limits by the Bank Insurance Fund ("BIF") and by the Savings Association Insurance Fund ("SAIF"), respectively, of the FDIC. Consequently, both are subject to regulation, supervision and regular examination by the FDIC. The regulations of these agencies govern most aspects of the subsidiaries' business, including capital adequacy ratios, reserves against deposits, restrictions on the rate of interest which may be paid on some deposit instruments, limitations on the nature and amount of loans which may be made, the location of branch offices, borrowings, and dividends. Supervision, regulation and examination of the Subsidiaries by the regulatory agencies are generally intended to protect depositors and are not intended for the protection of the Subsidiaries' shareholder. California law also exempts all banks from usury limitations on interest rates. RECENT LEGISLATION AND REGULATORY CHANGES - --------------------------------------------- 1. Introduction ------------ General. From time to time legislation is proposed or enacted which has the - -------- effect of increasing the cost of doing business and changing the competitive balance between banks and other financial and non-financial institutions. Various federal laws enacted over the past several years have provided, among other things, for the maintenance of mandatory reserves with the Federal Reserve Bank on deposits by depository institutions (state reserve requirements have been eliminated); the phasing-out of the restrictions on the amount of interest which financial institutions may pay on certain of their customers' accounts; and the authorization of various types of new deposit accounts, such as NOW accounts, "Money Market Deposit" accounts and "Super NOW" accounts, designed to be competitive with money market mutual funds and other types of accounts and services offered by various financial and non-financial institutions. The lending authority and permissible activities of certain non-bank financial institutions such as savings and loan associations and credit unions have been expanded, and federal regulators have been given increased authority and means for providing financial assistance to insured depository institutions and for effecting interstate and cross-industry mergers and acquisitions of failing institutions. These laws have generally had the effect of altering competitive relationships existing among financial institutions, reducing the historical distinctions between the services offered by banks, savings and loan associations and other financial institutions, and increasing the cost of funds to banks and other depository institutions. Other legislation has been proposed or is pending before the United States Congress which would effect the financial institutions industry. Such legislation includes wide-ranging proposals to further alter the structure, regulation and competitive relationships of the nation's financial institutions, to reorganize the federal regulatory structure of the financial institutions industry, to subject banks to increased disclosure and reporting requirements, and to expand the range of financial services which banks and bank holding companies can provide. Other proposals which have been introduced or are being discussed would equalize the relative powers of savings and loan holding companies and bank holding companies, and authorize such holding companies to engage in insurance underwriting and brokerage, real estate development and brokerage, and certain securities activities, including underwriting and dealing in United States Government securities and municipal securities, sponsoring and managing investment companies and underwriting the securities thereof. It cannot be predicted whether or in what form any of these proposals will be adopted, or to what extent they will effect the various entities comprising the financial institutions industry. 26 Certain of the potentially significant changes which have been enacted in the past several years are discussed below. Interstate Banking. The Riegle-Neal Interstate Banking and Branching Efficiency - ------------------- Act of 1994 (the "Riegle-Neal Act"), enacted on September 29, 1994, repealed the McFadden Act of 1927, which required states to decide whether national or state banks could enter their state, and, effective June 1, 1997, allows banks to open branches across state lines. The Riegle-Neal Act also repealed the 1956 Douglas Amendment to the Bank Holding Company Act, which placed the same requirements on bank holding companies. The repeal of the Douglas Amendment made it possible for bank holding companies to buy out-of-state banks in any state after September 29, 1995, which, after June 1, 1997, may now be converted into interstate branches. The Riegle-Neal Act permitted interstate banking to begin effective September 29, 1995. The amendment to the Bank Holding Company Act permits bank holding companies to acquire banks in other states provided that the acquisition does not result in the bank holding company controlling more than 10 percent of the deposits in the United States, or 30 percent of the deposits in the state in which the bank to be acquired is located. However, the Riegle-Neal Act also provides that states have the authority to waive the state concentration limit. Individual states may also require that the bank being acquired be in existence for up to five years before an out-of-state bank or bank holding company may acquire it. The Riegle-Neal Act provides that, since June 1, 1997, interstate branching and merging of existing banks is permitted, provided that the banks are at least adequately capitalized and demonstrate good management. Interstate mergers and branch acquisitions were permitted at an earlier time if the state chose to enact a law allowing such activity. The states were also authorized to enact laws to permit interstate banks to branch de novo. On September 28, 1995, the California Interstate Banking and Branching Act of 1995 ("CIBBA") was enacted and signed into law. CIBBA authorized out-of-state banks to enter California by the acquisition of or merger with a California bank that has been in existence for at least 5 years, unless the California bank is in danger of failing or in certain other emergency situations. CIBBA allows a California state bank to have agency relationships with affiliated and unaffiliated insured depository institutions and allows a bank subsidiary of a bank holding company to act as an agent to receive deposits, renew time deposits, service loans and receive payments for a depository institution affiliate. Proposed Expansion of Securities Underwriting Authority. Various bills have - ------------------------------------------------------------ been introduced in the United States Congress which would expand, to a lesser or greater degree and subject to various conditions and limitations, the authority of bank holding companies to engage in the activity of underwriting and dealing in securities. Some of these bills would authorize securities firms (through the holding company structure) to own banks, which could result in greater competition between banks and securities firms. No prediction can be made as to whether any of these bills will be passed by the United States Congress and enacted into law, what provisions such a bill might contain, or what effect it might have on the Bank. Expansion of Investment Opportunities for California State-Chartered Banks. - -------------------------------------------------------------------------------- Legislation enacted by the State of California has substantially expanded the authority of California state-chartered banks to invest in real estate, corporate stock and other corporate securities. National banks are governed in these areas by federal law, the provisions of which are more restrictive than California law. However, provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991, discussed below, limit state-authorized activities to that available to national banks, unless approved by the FDIC. Recent Accounting Pronouncements: In June 1997, the FASB issued SFAS No. 130, - ----------------------------------- "Reporting Comprehensive Income," effective for fiscal years beginning after December 15, 1997. This statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This Statement further requires that an entity display an amount representing total comprehensive income for the period in that financial statement. This Statement also requires that an entity classify items of other comprehensive income by their nature in a financial statement. For example, other comprehensive income may include foreign currency items, minimum pension liability adjustments, and unrealized gains and losses on certain debt and equity securities. Reclassification of financial statements for earlier periods, provided for comparative purposes, is required. The adoption of this statement did not have a material impact on the Company's consolidated financial statements. 27 In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," effective for financial statements for periods beginning after December 15, 1997. This statement establishes standards for reporting information about operating segments in annual financial statements and requires that enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The adoption of this statement did not have a material impact on the Company's financial statements. 2. Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ------------------------------------------------------------------------- General. On August 9, 1989, the Financial Institutions Reform, Recovery, and - -------- Enforcement Act of 1989 ("FIRREA") was signed into law. This legislation has resulted in major changes in the regulation of insured financial institutions, including significant changes in the authority of government agencies to regulate insured financial institutions. Under FIRREA, the Federal Savings and Loan Insurance Corporation ("FSLIC") and the Federal Home Loan Bank Board were abolished and the FDIC was authorized to insure savings associations, including federal savings associations, state chartered savings and loans and other corporations determined to be operated in substantially the same manner as a savings association. FIRREA established two deposit insurance funds to be administered by the FDIC. The money in these two funds is separately maintained and not commingled. The FDIC Permanent Insurance Fund was replaced by the Bank Insurance Fund (the "BIF") and the FSLIC deposit insurance fund was replaced by the Savings Association Insurance Fund (the "SAIF"). The Bank's deposit accounts are insured by the BIF, as administered by the FDIC, up to the maximum amount permitted by law. Palomar's deposit accounts are insured by the SAIF, as administered by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the institution's primary regulator. Deposit Insurance Assessments. Under FIRREA, the premium assessments made on - ------------------------------- banks and savings associations for deposit insurance were initially increased, with rates set separately for banks and savings associations, subject to statutory restrictions. The Omnibus Budget Reconciliation Act of 1990, designed to address the federal budget deficit, increased the insurance assessment rates for members of the BIF and the SAIF over that provided by FIRREA, and eliminated FIRREA's maximum reserve-ratio constraints on the BIF. The FDIC raised BIF premiums to 23 per $100 in insured deposits for 1993 from a base of 12 in 1990. Effective January 1, 1994, the FDIC implemented a risk-based assessment system, under which an institution's premium assessment is based on the probability that the deposit insurance fund will incur a loss with respect to the institution, the likely amount of such loss, and the revenue needs of the deposit insurance fund. As long as BIF's reserve ratio is less than a specified "designated reserve ratio," 1.25%, the total amount raised from BIF members by the risk-based assessment system may not be less than the amount that would be raised if the assessment rate for all BIF members were 23 per $100 in insured deposits. The FDIC determined that the designated reserve ratio was achieved on May 31, 1995. Accordingly, on August 8, 1995, the FDIC issued final regulations adopting an assessment rate schedule for BIF members of 4 to 31 per $100 in insured deposits that became effective June 1, 1995. On November 14, 1995, the FDIC further reduced the BIF assessment rates by 4 so that effective January 1, 1996, the premiums ranged from zero to 27 per $100 in insured deposits, but in any event not less than $2,000 per year. The Deposit Insurance Funds Act of 1996, signed into law on September 30, 1996, eliminated the minimum assessment, commencing with the fourth quarter of 1996. 28 Under the risk-based assessment system, as of December 31, 1995, SAIF members paid within a range of $.23 to $.31 per $100 insured deposits, depending upon the institution's risk classification. Pursuant to the Economic Growth and Paperwork Reduction Act of 1996 (the "EGPRA"), the FDIC imposed a special assessment on SAIF members to capitalize the SAIF at the "designated reserve ratio" of 1.25% as of October 1, 1996. Based on Palomar's deposits as of March 31, 1995, the date for measuring the amount of the special assessment pursuant to the EGPRA, Palomar paid a special assessment of $506,000 in October, 1996 to recapitalize the SAIF. This expense was recognized during the third quarter of 1996. Under the risk-based assessment system, a BIF member institution such as the Bank is categorized into one of three capital categories (well capitalized, adequately capitalized, and undercapitalized) and one of three categories based on supervisory evaluations by its primary federal regulator (in the Bank's case, the OCC). The three supervisory categories are: financially sound with only a few minor weaknesses (Group A), demonstrates weaknesses that could result in significant deterioration (Group B), and poses a substantial probability of loss (Group C). The capital ratios used by the OCC to define well-capitalized, adequately capitalized and undercapitalized are the same as in the OCC's and FRB's prompt corrective action regulations (discussed below). The BIF assessment rates since January 1, 1997, are summarized below; assessment figures are expressed in terms of cents per $100 in insured deposits. The capital and supervisory group ratings for SAIF institutions are the same as for BIF institutions. Accordingly, Palomar's deposit insurance assessment rate is also derived from the following table:
ASSESSMENT RATES EFFECTIVE JANUARY 1, 1997 SUPERVISORY GROUP CAPITAL GROUP GROUP A GROUP B GROUP C ------- ------- ------- Well Capitalized 0 3 10 Adequately Capitalized 3 10 24 Undercapitalized 17 24 27
Pursuant to the EGPRA, Palomar pays its normal deposit insurance premium as a member of the SAIF. In addition, Palomar also pays an amount equal to $.064 per $100 in deposits towards the retirement of the Financing Corporation Bonds ("FICO Bonds") issued in the 1980's to assist in the recovery of the savings and loan industry. Furthermore, after December 31, 1996, banks are required to share in the payment of interest on FICO bonds. Previously, the FICO debt was paid out of the SAIF assessment base. The assessments imposed on insured depository institutions with respect to any BIF-assessable deposit will be assessed at a rate equal to 1/5 of the rate of the assessments imposed on insured depository institutions with respect to any SAIF-assessable deposit. Although the FICO assessment rates are annual rates, they are subject to change quarterly. Since the FICO bonds do not mature until the year 2019, it is conceivable that banks will continue to share in the payment of the interest on the bonds until then. The following table shows the quarterly assessment rates for SAIF and BIF insured deposits, expressed in cents per $100 in insured deposits:
FICO ASSESSMENT RATES ----------------------- SAIF BIF ---- ----- First Quarter, 1997 6.48 1.296 Second Quarter, 1997 6.50 1.300 Third Quarter, 1997 6.30 1.260 Fourth Quarter, 1997 6.32 1.264 First Quarter, 1998 6.28 1.256 Second Quarter, 1998 6.22 1.244 Third Quarter, 1998 6.10 1.220 Fourth Quarter, 1998 5.82 1.164
