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 March 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to _________
Commission File Number: 0-24802
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: 3,483,718 shares of common
stock, par value $0.01 per share, were outstanding as of May 9, 2002.
1
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements Of Financial Condition (unaudited)
As Of March 31, 2002 And December 31, 2001 3 - 4
Condensed Consolidated Statements Of Income (unaudited) For The
Three Months Ended March 31, 2002 And March 31, 2001 5 - 6
Condensed Consolidated Statement Of Stockholders' Equity (unaudited) For
The Three Months Ended March 31, 2002 7
Condensed Consolidated Statements Of Cash Flows (unaudited) For The
Three Months Ended March 31, 2002 And March 31, 2001 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 - 46
Item 3. Quantitative And Qualitative Disclosure About Market Risk 46
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 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 (UNAUDITED)
MARCH 31, 2002 AND DECEMBER 31, 2001
(Dollars In Thousands)
--------------------------------------------------------------------------------
March 31, December 31,
2002 2001
-------- --------
ASSETS
Cash and cash equivalents $ 12,402 $ 13,079
Securities available for sale, at estimated fair value:
Investment securities (amortized cost of $7,710 and $7,707 at
March 31, 2002 and December 31, 2001, respectively) 7,270 7,300
Mortgage backed securities (amortized cost of $32,740 and $30,358 at
March 31, 2002 and December 31, 2001, respectively) 32,916 30,644
Loans held for sale, at lower of cost or market 661 713
Loans receivable held for investment (net of allowances for loan losses of
$6,958 at March 31, 2002 and $6,665 at December 31, 2001) 469,437 465,887
Investment in capital stock of the Federal Home Loan Bank, at cost 3,044 2,998
Accrued interest receivable 2,892 2,915
Premises and equipment, net 7,490 7,618
Core deposit intangibles, net 1,344 1,514
Other assets 4,769 4,723
------- -------
TOTAL ASSETS $542,225 $537,391
======= =======
See Notes to Condensed Consolidated Financial Statements
3
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED) (Continued)
MARCH 31, 2002 AND DECEMBER 31, 2001
(Dollars In Thousands)
--------------------------------------------------------------------------------
March 31, December 31,
2002 2001
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Non-interest bearing demand deposits $ 23,581 $ 21,062
Interest bearing NOW checking accounts 43,004 42,557
Savings deposits 18,824 19,127
Money market deposits 111,775 105,828
Certificates of deposit 238,630 243,765
-------- --------
Total deposits 435,814 432,339
-------- --------
Advances from the Federal Home Loan Bank and other borrowings 53,600 53,800
Accounts payable and other liabilities 1,038 1,090
-------- --------
Total liabilities 490,452 487,229
-------- --------
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 March 31, 2002 and December 31, 2001;
3,483,718 outstanding at March 31, 2002 and
3,456,097 outstanding at December 31, 2001 45 45
Additional paid-in capital 28,772 28,584
Retained earnings, substantially restricted 37,678 36,473
Unallocated ESOP shares (633) (690)
Treasury shares designated for compensation plans, at cost (16,486 shares
at March 31, 2002 and 17,969 shares at December 31, 2001) (159) (173)
Treasury stock, at cost (1,008,367 shares at March 31, 2002 and
1,035,988 shares at December 31, 2001) (13,775) (14,006)
Accumulated other comprehensive loss, net of taxes (155) (71)
-------- --------
Total stockholders' equity 51,773 50,162
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $542,225 $537,391
======== ========
See Notes to Condensed Consolidated Financial Statements
4
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2002 AND MARCH 31, 2001
(Dollars In Thousands, Except Per Share Amounts)
--------------------------------------------------------------------------------
FOR THE THREE MONTHS
ENDED MARCH 31,
----------------------
2002 2001
---- ----
INTEREST AND DIVIDEND INCOME:
Loans receivable $ 8,314 $ 8,890
Mortgage backed securities 312 808
Investment securities and cash equivalents 129 297
------ -----
Total interest income 8,755 9,995
------ -----
INTEREST EXPENSE:
Deposit accounts 2,813 4,684
Advances from the FHLB and other borrowings 592 559
------ -----
Total interest expense 3,405 5,243
------ -----
NET INTEREST INCOME BEFORE PROVISION
FOR LOAN LOSSES 5,350 4,752
PROVISION FOR LOAN LOSSES 325 500
------ -----
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 5,025 4,252
------ -----
NON-INTEREST INCOME:
Customer service charges 351 408
Gain on sale of mortgage backed securities 43 34
Commissions from sales of noninsured products 41 117
Gain on sale of loans 27 5
Income from loan servicing 14 2
Other income 36 77
------ -----
Total non-interest income 512 643
------ -----
See Notes to Condensed Consolidated Financial Statements
5
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Continued)
THREE MONTHS ENDED MARCH 31, 2002 AND MARCH 31, 2001
(Dollars In Thousands, Except Per Share Amounts)
--------------------------------------------------------------------------------
FOR THE THREE MONTHS
ENDED MARCH 31,
----------------------
2002 2001
---- ----
NON-INTEREST EXPENSE:
Compensation and employee benefits 1,905 1,658
Occupancy and equipment 424 350
Deposit insurance premiums 51 49
Data processing fees 136 442
Legal and accounting expenses 119 184
Supplies, postage, telephone, and office expenses 168 190
Advertising and promotion 77 31
Amortization of intangible assets 170 170
Consulting 22 242
Other expense 394 526
----- -----
Total non-interest expense 3,466 3,842
----- -----
INCOME BEFORE PROVISION FOR
INCOME TAXES 2,071 1,053
PROVISION FOR INCOME TAXES 866 451
----- -----
NET INCOME $1,205 $ 602
===== =====
EARNINGS PER SHARE:
BASIC EARNINGS PER SHARE $ 0.36 $ 0.19
===== =====
DILUTED EARNINGS PER SHARE $ 0.35 $ 0.18
===== =====
See Notes to Condensed Consolidated Financial Statements
6
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2002
(Dollars And Shares In Thousands)
--------------------------------------------------------------------------------
Treasury
Shares
Desig-
nated Accum-
For ulated
Addi- Unal- Com- Other
Common Stock tional located pen- Compre-
------------ Paid-In Retained ESOP sation Treasury hensive
Shares Amount Capital Earnings Shares Plans Stock Loss Total
------ ------ ------- -------- ------ ----- ----- ---- -----
Balance at December 31, 2001 3,456 $ 45 $ 28,584 $ 36,473 $ (690) $ (173) $(14,006) $ (71) $ 50,162
Purchase of treasury stock (5) (81) (81)
Exercise of stock options 30 78 285 363
Director fees paid using treasury 3 19 27 46
stock
Amortization of stock compensation 91 57 14 162
Comprehensive income:
Net income 1,205 1,205
Other comprehensive income:
Change in net unrealized loss
on securities available for
sale, net of taxes of ($41) (59) (59)
Reclassification adjustment for
gains on securities available
for sale included in income,
net of taxes of ($18) (25) (25)
-----
Other comprehensive income, net (84)
-----
Total comprehensive income 1,121
-----
----- ---- ------- ------- ----- ----- ------- ---- -------
Balance at March 31, 2002 3,484 $ 45 $ 28,772 $ 37,678 $ (633) $ (159) $(13,775) $(155) $ 51,773
===== ==== ======= ======= ===== ===== ======= ==== =======
See Notes to Condensed Consolidated Financial Statements
7
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2002 AND MARCH 31, 2001
(Dollars In Thousands)
--------------------------------------------------------------------------------
FOR THE THREE MONTHS
ENDED MARCH 31,
----------------------
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,205 $ 602
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Depreciation and amortization of premises and equipment 180 114
Amortization of intangible assets 170 170
Amortization of purchase premiums, net of accretion of purchase discounts 205 (8)
Amortization of deferred loan fees and costs, net (26) (78)
Provision for loan losses 325 500
Federal Home Loan Bank stock dividends (46) (48)
Gross ESOP expense before dividends received on unallocated shares 144 57
Compensation expense associated with stock compensation plans 15 30
Director retainer fees paid in stock 46 61
Gain on sale of mortgage-backed and investment securities (43) (34)
Gain on sale of loans (27) (5)
Loss on sale of fixed assets 8 --
Origination of loans held for sale (3,497) (1,920)
Proceeds from sales of loans held for sale 3,576 1,048
Decrease (increase) in accrued interest receivable 23 (141)
Increase in other assets (46) (255)
Decrease in accounts payable and other liabilities (52) (306)
Other, net (203) (494)
------ ------
Net cash provided by (used in) operating activities 1,957 (707)
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans held for investment (3,550) (22,615)
Purchases of investment securities available for sale (4,854) --
Proceeds from maturities of investment securities available for sale 4,850 --
Purchases of mortgage backed securities available for sale (14,456) (14,424)
Principal repayments on mortgage backed securities available for sale 9,231 7,660
Proceeds from sales of mortgage backed securities available for sale 2,732 2,907
Purchases of premises and equipment (60) (782)
------ ------
Net cash used in investing activities (6,107) (27,254)
------ ------
See Notes to Condensed Consolidated Financial Statements
8
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)
THREE MONTHS ENDED MARCH 31, 2002 AND MARCH 31, 2001
(Dollars In Thousands)
--------------------------------------------------------------------------------
FOR THE THREE MONTHS
ENDED MARCH 31,
--------------------
2002 2001
---- ----
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 3,475 7,724
Proceeds (repayments) from FHLB advances, net -- 10,000
(Repayments) proceeds of other borrowings, net (200) 26
Purchases of treasury stock (81) --
Sales of treasury stock for exercise of stock options 279 833
------ ------
Net cash provided by financing activities 3,473 18,583
------ ------
NET DECREASE IN CASH & CASH EQUIVALENTS (677) (9,378)
CASH & CASH EQUIVALENTS AT BEGINNING OF PERIOD 13,079 25,159
------ ------
CASH & CASH EQUIVALENTS AT END OF PERIOD $12,402 $15,781
====== ======
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid during the period for:
Interest on deposits and borrowings $ 3,196 $ 5,204
Income taxes $ 800 $ 200
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 month period ended March 31, 2002 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 incorporated in the State of
Delaware and 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 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 the 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, 2001 included in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001.
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 month periods ended March 31, 2002 and 2001 is
reconciled in the following table. The following table also presents the
calculation of the Company's Basic EPS and Diluted EPS for the periods
indicated.
