UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to _________
Commission File Number: 0-24802
MONTEREY BAY BANCORP, INC.
(Exact Name Of Registrant As Specified In Its Charter)
DELAWARE 77-0381362
(State Or Other Jurisdiction Of (I.R.S. Employer Identification Number)
Incorporation Or Organization)
567 Auto Center Drive, Watsonville, California 95076
(Address Of Principal Executive Offices)(Zip Code)
(831) 768 - 4800
(Registrant's Telephone Number, Including Area Code)
WWW.MONTEREYBAYBANK.COM
(Registrant's Internet Site)
INFO@MONTEREYBAYBANK.COM
(Registrant's Electronic Mail Address)
Indicate by check mark whether the registrant (1) has filed all the reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
-------- --------
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 3,438,098 shares of common
stock, par value $0.01 per share, were outstanding as of August 9, 2001.
1
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements Of Financial Condition As Of
June 30, 2001 (unaudited) And December 31, 2000 3 - 4
Condensed Consolidated Statements Of Operations (unaudited) For The
Three And Six Months Ended June 30, 2001 And June 30, 2000 5 - 6
Condensed Consolidated Statement Of Stockholders' Equity (unaudited) For
The Six Months Ended June 30, 2001 7
Condensed Consolidated Statements Of Cash Flows (unaudited) For The
Six Months Ended June 30, 2001 And June 30, 2000 8 - 9
Notes To Condensed Consolidated Financial Statements (unaudited) 10 - 15
Item 2. Management's Discussion And Analysis Of Financial Condition
And Results Of Operations 16 - 45
Item 3. Quantitative And Qualitative Disclosure About Market Risk 45
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 46
Item 2. Changes In Securities 46
Item 3. Defaults Upon Senior Securities 46
Item 4. Submission Of Matters To A Vote Of Security Holders 46 - 47
Item 5. Other Information 47
Item 6. Exhibits And Reports On Form 8-K 47
(a) Exhibits
(b) Reports On Form 8-K
Signature Page 48
2
Item 1. Financial Statements
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 2001 (UNAUDITED) AND DECEMBER 31, 2000
(Dollars In Thousands, Except Per Share Amounts)
---------------------------------------------------------------------------------------------------
June 30, December 31,
2001 2000
-------- --------
ASSETS
Cash and cash equivalents $ 11,150 $ 25,159
Securities available for sale, at estimated fair value:
Investment securities (amortized cost of $7,702 and $7,696 at
June 30, 2001 and December 31, 2000, respectively) 7,403 7,360
Mortgage backed securities (amortized cost of $38,491 and $43,675
at June 30, 2001 and December 31, 2000, respectively) 38,486 42,950
Loans held for sale 383 --
Loans receivable held for investment (net of allowances for loan losses of
$6,138 at June 30, 2001 and $5,364 at December 31, 2000) 441,128 391,820
Investment in capital stock of the Federal Home Loan Bank, at cost 2,981 2,884
Accrued interest receivable 3,126 2,901
Premises and equipment, net 7,870 7,375
Core deposit premiums, net 1,854 2,195
Real estate acquired via foreclosure, net -- --
Other assets 4,416 3,546
-------- --------
TOTAL ASSETS $518,797 $486,190
======== ========
See Notes to Condensed Consolidated Financial Statements
3
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Continued)
JUNE 30, 2001 (UNAUDITED) AND DECEMBER 31, 2000
(Dollars In Thousands, Except Per Share Amounts)
-----------------------------------------------------------------------------------------------------
June 30, December 31,
2001 2000
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Non-interest bearing demand deposits $ 20,248 $ 17,065
Interest bearing NOW checking accounts 41,505 41,859
Savings deposits 19,998 16,503
Money market deposits 85,151 87,651
Certificates of deposit 251,437 244,710
--------- ---------
Total deposits 418,339 407,788
--------- ---------
FHLB advances and other borrowings 51,766 32,582
Accounts payable and other liabilities 1,548 1,983
--------- ---------
Total liabilities 471,653 442,353
--------- ---------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value, 2,000,000 shares authorized; none issued -- --
Common stock, $0.01 par value, 9,000,000 shares authorized;
4,492,085 issued at June 30, 2001 and December 31, 2000;
3,428,440 outstanding at June 30, 2001 and
3,321,210 outstanding at December 31, 2000 45 45
Additional paid-in capital 28,352 28,278
Retained earnings, substantially restricted 34,273 32,722
Unallocated ESOP shares (805) (920)
Treasury shares designated for compensation plans, at cost (27,782 shares
at June 30, 2001 and 35,079 shares at December 31, 2000) (267) (338)
Treasury stock, at cost (1,063,645 shares at June 30, 2001 and
1,170,875 shares at December 31, 2000) (14,275) (15,326)
Accumulated other comprehensive loss, net of taxes (179) (624)
--------- ---------
Total stockholders' equity 47,144 43,837
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 518,797 $ 486,190
========= =========
See Notes to Condensed Consolidated Financial Statements
4
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE AND SIX MONTHS ENDED JUNE 30, 2001 AND JUNE 30, 2000
(Dollars In Thousands, Except Per Share Amounts)
-------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
INTEREST AND DIVIDEND INCOME:
Loans receivable $ 8,779 $ 8,117 $ 17,667 $ 15,853
Mortgage backed securities 675 917 1,483 1,876
Investment securities and cash equivalents 256 377 555 732
-------- -------- -------- --------
Total interest income 9,710 9,411 19,705 18,461
-------- -------- -------- --------
INTEREST EXPENSE:
Deposit accounts 4,355 4,198 9,040 8,038
FHLB advances and other borrowings 582 661 1,140 1,379
-------- -------- -------- --------
Total interest expense 4,937 4,859 10,180 9,417
-------- -------- -------- --------
NET INTEREST INCOME BEFORE PROVISION
FOR LOAN LOSSES 4,773 4,552 9,525 9,044
PROVISION FOR LOAN LOSSES 300 775 800 1,025
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 4,473 3,777 8,725 8,019
-------- -------- -------- --------
NON-INTEREST INCOME:
Gain (loss) on sale of mortgage backed securities
and investment securities, net -- 2 34 (77)
Commissions from sales of noninsured products 71 183 188 390
Customer service charges 473 312 882 592
Income from loan servicing 41 24 43 61
Other income 110 62 192 118
-------- -------- -------- --------
Total non-interest income 695 583 1,339 1,084
-------- -------- -------- --------
See Notes to Condensed Consolidated Financial Statements
5
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Continued)
THREE AND SIX MONTHS ENDED JUNE 30, 2001 AND JUNE 30, 2000
(Dollars In Thousands, Except Per Share Amounts)
-----------------------------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------- ---------------------
2001 2000 2001 2000
---- ---- ---- ----
NON-INTEREST EXPENSE:
Compensation and employee benefits 1,655 1,627 3,313 3,087
Occupancy and equipment 432 319 782 631
Deposit insurance premiums 49 46 98 93
Data processing fees 170 278 612 566
Legal and accounting expenses 267 132 451 342
Supplies, postage, telephone, and office expenses 162 170 352 358
Advertising and promotion 27 98 57 199
Amortization of intangible assets 170 175 341 349
Consulting 63 51 306 103
Other expense 525 473 1,051 978
------ ------ ------ ------
Total non-interest expense 3,520 3,369 7,363 6,706
------ ------ ------ ------
INCOME BEFORE INCOME TAXES 1,648 991 2,701 2,397
PROVISION FOR INCOME TAXES 699 437 1,150 1,044
------ ------ ------ ------
NET INCOME $ 949 $ 554 $1,551 $1,353
====== ====== ====== ======
EARNINGS PER SHARE:
BASIC EARNINGS PER SHARE $ 0.29 $ 0.18 $ 0.48 $ 0.44
====== ====== ====== ======
DILUTED EARNINGS PER SHARE $ 0.29 $ 0.18 $ 0.47 $ 0.43
====== ====== ====== ======
See Notes to Condensed Consolidated Financial Statements
6
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2001
(Dollars And Shares In Thousands)
------------------------------------------------------------------------------------------------------------------------
Treasury
Shares
Desig- Accum-
Nated ulated
For Other
Addi- Unal- Com- Compre-
Common Stock Tional Re- Located pen- hensive
------------ Paid-In Tained ESOP Sation Treasury Income/
Shares Amount Capital Earnings Shares Plans Stock (Loss) Total
------ ------ ------- -------- ------ ----- ----- ------ -----
Balance At December 31, 2000 3,321 $45 $ 28,278 $ 32,722 $ (920) $ (338) $(15,326) $ (624) $ 43,837
Exercise of stock options 95 (28) 929 901
Director fees paid using treasury 12 14 122 136
stock
Amortization of stock compensation 88 115 71 274
Comprehensive income:
Net income 1,551 1,551
Other comprehensive income:
Change in net unrealized
loss on securities
available for sale,
net of taxes of $325 465 465
Reclassification adjustment
for gains on securities
available for sale
included in income,
net of taxes of ($14) (20) (20)
--------
Other comprehensive income, net 445
--------
Total comprehensive income 1,996
----- ----- -------- -------- ------ ------ -------- ----- --------
Balance at June 30, 2001 3,428 $ 45 $ 28,352 $ 34,273 $ (805) $ (267) $(14,275) $(179) $ 47,144
===== ===== ======== ======== ====== ====== ======== ===== ========
See Notes to Condensed Consolidated Financial Statements
7
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2001 AND JUNE 30, 2000
(Dollars In Thousands)
-------------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------
2001 2000
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,551 $ 1,353
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Depreciation and amortization of premises and equipment 291 218
Amortization of intangible assets 341 349
Accretion of purchase premiums, net of amortization of purchase (discounts) 3 39
Amortization of deferred loan fees and costs, net (113) (142)
Provision for loan losses 800 1,025
Federal Home Loan Bank stock dividends (97) (111)
Gross ESOP expense before dividends received on unallocated shares 194 163
Compensation expense associated with stock compensation plans 60 151
(Gain) loss on sale of mortgage-backed and investment securities (34) 77
Gain on sale of loans (29) (11)
Gain on sale of fixed assets (9) --
Origination of loans held for sale (4,388) (1,097)
Proceeds from sales of loans held for sale 4,034 1,108
Increase in accrued interest receivable (225) (16)
Increase in other assets (870) (546)
(Decrease) increase in accounts payable and other liabilities (435) 405
Other, net (800) (437)
-------- --------
Net cash provided by operating activities 274 2,528
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans held for investment (49,308) (15,557)
Proceeds from sales of investment securities available for sale -- 3,730
Purchases of mortgage backed securities available for sale (14,424) (6,032)
Principal repayments on mortgage backed securities 16,712 4,259
Proceeds from sales of mortgage backed securities available for sale 2,907 12,572
Redemptions of FHLB stock -- 406
Proceeds from the sale of fixed assets 9 --
Purchases of premises and equipment (777) (336)
-------- --------
Net cash used in investing activities (44,881) (958)
-------- --------
See Notes to Condensed Consolidated Financial Statements
8
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)
SIX MONTHS ENDED JUNE 30, 2001 AND JUNE 30, 2000
(Dollars In Thousands)
---------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------
2001 2000
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 10,551 20,053
Proceeds (repayments) from FHLB advances, net 19,000 (9,000)
(Repayments) proceeds of securities sold under agreements to repurchase, net -- (2,410)
Proceeds of other borrowings, net 184 --
Cash dividends paid to stockholders -- (274)
Purchases of treasury stock -- (1,251)
Sales of treasury stock 863 122
Sales of treasury stock for stock compensation plans -- 216
-------- --------
Net cash provided by financing activities 30,598 7,456
-------- --------
NET (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS (14,009) 9,026
CASH & CASH EQUIVALENTS AT BEGINNING OF PERIOD 25,159 12,833
-------- --------
CASH & CASH EQUIVALENTS AT END OF PERIOD $ 11,150 $ 21,859
======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid during the period for:
Interest on deposits and borrowings $ 10,131 $ 9,217
Income taxes 2,000 2,050
SUPPLEMENTAL DISCLOSURES OF NON CASH
INVESTING AND FINANCING ACTIVITIES
Loans transferred to held for investment, at market value 85 202
See Notes to Condensed Consolidated Financial Statements
9
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
NOTE 1: Basis Of Presentation
The accompanying condensed consolidated unaudited financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP") for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by GAAP for annual financial statements. In the opinion of management, all
necessary adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation have been included. The results of operations
for the three and six month periods ended June 30, 2001 are not necessarily
indicative of the results that may be expected for the entire fiscal year or any
other interim period.
Monterey Bay Bancorp, Inc. ("MBBC") is the holding company for Monterey
Bay Bank ("Bank"). The Bank maintains a subsidiary, Portola Investment
Corporation ("Portola"). These three companies are referred to herein on a
consolidated basis as the "Company". The Company's headquarters are in
Watsonville, California. The Company offers a broad range of financial services
to both consumers and small businesses. All significant intercompany
transactions and balances have been eliminated.
Monterey Bay Bancorp, Inc. operates as a single business segment.
Consequently, no segment information is provided in this Form 10-Q.
These unaudited condensed consolidated financial statements and the
information under the heading "Item 2. Management's Discussion And Analysis Of
Financial Condition And Results Of Operations" and the information under the
heading "Item 3. Quantitative And Qualitative Disclosure About Market Risk" have
been prepared with presumption that users of this interim financial information
have read, or have access to, the most recent audited consolidated financial
statements and notes thereto of Monterey Bay Bancorp, Inc. for the fiscal year
ended December 31, 2000 included in the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2000.
The preparation of the condensed consolidated financial statements of
Monterey Bay Bancorp, Inc. and subsidiary requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the reported revenues and expenses for the periods covered. These estimates are
based on information available as of the date of the financial statements.
Therefore, actual results could significantly differ from those estimates.
10
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
--------------------------------------------------------------------------------
NOTE 2. Computation Of Earnings Per Share
All of the Company's net income has been available to common
stockholders during the periods covered in this Form 10-Q.
Basic earnings per share ("EPS") are computed by dividing net income by
the weighted average common shares outstanding for the period. Diluted earnings
per share reflect the potential dilution that could occur if options or other
contracts to issue common stock were exercised and converted into common stock.