Under the EGPRA, the FDIC is not permitted to establish SAIF assessment rates that are lower than comparable BIF assessment rates. Beginning no later than January 1, 2000, the rate paid to retire the FICO Bonds will be equal for members of the BIF and the SAIF. The EGPRA also provides for the merging of the BIF and the SAIF by January 1, 2000, provided that there are no financial institutions chartered as savings associations at that time. Should the insurance funds be merged before January 1, 2000, the rate paid by all members of this new find to retire the FICO Bonds will be equal. 29 With certain limited exceptions, FIRREA prohibits a bank from changing its status as an insured depository institution with the BIF to the SAIF and prohibits a savings association from changing its status as an insured depository institution with the SAIF to the BIF, without the prior approval of the FDIC. FDIC Receiverships. Pursuant to FIRREA, the FDIC may be appointed conservator - -------------------- or receiver of any insured bank or savings association. In addition, FIRREA authorized the FDIC to appoint itself as sole conservator or receiver of any insured state bank or savings association for any, among others, of the following reasons: (i) insolvency of such institution; (ii) substantial dissipation of assets or earnings due to any violation of law or regulation or any unsafe or unsound practice; (iii) an unsafe or unsound condition to transact business, including substantially insufficient capital or otherwise; (iv) any willful violation of a cease and desist order which has become final; (v) any concealment of books, papers, records or assets of the institution; (vi) the likelihood that the institution will not be able to meet the demands of its depositors or pay its obligations in the normal course of business; (vii) the incurrence or likely incurrence of losses by the institution that will deplete all or substantially all of its capital with no reasonable prospect for the replenishment of the capital without federal assistance; or (viii) any violation of any law or regulation, or an unsafe or unsound practice or condition which is likely to cause insolvency or substantial dissipation of assets or earnings, or is likely to weaken the condition of the institution or otherwise seriously prejudice the interest of its depositors. As a receiver of any insured depository institution, the FDIC may liquidate such institution in an orderly manner and make such other disposition of any matter concerning such institution as the FDIC determines is in the best interests of such institution, its depositors and the FDIC. Further, the FDIC shall as the conservator or receiver, by operation of law, succeed to all rights, titles, powers and privileges of the insured institution, and of any stockholder, member, account holder, depositor, officer or director of such institution with respect to the institution and the assets of the institution; may take over the assets of and operate such institution with all the powers of the members or shareholders, directors and the officers of the institution and conduct all business of the institution; collect all obligations and money due to the institution and preserve; and conserve the assets and property of such institution. Enforcement Powers. Some of the most significant provisions of FIRREA were the - -------------------- expansion of regulatory enforcement powers. FIRREA has given the federal regulatory agencies broader and stronger enforcement authorities reaching a wider range of persons and entities. Some of those provisions included those which: (i) expanded the category of persons subject to enforcement under the Federal Deposit Insurance Act; (ii) expanded the scope of cease and desist orders and provided for the issuance of a temporary cease and desist orders; (iii) provided for the suspension and removal of wrongdoers on an expanded basis and on an industry-wide basis; (iv) prohibited the participation of persons suspended or removed or convicted of a crime involving dishonesty or breach of trust from serving in another insured institution; (v) required regulatory approval of new directors and senior executive officers in certain cases; (vi) provided protection from retaliation against "whistleblowers" and establishes rewards for "whistleblowers" in certain enforcement actions resulting in the recovery of money; (vii) required the regulators to publicize all final enforcement orders; (viii) required each insured financial institution to provide its independent auditor with its most recent Report of Condition ("Call Report"); (ix) significantly increased the penalties for failure to file accurate and timely Call Reports; and (x) provided for extensive increases in the amounts and circumstances for assessment of civil money penalties, civil and criminal forfeiture and other civil and criminal fines and penalties. Crime Control Act of 1990. The Crime Control Act of 1990 further strengthened - ---------------------------- the authority of federal regulators to enforce capital requirements, increased civil and criminal penalties for financial fraud, and enacted provisions allowing the FDIC to regulate or prohibit certain forms of golden parachute benefits and indemnification payments to officers and directors of financial institutions. 30 3. Risk-Based Capital Guidelines ------------------------------- The federal banking agencies have established risk-based capital guidelines. The risk-based capital guidelines include both a new definition of capital and a framework for calculating risk weighted assets by assigning assets and off-balance sheet items to broad credit risk categories. A bank's risk-based capital ratio is calculated by dividing its qualifying capital (the numerator of the ratio) by its risk weighted assets (the denominator of the ratio). A bank's qualifying total capital consists of two types of capital components: "core capital elements" (comprising Tier 1 capital) and "supplementary capital elements" (comprising Tier 2 capital). The Tier 1 component of a bank's qualifying capital must represent at least 50% of qualifying total capital and may consist of the following items that are defined as core capital elements: (i) common stockholders' equity; (ii) qualifying noncumulative perpetual preferred stock (including related surplus); and (iii) minority interest in the equity accounts of consolidated subsidiaries. The Tier 2 component of a bank's qualifying total capital may consist of the following items: (i) allowance for loan and lease losses (subject to limitations); (ii) perpetual preferred stock and related surplus (subject to conditions); (iii) hybrid capital instruments (as defined) and mandatory convertible debt securities; and (iv) term subordinated debt and intermediate-term preferred stock, including related surplus (subject to limitations). Assets and credit equivalent amounts of off-balance sheet items are assigned to one of several broad risk categories, according to the obligor, or, if relevant, the guarantor or the nature of collateral. The aggregate dollar value of the amount in each category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are added together, and this sum is the bank's total risk weighted assets that comprise the denominator of the risk-based capital ratio. Risk weights for all off-balance sheet items are determined by a two-step process. First, the "credit equivalent amount" of off-balance sheet items such as letters of credit and recourse arrangements is determined, in most cases by multiplying the off-balance sheet item by a credit conversion factor. Second, the credit equivalent amount is treated like any balance sheet asset and generally is assigned to the appropriate risk category according to the obligor, or, if relevant, the guarantor or the nature of the collateral. The supervisory standards set forth below specify minimum supervisory ratios based primarily on broad risk considerations. The risk-based ratios do not take explicit account of the quality of individual asset portfolios or the range of other types of risks to which banks may be exposed, such as interest rate, liquidity, market or operational risks. For this reason, banks are generally expected to operate with capital positions above the minimum ratios. All banks are required to meet a minimum ratio of qualifying total capital to risk weighted assets of 8%, of which at least 4% should be in the form of Tier 1 capital net of goodwill, and a minimum ratio of Tier 1 capital to risk weighted assets of 4%. The maximum amount of supplementary capital elements that qualifies as Tier 2 capital is limited to 100% of Tier 1 capital net of goodwill. In addition, the combined maximum amount of subordinated debt and intermediate-term preferred stock that qualifies as Tier 2 capital is limited to 50% of Tier 1 capital. The maximum amount of the allowance for loan and lease losses that qualifies as Tier 2 capital is limited to 1.25% of gross risk weighted assets. Allowance for loan and lease losses in excess of this limit may, of course, be maintained, but would not be included in a bank's risk-based capital calculation. In addition to the risk-based guidelines, the federal banking agencies require all banks to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a bank rated in the highest of the five categories used by regulators to rate banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all banks not rated in the highest category, the minimum leverage ratio must be at least 4% to 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. In December, 1993, the federal banking agencies issued an interagency policy statement on the allowance for loan and lease losses which, among other things, establishes certain benchmark ratios of loan loss reserves to classified assets. The benchmark set forth by the policy statement is the sum of: (a) assets classified loss; (b) 50% of assets classified doubtful; (c) 15% of assets classified substandard; and (d) estimated credit losses on other assets over the upcoming twelve months. 31 The federal banking agencies have recently revised their risk-based capital rules to take account of concentrations of credit and the risks of non-traditional activities. Concentrations of credit refers to situations where a lender has a relatively large proportion of loans involving one borrower, industry, location, collateral or loan type. Non-traditional activities are considered those that have not customarily been part of the banking business but that start to be conducted as a result of developments in, for example, technology or financial markets. The regulations require institutions with high or inordinate levels of risk to operate with higher minimum capital standards. The federal banking agencies also are authorized to review an institution's management of concentrations of credit risk for adequacy and consistency with safety and soundness standards regarding internal controls, credit underwriting or other operational and managerial areas. Further, the banking agencies recently have adopted modifications to the risk-based capital rules to include standards for interest rate risk exposures. Interest rate risk is the exposure of a bank's current and future earnings and equity capital arising from adverse movements in interest rates. While interest rate risk is inherent in a bank's role as financial intermediary, it introduces volatility to bank earnings and to the economic value of the bank. The banking agencies have addressed this problem by implementing changes to the capital standards to include a bank's exposure to declines in the economic value of its capital due to changes in interest rates as a factor that the banking agencies will consider in evaluating an institution's capital adequacy. Bank examiners consider a bank's historical financial performance and its earnings exposure to interest rate movements as well as qualitative factors such as the adequacy of a bank's internal interest rate risk management. The federal banking agencies recently considered adopting a uniform supervisory framework for all institutions to measure and assess each bank's exposure to interest rate risk and establish an explicit capital charge based on the assessed risk, but ultimately elected not to adopt such a uniform framework. Even without such a uniform framework, however, each bank's interest rate risk exposure is assessed by its primary federal regulator on an individualized basis, and it may be required by the regulator to hold additional capital for interest rate risk if it has a significant exposure to interest rate risk or a weak interest rate risk management process. Effective April 1, 1995, the federal banking agencies issued rules which limit the amount of deferred tax assets that are allowable in computing a bank's regulatory capital. The standard had been in effect on an interim basis since March, 1993. Deferred tax assets that can be realized for taxes paid in prior carryback years and from future reversals of existing taxable temporary differences are generally not limited. Deferred tax assets that can only be realized through future taxable earnings are limited for regulatory capital purposes to the lesser of: (i) the amount that can be realized within one year of the quarter-end report date; or (ii) 10% of Tier 1 capital. The amount of any deferred tax in excess of this limit would be excluded from Tier 1 capital, total assets and regulatory capital calculations. 4. Federal Deposit Insurance Corporation Improvement Act of 1991 -------------------------------------------------------------------- General. The Federal Deposit Insurance Corporation Improvement Act of 1991 - -------- ("FDICIA") was signed into law on December 19, 1991. FDICIA recapitalized the BIF, granted broad authorization to the FDIC to increase deposit insurance premium assessments and to borrow from other sources, and continued the expansion of regulatory enforcement powers, along with many other significant changes. Prompt Corrective Action. FDICIA established five categories of bank - -------------------------- capitalization: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized" and mandated the establishment of a system of "prompt corrective action" for institutions falling into the lower capital categories. Under FDICIA, banks are prohibited from paying dividends or management fees to controlling persons or entities if, after making the payment the bank would be undercapitalized, that is, the bank fails to meet the required minimum level for any relevant capital measure. Asset growth and branching restrictions apply to undercapitalized banks, which are required to submit acceptable capital plans guaranteed by its holding company, if any. Broad regulatory authority was granted with respect to significantly undercapitalized banks, including forced mergers, growth restrictions, ordering new elections for directors, forcing divestiture by its holding company, if any, requiring management changes, and prohibiting the payment of bonuses to senior management. Even more severe restrictions are applicable to critically undercapitalized banks, those with capital at or less than 2%, including the appointment of a receiver or conservator after 90 days, even if the bank is still solvent. 32 The federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action. Under the regulations, a bank shall be deemed to be: (i) "well capitalized" if it has a total risk-based capital ratio of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a leverage capital ratio of 5.0% or more and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure; (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized"; (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0%, or a leverage capital ratio that is less than 4.0% (3.0% under certain circumstances); (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a leverage capital ratio that is less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Information concerning the Company's capital adequacy at December 31, 1998, is discussed in the capital adequacy section. FDICIA and the implementing regulations also provide that a federal banking agency may, after notice and an opportunity for a hearing, reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category if the institution is in an unsafe or unsound condition or engaging in an unsafe or unsound practice. (The federal banking agency may not, however, reclassify a significantly undercapitalized institution as critically undercapitalized.) Operational Standards. FDICIA also granted the regulatory agencies authority to - ---------------------- prescribe standards relating to internal controls, credit underwriting, asset growth and compensation, among others, and required the regulatory agencies to promulgate regulations prohibiting excessive compensation or fees. Many regulations have been adopted by the regulatory agencies to implement these provisions and subsequent legislation (the Riegal Community Development Act, discussed below) gave the regulatory agencies the option of prescribing the safety and soundness standards as guidelines rather than regulations. Regulatory Accounting Reports. Each bank with $500 million or more in assets is - ------------------------------ required to submit an annual report to the FDIC, as well as any other federal banking agency with authority over the bank, and any appropriate state banking agency; in the Bank's case, the OCC. This report must contain a statement regarding management's responsibilities for: (i) preparing financial statements; (ii) establishing and maintaining adequate internal controls; and (iii) complying with applicable laws and regulations. In addition to having an audited financial statement by an independent accounting firm on an annual basis, the accounting firm must determine and report as to whether the financial statements are presented fairly and in accordance with generally accepted accounting principles and comply with other requirements of the applicable federal banking authority. In addition, the accountants must attest to and report to the regulators separately on management's compliance with internal controls. Truth in Savings. FDICIA further established a new truth in savings scheme, - ------------------- providing for clear and uniform disclosure of terms and conditions on which interest is paid and fees are assessed on deposits. The FRB's Regulation DD, implementing the Truth in Savings Act, became effective June 21, 1993. Brokered Deposits. Effective June 16, 1992, FDICIA placed restrictions on the - ------------------- ability of banks to obtain brokered deposits or to solicit and pay interest rates on deposits that are significantly higher than prevailing rates. FDICIA provides that a bank may not accept, renew or roll over brokered deposits unless: (i) it is "well capitalized"; or (ii) it is adequately capitalized and receives a waiver from the FDIC permitting it to accept brokered deposits paying an interest rate not in excess of 75 basis points over certain prevailing market rates. FDIC regulations define brokered deposits to include any deposit obtained, directly or indirectly, from any person engaged in the business of placing deposits with, or selling interests in deposits of, an insured depository institution, as well as any deposit obtained by a depository institution that is not "well capitalized" for regulatory purposes by offering rates significantly higher (generally more than 75 basis points) than the prevailing interest rates offered by depository institutions in such institution's normal market area. In addition to these restrictions on acceptance of brokered deposits, FDICIA provides that no pass-through deposit insurance will be provided to employee benefit plan deposits accepted by an institution which is ineligible to accept brokered deposits under applicable law and regulations. 