ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS. - --------------------------------
Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K including, but not limited to, matters described in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations," are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Changes to such risks and uncertainties, which could impact future financial performance, include, among others, (1) competitive pressures in the banking industry; (2) changes in the interest rate environment; (3) general economic conditions, nationally, regionally and in operating market areas, including a decline in real estate values in the Company's market areas; (4) changes in the regulatory environment; (5) changes in business conditions and inflation; (6) changes in securities markets; (7) data processing compliance problems; (8) the California power crisis; (9) variances in the actual versus projected growth in assests; (10) return on assets; (11) loan losses; (12) expenses; (13) rates charged on loans and earned on securities investments; (14) rates paid on deposits; and (15) fee and other noninterest income earned, as well as other factors. This entire Annual Report should be read to put such forward-looking statements in context and to gain a more complete understanding of the uncertainties and risks involved in the Company's business. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company and the Bank.
Central Coast Bancorp (the "Company") is a California corporation, located in Salinas, California and was organized in 1994 to act as a bank holding company for Bank of Salinas. In 1996, the Company acquired Cypress Bank, which was headquartered in Seaside, California. Both banks were state-charted institutions. In July of 1999, the Company merged Cypress Bank into the Bank of Salinas and then renamed Bank of Salinas as Community Bank of Central California (the "Bank"). The Bank is headquartered in Salinas and serves individuals, merchants, small and medium-sized businesses, professionals, agribusiness enterprises and wage earners located in the California Central Coast area.
On February 21, 1997, the former Bank of Salinas purchased certain assets and assumed certain liabilities of the Gonzales and Castroville branch offices of Wells Fargo Bank. As a result of the transaction the Bank assumed deposit liabilities, received cash, and acquired tangible assets. This transaction resulted in intangible assets, representing the excess of the liabilities assumed over the fair value of the tangible assets acquired.
In January 1997, the former Cypress Bank opened a new branch office in Monterey, California, so that it might better serve business and individual customers on the Monterey Peninsula. In December 1998, the former Bank of Salinas opened an additional new branch office in Salinas, California, to better provide services to the growing Salinas community.
In June of 2000, the Bank opened a new branch office in Watsonville, which is in Santa Cruz County. In October of 2000, another new branch office was opened in Hollister, which is in San Benito County. The opening of these two branch offices was a first step in expanding the Bank's service area to include communities outside of Monterey County. Both of these communities are
of similar economic make-up to the agricultural based communities the Bank serves in Monterey County.
Other than holding the shares of the subsidiary Bank, the Company conducts no significant activities. Although, it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the "Board of Governors"), the Company's principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking.
The Bank operates through its main office in Salinas and through nine branch offices located in Castroville, Hollister, Gonzales, King City, Marina, Monterey, Salinas, Seaside and Watsonville, California. The Bank offers a full range of commercial banking services, including the acceptance of demand, savings and time deposits, and the making of commercial, real estate (including residential mortgage), Small Business Administration, personal, home improvement, automobile and other installment and term loans. The Bank also currently offers personal and business Visa credit cards. It also offers ATM and Visa debit cards, travelers' checks, safe deposit boxes, notary public, customer courier and other customary bank services. Most of the Bank's offices are open from 9:00 a.m. to 5:00 p.m., Monday through Thursday and 9:00 a.m. to 6:00 p.m. on Friday. The Westridge and Marina branch offices are also open from 9:00 a.m. to 1:00 p.m. on Saturdays. Additionally, on a 24-hour basis, customers can bank by telephone or online at the Bank's Internet site, www.community-bnk.com. The Bank also operates a limited service facility in a retirement home located in Salinas, California. The facility is open from 10:00 a.m. to 12:00 p.m. on Wednesday of each week. The Bank has automated teller machines (ATMs) located at the Castroville, Hollister, Gonzales, King City, Marina, Monterey, Salinas, Seaside and Watsonville offices, the Monterey County Fairgrounds, the Soledad Correctional Training Facility Credit Union, Salinas Valley Memorial Hospital and Fort Hunter Liggett which is located in Jolon, California. The Bank is insured under the Federal Deposit Insurance Act and each depositor's account is insured up to the legal limits thereon. The Bank is chartered (licensed) by the California Commissioner of Financial Institutions ("Commissioner") and has chosen not to become a member of the Federal Reserve System. The Bank has no subsidiaries.
The Bank operates an on-site computer system, which provides independent processing of its deposits, loans and financial accounting.
The Bank concentrates its lending activities in four principal areas: commercial loans (including agricultural loans); consumer loans; real estate construction loans (both commercial and personal) and real estate-other loans. At December 31, 2000, these four categories accounted for approximately 36%, 2%, 12% and 50% of the Bank's loan portfolio, respectively.
The Bank concentrates its lending activities in four principal areas: commercial loans (including agricultural loans); consumer loans; real estate construction loans (both commercial and personal) and real estate-other loans. At December 31, 2000, these four categories accounted for approximately 36%, 2%, 12% and 50% of the Bank's loan portfolio, respectively.
The Bank's deposits are attracted primarily from individuals, merchants, small and medium-sized businesses, professionals and agribusiness enterprises. The Bank's deposits are not received from a single depositor or group of affiliated depositors the loss of any one of which would have a materially adverse effect on the business of the Bank. A material portion of the Bank's deposits is not concentrated within a single industry or group of related industries.
As of December 31, 2000, the Bank served a total of 26 municipality and governmental agency depositors totaling $48,396,000 in deposits. In connection with the deposits of municipalities or other governmental agencies or entities, the Bank is generally required to pledge securities to secure such deposits, except for the first $100,000 of such deposits which are insured by the Federal Deposit Insurance Corporation ("FDIC").
As of December 31, 2000, the Bank had total deposits of $633,210,000. Of this total, $207,002,000 represented noninterest-bearing demand deposits, $88,285,000 represented interest-bearing demand deposits, and $337,923,000 represented interest-bearing savings and time deposits.
The principal sources of the Bank's revenues are: (i) interest and fees on loans; (ii) interest on investments (principally government securities); and (iii) interest on Federal Funds sold (funds loaned on a short-term basis to other banks). For the fiscal year ended December 31, 2000, these sources comprised 80.5 percent, 17.4 percent, and 2.1 percent, respectively, of the Bank's total interest income.
SUPERVISION AND REGULATION - --------------------------
The common stock of the Company is subject to the registration requirements of the Securities Act of 1933, as amended, and the qualification requirements of the California Corporate Securities Law of 1968, as amended. The Bank's common stock, however, is exempt from such requirements. The Company is also subject to the periodic reporting requirements of Section 13 of the Securities Exchange Act of 1934, as amended, which include, but are not limited to, annual, quarterly and other current reports with the Securities and Exchange Commission.
The Bank is licensed by the California Commissioner of Financial Institutions. Its deposits are insured by the FDIC, and it has chosen not to become a member of the Federal Reserve System. Consequently, the Bank is subject to the supervision of, and is regularly examined by, the Commissioner and the FDIC. Such supervision and regulation include comprehensive reviews of all major aspects of the Bank's business and condition, including its capital ratios, allowance for possible loan losses and other factors. However, no inference should be drawn that such authorities have approved any such factors. The Company and the Bank are required to file reports with the Commissioner, the FDIC and the Board of Governors and provide such additional information as the Commissioner, FDIC and the Board of Governors may require.
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is registered as such with, and subject to the supervision of, the Board of Governors. The Company is required to obtain the approval of the Board of Governors before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5% of the voting shares of such bank. The Bank Holding Company Act prohibits the Company from acquiring any voting shares of, or interest in, all or substantially all of the assets of, a bank located outside the State of California unless such an acquisition is specifically authorized by the laws of the state in which such bank is located. Any such interstate acquisition is also subject to the provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994.
The Company, and any subsidiaries, which it may acquire or organize, are deemed to be "affiliates" of the Bank within the meaning of that term as defined in the Federal Reserve Act. This means, for example, that there are
limitations (a) on loans by the Bank to affiliates, and (b) on investments by the Bank in affiliates' stock as collateral for loans to any borrower. The Company and its subsidiaries are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities.
In addition, regulations of the Board of Governors promulgated under the Federal Reserve Act require that reserves be maintained by the Bank in conjunction with any liability of the Company under any obligation (demand deposits, promissory note, acknowledgement of advance, banker's acceptance or similar obligation) with a weighted average maturity of less than seven (7) years to the extent that the proceeds of such obligations are used for the purpose of supplying funds to the Bank for use in its banking business, or to maintain the availability of such funds.
The Board of Governors and the FDIC have adopted risk-based capital guidelines for evaluating the capital adequacy of bank holding companies and banks. The guidelines are designed to make capital requirements sensitive to differences in risk profiles among banking organizations, to take into account off-balance sheet exposures and to aid in making the definition of bank capital uniform internationally. Under the guidelines, the Company and the Bank are required to maintain capital equal to at least 8.0% of its assets and commitments to extend credit, weighted by risk, of which at least 4.0% must consist primarily of common equity (including retained earnings) and the remainder may consist of subordinated debt, cumulative preferred stock, or a limited amount of loan loss reserves.
Assets, commitments to extend credit, and off-balance sheet items are categorized according to risk and certain assets considered to present less risk than others permit maintenance of capital at less than the 8% ratio. For example, most home mortgage loans are placed in a 50% risk category and therefore require maintenance of capital equal to 4% of such loans, while commercial loans are placed in a 100% risk category and therefore require maintenance of capital equal to 8% of such loans.
The Company and the Bank are subject to regulations issued by the Board of Governors and the FDIC which require maintenance of a certain level of capital. These regulations impose two capital standards: a risk-based capital standard and a leverage capital standard.
Under the Board of Governors' risk-based capital guidelines, assets reported on an institution's balance sheet and certain off-balance sheet items are assigned to risk categories, each of which has an assigned risk weight. Capital ratios are calculated by dividing the institution's qualifying capital by its period-end risk-weighted assets. The guidelines establish two categories of qualifying capital: Tier 1 capital (defined to include common shareholders' equity and noncumulative perpetual preferred stock) and Tier 2 capital which includes, among other items, limited life (and in case of banks, cumulative) preferred stock, mandatory convertible securities, subordinated debt and a limited amount of reserve for loan losses. Tier 2 capital may also include up to 45% of the pretax net unrealized gains on certain available-for-sale equity securities having readily determinable fair values (i.e. the excess, if any, of fair market value over the book value or historical cost of the investment security). The federal regulatory agencies reserve the right to exclude all or a portion of the unrealized gains upon a determination that the equity securities are not prudently valued. Unrealized gains and losses on other types of assets, such as bank premises and available-for-sale debt securities, are not included in Tier 2 capital, but may be taken into account in the evaluation of overall capital adequacy and net unrealized losses on available-for-sale equity securities will continue to be deducted from Tier 1 capital as a cushion against risk. Each institution is required to maintain a risk-based capital ratio (including Tier 1 and Tier 2 capital) of 8%, of which at least half must be Tier 1 capital.
Under the Board of Governors' leverage capital standard an institution is required to maintain a minimum ratio of Tier 1 capital to the sum of its quarterly average total assets and quarterly average reserve for loan losses, less intangibles not included in Tier 1 capital. Period-end assets may be used in place of quarterly average total assets on a case-by-case basis. The Board of Governors and the FDIC have adopted a minimum leverage ratio for bank holding companies as a supplement to the risk-weighted capital guidelines. The leverage ratio establishes a minimum Tier 1 ratio of 3% (Tier 1 capital to total assets) for the highest rated bank holding companies or those that have implemented the risk-based capital market risk measure. All other bank holding companies must maintain a minimum Tier 1 leverage ratio of 4% with higher leverage capital ratios required for bank holding companies that have significant financial and/or operational weakness, a high risk profile, or are undergoing or anticipating rapid growth.
At December 31, 2000, the Bank and the Company are in compliance with the risk-based capital and leverage ratios described above. See Item 8 below for a listing of the Company's risk-based capital ratios at December 31, 2000 and 1999.
The Board of Governors and FDIC adopted regulations implementing a system of prompt corrective action pursuant to Section 38 of the Federal Deposit Insurance Act and Section 131 of the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). The regulations establish five capital categories with the following characteristics: (1) "Well capitalized" - consisting of institutions with a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or greater, and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive; (2) "Adequately capitalized" - consisting of institutions with a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and a leverage ratio of 4% or greater, and the institution does not meet the definition of a "well capitalized" institution; (3) "Undercapitalized" - consisting of institutions with a total risk-based capital ratio less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or a leverage ratio of less than 4%; (4) "Significantly undercapitalized" - - consisting of institutions with a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%; (5) "Critically undercapitalized" - consisting of an institution with a ratio of tangible equity to total assets that is equal to or less than 2%.