There was no difference in the numerator, net income, used in the
calculation of basic earnings per share and diluted earnings per share. The
denominator used in the calculation of basic earnings per share and diluted
earnings per share for the three and six month periods ended June 30, 2001 and
2000 is reconciled in the following table. The following table also reconciles
the calculation of the Company's Basic EPS and Diluted EPS for the periods
indicated.
For The Three Months For The Six Months
Ended June 30, Ended June 30,
--------------------------- --------------------------
(In Whole Dollars And Whole Shares)
2001 2000 2001 2000
---- ---- ---- ----
Net income $ 949,000 $ 554,000 $ 1,551,000 $ 1,353,000
=========== =========== =========== ===========
Average shares issued 4,492,085 4,492,085 4,492,085 4,492,085
Less weighted average:
Uncommitted ESOP shares (130,273) (166,211) (134,766) (170,703)
Non-vested stock award shares (30,348) (71,322) (31,981) (71,664)
Treasury shares (1,069,461) (1,179,399) (1,080,716) (1,142,929)
----------- ----------- ----------- -----------
Sub-total (1,230,082) (1,416,932) (1,247,463) (1,385,296)
----------- ----------- ----------- -----------
Weighted average BASIC shares outstanding 3,262,003 3,075,153 3,244,622 3,106,789
Add dilutive effect of:
Stock options 38,175 1,250 42,452 6,581
Stock awards 417 -- 503 244
----------- ----------- ----------- -----------
Sub-total 38,592 1,250 42,955 6,825
----------- ----------- ----------- -----------
Weighted average DILUTED shares outstanding 3,300,595 3,076,403 3,287,577 3,113,614
=========== =========== =========== ===========
Earnings per share:
BASIC EPS $ 0.29 $ 0.18 $ 0.48 $ 0.44
=========== =========== =========== ===========
DILUTED EPS $ 0.29 $ 0.18 $ 0.47 $ 0.43
=========== =========== =========== ===========
11
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
--------------------------------------------------------------------------------
NOTE 3: Other Comprehensive Income
The Company's only source of other comprehensive income is derived from
unrealized gains and losses on the portfolios of investment and mortgage backed
securities classified as available for sale.
Reclassification adjustments for realized net gains (losses) included
in other comprehensive income for investment and mortgage backed securities
classified as available for sale for the three and six months ended June 30,
2001 and 2000 are summarized as follows:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2001 2000 2001 2000
---- ---- ---- ----
(Dollars In Thousands)
Gross reclassification adjustment $ -- $ 2 $ 34 $ (77)
Tax (expense) benefit -- (1) (14) 32
------ ----- ----- -------
Reclassification adjustment, net of tax $ -- $ 1 $ 20 $ (45)
====== ===== ===== =======
A reconciliation of the net unrealized gain or loss on available for
sale securities recognized in other comprehensive income is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2001 2000 2001 2000
---- ---- ---- ----
(Dollars In Thousands)
Holding gain (loss) arising during the period,
net of tax $ 186 $ (162) $ 465 $ (307)
Reclassification adjustment, net of tax -- (1) (20) 45
----- ------- ------ -------
Net unrealized gain (loss) recognized in
other comprehensive income $ 186 $ (163) $ 445 $ (262)
===== ======= ====== =======
12
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
--------------------------------------------------------------------------------
NOTE 4: Stock Option Plans
The Company maintains the Amended 1995 Incentive Stock Option Plan and
the 1995 Stock Option Plan For Outside Directors. Under these plans, stock
options typically vest over a five year time period, although other vesting
periods are permitted under the Amended 1995 Incentive Stock Option Plan and
have been utilized by the Company from time to time. All outstanding stock
options under both of these plans vest upon a change in control of the Company.
The following tables summarize the combined status of these plans:
Stock Stock Average
Options Stock Options Exercise
Stock Stock Cumulatively Options Available Price Of
Options Options Vested And Cumulatively For Future Vested
Date Authorized Outstanding Outstanding Exercised Grants Options
---- ---------- ----------- ----------- --------- ------ -------
December 31, 2000 757,929 550,236 325,502 80,150 127,543 $9.76
March 31, 2001 757,929 468,687 248,799 171,699 117,543 $10.05
June 30, 2001 757,929 418,384 249,655 174,992 164,553 $10.05
Activity during the three and six months ended June 30, 2001 included:
Three Months Ended Six Months Ended
June 30, 2001 June 30, 2001
------------- -------------
Granted 8,500 18,500
Canceled 55,510 55,510
Exercised 3,293 94,842
Vested 18,557 33,403
The exercise price of individual vested stock options ranged from a low
of $8.19 per share to a high of $16.60 per share as of June 30, 2001.
13
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
--------------------------------------------------------------------------------
NOTE 5: Stock Award Plans
The Company maintains the Performance Equity Program ("PEP") for
Officers and employees. Awards under the PEP typically vest over a five year
time period, although from time to time the Company has utilized unallocated or
forfeited PEP shares for immediately vested stock grants in lieu of cash
compensation. It is the Company's intention to utilize some or all of the PEP
shares available at June 30, 2001 in lieu of cash compensation during the
remainder of 2001. Awards under the PEP are both time-based and
performance-based. All outstanding stock awards under the PEP vest in the event
of a change in control of the Company. The following table summarizes the status
of this plan:
Stock
Stock Awards
Stock Stock Awards Available
Awards Awards Cumulatively For Future
Date Authorized Outstanding Vested Grants
---- ---------- ----------- ------ ------
December 31, 2000 141,677 35,079 106,598 --
March 31, 2001 141,677 31,082 110,595 --
June 30, 2001 141,677 23,782 113,895 4,000
Activity during the three and six months ended June 30, 2001 included:
Three Months Ended Six Months Ended
June 30, 2001 June 30, 2001
------------- -------------
Granted 1,350 2,675
Canceled 5,350 6,675
Vested 3,300 7,297
14
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
--------------------------------------------------------------------------------
NOTE 6: Commitments & Contingencies
At June 30, 2001, commitments maintained by the Company included firm
commitments to originate $35.0 million in various types of loans and optional
commitments to sell $1.7 million in fixed rate residential mortgages on a
servicing released basis. The Company maintained no firm commitments to purchase
loans or securities, to assume borrowings, or to sell securities at June 30,
2001.
At June 30, 2001, the Company was participating in ongoing binding
arbitration to address claims by the former President and Chief Operating
Officer regarding payments due under his employment contracts. In the third
quarter of 2000, the Company established a $250 thousand reserve for settlement
of these claims. At this time, the Company, after conferring with counsel,
believes this reserve to be adequate to cover its liabilities in this regard.
NOTE 7: Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB")
approved for issuance Statement of Financial Accounting Standard (SFAS) No. 141,
"Business Combinations", and SFAS No.142, "Goodwill and Other Intangible
Assets". SFAS No. 141 requires that all business combinations initiated after
June 30, 2001 be accounted for under the purchase method of accounting and
addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination. SFAS No. 142 addresses the
initial recognition and measurement of intangibles assets acquired outside of a
business combination whether acquired individually or with a group of other
assets. SFAS No. 142 also addresses the recognition and measurement of goodwill
and other intangibles assets subsequent to their acquisition. SFAS No. 142
provides that intangible assets with finite useful lives will be amortized and
that goodwill and intangible assets with indefinite lives will not be amortized,
but will be required to be tested at least annually for impairment. The Company
is required to adopt SFAS No. 142 beginning January 1, 2002. Early adoption is
not permitted. The Company does not expect the adoption of SFAS No. 142 to have
a material effect on its financial position, results of operations, or cash
flows, as the Company had no goodwill as of June 30, 2001 and as all of the
Company's intangible assets at June 30, 2001 were comprised of core deposit
intangibles that will continue to amortize.
NOTE 8: Reclassifications
Certain amounts in the December 31, 2000 and June 30, 2000 financial
statements have been reclassified to conform to the June 30, 2001 financial
statement presentation.
15
Item 2. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations
Forward-looking Statements
Discussions of certain matters in this Report on Form 10-Q may
constitute forward-looking statements within the meaning of the Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities and
Exchange Act of 1934, as amended (the "Exchange Act"), and as such, may involve
risks and uncertainties. Forward-looking statements, which are based on certain
assumptions and describe future plans, strategies, and expectations, are
generally identifiable by the use of words or phrases such as "believe", "plan",
"expect", "intend", "anticipate", "estimate", "project", "forecast", "may
increase", "may fluctuate", "may improve" and similar expressions or future or
conditional verbs such as "will", "should", "would", and "could". These
forward-looking statements relate to, among other things, expectations of the
business environment in which Monterey Bay Bancorp, Inc. operates, projections
of future performance, potential future credit experience, perceived
opportunities in the market, and statements regarding the Company's mission and
vision. The Company's actual results, performance, and achievements may differ
materially from the results, performance, and achievements expressed or implied
in such forward-looking statements due to a wide range of factors. These factors
include, but are not limited to, changes in interest rates, general economic
conditions, the demand for the Company's products and services, accounting
principles or guidelines, legislative and regulatory changes, monetary and
fiscal policies of the US Government, US Treasury, and Federal Reserve, real
estate markets, competition in the financial services industry, attracting and
retaining key personnel, performance of new employees, regulatory actions,
changes in and utilization of new technologies, and other risks detailed in the
Company's reports filed with the Securities and Exchange Commission ("SEC") from
time to time, including the Annual Report on Form 10-K for the fiscal year ended
December 31, 2000. These factors should be considered in evaluating the
forward-looking statements, and undue reliance should not be placed on such
statements. The Company does not undertake, and specifically disclaims any
obligation, to update any forward-looking statements to reflect occurrences or
unanticipated events or circumstances after the date of such statements.
General
Monterey Bay Bancorp, Inc. (referred to herein on an unconsolidated
basis as "MBBC" and on a consolidated basis as the "Company") is a unitary
savings and loan holding company incorporated in 1994 under the laws of the
state of Delaware. MBBC currently maintains a single subsidiary company,
Monterey Bay Bank (the "Bank"), a federally chartered savings & loan. MBBC was
organized as the holding company for the Bank in connection with the Bank's
conversion from the mutual to stock form of ownership in 1995.
At June 30, 2001, the Company had $518.8 million in total assets,
$441.5 million in net loans receivable, and $418.3 million in total deposits.
The Company is subject to regulation by the Office of Thrift Supervision ("OTS")
and the Federal Deposit Insurance Corporation ("FDIC"). The principal executive
offices of the Company and the Bank are located at 567 Auto Center Drive,
Watsonville, California, 95076, telephone number (831) 768 - 4800, facsimile
number (831) 722 - 6794. The Company may also be contacted via electronic mail
at: INFO@MONTEREYBAYBANK.COM. The Bank is a member of the Federal Home Loan Bank
of San Francisco ("FHLB") and its deposits are insured by the FDIC to the
maximum extent permitted by law. Additional information regarding the Company is
available at the www.montereybaybank.com Internet site. The Company's Internet
site is not part of this Form 10-Q.
The Company conducts business from eight branch offices, 11 automated
teller machines ("ATM's") including two stand-alone ATM's, and its
administrative facilities. In addition, the Company supports its customers
through bilingual (English / Spanish) 24 hour telephone banking, Internet
banking, electronic bill payment, and ATM access through an array of networks
including STAR, CIRRUS, and PLUS. Through its network of banking offices, the
Bank emphasizes personalized service focused upon two primary markets:
households and small businesses. The Bank offers a wide complement of lending
and deposit products.
16
The Bank also supports its customers by functioning as a federal tax
depository, selling and purchasing foreign banknotes, issuing debit cards,
providing domestic and international collection services, and supplying various
forms of electronic funds transfer. Through its wholly owned subsidiary, Portola
Investment Corporation ("Portola"), the Bank provides, on an agency basis,
mortgage life insurance, fire insurance, and a large selection of non-FDIC
insured investment products including fixed and variable annuities, mutual
funds, and individual securities.
The Company's revenues are primarily derived from interest on its loan
and mortgage backed securities portfolios, interest and dividends on its
investment securities, and fee income associated with the provision of various
customer services. Interest paid on deposits and borrowings constitutes the
Company's largest type of expense. The Company's primary sources of funds are
deposits, principal and interest payments on its asset portfolios, and various
sources of wholesale borrowings including FHLB advances and securities sold
under agreements to repurchase. The Company's most significant operating
expenditures are its staffing expenses and the costs associated with maintaining
its branch network. During the six months ended June 30, 2001, the Company
incurred non-recurring operating costs associated with the March 2001 conversion
of its primary data processing systems of approximately $447 thousand; in
addition to the approximately $108 thousand of similar costs incurred in the
fourth quarter of 2000.
Recent Developments
Recent regulatory and financial industry developments have included the
following:
o Federal legislation reforming the bankruptcy code remains stalled in
Congress. This legislation, depending upon its final form, if any, could
potentially assist the Bank in collecting on certain credits.
o Congress, the California State Legislature, and various other governmental
or municipal entities have been considering legislation to address
"predatory lending". While the Company does not conduct the practices most
often referred to in the media as being "predatory", the passage of one or
more pieces of legislation in this regard could potentially increase the
Company's cost of doing business, as the Company could possibly be required
to comply with multiple and perhaps inconsistent laws and regulations.
o Federal financial institution regulators on July 6, 2001 finalized a policy
statement for the allowance for loan and lease losses. In addition, the
Securities & Exchange Commission ("SEC") issued a parallel Staff Accounting
Bulletin (No. 102). The policy statement clarifies that a bank's board of
directors is responsible for maintaining proper reserves; states that the
process for reserve determination must be thorough, disciplined, and
consistently enforced; and says reserves should be supported by adequate
and suitable documentation. The Company does not believe that the new
policy statement will have a material impact on its financial condition or
results of operations.
o New capital and membership rules for the FHLB System continue to be
drafted, with implementation anticipated during late 2001. The FHLB-SF has
circulated a draft capital plan. The Company does not believe that this
draft plan would materially impact the Bank's balance of FHLB capital stock
owned.
o Federal regulators of insured depository institutions have recently
requested comments regarding potential changes in the Community
Reinvestment Act ("CRA"). Areas under consideration for change include
revamping the investment test and redefining assessment areas in light of
the impact of changes in technology. The Bank's most recent publicly
disclosed CRA rating is "satisfactory".
o The Bank implemented new federal regulations ("Regulation P") governing
customer privacy effective July 1, 2001. The State of California
Legislature has been considering potentially different and / or more
restrictive privacy requirements.
o A possible increase in (e.g. from $100,000 to $200,000 per depositor) or
broadening of (e.g. all public agency deposits) federal deposit insurance
coverage, perhaps combined with a new formula for FDIC insurance premiums,
is under evaluation at the FDIC and in Congress. Congress also continues to
discuss the potential merger of the Bank Insurance Fund ("BIF") and Savings
Association Insurance Fund ("SAIF") of the FDIC.