33 Lending. New regulations have been issued in the area of real estate lending, - ------- prescribing standards for extensions of credit that are secured by real property or made for the purpose of the construction of a building or other improvement to real estate. In addition, the aggregate of all loans to executive officers, directors and principal shareholders and related interests may now not exceed 100% (200% in some circumstances) of the depository institution's capital. State Authorized Activities. The new legislation also created restrictions on - ----------------------------- activities authorized under state law. FDICIA generally restricts activities through subsidiaries to those permissible for national banks, unless the FDIC has determined that such activities would pose no risk to the insurance fund of which it is a member and the bank is in compliance with applicable regulatory capital requirements, thereby effectively eliminating real estate investment authorized under California law, and provided for a five-year divestiture period for impermissible investments. Insurance activities were also limited, except to the extent permissible for national banks. Qualified Thrift Lender Test. Savings associations, like Palomar, must meet a QTL test, which test may be met either by maintaining a specified level of assets in qualified thrift investments as specified in the Home Owners Loans Act ("HOLA") or by meeting the definition of a "domestic building and loan association" in Section 7701 of the California Financial Code ("CFC"). If Palomar maintains an appropriate level of certain specified investments (primarily residential mortgages and related investments, including certain mortgage-related securities) and otherwise qualifies as a QTL or a domestic building and loan association, it will continue to enjoy full borrowing privileges from the FHLB. The required percentage of investments under HOLA is 65% of assets while the CFC requires investments of 60% of assets. An association must be in compliance with the QTL test or the definition of domestic buildings and loan association on a monthly basis in nine out of every twelve months. Associations that fail to meet the QTL test will generally be prohibited from engaging in any activity not permitted for both a national bank and a savings association. As of December 31, 1998, Palomar was in compliance with its QTL requirements and met the definition of a domestic building and loan association. Activities of Subsidiaries. A savings association seeking to establish a new subsidiary, acquire control of an existing company or conduct a new activity through a subsidiary must provide 30 days prior notice to the FDIC and the OTS and conduct any activities of the subsidiary in accordance with regulations and orders of the OTS. The OTS has the power to require a savings association to divest any subsidiary or terminate any activity conducted by a subsidiary that the OTS determines to post a serious threat to the financial safety, soundness or stability of the savings association or to be otherwise inconsistent with sound banking practices. Federal Home Loan Bank System. Palomar is a member of the FHLB system. Among other benefits, each FHLB serves as a reserve or center bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available to its members, loans (i.e., advances) in accordance with the policies and procedures established by the Board of Directors of the individual FHLB. 5. Riegle Community Development and Regulatory Improvement Act of 1994 ------------------------------------------------------------------------- The Riegle Community Development and Regulatory Improvement Act of 1994 (the "1994 Act"), which has been viewed as the most important piece of banking legislation since the enactment of FDICIA, was signed into law on September 23, 1994. In addition to providing funding for the establishment of a Community Development Financial Institutions Fund (the "Fund"), which provides assistance to new and existing community development lenders to help meet the needs of low- and moderate-income communities and groups; the 1994 Act mandated changes to a wide range of banking regulations. These changes included modifications to the publication requirements for Call Reports, less frequent regulatory examination schedules for small institutions, small business and commercial real estate loan securitization, amendments to the money laundering and currency transaction reporting requirements of the Bank Secrecy Act, clarification of the coverage of the Real Estate Settlement Procedures Act for business, commercial and agricultural real estate secured transactions, amendments to the national flood insurance program, and amendments to the Truth in Lending Act to provide greater protection for consumers by reducing discrimination against the disadvantaged. 34 The "Paperwork Reduction and Regulatory Improvement Act," Title III of the 1994 Act, required the federal banking agencies to consider the administrative burdens that new regulations will impose before their adoption and requires a transition period in order to provide adequate time for compliance. This Act also requires the federal banking agencies to work together to establish uniform regulations and guidelines as well as to work together to eliminate duplicative or unnecessary requests for information in connection with applications or notices. This Act reduces the frequency of examinations for well-rated institutions, simplifies the quarterly Call Reports and eliminated the requirement that financial institutions publish their Call Reports in local newspapers. This Act also established an internal regulatory appeal process and independent ombudsman to provide a means for review of material supervisory determinations. The Paperwork Reduction and Regulatory Improvement Act also amended the Bank Holding Company Act and Securities Act of 1933 to simplify the formation of bank holding companies. Title IV of the 1994 Act amended the Bank Secrecy Act by reducing the reporting requirements imposed on financial institutions for large currency transactions, expanding the ability of financial institutions to provide exemptions to the reporting requirements for businesses that regularly deal in large amounts of currency, and providing for the delegation of civil money penalty enforcement from the Treasury Department to the individual federal banking agencies. 6. Safety and Soundness Standards --------------------------------- In July, 1995, the federal banking agencies adopted final guidelines establishing standards for safety and soundness, as required by FDICIA and the 1994 Act. The guidelines set forth operational and managerial standards relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. Guidelines for asset quality and earnings standards will be adopted in the future. The guidelines establish the safety and soundness standards that the agencies will use to identify and address problems at insured depository institutions before capital becomes impaired. If an institution fails to comply with a safety and soundness standard, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action. The federal banking agencies issued regulations prescribing uniform guidelines for real estate lending. The regulations require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan to value limits that do not exceed the supervisory limits prescribed by the regulations. Appraisals for "real estate related financial transactions" must be conducted by either state certified or state licensed appraisers for transactions in excess of certain amounts. State certified appraisers are required for all transactions with a transaction value of $1,000,000 or more; for all nonresidential transactions valued at $250,000 or more; and for "complex" 1- 4 family residential properties of $250,000 or more. A state licensed appraiser is required for all other appraisals. However, appraisals performed in connection with "federally related transactions" must now comply with the agencies' appraisal standards. Federally related transactions include the sale, lease, purchase, investment in, or exchange of, real property or interests in real property, the financing or refinancing of real property, and the use of real property or interests in real property as security for a loan or investment, including mortgage-backed securities. 7. Consumer Protection Laws and Regulations -------------------------------------------- The bank regulatory agencies are focusing greater attention on compliance with consumer protection laws and their implementing regulations. Examination and enforcement have become more intense in nature, and insured institutions have been advised to monitor carefully compliance with various consumer protection laws and their implementing regulations. Banks are subject to many federal consumer protection laws and their regulations including, but not limited to, the Community Reinvestment Act (the "CRA"), the Truth in Lending Act (the "TILA"), the Fair Housing Act (the "FH Act"), the Equal Credit Opportunity Act (the "ECOA"), the Home Mortgage Disclosure Act ("HMDA"), and the Real Estate Settlement Procedures Act ("RESPA"). The CRA, enacted into law in 1977, is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal bank regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs of their entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA further requires the agencies to take a financial institution's record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions, or holding company formations. 35 The federal banking agencies have adopted regulations which measure a bank's compliance with its CRA obligations on a performance-based evaluation system. This system bases CRA ratings on an institution's actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. The ratings range from "outstanding" to a low of "substantial noncompliance." The ECOA, enacted into law in 1974, prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act. In March, 1994, the Federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in lending. The policy statement describes the three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment and evidence of disparate impact. This means that if a creditor's actions have had the effect of discriminating, the creditor may be held liable - even when there is no intent to discriminate. The FH Act, enacted into law in 1968, regulates many practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap, or familial status. The FH Act is broadly written and has been broadly interpreted by the courts. A number of lending practices have been found to be, or may be considered, illegal under the FH Act, including some that are not specifically mentioned in the FH Act itself. Among those practices that have been found to be, or may be considered, illegal under the FH Act are: declining a loan for the purposes of racial discrimination; making excessively low appraisals of property based on racial considerations; pressuring, discouraging, or denying applications for credit on a prohibited basis; using excessively burdensome qualifications standards for the purpose or with the effect of denying housing to minority applicants; imposing on minority loan applicants more onerous interest rates or other terms, conditions or requirements; and racial steering, or deliberately guiding potential purchasers to or away from certain areas because of race. The TILA, enacted into law in 1968, is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology and expressions of rates, the annual percentage rate, the finance charge, the amount financed, the total payments and the payment schedule. HMDA, enacted into law in 1975, grew out of public concern over credit shortages in certain urban neighborhoods. One purpose of HMDA is to provide public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. HMDA also includes a "fair lending" aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes. HMDA requires institutions to report data regarding applications for one-to-four family loans, home improvement loans, and multifamily loans, as well as information concerning originations and purchases of such types of loans. Federal bank regulators rely, in part, upon data provided under HMDA to determine whether depository institutions engage in discriminatory lending practices. RESPA, enacted into law in 1974, requires lenders to provide borrowers with disclosures regarding the nature and costs of real estate settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Violations of these various consumer protection laws and regulations can result in civil liability to the aggrieved party, regulatory enforcement including civil money penalties, and even punitive damages. 8. Recent California Developments - -- -------------------------------- In August, 1997, Governor Wilson of California signed Assembly Bill 1432 ("AB 1432"), which provides for certain changes in the Banking Laws of California. Effective January 1, 1998, AB 1432 eliminated the provisions regarding impairment of contributed capital and the assessment of shares when there is an impairment in a bank's capital. AB 1432 permits the Commission of the DFI ("the Commissioner") to close a bank if the Commissioner finds that the bank's tangible shareholders' equity is less than the greater of 3% of the bank's total assets of $1 million. 36 In addition, California law, in general, provides the Commissioner with certain additional enforcement powers. For example, if it appears to the Commissioner that a bank is violating its articles of incorporation or state law, or is engaging in unsafe or unsound business practices, the Commissioner can order the bank to comply with law or to cease unsafe or injurious practices. The Commissioner also has the power to suspend or remove a bank's officers, directors and employees who: (i) violate any law, regulation or fiduciary duty to the bank; (ii) engage in any unsafe or unsound practices related to the business of the bank; (iii) are charged with or convicted of a crime involving dishonesty or breach of trust. 9. Conclusion ---------- As a result of the recent federal and California legislation, there has been a competitive impact on commercial banking. There has been a lessening of the historical distinction between the services offered by banks, savings and loan associations, credit unions, and other financial institutions, banks have experienced increased competition for deposits and loans which may result in increases in their cost of funds, and banks have experienced increased costs. Further, the federal banking agencies have increased enforcement authority over banks and their directors and officers. Future legislation is also likely to impact the companies and the subsidiaries' business. Consumer legislation has been proposed in Congress which may require banks to offer basic, low-cost, financial services to meet minimum consumer needs. Various proposals to restructure the federal bank regulatory agencies are currently pending in Congress, some of which include proposals to expand the ability of banks to engage in previously prohibited businesses. Further, the regulatory agencies have proposed and may propose a wide range of regulatory changes, including the calculation of capital adequacy and limiting business dealings with affiliates. These and other legislative and regulatory changes may have the impact of increasing the cost of business or otherwise impacting the earnings of financial institutions. However, the degree, timing and full extent of the impact of these proposals cannot be predicted. Management of the Company and the Subsidiaries cannot predict what other legislation might be enacted or what other regulations might be adopted or the effects thereof. 37 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK - -------------------------------------------------------------------------- The Company's primary market risk is interest rate risk. Interest rate risk is the potential of economic losses caused by future interest rate change. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the risks. Community West Bancshares' exposure to market risk is reviewed on a regular basis by the Asset/Liability committee. Tools used by management include the standard GAP report. The Company has no market risk instruments held for trading purposes except for its interest only strip. Management believes the Company's market risk is reasonable at this time. The Company currently does not enter into derivative financial instruments. See "Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management". The table below provides information about the Company's financial instruments that are sensitive to changes in interest rates. For all outstanding financial instruments, the table presents the outstanding principle balance at December 31, 1998, and the weighted average interest yield/rate of the instruments by either the date the instrument can be repriced for variable rate financial instruments or the expected maturity date for fixed rate financial instruments,