For The Three Months
Ended March 31,
-----------------------
(In Whole Dollars And Whole Shares)
2002 2001
---- ----
Net income $1,205,000 $ 602,000
========= =========
Average shares issued 4,492,085 4,492,085
Less weighted average:
Uncommitted ESOP shares (103,320) (139,258)
Non-vested stock award shares (17,075) (33,615)
Treasury shares (1,023,303) (1,091,971)
--------- ---------
Sub-total (1,143,698) (1,264,844)
--------- ---------
Weighted average BASIC shares outstanding 3,348,387 3,227,241
Add dilutive effect of:
Stock options 115,534 46,729
Stock awards 1,365 589
--------- ---------
Sub-total 116,899 47,318
--------- ---------
Weighted average DILUTED shares outstanding 3,465,286 3,274,559
========= =========
Earnings per share:
BASIC $ 0.36 $ 0.19
===== =====
DILUTED $ 0.35 $ 0.18
===== =====
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 included in other
comprehensive income for investment and mortgage backed securities classified as
available for sale for the three month periods ended March 31, 2002 and 2001 are
summarized as follows:
Three Months Ended
March 31,
------------------
2002 2001
---- ----
(Dollars In Thousands)
Gross reclassification adjustment $ 43 $ 34
Tax expense (18) (14)
---- ----
Reclassification adjustment, net of tax $ 25 $ 20
==== ====
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
March 31,
------------------
2002 2001
---- ----
(Dollars In Thousands)
Holding (loss) gain arising during the period, net of tax $ (59) $ 279
Reclassification adjustment, net of tax (25) (20)
---- ----
Net unrealized (loss) gain recognized in
other comprehensive income $ (84) $ 259
==== ====
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, 2001 757,929 425,104 255,224 195,761 137,064 $ 10.88
March 31, 2002 757,929 390,999 238,390 225,566 141,364 $ 11.07
Activity during the three months ended March 31, 2002 included:
Three Months Ended
March 31, 2002
--------------
Granted 5,500
Canceled 9,800
Exercised 29,805
Vested 12,971
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 March 31, 2002.
13
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
--------------------------------------------------------------------------------
NOTE 5: Stock Award Plan
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. 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, 2001 141,677 17,969 123,708 --
March 31, 2002 141,677 16,486 125,191 --
Activity during the three months ended March 31, 2002 included:
Three Months Ended
March 31, 2002
--------------
Granted --
Canceled --
Vested 1,483
14
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
--------------------------------------------------------------------------------
NOTE 6: Commitments & Contingencies
At March 31, 2002, commitments maintained by the Company included firm
commitments to originate $27.4 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 March 31,
2002.
NOTE 7: Recent Accounting Pronouncements
Business Combinations and Goodwill and Other Intangible Assets
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 141, "Business Combinations" which addresses
the elimination of pooling accounting treatment in business combinations and the
financial accounting and reporting for acquired goodwill and other intangible
assets at acquisition and SFAS No. 142, "Goodwill and Other Intangible Assets"
which addresses financial accounting and reporting for acquired goodwill and
other intangible assets at acquisition in transactions other than business
combinations covered by SFAS No. 141, and the accounting treatment of goodwill
and other intangible assets after acquisition and initial recognition in the
financial statements. The adoption of these statements did not have any impact
on the Company's consolidated financial position, results of operations, or cash
flows, as the Company had no goodwill as of January 1, 2002 and all of the
Company's intangible assets, comprised of core deposit intangibles, have finite
lives and are continuing to be amortized.
Impairment or Disposal of Long-Lived Assets
Effective January 1, 2002, the Company adopted SFAS No. 144,
"Accounting For The Impairment Or Disposal Of Long-Lived Assets". SFAS No. 144
supersedes SFAS No. 121, "Accounting For The Impairment Of Long-Lived Assets And
For Long-Lived Assets To Be Disposed Of" and the accounting and reporting
provisions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting The
Results Of Operations - Reporting The Effects Of Disposal Of A Segment Of A
Business, And Extraordinary, Unusual and Infrequently Occurring Events And
Transactions". SFAS No. 144 unifies the accounting treatment for various types
of long-lived assets to be disposed of, and resolves implementation issues
related to SFAS No. 121. The adoption of SFAS No. 144 did not have any effect on
the Company's financial position, results of operations, or cash flows, as the
Company had no long-lived assets that were considered impaired or that were to
be disposed of as of January 1, 2002.
NOTE 8: Reclassifications
Certain amounts in the December 31, 2001 and March 31, 2001 financial
statements have been reclassified to conform to the March 31, 2002 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, opportunities
and expectations regarding technologies, anticipated performance or
contributions from new and existing employees, projections of future
performance, potential future credit experience, possible changes in laws and
regulations, potential risks and benefits arising from the implementation of the
Company's strategic and tactical plans, perceived opportunities in the market,
potential actions of significant stockholders and investment banking firms, 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, consumer and business response to news events or economic
trends, 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, 2001. 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.
Availability Of Information
This Report on Form 10-Q is available at the following Internet sites:
o www.sec.gov
o www.montereybaybank.com
Additional corporate information regarding Monterey Bay Bancorp, Inc. and
Monterey Bay Bank is also available at the www.montereybaybank.com Internet
site. This Internet site is not a part of this Report on Form 10-Q.
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.
16
At March 31, 2002, the Company had $542.2 million in total assets,
$470.1 million in net loans receivable, and $435.8 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.
The Company conducts business from eight full service branch offices in
its primary market area in Central California, one loan production office in Los
Angeles, 11 automated teller machines ("ATM's") including two stand-alone ATM's,
and its administrative facilities in Watsonville, California. 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 in
assisting individuals, families, community organizations, and businesses in
attaining their financial objectives. The Bank offers a wide complement of
lending and deposit products.
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, term, universal, and whole life 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 typically
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.
Critical Accounting Policies
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). The Company's significant accounting policies are presented in Note 1
to the Consolidated Financial Statements contained in the Company's 2001 Annual
Report on Form 10-K. The Company follows accounting policies typical to the
community commercial banking industry and in compliance with various regulations
and guidelines as established by the Financial Accounting Standards Board
("FASB") and the Bank's primary federal regulator, the OTS.
The Company's most significant management accounting estimate is the
appropriate level for the allowance for loan losses. The Company follows a
methodology for calculating the appropriate level for the allowance for loan
losses. However, various factors, many of which are beyond the control of the
Company, could lead to significant revisions in the amount of allowance for loan
losses in future periods, with a corresponding impact upon the results of
operations. In addition, the calculation of the allowance for loan losses is by
nature inexact, as the allowance represents Management's best estimate of the
loan losses inherent in the Company's credit portfolios at the reporting date.
These loan losses will occur in the future, and as such cannot be determined
with absolute certainty at the reporting date.
Other estimates that the Company utilizes in its accounting include the
expected useful lives of depreciable assets, such as buildings, building
improvements, equipment, and furniture. The useful lives of various technology
related hardware and software can be subject to change due to advances in
technology and the general adoption of new standards for technology or
interfaces among computer or telecommunication systems.
17
The Company applies Accounting Principles Board ("APB") Opinion No. 25
and related interpretations in accounting for stock options. Under APB No. 25,
compensation cost for stock options is measured as the excess, if any, of the
fair market value of the Company's stock at the date of grant over the amount
the employee or director must pay to acquire the stock. Because the Company's
stock option Plans provide for the issuance of options at a price of no less
than the fair market value at the date of grant, no compensation cost is
required to be recognized for the stock option Plans.
Had compensation costs for the stock option Plans been determined based
upon the fair value at the date of grant consistent with SFAS No. 123,
"Accounting For Stock Based Compensation", the Company's net income and earnings
per share would have been reduced. The amount of the reduction for the fiscal
years 1999 through 2001 is disclosed in Note 18 to the Consolidated Financial
Statements contained in the 2001 Annual Report on Form 10-K, based upon the
assumptions listed therein.
GAAP itself may change over time, impacting the reporting of the
Company's financial activity. Although the economic substance of the Company's
transactions would not change, alterations in GAAP could affect the timing or
manner of accounting or reporting.
Recent Developments
Recent regulatory, financial industry, and other developments have
included the following:
o Federal legislation reforming the bankruptcy code remains in conference
between the House of Representatives and the Senate. This legislation,
depending upon its final form, if any, could potentially assist the Bank in
collecting on certain credits.
o Congress continues to debate lifting restrictions on the payment of
interest on business checking accounts and easing restrictions on the
number of certain transactions for MMDA accounts at insured depository
institutions. The potential payment of interest on sterile reserves at the
Federal Reserve banks is also being considered. Depending on the nature of
such changes eventually approved, if any, there could be various favorable
and / or unfavorable impacts upon the Company.
o The FHLB-San Francisco has submitted its proposed new capital plan to its
primary regulator. The Company does not believe that this proposed plan
would materially impact the Bank's balance of FHLB capital stock owned. The
Federal Housing Finance Board is analyzing the potential to ease
restrictions on membership in more than one Federal Home Loan Bank. The
easing of these restrictions, if any, depending upon their nature, could
present a range of impacts upon the individual Federal Home Loan Banks,
including the FHLB-San Francisco.
o A possible increase in (e.g. from $100,000 to $130,000 per depositor, or
special limits for retirement accounts) or broadening of (e.g. all public
agency deposits) federal deposit insurance coverage, which may be combined
with a new formula for FDIC insurance premiums, is under evaluation at the
FDIC and in Congress. The impetus for this legislation has recently
increased due to the ratio of reserves to deposits in the Bank Insurance
Fund ("BIF") falling to 1.26%, or just 1 basis point above the statutory
limit. Congress also continues to discuss the potential merger of the BIF
and Savings Association Insurance Fund ("SAIF") of the FDIC.
o The State of California is facing a significant budget deficit and is
pursuing the issuance of a substantial volume of bonds in order to replace
monies from the general fund expended in conjunction with the State's
energy market. The potential imposition of new fees or taxes or higher tax
rates by the State of California could impact the Company's business and
earnings. The possible suspension, curtailment, or elimination of various
State programs could also affect the Company. In addition, the State has
not yet adopted legislation placing the State tax code in conformity with
recent changes in federal tax laws, including in regards to limits
applicable to certain tax advantaged savings plans such as IRA's and 401(k)
plans. The Company is unable to predict what, if any, actions might be
taken by the State of California and the possible impact of those actions
upon the Company's consolidated financial condition or results of
operations.