17
State of California Energy Crisis
Through the end of July, the 2001 State of California energy crisis
presented only limited disruptions in the availability of electricity. Moderate
weather, lower natural gas prices, new power plant openings, and conservation
were among the factors that prevented the recurring rolling blackouts that were
threatened in the spring. The Federal Energy Regulatory Commission ("FERC") has
imposed certain regional electricity price caps. The California legislature and
Governor Gray Davis continue to debate possible longer term solutions to the
State's energy crisis. The largest utility in the State, Pacific Gas & Electric
Company ("PG&E"), remains in bankruptcy. California is pursuing the sale of a
record sized municipal bond issue to finance the State's purchases of energy in
2001. The State is also pursuing the collection of substantial sums from energy
generators who sold energy during the spring at what the State government
believes to have been extraordinarily high prices.
The Company cannot predict what the price and availability of energy
might be in California during the coming months. The Company also cannot predict
the impact of the energy crisis upon the pace and nature of economic activity in
the State, and upon the financial condition and debt rating of the State of
California.
The Company's management remains concerned about the potential impact
of the energy crisis upon the Company's operations and the financial condition
of its borrowers and funds availability from its depositors. The Company itself
is not a particularly large user of energy, as it conducts no manufacturing and
operates in a moderate climate. The Company has a natural gas powered backup
generator installed at its administrative headquarters designed to keep its
computer network operational in the event of an electricity brown-out or
black-out. The Company is in the process of acquiring a larger backup generator
with sufficient capacity to supply all functions at its administrative
headquarters. The Bank's branches at this time do not have backup generators,
and hence would need to limit their operations in the event of an electricity
brown-out or black-out.
As subsequently discussed in this Report, the uncertain impact of the
California energy crisis upon consumers and businesses and the pace of State
economic activity was one factor in the Company's increasing its allowance for
loan losses during the first half of 2001.
The Company commenced a special credit review during the second quarter
of 2001 with the intent to identify significant credits that might be
particularly and materially adversely impacted by the California energy crisis.
This special review was in addition to the ongoing credit monitoring processes
conducted by the Company. To date, no loans have been identified as being
directly and materially adversely affected by the California energy crisis. The
Company has historically focused on real estate loans and has conducted only
limited lending to manufacturers and other industries with a significant rate of
energy utilization. The Company intends to continue this special credit review
during the third quarter of 2001. In addition, the Company now includes an
analysis of borrowers' exposure to energy availability and prices as part of its
underwriting process for new loans.
Depending upon the results of the special credit review and the effects
of the California energy crisis, the Company might need to increase its levels
of provision for loan losses in future periods above those that would have been
required in the absence of the California energy crisis.
The Company is also exposed to the California energy crisis via the
State's maintenance of $16.0 million in time deposits with the Bank as of June
30, 2001. Should the State need to withdraw such deposits, replacement funding
for the Bank would likely be more expensive.
18
Overview Of Business Activity
During the second quarter of 2001, the Company continued the
implementation of its strategic plan of transforming the Bank into a community
focused commercial bank serving the financial needs of consumers and businesses
throughout the Greater Monterey Bay Area. Major accomplishments during the
second quarter of 2001 included the expanded utilization of the new core data
processing system implemented in March, 2001, the hiring of several key
employees, and the attainment of record levels of total assets, loans, and
deposits at June 30, 2001.
Significant events during the three and six months ended June 30, 2001
included:
1. The Company's ratio of net loans to total assets increased from 80.6% at
December 31, 2000 to 85.1% at June 30, 2001, consistent with the strategic
objective of better supporting the credit needs of California communities.
2. Several new professional bankers were hired to augment the Company's sales
to doctors, accountants, attorneys, and other professionals while also
providing improved service to the Bank's retail customers.
3. The Company maintained favorable credit quality, with just $1.1 million in
non-accrual loans at June 30, 2001 and $26 thousand in net charge-offs
during 2001.
4. The Board of Directors reduced its size to ten following two retirements,
thereby reducing future non-interest expense.
5. The Bank hired a new Chief Administrative Officer with over twenty years of
banking experience.
6. The Company continued to enhance its technology utilization following the
March 2001 conversion of its primary data processing system from an
external service bureau to an in-house system built upon client / server
and relational database technology.
7. The Bank initiated its first major marketing campaign of 2001, centered
about the theme "Monterey Bay Bank. Expect More. Get The Best."
8. MBBC downstreamed $300 thousand in capital to the Bank during the second
quarter of 2001 to support the expansion in the Bank's balance sheet.
The Board of Directors and management have targeted this transformation
strategy based on their belief that this approach presents the best current
opportunity to enhance long term stockholder value. As evidence of the Board's
personal and professional support for the Company and its strategic plan, the
Directors have voted to continue receiving their retainer fees in Company common
stock. In addition, the Company has continued to pursue the use of stock based
compensation in lieu of cash compensation as a means of aligning employee
interests with improvements in stockholder value.
During 2001, the Company also achieved progress in addressing two
historical issues that have consumed significant resources:
A. The Special Residential Loan Pool, originally $40.0 million at its purchase
in 1998, (see "Special Residential Loan Pool") comprised of residential
mortgages with a lower credit quality than typically accepted by the Bank,
paid down to $7.3 million by July 20, 2001, compared with $16.5 million
outstanding at December 31, 2000, with the seller / servicer for the pool
continuing to meet its obligation to absorb all credit losses.
B. The Company commenced binding arbitration during the second quarter of 2001
to address claims by the former President and Chief Operating Officer
regarding payments due under his employment contracts. This issue has
required significant management time and has generated $161 thousand in
legal costs over the past six months.
19
Looking forward at the remainder of 2001, the Company plans to
substantially complete the installation of the technology and human
infrastructure integral to the Bank's conversion from a savings & loan into a
community focused commercial bank. The Bank is under no immediate pressure to
pursue a change in charter at this time, as its Qualified Thrift Lender ("QTL")
ratio was 74.6% at June 30, 2001, compared to a minimum requirement of 65.0% to
retain its federal thrift charter.
In conjunction with its strategic plan, the Company also intends to
accelerate the transformation of its balance sheet toward a greater amount of
income property and business lending funded with a higher percentage of
transaction accounts. In addition, the Company has targeted improvements in its
efficiency ratio and return on stockholders' equity, two key measures of
financial performance where the Company has lagged peer institutions. However,
the Company cannot provide assurance regarding its future results in these
regards, with such uncertainty magnified by the economic and energy issues
facing California in 2001.
Changes In Financial Condition From December 31, 2000 To June 30, 2001
Total assets increased $32.6 million, or 6.7%, from $486.2 million at
December 31, 2000 to a record $518.8 million at June 30, 2001. The rise in
assets was centered in loans and was funded with a combination of greater
deposits, increased borrowings, and an expansion in stockholders' equity.
Cash & cash equivalents decreased from $25.2 million at December 31,
2000 to $11.2 million at June 30, 2001. The Company maintained a higher than
usual balance of cash & cash equivalents at the end of 2000 in part due to loan
prepayments occurring late in the year and the Company's not reinvesting those
proceeds into longer term assets before year end 2000. In addition, strong loan
funding demand at the end June 2001 led to the Company's drawing down its cash
equivalents at the end of the second quarter.
Investment securities available for sale were little changed during the
first six months of 2001, totaling $7.4 million at both December 31, 2000 and
June 30, 2001. At both December 31, 2000 and June 30, 2001, the Company's
investment security portfolio was identically composed of two floating rate
corporate trust preferred bonds rated "A-" or better by Standards & Poors.
Mortgage backed securities available for sale decreased from $43.0
million at December 31, 2000 to $38.5 million at June 30, 2001. After purchasing
$14.4 million in primarily Agency mortgage backed securities during the first
quarter of 2001, the Company ceased purchases during the second quarter of 2001
in favor of redirecting cash flows into the expansion of the loan portfolio.
Prepayments on mortgage backed securities were significant during the first half
of 2001 due to a combination of the lower interest rate environment and the
payoff and / or pay down of various collateralized mortgage obligations
("CMO's"), particularly planned amortization classes ("PAC's") that the Company
had purchased over the past year in anticipation of the funding requirements for
expanded lending in 2001 in conjunction with the implementation of the strategic
plan.
During the first quarter of 2001, the Bank purchased a $1.0 million
fixed rate Agency mortgage backed security comprised of loans to low to moderate
income borrowers in the Bank's lending area. The Bank conducts such purchases in
support of its local communities and as part of its proactive efforts under the
CRA. The Bank also places certificates of deposit with minority focused
financial institutions as part of its CRA program.
The mortgage backed securities purchased during the first quarter of
2001 were a mix of fixed and variable rate Agency pass-through securities, and
Agency and non-Agency fixed rate, relatively low duration CMO's.
During the first quarter of 2001, the Bank sold a $2.9 million position
in a long term, fixed rate Agency mortgage backed security in conjunction with
its asset / liability management program. The Company's management believed that
re-allocating the asset duration from the security to new loans would facilitate
better community support and derive a higher yield for the same level of
exposure to future increases in general market interest rates.
20
Loans held for sale increased from none at December 31, 2000 to $383
thousand at June 30, 2001. The Company's pace of mortgage banking activity has
accelerated in 2001 in conjunction with the Federal Reserve's six interest rate
cuts and declines in mortgage rates from their levels of one year ago,
generating borrower impetus to refinance. The Company sells most of its long
term, fixed rate residential mortgage production into the secondary market on a
servicing released basis. All loans held for sale at June 30, 2001 were matched
with optional commitments to deliver such loans into the secondary market. The
Company sells its long term, fixed rate residential mortgages and purchases more
interest rate sensitive loans as part of its interest rate risk management
program.
Loans held for investment, net, increased from $391.8 million at
December 31, 2000 to a record $441.1 million at June 30, 2001. The increase
resulted from a combination of strong internal loan originations and from pool
purchases of various types of California real estate loans. Net loans as a
percentage of total assets increased from 80.6% at December 31, 2000 to 85.1% at
June 30, 2001, in conjunction with the Company's strategy of supporting its
interest margin, fostering economic activity in its local communities, and
effectively utilizing the Bank's capital. However, because $21.4 million in loan
pool purchases were funded in June 2001, the Company generated only limited net
interest income from such during the second quarter. The Company follows its
customary underwriting policies in evaluating loan pools. The expansion in the
Bank's loan portfolio during 2001 has been facilitated by the downstream of $2.1
million and $300 thousand in capital from MBBC during the fourth quarter of 2000
and the second quarter of 2001, respectively.
Even with the strong second quarter 2001 loan production, the Company's
pipeline at June 30, 2001 remained at a historically high level, including $35.0
million in outstanding firm loan commitments by the Bank, portending additional
loan portfolio expansion during the third quarter of 2001. The pipeline at June
30, 2001 included a number of commercial credits, as the Company has continued
to gradually expand its lending to local businesses in conformity with its
strategic plan. Commercial loans represented 1.3% of gross loans at June 30,
2001.
The Company reversed its long term loan portfolio diversification away
from residential mortgages during the first half of 2001, in part due to
management's concerns about the near term status of the California economy in
general and construction lending in particular. Residential mortgages comprised
43.4% of gross loans at June 30, 2001, up from 37.8% at December 31, 2000. In
contrast, construction loans declined from 13.9% of gross loans at December 31,
2000 to 10.0% of gross loans at June 30, 2001. In addition, land loans declined
from 3.8% of gross loans at December 31, 2000 to 2.8% of gross loan at June 30,
2001. A total of 79.2% of the Company's outstanding construction loan balances
at June 30, 2001 were associated with housing.
During the first quarter of 2001, the Company tightened its credit
criteria for land and construction loans, with a particular focus on requiring
greater borrower equity contribution and liquidity for new construction loans.
This credit tightening did not occur in response to any specific decline in
credit quality in the Company's loan portfolio, but rather as a proactive step
in light of the slowing national economy and the unique issues facing California
stemming from an uncertain supply and price of energy and the weakening of the
technology sector.
During the second half of 2001, the Company intends to continue
pursuing its long term shift in loan mix toward income property lending, with a
particular focus on mortgages secured by multifamily buildings and various types
of commercial real estate that is other than single-use. Multifamily loans
increased from $76.7 million at December 31, 2000 to $88.4 million at June 30,
2001. Cash flows for apartment buildings in many parts of California have been
bolstered in the past year by a combination of lower debt service due to
declining interest rates and greater revenue due to a combination of lower
vacancy rates and higher rental rates. Construction of new apartments in many
parts of California has lagged demand, resulting in more favorable financial
conditions for apartment building owners.
The Company also intends to pursue increased lending to small to medium
sized businesses during subsequent quarters in 2001, with an initial focus on
lending to local companies, many of which have been depositors at the Bank for
several years. The Company also intends to increase its lending to professionals
(e.g. accountants, doctors, attorneys) in the Greater Monterey Bay Area during
the second half of 2001. Early in the second quarter of 2001, the Bank hired
additional professional bankers and commercial lenders, consistent with the
strategic transformation of the Bank into a community focused commercial bank.