The regulations established procedures for classification of financial institutions within the capital categories, filing and reviewing capital restoration plans required under the regulations and procedures for issuance of directives by the appropriate regulatory agency, among other matters. The regulations impose restrictions upon all institutions to refrain from certain actions which would cause an institution to be classified within any one of the three "undercapitalized" categories, such as declaration of dividends or other capital distributions or payment of management fees, if following the distribution or payment the institution would be classified within one of the "undercapitalized" categories. In addition, institutions which are classified in one of the three "undercapitalized" categories are subject to certain mandatory and discretionary supervisory actions. Mandatory supervisory actions include (1) increased monitoring and review by the appropriate federal banking agency; (2) implementation of a capital restoration plan; (3) total asset growth restrictions; and (4) limitation upon acquisitions, branch office expansion, and new business activities without prior approval of the appropriate federal banking agency. Discretionary supervisory actions may include (1) requirements to augment capital; (2) restrictions upon affiliate transactions; (3) restrictions upon deposit gathering activities and interest rates paid; (4) replacement of senior executive officers and directors; (5) restrictions upon activities of
the institution and its affiliates; (6) requiring divestiture or sale of the institution; and (7) any other supervisory action that the appropriate federal banking agency determines is necessary to further the purposes of the regulations. Further, the federal banking agencies may not accept a capital restoration plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company under the guaranty is limited to the lesser of (i) an amount equal to 5 percent of the depository institution's total assets at the time it became undercapitalized, and (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it were "significantly undercapitalized." FDICIA also restricts the solicitation and acceptance of and interest rates payable on brokered deposits by insured depository institutions that are not "well capitalized." An "undercapitalized" institution is not allowed to solicit deposits by offering rates of interest that are significantly higher than the prevailing rates of interest on insured deposits in the particular institution's normal market areas or in the market areas in which such deposits would otherwise be accepted.
Any financial institution which is classified as "critically undercapitalized" must be placed in conservatorship or receivership within 90 days of such determination unless it is also determined that some other course of action would better serve the purposes of the regulations. Critically undercapitalized institutions are also prohibited from making (but not accruing) any payment of principal or interest on subordinated debt without the prior approval of the FDIC and the FDIC must prohibit a critically undercapitalized institution from taking certain other actions without its prior approval, including (1) entering into any material transaction other than in the usual course of business, including investment expansion, acquisition, sale of assets or other similar actions; (2) extending credit for any highly leveraged transaction; (3) amending articles or bylaws unless required to do so to comply with any law, regulation or order; (4) making any material change in accounting methods; (5) engaging in certain affiliate transactions; (6) paying excessive compensation or bonuses; and (7) paying interest on new or renewed liabilities at rates which would increase the weighted average costs of funds beyond prevailing rates in the institution's normal market areas.
Under the FDICIA, the federal financial institution agencies have adopted regulations which require institutions to establish and maintain comprehensive written real estate policies which address certain lending considerations, including loan-to-value limits, loan administrative policies, portfolio diversification standards, and documentation, approval and reporting requirements. The FDICIA further generally prohibits an insured state bank from engaging as a principal in any activity that is impermissible for a national bank, absent FDIC determination that the activity would not pose a significant risk to the Bank Insurance Fund, and that the bank is, and will continue to be, within applicable capital standards. Similar restrictions apply to subsidiaries of insured state banks. The Company does not currently intend to engage in any activities which would be restricted or prohibited under the FDICIA.
The Federal Financial Institution Examination Counsel ("FFIEC") on December 13, 1996, approved an updated Uniform Financial Institutions Rating System ("UFIRS"). In addition to the five components traditionally included in the so-called "CAMEL" rating system which has been used by bank examiners for a number of years to classify and evaluate the soundness of financial
institutions (including capital adequacy, asset quality, management, earnings and liquidity), UFIRS includes for all bank regulatory examinations conducted on or after January1, 1997, a new rating for a sixth category identified as sensitivity to market risk. Ratings in this category are intended to reflect the degree to which changes in interest rates, foreign exchange rates, commodity prices or equity prices may adversely affect an institution's earnings and capital. The revised rating system is identified as the "CAMELS" system.
The federal financial institution agencies have established bases for analysis and standards for assessing a financial institution's capital adequacy in conjunction with the risk-based capital guidelines including analysis of interest rate risk, concentrations of credit risk, risk posed by non-traditional activities, and factors affecting overall safety and soundness. The safety and soundness standards for insured financial institutions include analysis of (1) internal controls, information systems and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset growth; (6) compensation, fees and benefits; and (7) excessive compensation for executive officers, directors or principal shareholders which could lead to material financial loss. If an agency determines that an institution fails to meet any standard, the agency may require the financial institution to submit to the agency an acceptable plan to achieve compliance with the standard. If the agency requires submission of a compliance plan and the institution fails to timely submit an acceptable plan or to implement an accepted plan, the agency must require the institution to correct the deficiency. The agencies may elect to initiate enforcement action in certain cases rather than rely on an existing plan particularly where failure to meet one or more of the standards could threaten the safe and sound operation of the institution.
Community Reinvestment Act ("CRA") regulations evaluate banks' lending to low and moderate income individuals and businesses across a four-point scale from "outstanding" to "substantial noncompliance," and are a factor in regulatory review of applications to merge, establish new branch offices or form bank holding companies. In addition, any bank rated in "substantial noncompliance" with the CRA regulations may be subject to enforcement proceedings.
The Bank has a current rating of "satisfactory" or better for CRA compliance.
The Company's ability to pay cash dividends is subject to restrictions set forth in the California General Corporation Law. Funds for payment of any cash dividends by the Company would be obtained from its investments as well as dividends and/or management fees from the Bank. The payment of cash
dividends and/or management fees by the Bank is subject to restrictions set forth in the California Financial Code, as well as restrictions established by the FDIC. See Item 5 below for further information regarding the payment of cash dividends by the Company and the Bank.
COMPETITION - -----------
At June 30, 2000, the competing commercial and savings banks had 71 branch offices in the cities of Castroville, Hollister, Gonzales, King City, Marina, Monterey, Salinas, Seaside and Watsonville where the Bank has its ten branch offices. Additionally, the Bank competes with thrifts and, to a lesser extent, credit unions, finance companies and other financial service providers for deposit and loan customers.
Larger banks may have a competitive advantage because of higher lending limits and major advertising and marketing campaigns. They also perform services, such as trust services, international banking, discount brokerage and insurance services, which the Bank is not authorized nor prepared to offer currently. The Bank has made arrangements with its correspondent banks and with others to provide some of these services for its customers. For borrowers requiring loans in excess of the Bank's legal lending limits, the Bank has offered, and intends to offer in the future, such loans on a participating basis with its correspondent banks and with other independent banks, retaining the portion of such loans which is within its lending limits. As of December 31, 2000, the Bank's aggregate legal lending limits to a single borrower and such borrower's related parties were $9,929,000 on an unsecured basis and $16,549,000 on a fully secured basis based on regulatory capital of $66,194,000.
The Bank's business is concentrated in its service area, which primarily encompasses Monterey County, including the Salinas Valley area. With the branch office expansion in 2000 into Hollister and Watsonville, the Bank has more actively expanded its service area to include San Benito and Santa Cruz Counties. The Bank uses couriers to service the southern portion of Santa Clara County. The economy of the Bank's service area is dependent upon agriculture, tourism, retail sales, population growth and smaller service oriented businesses.
Based upon data as of the most recent practicable date (June 30, 2000 [1]), there were 73 operating commercial and savings bank branch offices in Monterey County with total deposits of $4,065,119,000. This was an increase of $215,433,000 over the June 30, 1999 balances. The Bank held a total of $585,225,000 in deposits, representing approximately 14.4% of total commercial and savings banks deposits in Monterey County as of June 30, 2000. In the two new expansion areas of Hollister and Watsonville, at June 30, 2000, there were 10 and 12 branch offices with total deposits of $472,032,000 and $661,886,000, respectively.
In order to compete with the major financial institutions in their primary service areas, the Bank uses to the fullest extent possible, the flexibility which is accorded by its independent status. This includes an emphasis on specialized services, local promotional activity, and personal contacts by the Bank's officers, directors and employees. The Bank also seeks to provide special services and programs for individuals in its primary service area who are employed in the agricultural, professional and business fields, such as loans for equipment, furniture, tools of the trade or expansion of practices or businesses. In the event there are customers whose loan demands exceed the Bank's lending limits, the Bank seeks to arrange for such loans on a
- -------- 1 "FDIC Institution Office Deposits", June 30, 2000
participation basis with other financial institutions. The Bank also assists those customers requiring services not offered by the Bank to obtain such services from correspondent banks.
Banking is a business that depends on interest rate differentials. In general, the difference between the interest rate paid by the Bank to obtain their deposits and other borrowings and the interest rate received by the Bank on loans extended to customers and on securities held in the Bank's portfolio comprise the major portion of the Bank's earnings.
Commercial banks compete with savings and loan associations, credit unions, other financial institutions and other entities for funds. For instance, yields on corporate and government debt securities and other commercial paper affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for loans with savings and loan associations, credit unions, consumer finance companies, mortgage companies and other lending institutions.
The interest rate differentials of the Bank, and therefore its earnings, are affected not only by general economic conditions, both domestic and foreign, but also by the monetary and fiscal policies of the United States as set by statutes and as implemented by federal agencies, particularly the Federal Reserve Board. This Agency can and does implement national monetary policy, such as seeking to curb inflation and combat recession, by its open market operations in United States government securities, adjustments in the amount of interest free reserves that banks and other financial institutions are required to maintain, and adjustments to the discount rates applicable to borrowing by banks from the Federal Reserve Board. These activities influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and timing of any future changes in monetary policies and their impact on the Bank are not predictable.
In 1996, pursuant to Congressional mandate, the FDIC reduced bank deposit insurance assessment rates to a range from $0 to $0.27 per $100 of deposits, dependent upon a bank's risk. Based upon the above risk-based assessment rate schedule, the Bank's current capital ratios and the Bank's current levels of deposits, the Bank anticipates no change in the assessment rate applicable to the Bank during 2001 from that in 2000.
Since 1996, California law implementing certain provisions of prior federal law has (1) permitted interstate merger transactions; (2) prohibited interstate branching through the acquisition of a branch office business unit located in California without acquisition of the whole business unit of the California bank; and (3) prohibited interstate branching through de novo establishment of California branch offices. Initial entry into California by an out-of-state institution must be accomplished by acquisition of or merger with an existing whole bank which has been in existence for at least five years.
The federal financial institution agencies, especially the OCC and the Board of Governors, have taken steps to increase the types of activities in which national banks and bank holding companies can engage, and to make it easier to engage in such activities. The OCC has issued regulations permitting national banks to engage in a wider range of activities through subsidiaries. "Eligible institutions" (those national banks that are well capitalized, have a high overall rating and a satisfactory CRA rating, and are not subject to an enforcement order) may engage in activities related to banking through operating subsidiaries subject to an expedited application process. In addition, a national bank may apply to the OCC to engage in an activity through a subsidiary in which the bank itself may not engage.
On November 12, 1999, President Clinton signed into law The Financial Services Modernization Act of 1999 (the "FSMA"), which is potentially the most significant banking legislation in many years. The FSMA eliminates most of the remaining depression-era "firewalls" between banks, securities firms and insurance companies which was established by The Banking Act of 1933, also known as the Glass-Steagall Act ("Glass-Steagall). Glass-Steagall sought to insulate banks as depository institutions from the perceived risks of securities dealing and underwriting, and related activities. The FSMA repeals Section 20 of Glass-Steagall which prohibited banks from affiliating with securities firms. Bank holding companies that can qualify as "financial holding companies" can now acquire securities firms or create them as subsidiaries, and securities firms can now acquire banks or start banking activities through a financial holding company. The FSMA includes provisions which permit national banks to conduct financial activities through a subsidiary that are permissible for a national bank to engage in directly, as well as certain activities authorized by statute, or that are financial in nature or incidental to financial activities to the same extent as permitted to a "financial holding company" or its affiliates. This liberalization of United States banking and financial services regulation applies both to domestic institutions and foreign institutions conducting business in the United States. Consequently, the common ownership of banks, securities firms and insurance firms is now possible, as is the conduct of commercial banking, merchant banking, investment management, securities underwriting and insurance within a single financial institution using a "financial holding company" structure authorized by the FSMA.
Prior to the FSMA, significant restrictions existed on the affiliation of banks with securities firms and on the direct conduct by banks of securities dealing and underwriting and related securities activities. Banks were also (with minor exceptions) prohibited from engaging in insurance activities or affiliating with insurers. The FSMA removes these restrictions and substantially eliminates the prohibitions under the Bank Holding Company Act on affiliations between banks and insurance companies. Bank holding companies which qualify as financial holding companies can now insure, guarantee, or indemnify against loss, harm, damage, illness, disability, or death; issue annuities; and act as a principal, agent, or broker regarding such insurance services.
In order for a commercial bank to affiliate with a securities firm or an insurance company pursuant to the FSMA, its bank holding company must qualify as a financial holding company. A bank holding company will qualify if (i) its banking subsidiaries are "well capitalized" and "well managed" and (ii) it files with the Board of Governors a certification to such effect and a declaration that it elects to become a financial holding company. The amendment of the Bank Holding Company Act now permits financial holding companies to engage in activities, and acquire companies engaged in activities, that are financial in nature or incidental to such financial activities. Financial holding companies are also permitted to engage in activities that are complementary to financial activities if the Board of Governors determines that the activity does not pose a substantial risk to the safety or soundness of depository institutions or the financial system in general. These standards expand upon the list of activities "closely related to banking" which have to date defined the permissible activities of bank holding companies under the Bank Holding Company Act.