18
Overview Of Business Activity
During the first quarter of 2002, the Company continued the
implementation of its strategic plan of transforming the Bank from a 76 year old
savings & loan into a community focused commercial bank serving the financial
needs of individuals, families, organizations, and businesses. The Bank focuses
on building longstanding customer relationships, investing the time and energy
to get to know customers well and understand their financial objectives. Another
key aspect of the Company's transformation strategy is a significant increase in
the community involvement and contributions made by the Bank, its Directors, and
its employees. These efforts are facilitated by the Bank's Director of Community
Relations. The Company seeks to differentiate itself from its competition
through various means, particularly by providing a superior level of customer
service.
Key accomplishments during the first quarter of 2002 included:
o record quarterly net income of $1.21 million and diluted earnings per share
of $0.35
o the attainment of record levels of total assets, loans, deposits, and
stockholders' equity at March 31, 2002
o progress in shifting the composition of the loan and deposit portfolios
o an expansion in the net interest margin
o continued maintenance of favorable credit quality as measured by net
charge-offs, although a rise in non-accrual loans (all real estate secured)
was experienced
o increases in local commercial banking business
o the hiring of additional individuals with significant commercial banking
experience in order to speed the implementation of the strategic plan and
augment customer service
o an expansion of the Bank's quality customer service program, with periodic
measurement provided by "mystery shoppers" and customer surveys
o the opening of a loan production office in Los Angeles focusing on
construction and income property lending
The Los Angeles loan production office is managed by an individual with many
years of local lending experience and expertise in the type of relationship
banking conducted by the Company.
The Company continued its focus on stockholder value during the first
quarter of 2002, increasing its tangible book value per share from $14.08 at
December 31, 2001 to $14.48 at March 31, 2002. The Company repurchased 5,000
shares of common stock at $16.25 per share during the first quarter of 2002. At
March 31, 2002, there were 109,035 remaining shares authorized for repurchase
under the Company's current stock repurchase program.
19
The Company's Directors and Officers continued to be net purchasers of
the Company's common stock during the first quarter of 2002. Similar to its
practice in 2001, the Company intends to pursue opportunities to utilize stock
based compensation in lieu of certain cash compensation in 2002 as a means of
aligning employee interests with improvements in stockholder value. The
Company's Directors continued to receive their retainer fees in common stock
during the first quarter of 2002, and plan to continue doing so throughout the
year. The Company is working with its investment banker to add coverage by a
second equity analyst during the second quarter. In addition, a significant
number of the Bank's employees have an ownership interest in the Company,
through one or more of the following:
o direct stock purchases
o the Employee Stock Ownership Plan ("ESOP")
o incentive stock options
o stock grant awards
o stock purchased with funds contributed by employees to the Bank's 401(k)
Plan
The Board of Directors and Management have targeted the transformation
strategy into a community focused commercial bank based on their belief that
this approach presents the best current opportunity to enhance long term
stockholder value.
The Company's strategic plan envisions a greater amount of income
property, construction, and business lending funded with a higher percentage of
transaction deposit accounts. The strategic plan also includes improvements in
the Company's efficiency ratio and return on stockholders' equity, two key
measures of financial performance where the Company has lagged high performing
peer institutions. However, the pace of the Company's conversion from a savings
& loan into a locally focused community bank will be impacted in coming quarters
by multiple factors, many of which are outside the Company's control, including
the strength of the California and national economies, competition, regulatory
and legislative changes, and trends in real estate values. The State of
California budget deficit and issues stemming from the availability and price of
energy in California could also unfavorably impact the Company and / or slow its
strategic transformation. The strategy being pursued by the Company also
presents various types of tactical implementation risks. The Bank is under no
immediate pressure to pursue a change in charter at this time, as its Qualified
Thrift Lender ("QTL") ratio was 73.8% at March 31, 2002, compared to a minimum
requirement of 65.0% to retain its federal thrift charter.
Changes In Financial Condition From December 31, 2001 To March 31, 2002
Total assets increased $4.8 million from $537.4 million at December 31,
2001 to a record $542.2 million at March 31, 2002.
Cash & cash equivalents decreased from $13.1 million at December 31,
2001 to $12.4 million at March 31, 2002 due to the Company's using cash
equivalents to fund expansions in the security and loan portfolios.
Securities
Investment securities available for sale were little changed during the
first three months of 2002, totaling $7.3 million at both December 31, 2001 and
March 31, 2002. At both these dates, the Company's investment security portfolio
was identically composed of two floating rate corporate trust preferred bonds
rated "A-" or better by Standards & Poors. The slight decrease in balance during
2002 resulted from the mark to market adjustment for available for sale
securities, which reflects increased credit spreads and reduced demand for long
term corporate bonds repricing based upon three month LIBOR.
20
The average balance of investment securities during the first quarter
of 2002 was increased by the purchase of Agency debentures which had been called
for redemption by the issuer. The Company acquired these bonds, which typically
have a remaining term of ten to fourteen days, as a higher yielding alternative
to federal funds sold, repurchase agreements, and other short term investments.
The Company owned no Agency debentures at March 31, 2002.
Mortgage backed securities available for sale increased from $30.6
million at December 31, 2001 to $32.9 million at March 31, 2002. The Company
purchased relatively low duration Agency collateralized mortgage obligations
("CMO's") during the first quarter of 2002 to serve as collateral for certain
deposits and to invest available liquidity. The low duration was targeted in
conjunction with the Company's asset / liability management program and in order
to provide cash flows later in the year to fund anticipated loan production.
Prepayments on mortgage backed securities were high during the first
quarter of 2002 due to a combination of the historically low interest rate
environment, high levels of borrower refinance activity, and the payoff and / or
pay down of various CMO's, particularly short term planned amortization classes
("PAC's") or sequential classes that the Company had purchased over the past
year in anticipation of funding requirements for expanded lending in 2002.
During the first quarter of 2002, the Company sold a somewhat higher
duration private label CMO with $2.7 million in par value in conjunction with
its interest rate risk management program. At March 31, 2002, the Company's
mortgage backed security portfolio was entirely comprised of Agency securities.
The vast majority of the Company's mortgage backed securities at March 31, 2002
were relatively low duration bonds. Management believes that allocating asset
duration to new loans versus securities facilitates better community support and
derives a higher yield for the same level of exposure to future increases in
general market interest rates.
Loans
Loans held for sale totaled $661 thousand at March 31, 2002, down from
$713 thousand at December 31, 2001. The Company sells most of its long term,
fixed rate residential mortgage production into the secondary market on a
servicing released basis, and purchases more interest rate sensitive loans as
part of its interest rate risk management program. All loans held for sale at
March 31, 2002 were matched with optional commitments to deliver such loans into
the secondary market.
Loans held for investment, net, increased from $465.9 million at
December 31, 2001 to a record $469.4 million at March 31, 2002. The increase
resulted from a combination of strong internal loan originations, including the
first loans from the new Los Angeles loan production office, and from purchases
of individual income property loans from correspondent banks. The Company
follows its customary underwriting policies in evaluating loan purchases. The
increase in loans held for investment, net, was restrained during the first
quarter by the Company's decision to reduce its lending concentration in loans
secured by hotel / motel / resort properties.
Total net loans as a percentage of total assets were 86.7% at March 31,
2002. The Company has targeted increasing this ratio as part of its strategy of
supporting its interest margin, fostering economic activity in its local
communities, and effectively utilizing the Bank's capital.
The product mix in the loan portfolio shifted during the first quarter
in conformity with the Company's strategic plan. Residential loans declined from
42.3% of gross loans at December 31, 2001 to 39.9% of gross loans at March 31,
2002. In contrast, construction loans increased from 7.9% to 9.2%, land loans
increased from 2.5% to 3.3%, and commercial loans rose from 1.8% to 2.4%. This
change in loan mix was facilitated by the commercial business relationship
officers the Company hired last year and by the new Los Angeles loan production
office, which concentrates on income property and construction lending. To the
extent economic and competitive conditions permit, the Company plans to continue
decreasing the percentage of its loan portfolio allocated to residential
mortgages in favor of other generally higher yielding and more interest rate
sensitive types of loans.
21
The Company's commercial banking group continued to generate increased
business during the first quarter of 2002. At March 31, 2002, this group had
attracted $6.3 million in deposits, $7.6 million in commercial real estate loans
(e.g. owner / user), and $11.8 million in business term loans and balances drawn
against business lines of credit. The commercial banking group's total credit
commitments at March 31, 2002 were $27.6 million. In addition, the commercial
lending pipeline at March 31, 2002 pointed toward the continued expansion of
commercial banking customer relationships during the second quarter of 2002.
The Company ended the first quarter of 2002 with a total loan pipeline
in excess of $65.0 million, including a significant volume of construction and
income property loans. The Company anticipates further growth in total assets
during the second quarter of 2002, and intends to continue expanding the balance
sheet throughout 2002 to more extensively meet the credit needs of its customers
and local communities.
Additional information regarding loan portfolio composition is
presented in the following table:
(Dollars In Thousands) March 31, December 31,
2002 2001
--------- ---------
Held for investment:
Loans secured by real estate:
Residential one to four unit $ 194,545 $ 204,829
Multifamily five or more units 106,796 103,854
Commercial and industrial 106,298 109,988
Construction 45,074 38,522
Land 16,279 11,924
--------- ---------
Sub-total loans secured by real estate 468,992 469,117
Other loans:
Home equity lines of credit 7,652 6,608
Loans secured by deposits 188 202
Consumer lines of credit, unsecured 149 170
Commercial term loans 3,945 3,163
Commercial lines of credit 7,857 5,680
--------- ---------
Sub-total other loans 19,791 15,823
Sub-total gross loans held for investment 488,783 484,940
(Less) / Plus:
Undisbursed construction loan funds (12,609) (12,621)
Unamortized purchase premiums, net of purchase discounts 565 435
Deferred loan fees and costs, net (344) (202)
Allowance for loan losses (6,958) (6,665)
--------- ---------
Loans receivable held for investment, net $ 469,437 $ 465,887
========= =========
Held for sale:
Residential one to four unit $ 661 $ 713
========= =========
22
FHLB Stock
The Company's investment in the capital stock of the FHLB-SF increased
by $46 thousand in the first quarter of 2002 due to stock dividends. The
Company's investment in FHLB stock will increase more significantly in the
second quarter of 2002 due to a mandatory purchase requirement of $216 thousand
associated with the growth in the Bank's balance sheet.
