SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
Amendment No. 1
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
or
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from____ to ______
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
445 Pine Avenue, Goleta, California 93117
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (805) 692-1862
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
None
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, No Par Value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. YES [X] NO[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained, and will not be contained, to the best of
the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Common Stock held by non-affiliates of the
registrant, based on the closing price of the stock on the Nasdaq National
Market System on April 12, 2002, was approximately $20,967,260.
There were 5,690,224 shares of Common Stock of the registrant issued and
outstanding as of April 12, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A in connection with
the 2002 Annual Meeting are incorporated by reference into Part III of this
Report. The proxy statement will be filed with the Securities and Exchange
Commission not later than 120 days after the registrant's fiscal year ended
December 31, 2001.
COMMUNITY WEST BANCSHARES
FORM 10-K/A
INDEX
PART I PAGE
ITEM 1. Description of Business 3
ITEM 2. Description of Property 11
ITEM 3. Legal Proceedings 12
ITEM 4. Submission of Matters to a Vote of Security Holders 16
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters 17
ITEM 6. Selected Financial Data 18
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk 57
ITEM 8. Consolidated Financial Statements F-1
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 60
PART III
ITEM 10. Directors, Executive Officers, Promoters and Control Persons 60
ITEM 11. Executive Compensation 60
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 60
ITEM 13. Certain Relationships and Related Transactions 60
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 61
SIGNATURES S-1
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
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This 2001 Annual Report on Form 10-K contains statements which constitute
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Those forward-looking statements include statements regarding the
intent, belief or current expectations of the Company and its management. Any
such forward-looking statements are not guarantees of future performance and
involve risks and uncertainties, and actual results may differ materially from
those projected in the forward-looking statements. Such risks and uncertainties
include, among other things, the reduction in our earnings by losses on loans,
the recent decline in our interest income, the risk that our borrowers will fail
to perform, the regulation of the banking industry, our compliance with our
Formal Agreement with the OCC and our Memorandum of Understanding with the
Reserve Bank, our dependence on real estate, risks associated with high
loan-to-value real estate loans, risks of natural disasters, the effect of
interest rate fluctuations, competition, operations risks, adverse publicity and
legal proceedings, curtailment of government guaranteed loan programs, the
Company's expectation not to pay dividends, volatility of the Company's stock
price, security risks related to online banking services, dependence on key
employees, environmental laws, and other risk and uncertainties that may be
detailed herein. See "Item 1. Description of Business - Factors that May
Affect Future Results of Operations."
GENERAL HISTORY
----------------
Community West Bancshares was incorporated in the State of California on
November 26, 1996, for the purpose of forming a bank holding company. On
December 31, 1997, Community West Bancshares acquired a 100% interest in Goleta
National Bank, herein referred to as "Goleta." Effective that date,
shareholders of Goleta (NASDAQ: GLTB) became shareholders of Community West
Bancshares (NASDAQ: CWBC) in a one-for-one exchange. The acquisition was
accounted at historical cost in a manner similar to a pooling-of-interests.
Community West Bancshares and Goleta are referred to herein as the "Company."
"Bancshares" refers to the parent company only.
On December 14, 1998, the Company acquired a 100% interest in Palomar Savings &
Loan Association, now known as Palomar Community Bank, herein referred to as
"Palomar." As of that date, shareholders of Palomar became shareholders of
Community West Bancshares by receiving 2.11 shares of Bancshares for each share
of Palomar they held. The acquisition was accounted for under the purchase
method. On August 17, 2001, the Company's 100% interest in Palomar was sold to
Centennial First Financial Services.
On October 16, 1997, the Company purchased a 70% interest in Electronic
Paycheck, LLC, a California limited liability company that is a provider of
customized debit card payment systems and electronic funds transfer services.
On November 4, 1999, Electronic Paycheck, LLC merged with ePacific.com
Incorporated, a Delaware corporation. The merger was accounted for in a manner
similar to a pooling-of-interests. ePacific.com has developed an Internet-based
transaction processing system using proprietary software. The system provides
complete front-end to back-end electronic funds transfer processing services.
ePacific.com markets its e-commerce payment services to consumer lenders,
companies with employees without banking relationships, network marketing
organizations and loyalty reward programs. On March 30, 2000, ePacific.com
redeemed 1,800,000 of the 2,100,000 shares held by the Company and repaid a loan
from the Company with a balance of $3,725,000, all for $4,500,000 in cash. The
Company continues to hold 300,000 shares of ePacific.com's common stock, which
it carries at $0 on its balance sheet.
In March 2000, Goleta entered into an agreement (the "Formal Agreement") with
its principal regulator, the Office of the Comptroller of the Currency (the
"OCC"). The Formal Agreement requires Goleta to maintain certain capital levels
and to adhere to certain operational and reporting requirements which could
limit Goleta's business activity and increase expense. Management has been
informed by the OCC that they do not believe that Goleta is in full compliance
with certain provisions of the Formal Agreement, which failure could adversely
affect the safety and soundness of Goleta and subject Goleta to additional
corrective and enforcement action by the OCC. The OCC has also expressed strong
reservations about Goleta and other national banks entering into arrangements
with third parties to make short-term consumer loans and believe this program
subjects Goleta and the Company to significant strategic, reputational,
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compliance and transaction risks. See "Item 1. Description of Business -
Factors That May Affect Future Results of Operations - Formal Agreement," "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations - Supervision and Regulation - Formal Agreement With the OCC," and
Note 15 of Notes to Consolidated Financial Statements.
RECENT RESULTS
---------------
The Company reported a net loss of $3,912,287, or $0.69 per share (both
undiluted and diluted), for the fourth quarter of 2001. The fourth quarter loss
was the result of a number of factors including, but not limited to: a) a loan
loss provision of $3,251,181; b) a reduction in SBA loan originations and sales
which reduced gain on sale of loans to $6.6 million; c) an increase in the
prepayment assumptions used to calculate the value of Goleta's SBA related
interest-only strip and servicing assets ($858,000); and d) a refinement of the
Company's estimated income tax expense relating to general operations ($600,000)
and the sale of Palomar ($246,296). The Company also made accounting
adjustments for a number of items including: a) the carrying values of accrued
interest income and expense (an expense of $892,536); b) bond discount (an
expense of $691,982); and c) bond issuance expense (a gain of $320,219).
LINES OF BUSINESS
-------------------
The Company, through its subsidiary, Goleta, offers a range of commercial and
retail financial services, including the acceptance of demand, savings, and time
deposits, and the origination of commercial, U.S. Small Business Administration,
herein referred to as "SBA," real estate, construction, home improvement,
short-term consumer, and other installment and term loans. It also offers cash
management, remittance processing, electronic banking, merchant credit card
processing, online banking, and other financial services to the public.
RELATIONSHIP BANKING
Relationship banking is conducted at the community level through two
full-service branches, one in Goleta, California, and the other in Ventura,
California. The primary customers are individuals and small to mid-sized
businesses in these communities. Products offered through the relationship bank
include demand, savings, and time deposit accounts, as well as commercial,
accounts receivable, real estate, construction, home improvement and installment
and term loans. Customers are also provided an array of ancillary services,
including remittance banking, merchant card processing, courier service, on-line
banking, and debit and credit cards.
SBA LENDING
Goleta has been an approved lender/servicer of loans guaranteed by the SBA since
late 1990. The Company originates SBA loans, sells the guaranteed portion into
the secondary market, and services the loans. The Company may, from time to
time, also sell some of the unguaranteed portions of the SBA loans which it
originates. The Company operates full-service SBA origination offices in
Goleta, California and Atlanta, Georgia. During 1995, the SBA designated the
Company as a "Preferred Lender." As a "Preferred Lender," the Company has the
ability to move loans through the approval process at the SBA much more quickly
than financial institutions that do not have such a designation. The Company
currently has SBA "Preferred Lender" status in the California districts of Los
Angeles, Fresno, Sacramento, San Francisco, and Santa Ana. The Company also has
"Preferred Lender" status in Georgia, South Carolina, Tennessee, Colorado,
Washington, Nevada, Oregon, and Florida.
In 2001, the Company began offering Business & Industry ("B & I") loans and was
ranked the 16th largest B & I lender in the country in 2001. These loans are
similar to the SBA product, except they are guaranteed by the U.S. Department of
Agriculture and are generally larger loans made to larger businesses. Similar
to the SBA product, they can be sold on the secondary market.
MORTGAGE LENDING
In 1995, the Company established a Wholesale and Retail Mortgage Loan Center.
The Mortgage Loan Center originates residential real estate loans and
manufactured housing loans primarily in the California counties of Ventura and
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Santa Barbara. After origination, the real estate loans are sold into the
secondary market and the manufactured housing loans are retained in Goleta's
portfolio.
From 1994 to 1998, the Company originated home improvement loans under the Title
I regulations of the Federal Housing Authority, herein referred to as "FHA."
This is the oldest government insured loan program in existence, having begun in
1934. After origination, the Title I loans were sold into the secondary market,
and the servicing was retained by the Company. During this period, the Company
was one of a small number of institutions approved to sell Title I loans
directly to the Federal National Mortgage Association, herein referred to as the
"FNMA." The Company no longer originates Title 1 loans.
In 1996, the Company began offering second mortgage loans. Second mortgage
loans allow borrowers to borrow, up to 125% of their home's appraised value,
when combined with the balance of the first mortgage loan, or a maximum of
$100,000. Proceeds are commonly used for debt consolidation, home improvement,
or school tuition. The Company relies primarily on the creditworthiness of the
borrower, combined with the underlying home value as collateral, to help ensure
repayment of these loans. The repayment term on these loans range from one to
25 years.
In March 1998, the Company began accumulating the majority of these second
mortgage loans for the purpose of securitization. Securitization is a process
in which the accumulated loans are transferred into a trust in exchange for cash
and an interest in the trust. The loans held in the trust are used as
collateral to issue bonds to third party investors to generate the cash. An
insurance policy is carried on the trust to guarantee full payment of the bonds.
On December 22, 1998, the Company completed the securitization of an $81 million
pool of loans. On June 18, 1999, the Company completed the securitization of a
$122 million pool of loans. In the fourth quarter of 1999, the Company decided
to cease securitization activities. The Company now sells its residential real
estate loans and second mortgage loans into the secondary market on a whole loan
basis
SHORT-TERM CONSUMER LENDING
In 1999, Goleta entered into a contract with America's Cash Express, herein
referred to as "ACE," and ePacific.com whereby ACE acts as an agent to originate
short-term consumer loans at over 1,100 national retail offices. Upon
origination, ACE purchases 90% of the principal and Goleta currently retains 10%
ownership in the principal of each loan. Loans currently yield approximately
338% interest and are for original terms of two weeks. The first loans of this
type were initiated in the second quarter of 2000. ACE and ePacific.com service
these loans. While this business activity makes significant contributions to
Goleta's net profit, it does experience high levels of loan losses. The OCC has
also expressed strong reservations about Goleta and other national banks
entering into arrangements with third parties to make short-term consumer loans
and believe this program subjects Goleta and the Company to significant
strategic, reputational, compliance and transaction risks. See "- Factors That
May Affect Future Results of Operations."
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
-----------------------------------------------------------
The short and long-term success of the Company is subject to certain risks, many
of which are substantial in nature. Shareholders and prospective shareholders
in the Company should consider carefully the following risk factors, in addition
to other information contained herein. This Annual Report on Form 10-K contains
forward-looking statements which are subject to a variety of risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of various factors,
including those set forth below.
NET INTEREST INCOME HAS RECENTLY DECLINED SIGNIFICANTLY
Net interest income declined by approximately $4.9 million, or 23.5%, to $20.8
million in 2001. Approximately $4.6 million of this decrease was due to a
decrease in the balance of Goleta's securitized loan portfolios. This decrease
occurred, in part, because of an accelerated rate of prepayment of these loans.
Continued high prepayment rates on these loans will reduce future net interest
income.
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EARNINGS HAVE RECENTLY BEEN REDUCED BY LOSSES ON LOANS
The Company's income after provision for loan losses for 2001 was $21,762, and
if not for income tax benefits the Company would have experienced a loss of
approximately $1.26 million. The Company's provision for loan losses was
approximately $6.8 million in 2000 and $11.9 million in 2001. If the
performance of the Company's loan portfolio does not improve in 2002, the
Company may again experience severely reduced earnings or losses.
BORROWERS COULD FAIL TO PERFORM
If a significant number of Goleta's borrowers and guarantors fail to perform
their obligations as required by the terms of their loans, larger than expected
loan losses could result. This risk increases when the economy is weak. In
2001, Goleta recorded a provision for loan losses of approximately $11.9
million, principally as the result of deterioration in Goleta's SBA, second
mortgage and securitized loan portfolios, and as the result of the growth in
Goleta's short-term consumer lending portfolio. The Company has established an
evaluation process designed to determine the adequacy of the allowance for loan
losses. While this evaluation process uses historical and other objective
information, the classification of loans and the establishment of loan losses
are dependent to a great extent on experience and judgment. The Company cannot
assure you that its allowance for loan losses will be sufficient to absorb
future loan losses or prevent a material adverse effect on its business,
profitability or financial condition. Earnings will continue to be at risk as
long as weak economic conditions persist.
REGULATION
The financial services industry is heavily regulated. The Company is subject to
federal and state regulation designed to protect the deposits of consumers, not
to benefit shareholders. These regulations include the following:
- the amount of capital the Company must maintain;
- the kinds of activities it can engage in;
- the kinds and amounts of investments it can make;
- the locations of its offices;
- how much interest Goleta can pay on demand deposits;
- insurance of the Company's deposits and the premiums paid for
this insurance; and
- how much cash the Company must set aside as reserves for
deposits.
The regulations impose significant limitations on operations, and may be changed
at any time, possibly causing future results to vary significantly from past
results. Government policy and regulation, particularly as implemented through
the Federal Reserve System, significantly affects credit conditions. See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations - Supervision and Regulation."
FORMAL AGREEMENT
In March 2000, Goleta entered into the Formal Agreement with its principal
regulator, the Office of the Comptroller of the Currency (the "OCC"). The
Formal Agreement requires Goleta to maintain certain capital levels and adhere
to certain operational and reporting requirements which could limit Goleta's
business activity and increase expense. Management has been informed by the
regulators that they do not believe Goleta is in full compliance with certain
provisions of the Formal Agreement, including (i) implementing and demonstrating
the effectiveness of its written risk management program, (ii) implementing a
program to ensure compliance with consumer protection laws applicable to
Goleta's short-term consumer loan program, (iii) accurately valuing, and
documenting the valuations of, interest-only assets, servicing assets, deferred
tax assets and deferred tax liabilities and (iv) ensuring compliance with
applicable laws and regulations, particularly as related to the short-term
consumer loan program. The failure to fully comply with such requirements could
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adversely affect the safety or soundness of Goleta. The OCC possesses broad
powers to take corrective and other supervisory action and bring enforcement
actions to resolve unsafe or unsound practices. The OCC has also expressed
strong reservations about Goleta and other national banks entering into
arrangements with third parties to make short-term consumer loans and believe
this program subjects Goleta and the Company to significant strategic,
reputational, compliance and transaction risks. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Supervision and Regulation - Formal Agreement With the OCC."
MEMORANDUM OF UNDERSTANDING
In March 2000, Bancshares entered into an agreement (the "Memorandum of
Understanding") with its principal regulator, the Federal Reserve Bank of San
Francisco (the "Reserve Bank"). The Memorandum of Understanding requires the
Company to maintain certain capital levels and adhere to certain operational and
regulatory requirements which could limit the Company's business activity and
increase expense. The Company believes that it is in substantial compliance
with the Memorandum of Understanding. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Supervision and
Regulation - Memorandum of Understanding With the Federal Reserve Bank."
SHORT-TERM CONSUMER LOAN PROGRAM
In 2001, the Company's short-term consumer lending program contributed
approximately $1.8 million to indirect and corporate overhead expenses after a
provision for loan losses of approximately $2.7 million. The OCC has expressed
strong reservations about Goleta and other national banks entering into
arrangements with third parties to make these loans and believe this program
subjects Goleta and the Company to significant strategic, reputational,
compliance and transaction risks. Some of these risks include: (i) reliance on
the automated processes of ACE, (ii) the difficulty of monitoring transaction
volume because of the geographic expanse and number of stores maintained by ACE,
(iii) the difficulty of managing an adequate system to ensure compliance by ACE
with consumer protection laws, (iv) the importance of this program to the
Company's growth plans, (v) the adverse publicity arising from recent lawsuits
associated with this program, and (vi) the risk of loss from such lawsuits.
These risks could have a materially adverse effect on Goleta's and the Company's
results of operations.
DEPENDENCE ON REAL ESTATE
Approximately 75% of the loan portfolio of the Company is secured by various
forms of real estate, including residential and commercial real estate and
manufactured housing. A decline in current economic conditions or rising
interest rates could have an adverse effect on the demand for new loans, the
ability of borrowers to repay outstanding loans, and the value of real estate
and other collateral securing loans. The real estate securing the Company's
loan portfolio is concentrated in California. If real estate values decline
significantly, especially in California, higher vacancies and other factors
could harm the financial condition of the Company's borrowers, the collateral
for its loans will provide less security, and the Company would be more likely
to suffer losses on defaulted loans.
RISKS ASSOCIATED WITH HIGH LOAN-TO-VALUE REAL ESTATE LOANS
The Company derives revenue from the origination and sale of high loan-to-value
or "HLTV" second mortgage home loans. These loans may have loan-to-value ratios
as high as 125%. The Company limits its exposure for losses due to defaults on
HLTV loans by re-selling them in the secondary market. Interest and fees on
some types of HLTV loans may be significantly higher than on more conventional
home equity loans. As a result, HLTV lenders have received negative publicity
and may be subject to future laws and regulations that limit rates and fees.
Some of the secondary market purchasers of home equity loans have announced
their intention to stop purchasing some types of HLTV loans. The loss of the
secondary market for some types of HLTV loans, or an increasingly negative
perception of HLTV lenders, could lead the Company to shift its marketing
emphasis from very high interest rate and fee products to more conventional home
loan products. These products could be less attractive to borrowers or less
profitable for the Company.
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RELIANCE ON LOAN SALES FOR FUTURE EARNINGS
For the year ended December 31, 2001, the Company recognized $6.6 million in
gain on sale of loans to a limited number of secondary market investors. The
Company plans to continue such sales. However, there is no assurance that these
secondary market investors will continue to purchase loans at terms which are
favorable to the Company. The withdrawal of these investors from the
marketplace, and an inability to replace them with other similar investors,
would have a materially adverse effect on the Company's financial condition and
results of operations.
RISKS OF NATURAL DISASTERS
The Company's operations and much of the collateral for its real estate loans
are concentrated in California, an area that experiences earthquakes, fires,
floods and other natural disasters. The San Andreas Fault runs through the
Company's service area. The Company has a disaster recovery plan, with off-site
data processing facilities located in Scottsdale, Arizona. However, many of the
Company's borrowers could suffer uninsured property damage, experience
interruption of their businesses or lose their jobs after an earthquake or other
natural disaster. Those borrowers might not be able to repay their loans, and
the collateral for loans could decline significantly in value. Unlike a bank
holding company with operations that are more geographically diversified, the
Company is vulnerable to greater losses if an earthquake, fire, flood or other
natural disaster occurs in the Company's service region.
INTEREST RATE CHANGES
A major portion of the Company's net income comes from its interest rate margin
or "spread," which is the difference between the interest rates paid by the
Company on interest-bearing liabilities, such as deposits and other borrowings,
and the interest rates the Company receives on interest-earning assets, such as
loans extended to clients and securities held in the Company's investment
portfolio. Interest rates are highly sensitive to many factors that are beyond
the Company's control, such as inflation, recession, global economic
disruptions, and unemployment. In addition to the effect on income from the
Company's interest margin, changes in interest rates affect the demand for new
loans, the credit profile of existing loans, the rates received on loans and
securities and the rates Goleta must pay on deposits and borrowings. Changes in
interest rates can also impact the speed of the repayment of sold loans. Goleta
has recorded servicing and interest-only assets in connection with its sold
loans. The faster the borrowers pay off these sold loans, the faster Goleta
must amortize these financial assets as an expense. Under these circumstances,
earnings are adversely affected by both the increased amortization expense and
the loss of loan servicing income. Goleta has also recorded bond discount and
issuance costs which must be amortized as an expense as the proceeds from the
payment of securitized loans are used to pay down related bonds. High levels of
prepayments of the securitized loans will accelerate the amortization of these
expenses. Finally, changes in interest rates can adversely affect the ultimate
sale price of certain fixed-rate loans held for sale.
COMPETITION
Competition may adversely affect Goleta's performance. The financial services
business in Goleta's markets is highly competitive, and becoming more so due to
changes in regulation, technology and the accelerating pace of consolidation
among financial service providers. Other banks and specialty and diversified
financial services companies, many of which are larger and have more capital
than the Company, offer lending, leasing and other financial products to the
Company's customer base. In some cases, competitors may offer a financial
product that provides an alternative to one of the products the Company offers
to its clients. When new competitors seek to enter one of the Company's
markets, or when existing market participants seek to increase their market
share, they sometimes undercut the pricing or credit terms prevalent in that
market. Increasing levels of competition in the banking and financial services
businesses may reduce market share or cause the prices the Company can charge
for products and services to fall.
OPERATIONS RISKS
Goleta is subject to operations risks, including, but not limited to, data
processing system failures and errors, customer or employee fraud and
catastrophic failures resulting from terrorist acts or natural disasters.
Goleta maintains a system of internal controls to mitigate against such
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occurrences and maintains insurance coverage for many of these risks. However,
should an event occur that is not prevented or detected by Goleta's internal
controls, or is uninsured or in excess of applicable insurance limits, it could
have a significant adverse impact on the Company's business, financial condition
or results of operations.
ADVERSE PUBLICITY AND LEGAL PROCEEDINGS
Goleta has been named in a number of lawsuits regarding its short-term consumer
lending program. See "Item 3. Legal Proceedings." These lawsuits, in general,
claim that Goleta has violated various state usury lending laws. In addition to
the potential of loss associated with these lawsuits, Goleta has been, and is
likely to continue to be, the subject of adverse publicity surrounding this
business activity, with resulting harm to Goleta's reputation.
Adverse determinations in one or more of these actions could have a material
adverse impact on the Company's financial condition or results of operations and
continuation of the short-term consumer lending business, and could result in
adverse actions by the regulatory agencies with authority over Goleta and the
Company, including the OCC and the Board of Governors of the Federal Reserve
System. The OCC has expressed strong reservations about Goleta and other
national banks entering into arrangements with third parties to make short-term
consumer loans and has implemented regulatory actions against two of these
banks.
CURTAILMENT OF GOVERNMENT GUARANTEED LOAN PROGRAMS COULD CUT OFF AN IMPORTANT
SEGMENT OF THE COMPANY'S BUSINESS
A major part of the Company's business consists of originating and selling
government guaranteed loans, in particular those guaranteed by the Small
Business Administration. From time to time, the government agencies that
guarantee these loans reach their internal limits, and cease to guarantee loans
for a stated time period. In addition, these agencies may change their rules
for loans. Also, Congress may adopt legislation that would have the effect of
discontinuing or changing the programs. Non-governmental programs could replace
government programs for some borrowers, but the terms might not be equally
acceptable. Therefore, if these changes occur, the volume of loans to small
business, industrial and agricultural borrowers of the types that now qualify
for government guaranteed loans could decline. Also, the profitability of these
loans could decline.
BANK REGULATIONS COULD DISCOURAGE CHANGES IN THE COMPANY'S OWNERSHIP
Bank regulations would delay and possibly discourage a potential acquirer who
might have been willing to pay a premium price to amass a large block of common
stock. That in turn could decrease the value of the Company's common stock and
the price that you will receive if you sell your shares in the future. Before
anyone can buy enough voting stock to exercise control over a bank holding
company like Bancshares, bank regulators must approve the acquisition. A
shareholder must apply for regulatory approval to own 10 percent or more of the
Company's common stock, unless the shareholder can show that he or she will not
actually exert control over the Company. In no case can a shareholder own more
than 25 percent of the Company's common stock without applying for regulatory
approval.
THE COMPANY DOES NOT EXPECT TO PAY DIVIDENDS
The Company does not intend to pay dividends on its common stock for the
foreseeable future. Instead, it intends to reinvest earnings in its business.
In addition, Bancshares would need the approval of the Reserve Bank (under the
terms of the Company's Memorandum of Understanding) to pay dividends to its
shareholders. One source of funds for the payment of dividends by Bancshares
would be from dividends paid by Goleta to Bancshares. Goleta's ability to pay
dividends to Bancshares is limited by California law, federal banking law, and
the terms of Goleta's Formal Agreement with the OCC. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Supervision and Regulation - Formal Agreement With the OCC" and "- Memorandum of
Understanding With the Federal Reserve Bank."
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THE PRICE OF THE COMPANY'S COMMON STOCK MAY CHANGE RAPIDLY AND SIGNIFICANTLY
The market price of the Company's common stock could change rapidly and
significantly at any time. The market price of the Company's common stock has
fluctuated in recent years. Between January 1, 2000 and December 31, 2001, the
closing market price of its common stock ranged from a low of $3.78 per share to
a high of $6.95 per share. Fluctuations may occur, among other reasons, in
response to:
- Short-term or long-term operating results;
- Regulatory action or adverse publicity;
- Perceived value of the Company's loan portfolio;
- Trends in the Company's nonperforming assets or the nonperforming
assets of other financial institutions;
- Announcements by competitors;
- Economic changes;
- General market conditions; or
- Legislative and regulatory changes.
The trading price of the Company's common stock may continue to be subject to
wide fluctuations in response to the factors set forth above and other factors,
many of which are beyond the Company's control. The stock market in recent
years has experienced extreme price and trading volume fluctuations that often
have been unrelated or disproportionate to the operating performance of
individual companies. The Company believes that investors should consider the
likelihood of these market fluctuations before investing in the Company's common
stock.
SECURITY RISKS RELATED TO ONLINE BANKING SERVICES
Goleta offers online banking services to its clients and other services on its
Web site. The secure transmission of confidential information over the Internet
is essential to maintain clients' confidence in the Company's online services.
Advances in computer capabilities, new discoveries or other developments could
result in a compromise or breach of the technology used by us to protect client
transaction data. Although the Company has developed systems and processes that
are designed to prevent security breaches, failure to mitigate breaches of
security could expose the Company to liability or inhibit its ability to expand
online services, which would adversely affect its financial condition.
Financial services customers are generally sensitive to security and privacy on
the Internet and any publicized security problems could inhibit the growth of
the Internet in general as a means of conducting commercial transactions. The
Company's ability to provide financial services over the Internet would be
severely impeded if clients became unwilling to transmit confidential
information online. As a result, the Company's operations and financial
condition could be adversely affected.
THE COMPANY DEPENDS ON KEY EMPLOYEES
If the Company lost key employees temporarily or permanently, the Company's
business could suffer material harm. The Company could be particularly hurt if
key employees went to work for competitors. The Company's future success
depends on the continued contributions of existing senior management personnel,
including the President and Chief Operating Officer of Bancshares, Stephen W.
Haley, and the President of Goleta, Lynda Nahra.
ENVIRONMENTAL LAWS COULD FORCE THE COMPANY TO PAY FOR ENVIRONMENTAL PROBLEMS
When a borrower defaults on a loan secured by real property, the Company often
purchases the property in foreclosure or accepts a deed to the property
surrendered by the borrower. The Company may also take over the management of
-10-
commercial properties whose owners have defaulted on loans. While Goleta has
guidelines intended to exclude properties with an unreasonable risk of
contamination, hazardous substances may exist on some of the properties that
Goleta owns, manages or occupies. The Company faces the risk that environmental
laws could force it to clean up the properties at the Company's expense. It may
cost much more to clean a property than the property is worth. The Company
could also be liable for pollution generated by a borrower's operations if the
Company took a role in managing those operations after a default. The Company
may also find it difficult or impossible to resell contaminated properties.
COMPETITION AND SERVICE AREA
-------------------------------
The financial services industry is highly competitive with respect to both loans
and deposits. Overall, the industry is dominated by a relatively small number
of major banks with many offices operating over wide geographic areas. Some of
the major commercial banks operating in the Company's service areas offer
certain services, which are not offered directly by the Company or any of its
subsidiaries. Some of these services include: in-depth trust and investment
services, international banking, and due to their size, a substantially higher
lending limit. To help offset the numerous branch offices of banks, thrifts,
and credit unions, as well as competition from mortgage brokers, insurance
companies, credit card companies, and brokerage houses within the Company's
service areas, the Company, through its subsidiaries, has established loan
production offices in Sacramento, Fresno, San Francisco, Santa Maria, Santa
Barbara, Orange County, and Ventura, California; Nevada; Georgia; Florida;
Oregon; Washington; Columbia, South Carolina; Tennessee and Colorado. The
Company's online capabilities allow it to support these offices from its main
computer center in Goleta, California. Part of the Company's strategy is to
establish loan production offices in areas where there is high demand for the
loan products that it originates.
The Company uses the flexibility of its independent status to compete for loans
and deposits within its primary service area. Management has established highly
personalized banking relationships with the Company's customers and is attuned
and responsive to their financial and service requirements. The Company
emphasizes its experienced management and trained staff to handle the
specialized banking needs of its customers. In the event there are customers
whose loan demands exceed the Company's lending limits, the Company works to
arrange for such loans on a participation basis with other financial
institutions. The Company also assists those customers requiring specialized
services not offered by the Company to obtain such services through
correspondent institutions.
EMPLOYEES
---------
As of December 31, 2001, the Company employed 230 people. The Company's
employees are not represented by a union or covered by a collective bargaining
agreement. Management of the Company believes that, in general, its employee
relations are good.
ITEM 2. DESCRIPTION OF PROPERTY
------- -------------------------
The Company owns the Goleta full-service branch located at 5827 Hollister
Avenue, Goleta, California. It consists of a 4,000 square-foot facility, and a
separate 400 square-foot building which currently is subleased to a third party.
The Company leases a 20,684 square-foot corporate office located at 445 Pine
Avenue, Goleta, California. The lease is for a term expiring March 31, 2007,
with a current monthly rent of $26,889. The lease also provides the Company
with two options of five years each, to extend the lease. This facility houses
the Company's corporate offices, comprised of various departments, including
finance, data processing, compliance, human resources, electronic business
services, special assets, operations and loan collection.