One further effect of the Act is to require that financial institutions must respect the privacy of their customers and protect the security and confidentiality of customers' non-public personal information. These regulations require, in general, that financial institutions (1) may not disclose non-public personal information of customers to non-affiliated third parties without notice to their customers, who must have opportunity to direct that such information not be disclosed; (2) may not disclose customer
account numbers except to consumer reporting agencies; and (3) must give prior disclosure of their privacy policies before establishing new customer relationships.
The Company and the Bank have not determined whether or when either of them may seek to acquire and exercise new powers or activities under the FSMA, and the extent to which competition will change among financial institutions affected by the FSMA has not yet become clear.
Certain legislative and regulatory proposals that could affect the Bank and the banking business in general are periodically introduced before the United States Congress, the California State Legislature and Federal and state government agencies. It is not known to what extent, if any, legislative proposals will be enacted and what effect such legislation would have on the structure, regulation and competitive relationships of financial institutions. It is likely, however, that such legislation could subject the Company and the Bank to increased regulation, disclosure and reporting requirements and increase competition and the Bank's cost of doing business.
In addition to legislative changes, the various federal and state financial institution regulatory agencies frequently propose rules and regulations to implement and enforce already existing legislation. It cannot be predicted whether or in what form any such rules or regulations will be enacted or the effect that such and regulations may have on the Company and the Bank.
ITEM 2.
ITEM 2. PROPERTIES
The headquarters office and centralized operations of the Company are located at 301 Main Street, Salinas, California. The Company owns and leases properties that house administrative and data processing functions and ten banking offices. Owned and leased facilities are listed below.
301 Main Street 1658 Fremont Boulevard Salinas, California Seaside, California 32,500 square feet 2,800 square feet Leased (term expires 2007, Leased (term expires 2009 with three 7 1/2 year with one 10 year renewal renewal options) options) Current month rent of Current month rent of $21,397.08 $5,483.92
10601 Merritt Street 228 Reservation Road Castroville, California Marina, California 2,500 square feet 3,000 square feet Owned Leased (term expires 2004 with three 5 year renewal options) Current month rent of $3,120.00
400 Alta Street 599 Lighthouse Avenue Gonzales, California Monterey, California. 5,175 square feet 2,160 square feet Leased (term expires 2003 Leased (term expires 2004 with three 5 year renewal with two 10 year renewal options) options) Current month rent of Current month rent of $4,132.00 $6,312.80
532 Broadway 155 Westridge Drive King City, California Watsonville, California 4,000 square feet 971 square feet Leased (term expires 2009 Leased (term expires 2003 with two 5 year renewal with two 3 year renewal options) options) Current month rent of Current month rent of $4,920.00 $1,204.04
1285 North Davis Road 491 Tres Pinos Road Salinas, California. Hollister, California 3,200 square feet 1,400 square feet Leased (term expires 2008 Leased (term expires 2003 with two 5 year renewal with two 3 year renewal options) options) Current month rent of Current month rent of $7,728.00 $2,101.00
The above leases contain options to extend for three to fifteen years. Included in the above are two facilities leased from shareholders at terms and conditions which management believes are consistent with the commercial lease market. Rental rates are adjusted annually for changes in certain economic indices. The annual minimum lease commitments are set forth in Footnote 5 of Item 8 Financial Statements and Supplementary Data included in this report and incorporated here by reference. The foregoing summary descriptions of leased premises are qualified in their entirety by reference to the lease agreements listed as exhibits hereto at page 62.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are no material proceedings adverse to the Company or the Bank to which any director, officer, affiliate of the Company or 5% shareholder of the Company or the Bank, or any associate of any such director, officer, affiliate or 5% shareholder of the Company or Bank are a party, and none of the above persons has a material interest adverse to the Company or the Bank.
Neither the Company nor the Bank are a party to any pending legal or administrative proceedings (other than ordinary routine litigation incidental to the Company's or the Bank's business) and no such proceedings are known to be contemplated.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 2000.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information
The Company's common stock is listed on the Nasdaq National Market exchange (trading symbol: CCBN). Among the Company's market makers, the most significant are Sandler O'Neill & Partners, L.P. and Hoefer & Arnett, Incorporated. The table below presents the range of high and low prices for the common stock for the two most recent fiscal years based on information provided to the Company from Nasdaq. The prices have been restated to reflect the 10% stock dividends paid in February 2000 and 2001.
The closing price for the Company's common stock was $19.00 as of March 7, 2001.
(b) Holders -------
As of March 7, 2001, there wereapproximately 3,200 holders of the common stock of the Company. There are no other classes of common equity outstanding.
(c) Dividends ---------
The Company's shareholders are entitled to receive dividends when and as declared by its Board of Directors, out of funds legally available therefor, subject to the restrictions set forth in the California General Corporation Law (the "Corporation Law"). The Corporation Law provides that a corporation may make a distribution to its shareholders if the corporation's retained earnings equal at least the amount of the proposed distribution. The Corporation Law further provides that, in the event that sufficient retained earnings are not available for the proposed distribution, a corporation may nevertheless make a distribution to its shareholders if it meets two conditions, which generally stated are as follows: (1) the corporation's assets equal at least 1-1/4 times its liabilities; and (2) the corporation's current assets equal at least its current liabilities or, if the average of the corporation's earnings before taxes on income and before interest expenses for the two preceding fiscal years was less than the
average of the corporation's interest expenses for such fiscal years, then the corporation's current assets must equal at least 1-1/4 times its current liabilities. Funds for payment of any cash dividends by the Company would be obtained from its investments as well as dividends and/or management fees from the Bank.
The payment of cash dividends by the subsidiary Bank is subject to restrictions set forth in the California Financial Code (the "Financial Code"). The Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of the lesser of (a) the bank's retained earnings; or (b) the bank's net income for its last three fiscal years, less the amount of any distributions made by the bank or by any majority-owned subsidiary of the bank to the shareholders of the bank during such period. However, a bank may, with the approval of the Commissioner, make a distribution to its shareholders in an amount not exceeding the greater of (a) its retained earnings; (b) its net income for its last fiscal year; or (c) its net income for its current fiscal year. In the event that the Commissioner determines that the shareholders' equity of a bank is inadequate or that the making of a distribution by the bank would be unsafe or unsound, the Commissioner may order the bank to refrain from making a proposed distribution.
The FDIC may also restrict the payment of dividends if such payment would be deemed unsafe or unsound or if after the payment of such dividends, the bank would be included in one of the "undercapitalized" categories for capital adequacy purposes pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991. Additionally, while the Board of Governors has no general restriction with respect to the payment of cash dividends by an adequately capitalized bank to its parent holding company, the Board of Governors might, under certain circumstances, place restrictions on the ability of a particular bank to pay dividends based upon peer group averages and the performance and maturity of the particular bank, or object to management fees on the basis that such fees cannot be supported by the value of the services rendered or are not the result of an arm's length transaction.
Under these provisions and considering minimum regulatory capital requirements, the amount available for distribution from the Bank to the Company was approximately $16,642,000 as of December 31, 2000.
To date, the Company has not paid a cash dividend and presently does not intend to pay cash dividends in the foreseeable future. The Company distributed a ten percent stock dividend in February 2001, a ten percent stock dividend in 2000 and a five-for-four stock split in February 1999. The Board of Directors will determine payment of dividends in the future after consideration of various factors including the profitability and capital adequacy of the Company and the Bank.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents certain consolidated financial information concerning the business of the Company and its subsidiary Bank. This information should be read in conjunction with the Consolidated Financial Statements, the notes thereto, and Management's Discussion and Analysis included in this report. Earnings per share information has been adjusted retroactively for all stock dividends and stock splits.
(a) (1) Distribution of Assets, Liabilities and Equity; Interest Rates and ------------------------------------------------------------------ Interest Differential ---------------------
Table One in Management's Discussion and Analysis included in this report sets forth the Company's average balance sheets (based on daily averages) and an analysis of interest rates and the interest rate differential for each of the three years in the period ended December 31, 2000 and is incorporated here by reference.
(2) Volume/Rate Analysis -------------------- Information as to the impact of changes in average rates and average balances on interest earning assets and interest bearing liabilities is set forth in Table Two in Management's Discussion and Analysis and is incorporated here by reference.
(b) Investment Portfolio --------------------
(1) The book value of investment securities at December 31, 2000 and 1999 is set forth in Note 3 of Item 8 - "Financial Statements and Supplementary Data" included in this report and is incorporated here by reference.
(2) The book value, maturities and weighted average yields of investment securities as of December 31, 2000 are set forth in Table Thirteen of Management's Discussion and Analysis included in this report and is incorporated here by reference.
(3) There were no issuers of securities for which the book value was greater than 10% of shareholders' equity other than U.S. Government and U.S. Government Agencies and Corporations.
(c) Loan Portfolio --------------
(1) The composition of the loan portfolio is summarized in Table Three of Management's Discussion and Analysis included in this report and is incorporated here by reference.
(2) The maturity distribution of the loan portfolio at December 31, 2000 is summarized in Table Twelve of Management's Discussion and Analysis included in this report and is incorporated here by reference.
(3) Nonperforming Loans -------------------
The Company's current policy is to cease accruing interest when a loan becomes 90 days past due as to principal or interest, when the full timely collection of interest or principal becomes uncertain or when a portion of the principal balance has been charged off, unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, the accrued and uncollected interest receivable is reversed and the loan is accounted for on the cash or cost recovery method thereafter, until qualifying for return to accrual status. Generally, a loan may be returned to accrual status when all delinquent interest and principal become current in accordance with the terms of the loan agreement or when the loan is both well secured and in process of collection.
A loan is considered to be impaired when it is probable that the Company will be unable to pay all of the amounts due according to the contractual terms of the loan agreement
For further discussion of nonperforming loans, refer to Risk Elements section of Management's Discussion and Analysis in this report.
(d) Summary of Loan Loss Experience -------------------------------
(1) An analysis of the allowance for loan losses showing charged off and recovery activity as of December 31, 2000 is summarized in Table Five of Management's Discussion and Analysis included in this report and is incorporated here by reference. Factors used in determination of the allowance for loan losses are discussed in greater detail in the "Risk Elements" section of Management's Discussion and Analysis included in this report and are incorporated here by reference.
(2) Management believes that any breakdown or allocation of the allowance for possible loan losses into loan categories lends an appearance of exactness, which does not exist in that the allowance is utilized as a single unallocated allowance available for all loans. Further, management believes that the breakdown of historical losses in the preceding table is a reasonable representation of management's expectation of potential losses in the next full year of operation. However, the allowance for loan losses should not be interpreted as an indication of when charge-offs will occur or as an indication of future charge-off trends.
(e) Deposits --------
(1) Table One in Management's Discussion and Analysis included in this report sets forth the distribution of average deposits for the years ended December 31, 2000, 1999 and 1998 and is incorporated here by reference.
(2) Table Eleven in Management's Discussion and Analysis included in this report sets forth the maturities of time certificates of deposit of $100,000 or more at December 31, 2000 and is incorporated here by reference.
(f) Return on Equity and Assets ---------------------------
(1) The Selected Financial Data table at page 16 of this section sets forth the ratios of net income to average assets and average shareholders' equity, and average shareholders' equity to average assets. As the Company has never paid a cash dividend, the dividend payout ratio is not indicated.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K including, but not limited to, matters described in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations," are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Changes to such risks and uncertainties, which could impact future financial performance, include, among others, (1) competitive pressures in the banking industry; (2) changes in the interest rate environment; (3) general economic conditions, nationally, regionally and in operating market areas, including a decline in real estate values in the Company's market areas; (4) changes in the regulatory environment; (5) changes in business conditions and inflation; (6) changes in securities markets; (7) data processing compliance problems; (8) the California power crisis; (9) variances in the actual versus projected growth in assests; (10) return on assets; (11) loan losses; (12) expenses; (13) rates charged on loans and earned on securities investments; (14) rates paid on deposits; and (15) fee and other noninterest income earned, as well as other factors. This entire Annual Report should be read to put such forward-looking statements in context and to gain a more complete understanding of the uncertainties and risks involved in the Company's business. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company and the Bank.
Business Organization
Central Coast Bancorp (the "Company") is a California corporation, located in Salinas, California and was organized in 1994 to act as a bank holding company for Bank of Salinas. In 1996, the Company acquired Cypress Bank, which was headquartered in Seaside, California. Both banks were state-charted institutions. In July of 1999, the Company merged Cypress Bank into the Bank of Salinas and then renamed Bank of Salinas as Community Bank of Central California (the "Bank"). As of December 31, 2000, the Bank operated ten full-service branch offices and one limited-service branch office. The Bank is headquartered in Salinas and serves individuals, merchants, small and medium-sized businesses, professionals, agribusiness enterprises and wage earners located in the tri-county area of Monterey, San Benito and Santa Cruz.
In December 1998, the former Bank of Salinas opened an additional new branch office in Salinas, California, to better provide services to the growing Salinas community.