Premises and Equipment
Premises and equipment, net, decreased from $7.6 million at December
31, 2001 to $7.5 million at March 31, 2002, as periodic depreciation and
amortization exceeded new purchases. Because the Company acquired significant
new hardware and software during 2001 in support of the new core processing
system, fixed asset acquisitions in 2002 are expected to be moderate. This
expectation could, however, change in the event the Company is successful in
opening a de novo branch or acquiring a branch from another financial
institution. Fixed asset requirements for the new Los Angeles loan production
office were not significant.
Core Deposit Intangibles
Core deposit intangibles, net, declined by $170 thousand during the
first three months of 2002 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.
Deposits
Total deposits increased from $432.3 million at December 31, 2001 to a
record $435.8 million at March 31, 2002. Key trends within the deposit portfolio
included:
o Non-interest bearing demand deposits increased from $21.1 million at
December 31, 2001 to $23.6 million at March 31, 2002. This rise was
supported by:
A. balances maintained by commercial banking customers
B. the accumulation of liquid funds by certain customers in advance of the
payment of property and income taxes in April
C. the Company's targeting demand deposit balances as part of its sales
management program
D. an increase in official checks outstanding (outstanding checks drawn on
the Bank's own account are accounted for as demand deposits)
o Interest bearing NOW checking account balances increased from $42.6 million
at December 31, 2001 to $43.0 million at March 31, 2002. NOW accounts
balances during the first quarter of 2002 were also favorably impacted by
the accumulation of funds for tax payments and by the Company's sales
program. During the first quarter of 2002, the Company experienced
particularly aggressive advertising and price competition for consumer NOW
deposits from one large national thrift. This thrift paid interest rates
far above market and significantly in excess of the federal funds rate. The
Company has been reluctant to match these prices, and has instead focused
on competing based upon service, convenience, flexible access (e.g.
bilingual telephone banking, Internet banking, ATM access, debit card, and
in-branch service), and overall business relationships.
23
o Savings deposits decreased from $19.1 million at December 31, 2001 to $18.8
million at March 31, 2002. While the Company continues to offer traditional
statement savings products, its sales focus has instead concentrated on
checking and money market accounts due to the greater features and
flexibility offered by those products.
o Money market deposits increased from $105.8 million at December 31, 2001 to
$111.8 million at March 31, 2002. Money market deposit balances during the
first quarter of 2002 were positively impacted by Bank advertising, the
accumulation of funds by certain customers for tax payments in April, and
by certain customers waiting to commit funds to certificates of deposit
given the historically low interest rate environment. In addition, during
the first quarter of 2002, the Company offered interest rates on its Money
Market Plus product that were in excess of many money market mutual funds
and money market accounts offered through securities firms. The Bank's
sales staff was trained to highlight this differential, and to explain the
many attractive attributes of the Money Market Plus product, including:
A. access via telephone banking, Internet banking, ATM's, bank by mail,
check writing, and in-branch service
B. extensively tiered interest rates, whereby earnings on the account
increase as each successively higher balance tier is attained
C. FDIC insurance to the maximum amount permitted by law
D. combined statement with other Bank products
E. automatic transfers and direct deposit
o Certificate of deposit balances decreased from $243.8 million at December
31, 2001 to $238.6 million at March 31, 2002. This decline in part resulted
from certain customers delaying committing funds to fixed term, fixed rate
certificates of deposit due to the historically low interest rate
environment. During the first quarter of 2002, the Company priced its
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. In addition, early in
the second quarter of 2002, the Company conducted a print advertising
campaign for 24 to 30 month certificates of deposits that attracted some
new customers. Certificate of deposit balances during the second quarter of
2002 will also be favorably affected by the receipt of an additional $3.0
million deposit from the State of California and the planned acceptance of
certain brokered deposit funds.
Transaction accounts increased from 43.6% of total deposits at December
31, 2001 to 45.2% of total deposits at March 31, 2002. Continuing this 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. The Company continues to focus its marketing, product
development, and sales efforts on attracting new deposit transaction accounts,
including those from businesses. The Company recently introduced Internet
banking for commercial business customers, complementing the existing consumer
Internet banking product. The Company is also developing new deposit products
and additional cash management services for businesses, with implementation
anticipated later in 2002.
24
The Company's ratio of loans to deposits was 107.87% at March 31, 2002,
nearly constant from December 31, 2001. In light of this ratio and the size of
the loan pipeline at March 31, 2002, the Company is exploring various strategic
and tactical alternatives for increasing its funding base, including:
o pursuing opportunities for additional branch locations (de novo or
acquisition)
o introducing new deposit products and related services
o modifying staff incentive programs to more strongly focus on expanding
deposit relationships
o directing a higher percentage of the advertising and promotion budget to
deposit generation
o accepting brokered deposits, which the Company has not historically
utilized, but anticipates using in a limited manner commencing in the
second quarter of 2002
o increased business lending with associated compensating customer deposit
balances
o relationship loan pricing for income property owners maintaining operating
accounts with the Company
o serving the depository needs of customers at the Los Angeles loan
production office in part through a correspondent banking relationship
Borrowings
Borrowings decreased slightly from $53.8 million at December 31, 2001
to $53.6 million at March 31, 2002. All of the Company's FHLB advances at March
31, 2002 were fixed rate, fixed term borrowings without call or put option
features. Early in the second quarter of 2002, the Company prepaid a $5.0
million FHLB advance due in the third quarter of 2002 in order to extend the
term structure of that debt in conjunction with the Company's asset / liability
management program.
Other Liabilities
Other liabilities decreased slightly from December 31, 2001 to March
31, 2002, as an increase in accrued interest on FHLB advances due to the timing
of interest payment dates was offset by a decrease in deferred compensation. The
Company recently paid out all deferred compensation and settled all
non-qualified retirement plan obligations via lump sum payments. These actions
accelerated the realization of deferred tax assets for the Company and reduced
operating costs slightly.
25
Stockholders' Equity
Total stockholders' equity increased from $50.2 million at December 31,
2001 to a record $51.8 million at March 31, 2002. Factors contributing to the
increase included:
o $1.2 million in 2002 year to date net income
o continued amortization of deferred stock compensation, including both ESOP
and PEP shares
o the ongoing payment of Director retainer fees with Company common stock
o the exercise of 29,805 vested stock options by former employees and
Directors, generating $363 thousand in additional stockholders' equity
The above factors more than offset the impacts of depreciation in the
portfolio of securities classified as available for sale and the repurchase of
5,000 shares of the Company's common stock at $16.25 per share. The Company did
not declare or pay any cash dividends during the first quarter of 2002. The
Board of Directors continues to believe that alternative uses for the Company's
capital, at this time, are more attractive than the payment of a cash dividend.
Interest Rate Risk Management And Exposure
The table below presents an overview of the interest rate environment
during the 15 months ended March 31, 2002. The 12 MTA 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 (1) 12/31/00 3/31/01 6/30/01 9/30/01 12/31/01 3/31/02
---------------- -------- ------- ------- ------- -------- -------
3 month Treasury bill 5.89% 4.28% 3.65% 2.37% 1.72% 1.78%
6 month Treasury bill 5.70% 4.13% 3.64% 2.35% 1.79% 2.10%
2 year Treasury note 5.09% 4.18% 4.24% 2.85% 3.02% 3.72%
5 year Treasury note 4.97% 4.56% 4.95% 3.80% 4.30% 4.84%
10 year Treasury note 5.11% 4.92% 5.41% 4.59% 5.05% 5.40%
Target federal funds 6.50% 5.00% 3.75% 3.00% 1.75% 1.75%
Prime rate 9.50% 8.00% 6.75% 6.00% 4.75% 4.75%
3 month LIBOR 6.40% 4.88% 3.84% 2.59% 1.88% 2.03%
12 month LIBOR 6.00% 4.67% 4.18% 2.64% 2.44% 3.00%
1 Year CMT (2) 5.60% 4.30% 3.58% 2.82% 2.22% 2.57%
12 MTA (2) 6.11% 5.71% 5.10% 4.40% 3.48% 2.91%
COFI (2) 5.62% 5.20% 4.50% 3.97% 3.07% 2.65%
-----------------------------------------------------------------
(1) Indices / rates are spot values unless otherwise noted.
(2) These indices / rates are monthly averages.
26
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.
The Company has recently maintained a relatively balanced, though
slightly net liability sensitive, 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 almost the same, though slightly less,
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, beginning in early 2001, the Federal
Reserve commenced decreasing its benchmark interest rates in response to the
slowing national economy, increases in unemployment, falling equity values, weak
manufacturing activity, and other negative or unfavorable economic trends or
statistics. By the end of 2001, the Federal Reserve had cut interest rates 11
times for a total of 475 basis points, representing one of the largest and
fastest series of rate decreases ever experienced in the United States. The
Federal Reserve continued cutting interest rates throughout 2001 in part in
response to the onset of the first national economic recession in many years. In
addition to cutting interest rates, the Federal Reserve also fostered
significant expansion in the money supply, with a particular increase following
the events of September 11, 2001.
The eleven rate cuts in 2001 led to nominal levels of interest rates
that were the lowest in decades, with the target federal funds rate decreasing
to 1.75%. The Prime Rate followed the target federal funds rate down in 2001,
while the COFI and 12 MTA indices lagged the more responsive Treasury and LIBOR
rates throughout 2001. The low nominal level of interest rates in effect in the
latter part of 2001 and in the first quarter of 2002 presented a particular
challenge to the Company, as the rates on its NOW and Savings deposit accounts
were already at low levels and could not be decreased to the same extent as
declines in many capital markets interest rates. The Company addressed this
issue through its asset / liability management program, whereby decisions
regarding pricing, promotion, and incentives are integrated with tactical
transactions to moderate the Company's exposure to changes in interest rates.