The Company also leases 18 additional office spaces ranging in size from 190 to
8,200 square feet with lease terms expiring in one month up to a maximum of 5
years. Monthly lease expense per premise ranges from $225 to $31,364. The
Company currently subleases two of the spaces to third parties. The Company's
total occupancy expense, including depreciation, for the year ended December 31,
2001 was $3,625,355. Management believes that its existing facilities are
adequate for its present purposes.
The more significant leases include the following:
-11-
The Company leases, under two separate leases, approximately 3,744 square feet
of office space located at 3891 State Street, Santa Barbara, California. The
leases are for terms expiring April 30, 2002 and April 30, 2003, with an
approximate rent of $7,890 per month. This facility houses the Retail and
Wholesale Mortgage Lending departments of the Company.
The Company leases approximately 3,431 square feet of office space located at
1463 South Victoria Avenue, Ventura, California. The lease is for a term
expiring July 20, 2002, with an approximate rent of $5,555 per month. This
facility houses the Ventura branch office of Goleta, as well as the Ventura
mortgage, SBA, and accounts receivable financing departments of the Company.
The Company leases approximately 7,570 square feet of space located at 681 South
Parker Street Suite 350, Orange, California. The lease is for a term expiring
September 30, 2003, with a current monthly rent of $9,463 per month. This
facility houses the Orange County loan production office of the Company.
The Company leases approximately 6,380 square feet of space located at 5383
Hollister Avenue, 2nd Floor, Goleta, California. The lease is for a term
expiring November 30, 2002, with an approximate rent of $8,932 per month. On
May 18, 2000, the Company sublet the entire space. The sublease does not
provide an option for the sublessee to extend the sublease.
The Company leases three suites in an office building at 5638 Hollister Avenue,
Goleta, California. The leases are for terms expiring May 31, 2003, with a
current monthly rent of $11,177 per month for all three suites. The leases also
provide the Company with two additional consecutive options of three years each
to extend the leases. The suites consist of approximately 8,200 square feet of
office space. The Company sublet these suites to an independent third party for
a term commencing May 1, 2000 and expiring May 31, 2003. The sublease does not
provide the sublessee an option to extend the sublease.
ITEM 3. LEGAL PROCEEDINGS
------- ------------------
The following summarizes the Company's significant legal proceedings.
FORMER ACCOUNTANTS
-------------------
In October 2000, the Company filed a lawsuit against its former accountants
alleging deficient consulting and audit services that led to the restatement of
the Company's 1998 financial statements and ultimately to an impairment of
capital. In April 2001, the Company settled the lawsuit and received $7 million
in cash. The proceeds are reflected as "other income" for financial reporting
purposes. The Company also incurred $2,392,000 in legal and professional fees
in connection with the litigation which are included as other expenses.
SHORT-TERM CONSUMER LENDING
-----------------------------
Goleta makes short-term consumer loans ("Bank Loans") using certain marketing
and servicing assistance of ACE at almost all of ACE's retail locations pursuant
to the terms of a Master Loan Agency Agreement between ACE and Goleta (the
"Goleta Agreement"). A number of lawsuits and state regulatory proceedings have
been filed or initiated against Goleta and/or ACE regarding the Bank Loans.
A key issue in the existing lawsuits and state regulatory proceedings concerning
the Bank Loans is whether Goleta or ACE is properly regarded as the lender.
Goleta and ACE maintain that, as provided by the legal documentation and
marketing materials for the Bank Loans, Goleta is the lender and that, because
Goleta is a national bank located in California, the Bank Loans, including the
interest that may legally be charged, should be governed by federal and
California law. The opposing parties in most of these lawsuits and regulatory
proceedings, however, maintain that ACE should be regarded as the lender,
because of the services it renders to Goleta under the Goleta Agreement and
ACE's purchase of participation interests in the Bank Loans, and that the Bank
Loans, including interest that may legally be charged, should be governed by the
laws of the respective states in which the borrowers reside. If ACE were held
to be the lender, then the interest charged for the Bank Loans would violate
most of the applicable states' usury laws, which impose maximum rates of
-12-
interest or finance charges that a non-bank lender may charge. The consequences
to the Company of such a holding in any lawsuit or regulatory proceeding would
depend on the applicable state's usury and consumer-protection laws and on the
basis for a finding of violation of those laws. Those consequences could include
the Company's obligation to refund interest collected on the alleged illegal
Bank Loans, to refund the principal amount of the alleged illegal Bank Loans, to
pay treble or other multiple damages, to pay monetary penalties specified by
statute, and to cease offering the Bank Loans (at least as theretofore offered).
Regarding each lawsuit, that amount would depend upon proof of the allegations,
the number or the amount of the loan-related transactions during relevant time
periods, and (for certain of the claims) proof of actual damages sustained by
the plaintiffs. The Goleta Agreement generally provides that ACE will be liable
for 90% to 95% of the costs and monetary damages, if any, that would be paid to
claimants in these actions and Goleta will generally be liable for 5% to 10% of
such costs and/or monetary damages. However, if the Goleta Agreement is invalid
or unenforceable, or if ACE is unable to pay, Goleta may be liable for up to the
full amount of any and all claims.
Adverse determinations in one or more of these actions could have a material
adverse impact on the Company's financial condition or results of operations and
continuation of the short-term consumer lending business, and could result in
adverse actions by the regulatory agencies with authority over Goleta and the
Company, including the OCC and the Board of Governors of the Federal Reserve
System. The OCC has expressed strong reservations about Goleta and other
national banks entering into arrangements with third parties to make short-term
consumer loans and has implemented regulatory actions against two of these
banks.
The following is a summary of the significant lawsuits relating to the Bank
Loans. Most of the following cases are in their early stages and the outcome of
any litigation is inherently uncertain. Based on advice from legal counsel,
management has no reason to believe it probable that the resolution of these
matters will have a material adverse impact on the Company's financial condition
or results of operations. However, it is possible that adverse determinations
in one or more of these actions could ultimately have a material adverse
financial impact on the Company and could also result in adverse actions by the
regulatory agencies with authority over Goleta.
1. JENNAFER LONG V. ACE CASH EXPRESS, INC. This lawsuit, originally filed
--------------------------------------
against ACE (and not Goleta) in Florida state court on behalf of a
putative class of Florida borrowers, alleges that the Bank Loans at
ACE's Florida locations should be deemed to be made by ACE rather than
by Goleta and, therefore, that those Bank Loans violate Florida usury
laws and Florida statutory prohibitions against misrepresentations and
deceptive practices. The plaintiff seeks an unspecified amount of
damages, including an amount equal to all interest charged on the Bank
Loans made in Florida, the plaintiff's attorneys' fees, and court
costs. ACE's earlier attempt to remove this case to federal court was
unsuccessful and Goleta subsequently intervened as a defendant in the
lawsuit. ACE and Goleta moved to dismiss the lawsuit on the ground
that, under governing federal law, Goleta is entitled to charge
interest on the Bank Loans at the rates permitted under the law of the
State of California, where Goleta is located. However, the court
denied the motion to dismiss.
2. NOTICE FROM OHIO DEPARTMENT OF COMMERCE. In July 2001, the
--------------------------------------------
Superintendent of the Ohio Division of Financial Institutions (the
"Ohio Superintendent") delivered to ACE a Notice of Intent to Issue
Cease and Desist Order and Notice of Opportunity for Hearing. This
Notice asserts that ACE, not Goleta, is the lender of the Bank Loans
made in Ohio; that those Bank Loans violate the Ohio Small Loan Act
and are void; that all finance charges and interest received from
those Bank Loans, as well as the outstanding principal of all such
existing Bank Loans, should be forfeited; and that ACE should be
ordered to cease violating the Ohio Small Loan Act. In response to the
Notice, Goleta initiated a lawsuit in federal court against the Ohio
Superintendent seeking declaratory and injunctive relief against the
Ohio Superintendent's pursuit of a regulatory action against ACE. The
thrust of Goleta's action is that, under federal law, the interest
charges on the Bank Loans are governed by California and not Ohio law.
In response to this federal court lawsuit, the Ohio Superintendent
agreed to suspend the Ohio regulatory proceeding against ACE until the
federal court rules on Goleta's complaint. The Ohio Superintendent has
moved to dismiss Goleta's lawsuit on a series of jurisdictional and
procedural grounds. Goleta's motion for a preliminary injunction and
the Ohio Superintendent's motion to dismiss have been largely briefed
but no hearing has yet been scheduled.
3. ORDER TO SHOW CAUSE FROM MARYLAND COMMISSIONER OF FINANCIAL
-------------------------------------------------------------------
REGULATION. In December 2001, ACE settled a regulatory proceeding
initiated against it in July 2001 by the Maryland Commissioner of
-13-
Financial Regulation. Among other things, the settlement agreement
provides for ACE to pay a total of $164,000 of penalties for failing
to maintain requisite licenses in connection with its activities
regarding Maryland Bank Loans. By agreement with ACE, Goleta did not
contribute to the costs or penalties in connection with this
regulatory proceeding.
4. STATE OF COLORADO, EX REL. KEN SALAZAR, ATTORNEY GENERAL FOR THE STATE
----------------------------------------------------------------------
OF COLORADO, AND LAURA E. UDIS, ADMINISTRATOR, UNIFORM CONSUMER CREDIT
----------------------------------------------------------------------
CODE V. ACE CASH EXPRESS, INC. This lawsuit regarding Bank Loans
-----------------------------------
offered and made at ACE's locations in Colorado was filed on behalf of
the State of Colorado against ACE (and not Goleta) in a Colorado state
court in Denver, Colorado in July 2001. The complaint alleges that
these Bank Loans are "deferred deposit" loans subject to the Colorado
Deferred Deposit Loan Act (the "DDLA"), which is part of the Colorado
Uniform Consumer Credit Code ("UCCC"); that the second and third
renewals of the Bank Loans violate the DDLA (which purports to permit
only one renewal of deferred deposit loans at the interest rates
permitted by the DDLA); and that ACE is required to maintain a license
as a "supervised lender" in Colorado because of its activities in
connection with the Bank Loans. ACE voluntarily relinquished its
license as a supervised lender in Colorado in December 2000.
In its complaint, the State of Colorado seeks various remedies against
ACE under the Colorado UCCC and other Colorado law, including the
refund to borrowers of all finance charges or interest received on all
Bank Loans made in Colorado while ACE was unlicensed; the refund to
borrowers of all finance charges or interest received on all second
and third renewals of the Bank Loans since July 1, 2000, the effective
date of the DDLA; and a penalty (to be determined by the court) equal
to the greater of either all of the finance charges or interest
received or up to ten times the amount of all excess finance charges
or interest received. The complaint also seeks an injunction
prohibiting ACE from continuing to engage in activities regarding the
Bank Loans in Colorado without a supervised lender license.
In or about July 2001, the State of Colorado filed a motion for a
preliminary injunction to require ACE to cease all activities
regarding the Bank Loans in Colorado immediately, subject to an
expedited hearing on the legality of those activities. In August 2001,
ACE removed this lawsuit to federal court. However, the case was
remanded to state court in January 2002. Arguments available to ACE in
defending the lawsuit include, without limitation, that: (1) the Bank
Loans are not deferred deposit loans under the DDLA; (2) the State is
not entitled to the remedies it is seeking for the alleged licensing
violations; and (3) the limits regarding loan renewals imposed by the
DDLA are preempted by federal law. Though ACE does not admit that it
is required to obtain a supervised lender license under the Colorado
UCCC, it has submitted applications for re-licensure and has begun
discussions with the State regarding resolution of the State's
licensing claims. Subject to approval of the ACE Board of Directors
and negotiation and execution of a definitive settlement agreement,
ACE and the State have informally agreed to a settlement of this
lawsuit under which ACE would make payments to Colorado borrowers in
exchange for releases; ACE would be retroactively licensed to make or
broker deferred deposit loans under the Colorado UCCC; and ACE would
commence making loans directly to Colorado borrowers rather than
brokering Bank Loans on behalf of Goleta. ACE has agreed with Goleta
that ACE will be solely liable for all costs and payments in
connection with this litigation.
5. RUFUS PATRICIA BROWN V. ACE CASH EXPRESS, INC. ET AL. This lawsuit, on
----------------------------------------------------
behalf of a punitive class of borrowers who obtained their Bank Loans
at ACE locations in Maryland, was filed in August 2001 in the Circuit
Court for Baltimore City, Maryland. While ACE removed the case to
federal court, the federal court remanded the case to state court.
Goleta subsequently intervened as a defendant in the case. In this
case, the plaintiff alleges that the Bank Loans violate Maryland usury
laws, the Maryland Consumer Loan Law, the Maryland Credit Services
Businesses Act, and the Maryland Consumer Protection Act and are
unconscionable under Maryland law. The plaintiff seeks relief of
various kinds, including a permanent injunction against any further
alleged illegal activities; an award of three times excess interest
charges on the Bank Loans; the return of principal on the Bank Loans;
and court costs and attorneys' fees and expenses. The defendants have
answered the complaint and discovery has commenced. However, this case
remains in its preliminary stages at present.
-14-
6. BEVERLY PURDIE V. ACE CASH EXPRESS, INC. ET AL. This lawsuit was filed
----------------------------------------------
in September 2001 in the United States District Court for the Northern
District of Texas and names Goleta, ACE and certain ACE executives as
defendants. In the complaint, the plaintiff purports to represent a
class of all consumers in the United States who obtained Bank Loans.
The plaintiff alleges that the Bank Loans and defendants' activities
in connection therewith violate the federal Racketeering and Corrupt
Organizations Act ("RICO") and the laws and regulations of various
states regarding usury, deceptive trade practices (including the Texas
Deceptive Trade Practices Act), and other consumer protections. The
plaintiff seeks relief of various kinds, including a permanent
injunction against collecting any moneys in connection with the Bank
Loans; restitution of all amounts paid to the defendants; damages
equal to three times the amount of all fees and interests paid by the
class; punitive damages of at least $250 million; the plaintiff's
attorneys' fees; and court costs. The defendants have moved to dismiss
the complaint on the grounds that the RICO claims are deficient as a
matter of law and that, after dismissing the RICO claims, the court
should not retain jurisdiction of the remaining state-law claims.
7. VONNIE T. HUDSON V. ACE CASH EXPRESS, INC. ET AL. This lawsuit on
-----------------------------------------------------
behalf of borrowers who received Bank Loans offered and made at ACE's
locations in Indiana was filed in September 2001 in federal court for
the Southern District of Indiana. The defendants include Goleta, ACE
and certain ACE executives. The plaintiff alleges that the Bank Loans
violate the Indiana Uniform Consumer Credit Code and the Indiana
"loansharking" statute, because the interest exceeds the finance
charges permitted by those statutes; that the Bank Loans violate the
federal Truth in Lending Act ("TILA") and the Indiana UCCC because the
disclosures to borrowers do not comply with the disclosure
requirements of those laws; and that the Bank Loans also violate RICO.
The plaintiff seeks relief of various kinds, including: (a) for the
members of the class of plaintiffs who were allegedly charged
excessive interest, an order declaring the Bank Loans "void," the
refund of all finance charges or interest paid by them in excess of
the maximum finance charges permitted under the Indiana UCCC, and a
penalty (to be determined by the court) in a maximum amount equal to
the greater of either all of the finance charges or interest received
from them or up to ten times the amount of all excess finance charges
or interest received from them; (b) for the members of the class of
plaintiffs who allegedly did not receive proper disclosures under TILA
and the Indiana UCCC, statutory damages of $500,000 for violations of
each statute; (c) for the members of the class of plaintiffs allegedly
damaged because of RICO violations, an amount equal to three times
those damages; and (d) the plaintiff's attorneys' fees and court
costs. The defendants have moved to dismiss this lawsuit on the ground
that the Bank Loans are made by Goleta and not ACE and, accordingly,
the interest charges are governed by federal and California law and
not Indiana law.
8. GOLETA NATIONAL BANK AND ACE CASH EXPRESS, INC. V. HAL D. LINGERFELT,
----------------------------------------------------------------------
IN HIS OFFICIAL CAPACITY AS THE COMMISSIONER OF BANKS OF NORTH
----------------------------------------------------------------------
CAROLINA, ET AL. In January 2002, Goleta and ACE instituted suit
------------------
against defendants for declaratory and injunctive relief with respect
to defendants' threatened initiation of state court proceedings
against ACE. Goleta and ACE allege that defendants threatened to
impair Goleta's federally created rights to make Bank Loans to North
Carolina residents, to charge the interest allowed by the laws of
California, where Goleta is located, to obtain assistance from ACE in
making its Bank Loans and to sell interests in its Bank Loans. The
State has moved to dismiss this lawsuit on the ground that the federal
court does not have the power to hear the case. Also in January 2002,
immediately after the filing of the Goleta/ACE lawsuit, the State of
North Carolina initiated the threatened lawsuit in North Carolina
state court against ACE (but not Goleta), alleging that ACE and not
Goleta is the lender and that the Bank Loans accordingly are usurious
and alleging in addition or in the alternative that ACE has violated
North Carolina loan broker and check cashing statutes. ACE removed the
State lawsuit to federal court and the State moved to remand the case
to state court. Answers have been filed in both cases.
OTHER LITIGATION
-----------------
The Company is involved in various other litigation of a routine nature which is
being handled and defended in the ordinary course of the Company's business. In
the opinion of management, based in part on consultation with legal counsel, the
resolution of these other litigation matters will not have a material impact on
the Company's financial position.
-15-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
------- ------------------------------------------------------------
None.
-16-
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
------- -------------------------------------------------------------------
MATTERS
-------
The following table sets forth the high and low closing sales prices on a per
share basis for the common stock as reported by the Nasdaq National Market for
the period indicated:
Common Stock
------------
Low High
----- -----
2002 First Quarter $3.95 $6.07
2001 First Quarter $3.78 $5.50
Second Quarter 3.95 6.25
Third Quarter 6.10 6.95
Fourth Quarter 5.50 6.50
2000 First Quarter $5.50 $8.00
Second Quarter 5.38 6.88
Third Quarter 5.13 6.25
Fourth Quarter 3.38 5.25
On April 12, 2002, the last reported sale price per share for the Company's
common stock was $4.55.
The Company had 514 shareholders of record of its common stock as of December
31, 2001.
No cash dividends have been paid to shareholders during the past two years, and
the Company does not expect to declare cash dividends in the foreseeable future.
The payment of dividends is within the discretion of the Company's Board of
Directors and will depend upon, among other things, the Company's earnings,
financial condition, capital requirements and general business condition. The
payment of dividends requires the approval of the Reserve Bank under the
Company's Memorandum of Understanding. One source of funds for the payment of
dividends by Bancshares would be from dividends paid by Goleta to Bancshares.
Goleta's ability to pay dividends to Bancshares is limited by California law,
federal banking law, and the terms of Goleta's Formal Agreement with the OCC.
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations - Supervision and Regulation - Limitations on Dividend
Payments," "- Formal Agreement With the OCC" and "-Memorandum of Understanding
With the Federal Reserve Bank."
-17-
ITEM 6. SELECTED FINANCIAL DATA
------- -------------------------
SUMMARY OF OPERATIONS
-----------------------
The following summary of the Company's consolidated financial condition and
results of operations, as of and for the years ended December 31, 2001, 2000,
1999, 1998 and 1997, should be read in conjunction with the consolidated
financial statements and the related notes included elsewhere in this report.
The notes to the consolidated financial statements include a summary of
significant accounting policies.
December 31,
------------------------------------------------------------
(Dollars in thousands, except per share data) 2001 2000 1999 1998 1997
----------- ---------- ----------- ---------- ----------
Interest income $ 40,794 $ 51,781 $ 48,495 $ 15,279 $ 8,009
Interest expense 19,967 26,060 25,145 6,317 2,910
----------- ---------- ----------- ---------- ----------
Net interest income 20,827 25,721 23,350 8,962 5,099
Provision for loan losses 11,880 6,794 6,133 1,759 260
----------- ---------- ----------- ---------- ----------
Net interest income after provision
for loan losses 8,947 18,927 17,217 7,203 4,839
Other operating income 22,171 16,283 11,021 11,022 9,432
Other operating expense 32,377 29,975 30,506 17,482 11,524
----------- ---------- ----------- ---------- ----------
(Loss) income before income taxes (1,259) 5,235 (2,268) 743 2,747
(Benefit) provision for income taxes (1,281) 2,538 (622) 289 1,158
----------- ---------- ----------- ---------- ----------
Net income (loss) $ 22 $ 2,697 $ (1,646) $ 454 $ 1,589
=========== ========== =========== ========== ==========
Income (loss) per common share - Basic $ 0.00 $ 0.44 $ (0.30) $ 0.12 $ 0.53
Number of shares used in income (loss)
per share calculation - Basic (1) 5,947,658 6,017,216 5,494,217 3,767,607 3,016,208
Income (loss) per common share - Diluted $ 0.00 $ 0.43 $ (0.30) $ 0.12 $ 0.44
Number of shares used in income (loss)
per share calculation - Diluted (1) 5,998,003 6,233,245 5,494,217 3,941,749 3,588,478
Net loans $ 260,955 $ 329,265 $ 451,664 $ 247,411 $ 59,315
Total assets 323,863 405,255 523,847 327,569 87,468
Deposits 196,166 228,720 313,131 223,853 75,962
Total liabilities 290,506 369,221 489,915 298,448 76,623
Total stockholders' equity 33,357 36,035 33,932 29,121 10,845
--------------------
(1) Earnings per common share information is based on a weighted average number
of common shares outstanding during each period. Earnings per share amounts
have been adjusted to reflect the 2-for-1 stock split in 1998.
-18-
RETURN ON EQUITY AND ASSETS
-------------------------------
Selected ratios, for the periods set forth, are indicated in the following
table:
Year Ended December 31,
---------------------------------------
2001 2000 1999 1998 1997
------ ------ ------- ------ ------
Net income (loss) to average stockholder equity 0.07% 7.35% (6.68)% 3.50% 14.64%
Net income (loss) to average total assets 0.01% 0.61% (0.37)% 0.20% 1.82%
Total interest expense to total interest income 48.95% 50.33% 51.85% 41.34% 36.33%
Other operating income to other operating expense 68.48% 54.32% 36.13% 63.05% 81.85%
Equity to assets ratio 10.30% 8.89% 6.51% 8.77% 12.73%
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
------- -------------------------------------------------------------------
RESULTS OF OPERATIONS
-----------------------
INTRODUCTION
------------
This discussion is designed to provide a better understanding of significant
trends related to the Company's consolidated financial condition, results of
operations, liquidity, capital resources, and interest rate sensitivity. It
should be read in conjunction with the consolidated financial statements and
notes thereto and the other financial information appearing elsewhere in this
report.
-19-
CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
The following table sets forth, for the period indicated, the increase or
decrease of certain items in the consolidated statements of operations of the
Company as compared to the prior periods:
Year Ended December 31,
--------------------------------------------------------------------------------
2001 versus 2000 2000 versus 1999 1999 versus 1998
-------------------------- ------------------------- -------------------------
Amount of Percent of Amount of Percent of Amount of Percent of
increase Increase increase increase increase increase
(decrease) (decrease) (decrease) (decrease) (decrease) (decrease)
------------- ----------- ------------ ----------- ------------ -----------
INTEREST INCOME:
Loans, including fees $(10,507,459) (21.1%) $ 2,767,595 5.89% $32,246,557 218.60%
Federal funds sold (310,841) (22.1%) 397,418 39.44% 597,248 145.49%
Time deposits in other financial
institutions 156,044 137.8% 66,107 140.27% (19,195) (28.94%)
Investment securities (325,137) (65.4%) 55,148 12.47% 390,840 758.81%
------------- ------------ ------------
Total interest income (10,987,393) (21.2%) 3,286,268 6.78% 33,215,450 217.39%
------------- ------------ ------------
INTEREST EXPENSE:
Deposits $ (1,873,474) (16.5%) $(3,745,649) (24.84%) $ 9,357,741 163.54%
Bonds payable and other borrowings (4,220,109) (28.7%) 4,660,533 46.30% 9,470,824 1592.52%
------------- ------------ ------------
Total interest expense (6,093,583) (23.4%) 914,884 3.64% 18,828,565 298.08%
NET INTEREST INCOME (4,893,810) (19.0%) 2,371,384 10.16% 14,386,885 160.52%
PROVISION FOR LOAN LOSSES 5,086,400 74.9% 660,853 10.78% 4,373,336 248.54%
------------- ------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES (9,980,210) (52.7%) 1,710,531 9.94% 10,013,549 139.02%
------------- ------------ ------------
OTHER INCOME:
Gains from loan sales $ (875,223) (11.7%) $ 1,503,300 25.11% $ 1,928,127 47.49%
Loan servicing fees (1,086,861) (39.0%) 2,290,448 458.36% (286,007) (36.40%)
Income from sale of interest in
Subsidiary (1,984,056) (95.4%) 2,080,000 100.00% - -
Other loan origination fees - sold
or brokered loans 1,606,101 88.0% (884,235) (32.63%) (969,273) (26.34%)
Document processing fees 861,535 77.2% 43,938 4.10% (150,590) (12.31%)
Service charges 16,171 2.9% 44,352 8.62% (349,759) (40.46%)
Gain from sale of servicing assets (186,531) (100.0%) 186,531 100.00% - -
Other income 536,018 229.0% (1,593) (0.68%) (174,318) (42.52%)
Proceeds from legal settlement 7,000,000 100.0% - - -
------------- ------------ ------------
TOTAL OTHER INCOME $ 5,887,154 36.2% $ 5,262,741 47.75% $ (1,820) (0.02)%
------------- ------------ ------------
-20-
Year Ended December 31,
-------------------------------------------------------------------------------
2001 versus 2000 2000 versus 1999 1999 versus 1998
------------------------- ------------------------- -------------------------
Amount of Percent of Amount of Percent of Amount of Percent of
increase Increase increase increase increase Increase
(decrease) (decrease) (decrease) (decrease) (decrease) (decrease)
------------ ----------- ------------ ----------- ------------ -----------
OTHER EXPENSES:
Salaries and employee benefits $ 2,463,080 16.2% $ (987,213) (6.08%) $ 5,428,596 50.27%
Occupancy expenses (194,628) (8.1%) (15,314) (0.63%) 981,684 68.41%
Depreciation expense (98,685) (6.5%) 89,399 6.26% 464,974 48.30%
Other operating expenses 48,877 1.5% 1,664,860 102.51% (145,639) (8.23%)
Loan servicing and collection
expense (1,146,585) (49.3%) 137,477 6.28% 1,931,479 752.09%
Impairment of goodwill (2,110,303) (100.0%) 2,110,303 100.00% - -
Professional services 1,288,628 135.7% (1,629,713) (63.19%) 2,058,416 395.31%
Advertising expense (44,118) (6.3%) (445,751) (38.72%) 357,215 44.98%
Amortization of intangible assets (226,119) (56.0%) 40,529 11.15% 300,008 471.99%
Office supply expense (56,427) (14.4%) 5,217 1.35% 192,142 99.21%
Data processing/ATM processing (20,866) (6.0%) (166,570) (32.55%) 262,746 105.52%
Postage and freight 107,412 36.4% (57,020) (16.20%) (84,920) (19.44%)
Lower of cost or market provision - - (1,276,709) (100.00%) 1,276,709 100.00%
Professional expenses associated
with legal settlement 2,391,576 100.0% - - - -
------------ ------------ ------------
TOTAL OTHER EXPENSES $ 2,401,842 8.0% $ (530,505) (1.74%) $13,023,410 74.50%
------------ ------------ ------------
(LOSS) INCOME BEFORE
(BENEFIT)PROVISION FOR
INCOME TAXES (6,494,898) (124.1%) 7,503,777 330.83% (3,011,681) (405.06%)
(BENEFIT) PROVISION FOR INCOME TAXES (3,819,523) (150.5%) 3,160,304 508.22% (911,286) (314.84%)
------------ ------------ ------------
NET INCOME (LOSS) $(2,675,375) (99.2%) $ 4,343,473 263.83% $(2,100,395) (462.58%)
------------ ------------ ------------
-21-
NET INTEREST INCOME AND NET INTEREST MARGIN
The Company earns income from two sources. The primary source is from the
management of its financial assets and liabilities. The second is from charging
fees for services it provides. The Company's income from managing assets
consists of gains realized on the sale of loans originated and the difference
between the interest income received from its loan portfolio and investments and
the interest expense paid on its liabilities, primarily interest paid on
deposits. This difference or spread is "net interest income." The net interest
income, when expressed as a percentage of average total interest-earning assets,
is referred to as the net interest margin on interest-earning assets. The
Company's net interest income is affected by the change in the level and the mix
of interest-earning assets and interest-bearing liabilities, referred to as
volume changes. The Company's net yield on interest-earning assets is also
affected by changes in the yields earned on assets and rates paid on
liabilities, referred to as rate changes. Interest rates charged on the
Company's loans are affected principally by the demand for such loans, the
supply of money available for lending purposes, competitive factors, and general
economic conditions such as federal economic policies, legislative tax policies
and governmental budgetary matters.
The following table presents the net interest income and net interest margin:
Year Ended December 31,
----------------------------------------
2001 2000 1999
------------ ------------ ------------
Interest income $40,793,796 $51,781,189 $48,494,921
Interest expense 19,966,531 26,060,114 25,145,230
------------ ------------ ------------
Net interest income $20,827,265 $25,721,075 $23,349,691
============ ============ ============
Net interest margin 5.6% 6.3% 5.4%
Total interest income decreased 21.2% from $51,781,189 in 2000 to $40,793,796 in
2001. Total interest expense decreased 23.4% from $26,060,114 in 2000 to
$19,966,531 in 2001. The decrease in both interest income and interest expense
was primarily due to: a) a decline in interest rates; b) the sale of Palomar
which is included in the income statement for 2001 for seven and one-half months
only; and c) prepayments experienced in the Company's securitized loan portfolio
off-set by increases in the level and yield of Goleta's short-term consumer
loans. As a result, net interest income decreased 19% from $25,721,075 in 2000
to $20,827,265 in 2001.