In June of 2000, the Bank opened a new branch office in Watsonville, which is in Santa Cruz County. In October of 2000, another new branch office was opened in Hollister, which is in San Benito County. The opening of these two branch offices was a first step in expanding the Bank's service area to include communities outside of Monterey County. Both of these communities are of similar economic make up to the agricultural based communities the Bank serves in Monterey County.
Other than holding the shares of the subsidiary Bank, the Company conducts no significant activities. Although, it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the "Board of Governors"), the Company's principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking.
The following analysis is designed to enhance the reader's understanding of the Company's financial condition and the results of its operations as reported in the Consolidated Financial Statements included in this Annual Report. Reference should be made to those statements and the Selected
Financial Data presented elsewhere in this report for additional detailed information. Average balances, including such balances used in calculating certain financial ratios, are generally comprised of average daily balances for the Company. Except within the "overview" section, interest income and net interest income are presented on a tax equivalent basis.
Overview
For the 17th consecutive year, Central Coast Bancorp earned record net income on a year over year basis. Net income in 2000 increased 10.9% to $8,926,000 versus $8,051,000 in 1999. Diluted earnings per share for 2000 was $1.14, up 14.0% from the $1.00 reported for 1999. For 2000, the Company realized a return on average equity of 16.0% and a return on average assets of 1.41%, as compared to 15.5% and 1.43% for 1999. The earnings per share for 2000 and 1999 have been adjusted for the 10 percent stock dividend distributed on February 28, 2001.
During 2000, total assets of the Company increased $113,248,000 (19.1%) to a total of $706,693,000 at year-end. At December 31, 2000, loans totaled $473,395,000, up $77,798,000 (19.7%) from the ending balances on December 31, 1999. Deposit growth in 2000, net of returning $20,000,000 of State of California certificates of deposit, was $135,021,000 (27.1%) resulting in ending deposit balances of $633,210,000.
The Bank's growth in total assets, loans and deposits reflected in the previous paragraph came from the hard work and dedication of our employees. In a time when many banks have been struggling to maintain customer relationships and their deposit base, Community Bank was able to exceed its growth goals for the year. Every one of the existing branch offices exceeded their deposit growth goals for 2000. Most of the branch offices also exceeded their loan goals. The two new branch offices in Hollister and Watsonville have been well received as their staffs immersed themselves in exposing those communities to the benefits of banking with Community Bank. In both of the new branch offices, deposit and loan growth exceeded the business plan forecasts.
In its continuing quest to offer products and services to make banking more convenient for the customer, the Bank introduced "Anytime Online" its Internet banking product in the spring of 2000. This product compliments and expands on the functionality of "Anytime Teller", a 24 hour banking by telephone product, which was introduced in 1999. Both systems provide a quick and easy way for both business and retail customers to check balances and account activity, transfer funds between accounts, make loan payments and order statements. Online banking provides the functionality to pay bills, open accounts, issue stop payments, purchase savings bonds and more. "Anytime Online" can be viewed at the Bank's web site address, www.community-bnk.com. These products along with the VISA Check Card, which was introduced in late 1999, have been well received by the Bank's customers.
As Internet only banks are discovering, bricks and mortar are necessary to build an effective franchise. We believe that branch offices are the building blocks of Community Bank. These business units with their front line employees are critical in providing the service that gives us a competitive edge against large impersonal financial institutions. As we go forward, a critical component of our strategic plan is to expand our branch office base. We believe this strategy will provide continued growth and the ability to achieve above average returns for our shareholders.
(A) Results of Operations
Net Interest Income/Net Interest Margin (fully taxable equivalent)
Net interest income represents the excess of interest and fees earned on interest-earning assets (loans, securities and federal funds sold) over the interest paid on deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets.
Net interest income for 2000 was $33,927,000, a $5,293,000 (18.5%) increase over 1999. The interest income component was up $9,935,000 to $52,217,000 (23.5%). About 65% of the increase was attributable to growth in the earning assets with the balance due to rates. Average outstanding loan balances of $417,075,000 for 2000 reflected a 19.8% increase over 1999 balances. This increase contributed an additional $6,388,000 to interest income. From July 1, 1999 through May 15, 2000, the Federal Reserve Board raised interest rates six times for a total of 175 basis points. The higher interest rates increased the average yield on loans 67 basis points, which added $2,783,000 to interest income. The securities portfolio average balances decreased $12,066,000 (7.8%) which offset the increases in interest income by $757,000. The average yield received on securities was up 44 basis points and added $613,000 to interest income. Federal Funds sold interest income increased $908,000 due to both higher average balances and higher rates. Interest income on variable rate loans and Federal Funds quickly reflect rate changes. During January of 2001, the Federal Reserve Board twice decreased the Federal Funds interest rates by 50 basis points for a total reduction of 1.0%. This reduction will negatively impact interest income in 2001 and it may affect the Bank's ability to attain interest income growth rates achieved in the past two years.
Interest expense increased $4,642,000 (34.0%) in 2000 over 1999. The average balances of interest bearing liabilities increased $49,628,000 (13.2%). The higher average balances resulted from a $58,677,000 (36.8%) increase in time deposits offset in part by an $8,768,000 decrease in interest bearing checking accounts. At times during 2000, the Bank had up to $40,000,000 in time deposits from the State of California. This compares to a maximum of $20,000,000 in 1999. In early November 2000, the last of the State deposits matured. Interest paid on time certificates in 2000 increased $4,569,000, which accounted for most of the overall increase in interest expense. Interest expense attributable to the higher volume in time deposits was $2,934,000 and the higher rates added $1,635,000. Average rates paid on time certificates were 75 basis points higher in 2000. Rates paid on all interest bearing liabilities were 66 basis points higher in 2000 than in 1999. Interest paid on interest bearing liabilities generally adjusts more slowly in response to market rate changes as time deposits and borrowings adjust at maturity. Net interest margin for 2000 was 5.88% versus 5.65% in 1999.
Net interest income for 1999 was $28,634,000, a $4,504,000 (18.7%) increase over 1998. The interest income component was up $4,833,000 to $42,282,000 (12.9%). Most of the increase was attributable to growth in the earning assets. Average outstanding loan balances of $348,086,000 for 1999 reflected a 28.2% increase over 1998 balances. This increase contributed an additional $7,619,000 to interest income. However, due to lower rates in the first half of the year and competitive pressures, the average yield was down 70 basis points, which offset the increase by $2,422,000. The securities portfolio average balances grew $30,041,000 (24.0%) which added $2,027,000 to interest income. The average yield received on securities was up 33 basis points and added $297,000 to interest income. Federal Funds sold interest income decreased $2,688,000 as the average balances decreased $50,031,000. Federal Funds were repositioned into securities and loans during 1999.
Interest expense increased $329,000 (2.5%) in 1999 over 1998. The average balances of interest bearing liabilities increased $43,021,000 (12.9%). The higher balances were due to internal growth of deposits, $8,125,000 of average borrowings (including Federal Funds purchased) and approximately $16,000,000 in average balances of State of California certificates of deposit. Interest expense attributable to the higher volume was $1,776,000. Rates paid on all interest bearing liabilities were 36 basis points lower in 1999 than in 1998. The lower rates offset the higher expense by $1,447,000. Net interest margin for 1999 was 5.65% versus 5.36% in 1998.
Table One, Analysis of Net Interest Margin on Earning Assets, and Table Two, Analysis of Volume and Rate Changes on Net Interest Income and Expenses, are provided to enable the reader to understand the components and past trends of the Banks' interest income and expenses. Table One provides an analysis of net interest margin on earning assets setting forth average assets, liabilities and shareholders' equity; interest income earned and interest expense paid and average rates earned and paid; and the net interest margin on earning assets. Table Two presents an analysis of volume and rate change on net interest income and expense.
1. Loans interest includes loan fees of $997,000, $1,096,000, and $951,000 in 2000, 1999 and 1998. 2. Average balances of loans include average allowance for loan losses of $7,097,000, $4,850,000 and $4,260,000 and average deferred loan fees of $719,000, $796,000 and $587,000 for the years ended December 31, 2000, 1999 and 1998, respectively. 3. Includes taxable-equivalent adjustments for income on securities that is exempt from federal income taxes. The federal statutory tax rate was 35% for 2000, 1999, and 1998. 4. Net interest margin is computed by dividing net interest income by total average earning assets.
1. The average balance of non-accruing loans is immaterial as a percentage of total loans and, as such, has been included in net loans. 2. Loan fees of $997,000, $1,096,000, and $951,000 for the years ended December 31, 2000, 1999, and 1998, respectively, have been included in the interest income computation. 3. Includes taxable-equivalent adjustments for income on securities that is exempt from federal income taxes. The federal statutory tax rate was 35% for 2000, 1999, and 1998. 4. The rate / volume variance has been included in the rate variance.
Provision for Loan Losses
In 2000, the Bank provided $3,983,000 for loan losses as compared to $1,484,000 in 1999. In providing for the allowance for loan losses the Company considered the significant growth in the loan portfolio of $77,798,000 (19.7%), geographic and industry concentrations, expansion into new geographic markets, and volatility and weaknesses in the local economy, including potential effects of power shortages, water supply, and volatile market prices for agricultural products. In addition, approximately $1.2 million was provided as a result of the downward classification to substandard of several loans to a single borrower. At December 31, 2000, these loans were performing in accordance with their terms and conditions. The allowances for loan losses to total loans at December 31, 2000 and 1999 were 1.98% and 1.41%, respectively. Net loans charged-off in 2000 totaled $208,000 or .05% of average loans outstanding.
In 1999, $1,058,000 of the provision of $1,484,000 was required for the $77,260,000 loan growth during the year. Additional provision was needed to replenish the allowance for charged-off loans. Net loans charged-off in 1999 totaled $240,000 or .07% of average loans outstanding. In 1998, net loans charged-off totaled $30,000 or .01% of average loans outstanding. Consequently, the Bank made provisions for loan losses of only $159,000.
Service Charges and Fees and Other Income
Noninterest income was up $202,000 (9.1%) in 2000 over the same period in 1999. Service charges and fees related to deposit accounts increased $401,000 (29.8%) due to higher volumes, the full year effect of new fees implemented in late 1999 and new products. Noninterest income was negatively impacted in the fourth quarter of 2000 as the Bank realized a loss of $194,000 on the sale and repositioning of investment securities. In all of 1999, the Bank had a realized gain of $45,000 on the sale of investment securities.
Noninterest income was up $147,000 (7.1%) to $2,231,000 in 1999 from the 1998 level. Service charges and fees made up $113,000 of the increase. Several new fees were implemented late in 1999. These new fees added about $40,000 of the increase. The remainder was due to higher volumes. Other income increased only $34,000 (4.0%) from the 1998 level. This change reflected some good growth in certain service fees that was offset in part by lower mortgage origination fees due to the higher mortgage interest rates and reduced up-charges on Bank supplied check stock.
Salaries and Benefits
Salary and benefit expenses increased $965,000 (10.6%) in 2000 over 1999. Salary expenses related to the staffing of the two new branch offices opened in the second half of the year accounted for $287,000 of the increase. Salaries and benefits from continuing operations were up $678,000 (7.4%). Base salaries increased $421,000 (6.2%) due to normal merit reviews, competitive salary adjustments and staffing additions during the year. Benefit costs increased commensurate with the salaries. At the end of 2000, the full time equivalent (FTE) staff was 211 versus 204 at the end of 1999.
For 1999, increases in salaries and benefits totaled $903,000 (11.0%). Base salaries increased $644,000 (10.4%) due to normal merit reviews, 11 additional months of operations for the Westridge branch office and staffing additions during the year. Benefit costs increased commensurate with the salaries. At the end of 1999, the full time equivalent (FTE) staff was 204 versus 197 at the end of 1998.
Occupancy and Furniture and equipment
Occupancy and fixed assets expense increased $542,000 (20.5%) in 2000 over 1999. The new Hollister and Watsonville branch offices accounted for $81,000 of the increase. For the rest of the Company occupancy and fixed assets expense increased $461,000 (17.4%). Much of the increase is attributable to the full year effect of the relocation of two branch offices and remodeling of one branch office and operations office space during 1999.
Occupancy and fixed assets expense increased $585,000 (28.5%) in 1999. Much of the increase was attributable to the remodeling of two branch offices and operations office space during the year as well as the full year of Westridge operations and upgrades to the MIS systems and computer network. Additional costs were incurred for an outside security service during the last quarter as the Bank increased its vault cash in preparation for year 2000 disruption concerns.
Other Expenses
Other expenses were down $142,000 (3.3%) in 2000 from 1999. Other expenses related to the two new branch offices were $45,000. Thus, other expenses for other operations decreased $187,000 (4.4%). In 1999, the Bank incurred one-time costs of approximately $263,000 associated with the merger of the Bank of Salinas and Cypress Bank to form Community Bank of Central California. Normal price increases and growth in the Bank's operations accounted for the remaining higher expenses. The efficiency ratio (fully taxable equivalent), calculated by dividing noninterest expense by the sum of net interest income and noninterest income, for 2000 was 47.9% as compared to 52.0% in 1999.