21
Additional information regarding the composition of the Company's loan
portfolio is presented in the following table:
June 30, December 31,
2001 2000
--------- ---------
(Dollars In Thousands)
Held for investment:
Loans secured by real estate:
Residential one to four unit $ 202,650 $ 160,155
Multifamily five or more units 88,442 76,727
Commercial and industrial 103,890 102,322
Construction 46,613 59,052
Land 13,097 16,310
--------- ---------
Sub-total loans secured by real estate 454,692 414,566
Other loans:
Home equity lines of credit 5,950 5,631
Loans secured by deposits 222 494
Consumer lines of credit, unsecured 192 175
Business term loans 1,978 1,641
Business lines of credit 4,113 1,438
--------- ---------
Sub-total other loans 12,455 9,379
Sub-total gross loans held for investment 467,147 423,945
(Less) / Plus:
Undisbursed construction loan funds (19,928) (26,580)
Unamortized purchase premiums, net of purchase discounts 205 21
Deferred loan fees and costs, net (158) (202)
Allowance for estimated loan losses (6,138) (5,364)
--------- ---------
Loans receivable held for investment, net $ 441,128 $ 391,820
========= =========
Held for sale:
Residential one to four unit $ 383 $ --
========= =========
Premises and equipment, net, increased from $7.4 million at December
31, 2000 to $7.9 million at June 30, 2001 primarily due to hardware and software
purchases in support of the new core processing system.
Core deposit premiums, net, declined by $341 thousand during the first
six months of 2001 in conjunction with periodic amortization. Under OTS
regulations, intangible assets, including core deposit premiums, reduce
regulatory capital, resulting in lower regulatory capital ratios than would
otherwise be the case.
22
Total deposits increased from $407.8 million at December 31, 2000 to a
record $418.3 million at June 30, 2001. Key trends within the deposit portfolio
included:
o Non-interest bearing demand deposits increased from $17.1 million at
December 31, 2000 to $20.2 million at June 30, 2001. This rise was
supported by balances maintained by new commercial business customers, as
the Bank often requires a certain amount of compensating balances in
conjunction with a commercial credit facility. The Company has also
targeted attracting DDA balances as part of its sales management program.
This increase was also supported by the Bank's issuing checks on its own
account following the computer systems conversion. Outstanding checks drawn
on the Bank's own account are accounted for as demand deposits.
o Interest bearing NOW checking account balances decreased slightly from
$41.9 million at December 31, 2000 to $41.5 million at June 30, 2001. The
Company revamped its checking products in March 2001 in conjunction with
the core processing system conversion, expanding the use of tiered interest
rates as a vehicle for encouraging customers to increase their balances and
concentrate their accounts with the Bank. In addition, the Bank introduced
bilingual (English and Spanish) telephone banking and continued to market
Internet banking and electronic bill payment.
o Savings deposits increased from $16.5 million at December 31, 2000 to $20.0
million at June 30, 2001. This increase was primarily due to the
re-categorization of approximately $4.2 million in balances from money
market accounts to savings accounts in conjunction with the computer
systems conversion. By the end of the first quarter of 2001, the Company
eliminated its passbook based deposit accounts in favor of statement based
accounts that integrate effectively with global ATM networks, debit cards,
Internet banking, and telephone access. Management also believes that
statement based deposit products present a lower likelihood of operating
losses and provide a more regular opportunity for customer communication
and marketing.
o Money market deposits declined from $87.7 million at December 31, 2000 to
$85.2 million at June 30, 2001, resulting from the re-categorization of
certain deposit accounts discussed above. During the first quarter of 2001,
the Company repositioned its consumer money market accounts to better serve
three distinct market segments, with the accounts designed for each market
segment including tiered interest rates and comprehensive and flexible
access.
o Certificate of deposit balances increased from $244.7 million at December
31, 2000 to $251.4 million at June 30, 2001. The Company redesigned its
certificate of deposit products during the first quarter of 2001, providing
the opportunity for customers to earn higher interest rates by increasing
their balances, expanding their relationship with the Bank, and / or
incrementally extending the term of their accounts. During the second
quarter of 2001, the Company advertised certain relatively higher rate "CD
Specials" with the objective of attracting new retail customers who might
subsequently expand their relationship with additional financial products
and services. In addition, the Company received an additional certificate
of deposit of $2.0 million from the State of California during the second
quarter of 2001. During most of 2001, the Company has priced it longer term
(18 to 60 months) certificates of deposit attractively as part of its asset
/ liability management program and to encourage the development of longer
term customer relationships.
During the first quarter of 2001, the Company generally targeted its
deposit rates at a higher competitive market percentile (i.e. relatively higher
than usual) due to concerns about potential customer impact stemming from the
computer systems conversion. For example, while the Company worked to minimize
the customer impact of branch staff being allocated to training on the new
computer system in advance of its implementation, branch staffing was lighter
than targeted levels during parts of the first quarter of 2001. By the end of
the second quarter of 2001, the Company had returned its deposit pricing to more
traditional levels.
Through the first six months of 2001, the Company experienced active
competition for certificates of deposit from several financial institutions,
particularly two large thrifts that frequently offered above market interest
rates on various types of deposit accounts.
23
Following the computer systems conversion, the Company experienced an
increase in the rate of deposit account closures. The account closures were
concentrated in lower balance transaction accounts that became subject to
service charges because of the new fee and service charge schedule implemented
with the computer systems conversion. Certain operational issues affecting
customers arose following the conversion, also contributing to certain deposit
account closures. However, the majority of these operating issues were
successfully addressed in the weeks following the computer systems conversion.
While the growth in total deposits during the first half of 2001 was
favorable, the Company did not achieve the desired progress in altering the
deposit mix to contain a higher percentage of transaction accounts. Transaction
accounts constituted 39.9% of total deposits at June 30, 2001, almost constant
versus 40.0% at December 31, 2000. Effecting a change in deposit mix is integral
to the Company's strategic plan, as transaction accounts provide for a lower
cost of funds versus most other funding sources, generate fee income, furnish
opportunities for cross-selling other products and services to customers, and
are typically less interest rate sensitive than many other funding sources.
During the second half of 2001, the Company intends to continue emphasizing the
acquisition of transaction accounts through employee incentives and via sales
calls by the recently hired commercial and professional bankers.
The Company's ratio of loans to deposits increased from 96.08% at
December 31, 2000 to 105.54% at June 30, 2001, as the strong loan growth
eclipsed the expansion in deposits. In light of this ratio, the Company is
exploring various strategic alternatives for increasing its funding base,
including new sites for traditional stand-alone branches and sites for branches
domiciled within larger retail outlets. The Bank is currently evaluating a
potential site for a de novo stand alone branch in a market adjacent to one of
its largest existing branches. No assurance can, however, be provided that the
Company will be successful in obtaining additional distribution and sales
locations.
Borrowings increased from $32.6 million at December 31, 2000 to $51.8
million at June 30, 2001. The Company has acquired additional FHLB advances
during 2001 to provide funding for the expansion in the loan portfolio and to
layer in borrowing maturities during 2002 as part of the Bank's cash management
and asset / liability management programs. All of the Company's FHLB advances at
June 30, 2001 were fixed rate, bullet (non-amortizing), without embedded
options, such as granting the FHLB the ability to call the borrowing prior to
maturity. The new FHLB advances during 2001 were collateralized by assets
pledged from the Company's loan and securities portfolios.
Total stockholders' equity increased from $43.8 million at December 31,
2000 to $47.1 million at June 30, 2001. Factors contributing to the increase
included:
o $1.6 million in 2001 year to date net income
o continued amortization of deferred stock compensation, including the
issuance of certain compensation plan shares in lieu of cash compensation
o the payment of Director retainer fees with Company common stock
o the exercise of ninety-five thousand vested stock options by former
employees and Directors, generating $901 thousand in additional
stockholders' equity
o $445 thousand in other comprehensive income, net, stemming from the
appreciation in the portfolios of securities classified as available for
sale, which in turn resulted from the decline in general market interest
rates during the first half of 2001
The Company plans to continue utilizing stock compensation in lieu of
cash compensation for certain payments during the second half of 2001.
Management believes that compensating employees in stock fosters an alignment of
employee interests with improvements in long term stockholder value. The Company
did not conduct any share repurchases during the first half of 2001. The
Company's tangible book value per share increased from $12.54 at December 31,
2000 to $13.21 at June 30, 2001.
24
Interest Rate Risk Management And Exposure
The table below presents an overview of the interest rate environment
during the eighteen months ended June 30, 2001. The 12MAT and 11th District Cost
Of Funds Index ("COFI") are by nature lagging indices that trail changes in more
responsive interest rate indices such as those associated with the Treasury or
LIBOR markets.
Index/ Rate 12/31/99 3/31/00 6/30/00 9/30/00 12/31/00 3/31/01 6/30/01
----------- -------- ------- ------- ------- -------- ------- -------
3 month Treasury bill 5.31% 5.87% 5.85% 6.20% 5.89% 4.28% 3.65%
6 month Treasury bill 5.73% 6.14% 6.22% 6.27% 5.70% 4.13% 3.64%
1 year Treasury bill 5.96% 6.23% 6.05% 6.08% 5.36% 4.11% 3.63%
2 year Treasury note 6.24% 6.47% 6.36% 5.97% 5.09% 4.18% 4.24%
5 year Treasury note 6.34% 6.31% 6.18% 5.85% 4.97% 4.56% 4.95%
10 year Treasury note 6.44% 6.00% 6.03% 5.80% 5.11% 4.92% 5.41%
30 year Treasury bond 6.48% 5.83% 5.90% 5.88% 5.46% 5.44% 5.76%
Target federal funds 5.50% 6.00% 6.50% 6.50% 6.50% 5.00% 3.75%
Prime rate 8.50% 9.00% 9.50% 9.50% 9.50% 8.00% 6.75%
12MAT 5.08% 5.46% 5.79% 6.04% 6.11% 5.71% 5.10%
COFI 4.85% 5.00% 5.36% 5.55% 5.62% 5.20% 4.50%
In an effort to limit the Company's exposure to interest rate changes,
management monitors and evaluates interest rate risk on a regular basis,
including participation in the OTS Net Portfolio Value Model and associated
regulatory reporting. Management believes that interest rate risk and credit
risk compose the two greatest financial exposures faced by the Company in the
normal course of its business. The Company is not directly exposed to risks
associated with commodity prices or fluctuations in foreign currency values.
In recent quarters, the Company has maintained a relatively balanced
exposure to changes in general market interest rates as measured by potential
prospective changes in net portfolio value, also referred to as market value of
portfolio equity. These potential prospective changes in net portfolio value are
calculated based upon immediate, sustained, and parallel shifts in the term
structure of interest rates, often referred to as the "yield curve". In other
words, these calculations highlight that the fair value of the Company's assets
exhibits about the same volatility as does its liabilities. However, in addition
to the overall direction of general market interest rates, changes in relative
rates (i.e. the slope of the term structure of interest rates) and relative
credit spreads also impact net portfolio value and the Company's profitability.
As highlighted in the above table, over the past eighteen months,
general market interest rates first increased rapidly in early 2000, reached a
plateau approximately during the third quarter of 2000, and then fell rapidly in
the first half of 2001. The Federal Reserve cut its benchmark interest rates a
total of six times during the first half of 2001, for a total decrease of 275
basis points. This decline represented a historically rapid and aggressive set
of actions by the Federal Reserve, as it sought to reinvigorate the pace of
national economic growth.
Throughout the volatile 18 month time period covered in the above
table, the impact of changing rates on the Company's interest margin was
moderate, providing empirical support for the financial modeling previously
described.
During the first half of 2001, the Company sought to maintain its
relatively balanced interest rate risk profile by avoiding adding significant
volumes of long term, fixed rate assets to the balance sheet. Long term, fixed
rate assets are relatively more challenging to match fund, and therefore can
expose the Company to interest rate risk in rising interest rate environments.
During the first six months of 2001, the Company continued to sell the majority
of its long term, fixed rate residential loan production into the secondary
market on a servicing released basis. Mortgage backed security purchases were
primarily either short term, fixed rate or longer maturity, but floating rate.
Loan pool purchases were generally either adjustable rate or seasoned hybrid
mortgages, as defined below.
25
The steeper yield curve present at the end of the second quarter of
2001 combined with the lagging nature of the COFI and 12MAT indices to encourage
more mortgage borrowers to select the Company's hybrid "3/1" and "5/1" loan
programs versus long term, fixed rate loans or traditional adjustable rate
mortgages. The hybrid programs provide initial fixed rates for three or five
years, after which time the mortgages adjust their rates semi-annually at a
margin over the One Year Treasury Constant Maturities Index. Should this trend
continue into the third quarter of 2001, the Company could become somewhat
liability sensitive in the absence of other actions to adjust its interest rate
risk profile.
The Company's strategic plan of transforming the Bank into a community
focused financial services provider by nature presents a lower interest rate
risk profile than historically experienced by the Bank when the balance sheet
was highly concentrated in residential mortgages (including long term, fixed
rate), which present greater embedded optionality than many other types of
loans. However, management is concerned about the possible impact of a
potentially historically low interest rate environment during the second half of
2001 if the Federal Reserve determines to continue decreasing interest rates in
an effort to support the US economy. If interest rates reach very low levels,
the Company could experience additional margin compression since rates on
various types of deposit accounts could reach either zero or near-zero, and thus
no longer provide an opportunity to reduce the Company's cost of funding. In
addition, historically low interest rates could spur a sufficiently large
refinancing wave that could present the Company with excess liquidity at a time
when reinvestment options would be relatively unattractive.
Liquidity
Liquidity is actively managed to ensure sufficient funds are available
to meet ongoing needs of both the Company in general and the Bank in particular.
Liquidity management includes projections of future sources and uses of funds to
ensure the availability of sufficient liquid reserves to provide for
unanticipated circumstances. The Company's primary sources of funds are customer
deposits, principal and interest payments on loans and securities, FHLB advances
and other borrowings, and, to a lesser extent, proceeds from sales of loans and
securities. While maturities and scheduled amortization of loans and securities
are predictable sources of funds, deposit flows and prepayments on mortgage
related assets are significantly influenced by general market interest rates,
economic conditions, and competition.
At June 30, 2001, the Company had $11.2 million in cash and cash
equivalents, untapped borrowing capacity in excess of $73.0 million at the
FHLB-SF, and a significant volume of residential mortgages that could be
securitized, liquidated, or used in collateralized borrowings in order to meet
future liquidity requirements. During the third quarter of 2001, the Bank
intends to pledge additional loan collateral to the FHLB-SF and enroll in the
FHLB's specific loan pledging program in order to significantly increase its
borrowing capacity.