-22-
The following table sets forth the changes in interest income and expense
attributable to changes in rates and volumes:
Year Ended December 31,
-----------------------------------------------------------------------------------------
(Dollars in thousands) 2001 versus 2000 2000 versus 1999 1999 versus 1998
----------------------------- ---------------------------- ----------------------------
Change Change Change Change Change Change
Total due to due to Total due to due to Total due to due to
change rate volume change rate volume change rate volume
--------- -------- -------- -------- -------- -------- -------- -------- --------
Time deposits in other
financial institutions $ 59 $ (32) $ 91 $ 66 $ 1 $ 65 $ (20) $ 48 $ (68)
Federal funds sold (311) (417) 106 397 195 202 597 16 581
Investment securities (229) 148 (377) 56 102 (46) 391 271 120
Loans, net (3,833) (4,006) 173 (7,159) (2,039) (5,120) 15,196 (3,299) 18,495
Short-term consumer loans 4,085 1,822 2,263 1,523 - 1,523 - - -
Securitized loans (10,758) (6,199) (4,559) 9,926 7,824 2,102 17,051 16,248 803
--------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-earning
assets (10,987) (8,684) (2,303) 4,809 6,083 (1,274) 33,215 13,284 19,931
--------- -------- -------- -------- -------- -------- -------- -------- --------
Interest-bearing
demand 35 72 (37) 214 29 185 74 (21) 95
Savings (249) (87) (162) (172) (159) (13) 396 45 351
Time certificates of
deposit (1,660) (531) (1,129) (3,788) (1,875) (1,913) 8,888 1,334 7,554
Federal funds
purchased (19) (29) 10 (25) 10 (35) (41) - (41)
Bonds payable (4,122) (551) (3,571) 4,223 3,734 489 9,428 - 9,428
Other borrowings (79) 186 (265) 463 29 434 83 - 83
--------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities (6,094) (940) (5,154) 915 1,768 (853) 18,828 1,358 17,470
--------- -------- -------- -------- -------- -------- -------- -------- --------
Net interest income $ (4,893) $(3,565) $(1,328) $ 2,371 $ 4,315 $(1,944) $14,387 $11,926 $ 2,461
========= ======== ======== ======== ======== ======== ======== ======== ========
PROVISION FOR LOAN LOSSES
The provision for loan losses corresponds directly to the level of the allowance
that management deems sufficient to provide for probable losses, inherent in the
loan portfolio. The accumulated balance in the allowance for loan loss reflects
the estimated amount which management determined is adequate to provide for any
probable inherent loan losses after considering the mix of the loan portfolio,
current economic conditions, past loan experience and any other relevant
factors.
Management reviews the allowance for loan losses on a monthly basis and records
additional provisions to the allowance as needed. Management allocated
$11,880,212 as a provision for loan losses in 2001, $6,793,812 in 2000 and
$6,132,959 in 1999. Beginning in the year 2001, management began tracking loan
loss provision by major business segment. The following table summarizes the
provision expense for the year ended December 31, 2001:
Provision Percent of Loans Ending Loan
Expense In Each Category Balance
----------- ----------------- ------------
Short-term consumer loan portfolio $ 2,635,303 1.4% $ 3,261,509
Securitized loan portfolio 4,126,287 45.4% 108,191,062
General loan portfolio (principally SBA) 5,118,622 53.2% 126,535,947
----------- ------------
Total provision $11,880,212 100.0% $237,988,518
=========== ============
Loans charged off, net of recoveries were $9,589,625 in 2001, $5,576,287 in
2000, and $3,977,108 in 1999. The increased charge-offs in 2001 were primarily
due to the short-term consumer, securitized loan, and SBA programs. The ratio
-23-
of the allowance for loan losses to total gross loans was 3.5% at December 3l,
2001, 2.2% at December 31, 2000, and 1.9% at December 31, 1999.
In management's opinion, the balance of the allowance for loan losses at
December 31, 2001 was sufficient to absorb known and inherent probable losses in
the loan portfolio at that time.
-24-
OTHER INCOME
Changes in the components of other income are summarized in the section entitled
"Results of Operations." The following table summarizes the Company's other
income for the three years indicated:
Year Ended December 31,
-------------------------------------
OTHER INCOME 2001 2000 1999
----------- ----------- -----------
Gains from sale of loans $ 6,616,020 $ 7,491,243 $ 5,987,943
Loan origination fees 3,431,804 1,825,703 2,709,938
Document processing fees 1,978,091 1,116,556 1,072,618
Service charges 575,313 559,142 514,790
Loan servicing income 1,703,290 2,790,151 499,703
Gain from sale of subsidiary 95,944 2,080,000 -
Proceeds from legal settlement 7,000,000 - -
Gain from sale of servicing asset - 186,531 -
Other income 770,070 234,052 235,645
----------- ----------- -----------
TOTAL OTHER INCOME $22,170,532 $16,283,378 $11,020,637
=========== =========== ===========
Other income increased by $5,262,741 from 1999 to 2000 and by another $5,887,154
from 2000 to 2001. The primary factors contributing to the $5,262,741 increase
in 2000 were: a) a $2,080,000 gain on the sale of the Company's ePacific.com
subsidiary; b) a $1,503,300 increase in gain on sale of loans, principally SBA
loans; and c) a $2,290,448 increase in loan servicing income. Part of the
$2,290,448 increase in 2000 loan servicing fees was due to a $1,085,453
write-down of the Company's consumer finance servicing asset in 1999. There was
no such write-down in 2000. Most of the remaining increase in 2000 loan
servicing income was due to increased volume in the Company's SBA loan business.
The increases in 2000 other income were partially offset by an $884,235 decrease
in loan origination fees, principally in the Company's mortgage origination
business.
The primary factors contributing to the $5,887,154 increase in other income in
2001 were: a) $7,000,000 in proceeds from a legal settlement against the
Company's former auditors; b) an $861,535 increase in document processing fees,
principally in the Company's mortgage origination business; and c) a $1,606,101
increase in loan origination fees, also principally in the Company's mortgage
origination business. Several factors adversely affected 2001 other income
including: a) an $875,223 reduction in the gain on sale of loans, principally
in the Company's SBA business; and b) a $1,086,861 reduction in loan servicing
fees. The $1,086,861 reduction in 2001 loan servicing fees was principally due
to an increase in the amortization and write-down of the Company's SBA related
servicing and interest-only strip assets. These assets were written down by
$969,720 in 2000 and $2,284,383 in 2001.
-25-
OTHER EXPENSES
Changes in the components of other expense are summarized in the section
entitled "Result of Operations." The following table summarizes the Company's
other expense for the three years indicated:
Year Ended December 31,
-------------------------------------
OTHER EXPENSE 2001 2000 1999
----------- ----------- -----------
Salaries and employee benefits $17,704,138 $15,241,058 $16,228,271
Occupancy and depreciation expense 3,625,355 3,918,668 3,844,583
Other operating expense 3,337,846 3,288,969 1,624,109
Loan servicing and collection expense 1,179,185 2,325,770 2,188,293
Professional services 2,238,044 949,416 2,579,129
Advertising 661,448 705,566 1,151,317
Data and ATM processing expense 324,307 345,173 511,743
Amortization of goodwill 177,980 404,099 363,570
Impairment charge for goodwill - 2,110,303 -
Lower of cost or market expense - - 1,276,709
Postage and freight 402,406 294,994 352,014
Office supplies 334,595 391,022 385,805
Legal settlement expense 2,391,576 - -
----------- ----------- -----------
TOTAL OTHER EXPENSE $32,376,880 $29,975,038 $30,505,543
=========== =========== ===========
Other expenses decreased by $530,505 from 1999 to 2000 and increased by
$2,401,842 from 2000 to 2001. The primary factors contributing to the $530,505
decrease in 2000 were: a) a $987,213 reduction in salaries and employee
benefits, principally due to the downsizing of the Company's consumer finance
and mortgage origination activities; b) a $445,751 reduction in advertising
expense; c) a $1,276,709 lower of cost or market adjustment to the Company's
consumer finance loan balances recorded in 1999, but not in the year 2000, and
d) a $1,629,713 reduction in professional service expense in 2000, principally
due to the elimination of the costs associated with securitization activities,
and in 1999 due to the restatement of financial statements.
Loans which are originated and sold in the secondary market are carried at the
lower of cost or estimated fair value determined on an aggregate basis. At
December 31, 1999, the Company recorded a valuation adjustment to these loans of
$1,276,709. At December 31, 2000 and 2001, management determined that carrying
value approximated fair value and, thus, no valuation adjustment was determined
to be necessary.
The primary factors contributing to the $2,401,842 increase in other expenses
from 2000 to 2001 were: a) $2,391,576 of professional expenses incurred in 2001
in connection with a legal settlement with the Company's former auditors; and b)
a $2,463,080 increase in salaries and employee benefits, principally commission
paid on SBA and mortgage loans originated or brokered. These increases were
offset, in part, by: a) the elimination in 2001 of the impairment of goodwill
charge from the sale of the Company's subsidiary, Palomar; and b) a reduction of
$1,146,585 in loan servicing and collection expense, principally due to the
paydown of Goleta's securitized loan portfolios which are serviced by a third
party servicer.
-26-
The following table compares the various elements of other expenses as a
percentage of average assets:
Total Salaries and Occupancy and Other
Year Ended December 31, Average Other Employee Depreciation Operating
(Dollars in thousands) Assets (1) Expense Benefits Expenses Expenses
----------- ------------- -------------- ------------- ----------
2001 $ 371,923 8.71% 4.76% 0.97% 0.90%
2000 $ 439,945 6.81% 3.46% 0.89% 0.75%
1999 $ 450,041 6.78% 3.61% 0.85% 0.36%
----------------
(1) Based on the average of daily balances.
INCOME TAXES
Income taxes (benefit)/provision was $(1,281,057) in 2001, $2,538,466 in 2000,
and $(621,838) in 1999. The effective income (benefit) tax rate was 101.8%,
48.5% and (27.4)% for 2001, 2000 and 1999, respectively. The change in
effective tax rates from 2000 to 2001 is principally due to the sale of Palomar
and the proceeds from capital recovery.
NET INCOME (LOSS)
Net income (loss) for the Company was $21,762 in 2001, $2,697,137 in 2000, and
$(1,646,336) in 1999. Earnings (loss) per share was $0.00 per share (both
undiluted and diluted) in 2001, $0.44 per share ($0.43 per share on a diluted
basis) in 2000, and ($0.30) per share (both undiluted and diluted) in 1999. The
reduction in net income in 2001 was the result of a number of factors including,
among other things: a) the impact of adverse economic conditions which caused
the Company to record an $11.8 million provision for loan losses; b) an increase
in prepayment speed assumptions of sold loans which caused the Company to record
$2.6 million in amortizations and/or write-downs of its servicing and
interest-only assets; c) a reduction in net interest income resulting from both
a lower interest rate environment and lower securitized loan and related bond
borrowing balances; and d) $2.4 million of expense associated with litigation
with the Company's former auditors. These adverse factors were partially offset
by the $7,000,000 proceeds from a legal settlement with the Company's former
auditors.
The loss in 1999 was the result of a number of factors including, but not
limited to: a) $2.1 million of losses suffered by the Company's ePacific.com
subsidiary, and b) an approximately $1.3 million write-down in the carrying
value of approximately $150 million of loans previously accumulated for a
canceled securitization transaction.
CAPITAL RESOURCES
------------------
The Federal Deposit Insurance Corporation Improvement Act, herein referred to as
the "FDICIA," was signed into law on December 19, 1991. FDICIA included
significant changes to the legal and regulatory environment for insured
depository institutions, including reductions in insurance coverage for certain
kinds of deposits, increased supervision by the federal regulatory agencies,
increased reporting requirements for insured institutions, and new regulations
concerning internal controls, accounting, and operations.
The prompt corrective action regulations of FDICIA define specific capital
categories based on the institutions' capital ratios. The capital categories,
in declining order, are "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized." To be considered "well capitalized" an institution must have
a core capital ratio of at least 5% and a total risk-based capital ratio of at
least 10%. Additionally, FDICIA imposed in 1994 a new Tier I risk-based capital
ratio of at least 6% to be considered "well capitalized." Tier I risk-based
capital is, primarily, common stock and retained earnings net of goodwill and
other intangible assets.
-27-
To be categorized as "adequately capitalized" or "well capitalized," Goleta must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
and values as set forth in the tables below:
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------------- ------------------------- --------------------------
Year Ended December 31, 2001: Amount Ratio Amount Ratio Amount Ratio
----------- ------------ ----------- ------------ ------------ ------------
Total Risk-Based Capital (to Risk Weighted Assets)
Consolidated $36,689,265 13.02% $22,546,200 8.00% N/A(1) N/A
Goleta National Bank $32,623,280 11.84% $22,049,503 8.00% $ 27,561,879 10.00%
Tier I Capital (to Risk Weighted Assets)
Consolidated $33,107,751 11.75% $11,273,100 4.00% N/A N/A
Goleta National Bank $29,121,872 10.40% $11,024,751 4.00% $ 16,537,127 6.00%
Tier I Capital (to Average Assets)
Consolidated $33,107,751 9.07% $14,602,150 4.00% N/A N/A
Goleta National Bank $29,121,872 9.05% $12,874,019 4.00% $ 16,092,524 5.00%
--------------------
(1) Not applicable.
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------------- ------------------------- --------------------------
Year Ended December 31, 2001: Amount Ratio Amount Ratio Amount Ratio
----------- ------------ ----------- ------------ ------------ ------------
Total Risk-Based Capital (to Risk Weighted Assets)
Consolidated $38,645,337 11.04% $28,013,787 8.00% N/A(1) N/A
Goleta National Bank $35,573,765 12.12% $23,473,626 8.00% $ 29,342,032 10.00%
Palomar Community Bank $ 7,329,473 13.89% $ 4,223,104 8.00% $ 5,278,879 10.00%
Tier I Capital (to Risk Weighted Assets)
Consolidated $31,898,901 9.11% $14,006,894 4.00% N/A N/A
Goleta National Bank $31,876,965 10.86% $11,736,813 4.00% $ 17,605,219 6.00%
Palomar Community Bank $ 6,669,613 12.64% $ 2,111,552 4.00% $ 3,167,328 6.00%
Tier I Capital (to Average Assets)
Consolidated $31,898,901 7.25% $17,597,784 4.00% N/A N/A
Goleta National Bank $31,876,965 8.87% $14,375,225 4.00% $ 17,969,031 5.00%
Palomar Community Bank $ 6,669,613 8.75% $ 3,048,776 4.00% $ 3,810,970 5.00%
--------------------
(1) Not applicable.
A bank may not be considered "well capitalized" if it is operating under a
regulatory agreement, as is the case of Goleta. See " - Supervision and
Regulation - Formal Agreement With the OCC."
In the fourth quarter of 1999, the OCC notified Goleta that it had incorrectly
calculated the amount of regulatory capital required to be held in respect to
residual interests retained by Goleta in two securitizations of loans that were
consummated in the fourth quarter of 1998 and the second quarter of 1999.
Accordingly, the OCC informed Goleta that it was significantly undercapitalized
at March 31, 1999, June 30, 1999 and September 30, 1999.
-28-
On November 17, 1999, certain directors of the Company made a new debt and
equity investment in the Company of approximately $11 million. Simultaneously,
the Company made a capital contribution to Goleta of approximately $11 million.
The OCC subsequently informed Goleta that it was again adequately capitalized.
On March 23, 2000, Goleta signed a written agreement (the "Formal Agreement")
with the OCC. Under the terms of the Formal Agreement, by September 30, 2000,
Goleta was required to achieve and maintain total capital at least equal to 12%
of risk-weighted assets, and Tier I capital at least equal to 7% of adjusted
total assets. The Formal Agreement also required submission of a capital plan,
which included, among other things, specific plans for meeting the special
capital requirements, projections for growth and a dividend policy. The Formal
Agreement placed limitations on growth and payments of dividends until Goleta
was in compliance with its approved capital plan. See "- Supervision and
Regulation - Formal Agreement With the OCC."
Goleta achieved and maintained both of the aforementioned required 12% and 7%
capital ratios from September 30, 2000 to the end of 2001. As the result of
fourth quarter 2001 losses, Goleta's risk-based capital ratio declined to 11.84%
at December 31, 2001. On March 8, 2002, the Company made a $750,000 capital
contribution to Goleta, which would have increased Goleta's risk-based capital
ratio to 12.11% at December 31, 2001, had the contribution been made on that
date.
-29-
SCHEDULE OF AVERAGE ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY
As of the dates indicated below, the following schedule shows the average
balances of the Company's assets, liabilities and stockholders' equity accounts
as a percentage of average total assets:
December 31,
---------------------------------------------------------
2001 2000 1999
------------------ ------------------ -----------------
(Dollars in thousands) Amount % Amount % Amount %
--------- ------- --------- ------- --------- ------
ASSETS
------
Cash and due from banks $ 8,327 2.2% $ 9,550 2.2% $ 8,582 1.9%
Federal funds sold 26,696 7.1% 22,833 5.2% 19,287 4.3%
Time deposits in other financial institutions 4,498 1.2% 1,654 0.4% 703 0.2%
FRB/FHLB Stock 1,141 0.3% 926 0.2% 621 0.1%
Investment securities 2,861 0.8% 6,445 1.5% 7,538 1.7%
Loans:
Commercial 41,102 11.1% 26,293 6.0% 19,545 4.3%
Real estate 33,827 9.1% 35,962 8.1% 43,627 9.7%
Unguaranteed portions of loans insured by SBA 38,431 10.3% 24,023 5.4% 24,139 5.4%
Installment 38,875 10.5% 16,598 3.8% 7,520 1.6%
Loan participations purchased 10,544 2.8% 20,453 4.6% 8,978 2.0%
Less: allowance for loan loss (3,251) (0.9%) (5,698) (1.3%) (2,179) (0.5%)
Less: net deferred loan fees and premiums (291) (0.1%) (118) 0.0% (103) 0.0%
Less: discount on loan pool purchase - (0.0%) (953) (0.2%) (970) (0.2%)
--------- ------- --------- ------- --------- ------
Net loans 159,237 42.8% 116,560 26.4% 100,557 22.3%
Securitized loans, net 132,973 35.8% 174,245 39.6% 156,900 34.9%
Loans held for sale 18,344 4.9% 79,222 18.0% 140,910 31.3%
Other real estate owned 207 0.1% 147 0.0% 361 0.1%
Premises and equipment, net 3,533 1.0% 4,302 1.0% 4,682 1.0%
Servicing asset 2,654 0.7% 2,051 0.5% 1,813 0.4%
Accrued interest receivable and other assets 11,452 3.1% 22,010 5.0% 8,087 1.8%
--------- ------- --------- ------- --------- ------
TOTAL ASSETS $371,923 100.0% $439,945 100.0% $450,041 100.0%
========= ======= ========= ======= ========= ======
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Deposits:
Noninterest-bearing demand $ 39,708 10.7% $ 30,381 6.9% $ 24,761 5.5%
Interest-bearing demand 22,476 6.0% 23,548 5.3% 17,975 4.0%
Savings 17,056 4.6% 23,254 5.3% 23,776 5.3%
Time certificates, $100,000 or more 79,195 21.3% 78,342 17.8% 93,668 20.8%
Other time certificates 65,102 17.5% 86,227 19.6% 105,062 23.3%
--------- ------- --------- ------- --------- ------
Total deposits 223,537 60.1% 241,752 54.9% 265,242 58.9%
Bonds payable 111,327 29.9% 151,126 34.4% 144,311 32.1%
Other borrowings 3,463 0.9% 5,795 1.3% 1,128 0.3%
Federal funds purchased - 0.0% 287 0.1% 844 0.2%
Accrued interest payable and other liabilities 395 0.1% 4,297 1.0% 5,838 1.3%
--------- ------- --------- ------- --------- ------
Total liabilities 338,722 91.0% 403,257 91.7% 417,363 92.8%
Stockholders' equity
Common stock 26,297 7.1% 26,571 6.0% 22,779 5.0%
Retained earnings 6,901 1.9% 10,163 2.3% 9,941 2.2%
Unrealized loss on AFS securities 3 0.0% (46) 0.0% (42) 0.0%
--------- ------- --------- ------- --------- ------
Total stockholders' equity 33,201 9.0% 36,688 8.3% 32,678 7.2%
--------- ------- --------- ------- --------- ------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $371,923 100.0% $439,945 100.0% $450,041 100.0%
========= ======= ========= ======= ========= ======
-30-
INVESTMENT PORTFOLIO
---------------------
The following table summarizes the year-end carrying values of the Company's
investment securities for the years indicated:
Year Ended December 31,
----------------------
2001 2000 1999
----- ------ ------
(Dollars in thousands)
U.S. Treasury Securities $ - $1,902 $ 497
FRB Stock 775 775 302
FHLB Stock - 395 474
FHLB Bond - 1,000 -
FHLMC Bond - 491 -
FHLB Securities 118 - -
GNMA Securities - 2,125 2,746
FNMA Securities - 878 1,107
FHLMC Securities - 325 1,044
----- ------ ------
Total $ 893 $7,891 $6,170
===== ====== ======
The Company held one FNMA security investment at December 31, 2001 with a face
value of $118,000 maturing on January 18, 2002 with a yield of 2.2%.
INTEREST-ONLY STRIPS
At December 31, 2001 and 2000, the Company held interest-only strips in the
amount of $7,693,102 and $7,540,824, respectively. These interest-only strips
represent the present value of the right to the estimated net cash flows
generated by the SBA loans sold. Net cash flows consist of the difference
between (a) interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors and (ii) contractual
servicing fees. The Company determines the present value of these estimated net
cash flows at the time each loan sale closes, utilizing discount rate and
prepayment rate assumptions for each transaction.
The value of these assets is recalculated each period by taking into account the
value of a) new loans added to the portfolio of serviced loans, b) loans paid or
charged off, c) the expected normal amortization payment schedule of the
serviced loan portfolio, d) a constant prepayment speed ("CPR") assumption, and
e) appropriate discount rates.
At December 31, 2001, the Company utilized a CPR assumption of 13.44% which is
the weighted average actual prepayment speed experienced by all serviced loans
which have been in the portfolio for more than eight quarters. This prepayment
speed assumption is applied to all loans including those which have been in the
portfolio for less than eight quarters. The Company uses discount rates of
9.25% to 10.25% in its calculations. At December 31, 2000, the Company utilized
an 8% CPR assumption and discount rates of 12% to 13%.
The interest-only strips are accounted for as investments in debt securities
classified as trading securities. Accordingly, the Company marks them to fair
value with the resulting increase or decrease recorded through operations in the
current period.
LOAN PORTFOLIO
---------------
The Company's largest categories of loans held in the portfolio are commercial
loans, real estate loans, unguaranteed portion of SBA insured loans, installment
loans, and second mortgage loans. Loans are carried at face amount, net of
payments collected, the allowance for possible loan losses, deferred loan fees
and discounts on loans purchased. Interest on all loans is accrued daily,
primarily on a simple interest basis. It is generally the Company's policy to
place a loan on nonaccrual status when the loan is 90 days past due.
-31-
Thereafter, previously recorded interest is reversed and interest income
typically recognized on a cash basis. Certain loans 90 days or more past due
are maintained on accrual status as long as the management of the Company
remains confident the loan will be repaid in full within a short period of time.
The rates charged on variable rate loans are set at specific increments. These
increments vary in relation to the Company's published prime lending rate or
other appropriate indices. At December 31, 2001, approximately 34% of the
Company's loan portfolio was comprised of variable interest rate loans. At
December 31, 2000 and 1999, variable rate loans comprised approximately 32% and
20%, respectively, of the Company's loan portfolio. Management monitors the
maturity of loans and the sensitivity of loans to changes in interest rates.
The following table sets forth, as of the dates indicated, the amount of gross
loans outstanding based on the remaining scheduled repayments of principal,
which either could be repriced or remain fixed until maturity, classified by
years until maturity.
December 31,
----------------------------------------------------------------
2001 2000 1999
-------------------- -------------------- --------------------
(Dollars in thousands) Fixed Variable Fixed Variable Fixed Variable
--------- --------- --------- --------- --------- ---------
Less than One Year $ 10,346 $ 26,532 $ 1,058 $ 100,717 $ 789 $ 87,313
One Year to Five Years 3,975 6,195 8,250 5,403 8,342 4,628
More than Five Years (1) 164,356 58,761 219,213 642 354,282 536
--------- --------- --------- --------- --------- ---------
Total $ 178,677 $ 91,488 $ 228,521 $ 106,762 $ 363,413 $ 92,477
========= ========= ========= ========= ========= =========
--------------------
(1) Approximately $108 million of these loans are in the Company's securitized loan
portfolio which is funded by approximately $89 million of bonds payable.
DISTRIBUTION OF LOANS
The distribution of the Company's total loans by type of loan, as of the dates
indicated, is shown in the following table:
Year Ended December 31,
----------------------------------------------------------------------
(Dollars in thousands)
2001 2000 1999
------------------------- --------------------- --------------------
Percentage Percentage Percentage
Loan to Gross Loan to Gross Loan to Gross
Type of loan Balance Loans Balance Loans Balance Loans
------------ ----------- ---------- --------- --------- ---------
Commercial $ 26,411 9.8% $ 36,188 10.8% $ 12,102 2.7%
Real estate 44,602 16.5% 55,083 16.5% 44,139 9.7%
Unguaranteed portion
of loans insured by SBA 31,889 11.8% 30,888 9.2% 25,073 5.5%
Installment 28,223 10.5% 22,898 6.8% 6,348 1.4%
Loan participations purchased - - - - 25,395 5.6%
Loans held for sale 30,849 11.4% 37,195 11.1% 158,274 34.7%
Securitized Loans 108,191 40.0% 153,031 45.6% 184,559 40.4%
------------ ----------- ---------- --------- --------- ---------
GROSS LOANS 270,165 100.0% 335,283 100.0% 455,890 100.0%
Less:
Allowance for loan losses 8,275 6,746 5,529
Deferred loan fees (costs) 222 (2,710) (3,079)
Discount on SBA loans 1,105 1,982 1,776
------------ ---------- ----------
NET LOANS $ 260,563 $ 329,265 $ 451,664
============ ========== ==========
-32-
COMMERCIAL LOANS
In addition to traditional term commercial loans made to business customers, the
Company grants revolving business lines of credit. Under the terms of the
revolving line of credit, the Company grants a maximum loan amount, which
remains available to the business during the loan term. As part of the loan
requirements, the business agrees to maintain its primary banking relationship
with the Company. It is the Company's policy not to extend material loans of
this type in excess of one year.
REAL ESTATE LOANS
Real estate loans are primarily made for the purpose of purchasing, improving,
or constructing, single family residences, commercial, or industrial properties.
The majority of the Company's real estate loans are collateralized by liens on
single family homes. Maturities on such loans are generally 15 to 30 years.
A large part of the Company's real estate construction loans are first and
second trust deeds on the construction of owner-occupied single family
dwellings. The Company also makes real estate construction loans on commercial
properties. These consist of first and second trust deeds collateralized by the
related real property. Construction loans are generally written with terms of
six to twelve months and usually do not exceed a loan to appraised value of 80%.
Commercial and industrial real estate loans are secured by nonresidential
property. Office buildings or other commercial property primarily secure these
loans. Loan to appraised value ratios on nonresidential real estate loans are
generally restricted to 70% of appraised value of the underlying real property.
UNGUARANTEED PORTION OF SBA LOANS
The Company is approved as a "Preferred Lender" by the SBA. Loans made by the
Company under programs offered by the SBA are generally made to small businesses
for the construction or purchase of facilities, purchase of equipment, working
capital or the initial business purchase. The SBA generally guarantees between
75% and 90% of the funded commitment. Borrowers are required to provide
adequate collateral for these loans, similar to other commercial loans. The SBA
allows less-collateralized loans under its "Low Doc" program for loan
commitments under $100,000. When the Company originates an SBA loan, the
guaranteed portion of the loan is typically sold into the secondary market. The
Company typically retains the unguaranteed portion of the loan, as well as the
servicing right and related fee income on the loan. The SBA loans are all
variable interest rate loans based upon the Wall Street Journal Prime Rate. The
servicing spread is a minimum of 1.00% on all loans. Income recognized by the
Company on the sales of the guaranteed portion of these loans and the ongoing
servicing income received, are significant revenue sources for the Company.
INSTALLMENT LOANS
Installment loans consist of automobile, small equity lines of credit, loans
secured by manufactured housing and general purpose loans made to individuals.
These loans are primarily fixed rate loans with terms up to five years.
Included in this category as of December 31, 2001 and 2000 are approximately
$3.2 million and $1.5 million, respectively of the Company's short-term consumer
lending product, which consists of 14-day loans to individuals. See "Item 1.
Business - Lines of Business - Short-Term Consumer Lending."
SECOND MORTGAGE LOANS
The Company originates second mortgage loans with loan to value ratios as high
as 125%. In 1998 and 1999, the Company transferred $81 million and $122 million
of these loans, respectively, to special purpose trusts (the "Trusts"). The
Trusts then sold bonds to third party investors, which were secured by the
transferred loans. The bonds are held in a trust independent of the Company,
the trustee of which oversees the distribution to the bondholders. The mortgage
loans are serviced by a third party (the "Servicer"), who receives a stated
servicing fee. There is an insurance policy on the subordinate bonds that
guarantees the payment of the bonds.
-33-
As part of the securitization agreements, the Company received an option to
repurchase the bonds when the aggregate principal balance of the mortgage loans
sold declined to 10% or less of the original balance of mortgage loans
securitized. Because the Company has a call option to reacquire the loans
transferred and did not retain the servicing rights, the Company has not
surrendered effective control over the loans transferred. Therefore, the
securitizations are accounted for as secured borrowings with a pledge of
collateral. Accordingly, the Company consolidates the Trusts and the financial
statements of the Company include the loans transferred and the related bonds
issued. The securitized loans are classified as held for investment.
The Company continues to originate second mortgage loans, but now sells them to
third parties approximately twice a month.