In 1999, other expenses increased $696,000 (19.4%). These include one-time costs of approximately $263,000 associated with merging Bank of Salinas and Cypress Bank. Also in 1999, the Bank recorded a $73,000 expense to write-down its former Gonzales branch office building to estimated net realizable value. Normal price increases and growth in the Bank's operations accounted for the remaining higher expenses. The efficiency ratio (fully taxable equivalent), for 1999 was 52.0% as compared to 52.9% in 1998.
Provision for Taxes
The effective tax rate on income was 37.0%, 36.0%, and 40.9% in 2000, 1999 and 1998, respectively. The effective tax rate of the Company was higher in 2000 over 1999 as tax exempt instruments were a smaller percentage of earning assets. In 1999, the effective tax rate of the Company was reduced 4.9% from the prior year as a result of investments made in tax qualified municipal bonds. The effective tax rate was greater than the federal statutory tax rate due to state tax expense of $1,512,000, $1,326,000 and $1,292,000 in these years. Tax-exempt income of $2,082,000, $1,998,000 and $266,000 from investment securities and loans in these years helped to reduce the effective tax rate.
(B) Balance Sheet Analysis
Central Coast Bancorp's total assets at December 31, 2000 were $706,693,000 compared to $593,445,000 at December 31, 1999, representing an increase of 19.1%. The average balances of total assets of $632,953,000 in 2000 represent an increase of $70,880,000 or 12.6% over $562,073,000 in 1999.
Loans
The Bank concentrates its lending activities in four principal areas: commercial loans (including agricultural loans); consumer loans; real estate construction loans (both commercial and personal) and real estate-other loans. At December 31, 2000, these four categories accounted for approximately 36%, 2%, 12% and 50% of the Bank's loan portfolio, respectively, as compared to 40%, 3%, 9% and 48% at December 31, 1999. The year 2000 saw continuing high levels of economic activity in the Bank's market area. Loan demand was strong throughout the year and remained so in the first months of 2001. All categories of loans, except consumer, reflect increased growth in 2000. The largest growth took place in the real estate-other category. However, the largest percentage gain of 63.5% was in the real estate-construction category. Table Three summarizes the composition of the loan portfolio for the past five years as of December 31:
The majority of the Bank's loans are direct loans made to individuals, local businesses and agri-businesses. The Bank relies substantially on local promotional activity, personal contacts by Bank officers, directors and employees to compete with other financial institutions. The Bank makes loans to borrowers whose applications include a sound purpose, a viable repayment source and a plan of repayment established at inception and generally backed by a secondary source of repayment.
Commercial loans consist of credit lines for operating needs, loans for equipment purchases, working capital, and various other business loan products. Consumer loans include a range of traditional consumer loan products offered by the Bank such as personal lines of credit and loans to finance purchases of autos, boats, recreational vehicles, mobile homes and various other consumer items. The construction loans are generally composed of commitments to customers within the Bank's service area for construction of both commercial properties and custom and semi-custom single family residences. Other real estate loans consist primarily of loans to the Bank's depositors secured by first trust deeds on commercial and residential properties typically with short-term maturities and original loan to value ratios not exceeding 75%. In general, except in the case of loans with SBA guarantees, the Bank does not make long-term mortgage loans; however, the Bank has informal arrangements in place with mortgage lenders to assist customers in securing single-family mortgage financing.
Average net loans in 2000 were $417,075,000 representing an increase of $68,989,000 or 19.8% over 1999. The favorable economic conditions provided
the impetus for continuing loan growth. Average net loans in 1999 were $348,086,000 representing an increase of $76,496,000 or 28.2% over 1998.
Risk Elements - The Bank assesses and manages credit risk on an ongoing basis through stringent credit review and approval policies, extensive internal monitoring and established formal lending policies. Additionally, the Bank contracts with an outside loan review consultant to periodically grade new loans and to review the existing loan portfolio. Management believes its ability to identify and assess risk and return characteristics of the Company's loan portfolio is critical for profitability and growth. Management strives to continue the historically low level of loan losses by continuing its emphasis on credit quality in the loan approval process, active credit administration and regular monitoring. With this in mind, management has designed and implemented a comprehensive loan review and grading system that functions to continually assess the credit risk inherent in the loan portfolio.
Ultimately, the credit quality of the Bank's loans may be influenced by underlying trends in the national and local economic and business cycles. The Bank's business is mostly concentrated in Monterey County. The County's economy is highly dependent on the agricultural and tourism industries. The agricultural industry is also the major driver of the economies of San Benito County and the southern portion of Santa Cruz County where the Bank's two newest branches are located. As a result, the Bank lends money to individuals and companies dependent upon the agricultural and tourism industries.
The Bank has significant extensions of credit and commitments to extend credit which are secured by real estate, totaling approximately $333 million at December 31, 2000. Although management believes this real estate concentration has no more that the normal risk of collectability, a substantial decline in the economy in general, or a decline in real estate values in the Bank's primary market areas in particular, could have an adverse impact on the collectability of these loans. The ultimate recovery of these loans is generally dependent on the successful operation, sale or refinancing of the real estate. The Bank monitors the effects of current and expected market conditions and other factors on the collectability of real estate loans. When, in management's judgement, these loans are impaired, an appropriate provision for losses is recorded. The more significant assumptions management considers involve estimates of the following: lease, absorption and sale rates; real estate values and rates of return; operating expenses; inflation; and sufficiency of collateral independent of the real estate including, in limited instances, personal guarantees. Not withstanding the foregoing, abnormally high rates of impairment due to general/local economic conditions could adversely affect the Company's future prospects and results of operations.
In extending credit and commitments to borrowers, the Bank generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers. The Bank's requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management's evaluation of the credit-worthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. The Bank secures its collateral by perfecting its interest in business assets, obtaining deeds of trust, or outright possession among other means. Loan losses from lending transactions related to real estate and agriculture compare favorably with the Bank's loan losses on its loan portfolio as a whole.
Management believes that its lending policies and underwriting standards will tend to minimize losses in an economic downturn, however, there is no
assurance that losses will not occur under such circumstances. The Bank's loan policies and underwriting standards include, but are not limited to, the following: 1) maintaining a thorough understanding of the Bank's service area and limiting investments outside of this area, 2) maintaining a thorough understanding of borrowers' knowledge and capacity in their field of expertise, 3) basing real estate construction loan approval not only on salability of the project, but also on the borrowers' capacity to support the project financially in the event it does not sell within the original projected time period, and 4) maintaining conforming and prudent loan to value and loan to cost ratios based on independent outside appraisals and ongoing inspection and analysis by the Bank's construction lending officers. In addition, the Bank strives to diversify the risk inherent in the construction portfolio by avoiding concentrations to individual borrowers and on any one project.
Nonaccrual, Past Due and Restructured Loans
Management generally places loans on nonaccrual status when they become 90 days past due, unless the loan is well secured and in the process of collection. Loans are charged off when, in the opinion of management, collection appears unlikely. Table Four sets forth nonaccrual loans, loans past due 90 days or more, and restructured loans performing in compliance with modified terms, for December 31:
Interest due but excluded from interest income on nonaccrual loans was approximately $64,000 in 2000, $82,000 in 1999 and $45,000 in 1998. In 1999 and 1998, interest income recognized from payments received on nonaccrual loans was $21,000 and $17,000, respectively (none was recognized in 2000).
At December 31, 2000, the recorded investment in loans that are considered impaired was $1,691,000 of which $215,000 is included in nonaccrual loans, and $1,010,000 is included in restructured loans above. Such impaired loans had a valuation allowance of $506,000. The average recorded investment in impaired loans during 2000 was $2,129,000. The Company recognized interest income on impaired loans of $161,000, $92,000 and $64,000 in 2000, 1999 and 1998, respectively (including interest income of $98,000 on restructured loans in 2000).
There were no troubled debt restructurings or loan concentrations in excess of 10% of total loans not otherwise disclosed as a category of loans as of December 31, 2000. Management is not aware of any potential problem loans,
which were accruing and current at December 31, 2000, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms.
The Company held no real estate acquired by foreclosure at December 31, 2000 or 1999.
Allowance for Loan Losses Activity
The provision for loan losses is based upon management's evaluation of the adequacy of the existing allowance for loans outstanding. This allowance is increased by provisions charged to expense and reduced by loan charge-offs net of recoveries. Management determines an appropriate provision based upon the interaction of three primary factors: (1) the loan portfolio growth in the period, (2) a comprehensive grading and review formula for total loans outstanding, and (3) actual previous charge-offs.
The allowance for loan losses totaled $9,371,000 or 1.98% of total loans at December 31, 2000 compared to $5,596,000 or 1.41% at December 31, 1999 and $4,352,000 or 1.39% at December 31, 1998. In 2000, the allowance for loan losses was increased in consideration of the significant growth in the loan portfolio of $77,798,000 (19.7%), geographic and industry concentrations, expansion into new geographic markets, and volatility and weaknesses in the local economy, including potential effects of power shortages, water supply, and volatile market prices for agricultural products. In addition, approximately $1.2 million was provided as a result of the downward classification to substandard of several loans to a single borrower. In 1999, the loan growth of $77,260,000 necessitated an increase of $1,058,000 in the allowance for loan losses. It is the policy of management to maintain the allowance for loan losses at a level adequate for known and future risks inherent in the loan portfolio. Based on information currently available to analyze loan loss potential, including economic factors, overall credit quality, historical delinquency and a history of actual charge-offs, management believes that the loan loss provision and allowance is prudent and adequate. However, no prediction of the ultimate level of loans charged off in future years can be made with any certainty.
Table Five summarizes, for the years indicated, the activity in the allowance for loan losses.
As part of its loan review process, management has allocated the overall allowance based on specific identified problem loans and historical loss data. Table Six summarizes the allocation of the allowance for loan losses at December 31, 2000 and 1999.
Other Real Estate Owned
The Company held no real estate acquired by foreclosure at December 31, 2000 or 1999.
Deposits
At December 31, 2000, deposits totaled $633,210,000 up from $518,189,000 at the end of 1999. However, the 1999 ending balance included $20,000,000 in State of California time deposits. These deposits matured by the end of 2000 and were no longer included in the deposit balances. Thus, the deposit growth in 2000, net of the $20,000,000 of State of California certificates of deposit, was $135,021,000 (27.1%). Because there was a large influx of demand deposits at year-end, management would expect that due to normal seasonal variations deposits will decrease approximately $30,000,000 to $50,000,000 in the first quarter of 2001.
Capital Resources
The current and projected capital position of the Company and the impact of capital plans and long-term strategies is reviewed regularly by management. The Company's capital position represents the level of capital available to support continued operations and expansion.
Since October of 1998 and through December 31, 2000, the Board of Directors of the Company has authorized two separate plans to repurchase up to 5% (in each plan) of the outstanding shares of the Company's common stock. Purchases are made from time to time, in the open market and negotiated transactions and are subject to appropriate regulatory and other accounting requirements. The Company acquired 410,894 shares of its common stock in the open market during 2000, 200,668 in 1999 and 29,645 in 1998 at average prices of approximately $14.85, $13.32 and $12.61 per share, respectively. The Company completed repurchases under the first plan in May 2000. At December 31, 2000, there were 112,240 shares remaining to repurchase under the second plan. The preceding common share amounts and average prices paid have been adjusted for the stock split and stock dividends issued from February 1999 through February 2001. These repurchases are made with the intention to lessen the dilutive impact of issuing new shares to meet stock option plans as well as for capital management objectives.
The Company's primary capital resource is shareholders' equity, which increased $6.5 million or 12.3% from the previous year-end. The ratio of total risk-based capital to risk-adjusted assets was 12.3% at December 31, 2000, compared to 13.8% at December 31, 1999. Tier 1 risk-based capital to risk-adjusted assets was 11.1% at December 31, 2000, compared to 12.6% at December 31, 1999. The capital ratios are lower in 2000 as compared to 1999 as risked based assets grew at a higher rate than did capital.
See the discussion of capital requirements in "Supervision and Regulation" on page 4 and Note 13 in the financial statements included in Item 8.
Inflation
The impact of inflation on a financial institution differs significantly from that exerted on manufacturing, or other commercial concerns, primarily because its assets and liabilities are largely monetary. In general, inflation primarily affects the Company indirectly through its effect on market rates of interest, and thus the ability of the Bank to attract loan customers. Inflation affects the growth of total assets by increasing the level of loan demand, and potentially adversely affects the Company's capital adequacy because loan growth in inflationary periods can increase at rates higher than the rate that capital grows through retention of earnings which the Company may generate in the future. In addition to its effects on interest rates, inflation directly affects the Company by increasing the Company's operating expenses. Inflation did not have a material effect upon the Company's results of operations during the year 2000.
Market Risk Management
Overview. The goal for managing the assets and liabilities of the Bank is to maximize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Bank to undue interest rate risk. The Board of Directors has overall responsibility for the Company's interest rate risk management policies. The Bank has an Asset and Liability Management Committee (ALCO) which establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates.
Asset/Liability Management. Activities involved in asset/liability management include but are not limited to lending, accepting and placing deposits, investing in securities and issuing debt. Interest rate risk is the primary market risk associated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To mitigate interest rate risk, the structure of the balance sheet is managed with the goal that movements of interest rates on assets and liabilities are correlated and contribute to earnings even in periods of volatile interest rates. The asset/liability management policy sets limits on the acceptable amount of variance in net interest margin and market value of equity under changing interest environments. The
Bank uses simulation models to forecast earnings, net interest margin and market value of equity.
Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer modeling techniques, the Company is able to estimate the potential impact of changing interest rates on earnings. A balance sheet forecast is prepared quarterly using inputs of actual loan, securities and interest bearing liabilities (i.e. deposits/borrowings) positions as the beginning base. The forecast balance sheet is processed against three interest rate scenarios. The scenarios include a 200 basis point rising rate forecast, a flat rate forecast and a 200 basis point falling rate forecast which take place within a one year time frame. The net interest income is measured during the first year of the rate changes and in the year following the rate changes. The Company's 2000 net interest income, as forecast below, was modeled utilizing a forecast balance sheet projected from year-end 2000 balances.
The following assumptions were used in the modeling activity: Earning asset growth of 7.1% based on ending balances Loan growth of 8.3% based on ending balances Investment and funds sold growth of 4.0% based on ending balances Deposit growth of 3.0% based on ending balances Balance sheet target balances were the same for all rate scenarios
The following table summarizes the effect on net interest income of a (+/-) 200 basis point change in interest rates as measured against a flat rate (no change) scenario.
Table Eight: Interest Rate Risk Simulation of Net Interest Income as of December 31, 2000 Estimated Impact on 2001 Net Interest Income ------ (in thousands) Variation from flat rate scenario +200 $2,731 - 200 ($3,310)
The simulations of earnings do not incorporate any management actions, which might moderate the negative consequences of interest rate deviations. Therefore, they do not reflect likely actual results, but serve as conservative estimates of interest rate risk.
The Company also uses a second simulation scenario that rate shocks the balance sheet with an immediate parallel shift in interest rates of +/-200 basis points. This scenario provides estimates of the future market value of equity (MVE) and net interest income (NII). MVE measures the impact on equity due to the changes in the market values of assets and liabilities as a result of a change in interest rates. The Bank measures the volatility of these benchmarks using a twelve month time horizon. Using the December 31, 2000 balance sheet as the base for the simulation, the following table summarizes the effect on net interest income of a +/-200 basis point change in interest rates:
Table Nine: Interest Rate Risk Simulation of NII as of December 31, 2000
% Change Change in NII in NII from Current from Current 12 Mo. Horizon 12 Month Horizon -------------- ---------------- (in thousands) + 200bp 16% $6,374 - 200bp (17%) ($6,618)
These results indicate that the balance sheet is asset sensitive since earnings increase when interest rates rise. The magnitude of the NII change is within the Company's policy guidelines. The asset liability management policy limits aggregate market risk, as measured in this fashion, to an acceptable level within the context of risk-return trade-offs.
Gap analysis provides another measure of interest rate risk. The Company does not actively use gap analysis in managing interest rate risk. It is presented here for comparative purposes. Interest rate sensitivity is a function of the repricing characteristics of the Bank's portfolio of assets and liabilities. These repricing characteristics are the time frames within which the interest-bearing assets and liabilities are subject to change in interest rates either at replacement, repricing or maturity. Interest rate sensitivity management focuses on the maturity of assets and liabilities and their repricing during periods of changes in market interest rates. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in the Bank's current portfolio that are subject to repricing at various time horizons. The differences are known as interest sensitivity gaps.
As reflected in Table Ten, at December 31, 2000, the cumulative gap through the one-year time horizon indicates a liability sensitive position. Somewhere between one and five years the Bank moves into an asset sensitive position. This interest rate sensitivity table categorizes interest-bearing transaction deposits and savings deposits as repricing immediately. However, as has been observed through interest rate cycles, the deposit liabilities do not reprice immediately. Consequently, the Bank's net interest income varies as though the Bank is asset sensitive, i.e. as interest rates rise net interest income increases and vice versa. This phenomenon is validated by the modeling as presented in Tables Eight and Nine.
Liquidity
Liquidity management refers to the Company's ability to provide funds on an ongoing basis to meet fluctuations in deposit levels as well as the credit needs and requirements of its clients. Both assets and liabilities contribute to the Company's liquidity position. Federal funds lines, short-term investments and securities, and loan repayments contribute to liquidity, along with deposit increases, while loan funding and deposit withdrawals decrease liquidity. The Bank assesses the likelihood of projected funding requirements by reviewing historical funding patterns, current and forecasted economic conditions and individual client funding needs. Commitments to fund loans and outstanding standby letters of credit at December 31, 2000, were approximately $145,839,000 and $4,634,000, respectively. Such loans relate primarily to revolving lines of credit and other commercial loans, and to real estate construction loans.
The Company's sources of liquidity consist of overnight funds sold to correspondent banks, unpledged marketable investments and loans held for sale. On December 31, 2000, consolidated liquid assets totaled $132.0 million or 18.7% of total assets as compared to $91.1 million or 15.4% of total consolidated assets on December 31, 1999. In addition to liquid assets, the Bank maintains short term lines of credit with correspondent banks. At December 31, 2000, the Bank had $80,000,000 available under these credit lines. Additionally, the Bank is a member of the Federal Home Loan Bank. At December 31, 2000, the Bank could have arranged for up to $176,673,000 in secured borrowings from the FHLB. Informal agreements are
also in place with various other banks to purchase participations in loans, if necessary. The Company serves primarily a business and professional customer base and, as such, its deposit base is susceptible to economic fluctuations. Accordingly, management strives to maintain a balanced position of liquid assets to volatile and cyclical deposits.
Liquidity is also affected by portfolio maturities and the effect of interest rate fluctuations on the marketability of both assets and liabilities. In 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities". In conjunction with the adoption of SFAS 133 the Bank reclassified all securities into the available-for-sale category. This enables the Bank to sell any of its unpledged securities to meet liquidity needs. Due to the rising interest rate environment throughout most of 1999 and the first half of 2000, much of the investment portfolio experienced price declines, which resulted in unrealized losses. These unrealized losses limited the Bank's ability to sell these securities without realizing those losses. Because of the rapid decrease in interest rates at the end of 2000 and continuing into January 2001, the unrealized loss in the investment portfolio has greatly diminished. Further declines in the market rates of interest could result in net unrealized gains in the portfolio. These securities are available to pledge as collateral for borrowings if the need should arise. The Bank has established a master repurchase agreement with a correspondent bank to enable such transactions.
The maturity distribution of certificates of deposit in denominations of $100,000 or more is set forth in Table Eleven. These deposits are generally more rate sensitive than other deposits and, therefore, are more likely to be withdrawn to obtain higher yields elsewhere if available.
Loan demand also affects the Bank's liquidity position. Table Twelve presents the maturities of loans for the period indicated.
Loans shown above with maturities greater than one year include $235,059,000 of floating interest rate loans and $82,820,000 of fixed rate loans.
The maturity distribution and yields of the investment portfolios are presented in Table Thirteen:
The principal cash requirements of the Company are for expenses incurred in the support of administration and operations of the Bank. These cash requirements are funded through direct reimbursement billings to the Bank. For non-banking functions, the Company is dependent upon the payment of cash dividends by the Bank to service its commitments. The Company expects that the cash dividends paid by the Bank to the Company will be sufficient to meet this payment schedule.
Off-Balance Sheet Items
The Bank has certain ongoing commitments under operating leases. (See Note 5 of the financial statements for the terms.) These commitments do not significantly impact operating results.
As of December 31, 2000, commitments to extend credit were the only financial instruments with off-balance sheet risk. The Bank has not entered into any contracts for financial derivative instruments such as futures, swaps,
options etc. Loan and letter of credit commitments increased to $150,473,000 from $131,398,000 at December 31, 1999. The commitments represent 31.8% of total loans at year-end 2000 versus 33.2% a year ago.
Disclosure of Fair Value
The Financial Accounting Standards Board (FASB), Statement of Financial Accounting Standards Number 107, Disclosures about Fair Value of Financial Statements, requires the disclosure of fair value of most financial instruments, whether recognized or not recognized in the financial statements. The intent of presenting the fair values of financial instruments is to depict the market's assessment of the present value of net future cash flows discounted to reflect both current interest rates and the market's assessment of the risk that the cash flows will not occur.
In determining fair values, the Company used the carrying amount for cash, short-term investments, accrued interest receivable, short-term borrowings and accrued interest payable as all of these instruments are short term in nature. Securities are reflected at quoted market values. Loans and deposits have a long term time horizon which required more complex calculations for fair value determination. Loans are grouped into homogeneous categories and broken down between fixed and variable rate instruments. Loans with a variable rate, which reprice immediately, are valued at carrying value. The fair value of fixed rate instruments is estimated by discounting the future cash flows using current rates. Credit risk and repricing risk factors are included in the current rates. Fair value for nonaccrual loans is reported at carrying value and is included in the net loan total. Since the allowance for loan losses exceeds any potential adjustment for nonaccrual valuation, no further valuation adjustment has been made.
Demand deposits, savings and certain money market accounts are short term in nature so the carrying value equals the fair value. For deposits that extend over a period in excess of four months, the fair value is estimated by discounting the future cash payments using the rates currently offered for deposits of similar remaining maturities.
At year-end 2000 and year end 1999, the fair values calculated on the Bank's assets were 0.4% below the carrying values.
Accounting Pronouncements
The Financial Standards Accounting Board released for comment on February 14, 2001, a revised proposal for the elimination of "pooling of interests" accounting. The FASB indicated that it will accept comments through March 16, 2001. As proposed, it is currently anticipated that the FASB will issue a final statement in June 2001, which would likely require, among other matters, that all mergers initiated after the issuance of the final statement be accounted for as "purchase" transactions. As proposed, a merger or business combination would be considered initiated if the major terms of the transaction, including the exchange or conversion ratio, are publicly announced or otherwise disclosed to shareholders of the combining companies. The revised proposal contemplates that goodwill will not be amortized to earnings as originally proposed. Instead, goodwill would be recognized as an asset in the financial statements, measured as the excess of the cost of an acquired entity over the net of the amounts assigned to identifiable assets acquired and liabilities assumed, and then tested for impairment to assess losses and expensed against earnings only in the periods in which the recorded value of goodwill exceeded its implied fair value, based on standards to be specified in the final statement. The effect of the proposal upon bank mergers is uncertain, however, the goodwill in a purchase accounting transaction may not be included in the calculation of regulatory capital requirements and some investment bankers have expressed the view that
the elimination of "pooling of interests" accounting will result in lower merger premiums for sellers with the possibility of fewer transactions occurring after the effective date of the final statement.
For additional discussion of accounting pronouncements, see Note 1 in the Consolidated Financial Statements at Item 8.
Other Matters
The State of California is presently experiencing serious periodic electric power shortages. It is uncertain whether or when these shortages will be discontinued. The Company and the Bank could be materially and adversely affected either directly or indirectly by a severe electric power shortage if such a shortage caused any of its critical data processing or computer systems and related equipment to fail, or if the local infrastructure systems such as telephone systems should fail, or the Company's and the Bank's significant vendors, suppliers, service providers, customers, borrowers, or depositors are adversely impacted by their internal systems or those of their respective customers or suppliers. Material increases in the expenses related to electric power consumption and the related increase in operating expense could also have an adverse effect on the Company's and the Bank's future results of operations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by Item 7A of Form 10-K is contained in the Market Risk Management section of Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" on page 33.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Independent Auditors' Report 42
Consolidated Balance Sheets, December 31, 2000 and 1999 43
Consolidated Statements of Income for theyears ended December 31, 2000, 1999 and 1998 44
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998 45
Consolidated Statements of Shareholders' Equity for the years ended December 31, 2000, 1999 and 1998 46
Notes to Consolidated Financial Statements 47-60
All schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements or notes thereto.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of Central Coast Bancorp:
We have audited the accompanying consolidated balance sheets of Central Coast Bancorp and subsidiary as of December 31, 2000 and 1999, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Central Coast Bancorp and subsidiary at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Salinas, California January 22, 2001 (February 28, 2001 as to the stock dividend information in Note 1)
See notes to Consolidated Financial Statements
Consolidated Statements of Income Central Coast Bancorp and Subsidiary
See Notes to Consolidated Financial Statements
Consolidated Statements of Cash Flows Central Coast Bancorp and Subsidiary
See Notes to Consolidated Financial Statements
Consolidated Statements of Shareholders' Equity Central Coast Bancorp and Subsidiary
See Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Central Coast Bancorp and Subsidiary Years ended December 31, 2000, 1999 and 1998
Note 1. Significant Accounting Policies and Operations. The consolidated financial statements include Central Coast Bancorp (the "Company") and its wholly-owned subsidiary, Community Bank of Central California (the "Bank"). All material intercompany accounts and transactions are eliminated in consolidation. The accounting and reporting policies of the Company and the Bank conform to accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan losses and the carrying value of other real estate owned. Management uses information provided by an independent loan review service in connection with the determination of the allowance for loan losses.
Community Bank of Central California operates ten full service branch offices in Monterey, Santa Cruz and San Benito Counties, serving small and medium sized business customers, as well as individuals. The Bank focuses on business loans and deposit services to customers throughout its service area.