MBBC and the Bank have each entered into several Master Repurchase
Agreements to permit securities sold under agreements to repurchase transactions
with a number of counterparties. In addition, at June 30, 2001, the Bank
maintained $25.5 million in unsecured federal funds lines of credit from four
correspondent financial institutions. However, there can be no assurance that
funds from these lines of credit will be available at all times, or that the
lines will be maintained in future periods. The Bank is able to issue wholesale
"DTC" certificates of deposit through two large, national investment banking
firms as an additional source of liquidity.
At June 30, 2001, MBBC on a stand alone basis had cash & cash
equivalents of $4.2 million. In addition, MBBC had no outstanding balance on a
$2.0 million revolving line of credit. The loan agreement for this line of
credit contains certain restrictions on the use of borrowed funds, including a
prohibition for such funds to be used to repurchase Company common stock. The
Company intends to seek an increase in this line of credit before the end of
2001 in order to enhance MBBC's available liquidity.
Due to additional capital requirements implemented by the OTS for the
Bank in conjunction with the Special Residential Loan Pool, the Bank is
currently limited in its ability to pay dividends to MBBC.
26
On June 19, 2001, the OTS issued Thrift Bulletin 77, "Sound Practices
for Liquidity Management at Savings Associations". This Thrift Bulletin provides
guidance to management and boards of directors of thrift institutions on
liquidity management. On March 15, 2001, the OTS issued an interim final rule
that repealed a statutory liquidity requirement for the Bank. The prior
requirement mandated that the Bank maintain an average daily balance of liquid
assets of at least 4.0% of its liquidity base (as defined). The Bank is,
however, still required to maintain a safe and sound level of liquidity at all
times, and will be examined by the OTS in this regard. Management believes that
having a surplus of available liquidity at all times is prudent. Management also
believes that the guidance contained within Thrift Bulletin 77 is fundamental to
effective financial management of the Bank.
Capital Resources And Regulatory Capital Compliance
Federal banking regulatory agencies maintain a system providing for
regulatory sanctions against financial institutions that are not adequately
capitalized. The severity of these sanctions increases to the extent that an
institution's capital falls further below the adequately capitalized thresholds.
OTS Prompt Corrective Action ("PCA") regulations require specific capital ratios
for five separate capital categories as set forth below:
Core Capital Core Capital Total Capital
To Adjusted To To
Total Assets Risk-weighted Risk-weighted
(Leverage Ratio) Assets Assets
---------------- ------ ------
Well capitalized 5% or above 6% or above 10% or above
Adequately capitalized 4% or above 4% or above 8% or above
Undercapitalized Under 4% Under 4% Under 8%
Significantly undercapitalized Under 3% Under 3% Under 6%
Critically undercapitalized Ratio of tangible equity to adjusted total assets of 2% or less
The following table summarizes the capital ratios required for an
institution to be considered well capitalized and the Bank's regulatory capital
at June 30, 2001 as compared to such ratios.
Core Capital Core Capital To Total Capital To
To Adjusted Risk-weighted Risk-weighted
(Dollars In Thousands) Total Assets Assets Assets
----------------------- ----------------------- -----------------------
Balance Percent Balance Percent Balance Percent
------- ------- ------- ------- ------- -------
Bank regulatory capital $41,210 7.97% $41,210 10.88% $45,961 12.14%
Well capitalized requirement 25,847 5.00% 22,722 6.00% 37,871 10.00%
------ ----- ------ ----- ------ ------
Excess $15,363 2.97% $18,488 4.88% $ 8,090 2.14%
======= ===== ======= ===== ======= =====
Adjusted assets (1) $516,939 $378,707 $378,707
======== ======== ========
-------------------------------------
(1) The above line for "adjusted assets" refers to the term "adjusted total
assets" as defined in 12 C.F.R. Section 567.1(a) for purposes of core capital
requirements, and refers to the term "risk-weighted assets" as defined in C.F.R.
Section 567.1(bb) for purposes of risk-based capital requirements.
The Bank has been informed by the OTS that it is to maintain its
regulatory capital ratios at levels no less than those in effect at December 31,
1999 until further notice (see "Special Residential Loan Pool"). The following
table demonstrates the Bank's compliance with this institution-specific
regulatory capital requirement.
June 30, 2001 December 31, 1999
------------- -----------------
Core capital to adjusted total assets 7.97% 7.11%
Core capital to risk-weighted assets 10.88% 9.58%
Total capital to risk-weighted assets 12.14% 10.56%
27
Other OTS capital regulations require the Bank to maintain: (a)
tangible capital of at least 1.5% of adjusted total assets (as defined in the
regulations), (b) core capital of at least 4.0% of adjusted total assets (as
defined in the regulations) (unless the Bank has been assigned the highest
composite rating under the Uniform Financial Institutions Rating System, in
which case 3.00%), and (c) total capital of at least 8.0% of risk-weighted
assets (as defined in the regulations).
The following table summarizes these regulatory capital requirements
for the Bank. As indicated in the table, the Bank's capital levels at June 30,
2001 exceeded all three of the currently applicable minimum regulatory capital
requirements.
Percent Of
Adjusted
(Dollars In Thousands) Total
Amount Assets
------ ------
Tangible Capital
----------------
Regulatory capital $41,210 7.97%
Minimum required 7,754 1.50%
----- -----
Excess $33,456 6.47%
======= =====
Core Capital
------------
Regulatory capital $41,210 7.97%
Minimum required 20,678 4.00%
------ -----
Excess $20,532 3.97%
======= =====
Percent Of
Risk-
weighted
Amount Assets
------ ------
Risk-based Capital
------------------
Regulatory capital $45,961 12.14%
Minimum required 30,297 8.00%
------ -----
Excess $15,664 4.14%
======= =====
At June 30, 2001, the Bank's regulatory capital levels exceeded the
thresholds required to be classified as a "well capitalized" institution. The
Bank's regulatory capital ratios detailed above do not reflect the additional
capital (and assets) maintained by MBBC. Management believes that, under current
regulations and institution-specific requirements, the Bank will continue to
meet its minimum capital requirements. However, events beyond the control of the
Bank, such as changing interest rates or a downturn in the economy or real
estate markets in the areas where the Bank has most of its loans, could
adversely affect future earnings and, consequently, the ability of the Bank to
meet its future minimum regulatory capital requirements.
28
Asset Quality / Credit Profile
Non-performing Assets
The following table sets forth information regarding non-performing
assets at the dates indicated.
(Dollars In Thousands) June 30, 2001 December 31, 2000
------------- -----------------
Outstanding Balances Before Valuation Reserves
Non-accrual loans $ 1,070 $ 4,666
Loans 90 or more days delinquent and accruing interest -- --
Restructured loans in compliance with modified terms -- 75
------- -------
Total gross non-performing loans 1,070 4,741
Investment in foreclosed real estate before valuation reserves -- --
Repossessed consumer assets -- --
------- -------
Total gross non-performing assets $ 1,070 $ 4,741
======= =======
Gross non-accrual loans to total loans 0.24% 1.17%
Gross non-performing loans to total loans 0.24% 1.19%
Gross non-performing assets to total assets 0.21% 0.98%
Allowance for loan losses $6,138 $5,364
Allowance for loan losses to non-performing loans 573.64% 113.14%
Valuation allowances for foreclosed real estate $ -- $ --
Non-accrual loans at June 30, 2001 are detailed in the following table:
(Dollars In Thousands) Number Principal Balance
Of Outstanding At
Category Of Loan Loans June 30, 2001
---------------- ----- -------------
Residential one to four unit mortgage 6 $ 1,039
Business line of credit 1 20
Business term loan 1 11
Consumer line of credit 1 --
----- -------
Total 9 $ 1,070
===== =======
In April 2001, the Bank collected in full on a $544 thousand commercial
& industrial real estate mortgage and the $2.85 million commercial real estate
construction loan that were on non-accrual status and classified as substandard
at March 31, 2001. Both loans were located in the Bank's primary market area.
The commercial construction loan had a $600 thousand specific reserve at March
31, 2001. In conjunction with both payoffs, the Bank received all principal,
interest, fees, and expense reimbursements due. In addition, during July 2001,
the Bank collected in full on the $11 thousand non-accrual business term loan
included in the above table.
29
Criticized And Classified Assets
The following table presents information concerning the Company's
inventory of criticized ("OAEM") and classified ("substandard" and lower)
assets. The category "OAEM" refers to "Other Assets Especially Mentioned", or
those assets which present indications of potential future credit deterioration.
(Dollars In Thousands) OAEM Substandard Doubtful Loss Total
---- ----------- -------- ---- -----
December 31, 2000 $ 2,283 $ 6,323 $ -- $ 600 $ 9,206
March 31, 2001 $ 5,182 $ 4,897 $ -- $ 600 $10,679
June 30, 2001 $ 5,100 $ 4,048 $ -- $ -- $ 9,148
Classified assets as a percent of stockholders' equity decreased from
15.8% at December 31, 2000 to 8.6% at June 30, 2001.
The June 30, 2001 substandard assets in the above table include a $2.3
million "mini-perm" mortgage loan participation maturing in 2004 secured by a
beach resort in the Company's primary business area. The resort has experienced
lower occupancy than forecast, contributing to a reduced cash flow and
inadequate debt service coverage. The borrowers have continued to timely make
all loan payments, however, and no delinquency was experienced through June 30,
2001. The Company downgraded this loan from OAEM during the second quarter of
2001 because of the cash flow inadequacy and concerns that a potential
additional slowdown in economic activity might further reduce occupancy or
realized average room rates. The Company intends to continue closely monitoring
this loan.
The Company's total loans graded "OAEM" did not decline in conjunction
with the downgrade of the aforementioned resort loan to substandard because of
the addition of a $2.8 million construction loan to the list of criticized
credits. The construction loan is for the development of a residential project
in the Coachella Valley in southern California. The borrowers were current in
their payments at June 30, 2001. However, slower than anticipated sales of homes
and lots within the development led to the credit's being identified as "OAEM".
In mid July 2001, the borrowers repaid over $500 thousand in principal on this
loan.
Impaired Loans
At June 30, 2001, the Company had total gross impaired loans, before
specific reserves, of $1.1 million, constituting 9 credits. This compares to
total gross impaired loans of $5.3 million at December 31, 2000. Interest is
accrued on impaired loans on a monthly basis except for those loans that are 90
or more days delinquent or those loans which are less than 90 days delinquent
but where management has identified concerns regarding the collection of the
credit. For the six months ended June 30, 2001, accrued interest on impaired
loans was zero and interest of $39 thousand was received in cash. If all
non-accrual loans had been performing in accordance with their original loan
terms, the Company would have recorded interest income of $69 thousand during
the six months ended June 30, 2001, instead of interest income actually
recognized, based on cash payments, of $39 thousand.
Special Residential Loan Pool
During 1998, the Bank purchased a $40.0 million residential mortgage
pool comprised of loans secured by homes throughout the nation (but with a
concentration in California) that presented a borrower credit profile and / or a
loan to value ratio outside of (less favorable than) the Bank's normal
underwriting criteria. To mitigate its credit risk for this portfolio, the Bank
obtained at purchase a scheduled principal / scheduled interest loan servicing
agreement from the seller. Further, this agreement also contains a guaranty by
the seller to absorb any principal losses on the portfolio in exchange for the
seller's retention of a portion of the loans' yield through loan servicing fees.
In obtaining these credit enhancements, the Bank functionally aggregated the
credit risk for this loan pool into a single borrower credit risk to the seller
/ servicer of the loans. The Bank was subsequently informed by the OTS that
structuring the purchase in this manner made the transaction an "extension of
credit" by the Bank to the seller, which, by virtue of its size, violated the
OTS' "Loans To One Borrower" regulation. The Bank continues to report to the OTS
in this regard on a monthly basis.
30
At June 30, 2001, the outstanding principal balance of this mortgage
loan pool was $8.1 million, comprised of 64 mortgages, with $721 thousand
received during July, 2001 (normal monthly remittance cycle) based upon
prepayments and scheduled principal for June, 2001. At December 31, 2000, the
outstanding principal balance of this mortgage loan pool was $16.5 million. The
loans in this mortgage pool bear interest rates significantly in excess of
current market rates for similar new loans extended to borrowers with moderate
or better credit profiles. This rate differential contributed to the prepayments
realized on the portfolio during the first half of 2001.
Through the July 20, 2001 regularly scheduled remittance date, the
seller performed per the loan servicing agreement, making scheduled principal
and interest payments to the Bank while also absorbing all credit losses on the
loan portfolio. At June 30, 2001, the Company categorized all loans within this
mortgage pool as performing based upon the continued payment performance of the
seller.
As of the July 20, 2001 remittance and reporting date for activity
through June 30, the mortgage pool included three foreclosed properties. The
seller continued to advance scheduled interest and principal payments to the
Company for these three mortgages, totaling $503 thousand in loan principal
balance.
Despite the performance of the seller, however, the Company has
allocated certain reserves to this mortgage pool at June 30, 2001 due to
concerns regarding the potential losses by the seller in honoring the guaranty,
the present delinquency profile of the pool, and the differential between loan
principal balances and current appraisals for foreclosed loans and loans in the
process of foreclosure.
The Company continues to monitor the financial performance and
condition of the seller on a monthly basis. The earnings and capital of the
seller experienced favorable results during the first and second quarters of
2001, supported by the strong mortgage refinance market. In addition, the
Company analyzes the payment performance and credit profile of the remaining
outstanding loans on a monthly basis.
During the first quarter of 2000, the Bank was informed by the OTS
that:
1. all loans associated with this loan pool would be required to be assigned
to the 100% risk based capital category in calculating regulatory capital
ratios that incorporate risk weighted assets
2. the Bank's regulatory capital position at December 31, 1999 and thereafter
was mandated to reflect the above requirement
3. until further notice, the Bank's regulatory capital ratios were required to
be maintained at levels no lower than the levels at December 31, 1999
Because remaining a "well capitalized" financial institution is
integral to the Bank's business strategy and due to the planned generation of
additional regulatory capital in 2001 through a combination of net income,
amortization of deferred stock compensation, and amortization of intangible
assets, management does not foresee that the aforementioned requirements will
have a material adverse impact upon the Company in 2001. However, depending upon
the tenure of and any potential modification of the additional requirements, as
determined by the OTS, such requirements could present an unfavorable impact
upon MBBC's liquidity and ability to pay cash dividends to stockholders and
conduct share repurchases, as a result of potential restrictions upon the Bank's
ability to pay dividends to MBBC.