Various interest rates commenced increasing in the first quarter of
2002 once the capital markets assumed, and the Federal Reserve later confirmed,
that benchmark interest rates would not continue being cut. In addition, higher
energy prices and concerns about the impact of interest rates staying at such
low levels for an extended period of time began to raise worries about potential
future inflation, leading to a rise in longer term interest rates. By the end of
the first quarter, the Treasury curve had become significantly steeper, with the
differential between federal funds and the 2 year Treasury Note at 197 basis
points. Steep yield curves are generally beneficial for financial institutions,
including the Bank, as greater income is derived from short term maturity
mismatches and as customer demand often shifts toward adjustable mortgages due
to the rate differential between adjustable and fixed rate loans.
The analytical results of the Company's interest rate risk modeling
have been empirically validated over the past several years, as the Company's
interest margin has remained stable or expanded during periods of both rising
and falling general market interest rates. The expansion in interest margin over
the past several years has been significantly impacted by the implementation of
the Company's strategic plan, in addition to being influenced by the interest
rate environment.
27
The Company plans 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 three months of
2002, 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. The low interest rate environment contributed to continued prepayments on
the Company's existing portfolios of residential fixed rate mortgages held for
investment and higher duration mortgage backed securities classified as
available for sale. Mortgage backed security purchases during the first quarter
of 2002 were primarily low duration CMO's with limited extension risk and above
market coupon rates. The Company also sold one relatively higher duration CMO.
Loan purchases during the first quarter of 2002 were generally either adjustable
rate or fixed rate for a short period of time, then converting to adjusting rate
("hybrid mortgages"). During the past six months, the Company had prepaid and
extended a total of $15.0 million in FHLB advances in order to increase the
duration of its funding and therefore moderate its net liability sensitivity.
These and other tactical and strategic actions were conducted as part of the
interest rate risk management program in general, and specifically to prepare
the Company for what Management believes is a likely eventual return to an
increasing interest rate environment commencing later in 2002.
The 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.
Serving the financial needs of local businesses is by nature asset sensitive, as
primarily variable rate commercial loans are in part funded with demand deposit
balances. Growth in the Company's business banking thus helps offset some of the
interest rate risk (net liability sensitivity) typically present in mortgage
lending.
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.
OTS regulations require that the Bank maintain a safe and sound level
of liquidity at all times. Management believes that having a surplus of
available liquidity at all times is prudent and fundamental to effective Bank
management.
At March 31, 2002, the Company had $12.4 million in cash and cash
equivalents, available borrowing capacity in excess of $160.0 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.
The State of California is the Bank's largest single depositor, with
$19.0 million in certificates of deposit placed in the Bank as of March 31,
2002. Should the State of California not renew these certificates of deposit
upon maturity, replacement funding would likely be more costly. The maturity
dates for the State of California certificates of deposit are staggered to avoid
a concentration of repricing and funding risk.
28
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 March 31, 2002, 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. The Bank intends to add the ability
to issue DTC certificates of deposit through an additional investment banking
firm during the second quarter of 2002. At March 31, 2002, the Bank had no DTC
certificates of deposit outstanding.
At March 31, 2002, MBBC on a stand alone basis had cash & cash
equivalents of $4.7 million. In addition, MBBC had no outstanding balance on a
$3.0 million revolving line of credit.
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
As of March 31, 2002, the most recent notification from the OTS
categorized the Bank as "well capitalized". There are no conditions or events
since that notification that Management believes have changed the Bank's
category. The following table summarizes the capital ratios required for an
institution to be considered "well capitalized" and the Bank's regulatory
capital at March 31, 2002 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 $ 45,695 8.45% $ 45,695 11.72% $ 50,587 12.97%
Well capitalized requirement 27,047 5.00% 23,403 6.00% 39,005 10.00%
------- ---- ------- ----- ------ -----
Excess $ 18,648 3.45% $ 22,292 5.72% $ 11,582 2.97%
======= ==== ======= ===== ======= =====
Adjusted assets (1) $540,943 $390,045 $390,045
======= ======= =======
---------------------------------------------
(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.
29
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 March 31,
2002 exceeded all three of the currently applicable minimum regulatory capital
requirements.
Percent Of
Adjusted
(Dollars In Thousands) Total
Amount Assets
------ ------
Tangible Capital
----------------
Regulatory capital $45,695 8.45%
Minimum required 8,114 1.50%
------ ----
Excess $37,581 6.95%
====== ====
Core Capital
------------
Regulatory capital $45,695 8.45%
Minimum required 21,638 4.00%
------ ----
Excess $24,057 4.45%
====== ====
Percent Of
Risk-
weighted
Amount Assets
------ ----
Risk-based Capital
------------------
Regulatory capital $50,587 12.97%
Minimum required 31,204 8.00%
------ ----
Excess $19,383 4.97%
====== ====
At March 31, 2002, 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.
30
Asset Quality / Credit Profile
Non-performing Assets
The following table sets forth information regarding non-performing
assets at the dates indicated.
(Dollars In Thousands) March 31, 2002 December 31, 2001
-------------- -----------------
Outstanding Balances Before Valuation Reserves
Non-accrual loans $ 4,547 $ 2,252
Loans 90 or more days delinquent and accruing interest -- --
Restructured loans in compliance with modified terms -- --
-- --
------ ------
Total gross non-performing loans 4,547 2,252
====== ======
Investment in foreclosed real estate before valuation reserves -- --
Repossessed consumer assets -- --
-- --
------ ------
Total gross non-performing assets $ 4,547 $ 2,252
====== ======
Gross non-accrual loans to total loans 0.95% 0.48%
Gross non-performing loans to total loans 0.95% 0.48%
Gross non-performing assets to total assets 0.84% 0.42%
Allowance for loan losses $ 6,958 $ 6,665
Allowance for loan losses to non-performing loans 153.02% 295.96%
Valuation allowances for foreclosed real estate $ -- $ --
Non-accrual loans at March 31, 2002 are detailed in the following
table:
(Dollars In Thousands) Number Principal Balance
Of Outstanding At
Category Of Loan Loans March 31, 2002
---------------- ------ -----------------
Residential mortgage one to four units 3 $ 1,224
Commercial & industrial real estate 3 3,323
----- -----
Total 6 $ 4,547
===== =====
Non-accrual loans increased from $2.3 million at December 31, 2001 to
$4.5 million at March 31, 2002 primarily due to the placement of a $2.3 million
commercial real estate mortgage on non-accrual status. This credit is a
participation loan where the Bank is not the lead financial institution. The
loan is secured by a first deed of trust on a hotel / resort located within the
Company's primary market area and is guaranteed by the borrower. The hotel is a
relatively new development that was experiencing limited cash flow. The hotel
was also adversely impacted by the decline in tourism and travel following the
events of September 11, 2001 and the onset of the national economic recession.
The Company is currently working with the lead bank and the borrower to address
collection. At March 31, 2002, the Company established a $754 thousand specific
reserve for this loan, based upon estimated net proceeds to the Company
following foreclosure and sale. The market value of the hotel is particularly
volatile at this time, given the uncertainty regarding the economy, the tourism
industry, and the outlook for business travel activity.
Non-accrual loans at March 31, 2002 also included a residential
mortgage with a principal balance of $846 thousand and a commercial real estate
mortgage also with a principal balance of $846 thousand. There are significant
junior mortgages from other lenders secured by the real estate collateral for
both of these loans. The home securing the residential loan is listed for sale
and the borrower has agreed to resume payments. The $846 thousand commercial
real estate mortgage was reinstated (paid current) in April 2002. Based upon a
review of comparable recent market sales, the Company, at this time, does not
anticipate incurring a loss on either of these two loans.
31
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, 2001 $ 6,207 $ 5,098 $ -- $ -- $11,305
March 31, 2002 $ 3,296 $ 4,386 $ -- $ 754 $ 8,436
Classified assets as a percent of stockholders' equity decreased from
10.2% at December 31, 2001 to 9.9% at March 31, 2002.
The $754 thousand asset classified as "Loss" in the above table as of
March 31, 2002 is associated with the specific reserve for the $2.3 million
commercial real estate mortgage secured by a hotel / resort located in the
Company's primary market area, as described above under "Non-performing Assets".
The remainder of this $2.3 million loan is classified as substandard. March 31,
2002 substandard assets in the above table also include the Company's other
non-accrual loans and $366 thousand in commercial loans to a corporation whose
sole stockholder recently declared personal bankruptcy. These $366 thousand in
loans were current in their payments as of March 31, 2002 and the borrower has
indicated his intent to continue making payments per the terms of the loans.
Criticized loans decreased during the first quarter of 2002 due to the
upgrade of several income property loans where the borrower was current in
payments and had documented the intent and capacity to continue making timely
loan payments. The largest OAEM loan at March 31, 2002 was a $1.3 million
mortgage, current in its payments at March 31, 2002, secured by a motel located
in the Silicon Valley area of the San Francisco Bay Area. The motel's cash flow
has been unfavorably impacted by the economic difficulties being experienced in
the technology industry and by a reduction in business travel in general. The
second largest OAEM loan at March 31, 2002 was a $986 thousand mortgage secured
by an apartment complex in the Silicon Valley area. This loan was current in its
payments at March 31, 2002; however, rents in the subject area have been
adversely affected by the economic difficulties in the technology industry.
Impaired Loans
At March 31, 2002, the Company had total gross impaired loans, before
specific reserves, of $4.5 million, constituting six credits. Specific reserves
on these $4.5 million in impaired loans totaled $754 thousand. This compares to
total gross impaired loans of $2.3 million, with no specific reserves, at
December 31, 2001. 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 three months ended March 31,
2002, accrued interest on impaired loans was zero and interest of $41 thousand
was received in cash. The average balance of impaired loans during the first
quarter of 2002 was $2.6 million. If all non-accrual loans had been performing
in accordance with their original loan terms, the Company would have recorded
interest income of $134 thousand during the three months ended March 31, 2002,
instead of interest income actually recognized, based on cash payments, of $41
thousand.
Hotel / Motel / Resort Loans
At March 31, 2002, the Company had 16 real estate loans outstanding
that are secured by hotel / motel / resort properties. The aggregate outstanding
balance for these loans at March 31, 2002 was $22.0 million. This compares to
$30.8 million in hotel / motel / resort loans at December 31, 2001. This
decrease in part resulted from the Company's not repricing certain hotel / motel
/ resort loans to reflect the decline in general market interest rates during
2001, thereby leading the borrowers to refinance with other lenders.