At December 31, 1998 Expected maturity dates or repricing dates by year 2003 and Fair Value (Dollars in thousands) 1999 2000 2001 2002 beyond Total at 12/31/98 Balance sheet financial instruments: Assets: Time deposits in other financial institutions: $ 1,500 - - - - $ 1,500 $ 1,500 Average Yield 5.7% Federal Funds Sold: $ 43,355 - - - - $ 43,355 $ 43,355 Average Yield 5.1% Investment securities, held to maturity: $ 501 - - - - $ 501 $ 502 Average Yield 6.8% Investment securities, available-for-sale: $ 754 - - - $ 7,541 $ 8,295 $ 8,295 Average Yield 6.0% 6.7% Federal Reserve Bank/Federal Home Loan Bank stock: - - - - $ 810 $ 810 $ 810 Average Yield 6.1% Interest only strip: $ 10,915 - - - - $ 10,915 $ 10,915 Average Yield 11.0% Servicing asset: $ 1,472 - - - - $ 1,472 $ 1,472 Average Yield 11.0% Liabilities: Non-interest bearing demand: $ 19,487 - - - - $ 19,487 $ 19,487 Average Yield 0.0% Interest- bearing demand: $ 19,976 - - - - $ 19,976 $ 19,976 Average Yield 2.8% Savings: $ 26,860 - - - - $ 26,860 $ 26,860 Average Yield 3.3% Time certificates of deposit: $157,221 - - - - $157,221 $ 162,260 Average Yield 5.7%
(continued on next page) 38
At December 31, 1997 Expected maturity dates or repricing dates by year 2002 and Fair Value (Dollars in thousands) 1998 1999 2000 2001 beyond Total at 12/31/97 Balance sheet financial instruments: Assets: Time deposits in other financial institutions: $ 2,477 - - - - $ 2,477 $ 2,477 Average Yield 5.7% Federal Funds Sold: $12,540 - - - - $12,540 $ 12,540 Average Yield 5.3% Investment securities, held to maturity: $ 998 - - - $ 4,156 $ 5,154 $ 4,964 Average Yield 6.0% 6.2% Investment securities, available-for-sale: $ 752 - - - $ 8,160 $ 8,912 $ 8,912 Average Yield 6.0% 6.7% Federal Reserve Bank/Federal Home Loan Bank stock: - - - - $ 763 $ 763 $ 763 Average Yield 6.5% Interest only strip: $ 2,529 - - - - $ 2,529 $ 2,529 Average Yield 11.0% Servicing asset: $ 664 - - - - $ 664 $ 664 Average Yield 11.0% Liabilities: Non-interest bearing demand: $15,597 - - - - $15,597 $ 15,597 Average Yield 0.0% Interest- bearing demand: $19,203 - - - - $19,203 $ 19,203 Average Yield 2.9% Savings: $25,847 - - - - $25,847 $ 25,847 Average Yield 3.2% Time certificates of deposit: $92,044 - - - - $92,044 $ 92,198 Average Yield 5.6%
39 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Community West Bancshares We have audited the consolidated balance sheets of Community West Bancshares and subsidiaries (the "Company") as of December 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits. The consolidated financial statements give retroactive effect to the merger of the Company and Palomar Savings and Loan Association ("Palomar"), which has been accounted for as a pooling of interests as described in Note 8 to the consolidated financial statements. We did not audit the balance sheet of Palomar as of December 31, 1997, or the related statements of income, stockholders' equity, and cash flows of Palomar for the years ended December 31, 1997 and 1996, which statements reflect total assets of $78,607,165 as of December 31, 1997, and total revenues of $6,009,798 and $6,004,002 for the years ended December 31, 1997 and 1996, respectively. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Palomar for 1997 and 1996, is based solely on the report of such other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Community West Bancshares and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. March 19, 1999 40
COMMUNITY WEST BANCSHARES CONSOLIDATED BALANCE SHEETS DECEMBER 31, - --------------------------------------------------------------------------------------------------- ASSETS 1998 1997 Cash and due from banks $ 6,124,128 $ 6,296,534 Federal funds sold 43,355,000 12,540,000 ------------- ------------ Cash and cash equivalents (Note 1) 49,479,128 18,836,534 Time deposits in other financial institutions 1,500,000 2,477,000 Federal Reserve Bank and Federal Home Loan Bank stock, at cost 810,350 763,300 Investment securities held to maturity, at amortized cost; fair value of $502,656 in 1998 and $4,963,528 in 1997 (Note 2) 501,094 5,154,479 Investment securities available for sale, at fair value (Note 2) 8,295,099 8,911,878 Investment securities held for trading, at fair value (Note2 and 3) 10,914,900 2,528,587 Servicing assets (Note 3) 1,472,453 664,402 Loans (Notes 3 and 4) Held for investment, net of allowance for loan losses of $2,128,710 in 1998 and $2,066,852 in 1997 107,099,184 112,645,496 Held for sale, at lower of cost or fair value 58,835,944 15,739,244 Other real estate owned, net 241,363 - Premises and equipment, net (Note 6) 4,538,999 2,852,624 Accrued interest receivable and other assets 8,345,538 3,346,066 ------------- ------------ TOTAL $252,034,052 $173,919,610 ============= ============ LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Deposits: (Note 7) Noninterest-bearing demand $ 19,487,328 $ 15,596,582 Interest-bearing demand 19,976,138 19,203,356 Savings 26,860,381 25,847,070 Time certificates of $100,000 or more 61,742,177 30,898,437 Other time certificates 95,478,775 61,145,627 ------------- ------------ Total deposits 223,544,799 152,691,072 Accrued interest payable and other liabilities (Note 11) 3,935,857 3,573,964 ------------- ------------ Total liabilities 227,480,656 156,265,036 ------------- ------------ COMMITMENTS AND CONTINGENCIES (Note 10) STOCKHOLDERS' EQUITY (Notes 8, 9 and 12) Common stock, no par value; 10,000,000 shares authorized; 5,479,710 and 4,380,475 shares issued and outstanding at December 31, 1998 and 1997 17,303,590 12,833,315 Less: Treasury stock, at cost (14,807 shares) (140,739) - Retained earnings 7,392,992 4,790,090 Accumulated other comprehensive (loss) income (2,447) 31,169 ------------- ------------ Total stockholders' equity 24,553,396 17,654,574 ------------- ------------ TOTAL $252,034,052 $173,919,610 ============= ============
See notes to consolidated financial statements. 41
COMMUNITY WEST BANCSHARES CONSOLIDATED STATEMENTS OF INCOME THREE YEARS ENDED DECEMBER 31, - ------------------------------------------------------------------------------------------- 1998 1997 1996 INTEREST INCOME: Loans, including fees $18,879,280 $11,762,488 $10,630,453 Federal funds sold 673,004 616,197 428,795 Time deposits in other financial institutions 123,317 229,670 196,826 Investment securities 870,997 944,152 1,203,854 ----------- ----------- ----------- Total interest income 20,546,598 13,552,507 12,459,928 INTEREST EXPENSE ON DEPOSITS 9,256,700 6,360,885 5,990,252 ----------- ----------- ----------- NET INTEREST INCOME 11,289,898 7,191,622 6,469,676 PROVISION FOR LOAN LOSSES (Note 4) 428,969 190,548 650,488 ----------- ----------- ----------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,860,929 7,001,074 5,819,188 ----------- ----------- ----------- OTHER INCOME: Gains from loan sales 6,393,786 4,389,936 2,645,371 Loan origination fees - sold or brokered loans 3,690,118 3,005,408 2,095,458 Document processing fees 1,647,708 819,355 509,650 Loan servicing fees 962,478 713,168 767,961 Service charges 887,188 961,797 646,253 Other income 454,610 21,293 311,944 ----------- ----------- ----------- Total other income 14,035,888 9,910,957 6,976,637 OTHER EXPENSES: Salaries and employee benefits (Note 13) 12,868,205 8,120,536 6,187,793 Occupancy expenses (Note 10) 2,738,790 1,735,730 1,397,966 Other operating expenses 1,657,226 1,149,318 1,645,470 Advertising expense 842,362 638,814 347,639 Professional services 840,931 506,845 350,927 Postage & freight 469,979 849,746 570,526 Data processing/ATM processing 390,091 242,696 219,212 Office supply expense 267,111 202,343 184,241 ----------- ----------- ----------- Total other expenses 20,074,695 13,446,028 10,903,774 INCOME BEFORE PROVISION FOR INCOME TAXES 4,822,122 3,466,003 1,892,051 PROVISION FOR INCOME TAXES (Note 11) 1,941,355 1,316,351 688,478 ----------- ----------- ----------- NET INCOME $ 2,880,767 $ 2,149,652 $ 1,203,573 =========== =========== =========== NET INCOME PER SHARE -- BASIC $ 0.57 $ 0.49 $ 0.32 =========== =========== =========== NET INCOME PER SHARE -- DILUTED $ 0.55 $ 0.43 $ 0.31 =========== =========== ===========
See notes to consolidated financial statements. 42
COMMUNITY WEST BANCSHARES - --------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY THREE YEARS ENDED DECEMBER, 31 - ------------------------------------------------------------------------------------------------------------------------ Accum. Common Stock Treasury Stock Other ----------------------- ------------------ Retained Comprehensive Shares Amount Shares Amount Earnings Income (loss) --------- ------------ ------ ---------- ----------- --------- BALANCE, JANUARY 1, 1996 3,335,759 $ 9,440,419 - $ - $1,508,300 $ (7,816) Secondary offering of common stock and warrants 859,368 2,788,048 - - - - Cash Dividend - - - - (71,435) - Exercise of Warrants 3,848 16,835 - - - - Exercise of Stock Options 47,168 107,230 - - - - Change in unrealized gains/(losses) on securities available-for-sale, net - - - - - 1,416 Net Income - - - - 1,203,573 - --------- ------------ ------ ---------- ----------- --------- BALANCE DECEMBER 31, 1996 4,246,143 12,352,532 - - 2,640,438 (6,400) Issuance of founders stock - 10,000 - - - - Exercise of Warrants 63,692 278,653 - - - - Exercise of Stock Options 70,640 192,130 - - - - Change in unrealized gains/(losses) on securities available-for-sale, net - - - - - 37,569 Net Income - - - - 2,149,652 - --------- ------------ ------ ---------- ----------- --------- BALANCE DECEMBER 31, 1997 4,380,475 12,833,315 - - 4,790,090 31,169 Retirement of founders stock - (10,000) - - - - Palomar Stock Dividend 68,383 276,381 - - (276,381) - Cash in lieu of fractional shares-stock dividend - - - - (1,484) - Exercise of Warrants 875,140 3,828,738 - - - - Exercise of Stock Options 155,712 375,156 - - - - Change in unrealized gains/(losses) on securities available-for-sale, net - - - - - (33,616) Treasury Stock Purchase - - 14,807 (140,739) - - Net Income - - - - 2,880,767 - --------- ------------ ------ ---------- ----------- --------- BALANCE DECEMBER 31, 1998 5,479,710 $17,303,590 14,807 $(140,739) $7,392,992 $ (2,447) ========= ============ ====== ========== =========== ========= Total Stockholders' Comprehensive Equity Income ------------ ----------- BALANCE, JANUARY 1, 1996 $10,940,903 $ (7,816) Secondary offering of common stock and warrants 2,788,048 - Cash Dividend (71,435) - Exercise of Warrants 16,835 - Exercise of Stock Options 107,230 - Change in unrealized gains/(losses) on securities available-for-sale, net 1,416 1,416 Net Income 1,203,573 1,203,573 ------------ ----------- BALANCE DECEMBER 31, 1996 14,986,570 1,204,989 Issuance of founders stock 10,000 - Exercise of Warrants 278,653 - Exercise of Stock Options 192,130 - Change in unrealized gains/(losses) on securities available-for-sale, net 37,569 37,569 Net Income 2,149,652 2,149,652 ------------ ----------- BALANCE DECEMBER 31, 1997 17,654,574 2,187,221 Retirement of founders stock (10,000) - Palomar Stock Dividend - - Cash in lieu of fractional shares-stock dividend (1,484) - Exercise of Warrants 3,828,738 - Exercise of Stock Options 375,156 - Change in unrealized gains/(losses) on securities available-for-sale, net (33,616) (33,616) Treasury Stock Purchase (140,739) - Net Income 2,880,767 2,880,767 ------------ ----------- BALANCE DECEMBER 31, 1998 $24,553,396 $2,847,151 ============ ===========
Disclosure of reclassification amount for December 31: 1998 1997 1996 --------- ------- --------- Unrealized holding gains (losses) arising during the period, net of tax expense (benefit) of ($69,763) in 1998, $18,502 in 1997, and $10,832 in 1996 $(96,340) $25,550 $ 14,959 Less: Reclassification adjustment for gains (losses) included in net income, net of tax (expense) benefit of ($45,421) in 1998, ($8,703) in 1997, and $9,807 in 1996 62,724 12,019 (13,543) --------- ------- --------- Net change in unrealized loss on investment securities available for sale, net of tax (expense) or benefit of $24,342 in 1998, ($27,205) in 1997, and ($1,025) in 1996 $(33,616) $37,569 $ 1,416 ========= ======= =========
See notes to consolidated financial statements. 43
COMMUNITY WEST BANCSHARES CONSOLIDATED STATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, - ------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 ------------- ------------- ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,880,767 $ 2,149,652 $ 1,203,573 Adjustments to reconcile net income to net cash used in operating activities: Provision for loan losses 428,969 190,548 650,488 Provision for losses on real estate owned - 70,211 15,784 Deferred income taxes provision 2,124,385 147,890 317,094 Depreciation and amortization 954,129 625,672 516,539 Gain on sale of other real estate owned (25,283) (37,273) (65,163) Gain on sale of loans held for sale (6,393,786) (4,389,936) (2,645,371) Losses (gains) on sale of securities, available-for-sale 108,145 20,722 (23,350) Sale of held to maturity security 0 - - Gain on sale of real estate investment (8,312) (10,740) (112,494) FHLB capital stock dividends (34,300) (30,400) (30,200) Origination of servicing and interest only strip assets, net of amortization (6,963,281) (294,947) (1,191,149) Net change in deferred loan fees and premiums (38,406) (39,500) 7,094 Changes in operating assets and liabilities: Accrued interest receivable and other assets (4,999,472) (1,174,846) 1,347,187 Accrued interest payable and other liabilities 361,893 2,650,848 (408,510) ------------- ------------- ------------ Net cash (used in) provided by operating activities (11,604,552) (122,099) (418,478) ------------- ------------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of held-to-maturity securities and FRB/FHLB stock (515,394) (1,096,395) (3,747,374) Maturities of held-to-maturity securities 1,736,143 2,996,191 1,000,000 Purchase of securities, Available-for-Sale (3,029,374) (6,838,572) (5,954,473) Proceeds from sale of securities, Available-for-Sale 3,296,112 4,100,377 12,190,353 Principal repayment on investments 3,582,559 778,187 1,409,900 Net increase in loans and loans held for sale (78,861,135) (28,284,029) (9,330,577) Proceeds from sale of loans 42,928,431 17,630,810 3,370,489 Purchase of loan servicing (319,152) - - Cash disbursement from real estate ventures, net 79,775 9,198 99,842 Proceeds from sale of real estate investments - - 94,995 Proceeds from sale of other real estate owned 112,591 725,603 1,193,385 Redemption of FHLB stock - - 195,000 Net decrease (increase) in time deposits in other financial institutions 977,000 (99,000) (1,000,000) Purchase of premises and equipment (2,645,808) (921,801) (1,340,793) ------------- ------------- ------------ Net cash used in investing activities (32,658,252) (10,999,431) (1,819,253) ------------- ------------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in demand deposits, and savings accounts 5,676,839 6,616,271 (522,502) Net increase in time certificates 65,176,888 2,969,193 6,033,882 Net decrease in borrowings from FHLB - (2,000,000) - Proceeds from the secondary offering of common stock and warrants - - 2,788,048 Purchase of treasury stock (140,739) - - Issuance of founder's stock Retirement of founder's stock (10,000) 10,000 Exercise of Stock options and warrants 4,203,894 470,783 124,065 Cash paid in lieu of fractional shares - stock dividend (1,484) - - Cash dividend paid - - (71,435) ------------- ------------- ------------ Net cash provided by financing activities 74,905,398 8,066,247 8,352,058 ------------- ------------- ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 30,642,594 (3,055,283) 6,114,327 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 18,836,534 21,891,817 15,777,490 ------------- ------------- ------------ CASH AND CASH EQUIVALENTS, END OF YEAR $ 49,479,128 $ 18,836,534 $21,891,817 ============= ============= ============ Supplemental Disclosure of Cash Flow Information: Cash paid for interest $ 7,499,017 $ 6,331,494 $ 5,991,836 Cash paid for income taxes 1,040,529 558,256 1,279,300 Supplemental Disclosure of Noncash Investing Activity: Transfers to other real-estate owned $ 370,937 $ 272,369 $ 1,014,175 Decrease (increase) in net unrealized losses on securities, available-for-sale 51,336 (56,869) (4,047)