31
Allowance For Loan Losses
The allowance for loan losses is established through a provision for
loan losses based on management's evaluation of the risks inherent in the loan
portfolio. In determining levels of risk, management considers a variety of
factors, including, but not limited to, asset classifications, economic trends,
industry experience and trends, geographic concentrations, estimated collateral
values, historical loan loss experience, and the Company's underwriting
policies. The allowance for loan losses is maintained at an amount management
considers adequate to cover losses in loans receivable which are deemed probable
and estimable. While management uses the best information available to make
these estimates, future adjustments to allowances may be necessary due to
economic, operating, regulatory, and other conditions that may be beyond the
Company's control. In addition, various regulatory agencies, as an integral part
of their examination process, periodically review the Bank's allowance for loan
losses. Such agencies may require the Bank to recognize additions to the
allowance based on judgements different from those of management.
The following table presents activity in the Company's allowance for
loan losses during the six months ended June 30, 2001 and June 30, 2000:
Six Months Ended June 30,
-----------------------------------------
2001 2000
---- ----
Allowance For Loan Losses (Dollars In Thousands)
-------------------------
Balance at beginning of year $ 5,364 $ 3,502
Charge-offs:
Residential one to four unit real estate loans -- (371)
Consumer lines of credit (1) --
Business lines of credit (25) --
------- -------
Total charge-offs (26) (371)
Recoveries -- --
Provision for loan losses 800 1,025
------- -------
Balance at June 30 $ 6,138 $ 4,156
======= =======
Annualized ratio of net charge-offs during the period to average
loans receivable, net, outstanding during the period 0.01% 0.20%
Additional ratios applicable to the allowance for loan losses include:
June 30, 2001 December 31, 2000
------------- -----------------
Allowance for loan losses as a percent of non-performing loans 573.64% 113.14%
Allowance for loan losses as a percent of gross loans receivable
net of undisbursed loan funds 1.37% 1.35%
Allowance for loan losses as a percent of classified assets 151.63% 77.48%
32
As subsequently discussed (see "Provision For Loan Losses"), the lower
provision for loan losses recorded during the first six months of 2001 versus
the same period in the prior year resulted from multiple factors, including
lower net charge-offs, the recapture of a $600 thousand specific reserve during
the second quarter of 2001, and changes in the volume and mix of the loan
portfolio.
Management anticipates that further growth in loans receivable, ongoing
emphasis on the origination and purchase of income property real estate loans,
and the continuing expansion of commercial business lending will result in
future provisions and in an increase in the ratio of the allowance for loan
losses to loans outstanding. Experience across the financial services industry
indicates that commercial business and income property loans present greater
risks than residential real estate loans, and therefore should be accompanied by
suitably higher levels of reserves.
Comparison Of Operating Results For The Three Months And Six Months
Ended June 30, 2001 and June 30, 2000
General
During the second quarter of 2001, the Company reported net income of
$949 thousand, equivalent to $0.29 diluted earnings per share. This compares to
net income of $554 thousand, or $0.18 diluted earnings per share, for the second
quarter of 2000. Net income during the quarter ended March 31, 2001 (the
immediately preceding quarter) was $602 thousand, equivalent to $0.18 diluted
earnings per share.
For the six months ended June 30, 2001, net income was $1.6 million,
equivalent to $0.47 diluted earnings per share. This compares to net income of
$1.4 million, or $0.43 diluted earnings per share, for the first six months of
2000.
The Company realized some of the financial benefits from its
transformation strategy during the first half of 2001. Net interest income rose,
primarily due to a larger average balance sheet fueled by increased deposits and
loans. Customer service charge income expanded, assisted by the new fee &
service charge schedule and financial product revisions implemented with the new
core processing system in March 2001. In addition, the Company began realizing
certain operating efficiencies from the new technology environment during the
second quarter of 2001. The Company maintained high credit quality during 2001,
thus avoiding significant operating costs for collections and foreclosures. Net
income during the first half of 2001 was impacted by (pre-tax) operating costs
for the conversion of the Company's core data processing system ($447 thousand)
and legal expenses associated with the arbitration of claims by a former
executive ($161 thousand).
Interest Rate Environment
The table presented above under "Interest Rate Risk Management And
Exposure" furnishes an overview of the interest rate environment during the most
recent six quarters. Market interest rates have varied considerably during this
time period. In early 2000, the Federal Reserve continued increasing its target
federal funds rate (commenced in 1999), expressing concern about the rapid pace
of economic expansion, the booming equity markets (particularly NASDAQ), and the
combination of very low unemployment, spot labor shortages, and increased
compensation costs which presented the potential for a rise in inflation. During
the second half of 2000, many capital markets interest rates (e.g. LIBOR and
Treasuries) began declining in response to falling equity markets and slowing
economic growth. The Federal Reserve did not commence cutting its benchmark
interest rates until the first week of 2001. The Federal Reserve then cut the
target federal funds rate a total of 275 basis points over six separate
occasions during the first half of 2001, taking the target federal funds rate
from 6.50% on January 2, 2001 to 3.75% on June 30, 2001.
33
The year 2001 began with an inverted Treasury curve, highlighting a
traditionally difficult interest rate environment for financial institutions,
including the Bank. Financial institutions generally benefit from a positively
sloped term structure of interest rates, whereby higher duration assets may be
funded at a favorable spread with shorter term liabilities, and whereby fixed
rate assets appreciate in market price as they move nearer to maturity. By the
end of the first quarter of 2001, the Treasury curve out through two years was
relatively flat. Following additional interest rate cuts by the Federal Reserve
during the second quarter of 2001, the Treasury curve became steeper, with short
term Treasury rates falling and long term Treasury rates rising between March 31
and June 30, 2001. In June 2001, the Company took advantage of the steeper term
structure of interest rates by funding certain hybrid residential loans (i.e.
fixed for 3 - 5 years, then floating) with lower duration liabilities.
Net Interest Income
Net interest income increased from $4.6 million and $9.0 million during
the second quarter and first half of 2000, respectively, to $4.8 million and
$9.5 million during the same periods in 2001 primarily due to greater average
balances of interest earning assets and liabilities. The Company's ratio of net
interest income to average total assets was 3.79% and 3.81% for the three and
six months ended June 30, 2001, down from 3.85% and 3.86% during the same
periods in 2000. The Company's margins were impacted in the most recent quarter
by a shift in loan mix toward residential mortgages. Margins were also hampered
by the Company's offering higher than normal relative retail deposit pricing to
facilitate customer retention following the core systems conversion. In
addition, during the second quarter of 2001, the Company experienced difficulty
decreasing its NOW and Savings deposit rates at the same pace as the declines in
indices utilized for adjustable rate loans, as the NOW and Savings rates were
already at low nominal levels.
Other factors influencing net interest income during the first three
and six months of 2001 compared to the same periods of 2000 included:
o During the first half of 2000, the Company benefited from locking in a
significant volume of funding during the fourth quarter of 1999 and early
2000 in a rising interest rate environment.
o The FHLB-SF paid particularly high dividend rates on its capital stock
during the first half of 2000 in conjunction with its capital management
program.
o The Company increased the size of its balance sheet early in 2001 in
anticipation of a declining interest rate environment, funding new short to
intermediate term assets with low duration borrowings. This favorably
impacted net interest income.
o Average net loans as a percentage of average total assets improved from
79.7% during the first half of 2000 to 81.6% during the first six months of
2001. Because loans constitute by far the Company's highest yielding type
of asset, this change in asset mix favorably affected net interest income.
o The Company maintained higher levels of non-interest earning correspondent
bank account balances than usual during March 2001 as a liquidity cushion
to address any potential operational or financial settlement issues arising
following the implementation of the new computer system. This excess
liquidity, which unfavorably impacted the Company's margins, was not
required.
o During the first half of 2001, the Bank was not able to decrease its
weighted average cost of deposits as rapidly as declines in indices used
for adjustable rate loans such as Prime, CMT, 12MAT, and COFI. The Bank's
weighted average cost of deposits declined from 4.72% at December 31, 2000
to 4.00% at June 30, 2001. In contrast, the Prime Rate declined 275 basis
points, COFI decreased 112 basis points, and the 1 Year CMT Index fell 198
basis points over the same time period.
During the second half of 2001, the Company plans to address the above issues
that unfavorably impact net interest income by continuing to increase the
average size of the balance sheet while also continuing the transformation into
a community commercial bank and repositioning the asset and liability mixes.
However, no assurance can be provided that the Company will be successful in
this regard, as interest rates and new business activity are influenced by many
factors beyond the control of the Company, such as actions by the Federal
Reserve and competition.
34
The following table presents the average annualized rate earned upon
each major category of interest earning assets, the average annualized rate paid
for each major category of interest bearing liabilities, and the resulting net
interest spread, net interest margin, and average interest margin on total
assets for the three months ended June 30, 2001 and 2000.
Three Months Ended June 30, 2001 Three Months Ended June 30, 2000
---------------------------------------- ----------------------------------------
(Dollars In Thousands) Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Assets
------
Interest earning assets:
Cash equivalents (1) $ 9,697 $ 103 4.25% $ 7,933 $ 125 6.34%
Investment securities 7,302 111 6.08% 9,259 177 7.69%
Mortgage backed securities (2) 43,312 675 6.23% 52,406 917 7.00%
Loans receivable, net (3) 413,107 8,779 8.50% 379,860 8,117 8.55%
FHLB stock 2,967 42 5.66% 3,023 75 9.98%
--------- ------ --------- ------
Total interest earning assets 476,385 9,710 8.15% 452,481 9,411 8.32%
------ ------
Non-interest earnings assets 27,281 20,980
--------- ---------
Total assets $ 503,666 $ 473,461
========= =========
Liabilities & Equity
--------------------
Interest bearing liabilities:
NOW accounts $ 40,843 100 0.98% $ 35,548 140 1.58%
Savings accounts 20,927 63 1.20% 15,429 68 1.77%
Money market accounts 86,283 913 4.23% 89,272 1,025 4.62%
Certificates of deposit 244,056 3,279 5.37% 227,228 2,965 5.25%
--------- ------ --------- ------
Total interest-bearing deposits 392,109 4,355 4.44% 367,477 4,198 4.59%
FHLB advances 43,280 579 5.35% 45,885 660 5.79%
Other borrowings (4) 115 3 10.43% 44 1 6.38%
--------- ------ --------- ------
Total interest-bearing liabilities 435,504 4,937 4.53% 413,406 4,859 4.73%
------ ------
Demand deposit accounts 19,208 17,221
Other non-interest bearing 2,302 3,079
liabilities --------- ---------
Total liabilities 457,014 433,706
Stockholders' equity 46,652 39,755
--------- ---------
Total liabilities & equity $ 503,666 $ 473,461
========= =========
Net interest income $4,773 $ 4,552
====== =======
Interest rate spread (5) 3.62% 3.59%
Net interest earning assets 40,881 39,075
Net interest margin (6) 4.01% 4.02%
Net interest income /
average total assets 3.79% 3.85%
Interest earnings assets /
interest bearing liabilities 1.09 1.09
Average balances in the above table were calculated using average daily figures.
----------------------------------------------------------------
(1) Includes federal funds sold, money market fund investments, banker's
acceptances, commercial paper, interest earning deposit accounts, and
securities purchased under agreements to resell.
(2) Includes mortgage backed securities, including CMO's, both available for
sale and held to maturity.
(3) In computing the average balance of loans receivable, non-accrual loans and
loans held for sale have been included. Amount is net of deferred loan
fees, premiums and discounts, and undisbursed loan funds. Interest income
on loans includes amortized loan fees and costs, net, of $35,000 and
$66,000 in 2001 and 2000, respectively.
(4) Includes federal funds purchased and securities sold under agreements to
repurchase.
(5) Interest rate spread represents the difference between the average rate on
interest earning assets and the average rate on interest bearing
liabilities.
(6) Net interest margin equals net interest income before provision for loan
losses divided by average interest earning assets.
35
The following table presents the average annualized rate earned upon
each major category of interest earning assets, the average annualized rate paid
for each major category of interest bearing liabilities, and the resulting net
interest spread, net interest margin, and average interest margin on total
assets for the six months ended June 30, 2001 and 2000.
Six Months Ended June 30, 2001 Six Months Ended June 30, 2000
---------------------------------------- ----------------------------------------
(Dollars In Thousands) Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Assets
------
Interest earning assets:
Cash equivalents (1) $ 9,184 $ 227 4.94% $ 7,448 $ 225 6.08%
Investment securities 7,332 245 6.68% 10,360 386 7.49%
Mortgage backed securities (2) 46,097 1,483 6.43% 53,382 1,876 7.03%
Loans receivable, net (3) 407,924 17,667 8.66% 373,185 15,853 8.50%
FHLB stock 2,945 83 5.64% 3,136 121 7.76%
--------- ------ --------- ------
Total interest earning assets 473,482 19,705 8.33% 447,511 18,461 8.25%
------ ------
Non-interest earnings assets 26,423 20,565
--------- ---------
Total assets $ 499,905 $ 468,076
========= =========
Liabilities & Equity
--------------------
Interest bearing liabilities:
NOW accounts $ 40,746 240 1.18% $ 33,462 261 1.57%
Savings accounts 19,126 136 1.42% 15,317 136 1.79%
Money market accounts 88,185 1,957 4.44% 85,746 1,898 4.45%
Certificates of deposit 244,264 6,707 5.49% 225,907 5,743 5.11%
--------- ------ --------- ------
Total interest-bearing deposits 392,321 9,040 4.61% 360,432 8,038 4.48%
FHLB advances 42,052 1,126 5.36% 47,749 1,369 5.76%
Other borrowings (4) 142 14 19.72% 333 10 6.04%
--------- ------ --------- ------
Total interest-bearing liabilities 434,515 10,180 4.69% 408,514 9,417 4.64%
------ ------
Demand deposit accounts 17,795 16,763
Other non-interest bearing 2,262 3,085
liabilities --------- ---------
Total liabilities 454,572 428,362
Stockholders' equity 45,333 39,714
--------- ---------
Total liabilities & equity $ 499,905 $ 468,076
========= =========
Net interest income $9,525 $9,044
====== ======
Interest rate spread (5) 3.64% 3.61%
Net interest earning assets 38,967 38,997
Net interest margin (6) 4.02% 4.04%
Net interest income /
average total assets 3.81% 3.86%
Interest earnings assets /
interest bearing liabilities 1.09 1.10
Average balances in the above table were calculated using average daily figures.