32
Various reports have indicated that travel industry businesses such as
hotels / motels / resorts have been particularly adversely impacted by the
national economic recession in 2001, and by reduced business and pleasure
travel. The Company's recent review of its hotel / motel / resort loans has in
general confirmed reduced occupancy rates and lower effective room rates than
experienced in 1999 and 2000, leading to decreased or in some cases negative net
cash flow from the properties. The Company cannot predict when or to what degree
the hospitality industry will recover, but intends to continue closely
monitoring its hotel / motel / resort loan portfolio. The Company increased its
formula general valuation reserve factors for these loans in the fourth quarter
of 2001 to reflect the inherent loss in this portfolio. The return of
unfavorable economic trends, the occurrence of additional terrorist activity, or
other factors could lead to additional reserve requirements for these loans and
thus impact the levels of future provisions for loan losses.
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.
At March 31, 2002, the outstanding principal balance of this mortgage
loan pool was $4.5 million, comprised of 44 mortgages, with $396 thousand
received during April, 2002 (normal monthly remittance cycle) based upon
prepayments and scheduled principal for March, 2002. At December 31, 2001, the
outstanding principal balance of this mortgage loan pool was $5.6 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 level of
prepayments realized on the portfolio during the first quarter of 2002.
Through the April 20, 2002 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 March 31, 2002, the Company categorized all loans within this
mortgage pool as performing based upon the continued payment performance of the
seller.
As of the April 20, 2002 remittance and reporting date for activity
through March 31, the mortgage pool included one foreclosed property. The seller
continued to advance scheduled interest and principal payments to the Company
for this mortgage, that had a principal balance of $59 thousand.
Despite the performance of the seller, however, the Company has
allocated certain reserves to this mortgage pool at March 31, 2002 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 2001 and early 2002, 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.
Because of the relatively small remaining balance of the Special
Residential Loan Pool, the continued capacity and intent by the seller to honor
its guarantee, and the establishment of what the Company believes to be adequate
loan loss reserves to address the inherent loss in the portfolio, the Company
does not plan to continue reporting on the Special Residential Loan Pool in
future reports in the absence of significant events.
33
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, including unused commitments to provide financing. 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 that 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 allowance for loan losses is comprised of three primary types of
allowances:
1. Formula Allowance
Formula allowances are based upon loan loss factors that reflect Management's
estimate of the inherent loss in various segments of or pools within the loan
portfolio. The loss factor is multiplied by the portfolio segment (e.g.
multifamily permanent mortgages) balance (or credit commitment, as applicable)
to derive the formula allowance amount. The loss factors are updated
periodically by the Company to reflect current information that has an effect on
the amount of loss inherent in each segment. The formula allowance at March 31,
2002 was $5.5 million, compared to $6.0 million at December 31, 2001.
2. Specific Allowance
Specific allowances are established in cases where Management has identified
significant conditions or circumstances related to an individually impaired
credit. In other words, these allowances are specific to the loss inherent in a
particular loan. The amount for a specific allowance is calculated in accordance
with SFAS No. 114, "Accounting By Creditors For Impairment Of A Loan". The
Company had $754 thousand in specific allowance at March 31, 2002, compared to
none at December 31, 2001.
3. Unallocated Allowance
The Company maintains an unallocated loan loss allowance that is based upon
Management's evaluation of conditions that are not directly measured in the
determination of the formula and specific allowances. The evaluation of inherent
loss with respect to these conditions is subject to a higher degree of
uncertainty because they are not identified with specific problem credits or
historical performance of loan portfolio segments. The conditions evaluated in
connection with the unallocated allowance at March 31, 2002 included the
following, which existed at the balance sheet date:
o General business and economic conditions affecting the Company's key
lending areas
o Real estate values in California
o Loan volumes and concentrations
o Seasoning of the loan portfolio
o Status of the current business cycle
o Specific industry or market conditions within portfolio segments
The unallocated allowance at March 31, 2002 was $738 thousand, compared to $668
thousand at December 31, 2001.
34
The following table presents activity in the Company's allowance for
loan losses during the three months ended March 31, 2002 and March 31, 2001:
Three Months Ended March 31,
----------------------------
2002 2001
------- -------
Allowance For Loan Losses (Dollars In Thousands)
-------------------------
Balance at beginning of year $ 6,665 $ 5,364
Charge-offs:
Consumer lines of credit (8) --
Commercial term loans (30) --
Commercial lines of credit -- (25)
------ ------
Total charge-offs (38) (25)
Recoveries:
Consumer lines of credit 4 --
Commercial lines of credit 2 --
------ ------
Total recoveries 6 --
Provision for loan losses 325 500
------ ------
Balance at March 31 $ 6,958 $ 5,839
====== ======
Annualized ratio of net charge-offs
during the period to average loans
receivable, net, outstanding during
the period 0.03% 0.02%
Additional ratios applicable to the allowance for loan losses include:
March 31, 2002 December 31, 2001
-------------- -----------------
Allowance for loan losses as a
percent of non-performing loans 153.02% 295.96%
Allowance for loan losses as a
percent of gross loans receivable
net of undisbursed loan funds and
unamortized yield adjustments 1.46% 1.41%
Allowance for loan losses as a
percent of classified assets 135.37% 130.74%
The $5.5 million in formula allowance at March 31, 2002 included
amounts for the Special Residential Loan Pool. The decrease in formula allowance
from December 31, 2001 resulted in part from:
o the reduction in the Special Residential Loan Pool
o a decrease in criticized assets
o the shift in loan loss reserves for the $2.3 million, non-accrual hotel
loan in the Company's primary market area from formula allowance to
specific allowance
35
The $738 thousand in unallocated allowance at March 31, 2002 reflected
the Company's consideration of the following factors, as well as the more
general factors listed above in conjunction with the definition of the
unallocated allowance:
o The adverse impacts of the weak technology industry upon commercial real
estate values. The Company's primary lending area is near the Silicon
Valley area of the San Francisco Bay Area, which has been impacted by the
slump in various technology and technology related businesses. This impact
could be in the range of $100 thousand to $800 thousand.
o Recent reports of selected areas of soft or declining apartment rents in
Northern California resulting from reduced employment, weakness in the
technology industry, and the national recession. The soft or declining
rents could lead to decreased multifamily property values. This impact
could be in the range of $100 thousand to $400 thousand.
As subsequently discussed (see "Provision For Loan Losses"), the lower
provision for loan losses recorded during the first three months of 2002 versus
the same period in the prior year resulted from multiple factors, including the
Company's concerns in the first quarter of 2001 regarding the State of
California energy crisis and the negative trends in national economic growth and
activity.
Management anticipates that should the Company accomplish its strategic
plan and be successful in:
o generating further growth in loans receivable held for investment
o emphasizing the origination, purchase, and participation of income property
real estate loans
o expanding the construction loan portfolio
o continuing expansion of commercial business lending
future provisions will result and the ratio of the allowance for loan losses to
loans outstanding will increase. Experience across the financial services
industry indicates that commercial business, construction, and income property
loans present greater risks than residential real estate loans, and therefore
should be accompanied by suitably higher levels of reserves.
36
Comparison Of Operating Results For The Three Months Ended March 31, 2002 and
March 31, 2001
General
During the first quarter of 2002, the Company reported net income of
$1.21 million, equivalent to $0.35 diluted earnings per share. This compares to
net income of $602 thousand, or $0.18 diluted earnings per share, for the same
period in 2001. Net income during the first quarter of 2001 was impacted by
(pre-tax) operating costs of $408 thousand for the Bank's core systems
conversion that was implemented in March 2001. Net income during the quarter
ended December 31, 2001 (the immediately preceding quarter) was $1.14 million,
equivalent to $0.33 diluted earnings per share.
The Company realized some of the financial benefits from its
transformation strategy during the first three months of 2002. Net interest
income rose, due to both a larger average balance sheet fueled by increased
deposits and loans and due to expanded spreads resulting from the planned change
in balance sheet composition. Mortgage banking income benefited from the
historically low interest rate environment during the first quarter of 2002 and
from efficiencies arising from new technology. The Company realized certain
other operating efficiencies from the new technology environment implemented and
better optimized over the past year. The Company maintained favorable credit
quality during the first quarter of 2002, thus avoiding significant operating
costs for collections and foreclosures.
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 five quarters. Market interest rates have varied considerably during this
time period, generally falling throughout 2001, with certain interest rates
rising in the first quarter of 2002. In addition, the slope of the Treasury
curve shifted from inverted at the beginning of 2001, to flatter by the end of
the first quarter of 2001, to positively sloped by mid 2001. Since mid 2001, the
Treasury curve has generally become progressively more steeply sloped (i.e. a
greater differential between short term and longer term interest rates).
Financial institutions, including the Bank, 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. In addition, steep yield curves often lead to increased customer
demand for adjustable rate mortgages due to the rate differential to long term,
fixed rate mortgages.
As a result of the interest rate environment over the past 15 months,
yields and rates for most assets and liabilities were substantially lower in the
first quarter of 2002 compared to the first quarter of 2001.
37
Net Interest Income
Net interest income increased from $4.8 million during the first
quarter of 2001 to $5.4 million during the first quarter of 2002 due to both
expanded spreads and greater average balances of interest earning assets and
liabilities. The Company's ratio of net interest income to average total assets
was 3.98% for the first three months of 2002, up from 3.83% during the same
period in 2001. The increased spread in part stemmed from the Company's
continued implementation of its strategic plan.
Margins were hampered during the early part of 2001 by the Company's
offering higher than normal relative retail deposit pricing to facilitate
customer retention following the core systems conversion. The Company also
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 additional liquidity was not
utilized.
During the first quarter of 2002, the Company experienced difficulty
decreasing its NOW and Savings deposit rates at the same pace as the declines in
certain indices (e.g. COFI, 12 MTA) utilized for adjustable rate loans, as the
NOW and Savings rates were already at low nominal levels at the end of 2001. In
addition, the spread derived from investing the Company's demand deposit
balances was lower in the first quarter of 2002 than the same period in 2001 due
to the significantly lower general interest rate environment. However, net
interest income during the first quarter of 2002 benefited from lifetime rate
floors on certain loans and prepayment penalties received on certain income
property loans.
Other factors influencing net interest income during the first three
months of 2002 compared to the same period in 2001 included:
o Average net loans as a percentage of average total assets improved from
81.2% during the first three months of 2001 to 86.1% during the first three
months of 2002. Because loans constitute by far the Company's highest
yielding type of asset, this change in asset mix favorably affected net
interest income.
o Average demand deposits as a percentage of average total assets increased
from 3.3% during the first three months of 2001 to 4.0% during the first
three months of 2002. Increases in interest free funding favorably impact
the Company's spreads.