LOAN COMMITMENTS OUTSTANDING
The Company's loan commitments outstanding at the dates indicated are summarized
below:
December 31,
-------------------------
(Dollars in thousands) 2001 2000 1999
------- ------- -------
Commercial $ 7,450 $ 9,776 $ 6,641
Real estate 6,370 8,323 4,135
Loans guaranteed by the SBA 4,712 4,545 5,266
Installment loans 13,339 2,260 2,205
Standby letters of credit 438 913 713
------- ------- -------
Total commitments $32,309 $25,817 $18,960
======= ======= =======
SUMMARY OF LOAN LOSSES EXPERIENCE
-------------------------------------
As is customary in the lending business, the Company experienced loan losses
during the year. The risk of loss varies depending on the type of loan granted
and the creditworthiness of the borrower. The degree of perceived risk is
addressed during the structure of the loan. The Company attempts to minimize
its credit risk exposure through the use of thorough approval and underwriting
procedures and a comprehensive loan application process.
The Company maintains a program of systematic review of its existing loans.
Loans are graded for their overall quality. The Company's management determines
which loans require further monitoring and supervision. These loans are
segregated for periodic review. The Company's Loan Committee reviews any loans
designated as significant problem loans on a monthly basis.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest under the contractual terms of the loan agreement.
Factors considered by management in determining impairment include, payment
status, collateral value, and the probability of collecting scheduled principal
and interest payments. Loans that experience insignificant payment delays or
payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis. When determining the possibility of impairment, management
considers the circumstances surrounding the loan and the borrower, including the
length of the delay, the reasons for the delay, the borrower's prior payment
record and the amount of the shortfall in relation to the principal and interest
owed. The Company uses the fair value of collateral method to measure
impairment. Impairment is measured on a loan by loan basis for all loans in the
portfolio except for the securitized and short-term consumer loans, which are
evaluated for impairment on a collective basis.
-34-
The recorded investment in loans that are considered to be impaired:
December 31,
----------------------------------------
December 31, 2001 2000 1999
------------ ------------ ------------
Impaired loans without
specific valuation allowances $ - $ 564,662 $ 3,250,576
Impaired loans with
specific valuation allowances 6,586,689 3,531,408 1,402,469
Specific valuation allowances
allocated to impaired loans (1,668,833) (1,206,706) (1,038,519)
------------ ------------ ------------
Impaired loans, net $ 4,917,856 $ 2,889,364 $ 3,614,526
============ ============ ============
Average investment in impaired loans $ 5,046,927 $ 4,676,705 $ 5,119,852
============ ============ ============
Interest income recognized on impaired loans $ 1,442,982 $ 386,704 $ 243,913
============ ============ ============
The accrual of interest is discontinued when substantial doubt exists as to
collectibility of the loan, generally at the time the loan is 90 days
delinquent, unless the credit is well secured and in process of collection. Any
unpaid but accrued interest is reversed at that time. Thereafter, interest
income is no longer recognized on the loan. As such, interest income may be
recognized on impaired loans to the extent they are not past due by 90 days or
more. Interest on non-accrual loans is accounted for on the cash-basis or
cost-recovery method, until qualifying for return to accrual. Loans are
returned to accrual status when all of the principal and interest amounts
contractually due are brought current and future payments are reasonably
assured. All of the impaired loans disclosed above are on nonaccrual status.
Financial difficulties encountered by certain borrowers may cause the Company to
restructure the terms of their loan to facilitate loan repayment. A troubled
loan that is restructured would generally be considered impaired. The balance
of impaired loans disclosed above includes all troubled debt restructured loans
that, as of December 31, 2001, 2000, and 1999 are considered impaired.
The following schedule reflects recorded investment at the dates indicated, in
certain types of loans:
December 31,
-----------------------
(Dollars in thousands) 2001 2000 1999
------- ------ ------
Nonaccrual loans $11,413 $2,095 $3,091
Troubled debt restructured loans, gross $ 1,093 $ 615 $ 656
Interest foregone on nonaccrual loans
and troubled debt restructuring outstanding $ 1,146 $ 592 $1,585
Loans 30 through 90 days past due with interest accruing $ 2,607 $4,277 $2,550
Goleta charges off: a) any loan classified as a "Loss"; b) portions of loans
which are deemed to be uncollectible; c) short-term consumer loans which are
past due 60 or more days; d) overdrafts which have been outstanding for more
than 30 days; e) consumer finance loans which are past due 120 or more days; and
f) all other unsecured loans past due 120 or more days. Charge offs are applied
as a reduction to Goleta's allowance for loan losses. Recoveries of previously
charged off loans are applied as increases to Goleta's allowance for loan
losses.
-35-
The following table summarizes the Company's loan loss experience for the
periods indicated:
Year Ended December 31,
-------------------------------
2001 2000 1999
--------- --------- ---------
(Dollars in thousands)
Average gross loans, held for investment $267,402 $297,574 $260,709
--------- --------- ---------
Gross loans at end of year, held for investment 237,989 302,476 297,616
--------- --------- ---------
Loans charged off (see detail below) 10,580 5,748 4,035
Recoveries of loans previously charged off
(see detail below) 990 171 58
--------- --------- ---------
Net loans charged off 9,590 5,577 3,977
--------- --------- ---------
Allowance for loan losses 8,275 6,746 5,529
--------- --------- ---------
Provisions for loan losses $ 11,880 $ 6,794 $ 6,133
--------- --------- ---------
Ratios:
Net loan charge-offs to average loans 3.6% 1.9% 1.5%
Net loan charge-offs to loans at end of period 4.0% 1.8% 1.3%
Allowance for loan losses to average loans 3.1% 2.3% 2.1%
Allowance for loan losses to loans
held for investment at end of period 3.5% 2.2% 1.9%
Net loan charge-offs to allowance
for loan losses at end of period 115.9% 82.7% 71.9%
Net loan charge-offs to provision for loan losses 80.7% 82.1% 64.8%
Roll forward of allowance for loan losses, with loans charged off and recoveries
of loans charged off by type, excluding securitized loans:
Year Ended December 31,
----------------------------
(Dollars in thousands) 2001 2000 1999
-------- -------- --------
Balance, beginning of year $ 2,704 $ 2,013 $ 2,154
Provision for loan losses 7,754 2,594 2,585
Loans charged off:
Real estate loans (3,129) (1,216) (971)
Installment Loans - (446) (3)
Short-term consumer loans (2,478) (2) -
Commercial Loans (614) (410) (1,119)
Recoveries of loans previously charged off:
Real estate loans 171 17 26
Installment Loans - - -
Short-term consumer loans 400 - -
Commercial Loans 40 154 6
Transfers to securitized loans - - (665)
Reductions due to sale of Palomar (762) - -
-------- -------- --------
Balance, end of year $ 4,086 $ 2,704 $ 2,013
======== ======== ========
-36-
An analysis of the allowance for loan losses for securitized loans is as
follows:
Year Ended December 31,
----------------------------
2001 2000 1999
-------- -------- --------
(Dollars in thousands)
Balance, beginning of year $ 4,042 $ 3,516 $ 1,219
Provisions for loan losses 4,127 4,199 3,548
Real estate loans charged off (4,358) (3,674) (1,942)
Recoveries on real estate loans previously charged off 378 1 26
Transfers from loans held for investment - - 665
-------- -------- --------
Balance, end of year $ 4,189 $ 4,042 $ 3,516
======== ======== ========
The Company's allowance for loan losses is maintained at a level believed
adequate by management to absorb known and inherent probable losses on existing
loans. A provision for loan losses is charged to expense. The allowance is
charged for losses when management believes that full recovery on the loan is
unlikely. Subsequent recoveries, if any, are credited to the allowance.
Management's determination of the adequacy of the allowance is based on periodic
evaluations of the loan portfolio, which take into consideration such factors as
changes in the growth, size and composition of the loan portfolio, overall
portfolio quality, review of specific problem loans, collateral, guarantees and
economic conditions that may affect the borrowers' ability to pay and and/or the
value of the underlying collateral. These estimates depend on the outcome of
future events and, therefore, contain inherent uncertainties.
Management of the Company reviews with the Board of Directors the adequacy of
the allowance for loan losses on a quarterly basis. The loan loss provision is
adjusted when specific items reflect a need for an adjustment. Management
believes the level of the allowance for loan losses as of December 31, 2001, is
adequate to absorb known and inherent losses; however, changes in the local
economy, the ability of borrowers to repay amounts borrowed and other factors
may result in the need to increase the allowance through charges to earnings.
-37-
INTEREST RATES AND DIFFERENTIALS
-----------------------------------
The following table illustrates average yields on our interest-earning assets
and average rates on our interest-bearing liabilities for the years indicated.
These average yields and rates are derived by dividing interest income by the
average balances of interest-earning assets and by dividing interest expense by
the average balances of interest-bearing liabilities for the years indicated.
Amounts outstanding are averages of daily balances during the period.
Year Ended December 31,
-------------------------------
(Dollars in thousands) 2001 2000 1999
--------- --------- ---------
Interest-earning assets:
Time deposits in other financial institutions:
Average outstanding $ 4,498 $ 1,654 $ 703
Average yield 3.8% 6.8% 6.7%
Interest income $ 172 $ 113 $ 47
Federal funds sold:
Average outstanding $ 26,696 $ 22,833 $ 19,287
Average yield 4.1% 6.2% 5.2%
Interest income $ 1,094 $ 1,405 $ 1,008
Investment securities:
Average outstanding $ 4,002 $ 7,371 $ 8,159
Average yield 6.7% 6.8% 5.4%
Interest income $ 269 $ 498 $ 442
Loans:
Average outstanding $181,122 $202,551 $244,719
Average yield 12.5% 11.0% 13.1%
Interest income $ 22,601 $ 22,348 $ 32,065
Securitized Loans:
Average outstanding $132,973 $174,245 $156,900
Average yield 12.5% 15.7% 9.5%
Interest income $ 16,658 $ 27,417 $ 14,933
Total interest-earning assets:
Average outstanding $349,291 $408,654 $429,768
Average yield 11.7% 12.7% 11.3%
Interest income $ 40,794 $ 51,781 $ 48,495
-38-
Interest-bearing liabilities:
Interest-bearing demand deposits:
Average outstanding $ 22,476 $ 23,548 $ 17,975
Average rate 3.7% 3.4% 3.2%
Interest expense $ 825 $ 790 $ 576
Savings deposits:
Average outstanding $ 17,056 $ 23,254 $ 23,776
Average rate 2.7% 3.1% 3.7%
Interest expense $ 464 $ 712 $ 884
Time certificates of deposit:
Average outstanding $144,297 $164,569 $198,730
Average rate 5.7% 6.0% 6.9%
Interest expense $ 8,172 $ 9,832 $ 13,620
Federal funds purchased:
Average outstanding - $ 287 $ 844
Average rate - 6.6% 5.2%
Interest expense - $ 19 $ 44
Bonds Payable:
Average outstanding $111,327 $151,126 $144,311
Average rate (1) 9.0% 9.4% 6.9%
Interest expense $ 10,039 $ 14,161 $ 9,938
Other borrowings:
Average outstanding $ 3,463 $ 5,795 $ 1,128
Average rate (1) 13.5% 9.4% 7.4%
Interest expense $ 467 $ 546 $ 83
Total interest-bearing liabilities:
Average outstanding $298,619 $368,579 $386,764
Average rate 6.7% 7.1% 6.5%
Interest Expense $ 19,967 $ 26,060 $ 25,145
Net interest income $ 20,827 $ 25,721 $ 23,350
Average net interest margin
on interest-earning assets 6.0% 6.3% 5.4%
--------------------
(1) A $183,000 reclassification adjustment was made from bond payable interest
expense to other borrowings interest expense in 2001. The actual average rate
for bonds payable and other borrowings would have been 9.1% and 8.2%,
respectively, without the adjustment.
LIQUIDITY MANAGEMENT
---------------------
The Company has an asset and liability management program which attempts to: a)
maintain interest margins during times of both rising and falling interest
rates; and b) maintain sufficient liquidity. Liquidity management is monitored
by the Principal Financial Officer daily and by the Asset/Liability Committee of
the Company's Board of Directors quarterly. The liquidity ratio of the Company
at December 31, 2001 and 2000 was 21% and 20%, respectively. The liquidity
ratio consist of cash and due from banks, deposits in other financial
institutions, available for sale investments, federal funds sold and loans held
for sale, divided by total assets. When the Company has more funds than it
needs for its reserve requirements or short-term liquidity needs, the Company
increases its securities investments or sells federal funds. Management
believes it maintains adequate liquidity levels.
-39-
DEPOSITS
--------
The following table shows the Company's daily average deposits for each of the
periods indicated below:
Year Ended December 31,
-------------------------------------------------------------
2001 2000 1999
------------------- ------------------- -------------------
Average Percent Average Percent Average Percent
(Dollars in thousands) Balance of Total Balance Of Total Balance of Total
-------- --------- -------- --------- -------- ---------
Noninterest-bearing demand $ 39,708 17.8% $ 30,381 12.6% $ 24,761 9.3%
Interest-bearing demand 22,476 10.1% 23,548 9.7% 17,975 6.8%
Savings 17,056 7.6% 23,254 9.6% 23,776 9.0%
TCDs of $100,000 or more 79,195 35.4% 78,342 32.4% 93,668 35.3%
Other TCDs 65,102 29.1% 86,227 35.7% 105,062 39.6%
-------- --------- -------- --------- -------- ---------
Total Deposits $223,537 100.0% $241,752 100.0% $265,242 100.0%
======== ========= ======== ========= ======== =========
The maturities of time certificates of deposit ("TCDs") were as follows:
December 31,
---------------------------------------------
December 31, 2001 2000
--------- ----------
TCD's over TCDs over
(Dollars in thousands) $100,000 Other TCD's $100,000 Other TCDs
-------- ------------ -------- -----------
Less than three months $ 34,483 $ 28,114 $ 37,299 $ 30,396
Over three months through six months 12,693 11,991 19,389 13,819
Over six months through twelve months 17,470 12,716 19,624 18,772
Over twelve months through five years 2,751 5,746 331 1,717
-------- ------------ -------- -----------
Total $ 67,397 $ 58,567 $ 76,643 $ 64,704
======== ============ ======== ===========
The deposits of the Company may fluctuate up and down with local and national
economic conditions. However, management does not believe that deposit levels
are significantly influenced by seasonal factors.
-40-
SUPERVISION AND REGULATION
----------------------------
INTRODUCTION
Banking is a complex, highly regulated industry. The primary goals of the
regulatory scheme are to maintain a safe and sound banking system, to protect
depositors and the FDIC insurance fund, and to facilitate the conduct of sound
monetary policy. In furtherance of these goals, Congress and the states have
created several largely autonomous regulatory agencies and enacted numerous laws
that govern banks, bank holding companies, and the banking industry.
Consequently, the Company's growth and earnings performance, as well as that of
Goleta, may be affected not only by management decisions and general economic
conditions, but also by the requirements of applicable state and federal
statutes and regulations and the policies of various governmental regulatory
authorities, including:
- the Board of Governors of the Federal Reserve Bank ("FRB");
- the Federal Deposit Insurance Corporation ("FDIC");
- the Office of the Comptroller of the Currency ("OCC"); and
- the California Department of Financial Institutions ("DFI").
Goleta is currently operating under a written agreement with the OCC (the
"Formal Agreement"). See "Formal Agreement With the OCC" at the end of this
section.
The system of supervision and regulation applicable to the Company and its
banking subsidiary, Goleta, governs most aspects of their business, including:
- the scope of permissible business activities;
- investments;
- reserves that must be maintained against deposits;
- capital levels that must be maintained;
- the nature and amount of collateral that may be taken to secure
loans;
- the establishment of new branches;
- mergers and consolidations with other financial institutions; and
- the payment of dividends.
From time to time legislation is enacted which has the effect of increasing the
cost of doing business and changing the competitive balance between banks and
other financial and non-financial institutions. Various federal laws enacted
over the past several years have provided, among other things, for:
- the maintenance of mandatory reserves with the FRB on deposits by
depository institutions;
- the phasing-out of the restrictions on the amount of interest
which financial institutions may pay on certain types of
accounts; and
- the authorization of various types of new deposit accounts, such
as "NOW" accounts, "Money Market Deposit" accounts and "Super
NOW" accounts, designed to be competitive with money market
mutual funds and other types of accounts and services offered by
various financial and non-financial institutions.
-41-
The lending authority and permissible activities of certain non-bank financial
institutions, such as savings and loan associations and credit unions, have been
expanded, and federal regulators have been given increased enforcement
authority. These laws have generally had the effect of altering competitive
relationships existing among financial institutions, reducing the historical
distinctions between the services offered by banks, savings and loan
associations and other financial institutions, and increasing the cost of funds
to banks and other depository institutions.
The following discussion of statutes and regulations affecting banks is only a
summary, does not purport to be complete, and is qualified in its entirety by
reference to the actual statutes and regulations. No assurance can be given
that the statutes and regulations will not change in the future. Moreover, any
changes may have a material adverse effect on our business.
SUPERVISION AND REGULATION OF THE COMPANY
GENERAL
The Company, as a bank holding company registered under the Bank Holding Company
Act of 1956, as amended herein referred to the "BHCA," is subject to regulation
by the FRB. Under FRB regulation, the Company is expected to act as a source of
managerial and financial strength for its bank subsidiary. It cannot conduct
operations in an unsafe or unsound manner and must commit resources to support
its banking subsidiary in circumstances where the Company might not otherwise do
so. Under the BHCA, the Company and its banking subsidiary are subject to
periodic examination by the FRB. The Company is also required to file periodic
reports of its operations and any additional information regarding its
activities and those of its subsidiaries with the FRB, as may be required.
The Company is also a bank holding company within the meaning of Section 3700 of
the California Financial Code. As such, the Company and its subsidiaries are
subject to examination by, and may be required to file reports with, the
Commissioner of the DFI, herein referred to as the "Commissioner." Regulations
have not yet been proposed or adopted or steps otherwise taken to implement the
Commissioner's powers under this statute.
BANK HOLDING COMPANY LIQUIDITY
The Company is a legal entity, separate and distinct from its bank subsidiary.
Although it has the ability to raise capital on its own behalf or borrow from
external sources, the Company may also obtain additional funds through dividends
paid by, and fees for services provided to, the bank subsidiary. However,
regulatory constraints may restrict or totally preclude its bank subsidiary from
paying dividends to the Company. See "- Limitations on Dividend Payments."
The FRB's policy regarding dividends provides that a bank holding company should
not pay cash dividends exceeding its net income or which can only be funded in
ways, such as by borrowing, that weaken the bank holding company's financial
health or its ability to act as a source of financial strength to its subsidiary
banks. The FRB also possesses enforcement powers over bank holding companies
and their non-bank subsidiaries to prevent or remedy actions that represent
unsafe or unsound practices or violations of applicable statutes and
regulations.
In March 2000, the Company entered into a Memorandum of Understanding with the
FRB, which requires the Company to refrain from declaring any dividends on the
Company's stock or redeeming any of its stock without the approval of the FRB.
See "- Memorandum of Understanding With the Federal Reserve Bank."
TRANSACTIONS WITH AFFILIATES
The Company and any subsidiaries it may purchase or organize are deemed to be
affiliates of the bank subsidiary within the meaning of Sections 23A and 23B of
the Federal Reserve Act, herein referred to as the "FRA," as amended. Pursuant
thereto, loans by Goleta to affiliates, investments by Goleta in affiliates'
stock, and taking affiliates' stock as collateral for loans to any borrower will
be limited to 10% of Goleta's capital, in the case of any one affiliate, and
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will be limited to 20% of Goleta's capital in the case of all affiliates. In
addition, such transactions must be on terms and conditions that are consistent
with safe and sound banking practices. Specifically, a bank and its
subsidiaries generally may not purchase from an affiliate a low-quality asset,
as defined in the FRA. Such restrictions also prevent a bank holding company
and its other affiliates from borrowing from a banking subsidiary of the bank
holding company unless the loans are secured by marketable collateral of
designated amounts. The Company and Goleta are also subject to certain
restrictions with respect to engaging in the underwriting, public sale and
distribution of securities. See "- Supervision and Regulation of the Bank
Subsidiary - Recent Legislation."
LIMITATIONS ON BUSINESSES AND INVESTMENT ACTIVITIES
Under the BHCA, a bank holding company must obtain the FRB's approval before:
- directly or indirectly acquiring more than 5% ownership or
control of any voting shares of another bank or bank holding
company;
- acquiring all or substantially all of the assets of another bank;
or
- merging or consolidating with another bank holding company.
The FRB may allow a bank holding company to acquire banks located in any state
of the United States without regard to whether the acquisition is prohibited by
the law of the state in which the target bank is located. In approving
interstate acquisitions, however, the FRB must give effect to applicable state
laws limiting the aggregate amount of deposits that may be held by the acquiring
bank holding company and its insured depository institutions in the state in
which the target bank is located, provided that those limits do not discriminate
against out-of-state depository institutions or their holding companies, and
state laws which require that the target bank have been in existence for a
minimum period of time, not to exceed five years, before being acquired by an
out-of-state bank holding company.
In general, the BHCA prohibits a bank holding company from acquiring direct or
indirect ownership or control of more than 5% of the voting securities of a
company that is not a bank or a bank holding company. However, with FRB
consent, a bank holding company may own subsidiaries engaged in certain
businesses that the FRB has determined to be "so closely related to banking as
to be a proper incident thereto." The Company, therefore, is permitted to
engage in a variety of banking-related businesses. Some of the activities that
the FRB has determined, pursuant to its Regulation Y, to be related to banking
are:
- making or acquiring loans or other extensions of credit for its
own account or for the account of others;
- servicing loans and other extensions of credit;
- operating a trust company in the manner authorized by federal or
state law under certain circumstances;
- leasing personal and real property or acting as agent, broker, or
adviser in leasing such property in accordance with various
restrictions imposed by FRB regulations;
- providing financial, banking, or economic data processing and
data transmission services;
- owning, controlling, or operating a savings association under
certain circumstances;
- selling money orders, travelers' checks and U.S. Savings Bonds;
- providing securities brokerage services, related securities
credit activities pursuant to Regulation T, and other incidental
activities; and
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- underwriting and dealing in obligations of the United States,
general obligations of states and their political subdivisions,
and other obligations authorized for state member banks under
federal law.
Generally, the BHCA does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
Federal law prohibits a bank holding company and any subsidiary banks from
engaging in certain tie-in arrangements in connection with the extension of
credit. Thus, for example, Goleta may not extend credit, lease or sell
property, or furnish any services, or fix or vary the consideration for any of
the foregoing on the condition that:
- the customer must obtain or provide some additional credit,
property or services from or to Goleta other than a loan,
discount, deposit or trust service;
- the customer must obtain or provide some additional credit,
property or service from or to the Company or Goleta; or
- the customer may not obtain some other credit, property or
services from competitors, except reasonable requirements to
assure soundness of credit extended
In late 1999, the Gramm-Leach-Bliley Act, herein referred to as the "GLB Act,"
was enacted. The GLB Act significantly changed the regulatory structure and
oversight of the financial services industry. The GLB Act permits banks and
bank holding companies to engage in previously prohibited activities under
certain conditions. Also, banks and bank holding companies may affiliate with
other financial service providers such as insurance companies and securities
firms under certain conditions. Consequently, a qualifying bank holding
company, called a financial holding company, herein referred to as "FHC," can
engage in a full range of financial activities, including banking, insurance,
and securities activities, as well as merchant banking and additional activities
that are beyond those traditionally permitted for bank holding companies.
Moreover, various non-bank financial service providers who were previously
prohibited from engaging in banking can now acquire banks while also offering
services such as securities underwriting and underwriting and brokering
insurance products. The GLB Act also expands passive investment activities by
FHCs, permitting them to indirectly invest in any type of company, financial or
non-financial, through merchant banking activities and insurance company
affiliations. See "- Supervision and Regulation of the Bank Subsidiary - Recent
Legislation."
CAPITAL ADEQUACY
Bank holding companies must maintain minimum levels of capital under the FRB's
risk based capital adequacy guidelines. If capital falls below minimum
guideline levels, a bank holding company, among other things, may be denied
approval to acquire or establish additional banks or non-bank businesses.
The FRB's risk-based capital adequacy guidelines for bank holding companies and
state member banks, discussed in more detail below (see "- Supervision and
Regulation of the Bank Subsidiary - Risk-Based Capital Guidelines"), assign
various risk percentages to different categories of assets, and capital is
measured as a percentage of those risk assets. Under the terms of the
guidelines, bank holding companies are expected to meet capital adequacy
guidelines based both on total risk assets and on total assets, without regard
to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will
be required if warranted by the particular circumstances or risk profiles of
individual organizations. For example, the FRB's capital guidelines contemplate
that additional capital may be required to take adequate account of, among other
things, interest rate risk, the risks posed by concentrations of credit, or
risks associated with nontraditional banking activities or securities trading
activities. Moreover, any banking organization experiencing or anticipating
significant growth or expansion into new activities, particularly under the
expanded powers of the GLB Act, may be expected to maintain capital ratios,
including tangible capital positions, well above the minimum levels.
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LIMITATIONS ON DIVIDEND PAYMENTS
The Company is entitled to receive dividends when and as declared by Goleta's
Board of Directors, out of funds legally available for dividends, as specified
and limited by the OCC's regulations. Pursuant to the OCC's regulations, funds
available for a national bank's dividends are restricted to the lesser of the
bank's: (i) retained earnings; or (ii) net income for the current and past two
fiscal years (less any dividends paid during that period), unless approved by
the OCC. Furthermore, if the OCC determines that a dividend would cause a
bank's capital to be impaired or that payment would cause it to be
undercapitalized, the OCC can prohibit payment of a dividend notwithstanding
that funds are legally available.
Since Goleta is an FDIC insured institution, it is also possible, depending upon
its financial condition and other factors, that the FDIC could assert that the
payment of dividends or other payments might, under some circumstances,
constitute an unsafe or unsound practice and, thus, prohibit those payments.
As a California corporation, the Company's ability to pay dividends is subject
to the dividend limitations of the California Corporations Code, herein referred
to as the "CCC." Section 500 of the CCC allows the Company to pay a dividend to
its shareholders only to the extent that the Company has retained earnings and,
after the dividend, the Company meets the following criteria:
- its assets (exclusive of goodwill and other intangible assets)
would be 1.25 times its liabilities (exclusive of deferred taxes,
deferred income and other deferred credits); and
- its current assets would be at least equal to its current
liabilities.
SUPERVISION AND REGULATION OF THE BANK SUBSIDIARY
GENERAL
Goleta, as a national banking association member, which is also a member of the
Federal Reserve System, is subject to regulation, supervision, and regular
examination by the OCC, the FDIC and the FRB. Goleta's deposits are insured by
the FDIC up to the maximum extent provided by law. The regulations of these
agencies govern most aspects of the Goleta's business. California law exempts
all banks from usury limitations on interest rates.
RECENT LEGISLATION
On November 12, 1999, the GLB Act was signed into law, significantly changing
the regulatory structure and oversight of the financial services industry.
Effective March 12, 2000, the GLB Act repealed the provisions of the
Glass-Steagall Act that restricted banks and securities firms from affiliating.
It also revised the BHCA to permit an FHC to engage in a full range of financial
activities, including banking, insurance, securities, and merchant banking
activities. It also permits FHCs to acquire many types of financial firms
without the FRB's prior approval.
The GLB Act thus provides expanded financial affiliation opportunities for
existing bank holding companies and permits other financial service providers to
acquire banks and become bank holding companies without ceasing any existing
financial activities. Previously, a bank holding company could only engage in
activities that were "closely related to banking." This limitation no longer
applies to bank holding companies that qualify to be treated as FHCs. To
qualify as an FHC, a bank holding company's subsidiary depository institutions
must be "well-capitalized," "well-managed" and have at least a "satisfactory"
Community Reinvestment Act, herein referred to as "CRA," examination rating.
"Non-qualifying" bank holding companies are limited to activities that were
permissible under the BHCA as of November 11, 1999.
Also, effective on March 12, 2000, the GLB Act changed the powers of national
banks and their subsidiaries, and made similar changes in the powers of
state-chartered banks and their subsidiaries. National banks may now
underwrite, deal in and purchase state and local revenue bonds. Subsidiaries of
national banks may now engage in financial activities that the bank cannot
itself engage in, except for general insurance underwriting and real estate
development and investment. In order for a subsidiary of a national bank to
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engage in these new financial activities, the national bank and its depository
institution affiliates must be "well capitalized," have at least "satisfactory"
general, managerial and CRA examination ratings, and meet other qualification
requirements relating to total assets, subordinated debt, capital, risk
management, and affiliate transactions. Subsidiaries of state-chartered banks
can exercise the same powers as national bank subsidiaries if they satisfy the
same qualifying rules that apply to national banks, except that state-chartered
banks do not have to satisfy the managerial and debt rating requirements
applicable to national banks.
The GLB Act also reformed the overall regulatory framework of the financial
services industry. In order to implement its underlying purposes, the GLB Act
preempted conflicting state laws that would restrict the types of financial
affiliations that are authorized or permitted under the GLB Act, subject to
specified exceptions for state insurance laws and regulations. With regard to
securities laws, effective May 12, 2001, the GLB Act removed the current blanket
exemption for banks from being considered brokers or dealers under the
Securities Exchange Act of 1934 and replaced it with a number of more limited
exemptions. Thus, previously exempted banks may become subject to the
broker-dealer registration and supervision requirements of the Securities
Exchange Act of 1934. The exemption that prevented bank holding companies and
banks that advised mutual funds from being considered investment advisers under
the Investment Advisers Act of 1940 was also eliminated.
Separately, the GLB Act imposes customer privacy requirements on any company
engaged in financial activities. Under these requirements, a financial company
is required to protect the security and confidentiality of customer nonpublic
personal information. Also, for customers that obtain a financial product such
as a loan for personal, family or household purposes, a financial company is
required to disclose its privacy policy to the customer at the time the
relationship is established and annually thereafter, including its policies
concerning the sharing of the customer's nonpublic personal information with
affiliates and third parties. If an exemption is not available, a financial
company must provide consumers with a notice of its information sharing
practices that allows the consumer to reject the disclosure of its nonpublic
personal information to third parties. Third parties that receive such
information are subject to the same restrictions as the financial company on the
reuse of the information. Finally, a financial company is prohibited from
disclosing an account number or similar item to a third party for use in
telemarketing, direct mail marketing or other marketing through electronic mail.