See notes to consolidated financial statements. 44 COMMUNITY WEST BANCSHARES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Community West Bancshares (the "Company") and its wholly-owned subsidiaries, Goleta National Bank and Palomar Savings and Loan, are in accordance with generally accepted accounting principles and general practices within the financial services industry. All material intercompany transactions and accounts have been eliminated. The following are descriptions of the more significant of those policies. Nature of Operations - The Company's primary operations are related to traditional financial services, including the acceptance of deposits and the lending and investing of money. In addition, the Company also engages in electronic services. The Company's customers consist of small to mid-sized businesses and individuals. The Company also originates and sells U. S. Small Business Administration ("SBA"), FHA Title I and first and second mortgage loans through its normal operations and fifteen loan production offices. Business Combinations - On December 14, 1998, the Company merged with Palomar Savings & Loan Association ("Palomar"). As of that date, shareholders of Palomar (OTCBB:PALO) became shareholders of the Company by receiving 2.11 shares of CWBC for each share of PALO they held. This acquisition was accounted for as a pooling-of-interests. Palomar is a state-chartered full service savings and loan association. It is the Company's intent to maintain Palomar as a separate subsidiary of the Company. Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased for one day periods. Loans - Generally, loans are stated at amounts advanced less payments collected. Interest on loans is accrued daily on a simple-interest basis, except where serious doubt exists as to collectibility of the loan, in which case the accrual of interest income is discontinued. Loans Held for Sale - Loans which are originated and are intended for sale in the secondary market, are carried at the lower of cost or fair value on an aggregate basis. Funding for SBA and FHA programs depends on annual appropriations by the U.S. Congress, and accordingly, the sale of loans under these programs is dependent on the continuation of such programs. Investment Securities - The Company classifies as held to maturity those debt securities it has the positive intent and ability to hold to maturity. Securities held to maturity are accounted for at cost and adjusted for amortization of premiums and accretion of discounts. Securities to be held for indefinite periods of time, but not necessarily to be held-to-maturity or on a long term basis are classified as available-for-sale and carried at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income, net of any applicable income taxes. Realized gains or losses on the sale of securities available-for-sale, if any, are determined on a identification basis. Investment Securities, Held for Trading -Interest Only Strips and Residual Asset - The Company originates certain loans for the purpose of selling either a portion or all of the loan into either the secondary market or a securitization. The guaranteed portion of SBA loans and FHA Title 1 loans are sold into the secondary market, servicing retained. Second mortgages ("HLTV") loans are sold into a securitization. On these sales, the Company retains interest only ("I/O") strips, which represent the present value of the right to the excess cash flows generated by the serviced loans which represents the difference between (a) interest at the stated rate paid by borrowers and (b) the sum of (i) pass-through interest paid to third-party investors, (ii) trustee fees, (iii) FHA insurance fees (if applicable), (iv) third-party credit enhancement fees (if applicable), and (v) stipulated servicing fees. The Company determines the present value of this anticipated cash flow stream at the time each loan sale transaction closes, utilizing valuation assumptions appropriate for each particular transaction. Loan sales are discussed in detail in Note 3. 45 The I/O Strips and Residual Assets are accounted for under Statement of Financial Accounting Standards ("SFAS") No. 65 "Accounting for Certain Mortgage Banking Activities". These assets are subject to significant prepayment risk, and accordingly have an undetermined maturity date; and therefore cannot be classified as held to maturity. The Company has chosen to classify these assets as trading securities. Based on this classification, the Company is required to mark these securities to fair value with the accompanying increases or decreases in fair value being recorded as earnings in the current period. The determination of fair value is based on the previously mentioned basis. As the gain recognized in the year of sale is equal to the net estimated future cash flows from the I/O Strips and Residual Assets, discounted at a market interest rate, the amount of cash actually received over the lives of the loans is expected to exceed the gain previously recognized at the time the loans are sold. The I/O Strips are amortized based on an accelerated method against the cash flows resulting in income recognition that is not materially different from the interest method. The Company generally retains the right to service loans it originates, or purchases, and subsequently sells. Provision and Allowance for Loan Losses - The allowance for loan losses is maintained at a level believed adequate by management to absorb possible losses on existing loans through a provision for loan losses charged to expense. The allowance is charged for losses when management believes that full recovery on loans is unlikely. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio, which take into consideration such factors as changes in the growth, size and composition of the loan portfolio, overall portfolio quality, review of specific problem loans, collateral, guarantees and economic conditions that may affect the borrowers' ability to pay and/or the value of the underlying collateral. These estimates depend on the outcome of future events and, therefore, contain inherent uncertainties. Management believes the level of the allowance for loan losses as of December 31, 1998, is adequate to absorb future losses; however, changes in the local economy, the ability of borrowers to repay amounts borrowed and other factors may result in the need to increase the allowance through charges to earnings. Loan Fees and Costs - Loan origination fees and costs are deferred and recognized as an adjustment to the loan yield over the contractual life of the loan using the straight-line or level yield method. Other Real Estate Owned - Real estate acquired by foreclosure is recorded at fair value at the time of foreclosure, less estimated selling costs. Any subsequent operating expenses or income, reduction in estimated values, and gains or losses on disposition of such properties are charged to current operations. Premises and Equipment - Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from 2 to 31.5 years. Leasehold improvements are amortized over the term of the lease or the estimated useful lives, whichever is shorter. Income Taxes - Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. 46 Net Income per Share and Share Equivalent - Net income per share - basic has been computed based on the weighted average number of shares outstanding during each year. Net income per share - diluted has been computed based on the weighted average number of shares outstanding during each year plus the dilutive effect of outstanding warrants and options. Net income per share amounts have been retroactively restated to reflect, the pooling of interests which resulted from the acquisition of Palomar Savings & Loan, and the two-for-one stock splits in 1996 and 1998. Earnings per share were computed as follows:
1998 1997 1996 ---------- ---------- ---------- Basic weighted average shares outstanding 5,069,596 4,383,878 3,723,832 Dilutive effect of options 174,142 209,970 127,384 Dilutive effect of warrants - 362,300 26,806 ---------- ---------- ---------- Diluted weighted average shares outstanding 5,243,738 4,956,148 3,878,022 ========== ========== ========== Net Income $2,880,767 $2,149,652 $1,203,573 Net income per share - Basic $ 0.57 $ 0.49 $ 0.32 Net income per share - Diluted $ 0.55 $ 0.43 $ 0.31
Reserve Requirements - All depository institutions are required by law to maintain reserves on transaction accounts and nonpersonal time deposits in the form of cash balances at the Federal Reserve Bank. These reserve requirements can be offset by cash balances held at the Company. At December 31, 1998, the Company's cash balance was sufficient to offset the Federal Reserve requirement. Use of Estimates in the Preparation of Financial Statements - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Current Accounting Pronouncements - In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and presenting comprehensive income and its components in a full set of financial statements. The term "comprehensive income" describes the total of all components of comprehensive income including net income. "Other comprehensive income" refers to revenues, expenses, and gains and losses that are included in comprehensive income but are excluded from net income as they have been recorded directly in equity under the provisions of other FASB statements. The Company presents the comprehensive income disclosure as a part of the statements of changes in stockholders' equity, by identifying each element of other comprehensive income including net income. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Comparative financial statements provided for earlier periods have been reclassified to reflect application of the provisions of SFAS No. 130. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Comparative financial statements provided for earlier periods have been reclassified to reflect application of the provisions of SFAS No. 130. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," effective for financial statements for periods beginning after December 15, 1997. This statement establishes standards for reporting information about operating segments in annual financial statements and requires that enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The disclosures required by this statement are presented in Note 15. 47 Accounting for Derivative Instruments and Hedging Activities - In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", was issued and is effective for fiscal years beginning after June 15, 1999. SFAS No. 133 requires companies to record derivatives on the balance sheet as assets and liabilities, measured at fair value. Gains or losses resulting from the changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. The Company early adopted FAS 133 on October 1, 1998. At the date of initial application of FAS 133, a company may transfer any held to maturity security into the available for sale category. In October 1998, FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." SFAS No. 134 amends SFAS No. 65, "Accounting for Certain Mortgage Banking Activities," which establishes accounting and reporting standards for certain activities of mortgage banking enterprises and other enterprises that conduct operations that are substantially similar. SFAS No. 134 requires that after the securitization of mortgage loans held for sale, the resulting mortgage-backed securities and other retained interests should be classified in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," based on the company's ability and intent to sell or hold those investments. SFAS No. 134 is effective for the first fiscal quarter beginning after December 15, 1998. Management of the Bank does not believe that the adoption of SFAS No. 134 will have a material impact on the Bank's results of operations or financial position when adopted. Statement of Position 98-1 "Accounting for the Costs of Computer Software Developed and Obtained for Internal Use", issued in March 1998 requires capitalization of certain costs of computer software developed or obtained for internal use. The SOP describes three stages of software development projects: the preliminary project stage where all costs are expensed, the application development state where some costs are capitalized, while others are expensed, and the post-implementation/operation state where all costs are expensed. Other costs associated with the development and implementation of internal-use software systems projects are expensed as incurred. The SOP does not change the requirement that the external and internal costs associated with modifying internal use software currently in use for the year 2000 should be charged to expense as incurred. The SOP is effective for financial statements for fiscal years beginning after December 15, 1998 with earlier application encouraged. The Company early adopted SOP 98-1 effective January 1, 1998 and has capitalized certain costs, amounting to $470,566, related to the development of internal use software as required by the SOP. Reclassifications - Certain amounts in the accompanying financial statements for 1997 and 1996 have been reclassified to conform to the 1998 presentation. 48 2. INVESTMENT SECURITIES The amortized cost and estimated fair value of investment securities at December 31 were as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gain Loss Value ----------- ----------- ----------- ---------- 1998 Available-for-Sale Securities - ------------------------------------------- Government National Mortgage Association participation certificates $ 4,208,179 $ 19,724 $ - $4,227,903 Federal National Mortgage Association and Federal Home Loan Mortgage Corporation participation certificates 2,841,118 - 25,815 2,815,303 Federal Home Loan Mortgage Corporation Bond 500,000 - 2,170 497,830 U.S. Treasury Securities 750,000 4,063 - 754,063 ----------- ----------- ----------- ---------- $ 8,299,297 $ 23,787 $ 27,985 $8,295,099 =========== =========== =========== ========== Held to Maturity - ------------------------------------------- Due in less than one year: U.S. Treasury note, par value $500,000, 5.875% due 7/31/99 $ 501,094 $ 1,562 $ - $ 502,656 ----------- ----------- ----------- ---------- $ 501,094 $ 1,562 $ - $ 502,656 =========== =========== =========== ==========
Gross Gross Amortized Unrealized Unrealized Fair Cost Gain Loss Value ----------- ----------- ----------- ---------- 1997 Available-for-Sale Securities - ------------------------------------------- Government National Mortgage Association participation certificates $ 3,838,357 $ 35,396 $ - $3,873,753 Federal National Mortgage Association and Federal Home Loan Mortgage Corporation participation certificates 4,276,174 9,585 - 4,285,759 U.S. Treasury Securities 750,178 2,188 - 752,366 ----------- ----------- ----------- ---------- $ 8,864,709 $ 47,169 $ - $8,911,878 =========== =========== =========== ==========
49
Gross Gross Amortized Unrealized Unrealized Fair Cost Gain Loss Value ---------- ----------- ----------- ---------- Held to Maturity - --------------------------------------- Due in less than one year: U.S. Treasury note, par value $500,000, 5.125% due 2/28/98 $ 499,700 $ - $ 3,200 $ 496,500 U.S. Treasury note, par value $500,000, 5.125%, due 6/30/98 498,751 - 2,400 496,351 Federal National Mortgage Association REMICs 3,419,885 - 187,021 3,232,864 Federal National Mortgage Association Bonds 736,143 1,670 - 737,813 ---------- ----------- ----------- ---------- $5,154,479 $ 1,670 $ 192,621 $4,963,528 ========== =========== =========== ==========
The following table presents contractual maturity information for investment securities at December 31, 1998.