Investment Securities are classified at the time of purchase into one of three categories: held-to-maturity, trading or available-for-sale. Investment securities classified as held-to-maturity are measured at amortized cost based on the Company's positive intent and ability to hold such securities to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term and are carried at market value with a corresponding recognition of unrecognized holding gain or loss in the results of operations. The remaining investment securities are classified as available-for-sale and are measured at market value with a corresponding recognition of the unrealized holding gain or loss (net of tax effect) as a separate component of shareholders' equity until realized. Accretion of discounts and amortization of premiums arising at acquisition are included in income using methods approximating the effective interest method. Gains and losses on sales of investments, if any, are determined on a specific identification basis.
Loans are stated at the principal amount outstanding, reduced by any charge-offs or specific valuation allowance. Loan origination fees and certain direct loan origination costs are deferred and the net amount is recognized using the effective yield method, generally over the contractual life of the loan.
Interest income is accrued as earned. The accrual of interest on loans is discontinued and any accrued and unpaid interest is reversed when principal or interest is ninety days past due, when payment in full of principal or interest is not expected or when a portion of the principal balance has been charged off. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Senior management may grant a waiver from nonaccrual status if a loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, the accrued and unpaid interest receivable is reversed and the loan is accounted for on the cash or cost recovery method thereafter, until qualifying for return to accrual status. Generally, a loan may be returned to accrual status when all delinquent interest and principal become current in accordance with the original terms of the loan agreement or when the loan is both well secured and in process of collection.
The allowance for loan losses is an amount that management believes will be adequate to absorb losses inherent in existing loans and commitments to extend credit, based on evaluations of collectibility and prior loss experience. The allowance is established through a provision charged to expense. Loans are charged against the allowance when management believes that the collectibility of the principal is unlikely. In evaluating the adequacy of the allowance, management considers numerous factors such as changes in the composition of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current and anticipated local economic conditions that may affect the borrowers' ability to pay.
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral-dependent.
Real estate and other assets acquired in satisfaction of indebtedness are recorded at the lower of estimated fair market value net of anticipated selling costs or the recorded loan amount, and any difference between this and the loan amount is treated as a loan loss. Costs of maintaining other real estate owned, subsequent write downs and gains or losses on the subsequent sale are reflected in current earnings.
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the lesser of the lease terms or estimated useful lives of the assets, which are generally 3 to 30 years.
Intangible assets representing the excess of the purchase price over the fair value of tangible net assets acquired, are being amortized on a straight-line basis over seven years and are included in other assets.
Stock Compensation. The Company accounts for its stock-based awards using the intrinsic value method in accordance with Accounting Principles Board No. 25, Accounting for Stock Issued to Employees and its related interpretations. No compensation expense has been recognized in the financial statements for employee stock arrangements. Note 9 to the Consolidated Financial Statements contains a summary of the pro forma effects to reported net income and earnings per share as if the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation.
Income taxes are provided using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences of differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities arise principally from differences in reporting provisions for loan losses, interest on nonaccrual loans, depreciation, state franchise taxes and accruals related to the salary continuation plan. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Earnings per share. Basic earnings per share is computed by dividing net income by the weighted average of common shares outstanding for the period (7,612,000, 7,779,000 and 7,305,000 in 2000, 1999 and 1998, respectively). Diluted earnings per share reflects the potential dilution that could occur if outstanding stock options and stock purchase warrants were exercised. Diluted earnings per share is computed by dividing net income by the
weighted average common shares outstanding for the period plus the dilutive effect of options and warrants (225,000, 270,000, and 661,000 in 2000, 1999 and 1998, respectively). All earnings per share information has been adjusted retroactively for stock dividends of 10% in January 2001, 2000 and 1998, and a 5-for-4 stock split in January 1999.
Stock dividend. On January 29, 2001 the Board of Directors declared a 10% stock dividend which was distributed on February 28, 2001, to shareholders of record as of February 14, 2001. All share and per share data including stock option and warrant information have been retroactively adjusted to reflect the stock dividend.
Comprehensive income. In 1998 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income, which requires that an enterprise report, by major components and as a single total, the change in net assets during the period from nonowner sources. Such amounts have been reported in the accompanying statements of shareholders' equity.
Segment reporting. In 1998 the Company adopted Financial Accounting Standards Statement (FAS) No. 131, Disclosures about Segments of an Enterprise and Related Information, which establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. Management has determined that since all of the commercial banking products and services offered by the Company are available in each branch office of the Bank, all branch offices are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank branch offices and report them as a single operating segment.
Reclassification of investment securities. Effective July 1, 1998 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments and hedging activities. In connection with the adoption of SFAS 133 the Company reclassified certain securities with an amortized cost of $18,085,000 and a fair value of $18,202,000 from held-to-maturity to available-for-sale. Adoption of this statement did not have any other impact on the Company's consolidated financial position and had no impact on the Company's results of operations or cash flows.
Note 2. Cash and Due from Banks. The Company, through its bank subsidiary, is required to maintain reserves with the Federal Reserve Bank. Reserve requirements are based on a percentage of deposits. At December 31, 2000 the Company maintained reserves of approximately $703,000 in the form of vault cash and balances at the Federal Reserve to satisfy regulatory requirements.
Note 3. Securities. The Company's investment securities portfolio as of December 31, 2000 and 1999 consisted of the following:
At December 31, 2000 and 1999, securities with a book value of $95,908,000 and $80,593,000 were pledged as collateral for deposits of public funds and other purposes as required by law or contract.
U.S. Treasury Securities with a market value of $19,806,000, $6,033,000 and $9,119,000, and an amortized cost of $20,000,000, $5,988,000 and $9,061,000 were sold during the fiscal years ended December 31, 2000, 1999 and 1998, respectively. In 2000, such sales resulted in gross realized losses of $194,000 and no gross unrealized gains. In 1999 and 1998, such sales resulted in gross realized gains of $45,000 and $58,000, respectively and no gross unrealized losses.
Note 4. Loans and allowance for loan losses. The Company's business is concentrated in Monterey County, California whose economy is highly dependent on the agricultural industry. As a result, the Company lends money to individuals and companies dependent upon the agricultural industry. In addition, the Company has significant extensions of credit and commitments to extend credit which are secured by real estate, the ultimate recovery of which is generally dependent on the successful operation, sale or refinancing of real estate, totaling approximately $333 million. The Company monitors the effects of current and expected market conditions and other factors on the collectibility of real estate loans. When, in management's judgment, these loans are impaired, appropriate provisions for losses are recorded. The more significant assumptions management considers involve estimates of the following: lease, absorption and sale rates; real estate values and rates of return; operating expenses; inflation; and sufficiency of collateral independent of the real estate including, in limited instances, personal guarantees.
In extending credit and commitments to borrowers, the Company generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers. The Company's requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management's evaluation of the credit worthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. The Company secures its collateral by perfecting its interest in business assets, obtaining deeds of trust, or outright possession among other means. Loan losses from lending transactions related to real estate and agriculture compare favorably with the Company's loan losses on its loan portfolio as a whole.
The activity in the allowance for loan losses is summarized as follows:
In determining the provision for estimated losses related to specific major loans, management evaluates its allowance on an individual loan basis, including an analysis of the credit worthiness, cash flows and financial status of the borrower, and the condition and the estimated value of the collateral. Specific valuation allowances for secured loans are determined by the excess of recorded investment in the loan over the fair market value or net realizable value where appropriate, of the collateral. In determining overall general valuation allowances to be maintained and the loan loss allowance ratio, management evaluates many factors including prevailing and forecasted economic conditions, regular reviews of the quality of loans, industry experience, historical loss experience, composition and geographic concentrations of the loan portfolio, the borrowers' ability to repay and repayment performance and estimated collateral values.
Management believes that the allowance for loan losses at December 31, 2000 is prudent and warranted, based on information currently available. However, no prediction of the ultimate level of loans charged off in future years can be made with any certainty.
Non-performing loans at December 31 are summarized below:
Interest due but excluded from interest income on nonaccrual loans was approximately $64,000, $82,000, and $45,000 in 2000, 1999 and 1998 respectively. In 1999 and 1998, interest income recognized from payments received on nonaccrual loans was $21,000 and $17,000, respectively (none was recognized in 2000).
At December 31, 2000, the recorded investment in loans that are considered impaired under SFAS No. 114 was $1,691,000 of which $215,000 are included as nonaccrual loans above, and $1,010,000 are included as restructured loans above. At December 31, 1999, the recorded investment in loans that are considered impaired was $2,165,000 of which $1,568,000 are included as nonaccrual loans above. Such impaired loans had valuation allowances totalling $809,000 and $821,000, in 2000 and 1999, respectively, based on
the estimated fair values of the collateral. The average recorded investment in impaired loans during 2000 and 1999, was $2,129,000 and $2,357,000, respectively. The Company recognized interest income on impaired loans of $161,000, $92,000 and $64,000 in 2000, 1999 and 1998, respectively (including interest income of $98,000 on restructured loans in 2000).
The Company held no real estate acquired by foreclosure at December 31, 2000 or 1999.
Note 5. Premises and equipment. Premises and equipment at December 31 are summarized as follows:
The Company's facilities leases expire in March 2003 through October 2009 with options to extend for five to fifteen years. These include two facilities leased from shareholders at terms and conditions which management believes are consistent with the market. Rental rates are adjusted annually for changes in certain economic indices. Rental expense was approximately $634,000, $565,000 and $456,000, including lease expense to shareholders of $122,000, $121,000 and $134,000 in 2000, 1999 and 1998 respectively. The minimum annual rental commitments under these leases, including the remaining rental commitment under the leases to shareholders, are as follows:
Note 6. Income Taxes. The provision for income taxes is as follows:
A reconciliation of the Federal income tax rate to the effective tax rate is as follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2000 and 1999, are presented below:
Note 7. Detail of Other Expense. Other expense for the years ended December 31, 2000, 1999 and 1998 consists of the following:
Note 8. Stock Purchase Warrants. During 1995 and 1994, warrants were issued in connection with the sale of the Company's common stock at a rate of one warrant for every share of stock purchased. The warrants expired on June 30, 1999. During 1999 and 1998, respectively 159,845 and 19,200 warrants were exercised. During 1999, 7,129 options expired.
Note 9. Employee Benefit Plans. The Company has two stock option plans under which incentive stock options or nonqualified stock options may be granted to certain key employees or directors to purchase authorized, but
unissued, common stock. Shares may be purchased at a price not less than the fair market value of such stock on the date of grant. Options vest over various periods not in excess of ten years from date of grant and expire not more than ten years from date of grant.
Activity under the stock option plans adjusted for stock dividends and stock splits is as follows:
Additional information regarding options outstanding as of December 31, 2000 is as follows:
At December 31, 2000, 1,433,399 shares were available for additional grants.
401(k) Savings Plan
The Company has a 401(k) Savings Plan under which eligible employees may elect to make tax deferred contributions from their annual salary, to a maximum established annually by the IRS. The Company matches 25% of the employees' contributions. The Company may make additional contributions to the plan at the discretion of the Board of Directors. All employees meeting age and service requirements are eligible to participate in the Plan. Company contributions vest after 3 years of service. Company contributions during 2000, 1999 and 1998 which are funded currently, totaled $114,000, $94,000 and $68,000, respectively.
Salary Continuation Plan
The Company has a salary continuation plan for three officers which provides for retirement benefits upon reaching age 63. The Company accrues such post-retirement benefits over the vesting periods (of five or ten years) based on a discount rate of 7.5%. In the event of a change in control of the Company, the officers' benefits will fully vest. The Company recorded compensation expense of $292,000, $256,000 and $225,000 in 2000, 1999 and 1998 respectively. Accrued compensation payable under the salary continuation plan totaled $1,140,000 and $848,000 at December 31, 2000 and 1999, respectively.
Deferred Compensation Plan
The Company has a deferred compensation plan for the benefit of the Board of Directors and certain officers. In addition to the deferral of compensation, the plan allows participants the opportunity to defer taxable income derived from the exercise of stock options. The participant's may, after making an election to defer receipt of the option shares for a specified period of time, use a "stock-for-stock" exercise to tender to the Company mature shares with a fair value equal to the exercise price of the stock options exercised. The Company simultaneously delivers new shares to the participant equal to the value of shares surrendered and the remaining shares under option are placed in a trust administered by the Company, to be distributed in accordance with the terms of each participant's election to defer. During 1999 and 1998, respectively, 48,101 and 27,140 shares with a fair value of approximately $666,000 and $384,000 were tendered to the Company using a "stock-for-stock" exercise and, at December 31, 2000, 271,862 shares (with a fair value of approximately $4,861,000 at December 31, 2000) were held in the Deferred Compensation Trust.
Additional Stock Plan Information
As discussed in Note 1, the Company continues to account for its stock-based awards using the intrinsic value method in accordance with Accounting Principles Board No. 25, Accounting for Stock Issued to Employees and its related interpretations. No compensation expense has been recognized in the financial statements for employee stock arrangements.