RISK-BASED CAPITAL GUIDELINES
General. The federal banking agencies have established minimum capital
standards known as risk-based capital guidelines. These guidelines are intended
to provide a measure of capital that reflects the degree of risk associated with
a bank's operations. The risk-based capital guidelines include both a new
definition of capital and a framework for calculating the amount of capital that
must be maintained against a bank's assets and off-balance sheet items. The
amount of capital required to be maintained is based upon the credit risks
associated with the various types of a bank's assets and off-balance sheet
items. A bank's assets and off-balance sheet items are classified under several
risk categories, with each category assigned a particular risk weighting from 0%
to 100%. The bank's risk-based capital ratio is calculated by dividing its
qualifying capital, which is the numerator of the ratio, by the combined risk
weights of its asserts and off-balance sheet items, which is the denominator of
the ratio.
Qualifying Capital. A bank's total qualifying capital consists of two types of
capital components: "core capital elements," known as Tier 1 capital, and
"supplementary capital elements," known as Tier 2 capital. The Tier 1 component
of a bank's qualifying capital must represent at least 50% of total qualifying
capital and may consist of the following items that are defined as core capital
elements:
- common stockholders' equity;
- qualifying non-cumulative perpetual preferred stock (including
related surplus); and
- minority interests in the equity accounts of consolidated
subsidiaries.
The Tier 2 component of a bank's total qualifying capital may consist of the
following items:
- a portion of the allowance for loan and lease losses;
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- certain types of perpetual preferred stock and related surplus;
- certain types of hybrid capital instruments and mandatory
convertible debt securities; and
- a portion of term subordinated debt and intermediate-term
preferred stock, including related surplus.
Risk Weighted Assets and Off-Balance Sheet Items. Assets and credit equivalent
amounts of off-balance sheet items are assigned to one of several broad risk
classifications, according to the obligor or, if relevant, the guarantor or the
nature of the collateral. The aggregate dollar value of the amount in each risk
classification is then multiplied by the risk weight associated with that
classification. The resulting weighted values from each of the risk
classifications are added together. This total is the bank's total risk
weighted assets.
A two-step process determines risk weights for off-balance sheet items, such as
unfunded loan commitments, letters of credit and recourse arrangements. First,
the "credit equivalent amount" of the off-balance sheet items is determined, in
most cases by multiplying the off-balance sheet item by a credit conversion
factor. Second, the credit equivalent amount is treated like any balance sheet
asset and is assigned to the appropriate risk category according to the obligor
or, if relevant, the guarantor or the nature of the collateral. This result is
added to the bank's risk-weighted assets and comprises the denominator of the
risk-based capital ratio.
Minimum Capital Standards. The supervisory standards set forth below specify
minimum capital ratios based primarily on broad risk considerations. The
risk-based ratios do not take explicit account of the quality of individual
asset portfolios or the range of other types of risks to which banks may be
exposed, such as interest rate, liquidity, market or operational risks. For
this reason, banks are generally expected to operate with capital positions
above the minimum ratios.
All banks are required to meet a minimum ratio of qualifying total capital to
risk weighted assets of 8%. At least 4% must be in the form of Tier 1 capital,
net of goodwill. The maximum amount of supplementary capital elements that
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of
goodwill. In addition, the combined maximum amount of subordinated debt and
intermediate-term preferred stock that qualifies as Tier 2 capital is limited to
50% of Tier 1 capital. The maximum amount of the allowance for loan and lease
losses that qualifies as Tier 2 capital is limited to 1.25% of gross risk
weighted asserts. The allowance for loan and lease losses in excess of this
limit may, of course, be maintained, but would not be included in a bank's
risk-based capital calculation.
The federal banking agencies also require all banks to maintain a minimum amount
of Tier 1 capital to total assets, referred to as the leverage ratio. For a
bank rated in the highest of the five categories used by regulators to rate
banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For
all banks not rated in the highest category, the minimum leverage ratio must be
at least 4% to 5%. These uniform risk-based capital guidelines and leverage
ratios apply across the industry. Regulators, however, have the discretion to
set minimum capital requirements for individual institutions, which may be
significantly above the minimum guidelines and ratios.
In March 2000, Goleta entered into a written agreement with the OCC to maintain
a 12% risk based capital and a 7% Tier I capital ratio. See "- Agreement With
the OCC."
OTHER FACTORS AFFECTING MINIMUM CAPITAL STANDARDS
The federal banking agencies have established certain benchmark ratios of loan
loss reserves to be held against classified assets. The benchmark by federal
banking agencies is the sum of:
- 100% of assets classified loss;
- 50% of assets classified doubtful;
- 15% of assets classified substandard; and
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- estimated credit losses on other assets over the upcoming twelve
months.
The federal banking agencies have recently revised their risk-based capital
rules to take account of concentrations of credit and the risks of engaging in
non-traditional activities. Concentrations of credit refers to situations where
a lender has a relatively large proportion of loans involving a single borrower,
industry, geographic location, collateral or loan type. Non-traditional
activities are considered those that have not customarily been part of the
banking business, but are conducted by a bank as a result of developments in,
for example, technology, financial markets or other additional activities
permitted by law or regulation. The regulations require institutions with high
or inordinate levels of risk to operate with higher minimum capital standards.
The federal banking agencies also are authorized to review an institution's
management of concentrations of credit risk for adequacy and consistency with
safety and soundness standards regarding internal controls, credit underwriting
or other operational and managerial areas.
The federal banking agencies also limit the amount of deferred tax assets that
are allowable in computing a bank's regulatory capital. Deferred tax assets
that can be realized for taxes paid in prior carry back years and from future
reversals of existing taxable temporary differences are generally not limited.
However, deferred tax assets that can only be realized through future taxable
earnings are limited for regulatory capital purposes to the lessor of:
- the amount that can be realized within one year of the
quarter-end report date; or
- 10% of Tier 1 capital.
The amount of any deferred tax in excess of this limit would be excluded from
Tier 1 capital, total assets and regulatory capital calculations.
The federal banking agencies have also adopted a joint agency policy statement
which provides that the adequacy and effectiveness of a bank's interest rate
risk management process, and the level of its interest rate exposure is a
critical factor in the evaluation of the bank's capital adequacy. A bank with
material weaknesses in its interest rate risk management process or high levels
of interest rate exposure relative to its capital will be directed by the
federal banking agencies to take corrective actions. Financial institutions
which have significant amounts of their assets concentrated in high risk loans
or nontraditional banking activities, and who fail to adequately manage these
risks, may be required to set aside capital in excess of the regulatory
minimums.
PROMPT CORRECTIVE ACTION
The federal banking agencies possess broad powers to take prompt corrective
action to resolve the problems of insured banks. Each federal banking agency
has issued regulations defining five capital categories: "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized,"
and "critically undercapitalized." Under the regulations, a bank shall be
deemed to be:
- "well capitalized" if it has a total risk-based capital ratio of
10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or
more, has a leverage capital ratio of 5.0% or more, and is not
subject to specified requirements to meet and maintain a specific
capital level for any capital measure;
- "adequately capitalized" if it has a total risk-based capital
ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0%
or more, and a leverage capital ratio of 4.0% or more (3.0% under
certain circumstances) and does not meet the definition of "well
capitalized";
- "undercapitalized" if it has a total risk-based capital ratio
that is less than 8.0%, a Tier 1 risk-based capital ratio that is
less than 4.0%, or a leverage capital ratio that is less than
4.0% (3.0% under certain circumstances);
- "significantly undercapitalized" if it has a total risk-based
capital ratio that is less than 6.0%, a Tier 1 risk-based capital
ratio that is less than 3.0% or a leverage capital ratio that is
less than 3.0%; and
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- "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2.0%.
Banks are prohibited from paying dividends or management fees to controlling
persons or entities if, after making the payment the bank would be
"undercapitalized," that is, the bank fails to meet the required minimum level
for any relevant capital measure. Asset growth and branching restrictions apply
to "undercapitalized" banks. Banks classified as "undercapitalized" are
required to submit acceptable capital plans guaranteed by its holding company,
if any. Broad regulatory authority was granted with respect to "significantly
undercapitalized" banks, including forced mergers, growth restrictions, ordering
new elections for directors, forcing divestiture by its holding company, if any,
requiring management changes, and prohibiting the payment of bonuses to senior
management. Even more severe restrictions are applicable to "critically
undercapitalized" banks, those with capital at or less than 2%. Restrictions
for these banks include the appointment of a receiver or conservator after 90
days, even if the bank is still solvent. All of the federal banking agencies
have promulgated substantially similar regulations to implement this system of
prompt corrective action.
A bank, based upon its capital levels, that is classified as "well capitalized,"
"adequately capitalized" or "undercapitalized" may be treated as though it were
in the next lower capital category if the appropriate federal banking agency,
after notice and opportunity for hearing, determines that an unsafe or unsound
condition, or an unsafe or unsound practice, warrants such treatment. At each
successive lower capital category, an insured bank is subject to more
restrictions. The federal banking agencies, however, may not treat an
institution as "critically undercapitalized" unless its capital ratios actually
warrant such treatment.
DEPOSIT INSURANCE ASSESSMENTS
The FDIC has implemented a risk-based assessment system in which the deposit
insurance premium relates to the probability that the deposit insurance fund
will incur a loss. The FDIC sets semi-annual assessments in an amount necessary
to maintain or increase the reserve ratio of the insurance fund to at least
1.25% of insured deposits or a higher percentage as determined to be justified
by the FDIC.
Under the risk-based assessment system adopted by the FDIC, banks are
categorized into one of three capital categories, "well capitalized,"
"adequately capitalized," and "undercapitalized." Assignment of a bank into a
particular capital category is based on supervisory evaluations by its primary
federal regulator. After being assigned to a particular capital category, a
bank is classified into one of three supervisory categories. The three
supervisory categories are:
- Group A - financially sound with only a few minor weaknesses;
- Group B - demonstrates weaknesses that could result in
significant deterioration; and
- Group C - poses a substantial probability of loss.
The capital ratios used by the FDIC to define "well-capitalized," "adequately
capitalized" and "undercapitalized" are the same as in the prompt corrective
action regulations.
The assessment rates are summarized below, expressed in terms of cents per $100
in insured deposits:
Assessment Rates Supervisory Group
----------------------------------
Capital Group Group A Group B Group C
------------- ------- ------- -------
Well Capitalized 0 3 17
Adequately Capitalized 3 10 24
Undercapitalized 10 24 27
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INTERSTATE BANKING AND BRANCHING
Banks have the ability, subject to specific restrictions, to acquire by
acquisition or merger branches located outside their home state. The
establishment of new interstate branches is also possible in those states with
laws that expressly permit it. Interstate branches are subject to many of the
laws of the states in which they are located.
California law authorizes out-of-state banks to enter California by the
acquisition of or merger with a California bank that has been in existence for
at least five years, unless the California bank is in danger of failing or in
certain other emergency situations. Interstate branching into California is,
however, limited to the acquisition of an existing bank.
ENFORCEMENT POWERS
In addition to measures taken under the prompt corrective action provisions,
insured banks may be subject to potential enforcement actions by the federal
regulators for unsafe or unsound practices in conducting their businesses, or
for violation of any law, rule, regulation, condition imposed in writing by the
regulatory agency, or term of a written agreement with the regulatory agency.
Enforcement actions may include:
- the appointment of a conservator or receiver for the bank;
- the issuance of a cease and desist order that can be judicially
enforced;
- the termination of the bank's deposit insurance;
- the imposition of civil monetary penalties;
- the issuance of directives to increase capital;
- the issuance of formal and informal agreements;
- the issuance of removal and prohibition orders against officers,
directors and other institution-affiliated parties; and
- the enforcement of such actions through injunctions or
restraining orders based upon a judicial determination that the
deposit insurance fund or the bank would be harmed if such
equitable relief was not granted.
FDIC RECEIVERSHIP
The FDIC may be appointed as conservator or receiver of any insured bank or
savings association. In addition, the FDIC may appoint itself as sole
conservator or receiver of any insured state bank or savings association for
any, among others, of the following reasons:
- insolvency;
- substantial dissipation of assets or earnings due to any
violation of law or regulation or any unsafe or unsound practice;
- an unsafe or unsound condition to transact business, including
substantially insufficient capital or otherwise;
- any willful violation of a cease and desist order which has
become final;
- any concealment of books, papers, records or assets of the
institution;
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- the likelihood that the institution will not be able to meet the
demands of its depositors or pay its obligations in the normal
course of business;
- the incurrence or likely incurrence of losses by the institution
that will deplete all or substantially all of its capital with no
reasonable prospect for the replenishment of the capital without
federal assistance; or
- any violation of any law or regulation, or an unsafe or unsound
practice or condition which is likely to cause insolvency or
substantial dissipation of assets or earnings, or is likely to
weaken the condition of the institution or otherwise seriously
prejudice the interests of its depositors.
As a receiver of any insured depository institution, the FDIC may liquidate such
institution in an orderly manner and dispose of any matter concerning such
institution as the FDIC determines is in the best interests of that institution,
its depositors and the FDIC. Further, the FDIC shall, as the conservator or
receiver, by operation of law, succeed to all rights, titles, powers and
privileges of the insured institution, and of any shareholder, member, account
holder, depositor, officer or director of that institution with respect to the
institution and the assets of the institution; may take over the assets of and
operate the institution with all the powers of the members or shareholders,
directors and the officers of the institution and conduct all business of the
institution; collect all obligations and money due to the institution and
preserve and conserve the assets and property of the institution.
SAFETY AND SOUNDNESS GUIDELINES
The federal banking agencies have adopted guidelines to assist in identifying
and addressing potential safety and soundness concerns before capital becomes
impaired. These guidelines establish operational and managerial standards
relating to:
- internal controls, information systems and internal audit
systems;
- loan documentation;
- credit underwriting;
- asset growth; and
- compensation, fees and benefits
Additionally, the federal banking agencies have adopted safety and soundness
guidelines for asset quality and for evaluating and monitoring earnings to
ensure that earnings are sufficient for the maintenance of adequate capital and
reserves. If an institution fails to comply with a safety and soundness
standard, the appropriate federal banking agency may require the institution to
submit a compliance plan. Failure to submit a compliance plan or to implement
an accepted plan may result in a formal enforcement action.
The federal banking agencies have issued regulations prescribing uniform
guidelines for real estate lending. The regulations require insured depository
institutions to adopt written policies establishing standards, consistent with
such guidelines, for extensions of credit secured by real estate. The policies
must address loan portfolio management, underwriting standards and loan-to-value
limits that do not exceed the supervisory limits prescribed by the regulations.
CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are focusing greater attention on compliance with
consumer protection laws and their implementing regulations. Examination and
enforcement have become more intense in nature, and insured institutions have
been advised to carefully monitor compliance with various consumer protection
laws and their implementing regulations. Banks are subject to many federal
consumer protection laws and their regulations, including:
-51-
- the CRA;
- the Truth in Lending Act (the "TILA");
- the Fair Housing Act (the "FH Act");
- the Equal Credit Opportunity Act (the "ECOA");
- the Home Mortgage Disclosure Act (the "HMDA"); and
- the Real Estate Settlement Procedures Act (the "RESPA").
The CRA is intended to encourage insured depository institutions, while
operating safely and soundly, to help meet the credit needs of their
communities. The CRA specifically directs the federal bank regulatory agencies,
in examining insured depository institutions, to assess their record of helping
to meet the credit needs of their entire community, including low- and
moderate-income neighborhoods, consistent with safe and sound banking practices.
The CRA further requires the agencies to take a financial institution's record
of meeting its community credit needs into account when evaluating applications
for, among other things, domestic branches, consummating mergers or
acquisitions, or holding company formations.
The federal banking agencies have adopted regulations which measure a bank's
compliance with its CRA obligations on a performance-based evaluation system.
This system bases CRA ratings on an institution's actual lending service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements. The ratings range from a high of "outstanding" to a
low of "substantial noncompliance."
The ECOA prohibits discrimination in any credit transaction, whether for
consumer or business purposes, on the basis of race, color, religion, national
origin, sex, marital status, age (except in limited circumstances), receipt of
income from public assistance programs, or good faith exercise of any rights
under the Consumer Credit Protection Act. In March 1994 the Federal Interagency
Task Force on Fair Lending issued a policy statement on discrimination in
lending. The policy statement describes the three methods that federal agencies
will use to prove discrimination:
- overt evidence of discrimination;
- evidence of disparate treatment; and
- evidence of disparate impact.
This means that if a creditor's actions have had the effect of discriminating,
the creditor may be held liable even when there is no intent to discriminate.
The FH Act regulates many practices, including making it unlawful for any lender
to discriminate against any person in its housing-related lending activities
because of race, color, religion, national origin, sex, handicap, or familial
status. The FH Act is broadly written and has been broadly interpreted by the
courts. A number of lending practices have been found to be, or may be
considered, illegal under the FH Act, including some that are not specifically
mentioned in the FH Act itself. Among those practices that have been found to
be, or may be considered, illegal under the FH Act are:
- declining a loan for the purposes of racial discrimination;
- making excessively low appraisals of property based on racial
considerations;
- pressuring, discouraging, or denying applications for credit on a
prohibited basis;
-52-
- using excessively burdensome qualifications standards for the
purpose or with the effect of denying housing to minority
applicants;
- imposing on minority loan applicants more onerous interest rates
or other terms, conditions or requirements; and
- racial steering, or deliberately guiding potential purchasers to
or away from certain areas because of race.
The TILA is designed to ensure that credit terms are disclosed in a meaningful
way so that consumers may compare credit terms more readily and knowledgeably.
As a result of the TILA, all creditors must use the same credit terminology and
expressions of rates, the annual percentage rate, the finance charge, the amount
financed, the total payments and the payment schedule.
HMDA grew out of public concern over credit shortages in certain urban
neighborhoods. One purpose of HMDA is to provide public information that will
help show whether financial institutions are serving the housing credit needs of
the neighborhoods and communities in which they are located. HMDA also includes
a "fair lending" aspect that requires the collection and disclosure of data
about applicant and borrower characteristics as a way of identifying possible
discriminatory lending patterns and enforcing anti-discrimination statutes.
HMDA requires institutions to report data regarding applications for one-to-four
family real estate loans, home improvement loans, and multifamily loans, as well
as information concerning originations and purchases of those types of loans.
Federal bank regulators rely, in part, upon data provided under HMDA to
determine whether depository institutions engage in discriminatory lending
practices.
RESPA requires lenders to provide borrowers with disclosures regarding the
nature and costs of real estate settlements. Also, RESPA prohibits certain
abusive practices, such as kickbacks, and places limitations on the amount of
escrow accounts.
Violations of these various consumer protection laws and regulations can result
in civil liability to the aggrieved party, regulatory enforcement including
civil money penalties, and even punitive damages.
OTHER ASPECTS OF BANKING LAW
Goleta is also subject to federal and state statutory and regulatory provisions
covering, among other things, security procedures, currency and foreign
transactions reporting, insider and affiliated party transactions, management
interlocks, electronic funds transfers, funds availability, and
truth-in-savings. There are also a variety of federal statutes which regulate
acquisitions of control and the formation of bank holding companies.
IMPACT OF MONETARY POLICIES
Banking is a business that depends on rate differentials. In general, the
difference between the interest rate paid by a bank on its deposits and its
other borrowings and the interest rate earned on its loans, securities and other
interest-earning assets comprises the major source of Goleta's earnings. These
rates are highly sensitive to many factors which are beyond Goleta's control
and, accordingly, the earnings and growth of Goleta are subject to the influence
of economic conditions generally, both domestic and foreign, including
inflation, recession, and unemployment; and also to the influence of monetary
and fiscal policies of the United States and its agencies, particularly the FRB.
The FRB implements national monetary policy, such as seeking to curb inflation
and combat recession, by:
- Open-market dealings in United States government securities;
- Adjusting the required level of reserves for financial
institutions subject to reserve requirements;
- Placing limitations upon savings and time deposit interest rates;
and
-53-
- Adjusting the discount rate applicable to borrowings by banks
which are members of the Federal Reserve System
The actions of the FRB in these areas influence the growth of bank loans,
investments, and deposits and also affect interest rates. The nature and timing
of any future changes in the FRB's policies and their impact on the Company and
Goleta cannot be predicted; however, depending on the degree to which our
interest-earning assets and interest-bearing liabilities are rate sensitive,
increases in rates would have a temporary effect of increasing our net interest
margin, while decreases in interest rates would have the opposite effect. In
addition, adverse economic conditions could make a higher provision for loan
losses a prudent course and could cause higher loan charge-offs, thus adversely
affecting our net income.
FORMAL AGREEMENT WITH THE OCC
In March 2000, Goleta entered into an agreement (the "Formal Agreement") with
its principal regulator, the Office of the Comptroller of the Currency (the
"OCC"). The Formal Agreement requires that Goleta maintain certain capital
levels and adhere to certain operational and reporting requirements, including
the following:
- submitting monthly progress reports;
- adopting a written asset diversification program to identify and
control any concentration of credit;
- maintaining total capital at least equal to 12% of risk-weighted
assets and Tier 1 capital at least equal to 7% of adjusted total
assets and developing a three year capital program to maintain
adequate capital and raise any required additional capital,
including a prohibition on the payment of dividends without the
approval of the OCC;
- refrain from permitting its average total assets in any quarter
to exceed its average total assets during the preceding quarter
except as specified;
- establishing a program to maintain an adequate allowance for loan
and lease losses;
- ensuring that it has adequate, full-time management;
- adopting a written strategic plan covering at least a three-year
period;
- developing a written risk management program;
- refiling certain amended regulatory reports and adopting policies
and procedures to ensure that all regulatory reports accurately
reflect its condition;
- adopting a written program to ensure compliance with all
applicable consumer protection laws, rules and regulations;
- appointing a capable officer vested with sufficient authority to
ensure compliance with the Bank Secrecy Act;
- documenting the support used to value loans held on its books,
servicing rights and interest-only assets;
- preparing a written analysis of its short-term consumer loan
program which fully assesses the risks and benefits of this
program and, thereafter, preparing a written analysis of any new
product or service; and
- correcting each violation of law, rule or regulation cited in any
report of examination.
-54-
Compliance with the provisions of the Formal Agreement could limit Goleta's
business activity and increase expense. Management has been informed by the
regulators that they do not believe that Goleta is in full compliance with the
following provisions of the Formal Agreement:
- implementing and demonstrating the effectiveness of its written
risk management program;
- implementing a program to ensure compliance with consumer
protection laws applicable to Goleta's short-term consumer loan
program;
- accurately valuing, and documenting the valuations of,
interest-only assets, servicing assets, deferred tax assets and
deferred tax liabilities; and
- ensuring compliance with applicable laws and regulations,
particularly as related to the short-term consumer loan program.
Goleta achieved and maintained both of the aforementioned required 12% and 7%
capital ratios from September 30, 2000 to the end of 2001. As the result of
fourth quarter 2001 losses, Goleta's risk-based capital ratio declined to 11.84%
at December 31, 2001. On March 8, 2002, the Company made a $750,000 capital
contribution to Goleta, which would have increased Goleta's risk-based capital
ratio to 12.11% at December 31, 2001, had the contribution been made on that
date.
Regulators have asserted that failure to comply with the provisions of the
Formal Agreement could adversely affect the safety or soundness of Goleta. The
OCC possesses broad powers to take corrective and other supervisory action and
bring enforcement actions to resolve unsafe or unsound practices.
MEMORANDUM OF UNDERSTANDING WITH THE FEDERAL RESERVE BANK
In March 2000, the Company entered into an agreement (the "Memorandum of
Understanding") with its principal regulator, the Federal Reserve Bank of San
Francisco (the "Reserve Bank"). The Memorandum of Understanding requires that
the Company maintain certain capital levels and adhere to certain operational
and reporting requirements, including the following:
- refrain from declaring any dividends or redeeming any of its
stock without the approval of the Reserve Bank;
- adopting a written plan to maintain a sufficient capital position
for the consolidated organization;
- refrain from increasing its borrowings or incurring or renewing
any debt without the approval of the Reserve Bank;
- correcting any violations of applicable laws, rules or
regulations and developing a written program to ensure compliance
in the future;
- developing written policies and procedures to strengthen the
Company's records, systems and internal controls;
- developing a written plan to enhance management information
systems and the Board of Director's supervision of operations;
- developing a written consolidated strategic plan;
- developing a written plan to address weaknesses in the Company's
audit program;
- complying with applicable laws with respect to the appointment of
any new directors or the hiring of any senior executive officers;
and
-55-
- submitting quarterly progress reports.
-56-
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
------- ---------------------------------------------------------------
The Company's primary market risk is interest rate risk. Interest rate risk is
the potential of economic losses caused by future interest rate change. These
economic losses can be reflected as a loss of future net interest income and/or
a loss of current fair values. The objective is to measure the effect on net
interest income and to adjust the balance sheet to minimize the risks. The
Company's exposure to market risks is reviewed on a regular basis by the
asset/liability committee. Tools used by management include the standard GAP
report and interest rate shock analysis. The Company has no market risk
instruments held for trading purposes except for its interest-only strips.
Management believes the Company's market risk is reasonable at this time. The
Company currently does not enter into derivative financial instruments.
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations - Asset and Liability Management."
-57-
The table below provides information about the Company's financial instruments
that are sensitive to changes in interest rates. For all outstanding financial
instruments, the tables present the outstanding principal balance at December
31, 2001 and 2000, and the weighted average interest yield/rate of the
instruments by either the date the instrument can be repriced for variable rate
financial instruments or the expected maturity date for fixed rate financial
instruments.
At December 31, 2001
------------------------------------------------------------
Expected maturity dates or repricing dates by year
--------------------------------------------------
2006 and Fair Value
(Dollars in thousands) 2002 2003 2004 2005 beyond Total at 12/31/01
--------- -------- -------- ------- -------- -------- ------------
Assets:
-------
Time Deposits in Other
Financial Institutions: $ 5,641 $ 297 - - - $ 5,938 $ 5,938
Average Yield 3.8% - - - -
Federal Funds Sold: $ 19,600 - - - - $ 19,600 $ 19,600
Average Yield 4.1% - - - -
Investment Securities, Held to Maturity: $ 118 - - - - $ 118 $ 118
Average Yield 6.7% - - - -
Federal Reserve Bank: $ 775 - - - - $ 775 $ 775
Average Yield 6.0% - - - -
Interest Only Assets: $ 1,034 $ 895 $ 775 $ 670 $ 4,319 $ 7,693 $ 7,693
Average Yield 12.7% 12.7% 12.7% 12.7% 12.7%
Servicing Asset: $ 334 $ 290 $ 251 $ 217 $ 1,398 $ 2,490 $ 2,490
Average Yield 12.7% 12.7% 12.7% 12.7% 12.7%
Securitized Loans: $ 47,648 $25,901 $14,079 $7,653 $ 9,115 $104,396 $ 110,799
Average Yield 12.5% 12.5% 12.5% 12.5% 12.5%
Liabilities:
------------
Non-Interest Bearing Demand: $ 33,312 - - - - $ 33,312 $ 33,312
Average Rate - - - - -
Interest-Bearing Demand: $ 22,518 - - - - $ 22,518 $ 22,518
Average Rate 3.7% - - - -
Savings: $14,371 - - - - $ 14,371 $ 14,371
Average Rate 2.7% - - - -
Time Certificates of Deposit: $117,467 $ 8,498 - - - $125,965 $ 125,965
Average Rate 5.7% - - - -
Bonds Payable: $ 41,404 $22,218 $11,922 $6,398 $ 7,409 $ 89,351 $ 100,502
Average Rate 9.0% 9.0% 9.0% 9.0% 9.0%
-58-
At December 31, 2000
-----------------------------------------------------------
Expected maturity dates or repricing dates by year
--------------------------------------------------
2005 and Fair Value
(Dollars in thousands) 2001 2002 2003 2004 beyond Total at 12/31/00
--------- -------- -------- -------- -------- -------- ------------
Assets:
-------
Time Deposits in Other Financial Institutions: $ 1,582 - - - - $ 1,582 $ 1,582
Average Yield 3.3% - - - -
Federal Funds Sold: $ 21,525 - - - - $ 21,525 $ 21,525
Average Yield 3.5% - - - -
Investment Securities,
Held to Maturity: $ 1,902 - - - - $ 1,902 $ 1,902
Average Yield 4.0% - - - -
Investment Securities,
Available-for-Sale: - - - - $ 4,819 $ 4,819 $ 4,819
Average Yield - - - - 8.1%
Federal Reserve Bank/
Federal Home Loan Bank stock: $ 1,170 - - - - $ 1,170 $ 1,170
Average Yield 6.0% - - - -
Interest Only Strip: $ 1,014 $ 877 $ 759 $ 657 $ 4,234 $ 7,541 $ 7,541
Average Yield 12.5% 12.5% 12.5% 12.5% 12.5%
Servicing Asset: $ 350 $ 303 $ 262 $ 227 $ 1,463 $ 2,605 $ 2,605
Average Yield 12.5% 12.5% 12.5% 12.5% 12.5%
Securitized Loans: $ 32,225 $25,395 $20,013 $15,771 $58,640 $152,044 $ 185,048
Average Yield 13.2% 13.2% 13.2% 13.2% 13.2%
Liabilities:
------------
Non-Interest Bearing Demand: $ 28,057 - - - - $ 28,057 $ 28,057
Average Yield 0.0% - - - -
Interest-Bearing Demand: $ 34,638 - - - - $ 34,638 $ 34,638
Average Yield 3.3% - - - -
Savings: $ 24,679 - - - - $ 24,679 $ 24,679
Average Yield 3.1% - - - -
Time Certificates of Deposit: $141,346 - - - - $141,346 $ 141,715
Average Yield 6.2% - - - -
Bonds Payable: $ 36,577 $26,345 $18,975 $13,667 $35,191 $130,755 $ 164,363
Average Yield 8.0% 8.0% 8.0% 8.0% 8.0%
-59-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
------- ------------------------------------------
The Company's consolidated financial statements begin on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
------- ---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
-------- -------------------------------------------------------------
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
-------------------------------------------------
The information concerning the directors and executive officers of the Company
is incorporated herein by reference from the section entitled "Proposal 1 -
Election of Directors" contained in the definitive proxy statement of the
Company to be filed pursuant to Regulation 14A within 120 days after the end of
the Company's last fiscal year (the "Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
-------- ----------------------
Information concerning executive compensation is incorporated herein by
reference from the section entitled "Proposal 1 - Election of Directors"
contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
-------- --------------------------------------------------------------
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the section entitled
"Proposal 1 - Election of Directors" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
-------- ----------------------------------------------
Information concerning certain relationships and related transactions is
incorporated herein by reference from the section entitled "Proposal 1 -
Election of Directors" contained in the Proxy Statement.