Amortized Fair Held-to-Maturity Cost Value - ----------------------- ---------- ---------- Due in one year or less $ 501,094 $ 502,656 ---------- ---------- $ 501,094 $ 502,656 ========== ========== Available-for-Sale - ----------------------- Due in one year or less $ 750,000 $ 754, 064 Due after ten years 7,549,297 $7,541,035 ---------- ---------- $8,299,297 $8,295,099 ========== ==========
Held-for-Trading - ---------------- The Company retains servicing spreads on loan sales that creates servicing assets. The servicing spreads are separated into three assets. A servicing asset is recorded for the present value of the excess of the contractual servicing spread over the expected cost of servicing the portfolio for the expected life of the loans sold. An interest-only strip asset is recorded for the present value of the servicing spread less the contractual servicing for the estimated expected life of the loans. A residual asset is recorded which represents the present value of the excess collateral less anticipated losses. The Company uses industry prepayment statistics and its own prepayment experience in estimating the expected life of the loans. The present value asset is amortized as an offset to loan servicing income over the estimated expected life of the servicing assets. The interest-only strips and residual asset are recorded as investments, held-for-trading at their fair market value. The sale of loans creating these assets is discussed in detail in Note 3. At December 31, 1998, a U.S. Treasury Note with a face value of $500,000 was pledged as collateral to the U.S. Treasury for its Treasury, Tax, and Loan account with the Company. 50 The Company early adopted FAS 133 on October 1, 1998. At the date of initial application of FAS 133, a company may transfer any held to maturity security into the available for sale category. As of October 1, 1998, the Company transferred securities with a carrying value $3,418,478 from investment securities held to maturity to investment securities available for sale. The securities were transferred at fair market value with an unrealized loss of $78,224 which was reported as a component of accumulated other comprehensive income. 3. LOAN SALES HLTV Loan Sales ----------------- During the year ended December 31, 1998, the Company completed the securitization of an $81 million pool of HLTV loans. These HLTV loans allow borrowers to receive up to 125% of their home value for debt consolidation, home improvement, school tuition, or any worthwhile cash outlay. There is an upper limit on these loans of $100,000. The Company retained a residual participation interest in the investor trust, reflecting the excess of the total amount of loans transferred to the trust over the portion represented by certificates sold to investors. As a result of the securitization, the Company also recorded interest-only strips (I/O Strips). The present value of these assets was calculated assuming a 13% discount rate, annual losses of 2.25%, and an 18.25% constant prepayment rate (CPR). As of December 31, 1998, the Company recorded a receivable from the underwriter of the securitization for $3 million, which represents the amount due to the Company upon the final sale of the remaining bonds. As of December 31, 1998, the Company had $24 million in loans held for sale in future securitizations. SBA Loan Sales ---------------- The Company sells the guaranteed portion of Small Business Administration ("SBA") loans into the secondary market in exchange for cash premium, servicing assets, and I/O strips. The Company retains the servicing rights. The present value of the interest only strips and servicing assets was calculated assuming an 11% discount rate, and an 8% CPR. As of December 31, 1998, the Company had $5 million in SBA loans held for sale. FHA Title 1 Loan Sales -------------------------- Since 1995, the Company has sold FHA Title 1 loans into the secondary market, on a whole loan basis, in exchange for cash premium, servicing assets, and I/O strips. The Company retains the servicing rights. In 1998 the present value of the interest only strips was calculated assuming a 11% discount rate, and a 15% CPR. As of December 31, 1998, the Company had $1 million in FHA Title 1 loans held for sale. Traditional Mortgages --------------------- Amount represents servicing purchased by Palomar in 1998. The balance of these assets are as follows:
December 31, 1998 December 31, 1997 ------------------------------- ---------------------------- Servicing Asset I/O Strip(1) Servicing Asset I/O Strip ---------------- ------------- ---------------- ---------- HLTV $ - $ 8,150,000 $ - $ - Guaranteed Portion of SBA 1,194,000 1,030,000 611,000 462,000 FHA Title 1 22,000 1,735,000 53,000 2,067,000 Traditional Mortgages 256,000 - - - ---------------- ------------- ---------------- ---------- Total $ 1,472,000 $ 10,915,000 $ 664,000 $2,529,000 ================ ============= ================ ========== (1) Includes the residual asset recorded on the securitization of the HLTV loans.
51 4. LOANS The composition of the Company's loan portfolio at December 31 was as follows: (rounded to the thousand)
1998 1997 ------------ ------------ Installment $ 5,637,827 $ 4,056,774 Commercial 10,612,861 13,195,325 Real estate 64,874,706 76,190,139 Loan participations purchased - real estate 2,287,036 2,246,855 Unguaranteed portion of SBA loans 26,686,850 19,602,136 ------------ ------------ 110,099,280 115,291,229 Less: Allowance for loan losses 2,128,710 2,066,852 Net deferred loan fees and premiums 112,199 150,605 Other discount on SBA loans 759,187 428,276 ------------ ------------ Loans held for investment, net $107,099,184 $112,645,496 ============ ============ Loans held for sale $ 58,835,944 $ 15,739,244 ============ ============
Loans held for sale include the guaranteed and unguaranteed portion of SBA loans and loans insured by the FHA, and first and second mortgages. Loans are held for sale and are recorded at the lower of cost or fair value. Transactions in the allowance for loan losses for the years ended December 31 are summarized as follows:
1998 1997 1996 ----------- ----------- ----------- Balance, beginning of year $2,066,852 $2,379,321 $2,353,939 Provision for loan losses 428,969 190,548 650,488 Loans charged off (402,452) (520,293) (646,982) Recoveries on loans previously charged off 35,341 17,276 21,876 ----------- ----------- ----------- Balance, end of year $2,128,710 $2,066,852 $2,379,321 =========== =========== ===========
52 The recorded investment in loans that are considered to be impaired under SFAS No. 114 was as follows:
December 31, ------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Impaired loans without specific valuation allowances $4,450,345 $2,461,168 $1,111,388 Impaired loans with specific valuation allowances 813,652 1,266,964 2,490,435 Specific valuation allowance allocated to impaired loans (464,336) (521,994) (736,853) Impaired loans, net $4,799,661 $3,206,138 $2,864,970 =========== =========== =========== Average investment in impaired loans $4,009,400 $3,056,054 $3,620,236 =========== =========== =========== Interest income recognized on impaired loans $ 288,607 $ 360,309 $ 190,559 =========== =========== =========== Nonaccrual loans $2,971,000 $1,714,000 $ 634,000 =========== =========== =========== Troubled debt restructured loans, gross $1,313,000 $3,289,000 $1,238,000 =========== =========== =========== Interest foregone on nonaccrual loans and troubled debt restructuring outstanding $ 414,000 $ 203,000 $ 226,000 =========== =========== =========== Loans 30 through 90 days past due with interest accruing $ 678,000 $ 631,000 $ 838,000 =========== =========== ===========
It is generally the Company's policy to place loans on nonaccrual status when they are 90 days past due, and any unpaid, but accrued interest is reversed. Thereafter, interest income is no longer recognized. As such, interest income may be recognized on impaired loans to the extent they are not past due by 90 days or more. Upon the adoption of SFAS No. 114, the Company classified all loans on nonaccrual status as impaired. Accordingly, the impaired loans disclosed above include all loans that were on nonaccrual status. Financial difficulties encountered by certain borrowers may cause the Company to restructure the terms of their loans to facilitate loan payments. In accordance with the provisions of SFAS No. 114, a troubled loan that is restructured subsequent to the adoption of SFAS No. 114 would generally be considered impaired, while a loan restructured prior to adoption would not be considered impaired if, at the date of measurement, it was probable that the Company will collect all amounts due under the restructured terms. Accordingly, the balance of impaired loans disclosed above includes all troubled debt restructured loans that, as of December 31, 1998, 1997, and 1996, are considered impaired. The Company makes loans to borrowers in a number of different industries. No single industry comprises 10% or more of the Company's loan portfolio. Although the Company has a diversified loan portfolio, the ability of the Company's customers to honor their loan agreements is dependent upon, among other things, the general economy of the Company's market area. Approximately 60% on the Company's loans are secured by real estate located in California. 53 5. TRANSACTIONS INVOLVING DIRECTORS AND EMPLOYEES In the ordinary course of business, the Company has extended credit to directors and employees of the Company. Such loans are subject to approval by the Loan Committee and ratification by the Board of Directors, exclusive of the borrowing director. The following is an analysis of the activity of all such loans:
1998 1997 1996 ------------ ----------- ----------- Outstanding balance, beginning of year $ 2,554,699 $2,784,834 $1,860,382 Credit granted, including renewals 1,454,000 751,534 973,305 Repayments (1,252,630) (981,669) (48,853) ------------ ----------- ----------- Outstanding balance, end of year $ 2,756,069 $2,554,699 $2,784,834 ============ =========== ===========
6. PREMISES AND EQUIPMENT Premises and equipment as of December 31 was as follows:
1998 1997 ---------- ---------- Furniture, fixtures and equipment $5,114,683 $3,565,851 Building & land 782,423 782,423 Leasehold improvements 1,389,749 932,232 Construction in progress 705,116 65,657 ---------- ---------- 7,991,971 5,346,163 Less accumulated depreciation and amortization 3,452,972 2,493,539 ---------- ---------- Premises and equipment, net $4,538,999 $2,852,624 ========== ==========
7. DEPOSITS At December 31, 1998, the scheduled maturities of time certificates of deposits are as follows:
1999 $144,321,583 2000 8,612,738 2001 4,195,927 2002 and thereafter 90,704 ------------ $157,220,952 ============
8. BUSINESS COMBINATION Effective December 18, 1998, the Company issued 1,367,542 common shares to facilitate a merger with Palomar Savings and Loan ("Palomar"). The Company exchanged 2.11 shares of its common stock for each share of Palomar common stock. The transaction constituted a tax-free reorganization and has been accounted for as a pooling-of-interests under Accounting Principles Board Opinion No. 16. Accordingly, all prior period consolidated financial statements have been restated to include the operations and financial position of Palomar as though it had always been a part of the Company. The combined Company had assets of $250 million and deposits of $226 million as of the date of the merger. Prior to the merger, Palomar's fiscal year-end was September 30. In recording the business combination, Palomar's prior period financial statements have been restated to a year-end of December 31, to conform with the Company's fiscal year-end. 54 Revenue and Net Income for the years December 31, 1998, 1997 and 1996 are as follows:
Nine Months Ended (Unaudited) September 30, Year Ended December 31, ---------- ---------------------- 1998 1997 1996 ---------- ----------- ----------- Community West - --------------------- Net Interest Income $6,341,000 $ 5,098,982 $ 4,387,342 Net Income $1,801,000 $ 1,588,940 $ 1,105,422 Palomar - --------------------- Net Interest Income $1,631,000 $ 2,092,640 $ 2,082,334 Net Income $ 521,000 $ 560,712 $ 98,151 Combined - --------------------- Net Interest Income $7,972,000 $ 7,191,622 $ 6,469,676 Net Income $2,322,000 $ 2,149,652 $ 1,203,573
There were no transactions between the Company and Palomar prior to the business combination other than loan participations. These participations were transacted in the normal course of business. Immaterial adjustments were recorded to conform Palomar's accounting policies. Certain reclassifications were made to the Palomar financial statements to conform to the Company's presentations. 9. STOCKHOLDERS' EQUITY Common Stock In 1996, cash dividends of $.04 per share, were declared and paid. In the first quarter of 1996, the shareholders of the Company approved a two-for-one stock split effective for shareholders of record on February 18, 1996. During the third quarter of 1996, the Company successfully completed a secondary stock offering which resulted in the issuance of 472,653 warrants and 859,368 additional shares of common stock. Net proceeds of $2,788,048 were realized on this offering after issuance costs of $219,740. Each warrant entitled the holder to purchase two shares of common stock for $4.375 per share, and expired on June 30, 1998. Warrant exercises resulted in net proceeds of $4,124,226 and the issuance of 942,680 shares of common stock. 1,313 warrants expired unexercised. In conjunction with the secondary stock offering, the Company listed its common stock on the NASDAQ National Market and is currently traded under the symbol 'CWBC'. Prior to the business combination of Community West Bancshares and Palomar Savings and Loan; on October 27, 1997, the Board of Directors of Palomar approved a 5% stock dividend on issued and outstanding shares. The dividend was issued on February 18, 1998, to the shareholders of record at the close of business on February 2, 1998. 55 On January 22, 1998, the Company declared a two-for-one stock split for shareholders of record on February 3, 1998, which was paid on February 27, 1998. All share and per share amounts included in the accompanying financial statements and related notes have been retroactively restated for the effect of this split. On December 18, 1998, the Company declared a quarterly cash divided of $.04 per share for shareholders of record on January 5, 1999, which was paid on January 20, 1999. Additionally, on December 28, 1998, the Board of Directors of the Company authorized a stock buy-back plan. Under this plan management is authorized to repurchase up to $2,000,000 worth of the outstanding shares of its common stock . As of December 31, 1998, management had repurchased 14,807 shares of common stock at a cost of $140,739. Stock Options Under the terms of the Company's stock option plan, full-time salaried employees may be granted nonqualified stock options or incentive stock options, and directors may be granted nonqualified stock options. Options may be granted at a price not less than 100% of the fair market value of the stock on the date of grant. Options are generally exercisable in cumulative 20% installments. However, in certain circumstances, the vesting of these options may be adjusted, as determined by the Board of Directors. All options expire no later than ten years from the date of grant. As of December 31, 1998, all options are outstanding at prices of $2.28 - $14.00 per share with 287,766 options exercisable and 353,320 options available for future grant. As of 12-31-98 the weighted average life of the outstanding options was 8 years. Stock option activity is as follows:
1998 1997 1996 --------- ----------- -------------------- -------------------- Shares Price (1) Shares Price (1) Shares Price (1) --------- ---------- -------- ---------- -------- ---------- Options outstanding, January 1, 359,652 $ 3.10 427,812 $ 2.78 398,680 $ 2.27 Granted 218,986 10.11 20,000 8.30 93,740 4.24 Canceled (7,560) 3.21 (17,520) 2.67 (17,440) 2.93 Exercised (155,712) 2.90 (70,640) 2.72 (47,168) 2.28 --------- ---------- -------- ---------- -------- ---------- Optons outstanding, December 31, 415,366 $ 6.95 359,652 $ 3.10 427,812 $ 2.78 ========= ========== ======== ========== ======== ========== Options exercisable, December 31, 287,766 $ 4.11 280,132 $ 2.73 311,372 $ 2.73 ========= ========== ======== ========== ======== ========== (1) Weighted Average
56 The estimated fair value of options granted ranged from $2.93 - $4.69 per share in 1998, from $3.78 - $5.11 per share in 1997, and from $2.34 - $3.05 per share in 1996. The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock option plan. Accordingly, no compensation cost has been recognized for its stock option plan. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method prescribed by SFAS No. 123, the Company's net income and earnings per share for the years ended December 31, 1998, 1997, and 1996 would have been reduced to the pro forma amounts indicated below:
Net income 1998 1997 1996 As reported $2,880,767 $2,149,652 $1,203,573 Pro forma $2,374,582 $2,114,304 $1,095,713 Net income per common share - Basic As reported $ .57 $ .49 $ .32 Pro forma $ .47 $ .48 $ .28 Net income per common share - assuming dilution As reported $ .55 $ .43 $ .31 Pro forma $ .44 $ .43 $ .29