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, (SFAS 123) requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method as of the beginning of fiscal 1995. Under SFAS 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: expected life, four years following vesting; average stock volatility of 15.3%; risk free interest rates ranging from 4.52% to 6.57%; and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. If the computed fair values of the 2000, 1999 and 1998 awards had been amortized to expense over the vesting period of the awards, pro forma net income would have been $8,548,000 000 ($1.12 basic and $1.09 diluted earnings per share), $7,939,000 ($1.02 basic and $0.99 diluted earnings per share) and $6,957,000 ($0.95 basic and $0.87 diluted earnings per share) in 2000, 1999 and 1998, respectively. The impact of outstanding non-vested stock options granted prior to 1995 has been excluded from the pro forma calculation; accordingly, the 2000, 1999 and 1998 pro forma adjustments are not indicative of future period pro forma adjustments, when the calculation will apply to all applicable stock options.
Note 10. Disclosures About Fair Value of Financial Instruments. The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures About Fair Value of Financial Instruments". The estimated fair value amounts have been determined by using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation techniques may have a material effect on the estimated fair value amounts.
The following estimates and assumptions were used to estimate the fair value of the financial instruments.
Cash and equivalents - The carrying amount is a reasonable estimate of fair value.
Securities - Fair values of securities are based on quoted market prices or dealer quotes. If a quoted market price was not available, fair value was estimated using quoted market prices for similar securities.
Loans, net - Fair values for certain commercial, construction, revolving customer credit and other loans were estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and similar maturities, adjusted for the allowance for loan losses.
Certain adjustable rate loans have been valued at their carrying values, if no significant changes in credit standing have occurred since origination and the interest rate adjustment characteristics of the loan effectively adjust the interest rate to maintain a market rate of return. For adjustable rate loans which have had changes in credit quality, appropriate adjustments to the fair value of the loans are made.
Demand, time and savings deposits - The fair value of noninterest-bearing and adjustable rate deposits and savings is the amount payable upon demand at the reporting date. The fair value of fixed-rate interest-bearing deposits with fixed maturity dates was estimated by discounting the cash flows using rates currently offered for deposits of similar remaining maturities.
Off-balance sheet instruments - The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit-worthiness of the counterparties. The fair values of standby and commercial letters of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. The fair values of such
off-balance sheet instruments were not significant at December 31, 2000 and 1999, therefore, have not been included in the table above.
Note 11. Commitments and Contingencies. In the normal course of business there are various commitments outstanding to extend credit which are not reflected in the financial statements, including loan commitments of approximately $145,839,000 and standby letters of credit and financial guarantees of $4,634,000 at December 31, 2000. The Bank does not anticipate any losses as a result of these transactions.
Approximately $27,223,000 of loan commitments outstanding at December 31, 2000 relate to construction loans and are expected to fund within the next twelve months. The remainder relate primarily to revolving lines of credit or other commercial loans. Many of these loan commitments are expected to expire without being drawn upon. Therefore the total commitments do not necessarily represent future cash requirements.
Stand-by letters of credit are commitments written by the Bank to guarantee the performance of a customer to a third party. These guarantees are issued primarily relating to purchases of inventory by the Bank's commercial customers, are typically short-term in nature and virtually all such commitments are collateralized.
Most of the outstanding commitments to extend credit are at variable rates tied to the Bank's reference rate of interest. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit issued is the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The Company controls the credit risk of the off-balance sheet financial instruments through the normal credit approval and monitoring process.
Note 12. Related Party Loans. The Company makes loans to officers and directors and their associates subject to loan committee approval and ratification by the Board of Directors. These transactions are on substantially the same terms as those prevailing at the time for comparable transactions with unaffiliated parties and do not involve more than normal risk of collectibility. An analysis of changes in related party loans for the year ended December 31, 2000 is as follows:
Committed lines of credit, undisbursed loans and standby letters of credit to directors and officers at December 31, 2000 were approximately $2,461,000.
Note 13. Regulatory Matters. The Company is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly, additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Capital adequacy guidelines and the regulatory framework for prompt corrective action require that the Company meet specific capital adequacy guidelines that involve quantitative measures of the Company's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weighting and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and a minimum leverage ratio of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2000 that the Company meets all capital adequacy requirements to which it is subject.
As of December 31, 2000 and 1999, the most recent notifications from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category.
The following table shows the Company's and the Bank's actual capital amounts and ratios at December 31, as well as the minimum capital ratios to be categorized as "well capitalized" under the regulatory framework:
The ability of the Company to pay cash dividends in the future will largely depend upon the cash dividends paid to it by its subsidiary Bank. Under State and Federal law regulating banks, cash dividends declared by a Bank in any calendar year generally may not exceed its net income for the preceding three fiscal years, less distributions to the Company, or its retained earnings. Under these provisions, and considering minimum regulatory capital requirements, the amount available for distribution from the Bank to the Company was approximately $16,642,000 as of December 31, 2000.
The Bank is subject to certain restrictions under the Federal Reserve Act, including restrictions on the extension of credit to affiliates. In particular, the Bank is prohibited from lending to the Company unless the loans are secured by specified types of collateral. Such secured loans and other advances from the Bank is limited to 10% of Bank shareholders' equity, or a maximum of $5,682,000 at December 31, 2000. No such advances were made during 2000 or 1999.
Note 14. Central Coast Bancorp (Parent Company Only) The condensed financial statements of Central Coast Bancorp follow (in thousands):
Condensed Balance Sheets
Note 15. Selected Quarterly Information (unaudited) In thousands (except pershare data)
The principal market on which the company's common stock is traded is Nasdaq.
The earnings per share amounts in the preceding table have been adjusted retroactively for stock dividends of 10% in January 2001 and 2000, and a 5-for-4 stock split in January 1999.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by Item 10 of Form 10-K is incorporated by reference to the information contained in the Company's Proxy Statement for the 2001 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by reference to the information contained in the Company's Proxy Statement for the 2001 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 of Form 10-K is incorporated by reference to the information contained in the Company's Proxy Statement for the 2001 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 of Form 10-K is incorporated by reference to the information contained in the Company's Proxy Statement for the 2001 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements. Listed and included in Part II, Item 8.
(2)Financial Statement Schedules. Not applicable.
(3)Exhibits.
(2.1) Agreement and Plan of Reorganization and Merger by and between Central Coast Bancorp, CCB Merger Company and Cypress Coast Bank dated as of December5, 1995, incorporated by reference from Exhibit 99.1 to Form 8-K, filed with the Commission on December 7, 1995.
(3.1) Articles of Incorporation, incorporated by reference from Exhibit 4.8 to Registration Statement on Form S-8, No. 33-89948, filed with the Commission on March 3, 1995.
(3.2) Bylaws, as amended, incorporated by reference from Exhibit 3.2 to the Company's 1999 Annual Report on Form 10-K, filed with the commission on March 28, 2000.
(4.1) Specimen form of Central Coast Bancorp stock certificate, incorporated by reference from the Company's 1994 Annual Report on Form 10-K, filed with the Commission on March 31, 1995.
(10.1) Lease agreement dated December 12, 1994, related to 301 Main Street, Salinas, California, incorporated by reference from the Company's 1994 Annual Report on Form 10K, filed with the Commission on March 31, 1995.
(10.2) King City Branch Office Lease, incorporated by reference from Exhibit 10.3 to Registration Statement on Form S-4, No. 33-76972, filed with the Commission on March 28, 1994.
(10.3) Amendment to King City Branch Office Lease, incorporated by reference from Exhibit 10.4 to Registration Statement on Form S-4, No. 33-76972, filed with the Commission on March 28, 1994.
*(10.4) 1982 Stock Option Plan, as amended, incorporated by reference from Exhibit 4.2 to Registration Statement on Form S-8, No. 33-89948, filed with the Commission on March 3, 1995.
*(10.5) Form of Nonstatutory Stock Option Agreement under the 1982 Stock Option Plan, incorporated by reference from Exhibit 4.6 to Registration Statement on Form S-8, No. 33-89948, filed with the Commission on March 3, 1995.
*(10.6) Form of Incentive Stock Option Agreement under the 1982 Stock Option Plan, incorporated by reference from Exhibit 4.7 to Registration Statement on Form S-8, No. 33-89948, filed with the Commission on March 3, 1995.
*(10.7) 1994 Stock Option Plan, incorporated by reference from Exhibit 4.1 to Registration Statement on Form S-8, No. 33-89948, filed with the Commission on March 3, 1995.
*(10.8) Form of Nonstatutory Stock Option Agreement under the 1994 Stock Option Plan, incorporated by reference from Exhibit 4.3 to Registration Statement on Form S-8, No. 33-89948, filed with Commission on March 3, 1995.
*(10.9) Form of Incentive Stock Option Agreement under the 1994 Stock Option Plan, incorporated by reference from Exhibit 4.4 to Registration Statement on Form S-8, No. 33-89948, filed with the Commission on March 3, 1995.
*(10.10) Form of Director Nonstatutory Stock Option Agreement under the 1994 Stock Option Plan, incorporated by reference from Exhibit 4.5 to Registration Statement on Form S-8, No. 33-89948, filed with the Commission on March 3, 1995.
*(10.11) Form of Bank of Salinas Indemnification Agreement for directors and executive officers, incorporated by reference from Exhibit 10.9 to Amendment No. 1 to Registration Statement on Form S-4, No. 33-76972, filed with the Commission on April 15, 1994.
*(10.12) 401(k) Pension and Profit Sharing Plan Summary Plan Description, incorporated by reference from Exhibit 10.8 to Registration Statement on Form S-4, No. 33-76972, filed with the Commission on March 28, 1994.
*(10.13) Form of Employment Agreement, incorporated by reference from Exhibit 10.13 to the Company's 1996 Annual Report on Form 10-K, filed with the Commission on March 31, 1997.
*(10.14) Form of Executive Salary Continuation Agreement, incorporated by reference from Exhibit 10.14 to the Company's 1996 Annual Report on Form 10-K, filed with the Commission on March 31, 1997.
*(10.15) 1994 Stock Option Plan, as amended, incorporated by reference from Exhibit A to the Proxy Statement filed with the Commission on September 3, 1996, in connection with Central Coast Bancorp's 1996 Annual Shareholders' Meeting held on September 23, 1996.
(10.16) Form of Indemnification Agreement, incorporated by reference from Exhibit D to the Proxy Statement filed with the Commission on September 3, 1996, in connection with Central Coast Bancorp's 1996 Annual Shareholders' Meeting held on September 23, 1996.
(10.17) Purchase and Assumption Agreement for the Acquisition of Wells Fargo Bank Branch Offices, incorporated by reference from Exhibit 10.17 to the Company's 1996 Annual Report on Form 10-K, filed with the Commission on March 31, 1997.
(10.18) Employee Stock Ownership Plan and Trust Agreement, incorporated by reference from Exhibit 10.18 to the Company's 1996 Annual Report on Form 10-K, filed with the Commission on March 31, 1997.
(10.19) Lease agreement dated March 7, 1997, related to 484 Lighthouse Avenue, Monterey, California, incorporated by reference from Exhibit 10.19 to the Company's 1997 Annual Report on Form 10-K, filed with the Commission on March 27, 1998.
(21.1) The Registrant's only subsidiary is Community Bank of Central California (the successor entity resulting from the merger of Registrant's wholly-owned subsidiaries, Bank of Salinas and Cypress Bank, as referenced in Exhibit 2.1 above).
(23.1) Independent auditors' consent
*Denotes management contracts, compensatory plans or arrangements.
(b) Reports on Form 8-K. Not Applicable.
An Annual Report for the fiscal year ended December 31, 2000, and Notice of Annual Meeting and Proxy Statement for the Company's 2001 Annual Meeting will be mailed to security holders subsequent to the date of filing this Report. Copies of said materials will be furnished to the Commission in accordance with the Commission's Rules and Regulations.
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CENTRAL COAST BANCORP
Date: March 15, 2001 By: /S/ NICK VENTIMIGLIA ------------------------ Nick Ventimiglia, President and Chief Executive Officer (Principal Executive Officer)
Date: March 15, 2001 By: /S/ ROBERT STANBERRY ------------------------ Robert Stanberry, Chief Financial Officer (Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934 this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ----
/S/ C. EDWARD BOUTONNET Director 3/15/01 - ----------------------- (C. Edward Boutonnet)
/S/ BRADFORD G. CRANDALL Director 3/15/01 - ------------------------ (Bradford G. Crandall)
/S/ ALFRED P. GLOVER Director 3/15/01 - -------------------- (Alfred P. Glover)
/S/ MICHAEL T. LAPSYS - --------------------- Director 3/15/01 (Michael T. Lapsys)
/S/ ROBERT M. MRAULE Director 3/15/01 - -------------------- (Robert M. Mraule)
/S/ DUNCAN L. MCCARTER Director 3/15/01 - ---------------------- (Duncan L. McCarter)
/S/ LOUIS A. SOUZA Director 3/15/01 - ------------------ (Louis A. Souza)
/S/ MOSE E. THOMAS Director 3/15/01 - ------------------ (Mose E. Thomas)
/S/ NICK VENTIMIGLIA Chairman, President 3/15/01 - -------------------- (Nick Ventimiglia) and CEO
EXHIBIT INDEX -------------
Exhibit Sequential Number Description Page Number - ------ ----------- -----------
23.1 Independent auditors' consent. 67