-60-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
-------- ----------------------------------------------------------------
(a)(1) The following consolidated financial statements of Community West
Bancshares are filed as part of this Annual Report.
Report of Independent Public Accountants F-1
Consolidated Balance Sheets as of December 31, 2001 and 2000 F-2
Consolidated Statements of Operations for each of the
in the period ended December 31, 2001 three years F-3
Consolidated Statements of Stockholders' Equity for each
of the three years ended in the period ended December
31, 2001 F-4
Consolidated Statements of Cash Flows for each of the
three years in the period ended December 31, 2001 F-5
Notes to Consolidated Financial Statements F-7
(a)(2) Financial Statement Schedules
Financial statement schedules other than those listed above have been omitted
because they are either not applicable or the information is otherwise included.
(b) A report on Form 8-K was filed as follows:
October 4, 2001: Item 5 - Other Events
-61-
(c) Exhibits. The following is a list of exhibits filed as a part of this
report.
2.1 Plan of reorganization. (1)
2.2 Stock Purchase Agreement dated December 1, 2000 regarding the sale of all
of the outstanding stock of Palomar Community Bank. (4)
3.1 Articles of Incorporation. (3)
3.2 Bylaws. (3)
4.1 Common Stock Certificate. (2)
10.1 1997 Stock Option Plan and Form of Stock Option Agreement. (1)
10.2 Employment Contract between Goleta National Bank and Llewellyn Stone,
President and CEO dated November 16, 1993. (3)
10.3 Salary Continuation Agreement between Goleta National Bank and Llewellyn
Stone, President and CEO dated January 1, 1994. (3)
10.4 Master Loan Agency Agreement between the Company's subsidiary, Goleta
National Bank, and Ace Cash Express, Inc., dated August 11, 1999;
Amendment No. 1 thereto dated March 29, 2001; Amendment No. 2 thereto
dated June 30, 2001. (5)
10.5 Formal Agreement between Goleta National Bank and the Office of the
Comptroller of the Currency, dated March 23, 2000.
10.6 Memorandum of Understanding between the Company and the Federal Reserve
Bank of San Francisco, dated February 22, 2001.
10.7 Consulting Agreement between the Goleta National Bank and Llewellyn Stone.
10.8 Indemnification Agreement between the Company and Stephen W. Haley dated
December 20, 2001.
10.9 Indemnification Agreement between the Company and Lynda Nahra dated
December 20, 2001.
10.10 Indemnification Agreement between the Company and Philip E. Guldeman,
dated April 1, 2002.
10.11 At-Will Agreement between the Company and Stephen W. Haley dated
March 29, 2001.
10.12 At-Will Agreement between the Company and Philip E. Guldeman, dated
March 14, 2002.
21 Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP.
99 Letter of Registrant pursuant to Temporary Note 3T to Rule 2-02
of Regulation S-X.
----------------------------------
(1) Filed as an exhibit to the Registrant's Registration Statement on
Form S-8 filed with the Commission on December 31, 1997 and
incorporated herein by reference.
(2) Filed as an exhibit to the Registrant's Amendment to Registration
Statement on Form 8-A filed with the Commission on March 12, 1998 and
incorporated herein by reference.
(3) Filed as an exhibit to the Registrant's Annual Report on Form 10-K
filed with the Commission on March 31, 1998 and incorporated herein by
reference.
(4) Filed as Exhibit 2 to the Registrant's Current Report on Form 8-K
filed with the Commission on December 5, 2000.
(5) Filed as Exhibit 10 to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 2001, and incorporated herein by
reference.
-62-
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Community West Bancshares:
We have audited the accompanying consolidated balance sheets of Community West
Bancshares and subsidiaries (the "Company") as of December 31, 2001 and 2000,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Community West Bancshares and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
Arthur Andersen LLP /s/
Los Angeles, California
March 8, 2002
F-1
COMMUNITY WEST BANCSHARES 2001 2000
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31,
ASSETS
---------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 9,806,201 $ 14,957,879
Federal funds sold 19,600,000 21,525,771
------------ -------------
Cash and cash equivalents 29,406,201 36,483,650
Time deposits in other financial institutions 5,938,000 1,582,000
Federal Reserve Bank and Federal Home Loan Bank stock, at cost 775,073 1,170,073
Investment securities held-to-maturity, at amortized cost;
fair value of $117,920 in 2001 and $1,905,155 in 2000 117,923 1,901,615
Investment securities available-for-sale, at fair value; amortized cost
of $4,855,426 in 2000 - 4,819,666
Interest only strips, at fair value 7,693,102 7,540,824
Loans
Held for sale, at lower of cost or fair value 30,848,631 37,195,127
Held for investment, net of allowance for loan losses
of $4,086,460 in 2001 and $2,703,990 in 2000 125,710,996 140,025,820
Securitized loans, net of allowance for loan losses
of $4,188,655 in 2001 and $4,042,446 in 2000 104,395,572 152,043,650
Servicing assets 2,489,804 2,605,477
Other real estate owned, net 265,882 226,688
Premises and equipment, net 2,725,701 4,067,817
Goodwill and other intangible assets, net - 3,443,344
Accrued interest receivable and other assets 13,496,224 12,149,569
------------ -------------
TOTAL ASSETS $323,863,109 $405,255,320
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing demand $ 33,312,436 $ 28,056,602
Interest-bearing demand 22,517,679 34,638,076
Savings 14,371,451 24,679,041
Time certificates of $100,000 or more 67,397,455 76,642,309
Other time certificates 58,567,408 64,703,951
------------ -------------
Total deposits 196,166,429 228,719,979
Bonds payable in connection with securitized loans 89,350,791 130,754,823
Other borrowings - 5,293,072
Accrued interest payable and other liabilities 4,989,158 4,452,838
------------ -------------
Total liabilities 290,506,378 369,220,712
------------ -------------
COMMITMENTS AND CONTINGENCIES (Notes 12 and 14)
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized; 5,690,224 and
6,107,216 shares issued and outstanding at December 31, 2001 and 2000 29,797,590 32,517,989
Retained earnings 3,559,141 3,537,379
Accumulated other comprehensive loss - (20,760)
------------ -------------
Total stockholders' equity 33,356,731 36,034,608
------------ -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $323,863,109 $405,255,320
============ =============
The accompanying notes are an integral part of these consolidated balance sheets.
F-2
COMMUNITY WEST BANCSHARES 2001 2000 1999
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------------
INTEREST INCOME:
Loans $39,257,820 $49,765,279 $46,997,684
Federal funds sold 1,094,338 1,405,179 1,007,761
Time deposits in other financial institutions 269,280 113,236 47,129
Investment securities 172,358 497,495 442,347
------------ ----------- ------------
Total interest income 40,793,796 51,781,189 48,494,921
------------ ----------- ------------
INTEREST EXPENSE:
Deposits 9,460,576 11,334,050 15,079,699
Bonds payable and other borrowings 10,505,955 14,726,064 10,065,531
------------ ----------- ------------
Total interest expense 19,966,531 26,060,114 25,145,230
------------ ----------- ------------
NET INTEREST INCOME 20,827,265 25,721,075 23,349,691
PROVISION FOR LOAN LOSSES 11,880,212 6,793,812 6,132,959
------------ ----------- ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 8,947,053 18,927,263 17,216,732
OTHER INCOME:
Gains from loan sales, net 6,616,020 7,491,243 5,987,943
Loan servicing fees, net 1,703,290 2,790,151 499,703
Income from sale of interest in subsidiary 95,944 2,080,000 -
Other loan fees - sold or brokered loans 3,431,804 1,825,703 2,709,938
Document processing fees 1,978,091 1,116,556 1,072,618
Service charges 575,313 559,142 514,790
Gain from sale of servicing asset - 186,531 -
Other income 770,070 234,052 235,645
Proceeds from legal settlement 7,000,000 - -
------------ ----------- ------------
Total other income 22,170,532 16,283,378 11,020,637
------------ ----------- ------------
OTHER EXPENSES:
Salaries and employee benefits 17,704,138 15,241,058 16,228,271
Occupancy expenses 2,206,822 2,401,450 2,416,764
Depreciation expense 1,418,533 1,517,218 1,427,819
Other operating expenses 3,337,846 3,288,969 1,624,109
Loan servicing & collection expense 1,179,185 2,325,770 2,188,293
Professional services 2,238,044 949,416 2,579,129
Advertising expense 661,448 705,566 1,151,317
Amortization of intangible assets 177,980 404,099 363,570
Impairment of goodwill - 2,110,303 -
Office supply expense 334,595 391,022 385,805
Data processing/ATM processing 324,307 345,173 511,743
Postage & freight 402,406 294,994 352,014
Lower of cost or market provision - - 1,276,709
Professional expenses associated with legal settlement 2,391,576 - -
------------ ----------- ------------
Total other expenses 32,376,880 29,975,038 30,505,543
------------ ----------- ------------
(LOSS) INCOME BEFORE (BENEFIT)
PROVISION FOR INCOME TAXES (1,259,295) 5,235,603 (2,268,174)
(BENEFIT) PROVISION FOR INCOME TAXES (1,281,057) 2,538,466 (621,838)
------------ ----------- ------------
NET INCOME (LOSS) $ 21,762 $ 2,697,137 $(1,646,336)
============ =========== ============
EARNINGS (LOSS) PER SHARE - BASIC $ 0.00 $ 0.44 $ (0.30)
============ =========== ============
EARNINGS (LOSS) PER SHARE - DILUTED $ 0.00 $ 0.43 $ (0.30)
============ =========== ============
The accompanying notes are an integral part of these consolidated financial statements.
F-3
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE
THREE YEARS ENDED DECEMBER 31
Accumulated
Other Total
Common Stock Retained Comprehensive Stockholders' Comprehensive
Shares Amount Earnings Income Equity Income (loss)
(loss)
------------- ------------ --------------- --------------- --------------- --------------
BALANCE JANUARY 1, 1999 5,464,903 $25,108,812 $ 4,012,613 $ - $ 29,121,425
Issuance of stock to directors 582,924 7,522,698 - - 7,522,698
Exercise of stock options 179,159 955,710 - - 955,710
Cash dividends paid
($0.16 per share) - - (871,005) - (871,005)
Stock repurchase (122,630) (1,095,017) - - (1,095,017)
Comprehensive loss:
Net loss - - (1,646,336) - (1,646,336) $ (1,646,336)
Other comprehensive loss (55,333) (55,333) (55,333)
----------------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 1999 6,104,356 32,492,203 1,495,272 (55,333) 33,932,142 $ (1,701,669)
==============
Exercise of stock options 2,860 25,786 - - 25,786
Cash dividends paid ($0.04
per share) - - (245,654) - (245,654)
Effect of unconsolidation of
sold subsidiary - - (409,376) - (409,376)
Comprehensive income:
Net income - - 2,697,137 - 2,697,137 $ 2,697,137
Other comprehensive income - - - 34,573 34,573 34,573
----------------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 2000 6,107,216 32,517,989 3,537,379 (20,760) 36,034,608 $ 2,731,710
==============
Exercise of stock options 34,100 114,675 - - 114,675
Stock repurchase (451,092) (2,835,074) - - (2,835,074)
Comprehensive income:
Net income - - 21,762 - 21,762 $ 21,762
Other comprehensive income - - - 20,760 20,760 20,760
----------------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 2001 5,690,224 $29,797,590 $ 3,559,141 $ - 33,356,731 $ 42,522
==============================================================================================
The accompanying notes are an integral part of these consolidated financial statements.
F-4
COMMUNITY WEST BANCSHARES 2001 2000 1999
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE
THREE YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 21,762 $ 2,697,137 $ (1,646,336)
Adjustments to reconcile net income (loss) to net cash provided by (used
in) operating activities:
Provision for loan losses 11,880,212 6,793,812 6,132,959
Provision for losses on real estate owned 50,331 85,240 130,643
Losses on sale of premises and equipment - (17,488) -
Deferred income taxes provision (benefit) 605,262 1,543,598 (3,745,819)
Depreciation and amortization 1,418,533 1,290,296 1,568,060
Amortization of goodwill and other intangibles 177,980 404,099 363,570
Impairment of goodwill - 2,110,303 -
Gain on sale of other real estate owned (41,577) (26,878) -
Gain on sale of subsidiary (95,944) - -
Gain on disposal of servicing asset - (186,531) -
Amortization of discount on available-for-sale securities - 12,653 42,109
Gain on sale of available-for-sale securities (20,760) - -
Gain on sale of loans held for sale (6,616,020) (7,491,243) (5,987,943)
Lower of cost or market provision for loans held for sale - - 1,276,709
Change in market valuation of interest only strips 2,693,796 1,228,235 1,540,348
Additions (reductions) to servicing assets, net of amortization and
valuation adjustments 115,673 (250,213) (583,813)
Changes in operating assets and liabilities:
Accrued interest receivable and other assets 1,450,910 (2,072,198) (3,548,406)
Accrued interest payable and other liabilities 536,397 2,307,896 (378,845)
------------- -------------- --------------
Net cash provided by (used in) operating activities 12,176,555 8,428,718 (4,836,764)
------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities (118,000) (1,902,656) (495,553)
Purchase of available-for-sale securities - (1,014,970) -
Purchase of Federal reserve stock - (473,523) (37,500)
Proceeds from sale of servicing asset - 334,528 -
Proceeds from sale of subsidiary - 775,000 -
Principal paydown on available-for-sale securities - 1,114,466 -
Redemption of FHLB stock 395,000 109,200 72,200
FHLB stock dividend - (30,100) -
Maturities of held-to-maturity securities 1,901,615 497,688 500,000
Proceeds from payments and maturities of available-for-sale securities 4,819,666 - 3,279,214
Additions to interest only strip assets (2,846,074) (3,933,060) (4,154,447)
Loan originations and principal collections, net 62,505,129 122,645,116 (205,959,393)
Proceeds from sale of other real estate owned 492,130 512,987 -
Net (increase) decrease in time deposits in other financial institutions (4,356,000) (1,582,000) 1,500,000
Purchase of premises and equipment, net of sales (76,418) (1,388,383) (1,621,395)
------------- -------------- --------------
Net cash provided by (used in) investing activities 62,717,048 115,664,293 (206,916,874)
------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in demand deposits and savings accounts (17,172,153) 15,152,529 5,897,343
Net (decrease) increase in time certificates of deposit (15,381,397) (99,644,835) 83,380,573
Bonds issued - - 116,876,000
Bond repayments (41,404,032) (36,576,842) (21,595,833)
Proceeds from issuance of other borrowings - - 7,307,303
Repayment of other borrowings (5,293,072) (2,014,231) -
Repurchase of outstanding shares (2,835,073) - (1,095,017)
Proceeds from exercise of stock options 114,675 25,786 955,710
Effect of unconsolidation of sold subsidiary - (409,376) -
Issuance of common stock - - 7,522,698
Cash dividend paid - (245,654) (871,005)
------------- -------------- --------------
Net cash (used in) provided by financing activities (81,971,052) (123,712,623) 198,377,772
------------- -------------- --------------
F-5
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (7,077,449) 380,388 (13,375,866)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 36,483,650 36,103,262 49,479,128
------------- -------------- --------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 29,406,201 $ 36,483,650 $ 36,103,262
============= ============== ==============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 18,949,624 $ 25,940,918 $ 24,401,341
Cash paid for income taxes $ 2,390 $ 1,312,379 $ 4,061,182
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real estate owned $ 540,078 $ 451,554 $ 284,692
Transfers from loans held for sale to securitized loans $ - $ - $ 123,328,043
Transfers from loans held for sale to loans held for investment $ 5,023,405 $ 3,338,776 $ 1,042,453
The accompanying notes are an integral part of these consolidated financial statements.
F-6
COMMUNITY WEST BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Community West Bancshares, a California
Corporation, and its wholly-owned subsidiary, Goleta National Bank ("Goleta"),
herein referred to as (the "Company"), are in accordance with accounting
principles generally accepted in the United States of America ("GAAP") and
general practices within the financial services industry. All material
intercompany transactions and accounts have been eliminated. The following are
descriptions of the most significant of those policies:
Nature of Operations - The Company's primary operations are related to
traditional banking and financial services through Goleta which include the
acceptance of deposits and the lending and investing of money. The Company also
engages in electronic banking services. The Company's customers consist of
small to mid-sized businesses, as well as individuals. The Company also
originates and sells U. S. Small Business Administration ("SBA") and first and
second mortgage loans through its normal operations and seventeen loan
production offices.
Business Combinations and Dispositions - On December 14, 1998, the Company
acquired Palomar Community Bank (then known as Palomar Savings and Loan)
("Palomar"). As of that date, shareholders of Palomar became shareholders of
the Company by receiving 2.11 shares of Community West Bancshares stock for each
share of Palomar stock they held. This acquisition was accounted for under the
purchase method of accounting. On August 17, 2001, the Company sold Palomar
Community Bank to Centennial First Financial Services for $10.5 million. The
sale reflects a gain of $95,944 that has been recorded in the Company's
Statement of Operations.
Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks, and federal funds
sold. Generally, federal funds are sold for one-day periods.
Reserve Requirements - All depository institutions are required by law to
maintain reserves on transaction accounts and nonpersonal time deposits in the
form of cash balances at the Federal Reserve Bank. These reserve requirements
can be offset by cash balances held at the Company. At December 31, 2001 and
2000, the Company's cash balance was sufficient to offset the Federal Reserve
requirement.
Investment Securities - The Company classifies as held to maturity those debt
securities it has the positive intent and ability to hold to maturity.
Securities held to maturity are accounted for at amortized cost. Debt
securities to be held for indefinite periods of time, but not necessarily to be
held to maturity or on a long term basis, are classified as available-for-sale
and carried at fair value with unrealized gains or losses reported as a separate
component of accumulated other comprehensive income (loss), net of any
applicable income taxes. Realized gains or losses on the sale of securities
available-for-sale, if any, are determined on a specific identification basis.
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Declines in the fair value of
available-for-sale or held-to-maturity securities below their cost that are
deemed to be other than temporary, if any, are reflected in earnings as realized
losses.
F-7
Interest only strips and Servicing Assets - The Company originates certain loans
for the purpose of selling either a portion of, or the entire loan, into the
secondary market. FHA Title 1 loans and the guaranteed portion of SBA loans are
sold into the secondary market. Servicing assets are recognized as separate
assets when loans are sold with servicing retained. Servicing assets are
amortized in proportion to, and over the period of, estimated future net
servicing income. Also, at the time of the loan sale, it is the Company's
policy to recognize the related gain on the loan sale in accordance with
generally accepted accounting principles. The Company uses industry prepayment
statistics and its own prepayment experience in estimating the expected life of
the loans. Management periodically evaluates servicing assets for impairment.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost on a loan by loan basis. Fair value is
determined using prices for similar assets with similar characteristics, when
available, or based upon discounted cash flows using market based and
experienced assumptions. Impairment is recognized through a valuation allowance
for an individual loan, to the extent that fair value is less than the
capitalized amount for the loan.
On SBA loan sales, the Company also retains interest only ("I/O") strips, which
represent the present value of excess net cash flows generated by the difference
between (a) interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors and (ii) contractual
servicing fees. The Company determines the present value of this estimated cash
flow at the time each loan sale transaction closes, utilizing valuation
assumptions as to discount rate, prepayment rate and default rate appropriate
for each particular transaction.
The I/O strips are accounted for like investments in debt securities classified
as trading securities. Accordingly, the Company records the I/O's at fair value
with the resulting increase or decrease in fair value being recorded through
operations in the current period. For the years ended December 31, 2001, 2000
and 1999, net unrealized (losses) gains of $(2,694,000), $(858,000), and
$187,000, respectively, are included in results of operations.
Loans Held for Sale - Loans which are originated and intended for sale in the
secondary market are carried at the lower of cost or estimated fair value
determined on an aggregate basis. Net unrealized losses, if any, are recognized
through a valuation allowance by charges to income. Loans held for sale are
primarily comprised of SBA loans, second mortgage loans, and residential
mortgage loans. Funding for SBA programs depends on annual appropriations by
the U.S. Congress, and accordingly, the continued sale of loans under these
programs is dependent on the continuation of such programs. At December 31,
2001 and 2000, the Company did not incur a lower of cost or market provision.
Loans Held for Investment - Generally, loans are stated at amounts advanced less
payments collected. Interest on loans is accrued daily on a simple-interest
basis. The accrual of interest is discontinued when substantial doubt exists as
to collectibility of the loan, generally at the time the loan is 90 days
delinquent, unless the credit is well secured and in process of collection. Any
unpaid but accrued interest is reversed at that time. Thereafter, interest
income is no longer recognized on the loan. As such, interest income may be
recognized on impaired loans to the extent they are not past due by 90 days or
more. Interest on non-accrual loans is accounted for on the cash-basis or
cost-recovery method, until qualifying for return to accrual. Loans are
returned to accrual status when all of the principal and interest amounts
contractually due are brought current and future payments are reasonably
assured.
Securitized Loans and Bonds Payable - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
trusts (the "Trusts"). The transfers have been accounted for as secured
borrowings with a pledge of collateral, and accordingly the mortgage loans and
related bonds issued are included in the Company's balance sheet. The
transferred loans are classified on the balance sheet as securitized loans and
the bonds issued in connection with securitized loans are classified as bonds
payable. Such loans are accounted for in
the same manner as loans held to maturity. Deferred debt issuance costs and
bond discount related to the bonds are amortized on a method which approximates
the level yield basis over the estimated life of the bonds.
Loan Fees and Costs - Loan origination fees, certain direct origination costs,
purchase premiums and discounts, are deferred and recognized as an adjustment to
the loan yield over the life of the loan using the level yield method.
F-8
Provision and Allowance for Loan Losses - The allowance for loan losses is
maintained at a level believed adequate by management to absorb known and
inherent probable losses on existing loans through a provision for loan losses
charged to expense. The allowance is charged for losses when management
believes that full recovery on loans is unlikely. Subsequent recoveries, if
any, are credited to the allowance. Management's determination of the adequacy
of the allowance is based on periodic evaluations of the loan portfolio, which
take into consideration such factors as changes in the growth, size and
composition of the loan portfolio, overall portfolio quality, review of specific
problem loans, collateral, guarantees and economic conditions that may affect
the borrowers' ability to pay and/or the value of the underlying collateral.
These estimates depend on the outcome of future events and, therefore, contain
inherent uncertainties.
In addition, as an integral part of their examination process, various
regulatory agencies, periodically review the Goleta's allowance for loan losses.
Such agencies may require Goleta to recognize additions to the allowance based
on judgments different from those of management.
Management believes the level of the allowance for loan losses as of December
31, 2001, is adequate to absorb known and inherent probable losses; however,
changes in the local economy, the ability of borrowers to repay amounts borrowed
and other factors may result in the need to increase the allowance through
charges to earnings.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest under the contractual terms of the loan agreement.
Factors considered by management in determining impairment include, payment
status, collateral value, and the probability of collecting scheduled principal
and interest payments. Loans that experience insignificant payment delays or
payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays or payment shortfalls on a
case-by-case basis. When determining the possibility of impairment, management
considers all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower's
prior payment record and the amount of the shortfall in relation to the
principal and interest owed. The Company uses the fair value of collateral
method to measure impairment. Impairment is measured on a loan-by-loan basis
for all loans in the portfolio except for the securitized loans and short-term
consumer loans, which are collectively evaluated for impairment.
Other Real Estate Owned - Real estate acquired by foreclosure is recorded at
fair value at the time of foreclosure, establishing a new cost basis.
Subsequent to foreclosure, valuations are periodically performed by management
and assets are carried at the lower of carrying amount or fair value less costs
to sell. Operating expenses or income, and gains or losses on disposition of
such properties are charged to current operations.
Premises and Equipment - Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, which range
from 2 to 31.5 years. Leasehold improvements are amortized over the term of the
lease or the estimated useful lives, whichever is shorter.
Intangible Assets - Intangible assets include goodwill, which was recorded as
the excess of the purchase price of Palomar over the fair value of net assets
acquired, and core deposit intangible, which was recorded as the long-term
deposit relationships resulting from deposit liabilities assumed in an
acquisition. Goodwill was amortized using the straight-line method over the
estimated useful life, not to exceed 20 years. Core deposit intangible was
amortized using a method that approximates the expected run-off of the deposit
base, which averaged 7 years. The Company periodically evaluates whether events
and circumstances have occurred that may affect the estimated useful lives or
the recoverability of the remaining balance of the intangible assets. An asset
is deemed impaired if the sum of the expected future cash flows is less than the
carrying amount of the asset and any excess of the carrying value over fair
value will be written off through a charge to current operations. In August of
2001, the Company sold Palomar Community Bank to Centennial First Financial
Services for $10.5 million in cash. Accumulated amortization of intangible
assets was $0 and $831,230 as of December 31, 2001 and 2000, respectively.
F-9
Income Taxes - Deferred income taxes are recognized for the tax effect of
differences between the tax basis of assets and liabilities and their financial
reporting amounts at each year-end based on enacted tax laws and statutory tax
rates applicable to the periods in which the differences are expected to affect
taxable income. A valuation allowance is established for deferred tax assets,
if based on weight of available evidence, it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
Earnings per Share - Earnings (loss) per share - Basic is computed based on the
weighted average number of shares outstanding during each year divided into net
income. Earnings (loss) per share - Diluted, is computed based on the weighted
average number of shares outstanding during each year plus the dilutive effect,
if any, of outstanding warrants and options divided into net income.
Earnings (loss) per share:
For the Year Ended December 31, 2001 2000 1999
---------- ---------- ------------
Basic weighted average shares outstanding 5,947,658 6,107,216 5,494,217
Dilutive effect of stock options 50,345 126,029 -
---------- ---------- ------------
Diluted weighted average shares outstanding 5,998,003 6,233,245 5,494,217
========== ========== ============
Net income (loss) $ 21,762 $2,697,137 $(1,646,336)
Earnings (loss) per share - basic $ 0.00 $ 0.44 $ (0.30)
Earnings (loss) per share - diluted $ 0.00 $ 0.43 $ (0.30)
Stock options on 226,016 shares in 2001 and 274,616 in 2000 were excluded from
the computations of diluted earnings per share because they are anti-dilutive.
Use of Estimates in the Preparation of Financial Statements - The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
New Accounting Pronouncements - In June 1998, the Financial Accounting Standards
Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS")
No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS
133 was subsequently amended by SFAS No. 137 and No. 138 which deferred the
effective date and addressed certain issues causing implementation difficulties
in the application of SFAS No. 133. Collectively, these statements establish
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or a liability measured at its
fair value. The statements require that changes in the derivative's fair value
be recognized currently in earnings unless specific hedge accounting criteria
are met. Special accounting for qualifying hedges allow a derivative's gain and
losses to offset related results on the hedged item in the income statement, and
requires that a company must formally document, designate, and assess the
effectiveness of transactions that receive hedge accounting. The statements are
effective in all fiscal quarters of all fiscal years beginning after October 1,
1998. The Company early adopted SFAS No. 133 on October 1, 1998. The impact of
the adoption did not have a material effect on the Company's financial position
or results of operations.
In September of 2000, the FASB issued SFAS No. 140 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities - a replacement
of FASB Statement No. 125." The Company has adopted accounting and disclosure
requirements of SFAS No. 140 as of December 31, 2000 as set forth in paragraphs
15 and 17 of the statement. The adoption of SFAS No. 140 did not have an impact
on the financial condition or the results of operations of the Company.
F-10
The FASB has finalized new accounting standards covering business combinations,
goodwill and intangible assets. These new rules published in July 2001, consist
of SFAS No. 141, "Business Combinations" and No. 142, "Goodwill and Other
Intangible Assets." In conjunction with these new accounting standards, the FASB
has issued "Transition Provisions for New Business Combination Accounting Rules"
that require companies to cease amortization of goodwill and adopt the new
impairment approach as of January 1, 2002. Management does not expect adoption
of SFAS Nos. 141 and 142 to have a material effect on the bank's financial
position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" which supersedes SFAS No. 121. SFAS No. 144,
which governs accounting for the impairment of long-lived assets, is effective
for financial statements issued for fiscal years beginning after December 15,
2002. Management does not believe that the adoption of this statement will have
a significant impact on the Company's financial position or results of
operations.
Reclassifications - Certain amounts in the accompanying financial statements for
2000 and 1999 have been reclassified to conform to the 2001 presentation.
2. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities is as
follows:
December 31, 2001 Gross Gross
Amortized Unrealized Unrealized Fair
Held to Maturity Securities Cost Gain Loss Value
--------------------------- ---------- ----------- ------------ --------
Federal National Mortgage Association $ 117,923 $ - $ (3) $117,920
Discount Note, par value $118,000 2.22% ---------- ----------- ------------ --------
due January 18, 2002 $ 117,923 $ - $ (3) $117,920
========== =========== ============ ========
At December 31, 2001, the FNMA security, with was pledged as collateral to the
U.S. Treasury for its treasury, tax and loan account.
December 31, 2000 Gross Gross
Amortized Unrealized Unrealized Fair
Available-for-Sale Securities Cost Gain Loss Value
--------------------------- ---------- ----------- ------------ --------
Government National Mortgage Association
participation certificates $2,141,586 $ 2,746 $ (19,393) $2,124,939
Federal National Mortgage Association 884,101 - (5,920) 878,181
Federal Home Loan Mortgage Corporation
bond and participation certificates 1,829,739 731 (13,924) 1,816,546
---------- ----------- ------------ ----------
$4,855,426 $ 3,477 $ (39,237) $4,819,666
========== =========== ============ ========
Held-to-Maturity Securities
---------------------------
U.S. Treasury Note, par value $1,500,000
6.25% due April 30, 2001 $1,499,792 $ 2,083 $ - $1,501,875
Federal Home Loan Bank bond par value
400,000 4.5% due August 10, 2001 401,823 1,457 - 403,280
---------- ----------- ------------ ----------
$1,901,615 $ 3,540 $ - $1,905,155
========== =========== ============ ==========
F-11
The Company's available-for-sale securities consist of mortgage backed
securities with varying maturities based upon the underlying collateral
mortgages.