The fair value of options granted under the Company's fixed stock option plan during 1998, 1997 and 1996 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
1998 1997 1996 ----- ----- ----- Annual dividend yield 5.0% 8.5% 8.5% Expected volatility 47% 53% 18% Risk free interest rate 6.0% 6.5% 6.5% Expected life (in years) 6 6 6
10. COMMITMENTS AND CONTINGENCIES The Company leases twenty office facilities under various operating lease agreements with terms that expire at various dates between March 1999, and November 2007, plus options to extend the lease terms for periods of up to ten years. The minimum lease commitments as of December 31, 1998, under all operating lease agreements are as follows:
For the Year Ending December 31, 1999 $ 706,537 2000 510,559 2001 340,056 2002 299,497 2003 155,652 Thereafter 605,097 ---------- Total $2,617,398 ==========
Rent expense for the years ended December 31, 1998, 1997 and 1996 was $674,893, $446,430 and $368,187. The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of nonperformance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. At December 31, 1998, the Company had commitments to extend credit of $28,731,000 and obligations under standby letters of credit of $35,000. 57 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. All guarantees are short term and expire within one year. The Company uses the same credit policies in making commitments and conditional obligations as it does for extending loan facilities to customers. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. The Company has sold loans that are guaranteed or insured by government agencies for which the Company retains all servicing rights and responsibilities. The Company is required to perform certain monitoring functions in connection with these loans to preserve the guarantee by the government agency and prevent loss to the Company in the event of nonperformance by the borrower. Management believes that the Company is in compliance with these requirements. The outstanding balance of the sold portion of such loans was approximately $100,000,000 at December 31, 1998. The Company is involved in various litigation matters through the normal course of business. In the opinion of management, based upon the advice of the Company's legal counsel, the disposition of all pending litigation should not have a material effect on the Company's financial position or results of operations. 11. INCOME TAXES The provision for income taxes consists of the following:
1998 1997 1996 ----------- ----------- --------- Current: Federal $ (72,894) $ 914,400 $219,370 State (110,136) 254,061 152,014 ----------- ----------- --------- (183,030) 1,168,461 371,384 Deferred: Federal 1,708,853 309,153 399,518 State 415,532 (161,263) (82,424) ----------- ----------- --------- 2,124,385 147,890 317,094 ----------- ----------- --------- Total provision $1,941,355 $1,316,351 $688,478 =========== =========== =========
58 Significant components of the Company's net deferred tax account at December 31, are as follows:
1998 1997 ------------ ----------- Deferred tax assets: Allowance for loan loss $ 867,051 $ 775,488 Depreciation 52,323 2,000 Deferred transaction costs 739,860 - State taxes 151,927 101,589 Unrealized loss on investment securities 1,750 21,000 State NOL 92,271 87,000 Other 170,212 101,421 Total 2,075,394 1,088,498 ------------ ----------- Deferred tax liabilities: Deferred loan fees (1,762,793) (521,189) Depreciation - (8,087) FHLB stock dividends (89,111) (69,000) Deferred loan costs (1,962,944) (34,823) Other (235,804) (115,022) Total (4,050,652) (748,121) ------------ ----------- Valuation allowance - (172,000) ------------ ----------- Net deferred tax asset (liability) $(1,975,258) $ 168,377 ============ ===========
The federal income tax provision for the years ended December 31 differs from the applicable statutory rate as follows:
1998 1997 1996 ----- ----- ----- Federal income tax at statutory rate 35.0% 35.0% 35.0% State franchise tax, net of federal 7.0 6.8 7.5 Change in valuation allowance (3.6) (7.5) (8.4) Other 1.9 3.7 2.3 40.3% 38.0% 36.4% ===== ===== =====
12. REGULATORY MATTERS The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital 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 classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of Total and Tier I capital (primarily common stock and retained earnings less goodwill) to risk-weighted assets, and of Tier I capital to average assets. Management believes, as of December 31, 1998, that the Company meets all capital adequacy requirements to which it is subject. 59 As of December 31, 1998 and 1997, the most recent notification from the Federal Deposit Insurance Corporation ("FDIC") categorized the Company as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized" the Company must maintain minimum Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification which management believes have changed the Company's category. The Company's actual capital amounts and ratios at December 31 are as follows:
To Be Well For Capital Capitalized Under Adequacy Prompt Corrective Actual Purposes Action Provisions ------ -------- ----------------- Amount Ratio Amount Ratio Amount Ratio ----------- ------ ----------- ------ ----------- ------ As of December 31, 1998: Total Capital (to Risk Weighted assets) Consolidated . . . . . . . . . . . . . . . $26,109,980 15.27% $13,674,814 8.00% $17,093,519 10.00% Goleta National Bank . . . . . . . . . . . $16,152,794 13.88% $ 9,309,968 8.00% $11,637,460 10.00% Palomar Savings and Loan . . . . . . . . . $ 6,492,000 12.45% $ 4,172,240 8.00% $ 5,215,300 10.00% Tier I Capital (to Risk Weighted assets) Consolidated . . . . . . . . . . . . . . . $23,972,867 14.02% $ 6,837,407 4.00% $10,256,111 6.00% Goleta National Bank . . . . . . . . . . . $14,698,113 12.63% $ 4,654,984 4.00% $ 6,982,476 6.00% Tier I Capital (to Average Assets) Consolidated . . . . . . . . . . . . . . . $23,972,867 9.49% $10,102,001 4.00% $12,627,501 5.00% Goleta National Bank . . . . . . . . . . . $14,698,113 8.07% $ 7,285,310 4.00% $ 9,106,638 5.00% Core Capital (to Adjusted Tangible Assets) Palomar Savings and Loan . . . . . . . . . $ 5,865,000 7.11% $ 3,299,000 4.00% $ 4,124,200 5.00% Tangible Capital (to Tangible Assets) Palomar Savings and Loan . . . . . . . . . $ 5,865,000 7.11% $ 1,237,260 1.50% N/A N/A
To Be Well For Capital Capitalized Under Adequacy Prompt Corrective Actual Purposes Action Provisions ------ -------- ----------------- Amount Ratio Amount Ratio Amount Ratio ----------- ------ ---------- ------ ----------- ------ As of December 31, 1997: Total Capital (to Risk Weighted assets) Consolidated . . . . . . . . . . . . . . . $18,535,374 15.88% $9,336,643 8.00% $11,670,804 10.00% Goleta National Bank . . . . . . . . . . . $12,990,366 17.36% $5,986,344 8.00% $ 7,482,930 10.00% Palomar Savings and Loan . . . . . . . . . $ 6,055,541 13.49% $3,591,129 8.00% $ 4,488,911 10.00% Tier I Capital (to Risk Weighted assets) Consolidated . . . . . . . . . . . . . . . $17,071,672 14.63% $4,668,321 4.00% $ 7,002,482 6.00% Goleta National Bank . . . . . . . . . . . $12,054,016 16.11% $2,992,928 4.00% $ 4,489,391 6.00% Tier I Capital (to Average Assets) Consolidated . . . . . . . . . . . . . . . $17,071,672 9.84% $6,939,541 4.00% $ 8,674,427 5.00% Goleta National Bank . . . . . . . . . . . $12,054,016 12.63% $3,917,582 4.00% $ 4,771,978 5.00% Core Capital (to Adjusted Tangible Assets) Palomar Savings and Loan . . . . . . . . . $ 5,494,541 6.99% $3,144,229 4.00% $ 3,930,287 5.00% Tangible Capital (to Tangible Assets) Palomar Savings and Loan . . . . . . . . . $ 5,494,541 6.99% $1,179,086 1.50% N/A N/A
13. EMPLOYEE BENEFIT PLAN On September 1, 1995, the Company established a 401(k) plan for the benefit of its employees. Employees are eligible to participate in the plan if they were employed by the Company on September 1, 1995, or after 3 months of consecutive service. Employees may make contributions to the plan under the plan's 401(k) component, and the Company may make contributions under the plan's profit sharing component, subject to certain limitations. The Company's contributions are determined by the Board of Directors and amounted to $122,767, $112,592 and $49,466 in 1998, 1997, and 1996, respectively. 60 14. FAIR VALUES OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires the Company disclose estimated fair values for its financial instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair amounts.
December 31, 1998 December 31, 1997 -------------------- -------------------- Carrying Estimated Carrying Esimated (in thousands) Amount Fair Value Amount Fair Value -------- ---------- -------- ---------- Assets: Cash and cash equivalents $ 49,479 $ 49,479 $ 18,837 $ 18,837 Investment Securities 20,521 20,226 17,359 17,168 Net Loans 165,935 178,115 128,385 129,937 Liabilities: Deposits (other than TDs) 66,324 66,324 60,647 60,647 Time deposits 157,221 162,260 92,044 92,198 Off-balance Sheet Financial Instruments: - - - - Commercial letters of credit - - - - Standby letters of credit - - - - Commitments to extend credit - - - -
The methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value are explained below: Cash and cash equivalents - The carrying amounts approximate fair values because of the short-term nature of these investments. Investment securities - The fair value is based on quoted market prices from security brokers or dealers if available. If a quoted market price is not available, fair value is estimated using the quoted market price for similar securities. Securities held for trading are carried at fair value Federal Reserve and Federal Home Loan Bank stock carrying value approximates the fair value because the stock can be sold back to the Federal Reserve and Federal Home Loan Bank at anytime. Loans, net - Fair values are estimated for portfolios of loans with similar financial characteristics, primarily fixed and adjustable rate interest terms. The fair values of fixed rate mortgage loans are based upon discounted cash flows utilizing the rate that the Company currently offers as well as anticipated prepayment schedules. The fair values of adjustable rate loans are also based upon discounted cash flows utilizing discount rates that the Company currently offers, as well as anticipated prepayment schedules. No adjustments have been made for changes in credit within the loan portfolio. It is management's opinion that the allowance for estimated loan losses pertaining to performing and nonperforming loans results in a fair valuation of such loans. Loans available for sale are recorded at fair market value and are included at their carrying value. 61 Deposits - The fair values of deposits are estimated based upon the type of deposit products. Demand accounts, which include savings and transaction accounts, are presumed to have equal book and fair values, since the interest rates paid on these accounts are based on prevailing market rates. The estimated fair values of time deposits are determined by discounting the cash flows of segments of deposits that have similar maturities and rates, utilizing a yield curve that approximates the prevailing rates offered to depositors as of the measurement date. Commitments to Extend Credit, Commercial and Standby Letters of Credit - The fair values of commitments are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparty's credit standing. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 1998 and 1997. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those dates, and therefore, current estimates of fair value may differ significantly from the amounts presented herein. 15. SEGMENT PROFIT (LOSS) The Company adopted Statement of Financial Accounting Standards No. 131 ("SFAS 131"), Disclosures about Segments of an Enterprise and Related Information in 1998. SFAS 131 established standards for reporting information about operating segments. The 1998 information is presented below; prior year information is not presented because the data is not available and would be impracticable to develop. The Company's management, while managing the overall company, also, looks at individual areas considered "significant" to revenue and net income. These significant areas, or segments, are: SBA Lending, Alternative Lending, the Mortgage Division, Goleta National Bank Branch Operations, and Palomar Savings and Loan. For this discussion, the remaining divisions are considered immaterial and are consolidated into "Other." The Other segment includes the administration areas, human resources, and tech support, along with others. The accounting policies of the individual segments are the same as those described in the summary of significant accounting policies. The SBA Lending, Alternative Lending, and Mortgage Divisions from Goleta National Bank are considered individual segments because of the different loan products involved and the significance of the associated revenue. Goleta National Bank Branch Operation, includes the deposits and commercial lending. Management analyzes Palomar separately from Goleta National Bank, as they are two different subsidiaries under Community West Bancshares. 62 All of the Company's assets and operations are located within the United States. The assets shown below for each segment, other than Palomar, are estimates. The following table sets forth various revenue and expense items that management relies on in decision making.
Goleta Year Ended National Palomar December 31, Alternative Mortgage Bank Branch Savings and Consolidated 1998 SBA Lending Lending Division Operations Loan Other Total ------------ ----------- ------------ ------------ -------------- ------------ ------------ Interest Income $ 2,833,717 $ 5,019,338 $ 734,133 $ 6,270,687 $ 5,688,723 $ - $ 20,546,598 Interest Expense 1,107,459 1,961,632 286,910 2,450,679 3,450,020 - 9,256,700 ------------ ----------- ------------ ------------ -------------- ------------ ------------ Net Interest Income 1,726,258 3,057,706 447,223 3,820,008 2,238,703 - 11,289,898 Provision/(credit) For Loan Losses 245,374 179,452 - 115,174 (111,031) - 428,969 Noninterest Income 2,920,173 2,302,168 5,200,837 360,554 901,635 2,350,521 14,035,888 Noninterest Expense 2,047,855 3,634,531 4,332,755 762,420 2,682,306 6,614,828 20,074,695 ------------ ----------- ------------ ------------ -------------- ------------ ------------ Segment Profits 2,353,202 1,545,891 1,315,305 3,302,968 569,063 (4,264,307) 4,822,122 ============ =========== ============ ============ ============== ============ ============ Segment Assets $ 32,141,624 $28,608,780 $ 22,099,164 $ 60,902,038 $ 82,507,801 $25,774,645 $252,034,052 ============ =========== ============ ============ ============== ============ ============
16. COMMUNITY WEST BANCSHARES (PARENT COMPANY ONLY)
(DOLLARS IN THOUSANDS) December 31, December 31, BALANCE SHEET 1998 1997 -------------- ------------- ASSETS - ------------------------------------------- Cash and equivalents $ 3,171 $ 255 Investment in the Subsidiaries 21,144 17,644 Other Assets 379 21 -------------- ------------- TOTAL ASSETS $ 24,694 $ 17,920 ============== ============= LIABILITIES AND SHAREHOLDER EQUITY - ------------------------------------------- Other Liabilities $ 141 $ 266 Common Stock 17,303 12,833 Retained Earnings 7,393 4,790 Treasury Stock (141) - AFS Gain/Loss Unrealized (2) 31 -------------- ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 24,694 $ 17,920 ============== =============
For the year ended December 31, 1998 1997 1996 -------- -------- -------- STATEMENT OF INCOME - ------------------------------------------------ Dividends from subsidiary $ - $ - $ - -------- -------- -------- Total Income - - - Other Expense 195 5 - -------- -------- -------- Total Expense 195 5 - Equity in undistributed income from subsidiary 2,994 2,155 1,204 Income before income taxes 2,799 2,150 1,204 -------- -------- -------- Income taxes (82) - - -------- -------- -------- Net Income $ 2,881 $ 2,150 $ 1,204 ======== ======== ======== 63 STATEMENT OF CASHFLOWS 1998 1997 1996 -------- -------- -------- Cash Flows from Operating Activities: Net Income $ 2,881 $ 2,150 $ 1,204 Adjustments to reconcile net income to net Cash used by operating activities: Equity in undistributed income from subsidiary (2,994) (2,155) (1,204) Net change in other liabilities 125 - - Net change in other assets (448) - - -------- -------- -------- Total adjustments (3,317) (2,155) (1,204) -------- -------- -------- Net cash used by operating activities: (436) (5) - Cash flows from investing activities Payments for investments in and advances to subsidiaries (700) - -------- -------- -------- Net cash used by investing activities: (700) - - Cash flows from financing activities Proceeds from issuance of common stock 4,193 10 - Bridge loan from nonbank subsidiary 250 Payments to repurchase common stock (141) - -------- -------- -------- Net cash provided by financing activities 4,052 260 - Cash and cash equivalents: Net increase in cash and cash equivalents 2,916 255 - Cash and cash equivalents at beginning of year 255 - - -------- -------- -------- Cash and Cash Equivalents, at end of year $ 3,171 $ 255 $ - ======== ======== ========
Community West Bancshares was created for the purposes of forming a financial services holding company. Prior to the acquisition of Goleta National Bank, which became effective on December 31, 1997, the Company had minimal activity. 64 17. CONSOLIDATING INFORMATION The tables below show the consolidating Balance Sheet and Statement of Income.