The Company plans to continue increasing its net interest margin by
continuing the transformation into a community commercial bank, increasing the
percentage of total assets constituted by loans, decreasing the percentage of
the loan portfolio comprised of residential mortgages, and increasing the
percentage of the deposit portfolio composed of transaction accounts. 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.
38
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 March 31, 2002 and 2001.
Three Months Ended March 31, 2002 Three Months Ended March 31, 2001
---------------------------------------- ----------------------------------------
(Dollars In Thousands) Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Assets
Interest earning assets:
Cash equivalents (1) $ 5,761 $ 25 1.74% $ 8,642 $ 124 5.74%
Investment securities 7,788 57 2.93% 7,363 133 7.23%
Mortgage backed securities (2) 31,373 312 3.98% 48,956 808 6.60%
Loans receivable, net (3) 462,480 8,314 7.19% 402,656 8,890 8.83%
FHLB stock 3,019 47 6.23% 2,922 40 5.48%
-------- ----- -------- ------
Total interest earning assets 510,421 8,755 6.86% 470,539 9,995 8.50%
----- ------
Non-interest earnings assets 26,952 25,551
-------- --------
Total assets $ 537,373 $ 496,090
======== ========
Liabilities & Equity
--------------------
Interest bearing liabilities:
NOW accounts $ 41,682 41 0.39% $ 40,658 141 1.39%
Savings accounts 19,023 26 0.55% 17,279 73 1.69%
Money market accounts 107,640 593 2.20% 90,144 1,044 4.63%
Certificates of deposit 240,440 2,153 3.58% 244,493 3,426 5.61%
-------- ----- -------- ------
Total interest-bearing deposits 408,785 2,813 2.75% 392,574 4,684 4.77%
FHLB advances 53,682 589 4.39% 40,799 547 5.36%
Other borrowings (4) 213 3 5.63% 170 12 28.24%
-------- ----- -------- ------
Total interest-bearing liabilities 462,680 3,405 2.94% 433,543 5,243 4.84%
----- ------
Demand deposit accounts 21,260 16,341
Other non-interest bearing 1,988 2,226
-------- --------
liabilities
Total liabilities 485,928 452,110
Stockholders' equity 51,445 43,980
-------- --------
Total liabilities & equity $ 537,373 $ 496,090
======== ========
Net interest income $5,350 $ 4,752
===== ======
Interest rate spread (5) 3.92% 3.66%
Net interest earning assets 47,741 36,996
Net interest margin (6) 4.19% 4.04%
Net interest income /
average total assets 3.98% 3.83%
Interest earnings assets /
Interest bearing liabilities 1.10 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 and collateralized mortgage obligations.
(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 $26,000 and
$78,000 in 2002 and 2001, respectively.
(4) Includes federal funds purchased, securities sold under agreements to
repurchase, and borrowings drawn on MBBC's line of credit.
(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.
39
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 March 31, 2002
Compared To
Three Months Ended March 31, 2001
----------------------------------------------
Volume
(Dollars In Thousands) Volume Rate /Rate Net
------ ------ ------ ------
Interest-earning assets
Cash equivalents $ (41) $ (86) $ 28 $ (99)
Investment securities 8 (79) (5) (76)
Mortgage backed securities (290) (321) 115 (496)
Loans receivable, net 1,321 (1,651) (246) (576)
FHLB Stock 1 5 1 7
------ ------ ------ ------
Total interest-earning assets 999 (2,132) (107) (1,240)
------ ------ ------ ------
Interest-bearing liabilities
NOW Accounts 4 (101) (3) (100)
Savings accounts 7 (49) (5) (47)
Money market accounts 203 (547) (107) (451)
Certificates of deposit (57) (1,237) 21 (1,273)
------ ------ ------ ------
Total interest-bearing deposits 157 (1,934) (94) (1,871)
FHLB advances 173 (99) (32) 42
Other borrowings 3 (10) (2) (9)
------ ------ ------ ------
Total interest-bearing liabilities 333 (2,043) (128) (1,838)
------ ------ ------ ------
Increase in net interest income $ 666 $ (89) $ 21 $ 598
====== ====== ====== ======
Interest Income
Interest income decreased from $10.0 million during the three months
ended March 31, 2001 to $8.8 million during the same period in 2002. This
decrease was primarily due to the much lower interest rate environment present
in 2002. The effect of lower general market interest rates more than offset the
impact of an 8.5% rise in average interest earning assets and a shift in asset
mix towards loans, coincident with the Company's strategic plan of better
supporting its local communities with the delivery of credit.
40
Interest income on loans decreased from $8.9 million during the three
months ended March 31, 2001 to $8.3 million during the same period in 2002. The
effect of lower interest rates more than offset the impact of a 14.9% rise in
average net loan balances outstanding. 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 purchases from
correspondent banks, and loan participations; with the latter primarily sourced
through other California community banks. The Company plans to increase total
loans to approximately 90.0% of total assets over time. Management believes
stockholder value is maximized through the extension and effective management of
credit.
Interest income on cash equivalents decreased from $124 thousand for
the three months ended March 31, 2001 to $25 thousand for the same period in
2002. This decline was due to:
o lower average rates resulting from the interest rate cuts implemented by
the Federal Reserve in 2001
o lower average volumes stemming from:
A. the Company's redeploying funds from cash equivalents into loans as a
result of the demand for credit
B. the Company's purchasing short term investment securities (called
Agency debentures) during the first quarter of 2002 in lieu of
investing in cash equivalents
Interest income on investment securities declined from $133 thousand
during the three months ended March 31, 2001 to $57 thousand during the same
period in 2002. The reduced interest income resulted from lower yields on
variable rate corporate trust preferred securities that reprice quarterly based
upon 3 month LIBOR, which was significantly lower in the first three months of
2002 than during the same period in 2001. This impact was only partially offset
by interest income earned on short term Agency debentures purchased during the
first quarter of 2002 as a vehicle for investing short term excess liquidity.
Interest income on mortgage backed securities fell from $808 thousand
during the three months ended March 31, 2001 to $312 thousand during the same
period in 2002. 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 two years, 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 2001, which adjusted downward in rate in
conjunction with the decline in interest rates during 2001.
Interest income on FHLB stock increased from $40 thousand during the
three months ended March 31, 2001 to $47 thousand during the same period in
2002. The FHLB-SF declared a particularly high fourth quarter 2001 dividend rate
of 5.99% during the first quarter of 2002. This rate was above that accrued by
the Company in 2001, and therefore increased the Company's reported yield on
FHLB stock during the first quarter of 2002.
41
Interest Expense
Interest expense decreased from $5.2 million during the quarter ended
March 31, 2001 to $3.4 million during the quarter ended March 31, 2002, as the
effect of the lower interest rate environment more than offset the impact of a
rise in average interest bearing liabilities.
Interest expense on deposits decreased from $4.7 million in the quarter
ended March 31, 2001 to $2.8 million during the quarter ended March 31, 2002.
This decline was due to the effect of a significant decrease in average interest
rate more than offsetting the impact of a rise in average balances. The large
decrease in average rates resulted from the lower interest rate environment and
a shift in the composition of the deposit portfolio. Relatively higher cost
certificates of deposit decreased from 59.8% of average total deposits during
the first quarter of 2001 to 55.9% during the first quarter of 2002. Relatively
lower cost transaction deposit accounts experienced a complementary increase,
with money market deposits experiencing a significant rise from 22.0% to 25.0%
of average total deposits. This change in deposit mix is a fundamental component
of the Company's strategic plan.
At March 31, 2002, the Company's weighted average nominal cost of
deposits was 2.51%, down from 2.87% at December 31, 2001. The Company paid an
average rate of just 0.39% on its NOW deposits and 0.55% on its savings deposits
during the first quarter of 2002, highlighting the limited ability of the
Company to further reduce the cost of this funding should general market
interest rates decline in future periods.
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, 8, and 19 months, augmented by ongoing sales and periodic
print advertising of longer term certificates of deposit. For example, the
Company conducted two rounds of print advertising throughout its primary market
area early in the second quarter of 2002 promoting 24 month and 30 month
certificates of deposit. At March 31, 2002, the weighted average cost of the
certificate of deposit portfolio was 3.43%, with 27.0% of the portfolio (by
balance) scheduled to reprice during the second quarter of 2002.
During the second quarter of 2002, the Company plans to continue
promoting its Money Market Plus account, Direct Deposit Checking account (no-fee
consumer checking), intermediate to longer term certificates of deposit, and
business checking accounts. The Company's deposit products are highly tiered,
encouraging greater account balances in order to earn higher rates of interest.
Customer accounts are 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 commercial credit facilities.
Interest expense on total borrowings increased from $559 thousand
during the three months ended March 31, 2001 to $592 thousand during the three
months ended March 31, 2002 due to the effect of greater average balances more
than offsetting the impact of lower average rates. The Company had higher levels
of borrowings outstanding in the first quarter of 2002 than the same period in
2001 due to borrowings being utilized to fund some of the growth in the loan
portfolio. While the Company did not enter into any new term borrowings during
the first quarter of 2002, the average effective cost of borrowings was lower in
the first quarter of 2002 than during the same period in 2001 due in part to
new, relatively lower cost term FHLB advances acquired during the fourth quarter
of 2001. At March 31, 2002, the next two scheduled maturities of FHLB advances
were $5.0 million in July 2002 and $5.0 million in November 2002. In April 2002,
the Company prepaid the advance originally scheduled to mature in July 2002 and
entered into a new $5.0 million advance maturing in June, 2003 in conjunction
with the interest rate risk management program.
The Company's average interest rate on other borrowings was inflated
during 2001 and 2002 as a result of the amortization of loan fees (discount on a
liability) on MBBC's $3.0 million revolving line of credit combined with a lack
of draws (outstanding balances) on the line.
42
Provision For Loan Losses
The Company recorded a $325 thousand provision for loan losses during
the first quarter of 2002, down from $500 thousand during the first quarter of
2001. The Company determines its periodic provision for loan losses based upon
its analysis of loan loss reserve adequacy. Net charge-offs during the first
three months of 2002 were $32 thousand, versus $25 thousand during the first
three months of 2001. The Company's ratio of loan loss reserves to loans
outstanding increased from 1.41% at December 31, 2001 to 1.46% at March 31,
2002, while the nominal amount of the loan loss reserve rose from $6.7 million
at December 31, 2001 to $7.0 million at March 31, 2002.