3. LOAN SALES AND SERVICING
SBA Loan Sales
----------------
The Company sells the guaranteed portion of SBA loans into the secondary market,
on a servicing retained basis, in exchange for cash, retained servicing assets,
and I/O strips. Fair value of the I/O strips and servicing assets was
determined using a 9.25%-10.25% discount rate based on the term of the
underlying loan instrument, and a 13.44% prepayment rate at December 31, 2001.
An estimated 12-13% discount rate and an 8% prepayment rate was utilized at
December 31, 2000. As of December 31, 2001, the Company had $10,466,007 in SBA
loans held for sale.
F-12
FHA Title 1 Loan Sales
--------------------------
The Company has retained servicing rights on FHA Title 1 loans sold in the
secondary market from 1995 to 1997. At December 31, 2001 and 2000, the fair
value of the related servicing asset was estimated using a weighted average
prepayment rate of 18%.
The following table represents the balances of the aforementioned assets:
December 31, 2001 December 31, 2000 December 31, 1999
---------------------- ---------------------- ----------------------
Servicing Servicing Servicing
Asset I/O Strip Asset I/O Strip Asset I/O Strip
---------- ---------- ---------- ---------- ---------- ----------
SBA $2,172,471 $7,693,102 $2,090,777 $7,540,824 $1,771,007 $4,835,999
FHA Title I 317,333 - 514,700 - 546,813 -
Traditional
Mortgages - - - - 185,441 -
---------- ---------- ---------- ---------- ---------- ----------
$2,489,804 $7,693,102 $2,605,477 $7,540,824 $2,503,261 $4,835,999
========== ========== ========== ========== ========== ==========
The following is a summary of activity in I/O Strips:
For the Year Ended 2001 2000 1999
============ ============ ============
December 31,
Balance, beginning of year $ 7,540,824 $ 4,835,999 $ 2,221,900
Additions through loan sales 2,846,074 3,933,060 4,154,447
Valuation adjustment (2,693,796) (1,228,235) (1,540,348)
------------ ------------ ------------
Balance, end of year $ 7,693,102 $ 7,540,824 $ 4,835,999
============ ============ ============
The following is a summary of activity in Servicing Assets:
For the Year Ended 2001 2000 1999
----------- ----------- ------------
December 31,
Balance, beginning of year $2,605,477 $2,503,261 $ 2,444,130
Additions through loan sales 689,277 854,009 1,136,212
Reductions, sale of servicing assets - (147,997) -
Amortization (197,367) (581,947) (1,207,648)
Valuation adjustment (607,583) (21,849) 130,567
----------- ----------- ------------
Balance, end of year $2,489,804 $2,605,477 $ 2,503,261
=========== =========== ============
The principal balance of loans serviced for others at December 31, 2001, 2000
and 1999 totaled $288,232,508, $136,420,048 and $121,935,031 respectively.
4. SECURITIZED LOANS
The Company originates and purchases second mortgage loans that allow borrowers
to borrow up to 125% of their home's appraised value, when combined with the
balance of the first mortgage loan, up to a maximum loan of $100,000. Proceeds
are commonly used for debt consolidation, home improvement, or school tuition.
During 1998, the Company sold these loans for cash to third parties, servicing
released.
F-13
In 1998 and 1999, the Company transferred $81 million and $122 million,
respectively, of these loans to two special purpose trusts. These loans were
both originated and purchased by the Company. The trusts, then sold bonds to
third party investors which were secured by the transferred loans. The loans and
bonds are held in the trusts independent of the Company, the trustee of which
oversees the distributions to the bondholders. The mortgage loans are serviced
by a third party (the "Servicer"), who receives a stated servicing fee. There
is an insurance policy on the bonds that guarantees the payment of the bonds.
As part of the securitization agreements, the Company received an option to
repurchase the bonds when the aggregate principal balance of the mortgage loans
sold declined to 10% or less of the original balance of mortgage loans
securitized. Because the Company has a call option to reacquire the loans
transferred and did not retain the servicing rights, the Company has not
surrendered effective control over the loans transferred. Therefore, the
securitizations are accounted for as secured borrowings with a pledge of
collateral. Accordingly, the Company consolidates the trusts and the financial
statements of the Company.
At December 31, 2001 and 2000, respectively, securitized loans are net of an
allowance for loan losses as set forth below, and include purchase premiums (net
of deferred fees/costs) of 2,177,834 and $3,055,206.
An analysis of the allowance for loan losses for securitized loans is as
follows:
For the Year Ended December 31, 2001 2000 1999
------------ ------------ ------------
Balance, beginning of year $ 4,042,446 $ 3,516,000 $ 1,219,622
Provisions for loan losses 4,126,287 4,199,409 3,547,720
Loans charged off (4,358,139) (3,673,965) (1,942,342)
Recoveries on loans previously charged off 378,061 1,002 26,000
Transfers from loans held for investment - - 665,000
------------ ------------ ------------
Balance, end of year $ 4,188,655 $ 4,042,446 $ 3,516,000
============ ============ ============
5. LOANS HELD FOR INVESTMENT
The composition of the Company's loans held for investment portfolio, excluding
securitized loans:
For the Year Ended December 31, 2001 2000
------------ ------------
Installment $ 28,223,225 $ 22,898,456
Commercial 26,411,381 36,188,496
Real estate 44,601,541 55,082,680
Unguaranteed portion of SBA Loans 31,888,762 30,888,172
------------ ------------
131,124,909 145,057,804
Less:
Allowance for loan losses 4,086,460 2,703,990
Deferred fees, net of costs 222,477 345,293
Discount on SBA loans 1,104,976 1,982,701
------------ ------------
Loans held for investment, net $125,710,996 $140,025,820
============ ============
An analysis of the allowance for loan losses for loans held for investment is as
follows:
For Year Ended December 31, 2001 2000 1999
------------ ------------ ------------
Balance, beginning of year $ 2,703,990 $ 2,013,298 $ 2,154,167
Provision for loan losses 7,753,925 2,594,403 2,585,239
Loans charged off (6,221,404) (2,074,129) (2,093,159)
Recoveries on loans previously charged off 611,857 170,418 32,051
Transfers to securitized loans - - (665,000)
Transfers and reductions due to sale of Palomar, net (761,908) - -
------------ ------------ ------------
Balance, end of year $ 4,086,460 $ 2,703,990 $ 2,013,298
============ ============ ============
F-14
The recorded investment in loans that are considered to be impaired:
For the Year Ended December 31, 2001 2000 1999
------------ ------------ ------------
Impaired loans without specific valuation allowances $ - $ 564,662 $ 3,250,576
------------ ------------ ------------
Impaired loans with specific valuation allowances 6,586,689 3,531,408 1,402,469
Specific valuation allowance related to impaired loans (1,668,833) (1,206,706) (1,038,519)
------------ ------------ ------------
Impaired loans, net $ 4,917,856 $ 2,889,364 $ 3,614,526
============ ============ ============
Average investment in impaired loans $ 5,046,927 $ 4,676,705 $ 5,119,852
============ ============ ============
Interest income recognized on impaired loans $ 1,442,982 $ 386,704 $ 243,913
============ ============ ============
Non-accrual loans $11,413,000 $ 2,095,020 $ 3,090,684
============ ============ ============
Troubled debt restructured loans, gross $ 1,093,310 $ 614,770 $ 655,597
============ ============ ============
Interest foregone on non-accrual loans and
troubled debt restructured loans outstanding $ 1,146,000 $ 591,928 $ 1,584,546
============ ============ ============
Loans 30 through 90 days past due with interest accruing $ 2,607,000 $ 4,276,860 $ 2,549,632
============ ============ ============
The Company makes loans to borrowers in a number of different industries. No
single industry comprises 10% or more of the Company's loan portfolio. Although
the Company has a diversified loan portfolio, the ability of the Company's
customers to honor their loan agreements is dependent upon, among other things,
the general economy of the Company's market area.
6. TRANSACTIONS INVOLVING RELATED PARTIES
In the ordinary course of business, the Company has extended credit to directors
and employees of the Company. Such loans are extended at current market rates
and are subject to approval by the Loan Committee as well as ratification by the
Board of Directors, exclusive of the borrowing director. The following is an
analysis of the activity of these loans:
F-15
For the Year Ended December 31, 2001 2000 1999
----------- ------------ -----------
Balance, beginning of year $1,516,000 $ 5,120,585 $2,756,069
Credit granted 86,507 586,733 2,649,419
Repayments (361,326) (4,191,318) (284,903)
----------- ------------ -----------
Balance, end of year $1,241,181 $ 1,516,000 $5,120,585
=========== ============ ===========
7. PREMISES AND EQUIPMENT
As of the Year Ended December 31, 2001 2000
------------ ------------
Furniture, fixtures and equipment $ 6,894,010 $ 7,200,432
Building and land 782,423 782,423
Leasehold improvements 1,724,374 1,862,601
Construction in progress 9,577 123,931
------------ ------------
9,410,384 9,969,387
Less: accumulated depreciation and amortization (6,684,683) (5,901,570)
------------ ------------
Premises and equipment, net $ 2,725,701 $ 4,067,817
============ ============
Depreciation and amortization expense was $1,418,533, $1,290,296 and $1,568,060
for the year ending December 31, 2001, 2000 and 1999, respectively.
8. DEPOSITS
At December 31, 2001, the scheduled maturities of time certificates of deposits
are as follows:
2002 $117,467,583
2003 7,778,640
2004 631,459
2005 87,181
2006 and thereafter -
------------
$125,964,863
============
F-16
9. BONDS PAYABLE
The following is a summary of the outstanding bonds payable, by class:
For the Year Ended Fixed
December 31, 2001 2000 Interest rate Stated Maturity date
------------------ ----------- ------------ -------------- --------------------
Series 1998-1:
Class A $10,296,938 $ 30,383,751 7.057% November 25, 2024
Class B 19,994,000 19,994,000 7.950% November 25, 2024
30,290,938 50,377,751
Series 1999-1:
Class A1 1,252,471 4,217,109 6.455% May 25, 2025
Class A2 32,550,882 52,989,528 7.050% May 25, 2025
Class M1 14,335,000 14,335,000 7.850% May 25, 2025
Class M2 15,860,000 15,860,000 8.750% May 25, 2025
----------- ------------
63,998,353 87,401,637
----------- ------------
$94,289,291 $137,779,388
=========== ============
The bonds are collateralized by securitized loans with an aggregate outstanding
principal balance of $35,023,201 and $70,990,027 as of December 31, 2001 for
Series 1998-1 and Series 1999-1, respectively. There is no cross
collateralization between the bond issues. Unamortized debt issuance costs are
$1,679,700 and $2,312,335 at December 31, 2001 and 2000, respectively, is
included in the bonds payable balance. Outstanding balance of debt discount is
$3,258,800 at December 31, 2001 and $4,712,230 at December 31, 2000.
Amounts collected by the servicer of the mortgage loans are distributed by the
trustee each month to the bondholders, net of fees paid to the servicer,
trustee, and insurance on the bonds. Interest collected each month on the
mortgage loans will generally exceed the amount of interest accrued on the
bonds. A portion of such excess interest will initially be distributed as
principal to the bonds. As a result of such principal distributions, the excess
of the unpaid principal balance of the loans over the unpaid principal balance
of the bonds ("overcollateralization") will generally increase. The
securitization agreements require that a certain level of overcollateralization
be maintained. Once the required level has been reached, excess interest will
no longer be used to accelerate the amortization of the bonds. Whenever the
level of overcollateralization falls below the required level, excess interest
will again be paid as principal to the bonds until the required level has been
re-established. Excess interest that is not paid to the bonds is used to make
certain other payments or is passed through to the Company. As a result of
excess interest payments, the bonds are expected to pay off prior to the stated
maturity date.
Although bondholders receive monthly interest payments, the various classes of
bonds have different priorities for the timing of receipt of principal
repayments. The classes of bonds presented table are shown in order of
repayment priority.
10. OTHER BORROWINGS
From time to time, the Company will access funds on an overnight basis to manage
its liquidity or reserve needs. These funds consist of a federal line of credit
with the correspondent banks as of December 31, 2001 and 2000. The total
availability of funding under these arrangements was $5,000,000, which may be
used by management on a discretionary basis. The credit line is renewed
annually with various maturity dates and borrowing rates. The Company must
comply with certain conditions in order to retain this line. At December 31,
2001 and 2000, no amounts were outstanding on these lines.
F-17
The Company had no activity in its line of credit during 2001. During 2000, the
average balance on the combined lines of credit was $287,440, the maximum amount
outstanding at any month-end was $3,000,000, and the weighted average interest
rate was 6.32%.
11. BUSINESS COMBINATION AND DISPOSITIONS
Palomar Community Bank
------------------------
On December 14, 1998, the Company issued 1,367,542 common shares with a market
value of approximately $12.5 million to consummate a merger with Palomar. The
Company exchanged 2.11 shares of its common stock for each share of Palomar
common stock. The transaction was accounted for using the purchase method of
accounting. The Company's total cost for the acquisition was approximately
$12.5 million which was allocated to the fair value of the assets acquired and
liabilities assumed. The amount paid in excess of the fair value of the net
tangible and intangible assets acquired, approximately $6.2 million, was
recorded as goodwill and was amortized on a straight-line basis over 20 years,
until August, 2001 when Palomar was sold. Approximately $571,000 of the
purchase price was allocated to core deposit intangible and was amortized on an
accelerated basis over seven years until August, 2001 when Palomar was sold.
On December 1, 2000, the Company signed a definitive agreement to sell Palomar
Community Bank to Centennial First Financial Services for $10.5 million. Under
the terms of the agreement, Centennial acquired all the outstanding stock of
Palomar in exchange for $10.5 million in cash. In December 2000, as a result of
the Company's commitment to sell Palomar, the Company recorded a goodwill
impairment charge of $2.1 million, which represents the difference between the
book value of the asset and the sales price discussed below. The sale was
completed on August 17, 2001.
There were no transactions between the Company and Palomar prior to the business
combination other than loan participations. These participations were transacted
in the normal course of business.
ePacific.com
------------
On March 30, 2000, ePacific.com redeemed 1,800,000 of the Company's 2,100,000
shares and repaid a loan from the Company with a balance of $3,725,000 for
$4,500,000 in cash. As a result, the Company reversed previously consolidated
losses in 2000 and since March 30, 2000 has reflected the remaining 10%
investment at cost, which is zero.
12. STOCKHOLDERS' EQUITY
Common Stock
-------------
On December 28, 1998, the Board of Directors of the Company authorized a stock
buy-back plan. Under this plan, the Company is authorized to repurchase up to
$2,000,000 worth of the outstanding shares of the Company's common stock on the
open-market. As of December 31, 2001, pursuant to this plan, the Company has
repurchased 138,937 shares at a cost of $1,240,148.
In addition, the Company has repurchased 449,592 shares in a privately
negotiated transaction at a cost of $2,830,682 as of December 31, 2001.
F-18
Stock Options
--------------
Under the terms of the Company's stock option plan, full-time salaried employees
may be granted qualified stock options or incentive stock options and directors
may be granted nonqualified stock options. Options may be granted at a price not
less than 100% of the fair market value of the stock on the date of grant.
Options are generally exercisable in cumulative 20% installments. All options
expire no later than ten years from the date of grant. As of December 31, 2001,
options are outstanding at prices $3.00 to $16.875 per share with 176,096
options exercisable and 214,291 options available for future grant. As of
December 31, 2000, options were outstanding at prices of $2.275 to $16.875 per
share with 158,796 options exercisable and 194,471 options available for future
grant. As of December 31, 2001, the average life of the outstanding options was
approximately 6 years. Stock option activity is as follows:
For the Year Ended December 31, 2001 2000 1999
--------------------- -------------------- ---------------------
Shares Price (1) Shares Price (1) Shares Price (1)
--------- ---------- -------- ---------- --------- ----------
Options outstanding, January 1, 392,196 $ 7.35 269,027 $ 8.48 415,366 $ 6.95
Granted 186,228 1.08 167,800 6.13 85,000 10.51
Canceled (111,700) 8.03 (41,771) 9.88 (52,180) 10.39
Exercised (34,100) 3.36 (2,860) 4.56 (179,159) 5.33
--------- ---------- -------- ---------- --------- ----------
Options outstanding, December 31, 432,624 $ 6.31 392,196 $ 7.35 269,027 $ 8.48
========= ========== ======== ========== ========= ==========
Options exercisable, December 31, 282,824 $ 5.81 158,796 $ 7.15 139,456 $ 6.90
========= ========== ======== ========== ========= ==========
(1) Weighted Average Exercise Price
The weighted average grant date estimated fair value of options was $4.67 per
share in 2001, $6.13 per share in 2000, and $5.11 per share in 1999. The
Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option plan. Accordingly, no
compensation cost has been recognized for its stock option plan. Had
compensation cost for the Company's stock option plan been determined based on
the fair value at the grant dates for awards under the plan consistent with the
method prescribed by SFAS No. 123 "Accounting for Stock Compensation", the
Company's net income (loss) and income (loss) per share for the years ended
December 31, 2001, 2000, and 1999 would have been adjusted to the pro forma
amounts indicated below:
Earnings (loss): 2001 2000 1999
---------- ---------- ------------
As reported $ 21,762 $2,697,137 $(1,646,336)
Pro forma $(691,744) $2,491,570 $(1,812,788)
Earnings (loss) per common share - basic
As reported $ 0.00 $ 0.44 $ (0.30)
Pro forma $ (0.12) $ 0.41 $ (0.33)
Earnings (loss) per common share - assuming dilution
As reported $ 0.00 $ 0.43 $ (0.30)
Pro forma $ (0.12) $ 0.40 $ (0.33)
The fair value of options granted under the Company's stock option plan during
2001, 2000 and 1999 was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions:
2001 2000 1999
----- ----- -----
Annual dividend yield 0.0% 0.0% 2.0%
Expected volatility 37.0% 39.0% 54.0%
Risk free interest rate 5.9% 6.5% 6.5%
Expected life (in years) 6 6 6
13. COMMITMENTS AND CONTINGENCIES
Leases
------
The Company leases office facilities under various operating lease agreements
with terms that expire at various dates between January 2002 and March 2007,
plus options to extend the lease terms for periods of up to ten years. The
minimum lease commitments as of December 31, 2001, under all operating lease
agreements are as follows:
F-19
For the Year Ending December 31,
2002 $ 955,591
2003 617,688
2004 500,050
2005 463,359
2006 422,574
Thereafter 108,018
----------
Total $3,067,280
==========
Rent expense for the years ended December 31, 2001, 2000, and 1999, included in
occupancy expense, was $894,586, $902,735 and $953,022, respectively.
Financial Statements with Off-Balance Sheet Risk
-----------------------------------------------------
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet. The Company's exposure to credit loss in the event of nonperformance by
the other party to commitments to extend credit and standby letters of credit is
represented by the contractual notional amount of those instruments. At December
31, 2001 and 2000, the Company had commitments to extend credit of approximately
$20,309,000 and $25,817,000, respectively, including obligations to extend
standby letters of credit of approximately $438,000 and $913,000, respectively.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support private borrowing arrangements. All guarantees are
short term and expire within one year.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for extending loan facilities to customers. The Company
evaluates each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company upon extension of
credit, is based on management's credit evaluation of the counterparty.
Collateral held varies but may include accounts receivable, inventory, property,
plant and equipment and income-producing commercial properties.
Loans Sold
-----------
The Company has sold loans that are guaranteed or insured by government agencies
for which the Company retains all servicing rights and responsibilities. The
Company is required to perform certain monitoring functions in connection with
these loans to preserve the guarantee by the government agency and prevent loss
to the Company in the event of nonperformance by the borrower. Management
believes that the Company is in compliance with these requirements. The
outstanding balance of the sold portion of such loans was approximately
$146,794,000 and $145,673,000 at December 31, 2001 and 2000, respectively.
F-20
Although the Company sells without recourse substantially all of the mortgage
loans it originates or purchases, the Company retains a substantial degree of
risk relating to the servicing activities and retained interest in sold SBA
loans. In addition, during the period of time that the loans are held for sale,
the Company is subject to various business risks associated with the lending
business, including borrower default, foreclosure, and the risk that a rapid
increase in interest rates would result in a decline of the value of loans held
for sale to potential purchasers. In connection with its loan sales, the
Company enters agreements which generally require the Company to repurchase or
substitute loans in the event of a breach of a representation or warranty made
by the Company to the loan purchaser, any misrepresentation during the mortgage
loan origination process or, in some cases, upon any fraud or early default on
such mortgage loans.
The Company's ability to originate, purchase and sell loans is also
significantly impacted by changes in interest rates. Increases in interest
rates may also reduce the amount of loan and commitment fees received by the
Company. A significant decline in interest rates could also decrease the size
of the Company's servicing portfolio and the related servicing income by
increasing the level of prepayments. The Company does not currently utilize any
specific hedging instruments to minimize exposure to fluctuations in the market
price of loans and interest rates with regard to loans held for sale in the
secondary mortgage market. Therefore, between the time the Company originates
and sells the loans, the Company is exposed to decreases in the market price of
such loans due to increases in interest rates.
Salary Continuation
--------------------
The Company entered into a salary continuation agreement with a former officer
and director. The agreement provides monthly cash payments to the officer or
beneficiaries in the event of death or disability, beginning in the month after
retirement date or death and extending for a period of fifteen years. The
Company purchased a life insurance policy as an investment. The income from the
policy investment will help offset this liability. The cash surrender value of
the policy was $640,098 and $631,391 at December 31, 2001 and 2000,
respectively, and is included in other assets. The present value of the
Company's liability under the agreement is included in accrued interest payable
and other liabilities in the accompanying consolidated balance sheets.
The Company also has two Key Man life insurance policies. The combined cash
surrender value of the policies are $165,193 and $163,944 at December 31, 2001
and 2000, respectively.
Litigation
----------
The following sections summarize the Company's significant legal proceedings.
Former Accountants
-------------------
In October 2000, the Company filed a lawsuit against its former accountants
alleging deficient consulting and audit services that led to the restatement of
the Company's 1998 financial statements and ultimately to an impairment of
capital. In April 2001, the Company settled the lawsuit and received $7 million
in cash. The proceeds are reflected as "other income" for financial reporting
purposes. The Company also incurred $2,392,000 in legal and professional fees
in connection with the litigation which are included as other expenses.
Short-Term Consumer Lending
-----------------------------
Goleta makes short-term consumer loans ("Bank Loans") using certain marketing
and servicing assistance of ACE at almost all of ACE's retail locations pursuant
to the terms of a Master Loan Agency Agreement between ACE and Goleta (the
"Goleta Agreement"). A number of lawsuits and state regulatory proceedings have
been filed or initiated against Goleta and/or ACE regarding the Bank Loans.
A key issue in the existing lawsuits and state regulatory proceedings concerning
the Bank Loans is whether Goleta or ACE is properly regarded as the lender.
Goleta and ACE maintain that, as provided by the legal documentation and
marketing materials for the Bank Loans, Goleta is the lender and that, because
Goleta is a national bank located in California, the Bank Loans, including the
interest that may legally be charged, should be governed by federal and
California law. The opposing parties in most of these lawsuits and regulatory
proceedings, however, maintain that ACE should be regarded as the lender,
because of the services it renders to Goleta under the Goleta Agreement and
ACE's purchase of participation interests in the Bank Loans, and that the Bank
Loans, including interest that may legally be charged, should be governed by the
laws of the respective states in which the borrowers reside. If ACE were held
to be the lender, then the interest charged for the Bank Loans would violate
most of the applicable states'
F-21
usury laws, which impose maximum rates of interest or finance charges that a
non-bank lender may charge. The consequences to the Company of such a holding
in any lawsuit or regulatory proceeding would depend on the applicable state's
usury and consumer-protection laws and on the basis for a finding of violation
of those laws. Those consequences could include the Company's obligation to
refund interest collected on the illegal Bank Loans, to refund the principal
amount of the illegal Bank Loans, to pay treble or other multiple damages, to
pay monetary penalties specified by statute, and to cease offering the Bank
Loans (at least as theretofore offered). Regarding each lawsuit, that amount
would depend upon proof of the allegations, the number or the amount of the
loan-related transactions during relevant time periods, and (for certain of the
claims) proof of actual damages sustained by the plaintiffs. The Goleta
Agreement generally provides that ACE will be liable for 90% to 95% of the costs
and monetary damages, if any, that would be paid to claimants in these actions
and Goleta will generally be liable for 5% to 10% of such costs and/or monetary
damages. However, if the Goleta Agreement is invalid or unenforceable, or if
ACE is unable to pay, Goleta may be liable for up to the full amount of any and
all claims.
Adverse determinations in one or more of these actions could have a material
adverse impact on the Company's financial condition or results of operations and
continuation of the short-term consumer lending business, and could result in
adverse actions by the regulatory agencies with authority over Goleta and the
Company, including the OCC and the Board of Governors of the Federal Reserve
System. The OCC has expressed strong reservations about Goleta and other
national banks entering into arrangements with third parties to make short-term
consumer loans and has implemented regulatory actions against two of these
banks.
In 2001, the Company's short-term consumer lending program contributed
approximately $1.8 million to indirect and corporate overhead expenses after a
provision for loan losses of approximately $2.7 million. The OCC has expressed
strong reservations about this program and believes it subjects Goleta and the
Company to significant strategic, reputational, compliance and transaction
risks. Some of these risks include: (i) reliance on the automated processes of
ACE, (ii) the difficulty of monitoring transaction volume because of the
geographic expanse and number of stores maintained by ACE, (iii) the difficulty
of managing an adequate system to ensure compliance by ACE with consumer
protection laws, (iv) the importance of this program to the Company's growth
plans, (v) the adverse publicity arising from recent lawsuits associated with
this program, and (vi) the risk of loss from such lawsuits. These risks could
have a materially adverse effect on Goleta's and the Company's results of
operations.
The following is a summary of the significant pending litigation relating to the
Bank Loans. Most of the following cases are in their early stages and the
outcome of any litigation is inherently uncertain. Based on advice from legal
counsel, management has no reason to believe it probable that the resolution of
these matters will have a material adverse impact on the Company's financial
condition or results of operations. However, it is possible that adverse
determinations in one or more of these actions could ultimately have a material
adverse financial impact on the Company and could also result in adverse actions
by the regulatory agencies with authority over Goleta.
1. JENNAFER LONG V. ACE CASH EXPRESS, INC. This lawsuit, originally filed
----------------------------------------
against ACE (and not Goleta) in Florida state court on behalf of a
putative class of Florida borrowers, alleges that the Bank Loans at ACE's
Florida locations should be deemed to be made by ACE rather than by Goleta
and, therefore, that those Bank Loans violate Florida usury laws and
Florida statutory prohibitions against misrepresentations and deceptive
practices. The plaintiff seeks an unspecified amount of damages, including
an amount equal to all interest charged on the Bank Loans made in Florida,
the plaintiff's attorneys' fees, and court costs. ACE's earlier attempt to
remove this case to federal court was unsuccessful and Goleta subsequently
intervened as a defendant in the lawsuit. ACE and Goleta moved to dismiss
the lawsuit on the ground that, under governing federal law, Goleta is
entitled to charge interest on the Bank Loans at the rates permitted under
the law of the State of California, where Goleta is located. However, the
court denied the motion to dismiss.
2. NOTICE FROM OHIO DEPARTMENT OF COMMERCE. In July 2001, the
---------------------------------------------
Superintendent of the Ohio Division of Financial Institutions (the "Ohio
Superintendent") delivered to ACE a Notice of Intent to Issue Cease and
Desist Order and Notice of Opportunity for Hearing. This Notice asserts
that ACE, not Goleta, is the lender of the Bank Loans made in Ohio; that
those Bank Loans violate the Ohio Small Loan Act and are void; that all
finance charges and interest received from those Bank Loans, as well as
the outstanding principal of all such existing Bank Loans, should be
forfeited; and that ACE should be
F-22
ordered to cease violating the Ohio Small Loan Act. In response to the
Notice, Goleta initiated a lawsuit in federal court against the Ohio
Superintendent seeking declaratory and injunctive relief against the Ohio
Superintendent's pursuit of a regulatory action against ACE. The thrust of
Goleta's action is that, under federal law, the interest charges on the
Bank Loans are governed by California and not Ohio law. In response to
this federal court lawsuit, the Ohio Superintendent agreed to suspend the
Ohio regulatory proceeding against ACE until the federal court rules on
Goleta's complaint. The Ohio Superintendent has moved to dismiss Goleta's
lawsuit on a series of jurisdictional and procedural grounds. Goleta's
motion for a preliminary injunction and the Ohio Superintendent's motion
to dismiss have been largely briefed but no hearing has yet been
scheduled.
3. ORDER TO SHOW CAUSE FROM MARYLAND COMMISSIONER OF FINANCIAL REGULATION.
-------------------------------------------------------------------------
In December 2001, ACE settled a regulatory proceeding initiated against it
in July 2001 by the Maryland Commissioner of Financial Regulation. Among
other things, the settlement agreement provides for ACE to pay a total of
$164,000 of penalties for failing to maintain requisite licenses in
connection with its activities regarding Maryland Bank Loans. By agreement
with ACE, Goleta did not contribute to the costs or penalties in
connection with this regulatory proceeding.
4. STATE OF COLORADO, EX REL. KEN SALAZAR, ATTORNEY GENERAL FOR THE STATE OF
--------------------------------------------------------------------------
COLORADO, AND LAURA E. UDIS, ADMINISTRATOR, UNIFORM CONSUMER CREDIT CODE
--------------------------------------------------------------------------
V. ACE CASH EXPRESS, INC. This lawsuit regarding Bank Loans offered and
--------------------------
made at ACE's locations in Colorado was filed on behalf of the State of
Colorado against ACE (and not Goleta) in a Colorado state court in Denver,
Colorado in July 2001. The complaint alleges that these Bank Loans are
"deferred deposit" loans subject to the Colorado Deferred Deposit Loan Act
(the "DDLA"), which is part of the Colorado Uniform Consumer Credit Code
("UCCC"); that the second and third renewals of the Bank Loans violate the
DDLA (which purports to permit only one renewal of deferred deposit loans
at the interest rates permitted by the DDLA); and that ACE is required to
maintain a license as a "supervised lender" in Colorado because of its
activities in connection with the Bank Loans. ACE voluntarily relinquished
its license as a supervised lender in Colorado in December 2000.