December 31, 1998 Community West Goleta Palomar Bancshares National Savings ASSETS (parent-only) Bank and Loan Eliminations Consolidated - ----------------------------------------- ---------------- ------------ ------------ -------------- -------------- Cash and due from banks $ 3,170,966 $ 4,476,373 $ 1,647,755 $ (3,170,966) $ 6,124,128 Federal funds sold - 36,255,000 7,100,000 - 43,355,000 ---------------- ------------ ------------ -------------- -------------- Cash and cash equivalents 3,170,966 40,731,373 8,747,755 (3,170,966) 49,479,128 Time deposits in other financial institutions - - 1,500,000 - 1,500,000 FRB and FHLB stock - 264,050 546,300 - 810,350 Investment securities, held to maturity - 501,094 - - 501,094 Investment securities, available for sale - - 8,295,099 - 8,295,099 Investment securities, held for trading - 10,914,900 - - 10,914,900 Investment in subsidiary 21,143,524 - - (21,143,524) - Loans, held for investment, net - 49,179,918 57,919,266 - 107,099,184 Loans, held for sale - 54,661,250 4,174,694 - 58,835,944 Other real estate owned, net - 241,363 - - 241,363 Premises and equipment, net 64,976 4,183,951 290,072 - 4,538,999 Servicing assets - 1,216,064 256,389 - 1,472,453 Other assets 314,669 7,252,643 778,226 - 8,345,538 ---------------- ------------ ------------ -------------- -------------- TOTAL $ 24,694,135 $169,146,606 $82,507,801 $ (24,314,490) $ 252,034,052 ================ ============ ============ ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY - ----------------------------------------- LIABILITIES: Deposits: Noninterest-bearing demand $ - $ 21,932,636 $ 725,658 $ (3,170,966) $ 19,487,328 Interest-bearing demand - 14,372,467 5,603,671 - 19,976,138 Savings - 16,105,995 10,754,386 - 26,860,381 Time certificates of $100,000 or more - 48,395,302 13,346,875 - 61,742,177 Other time certificates - 50,115,868 45,362,907 - 95,478,775 ---------------- ------------ ------------ -------------- -------------- Total deposits - 150,922,268 75,793,497 (3,170,966) 223,544,799 Other liabilities 140,739 2,968,887 826,231 - 3,935,857 ---------------- ------------ ------------ -------------- -------------- Total liabilities 140,739 153,891,155 76,619,728 (3,170,966) 227,480,656 ---------------- ------------ ------------ -------------- -------------- STOCKHOLDERS' EQUITY Common stock 17,303,590 4,051,645 2,592,744 (6,644,389) 17,303,590 Surplus - 5,448,665 1,946,642 (7,395,307) - Treasury stock (140,739) - - - (140,739) Retained earnings 7,392,992 5,755,141 1,351,134 (7,106,275) 7,392,992 Unrealized gain/(loss) on available for sale securities (2,447) - (2,447) 2,447 (2,447) ---------------- ------------ ------------ -------------- -------------- Total stockholders' equity 24,553,396 15,255,451 5,888,073 (21,143,524) 24,553,396 ---------------- ------------ ------------ -------------- -------------- ---------------- ------------ ------------ -------------- -------------- TOTAL $ 24,694,135 $169,146,606 $82,507,801 $ (24,314,490) $ 252,034,052 ================ ============ ============ ============== ==============
65
Community West Goleta Palomar STATEMENT OF INCOME Bancshares National Savings For the year ended December 31, 1998 (Parent Only) Bank and Loan Eliminations Consolidated ---------------- ----------- ----------- -------------- ------------- INTEREST INCOME: Loans, including fees $ - $14,329,531 $4,549,749 $ - $ 18,879,280 Federal funds sold - 410,513 262,491 - 673,004 Time deposits in other financial institutions - 66,324 56,993 - 123,317 Investment securities - 51,507 819,490 - 870,997 ---------------- ----------- ----------- -------------- ------------- Total interest income - 14,857,875 5,688,723 - 20,546,598 INTEREST EXPENSE ON DEPOSITS - 5,806,680 3,450,020 - 9,256,700 ---------------- ----------- ----------- -------------- ------------- NET INTEREST INCOME - 9,051,195 2,238,703 - 11,289,898 PROVISION FOR LOAN LOSSES - 540,000 (111,031) - 428,969 ---------------- ----------- ----------- -------------- ------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES - 8,511,195 2,349,734 - 10,860,929 ---------------- ----------- ----------- -------------- ------------- OTHER INCOME: Gains from loan sales - 5,763,921 629,865 - 6,393,786 Loan origination fees - 3,679,211 10,907 - 3,690,118 Document processing fees - 1,647,708 - - 1,647,708 Loan servicing income - 785,710 176,768 - 962,478 Service charges - 864,549 22,639 - 887,188 Other income 60 393,094 61,456 - 454,610 ---------------- ----------- ----------- -------------- ------------- Total other income 60 13,134,193 901,635 - 14,035,888 OTHER EXPENSES: Salaries and employee benefits 1,415 11,666,003 1,200,787 - 12,868,205 Occupancy expenses 3,216 2,394,709 340,865 - 2,738,790 Other operating expenses 22,211 1,175,426 459,589 - 1,657,226 Advertising 1,910 727,192 113,260 - 842,362 Professional fees 163,747 356,966 320,218 - 840,931 Postage and freight 57 436,877 33,045 - 469,979 Data processing/ATM processing 1,770 247,227 141,094 - 390,091 Office supply expense 1,025 192,638 73,448 - 267,111 ---------------- ----------- ----------- -------------- ------------- Total other expenses 195,351 17,197,038 2,682,306 - 20,074,695 ---------------- ----------- ----------- -------------- ------------- INCOME BEFORE PROVISION FOR INCOME TAXES (195,291) 4,448,350 569,063 - 4,822,122 PROVISION FOR INCOME TAXES (82,022) 1,851,777 171,600 - 1,941,355 ---------------- ----------- ----------- -------------- ------------- INCOME BEFORE EQUITY IN SUBSIDIARY (113,269) 2,596,573 397,463 - 2,880,767 Equity in subsidiaries 2,994,036 - - (2,994,036) - ---------------- ----------- ----------- -------------- ------------- NET INCOME $ 2,880,767 $ 2,596,573 $ 397,463 $ (2,994,036) $ 2,880,767 ================ =========== =========== ============== =============
66 18. QUARTERLY FINANCIAL DATA (unaudited) Summarized quarterly financial data follows: (All amounts in thousands except per share data)
Quarter Ended March 31 June 30 September 30 December 31 --------- -------- ------------- ------------ 1998 Net interest income $ 1,872 $ 2,958 $ 3,152 $ 3,308 Provision for loan losses 61 103 175 90 Net income 554 962 806 559 Net income per share - basic $ .10 $ .20 $ .18 $ .10 - diluted $ .09 $ .19 $ .18 $ .10
Quarter Ended March 31 June 30 September 30 December 31 --------- -------- ------------- ------------ 1997 Net interest income $ 1,683 $ 1,860 $ 1,831 $ 1,818 Provision for loan losses 81 10 100 - Net income 384 534 640 592 Net income per share - basic $ .09 $ .12 $ .14 $ .14 - diluted $ .09 $ .11 $ .12 $ .12
****** 67 PART III ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - -------------------------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------- None ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; - ------------------------------------------------------------------------------ COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT -------------------------------------------------------- Reference is made to the information contained in the Registrant's definitive Proxy Statement for the Annual Meeting of shareholders to be held in 1999. Such information is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION - ---------------------------------- Reference is made to the Registrant's definitive Proxy Statement for the Annual Meeting of shareholders to be held in 1999. Such information is incorporated herein by reference ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------------------------------------------------------------------------------- Reference is made to the information contained in the Registrant's definitive Proxy Statement for the Annual Meeting of shareholders to be held in 1999. Such information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ------------------------------------------------------------- Reference is made to the information contained in the Registrant's definitive Proxy Statement for the Annual Meeting of shareholders to be held in 1999. Such information is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K - -------------------------------------------------------------------------------- (a)(1) The following consolidated financial statements of Community West Bancshares are filed as part of this Annual Report. Report of Independent Accountants 40 Consolidated Balance Sheets as of December 31, 1998 and 1997 41 Consolidated Statements of Income for each of the three years in the period ended December 31, 1998 42 Consolidated Statements of Changes in Shareholders' Equity for each of the three years ended in the period ended December 31, 1998 43 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1998 44 Notes to Consolidated Financial Statements 45 (a)(2) Financial statement schedules other than those listed above have been omitted because they are either not applicable or the information is otherwise included. (a)(3) Exhibits (2) Plan of Reorganization (1) (3)(i) Articles of Incorporation (3) (3)(ii) By-laws (3) 68 (4)(i) Common Stock Certificate (2) (4)(ii) Warrant Certificate (2) (10)(i) 1997 Stock Option Plan and Form of Stock Option Agreement (1) (10)(ii) Employment Contract between Goleta National Bank and Llewellyn Stone, President & CEO (3) (10)(iii) Salary Continuation Agreement between Goleta National Bank and Llewellyn Stone, President & CEO (3) (21) Subsidiaries of the Registrant (3) (23) Consent of Deloitte & Touche, LLP (27) Financial Data Schedule (1) Filed as an exhibit to the Registrant's registration Statement on Form S-8 filed with the Commission on 12-31-97 and incorporated herein by reference. (2) Filed as an exhibit to the Registrant's Amendment to Registration Statement on Form 8-A filed with the Commission on 3-12-98 and incorporated herein by reference. (3) Filed as an exhibit to the Registrant's Form 10-K filed with the Commission on March 26, 1998 and incorporated herein by reference. 69 SIGNATURES ---------- Pursuant to the requirements of Section 13 of 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 25th day of March, 1999. COMMUNITY WEST BANCSHARES (Registrant) By: /S/ Llewellyn W. Stone --------------------------------- Llewellyn W. Stone President and Chief Executive Officer Pursuant to the requirements of the Securities and 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/ Michael A. Alexander Director March 25, 1999 - -------------------------------- Michael A. Alexander /S/ Mounir R. Ashamalla Director March 25, 1999 - -------------------------------- Mounir R. Ashamalla /S/ Robert H. Bartlein Director and Vice Chairman of the Board March 25, 1999 - -------------------------------- Robert H. Bartlein /S/ Jean W. Blois Director March 25, 1999 - -------------------------------- Jean W. Blois /S/ John D. Illgen Director March 25, 1999 - -------------------------------- John D. Illgen /S/ John D. Markel Chairman of the Board March 25, 1999 - -------------------------------- John D. Markel /S/ Michel Nellis Director and Secretary March 25, 1999 - -------------------------------- Michel Nellis /S/ William R. Peeples Director March 25, 1999 - -------------------------------- William R. Peeples /S/ James Rady Director March 25, 1999 - -------------------------------- James Rady /S/ C. Randy Shaffer Director, Executive Vice President and Chief March 25, 1999 - -------------------------------- C. Randy Shaffer Financial Officer (Principal Financial and Accounting Officer) /S/ James R. Sims Jr. Director March 25, 1999 - -------------------------------- James R. Sims Jr. /S/ Llewellyn W. Stone Director, President and Chief Executive Officer March 25, 1999 - -------------------------------- Llewellyn W. Stone
70 EX-23 2 INDEPENDENT AUDITOR'S CONSENT We consent to the incorporation by reference in Registration Statement No. 333-43531 Community West Bancshares on Form S-8 of our report dated March 19, 1999 appearing in this annual report on Form 10-K of Community West Banchsares for the year ended December 31, 1998. March 30, 1999 Los Angeles, California EX-27 3
9 1000 YEAR DEC-31-1999 JAN-01-1998 DEC-31-1998 6124 1500 43355 10915 8295 501 503 168064 2129 252034 223545 0 3936 0 0 0 17304 7250 252034 18879 871 796 20547 9257 0 11290 429 (62) 20013 4822 4822 0 0 2881 .57 .55 4 2971 678 1313 0 2067 403 36 2129 2129 0 0
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