The primary factor contributing to the provision for loan losses during
the first quarter of 2002 was the need to establish a specific reserve of $754
thousand associated with a $2.3 million commercial real estate mortgage secured
by a hotel / resort described above under "Non-performing Assets". Because this
loan was already classified as substandard at December 31, 2001, the incremental
loan loss reserves associated with this loan at March 31, 2002 were less than
the $754 thousand specific reserve.
Other factors contributing to the provision for loan losses during the
first quarter of 2002 included the expansion in the loan portfolio, the addition
of a large volume of new credits to the loan portfolio, the stage of the
economic cycle, and the change in loan portfolio mix, particularly the reduced
concentration of relatively lower risk residential mortgages. 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. Commercial lines of credit and term loans to
businesses also typically present a greater level of credit risk than
residential mortgages.
Factors moderating the amount of provision for loan losses during the
first quarter of 2002 included a reduction in the portfolio of hotel / motel
loans, a decline in the balance of the Special Residential Loan Pool, and a
decrease in total criticized assets.
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,
construction, and commercial business lending. This change in portfolio mix is
anticipated to be accelerated by the Los Angeles loan production office, which
concentrates on construction and income property lending. The Los Angeles loan
production office presents the Company with the opportunity to better
geographically diversify its real estate loan portfolio, such that the Company
becomes less exposed to a downturn in real estate values, economic weakness, or
a natural disaster in any one local real estate market. The Company does not,
however, pursue lending outside the State of California, but does occasionally
make real estate loans secured by property in other states as an accommodation
to existing customers.
43
Non-interest Income
Non-interest income totaled $512 thousand during the first quarter of
2002, down from $643 thousand during the same period in 2001. This decline was
primarily due to the impact of lower commissions from sales of non-FDIC insured
investment products and reduced customer service charges.
Commissions from the sale of non-FDIC insured investment products
during the first quarter of 2002 were $41 thousand, down from $117 thousand
during the same period the prior year due to vacancies in positions for licensed
investment sales representatives.
Customer service charge income totaled $351 thousand during the first
quarter of 2002, down from $408 thousand during the first quarter of 2001. This
decrease was primarily due to the Company's charging uncollected funds fees
during the first quarter of 2001 but not charging these fees during the same
period in 2002 in response to competitive factors and due to a change in the
profile of the consumer checking portfolio. In conjunction with the conversion
to the new core data processing system in March 2001, the Company implemented a
revamped consumer checking product line and an associated revised fee and
service charge schedule. These changes contributed to the closing of certain
lower balance and / or higher transaction volume consumer checking accounts over
the past year, as such accounts began incurring increased service charges.
Loan servicing income totaled $14 thousand during the three months
ended March 31, 2002, compared to $2 thousand during the same period in 2001.
Loan servicing income during the first quarter of 2001 was reduced by
accelerated amortization of mortgage servicing rights because of faster
prepayments, which in turn were increased by the commencement of decreases in
the target federal funds rate by the Federal Reserve. 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 March
31, 2002, the Company serviced $37.3 million in various types of loans for other
investors, compared to $42.6 million at December 31, 2001.
Gains on the sale of loans increased from $5 thousand during the first
quarter of 2001 to $27 thousand during the first quarter of 2002. The lower
interest rate environment in the first quarter of 2002 compared to the same
period in 2001 contributed to a greater level of refinance activity for
residential loans, which in turn increased the Company's mortgage banking
activity.
Gains on the sale of securities were $43 thousand during the first
quarter of 2002, compared to $34 thousand during the first quarter of 2001. The
gain during the first quarter of 2002 resulted from the sale of a $2.7 million
(par value) private label CMO in conjunction with the Company's interest rate
risk management program.
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 periods 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 expanded sale of Internet banking and cash management services for
businesses
o the continued marketing of debit cards
However, no assurance can be provided regarding the amount of or trends in the
Company's future levels and composition of non-interest income.
44
Non-interest Expense
Non-interest expense totaled $3.5 million during the first quarter of
2002, compared to $3.8 million during the same period in 2001. This decline in
expense was primarily due to the Company's incurring $408 thousand in
non-recurring expenses during the first quarter of 2001 in conjunction with the
data processing conversion. These non-recurring operating costs included
de-conversion charges from the Company's external service bureau, travel and
training costs for employees to assist with the implementation of the new
system, printing and postage for additional customer mailings, and consultant
fees.
Compensation and employee benefits expense rose from $1.7 million
during the first quarter of 2001 to $1.9 million during the first quarter of
2002. Factors contributing to this increase included staff additions in data
processing and commercial lending. The staff additions in data processing
stemmed from the switch from an external service bureau environment to an
in-house system for the Company's primary data processing. The staff additions
in commercial lending were primarily comprised of new business account
relationship officers. Compensation and employees benefits costs also rose in
the first quarter of 2002 when compared to the same period during the prior year
due to the opening of the Los Angeles loan production office and because of
higher costs for the Bank's employee stock ownership plan ("ESOP"). The ESOP
expenses increased in 2002 versus 2001 because of the higher average price of
Monterey Bay Bancorp, Inc. common stock.
Costs for employee incentive programs were higher in the first quarter
of 2002 than during the first quarter of 2001 in conjunction with the Company's
better financial performance. For 2002, the Company redesigned various incentive
plans to better correlate bonus payments with contributions to increased
profitability, achievements in support of the strategic plan, and improvements
in stockholder value.
The change in the Company's systems environment also impacted various
other operating expenses. Data processing fees were much lower in 2002 versus
2001, while equipment expense was higher due to the added depreciation from the
new hardware and software installed in 2001.
Consulting expenses were much lower in the first quarter of 2002 versus
the same period in 2001 because of consultants hired to assist with the core
systems conversion in 2001. Legal expenses declined $48 thousand from the first
quarter of 2001 to the first quarter of 2002 primarily due to expenditures in
2001 associated with claims by a former executive regarding payments due under
his employment contracts. Accounting expenses were lower in the first quarter of
2002 versus the first quarter of 2001 primarily due to the hiring of a more cost
effective firm for selected internal auditing functions commencing in mid 2001.
Advertising and promotion costs totaled $77 thousand in the first
quarter of 2002, up from $31 thousand during the same period in 2001. These
costs were unusually low in the first quarter of 2001, as the Company postponed
certain advertising and promotional activities pending the implementation of the
new computer systems environment.
Advertising during the first quarter of 2002 included newspaper ads for
deposit products, targeted direct mail to businesses in the Bank's primary
market area, and local radio ads that focused on attracting business customers
through the communication of the Bank's "relationship banking" approach to
customer service. The Company's visibility was also enhanced during the first
quarter by the extensive participation of employees and Directors in a
significant number of community events and organizations.
45
The Company's efficiency ratio during the first quarter of 2002 was
59.13%, comparing favorably to 71.22% during the first quarter of 2001 and
improving slightly from 59.59% during the fourth quarter of 2001 (the
immediately preceding quarter). Despite this progress, the Company's efficiency
ratio is still above those of high performing peer financial institutions. The
expansion in the Company's interest margin has been a primary factor in the
improvement in the efficiency ratio during the past year.
The Company continues to restructure its operations both to better
utilize new technology and improve efficiency. The Company also continues to
evaluate new vendors for various products and services, seeking more cost
effective business relationships. In 2002, the Company altered the manner in
which its facilities management is conducted to provide for better expense
control. By mid 2002, the Company plans to implement revised practices for check
ordering and printing, leading to cost savings. Through these and other
initiatives, the Company continues to target progress in improving its
efficiency ratio.
Income Taxes
Income tax expense increased in 2002 versus 2001 due to greater pre-tax
income. The Company's effective book tax rate was slightly lower in 2002 versus
2001 due to non-deductible expenses and other adjustments to taxable income
representing a smaller percentage of the increased amount of book pre-tax
income.
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, 2001. There has been no significant change in these
disclosures since the filing of that document.
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.
Item 2. Changes In Securities
None.
Item 3. Defaults Upon Senior Securities
Not applicable.
46
Item 4. Submission Of Matters To A Vote Of Security Holders
---------------------------------------------------
On April 9, 2002, the Company issued its 2002 Proxy Statement. Matters
submitted to a vote of security holders via that Proxy Statement
included:
1.) The proposed election of four individuals as Directors of the
Company:
Proposed Term
Individual To Expire
------------------------- -------------------
Larry A. Daniels 2004
Steven Franich 2005
Stephen G. Hoffmann 2005
Gary L. Manfre 2005
2.) The proposed ratification of the appointment of Deloitte & Touche
LLP as the independent auditors of the Company for the fiscal
year ending December 31, 2002.
The Company's Annual Meeting of Stockholders is scheduled for Thursday,
May 23, 2002 at 9:00 AM Pacific Time at the Watsonville Women's Club,
12 Brennan Street, Watsonville, CA. 95076.
Item 5. Other Information
None.
Item 6. Exhibits And Reports On Form 8-K
A. Exhibits
10.21 Employment Agreement With C. Edward Holden
10.22 Employment Agreement With Mark R. Andino
B. Reports On Form 8-K
The Company has recently filed the following Current Reports
on Form 8-K:
1. Form 8-K dated January 29, 2002. This Current
Report reported the Company's results for the
fourth quarter and the fiscal year 2001, the date
for the 2002 Annual Meeting of Stockholders, and
the record date for voting at the 2002 Annual
Meeting of Stockholders.
2. Form 8-K dated March 15, 2002. This Current Report
reported the Company's opening of a Southern
California loan production office, the elimination
of institution specific regulatory capital
requirements for Monterey Bay Bank, the repurchase
of additional shares of Company common stock, and
the resignation of a Monterey Bay Bank senior
officer.
3. Form 8-K dated April 22, 2002. This Current Report
reported the Company's operational and financial
results for the first quarter of fiscal year 2002.
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: May 13, 2002 By: /s/ C. Edward Holden
--------------------
C. Edward Holden
Chief Executive Officer
President
Vice Chairman Of The
Board Of Directors
Date: May 13, 2002 By: /s/ Mark R. Andino
------------------
Mark R. Andino
Chief Financial Officer
Treasurer
(Principal Financial &
Accounting Officer)
48