In its complaint, the State of Colorado seeks various remedies against ACE
under the Colorado UCCC and other Colorado law, including the refund to
borrowers of all finance charges or interest received on all Bank Loans
made in Colorado while ACE was unlicensed; the refund to borrowers of all
finance charges or interest received on all second and third renewals of
the Bank Loans since July 1, 2000, the effective date of the DDLA; and a
penalty (to be determined by the court) equal to the greater of either all
of the finance charges or interest received or up to ten times the amount
of all excess finance charges or interest received. The complaint also
seeks an injunction prohibiting ACE from continuing to engage in
activities regarding the Bank Loans in Colorado without a supervised
lender license.
In or about July 2001, the State of Colorado filed a motion for a
preliminary injunction to require ACE to cease all activities regarding
the Bank Loans in Colorado immediately, subject to an expedited hearing on
the legality of those activities. In August 2001, ACE removed this lawsuit
to federal court. However, the case was remanded to state court in January
2002. Arguments available to ACE in defending the lawsuit include, without
limitation, that: (1) the Bank Loans are not deferred deposit loans under
the DDLA; (2) the State is not entitled to the remedies it is seeking for
the alleged licensing violations; and (3) the limits regarding loan
renewals imposed by the DDLA are preempted by federal law. Though ACE does
not admit that it is required to obtain a supervised lender license under
the Colorado UCCC, it has submitted applications for re-licensure and has
begun discussions with the State regarding resolution of the State's
licensing claims. Subject to approval of the ACE Board of Directors and
negotiation and execution of a definitive settlement agreement, ACE and
the State have informally agreed to a settlement of this lawsuit under
which ACE would make payments to Colorado borrowers in exchange for
releases; ACE would be retroactively licensed to make or broker deferred
deposit loans under the Colorado UCCC; and ACE would commence making loans
directly to Colorado borrowers rather than brokering Bank Loans on behalf
of Goleta. ACE has agreed with Goleta that ACE will be solely liable for
all costs and payments in connection with this litigation.
F-23
5. RUFUS PATRICIA BROWN V. ACE CASH EXPRESS, INC. ET AL. This lawsuit, on
-------------------------------------------------------
behalf of a punitive class of borrowers who obtained their Bank Loans at
ACE locations in Maryland, was filed in August 2001 in the Circuit Court
for Baltimore City, Maryland. While ACE removed the case to federal court,
the federal court remanded the case to state court. Goleta subsequently
intervened as a defendant in the case. In this case, the plaintiff alleges
that the Bank Loans violate Maryland usury laws, the Maryland Consumer
Loan Law, the Maryland Credit Services Businesses Act, and the Maryland
Consumer Protection Act and are unconscionable under Maryland law. The
plaintiff seeks relief of various kinds, including a permanent injunction
against any further alleged illegal activities; an award of three times
excess interest charges on the Bank Loans; the return of principal on the
Bank Loans; and court costs and attorneys' fees and expenses. The
defendants have answered the complaint and discovery has commenced.
However, this case remains in its preliminary stages at present.
6. BEVERLY PURDIE V. ACE CASH EXPRESS, INC. ET AL. This lawsuit was filed
-------------------------------------------------
in September 2001 in the United States District Court for the Northern
District of Texas and names Goleta, ACE and certain ACE executives as
defendants. In the complaint, the plaintiff purports to represent a class
of all consumers in the United States who obtained Bank Loans. The
plaintiff alleges that the Bank Loans and defendants' activities in
connection therewith violate the federal Racketeering and Corrupt
Organizations Act ("RICO") and the laws and regulations of various states
regarding usury, deceptive trade practices (including the Texas Deceptive
Trade Practices Act), and other consumer protections. The plaintiff seeks
relief of various kinds, including a permanent injunction against
collecting any moneys in connection with the Bank Loans; restitution of
all amounts paid to the defendants; damages equal to three times the
amount of all fees and interests paid by the class; punitive damages of at
least $250 million; the plaintiff's attorneys' fees; and court costs. The
defendants have moved to dismiss the complaint on the grounds that the
RICO claims are deficient as a matter of law and that, after dismissing
the RICO claims, the court should not retain jurisdiction of the remaining
state-law claims.
7. VONNIE T. HUDSON V. ACE CASH EXPRESS, INC. ET AL. This lawsuit on behalf
-------------------------------------------------
of borrowers who received Bank Loans offered and made at ACE's locations
in Indiana was filed in September 2001 in federal court for the Southern
District of Indiana. The defendants include Goleta, ACE and certain ACE
executives. The plaintiff alleges that the Bank Loans violate the Indiana
Uniform Consumer Credit Code and the Indiana "loansharking" statute,
because the interest exceeds the finance charges permitted by those
statutes; that the Bank Loans violate the federal Truth in Lending Act
("TILA") and the Indiana UCCC because the disclosures to borrowers do not
comply with the disclosure requirements of those laws; and that the Bank
Loans also violate RICO. The plaintiff seeks relief of various kinds,
including: (a) for the members of the class of plaintiffs who were
allegedly charged excessive interest, an order declaring the Bank Loans
"void," the refund of all finance charges or interest paid by them in
excess of the maximum finance charges permitted under the Indiana UCCC,
and a penalty (to be determined by the court) in a maximum amount equal to
the greater of either all of the finance charges or interest received from
them or up to ten times the amount of all excess finance charges or
interest received from them; (b) for the members of the class of
plaintiffs who allegedly did not receive proper disclosures under TILA and
the Indiana UCCC, statutory damages of $500,000 for violations of each
statute; (c) for the members of the class of plaintiffs allegedly damaged
because of RICO violations, an amount equal to three times those damages;
and (d) the plaintiff's attorneys' fees and court costs. The defendants
have moved to dismiss this lawsuit on the ground that the Bank Loans are
made by Goleta and not ACE and, accordingly, the interest charges are
governed by federal and California law and not Indiana law.
F-24
8. GOLETA NATIONAL BANK AND ACE CASH EXPRESS, INC. V. HAL D. LINGERFELT, IN
--------------------------------------------------------------------------
HIS OFFICIAL CAPACITY AS THE COMMISSIONER OF BANKS OF NORTH CAROLINA, ET
--------------------------------------------------------------------------
AL. In January 2002, Goleta and ACE instituted suit against defendants for
---
declaratory and injunctive relief with respect to defendants' threatened
initiation of state court proceedings against ACE. Goleta and ACE allege
that defendants threatened to impair Goleta's federally created rights to
make Bank Loans to North Carolina residents, to charge the interest
allowed by the laws of California, where Goleta is located, to obtain
assistance from ACE in making its Bank Loans and to sell interests in its
Bank Loans. The State has moved to dismiss this lawsuit on the ground that
the federal court does not have the power to hear the case. Also in
January 2002, immediately after the filing of the Goleta/ACE lawsuit, the
State of North Carolina initiated the threatened lawsuit in North Carolina
state court against ACE (but not Goleta), alleging that ACE and not Goleta
is the lender and that the Bank Loans accordingly are usurious and
alleging in addition or in the alternative that ACE has violated North
Carolina loan broker and check cashing statutes. ACE removed the State
lawsuit to federal court and the State moved to remand the case to state
court. Answers have been filed in both cases.
OTHER LITIGATION
-----------------
The Company is involved in various other litigation of a routine nature which is
being handled and defended in the ordinary course of the Company's business. In
the opinion of Management, based in part on consultation with legal counsel, the
resolution of these other litigation matters will not have a material impact on
the Company's financial position or results of operations.
14. INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31
consists of the following:
2001 2000 1999
------------ ---------- ------------
Current:
Federal $(1,385,497) $ 836,458 $ 2,456,745
State (500,822) 158,410 667,236
------------ ---------- ------------
(1,886,319) 994,868 3,123,981
Deferred:
Federal 343,131 1,036,494 (2,889,569)
State 262,131 507,104 (856,250)
------------ ---------- ------------
605,262 1,543,598 (3,745,819)
------------ ---------- ------------
Total provision (benefit) $(1,281,057) $2,538,466 $ (621,838)
============ ========== ============
The federal income tax provision (benefit) for the years ended December 31
differs from the applicable statutory rate as follows:
2001 2000 1999
-------- ------- -------
Federal income tax at statutory rate (34.0)% 34.0% (35.0)%
State franchise tax, net of federal (12.9)% 7.1% (5.5)%
Amortization and impairment of goodwill 3.4% 19.2% 5.6%
Taxable gain on sale of Palomar 81.8% - -
Capital recovery proceeds (137.4)% - -
Disallowed losses on ePacific.com - - 3.9%
Other (2.7)% (11.8)% 3.6%
-------- ------- -------
(101.8)% 48.5% (27.4)%
======== ======= =======
The table above expresses the effective tax rates including the impact of taking
an IRC 338(h)(10) election on the sale of Palomar and the tax effect of the
legal settlement with the Company's former auditors ("Capital Recovery
Proceeds") in 2001.
F-25
Significant components of the Company's net deferred tax account as of December
31 are as follows:
2001 2000
------------ ------------
Deferred tax assets:
Allowance for loan losses $ 1,484,542 $ 1,752,814
Depreciation 436,502 374,652
State taxes 51,323 227,410
Unrealized loss on investment securities - 15,000
Investment in ePacific.com - 75,776
Accrued professional fees 147,365 315,365
Other 529,598 611,383
------------ ------------
2,649,330 3,372,400
------------ ------------
Deferred tax liabilities:
Deferred loan fees (1,226,290) (795,281)
Purchase accounting - (281,700)
FHLB stock dividends - (60,200)
Investment in ePacific.com (241,714) -
Deferred loan costs (278,353) (814,232)
Other (87,484) (80,237)
------------ ------------
(1,833,841) (2,031,650)
------------ ------------
Net deferred tax asset $ 815,489 $ 1,340,750
============ ============
At December 31, 2001 and 2000, the deferred tax asset is included in other
assets in the accompanying consolidated balance sheets.
15. REGULATORY MATTERS
The Company (on a consolidated basis) and Goleta are subject to various
regulatory capital requirements administered by the Federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory -
and possibly additional discretionary - actions by regulators that, if
undertaken, could have a direct material effect on the Company's and Goleta's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and Goleta must meet
specific capital guidelines that involve quantitative measures of the Company's
and Goleta's assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Company's and Goleta's
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings and other factors. Prompt
corrective action provisions are not applicable to bank holding companies.
The Federal Deposit Insurance Corporation Improvement Act, ("FDICIA"), was
signed into law on December 19, 1991. FDICIA included significant changes to
the legal and regulatory environment for insured depository institutions,
including reductions in insurance coverage for certain kinds of deposits,
increased supervision by the federal regulatory agencies, increased reporting
requirements for insured institutions, and new regulations concerning internal
controls, accounting, and operations.
The prompt corrective action regulations of FDICIA, define specific capital
categories based on the institutions' capital ratios. The capital categories,
in declining order, are "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized", and "critically
undercapitalized". To be considered "well capitalized" an institution must have
a core capital ratio of at least 5% and a total risk-based capital ratio of at
least 10%. Additionally, FDICIA imposed in 1994 a new Tier I risk-based capital
ratio of at least 6% to be considered "well capitalized". Tier I risk-based
capital is, primarily, common stock and retained earnings net of goodwill and
other intangible assets.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as
defined) to average assets (as defined). The Company's and the Bank's actual
capital amounts and ratios as of December 31, 2001 and 2000 are also presented
in the table below.
F-26
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------- ------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------------------- ------------------- -----------------------
As of December 31, 2001:
Total Risk-Based Capital (to Risk Weighted Assets)
Consolidated $36,689,265 13.02% $22,546,200 8.00% N/A N/A
Goleta National Bank $32,623,280 11.84% $22,049,503 8.00% $27,561,879 10.00%
Tier I Capital (to Risk Weighted Assets)
Consolidated $33,107,751 11.75% $11,273,100 4.00% N/A N/A
Goleta National Bank $29,121,872 10.40% $11,024,751 4.00% $16,537,127 6.00%
Tier I Capital (to Average Assets)
Consolidated $33,107,751 9.07% $14,602,150 4.00% N/A N/A
Goleta National Bank $29,121,872 9.05% $12,874,019 4.00% $16,092,524 5.00%
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
------------------- ------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------------------- ------------------- -----------------------
As of December 31, 2000:
Total Risk-Based Capital (to Risk Weighted Assets)
Consolidated $38,645,337 11.04% $28,013,787 8.00% N/A N/A
Goleta National Bank $35,573,765 12.12% $23,473,626 8.00% $29,342,032 10.00%
Palomar Community Bank $ 7,329,473 13.89% $ 4,223,104 8.00% $ 5,278,879 10.00%
Tier I Capital (to Risk Weighted Assets)
Consolidated $31,898,901 9.11% $14,006,894 4.00% N/A N/A
Goleta National Bank $31,876,965 10.86% $11,736,813 4.00% $17,605,219 6.00%
Palomar Community Bank $ 6,669,613 12.64% $ 2,111,552 4.00% $ 3,167,328 6.00%
Tier I Capital (to Average Assets)
Consolidated $31,898,901 7.25% $17,597,784 4.00% N/A N/A
Goleta National Bank $31,876,965 8.87% $14,375,225 4.00% $17,969,031 5.00%
Palomar Community Bank $ 6,669,613 8.75% $ 3,048,776 4.00% $ 3,810,970 5.00%
A bank may not be considered "well capitalized" if it is operating under a
regulatory agreement, as is the case for Goleta. Under the regulatory
framework, until the regulatory agencies agreement is lifted and the regulatory
agencies notify Goleta that it is deemed "well capitalized", Goleta may not
accept brokered deposits without prior approval from the regulators. Goleta has
no brokered deposits at December 31, 2001 or 2000.
In fourth quarter of 1999, the Office of the Comptroller of Currency of the
United States of America, herein referred to as the OCC, notified Goleta that it
had incorrectly calculated the amount of regulatory capital required to be held
in respect of residual interests retained by Goleta in two securitizations of
loans that were consummated in the fourth quarter of 1998 and the second quarter
of 1999. Accordingly, the OCC informed Goleta that it was significantly
undercapitalized at March 31, 1999, June 30, 1999 and September 30, 1999.
On November 17, 1999, certain directors of the Company made a new debt and
equity investment in the Company of approximately $11.15 million.
Simultaneously, the Company made a capital contribution to Goleta of
approximately $11.15. The OCC subsequently informed Goleta that it was again
adequately capitalized.
F-27
In March 2000, Goleta entered into an agreement (the "Formal Agreement") with
its principal regulator, the Office of the Comptroller of the Currency (the
"OCC"). The Formal Agreement requires that Goleta maintain certain capital
levels and adhere to certain operational and reporting requirements, including
the following:
- submitting monthly progress reports;
- adopting a written asset diversification program to identify and
control any concentration of credit;
- maintaining total capital at least equal to 12% of risk-weighted
assets and Tier 1 capital at least equal to 7% of adjusted total
assets and developing a three year capital program to maintain
adequate capital and raise any required additional capital, including
a prohibition on the payment of dividends without the approval of the
OCC;
- refrain from permitting its average total assets in any quarter to
exceed its average total assets during the preceding quarter except as
specified;
- establishing a program to maintain an adequate allowance for loan and
lease losses;
- ensuring that it has adequate, full-time management;
- adopting a written strategic plan covering at least a three-year
period;
- developing a written risk management program;
- refiling certain amended regulatory reports and adopting policies and
procedures to ensure that all regulatory reports accurately reflect
its condition;
- adopting a written program to ensure compliance with all applicable
consumer protection laws, rules and regulations;
- appointing a capable officer vested with sufficient authority to
ensure compliance with the Bank Secrecy Act;
- documenting the support used to value loans held on its books,
servicing rights and interest-only assets;
- preparing a written analysis of its short-term consumer loan program
which fully assesses the risks and benefits of this program and,
thereafter, preparing a written analysis of any new product or
service; and
- correcting each violation of law, rule or regulation cited in any
report of examination.
F-28
Compliance with the provisions of the Formal Agreement could limit Goleta's
business activity and increase expense. Management has been informed by the
regulators that they do not believe that Goleta is in full compliance with the
following provisions of the Formal Agreement:
- implementing and demonstrating the effectiveness of its written risk
management program;
- implementing a program to ensure compliance with consumer protection
laws applicable to Goleta's short-term consumer loan program;
- accurately valuing, and documenting the valuations of, interest-only
assets, servicing assets, deferred tax assets and deferred tax
liabilities; and
- ensuring compliance with applicable laws and regulations, particularly
as related to the short-term consumer loan program.
Goleta achieved and maintained both of the aforementioned required 12% and 7%
capital ratios from September 30, 2000 to the end of 2001. As the result of
fourth quarter 2001 losses, Goleta's risk-based capital ratio declined to 11.84%
at December 31, 2001. On March 8, 2002, the Company made a $750,000 capital
contribution to Goleta, which would have increased Goleta's risk-based capital
ratio to 12.11% at December 31, 2001, had the contribution been made on that
date.
Regulators have asserted that failure to comply with the provisions of the
Formal Agreement could adversely affect the safety or soundness of Goleta. The
OCC possesses broad powers to take corrective and other supervisory action and
bring enforcement actions to resolve unsafe or unsound practices.
In March 2000, the Company entered into an agreement (the "Memorandum of
Understanding") with its principal regulator, the Federal Reserve Bank of San
Francisco (the "Reserve Bank"). The Memorandum of Understanding requires that
the Company maintain certain capital levels and adhere to certain operational
and reporting requirements, including the following:
- refrain from declaring any dividends or redeeming any of its stock
without the approval of the Reserve Bank;
- adopting a written plan to maintain a sufficient capital position for
the consolidated organization;
- refrain from increasing its borrowings or incurring or renewing any
debt without the approval of the Reserve Bank;
- correcting any violations of applicable laws, rules or regulations and
developing a written program to ensure compliance in the future;
- developing written policies and procedures to strengthen the Company's
records, systems and internal controls;
- developing a written plan to enhance management information systems
and the Board of Director's supervision of operations;
- developing a written consolidated strategic plan;
- developing a written plan to address weaknesses in the Company's audit
program;
- complying with applicable laws with respect to the appointment of any
new directors or the hiring of any senior executive officers; and
- submitting quarterly progress reports.
F-29
16. EMPLOYEE BENEFIT PLAN
The Company has established a 401(k) plan for the benefit of its employees.
Employees are eligible to participate in the plan after 3 months of consecutive
service. Employees may make contributions to the plan under the plan's 401(k)
component, and the Company may make contributions under the plan's profit
sharing component, subject to certain limitations. The Company's contributions
were determined by the Board of Directors and amounted to $176,782, $164,125 and
$149,037, in 2001, 2000, and 1999 respectively.
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required to interpret market
data to develop estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Company could realize
in a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
The following table represents the estimated fair values:
December 31, 2001 December 31, 2000
---------------------- ----------------------
Carrying Estimated Carrying Estimated
(Dollars in thousands) Amount Fair Value Amount Fair Value
--------- ----------- --------- -----------
Assets:
Cash and cash equivalents $ 29,406 $ 29,406 $ 36,484 $ 36,484
Time deposits in other financial institutions 5,938 5,938 1,582 1,582
Investment securities 893 893 7,891 7,895
Interest-only strips 7,693 7,693 7,541 7,541
Accrued interest receivable 2,702 2,702 3,841 3,841
Net Loans 260,955 283,939 329,265 374,272
Liabilities:
Deposits (other than time deposits) 70,202 70,202 87,374 87,374
Time deposits 125,965 130,515 141,346 141,715
Accrued interest payable 602 602 1,036 1,036
Bonds payable 89,351 100,502 130,755 164,363
Other borrowings - - 5,293 5,293
The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below:
Cash and cash equivalents - The carrying amounts approximate fair value because
of the short-term nature of these instruments.
Investment securities - The fair value is based on quoted market prices from
security brokers or dealers if available. If a quoted market price is not
available, fair value is estimated using the quoted market price for similar
securities.
Federal Reserve and Federal Home Loan Bank stock carrying value approximates the
fair value because the stock can be sold back to the Federal Reserve and Federal
Home Loan Bank at anytime.
F-30
Loans - The fair value of loans is estimated for portfolios of loans with
similar financial characteristics, primarily fixed and adjustable rate interest
terms. The fair value of fixed rate mortgage loans is based upon discounted cash
flows utilizing the rate that the Company currently offers as well as
anticipated prepayment schedules. The fair value of adjustable rate loans is
also based upon discounted cash flows utilizing discount rates that the Company
currently offers, as well as anticipated prepayment schedules. No adjustments
have been made for changes in credit within the loan portfolio. It is
management's opinion that the allowance for estimated loan losses pertaining to
performing and non-performing loans results in a fair valuation of such loans.
The fair value of loans held for sale is determined based on quoted market
prices or dealer quotes.
Interest Only Strip - The fair value of the interest-only strip has been
determined by the discounted cash flow method, using market discount and
prepayment rates.
Deposits - The fair values of deposits are estimated based upon the type of
deposit products. Demand accounts, which include savings and transaction
accounts, are presumed to have equal book and fair values, since the interest
rates paid on these accounts are based on prevailing market rates. The estimated
fair values of time deposits are determined by discounting the cash flows of
segments of deposits that have similar maturities and rates, utilizing a yield
curve that approximates the prevailing rates offered to depositors as of the
measurement date.
Bonds Payable - The fair value is estimated using discounted cash flow analysis
based on rates for similar types of borrowing arrangements.
Other Borrowings - The carrying amount is assumed to be the fair value because
the interest rate is the same as rates currently offered for borrowings with
similar remaining maturities and characteristics.
Accrued Interest - The carrying amounts approximate fair value.
Commitments to Extend Credit, Commercial and Standby Letters of Credit - Due to
the proximity of the pricing of these commitments to the period end the fair
values of commitments are immaterial to the financial statements.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 2001, and 2000. Although management
is not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since those dates, and therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
18. SEGMENT INFORMATION
Reportable business segments are determined using the "management approach" and
are intended to present reportable segments consistent with how the chief
operating decision maker organizes segments within the company for making
operating decisions and assessing performance. The Company has had three
reportable business segments, Goleta National Bank, Palomar Community Bank
(until it was sold on August 17, 2001) and "Other" which includes holding
company administration areas.
Below is a summary statement of income and certain selected financial
data. The accounting policies used in the disclosure of business segments is
the same as those described in the summary of significant accounting policies.
Certain assumptions are made concerning the allocations of costs between
segments which may influence relative results, most notably, allocations of
various types of overhead and administrative costs and tax expense. Management
believes that the allocations utilized below are reasonable and consistent with
the way it manages the business.
F-31
DECEMBER 31, 2001
CONSOLIDATED
(Dollars in thousands) GOLETA PALOMAR OTHER ELIMINATIONS TOTALS
--------- --------- -------- -------------- --------------
Interest income $ 37,050 $ 3,730 $ 79 $ (65) $ 40,794
Interest expense 18,147 1,418 467 (65) 19,967
--------- --------- -------- -------------- --------------
Net interest income 18,903 2,312 (388) - 20,827
Provision for loan losses 11,472 408 - - 11,880
Non interest income 14,834 173 9,647 (2,483) 22,171
Non interest expense 27,157 2,185 3,035 - 32,377
--------- --------- -------- -------------- --------------
(Loss) income before taxes $ (4,892) $ (108) $ 6,224 $ (2,483) $ (1,259)
========= ========= ======== ============== ==============
Total assets $320,474 $ - $36,369 $ (32,980) $ 323,863
========= ========= ======== ============== ==============
DECEMBER 31, 2000
CONSOLIDATED
(Dollars in thousands) GOLETA PALOMAR OTHER ELIMINATIONS TOTALS
--------- --------- -------- -------------- --------------
Interest income $ 45,908 $ 5,873 $ - $ - $ 51,781
Interest expense 23,252 2,531 277 - 26,060
--------- --------- -------- -------------- --------------
Net interest income 22,656 3,342 (277) - 25,721
Provision for loan losses 6,584 210 - - 6,794
Non interest income 15,736 538 10 - 16,284
Non interest expense 25,472 5,043 (540) - 29,975
--------- --------- -------- -------------- --------------
Income (loss) before taxes $ 6,336 $ (1,373) $ 273 $ - $ 5,236
========= ========= ======== ============== ==============
Total assets $316,570 $ 78,274 $53,025 $ (42,614) $ 405,255
========= ========= ======== ============== ==============
DECEMBER 31, 1999
CONSOLIDATED
(Dollars in thousands) GOLETA PALOMAR OTHER ELIMINATIONS TOTALS
--------- --------- -------- -------------- --------------
Interest income $ 42,166 $ 5,889 $ 440 $ - $ 48,495
Interest expense 21,849 2,884 412 - 25,145
--------- --------- -------- -------------- --------------
Net interest income 20,317 3,005 28 - 23,350
Provision for loan losses 6,009 115 9 - 6,133
Non interest income 10,288 733 - - 11,021
Non interest expense 18,583 3,466 8,457 - 30,506
--------- --------- -------- -------------- --------------
Income (loss) before taxes $ 6,013 $ 157 $(8,438) $ - $ (2,268)
========= ========= ======== ============== ==============
Total assets $447,181 $ 76,076 $ 590 $ 41,009 $ 523,847
========= ========= ======== ============== ==============
F-32
19. COMMUNITY WEST BANCSHARES (PARENT COMPANY ONLY)
(Dollars in thousands) December 31, December 31,
Balance sheets 2001 2000
-------------- ------------- --------------
Assets
Cash and equivalents $ 2,001 $ 82
Time deposits in financial institutions 4,487 -
Investment in subsidiaries 29,371 42,593
Loan Participation Purchased, net of
$279,836 allowance for loan losses 356 -
Other assets 154 91
------------- --------------
Total assets $ 36,369 $ 42,766
============= ==============
Liabilities and shareholders' equity
Other liabilities $ 3,012 $ 6,776
Common stock 29,798 32,518
Retained earnings 3,559 3,493
Accumulated other comprehensive loss - (21)
------------- --------------
Total liabilities and shareholders' equity $ 36,369 $ 42,766
============= ==============
For the year ended December 31, 2001 2000 1999
------------- -------------- --------
(Dollars in thousands)
Statements of operations
------------------------
Total income $ 5,263 $ - $ -
Total expense 1,522 (1,137) (1,167)
Equity in undistributed
net income(loss) from subsidiaries
subsidiaries (2,483) 3,949 (969)
------------- -------------- --------
Income(loss) before
income tax provision(benefit) 1,258 2,812 (2,136)
Income tax provision (benefit) 1,236 115 (490)
------------- -------------- --------
Net income(loss) $ 22 $ 2,697 $(1,646)
============= ============== ========
F-33
COMMUNITY WEST BANCSHARES
STATEMENT OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------------
(Dollars in thousands) 2001 2000 1999
-------- -------- ---------
Cash Flows from operating activities:
Net Income(loss) $ 22 $ 2,697 $ (1,646)
Adjustments to reconcile net (income) loss to
cash provided by(used in) operating activities:
Equity in undistributed
(income) loss from subsidiaries 2,483 (3,949) 969
Net change in other liabilities 1,505 1,411 7,167
Net change in other assets (419) (32) (148)
-------- -------- ---------
Net cash provided by (used in) operating activities 3,591 127 6,342
Cash flows from investing activities:
Net (increase) in time deposits in
other financial institutions (4,405) - -
Net payments and investments in subsidiaries 10,726 2,167 (16,025)
-------- -------- ---------
Net cash provided by (used in) investing activities 6,321 2,167 (16,025)
Cash flows from financing activities:
Proceeds from issuance of common stock 112 26 8,478
Principal payments on borrowings (5,270) (2,016) -
Dividends - (222) (871)
Payments to repurchase common stock (2,835) - (1,095)
-------- -------- ---------
Net cash provided by financing activities (7,993) (2,212) 6,512
Net increase (decrease) in cash and
Cash equivalents 1,919 82 (3,171)
Cash and cash equivalents at beginning of year 82 - 3,171
-------- -------- ---------
Cash and cash equivalents, at end of year $ 2,001 $ 82 $ -
======== ======== =========
F-34
20. QUARTERLY FINANCIAL DATA (unaudited)
Summarized quarterly financial data follows:
(All amounts in thousands except per share data)
Quarter Ended
Mar 31, 2001 Jun 30, 2001 Sept 30, 2001 Dec 31, 2001
-------------------------------------------------------------
2001
----
Net interest income $ 5,207 $ 5,381 $ 5,794 $ 4,445
Provision for loan losses 2,986 2,017 3,626 3,251
Net income (loss) 502 4,556 (1,118) (3,918)
Net income (loss) per share - basic $ 0.08 $ 0.75 $ (0.19) $ (0.64)
- diluted $ 0.08 $ 0.75 $ (0.19) $ (0.64)
Quarter Ended
Mar 31, 2000 Jun 30, 2000 Sep 30, 2000 Dec 31, 2000
-------------------------------------------------------------
2000
----
Net interest income $ 7,203 $ 4,913 $ 6,317 $ 7,288
Provision for loan losses 896 628 2,043 3,227
Net income(loss) 2,677 1,137 300 (1,417)
Net income(loss) per share - basic $ 0.44 $ 0.18 $ 0.05 $ (0.23)
- diluted $ 0.44 $ 0.18 $ 0.05 $ (0.23)
F-35
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 16th day of
April, 2002.
COMMUNITY WEST BANCSHARES
(Registrant)
By
/s/ Stephen W. Haley
-----------------------------------------
Stephen W. Haley
President and Chief Operating Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated
SIGNATURE TITLE DATE
/s/ Michael A. Alexander Director and Chairman of the Board April 16, 2002
------------------------
Michael A. Alexander
/s/ Mounir R. Ashamalla Director April 16, 2002
------------------------
Mounir R. Ashamalla
/s/ Robert H. Bartlein Director April 16, 2002
------------------------
Robert H. Bartlein
/s/ Jean W. Blois Director April 16, 2002
------------------------
Jean W. Blois
/s/ John D. Illgen Director April 16, 2002
------------------------
John D. Illgen
/s/ Lynda J. Nahra Director April 16, 2002
------------------------
Lynda J. Nahra
/s/ Michael Nellis Director and Secretary April 16, 2002
------------------------
Michael Nellis
/s/ William R. Peeples Director and April 16, 2002
------------------------
William R. Peeples Vice Chairman of the Board
/s/ James R. Sims Jr. Director April 16, 2002
------------------------
James R. Sims Jr.
S-1