------------------------------------------------------
(1) Includes federal funds sold, money market fund investments, banker's
acceptances, commercial paper, interest earning deposit accounts, and
securities purchased under agreements to resell.
(2) Includes mortgage backed securities, including CMO's, both available for
sale and held to maturity.
(3) In computing the average balance of loans receivable, non-accrual loans and
loans held for sale have been included. Amount is net of deferred loan
fees, premiums and discounts, and undisbursed loan funds. Interest income
on loans includes amortized loan fees and costs, net, of $113,000 and
$142,000 in 2001 and 2000, respectively.
(4) Includes federal funds purchased and securities sold under agreements to
repurchase.
(5) Interest rate spread represents the difference between the average rate on
interest earning assets and the average rate on interest bearing
liabilities.
(6) Net interest margin equals net interest income before provision for loan
losses divided by average interest earning assets.
36
Rate / Volume Analysis
The most significant impact upon the Company's net interest income
between periods is derived from the interaction of changes in the volumes of and
rates earned or paid on interest-earning assets and interest-bearing
liabilities. The following table utilizes the figures from the preceding table
to present a comparison of interest income and interest expense resulting from
changes in the volumes and the rates on average interest-earning assets and
average interest-bearing liabilities for the periods indicated. Changes in
interest income or interest expense attributable to volume changes are
calculated by multiplying the change in volume by the prior period average
interest rate. The changes in interest income or interest expense attributable
to interest rate changes are calculated by multiplying the change in interest
rate by the prior year period volume. The changes in interest income or interest
expense attributable to the combined impact of changes in volume and changes in
interest rate are calculated by multiplying the change in rate by the change in
volume.
Three Months Ended June 30, 2001
Compared To
Three Months Ended June 30, 2000
----------------------------------------------------------------------
Volume
(Dollars In Thousands) Volume Rate / Rate Net
------ ---- ------ ---
Interest-earning assets
-----------------------
Cash equivalents $ 28 $ (41) $ (9) $ (22)
Investment securities (38) (37) 9 (66)
Mortgage backed securities (159) (100) 17 (242)
Loans receivable, net 710 (45) (3) 662
FHLB Stock (1) (33) 1 (33)
----- ------- ------ ------
Total interest-earning assets 540 (256) 15 299
----- ------- ------ ------
Interest-bearing liabilities
----------------------------
NOW Accounts 21 (53) (8) (40)
Savings accounts 24 (22) (7) (5)
Money market accounts (35) (86) 9 (112)
Certificates of deposit 221 72 21 314
----- ------- ------ ------
Total interest-bearing deposits 231 (89) 15 157
FHLB advances (38) (50) 7 (81)
Other borrowings 1 -- 1 2
----- ------- ------ ------
Total interest-bearing liabilities 194 (139) 23 78
----- ------- ------ ------
Increase in net interest income $ 346 $ (117) $ (8) $ 221
===== ======= ====== ======
37
Six Months Ended June 30, 2001
Compared To
Six Months Ended June 30, 2000
----------------------------------------------------------------------
Volume
(Dollars In Thousands) Volume Rate / Rate Net
------ ---- ------ ---
Interest-earning assets
-----------------------
Cash equivalents $ 53 $ (42) $ (9) $ 2
Investment securities (113) (42) 14 (141)
Mortgage backed securities (256) (159) 22 (393)
Loans receivable, net 1,476 309 29 1,814
FHLB Stock (7) (33) 2 (38)
----- ------- ------ ------
Total interest-earning assets 1,153 33 58 1,244
----- ------- ------ ------
Interest-bearing liabilities
----------------------------
NOW Accounts 57 (65) (13) (21)
Savings accounts 34 (28) (6) --
Money market accounts 54 (6) 11 59
Certificates of deposit 469 428 67 964
----- ------- ------ ------
Total interest-bearing deposits 614 329 59 1,002
FHLB advances (164) (98) 19 (243)
Other borrowings (6) 23 (13) 4
----- ------- ------ ------
Total interest-bearing liabilities 444 254 65 763
----- ------- ------ ------
Increase in net interest income $ 709 $ (221) $ (7) $ 481
===== ======= ====== ======
38
Interest Income
Interest income increased from $9.4 million and $18.5 million during
the three and six months ended June 30, 2000 to $9.7 million and $19.7 million
during the same periods in 2001. These increases were primarily due to:
o higher interest earning assets in 2001: 5.3% greater for the three months
ended June 30, 2001, and 5.8% greater for the six months ended June 30,
2001 versus the same periods in 2000
o a shift in asset mix towards relatively higher yielding loans versus
securities, coincident with the Company's strategic plan of better
supporting its local communities with the delivery of credit
The above factors more than offset the impact of a lower interest rate
environment during the first six months of 2001 versus the same period in 2000.
Interest income on loans rose from $8.1 million and $15.9 million
during the three and six months ended June 30, 2000 to $8.8 million and $17.7
during the same periods in 2001. This expansion in interest income was primarily
due to greater average volumes. The greater volume stemmed from the Company's
strategic plan of increasing the percentage of the balance sheet comprised of
loans through internal originations, loan pool purchases on the secondary
market, and loan participations; with the latter primarily through other
California community banks. The Company plans to increase total loans to
approximately 90.0% of total assets by the end of 2001, market conditions
permitting. Management believes stockholder value is maximized through the
extension and effective management of credit, versus leveraging the balance
sheet through securities transactions where the Company provides comparatively
little economic value added.
Interest income on cash equivalents decreased from $125 thousand for
the three months ended June 30, 2000 to $103 thousand for the same period in
2001. This decline was due to lower average rates stemming from the interest
rate cuts implemented by the Federal Reserve in 2001. Interest income on cash
equivalents rose slightly from $225 thousand during the six months ended June
30, 2000 to $227 thousand for the same period in 2001, as an increase in average
volume more than offset a decline in average rate.
Interest income on investment securities declined from $177 thousand
and $386 thousand during the three and six months ended June 30, 2000 to $111
thousand and $245 thousand during the same periods in 2001. The reduced interest
income resulted from lower average balances and lower average rates. The Company
maintained a smaller portfolio of variable rate corporate trust preferred
securities during 2001 versus 2000. In addition, the variable rate corporate
trust preferred securities reprice quarterly based upon 3 month LIBOR, which was
significantly lower in the first half of 2001 than during the first half of
2001.
Interest income on mortgage backed securities fell from $917 thousand
and $1.9 million during the three and six months ended June 30, 2000 to $675
thousand and $1.5 million during the same periods in 2001. This decrease was
caused by reductions in average volume and average rates. Over the past year,
the Company has reduced the percentage of its balance sheet allocated to
securities in favor of increased lending. In addition, the mix of the Company's
mortgage backed securities has changed over the past year, with an increase in
lower duration, high cash flow instruments and a reduction in higher duration,
lower cash flow securities in order to better support greater funding
requirements stemming from the Company's increased lending. The Company also
purchased additional adjustable rate mortgage backed securities during the first
quarter of 2001, which adjusted downward in rate in conjunction with the decline
in general capital market interest rates.
Interest income on FHLB stock decreased from $75 thousand and $121
thousand during the three and six months ended June 30, 2000 to $42 thousand and
$83 thousand during the same periods in 2001. This reduction in interest income
stemmed from a combination of reduced average balances and lower effective
earnings rates. The Bank was required by the FHLB-SF to sell some its capital
stock in the FHLB during 2000 under the FHLB's mandatory capital redemption
program. The Company anticipates increasing its investment in the capital stock
of the FHLB during the second half of 2001 in conjunction with increased
utilization of FHLB advances to fund the expansion in the balance sheet and
contribute to the Company's asset / liability management program.
39
Interest Expense
Interest expense was $4.9 million for both the quarter ended June 30,
2001 and the quarter ended June 30, 2000. Interest expense increased from $9.4
million during the six months ended June 30, 2000 to $10.2 million during the
first half of 2001. Comparing the second quarter of 2001 to the same period in
2000, the impact of greater average balances during 2001 was offset by the
effect of lower average rates. Greater average balances and higher average rates
led to the increase in interest expense during the six months ended June 30,
2001 versus the same period the prior year.
Interest expense on deposits increased from $4.2 million and $8.0
million during the three and six months ended June 30, 2000 to $4.4 million and
$9.0 million during the same periods in 2001. Average interest bearing deposits
were 6.7% greater in the second quarter of 2001 versus the second quarter of
2000 and 8.8% greater in the first half of 2001 versus the first six months of
2000. The Company's weighted average cost of interest bearing deposits was 15
basis points lower in the second quarter of 2001 versus the same period the
prior year, but 13 basis points higher for the six months ended June 30, 2001
versus the same period in 2000.
Average deposit transaction account rates were significantly lower
during the second quarter of 2001 compared to the second quarter of 2000, in
conjunction with the lower interest rate environment. The Company paid an
average rate of just 0.98% on its NOW deposits and 1.20% on its savings deposits
during the second quarter of 2001, highlighting the limited ability of the
Company to further reduce the cost of this funding should general market
interest rates continue to decline.
Certificates of deposit comprised 59.3% of average total deposits
during the second quarter of 2001, up slightly from 59.1% during the second
quarter of 2000. The Company's progress in restructuring its deposit mix to
include a greater percentage of transaction accounts was slowed during the first
half of 2001 because of the resources committed to the core systems conversion,
certain account closures stemming from the revised fee schedule and product mix
implemented with the new data processing system, and by aggressive competition
for checking and money market accounts during 2001, particularly from large
thrifts, including one financial institution that extensively advertised annual
percentage yields of 4.00% or more on one of its NOW checking products during
the first half of 2001.
The rapidly declining interest rate environment experienced during the
first half of 2001 contributed to "sticker shock" for certificate of deposit
account holders with maturing deposits. With interest rates down from 100 to 200
(or more) basis points below their levels of just six months earlier, many
maturing CD holders, particularly those dependent upon their interest income for
day to day living expenses, aggressively shopped for interest rates, causing the
Bank to selectively match high rate competitors in order to maintain customer
relationships and continue growing the deposit portfolio. In contrast, during
the first half of 2000, interest rates were generally increasing, presenting
less impetus for maturing certificate of deposit holders to extensively shop for
peak interest rates.
Over the past year, the Company has worked to more uniformly distribute
its certificate of deposit maturities by month in order to facilitate cash
management and avoid concentrated exposure to capital market events at any one
point in time. This objective has been accomplished through the use of "odd
term" certificates of deposit such as 7 and 8 months, augmented by ongoing sales
of longer term certificates of deposit. The Company's new professional bankers
have incorporated calling on maturing certificate of deposit customers as a
fundamental component of their sales management and customer service program.
During the second half of 2001, the Company plans to continue promoting
its Money Market Plus account, Interest Checking Plus account, "40+" NOW
checking account, and business checking accounts. The consumer products present
attractive benefits to both customers and the Company. For example, all three
consumer transaction accounts are highly tiered, encouraging greater account
balances in order to earn higher rates of interest. These three products are
also accessible via bilingual telephone banking, Internet banking, global ATM
networks, mail, and in-branch service. The Company also intends to continue
pursuing compensating balances, typically demand deposit balances, for business
credit facilities.
40
At June 30, 2001, the Bank's weighted average nominal cost of deposits
was 4.00%, or 50 basis points below the COFI Index for the same date. The
Company utilizes a comparison of its cost of deposits and cost of funds to COFI
as one measure of relative performance. The Company's weighted average nominal
cost of deposits was 4.72% at December 31, 2000, or 90 basis points below the
COFI Index for the same date. Should capital markets interest rates stabilize,
the Company will benefit from the significant downward repricing of maturing
certificates of deposit over the next several months.
Interest expense on total borrowings decreased from $661 thousand and
$1.4 million during the three and six months ended June 30, 2000 to $582
thousand and $1.1 million during the same periods in 2001. This decrease was
caused by smaller average balances and lower average rates. The Company
maintained a lower cost portfolio of FHLB advances during the first half of 2001
than during the prior year, as several higher cost advances matured or were
prepaid during 2000. In addition, the Company borrowed $10.0 million in new one
year FHLB advances during the first quarter of 2001 with a weighted average rate
of 5.13%; and utilized low cost overnight FHLB advances for incremental funding
requirements during June 2001. The Company's average interest rate on other
borrowings was inflated during 2001 as a result of the amortization of loan fees
(discount on a liability) on MBBC's $2.0 million revolving line of credit
combined with a lack of draws (outstanding balances) on the line.
Provision For Loan Losses
The Company recorded a $300 thousand provision for loan losses during
the second quarter of 2001, down from $775 thousand during the second quarter of
2000. For the first half of 2001, provisions for loan losses totaled $800
thousand, down from $1.0 million during the first six months of 2000. No
recoveries were realized during the first half of 2001, and charge-offs during
the period totaled $26 thousand. Net charge-offs during the first six months of
2000 were $371 thousand, associated with a residential mortgage secured by a
real property that suffered substantial earth movement. The Company's ratio of
loan loss reserves to loans outstanding increased slightly from 1.35% at
December 31, 2000 to 1.37% at June 30, 2001, while the nominal amount of the
loan loss reserve rose from $5.4 million at December 31, 2000 to $6.1 million at
June 30, 2001. In comparison, at June 30, 2000 the Company maintained $4.2
million in loan loss reserves, equivalent to 1.09% of loans outstanding.
The Company's management remains concerned about the negative impacts
upon the amount of loss inherent in the loan portfolio at June 30, 2001 arising
from the following factors:
o the California energy crisis, with effects upon the availability and price
of electricity, business costs, consumer spending and disposable income,
and the pace of economic activity in the State
o the financial difficulties experienced by many technology related companies
in the Silicon Valley area adjacent to the Bank's primary market areas
o the impact of lower stock prices on consumer spending, liquidity, and
investment, with a particular concern regarding the effects on the demand
and pricing for real estate in the Bank's primary market areas
o the significant number of layoffs announced during the first half of 2001
by California companies, with a related rise in the rate of unemployment in
California
o the general reduction in national economic growth
41
Other factors contributing to the increased nominal and relative
reserves in 2001 versus 2000 included:
o the increasing concentration of the portfolio in relatively less seasoned
credits, because of the Company's growth rate in recent periods
o higher concentrations of credit exposure as a result of increased income
property lending, as these loans generally are larger than residential
mortgages
o the allocation of increased reserves during the second quarter of 2001 for
the Special Residential Loan Pool (see "Special Residential Loan Pool")
based upon recent loss rates by the seller / servicer on disposition of
foreclosed collateral
o the increase in the size of the loan portfolio
Commercial & industrial and multifamily real estate loans typically
present greater credit, concentration, and event risks than home mortgages,
thereby requiring proportionately greater reserve levels. Newer loans typically
present more credit exposure than seasoned loans with many years of prompt
payment experience and amortized principal balances.
The Company commenced a special credit review during the second quarter
of 2001 with the intent to identify significant credits that might be
particularly and materially adversely impacted by the California energy crisis.
This special review was in addition to the ongoing credit monitoring processes
conducted by the Company. To date, no loans have been identified as being
directly and materially adversely affected by the California energy crisis. The
Company has historically focused on real estate loans and has conducted only
limited lending to manufacturers and other industries with a significant rate of
energy utilization. The Company intends to continue this special credit review
during the third quarter of 2001. In addition, the Company now includes an
analysis of borrowers' exposure to energy availability and prices as part of its
underwriting process for new loans.
The Company anticipates that its ratio of loan loss reserves to loans
outstanding will continue to increase in future periods to the extent that the
Company is successful in its strategic plan of increasing total loans while
expanding the proportion of the loan portfolio represented by income property
and commercial business lending. The Company's strategic plan also incorporates
expanded construction lending, although the Company has tightened its credit
requirements for such lending during 2001 in light of the trends within the
California economy.
Non-interest Income
Non-interest income totaled $695 thousand and $1.3 million during the
three and six months ended June 30, 2001, comparing favorably to $583 thousand
and $1.1 million during the same periods in 2000.
Service charge income rose from $312 thousand and $592 thousand during
the three and six months ended June 30, 2000 to $473 thousand and $882 thousand
during the same periods in 2001. This increase in part resulted from the revised
fee and service charge schedule implemented with the new core processing system
in March, 2001. Following the computer systems conversion, the Company increased
its fee for checks drawn against insufficient funds ("NSF Fees") from $17 to $20
per check. The Company also stopped providing lifetime free checks for certain
deposit accounts, thereby not only reducing non-interest expenses for check
printing but also increasing fee income from "upcharges" for check orders
initiated and paid for by customers. In addition, the revised fee and service
charge schedule established certain minimum balance requirements and maximum
free usage limits for certain deposit accounts.
The Bank has also benefited from fees generated from an additional
remote ATM during the first six months of 2001 that was not in place in the
first half of the prior year. In addition, selected higher ATM fees and
increased debit card transaction volume contributed to a $44 thousand increase
in combined ATM and debit card fee income in the first six months of 2001 versus
the same period in 2000.
42
There were no sales of mortgage backed and investment securities during
the second quarter of 2001. During the second quarter of 2000, security sales
generated a pre-tax gain of $2 thousand. For the six months ended June 30, 2001,
security sales produced a pre-tax gain of $34 thousand, versus a pre-tax loss of
$77 thousand during the first half of 2000. Although many of the Company's
securities appreciated during the second quarter of 2001 in conjunction with
interest rate cuts implemented by the Federal Reserve, management decided to
retain the securities as a means of generating net interest income.
Loan servicing income totaled $41 thousand and $43 thousand during the
three and six months ended June 30, 2001, compared to $24 thousand and $61
thousand during the same periods in 2000. The Company continues to sell the vast
majority of its long term, fixed rate residential loan production into the
secondary market on a servicing released basis. As a result, the portfolio of
loans serviced for others is declining as loans pay off. At June 30, 2001, the
Company serviced $51.0 million in various types of loans for other investors,
compared to $62.0 million at December 31, 2000.
During the second quarter of 2001, the Company continued the revamping
of its non-FDIC insured investment sales program to improve franchise value and
better integrate this operation with the overall strategic plan. Staffing
changes contributed to commissions from the sale of annuities, mutual funds,
insurance, and individual securities declining from $183 thousand and $390
thousand during the three and six months ended June 30, 2000 to $71 thousand and
$188 thousand during the same periods in 2001. Commission revenue during the
third quarter of 2001 is anticipated to be below the similar period in 2000.
Revenue from the sale of non-FDIC insured investments has also been hampered
during the first half of 2001 versus the same period in the prior year by less
favorable capital market conditions.
Other non-interest income increased from $62 thousand and $118 thousand
during the three and six months ended June 30, 2000 to $110 thousand and $192
thousand during the same periods in 2001. This rise was partially due to
increased rental income, which in turn derived from the Bank's leasing the
second floor of one of its branches in late 2000 following an extensive
remodeling.
The Company's strategic plan incorporates non-interest income
representing a greater percentage of total revenue. The Company intends to
pursue increased non-interest income in future quarters through:
o seeking additional remote ATM sites
o further increases in the portfolio of deposit transaction accounts
o the continued sale of consumer Internet banking with electronic bill
payment
o the planned introduction of Internet banking and cash management services
for businesses
o the continued marketing of debit cards and the possible introduction of
corporate credit cards for the Company's commercial customers
o the hiring of additional licensed investment counselors to sell non-FDIC
insured products including mutual funds, annuities, and individual
securities
However, no assurance can be provided regarding the amount of or trends in the
Company's future levels and composition of non-interest income.
43
Non-interest Expense
Non-interest expense totaled $3.5 million and $7.4 million for the
three and six months ended June 30, 2001, compared to $3.4 million and $6.7
million for the same periods in 2000. Total non-interest expense in 2001 has
been increased by costs for the data processing conversion ($447 thousand) and
legal expenses associated with the arbitration of claims by a former executive
($161 thousand). Costs for the data processing conversion included deconversion
fees to the prior service bureau, printing and postage costs for additional
customer communications, employee training and travel costs, and consulting fees
for technology professionals retained to assist with and speed the
implementation of the new system.
The Company's efficiency ratio during the second quarter of 2001 was
64.37%, comparing favorably to 65.61% during the second quarter of 2000, but
still above high performing peer financial institutions. The Company has
identified reducing the efficiency ratio as a key objective of its strategic
plan and an important component of executive incentive compensation.
During the first half of 2001, the Company has adjusted its staffing to
advance the strategic plan. During 2001, the Bank has added an additional
commercial loan officer and hired three new professional bankers, with a fourth
scheduled to join the Company in early August 2001. Staffing has increased in
the data processing function, coincident with the Company's shifting from an
external service bureau to in-house data processing. The change in the Company's
systems environment also impacted various other operating expenses. Data
processing fees were much lower in the second quarter of 2001 than the same
period in 2000, while equipment expense was higher due to the added depreciation
from the new hardware and software installed in 2001. In addition to the
aforementioned increase in non-interest income, the Company's new client-server
technology platform, combined with the associated product redesign, has fostered
various operating efficiencies, including reduced costs for customer statements,
certificate of deposit maturity notices, and certain electronic transaction
processing.
Supplies, postage, telephone, and office expenses were slightly lower
in the three and six months ended June 30, 2001 than during the same periods the
prior year despite the non-recurring expenses for the core systems conversion.
In 2001, the Company is utilizing a lower cost supplies vendor, accessed through
the Internet, with next day delivery avoiding the need to maintain local
supplies inventories. In addition, most forms are now dynamically created
through the new core processing system, avoiding forms obsolescence, shipping
costs, and local inventory requirements. During the second half of 2001, the
Company plans to further leverage its new systems environment to improve
efficiencies, potentially shifting its internal LATA (in-State long distance)
telephone traffic to its wide area network through voice over Internet protocol
technology. Despite these and other initiatives in reducing operating costs, no
assurance can be provided that the Company's efficiency ratio will improve in
future quarters or that the Company's level of non-interest expenses will
decrease in the future on a nominal or relative basis (e.g. as a percentage of
average total assets).
Advertising and promotion costs were lower in the three and six months
ended June 30, 2001 than during the same periods the prior year. This stemmed
from the Company's awaiting the completion of the systems conversion and product
redesign prior to conducting extensive advertising. By mid-2001, however, the
Bank had commenced a significant local radio advertising campaign focused on
building customer relationships and centered about the theme "Monterey Bay Bank.
Expect More. Get The Best." In addition, the Bank recently expanded the
responsibilities of Ms. Mary Anne Carson, Corporate Secretary, to include the
title of "Director of Community Relations". Ms. Carson will orchestrate the
Bank's expanded community involvement in a wide range of functions, a role she
successfully played in the local area for another community bank that was
acquired by a large financial institution. In June 2001, the Bank made its
second of five pledged $15 thousand annual contributions to support the Cabrillo
College Foundation, representing a major sponsorship for the organization. The
Company anticipates spending more on advertising, promotion, and community
outreach during the second half of 2001 than the amounts spent during the first
half of this year.
44
Legal and accounting expenses during the first quarter of 2001 were
impacted by significant legal costs associated with the pending arbitration of
claims by the former President & Chief Operating Officer regarding payments due
under his employment contracts. The Company anticipates incurring at least $150
thousand in additional legal costs in this regard during the third quarter of
2001 should the binding arbitration proceeding continue along its full course
without settlement. The Company has previously unsuccessfully attempted to
settle this matter. Accounting expenses are projected to decline during the
second half of 2001, as the Company has retained a new, more cost effective, but
also highly experienced firm to perform selected internal audit services.
Consulting expenses rose from $51 thousand and $103 thousand during the
three and six months ended June 30, 2000 to $63 thousand and $306 thousand
during the same periods in 2001 primarily due to consultant services associated
with the core systems conversion. The Company anticipates a lower level of
consulting expense in the second half of 2001 than during the first half due to
the completion of the core systems conversion and due to the hiring of Ms. Susan
M. Carlson as Chief Administrative Officer for the Bank at the end of the second
quarter. Ms. Carlson had previously provided certain more limited services to
the Bank on a consulting basis.
Director expenses are projected to decline in the latter half of 2001
due to the smaller number of Board members and the final expense recognition for
the Directors Emeritus Plan during the second quarter.
Income Taxes
Income tax expense increased in 2001 versus 2000 primarily due to
greater pre-tax income. The Company's effective book tax rate during the first
six months of 2001 was slightly lower than for the comparable period in 2000.
Item 3. Quantitative And Qualitative Disclosures About Market Risk
For a current discussion of the nature of market risk exposures, see
"Item 2. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations - Interest Rate Risk Management And Exposure". Readers should also
refer to the quantitative and qualitative disclosures (consisting primarily of
interest rate risk) in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2000. There has been no significant change in these
disclosures since the filing of that document.
45
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, the Company is party to claims and legal proceedings
in the ordinary course of business. Management believes that the
ultimate aggregate liability represented thereby, if any, will not have
a material adverse effect on the Company's consolidated financial
position or results of operations, with the possible exception of the
legal proceeding discussed in the subsequent paragraph.
The Company commenced binding arbitration proceedings during the second
quarter of 2001 to address claims by the former President and Chief
Operating Officer regarding payments due under his employment
contracts. These proceedings are scheduled to continue during the third
quarter of 2001. In the third quarter of 2000, the Company established
a $250 thousand reserve for the settlement of these claims. At this
time, the Company, following consultation with counsel, believes this
reserve to be adequate to cover its liabilities in this regard. The
Company is recognizing legal expenses in this regard as incurred.
Item 2. Changes In Securities
None.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission Of Matters To A Vote Of Security Holders
a) The Company's Annual Meeting of Stockholders was held on May
24, 2001.
b) Not applicable.
c) At the Company's Annual Meeting of Stockholders held on May
24, 2001, the Company's stockholders approved the following:
1.) The election of the following individuals as
Directors for the terms indicated:
Votes Votes Term
Individual For Withheld Expires
-------------------------- ------------- ------------- ---------
Mr. Josiah T. Austin 2,404,403 184,435 2003
Mr. Edward K. Banks 2,400,761 188,077 2004
Mr. Nicholas C. Biase 2,425,544 163,294 2004
Mr. Larry A. Daniels 2,400,361 188,477 2002
Mr. C. Edward Holden 2,382,346 206,492 2004
In addition to the above five individuals, the following
Directors were in office as of July 26, 2001:
Ms. Diane S. Bordoni
Mr. Steven Franich
Mr. Stephen G. Hoffmann
Mr. Gary L. Manfre
Mr. McKenzie Moss, Chairman Of The Board
Mr. Eugene R. Friend and Mr. P. W. Bachan retired as active
Directors at the Company's Annual Meeting of Stockholders on
May 24, 2001 and became Directors Emeritus.
46
PART II - OTHER INFORMATION (Continued)
2.) The ratification of the appointment of Deloitte &
Touche LLP as the independent auditors of the Company
for the fiscal year ending December 31, 2001 was
approved as follows:
For Against Abstain
------------- ------------- ------------
2,580,507 7,473 77
d) Not applicable.
Item 5. Other Information
None.
Item 6. Exhibits And Reports On Form 8-K
A. Exhibits
None.
B. Reports On Form 8-K
The Company has recently filed the following Current Reports
on Form 8-K:
1. Form 8-K dated July 20, 2001. This Current
Report reported the Company's results for
the three and six months ended June 30,
2001, the addition of a new member of the
senior management team for the Company's
subsidiary, Monterey Bay Bank, and the
continued binding arbitration proceeding
with the former President and Chief
Operating Officer in regards to amounts due
under his employment contracts.
47
SIGNATURES
Pursuant to the requirements 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.
MONTEREY BAY BANCORP, INC.
(Registrant)
Date: August 13, 2001 By: /s/ C. Edward Holden
--------------------
C. Edward Holden
Chief Executive Officer
President
Vice Chairman Of The Board Of Directors
Date: August 13, 2001 By: /s/ Mark R. Andino
------------------
Mark R. Andino
Chief Financial Officer
Treasurer
(Principal Financial & Accounting Officer)
48